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Last Updated: Tuesday, 16 March, 2004, 15:50 GMT
Stuck in the Chancellor's loophole
By Sarah Toyne
BBC News Online business reporter

Ann Coombe and one of her Hungarian Vizslas
Ann Coombe and one of her Hungarian Vizslas

Beware Chancellors bearing gifts.

In Budget 2002, Gordon Brown waved his magic fiscal wand and handed over one of the sweetest tax deals in years to Britain's 3.8m self-employed.

But the move, which encouraged sole traders to incorporate their businesses, is estimated to have cost him more than 1bn in lost tax revenues.

Two years on, the UK's small business owners are now biting their nails, in anticipation of an expected tax clampdown in this Wednesday's Budget.

To incorporate or not

Setting up a business can be a confusing affair for even the most savvy entrepreneur.

2000 to 2001: 238,000
2001 to 2002: 225,000
2002 to 2003: 325,900
2003 to 2004 (11 month year): 357,900
*Companies House

There are a range of legal and tax structures you can choose from.

The two main ones are becoming an unincorporated business, as a sole trader for example, or opting to incorporate - a more complex process - and becoming a limited company.

In Budget 2002, the Chancellor effectively took the decision out of the hands of many businesses.

Put your question to Anne Redston from accountants Ernst & Young at 1430GMT

He cut the rate of corporation tax on the first 10,000 of profits made by small businesses to zero.

This meant a sole trader with annual profits of 15,000 could save about 3,000 tax if they switched to incorporation.

The move was a "gift horse" to many of Britain's small businesses.

A tempting offer

In the year before the announcement, 225,000 businesses had incorporated.

Every year my accountant said don't do it - until last year
Ann Coombe

Within a year that number had risen by 100,000 to 325,900.

Over the last eleven months, 357,900 more have registered.

It wasn't only new businesses that were taking the plunge.

Many people who had operated as sole traders for years took up the Chancellor's tempting offer.

Ann Coombe, a kennel owner, from Ilkeston in Derbyshire and member of the Federation of Small Businesses, was one such sole trader.

"I've had the same accountant since I started back in 1987 and we have discussed incorporating every year, and every year my accountant said don't do it - until last year," she told BBC News Online.


In the December pre-Budget report, the Chancellor fired a warning shot at small businesses, including those who had newly incorporated.

Paragraph 5.91 in the report warned small businesses that the Treasury would "bring forward specific proposals for action in Budget 2004 to ensure that the right amount of tax is paid by owner-managers of small incorporated businesses."

Having got them inside then they remove the goodies. Two year's later that's what looks like what's happening
Neil Hamper, Federation of Small Businesses

Since then, the government has remained tight-lipped about the changes and says anything that has been written about its proposals is "pure speculation".

But the reluctance to discuss the issue has angered accountants and small business owners

"It's a bit like throwing your darts at the board and not knowing where the board is," says Anne Redston, tax partner of Ernst & Young.

"It is not a satisfactory way to run tax policy."

Ms Redston suspects many businesses are unaware of the changes, particularly at the smaller end - and they could be rushing like "lemmings over a cliff" into incorporation.

For other businesses, she says, it is the uncertainty of the proposals that is the biggest annoyance.

"It is very difficult for people to know whether to incorporate, to price contracts or for people who want to start a new business venture," she says.

Others are suspicious about the government's original motives.

"We always thought this was a cynical move to get people into a regulatory environment," says Neil Hamper of the Federation of Small Businesses.

"So having got them inside then they remove the goodies. Two year's later that's what looks like what's happening."


Mrs Coombe is among many people waiting to see what the Chancellor will announce.

She jokes that she is too old to be angry, but she is "peeved".

Changing to incorporation cost her about 1,000 fees and about 40 hours of extra work, but what annoys her most is the government's unwillingness to discuss its ideas in advance of the Budget.

"The thing that peeves me most is that he has just dropped some tiny nugget in his pre-Budget and then refused to tell people what it is about and what is going on."

Tax shock for small businesses
10 Dec 03  |  Business

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