Tax avoidance

Posted on 3 May 2013 by Tim Brown

Looking at the tax system as a potential candidate for continuous improvement, Tim Brown investigates whether the current system for raising government revenue is fit for purpose and what alternatives exist.

Imagine, if you will, that the tax system is a large manufacturing business. This particular business has the enviable position of holding 100% market share in the UK and there is little prospect of new entrants into the market. However, its products are overpriced, complicated beyond necessity, difficult to assemble and, in the end, all offer the same proposition – the right to live and work in the UK.

Taking the scenario further, we see overseas competitors offer more competitive prices, luring away some of the tax system’s bigger customers. Those customers that have remained are often demanding and are always trying to negotiate a discount or avoid paying altogether.

The company is understaffed, under-resourced and furthermore, the fence around the perimeter of the business is full of holes and the security guard falls asleep constantly. As a result its products are often stolen and its stocktaking is questionable.

If the tax system was a business, you’d take a long hard look whether or not you were running it as efficiently as you could. Indeed, you’d probably get in some lean gurus to shake things up a bit – improve the processes, streamline the offering and improve the profit margins.

However, over recent years, successive governments have taken the opposite approach. Instead of simplifying and improving the tax system, complexity has increased and effectiveness waned. In the last two decades, Tolley’s Yellow and Orange Tax Handbooks have tripled in size to 17,795 pages. Yet despite the increase in rules, in 2012 a quarter of FTSE 100 companies paid no corporation tax at all in the UK.

While the likes of Starbucks, Google and Amazon have dominated recent headlines on tax avoidance, many other companies also allegedly manage to avoid paying tax. British American Tobacco, Tate & Lyle and Rolls-Royce were among the dozen FTSE 100 firms who paid no corporation tax last year, according to research by the Mail on Sunday.

David Cameron has made strident statements of intent to crack down on tax avoidance, but the Mail on Sunday’s analysis of annual reports and accounts found that 47 companies gave no obvious figures for corporation tax paid in Britain in 2012. Among those 53 which did give figures, 12 paid no corporation tax at all, and of those dozen, half received a tax credit. Rolls-Royce, for example, got a £2m tax credit, while paying no corporation tax according to the newspaper. The engine manufacturer said it made 85% of profits abroad and was spending “hundreds of millions” on research in the UK, justifying its tax position. A separate investigation by the charity Action Aid, showed that nearly all of Britain’s biggest companies legally avoid tax in the UK. According to the organisation, 98 out of the 100 companies on the FTSE 100 base their taxable operations in territories where there is low or no tax.

Behaviour leading to tax gap 2010-2011
Behaviour leading to tax gap 2010-2011

HMRC estimated that in 2010-2011 its total ‘tax gap’ was around £32bn, representing 6.7% of the total tax collected and an increase of £1bn from the previous year. Of the total tax gap, £9bn was attributed to legal interpretation and tax avoidance.

Tax avoidance is bending the rules of the tax system to gain a tax advantage that Parliament never intended. Legal interpretation, meanwhile, relates to potential tax loss from cases where HMRC and the tax payer have different views of how, or whether, the law applies to specific and often complex transactions. And failure to collect tax from large companies is only one part of the problem. The contribution to the issue by individuals, contractors and small businesses is arguably even greater. The accountancy firms tasked with exploiting tax loopholes are generally better resourced than the HMRC departments tasked with investigating them. So what can be done?

Flat tax as an alternative

A report by the 2020 Tax Commission, titled The Single Income Tax (pictured right), proposes the introduction of a flat tax system. The report, supported by the Tax Payers Alliance and the Institute of Directors, promotes the reduction of other taxes in favour or an unavoidable 30% flat rate tax on distributed income – above £10,000 personal allowance – from capital, be it equity, debt or property.

“Whether someone’s money comes from a salary, from a company, from dividends or from interest payments, we think it should be taxed at the same rate,” says Rory Meakin of the Tax Payers Alliance and lead researcher of the report. “This will stop people trying to shuffle money between the different types of income streams. “We think the current system lacks legitimacy. We think people should be taxed on their income and if a company is investing money, then there is no real reason to tax the money just because a profit has been made.”

The 2020 Tax Commission’s recommendations would abolish eight national taxes, and create just one. The abolished taxes would be:

  • Employers’ National Insurance
  • Employees’ National Insurance
  • Corporation Tax Capital Gains
  • Tax Inheritance
  • Tax Stamp Duty
  • Land Tax
  • Stamp Duty on shares
  • Air Passenger Duty

Excluding National Insurance, these taxes are responsible for 499 exemptions or reliefs, out of a total of 1,042. The latest individual Tolley’s guides for Capital Gains Tax, Corporation Tax and Inheritance Tax alone contain 4,318 pages. Abolishing them would allow the tax code to be shortened substantially.

The primary goals of the 2020 Tax Commission’s proposals are to:

  • Reduce the tax burden and gain neutrality between types of income
  • Capture taxable income that is currently evading tax
  • Reduce the overall tax rate to encourage inward investment and discourage the migration of business overseas
  • Transfer the burden from profit, which is easy to move overseas, to income which is more easily defined and somewhat harder to shift
  • Provide legitimacy for the tax system by being more transparent

The 2020 Tax Commission state that taxes and government spending should represent 33% of national income (GDP). For comparison, spending in 2011-12 was 45.5% and taxes were 37.5% according to figures released in Budget 2013. On the internationally comparable OECD measure cited in their report, UK public spending represented 49.8% of GDP in 2011 while, by comparison, the US was 41.9% and Australia was 35.0%. It says that the reduction of UK spending would be achieved partly by economic growth but would also require further cuts in public spending.

There are two things companies can do with their profits explains Meakin. “They can reinvest them by keeping the money in the company or distribute it to shareholders, which means that it becomes personal income. We say that it is when it is distributed, when that money turns into income that the tax should be applied. We shouldn’t be taxing companies who are investing and that are boosting the economy as they do that.”

“All the effort that people and companies put into hiring clever accountants to work their way around the system is madness,” says Mr Meakin. “The cause of this is not evil people trying to keep their money; it is just the result of an unnecessarily overcomplicated system.

Meakin says that because people put their money through these exemptions and schemes and then pay less tax, the overall rate for everyone else needs to go up. “We need lower rates in general and less exemptions and loopholes so that the rules are simpler. Such a system would then be a benefit for everyone and not just the people with the best accountants.”

“By having such a fiddly and incomprehensible system, it has become impossible for any one person to have to fully comprehend the entire tax system,” says Meakin. “People don’t understand how much they are paying, let alone how much other people are paying. If you had a simpler system, with reasonable rates and greater transparency, then we think that most would be happier to cooperate with the system.”

Rory Meakin of the Tax Payers Alliance and lead researcher of the report 'The Single Income Tax'
Rory Meakin of the Tax Payers Alliance and lead researcher of the report 'The Single Income Tax'

“We need lower rates in general and less exemptions and loopholes so that the rules are simpler. Such a system would then be a benefit for everyone and not just the people with the best accountants”

Rory Meakin, Tax Payers Alliance

How it would work

According to Meakin, the proposed system would work as follows. Normal income (eg. salaries) would operate in a similar way to the way PAYE does currently. However, on the corporate side it would be quite a different system with tax being paid by UK companies rather than individuals.

Under the proposed system when a company received money, from shareholders for instance, to start up a company or make an investment, the company would receive a credit. When the company sends money out to shareholders in the form of dividends or share buybacks then it would apply the single rate of tax on that money but only once the company has exceeded the credits for the money that went in.

Osborne’s GARRulous attempt to curtail tax evasion

“Today, I am unveiling one of the largest ever packages of tax avoidance and evasion measures presented at a Budget.” Those were the words of Chancellor of the Exchequer, George Osborne, during a somewhat rambling budget speech on March 20, 2013.

Unfortunately, according to most reports, including that of the Financial Times, the key weapon in Osborne’s arsenal to tackle the problem – the General Anti-Abuse Rule (GAAR) – is far too narrow to prevent the majority of schemes.

Despite one of its components promising to name and shame of promoters of tax avoidance schemes and their participators , The House of Lords’ Select Committee on Economic Affairs noted that “none of our witnesses thought [the GAAR] would meet media and public expectations that international tax planning should be addressed and multinational companies made to pay more tax in the UK”. Neither did any of the witnesses think the arrangements entered into by multinational corporations would be affected by the GAAR.

Look out for EEF’s tax report later this month, defining the trade body’s stance on government’s crack down on tax avoidance.

British American Tobacco, Tate & Lyle and Rolls-Royce paid no corporation tax in 2012, according to research by the Mail on Sunday

But would flat tax really level the playing field?

Richard Murphy is a chartered accountant, the founder of the Tax Justice Network, an advisor to the TUC on taxation and economic issues, and a columnist for The Guardian and He says that flat taxes only serve to do one thing.

“The reason why people like Boris Johnson are so keen on Flat Tax is because it makes the rich richer and the poor poorer because the rich would see a tax rate cut. I think one could understand why Boris Johnson is very keen on it when he has an income of over £500,000 per year. I have no confidence whatsoever in flat taxes.”

Boris Johnson. An advocate of flat tax. Image courtesy of BackBoris2012.
Boris Johnson. An advocate of flat tax. Image courtesy of BackBoris2012.

High profile support for flat tax

The London Mayor Boris Johnson revealed earlier this year that he would support a flat tax proposal of the kind suggested by the 2020 Tax Commission. “We need to send a signal to enterprise. I think we should look at a flat tax. It works brilliantly in some places, and I’m told it would be ideal for us,” said Mr Johnson.

“It’s the idea of having a much more simplified system of tax, so we all pay 25 or 30 per cent.” Admitting the Treasury may lose a lot of cash initially, he said: “Revenue would go up as you liberated enterprise. People would say: ‘Wow, this is the place to do business’.”

According to Mr Murphy, if a flat tax system is designed to ensure that you won’t make the poor poorer then you have to have a massive cut in taxes and government spending. Highlighting the current £120bn deficit, he says that such a move would be unlikely “while we’re trying to make the books balance”.

Richard Murphy, chartered accountant and founder of the Tax Justice Network
Richard Murphy, chartered accountant and founder of the Tax Justice Network

“If we get profit sharing right we might raise an extra £10bn in tax revenue per year?”Richard Murphy, founder, the Tax Justice Network

Mr Murphy proposes that an alternative to flat tax would be unitary taxation, also known as profit sharing. In simple terms, a company’s profits are split into three and the taxable income is shared evenly according to where the customers are located, where the employees located, and where the physical tangible assets of the business are located. The corporation tax rate is then applied according to how those profits are divided. “If we get profit sharing right we might raise, in my estimates, an extra £10bn in tax revenue per year,” says Murphy.

Continuing, he says that the benefit of profit sharing is that it more clearly allocates taxable income whereas most flat tax propositions would exclude income arising outside of the UK. “If you exclude income arising outside the UK, the moment you manage to shift your profit into a tax haven, then you’ve won it. You are never going to pay tax on it. The incentive to shift income outside of the UK into a tax haven would be very high indeed.”

Furthermore says Murphy, not only are company owners often based overseas, often it isn’t possible to identify the owner of a company at all. “In such a case we won’t, therefore, charge them for tax in the UK so the tax has got to be paid by the company themselves. Corporation tax is quite clearly a tax that is charged on capital and the owners of the business. No other tax could achieve that result that I’m aware of.”

Under the proposed Tax Payers Alliance system, all distributions out of UK companies would be subject to UK tax prior to being paid into an account, no matter where that account was located. While acknowledging that the Government would still need investigative powers to ensure the books were being balanced correctly, the Tax Payers Alliance says that a simplified system would allow investigators to uncover tax dodging more easily.

Allister Heath, editor of City AM and contributor to the 2020 Tax Commission report
Allister Heath, editor of City AM and contributor to the 2020 Tax Commission report

The argument to support the flat tax proposal promoted by the 2020 Tax Commission is convincing. The idea of a more simplified system is undoubtedly appealing to most businesses – except perhaps accountancy firms. However, its aim to reduce tax as a share of national income to 33% is ambitious, particularly considering the current deficit and already arguably constrained public spending.

What is evident is that the current system is floundering. As editor of City AM and contributor to the 2020 Tax Commission, Allister Heath wrote: “Our economy is stagnant, crippled by excessively high public spending, high levels of leverage, a mismanaged and inefficient public sector, an extraordinarily complex and punitive tax system and a public mood that has become increasingly anti-capitalist.”

Change is needed and a new system, such as that suggested in the The Single Income Tax report, would represent not only a step change but also a leaner way for the government to support business and industry.