Following the autumn statement last November, I wrote about the Chancellor’s concerns that the tax take was being reduced as a result of individual taxpayers incorporating their businesses as companies.

These concerns have not yet led to any firm proposals for changes in the tax system and in the short term the most likely reaction seems to be an increase in personal tax rates on dividends to compensate for the falling corporation tax rate, perhaps accompanied by some tinkering with national insurance and capital gains tax rules to smooth out a few of the bigger discrepancies.

In the meantime, another headache for the Chancellor is the growth in self-employment relative to employment. This, coupled with the favourable tax treatment enjoyed by the self-employed, means that the fall in unemployment over recent years has not been accompanied by the expected improvement in the public finances. Despite recent legal developments such as the Uber tribunal decision, the rush towards business models that seek to treat workers as flexible independent resources rather than employees is not showing any sign of slowing down. Once employees have chosen (or been forced) to leave behind the protection of employed status, it seems likely that an increasing number will respond to the further tax incentives available and progress to setting their new businesses up as fully-fledged companies, making the Chancellor’s problem even worse.

We’ve seen some steps to limit some of the most glaring differences between incorporated and unincorporated structures, including restrictions to the capital gains tax advantages of extracting value from a business through the use of entrepreneurs’ relief on incorporation, and constraints on the ability of company owners to take money out of ongoing businesses through liquidation. From a slightly different angle, the reforms to the use of off-payroll workers in the public sector also seek to recapture tax revenues currently being lost as a result of company structures, although in this case the measures are marketed as a means of collecting the tax that is properly due, rather than a change in the underlying tax rules. It’s not much of a stretch to see this as a first step in a kind of “shadow PAYE” scheme that tries to paper over the cracks by pushing more tax responsibilities onto companies that engage workers, whilst leaving the basic differentials between employed, self-employed and company taxation in place.

So what options are there for more fundamental change? The room for manoeuvre seems limited by the Government’s ongoing commitment to cutting direct taxation on companies, unless some distinction can be made between “good” and “bad” companies which allows future corporation tax rate cuts to be made in a more targeted fashion. We will probably see ongoing increases in dividend rates in order to claw back the effect of lower taxes at the company level when profits are distributed, but there are also problems with this approach at a time when it is particularly important for the Chancellor to be seen to encourage investment in British companies.

As I wrote in my previous article, one possibility under consideration is some kind of look-through approach allowing taxation of undistributed profits of close companies at rates effectively equivalent to income tax rates. It’s not clear how seriously the idea is being explored and it would undoubtedly add a huge layer of complexity to the tax compliance process for small companies. However, given the growing tax gap in this area, it’s possible that Philip Hammond might seek to introduce a Churchillian tone to his Budget speech next Wednesday and declare that he plans to pursue this approach on the basis that it’s “the worst form of small company taxation except all those others that have been tried”.

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