Big firms profiting from tax collection

News Analysis: High cost of running a payroll punishes small businesses

GOVERNMENT red tape is strangling many small businesses while allowing their larger rivals to make money out of the system, according to an authoritative Government report published yesterday.

For the first time it has been proved that companies employing more than 1,000 employees make money out of the tax and national insurance system.

Yet business start-ups with one to four employees pay over pounds 270 per person on complying with red tape. And the system is steadily sliding even more in favour of larger companies, according to the study.

The result is that the smallest 30 per cent of businesses pay 75 per cent of total costs of complying with red tape in the UK.

Three years ago the then government commissioned Professor David Collard of the Centre for Fiscal Studies at the University of Bath to undertake a comprehensive study of the costs of complying with tax and national insurance. "The Tax Compliance Costs for Employers of PAYE and National Insurance in 1995-6" is set to alarm employers and accountancy firms alike.

Over 1,300 companies were polled by post while the research team conducted 300 face-to-face interviews. Professor Collard then compared the results to the last study of the subject in 1981/2

The picture that emerged was that of small start-up companies being strangled by the high costs of organising payroll systems, while their larger rivals were able to make money out of the process by using computerised systems.

The report also found that small firms were paying far too much to accountancy firms for routine book-keeping work, which could be done far more cheaply by staff in-house.

The report made eight recommendations to employers and 31 to the Government. Several proposals were radical.

For instance, Professor Collard calls for the development of a "smart card" which freelancers could use, embodying all their various tax allowances. The card would be "swiped" by each new employer, rendering much form-filling unnecessary.

The Professor also questions the very idea of collecting PAYE from small businesses at all. Since it is relatively so expensive for small companies to do it, it makes sense for the Government to switch some of the burden for PAYE collection on to employees, he suggested.

The most striking finding of the study was that companies over a certain size make money when they collect PAYE and National Insurance Contributions on behalf of employees. This is because the government allows them a certain period in which to hand over the proceeds. During that time the companies use the money - entirely legally - to boost their cash-flow.

Professor Collard says: "For small employers the cash-flow benefit is only a small offset to compliance costs, but for employers in the 1,000- plus bands, cash-flow benefit more than than offsets such costs.

"In this sense the largest employers actually benefit from acting as unpaid tax collectors: the cash-flow benefits of withholding tax exceed their gross compliance costs."

A spokesman for the Inland Revenue said: "This looks like a strange result, but it is credible. The existence of this cash-flow benefit has been known before now, but this is the first time anyone has calculated how much it is worth to business."

The total cost to British companies of complying with PAYE, expenses and benefits-in-kind, National Insurance, statutory sick pay and statutory maternity pay is now pounds 1.32bn.

This represents a rise in real terms of 42 per cent since the last study in 1981/2. The Inland Revenue points out that this is roughly in line with the growth in the UK's gross domestic product.

Real compliance costs per employee have hardly changed over the period for middle sized employers with 10-49 people on the payroll. They have fallen by about a quarter for employers with over 100 people, but have almost doubled for employers with one to four employees.

This is not a good time to start a company, it would appear.

Last week Gordon Brown announced in his pre-Budget speech that the merger of the 50,000-strong Inland Revenue and the 10,000-strong Contributions Agency was being speeded up in order to cut this kind of red tape.

A pilot scheme for "one-stop shops" run by the newly merged agency in Leicester has proved popular with small businesses, since they can get practical advice on setting up payroll systems for free.

The Revenue spokesman observed: "People starting businesses used to be just thrown a starter pack and told to get on with it. Now we will talk them through the process."

The report is likely to enrage accountants. Professor Collard blasts them for doing far too much work for small firms which could be done more cheaply by the companies themselves.

"Resort to accountants is one reason why compliance costs are so high for small employers," the report says. It notes that the Inland Revenue is determined to expand its free advice on this subject. It also says small firms currently filling in tax forms by hand could make large gains by switching to electronic filing.