Martin Devlin: Small Businesses beware!

Our Prime Minister assures farmers and small business owners that they have “nothing to fear’ from a proposed capital gains tax.

But they have much to fear.

Why? Because small businesses already have to deal with an overwhelmingly onerous, highly regressive, taxation compliance regime, to which they must conform, at considerable cost ,with significant financial and personal penalties if they do not.

These include company tax; income tax on salaries and drawings; fringe benefit tax; goods and services tax(GST); ACC levys; resident withholding tax on investments or dividends such as a shareholding in a partnering business; imputation tax issues; employer subsidy contributions ;the cost of filing annual returns; franchise fees. The list goes on and on.

The cost of complying with these government requirements is already astronomical for small businesses. The Cullen-led Tax Working Group appears to be both ignorant of and unsympathetic to the fact that these compliance costs are hugely regressive. The cost of compliance as a proportion of turnover is far higher for small businesses than for larger businesses.

Small businesses account for 50-60%of all employees. They provide us with personal services, shops, restaurants, and trades, to name just a few.

Imagine your community without these facilities?

Small business ownership is hazardous. Of 100 new start-ups this year, more than 80% will not survive the first five years.-an alarming failure rate. The social cost is  extremely high.

So, why, then, would a person seek to start a new small business? Unemployment is one reason. Independence is the most often quoted reason. Testing an innovative idea is also significant. Many entrepreneurs attempt to sell their nascent businesses to a larger organisation which can develop their innovation. But this step will inevitably attract  CGT. This very fact could constitute a significant brake on innovation and entrepreneurial activity in New Zealand . Did Cullen and colleagues consider this?

Research also shows that the prize of making a substantial capital gain when the business is eventually sold, is definitely not a  motivational element in starting up a new enterprise. How can it be, given the almost impossible outcomes which would need to be overcome to realise such a gain?

The life cycle of the small business has a number of phases: start up; growth; maturity; and decline.

At some point in the maturity phase,, signs of decline will emerge such as falling sales, increased competition, changing markets and restrictive government regulations. The owners must then decide either to continue, try to expand or to sell up. In a majority of cases, they will decide to simply close the door, often because family members, having experienced the sheer burden and sacrifices made, have no desire to take on such burdens themselves.

Perhaps the single biggest issue in applying a CGT to small businesses is what to tax? And when? Most small businesses have few tangible assets. Most lease their premises. A small business is very much the owner/manager and their skills, experience, knowledge and networks. This is identified as goodwill and increasingly, social capital. The Cullen group ignores these values. How can a CGT be applied to goodwill and social capital?

The taxation review has been trumpeted as being all about “fairness”.

But how fair is it to tax the residual value of a business which has had to survive in an unsympathetic, highly regressive and often ideologically-hostile environment requiring owners to  expend huge personal effort, time and money over many years, only to find that at the end of a difficult journey, a rapacious government will requisition 33%  of their realisation, in the name of “fairness”?Applying a CGT to small businesses will encourage many to simply walk away. What a disaster, in terms of fewer jobs, reduced community services and a disincentive to entrepreneurship.

Governments would be well advised to abandon any proposal to further tax small businesses, if they seek to encourage a vibrant and progressive small business sector.

And small businesses have nothing to fear?

Martin Devlin is emeritus professor of management from Massey University where he has lectured, conducted research and actively consulted, for 35 years, in the fields of management, entrepreneurship, SMEs and corporate governance.