AS SOME small business owners in the UK complete their tax returns this month, they will be envious to hear that their German and Spanish counterparts could soon be free of the irksome task.

Spain and Germany are debating the benefits of a “flat tax” — already adopted in many former communist states — under which all personal income and corporate taxes are rolled into one base tax. All exemptions, apart from a large personal allowance, are also abolished.

A flat tax system, while simpler to administer and easier to understand, could be a mixed blessing for the UK. It would cut the cost for small businesses of complying with the Treasury’s tax regime, but entrepreneurs could pay more tax depending on the rate at which it is set.

Chas Roy-Chowdhury, head of taxation at the Association of Chartered Certified Accountants, says that small businesses are likely to benefit more than large companies from the introduction of a flat tax. “Most businesses would benefit from the economic boom associated with (the introduction of) a flat tax, but smaller companies would benefit even more than large businesses,” he says.

“Small and medium-sized enterprises (SMEs) spend more on the overall cost of complying with the tax system. This includes completion and filing of returns and payments of taxes across the range of taxes in existence. The flat tax would simplify the system and they would benefit from reduced compliance costs.

“Additionally, because many SMEs are taxed at rates based on their owners’ returns, they would benefit from the large personal exemption. They would also be more likely to benefit from the lower interest rates since a flat tax would reduce demand for credit.”

The complexities of the current tax legislation, which is contained in more than 11,000 pages of documents, are such that annual compliance costs for small businesses are estimated at £6 billion — 60 per cent of which is for sole traders and 40 per cent for small companies. According to Professor Francis Chittenden of the Manchester Business School, PAYE compliance costs for small firms are £1.3 billion.

Accountants estimate a flat tax could cut those compliance costs by up to 90 per cent.

Simon Sweetcorn, vice-chairman of tax at the Federation of Small Business, says that members’ compliance costs often exceed the amount they pay in taxes. Moreover, many members shelve their expansion plans because of the complicated tax system.

Kevin Nicholson, the UK head of entrepreneurs and private companies tax at PricewaterhouseCoopers, says that the success of a flat tax in the UK would depend on the rate at which it is set. “A flat tax is supposed to increase the Government’s revenues by both encouraging enterprise and reducing tax avoidance, since tax credits and exemptions would not exist,” he says.

Critics say that the tax rate would need to be relatively high to ensure that the Treasury does not lose revenue. Mr Nicholson adds: “Entrepreneurs and small businesses may be put at such a disadvantage that they may relocate outside of the UK to another country with a lower rate.”

The Adam Smith Institute, the think-tank, has proposed that current UK income tax rates (between 10 per cent and 40 per cent), could be simplified to have a flat 22 per cent rate with a £12,000 personal allowance. Similar proposals also apply for corporation tax, where a single tax could replace current rates of up to 30 per cent.

Mr Nicholson says that, while a flat tax scheme would enable businesses to plan for the long term, the risks could outweigh the benefits: “There is a risk that some of the smallest businesses, who currently pay less than 10 per cent in corporation tax, would end up paying more even if the flat tax was set at a moderate rate.”

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