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

2. 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’

3. 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

4. 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

5. 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

6. 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)

7. 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

8. Structural Issues: UK

9. Structural issues: UK

10. Structural changes UK

11. 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

12. 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.