As we start a new year that promises to have a larger than usual focus on tax itâ€™s a good time to think about tax reform from an SME perspective.
It is often said, but needs constant repetition, that the business tax system should be designed for the majority of businesses, ie SMEs, with carve outs for the minority, ie large businesses. Our current system works more in reverse â€“ with complex provisions applying to all businesses and some special provisions for small business.
This is why we now have the unworkable situation where much of the tax legislation that applies to SMEs is incomprehensible, not only to the taxpayers it applies to, but even to their advisers.
The system seems predicated on the assumption that all businesses are able to access highly sophisticated tax advice, but that assumption is just not valid either in practice or in principle. The result of this invalid assumption is that ordinary business owners with sound, but not sophisticated, advisers constantly and unconsciously walk through a mine field of hidden tax hazards that may one day blow up and threaten the solvency of their businesses.
A good case in point is the trust loss legislation which we have been trying to live with for over a decade but still defies the understanding of the SME community which it most effects.
A classic case of â€˜sledgehammer to crack a walnutâ€™ it was aimed at preventing trafficking in trust losses (which is a perfectly reasonable aim) but ended up preventing many businesses from using their own losses.
This piece of legislation is ridiculously complex, involving obscure terminology, an unclear categorisation of trusts and a raft of tests all drafted in terms that appear to have had the express intention of providing maximum confusion to the reader.
It is even difficult to locate this appalling piece of legislation â€“ hidden away in Schedule 2F at the end of the 1936 Assessment Act. While some schedules were recently rewritten and incorporated into the 1997 Act the trust loss provisions remain untouched.
An indication of how abstruse these provisions are was the amnesty in 2004 allowing trustees an extension of time to lodge family trust elections for losses incurred in previous years, and correct elections previously made. This shows the extent to which tax professionals were unaware of how the provisions operated.
One of the worst examples of a â€˜one-size-fits-allâ€™ approach to complex tax legislation is the consolidation regime. The Board of Taxation recently announced that, as part of its consolidation post-implementation review, it will investigate why there is a low take-up of small businesses electing to consolidate and whether the consolidation regime can be simplified for small businesses.
Tax advisers to corporates have acquired specialist skills to navigate over 800 pages of consolidation legislation and hundreds of rulings, determinations and interpretive decisions. It is unreasonable to expect small practitioners who advise small business to be able to deal with this level of complexity. It is not just the fact that the provisions are complex, it is the traps contained in that complexity that make SMEs shy away from consolidations; for example, a tax liability can arise as a result of cost-setting rules just by electing to consolidate.
To an SME, the cost of trying to apply the legislation, and the potential cost of getting it wrong, will usually far outweigh any benefit of lodging a single tax return for a group. The only time most SMEs usually even consider consolidation is when they are thinking about restructuring, which may result in commercial benefits that justify the costs. Who knows how many SME groups forego offsetting profits of one wholly-owned entity against losses of others, or operate through inefficient structures, simply because they are unable to deal with the complexities of the consolidation legislation?
The old rules that allowed company groups to transfer tax losses, unfranked profits and assets between group members were, compared with the consolidation regime, relatively simple and accessible to SMEs. Rather than leave this regime in place and make consolidation an option for those able to deal with it, the old regime was removed altogether apparently on the basis that it had allowed some groups to â€˜double dipâ€™ into their tax losses. While it is unlikely that the revenue had suffered significantly from â€˜double dippingâ€™ by SMEs, it was SMEs that lost out from the replacement of the old regime with the unwieldy consolidation rules.
While the small business CGT concessions are highly valued by SMEs the legislation itself is still incredibly complex.
It is impossible to give business owners a definitive answer to whether they are eligible for the concessions without the costly exercise of working through each of the many applicable sections containing numerous tests with idiosyncratic terminology.
The legislation is full of traps that catch an SME owner who has not been able to access the level of sophisticated advice necessary to negotiate them. Another example of a mismatch of legislation to the taxpayers it is intended to affect.
Surely legislation has failed when the people it affects, and even their qualified professional advisers, are unable to understand it. I believe we are at this stage with much of the tax legislation that applies to SMEs.
Letâ€™s hope that any changes to the tax system are based on a â€˜think small firstâ€™ approach.