More Pain On The Way For Family Companies?

There was much to welcome about the new Chancellor’s Autumn Statement – not least that it was not by his predecessor, so was mercifully free of gimmickry! But both the speech and the accompanying documentation suggested that the government continues to harbour concerns about the tax cost of companies and incorporation. I believe these concerns are ill-founded. And it will almost certainly be family companies that pay the price.

Readers should be aware that the new dividend regime installed in April 2016 is likely to prove significantly more expensive to those who rely extensively on dividends for their income – typical of family companies with director/shareholders, who may draw a modest salary and receive much of their annual corporate incomes by way of dividends. The summer 2015 Budget Red Book suggested that the new regime would raise money for the Exchequer (by costing taxpayers) more than £2.5 billion in 2016/17.

At the time, there was much talk of how companies were benefitting from falling corporation tax rates – but as most family company owners will be all too aware, the real savings had been falling to very large companies with large profits, and not to the smaller companies that make up the vast majority of corporate taxpayers.

The effects of the change in the dividend tax regime will not really be felt until 31 January 2018, when people have to settle their personal tax balancing payments for 2016/17 (i.e. the tax year of the change) – and it is worth emphasising that the first interim payments for 2017/18 are likely to be uncomfortably high as well – so HMRC is unlikely yet to be able to gauge the effects of the new dividend regime. 

But the government seems to have made its mind up already, and I don’t think it is good news for smaller companies.

Take for instance this extract from the Chancellor’s Autumn Statement:

‘And tax receipts have been lower than expected this year, causing the OBR to revise down projected revenues in future. Added to this is a structural effect of rapidly rising incorporation and self-employment, which further erodes revenues.’

‘The tax system needs to keep pace. For example, the OBR has today highlighted the growing cost to the Exchequer of incorporation. So, the government will consider how we can ensure that the taxation of different ways of working is fair between different individuals, and sustains the tax-base as the economy undergoes rapid change.’

This was echoed in the Autumn Statement Green Book, which blamed a forecast loss of £3 billion in tax receipts up to 2020/21 on higher rates of incorporation (page 12). The figures were in turn attributed to the Office for Budget Responsibility’s (OBR’s) Economic and Fiscal Outlook report of November 2016. 

I must admit I was surprised by this claim, since the benefit of incorporating a business has surely been significantly curtailed – at best – since the introduction of the new dividend regime: it is now entirely possible, depending on the level of business profits, for incorporation to be more expensive, not less – and this is without considering the additional costs of running a limited company, which any sensible entrepreneur would have to consider, when weighing up whether or not to incorporate. So, I read the OBR’s report – or the relevant parts, at least. I was less than impressed. Bearing in mind this is guiding government policy in relation to the taxation of small companies, ‘less than impressed’ is putting it mildly. 

The offending section of the November 2016 report is table 4.11, and box 4.1 starting on page 121 of the report. Reading the OBR’s report, some points become clear:

The OBR’s model reckons that the tax incentive for an employed individual to incorporate (out of choice) is £3,300 in 2016/17, rising to £4,200 by 2021/22. Which is rubbish: the figure is more like £1,300, rising to around £1,700 by 2020/21, or roughly 40% of the OBR’s figures. There is insufficient space here to show the calculation, but even a modest grasp of the maths involved would indicate £3,300 is way off the mark: one has to consider only the cumulative tax due on company profits and then the cost of extracting those profits to personal income, to realise that the OBR’s figures are plainly wrong. 

This is after having ‘worked with HMRC to overhaul the forecast model in order better to reflect the affected population [of candidate businesses], the tax incentives they face and the exchequer cost of a typical incorporation’(!) 

The OBR’s data only goes so far as 2014, which is clearly out of date and a woefully inadequate starting point, since the full effects of the new regime have hardly begun to be ‘felt’. 

The problem is that this dodgy maths is clearly influencing the government’s attitude towards the taxation of companies, and my inference is that the government feels it should be doing more to dis-incentivise incorporation, whereas most owners of family companies would probably argue that more than enough has been done already.

Last year, the Office of Tax Simplification (OTS) undertook a review of a proposal to tax small companies on a ‘lookthrough’ basis, i.e. the company’s shareholders would be subjected to tax on the company’s profits, rather than on its dividends. The attraction for the OTS was in terms of simplifying small company taxation; rather than a two-stage process as now, where the company is first taxed on its profits, and the shareholders are then taxed on the dividends withdrawn, the shareholders would be taxed directly, and that would basically be that. The attraction for government would be that shareholders would be taxed on all profits in the year, rather than having to wait until they actually took any dividends.

The OTS concluded that there was no simplification opportunity in lookthrough taxation, noting:

‘On balance, we feel that it would actually be more complicated than the current corporation tax system, given the additional rules that would be needed.’

‘Although lookthrough tries to even up the tax bills for the unincorporated trader and the equivalent business conducted through a company, it does so by increasing the tax immediately due on retained profits. That risks damaging investment.’ 

‘…we have heard equally strong representations against lookthrough due to the distortions it could create between smaller and larger companies.’

While this may have satisfied the OTS, I fear it may not dissuade a government that is extremely concerned about preserving its tax base, and that seems to have no qualms about attracting very large companies with low business tax rates, while making small UK-bound companies foot the bill for such largesse. But it is particularly galling to think that the government could be spooked into taking drastic measures to increase the tax cost to small companies – by lookthrough taxation or by other means, such as simply raising dividend tax rates still further – thanks to schoolboy errors made by the OBR. 

We can only hope that someone in government takes the time to check the OBR’s maths, rather than take their modelling at face value. There is perhaps little else to do, over and above crossing one’s fingers – or perhaps starting a collection to buy the OBR a decent calculator! Company owners need to be aware of just how much more expensive the 2016 regime will soon prove to be – let alone any further action the government may take.