If there is one comment from a Chancellor guaranteed to get the tax profession excited, it is a proposal that he describes (when ARE we going to have a female Chancellor, by the way) as a simplification of the tax system. This is because history and experience have taught that this usually means that the tax system is going to get more complicated, at least in the short to medium term. And in the long term, as John Maynard Keynes so rightly said, we are all dead.
So when George Osborne, in his March 2012 Budget speech, said that the government was going to consult on a simpler system of taxation for micro businesses, it may be fair to see that there was a degree of cynicism within the tax profession. So was it justified, and what is proposed?
HM Revenue & Customs has just concluded the consultation exercise, so it is interesting to review their consultation document to see what they have in mind for the future tax treatment of micro businesses.
Currently 6 out of 7 sole traders in theUK(some 3 million people in total) have a turnover below the £77,000 VAT threshold. The requirements of accounting practice are the same for them as for the largest of multinationals, at least in the sense that the accounts that they submit to HMRC have to be prepared in accordance with Generally Accepted Accounting Practice (“GAAP”), which means for example using the accruals basis, requiring accounts to be prepared on the basis of revenue earned and costs incurred rather than on the basis of money received and expended.
There used to be some exceptions to this rule, but they were based on the nature of the business rather than its size. Solicitors and barristers were those to benefit from the last vestiges of the so-called cash basis, but even they are now required to accrue for unpaid bills and recognise non-contingent work in progress.
The cash basis lives on in the form of the VAT cash accounting scheme for smaller businesses, but the consultation document suggests it may also be going to make an income tax comeback for smaller sole traders. Apart from being allowed to account on the basis of cash receipts and payments, the proposal is also to allow them to use standardised expenses in some cases rather than requiring them to specifically identify and account for every pound spent.
The proposal is to introduce the new regime from April 2013. Originally the Office for Tax Simplification proposed that it be available to sole traders and partnerships turning over up to £30,000, but the Document suggests that a more appropriate turnover threshold might be the VAT registration threshold of £77,000, with businesses allowed to use the scheme until their turnover exceeds £150,000. If VAT registered, using the cash accounting scheme would be a (logical) requirement Farmers with averaging claims or using the herd basis would also be excluded from the scheme.
The attractions of the system are that there would no longer be a requirement to keep records of stock, debtors and creditors, although clearly there is a business requirement to keep such records to ensure that money is collected and paid out on a timely basis, and that purchasing is kept under control, and that records of some expenses would no longer need to be kept, although again for business purposes it would appear to be wise to do so. So quite how much simpler the new system would be in practice is extremely questionable. Its use would be voluntary for taxpayers.
One expense that would cease to be allowable would be interest in cash borrowings, which appears harsh. Another complication would be that if it was necessary, or desired, to join or leave the cash basis, adjustments would be required to allow for the transition between bases. So not necessarily looking that much simpler then.
Businesses would have a choice whether to claim a deduction for the cost of purchase of a van, or claim the fixed mileage rates available for business mileage. There would be a restriction on the cost of the van claimable in accordance with the level (if any) of private use of the vehicle.
Rather confusingly, if the business was VAT registered, VAT paid to HMRC would be an allowable expense, and VAT recovered would be taxable as a receipt, with receipts and payments treated as VAT inclusive. This achieves the correct result, but in a rather roundabout and less than simple way.
It is also proposed that losses on cash basis businesses would not be allowable against other income of the year of loss, but only to carry forward. Again this is a restriction that would make the cash basis much less attractive to many businesses.
The following simplified expenses, based on flat rate figures, would be available as an alternative to actual costs incurred:
Standard mileage rates for business use of cars (which is actually fairly common, if not strictly permitted by legislation, at present). Currently 45p per mile for the first 10,000 miles and 25p thereafter, these rates are proposed to continue.
Flat rate expenses for business use of home. The proposals are:
25 – 50 hours per month £8 per month
51 – 100 hours per month £16 per month
101 or more hours per month £24 per month
I suggest this is less than generous in many cases compared to a detailed apportionment of actual costs.
Flat rate adjustment for personal use of business premises (e.g. living in a flat above a shop). This would operate on the basis of all costs being claimed and then an adjustment applied, as follows:
1 person occupying £350 per month
2 people occupying £500 per month
3+ people occupying £650 per month
There is also discussion of ignoring incidental private use of telephone and internet services and allowing clams for stationery on a unit costs basis (e.g. per business letter).
I am not fond of these proposals. To have a proper idea of how even a small business is performing it is necessary to know the value of stock, how much is owing from customers and how much is owed to suppliers and others. Even more so is it necessary to keep records of how much is being spent on motor expenses.
I can see the logic of the £30,000 limit proposed by the OTS, because such businesses really are micro businesses, but to apply these rules to business up to 5 times the size is unrealistic. I could see the logic of allowing only businesses below the VAT threshold and not voluntarily registered to use the scheme, but anything beyond that appears ridiculous.
This therefore sounds good, but in practice could present some major problems, and should thus be restricted to the very smallest of businesses.