Corporation Tax » Tax Research UK

How to tackle the crisis in small business taxation

Corporation Tax, HMRC, Small business No Responses »

Feb 042012

This weeks ‘scandal’ at the Student Loan Company, where a director who appears to be an employee has been paid through a personal service company has excited lots of attention. I know there will be more similar stories: I have been called about them.

But I’m not interested in the stories of the people involved; I am more interested in the systemic issues. There are two of these. The first is the problem that small business tax is too complicated and fails to reflect the economic reality of the way in which many small businesses work. The second is that the government through H M Revenue & Customs and Companies House is simply failing to collect the tax due from small companies.

I deal with the first here. I wrote the following in 2007 when H M Revenue & Customs had lost its last major anti-avoidance case against the use of a small limited company to both receive the income of what was claimed to be a disguised employment and which then split that benefit between a husband and wife. I wrote then:

The Arctic Systems case has been widely reported, but much of the comment made upon it has been high on emotion, but low on analytical content.

I wrote on this case, and as a result was challenged to produce a suitable response. That I have now done. The full paper is available here. The summary says:

This paper analyses the way in which the owners of many small limited companies reward themselves and members of their families out of the income that their labour generates for those companies. This is particularly relevant in the light of the recent House of Lords ruling in what is known as the ‘Arctic Systems’ case. The paper shows that many of these arrangements do constitute tax avoidance because the rewards paid do not much the underlying economic substance of the transactions that are taking place.

In the interests of promoting tax justice for all taxpayers HM Revenue & Customs have a consequent duty to promote new arrangements that will encourage tax compliant behaviour in this sector. Tax compliance is defined as paying the right amount of tax (but no more) in the right place at the right time where ‘right’ means that the economic substance of the transaction accords with the declaration made for taxation purposes.

The paper does then show that this problem is almost insoluble whilst these businesses are operated through the medium of small limited companies which were not designed for and are unsuitable for the type of activity they undertake.

As a result this paper proposes that:

1. A change in company law to allow the re-registration of small limited companies as LLPs. An LLP is tax transparent: its income is taxed as if it belongs to its members even though it is a legal entity that is separate from them for contractual purposes;

2. The introduction of new capital requirements for the incorporation of limited companies undertaking trades, and over time forced re-registration of those that do not meet that standard as LLPs;

3. The introduction of a new investment income surcharge at rates broadly equivalent to national insurance charges that would have the benefit of reducing the incentive to split income, restore the taxation balance between income earned from all sources and allow a reduction in the base rate of income tax without adding substantially to the burden of administration for taxpayers since those liable will, in the vast majority of cases, already be submitting tax returns;

4. Create new, economically justifiable and verifiable standards for splitting income in LLPs so that the risk of legal challenge to such arrangements will be substantially reduced whilst recognising the significant role that the partners of those who supply their services through owner managed corporate entities play in the undertaking of that activity.

If this were done then:

a. The administrative burdens for many small businesses would be reduced;

b. The certainty of the arrangements under which they can operate would be increased;

c. The rewards that they rightly seek to pay to those who contribute to the management of these companies from within domestic relationships will be rewarded, but within appropriate constraints;

d. The attraction of freelance status in tax terms would be retained;

e. The current injustice that sees income from labour more heavily taxed in the UK than income from capital would be eliminated in large part without prejudicing the required favoured status of pensioners;

f. The incentives for tax planning would be reduced, so simplifying tax administration;

g. The tax yield might either rise, or a reduction in the tax rate might result.

The challenge in creating such a system is significant because it requires cooperation across government departments, but far from insurmountable. It is part of the challenge of creating an enterprise culture that meets the needs of the UK in the 21st century, and that is a challenge that any government needs to meet.

As I note at the end of the paper, suggestions and comments are welcome. But please do read the paper first and not just the summary.

That invitation still stands: the problem remains. I remain sure I have offered a viable alternative. I know it was well read and discussed in the Treasury at the time. Is this the time for change?

Remove limited liability from those companies who act anti-socially

Accounting, Corporation Tax, CSR 23 Responses »

Jan 112012

I’d love to say the following idea was mine, but it wasn’t, so I’m going to give credit for where it came from, in a letter to the Guardian today:

Shareholders in a limited company that goes bad are liable for no more than the money they have already paid for their shares – the company’s creditors stand the loss, not the owners of the company, the shareholders or the directors. This is not a right, but a privilege we grant so that people will be ready to invest in new enterprises without fear of taking on unlimited liabilities.

We don’t have to privilege all companies, directors and shareholders over their creditors in this way – there’s no human right to it. We could instead say that liability is only limited if the highest-paid executive’s remuneration does not exceed, say, 30 times the median employee’s salary. It would be a brave shareholder, individual or institutional, that permitted any executive’s remuneration package to approach the point where they, the shareholders and directors, might be found personally liable if things go wrong.
David Harington
Worcester

I have long argued that the right to limited liability is a privilege that carries obligations, including the duty to pay tax and to file accounts. I haven’t argued often, and certainly not in the case of public companies, that the privilege of liability should be withdrawn as a sanction.

I think that’s been an omission on my part. We should be much more straightforward in saying that limited liability is a privilege to be used for the benefit of society, and with care, and that if obligations to society are not respect then it should simply be withdrawn with the shareholders and not society at large then having the duty to remedy the defect. When should that happen? Let me suggest the following occasions for a start:

1) When excess pay is allowed, as noted above.

2) When accounts are not filed on time, for any reason.

3) When corporation tax returns are not filed, for any reason. Of course these are not public documents now: they soon would be if this was the case.

4) Three months after any set of accounts is filed showing the company to be insolvent unless action to remedy the defect has been taken in the meantime.

That will concentrate minds I think.

Now which MP would like to propose it as a private member’s bill?

A corporation tax is an essential part of any tax system

Corporation Tax, Economics, Tax justice, Uncategorized 12 Responses »

Dec 192011

There are occasions when even Guardian economists can prove just how closely wedded to the blackboard and how out of touch with reality they are. Phillip Inman did so this afternoon when writing about corporation tax. He said this afternoon:

Soon there will be no such thing as corporation tax. Among the first items on the shopping list of reforms outlined by Spain’s new prime minister Mariano Rajoy on Monday is a cut in the main business tax.

He said more firms would enjoy a 20% rate as a central plank of his mission to make Spain more business friendly.

And from this Phillip moved on to argue:

The TUC and tax campaigner Richard Murphy’s groundbreaking 2008 report The Missing Billions: The UK Tax Gap (pdf), found a £12.5bn difference between what companies should have paid in corporation tax annually and what they really paid.

Some on the left argue, as the TUC did, that government’s should play hardball with companies and make them pay the full charge.

But not only is that a forlorn task against the run of play (when governments across Europe are reducing corporation tax rates), it is wrong headed.

We need to generate taxes to fund social welfare and for that we need to redraw the tax map. I subscribe to the OECD’s recipe for reform. Despite the Paris think tank’s reputation for rightwing, pro-capitalist reforms, in this case it is pretty even-handed.

It would reduce all taxes on income and increase taxes on spending and wealth.

As he continues:

Unfortunately, the proposal leaves most leftists gasping for air. What do you say when a proposal slays the sacred cows you hold dear, but also slays those of the opposition.

The left loses a tax on businesses, and must suffer the regressive nature of high consumption taxes. On the other hand, workers pay less tax and crucially, the owners of wealth, be they rich individuals or corporations, must pay a new tax on their holdings.

The OECD, like most economists I speak to across Europe, subscribes to a tax on land as the simplest and fairest tax on wealth.

He tries to justify his position:

The shift has many positive benefits. They key must be to unlock a desire for work by cutting taxes on incomes. At the moment we lock families into static or falling living standards, partly through the interaction to income tax, tax credits and benefits.

Consumption taxes rise, but there is evidence that skewing VAT away from food to luxuries makes it much less regressive. Land taxes would discourage the wealthy from hoarding land without doing something with it (planning rules permitting). If they want to live in expensive areas of the country or base their businesses in the south-east, then there would be a significant tax charge for doing so, and one they cannot dodge with elaborate schemes or offshore trusts.

Rajoy is, like most rightwing politicians, only tacking one side of the equation. The left should argue the logic of the right’s position on income taxes with demands for taxes on wealth.

We do argue for a wealth tax Phillip, we do. But we do so based on our understanding of the real world, which is what Inman’s suggestion so clearly lacks.

Let’s just address one very obvious problem. About 700 companies pay more than half of all corporation tax in the UK. Details of the £42 billion paid in 2010/11 are here. But this misses the fact that maybe £12 billion is paid by small business - who should also, as I have shown, be liable for much more if only this tax were not so heavily evaded. Inman says we should have no corporation tax but a tax on wealth instead. How is he going to address the taxation of 1 million or probably more small businesses as a result? And how will he stop everyone forming companies to avoid tax henceforth? The naivety of suggesting the abolition of corporation tax to create this potential tax chaos is staggering. The back hole in government finances would be enormous.

Let’s take a second issue. We would lose £42 billion from corporation tax. Inman suggests we recover this from VAT or wealth taxes. First, Inman suggests we skew VAT from food to luxuries. We already zero rate food. That shows how much he knows about that: precisely nothing by the look of it. Secondly, perhaps he does not realise there is no EU provision right now for a luxury wealth rate of VAT – although I would prefer one. So, to recover his VAT we’d need not a VAT rate of at least 28% based on this year’s forecast yield of £100 billion. That’s going to help inflation, isn’t it Phillip? And boost the economy a lot, isn’t it? Whilst of course creating no labour market distortions, at all. Nor will it create any benefits re-rating issues whatsoever, of course. And let’s ignore for a moment the impact on those on pay freezes. The proposal should make every right thinking person shrink in horror. How come Inman thought of none of these issues?

And can we just ignore the suggestion that income tax rates will fall? How does cutting a whole tax raising £42 billion mean income tax rates fall? That’s just fantasy. Making up the deficit will be enough of a challenge. Other cuts is just a ludicrous claim.

As is the argument for a wealth tax. I agree with these. Fundamentally. Completely. I want them. But there are some conditions. Like securing the data to assess them. And whilst we have tax havens that let anyone hide their wealth in offshore companies – which are tax free entities that no authority asks questions about – the chance of collecting wealth taxes is about zero percent. Of course I want to shatter that secrecy but suggesting a wealth tax without mentioning that pre-condition is plain absurd.

As for taxing land. Yes, I agree: that has to be done too. But there’s an issue Phillip. It’s called cash flow in the first instance. Is it reasonable to charge tax when there is no means to pay it? This is the perennial argument with taxing land. How are you going to overcome it? No mention is made? And then there are other problems you ignore. Like finding the owner. Not all land is registered, and much is registered offshore. How do you overcome that? And last, but by no means least – land (despite the Georgists’s claim) is not the sole source of wealth. Cash generating assets are as well, very much so, but it seems Inman wants to ignore them.

I could go on, but won’t. I want radical reform of taxation. But I also want a tax system that works. I find those like Phillip Inman who’re still wedded to the old theories of economics and who have had no real encounter with the real world of tax where the problem of extracting payment is the number one priority putting forward ideas that are barking mad on a blackboard and economic insanity in the real world profoundly annoying. Even if they do work for the Guardian. Especially when they can only increase the wealth gap in society and the opprtunities for tax evasion that corrode social justice.

Inman owes the Guardian and its readers an apology.

The Cayman Islands’ director – almost as flexible as the Sark postman

Cayman, Corporation Tax, HMRC, Secrecy jurisdictions, Tax Havens, Uncategorized 39 Responses »

Nov 212011

Once upon a time the postman on Sark was the symbol of offshore farce: rumour had it he held more than 2,000 directorships and quite clearly knew little or nothing about any of them, each being held as a pure nominee to supposedly locate the company of which he was a director for tax purposes on that once idyllic and now rather troubled Channel Island.

Then the ‘Sark lark’ was brought to an end, the postman went back to the day job and examples of such farce, where nominees were so blatant that the sheer lack of likelihood that they really undertook the task supposedly entrusted to them was harder (not not impossible) to find.

Today the FT reveals the practice of nominee directors holding far more positions than they can possibly manage is alive and well and riddles the Cayman hedge fund industry, which claims to be resident in those islands even though it is very obviously likely that real decisions must be made elsewhere. As they report:

A small group of Cayman Islands “jumbo directors” are sitting on the boards of hundreds of hedge funds as demand for independent directors booms in the Caribbean tax haven.

At least four individuals hold more than 100 non-executive directorships each, and 14 have more than 70 – each worth as much as $30,000 a year.

One has been listed as on the boards of 567 Cayman entities, almost all of which were hedge funds.

The revelation of the figures, in a Financial Times investigation, comes amid calls from some of the world’s leading hedge fund investors for greater transparency in the Caymans as part of a global effort to improve fund governance.

This practice suggests three things. First of all, as I have often argued, the supposed centre of decision making that suggests these funds are located where their directors are is little more than a charade in many cases.

Secondly, any directors who can believe in this charade must have suspended their judgement: if you can believe in these structures it is highly likely that sound governance has flown out of the window.

Thirdly, and as I have again argued, often, the time for a change in the rules regarding the determination of residence on the basis of where the directors of an entity supposedly meet is more than overdue for reform. As is likely in these cases, real decisions are almost certainly taken in places like London and New York but ta x is not paid there as a result of playing games in Cayman. That has to stop. Pretending we can determine residence on rules written for the era of the steam ship and telegram when we live in the age of the internet is just madness, and is giving companies the most massive loophole to abuse the tax rules and revenues of major democratic states. The objections of business have to be ignored and such schemes have to be looked through now wherever possible.

Is this a case for the proposed GAAR? I think it should be, but I fear the hurdle has set been too high for it to be used in such cases. If so then specific legislation is needed. Either way, reform is possible and overdue.

Transfer pricing – the video

Corporation Tax, Transfer Pricing 5 Responses »

Nov 092011

I made this video a while away (I don’t even recall those glasses!) but since I’ve been asked about transfer pricing and this seems to do the job I thought I’d put it up again:

Who is paying for Jersey to be a tax haven?

City of London, Corporation Tax, Economics, Guernsey, Isle of Man, Jersey, Secrecy jurisdictions, Tax avoidance, Tax Havens, Uncategorized 24 Responses »

Nov 072011

The reason why places like Jersey became tax havens was to raise tax revenue from third parties. The tax revenues raised were, in effect, export earnings that kept their economies afloat.

Deputy Geoff Southern in Jersey has tabled an amendment to the current Jersey budget that shatters the myth that this is still the case. As his amendment says:

Geoff is right to acknowledge there is a race to the bottom in Jersey, Guernsey and the Isle of Man. Promoted by the pinstripe infrastructure of lawyers, accountants and bankers through such coordinating bodies as the Society for Trust and Estate Practitioners (who have their single biggest branch in Jersey but who are active in all three locations) the pernicious influence of these groups has driven these three jurisdictions on a destructive path towards shattering their tax base by eliminating corporate taxes for their clients.

The result is all too apparent. The tax burden has shifted dramatically from businesses using Jersey as a tax haven to the local population who are now paying for the privilege of hosting the tax abuse industry whilst at the same time their economy is facing ruin as local politicians realise they have no idea how to plug the continuing deficits they face and are now suggesting plundering the rainy day fund – a sure sign they are on the slippery slope to running out of money, as I have long predicted.

Geoff Southern has in this case study provided the evidence of what I and the Tax Justice Network have long argued – that the ‘race to the bottom’ in corporate taxes is simply an excuse to shift the tax burden from those able to pay tax (let’s call them the 1%) on to those less able or unable to afford them (again, for simplicity, let’s call them the 99%).

This is happening everywhere but Jersey’s clearly leading the way.

This is what the Tax Justice Network is about.

This is what #occupy is about.

Beating this pernicious process is what re-engagement in democracy should be about for many who feel disenchanted by it.

And this is what beating the exploitative activities of the City of London – the most undemocratic local authority in the UK – has to be about.

The UK is a low tax state – so shall we move on and discuss the real economic issues that matter?

Corporation Tax, Uncategorized 1 Response »

Oct 032011

Accountancy Age reported this today:

The UK has the second lowest corporate tax burdens in the G8, research has shown.

A study by UHY Hacker Young, released today, shows that only Russia imposes lighter corporation tax on businesses. It also has the lowest business tax burden among the major European economies, with only Estonia, Romania, Ireland and occasionally the Netherlands imposing lower rates.

The research looked at how much tax is paid by businesses with pre-tax profits of $100,000, $1m and $100m. The UK had the 16th highest burden out of 21 countries for $100,000 profit, 14th for $1m profit and 12th for $100m profit.

Roy Maugham, tax partner at UHY Hacker Young, said: “The perception that the UK is a high tax jurisdiction for business is now something of a myth. There has been a lot of discussion about UK-resident businesses moving overseas – and this has happened – but the reality is that the UK is a considerably more welcoming business environment than most other major economies.

Now shall we stop all these silly discussions about lowering business tax any further, and abandon talk of companies moving offshore and instead talk about real issues in the real economy?

Hat tip: Richard Brooks

No cut in Northern Ireland’s corporation tax rate for 4 years at least

Corporation Tax, Ireland, Uncategorized Comments Off

Sep 202011

This is welcome news from the Press Association:

Any future cut to the corporation tax rate in Northern Ireland will have to wait for at least four years, Stormont’s finance minister has indicated.

Sammy Wilson told MLAs he did not believe a reduction in the business levy, if one was made, would be implemented in the lifetime of the current Assembly.

The power-sharing administration is currently awaiting a Treasury decision on whether the power to set the rate will be devolved to Stormont.

I have been waging what might be called a pretty much one man campaign against such a cut from the safe distance of East Anglia and it looks like sense has prevailed and the cut will not happen.

I’ll count that another success – because in four years this issue won’t be near anyone’s agenda. Game over, I say.

And now let’s move on to stop Scotland committing the same folly.

The Scottish government is living in La-La Laffer Land

Corporation Tax, Scotland 10 Responses »

Aug 242011

John Swinney, Scottish Finance Minister issued a press release today saying:

“Scotland needs full control of the key economic levers to meet the specific challenges facing the Scottish economy – and the cross-party Scotland Bill Committee in the last parliament concluded that this power should be available to the Scottish Government if it is granted to Northern Ireland.

“Control over corporation tax would enable us to boost investment, bringing jobs to communities across Scotland, grow the economy and take the right decisions for Scotland.

“There is clear evidence from around the world of the benefits from lowering burdens on business – and this 54-page document sets out the compelling evidence in more detail than ever before.

“Lower corporation tax is a vital source of competitive advantage in an integrated global economy, helping to attract new businesses and highly-skilled jobs. A competitive corporation tax regime has been a feature of the economic success of many countries, and we want Scotland to have the same opportunities to bring in jobs and boost growth.

And much more in similar style.

But as the Telegraph noted this morning:

Figures on Friday are expected to show that companies are not spending despite the Government’s best efforts to encourage corporate activity by slashing employers’ National Insurance contributions and corporation tax.

Stagnant investment in the second quarter, as BarCap has forecast, would follow a 3.2pc decline in the first three months of the year. By contrast, the Office for Budget Responsibility expects business investment to expand by 6.7pc this year and contribute a third of total growth.

Let’s explain that in simple terms. Tax rates have never, and tax rates never will encourage real growth.

Low tax rates do encourage people to artificially relocate profits to low tax locations. But they never encourage people to make more real money. That’s because making money requires a strong top line and corporation tax is charged on what’s l;eft over at the bottom line. And as is obvious, if government withdraws from the economy (as now) because it does not believe in tax then top lines are weak and bottom lines disappear – and tax considerations go out of the window in a panic about survival.

But John Swinney and the Office for Budget Responsibility are still living in the La-La Land of the Laffer curve that says cutting tax rates increases yields.

They rely on a graph like this:

They implicitly argue that we’re on the right hand side of the graph i.e. the downward sloping but of the graph and if only we cut tax rates then yield would increase.

The trouble is I did a survey of the academic literature a while back and found the only place that might be on the right hand side of the graph was Sweden and there was not a hope that any tax rate in the UK (including the 50% income tax rate we now have) would put us anywhere near that point.

So tax cuts in the UK always mean less tax.

And more corporate profit – none of which would stay in Scotland you can be sure.

So candidly, these people really are in La La land and it’s time they woke up and saw the reality of the harm they’re really proposing to the ordinary people who will suffer cuts in education, health care, pensions and other essential services as a result of their mad thinking. Because that’s what they’re really prescribing. Which is exactly why the Taxpaters’ Alliance sells this myth to them.