For a sector that wields so much influence in the country, the level of expertise in the media on some of the subjects that it tackles is less than impressive. I am reminded of Harold Wilson’s famous quote about “power without responsibility: the prerogative of the harlot down the ages”.
The cause of my ire this morning is a purported guide to tax avoidance on the BBC News website. Entitled “Tax avoidance: The most common schemes”, although purportedly written with the assistance of two eminent tax advisers, actually skates over the service of an extremely complicated subject, and appears to confuse tax reliefs, what I would refer to as tax mitigation and what the government refers to as abusive tax avoidance.
It does not help public understanding of the issue of tax avoidance to lump three very different concepts into one in this manner. There is a continuum of tax avoidance activity, and this is a guide to that continuum, starting at the mild end and ending up with the abusive. Hopefully this will make clear what I am saying. Of course one man’s mitigation is another man’s avoidance, so I will try to be dispassionate and objective about the approaches I outline, but I do have opinions on the methods outlined.
I would argue that these do not constitute tax avoidance at all, because they are tax incentives introduced by governments to encourage particular forms of behaviour by taxpayers, and thus have the clear approval of the Treasury, at least when used as intended by the legislation.
Some examples are:
Venture capital reliefs
There are three examples of reliefs designed to encourage investment in smaller trading companies, engaged in riskier business sectors of the economy. These are venture capital trusts (which invest in a range of such small & medium-sized companies), the enterprise investment scheme (“EIS”) and the seed enterprise investment scheme (“SEIS”), both of which encourage investment in particular small and medium-sized companies. I will concentrate on the latter two in this post.
The EIS has been with us for a long time, and offers income tax and capital gains tax incentives for investment in riskier trading companies. There are size limits to eligible companies, limits on the amount that can be invested by an individual and the amount that can be raised by a company. Broadly, 30% income tax relief is available on an EIS investment, as well as deferral of capital gains on other assets and capital gains tax exemption for the EIS investment itself.
The excluded trades are largely those backed by significant property assets (e.g. hotels, nursing homes, farming, property development0 and financial and professional activities regarded as relatively low risk (e.g. banking, accountancy, legal practice).
The SEIS is a new relief introduced in April 2012 to encourage investment in very small, high-risk start-up companies. In recognition of the greater level of risk involved, the tax incentives are more generous. 50% income tax relief is available, as well as exemption for gains made in 2012-13 and reinvested in an SEIS company and capital gains tax exemption for the investment itself. It has been pointed out that in some circumstances this combination can lead to relief of 103%, which is clearly ridiculous, but that is how the legislation is drafted.
There are two forms of relief in this respect. The first, and most commonly known and used, is Gift Aid. This allows charities to add 25% to net donations by eligible taxpayers by way of government tax distribution, and higher rate taxpayer donors to claim additional tax relief for their donations. The second is charity share gift relief, whereby a taxpayer can claim relief against income tax for the market value of quoted shares gifted to a charity.
Again this is deliberate government policy to encourage donations to charity. Fears of abuse led George Osborne to propose a £50,000 limit on such donations qualifying for tax relief, but a storm of protest led him to withdraw this proposal.
And fears of abuse have in the past been justified. In the case of the charity share gift scheme there have been examples of company promoters floating shares on the AIM or USM at artificially inflated prices to allow donors to claim excessive amounts of relief on share donations to charities. This is a good example of inappropriate use of a specific tax relief introduced by government.
Research and development tax reliefs
The government has identified that the future of the British economy lies partly in the areas of high tech manufacturing and product development, and thus very generous tax reliefs are available to companies that spend money on research and development. For smaller companies these reliefs include a 225% corporation tax deduction for relevant expenditure, or a cash repayment of 32.625% for loss-making or pre-trading companies.
Share incentive plans and enterprise management incentive schemes
Governments are keen to encourage wider employee share ownership in their employer companies, and thus there are income tax and capital gains tax reliefs available to encourage both schemes to benefit the workforce as a whole (“SIP”) and specific key employees (“EMIS”).
It seems to me that no one can take exception to a taxpayer using these schemes for their intended purpose, as they reflect specific government policy to encourage particular taxpayer behaviour.
We then move to an area that HMRC refers to in the Consultation Document on a General Anti-Abuse Rule (see below) as ‘the centre ground of tax planning’. Of course this is a phrase easy to coin but harder to define, and HMRC defines it by exception, by making clear what it regards as abusive tax planning. It is therefore reasonable to draw the conclusion that such planning is (at least for the moment) acceptable to HMRC as appropriate taxpayer behaviour.
There are a huge number of examples of this, of which I will illustrate four. The one chosen in the article is interesting, as I would say that in many circumstances this could actually fall foul of existing anti-avoidance legislation. This is the employment of a husband or wife in the other spouse’s business. The article refers to such spouses who “…might do very little work, but are still paid a salary”.
I would never recommend a client to pay a spouse more than the value of the work that they do for a business, as this falls foul of what is referred to as the settlements legislation, which catches gifts of income only between spouses. It seems to me that paying a salary in excess of the market value of services provided is just such a gift of income, which HMRC could attack, reallocating the excess salary to the profits of the spouse’s business. This illustrates rather well my point about the inaccuracies and misunderstandings in so much press coverage of this issue.
The more common and more successful tax planning strategy is mentioned in a throwaway line at the end of the relevant section, being the issue of shares in one spouse’s trading company to the other spouse. As the article says, this has been the subject of an attempted government crackdown using the settlements legislation referred to above, a crackdown which failed in the courts because a share is not a right to income only; it also carries rights to vote and to receive capital when a company is wound up.
The interesting element here is that, in the wake of the House of Lords decision rejecting HMRC’s case, the then Labour government introduced draft legislation to combat what it referred to as ‘income shifting’, and then withdrew it, with the current government since indicating that it had no plans to revisit the matter.
In my view, this reflects the fact that more and more taxpayers (or perhaps more to this point, voters) have been obliged over recent years to take up self-employment as a result of losing their jobs, and many of them have no doubt been advised to undertake precisely this type of planning. Blocking this type of planning may well have therefore appeared less than politically expedient to all parties.
Similar considerations probably apply to a related strategy, which is for small company director/shareholders to take dividends in preference to salary, thus saving significant amounts of national insurance. There are a number of interesting aspects to this type of planning, which have been well known for years but significantly not blocked by successive governments:
- By taking a particular level of salary it is possible both to avoid national insurance contributions (and PAYE) and to receive credit for having paid them for state benefits purposes.
- By avoiding having a service contract with their company, director/shareholders can avoid the application of minimum wage legislation, which would otherwise oblige them to take sufficient salary to pay national insurance and PAYE.
- Dividend income is effectively not taxed in the hands of basic rate taxpayers.
In my view, this is because government wishes to encourage a thriving small business sector, which is again part of the current government’s vision of the future of theUKeconomy. In this context, these can be seen as somewhat akin to the specific reliefs mentioned above, in that they are intended to encourage the formation and success of small businesses. There is nothing explicit about this policy, presumably on the basis that it would be highly controversial with the majority of taxpayers who are employees, but it seems clear to me that it exists in practice. This would explain why HMRC is happy to describe this type of tax planning as ‘the centre ground’.
Another couple of examples, the first again relating to businesses. For inheritance tax purposes, trades and shares in unlisted trading companies are effectively exempt. By careful but relatively simple planning, it is possible for husband and wife each to obtain this effective exemption on the value of the business interest of the first spouse to die. Again this has been well known for years but has not been blocked; is this again one of the hidden tax perks of running a small business?
Incidentally, because of these reliefs, it annoys me when I hear small business representatives complain about excessive red tape associated with running a business, as it appears that they are ignoring the tax incentives offered to them for their pains, and for the commercial risks that they take.
The survival of the final example is a little more difficult to understand, unless you take the cynical point of view that it is a useful relief for many MPs. It is possible, where a taxpayer owns two properties that have each at different times been a residence, to obtain very generous capital gains tax reliefs and exemptions on the disposal of both properties, often out of all proportion to the actual period of residence in the property, particularly where the property has been commercially let. This is what was referred to during the MPs expenses scandal as ‘flipping’, but no moves have been made to prevent this.
The true purpose of the primary reliefs that makes this possible was to allow for the situation where a taxpayer had to move (usually to take a new job) and struggled to sell their previous home. However, the reliefs are of much wider application than that, and can be a massive advantage to owners of more than one residential property. It is very difficult to justify this on tax policy grounds, yet the opportunities remain on the statute book, and have done for many years. Again, one can only assume that this is deliberate on the part of successive governments, and so again it is difficult to argue that people who take advantage of the legislation are in some way abusing the system.
Having justified the use of such ‘centre ground’ planning, which I certainly use on a daily basis for our clients, it is necessary to recognise that the centre ground of tax planning is likely to be a moving target. Today’s acceptable tax planning may be tomorrow’s abusive tax planning, depending on public opinion and government fiscal and economic objectives. I could certainly see multiple main residence reliefs becoming a controversial topic if the general public were better informed about its potential scope.
Abusive tax avoidance
This is where life gets interesting. Ever since the 1960s there has been a growing section of the accountancy and tax professions devoted to the design, development and distribution of artificial tax avoidance schemes. Government efforts to combat their activities have included specific anti-avoidance legislation, requirements to disclose commercially marketed tax avoidance schemes and a large number of court cases, which have led to the development of the ‘Ramsey doctrine’, which permits the courts to ignore the results of any steps inserted into a series of transactions purely for tax avoidance reasons.
None of this has been successful in eradicating abusive tax avoidance, either on a bespoke basis by large corporates or on the basis of schemes marketed by large accountancy firms and, latterly, specialist tax boutiques. Hence the proposed introduction of a General Anti-Abuse Rule (“GAAR”) in April 2013 to combat abusive tax avoidance.
I would love to give you copious examples of how specific artificial tax avoidance schemes work, but here I come up against a problem, reflecting the schizophrenic life that the modern tax adviser has to live. Readers will have gathered that I do not approve of artificial tax avoidance schemes, which I consider have no place in aUKin long-term economic difficulties. However, if I am to give my clients best and most comprehensive tax advice, and more to the point avoid being sued for not doing so, I need to be aware of available schemes.
This requires me to maintain a working relationship with the most ethical, honest and straightforward tax boutique I have been able to identify, so that I am aware of the comprehensive range of schemes that they offer, across the range of UK taxes. This enables me to bring them to clients’ attention, invariably together with warnings about their cost (usually astronomical), the risk of them failing or being blocked (often significant), the HMRC attention they will attract (close and usually unwelcome) and now the impact of the impending GAAR (likely to be fatal). Oddly enough this tends to result in my clients not taking them up, but I have done my professional duty by them.
However, in order to be made aware of what the schemes are, I have to sign a non-disclosure agreement, and thus I can tell you nothing about the schemes whose (theoretical) workings I am most intimately familiar with. This is as frustrating for me as I am sure it is for you, but I will seek to compensate by explaining how the GAAR will identify abusive schemes, and giving some quick examples of planning that it should catch.
The draft GAAR identifies four hallmarks of abusive avoidance schemes, at least one of which would be present in such a scheme. These are as follows:
- The arrangements result in an amount of income, profits or gains for tax purposes that is significantly less than the amount foe economic purposes.
- The arrangements result in deductions or losses of an amount for tax purposes that is significantly greater than the amount for economic purposes.
- The arrangements result in a claim for the repayment or crediting of tax (including foreign tax) that has not been, and is unlikely to be, paid.
- The arrangements involve a transaction or agreement the consideration for which is an amount or value significantly different from market value or which otherwise contains non-commercial terms.
Jimmy Carr’sK2scheme is considered by HMRC to be an example of 1, as it replaces taxable earnings with non-taxable loans. Take That’s Icebreaker scheme is considered by HMRC to be an example of 2, in that it aims to inflate the upfront loss suffered by investors above a commercial or economic level. Sir Chris Hoy’s temporary loan from his company, on the other hand, is very much in the centre ground of tax planning as I currently see it, particularly as it was short term and cleared by the payment of taxable dividends. However, the prominence given to this in the media again shows the need for clarity as to where on the avoidance continuum a particular scheme or taxpayer action lies.
It is therefore clear that the GAAR aims to catch artificial tax avoidance schemes that produce tax results significantly different from their economic outcomes, characterised by HMRC as abusive tax avoidance. In my view it will work to catch the vast majority of current schemes at which it is aimed; the key question is whether the ingenuity of the tax avoidance industry is sufficient to enable them to circumvent even the GAAR. I suspect I speak for the majority ofUKtaxpayers when I say that I hope it is not.
I trust this post has cleared away some of the ‘fog’ surrounding tax avoidance, and has clarified the different types of tax planning activity undertaken and the government and HMRC’s current attitude to each type of activity.