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.
Tax law should aim to identify the economic consequences of what people have done, and tax them accordingly. If the objective is indeed to tax real profits and give tax relief for real losses, no- one would now dream of creating our current mish mash of tax rules to achieve that.
We have the problem of too many reliefs and allowances, but analysis shows our problems go deeper than this.
The suggested approach is simply to take the profits of the business as a starting point for tax calculation. A business has continuity, and it is appropriate to assimilate all results of the business into a single account. The accounting concept of “profits” would therefore be used for tax, since tax cases decided before the courts have confirmed tax does not have its own independent concept of “profit”. Smaller and less sophisticated businesses would be allowed simpler - perhaps very much so - accounts than are required under the accounting standards. For the simplest businesses a three-line account (income minus expenses = profit) would be all that is needed. This should be clearly set out in the tax code.
Under a “one bucket approach” the results of the business are not separated into trading, non-trading and capital elements. This would have many advantages over the current fragmented rules-based approach. To take just one example, tax law has a wealth of unnecessary rules for taxing property transactions, such as the grant of a lease for a premium, or for sales and reconveyances. These ad hoc rules are unnecessary and should be abolished.
The accounts should capture all the economic activity of the business – whereas “tax nothings” such as non-deductible capital expenses, or non- taxable capital receipts, are an unjustified feature of existing tax law.
Concern might arise that businesses could fiddle profits to achieve tax objectives while arguing they are complying with the accounting rules. The proper application of accounting rules is intended to prevent the understatement of profit, as well as to prevent profit being exaggerated - see for example the principles that apply to accounting for contingent liabilities. Generally big companies want to report big profits, and small businesses have less scope for manipulation.
There is another important consideration. Where discretion is available in preparing accounts it almost invariably relates to the timing of the recognition of income and expenditure. Under our tax rules we more often have “all or nothing” outcomes. An asset is either “plant or machinery” in which case generous capital allowances are available, or it is not and no tax relief is given for the cost of the asset. An expense is either revenue in nature - in which case tax relief is probably available for it - or it is capital in nature and no tax relief is available. Distinctions between these categories are often wafer thin and without any real underlying rationale. By moving to a more accounts-based system, where differences of opinion are more likely to relate to timing rather than the absolute amount, one is actually reducing risks, both for the taxpayer and the taxman. This is surely to be welcomed.
Adjustments would still be needed to the basic figure of profit to provide reliefs and exemptions, to prevent avoidance, and to make the tax code work properly, but the tax code could include these and still be made much shorter and more user friendly than present.
This is the second blog in the current series. The next blog will look at problems and risks for the suggested approach and will be published Monday. The final blog will provide a link to two papers published on the CPS website on reform and simplification of tax law for business. One of these papers will set out a proposed revised tax code.