02/09/10

By Richard Mannion, Head of National Tax at Smith & Williamson

The UK’s tax code extends to over 10,000 pages of legislation and is the second largest in the world. Pages of new legislation are added to the existing code every year and the new rules are usually bolted on to what went before. As a result, the system has ‘grown like Topsy’, with no discernable structure. Moreover, the UK’s self-assessment tax system means that every individual taxpayer is expected to know the whole of the law as it applies to them in the light of their particular circumstances. This is clearly an impossible task.

A welcome move

In the light of all this, the new Government’s Office of Tax Simplification (OTS) is extremely welcome, but the size of its task should not be underestimated. Previous attempts have been made to remove superfluous legislation, but on each occasion the few pages that were removed as a consequence were dwarfed by the hundreds of additional pages added in the same Budget.

To its credit, the previous Government established a tax law rewrite exercise which was designed to replace the use of legalese with more modern English, but this did nothing to simplify the system itself. Part of the current complexity results from policy makers striving to make tax as fair as possible. To illustrate this point let’s assume that Government decided to scrap all taxes other than VAT and increase the VAT standard rate to a level that would bring in sufficient tax to meet the country’s needs. That would undoubtedly produce a much simpler tax system, but quite clearly the resulting VAT rate would be considerably higher than the proposed 20% rate. In addition, many would argue that this would be unfair because it would impact most heavily on those with lower incomes.

The OTS will be reviewing all reliefs, allowances and exemptions, applying to both businesses and individuals, to identify those that should be repealed or simplified. The plan is to have an interim report ready by autumn 2010, with recommendations ready in time for next year’s Budget. In practice, the autumn 2010 deadline gives very little time for a proper review to be carried out.

Small businesses

The OTS will also be looking at areas of the tax system that cause the most day to day complexity and uncertainty for small businesses and recommending priority areas for simplification. As part of this, the OTS has been asked to explore ways in which the dreaded IR35 rules for intermediaries might be replaced.

One of the major stumbling blocks to simplification in the small business arena is the fact that a much higher national insurance contribution (NIC) levy applies to earnings from employment than to self-employed income, and NIC does not apply at all to investment income like dividends. This results in an uneven playing field which has a direct bearing on the commercial decision as to whether a business should operate as a sole trader, a partnership or as a limited company. The only real way to level that playing field entirely would be to abolish NICs and increase the basic rate of income tax accordingly. But that would be a very brave decision for the new Government to contemplate and is therefore unlikely.

The previous Government invested significant time and trouble considering ways of simplifying the tax system for small businesses including looking at the possibility of switching to a flat tax system like those operated in some European countries, but it soon became apparent that a fair flat tax system would quickly become as complicated as the present system. So, again, simplicity and fairness are not easy bedfellows.

Root and branch review of the tax system needed

The OTS is a welcome step but it is only part of the jigsaw. For far too long the UK tax code has suffered from a lack of long term strategy and far too much legislation has been introduced without sufficient thought, meaning that yet more legislation was then needed to close the loopholes. It is just as important to have well drafted legislation based on a long term strategy as to aim for simplicity. So the proper place to start would be to design a core tax system capable of lasting for the next 20 years. That would require a root and branch review of all of our existing taxes and lead to some very searching questions.

Smith & Williamson provides a comprehensive range of tax and consulting services to help businesses and individuals minimise their tax exposure. For help and advice with any aspect of your tax affairs, contact Richard Mannion, National Tax Director, on 020 7131 4252 or email richard.mannion@smith.williamson.co.uk

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