Taxation: Families

Baroness Donaghy Excerpts

Thursday 17th January 2013 Lords Chamber

[Baroness Donaghy]

My Lords, I thank my noble friend Lady Hollis for introducing this debate and for her leadership. She keeps us all on our toes. Equally, I would like to say how pleased I am that the noble Lord, Lord Freud, is still in his place. It is nice to know that there is somebody there who understands what we are talking about, even if we do not always agree with what he says. I want to deal with the self-employed and the impact on them of draft Universal Credit Regulations 57 to 59 and 62 to 64.

Many self-employed people will not become IT moguls, business entrepreneurs or worldwide rock stars. Many are self-employed because they cannot find secure employment. They are often self-employed on building sites, because the choice is either that or no job at all. They are “white van man”. They are those who, 50 years ago, would have worked in large factories, utilities or local authorities, doing manual or craft jobs. Often, they have been failed by our education system; they are important. Many such people prefer to be independent and would never assume that they would have to turn to the state for help. It is against their natural inclinations. However, sometimes they need assistance, particularly if they have a family to support in hard times. They should be able to expect a state system that responds to their needs. I am grateful to the Low Incomes Tax Reform Group for its briefing on this subject. There have been some improvements to the rules for the deduction of expenses but the most serious objections that were raised last summer remain.

The monthly assessment requirement will mean that small businesses will draw up accounts not once but 12 times a year. The absence of any carry-forward rule will result in genuine trading losses going unrecognised. In addition, the minimum income floor does not allow enough time for a business to grow and develop. It gives no help when a business is experiencing a temporary dip in profits. It also prevents pension contributions and legitimate business expenses being fully recognised.

Under generally accepted accounting principles, a true and far statement of how a business is doing involves accounting for business receipts and expenditure over the period to which they relate. If a business buys stock for resale, it will account for the purchase price over the period in which the stock is expected to be sold. A tax bill, referable to a tax year, may be paid in two instalments but accounted for over the whole year. An insurance premium, paid in one instalment, will be spread over the period of the insurance cover, which is usually a year. Investment in essential equipment will be written down over the equipment’s expected life. If there is a deficit in one accounting period, it can be set against surpluses in other periods which give a true and fair picture of the state of the business.

This method of accounting is also followed for working tax credit, enabling claimants to draw up one set of accounts that keeps administration costs down and matches the support given by the welfare system to the actual state of the business. The universal credit regulations depart completely from these generally accepted principles. Under Regulations 57 to 59, businesses will account to the DWP month by month on the basis of amounts received in the month, minus business expenditure paid out in the month. If that produces a loss for the month, it may be not be carried forward to subsequent months. It is simply disregarded.

If it produces a result lower than the minimum income floor, or MIF, Regulation 62 will substitute a minimum income floor equal in most cases to the national minimum wage for a 35-hour working week, less a deemed amount of tax and national insurance on that level of earnings. It is almost as though someone has drafted these regulations with no experience of the fluctuations of running a business.

Although I was not self-employed myself, I ran a student union for 16 years with a turnover of about £750,000 a year. You learnt that, to get a true picture of March and April, it was better to take the figures together because Easter came at different times each year. You learnt that because of a large booking in July, you made more profit than during the rest of the year. The following month, because it was the only chance for major refurbishment projects and major expenditure, the figures would look pretty dreadful, but I still collected my salary. Unlike a person running their own business under these regulations, it did not have any consequences.

The real objections to this method of accounting are that one month is an artificially short period over which to draw up a set of accounts, and that cash-in, cash-out does not present a true and fair view as it does not relate receipts and expenses to the period over which they accrue. The failure to recognise losses further distorts the economic picture, and imposing a minimum income floor does not allow for events beyond the claimant’s control.

This particularly applies to farmers. It does not take account of the ups and downs in a normal trading cycle that are part and parcel of any self-employed business. Legitimate business expenditure is doubly limited by the denial of any carry-forward relief and by substituting the minimum income floor for the net profit figure for any month in which the net profit figure is lower.

The accounting method imposed by the regulations presents a wholly distorted picture of how the business is doing and ignores the economic reality. The minimum income floor will apply to most businesses after a start-up period of 12 months. Originally, each claimant was to be allowed one start-up period in their lifetime. Since the consultation in the summer, that has been relaxed in that a start-up period may be permitted once in every five years to accommodate a claimant who did not succeed in their first attempt at running their own business but wants to try again. This is a small improvement and should be acknowledged.

After the start-up period, the minimum income floor will apply to every claimant who is “gainfully self-employed” unless they are subject to no work-related requirements, a work-focused interview requirement or a work preparation requirement. A claimant is gainfully self-employed if the business is their main employment and is,

“organised, developed, regular and carried on in expectation of profit”.

If the claimant is not gainfully self-employed, they are not subject to the minimum income floor. Instead, they will face work-search or other requirements imposed by jobcentre staff and sanctions for non-compliance.

One change since the summer is that in calculating the minimum income floor there will be deducted,

“an amount that the Secretary of State considers appropriate to take account of any income tax or national insurance contributions for which the person would be liable in respect of the assessment period if they had earned income of that amount”.

Whether this change is good news or not will depend on what amount the Secretary of State considers appropriate for the purpose. There is a risk that the Secretary of State will assume that a self-employed person pays the same amount of tax and national insurance, over the same period, as an employed person.

In reality, the self-employed pay tax and national insurance in two instalments, in January and July, based on their earnings in the previous period. If the Secretary of State considers it appropriate to take account of the tax and national insurance actually paid by the self-employed claimant, at the time they pay it, that will give at least some measure of relief when the business needs it. Otherwise, the self-employed claimant would be earning less than an employed claimant, yet receive less by way of universal credit because of the distorting effect of the minimum income floor.

On pensions, the self-employed are responsible for their own pension provision, but they will receive no recognition for it under the minimum income floor. They will be at a disadvantage over the employed claimant, whose pension contributions will be relieved in full as and when they are paid.

I raised the issue in November 2011 about what happens when a business suffers a downturn or undergoes a period of economic difficulty. I think I used the example of a farmer who was affected by foot and mouth disease in neighbouring stock and was working twice as hard but could not move his stock for sale. I hoped that the minimum income floor could be suspended during periods when the business suffered in such a way. Assurances were given in the debate that these were,

“issues that we are looking at very closely”.—[Official Report, 1/11/11; col. GC 453.]

However, no such provision has been made by the regulations. There is no recognition in the regulations that a business may experience low or no profits.

The absence of any facility for carrying forward a loss made in one month to subsequent months remains a fundamental flaw in the design of universal credit for the self-employed. In discussion, the Government have appeared to see the need for this facility but have not made any changes because the IT system has not been designed to allow carry-forward.

The burdens that the proposed regulations impose on the smallest businesses and the disregard for the most basic principles of accountancy will seriously hamper claimants who wish to enter work via the self-employed route. In many cases, they would find themselves better off on benefits than in work, which is plainly contrary to the Government’s intention.

There are 4.5 million self-employed people in this country, any of whom may at some point need to claim universal credit due to the risk and uncertainties inherent in running one’s own business. Self-employment is a viable route out of welfare and into work. I hope that the Government will reconsider the regulations and create a system that is as responsive to the self-employed as it is to the employed and unemployed.