“If it isn’t broken, don’t fix it” is a rule of thumb that I have always tried to apply. My wife would tell you that this is because I am so impractical that there would be no chance of me fixing it whether it was broken or not, and might go on to quote her father’s excellent advice in his speech at our wedding:
“If at first you don’t succeed, do it the way she told you to”. Whilst I cannot vouch for the factual accuracy of Rex’s speech (at one point he described his wife Barbara as “The Marchioness of Budleigh Salterton”, a title which I cannot trace in Debrett’s Peerage) I can vouch for the sound common sense behind this suggestion.
Some things in government are clearly broken (the Child Support Agency springs irresistibly to mind) and some are clearly not (HMRC’s research and development unit in Manchester for one). On some the jury is out, and I would have included tax credits in that category. The system we have become used to is complex, and does not deal well with levels of income that vary from year to year; it also suffers from the classic government failing of giving with one hand and taking away with the other (see the child benefit tax charge). But after a number of years it is a sort of workable system, and people have pretty much got used to it. And one of the really good things about it is that HMRC administers it, so they have ready access to the necessary income details to check claims.
Now if modern governments have one besetting sin, for which I blame 24 hour rolling news channels, it is a constant need to be seen to be doing something. The other sin which goes along with this is a constant need to be saying something, which leads directly to comments like David Gauke’s about people paying tradesmen in cash. In government, as in so many other areas of life, less is often more. As W S Gilbert so memorably put it in Iolanthe:
“The House of Lords throughout the war
Did nothing in particular
And did it very well.”
Modern governments have lost the art of doing ‘nothing in particular’, and we are the poorer for it.
Nowhere is this better illustrated than in the plans to replace tax credits, housing benefit, jobseeker’s allowance and several other benefits with Universal Credit. Sounds like a great idea, doesn’t it? Real simplification there. Well the trouble is great ideas need to be put into great practice, and what we have seen so far in this respect is not, to put it mildly, encouraging.
As I said above, one of the great things about tax credits is that HMRC administers them. So who shall we ask to administer Universal Credit? Yes, that’s right, the Department for Work and Pensions. Judging from their draft Universal Credit regulations, this may not have been a very good idea.
As I mentioned above, one of the recurring problems with tax credits was the mismatch between credit claims and income levels when the latter were subject to variation, whether as a result of getting a job, losing a job, getting a pay rise, getting promoted, changing jobs or simply being self-employed and thus earning a variable level of income. The tax credit system has recently been to base the initial assessment on the previous year’s income (oh happy memories of the pre-self assessment taxation of sole trades and partnerships) and to adjust this to a current year basis only if the claimant declares a drop in income.
This has been achieved by having a very large disregard for income increases (£25,000 from 2006-07 to 2010-11), which was a reaction to the furore in earlier years when the disregard was only £2,500 and lots of people had tax credits clawed back. We have already seen, in the light of the financial crisis, a reaction to this deliberate policy of allowing people to receive what are effectively tax credit overpayments in the form of a reduction ion the disregard to £10,000, and it is due to fall to £5,000 for 2013-14, at which point Universal Credit will supersede tax credit.
The current government clearly hates the whole concept of the disregard, with its inevitable overpayments of credits, and thus the Universal Credit system has been designed to operate in real time. 10 out of 10 for ambition, but how is that going to work in practice?
From a PAYE perspective, it is going to work because of the introduction of Real-Time Information, currently being trialled for implementation in 2013-14. This will require employers to submit to HMRC details of all earnings paid to taxpayers at the time of payment, which is wonderful in theory, although the all-party parliamentary taxation group recently expressed doubts as to whether RTI could be delivered. Let’s just say we’re all going to have lots of problems if it can’t.
Assuming it can, this should make Universal Credit work for employees, provided HMRC tells the DWP all the income details (why is the DWP administering this, again?) Which just leaves the self-employed. As mentioned above, until 1996/97 it was felt necessary to have a prior year basis for taxation of the self-employed, who thus only moved onto an actual year basis of reporting 15 years ago, and are now to be expected to move onto a real time basis. See what I mean about ambition?
HMRC does not intend to obtain information from the self-employed about their taxable income other than via self-assessment, and VAT returns. So if you have a 30 April year end, you report your profits to HMRC 21 months thereafter. OK for income tax, but not great for a real time Universal Credit system.
So we need a monthly profit reporting system for the self-employed. But don’t small businesses constantly complain about increasing red tape and the growing burden of bureaucracy, and don’t we the government tell them that we’re cutting red tape and making their life easier? Yes to both of those, but let’s introduce a new requirement for them to tell the DWP (who they have nothing to do with at present) every month about their trading profits. Fantastic, they’ll really love that.
So this is going to be tricky; presumably every small business will be required to produce monthly management accounts, and it will be bonanza time for accountants? Well, no actually. Income will be reported on a ‘simplified cash income basis’, and apparently ‘these requirements have been designed to make it possible for claimants to report monthly without employing an accountant’.
At this point I would like to request a transfer to the parallel universe in which the author of the guidance lives, where self-employed taxpayers religiously keep their books up to date monthly and hand them to their accountant with a cheery smile as soon as their accounting period ends. Meanwhile, back in the real world that the rest of us have to inhabit…………..
The one compensation for small business owners faced with these monthly returns is that, once they have completed a year’s worth of them, they will be able to add them together (or give them to their accountant to add them together) and, hey presto, they will have their year end accounts for self assessment purposes. Whoopee, joined-up government! Except that they won’t be able to do that.
At the moment, self assessment returns of trading income are made on an accruals basis. In other words you account for what you have earned and expended, not what you have received and paid out. If you have bought stock and not sold it, you exclude it from your purchases for the year, and include it next year when you sell it. So for most businesses, other than those that literally buy and sell for cash with no time lags, accounts on a cash basis will bear no clear relation to accounts on an accruals basis, so they will need two sets of accounts, one for HMRC and one for the DWP.
Well, not necessarily. In a move not entirely unconnected with the impending introduction of Universal Credit, the government announced in the 2012 Budget a consultation on a cash basis of accounting for smaller businesses (being those with turnover below the current VAT registration threshold of £77,000). Thus, as the UC regulations state:
“the book-keeping a Universal Credit claimant who also reports his/her income for income tax has to maintain will be streamlined if the tax system is changed in line with this consultation.”
While this sounds great, it does beg some key questions, not least in what circumstances a UC claimant would not be reporting his or her income for income tax purposes, but let that pass. By ‘this consultation’, does it mean the HMRC consultation? If so, why do the UC regulations not simply adopt the proposals in the HMRC consultation as the measure of income for UC purposes, thus achieving consistency? You will have gathered from this that they don’t do so. Or does it mean the UC consultation, in which case the DWP appears to be approaching its aged grandmother HMRC and gently explaining to her how to suck eggs? On the basis that it means the former, there are three fundamental areas of mismatch between the proposed computation rules:
- 1. Mixed use of assets
The UC regulations only permit the deduction of expenses incurred ‘wholly and exclusively’ for business purposes, whereas there is a long and honourable tradition of allowing the deduction of identifiable parts or proportions of expenditure which are incurred wholly or exclusively for the purposes of the trade. There are common flat rate deductions, but there are differences in the acceptable measures of use of home as office. Also, cash basis is to be optional for self assessment but mandatory for UC purposes.
- 2. Exclusion of ‘unreasonable’ expenditure
No deduction will be allowed for UC purposes for any payment incurred ‘unreasonably’. What does this mean, given that there is no guidance In the regulations As there is also a wholly and exclusively test, it must be possible to incur expenditure wholly and exclusively for business purposes which is nonetheless incurred unreasonably. How exactly is this possible?
- 3. Carry forward
In case you think I am splitting hairs, how about this example? The proposed cash accounting system for tax, based on a one year period, carries forward negative balances against future positive balances. The draft UC regulations treats them as zero. I am indebted to Taxation Magazine for the following example of the absurdity of this provision:
Wenlock and Mandeville sold Olympic merchandise, selling £5,000 per month each in May, June and July at a 50% profit margin. Wenlock bought all his stock in May, and Mandeville bought his at the start of the month in which he sold it.
|Cost of stock purchased||£7,500||£2,500|
|Deficit / surplus||(£2,500)||£2,500|
|Reportable for Universal Tax Credit||£0||£2,500|
|Cost of stock purchased||£0||£2,500|
|Reportable for Universal Credit||£5,000||£2,500|
|Cost of stock purchased||£0||£2,500|
|Reportable for Universal Credit||£5,000||£2,500|
|Total income reportable for Universal Credit||£10,000||£7,500|
So despite having exactly the same trading results, Wenlock has to declare £2,500 more income for UC purposes than Mandeville, presumably as his punishment for stocking up in advance rather than buying to order. Clearly this is ridiculous and unacceptable, and some provision for carrying forward negative balances has to be made.
But it gets worse. You will note that the above example features no expenses other than cost of stock. On a cash basis expenses for a full year will often be included in the month they arise, such as annual subscriptions, insurance premiums etc. Also, rather bizarrely, the method of converting pre-tax income to post-tax income for UC purposes is to deduct tax payments like any other expense in the month they arise.
Thus, given that January is often a poor trading month as the country recovers financially from the annual Christmas over-spend, lots of businesses are going to show negative results for that month, given that they also pay their balancing payment and first payment on account for self assessment. So lots of inherently profitable businesses will be able to claim UC for January, and possibly also July due to the second payment on account. No doubt tax avoidance gurus are already plotting other ways to manipulate the system as we speak.
According to the regulations there appears to be no such thing as a partnership, but partners will need to provide details of their share of partnership income, which will be calculated on a different accounting basis, within 7 days of the month end for UC purposes. Hark, is that a pink thing with wings I see hovering over the office, saying “oink, oink”?
And what about companies? The regulations talk about ‘value extracted’ being the measure of income, at the point of extraction. But given that family company director / shareholders have full control over both means and timing of extraction, much planning will no doubt go into structuring dividends to make the majority of months eligible for a claim – indeed achieving this for 11 months should not be beyond the wit of an adept tax planner.
This will presumably be the trigger for a fundamental re-think of these regulations, even if the inconvenience and unfairness caused to business owners is not. There is no point in the advances made by government and HMRC against abusive tax avoidance if every Tom, Dick and Harriet can drive a coach and horses through the Universal Credit regulations and establish claims to which they are, by all that is right, not entitled. We are entitled to expect better than this from our government and civil service, and we should shout loudly and persistently until we get it.