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Office of Tax Simplification invites debate on small business tax reform

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A tax relief for disincorporation of small businesses and a system of flat rate expenses allowances for the smallest businesses are among options for reform being suggested by the Office of Tax Simplification.

Members of the OTS’s own consultative committee have expressed doubts about the need for a disincorporation relief, which would add complexity to tax law and require new anti-avoidance provisions.

The OTS has published two consultation documents inviting views on ideas for reform designed to ‘ease some of the tax and administrative burdens’ faced by small businesses.

The announcement comes just a few days after the Forum of Private Business said research showed that administering tax has become ‘the top regulatory burden’ for small business owners.

The options are not firm proposals but are ‘intended to get people thinking and generate a debate’, the OTS said. Final recommendations will be made ahead of Budget 2012.

A simpler income tax for the smallest businesses

‘There are three million unincorporated businesses in the UK that have a turnover of £70,000 or less, including approximately two million with a turnover of £20,000 or less,’ the OTS said.

‘Although these are the smallest businesses in the UK, they form a vital part of the UK economy. However, these very small businesses bear a disproportionate burden when dealing with their tax obligations, and are the least likely group to have the training, skills and time to cope with their obligations.’

The OTS is examining a number of possible options:

  • Cash accounting: businesses prepare accounts based on income and outgoings with no adjustments for accruals, prepayments, or work in progress.
  • Fixed rate deductions for expenses: businesses are allowed, for certain expenses, to deduct a percentage of [for example] turnover, instead of recording actual amounts expended.
  • Fixed amount deductions for expenses: businesses are allowed, for certain expenses, to deduct a fixed amount instead of recording actual amounts.
  • Treat small capital expenditures as allowable revenue expenses: small items of capital expenditure, say up to £200 per item, are treated as a revenue expense rather than capital expenditure.
  • Turnover or adjusted turnover:  Tax is levied on turnover, adjusted turnover, or turnover from a previous year.
  • Flat rate charge: The business is charged a flat rate amount. This amount might vary according to the business sector.
  • ‘Indicator’ based measures: The tax charge is determined by indicators e.g. tables in restaurants, number of employees.

Disincorporation of small businesses

The OTS aims to determine whether there is a need for a relief allowing companies to transfer a business and its assets to the shareholders ‘without there being a significant tax disadvantage’, and to consider the possible form of any such relief.

It puts forward options for a narrow form of capital gains relief, and a wider form of disincorporation relief to include rules to eliminate a second layer of taxation at the shareholder level.

The OTS accepts that such a relief would introduce additional complexity to tax law. It revealed that a number of members of its own small business tax consultative committee have ‘challenged us on whether there is a need’ for the relief.

Minutes of the May 2011 meeting of the committee record that if disincorporation relief is to be a priority, evidence is needed on the demand for disincorporation.

‘There is a continuing incentive for incorporation, which was increased through recent changes to NICs and corporation tax rates. Anti-avoidance provisions will be required, which add complexity,’ the minutes said.

Assessing potential demand is a key objective of the consultation, the OTS said.

Tax reliefs apply to individuals on the incorporation of a business, so that for example no charge to capital gains tax need arise on a transfer of assets to the company.

No corresponding reliefs are available where a business returns to unincorporated status. A concessionary form of relief is provided by ESC C16, which allows a company to be struck off without a formal liquidation.

Many of the businesses that were incorporated to take advantage of the zero rate of corporation tax between 2002 and 2006 would be better off returning to unincorporated status, to save administrative burdens, the OTS said.

‘Against that, the decision to incorporate was taken to obtain a tax advantage so there is an argument that all consequences should follow. In any event, the point is regularly made that current tax and national insurance rates do, if anything, encourage businesses to incorporate and so it is questionable whether there is currently a real demand for this potential new relief.’

Comments on the OTS proposals are invited by 7 October.