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People here will know

There’s something called a “close company”. I get the general drift: something that’s under the control of only a few people, can rather be regarded as an extension of their persons, rather than truly an independent entity, yes?

The tax laws are different. But how are they different?

My assumption is that this is important to the idea of abolishing corporation tax. If we do that then some say that rich peeps will just incorporate and never pay any tax. But isn’t that what this definition of a close company is trying to deal with? If you’re little more than an investment fund for one or a few people, then you get taxed differently anyway?

37 thoughts on “People here will know”

  1. Yes taxes are bad. But why is corporation tax badder than personal tax? Where are you going to shift the tax burden? Sales tax? Import tarriffs? More income tax? Window tax?

    I can see a lot of good arguments for lowering tax generally, or for tax simplification. But why corporation tax in particular? I hope this isn’t the Incidence Fallacy (the “other people have to pay it” argument (which applies to all taxes)).

  2. The extra rules make it harder for the participators to extract value from the close company without paying tax (e.g. loans or leases of close company property). Apart from that close companies are largely treated the same as other companies.

  3. If I remember rightly a close company is one under the control of 5 or less people in which case the profits are treated as if they are paid out by dividends to the shareholders and the shareholders taxed on the income

  4. If rich people incorporate, they’ll still pay tax when they take the money out of the company. For example if they actually want to buy something.

    There are already plenty of rules taxing your company heavily if you try e.g. to buy a Ferrari as company car. Likewise for most people’s largest asset (their home): if you live in a property rented to you by your company, all sorts of petty rules apply.

    Doesn’t stop some people trying. For example if the company that owns Worstall Manor is an anonymous trust in the Caymans, then nobody can prove that you’re the real owner and thus may be avoiding some taxes.

  5. The Other Bloke in Italy

    I think the main point these days is that if I overdraw my loan account with my little company, I have to pay it back toute suite, or I am charged tax at 25% on the outstanding balance.

    Long ago, a close company could be forced to declare a dividend on retained profits so as to trigger Advance Corporation Tax, but St Maggie’s government did away with that.

    The good Pellinor and other will know better.

  6. @Wack “If I remember rightly a close company is one under the control of 5 or less people”

    Or any number of participators who are directors.

    Or a company where more than half the assets would be distributed to 5 or fewer participators or any number of participators who are directors in the event of a winding up.

    As Alex says, Close Company rules restrict the ability of those that control to take money out of the company.

    These rules have evolved because HMRC are not simpletons having rings run round them by clever accountants.

    The media, Richard Murphy and MPs (who make the rules) would have you believe it’s really easy to avoid taxes and that every tax avoided is somehow an unintended wheeze on the part of the rich.

    It just isn’t so.

  7. Close companies have certain special rules on distributions, the point being to stop the participators using the structure to extract value from the business with undue tax advantages. Other than that, they’re all pretty much the same: the profit is charged to CT and plain vanilla dividends are treated the same as for any other company. So the idea that rich people would incorporate blah blah blah: bollocks. They would be charged at the point they took the money from the business. Yes, there would be no tax whilst the money stayed in the business, but that would be the same for any company.

    One thing though; beware IHT rules for close companies. Certain payments could be treated as lifetime gifts; ouch.

  8. @Ian B
    “Yes taxes are bad. But why is corporation tax badder than personal tax? Where are you going to shift the tax burden? Sales tax? Import tarriffs? More income tax? Window tax?”

    All (almost all) taxes cause tax wedge effects, reducing growth. Different taxes have different impacts. The OECD did an empirical analysis of the effects of multiple types of taxes.

    Worst of all they investigated was corporation tax (Albeit a FTT would be even worse)

    Then it was income tax (progressive taxes worse than flat taxes, as substitution effects are easier for the more affluent).

    Then it’s consumption taxes, and finally taxes levied on property, with immobile property (eg land) the least damaging by far.

    You can therefore promote growth with the same level of taxation by shifting from worst to better down the list.

  9. Hmm, colour me sceptical. That sort of analysis seems to be predicated on the idea that growth is a monetary phenomenon. All this seems to me to be, like virtually all arguments about tax, special pleading of the “it would be much better if taxes were levied on people different to me” principle. People who earn more than they consume tend to plead for consumption taxes. And so on.

    Growth (in any meaningful sense) is a function of innovation, which is why backward countries can achieve very high growth rates when they start playing catch-up. Not taxation policy.

  10. “That sort of analysis seems to be predicated on the idea that growth is a monetary phenomenon. ”

    No, it is predicated on the “tax wedge” idea, also known as “deadweight cost”.

    Have you considered reading an A level economics textbook Ian? I know you’re interested in economics and spend a lot of time prognosticating on it. If I recall correctly you slogged your way through Keynes in the original? I think you might get more out of (be more informed by, enjoy more) working through something more holistic and introductory (even if it is teaching you to suck eggs in a lot of respects it is always nice to fill in the gaps, where they occur). There’s also Mankiw’s textbooks, which are very readable.

  11. (Re “Growth (in any meaningful sense) is a function of innovation” … Macro textbooks will split this out in terms of how long-term you’re talking. Policies other than on productivity and innovation can matter too. Go have a read.)

  12. I was under the impression that consumption taxes were actually one of the worst. Not only do they add complexity for retailers and lower the total consumption but they are regressive.

    I attempted to find the study you site but I had no luck. Do you have a source?

  13. Andy Cooke

    I would second Liberal Yank’s question. I am not challenging you, but it does seem counter-intuitive to me. Land taxes ahev no tax wedge – Ricardo. Capital taxes are a very bad idea. However, I would have thought consumption taxes, rather like transaction taxes, would carry a very significant deadweight cost.

    Anything you could offer to elaborate would be welcome.

  14. That’s actually the standard OECD calculation on the matter. And I’ve been repeating it for years which might be where Andy got it. Yes, consumption taxes (VAT) have deadweight costs. But they are lower than those of income taxes.

  15. I’m an Austrian, so I consider most arithmetical economics and econometrics to be bullshit or, to put it politely, pareidolia. You know, the one fact about macro is there is no macro, that kind of thing.

  16. Having a close company does not mean much unless trying to use it as a piggy bank.
    For many of us there really is no difference. HMRC are aware who we are.

  17. In the USA:

    A Closely Held Corporation:
    1) At least 50% of stock held (constructively) by 5 or fewer persons.
    2) Has not elected to be treated as a Personal Services Corporation.

    Characteristics:
    1) Increased limitations on officer compensation.
    2) Increased limitations on passive activity losses.
    3) Increased thresholds related to what constitutes ‘at-risk’ activities.
    4) Increased limitations of related party transactions.

    Given that, the real purpose of US tax law with relation to closely held corporations is aimed at establishing appropriate value for the corporation. What the IRS wants to thwart is the sale of stock between related parties at an unrealistically low price.

  18. Is it just the dead weight costs that the taxes are rated by or are there other factors?

    If so what are those factors?

    Are the dead weight costs just those of the government or do they include the costs to the agent that transfers the tax to the government?

  19. Thjis is rating just by deadweight costs: or “efficiency” in hte jargon. There’s also “effectiveness” (how much revenue?) and “equity” (fairness) to consider. That ranking is on efficiency.

  20. As people have said, a close company is one where a few people (“participators”) own it and run it.

    The main impact at the moment is around loans from the company. HMRC consider that a participator borrowing money is effectively a dividend, and so there is tax on the loan which HMRC regard as a proxy for the income tax the participator would have paid on a dividend.

    Which essentially means that you can’t get tax-free value out of a close company – you either take it as taxable income or as a taxable loan (trying to restructure as a capital receipt is pretty much impossible now). So to avoid or defer tax you pretty much have to leave the cash in the company and reinvest it (which to certain observers still means you’re avoiding tax).

    They don’t care about non-close companies so much, as from a commercial point of view a company with a diverse group of shareholders is much less likely to be dishing out cash to people in an unstructured way. As you say, it’s at the close end of the spectrum that the corporate veil tends to be a bit thin.

    Some of the OTS work on small company taxation seems to be suggesting that small companies (more likely to be close) might (or ought to) be regarded as transparent. We’re resisting that, but it’s maybe an indication of a possible direction of travel.

  21. If the rating is just dead weight costs than it doesn’t mean much. I hope we all can agree that the single working mother barely making ends meet should not be paying a higher tax rate than the Trump just because tax collection is more efficient.

    Is there a place I can find actual numbers for all 3 factors?

  22. Liberal Yank

    No, the efficiency in deadweight costs, the tax wedge, is.ecomokic and not the costs of collection.

    The fairness sent is well made. It’s why we have personal allowances, National Insurance thresholds etc.

  23. Dennis the Peasant

    The personal service company or ‘S’ corporation (please correct me if I’m wrong) doesn’t exist for tax purposes in the UK. They’re just companies.

  24. Since we have yet to pay for the wars in Afghanistan and Iraq, Medicare part D, as well as the interest accrued someone in the country needs to figure out how to do it. Since no one else seems to want to bother I guess I might as well. Understanding how taxes actually work is an important step.

    Did you ever think you’d come across a fiscally responsible socialist?

  25. Ironman, the equivalent to an S corporation in the UK is IR35. But here it’s compulsory if you meet the tests; in the US it’s optional.

  26. Consumption taxes are flat taxes. Some people analyse consumption taxes in the UK and find that the poorest 10% pay a bigger share of their after-redistribution income in consumption taxes and conclude they are regressive.
    They make the mistake of not accounting for the fact that the various 0%-5% rates of VAT advantage smart people and the 20% and higher rates disadvantage the thickos.
    Example: Smart people do organised exercise and eat home-cooked food from fresh air-freighted ingredients from Waitrose ( all 0% ) – while the thickos go to Slimming World and then eat a take-away ( both 20% ).

  27. One option, make company taxation a tax credit when dividends are paid. Thus a company making a profit and paying say) 25% in tax, pays out a $1,000 dividend that is issued as a total of $750 cash and a $250 tax credit. The $750 is taxed at the recipients marginal tax level with the $250 credit applied against any resulting tax liability. If Company and personal tax rates are aligned, dividends are “tax free” as the tax has already been paid.

    This is used in some jurisdictions already.

  28. I could see a corporation not having to pay any tax but every £ that should be taxed is.

    What happens when foreign dividends are paid?

  29. “I hope we all can agree that the single working mother barely making ends meet should not be paying a higher tax rate than the Trump just because tax collection is more efficient.”

    No we can’t all agree. Because its entirely possible, indeed probable, that the economy will be bigger if the more efficient taxes are imposed, thus resulting in more tax revenue, and the ability to pay the single mother higher benefits than would otherwise be possible.

    We could impose 100% tax on Donald Trump and his ilk, and zero on single mothers, but that would mean far less tax revenue and maybe no single mother benefits at all. You are making the assumption that changing the type of tax does not change the size of the economy (in the long run), and result in differing outcomes.

    Would you rather be a single parent who got £5k/yr benefit and paid no tax, while basking in the knowledge that Donald paid lots of tax, or one who got £10k but paid VAT of 25% on your purchases, and had to suffer the knowledge Donald paid exactly the % on his purchases? Is the sense of smugness worth hard cash in your pocket?

  30. The personal service company or ‘S’ corporation (please correct me if I’m wrong) doesn’t exist for tax purposes in the UK. They’re just companies.

    Dunno, UK taxes ain’t my thing. Was just throwing the US version out there for giggles.

  31. Dividends paid to foreign investors. Imagine if I invested in your soapbox company. The US government would tax me here. If your company still gets a tax credit then that profit in untaxed in Britain. If it doesn’t get a credit or I have to pay British taxes it is a double taxation situation discouraging foreign investors.

  32. Jim the single mother is making enough to live on without a special handout* so why would we give her one if we don’t need to?

    My argument is that a regressive tax is a drain on society compared to equal rates across equal income brackets. I do not, at this time, make any arguments on the effects of the overall tax rate on the economy. Adding tax credits that lower what the poor pay leads to progressive tax schemes which will have a different effect so I am not adding it here. Welfare for people making more than the poverty level is a debate for another time. To further explain what I mean I will make some simplifications.

    In our fictional world the 10% of all British income needs to be taxed to balance the budget. Let’s say that our mother needs £17k a year to survive and is able to make £20k before taxes. If everyone pays the 10% that is their fair share she still has £1k left over, not much but still enough to get a few luxuries.

    When she has to pay a higher rate than Trump** that £1k can quickly disappear. Thanks to the regressive tax rates she now may need wealth transferred, either through the government or charity, to survive. As neither government or charity is 100% effective at wealth transfer the cost to society is higher than Trump’s savings. We will save discussing which is more effective for another time.

    If we are to use government for the wealth transfer tax rates will have to be raised. This will push more people, as they still pay a higher tax rate, at the lower end onto welfare to pay for the cost of the existing welfare until the new equilibrium is reached.

    In this case charity can be thought of as Trump volunteering to pay additional tax. Other than a sense of do-gooder entitlement Trump gains nothing for his acts. The advantage is that fewer additional people will need assistance. The disadvantage is that we have to trust Trump to voluntarily give up his wealth in a way that is more effective than the government.

    I do admit I used the hard working, tax paying, mother for emotional reasons. I would hope that all of us would want to avoid pushing her into poverty, by making what they earn insufficient, simply so we individually pay a low income percentage for the cost of our government. Policies for the junkie ODing in the corner can be completely different. I do hope I have included all of my major objections to regressive taxes without missing any key points.

    *I am just looking at regressive versus equal for all income level tax rates. Welfare for people making more than the poverty level is a debate for another time.
    **Insert the billionaire of your choice here. I choose Trump as he is running for public office but it could just as easily be Soros.

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