going after low-hanging fruit
Kitty Miv, Editor
25 October, 2017
Kitty's Country Rankings are below, with a description of how they are compiled. This week, as every week, I give out Encomiums to countries which have done Good Things, and award Execrations for countries which according to my highly personal and partial views have done Bad Things.
The taxation of small businesses is an area of tax policy about which governments are almost guaranteed to tie themselves up into knots. And it's often up to the owners and operators of small business – already some of the most time-deprived (and no doubt sleep-deprived) people in the world – to disentangle them.
Confusion and complexity around small business taxation is often the result of governments trying to do two things at once. On the one hand, they are in the habit of providing various forms of tax relief to encourage people to form more businesses, help people invest in their enterprise(s), and incentivize others to invest in young, innovative ventures. But, on the other hand, the interplay between the tax treatment of the employed, the non-incorporated self-employed, and incorporated companies, provides opportunities for income and social security tax avoidance.
Achieving an appropriate balance between the two competing goals – of trying to encourage entrepreneurial activity and preventing avoidance and evasion – without creating a host of unintended consequences is a difficult one for governments to achieve, as we see this week.
Recent developments in Canada are a prime example of this push and pull in tax policy, and how governments can easily make themselves look foolish. One of the Liberal Government's first major tax announcements was the cancellation of a small business tax cut. Then it went on the offensive against tax avoidance, announcing earlier this year strict new measures to prevent high-income taxpayers from using corporate vehicles and tax planning techniques to reduce exposure to high rates of personal income tax by converting pay to corporate and investment income.
However, in the last couple of weeks, the Government has signaled an almost complete u-turn on the matter. Unexpectedly, it announced that small businesses would get an income tax cut after all. Then a series of announcement followed about the watering down of the draft anti-avoidance rules.
So, what might have brought about such a dramatic volte face? Well, it would appear that ministers were genuinely taken aback from the "firestorm" of protest, as Dan Kelly, President of the Canadian Federation of Independent Business, put it, from Canada's small businesses, who were angry at being on the receiving end of the same brush used to tar the small minority that abuse tax rules. It was a protest all the more remarkable given that business owners had to take time away from their busy lives to make their views known, Kelly said.
It just goes to show that SMEs often ignored and lacking a voice, but vitally important pillars of the economy, providing the overwhelming majority of jobs – can be pushed too far. This example should serve as encouragement to small taxpayers elsewhere in the world growing weary of falling victim to the policy whims of governments.
Nevertheless, it is a sad truth that in many economies, small firms and sole traders still bear a disproportionate impact of the compliance campaigns run by national and local revenue authorities.
According to testimony by Donald T Williamson at a 2016 hearing of the United States House of Representatives Small Business Committee, the Internal Revenue Service audit strategy is far from "random," contrary to claims. Instead, the agency has an algorithm that picks out those most likely to have unreported income, which is generally individuals reporting business income on their tax returns.
Given that such taxpayers are often paid in cash, which can easily be misreported, Williamson testified, such targeting by the IRS is understandable. But its algorithm doesn't take into account the toll that an audit takes on small businesses in terms of monetary cost, time spent, and distress to the individuals running the business.
Similarly, the United Kingdom tax authority has been accused of going after low-hanging fruit in its quest to narrow the tax gap. Accountancy firm UHY Hacker Young reported last month that HM Revenue and Customs collected almost GBP500m (USD660m) in additional revenue from its compliance investigations in 2016/17, a five percent increase over the previous year. And Roy Maugham, a tax partner at UHY, is clear that HMRC is focusing its compliance activities on small firms because they are "an easier target than many larger businesses."
He also emphasized that such audits can have a disproportionately detrimental effect on these taxpayers. "The cost of tax inquiries for SMEs can be high, and the investigations disruptive," he noted, adding: "Small companies may not have the necessary resources to bounce back."
Maugham suggested that the best way for small business to avoid being in HMRC's sights is to make sure they complete their tax returns correctly in the first place. The problem many small businesses face, however, is that domestic law is often unclear.
So, yes, small businesses can help themselves by ensuring their tax returns are as accurate and honest as possible. But equally, they can hardly be blamed for falling down trapdoors set by less-than-perfectly drafted tax law and tax breaks aimed at entrepreneurs, or for claiming more tax relief than was intended when outdated tax relief measures begin to show their age.
The latter point was raised recently by the Chartered Institute for Taxation (CIOT) in the UK, when it urged the Government to ensure that tax reliefs intended to help small businesses grow are reviewed at regular intervals. The CIOT also implied that it's time to dispel some myths about small businesses, their owners, participants, and investors, and separate "fact from fiction" with regards to tax reliefs: they're there to be used, and aren't, for the most part, being misused.
Ultimately, perhaps small businesses need more help. Tighter definitions might be start. Indeed, this references small companies, small firms, small businesses, SMEs, the self-employed, and individuals in businesses, being terms often used interchangeably, but in terms of tax outcomes, they can be miles apart in many jurisdictions, and governments are often guilty of blurring the lines too.
Indeed, as Congress prepares to draft new tax laws to provide substantial tax cuts for many small businesses, agreeing what a small business is when developing policy could be a major stumbling block in the push towards tax reform.
However, instead of waiting for small businesses – however we chose to define them – to fall down legal rabbit warrens, perhaps governments and tax authorities could be more proactive. Denmark, for instance, where almost 50 percent of SMEs make unintended errors in their tax filings, is launching a project to allow small businesses to have their tax returns vetted for mistakes before submission. This, in theory, is intended to provide a double dividend, reducing the chances that small firms will face long and costly tax audits, and freeing up tax authority resources to pursue actual tax evaders.
No doubt, taxpayers in other parts of the world are hoping this is an idea that will catch on. Some governments, thirsty for revenue, might hope otherwise. Either way, Denmark can always be relied upon to spark a lively discussion about tax.
Kitty's Encomiums and Execrations
Methodology: each week (this is the 147th) one or more countries are given encomiums and one or more are given execrations. Those are the entries below with descriptive links. In the following week, each encomium counts as + 1 for that country, and each execration counts as - 1, being added to that country's existing score. Over time, therefore, a ranking will build up for each country, and further countries will join the listing. Germany is at minus 2, since in the second week it had an execration and in the first week it had an encomium, leaving it at neutral; then it had an execration in week four, thus dropping to - 1, and another one in week six, dropping to - 2; finally in week 13 it got something right, so it went back up to - 1; then in week 16 it gained a further star, so then it was in neutral territory until week 23 when it dropped back to minus one, but reverting to neutral territory in the following week, then dropping to minus one in week 50, and back up to plus one in week 51, then to plus two in week 52. Some weeks ago it dropped a place, but then quickly recovered one step. Etc etc.
The rankings are intended to be a proxy for business friendliness; evidently they are highly partisan, but as time goes by they are becoming useful for decision-making. For any country in negative territory, you should think carefully before starting a business there.
United Kingdom (un)fair play
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