Small business taxation

This chapter considers the taxation of small, owner-managed businesses. It focuses on the difficulties created by treating employees, unincorporated and incorporated businesses differently for tax and social security purposes. The authors reject blanket tax incentives for small firms and differentiation between legal forms and concentrate on issues arising from opportunities created on incorporation for the conversion of income from labour into income from capital (taxed at a lower rate). Experience in the UK and elsewhere suggests that an approach that relies on defining a sub-category of small businesses will not produce a satisfactory solution. The chapter therefore examines methods of aligning the effective tax treatment of different legal forms: in particular it considers the advantages of combining a Rate of Return Allowance with an Allowance for Corporate Equity, so as to tax income above the normal return to capital at the same rate whether it is described as dividend, capital gain or salary.