Corporation Tax (and its avoidance) is once again in the spotlight. But the tax arrangements of small businesses can be just as contentious as those of global behemoths like Apple. Here we take a closer look at 5 potential tax changes that could bring about a more entrepreneurial society.
Tax can indeed by taxing. But you don’t have to be an expert to understand what a good tax system should aspire to. It should be clear and straightforward, fair in the way it treats citizens, resilient to abuse and free from loopholes that can be exploited. Most people would also add that it should be progressive, such that those with the greatest financial capacity bear the greatest burden.
How do small business taxes fare against the above criteria? This is one among several questions we’re seeking to answer as part of our new project with Crunch, which is exploring how to strengthen policy support for the self-employed and micro businesses. While the EU-Apple tax saga may be dominating today’s business pages, equally lively tax debates have been playing out for years at the smaller end of the business spectrum.
It may not be obvious why we’d be looking at taxation within our research. After all, the previous Chancellor George Osborne made the sharp reduction of Corporation Tax one of his defining legacies. Under his tenure, Corporation Tax was reduced from 28 percent in 2010 to 20 percent today, with a further promise to reduce it to 17 percent by 2020. How much more is there left to do?
Quite a lot, as it happens. Amidst the flurry of commentary surrounding Corporation Tax, it is easy to forget that small businesses face a variety of other levies. Among them are Income Tax and National Insurance contributions (NICs), Business Rates, VAT, Capital Gains and dividend taxes. Once you get into the nitty gritty of these different charges you realise just how much room there is for improvement, and how complicated they can all be to navigate for those running a small venture.
Before I lay out some of our initial ideas, it’s first worth saying what we won’t be arguing for: the full abolition of individual taxes. Calling for the removal of Corporation Tax for small businesses, or urging an end to employer NICs, might be tempting but is a crude response to a wicked problem. Sweeping demands such as these fail to recognise that the self-employed and micro businesses have an obligation to pay their fair share to the Exchequer. They also risk damaging the breadth of the UK’s tax base.
We also won’t be making generic calls for tax reductions. This is a rather lazy method of business lobbying and ultimately serves to damage the standing of small businesses in the long run. Why, some may ask, should they deserve special tax favours? Can they not stand up on their own two feet? Our answer is a resolute yes, and that what is needed is not blunt tax cuts but rather more intelligently designed taxes that are truly progressive.
On that basis, we’ve been toying with the following tax changes – some more radical than others…
Align National Insurance contributions for employees and the self-employed – This may seem at first like an odd tax change to request. The self-employed currently pay lower NICs rates than employees (9% vs. 12% on income over £8,060) so there would be an obvious loss to many people who work for themselves. But under our proposal the NICs threshold would be raised to the same level used for Income Tax purposes, taking some of the lowest self-employed earners out of tax altogether. As we have argued elsewhere, putting the self-employed on a par with employees (excluding employer NICs) would also place them in a better position to argue for greater social security protections, for example Statutory Maternity Pay. There may even be an argument for charging NICs on company dividend taxes, which would help to equalise the tax liabilities of incorporated and unincorporated businesses and lessen the need for IR35 legislation (see below).
Overhaul Business Rates and replace with a system of Revenue Rates – Business Rates is an antiquated tax unsuited to an era of e-commerce and declining footfall on high streets. In his 2016 Budget, Osborne sought to relieve the pressure of this tax by increasing the Small Business Rate Relief threshold and swapping the uprating system with one based on CPI rather than RPI inflation measures. Yet the fundamental problem with Business Rates is that it takes little account of how much a business can afford to pay, being based on the ‘rentable value’ of a property rather than how much money a business makes. An unintended consequence can be to make some high street premises unaffordable for innovative, new uses. One solution could be to transition to a Revenue Rates system where tax liabilities are based on business performance. Since revenues are less ambiguous than property values, this would avoid the substantial number of appeals currently crippling the Business Rates structure.
Allow smaller companies to use cash accounting over accruals accounting – Cash accounting allows for the recording of income and expenses as and when money enters and leaves a business. In contrast, accruals accounting requires that income and expenses are recorded at the point they are incurred, regardless of whether the transaction happens later. Accruals accounting can cause particular headaches for small businesses because it may require them to pay tax on money they have yet to receive. We agree with the Office for Tax Simplification that small companies could benefit from being able to use cash accounting methods, which would ease compliance and lesson cash flow problems. In the US, a federal taskforce has proposed that all businesses generating revenue less than $1m should be able to use cash accounting, in return for operating with a designated business account linked to the tax authorities.
Maintain the IR35 ruling that places the onus on contractors to prove independence – IR35 is a tax treatment that was formed to prevent disguised employment, whereby employees create personal service companies in order to benefit from lower tax rates. If found to be working as an employee, HMRC’s IR35 arrangement places workers on the payroll of the purchasing client – making them pay employee taxes without necessarily benefiting from the same protections as employees. The government plans to tighten its IR35 ruling in the public sector such that the onus of proving the independence of a contractor is shifted from the worker to the client. However, one unintended consequence could be that risk-averse public sector buyers shy away from purchasing services from individual contractors in order to avoid potential liabilities. It seems sensible to leave the IR35 mechanism with the contractor, as it is today, but look to simplify the application of IR35 so there’s less chance of genuine business owners being unintentionally caught by the rules.
Rebalance the overall tax burden away from income and towards wealth – As a general rule, there is a moral duty to tax unearned income (e.g. from inheritances or property appreciation) more than earned income (e.g. from employment or entrepreneurial activity). As far as taxes must be levied, the burden should arguably be placed on values and transactions that involve the least effort and the best fortune. Would it be possible, for example, to introduce a radical reduction in Income Tax or Corporation Tax, paid for with a larger levy on inheritances? A first step for the government would be to withdraw its intention to increase the Inheritance Tax threshold from £325,000 to £500,000 and use the savings instead to lessen tax on entrepreneurial behaviours. Inspiration can be taken from a number of US states like New Hampshire, which have close to zero Income Tax rates but relatively high property taxes.
Are these tax reforms workable? Would they be fair and progressive? Would they promote entrepreneurial behaviour?
Let us know your thoughts by emailing me directly (firstname.lastname@example.org) or leaving a comment in the box below.
The RSA is working with Crunch, the online accountants for micro businesses, on a project that seeks to deepen our understanding of what works in supporting the self-employed and micro-businesses.