Small Business Taxation A special study for the Mirrlees Review

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Presentation transcript:

Small Business Taxation A special study for the Mirrlees Review Claire Crawford (IFS) Judith Freedman (Oxford)

Why a small business paper? Special study (not a chapter!) Focus on structural issues Significance for tax system design – at the interface of personal and corporate taxes Economic and social role Political significance and perceptions of ‘fairness’

Defining “small” businesses Definition depends on purpose Of the 4.3 million private sector businesses in the UK in 2005, how many were “small”? 96% had fewer than 10 employees 92% of all companies paid the small companies’ rate 66% below the VAT registration threshold Due to structural focus we are most concerned with firms where there is an identity between owners and employees 73% had no employees in 2005 (39% of companies) Up from 63% in 1999

Should tax system favour “small” businesses? Market failures- removing barriers and encouraging competition Compliance costs – burdens greater on small firms- reducing cost to encourage entrepreneurs and to improve perceptions and therefore compliance Encouraging risk taking eg sharing of losses of new businesses Business transfers

Traps for special small business measures Size not a proxy for growth and entrepreneurship (Harrison; Storey) Targeting issues Distorting commercial decisions and the market Proliferation of thresholds creating barriers to growth eg VAT threshold Complexity in deregulation eg VAT schemes- poor take up Encouraging inefficiency – eg retention of family business which should be sold

Structural issues Employees, self-employed (unincorporated), incorporated firms A continuum governed by fact based tests at employee/self-employed line Some terminology- Sole traders and partnerships Limited liability companies – UK (Limited liability companies (LLCs) in USA are unincorporated)

Structural issues: general principles Real legal and practical consequences of legal form Sometimes a mismatch with economic substance Differential tax and social security treatment of income from labour and from capital encourages attempts at conversion De-linking from legal form (US- but not entirely) Overriding legal form- eg IR35, MSCs

Structural Issues: UK

Structural issues: UK

Structural changes UK

Alternatives Alignment of taxes on labour (including social security payments) and return to capital (UK changes). Utilizing incentive effects of differences and permit taxpayers to choose Recharacterise income where legal classification does not accord with perceived economic reality. Nordic dual income tax solution to income shifting problem (Sorensen) BUT self-generated good-will; recognising risk; higher return than labour income not linked to physical investment

Importance to tax design Small businesses cannot be ignored in personal or corporate tax design Legal form has implications – eg unincorporated firms do not have clear separation of personal and business assets; incorporated firms - distribution rules Removal or reduction of tax on income from capital has potential to increase problem if taxes on labour remain higher Need for holistic approach across whole spectrum and clear rationales Perceptibly fair treatment necessary to encourage compliance.