CONCLUSION It is the conclusion of this study that a necessary starting point for meaningful comprehensive tax reform and simplification is to establish a uniform tax definition for small business. The study has revealed that: Existing tax definitions are inconsistent, uncoordinated, and do not provide an adequate framework for addressing the practical economic and administrative realities con- Existing income tax entities have no relevance to the tax problems of small business; Complexities and pitfalls of Subchapter S have caused this provision to fail in its stated purpose of removing tax but removal of such considerations is necessary; The elimination of double taxation of the earnings of corporate small businesses is necessary to promote the 42 PART II OTHER DEFINITIONS OF SMALL BUSINESS Treatment of Small Business Under Foreign Law Many foreign countries have created special entities for operating a small business. These are usually called "limited liability companies." These entities have separate legal existence under the law of the central government. In all cases there are limitations on the maximum number of equity owners. In other respects, these entities have characteristics of both partnerships and corporations. The legal definitions are tailored to what the country considers to be a typical economic small business enterprise. In all cases, there Various rules exist is a minimum capital required, and in some cases a maximum. with respect to continuity of life of the entity upon death of an owner and limitation of the owners' liability. There are usually requirements concerning how much capital must be subscribed upon formation and how much must be paid-up when the official charter is granted. In many cases, some earnings must be retained in the entity in what is generally known as a "legal reserve." This is similar to the concept of appropriated retained earnings, except that it is required under statute rather than by voluntary action of the enterprise. Tax characteristics of limited liability companies vary from country to country. In some countries they are taxed as corporations and in others they are taxed as partnerships. Most corporate tax laws have special provisions tailored to the economic realities of a smaller enterprise. Some countries tax partner ships as separate entities, imposing tax at both the partnership level and at the partner level. Thus, although the country claims to tax the small business entity as a partnership, the resulting tax treatment resembles U.S. corporate taxation. Colombia is an example of such a country. Belgium takes another approach, taxing the entity as a partnership if there are less than ten owners, and taxing it as a corporation if there are more than ten. This study analyzed the law of twenty-two countries. The criteria utilized to define limited liability companies are summarized in Exhibit 3-1. Other Non-Tax Definitions of Small Business Those suggesting that tax incentives be granted to "small business" rarely attempt to formulate a definition whereby it can be determined exactly what enterprises are benefited. There is no doubt that "small business" exists. Frequent references are made to it in political, social and economic contexts. One approach is to define "small business" as anything which is not "big business." The advocates of this exclusionary definition argue that it is easier to identify the firms in the "big business" sector that those in the "small business" sector. "Big business" consists of giant corporations whose securities are widely traded in the securities markets. The residual "small business" sector is too amorphous to form a foundation for rational and systematic tax policy decisions. The problems, needs, and characteristics of firms in the "non-big-business" sector are so different that tax relief could not be granted to enterprises defined in this manner without working havoc with the revenue system. In its twenty-four years of existence, the Small Business Administration has been struggling with the definition of small business. It is the only government agency which must rely on such a definition for carrying out programs granted to it under its Congressional mandate. It has been suggested that these definitions be incorporated into the tax law. This approach has considerable merit as a theoretical proposition. Presumably the small business size standards of the SBA are undergoing constant review to conform them to economic developments and individual industry fluctuations. The problem of establishing and reviewing size standards is fully discussed in Chapter 2 of the Study of 37 Small Business. Despite their defects, SBA size standards are more reasonable and systematic than other existing definitions. They are, however, complex and voluminous. There are approximately eight hundred eighty industries for which size standards have been established for loan or government procurement purposes. Obviously, statutory incorporation of the details of these standards into the Internal Revenue Code would cause undue complication. In some instances however, these standards are descriptive of businesses needing certain types of tax relief. Incorporation of certain of the standards into the tax law by reference seems appropriate for specific purposes. Accordingly, the Medium Business Enterprise, discussed in Chapter 6 of this report adopts some SBA standards. It is the conclusion of this study that non-tax definitions of small business are generally not appropriate for equitable, efficient and practical administration of the revenue laws, but that certain size standards of the Small Business Administration might be adopted for limited tax purposes. 37/ Office of Advocacy, U.S. Small Business Administration PART III IN SEARCH OF A NEW TAX DEFINITION A New Tax Definition for a Small Business Entity To establish a tax reform program for small business consistent with sound tax policy, a special small business tax entity must be created. The entity would serve to limit tax relief to a specifically identifiable sector of the economy. Further, tax returns filed by such entities would provide 38 the data base now lacking for evaluation of the impact of taxation. The definition of the new entity must address itself to the economic characteristics of the enterprises rather than to its legal form of organization. Thus, the new entity should accomplish the stated purpose of Subchapter S: to allow a small businessperson to "select a form of business organization desired, without the necessity of taking into account major differences in tax consequences." The definition and tax treatment of such an entity should also accomplish a significant measure of tax simplification. Many proposals have advocated amendment of Subchapter S to make it con39 form more closely to partnership tax treatment. These suggestions seem to presuppose that partnership tax treatment is the remedy for small business tax ills. Such a presumption is difficult to sustain. Cursory examination of the partnership tax provisions reveal that in many respects they are as complex as those for corporations. They are designed, like the corporate tax rules, to accomodate many transactions rarely encountered by the average small businessperson. 39/ See the articles cited in Notes 29, 30, 31, 32 for a representative |