The move comes as an increasing number of small businesses complain about the over-complexity of the current PAYE system and lack of cohesion between agents and the tax authority when dealing with compliance problems.

In a wide ranging report into the small business taxation problems facing businesses from start-up stage to growth and maturity, OTS is also urging the government to simplify corporation tax reporting and set a more strategic approach to tax administration and system changes. 

The OTS says that when companies are setting up for the first time - the so-called ‘pre-formalisation’ stage - many people make decisions that have unintended negative consequences, such as whether to establish a company, partnership or act as a sole trader, while in some cases, the focus on day-to-day business may mean that there is an almost complete absence of records. Advisers, when they are eventually consulted, frequently find themselves needing to resolve such issues much later on, this adds to inefficiency and cost.

Bill Dodwell, OTS tax director, and former head of tax policy at Deloitte, said: ‘Many new businesses are formed without sufficient help and guidance. This can lead to mistakes being made, resulting in substantial costs or penalties as their tax compliance affairs are put in order.

‘We recommend that government offer better and more readily accessible guidance, joined-up across government and communicated through multiple channels, to help people starting small businesses.’

The report calls for HMRC to do more modelling of the taxpayers' ‘journey’ and to ensure that when new tax systems are planned, such as the extension of Making Tax Digital, the tax authority needs to take account of the taxpayer’s view of how they are used as well as its own internal requirements and targets.

The OTS says the current PAYE system is failing to handle the fluidity of the modern workplace effectively, for example in relation to changes of job mid-month or individuals holding multiple jobs or concurrent employment and self-employment, while system problems lead to significant costs for businesses, agents, employees, and HMRC itself. For example, there are around 350,000 duplicate employment records, and around 5% of returns are received late.

There are around 350,000 duplicate employment records, and around 5% of returns are received late

Dodwell said: ‘It is time for a new review of PAYE, to look at areas where the inputs from employers do not work well and how they are processed by HMRC to update tax codes and the new personal tax accounts.  The review needs to update PAYE for modern working patterns.’

The report indicates there would be merit in exploring an optional PAYE-like experience for self-employed people, who would benefit from being able to set aside some tax payments in advance in order to ensure future compliance, but with the facility to draw on this fund if they experienced cashflow difficulties.

Tax agents

HMRC’s data shows that over 70% of small businesses use a tax agent to handle their tax compliance. However, HMRC does not currently provide tax agents with access to the same information as their clients or enable them to carry out a very wide range of tax transactions for them.

The OTS argues that if tax agents were able to see relevant client information and carry out such tasks routinely, they would be completed more quickly and with fewer mistakes, which on its own would be a major improvement. This change would reduce costs for taxpayers and for HMRC, as there would be fewer calls and queries to resolve. Experienced tax agents can also add value by being consistently consulted when changes are being implemented or communications developed.

Dodwell said: ‘HMRC could do much more to leverage the support agents can bring in making the tax system work for millions of taxpayers. Ensuring that the valuable role of agents is built in to all new or redesigned systems, would go a long way to support small businesses – and support HMRC too.’

The OTS report recommends HMRC should appoint a senior official to oversee and prioritise implementation of the agent strategy. The focus of this role should include ensuring that agent needs are built into new systems; developing constructive engagement with the profession, to ensure that agents feel listened to and understood; and working with HMRC officials to increase their understanding of the role of agents.

Corporation tax

In the report, the OTS says it considers there is also scope to simplify the corporation tax process. One particular concern is that almost 60% of companies formed since 2010 have needed to do two tax returns to cover their first accounting period: one for 12 months and one for a few days or weeks. It wants HMRC to work with partners such as Companies House to develop digital options to help small companies prepare accounts and tax returns, including the use of an optional accounts template that is simple to use and acceptable to HMRC and other departments.

It also wants HMRC to simplify the corporation tax online return process as part of any future extension of Making Tax Digital to corporation tax, so that, as with the online income tax process, taxpayers only see the pages and information relevant to them and have pop-up information and help screens at key points.

Tina Riches, chair of CIOT’s owner managed business sub-committee, said: ‘The OTS is on the money with its recommendations to address the tax challenges faced by small businesses. Tax advisers that act for small businesses have been calling for change in a number of these areas for years. It is great that the OTS has picked up on many of them and is calling for action to be prioritised.

‘One of the most important areas is around removing the barriers for those professionals that are genuinely trying to help small businesses. Many businesses realise that their business can be more successful if they concentrate on running the business and outsource specialist areas. This includes using a tax adviser to assist with their tax compliance.’

The HMRC definition of a small business has annual sales not exceeding £20m and employs no more than 20 people. A micro business has sales up to £2m and maximum 10 employees. Three quarters of small businesses are sole traders, with only the owner as employee.

Small businesses make up over 99% of all the 5.7m businesses in the UK; employ 12.9m people and pay over £205bn in tax.

OTS Simplifying everyday tax for smaller businesses: a further business lifecycle review

Pat Sweet