JOURNAL 12

FIRST INHERITANCE TAX PROSECUTION

HMRC have issued a press release telling us that a Mr Gray has been sentence by Bournemouth Crown court to three years imprisonment for false accounting in respect of inheritance tax returns. They say that this is the first inheritance tax prosecution in England. Bearing in mind that inheritance tax has been with us since 1986 (when capital transfer tax was renamed inheritance tax) I find it extraordinary that it has taken almost twenty years before any criminal prosecutions have taken place. It only took two to three years before the first criminal prosecution for tax credit fraud. It does seem an odd sense of priority for the HMRC Prosecution Office to have homed in on prosecuting the poor, who in general are the people entitled to tax credits, but to have seemingly dismissed the possibility of prosecuting the rich for inheritance tax fraud. It seems to me most unlikely that there has been no inheritance tax fraud in the last twenty years other than that committed by Mr Gray.

For income tax purposes, where the Revenue much prefer to accept a monetary settlement than to prosecute people, they do at least prosecute some cases to make an example of people to discourage others from fraud. It is odd that they do not seem to have done the same with inheritance tax. This gives the appearance, which I sincerely hope is an incorrect impression, that tax criminals who can afford to buy off the tax authorities are allowed to do so, but those who cannot afford to do so are prosecuted.

Indeed the prosecution of Mr Gray seems from the HMRC press release not to be so much because he completed the inheritance tax return incorrectly, but because he in fact forged the deceased’s will to make himself the major beneficiary in place of the charities to which the deceased had intended the bulk of the estate to go.


Robert W Maas

JOURNAL 11

BIG BROTHERS COUNCIL TAX

I have been reading on Accountancyage.com that, followed questions from an MP before Christmas, the Valuation Office Agency have sent an Inspector to assess whether the Big Brother house is liable for council tax.

The article quotes the Financial Times as saying that experts think that it is probably not liable because the celebrities are only there for three weeks, which is only a short period. I am somewhat puzzled by this and wonder what experts have expressed this view. Section 2 of the Local Government Finance Act 1992, which introduced the council tax, firmly states that “liability to pay council tax shall be determined on a daily basis”. It therefore seems to me irrelevant that the celebrities are only there for three weeks.

What is more relevant is that I suspect that the Big Brother house is not the main residence of the celebrities so the discount for second homes will apply. Perhaps of even more relevance is that I think it questionable whether the Big Brother’s house is a “dwelling” at all. It seems to me much more likely to be business premises and, as such, to be liable for business rates rather than council tax. I can certainly see no reason why it should not be bearing one or the other.

Robert W Maas

JOURNAL 9

ARCTIC SYSTEMS

I was wrong! I felt very certain that HMRC would win the Arctic Systems case (Jones v Garnett) in the House of Lords. I have not rushed into commenting on this case as I have been struggling to understand the basis of the decision. I am surprised that the taxpayer won – and even more surprised at the reason he seems to have done so.

Mr Jones is an IT consultant. He and his wife each subscribed for one share of £1 in Arctic Systems Ltd. He was the only consultant the company employed. Its results were as follows:


Salary Salary Net Profit Dividend
Mr Jones Mrs Jones
1996/97 £7,146 £2,400 68,307 54,000
1997/98 7,140 2,400 62,439 46,900
1998/99 6,868 3,600 74,707 57,500
1999/00 6,520 3,600 26,372 51,535

HMRC contended that there was a settlement, namely an arrangement under which Mr Jones agreed to work for Arctic for a nominal salary, with half of the bulk of the earnings that he generated then being distributed to Mrs Jones as a dividend. That’s what it looked like to me too!

There are a number of decisions in which an arrangement under which a person works for a company at a nominal salary to enable a dividend to be paid to someone else has been held to be a settlement; such as Crossland v Hawkins (Jack Hawkins) in the House of Lords in 1961, Mills v CIR (Hayley Mills) in the House of Lords in 1974, and in the High Court, Copeman v Coleman in 1939 and Butler v Wilding in 1988. It is hard to see why Mr Jones’ position was any different.

The answer I find surprising. Firstly, Mrs Jones worked in the business. She had experience (as a former catering manager responsible for 11 staff) in financial and business management! Although the business of Arctic Systems, being very small, did not need much management, her role in the business was to do what management was required (and her salary was a fair reward for such work). “Ah” said the Court of Appeal, “This is a joint commercial enterprise. Indeed Lord Justice Keen and Lord Justice Cornwath (whose background is in tax) thought that it would be a significant extension of the law to extend the settlement provision to “a normal commercial transaction between two adults, to which each is making a substantial commercial contribution, albeit not of the same economic value”.

Secondly the Court of Appeal held that the arrangement could not include what actually happened as “all those additional factors depended on the will of Mr Jones or wholly extraneous factors. He did not commit himself to working for the Company at any particular rate of salary or at all…If the Company made profits whether to declare any and if so what dividend was a matter for Mr Jones as the sole director and controlling shareholder…I do not think these elements can be included in the “arrangement”. They did not form any part of a structure of things or combination of objects; their uncertainty and fluidity is the converse of an arrangement”.

Thirdly Jack Hawkins and Hayley Mills had service agreements; they had committed themselves to working for the company at a salary substantially less than the going rate for those services; those service agreements were accordingly a part of the “arrangements” in those cases.

Where does this leave HMRC? I suspect petitioning the House of Lords for leave to appeal (the Court of Appeal refused leave). The judgement clearly points the way to how to avoid the settlement provisions in relation to services, namely:

(a) make sure the spouse does some part-time work in the business,
(b) send her on a book-keeping course so that she has the skill to do so,
(c) do not make the spouse a director, and
(d) do not have a service agreement.

Where does this leave the settlement legislation? In tatters.

Where does this leave tax planning? That is an interesting question. Jack Hawkins and John Mills engaged top accountants and solicitors to provide the best advice available. They now seem to have failed because the advice was too good. They were told that the arrangement needed a service agreement to evidence that the company was entitled to the income. Mr Jones seems to have taken advice from a general practitioner accountant who told him that he should have a company and take the bulk of the income as dividends to split it between himself and his wife. I suspect he had no service agreement because the accountant did not think of having one. I suspect his wife was not a director by accident rather than design. The lesson seems to be that muddling along has a much better chance of success than buying expensive advice. Perhaps that leaves the tax planning profession in tatters too!

Robert W Maas

JOURNAL 10

THE HMRC’s EMPLOYMENT STATUS INDICATOR TOOL

HMRC’s Employment Status Indicator (ESI) tool went live on 19 December 2005. This is an interesting concept. It seems to be a computerised decision tree to help someone who engages or proposed to engage a worker to work out his employment status.

I was pleasantly surprised to find that it does not automatically come up with the answer that the person in an employee. Indeed, when I trailed the beta version I put through it all of the cases in the office where HMRC are arguing strongly that the person is an employee and it either came up either with the answer “self-employed” or “we don’t have enough information to decide”. That suggests that it is a useful tool. Unfortunately it also suggests that using it won’t avoid the problems with HMRC that normally arise in relation to status.

I cannot recollect a PAYE visit on a client who used self-employed people to carry out routine work where HMRC did not challenge the status of at least one of such people. If I assume HMRC want to collect the right amount of tax at the right time (which they are constantly telling us is the case) there is something very strange about that.

I want over the next week or two to look in detail at the ESI tool, but first want to start with its own status. It is heavily caveated. “Outcomes will be based purely on the information you provide”. This is obviously reasonable. Or is it? It is reasonable if the questions you are asked elicit the information that is needed to make the correct decision. But as there is no “additional information” box and the questions are very general, is it reasonable not to tell you that the questions are in fact aimed primarily at construction industry subcontractors and if you do not work in the construction industry the questions asked may well not be those that are needed to elicit a reliable outcome?

Then comes the big caveat. “This version of ESI will not only provide an indication of employment status. It will not give a definitive or legally-binding opinion”. So what’s the point of using it? HMRC are not even prepared to say that if you use it and answer all their questions honestly they will not penalise you for having done your best.

What is likely to happen? I don’t know, but my guess is that when you get a status enquiry the first question you will be asked is whether you use the ESI tool. If so, did you follow its answer? If not (to either question) why not? If you used it and got the answer that the person is self-employed – yes, it is very definitive, it does not say “probably” self-employed – I suspect that you will be told that it is purely an indicator and the question it asks are not exhaustive so it is now the Officer’s duty to discover the overall facts.

Or perhaps you won’t be asked if you used the tool. The conditions of use include the statement that “HMRC routinely carries out compliance activities. In the course of these activities we will check that the working arrangements reflect the information provided.” What does this mean? The tool is anonymous. You don’t have to give your name and address. How will they know you have used it? I don’t know. Perhaps the above note is a bluff. Or perhaps not. If you use the tool it creates an ESI Ref (mine was 14 digits). So perhaps HMRC have sent a “cookie” to your computer that tells them who you are and tells your PAYE District that you have used the tool and that they ought to look at people that you claim to be self-employed.

It should also be noted that the Conditions of Use state, “Where the …terms [of the written document] have been varied by agreement or by practice…then the information entered into ESI may reflect the terms of the contract, what the parties carry out in practice, or a combination of both”. This is not in accordance with the law. The leading case is a Privy Council case (the Privy Council is made up of the members of the House of Lords Judicial committee and hears appeals from courts of other Commonwealth countries), Narich Pty v Commission of Payroll Taxes of New South Wales. What the Privy Council said there is that where there is a written contract status must be decided on one basis alone, namely by considering the terms of that contract. The only exception is where what happens in practice evidences an agreed variation. That is very different from looking at what happens in practice irrespective of whether a departure from the contract is something that has been agreed, or it is something that one of the parties has unilaterally imposed and the other puts up with.

In this context why is the above statement part of the Conditions of Use, not part of the introductory explanation? Could it be that by making it part of the Conditions the user of the ESI tool is agreeing not to invoke the legal position?

Robert W Maas

JOURNAL 8

WAS IT REALLY IN TIME?

A frustrating feature of published tax decisions and judgements is that they do not always fully spell out the facts on which the decision is based. My eye was caught by a comment in the High Court judgement in O’Sullivan v Philip, which concerned an HMRC enquiry notice, that “as the notice was given within a year of the date of the amendment, it was clearly in time”. This was actually a quote from the Special Commissioner’s decision. This recounts that the amendment was made on 9 October 2001 and the enquiry notice in respect of which it was issued was dated 8 October 2002.

It is not at all clear to me that the notice was in time! In Wing Hung Lai v Bale (1999 STC (SCD) 238) it was held that the notice had to be served on (ie received by) the taxpayer within the 12 month period. A notice issued on 8 October 2002 could meet this test only if it had been hand delivered.

The taxpayer appealed only against the substantive decision not this procedural one. What we are therefore left with is the question of whether the notice was in fact hand-delivered, which would be highly unusual, or if not whether Dr Williams intended to disagree with the earlier decision of Mr Everett.

This is clearly an issue of major importance if Dr Williams did indeed feel that the Wing Hung Lai decision was wrong. Does anyone know the answer?

Robert W Maas

JOURNAL 7

THE FAIR TAX (2)

In my entry of 19 December 2005 I raised the subject of the Fair Tax, a US suggestion for a consumption tax to replace all other taxes. I said then that I thought it factually flawed. Today I want to explain why.

But first what is the attraction of replacing income tax and other direct taxes by a consumption tax? The many advantages claimed for the fair tax are:

1. Taxpayers (other of course than retailers) will be relieved of the costs of complying with tax laws – which the (US) Tax Foundation estimates at $194 billion.

2. Most of the 100,000 people who work for the IRS (the US equivalent of the direct tax and VAT collection side of HMRC (the US Customs Service handle the Customs side) will be able to be redeployed to more useful occupations (the authors of the book suggests as assistants in burger bars, which some might question whether is really a more useful occupation).

3. Every one will have more money as they will receive their gross earnings and prices are likely to adjust downwards to such an extent that the FairTax inclusive price will be roughly equal to current prices – so everyone will be better off by the amount of tax that they currently pay.

4. US multinationals will close down their international operations and bring everything back home so as to avoid paying foreign taxes.

5. The US will be so competitive internationally that overseas companies will rush to set up in the US and employ US workers.

6. It will put an end to the black economy (or the underground economy, or invisible economy as it is now often called in the PC world).

7. As the government will pay the FairTax on its purchases whereas private business won’t, it will be unable to compete with private business and will have to divest itself of business such as electricity generation or garbage collection.

8. A tax on consumption encourages savings, which in turn encourages investment. It also incentivises people to work harder and earn more untaxed income that they can save.

9. The rich can avoid income tax but won’t be able to avoid the Fair Tax. Indeed because they spend more than the poor they will pay more tax than the poor.

Sounds good. Why won’t it work? Because the arithmetic seems to me to be flawed. And if the arithmetic is flawed most of the above benefits are illusory.

This hit me when the authors explained “The FairTax is not a VAT or value-added tax similar to European VATs. VATs are added at every stage of production and hide tax costs in the price of goods. In contrast the FairTax is levied once and once only – at the retail cash register – and it is printed on the sales receipts for all to see”.

Firstly this demonstrates that the authors do not understand VAT. VAT is not a cascade tax which is levied again and again at each stage of production. It is a tax on the value added. In its purest form a seller charges VAT only on the difference between his selling and purchase price. Accordingly if the VAT at all of the stages of production is added together the total is exactly the same as the single charge under a FairTax. (The European VAT system does not wholly achieve this as it is imperfect and sometimes inconsistent because of the effect of exemptions, multiple rates and exclusions, but a perfect VAT system would have the same result as a consumption tax charged at the retail stage only). Yes the amount of VAT included in the price of an item is hidden, but who really cares how much of the price that they pay for something is tax? The FairTax envisages a tax inclusive price so a person will not know how much tax he is being asked to pay before he buys; he will need to study the till slip - and when he gets that it is too late to be deterred by the tax.

Secondly a VAT is superior to the FairTax as it is more difficult to evade. The authors claim that evading the FairTax will require collusion between the customer and the retailer and that is unlikely to occur. They also believe that most of us are inherently dishonest. It is accordingly unclear why they dismiss (or possibly overlook) the risk that retailers or their staff will simply charge the tax to the customer and not account for it to the IRS. That is far more likely than collusion. With a fair tax it is the entire tax that will be stolen. With a VAT it is normally a proportion only of the tax, normally that on the value added at the final stage, as the purchaser at an intermediate stage is likely to want to ensure that his vendor pays the tax as he wants to claim credit for it.

But that is not the fatal flaw. That is simply what got me thinking about the author’s arithmetical competence. The fatal flaw is the assumption that prices will fall by 23% to compensate for the tax. Take WalMart for example. It’s 2005 accounts show sales of $285,222m, total operating costs of $51,105m and pre- tax income of $16,105 on which it paid tax at an effective 34.7%. Assume half of the cost of sales is wages attracting employee’s social security at 7.65%. That comes to $5,588m corporate tax plus $1,955m social security, a total of $7,543m or 2.65% of its sales. Its FairTax bill at 23% on $285,222m would be $65,601m, an increase in its overall tax liability of $58,058m. If it didn’t have to pay the existing taxes its net profit would be $23,648m. So how is it going to absorb $65,601m and stay in business. Answer: It can’t.

I suspect that in looking at existing taxes the authors have counted in payroll taxes. But their starting point is that workers’ take home pay increases, i.e. that they keep their existing earnings but pay no tax on them. On that basis Walmart does not benefit from the tax saving; its employees do. And if Walmart does not obtain the benefit of the saving it clearly cannot pass the cost of that saving on to it’s customers. Of course there is some embedded tax in Walmart’s expenses and its $219,793 cost of sales (i.e. taxes paid by its suppliers), but that is likely to be at a similar rate to Walmart’s 2.65%.

The authors also do not say what happens if customers drive to Canada or Mexico for their major items of shopping. Unless FairTax is charged at the border that will reduce US sales and therefore the US tax yield. So will not charging tax on second-hand goods. Currently every time something is sold it attracts tax. And what about refurbishing second-hand goods prior to sale. There will be no FairTax on that either. Accordingly the taxbase will be much smaller than at present, which makes even the 23% figure look suspiciously low.

All in all the FairTax looks to me to be an idea that has not been thought through very far. It seems to me to be completely unworkable.

Robert W Maas

JOURNAL 6

NO TAXATION WITHOUT REPRESENTATION

Catching up on my reading over the holiday period I noticed an HMRC press release of 3 November in which they say that they have changed their mind on the interpretation of section 209(4) of the Income and Corporation Taxes Act 1988 and now accept that the reference in it to “assets” does not include cash. HMRC are of course perfectly entitled to change their mind on the interpretation of legislation, even after it has been on the statute book for many years.

What caught my eye is that the press release goes on to say “ The reference in TA 1988 s 339(1)(a) to TA 1988 s 209(4) was made as a consequence of the incorrect view taken by the Inland Revenue. HMRC now accepts that reference is inappropriate.”

Section 339(1)(a) says that “a qualifying donation is a payment of a sum of money made by a company to a charity other than a payment which, by reason of any provision of the Taxes Act …except section 209(4) is regarded as a distribution”. The reference to a sum of money was inserted by the Finance Act 1990.

I am under the impression (or perhaps misapprehension ??) that tax law is made by Parliament. I appreciate that over the last few years Tony Blair seems to have been largely contemptuous of Parliament and that the new intake of MPs seems to have been quite happy to put up with this.

Nevertheless the rallying cry of the founding fathers of the USA, “no taxation without representation” was based on the belief that in the UK Parliament imposes taxation, combined with a determination that the same should apply in America and that non elected representatives should not be entitled to impose taxation on Americans. If that correctly reflects the UK position, then the reference in section 339(1)(a) to section 209(4) having been made “as a consequence of the incorrect view taken by the Inland Revenue” is incorrect. It was surely made because the then Chancellor of the Exchequer, John Major, persuaded Parliament at the time that it was the right thing to do. As Mr Major is still an MP it is surely incumbent on him to tell Parliament on what basis he asked them to make this change and for those MPs who were members of the House in 1990 and are still members to similarly explain the basis on which they thought that it was the most appropriate change to make.

English law courts strive to give a meaning to the words used by Parliament. It is accordingly anybody’s guess how they will interpret section 339(1)(a) if called upon to do so.

Whatever Mr Major meant, it seems to me constitutionally outrageous for HMRC to say that they now accept that the change Mr Major, and the MPs who supported him in 1990, made to section 339 “is inappropriate”. Surely it should not be up to HMRC to decide whether or not what Parliament chooses to do is inappropriate. It should be up to Parliament to apologise to the electorate and say that they are very sorry that they enacted inappropriate legislation in 1990 but this was done on the basis of inappropriate advice by the Inland Revenue, which either seemed to them correct at the time or which they could not be bothered to question, whichever the case may be.

Robert W Maas