| Nurturing smaller businesses |
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| The report of the Small Business Forum has analysed the position of small and growing businesses in Ireland, and made recommendations for government measures to assist the sector. The analysis and recommendations echo the findings of a report produced by KPMG for the Inland Revenue in the UK, writes Mike Gaffney, partner, KPMG Tax Department. |
Small Business Forum
The Small Business Forum was set up by the Minister for Enterprise, Trade & Employment and commenced work in September 2005. It delivered its report in April 2006. It was chaired by Joe Macri, Managing Director of Microsoft Ireland. The speed with which the report was produced, and the clarity of its analysis and recommendations show what can be done when government chooses to consult the private sector, something which it does far too little.  | | Mike Gaffney |
Small Business
The report found that 97per cent of businesses operating in Ireland today employ fewer than 50 people - which is taken to be the benchmark for 'small'. A quarter of a million small businesses in Ireland employ 770,000 people in total, which represents more than half of the total private sector, non-agricultural work force.
The breakdown of the work force over sectors is interesting.
Small Business 39 per cent
Medium/Large Business 34 per cent
Public Services 17 per cent
Agriculture 6 per cent
Unemployed 4 per cent
This is not dissimilar from the findings of the KPMG report in relation to the UK. There, the report identified a total of 4,162,477 businesses, of which 3,064,891 consisted of self-employed individuals. In other words, 72 per cent of businesses were self-employed individuals. A further 23% were micro-businesses with less than ten employees. Only 0.2 per cent of businesses in the UK have 250 employees or more.
When job creation receives media publicity, it is usually in terms of a ministerial announcement that 200 or 300 jobs have been 'created' in this or that town. The analysis above would suggest that there is an unheralded, almost unseen, but more important job growth in process all over the country, consisting of individuals taking up self-employment, setting up their own businesses, and perhaps employing one or two others. Such new enterprises on their own are not, of course, significant. The figures suggest that, in total, they matter more than the 'big job announcement' projects do.
Regulation
The forum recommended a special regulatory impact analysis over a seven year period of all existing regulations impacting on small business, in the areas of taxation, health & safety, and employment with a view to reducing the burden of compliance. It also recommended that exemptions for small businesses be more widely applied in the area of regulation, and that a risk-based approach to regulatory implementation and enforcement to be adopted.
Specific areas were identified in the context of tax. The turnover threshold for VAT exemption, and the threshold for the cash basis of accounting for VAT and non-retail businesses, were both the subject of a recommendation for significant increases. The forum also recommended that where a previous year's tax liability was less than €100,000, the business should be entitled to base its pre-year end preliminary tax payment on its prior year tax figure.
The recommendation regarding preliminary tax is arguably excessively modest. In previous issues of KPMG's Tax Monitor, attention was drawn to this feature of the tax system as iniquitous and illogical. Even a very large business cannot be expected to accurately compute its tax liability five weeks (in some cases, two months) ahead of year end. Yet, that is what the law requires of it. This system is unjust to all business, and not merely small business.
The report carried out by KPMG for the UK Revenue highlighted the impact of the cost to compliance with tax obligations on small businesses. The report calculated that the total cost of complying with tax obligations (quite apart from paying tax itself) in the UK amounted to Stg ?5,100 million. Of that, Stg ?3,168 million was borne by the self-employed and by businesses employing than ten employees. In contrast, the bulk of all taxes are actually paid by businesses with 250 or more employees. It is evident that the burden of tax compliance falls more heavily on small businesses than it does on large, having regard to the relative tax take from each sector. This points to the need to focus enquiry on how to reduce compliance costs for smaller businesses.
The UK report also produced evidence arising from interviews, that the perceived complexity of the tax system and of the burdens which it imposed as a business got larger, deterred businesses from growing. Due to fear of facing PAYE and Social Insurance obligations, self-employed people have been reluctant to take on new employees. Very small businesses were reluctant to grow to the point where their turnover would exceed the low VAT registration thresholds. Due to lack of familiarity with overseas VAT requirements, businesses were reluctant to seek overseas customers.
These findings suggest that entrepreneurship, the creation of new businesses, and the growth of smaller business, would be encouraged if they had relatively greater freedom from tax administration obligations (as opposed to taxation itself). Our tax system is heavily dependent on collection of tax by the private sector, e.g. PAYE, PRSI, VAT and withholding tax on interest, etc. That may save the government costs in terms of Revenue salaries, etc. However, if it deters businesses from being set up, or from growing, it does so at a huge cost to the economy. It might be sensible to grant an exemption to new businesses from all such obligations in (say) the first five years of their existence, as well as significantly increasing (as the forum has suggested in quite modest terms) the thresholds for registration for the various taxes.
Another interesting finding of the KPMG report, again based on interviews, was that there was a widespread anxiety amongst taxpayers to be tax compliant. It was accompanied by a huge fear that no matter what the tax payer does, should a Revenue audit occur, the taxpayer would be found to be non-compliant and suffer potentially large financial consequences. This 'fear factor' was found to be an important deterrent to setting up in business. That the fear has a certain basis in reality was illustrated by the fact that the survey identified no less than 2,692 separate potential obligations which could be imposed upon a taxpayer by the tax code! These are supported by no less than 279 Revenue forms. Most of these obligations and forms will never impact on a taxpayer throughout his or her life. The existence of such a dizzying mass of potential obligations, most of which the taxpayer he or is unaware of, create a climate of uncertainty and obscurity that breeds fear and deters enterprise.
There can be little doubt that a large part of the 2,692 separate obligations could be scrapped from the tax code without any significant impact on tax take, and that the national Revenues would not suffer greatly if a bonfire were made of most of the 279 Revenue forms.
The KPMG report found that the largest single cost of meeting with Revenue requirements was the cost of information retrieval. This amounted to 38 per cent of the internal costs involved. It arises because the Revenue require information of a type, and in a form, not normally generated for financial accounting or management information purposes. As a result, special accounting systems have to be created, or information has to be reanalysed, to meet Revenue requirements. This cost could be minimised if those requirements more closely fell into line with the information that might be expected to be routinely generated for an accounting system.
Changes in tax rules are another major source of cost and irritation. Annually, there are trifling changes, frequently mere tinkering, in tax rules that require businesses to make changes in software, and reacquaint themselves with new rules, often on short notice.
It seems reasonably clear that the cost to business of administering the tax system would be minimised by reducing the frequency of change in the system; by aligning information needs of the Revenue more closely to those that an accounting system would normally produce; and by aligning the computation of a tax liability more closely with accounting profits. The complexity of the system, and the deterrent fear which it creates, could be reduced by pruning away the vast majority of the over 2,900 separate obligations, so as to retain only those that really matter, that arise frequently, and with which a business might reasonably be expected to acquaint itself. The disincentives for economic development caused by the burden of administering the tax system could be reduced if smaller businesses (e.g. those with less than ten employees) were permanently excluded from the bulk of tax obligations (other than that of paying their own taxes!) for some initial period (say), five years after being formed.
Other Recommendations
The Forum recommended that BES be extended until at least 2013, and that the limits on the amount of BES based finance of the company might raise should be increased, as well as the limit of relief for individual investors. It also recommended similar changes in the Seed Capital Scheme.
The Seed Capital Scheme is of considerable importance in helping an individual move from being an employee to being self-employed, or even to becoming an employer. It enables one to obtain a refund of past taxes to help finance one's new business.
BES allows capital to be raised on a tax efficient basis. However, insofar as the capital is raised from third parties, and outside the immediate family, there are necessarily administrative costs involved in the issue of a prospectus, etc. These costs can be disproportionately high where the capital raised is small. For that reason, the tight limit imposed on the total capital that the company can raise under BES greatly reduces the attractions of BES in the financing of the business. Now that we are entering into a higher interest rate environment than we have experience for the last several years, it is important that BES be revitalised. The cap on the amount of finance should be significantly raised.
The Forum rightly identifies the fact that research and development tax credits are not very relevant to small business. The tax credit scheme is focused on innovative, original research. This is likely to be of limited relevance to a new business and beyond the resources of a new business.
The Forum has suggested that instead, new businesses should be provided with innovation vouchers or knowledge acquisition grants. This would more directly meet the real needs of small business, which is to increase their access to existing cutting edge technology, and to existing sources of knowledge.
The Forum have correctly identified locally authority charges - both user charges, developer levies, and conventional 'rates' - as an increasing burden on business. Business appears to be a soft target for local authorities. Levies on business can appear to be more attractive than the pursuit of greater efficiency, or the proper application of 'user pay' charges for local authority services.
Lets Hope for Action
It is too easy for the government to put a report in the drawer and forget about it. Ministers should recall the large role played by reports, such as the Culleton Report, in creating our present economic prosperity. Reports such as the Small Business Forum Report represent one of those rare opportunities that the government has to hear the voice of those with practical experience in wealth creation, job creation, and in running businesses. Ministers should ensure that the report is moved to the top of the agenda of all government departments. Those who took part in the forum and Joe Macri, its chairman, are to be congratulated on an excellent report produced in a timely fashion. |
Mike Gaffney is a partner in KPMG’s Tax Department
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| Article appeared in the August 2006 issue.
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