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Tax reform - taxing a business

    David Martin enjoyed a career spanning 23 years as a tax lawyer within a large City Law Firm, latterly as Head of the Tax Department, before retiring in 2002. During that time he advised both company and individual clients. In a new series of four blogs, he looks at simplification of business taxes. 

    The Tax Simplifier blogs on the CPS website last year sought to identify problems with our tax code and suggest what might be done to improve it.

    We now have over 18,000 pages of tax law in Tolleys tax handbooks – an indication something has gone badly wrong, and that we need to reconsider what is happening. Is there scope for any real improvement?

    The Office of Tax Simplification was set up to suggest tax reforms but its remit and resources have been limited.

    A tax system needs good foundations just as a physical building, otherwise you can patch up problems, but repairs prove to be temporary, and as time passes the building gets more ramshackle. To achieve substantive tax reform one should begin by asking basic questions such as ‘what are we trying to tax?’

    Over these four blogs, I will look at such basic questions in relation to business tax. The last blog will include a link to a draft of a suggested new Business Tax Act, so that any reader who is sufficiently interested may take a look at a concrete proposal for substantive tax reform. 

    It is hoped that this will contribute to the debate on whether major reform is desirable - and also achievable.

    1.    TAXING A BUSINESS

    Older readers will recollect that income tax used to be assessed under six schedules, labelled Schedules A – F.  Schedule D was further sub-divided into six cases, and Schedule E was subdivided into three cases.

    Why did this happen? The reason may come as a surprise for us today because it was not primarily due to any underlying tax logic. Different inspectors were tasked with making assessments on an individual’s different sources of income because it was not considered appropriate that any one inspector should “know all the income of a gentleman”.

    We have long accepted that an inspector of taxes can see all our income, and there has been a trend to move away from the old schedular system, abolishing boundaries where we can.

    But for historic reasons, no longer justified if ever they were valid, we still have a system for segregating profits into several different categories of income, each category having its own rules. Then we calculate capital gains separately under a different set of rules. Then we have a separate tax act for capital allowances. 

    More rules follow for aggregating the results together to determine the overall tax due.

    A large number of ad hoc tax rules are stirred into this mix to get our current tax code.

    Instead of this it is suggested that profits from trades, professions and vocations, properties, business investments, capital gains and foreign source profits realised by a business are all subsumed under one heading – “business”.

    It seems natural to tax “business” as a head of charge.  The commercial world refers to “business”, and does not normally find it useful for example to refer separately to a “trade”. Banks will have “business accounts” for business customers. Accounting standards refer to “business”. A partnership is “the relation which subsists between persons carrying on a business in common with a view of profit”.

    Support for taxing a “business” also comes from the approach to tax taken overseas, which often emerges when this impacts on UK tax law - for example Double Tax Treaties always have a “business profits” article, or the EU Merger Directive deals with “business” reconstructions. 

    The Office for Tax Simplification published a report on the competitiveness of the UK Tax administration earlier this month, following a wide ranging consultation. The report supported taxing business on business profits, rather than streaming trading and investment results.

    An individual might also be subject to two other heads of charge to tax in addition to the charge on business profits - employment income, and non- business profits. Non-business profits would normally be charged, as is currently the case, on cash realisations. 

    But all the activities of a company would expressly be deemed to be activities of a business, (save for the unusual circumstance where a company is appointed to the office of director or secretary of another company).

    David’s second blog will be published Thursday and will be on taking the profits of the business as a starting point for tax calculation.

    David Martin enjoyed a career spanning 23 years as a tax lawyer within a large City Law Firm, latterly as Head of the Tax Department, before taking early retirement in 2002. During that time he advised both company and individual clients. He now lives a less pressurised life in Devon with his wife and two daughters and maintains an active interest in tax law.

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