A week is a long time in politics – and at the moment, it is also a long time in tax policy. Measures announced in the Budget on 11 March have been rapidly superseded by a slew of incentives to help businesses and employees affected by COVID-19, particularly the coronavirus job retention scheme (CJRS) and the self-employment income support scheme (SEISS). At the time of writing, there has been no comparable help for owner-managers of limited companies, although this may have changed by the time you read this.
The way in which the schemes have been designed – at great speed, and clearly with intensive effort on the part of HMRC and the Treasury – highlights the complexities and inconsistencies within the UK tax system, particularly in relation to the taxation of income from small businesses. An employee, whose employer agrees to furlough them, will receive up to 80% of their salary, up to a maximum of £2,500 a month, but can do no work at all for that employer while they are on furlough (with a very limited exception for the statutory duties of furloughed directors). Meanwhile a self-employed person whose business has been affected by Covid-19 (and are there any businesses which are not affected?) can claim a taxable grant up to £2,500 per month, but only if their self-employed earnings comprised the majority of their income, and with an absolute ceiling of £50,000. On the other hand, a self-employed person can continue to generate business while claiming the grant.
The IFS has calculated (press release, 2 April 2020) that, on average, furloughed employees will lose about 12% of net family income, compared to 53% without the scheme. For self-employed individuals, the effects are more varied: on average, if the business closes completely, they will lose about 14% of family income, compared to 44% before the reforms, but some may face a severe cashflow struggle before the grant comes through in June. However, if the business suffers only a small fall in profits, about half will be better off overall, with a family income higher than its usual level.
The schemes do not cover all the employed or self-employed. For employees, the crucial cut off is that they must have been on the payroll at 28 February 2020, so anyone who changed jobs in March (or even on 29 February) will not qualify. Meanwhile, to qualify for SEISS an individual must have filed a 2018/19 tax return, so businesses which started after 5 April 2019 will not qualify. Someone who left their previous job in the second half of 2019 to become self-employed will fall through the cracks of both systems. While this is harsh, the government response so far has been that it has had to draw the line somewhere, and extending the schemes would cost more money and increase the risk of fraud.
The group which has received the least support are directors of owner-managed companies – particularly personal service companies (PSCs). Many of them regard themselves as self-employed, but in law they are employees so cannot qualify for SEISS. HMRC has now confirmed that directors can be furloughed, so can claim CJRS – but only in respect of the salary paid under PAYE. Since most PSCs will have chosen to pay only a minimum salary (enough to qualify for benefits but not to pay NICs – the primary earnings threshold for 2019/20 was £8,632), their CJRS claim is likely to be a mere £575 per month.
Some would argue that those who have saved tax in the past should receive less support now, but this seems very harsh in the current circumstances. At Blick Rothenberg we have put forward a practical proposal, which would extend CJRS to dividends received in 2018/19 in the case of active personal trading companies. We believe that this support is urgently needed to prevent many smaller companies collapsing completely, but so far there is no sign that the chancellor will respond positively – although I hope that I may be proved wrong.
The need to design separate schemes for the employed and self-employed, and the significant gap for owner-managed companies, highlights that business income in the UK is taxed very differently depending on precisely how it is received. This is not a new problem; as the Mirrlees report said in 2011: ‘The diverse nature of small business organisations requires careful consideration in the design of the tax system.’ (Tax by design, Chapter 19, first sentence). And many of us involved in tax policy have been saying for even longer that the current system creates distortions and, in some cases, perverse incentives to structure a business in a particular way. The long-running saga of IR35 is a symptom, not a cause, of the underlying problems.
So, what should be done once the immediate crisis is over?
It is clear that the significant costs of providing short-term support will have to be recouped somehow, and hence there will probably be tax rises, in the short or longer term. But more importantly, there is surely a once in a generation opportunity to rebalance small business taxation, so that those carrying on substantially the same activity face similar tax burdens. As is often the case, the IFS has already been considering this, and published a paper in December 2019 on the principles and practice of taxing small business, which looked back at Mirrlees and considered the practical options for the future.
The long-term aim would be to align the overall tax treatment of different legal forms, so that business decisions are not distorted by the tax system. However, this would not prevent incentives being given – for example, in order to encourage investment, full relief could be given immediately for capital costs (as has been done in practice via the annual investment allowance for many businesses in recent years). While such radical reform might once have been thought too difficult, it seems that its time may now have come, to judge by the words of the Chancellor Rishi Sunak in his speech on 26 March:
‘I must be honest and point out that in devising this scheme – in response to many calls for support – it is now much harder to justify the inconsistent contributions between people of different employment statuses. If we all want to benefit equally from state support, we must all pay in equally in future.’
A week is a long time in politics – and at the moment, it is also a long time in tax policy. Measures announced in the Budget on 11 March have been rapidly superseded by a slew of incentives to help businesses and employees affected by COVID-19, particularly the coronavirus job retention scheme (CJRS) and the self-employment income support scheme (SEISS). At the time of writing, there has been no comparable help for owner-managers of limited companies, although this may have changed by the time you read this.
The way in which the schemes have been designed – at great speed, and clearly with intensive effort on the part of HMRC and the Treasury – highlights the complexities and inconsistencies within the UK tax system, particularly in relation to the taxation of income from small businesses. An employee, whose employer agrees to furlough them, will receive up to 80% of their salary, up to a maximum of £2,500 a month, but can do no work at all for that employer while they are on furlough (with a very limited exception for the statutory duties of furloughed directors). Meanwhile a self-employed person whose business has been affected by Covid-19 (and are there any businesses which are not affected?) can claim a taxable grant up to £2,500 per month, but only if their self-employed earnings comprised the majority of their income, and with an absolute ceiling of £50,000. On the other hand, a self-employed person can continue to generate business while claiming the grant.
The IFS has calculated (press release, 2 April 2020) that, on average, furloughed employees will lose about 12% of net family income, compared to 53% without the scheme. For self-employed individuals, the effects are more varied: on average, if the business closes completely, they will lose about 14% of family income, compared to 44% before the reforms, but some may face a severe cashflow struggle before the grant comes through in June. However, if the business suffers only a small fall in profits, about half will be better off overall, with a family income higher than its usual level.
The schemes do not cover all the employed or self-employed. For employees, the crucial cut off is that they must have been on the payroll at 28 February 2020, so anyone who changed jobs in March (or even on 29 February) will not qualify. Meanwhile, to qualify for SEISS an individual must have filed a 2018/19 tax return, so businesses which started after 5 April 2019 will not qualify. Someone who left their previous job in the second half of 2019 to become self-employed will fall through the cracks of both systems. While this is harsh, the government response so far has been that it has had to draw the line somewhere, and extending the schemes would cost more money and increase the risk of fraud.
The group which has received the least support are directors of owner-managed companies – particularly personal service companies (PSCs). Many of them regard themselves as self-employed, but in law they are employees so cannot qualify for SEISS. HMRC has now confirmed that directors can be furloughed, so can claim CJRS – but only in respect of the salary paid under PAYE. Since most PSCs will have chosen to pay only a minimum salary (enough to qualify for benefits but not to pay NICs – the primary earnings threshold for 2019/20 was £8,632), their CJRS claim is likely to be a mere £575 per month.
Some would argue that those who have saved tax in the past should receive less support now, but this seems very harsh in the current circumstances. At Blick Rothenberg we have put forward a practical proposal, which would extend CJRS to dividends received in 2018/19 in the case of active personal trading companies. We believe that this support is urgently needed to prevent many smaller companies collapsing completely, but so far there is no sign that the chancellor will respond positively – although I hope that I may be proved wrong.
The need to design separate schemes for the employed and self-employed, and the significant gap for owner-managed companies, highlights that business income in the UK is taxed very differently depending on precisely how it is received. This is not a new problem; as the Mirrlees report said in 2011: ‘The diverse nature of small business organisations requires careful consideration in the design of the tax system.’ (Tax by design, Chapter 19, first sentence). And many of us involved in tax policy have been saying for even longer that the current system creates distortions and, in some cases, perverse incentives to structure a business in a particular way. The long-running saga of IR35 is a symptom, not a cause, of the underlying problems.
So, what should be done once the immediate crisis is over?
It is clear that the significant costs of providing short-term support will have to be recouped somehow, and hence there will probably be tax rises, in the short or longer term. But more importantly, there is surely a once in a generation opportunity to rebalance small business taxation, so that those carrying on substantially the same activity face similar tax burdens. As is often the case, the IFS has already been considering this, and published a paper in December 2019 on the principles and practice of taxing small business, which looked back at Mirrlees and considered the practical options for the future.
The long-term aim would be to align the overall tax treatment of different legal forms, so that business decisions are not distorted by the tax system. However, this would not prevent incentives being given – for example, in order to encourage investment, full relief could be given immediately for capital costs (as has been done in practice via the annual investment allowance for many businesses in recent years). While such radical reform might once have been thought too difficult, it seems that its time may now have come, to judge by the words of the Chancellor Rishi Sunak in his speech on 26 March:
‘I must be honest and point out that in devising this scheme – in response to many calls for support – it is now much harder to justify the inconsistent contributions between people of different employment statuses. If we all want to benefit equally from state support, we must all pay in equally in future.’
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