Why small businesses should fear a CGT

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

Small businesses account for 50-60 per cent of all employees. They provide us with personal services, shops, restaurants, and trades. Imagine your community without them.

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

So why would a person seek to start a new small business? Unemployment is one reason. Independence is the most often quoted. 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 could constitute a significant brake on innovation and entrepreneurial activity. Did Cullen and colleagues consider this?

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

The life cycle of the small business has a number of phases: startup; 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. In a majority of cases, they will decide to simply close the door, often because family members, having experienced the burden and sacrifices made, have no desire to take them on.

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 taxation review has been trumpeted as being all about ‘‘fairness’’. But how fair is it to tax the residual value of a business that has had to survive in an unsympathetic, highly regressive and often ideologically hostile environment, only to find that, at the end of a difficult journey, a rapacious government will requisition 33 per cent 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.

And small businesses have nothing to fear?

Emeritus professor Martin Devlin conducted the first research into small businesses in New Zealand while at Otago University in 1976.