Following a flurry of posts about the recent Arctic Systems apparent pyhrric victory, Richard Murphy developed a detailed response that provides an alternative approach to the topic. Richard provides broad strokes at arriving at his numbers and while I could spend hours picking holes in his argument, it is interesting to note that he assesses the tax ‘lost’ at around £1.2 billion. It’s not a small sum, but it’s not that big either in the scheme of things. Under Richard’s scheme, it appears something like £500 million would come back to the Treasury through the widespread us of an alternative vehicle – the LLP.
Richard points out that the LLP solution he offers is not with out difficulty and inherits a series of important problems. For example:
- It is not clear that an LLP overcomes the objection of a person engaging a consultant who wishes a legal entity to be placed between the two so that the ‘IR35’ risk with regard to failure to operate PAYE is transferred to the consultant’s company;
- There is tax risk in transferring a trade owned by a limited company to an LLP: a capital gains charge can arise in the company on the transfer to an LLP taking place even though the ultimate beneficial ownership has not changed. This is a major impediment to people switching from using limited companies to using LLPs;
- A limited company cannot be re-registered as an LLP, instead the trade has to be transferred and bank accounts, all contracts and employments etc., all have to be transferred from one to the other, with considerable cost arising as a result. This is, again, a major obstacle to re-registration, especially as a stamp duty charge may also arise on the transaction;
- The tax charge in an LLP can be higher than in an equivalent limited company because the profits of an LLP are subject to national insurance and dividends from a limited company are not when received by an individual.
- An LLP can be used for ‘income switching’: a partnership share can be attributed to someone with a low tax rate who has not worked for it.
I question whether Richard’s solution is more deeply flawed. Richard develops his ideas based on the thesis that:
The paper does then show that this problem is almost insoluble whilst these businesses are operated through the medium of small limited companies which were not designed for and are unsuitable for the type of activity they undertake.
His solution to ‘income splitting’ of the kind common in small limited companies involves what I believe are unworkable measures but ones that make trading through a Ltd economically untenable :
Increase the minimum required share capital. If set at a level of only £20,000 this would discourage the vast majority of small businesses from registering as a limited company
In France, the lowest level of investment required to establish an equivalent entity is €7,500. That is seen as a significant impediment to helping business get off the ground and has been a constant source of complaint by those seeking to set up in business. So at £20K I can envisage all sorts of howls from small business. Richard then goes on to apply tests for assessing income splitting based upon:
i.Time expended;
ii. Evidence of management input e.g. attendance at meetings, client premises, emails sent, etc.;
iii. Evidence of key services supplied e.g. technical input,invoicing, project management, product sourcing, etc.
This is unworkable and unrealistic. Apart from radically increasing the administrative burden, it makes no allowance for innovations like value based pricing. Neither does it allow for those moments when, as I have found, my wife comes up with flashes of inspirational brilliance although she has very little to do with my business. What reward does that carry? How is that assessed? And to take it to the extreme, where does this start and stop? What about those PE companies ostensibly under the control of a single individual? Does the very fact that certain types of relationship confer special circumstances that attract Richard’s approach?
I see Richard’s approach to limited companies as at best discriminatory. It doesn’t potentially allow for those small partnerships where – as is often the case – profit division is decided on a year to year basis. There may be no familial relationship between the parties but you can be sure there are tax considerations in play. Richard may argue that none of these things are his intent but we have seen over the years how HMRC has indeed invoked interpretations that would fall under that description to increase the tax take.
Who will be the arbiter and on what terms that make sense to business? Will we be stuck (as is so often the case) with arbitrary and uneven application of rules? What would be the cost of resolving conflicts and how would that mechanism operate? What level of cases are we likely to be talking about? Would there be a genuine incentive to settle what are almost certain to be long and drawn out negotiations reminiscent of pub landlord GP ratio arguments?
Is Richard suggesting this type of arrangement should only apply when there is the equivalent of a husband and wife company? If so then he will incur the wrath of many a person who has found that on a divorce, their business assets are seen in an entirely different manner.
Having said all that, Richard makes a brave attempt at offering an alternative and despite my reservations, I do not believe it should be dismissed. It is for example worth looking at at least one of Richard’s other suggestions; that of imposing NIC charge on dividends. That has been used in EU as a tax raising measure with good effect. It would be simple to apply and administer if part of the ACT regime and would be utterly fair as applying to ALL dividends. As a different style of tax, it would not be something that could be offset so even at relatively low levels – say 2.5%, would have a significant impact on collections.
But far deeper than any specific objection, responses to Arctic Systems only serve to highlight the mess in which the UK taxing system is currently mired. If government wants to sort this out, I suspect there will be a difficult period of negotiating with professional and business interests.
Technorati Tags: tax justice, tax avoidance, tax evasion
