Building on the OTS’s interim report on small business tax in March of this year they have recently published two consultation papers that focus on disincorporation of small companies and a simpler income tax for the smallest businesses.
The options that run from clerical changes to more fundamental reform, set out in both papers, are not firm proposals but rather intended to provoke debate to enable the OTS to develop its final recommendations to the Treasury ahead of Budget 2012.
Both consultations close on 7th October and there will be opportunity for interested parties to attend one of the meetings and workshops taking place around the country in September and October.
Disincorporation of Small Companies
The issue of a tax relief for companies that wished to change their legal status, ie, disincorporation, was considered back in 1987 but did not gather any head of steam. Many businesses that incorporated, however, between 2002 and 2006 to take advantage of the then 0% starting rate of corporation tax could be better off returning to unincorporated status to save administrative burdens and professional fees.
There currently exists a form of disincorporation relief in the shape of extra-statutory concession C16 which HMRC is consulting on as to how to replace it with legislation in 2012. There are also other future burden easing measures that are being considered by the Department for Business, Innovation and Skills, one of which is the introduction of a new business entity, the single person corporate form. Presently, however, there are significant potential tax barriers that hinder small businesses wishing to operate through an non-corporate structure. This paper therefore considers whether there is a need or demand for a disincorporation relief and, if so, what sort of companies would qualify for such a relief? In answer to the second question, the OTS has proceeded on the basis that any relief would be available to companies carrying on a trade.
Operating through a company involves more regulation, greater administrative burdens, particularly those imposed by the Companies Act 2006, and professional costs. This is offset by the advantages of prestige, limited liability, greater ability to raise money for capital investment and more flexibility in selling the business. In reality, however, it is suggested that many businesses do not need these benefits, especially if they have no intentions of growing, invest or borrow.
The OTS has estimated that small one man companies are subject to double the administrative burden compared to small unincorporated businesses.
So who would benefit from a disincorporation relief? Broadly, such companies fall into two categories:
- Small companies with just one or two owner/manager(s). The company is likely to have few capital assets but there maybe goodwill associated with the business; and
- Small companies with more than one shareholder/manager which have capital assets such as property or plant, and may also have built up goodwill over time.
A potential narrow form of disincorporation relief might be to exempt the corporation tax charge on the transfer of a company’s goodwill to its shareholder(s) carrying on the business and to eventually charge a ‘catch up’ tax in the form of capital gains tax when they then later dispose of the business. Valuing goodwill is complex and it is suggested that disincorporation relief should not require this.
Companies that are likely to hold assets other than and including goodwill are obstructed by a chargeable gains tax charge for the company and the income tax or further capital gains tax for the shareholders. A wider form of disincorporation relief would be to eliminate both levels of immediate taxation.
In considering this relief it will also be necessary to address unintended consequences with anti-avoidance provisions. The key issues here are to prevent companies from disappearing, thus prejudicing the interests of creditors, minority shareholders and the Exchequer. Also, the practice of asset stripping or “phoenix” companies that allow the same shareholder(s) to serially form and close down companies, each time exploiting the advantage of tax neutral or tax favoured status.
The issue of whether or not such a relief would be viewed by the European Commission as State Aid also needs to be properly explored.
A simpler income tax for the smallest businesses…
There are currently 3 million unincorporated businesses in the UK that have a turnover of £70K or less, with approximately 2 million of these having a turnover of £20K or less. These businesses include a wide range of trades, occupations and professions. Despite their size these businesses form a vital part of the UK economy but they bear a disproportionate burden when dealing with their tax obligations for which they are inadequately equipped.
The focus of this discussion paper is on income tax as the businesses under consideration are below the VAT registration limit and will have few, if any employees. The aim therefore is to:
- identify simpler tax compliance procedures; and
- consider alternative ways of calculating the tax liability, which might be a simplified profit calculation or more radical measures not based on profit.
A range of options for taxing small businesses are set out in this report, some of which may be inappropriate for the UK. The OTS are keen to hear the views from unrepresented business owners as well as professional advisors as to which proposals are likely to make it easier, less time consuming and provide more certainty in dealing with their tax obligations.
The current basis of taxing businesses is that tax is determined by reference to profits calculated according to accounting rules. Some small business proprietors and, indeed, some advisers have stated that they have no need for detailed accounting information nor do they need such for preparing their tax returns. There are other reasons for having accounts prepared such as evidence of profitability that is required when seeking finance as a result of growth and for management purposes. There is evidence to suggest however that the majority of small businesses do not grow and will not need access to finance.
Small companies have not been included in this discussion paper due to the complex interaction with company law.
In determining which businesses would be eligible to participate in a simplified system, a turnover ceiling is suggested of either £20K, £30K or the VAT registration threshold, currently £73K. This would cover 2 million, 2.5 million and 3 million sole traders and partnerships respectively.
As with disincorporation relief, introducing rules for different size businesses can create unintended consequences, in this case an incentive for a business to remain below the turnover threshold.
Many members of the OTS small business committee regard simplified schemes as rewarding those who cannot be bothered to keep records.
The two options for change fall broadly into two camps. Firstly, changing some existing rules to ease complexity in certain areas. This would include:
Cash accounting;
- Fixed rate (%) and/or fixed amount (£) deductions for certain expenses;
- Fixed rate (%) and /or fixed amount (£) deductions for total expenses;
- Allowing small expenditure on capital items to be treated as revenue expenses.
Secondly and more radically is the use of non-profit measures as the basis for taxation. Here the tax charge could be calculated by reference to:
- Turnover, which is used as the basis for taxing small businesses in a number of countries, including France, Poland and South Africa;
- A flat charge on the business, comparable to the TV licence fee, where there is a single fixed charge for being in business. This is a popular method in a number of Central and Eastern European countries;
- “Indicator based” measures where, for example, the tax charge is fixed by reference to the number of tables in restaurants, the footprint of the business premises or the number of employees. Such measures are used in Spain and Poland.
The report cites a number of interesting worldwide examples of alternative systems for taxing income, many of which may not be feasible for the UK.
Whatever system or new rules the OTS decide to put forward it is important that any change produces real long term simplification.
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