"No man in this country is under the smallest obligation, moral or other, so to arrange his legal relations to his business or to his property as to enable the Inland Revenue to put the largest possible shovel into his stores."
"Every man is entitled if he can to order his affairs so as that the tax attaching under the appropriate Acts is less than it otherwise would be. If he succeeds in ordering them so as to secure this result, then, however unappreciative the Commissioners of Inland Revenue or his fellow taxpayers may be of his ingenuity, he cannot be compelled to pay an increased tax."
"Any one may so arrange his affairs that his taxes shall be as low as possible; he is not bound to choose that pattern which will best pay the Treasury; there is not even a patriotic duty to increase one's taxes."
What do the above quotes have in common? They are all quotes from learned judges in tax cases of the 1920s and 1930s, and have been graven on my heart throughout my 23-year career as a tax specialist. They encapsulate the crucial distinction between tax avoidance, being the legitimate (and sometimes ingenious) use of the tax legislation to minimise tax liabilities, and tax evasion, the illegitimate use of deceit to defraud the tax authorities. No tax specialist worth his salt would countenance the latter, although we are happy to help those who have done this to return to the straight and narrow path by disclosing the error of their ways to HMRC.
Denis Healey said that "the difference between tax avoidance and tax evasion is the thickness of a prison wall", which neatly encapsulates the Treasury / HMRC distaste for artificial tax avoidance schemes. For a while in the 1970s, 1980s and early 1990s the Courts appeared to share the authorities' distaste for artificial schemes, led by Lord Templeman, who once memorably said "In common with my predecessors I regard tax avoidance schemes of the kind invented and implemented in the present case as no better than attempts to cheat the Revenue." However, the fight against tax avoidance has now been left to the Treasury and HMRC again, using such weapons as the disclosure requirements for tax avoidance schemes.
For a long time now I have drawn a distinction between tax avoidance and tax mitigation. The former involves highly artificial schemes, and I was for many years ambivalent about these. I would not implement them myself; I would if pressed pass clients on to people who could and did, but only with a heavy health warning about HMRC crawling all over their tax affairs if they went for the scheme. To do otherwise would be to risk being sued for professional negligence for not identifying all tax saving possibilities.
On the other hand I was perfectly content to advise people on tax mitigation, being the legitimate use of the tax legislation as drafted to minimise tax liabilities, which to my mind is what the judges I quoted above were talking about. In other words, there are two pretty straightforward ways to do this, and I will choose the one which results in less tax. I will never apologise for being happy to advise clients on this basis.
Today the time has come for me to come down off the fence on the subject of artificial tax avoidance. I am dead set against it, and I will never recommend a client even to consider an artificial avoidance scheme again. My thinking runs as follows:
1. The country is in a terrible economic state, and needs everyone to pull together to help it to recover as quickly as possible. There may not even be a patriotic duty to increase one's taxes, but there is at least a duty to my mind not to artificially arrange matters to achieve huge tax reductions.
2. The major culprits in the world of major tax avoidance have been, surprise surprise, the banks. No-one who reads this blog will be in any doubt what I think about the senior bankers who largely got us into this unholy mess. To coutenance advising others to do what they have done (and I fear continue to do, despite the huge public bail out which they have enjoyed) is utterly repugnant to me. And how bank executives can look at themselves in the mirror if they continue to use such schemes is utterly beyond me. To my mind any bank in receipt of public money found to be using a tax avoidance scheme should be immediately nationalised.
3. The straw that broke this particular camel's back was a scheme that I saw today, which broadly works as follows:
i. UK business transfers its employees to (unconnected) Isle of Man company.
ii. Isle of Man company creates an employee benefit trust for the benefit of its new employees.
iii. Isle of Man company makes loans to employees, on which they suffer income tax at a rate of 1% or 2% per year (cumulative over time).
iv. The arrangement is funded by the UK business paying the Isle of Man company consultancy fees.
I will be charitable and assume that the UK business will share the tax saving with the employees (after taking account of the no doubt colossal fees of the Isle of Man company). I will put to one side concerns that the UK business may lose tax relief on some of the fees due to the UK transfer pricing legislation, and will have HMRC crawling all over it for a significant period trying to find flaws in the principles or implemenation of the scheme. I will concentrate instead on the position of the poor employees:
1. Do they get the benefit of Transfer of Undertakings legislation to protect their rights to redundancy pay, maternity pay etc,, and how do they enforce those rights against an Isle of Man company?
2. Given the radical reduction in their pay levels implied by the scheme, how much are the rights to the above worth anyway under the new arrangements?
3. What about minimum wage requirements?
4. What guarantees are there for the employees that, if the arrangement ends, they will be re-employed at their current salary levels?
5. What guarantee do the employees have that loans will continue to be made to them?
6. How can employees influence the trading success of the Isle of Man company?
7. How can employees communicate effectively with their employer?
8. The loans must remain outstanding indefinitely if the scheme is to work as envisaged. What guarantees do the employees have that the loans will not be called in at some future point, particularly if the EBT or the Isle of Man company become insolvent?
Of course, if properly informed the employees will not touch this with a bargepole. But what if they are not properly informed, or what if their employer puts them under pressure to conform to the arrangements, with threats of redundancies etc if this does not happen?
I suspect this is an extreme example (at least I hope it is) but the thought of sharing a profession with those who peddle this sort of scheme revolts me to the core. I think there is a rising public tide of anger about this type of artificial tax avoidance, and I find myself sharing it fully. The more quickly the government acts to bring the Isle of Man and Channel Islands into line with more responsible tax regimes the better, difficult as it is to achieve this through moral force of argument alone. And the greater success that HMRC has against such schemes the better, as far as I am concerned.
Having said all this, I need to justify my position on tax mitigation, which also prevents money flowing to the Exchequer. I think that is surprisingly easy. Tax mitigation does not depend upon exploiting tiny loopholes in the tax legislation to achieve a result that was never contemplated. let alone condoned, when the legislation was introduced, in the way that tax avoidance does. And tax mitigation is readily susceptible to striahgtforward government action to counter it, if the government so desires. Let me give you two examples.
The first relates to the method of shareholder/directors in small companies drawing their income from the company. It is fairly standard tax planning advice to recommend taking a salary equal to the natiobnal insurance lower contribution limit (£5,720 for 2009/10) plus net dividends of 90% of the balance of the personal allowance basic rate band (£33,660 for 2009/10). In this way £39.380 can be drawn with no income tax or national insurance liability, although the company will pay corporation tax on the profits drawn as dividends (but not salary).
This is highly effective tax planning, but it is in no way artificial; indeed it is extremely simple. If the government wished to stop it they could change the dividend tax rate or put national insurance on close company dividends, among other potential remedies. But they choose not to. I will come back to why.
The second relates to the cause celebre of income shifting. My old schoolmate Angela Eagle excelled herself in the Commons the day after the Arctic Systems decision in favour of the taxpayer in the House of Lords by making what I refer to as her 'King Lear' statement on income shifting and those who have the temerity to practice it:
"I will have such revenges on you both,
That all the world shall -- I will do such things --
What they are, yet I know not: but they shall be
The terrors of the earth!"
That was Shakespeare, not Angela by the way, but her statement was very reminiscent.
So what has happened since? We had some half baked draft legislation, and then in the pre-Budget report in November 2008 anti-income splitting legislation was dropped, with the classic quote from the Press Notice:
"The Government firmly believes it is unfair to allow a minority of individuals to benefit financially from shifting part of their income to someone else who is subject to a lower rate of tax - known as income shifting. The Government has consulted on this issue, but given the current economic challenges is deferring action on income shifting and will not bring forward legislation at Finance Bill 2009. The Government will instead keep this issue under review." So again they could legislate if they chose to, but they chose not to. Why? For the same reason that they have not acted to change the taxation of dividends, which is that lots of people have small family companies and lots of people split their income as well as taking income from their companies in the most tax-efficient manner. And they all have a vote. Call me cynical if you like, but I have practiced tax for 23 years and seen enough to make cynicism appear to be the wisest course when dealing with politicians of all hues. Thus if the government has considered the issue of tax mitigation and ducked it, why should my clients be under any obligation to voluntarily increase their tax bills? I have every sympathy with the fight against artificial tax avoidance, but I have none with a government that bewails the widespread use of straightforward tax mitigation techniques but fails to use its House of Commons majority to block them. If they calculate that it is in their interests to allow tax mitigation to continue, who am I to argue? Mark Simpson 24 April 2009
I am looking into how these companies work - we have been reduced to benefits, reduced education, quality of life and greatly incereased levels in stress because of a contractor using an Isle of Man company to keep his income at the rate to show CSA, DHS and Legal Aid how little he has to live on. Not helped by all these agencies being fooled by these companies making them look like 'employees' and producing 'wage slips' Misery, misery and more misery. Cost the country far more than elastic expenses claimed by MP disgusting though that is. Your article was, however, a ray of light in our quest to get these assessments made fairly. THANK you
Posted by: THERESE MONTIER | May 14, 2009 at 11:57 AM