With Brexit a certainty and a new prime minister and chancellor in place, now is the time for bold reform of business taxation, says the IoD’s Stephen Herring. Here, he offers six ways to streamline and simplify the system
The business tax reforms of the current Conservative government, the coalition government that preceded it and the previous Labour administration have focused mainly on multinationals and, to a lesser extent, on micro-companies. These reforms have ranged from the inadequately debated and poorly enacted diverted profits tax (DPT) to active support for the OECD/G20’s base erosion and profit shifting (BEPS) proposals – shortly to be introduced across the G20. Arguably, cuts in the rate of corporation tax are similarly focused on, and mainly to the benefit of, the largest multinationals and FTSE 100-listed companies.
A sector overdue fundamental tax reform and simplification is the middle market: companies employing between, say, 50 and 500 people. These firms have benefited to an extent from progressive cuts in corporation tax from 30 per cent in 2007 to 17 per cent (from 2020). The rate may drop further if the new chancellor, Philip Hammond, delivers upon a promise to cut the rate made in the aftermath of June’s EU referendum result.
Most middle-market companies have lost more from the cut in the annual capital allowances write-down from 20 per cent to 18 per cent over the same period and, in particular, a decision to slash the annual investment allowance cap from £500,000 to £200,000 from January 2016.
What could be done to remedy this shortcoming? Below the IoD lists six propositions for business tax reform and simplification that are complementary approaches rather than alternatives. Some might argue that such changes could lead to further complexity, but we prefer to focus on streamlining solely from the view of the taxpayer rather than HM Revenue & Customs (HMRC). The ideas here all satisfy that strategy but would benefit from consultation being undertaken by the Treasury and HMRC with businesses, their advisers and taxpayers in general.
1 A slimmed-down corporation tax for SMEs
The same tax law that applies to FTSE 100 titans, such as BP, HSBC, GSK and Tesco, applies to small and medium-sized companies on the high streets and in local business parks even if their turnover is a few hundred thousand pounds. Most of the corporation tax code has no relevance to such SMEs but, occasionally, these firms are caught by the intricacies of the legislation even if it applies to trifling amounts with little or no impact on the Exchequer’s tax receipts.
We need a separate, much-simplified corporate tax code that is designed to meet the requirements of the SME sector on the assumption that its yield will need initially to be comparable – within a few hundred million of the corporation tax already received from SMEs. We favour the simplest possible approach to such an SME tax, which provides for accounting profits (adequately audited or independently verified) to be taxed with a single adjustment to replace accounting depreciation by a generous capital allowances system. An enhanced annual investment allowance would be set at £1m per annum to encourage capital investment – and perhaps boost productivity – in this key sector.
Such a change would significantly reduce the compliance burden upon SMEs and ought to cut their tax compliance fees. Would there be a net cost to the Exchequer? Yes. Would it be significant? No. Why? Because, out of the total corporation tax collected in 2013/14 of £40.2bn, more than £21.6bn was taken from the top 6,400 companies paying corporation tax. Many of these businesses will be subsidiaries of multinationals.
There would need to be suitable tax avoidance legislation to prevent abuse, but this should be kept to a minimum and focused upon removing aggressive tax avoidance where it occurs rather than more esoteric concerns about where it might occur.
2 An option for SMEs to bypass corporation tax
Companies with less than, say, 100 shareholders ought to have an option to be treated as tax-transparent rather than tax-opaque entities. In other words, their profits would be assessed for income tax upon the shareholders pro rata to their individual shareholdings.
This option has been available to those US corporations that file as S-corporations for over 50 years. It is a successful and popular strategy in the US with more than 4.6 million corporations filing on this basis.
If it works well in the US, there is no reason why it should not be used in the UK. Companies that distribute profits to their owners as either dividends or remuneration would pay, broadly, the same amount of tax in total. Those firms which retain more of their profits for immediate reinvestment would have to consider whether the lower rate of corporation tax was a sufficient incentive to stay within the corporation tax net and negotiate in the future the often-complex interface between corporation tax, income tax, national insurance contributions and dividend tax.
It is surprising that the Treasury has not already launched a consultation with business upon tax transparency, and the UK tax authorities should show a willingness to explore reforms that have worked well in other leading successful economies. We understand that the Treasury has discussed this internally, but we consider that consultation benefits, and requires, the involvement of business and the public rather than being limited to civil servants.
3 Liberalise Enterprise Investment Scheme relief
Both the Enterprise Investment Scheme (EIS) and the Seed Enterprise Investment Scheme (SEIS) have been successful in attracting investment into start-ups and scale-ups, but they are too restrictive in their application and have cumbersome requirements from the relevant investor protection legislation.
In essence, we see no adequate reason why securing investment from family members, friends, colleagues and former university and college alumni should be prohibited under tax legislation or made more bureaucratic by investor protection law. Other leading economies such as the US have a much better record of launching successful start-ups on academic campuses and the UK should seek to replicate that success.
Moreover, the IoD considers that the requirements for the content of the relevant information memorandum provided to potential investors could be dramatically reduced. Such investors need to be put on warning that investment into the share capital of an unlisted small company carries both business risk and, even if the company is successful, capital realisation risk assuming there is no clear market to sell the shares or to ensure that a dividend will be paid.
However, the requirements of the legislation are excessive and expensive for those start-ups and scale-ups seeking to raise share capital and should be revisited and, almost certainly, significantly reduced. Why do these risks require more communication and associated costs than the basic information provided to a person placing a bet online upon the outcome of a sporting event?
4 Business rates relief for SMEs
There is a relief from business rates for SMEs occupying premises with a rateable value of up to £10,000 with a form of marginal relief for business premises that have a rateable value up to £15,000. Business rates now collect over £27bn and the system is overdue radical reforms to incentivise smaller and medium-sized firms to launch and expand. SMEs often benefit less rapidly from the emerging trends in the globalisation of supply chains and digital business propositions than multinational corporations. The damage caused is often visible on our high streets and in local business parks.
Business rates should be simplified and reduced with broadly based reliefs and exemptions focused upon entrepreneurial businesses. We would never view tax reforms focused upon multinationals or entrepreneurial businesses as alternatives to each other. The economy contains interdependent companies of all sizes, but it is imperative that the impact of a relatively fixed tax cost such as business rates is properly understood. Reforms must be introduced where they support UK plc.
5 The interface between corporate taxation and remuneration and dividends
Owners and managers of many entrepreneurial companies often criticise the complexity – and often-unpredictable consequences – of the distribution of profits to owner-managers through dividends or bonuses. At present, there is the need to consider the varying taxation liabilities generated by corporation tax, income tax, employees’ national insurance contributions, employers’ national insurance contributions and dividend tax. In recent tax years it has also been necessary to consider the impact on the individual’s pension contributions and accumulated fund. Entrepreneurial businesses generally place a high value on simplicity and certainty. The government must consider how this area can be made easier for those businesses which choose such a simplification by, for example, allowing distributions to entrepreneurial owners to be taxed at a flat rate of, say, 35 per cent on the basis that payments are neither deductible for corporation tax purposes nor capable of being reduced by other personal tax reliefs.
Not all businesses would choose to benefit from such simplification but a more streamlined treatment would be welcomed by many entrepreneurs – even if the price paid was, in some cases, a little more tax paid in aggregate.
6 Tax evasion, abuse, avoidance and planning
IoD members have consistently supported the attempts of recent governments to prevent tax evasion from occurring and abusive tax schemes from succeeding. We supported the coalition government’s introduction of its general anti-abuse rule (GAAR). There is no satisfactory definition of tax avoidance which does not depend upon the political view of the commentator so, until there is sufficient agreement on its meaning, it is a poor term upon which to base tax law.
Most entrepreneurial businesses have no interest in undertaking abusive tax schemes as, among other things, they understand that it is unlikely that such schemes will succeed and that pursuing them will absorb excessive amounts of management time and incur substantial fees from the so-called advisers. Nevertheless, entrepreneurial businesses and their owners do wish to consider the tax impact of their transactions and whether authentic, sensible tax planning can mitigate or defer tax liabilities that might arise if a different structure or alternative route were chosen.
Politicians and HMRC are understandably keen to state what they consider to be tax avoidance but are strangely unwilling to highlight what they recognise as acceptable tax planning. This often results in businesses adopting an unnecessarily cautious stance on tax planning which HMRC would not seek to overturn. Examples include accelerating capital expenditure to secure an enhanced annual investment allowance or disposing of an investment asset to protect the availability of the business property relief from inheritance tax.
Our recommendation is that HMRC issues and maintains a list of acceptable tax planning approaches that it will not seek to challenge when a company’s corporation tax computations, or its proprietors’ income tax returns, are filed. Examples include the timing of capital expenditure, the scheduling of bonuses and dividends, and whether a business’s assets are acquired or sold or the entity that owns these assets is acquired or sold.
There are existing examples in the UK’s tax code where such guidance is already provided to taxpayers, such as the investment management exemption and collective investment scheme white list for transactions that are not treated as UK-taxable trading transactions.
There are other areas of tax law where helpful guidance is similarly provided but the government should ensure that a comprehensive list is maintained, publicised and focused on removing the concerns of entrepreneurial businesses and their owners that authentic, acceptable tax planning will not be met by unmerited challenge from HMRC.
The way ahead
In the aftermath of the summer’s EU referendum, there is both the opportunity and the need for a much bolder agenda for tax reform and simplification. This should range from the personal taxation of individuals across the income range to the taxation of multinational companies.
Philip Hammond should, however, focus firstly upon entrepreneurial businesses to ensure that there are no taxation hurdles which prevent them launching ventures, expanding those companies or raising the equity necessary to achieve these goals.
While Hammond will continue to be judged by the progress towards completing the elimination of the UK’s annual fiscal deficit, he will also be assessed upon his willingness to reform and simplify taxation.
Tax reforms, especially bolder tax changes, almost invariably call for appropriate consultation, so there is no time to be lost if these reforms are to be enacted before the next general election, scheduled for May 2020.
At a glance: The next move for business taxation
• Cuts in corporation tax tend to benefit the largest multinationals and FTSE 100-listed companies.
• The IoD has set out six ideas for business taxation reform and simplification that are complementary approaches rather than alternatives.
• UK tax authorities should show a willingness to explore tax reforms that have proven themselves in other leading successful economies.
• The IoD sees no adequate reason why securing investment from family members, friends, colleagues and former university and college alumni should be prohibited under tax law or made more bureaucratic by investor protection legislation.
• Business rates should be simplified and reduced with broadly based reliefs and exemptions focused on entrepreneurial businesses.
• Chancellor Philip Hammond must focus first upon entrepreneurial businesses to ensure there are no tax hurdles that prevent them launching businesses, expanding those firms or raising the equity necessary to achieve these goals.
• The chancellor will be judged on his willingness to reform and simplify taxation – as well as progress towards eliminating the annual fiscal deficit.
More on business taxation and finance
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Stephen Herring is the IoD’s head of taxation