George Osborne has been studying the (anonymous) tax returns of the very rich, and he has not liked what he has seen. David Cameron has commented unfavourably on Ken Livingstone’s tax mitigation strategy. Given that the Government is pondering the introduction of what they term a “General Anti-Abuse Rule” in April 2013, any current government pronouncements on tax avoidance will be scrutinised with particular care, in view of the key question “what is abusive tax avoidance”?
I for one thought that it was highly significant that the Government chose to call their proposal an anti-abuse rule as opposed to a general anti-avoidance rule (such as the one that Australia has operated for a number of years). The implication I took from this is that they are seeking to draw a key distinction in the definition of what they regard as unacceptable and abusive tax avoidance.
In recent years within the tax profession a distinction has begun to be made between tax mitigation, which I would define as the use in tax planning of the tax legislation in a manner that is not intended to defeat the entire intention of that legislation, and tax avoidance, which is the exploitation of loopholes in the wording of legislation to achieve a tax effect counter to that intended by the legal draftsman. Like any attempt to draw distinctions in this respect, this is far from perfect, but I felt it had some significance.
This significance manifests itself to me in typical client reactions to tax planning strategies. A very small minority of my clients is at all interested in complex and, to some extent, artificial tax avoidance schemes, typically sold at high fee levels to achieve high levels of tax saving. However, they are all interested in tax mitigation strategies at a more basic level, which they can by and large understand and appreciate.
My initial reading of the description of the proposed new rule was that the government was taking this distinction on board, and seeking to distinguish abusive tax avoidance (artificial. complex, large scale) from more straightforward tax mitigation. I think this is a distinction that the majority of advisers in the tax profession would now recognise and accept.
However, I am now starting to wonder, particularly in the light of George Osborne’s comments. The main area of concern here is the reference, among the three types of tax loopholes (my italics) typically used by the wealthy taxpayers concerned, to “taking advantage of tax breaks on charitable donations”.
I am aware that there are complex avoidance schemes in circulation relating to the other two areas (business losses and business mortgages), but I think care needs to be taken in dealing with the issue of tax relief for charitable donations in the same context.
By way of completeness I should say that there were, a few years ago, a number of schemes doing the rounds which arguably involved the manipulation of quoted share values of AIM companies to obtain a level of income tax relief on gifts of shares to charity that exceeded the true market value of those shares.
One particular scheme, involving Northern Lynx plc, has resulted in a long-running Financial Services Authority investigation into the promoters of the company and consequent denial of tax relief to investors in the company who gave their shares to charity. My argument to HMRC in that case is that the individual investors were not party to the alleged price manipulation, and should not therefore be punished for the possible transgressions of others. Nonetheless I need to make it clear that the income tax relief for gifts of quoted shares to charity has allegedly been abused in the past, to the detriment not only of the Exchequer, but also arguably the charities concerned, who clearly are innocent parties in all this.
I have always been concerned that any attempts to legislate against such avoidance would adopt the usual approach of UK governments by taking a very large sledgehammer to a rather small nut. This concern appears to have been borne out to some extent by the restriction on charitable reliefs announced in the recent Budget, and the Chancellor’s comments do not give me any comfort in this respect.
Gift Aid and the income tax relief for quoted shares gifted to charity are not “tax loopholes”, but a vital incentive at a time of economic hardship for many donors and charities for higher rate taxpayers to make generous charitable donations. I had thought that this was one of the cornerstones of David Cameron’s “Big Society” concept, but perhaps I have got that wrong?
Never did Gordon Brown appear so foolish as when he abolished the zero rate of corporation tax rate he himself had introduced whilst fulminating against tax avoidance by the use of companies. If you are going to give people tax incentives to act in a particular manner, please don’t be surprised when they take you up on the offer. Shades here of the disastrous government own goal over the solar panel Feed-in Tariff saga, where government offers an incentive, people rush to take it up and the government panics that it is going to cost too much and does something stupid as a result that negates much of the good achieved by the original change.
We either want people to give to charity or we do not. If we do, offering them tax incentives is a good way to encourage them. Taking away or restricting those tax incentives sends a message every bit as powerful, if not more so, than granting the reliefs in the first place. So what message does the government wish to give?
My larger concern stemming from this is that the government will seek to define abuse not in terms of “does this tax avoidance subvert the purpose of the legislation?”, which to my mind is a fair question, but “how much does this tax mitigation cost us”, which I would argue is not a fair question in this context.
“Abuse” is defined as ‘misuse, use of something to a bad effect or purpose’, and that is why I find the use of the word ‘abuse’ in the name of the proposed rule so significant, as I suspect would the courts if the rule is in fact enacted. My view is that, if a piece of tax planning or mitigation does not seek to defeat the object of a piece of tax legislation, but merely to place the taxpayer in the best tax position within the framework of options available under the system, that planning is not, and cannot be fairly defined as, abusive.
Let us recall in this context the words of Baron Tomlin in the Duke of Westminster taxcase in 1936: “every man is entitled to arrange his affairs so that the tax attaching under the appropriate act is less than it otherwise would be”. I think that is a sound principle still, and one with which any government would tamper at its peril.
Consider if you would the following half a dozen pieces of what I would regard as routine, unexceptionable tax planning, placed in what I consider to be an ascending order of risk from an anti-abuse rule, but none of which in my view should be remotely within the scope of such a rule. What do you think?
1. VAT flat rate scheme
A not for profit networking organisation, run by its members for its members, voluntarily registers for VAT. It applies to use the flat rate scheme, the VAT flat rate for membership organisations being 8%. It collects 20% VAT from its members (which they recover as business input VAT), pays over 8% to HMRC and keeps the other 12%, thereby paying for its Christmas party each year.
2. Charity share gifts
An elderly taxpayer, with significant pension income and a large share portfolio but no close relatives, sets up a charity which donates its income to other charities. Having initially set up the charity with a seven figure donation of shares, the taxpayer now gives to her charity sufficient value in quoted shares each year to eliminate her (significant) higher rate income tax liability.
3. Inheritance tax business property
A husband leaves all of his assets to his wife, except for the business which they jointly run and his wife will continue to run. This is eligible for 100% business property relief, and is left to his children. Wife then buys the business from the children, with the purchase price left outstanding as an interest-free loan repayable after her death. On wife’s death, she can use both her nd her husband’s nil rate bands, the business qualifies for 100% relief and the debt is an allowable deduction in her estate. She has therefore effectively obtained business property relief twice, and the value of the business at husband’s death is thus effectively made a deduction in her estate.
4. Capital gains tax – two residences
A taxpayer lives in Manchester, where his daughter has just started a three-year university course, but is offered a lucrative job in London. He buys a flat in London but keeps his Manchester property for his daughter to live in whilst at University and for him to live in at weekends and during holidays from work. He intends to sell the Manchester property once his daughter has left university. If he elects for the London property to be his main residence for CGT purposes from day 1, the sale of the Manchester property is likely to be fully exempt from CGT without prejudice to full exemption for the London property, because he is deemed to have occupied it as his main residence for the last 3 years of ownership. (NB When a cabinet minister does this, it is known in the media as ‘flipping’).
5. Business incorporation
A married woman operates a profitable business as a sole trade, whilst her husband is a house husband. She forms a company and transfers the business to it, her husband being a 50% shareholder in the company. She takes a salary of £7,605 per year, which means she pays neither income tax nor national insurance, but is credited for benefits purposes as if she did pay NI. She and her husband each take dividends of £30,933 from the company, also carrying no income tax. The only tax payable is 20% corporation tax on the company’s profits, after salary but before dividends. (NB This is what Ken Livingstone apparently does with his speaking inc0me).
6. Limited liability partnership with corporate partner
The above woman is considering incorporation, but holds valuable business assets in her own name which she does not wish to transfer to the company and thus put at risk, but on which she wishes to remain eligible for 100% business property relief.
She forms a limited liability partnership with herself and her husband as partners, along with a limited company owned jointly by them. The trade and the assets are transferred to the LLP. The LLP profit sharing arrangements provide for she and her husband to take a percentage of income profits equal to the employers’ national insurance threshold for the relevant tax year with the balance due to the company. Capital gains are all allocated to husband and wife. Thus the benefits of incorporation are obtained without detrimental capital gains tax and inheritance tax effects in rsspect of the assets.
So where would you draw the line in terms of what is and is not abusive planning (I have done all of these things with cklients in the past few years)? Indeed, have I got them in the right order? A client has recently declined to do #6 because he fears the HMRC scrutiny he feels it would attract; are his concerns justified and appropriate?
I am happy to nail my colours to the mast on this one; as I said above, I do not consider that any of this could remotely be characterised as abusive. The Courts have increasingly sought to divine the intention of the Parliamentary draftsman and the politicians instructing him from the wording of the legislation, whether by reference to Hansard in respect of Finance Bill debates (inadequate as they now are) or by adopting a ‘purposive’ reading of the legislation. And it seems to me that any of the above planning can be justified by reference to the purpose for which the relevant legislation was presumably enacted:
1. The VAT flat rate scheme was intended to simplify the VAT affairs of smaller businesses, the rates were reduced to make the scheme more attractive when few taxpayers originally took it up and the EU has consistently maintained that a business making any taxable supplies has the right to be VAT registered.
2. As mentioned above, the tax reliefs for gifts to charity are designed to encourage people to support financially the voluntary sector.
3. Business property relief is intended to allow businesses to pass down the generations (a difficult enough feat as it is) without tax preventing this.
4. The last 3 years of ownership rule is intended to allow time to sell a property which a taxpayer has moved out of (important in the current times of a sluggish property market) and the main residence exemption is intended to encourage fluidity and prevent stagnation within the property market.
5. The whole purpose of a limited company is, and has always been, to permit an entrepreneur to take business risks without (necessarily) putting all of his or her personal assets on the line. The tax system has also systematically discriminated in favour of companies over partnerships and sole trades over the past 15+ years, which is presumably indicative of government policy.
6. The limited liability partnership was intended to allow entrepreneurs the benefits of limited liability without the constraints of a limited company structure.
However, media reaction to the tax planning activities of politicians suggests that 4 and 5 are considered open to legitimate public criticism. Is this simply because those concerned are politicians (and Labour ones at that), and thus potentially open to charges of hypocrisy? And if that is the case, and such planning is regarded as legitimate for those of us with ‘proper’ jobs and businesses, isn’t that hypocritical too?
Personally I have no problem with Hazel Blears taking best tax planning advice on her properties (she clearly needed more than one as a North West MP with a cabinet post) or with Ken Livingstone mitigating his tax liabilities on his speaking income to best effect. But plenty of my non-taxation practitioner friends were up in arms about Hazel Blears’ property transactions; if I blame media distortion and misrepresentation for them not understanding the issues, isn’t that insufferably arrogant of me?
Thus, in conclusion, the consultation process on the general anti-abuse rule is absolutely vital, and I hope and trust that as many people as possible will avail themselves of the opportunity to comment. In the end abuse is in the eye of the beholder, and if a significant majority of the UK public (in the light of all the facts) thinks that a piece of tax planning is abusive, then there is a strong argument that it is, whatever I and my colleagues might think about it. Whether there is any chance of them getting undistorted access to all the facts is another matter entirely.
But before politicians seek to use pubic opinion to justify wide application of the GAAR, they might care to ponder that if they thought carefully enough about, and debated thoroughly enough, the tax legislation that they pass in such vast quantities, and in particular if they stopped tinkering with a system that is well past its sell-by date and opted instead for root and branch reform and redesign, the opportunities for tax avoidance, whether abusive or benign, might be greatly reduced.
In the end I suspect we get the tax system we deserve, and we must have done something fairly awful to deserve the one we currently have. Whether the GAAR makes it better or worse will be one of the more interesting tax issues of the next few years – watch this space!