Small business » Tax Research UK

Are accountants really so incapable?

Accounting, Small business 13 Responses »

Mar 192008

AccountingWEB’s Business Zone has covered David Drew’s EDM on income shifting. What’s really interesting though is the reaction of Grant Thornton’s George Bull, who has said:

At the heart of this EDM are the same problems for HMRC, [which is] how do you value the contribution of different people in a small business? You end up with the same problem of having to find a statutory method of measuring an individual contribution to a business.

Amazing isn’t it? Accountants are meant to be able to measure value, but profess they can’t when it suiots them. Accountants are meant to believe in the market, but suggest that there is no market indicator in this case. Do they really believe that, because if they do I have a simple answer. Statute should provide the basis of apportionment if the market does not work.

Perhaps they’d like to reassess their capabilities in that case and work just how the market should indicate value arises. Let’s start with these key performance indicators, some or all of which could be used to indicate a basis for apportionment, and none of which need take long to assemble on an annual basis:

1) What does the business do. Who of those sharing its rewards has the training or qualifications to provide that service?

2) How many hours does each participant in reward work for the enterprise each year, approximately?

3) Of the hours worked, what proportion were spent in dealing with customers?

4) Who runs the administration of the business? Administration includes (but not exclusively) billing, accounting, managing correspondence, liaising with suppliers, dealing with accountants, taxation and business regulatory issues. Separate estimates for each category of administration can be given if appropriate.

5) Does each participant in the rewards of the business have their own computer? If not, why not?

6) How many business emails were sent by each participant in the reward of the business each year? Can this be proven by the use of different email addresses?

7) Does each participant in reward have their own business mobile phone? From billing records can it be shown what proportion of business calls were made by each?

If the company has a vehicle who usually drives it?

9) Do any of the participants have other employment? If so, how many hours a week do they, on average, spend on that employment?

10) If neither has other employment do either have child care or other care obligations? Do these limit their capacity to work?

Answer these (and in the case of Tax Research LLP my guess is my wife and I could answer these questions, accurately, in less time than it took me to type them) and you’ll have a very good overview of who is generating the profits in an enterprise.

That will be true for 97% of all businesses affected by income shifting, in my experience (and I’ve seen hundreds of this sort of entity in my time). The rest will have to create their own evidence. That’s always true of all systems, so the exceptions are not a problem.

Having determined who is generating the profit it’s then a matter of assessing the value of the supporting partner’s services. I’ve suggested a de minimis be allowed, which I think is fair. Try to increase that and evidence must be given (and reasonable and supported answers to the above would be a good starting point in supplying relevant evidence). And if the rate to be attributed to support time is to be beyond market rates then again reason must be given for use of a non-standard, out of line with market figure.

Is this fair? Yes.

Is this what accountants do all the time? Yes.

Is it a burden? No.

Are those accountant who say it is not possible to do this simply hiding tax avoidance? You know the answer to that.

Small business taxation Early Day Motion

Small business 2 Responses »

Mar 192008

The following Early Day Motion was tabled in the House of Commons yesterday:

EDM 1195

INCOME SHIFTING AND THE FUTURE OF SMALL BUSINESS TAXATION

17.03.2008

Drew, David

That this House welcomes the decision announced in the Budget to defer legislation on what has been described as income shifting within small limited companies and partnerships; and calls on HM Treasury and other affected departments to use the additional year that they have allowed themselves for consultation on this issue to undertake a thorough review of more appropriate means of providing smaller enterprises with a suitable legal entity designed for use in the 21st century, and not the 19th century as the limited company was, that will simultaneously reduce the taxation, accounting and regulatory burdens on smaller enterprises, so freeing them to generate wealth and employment in the UK economy, whilst ensuring that they can with minimum effort comply with the taxation and other requirements imposed upon them by law in a way that minimises risk of tax avoidance, creates a level playing field in which all in the sector can compete fairly and ensures that the right person is taxed on the reward they have earned at the right time and in ways which do not create artificial and inappropriate incentives to recategorise employment as self-employment, and the reward for labour effort expended as investment income.

I warmly welcome this EDM. David takes forward the ideas I discussed in my papers on this issue, parts at least of which I know have been placed in the House of Commons library.

It would be very good if this EDM now got wide support, and it already has signatories from all the main parties. Small business does not now need a ‘lash up’ solution on income shifting. Real change is needed to provide it with an appropriate structure and accounting and tax environment for the 21st century.

Income shifting

Small business, Tax management Comments Off

Mar 122008

The Chancellor has listened to me: the rules on income shifting will be postponed for a year.

Let’s hope he really consults.

Income shifting: why accountants are protesting too much

Accounting, Ethics, Small business, Tax management 9 Responses »

Dec 142007

I have been reading the reaction on AccountingWEB to the HM Revenue & Customs’ paper on income shifting.

As far as I can tell I am the only accountant who thinks income shifting is a problem. That of course probably means I have the support of the vast majority of the population, since accountants are usually out of step with public opinion on most issues so this does not unduly concern me.

Let me also be clear: I do not think this document has got the arrangements for income shifting right. My own paper on this shows that HM Revenue & Customs should be much more comprehensive in its approach and it is the application of this approach to self employed income alone that is in this case the mistake HM Revenue & Customs have made.

But let me come to my main point, which is that the Revenue should dismiss much of the comment that has been written on AccountingWEB.

First of all, it is easy to do so. I’m sure the Revenue must wonder, as I do , what advice accountants who only seem capable of moaning actually offer their clients.

Second, even from some more able commentators much of what has been said is wholly unrealistic. A husband who comes to rescue a self employed wife whose car has broken down is not offering a business service. I did the same for my wife when she was in employment – and never expected reward from her employer. You do this because you are married. It is quite absurd to suggest that this is a business supply.

Third, it is also absurd to suggest that in this day and age people need a wife (and it seems almost exclusively to be wives who do this) sitting at home by the phone to get business. You don’t, and anyway, I’ll guarantee they don’t stay there all day. This is an excuse, not a justification. Mobile communications have completely destroyed this argument and those who will not use them need to get a life, not a servile wife.

But worse, and fourthly, there seems implicit in the comments a level of surrealness that is hard to credit. An attack by HM Revenue & Customs on income shifting is not an attack on marriage, it is an attack on tax abuse. A requirement to prove that an expense is properly incurred by a business is no more than suggesting that proper books and records be kept. Can anyone, let alone an accountant, object to that? And the same is true of the allocation of reward to capital if the dividend route is adopted and the payment is out of proportion to the risk that the capital bears – and this will not be an issue if it is not. Again, what is unreasonable about that? We have always known that records need be kept for business purposes.

Which makes the suggestion from the accountancy profession that it will not be possible to prove the proper allocation of reward a simple cry of incompetence. I wonder, are those who claim this really accountants at all? Is it beyond their wit to come up with some key performance indicators that might suggest degrees of involvement in a business? Some such indicators might be:

1) Time spent business planning, which is an hours measurement;
2) Dealing with correspondence (count the emails – it’s an easy test);
3) Time on the accounts – not hard to prove – sign the vouchers as they’re processed and keep copies of signed cheques as evidence of involvement and the case is proven, I suggest;
4) Log the business phone calls received – doesn’t that make sense anyway, and won’t a simple book by the phone do for the job?
5) Estimate the work contribution to productive output if there is one – but be realistic as to what it is and what it’s worth. My wife, for example, reads some of my stuff before it is published to offer a second opinion, style comment and so on even though she has no tax knowledge. That has a value. Is it beyond anyone’s wit to attribute reasonable value to that, and to keep a record? No one will be seeking precision to the last 10p, after all.

My answer is that this is entirely feasible, perfectly possible to do, and necessary if you want the tax advantage. I just don’t see the issue.

Or rather, I think I do. You see over very many years during which I have been responsible for thousands of sets of accounts I can’t recall more than a handful where a salary was paid to a spouse. But once I worked for a firm where it was routine to income split – indeed the client was never asked for their consent. It was routine.

My approach required me to justify why I income split, although it was never a problem – the most basic questions could establish if there was a real partnership or not. And if it existed then a note was made as to the reasoning, because I believed that the settlement legislation applied in the 1980s, not just now. And the reasoning would not have been extensive but would have covered key issues on which evidence could be secured of the type noted above so that if enquiry arose the matter could be dealt with. I just thought that common sense.

But the reality is, I suspect that this was an unusual approach to accountancy and that the routine claiming of deductions for which there is no support and the reallocation of income without economic justification has been the norm and that as a result many accountants have been assisting an unjustifiable exploitation of the tax system which they know has now been rumbled.

That’s what the protests are about. And that’s why they should be ignored.

Income shifting – the Treasury misses the point, again

Small business, Tax management 4 Responses »

Dec 072007

The Treasury has published its proposals for tackling income shifting following HM Revenue & Customs’ loss in the House of Lords in the Arctic Systems case.

This is one of those situations where I wrote my submission to this consultation in advance, and informed sources tell me this has been well read in the Treasury. But that doesn’t mean I am happy with this consultation paper. Far from it in fact.

I think income shifting is a real problem in the UK tax system. My further research on this issue will be published early next year. But let me say for now that the problem is big. But, and this is the key issue, it is widespread. In other words, it may take place in the context of self employment but it is almost certainly more significant with regard to investment income such as that from bank deposits, share portfolios and buy-to-let properties.

So there is in this consultation paper there is an elephant sitting in the middle of each page which is deliberately ignored, but which is asking why this issue is only being tackled with regard to small business activity. The opening paragraph of the report says:

The Government believes that it is right for everyone to pay income tax on their own income. This principle, by which individuals are taxed on their income independently of others and of their personal choices, ensures that the income tax system is fair and remains progressive.

If that is true then the Government has a duty to tackle this issue with regard to investment income as well. More than that. They have a duty to close the incentive to recategorise income as being from an investment source rather than being from individual human endeavour. The biggest anomaly in our tax system is that unearned income is taxed much more lightly than is earned income because of the incidence of national insurance charges. It is this anomaly that has encouraged the abuse that hes led to income splitting. Unless it is ended the problem will persist.

This, therefore, is the fundamental intellectual flaw in this paper, and yet again one senses within it the tension between the Treasury and HMRC that is apparent in the domicile consultation paper, also published yesterday. The Treasury demands that the investment community in the City keep their favourable tax system, whilst HM Revenue & Customs gets the flack for having to try to enforce obvious iniquity upon a majority of the population.

What we really need is a principles based tax system. And that means principles underpin the design taxes as well as underpinning the regulation of compliance with the tax. I’m sorry to say that this new proposals takes us no nearer that principles base: indeed, it creates further injustice and the perception of increased unfairness in the tax system when the issue it is tackling is the right one, but is addressed in the wrong way. It’s just another shot in the foot by the Treasury in that case.

All of which means I just hope Hartnett gets the top job at HMRC, for two reasons. Some say he would be wasted on the role as he is best at policy. But tax policy is the biggest weakness at the top of HMRC and the Treasury right now. Second, I think he’s tough enough to say that this sort of proposals is plain daft. His two predecessors were not.

The UK Tax Gap exceeds £80 billion

Domicile, Economics, Small business, Tax avoidance, Tax management 7 Responses »

Oct 102007

Slipped into yesterday’s PBR releases were two reports from HMRC – one called Measuring Indirect Tax Losses and the other called Methodologies for Measuring Direct Tax Losses.

Now the titles may not be gripping, but these are important. Lets take the first. The highlights are this:

- 14.2% of VAT is not collected. Current cost (my estimate based on HMRC data) – £13.24 billion

- £400 million of duty on spirits is not collected

- 13% of cigarettes are smuggled – cost £1.65 billion

- 56% of hand rolled tobacco is black market – cost £750 million

- £350 mill ion of diesel duty is evaded in the UK

- 43% of all diesel duty is evaded in Northern Ireland (people cross the border) – cost £210 million

The overall rate of weighted loss on indirect taxes excluding VAT is, I estimate about 9.4% based on this data.

Then let’s look at Direct Taxes. Here HMRC show very muddled thinking, They admit they should do a ‘top down’ analysis of tax lost, which is what they do on indirect taxes. But they then say they can’t do it. So they do a ‘bottom up analysis’ instead, which works solely on the basis of the returns made and the tax estimated to be unpaid by those submitting them based on investigation work. But as they admit this means they do not really measure tax lost by:

- non-payment;
- large business;
- the use of avoidance schemes/devices to reduce liability;
- the informal economy; and
- individuals who are not issued a return.

Which means that as a measure what comes out is not that useful.

Even so they note that:

- 13% of tax due by those subject to self assessment is lost

- 1.2% of PAYE and NI due on small and medium sized payrolls is lost

- About 14% of tax due by small and medium sized companies is lost.

The losses on that lot come to £5 billion – but their data is up to 5 years out of date – amazingly.

I’ve reflected on this data. Extrapolating the average tax lost on direct taxes and those taxes that probably behave like them and applying this to 2007/08 HMRC data then total direct tax losses might be £17.6 billion, VAT might be £13.2 billion and other indirect taxes £4.8 billion – a loss of £35.6 billion.

Now that’s big. But it’s wrong. It understates the loss. That’s because:

- The direct tax losses are understated for the reasons noted above;

- The Revenue themselves fail to take into account the fact that if VAT is lost then the income related to it is almost certain to be suppressed as well, meaning that there are direct losses resulting from this evasion. These would not be counted in the above figure as this would be in the informal economy. In other words, only a top down approach works.

Now, £13.24 billion of lost VAT suggests an undeclared turnover net of costs of £75.6 billion. It’s this sum that has not been taxed or not been declared for direct tax purposes. This is a measure of the ‘informal’ economy missed out of the direct tax loss calculations noted above.

What’s the right tax rate on this?

- It’s fair to assume that this is additional income – so no personal and other allowances for income tax need be given.

- It’s fair to assume that this activity is not being done through many companies, or if it is that they are not complying with legal requirements, so the cash is being paid straight on to owners.

- This is earned income. NIC should apply.

- Some of this will be organised and give rise to high income. A lot will not be. It will be living wage abuse.

- So, let’s take the likely situation that the tax due will be at basic rate for income tax or the broadly similar small company corporation tax rate and call that 22%. And then apply employer and employee NIC rates at a combined figure of, say 20% (which is less than the maximum). That’s a 42% loss.

On £75 billion that’s £31.7 billion.

So the combined loss is now £67.3 billion.

Now lets add the loss amongst large companies. I calculated that as £4.6 billion in Mind the Tax Gap for 2004/05. But Corporation Tax yields have risen since then, and so will this gap have done. Pro rata the figure should be £6.8 billion now.

That brings us to £74.1 billion.

No lets assume that tax planning by individuals increases the gap. I have shown that the domicile rule costs £4.3 billion. Let’s very modestly assume that all otter planning contributes no more (and this is very generous).

Now the Tax Gap is not less than £82.7 billion. Which happens to exceed the amount of VAT collected this year. Or the cost of education in the UK, with almost £5 billion over.

Sobering, isn’t it?