Each Budget in the last few years has had at least one aspect to it that appears to be potential dynamite. In March 1999, we had our first introduction to ir35. In March 2000, we had more changes to double taxation relief. And this year, we have a Technical Note entitled A Review of Small Business Taxation.

The purpose of this Review is to sound out how people will react to a range of possible proposals, all ostensibly aimed at reducing the costs and regulations faced by small businesses. It will be followed by a formal consultation document, probably in the autumn or even next year.

Anything that simplifies taxation and takes some of the administrative pressure off smaller enterprises can only be welcomed. It is good that the Inland Revenue is giving us the opportunity to have a wide-ranging discussion of how aspects of the tax system can be improved and to consider radical ideas. But what is the Review suggesting?

The Review puts forward a variety of ideas in a very broad-brush fashion and asks the reader what he or she thinks of them. All the ideas are aimed at a ‘small business’ and the suggested definition is the Companies Act one, which encompasses businesses with two of the following three features: a turnover of under £2.8 million, balance sheet assets of less than £1.4 million or fewer than 50 employees. Although the Review does mention unincorporated businesses, it notes that the problems which face these entities are not always the same as those facing a small company. Of course, unincorporated businesses do make up a substantial proportion of the UK’s small enterprises.

The key suggestion in the paper involves a step towards aligning the tax computation with the accounts. This could encompass the replacement of capital allowances with commercial depreciation and taxing capital profits and allowing capital losses on the basis shown in the accounts.

The Review document is short on detail and gives the impression of being intended to test which ideas can feasibly be taken forward. It does note that the idea is to follow up the review with detailed discussions among interested parties and this should help flesh out where this initiative is really going.

The Technical Note states that one of the main objectives of any change to the current rules is to reduce regulatory and compliance costs - a highly laudable aim. Let us hope, therefore, that any changes that result from it do not lead to increases in the cost of preparing accounts. Equally, it would be very worrying if any of the proposals were to lead to increases in the actual tax liability, something that would clearly outweigh any deregulatory benefit.

What must be determined from the outset is what the participants hope will be achieved by any changes. The fact that the paper has come into the public domain shows recognition of the difficulties being faced by smaller business in terms of compliance costs and burdens. But, despite the oddities of the UK tax system, small business tax computations are not generally overly complicated. Far harsher than tax computations are the burdens of onerous payroll-related compliance work for those businesses with employees and the compliance burdens of VAT. These do not get a mention in the review paper but would be a welcome extension to any discussions in this area.

There is also a fine line to tread between assisting smaller businesses and keeping a fair balance between all taxpayers. There will always be difficulties where dividing lines are drawn and different regimes are applied, especially for those businesses which move in and out of different definitions of an enterprise, such as those which are on the margin of ‘small’ and ‘large’ business. Therefore, if a new regime is introduced, there would need to be careful consideration of those businesses and it would be necessary to determine whether, if a change is good per se, it is best to offer it to all businesses and not just small ones.

The Review confirms that the effect of various tax incentives is meant to be maintained. This suggests that the intention is to seek out specific adjustments which could be waived for small businesses (if not for everyone). We could all probably come up with some ideas in this area and it would be interesting, for example, to see what could be done to help with regard to expensive cars and business entertaining.

Some concern has been expressed that this Review may lead to the Revenue taking a more pro-active interest in how accounts are prepared. The main issue here is that accounts are put together on a ‘true and fair’ basis, where materiality plays an important role. But materiality is not a concept that the Revenue has ever been enamoured with and an obvious conflict could arise.

There is clearly still a long way to go on this issue, and much talking to be done. By the time this article has gone to press, the Tax Faculty will have submitted a formal response to the review document and will be waiting to hear the feedback. This will be accessible on our website at www.taxfac.co.uk (look under ‘Faculty Publications/Tax Representations’). However, the discussions in this area will go on for some time to come and we would welcome your views. We can be reached by e-mail to [email protected]

Francesca Lagerberg is senior tax consultant to the Tax Faculty of the ICAEW

AT, June 2001, page 13