When is avoidance not avoidance?
Posted by Christie Malry on November 12, 2012 at 10:04 am
A common "reductio ad absurdum" argument against the current spate of tax avoidance stories goes like this:
- Tax avoidance is using the tax system to reduce your taxes.
- ISAs reduce your taxes.
- Therefore ISAs are tax avoidance.
"But no," howl the tax justice campaigners. Because ISAs are using the tax system in exactly the way Parliament intended when it passed the law. Our legislators wanted ordinary people to be able to shield some of their investment income from capital gains and income tax. Therefore one cannot argue that anyone doing this is "avoiding" tax. Tax simply doesn't apply to any income or gain within the ISA wrapper.
However, get beyond ISAs and this line of argument very quickly dries up. Pension contributions and charitable donations would seem - to me at least - to be identical to ISAs. The basic principle is that you may elect to treat some of your income differently and that, because Parliament says so, you get a tax benefit as a result. But both have been described as tax avoidance.
For companies, the situation is even more uncompromising. Almost anything that companies do is deemed to be tax avoidance. Now it's very important to realise something here: accounting profits and taxable profits don't always coincide. Quite often, financial reporting standards require profits to be recorded now but those profits aren't taxable now. For example, capital investment is typically recorded as an asset in a company's balance sheet and then depreciated over its useful economic life. However, this means a large cash outflow results in only a small financial reporting expense each year. If the tax system adopted the same approach, companies investing in long-lived assets would suffer both the cash cost of the assets themselves and the tax cost of having only a tiny deduction. Tax would become a disincentive to investment. Mercifully, many tax systems recognise this, and provide tax relief (capital allowances in the UK) that more closely aligns to the cash flow. A side effect of this intended relief is that accounting profit will exceed taxable profit in periods of heavy investment.
Also, there are financial reporting measures of performance that need further adjustment to produce taxable profit. Companies, like sole traders and partnerships, typically get to deduct almost all the costs of doing business in arriving at taxable profit. So it's daft to compare tax paid to measures of profitability that exclude deductions, such as operating profit, gross profit or turnover. Tax law specifically intends interest to be deducted in calculating taxable profit. Saying it's "unfair" doesn't change that. And HMRC has powers - which it does use - to challenge and disallow excessive deductions.
You see, for companies, capital allowances and interest are exactly like ISAs. Their use for tax purposes was deliberately introduced into law by Parliament and they should be uncontroversial. Sloppy reporting by journalists and unethical tax justice campaigners cannot change that fact. For it would appear that these campaigners respect not the will of Parliament but only their own ex post political objectives. That's not good enough.
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Hmm. Bit disingenuous, I think. I agree RM's comment in the post you link to suggests that he had listed 'avoidance' techniques, but the post itself simply refers to making the system fairer - it's politics rather than compliance, I think.
I think we need four categories:
Tax mitigation - using the system as clearly intended. Standard ISA investments, pension contributions etc. Even the "can't lose" investment in an SEIS this year with CGT exemption, because government clearly knew what it was doing.
Tax planning - using the tax system in a way which might not have been intended, but is clearly a valid choice within the system, e.g. the low salary + dividends approach to incorporation.
Tax abuse - wholly artificial transactions, or large sections of transactions, that have little or no commercial puropose, but which still succeed technically, e.g. Barclays Mercantile, SHIPS-2. Will be stopped by GAAR.
Tax evasion - Skimming 10% off the top and sticking it in under the mattress.
I agree the dividing line between the middle two isn't always clear, but it tends to be a bit of an elephant test - you know it when you see it. Broadly it is where the overwhelming bulk of the transactions involved is totally articfical.
I think if there is one thing that the tax profession should be doing to help the public debate, it is outlining the distinction that Mike makes here.
I know Christie has commented on this previously here, and Chris Jones from Tolley did something similar here.
One of the biggest problems with the current debate is that the public generally don't perceive that there is a lot of ambiguity over the "right" amount of tax, and that this is subject to interpretation through the legal system. It's hardly surprising when you consider that very few employees take an active interest in the calculation of the tax deducted from their payslips.
Are you really claiming that all the private equity finance structures set up which lead to very high interest rates being paid to offshore entities etc.etc. are really just giving a relief from tax as intended by Parliament in the same way as ISAs? Even Osborne was making noises about dealing with these abuses before he was elected and got at by the private equity funders of the Tory Party. There are a lot of people out there who pay their fair whack of tax who are now getting just a little bit sick of the special pleading from those who are not - this is not going to go away until we have a proper debate out in the open as to what constitutes fair taxation including who and what activities should be subject to lower and higher rates of taxation - and then attempt to design a tax system that gets a lot nearer to the democratic consensus than is currently the case.
Ben your argument is verging on a Brechtian call to change the electorate - much of the public know only too well that there is something wrong and unfair about the current tax system - the tax profession needs to recognise this is the case and put its efforts into developing workable and practical solutions - if not do not be surprised if the likes of the Tax Justice Network continue to make the running; and while their hearts may be in the right place I would be the first to acknowledge that their skills and understanding of how modern tax systems work would create all sorts of problems.
It's interesting to see what you think I've said. I suspect you and I don't actually disagree about things as much as you think.
What I'm talking about is educating people. People might make better decisions if they are better informed. Call me optimistic...
You raise an interesting question as to whether Parliament can intend something that it didn't foresee. I would say that you have to assume that it is willing to accept the consequences of failing to foresee situations. The alternative is retrospection which I don't feel is particularly fair on any taxpayers, certainly not where they have tried to stay within the "spirit of the law".
Given that Parliament could legislate and determine the matter outright at any time, is failing to legislate a form of implicit acceptance of current practices?
I'd offer you an answer but it's been a long day...
Anyway, I think that, for me at least, it's more important to understand the underlying problems than have my say on the sticking plaster solutions of the day. After all, I'm still a young man...
Ben
I've no problem with educating people so that they are in a position to make better decisions - my concern is more that there isn't an appreciation that most people believe quite correctly that the tax burden is not being shared fairly and that some people and companies are paying a lot less than what most people believe to be their fair share.
Unfortunately most laws don't have sprits and I'm not awfully keen on politicians or lawyers interpreting what that spirit is - the precedents from totalitarian regimes are not good. What is needed is a sensible and workable anti-avoidance law and probably a wholesale change in the UK tax framework - but to achieve that you need a political consensus as to what is required and tax professionals who are committed to becoming game keepers rather than poachers. Most people know that the best game keepers used to be the best poachers.
Are you offering me a job or something?
The point I'm making is this: there's a lot of things that people are describing as tax avoidance, which are unquestionably permissible choices within the law.
I'm pretty sure an anti-avoidance rule isn't needed to combat those activities. And it would not be effective were one introduced. The "right amount of tax" is already being paid. What is needed is a change in how the law is intended to work.
So if Starbucks' royalties are already correctly dealt with by transfer pricing rules (note the word if - I know you disagree), an anti-avoidance rule isn't going to overturn that unless it is capable of overturning something that be may considered to be reasonably dealt with under other sections of the law. If the latter is the case, we're talking about something so fundamental that it needs to be discussed openly in order that people understand it prior to introducing it.
With regards to the "spirit" of the law, it isn't open to interpretation by politicians or lawyers, unless you mean judges. It is declared by an independent judiciary.
I am thinking primarily of a purposive reading, as arose out of the Arrowtown case. That has given HMRC a significant amount of success recently. But even if you don't go as far adopting that, you might need to consider what was intended by Parliament in introducing the law,ie the 'mischief rule'. That is almost a question of fact, by reference to Hansards or other contemporaneous materials.
With regards to creating consensus, I'd like to make one point. People have various measures of morality. And not all see the same "immorality" that the voices heard in the press do. Alienating those people won't help create a consensus.
I'm talking about getting the fundamentals of the conversation right. Without that, I don't think there's going to be the consensus we both want.
Ben
I would agree that anti avoidance rules wouldn't solve everything. The problem with transfer pricing rules is that they have really become a pretty complex set of rules and it is pretty difficult to see the principles on which they are based. If there was a clearer statement of the principles to be applied, supported by an anti avoidance rule that gave precedence to those principles over any subsequent detailed rules then I think a lot of the problems would be solved. I think it is pretty dangerous to leave too much interpreation of what is the spirit of the law to lawyers (and then the judges who decide on the lawyers arguments) - much of the old Soviet bloc has a culture of where ambiguities in the law including tax laws are interpreted according to the interests of the authorities and it is not a pleasant sight - look at how Putin and Co are not averse to using tax as a tool against their opponents. So I would agree that most of this has to be done through a change in the law.
Re consensus - I would see this as being something different from total agreement - there are some who believe that there is no moral basis for taxation whatsover. Morality of course is an individual thing so you will never get total agreement. What we should be looking for is an ethical consensus - and if I look at the overall reaction to the Parlimentary hearings yesterday, my guess is that it some way away from the Google/Amazon/Starbucks view of the world.
On the subject of the allowability of interest Anthony Hilton pretty much hits that particular nail on the head
http://www.standard.co.uk/business/markets/anthony-hilton-time-to-do-away-with-tax-relief-on-debt-8312515.html
But do you see why I make the point that it is important to understand the difference between avoidance and choices that are permissible within the law? If you don't acknowledge what the current law does and doesn't do, you go off half-cocked.
The argument to disallow interest is a case in point.
The article doesn't discuss the effectiveness of the thin capitalisation or the worldwide debt cap rules which came in for 2010. I'm pretty sure "getting rid of tax relief for debt" is Hilton paraphrasing. If he isn't, well that's going to hit all businesses, especially small startup businesses, so I'm not particularly keen on that. It would give larger businesses a bigger advantage, in my opinion.
If he means between connected parties, well, there are rules (as mentioned above) to cover that. In which case you're talking about improving those rules.
If he means just disallowing transactions between connected parties, then there are issues with that too. Again, consider where small businesses get their funding from: friends and family (and fools if you want to complete the cliche).
Inserting thresholds and cutoffs is fine, to prevent excessive abuse, but you need to decide how to protect smaller businesses and what you mean by smaller businesses. So you need to establish the fair point at which your restrictions kick in. Then you might need to consider whether those rules are discriminatory in any way.
Without understanding the current rules and by conflating legal choices that are accepted by Parliament with avoidance, the contribution by Hilton is empty of value. To be fair to him, it's in a newspaper, not a professional publication, so his audience may not be interested in details.
As far as morality goes and reaching a consensus goes, I suggest you consider our discussion about Starbucks on a previous post and who was trying to dismiss an approach reached by consensus.
"If you don't acknowledge what the current law does and doesn't do, you go off half-cocked."
No problem with that whatsoever you have to understand the current laws in order to change them. But the same applies if you don't form a view about what is deficient with the current law and don't form a view as to where you want to end up as well. I don't think I was dismissing an approach based on consensus on Starbucks - I think most people would believe a 6/4.7% intra group payment for the brand/technical know how that StarbucksUK receives from the Dutch subsidiary and paying 20% over the market price for coffee beans from the Swiss subsidiary represent something of a deficiency in the current transfer pricing rules and how they are enforced by HMRC and also most people would like to see the corporate sector (which has a healthy surplus) contribute rather more to the reduction of the public sector deficit rather than leaving most of burden on individuals through tax increases and public expenditure cuts.
I don't think you were dismissing a consensus approach, but I do think it is bit inconsistent with your statement on looking for a consensus. It's not about your argument, which may or may not be reasonable, but the fact that you are arguing that somebody else's view is not also reasonable. That's a much harder thing to show.
As for "most people", they haven't seen the detailed transfer pricing documentation. I haven't either, but then I'm not telling the HMRC transfer pricing experts that they've done a crap job.
On deficiencies, as I said, you need to know what the current system doesn't do. We all have our opinions on how we'd like things to work. I'm fairly open-minded about most courses of action.
In terms of settlement, HMRC will have settled for a higher amount than they wished for. But Starbucks will have settled for a lower amount than they wanted. Therefore, what do you think HMRC asked for? Perhaps 3% if they settled in the middle somewhere?
Also, you've got to remember that the Dutch authorities would want to see that 6% taxed too. They probably have an opinion on it too. Was it actually Starbucks who stopped HMRC adjusting further? (I don't think so, but I don't know for sure).
I find it fascinating to watch the effect of the various campaigns. I actually think it will have a counter-productive effect for their interests ultimately, but that's just my gut instinct.