Benefits of merger for small businesses

The Chartered Institute of Taxation (CIOT) looks at the benefits and opportunities for improvement that the merger of Customs and the Inland Revenue can bring to small businesses.

The merged revenue department, HM Revenue and Customs, will, in essence, be a revenue collection department. The policy-making functions of HM Customs and Excise and the Inland Revenue will be transferred to HM Treasury.

The decision to merge follows the publication of a report by Gus O'Donnell, Financing Britain's Future: Review of the Revenue Departments. The Chancellor accepted the Report's recommendations and announced a merger of HM Customs and Excise and the Inland Revenue.

O'Donnell suggested that "there is a potential to transform the way that Government works with small businesses". The CIOT agrees with this and sets out its view of what can be done in order to bring about this transformation in a paper to the Government's Small Business Service (SBS).

Classification of small businesses

It begins with some general comments on the nature and classification of small businesses.

The European Commission broadly defines them as businesses with fewer than 250 employees and the Small Business Service subdivides this broad category into the following classes according to the number of employees:

• Micro businesses (0 - 9 employees)
  
• Small businesses (10 - 49 employees)
  
• Medium-sized businesses (20 - 249 employees).

The CIOT highlights its concerns about treating all these categories as one. Its paper says: "It is wrong - even dangerous - to design tax or any other policy for SMEs as a whole without considering the differing needs of these three very different types of activity. For example, we have severe reservations about the current IASB discussion paper on "Accounting Standards for SMEs". This seems to be driven by the need to prepare a medium-sized business for possible flotation, and ignores the fact that the vast majority of SMEs have very simple accounting needs and will remain proprietor-owned."

This paper is broadly concerned with micro-businesses for three reasons. First, some 95 per cent of businesses fall within this class. Secondly, they are proportionately most affected by compliance burdens. Thirdly, they are more likely to rely on their own efforts to comply with tax obligations, yet are less likely to possess the necessary skills to do so properly. It says that any revenue department should have a clear policy regarding the overwhelming majority of its "customers".

Within these micro-businesses there are differences which set them apart. The CIOT adopts the following profiles.

• Sole proprietor or partnership, usually home-based, with an annual turnover of £150,000 or less, eg consultant, commission agent, freelance journalist and jobbing builder.
  
• Businesses requiring appropriate premises, or the employment of staff, with an annual turnover of £660,000 or less, eg estate agent, retail shop and public house.
  
• Small manufacturers, etc, requiring appropriate premises, specialist equipment and skilled employees with an annual turnover of £1,000,000 or less, eg engineering, printing and motor vehicle repair.

It draws a number of conclusions:

• Many traders in the first category may prefer to pursue their occupation in a self-employed capacity as a lifestyle choice, or through force of circumstances, and may be more concerned with making a reasonable living than building a business empire.
  
• Traders in the second category need to increase turnover in order to cover their larger fixed costs but may find, particularly in the retail sector, that the size of the business is determined by the nature of the premises and the locale from which it draws its customers.
  
• Businesses in the third category require a significant capital base. The owners need to finance the necessary investment, find and retain staff and actively seek out customers in order to keep the business running at full capacity.
  
• While some businesses in all categories may grow to become the large companies of tomorrow, most will not. Some businesses - especially those in the second category - have finite growth potential, so that expansion often involves moving premises or opening new branches. For many, growth is limited by the proprietor's imagination, skill, finance, desire or good luck. Remaining small is a lifestyle choice for many.

Merger

The paper moves on to consider the implications of the merger between Customs and the Inland Revenue, with particular reference to the tax system.

Simplicity

The paper highlights 'simplicity' as a virtue in any tax system, which is of considerable importance in relation to micro-businesses where transactions are likely to be routine, cash flow is likely to be stretched (so that employing a tax adviser is likely to be a real financial burden) and, as likely as not, the owners may possess practical rather than academic skills.

The CIOT considers that the quid pro quo of self-assessment is that the average taxpayer should be able to complete his own tax return with some confidence that he has arrived at the right result, and that the tax officers reviewing his return should not need any great depth of technical expertise in order to verify its accuracy.

It says that merger creates an additional need for simplicity. The concept of a "one stop shop" for small businesses suggests that tax officers will need a wider range of technical expertise if the system is to run efficiently. It sees no difficulty in achieving this if proper training is given.

It notes that the merger will lead to staff reductions and therefore, that resources will be spread more thinly. Time will be too short for tax officers to research arcane legislation. A simpler tax system is likely to lead to fewer mistakes by taxpayers, tax advisers and tax officers.

It says: "Simplicity involves formulating rules that are easy to apply and stating them clearly so that everyone can understand what is required of them. Simple formulation is the responsibility of policy makers. A clear statement of the rules is the function of Parliamentary Counsel and departmental draftsmen."

It suggests three possibilities for ameliorating the difficulties encountered by micro businesses:

• policy makers should design the essential features of computations and procedures with micro businesses in mind and then add on whatever is necessary to make them appropriate for larger businesses. In other words, policy makers should start off by thinking small.
  
• Another way of approaching the problem is by means of simplification schemes.
  
• A further approach is to reconsider the manner in which the tax system is "reformed". The tax system must clearly change to meet new conditions. The practical problems arise from the manner in which changes are introduced. Policy makers should take more care of the legislation. If change is necessary - especially to a provision relevant to micro-businesses - thought should always be given to starting again from scratch rather than adding yet more encrustations to what is already there.

The CIOT report says: "It is necessary to remember that many small traders are not scholars. They have neither the time nor the intellectual curiosity to make sense of complex rules."

Harmonisation

The paper makes a number of observations regarding the creation of a single culture and adopting the best practices and procedures currently used by the two departments and, where necessary, starting afresh from basic principles.

• First, as far as possible, all taxes should be administered under common rules. Thus, for example, "assessment" should have the same meaning for all taxes; notices of assessment should be issued in the same manner and under the same time limits; and the forms used should follow the same format so that taxpayers can recognise them for what they are.
• Secondly, as far as possible, common definitions should be used. For example, the terms "motor car" and "business entertainment" are common to both income tax and VAT, and (if they do not already do so) should have the same meaning.
• Thirdly, as far as possible, common concepts should be applied. For example, the need to distinguish employment and self-employment is common to income tax, national insurance and VAT. Using different tests is both an obvious nonsense and the obverse of simplicity. A common test should be applied.
• Fourthly, some indirect taxes (particularly VAT and certain excise duties) derive their legal basis from EU directives. The consequence is that some terms are interpreted in accordance with EU rather than UK law, and that some concepts follow continental rather than UK practice. It suggests that a close analysis of these divergences may suggest an approach that leads to an improvement to the UK tax system.
• Fifthly, special schemes or reliefs for small businesses have been introduced on a piecemeal basis for many years often using different criteria or different thresholds for determining what is, or is not, a small business. In consequence, a business may be treated as "small" for one purpose but not for another. This is an obvious source of confusion. Wherever possible, the same criteria (turnover, profits, employees or whatever) should be used in all taxes to define provisions applicable to small businesses, or particular classes of them.

Neutrality

The paper notes that tax burdens are better governed by the nature of the activities pursued or the transactions made rather than by the legal personality adopted by the business. Put another way, decisions on legal personality should be driven by the practical requirements of the business rather than by the tax consequences.