I have this morning published the next in my series of proposals that will make up the Taxing Wealth Report 2024.
In this latest note, I consider another change in the law that is required to tackle a significant tax avoidance activity that is primarily undertaken by the wealthiest in society. This is the retention of profits in private limited companies so that they might grow through the accumulation of retained profits within those entities that are only taxed at the relatively low rates charged on them when that same income would, if earned by the shareholders of the companies in question, have been taxed at much higher rates. A provision called 'close company rules' could tackle this issue.
The need for close company rules was recognised when corporation tax was introduced in 1965, but for most purposes the rules were abolished by 1984. The consequence has been a considerable increase in the income and wealth divide in the UK that needs to be tackled by their reintroduction.
The summary of this note says:
Brief summary
This note proposes that close company rules be reintroduced into UK taxation. It should be required as a result that:
- The income of all close companies with retained investment income and gains exceeding £50,000 should be required to distribute such sums to their members or they shall be deemed to have done so for income tax purposes.
- The retained profits of all close trading companies in excess of £200,000 not demonstrably being used for the purposes of a trade shall likewise be required to be distributed to the members of that company or shall be deemed to be so for income tax purposes.
For these purposes, a close company is defined as a company:
- under the control of:
- five or fewer participators, or
- any number of participators if those participators are directors.
- Or companies where more than half the assets of which would be distributed to five or fewer participators, or to participators who are directors, in the event of the winding up of the company.
A participator is usually a shareholder or director, although loan creditors can occasionally count if they have influence over a company.
Discussion
Provisions of the type noted here are surprisingly common. They are used in the USA, exist in the UK's Crown Dependencies and exist in UK law already because this is the way in which UK limited liability partnerships are taxed.
However, to avoid the undue imposition of this law on the vast majority of UK small private limited companies de minimis limits are proposed for use as noted above.
That said, note that these de minimise limits are not set for a year: they do instead refer to retained profits from a source of income.
This law would essentially end the accumulation of investment income in private limited companies.
The same rule change would also require that private limited companies be required to justify the retention of their profits from trading to meet future business needs when they exceed the de minimis limit. The supply of a business plan and cash flow to HMRC should achieve that goal in most cases.
HMRC would be required to use a principles-based approach to appraising this issue. In other words, if it could be demonstrated that a close trading company has the clear intention to grow, requiring the retention of profit for investment in either fixed or working capital then, broadly speaking, a relaxed approach towards the application of this rule should be used by HM Revenue & Customs. In the absence of clear evidence on this issue, however, particularly over a period of time, HMRC must be empowered to act to require that profits are distributed or are deemed to be so, and that they would, therefore, become subject to tax in the hands of the shareholders of these companies.
Used in the way suggested these rules would end a very clear abuse that significantly increases the wealthy divide in the UK whilst simultaneously placing no obstacles in the path of a company that needs to retain funds to grow. That is why they are appropriate now.
Potential tax raised
Given the number of variables involved, it is hard to estimate the sums likely to be distributed, but if only £10 billion was distributed a year as a result of this policy (and that would appear to be a modest estimate), the likely increase in tax yield might be more than £3 billion a year at current tax rates, and somewhat more at the rates of tax proposed in the Taxing Wealth Report 2024, especially if an investment income surcharge was taken into account.
Cumulative value of recommendations made
The recommendations now made as part of the Taxing Wealth Report 2024 would, taking this latest proposal into account, raise total additional tax revenues of approximately £108.2 billion per annum.
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So you want retained profits to be spent /reinvested immediately or paid out?? And in the same breath you moan about the financial resilience of corporates!!.. it makes every sense for companies to maintain a liquidity buffer for future (often unforeseen) expenditure and expense. it to do is is imprudent as will in likelihood force companies to take out borrowings to fund expenditure. In fact an obvious consequence of what you say is excessive balance sheet leverage, something else you would eventually complain about.
I suggest you spend some time forward thinking about the consequences of what you say.
I suggest you read what I said because your response very clearly shows that you have not.
Good to see the boxing community taking such an interest in tax affairs.
Nobody is suggesting companies be run imprudently…. merely that running companies to delay/smooth/redistribute income for tax purposes should be prevented.
I must confess that I have done this for 20 years with my company – although I am under Richard’s proposed thresholds.
(I would also add that the primary purpose of setting up as a company was not tax avoidance).
Tha nks Clive…
I know nothing about boxing
Thanks for pointing out we have another troll here
I know that I sound naive but given our addiction to the notion that tax pays for everything, this work needs to be looked at seriously by Parliament.
I am all in favour of reducing scope for tax avoidance.
Eventually retained profits do have to leave a company if they are to benefit the owners. At that point they are taxed. It seems that this proposal just shifts when those profits are taxed. I’d be grateful of an explanation, probably obvious to you, how this prevents tax avoidance in the long run. I suspect I, and perhaps other readers, are missing something.
Does this not highlight the need to tax all forms of income at the same rate?
Sometimes if does not need to leave.
When you have so much you can use these funds to reinfornce your status, investments and power ad infinitum.
All you have to do is leave the UK for over a year to become non-resident for tax purposes and then dividends can be paid tax free (as long as you choose an appropriate home).
It may need a bit longer than that….
You could also donate some of the retained profits to politicians, who then wouldn’t reintroduce the close company rules.
Or donate to a charity, who then names a facility after you. (See yesterday’s proposal on reforming charity tax relief rules.)
I’m sure there’s lots more.
Presumably the time value of money stimulates the desire to exit, but is more than compensated by the saving in tax. At the same time the money is not wasted by sitting there, if it can be used in parallel, as collateral …. to do something else in another vehicle, using other sources?
You get it John
“2. The retained profits of all close trading companies in excess of £200,000 not demonstrably being used for the purposes of a trade shall likewise be required to be distributed to the members of that company or shall be deemed to be so for income tax purposes”.
I think you suggested elsewhere in your Taxing Wealth Report that such profits should be paid at the marginal tax rate of the recipient? I know insufficient about the capacity of HMRC to execute that requirement both effectively, and fairly; but merely as a matter of practical execution. may doubt it. As for LLPs, the Government was going to legislate to stop their misuse, and took evidence as far back as 2017. I do not know where that legislations stands. I do not know how much money is there, or what tax may yet be raised, but I son’t recall that you have yet addressed it? My instinct is that if LLPs are being abused, they have probably become much more widely used: call me cynical.
The problem is overseas controlled llps, not domestic ones
And remember, HMRC do not assess tax: the duty is on the taxpayer to declare it properly. HMRC can then check it.
What is the tax concern about LLPs, John? In the main, if they have any business, their income and gains are allocated to and taxed in the hands of the members, whether or not the amounts are actually distributed out or are retained or reinvested.
There are games that people used to play, particularly with corporate members and differential allocation of different sorts of income, and base cost shifting for capital gains particularly in limited partnerships (rather than LLPs) but the rules on salaried members and mixed partnerships and other changes have largely stopped them.
Like most gains, carried interest is still taxed at too low a rate in my view. But that is a different issue.
On 22nd March, 2018 (over fiver years ago) ‘The Herald’ in Scotland published this article, titled ‘Theresa May set to ban secretive Scottish shell companies to halt flow of dirty Russian money’ i.e., Scottish LLPs. I leave others to reflect on English LLPs. The Herald wrote that: “UK ministers have signalled they will kill off controversial Scottish limited partnerships used by Vladimir Putin’s cronies to launder billions of pounds. Their move comes after constructive pressure from the Scottish Government and a Westminster campaign led by the SNP and a three-year campaign of investigative journalism from The Herald”.
Theresa May wrote with then SNP Westminster leader Ian Blackford MP to arrange a meeting.
The Solicitors Dentons wrote this on their website, 16th December, 2022: “There have been increasing reports recently of the misuse of English limited partnership and Scottish limited partnership vehicles (together, LPs), and links to criminal activities such as money laundering and fraud. Of particular concern is the fact that, under the current legislation (the Limited Partnerships Act 1907), LPs must have a principal place of business in the UK on registration but are free to subsequently move abroad without needing to notify Companies House. Therefore, an LP may become disconnected from the UK by moving its principal place of business abroad and the relevant individuals may become difficult to track down, meaning it is possible to potentially exploit the opaque nature of the LP structure.
With LPs commonly utilised in investment fund and property holding structures, as well as in the venture capital industry, it is important, not least for the UK as a global financial and asset management centre and its role as a leader in corporate transparency, that the LP structure is robust. LPs can be part of complex structures and, with limited information required to be registered at Companies House, it can also be difficult to determine the persons controlling the LP under the current legislation. In particular, Scottish limited partnerships have been exploited because of their separate legal personality, albeit mitigated to a degree by the People with Significant Control (PSC) regime, which makes it even harder to trace back control”.
Andrew I don’t know where we are, like most people, about just about everything , so – you tell me.
There is a confusion here
Scottish limited partnerships are not the same as limited liability partnerships
I appreciate there is a difference (eg., ‘legal personality’), but I confess I am not expert in this area, but have followed Denton’s comments that appear to suggest there are also problems with English LLPs. I did try to maintain the distinction in my comments.
There was a problem with English llps, but as Andrew noted recently, legislation has certainly helped tackle it.
Thanks for explaining, John. There are certainly substantial problems with the regulation of limited partnership, particularly in Scotland where they have legal personality which makes them an attractive investment vehicle in a number of other countries, and the way they have been used and abused for all sorts of nefarious activities.
I’ve not heard anything like the same level of concerns about the way LLPs are used (and if they don’t have a business, they are taxed as companies). But there is a similar regulatory problem with the use and abuse of limited companies in England, as Companies House is more of a filing clerk than a regulator.
In either case, that is not a tax issue. (There are still some tax concerns to address, like carried interest, but again that is a separate point.)
See my recent comments on this in the Taxing Wealth Report 2024
Andrew, in response to your second comment, I think there may be confusion over my original comment. My response on the tax issue was to suggest that perhaps HMRC was not adequately resourced to do the required job (if I understand Richard’s point about the marginal tax rate). That was all I had to say on the tax issue.
My point about “abuse” of LLPs arose separately to the tax issue, from the reference to close companies; which I suggest are broadly in the same conceptual field as LLPs for those looking for a suitable vehicle; and provided the opening for me to raise the matter. My issue with (Scottish) LLPs was “abuse” and the notable prevarication of the UK Government, at least as far as I am aware. Perhaps my framing of the point could have been clearer.
And Scottish LLPs? Remembering, as the background to my comment suggests, although this is a Scottish legal issue; this requires Westminster to resolve; and there you have the endemic, elusive muddle that is devolution (allowing Westminster to play the game of ‘pass the parcel’, giving the British public impression the problem is a failure of Holyrood, while they merrily screw-up everything they touch).
Entirely accepted
Of course we did use to have apportionment, which this sounds like a call to restore. It was abolished by the Thatcher government in the late 1980s.
The trolls may care to note that it didn’t lead to the demise of companies subject to it. And as (effectively) a tax on capital rather than income, I don’t find this suggestion in any way objectionable.
Thanks