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Meanwhile, the UK government has recently hit shareholders, including most small business owners and solo freelancers/contractors, with a 7.5% increase in their

Meanwhile, the UK government has recently hit shareholders, including most small business owners and solo freelancers/contractors, with a 7.5% increase in their tax rate on dividends. This after a succession of other changes in recent years that have all made starting or running a smaller business less attractive. It's very strange how they turn such a blind eye to massive tax avoidance (or even tax evasion?) schemes from large businesses, while simultaneously leaning on by far the largest part of the business economy. Leaving aside the ethical considerations, I have never understood how this makes much economic sense either.

madeofpalk 9y ago
Why do countries like, the UK, tax income from dividends differently to regular PAYE income? By creating a complicated system like they have it seems like they just invite people to create structures to pay themselves in dividends and reduce the tax they should pay.
- Silhouette 9y ago
  Why do countries like, the UK, tax income from dividends differently to regular PAYE income? I suppose there are two basic reasons. The first reason is that the two types of income derive from different mechanisms, and have different contexts. If you're working as an employee and receiving a salary through PAYE, then in places like the UK that comes with many rights and protections. Those are supported by legal obligations and risks borne by the employer (and to some relatively small extent the government). In contrast, if you're working through your own company, you take on all the risks and overheads of the employer as well as the employee. More generally, if you're receiving income from dividends whether from your own company or someone else's, it's because you have invested in one way or another in supporting that company. The dividend is your reward for taking that risk if things work out, and unlike PAYE salary, there is no guarantee that you will get that money, or even get back whatever you invested in the hope of receiving that return. The second reason is that as a practical matter, it is necessary for the health of the economy to support the creation and growth of new businesses. That requires a mechanism for progression: someone has to stop being an employee of someone else's business and transition instead to either being self-employed (which is OK for very small businesses, but limits growth in many practical ways) or forming a separate legal business entity (typically a limited company or partnership in the UK). But if you start your own company, its profits are already going to be subject to corporation tax before you can pay out anything left over as a dividend. If you also imposed the same income tax on the dividends themselves, you would essentially be saying a solo founder or small group must accept being double-taxed on the money the business makes in return for operating through a legal entity, which in itself already comes with various overheads and costs. Clearly that is a huge deterrent to anyone taking the step from operating solo to creating a more robust and scalable business structure, which is something that needs to be incentivized for the general development of our economic and business environment. In short, the reason you get some income via PAYE salary is completely different to the reason you get it from dividends, so there's no reason the tax treatment should necessarily be the same. Attempting to equate the two scenarios penalises investment and heavily penalises setting up new businesses, and if people aren't willing to take on those risks and overheads, you won't have businesses creating new jobs and opportunities that will support tomorrow's PAYE employees either. By creating a complicated system like they have it seems like they just invite people to create structures to pay themselves in dividends and reduce the tax they should pay. This is a real danger, and the government has repeatedly tried to clamp down on "disguised employment", for example via the IR35 rules that essentially say if you're working like an employee, you get taxed like an employee, even if your contract claims you're a freelancer or contractor. These measures were spectacularly unsuccessful for many years, essentially just creating a new industry around insurance for legitimate independent workers that was a drag on the whole sector, while pulling in very little extra money from those who really were abusing the loophole before. A lot of people in the independent sector believe that the massive increase in dividend tax was basically the government giving up on IR35 and just hitting every small business without discrimination. Of course, while that certainly pulls in a lot of extra tax money that the government wanted, it also hurts all the people who were quite legitimately operating as independent businesses that just happened to have only one employee but otherwise still had all the normal control, risks, overheads, reporting, etc. like any other business.
- neilwilson 9y ago
  There's no good reason. If a service business is worth having it can charge its clients enough to cover its tax bills.
  - Silhouette 9y ago
    Just curious: How many service businesses have you owned/managed to reach that conclusion? Your premise seems to imply that every such business can afford to lose 20% or so off its margins and still remain viable. (Or that the market will bear all such businesses increasing their prices accordingly, but in that case, we have to ask why they have not done so already.)
    - TheCoelacanth 9y ago
      They can't because their competitors don't. If their competitors had to, then they would be able to as well. If that didn't happen, then even a sales tax of a few percent would destroy every grocery store because that is as big as their entire profit margin.
      - Silhouette 9y ago
        They can't because their competitors don't. That's one possible factor, but not the only one. Otherwise any business with no direct competition could increase its prices arbitrarily, and clearly that's nonsensical.
        TheCoelacanth 9y ago
        > Otherwise any business with no direct competition could increase its prices arbitrarily, and clearly that's nonsensical. That's the entire theory behind why monopolies are bad. It's not nonsensical at all. Monopolies can increase their prices far beyond what the market would bear if they had competition. Obviously, they can't increase their prices without any limit at all, because at some point people would decide to do without instead of paying the higher prices, but they can increase their prices far beyond what a normal business with competition could.
Digit-Al 9y ago
That's reasonably easy to explain. It's called 'going after the low hanging fruit'. Here's the problem: very large companies have very expensive accountants. These accountants are quite often ex-HMRC so know tax law very well. They know all the loopholes and how to play the system. They also have a big budget for political 'donations' which those in power don't want to lose. Plus a lot of very expensive lawyers to defend them from charges. All of this makes it much more difficult and expensive to investigate and prosecute large companies for tax dodging. Small companies, on the other hand, are a fruit ripe for the picking. They don't have much money for fancy accountants and lawyers so it is easy to create legislation to make them pay more money and know that they will have to cough up - or face the consequences. The final piece of the puzzle is that a lot of the top MPs have 'Directorship' positions at the big companies, so have an interest in protecting them. Plus a lot of them are taking advantage of tax loopholes themselves, so have a vested interest in not closing them. (Remember Cameron being outed for being in a tax scheme that was legal, but not entirely ethical?)
- Silhouette 9y ago
  Oh, yes, it's quite clear how it works in the short term. It's just incredibly naive in the longer term, because the alternative for founders of new businesses typically isn't hiring expensive accountants of their own, it's just not bothering at all. Why should anyone risk their savings and give up the security of a well-paid job (which people in a position to start a viable new business very often already have beforehand) if in return you get all the costs and overheads of running a small business to deal with and then the government is going to impose a very high tax rate on the profits as well? If they had imposed a sudden 7.5% increase on the general rate of income tax, they'd have been out of power for a generation.
  - pmyteh 9y ago
    To be fair, the 'very high tax rate' it's been put up to is still less than income tax levels, so it's still being incentivised. I used to be a self-employed consultant. The number of my peers who set up one-man companies, stayed (or claimed to stay) just a whisker outside IR35 and paid themselves in dividends was astonishing. I see no reason why dividends from a company with no fucking capital should be seen as anything other than regular taxable income.
barrkel 9y ago
The general rule I tend to think of is that upward mobility in the wealth distribution is taxed, but position in the wealth distribution isn't. For example, take employee options, typically EMI in the UK. The tax advantages only exist for 10 years from option grant, and only while you continue to work for the company that granted them - the employee needs to maximize their value to the owners of capital. People with lots of capital already, OTOH, get tax incentives to invest.
- pjc50 9y ago
  Exactly this. It's why the UK doesn't have a meaningful property tax, just the (capped) council tax and a tax on transfer of housing. The last time there was taxation that was genuinely order-redistributive on a large scale was death duties before the war on hereditary landowners who'd not yet figured out how to avoid them.

madeofpalk 9y ago

Why do countries like, the UK, tax income from dividends differently to regular PAYE income? By creating a complicated system like they have it seems like they just invite people to create structures to pay themselves in dividends and reduce the tax they should pay.

Silhouette 9y ago
Why do countries like, the UK, tax income from dividends differently to regular PAYE income? I suppose there are two basic reasons. The first reason is that the two types of income derive from different mechanisms, and have different contexts. If you're working as an employee and receiving a salary through PAYE, then in places like the UK that comes with many rights and protections. Those are supported by legal obligations and risks borne by the employer (and to some relatively small extent the government). In contrast, if you're working through your own company, you take on all the risks and overheads of the employer as well as the employee. More generally, if you're receiving income from dividends whether from your own company or someone else's, it's because you have invested in one way or another in supporting that company. The dividend is your reward for taking that risk if things work out, and unlike PAYE salary, there is no guarantee that you will get that money, or even get back whatever you invested in the hope of receiving that return. The second reason is that as a practical matter, it is necessary for the health of the economy to support the creation and growth of new businesses. That requires a mechanism for progression: someone has to stop being an employee of someone else's business and transition instead to either being self-employed (which is OK for very small businesses, but limits growth in many practical ways) or forming a separate legal business entity (typically a limited company or partnership in the UK). But if you start your own company, its profits are already going to be subject to corporation tax before you can pay out anything left over as a dividend. If you also imposed the same income tax on the dividends themselves, you would essentially be saying a solo founder or small group must accept being double-taxed on the money the business makes in return for operating through a legal entity, which in itself already comes with various overheads and costs. Clearly that is a huge deterrent to anyone taking the step from operating solo to creating a more robust and scalable business structure, which is something that needs to be incentivized for the general development of our economic and business environment. In short, the reason you get some income via PAYE salary is completely different to the reason you get it from dividends, so there's no reason the tax treatment should necessarily be the same. Attempting to equate the two scenarios penalises investment and heavily penalises setting up new businesses, and if people aren't willing to take on those risks and overheads, you won't have businesses creating new jobs and opportunities that will support tomorrow's PAYE employees either. By creating a complicated system like they have it seems like they just invite people to create structures to pay themselves in dividends and reduce the tax they should pay. This is a real danger, and the government has repeatedly tried to clamp down on "disguised employment", for example via the IR35 rules that essentially say if you're working like an employee, you get taxed like an employee, even if your contract claims you're a freelancer or contractor. These measures were spectacularly unsuccessful for many years, essentially just creating a new industry around insurance for legitimate independent workers that was a drag on the whole sector, while pulling in very little extra money from those who really were abusing the loophole before. A lot of people in the independent sector believe that the massive increase in dividend tax was basically the government giving up on IR35 and just hitting every small business without discrimination. Of course, while that certainly pulls in a lot of extra tax money that the government wanted, it also hurts all the people who were quite legitimately operating as independent businesses that just happened to have only one employee but otherwise still had all the normal control, risks, overheads, reporting, etc. like any other business.
neilwilson 9y ago
There's no good reason. If a service business is worth having it can charge its clients enough to cover its tax bills.
- Silhouette 9y ago
  Just curious: How many service businesses have you owned/managed to reach that conclusion? Your premise seems to imply that every such business can afford to lose 20% or so off its margins and still remain viable. (Or that the market will bear all such businesses increasing their prices accordingly, but in that case, we have to ask why they have not done so already.)
  - TheCoelacanth 9y ago
    They can't because their competitors don't. If their competitors had to, then they would be able to as well. If that didn't happen, then even a sales tax of a few percent would destroy every grocery store because that is as big as their entire profit margin.
    - Silhouette 9y ago
      They can't because their competitors don't. That's one possible factor, but not the only one. Otherwise any business with no direct competition could increase its prices arbitrarily, and clearly that's nonsensical.
      - TheCoelacanth 9y ago
        > Otherwise any business with no direct competition could increase its prices arbitrarily, and clearly that's nonsensical. That's the entire theory behind why monopolies are bad. It's not nonsensical at all. Monopolies can increase their prices far beyond what the market would bear if they had competition. Obviously, they can't increase their prices without any limit at all, because at some point people would decide to do without instead of paying the higher prices, but they can increase their prices far beyond what a normal business with competition could.

Digit-Al 9y ago

That's reasonably easy to explain. It's called 'going after the low hanging fruit'. Here's the problem: very large companies have very expensive accountants. These accountants are quite often ex-HMRC so know tax law very well. They know all the loopholes and how to play the system. They also have a big budget for political 'donations' which those in power don't want to lose. Plus a lot of very expensive lawyers to defend them from charges. All of this makes it much more difficult and expensive to investigate and prosecute large companies for tax dodging. Small companies, on the other hand, are a fruit ripe for the picking. They don't have much money for fancy accountants and lawyers so it is easy to create legislation to make them pay more money and know that they will have to cough up - or face the consequences. The final piece of the puzzle is that a lot of the top MPs have 'Directorship' positions at the big companies, so have an interest in protecting them. Plus a lot of them are taking advantage of tax loopholes themselves, so have a vested interest in not closing them. (Remember Cameron being outed for being in a tax scheme that was legal, but not entirely ethical?)

Silhouette 9y ago
Oh, yes, it's quite clear how it works in the short term. It's just incredibly naive in the longer term, because the alternative for founders of new businesses typically isn't hiring expensive accountants of their own, it's just not bothering at all. Why should anyone risk their savings and give up the security of a well-paid job (which people in a position to start a viable new business very often already have beforehand) if in return you get all the costs and overheads of running a small business to deal with and then the government is going to impose a very high tax rate on the profits as well? If they had imposed a sudden 7.5% increase on the general rate of income tax, they'd have been out of power for a generation.
- pmyteh 9y ago
  To be fair, the 'very high tax rate' it's been put up to is still less than income tax levels, so it's still being incentivised. I used to be a self-employed consultant. The number of my peers who set up one-man companies, stayed (or claimed to stay) just a whisker outside IR35 and paid themselves in dividends was astonishing. I see no reason why dividends from a company with no fucking capital should be seen as anything other than regular taxable income.

barrkel 9y ago

The general rule I tend to think of is that upward mobility in the wealth distribution is taxed, but position in the wealth distribution isn't. For example, take employee options, typically EMI in the UK. The tax advantages only exist for 10 years from option grant, and only while you continue to work for the company that granted them - the employee needs to maximize their value to the owners of capital. People with lots of capital already, OTOH, get tax incentives to invest.

pjc50 9y ago
Exactly this. It's why the UK doesn't have a meaningful property tax, just the (capped) council tax and a tax on transfer of housing. The last time there was taxation that was genuinely order-redistributive on a large scale was death duties before the war on hereditary landowners who'd not yet figured out how to avoid them.