Big tax changes for small businesses

Wednesday, May 11, 2011 | Posted by: Francesca Lagerberg
Categories: Business advice | Tags: tax, income tax, budget, NIC, Office for Tax Simplification, OTS, National Insurance, allowances, policy, IR35, contractors, integration, intermediaries, small business review, merging income tax and NIC, SME

Small business taxation is facing major reform with the potential merging of income tax and national insurance contributions, new approaches to taxing very small, unincorporated businesses, and a review of IR35 rules, says Francesca Lagerberg, Head of Tax at Grant Thornton.

In his 2011 budget speech, Chancellor George Osborne announced changes to the way small businesses are to be taxed. This follows the advice and recommendations proposed by the Office of Tax Simplification (OTS).

Following its initial review of the tax reliefs available in today’s tax system, the OTS’s second job was to carry out a review of small business taxation (PDF). The interim report, published on 10 March 2011, identifies those areas of the tax system that cause the most day-to-day complexity and uncertainty for small businesses, and recommends where to prioritise efforts in simplifying the regime.

The overwhelming conclusion is that major structural changes are required if the Government is to achieve a genuine and long-lasting simplification of the UK tax system.

Two key areas are highlighted for tax reform:
1. The integration of income tax and national insurance contributions (NIC) – the current operation of two separate systems can often lead to anomalies and this in turn can distort behaviour. It is suggested that the merging of income tax and NIC would reduce the differential and result in a reduced and more straightforward administration.

2. A new approach to the taxation of very small, unincorporated businesses – the report proposes that introducing a tax based on turnover (rather than profit), or a fixed or flat rate expense deduction, could reduce compliance costs and the costs of administration.

The Government has subsequently confirmed that it will consult on the potential integration of income tax and NICs in the summer of 2011, with the aim of reducing the administrative burden on businesses and removing the unintended distortions created by the current tax system.

However, businesses should be warned that any change will be complex and will take a great deal of time and consideration before a satisfactory solution is achieved.

New approach to IR35
The OTS also considered the complexities of the anti-avoidance ‘intermediaries legislation’, more commonly known by its original guidance name of IR35. The report made several recommendations for amendments and alternative approaches to the taxation of ‘disguised employment’ income, concluding that there are three options available for reform:

• Suspend the current IR35 rules, before abolishing it after a period of review. The report points out that the proposed merging of income tax and NICs would effectively render the IR35 legislation redundant.
• Keep IR35 unchanged but improve the way it is administered.
• Introduce a new ‘business test’ to exclude a large proportion of those currently affected by IR35.

The Chancellor has since confirmed that IR35 will be retained and simplified, thus taking the least controversial route suggested.

It is proposed that this will be achieved by the introduction of a dedicated helpline and the provision of better guidance on those types of cases HMRC views as outside the scope of IR35. It is also intended that HMRC will adopt a more fastidious policy in selecting only high-risk cases for review in future, to be carried out only by specialist teams.

IR35 and contractors
This option, however, is unlikely to appease the contractor groups who have been keen to see IR35 abolished. Equally, the suggested reforms do not seem sufficiently deep to tackle an area of law that has been in existence for a decade and spawned hundreds of tax cases as taxpayers and HMRC have done battle over the meaning of the rules.

The challenge for HMRC is to show that it can provide an administrative framework for improvement. If this is not achieved, the contractor groups are unlikely to remain silent and IR35 may find itself back on the reform agenda quicker than you can say intermediaries legislation.

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