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Economics 101…

Economics 101…

The discussion about the Office of Tax Simplification is gaining momentum as the body itself starts to get fully organised. A fair range of interested parties have been discussing how they want to see things change. Naturally, for those of us who have lived with it for eleven years, a lot of this discussion has been about IR35.

Actually that is a little lopsided: there are many aspects of the tax system that need to be looked at, such as the hundred or more tax releifs you can claim for depending on your income, outgoings and inside leg measurement. However, IR35 is an obvious target, being both ridiculous and onerous in roughly equal measure.

But can I point out that much of that debate is starting from entirely the wrong premise?

Ostensibly IR35 is about ensuring an individual can’t reduce their tax liability by channelling their earnings through a different commercial vehicle and by not being employed by anyone. For example, if you have a company that has made a handsome £700 million net profit, you could potentially pay a £1.2 billion dividend to your Monaco-resident 100% shareholding other half. Leaving aside the minor detail of how you pay a dividend that represents 130% of your net profit, the point is you pay no tax at all on your personal income, perfectly legally. I mean, how ridiculous is that?

Oh, hang on a minute….

OK, so that’s an extreme case but if you think about it, Mr Green actually has a glimmering of a valid argument in his apparently specious assertion that paying lots of tax through his company somehow compensates for his not paying any tax at all on his beer and skittles money – or at least, nowhere near as much as a Brownian economist might think he owes.

My point is that most, if not all of the IR35 debate is about how to level the tax paid by a small business owner compared to an employee doing much the same job. The answer is actually blindingly obvious: the employee needs to pay more taxes to catch up.

Say what?

Think about it. Assume an individual with a not unreasonable potential income of £75k, either as salary or as net profits from their business. And, for the sake of argument, we’ll assume that none of that money is going to be ploughed back into the business for growth or protection against future gaps in earnings.

An employee would pay roughly 39% in tax and a company owner using the minimum salary and dividends option would pay a mere 26%. Clearly unfair chaps, come on, play the game.

But – and I think it’s quite a big but – look at the actual numbers. Against that income, the employee would pay £29,250 in tax. The company owner, however, would pay £32,625. That’s £33,75 more than the employee does.

Sorry?

It’s because the company owner would also have generated £13,125 in VAT (or £15,000 from January 2011 if you want to be really pedantic, which makes the gap even wider). And since it’s all about income for the Exchequer, the only possible conclusion is that to achieve a level playing field, personal taxation for employees needs to go up by some 13% to ensure they are providing the same level of tax income as the business owner.

Unfortunately I don’t think that is on Mr Osborne’s radar.

Anyhow, I’ve said it before and I’ll say it again; if I’m a tax avoider I’m clearly a very bad one. It really is about time we forgot all about Labour’s stupid notions of fairness and applied a bit of objective thinking to the whole debate. We money-grabbing contractors may take home more than many employees, but we do so by taking much greater risks with our income than an equivalent employee. At the same time we put a lot more back in to the economy.

And after eleven years of IR35, it would really be nice if people began to understand what it is they’re talking about.

Alan Watts can found at LinkedIn.
© 2010 All rights reserved. Reproduction in whole or in part without permission is prohibited.

Image: economics anyone? by bonbongirl

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