Tax is too important to be entrusted to politicians to deal with. If you doubt this confident assertion, look at our tax system in all its complex, illogical, loophole-ridden, underlying principle-free glory, and see what I mean. And consider in particular the new breed of professional politicians who have never in any meaningful sense been at the sharp end of the tax system as business owners etc.
A constant refrain in this and my previous blog has been the fact that politicians are particularly bad at identifying that there are lots of UK businesses that are sole trades, partnerships and limited liability partnerships as well as limited companies. Thus whenever they wish to provide a tax incentive to UK business, they will insist on providing it through the corporation tax system. For example:
1. Recent tax rate cuts for business have focused pretty much exclusively on corporation tax as opposed to income tax, and thus have been directed at companies and not unicnorporated businesses.
2. It is much easier to control individual income levels through the medium of a company. An individual is taxed on undrawn profits from a sole trade or partnership, but not on undrawn profits from a company.
3. There are a number of reliefs designed to smooth the tax path on incorporation of a business, and specifically to eliminate tax charges arising as a result of so doing. The government is only just consulting on a similar regime for disincorporation; i.e moving from company to sole trade or partnership.
4. Highly generous research and development tax relief enhancements are only available to companies.
5. The Enterprise Investment Scheme and Seed Enterprise Investment Scheme only incentivise investment in companies.
6.The favourable tax regime for Enterprise Management Incentive Scheme share options applies only to employees of companies.
And I could go on, but I won’t.
The problem is that income tax can be seen as a dual purpose tax, in that it covers both employees and unincorporated businesses, and it is therefore difficult to give incentives to the latter without including the former. That is why politicians opt for the simplistic approach of giving corporation tax reliefs, and thus ignoring a huge chunk of the UK business sector when it comes to tax incentives.
So the answer to producing an inclusive tax regime that offers the same tax reliefs to all businesses is obvious; make it compulsory to trade through a limited company. Many who had too high a regard for Gordon Brown’s grasp of fiscal matters thought this was what he was effectively doing when he introduced the ingenious zero rate of corporation tax, but sadly it later became clear that he was just suffering from the same blind spot as his colleagues.
At first sight this might seem like an utterly bizarre idea, but actually it would have a number of significant potential advantages if structured correctly:
1. When the government thinks it is giving all (profitable) businesses a tax break by cutting corporation tax, it actually would be.
2. It could be seen as a powerful weapon against the black economy; given that all companies have to be registered at Companies House and file accounts it would be more difficult for businesses to evade their tax obligations. This would particularly be the case if all businesses were required to provide proof of registration with HMRC to their customers (perhaps something like the subcontractors’ exemption certificate?)
3. It would be easier for HMRC to keep track of employment categorisation issues; following on logically from 2, businesses might have to submit details of other registered businesses which have supplied services to them, and also the reverse, in terms of businesses identifying to HMRC who they have supplied services to. Businesses with single customers would thus be more easily identifiable, enabling HMRC to identify more easily those cases where IR35 should be applied.
This proposal would also in my view require a sea-change in the culture surrounding company accounts and tax. A significant simplification of the company accounts regime for smaller businesses would be required, as would the offer of cheaper and simpler facilities to set up limited companies than are currently available.
Some might see this as an infringement of human rights, enforcing a particular type of business structure on taxpayers, but it would actually significantly simplify the tax system, and enable governments to deal with corporation tax as the tax on businesses and income tax as the tax on idnviduals. Given the other potential advantages in terms of taxpayer compliance, I suggest that this idea is not as crazy as it may appear at first sight, and is worthy of some further consideration.