Article by Colin Davis, Technical Officer, published in the May 2001 issue of Tax Adviser. Introduction
In his Budget, the Chancellor announced consultations on various aspects of the taxation of small businesses, the purpose of which is to identify changes which could be made to the system to reduce the administrative burdens on small businesses.
The background to this is that successive governments have imposed more burdens on businesses – the most recent additions being the administration of working families tax credits and the collection of student loan repayments. Whilst large businesses may have the resources to cope with all this, there is a perception that the cumulative effect of all these tasks is to impose excessive burdens on small businesses.
Consultations are taking place under a number of headings, discussed below.
There is a proposal to increase the registration threshold and extend the availability of the cash accounting scheme. This is to be welcomed. Consultations are also taking place on how to deal with the ‘cliff edge’ problem which arises where turnover goes over the registration threshold for the first time.
These are not being reduced, but employers can now file certain PAYE returns over the internet. They are forms P35 (Employer’s Annual Return), P14 (Individual Employee’s End of year Summary), and P38A (Employer’s Supplementary Statement). It is hoped that this facility will be of particular use to small businesses which do not operate payroll software.
There is also a continuing consultation on the alignment of income for PAYE purposes and NIC purposes.
Corporation tax and income tax returns and computations
As from July 2001, it will be possible for agents to file income tax returns over the internet. A similar service for corporation tax returns is being developed, but is presently at the design stage. Meanwhile, the Chancellor announced consultation on a proposal to base the taxable business profits of small enterprises on accounting profits, thus eliminating the need for a tax computation, or at any rate simplifying the computation.
Computation of business profits
The current consultation will examine the adjustments which are made in order to get from accounting profits to taxable profits and will consider the implications of eliminating them so that taxable profits are the same as accounting profits. The main ones are considered below.
If tax is to be charged on accounting profits, then it seems axiomatic that accounts will have to be drawn up in accordance with generally accepted accounting principles (GAAP). At present, the accounts of many small companies do not have to be audited and there is no legal requirement for unincorporated business to draw up accounts. Indeed, sole traders whose turnover does not exceed £15,000 do not need to prepare formal accounts at all, but simply fill in the three-line return. The Revenue’s Technical Note makes it clear that they will want to be confident that accounting standards are appropriate and are being followed.
The business/private distinction
The Revenue will want to be satisfied that only business expenses are being charged in business accounts. In the case of a company, it may be that the payment of directors’ private expenses forms part of their remuneration package, and that such expenses are included on the P11Ds. For unincorporated business, however, a distinction has to be made. The question then arises as to how to deal with assets such as cars or home telephones which are used partly for business purposes and partly for private purposes. One possibility is to produce Revenue-approved accounts software which will deal with this satisfactorily.
The revenue/capital distinction
At present capital gains on the disposal of business premises and other fixed assets come within the capital gains tax regime. Rollover relief is available where such assets are replaced. Indexation relief or taper relief is available generally. There might be a risk of losing these reliefs where the new accounts basis applies.
As regards plant and machinery and other assets qualifying for capital allowances, the new basis would involve allowing depreciation rather than adding it back and computing capital allowances. In many cases, this would bring a welcome simplification and hopefully it would deal with some of the ‘nothings’ which appear under the present system. However, it would be necessary to deal with cases where first year allowances or research and development tax credits are available, since these are specifically aimed at small and medium-sized enterprises. First year allowances could, in principle, be replaced by investment allowances, but it would still be necessary to identify the qualifying expenditure. In general, the Revenue will, presumably, want to be satisfied that depreciation rates being used in accounts are not unreasonable.
It is assumed that items such as expenditure on business entertaining will be disallowed. It is hoped that the number of such items can be kept to a minimum and that accounting software packages can be extended to deal with them so that taxable profits can be produced from the accounts package.
At present, dividends received by one UK company from another UK company are outside the charge to corporation tax. The question is whether this rule should be retained under a new system, or whether such dividends should be taxable (with appropriate credit). It would certainly seem unfair if intra-group dividends and dividends from joint venture companies were taxed. The position of dividends on portfolio investments is not so clear.
The main question is whether small enterprises should be able to opt for the new system or whether it should be mandatory. In the former case, should the exercise of the option be irrevocable?
Another question is what happens when a company crosses the threshold for the new regime. Should there be two thresholds, corresponding to the registration and de-registration thresholds for VAT, in order to reduce the incidence of companies crossing and re-crossing?
We would welcome comments from readers on the above proposals. They should be sent to Colin Davis at the CIOT.
020 7235 9381
May 2001 by