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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