In the sixth of the CPS' 'UK Policy Resolutions for 2012' series, David Martin, CPS Research Fellow and tax expert, examines how business taxation could be simplified in 2012. On Christmas eve, in the fifth in the series , Conservative MP Charlie Elphicke looked at how the Government could make life easier for small businesses.
UK Policy Resolutions for 2012:
At present the UK has one of the most complex codes in the developed world for taxing business.
It is often said that our tax is so complicated because we have a proliferation of reliefs. These reliefs are then exploited, and a cycle ensues of anti-avoidance measures followed by yet more tax planning to get round these new rules.
While there is of course some truth in this, a detailed examination of the tax code reveals that actually the underlying cause of complexity is that we have a fragmented and unsatisfactory tax base.
The tax code contains separate rules for income, unnecessarily sub-divided into different sources (particularly the division between trading and other income), a separate set of rules for calculating capital gains, and a separate system for providing capital allowances for some assets. The rules for these systems do not marry together well.
Further, the rules are needlessly different for companies and individuals.
We have become so used to this segmented approach to the tax computation that it has become difficult to see the extent to which it is artificial and unnecessary. Overseas jurisdictions do not approach the problem of taxing business profits in this way.
UK POLICY RESOLUTION IN 2012
The tax base should simply be the aggregate business profits pooled together “in one bucket”, and those profits should be determined by reference to their accounts. For small and uncomplicated businesses this would simply mean taxing all profits on an accruals basis -- i.e. taxing profits when they have been earned.
This is not an original suggestion. Michael Forsyth’s Tax Reform Commission endorsed the idea, as did the more recent CBI Tax Task Force. Indeed the Government itself was in favour of moving in this direction, but their final proposals 6 years ago were limited to a merger of property and trading income. Business rejected this, because the rewards of such limited reform would not have been worth the effort of implementing it.
Adjustments to accounting profit will always of course be appropriate for tax purposes, but very few adjustments would be required for small and uncomplicated businesses. (Examples of such tax adjustments would be to deny relief for expenses not incurred for business purposes, or conversely to provide accelerated relief for capital expenditure up to a prescribed limit through the annual investment allowance.)
More tax law will be required for businesses which are for involved, say, with sophisticated financial instruments, or have overseas aspects, or are operated within a group of companies, or which indulge in tax avoidance. But even allowing for adjustments, the aggregate tax code could be made hugely shorter and simpler than at present. Anti-avoidance rules could be very much clarified and simplified. A preliminary exercise has been done which suggests for example that tax law for assets which are not trading stock could be reduced by 80 -90%
The requirements of GAAP could be relaxed to some extent in order to work out the profits of a small business, but this should not result in a step change in tax treatment as a business grows in size. A short tax code could be published which would be sufficient for small businesses, although more rules in the complete code might become relevant as they became larger and more complicated.
Tax law for incorporated and unincorporated businesses should be the same, with only isolated exceptions.
This approach should be further developed, costed, explained and consulted on. If sufficient simplification and rationalisation can be shown to be achievable it is very likely that taxpayers will be attracted by this approach.
David Martin spent 23 years as a tax lawyer and served as a member of the Tax Law Review Committee of the Institute of Fiscal Studies. He is a Research Fellow at the Centre for Policy Studies and has previously written for the CPS on abolishing NICs.
This article represents the views of the author only and does not necessarily represent the policy outlook of the Centre for Policy Studies, its board, staff or affiliated members.