Huw Witty on why he has no sympathy for the chancellor’s recent tax controversy
George Osborne has recently received criticism for his involvement in tax avoidance. His ‘avoidance’ constituted him receiving a dividend of less than £1,500 from a company in which he was a minority shareholder; small beer some might say, and as the dividend was outside his control, hardly a major sin one would have thought.
Perhaps the controversy arose because the paying company had not paid corporation tax for a number of years. This was because it had made losses which it was carrying forward.
Benefiting from the practice of carrying losses forward is hardly revolutionary or exciting, unless perhaps you are a bank (in 2014 George restricted their right to carry forward losses).
Reading between the lines, however, there may be more to this. If the company had losses how could it have reserves to distribute to its shareholders? This is often done by accumulating profits in earlier years. If this is what happened in the company of which George is a minority shareholder, then it gets more interesting and it’s something that seems to concern both HMRC and George.
The point at issue is the accumulation of profits in companies at the comparatively low rate of corporation tax (20% and descending) and deferring any liability to income tax (top rate 45%) or indeed avoiding it by either borrowing the profits from the company and or liquidating it to access the lower rate of capital gains tax (potentially as low as 10%).
In his ministerial position George has been chipping away at this practice. He is changing the rules on taxation of dividends so that the incorporation of an owner managed business to avoid national insurance (as national insurance contributions are not paid on dividends) has become far less attractive (a practice that affected in the main those in the media and IT industries who often used this model).
He has also announced that the extraction of funds from a company on liquidation will be taxed as income rather than capital if the recipient starts a similar business to that carried on by the liquidated company within 2 years. The idea is to attack so called phoenix companies which are liquidated only for the owner of that company to then immediately form a new company to carry on effectively the same business. The concern being that this enables a taxpayer to continue effectively the same business but take the profits from the liquidated business out as capital rather than income. However, there are already existing rules that restrict the use of phoenix companies and so the new rules may well be overkill which damages genuine commercial transactions.
Finally, George is considering attacking cash box companies; ones that simply accumulate profits deferring any income tax liability on a distribution of profits until a dividend is paid. HMRC is considering taxing shareholders on profits arising in the company whether they are distributed or not. This is a particularly aggressive proposal. A version of this rule was abolished almost 30 years ago as the rates of capital and income merged. They are different today but this is in part because a number of capital gains reliefs which existed 30 years ago have been removed and partly because of entrepreneurs’ relief, the existence of which seems a thin justification to change the current regime for taxing small companies.
At a time when government is trying to encourage small business and start-ups to boost our economy these rules seem counterproductive so perhaps we should not have too much sympathy for George after all.
Huw Witty is the Head of Tax, law and professional services at Gordon Dadds.