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Revenue based taxation

Revenue based taxation

Imagine a world of revenue based taxation, rather than the profit based taxation approach we have today.

This week the newspapers were full of stories about such a proposal by the authorities, aimed at stopping multinational firms from selling lots of product without paying much tax.

The proposal isn’t as novel as it first appears to be.

In recent times the United Kingdom tax authorities removed an individual (i.e. non corporate) landlord’s ability to offset mortgage interest against rental income. This change is being phased in over the next three years.

Other landlord expenses such as property management fees and repairs remain tax deductible (for now).

Mortgage interest is the largest expense for many landlords. This change effectively shifts the basis of investment property taxation from profits towards being revenue based.

Think about that for a minute.

Today if a business operates at a loss then it pays no tax. This principle is how the large multinationals avoid paying taxes on their sales in the United Kingdom.

Under the new rules a landlord would effectively be taxed based upon rental revenue. If generating that revenue cost more than it is worth then tough! The tax authorities demand their share regardless, even if the business doesn’t have it… as Toys R Us discovered to their cost this week.

Operating at a loss

The problem landlords now face is that many of them (particularly in London where rental yields are laughably low) are operating investment property businesses at a loss. The residential landlord business model was often:

  • buy a property
  • (possibly) rent it out to minimise the holding costs, often operating at a loss
  • wait for the market to rise
  • sell the property for a hefty capital gain.

Any business model that relies upon the Greater Fool is a risky proposition. The capital gains fairy may perform her magic, but that is never guaranteed.

Smarter residential landlords properly run the numbers on potential property deals. They made sure a property will be both self-funding and profitable, without needing to rely on tax deductions and figments of an accountant’s imagination such as depreciation.

The important of a sustainable business model

As a landlord I was a tad miffed at the changing of the rules. It reduces the profitability of operating a leveraged residential property business, a model that has contributed to my own financial freedom.

However I believe that if a landlord’s business model relies upon tax relief to be sustainable then it isn’t much of a business model in the first place. I disagree with subsidies, tariffs and rent-seeking at the best of times. If a business can’t stand on its own feet then it should be allowed to fall over.

Revenue based taxation

As a business owner I am intrigued by the notion of a revenue-based taxation. On balance I think the concept would be a positive thing, though the practicalities of implementing one make it unlikely.

Capital allocation and investment decisions would improve. A proper cost/benefit analysis would be necessary to determine whether the earning of a revenue stream warranted the costs of doing so.

The tax system could be greatly simplified, as tax deductions would no longer be required.

An individual or corporation’s self-interest would determine if a job were worth doing.

Next Steps

  • How sustainable is your business model?
  • How would it cope under a revenue based tax system? Does that identify any weaknesses in the current model?
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