According to the Institute for Fiscal Studies (IFS) incentives such as entrepreneurs’relief are encouraging business owners to shift around their income to minimise tax payments.
The IFS says its analysis of UK tax records shows that, in general, company owner-managers respond to changes in income taxes by adjusting how and when they take money out of their company and not by changing the amount of income they create or how much investment they do.
It claims the findings indicate many company owner-managers hold significant sums of cash in their companies in order to access lower capital gains tax (CGT) rates and thereby substantial tax savings. It also says business incomes, and therefore the benefits of lower taxes on such income, accrue disproportionately to those at the very top of the income distribution. According to the IFS, systematic retention of income within owner-managed companies is large, particularly for higher income individuals. This income is held as cash and equivalent assets, and is not associated with increased investment in business capital.
What the research shows
The research indicates that company owners are very alert and responsive to taxes, there is a large number who report earning an income exactly equal to the higher rate threshold in income tax, along with the large reductions in taxable income following the introduction of the 50% additional rate and the withdrawal of the personal allowance above £100,000.
The IFS says that, in principle, these responses could reflect a higher rate of tax deterring real business activity, but states it could find no evidence of this. Instead, the responses to thresholds and policy changes are due to a change in the timing of when dividends are taken out of the company.
Those whose income fluctuates around the higher rate threshold choose when to withdraw income in order to spread their taxable income across tax years and thereby avoid paying the higher rate when their incomes are temporarily high.
Company owner managers enjoy significant tax savings by retaining income in their companies, often for long periods and until liquidation, in order to access entrepreneurs’relief, which enables business owners to pay a reduced 10% rate of CGT on all gains on qualifying assets, rather than the standard 20% rate.
The IFS’s findings
The IFS did not find any evidence that tax-motivated retention of profits translates into more investment in business capital; profits retained with companies are held as cash or other liquid assets.