ARE YOU RESPONSIBLE FOR THE TAX GAP?

BLOG 190

ARE YOU RESPONSIBLE FOR THE TAX GAP?

Pre Gordon Brown, HMRC press releases tended to be primarily factual and probably not of much interest to those with no interest in tax, Gordon, or rather his acolyte Dawn Primorola, spiced them up (some say politicised them).  From mixing with us common people they seem to have formed the impression that everyone is desparate to learn about tax.  Much of the impetus for digital tax is expressed as intended to feed this insatiable quest to build one’s life around one’s tax position.

I don’t know what pub the Treasury mandarins use.  Tax has never been a strong topic of conversation in the many that I have visited over the years.  I have rarely felt an urge to check my tax position and I doubt that many of the non-tax people that I know are eager for more tax knowledge.  No one at a party has ever begged me to tell them about tax.  So I think that government efforts to publicise tax are a complete waste of taxpayers’ money, but I would be happy to be proved wrong.

Tax gap figures are fun even without the spice (or politicisation).  They are fun because they are guesses dressed up as fact.  Of course HMRC will call them educated estimates but that simply means guesses informed by knowledge.  However that is not true in this case.  No one has sufficient knowledge to enable them to measure the tax gap.

HMRC tell us that “the tax gap measures the difference between tax due and tax paid to HMRC”.  But even that is not right.  They attribute 0.9% of the tax gap, or £5.3billion, to what they call “legal interpretation”.  This is “where the customer’s and HMRC’s interpretation of the law and how it applies to the facts in a particular case, result in a different tax outcome”.  This might occur for example because the Supreme Court upholds the taxpayer’s position.  In HMRC’s world, “legal interpretation” is a type of “customer behaviour”.  In other words, the government were deprived of £5.6billion of taxpayer money in 2016/17 because people challenged HMRC’s interpretations and the Supreme Court (and the lower Courts and Tribunals) decided that HMRC did not properly understand the law.  I am not a statistician but, in my naivety, I regard that as an HMRC error in measuring the “tax due”; not a result of the HMRC measure being correct and the Supreme Court undermining the tax system by letting people off tax that is legally due when such people engage in what HMRC no doubt regard as the socially unacceptable behaviour of challenging HMRC’s interpretation.

But there is a more fundamental problem with measuring the tax gap.

This is that it is impossible to measure.  All that one can do is what HMRC do; start with the estimated yield from a tax measure, deduct the tax that they have received, and allocate the shortfall by reference to the tax collected as a result of HMRC interventions (i.e. enquiries and investigations) and taxpayer’s post tax return disclosures.  I do not have time to read HMRC’s 94-page detailed explanation (although I have read one of the earlier ones), but estimating the yield itself has a number of variablers.  Firstly, it depends on profits (or in some cases turnover) for the year concerned, so any error in the estimate of undisclosed profits leads to the yield being wrong too.  Secondly, measurement depends on having the full information on compliant taxpayers.  Bearing in mind that it can take a good 10 years before the Supreme Court decides whether tax is due or is not due, such disputed amounts are bound to distort estimates that have to be made in year 2.  Thirdly, there are an awful lot of disputes over what tax is due in a particular case and many of these will not have been resolved by the time the estimate needs to be made (although, on reflection, on the HMRC basis that HMRC are always right and it is the Courts that get the interpretation wrong, whilst that makes measuring the actual tax gap difficult it does not impede measuring HMRC’s fantasy tax gap).

The HMRC detailed tables only start from 2011/12 (they show 2005/06, but not intermediate years).  It is interesting to look at what has happened.  They analyse the tax gap in several ways.  I will take two.

Types of taxpayer                  2005/06                      2011/12                      2016/17

Small businesses                     2.6%    11.2bn             2.4%    14.0bn             2.3%    13.7bn

Large businesses                     1.8%    7.7bn               1.2%    6.0bn               1.2%    7.0bn

Criminals                                 1.7%    7.4bn               0.9%    4.8bn               0.9%    5.4bn

Mid-sized businesses              0.8%    3.4bn               0.6%    3.7bn               0.7%    3.9bn

Individuals                               0.5%    2.2bn               0.5%    3.1bn               0.6%    3.4bn

                                                7.4%    31.9bn             5.6%    31.6bn             5.7%    34.3bn

Less criminals                         1.7%    7.4bn               0.9%    4.8bn               0.9%    5.4bn

                                                5.7%    24.5bn             4.7%    26.8bn             4.8%    28.9bn

I have taken out criminal (which in HMRC speech is organised crime and does not include tax evasion (can you have a criminal offence perpetrated by a non-criminal?)) because I think this distorts the figures.

Behaviours

Failure to take

  reasonable care                    1.0%    4.6bn               0.8%    4.0bn               1.0%    5.9bn

Criminal attacks                      1.7%    7.4bn               0.9%    4.6bn               0.9%    5.4bn

Evasion                                    0.9%    4.0bn               0.8%    3.9bn               0.9%    5.3bn

Legal interpretation                0.9%    4.1bn               0.7%    3.5bn               0.9%    5.3bn

Non-payment                          0.5%    2.1bn               0.9%    4.5bn               0.6%    3.4bn

Error                                        0.6%    2.8bn               0.5%    2.3bn               0.5%    3.2bn

Hidden economy                     0.5%    2.0bn               0.5%    2.5bn               0.5%    3.2bn  

Avoidance                               1.1%    4.9bn               0.5%    2.7bn               0.3%    1.7bn

                                                7.2%    31.9bn             5.6%    28.0bn             5.6%    33.4bn

I am fascinated at some of the HMRC explanations of their analysis.  Non-payment is tax debts that are written off by HMRC – mainly as a result of insolvency.  I would myself describe insolvency as misfortune – often as an unavoidable result of entrepreneurship – rather than a taxpayer behaviour.  Avoidance is exploiting the tax rules to gain a tax advantage that Parliament never intended, so HMRC  believe (I will resist the temptation to question how anyone knows what our 630 representatives intend when waving through, largely without debate, a 665-page Finance Bill).  However “it does not include international tax arrangements like base erosion and profit shifting”.  So it’s nice to have an official acknowledgement that, in HMRC’s view at least, Amazon and Google are not avoiding UK tax; they never owed any UK tax under current international tax rules.  There is also an odd distinction between the hidden economy “where an entire source of income is not declared”, and tax evasion “where a declared source of income is deliberately understated”.  I have specialised in tax for over 50 years and have always believed that not declaring income is as much tax evasion as under-declaring it.  Indeed I would myself regard under-declaring as less egregious than not declaring at all, as it at least gives HMRC a sporting chance to challenge the figure.  I am puzzled how under-declaring is apparently criminal, while hiding the existence of the income completely seems to be acceptable behaviour to HMRC.

There is also a potential problem with failure to take reasonable care and errors.  I would expect HMRC to investigate cases where something looks wrong, in which case those that they do not enquire into must be those where it is less likely that something is wrong.  If so, using the results from enquiries to predict the result what would have transpired if HMRC had investigated cases where nothing looks wrong, seems somewhat flawed.

HMRC tell me that “since 2010 the government has invested more than £2billion in HMRC to tackle evasion, avoidance and non-compliance”.  So has this been value for money?  You decide!

                                                                        2011/12                      2016/17

Evasion:  criminal attacks                   0.9%                            0.9%

            Evasion                                    0.8%                            0.9%

            Hidden economy                     0.5%    2.2%                0.5%    2.3%

Avoidance                                                       0.5%                            0.3%

Non-compliance: reasonable care     0.8%                            1.0%

                             errors                      0.5%    1.3%                0.5%    1.5%   

                                                                        4.0%                            4.1%

I have adopted my view that the hidden economy is evasion, rather than HMRC’s apparent view that it is OK.  I have excluded legal interpretation and non-payment as these do not seem to me to be attributable to taxpayer behaviour at all. They are certainly not affected by the extra money the government has given HMRC.

Whilst nothing to do with the tax gap, HMRC throw into their press release a section headed “Support and help for businesses”.  This tells me that “HMRC aims to ensure that the tax system is not a barrier to setting up, running and growing a business.  We are working hard to ensure that businesses, small or large, can access the information and support they need, at every stage of their lifecycle and whatever their ambition”.  Sadly clients, and my many friends who act for small businesses, are not endorsing this HMRC perception of how helpful they find HMRC to be!

ROBERT MAAS

HAS GEORGE OSBORNE BECOME THE TAX AVOIDERS' FRIEND?

BLOG 189

HAS GEORGE OSBORNE BECOME THE TAX AVOIDERS' FRIEND?

I was prompted to pose that question by a recent article in the Evening Standard.  It was not by George Osborne, it was by Russell Lynch but, on the assumption that as Editor of the Evening Standard, Mr Osborne would hardly include in the paper anything to which he was violently opposed, I think it a reasonable assumption that the article has Mr Osborne’s editorial blessing.  This also assumes of course that he is really the editor and not merely engaged as a figurehead with someone with greater journalistic experience actually editing the paper; or merely there to do Mr Lebadev’s bidding and it is really the Russian government that calls the editorial shots; or is kept well away from the City pages (in which the full-page article appeared) and allowed only to edit the gossipy bits of the paper.

I should also admit that Mr Lynch’s article does not actually say, “Hurrah for tax avoidance, long live tax avoiders everywhere”.  Indeed, it does not actually mention the dreaded phrase at all.  “It is headed “Suicide watch”; “the preventable tax timebomb” looming for freelancers”.

If this worries freelancers, I should say immediately that there is actually no tax timebomb for the vast majority of freelancers.  There are tax problems for some because HMRC seems suddenly to be looking at many personal service companies and contending that they fall within an anti-avoidance provision that applies where a person’s services are lent out by a company and the person would have been an employee of the end user had he contracted direct with that person.  These rules, known colloquially as IR35, were introduced in 1999 and until recently HMRC seems to have been almost unbelievably lax in policing them.  Their sudden interest is creating a lot of worry, as they do not simply attack the current year; they go back for fur years and present the worker with what is sometimes an enormous supplementary tax bill.  There is a growing scandal because it appears that the BBC and similar quasi-government bodies encouraged people to use companies so as to shift the liability to tax from themselves to the worker.  But that is not what is worrying Mr Lynch.  After all, the distinction between employed and self-employed is one of the great mysteries of life.  These freelancers genuinely believed themselves to be freelancers and are shocked that HMRC is suddenly seeking to treat them as employees of the BBC or the NHS or, indeed, HMRC who are one of the largest users of freelance IT people in the country.

No.  What concerns Mr Lynch is the “loan charge” that will become payable on 5 April 2019.  What concerns Mr Lynch most of all is users of a particularly nasty tax avoidance scheme that was promoted by a number of scheme merchants mainly based overseas out of the reach of HMRC.  I will call such people promoters.  The promoter would advertise on the web or on journals read by freelancers.  The adverts were along the lines of, “Don’t be a mug.  Why should you pay tax?  We have a way to let you get your earnings completely tax-free”.  They would probably then explain that for every £1,000 employees earn, £200 or £400 (depending on the employee’s level of income) goes in tax;, on the first £30,000 or so another 12% goes in National Insurance and above that, 2% goes in National Insurance.  That means that out of his £1,000, the employee is left with around £500-700.  Under the tax avoidance scheme, the promoter would make a charge of, say, 15% to run the scheme leaving the worker with £850.

I don’t always agree with HMRC – indeed sometimes I think I don’t often agree with HMRC – but I agree with their mantras on tax avoidance that if it sounds to good to be true it probably isn’t true, and that tax avoidance schemes rarely work and can cause the user a lot of aggravation as HMRC aim to pursue them right up to the Supreme Court.

And so to the loan.  Mr Lynch explains, “Employers could pay salaries into a trust, set up by the promoter, which then mostly paid the employee in the form of loans, which were tax-free as they were not deemed income or earnings at the time.  The “loans” were never intended to be paid back”.  I will come back to that in a minute, but first Mr Lynch’s explanation of why he thinks HMRC (or possibly the government) are acting unreasonably in seeking to collect the tax that people sought to avoid.  “In March 2016, the Government delivered a bombshell on what it deemed disguised remuneration.  HMRC would now levy a tax charge on the loans, which were now to be treated as taxable income”.  We have an odd system in this country of which Mr Lynch appears unaware.  Neither the Government or HMRC impose taxes; that is wholly down to Parliament.  The legislation that he complains about is in Schedule 11 of the Finance (No 2) Act 2017.  Debating the provision, Anelisise Dodds said “the Opposition wants to see changes in this area because abuses have been clearly documented”.  She later said, “However these measures come after a long period of relative inaction, at least in the areas where this legislation is focussed.  This has meant that many people believed the arrangements they entered into were legal and did not constitute tax avoidance.  The April 2019 charge in these circumstances could, some have opined to us, cause significant problems, for example, to individuals whose situation has changed such that they no longer have the funds to meet the tax charge.  How will the Minister ensure that this measure will not cause hardship or injustice to individuals who planned on the basis of previous arrangements, and how will that be balanced against the clear and pressing need to prevent the abuse, which the measure is targeted at?”  The Minister responded, “We will certainly be looking at individuals who may have entered into these kinds of arrangements as far back as 1999.  Critically, they have until 2019 to clean those arrangements up, if they wish to.  If the schemes are legitimate and above board, they have no reason to be concerned because those schemes will stand the tests we have met.  Let us be clear about what we are looking at; clear tax avoidance”.  He later says, “The Hon Lady asked how we will meet our objectives …  She gave the example of people struggling to pay after being clamped down on.  HMRC often confronts that circumstance in its lime of work.  People who are concerned about their ability to make a full payment of tax on time should contact HMRC at the earliest opportunity.  It considers all requests for time to pay individually, based on the customer’s financial circumstances”. 

I assume that this explanation satisfied Ms Dodds, albeit that it now appears not to satisfy Mr Lynch and, presumably, his editor, Mr Osborne, as neither she nor anyone else called for a vote and the legislation was simply approved by the relevant parliamentary Committee.

Let me get technical for a bit.  The avoidance scheme never worked.  The law says that salaries are taxable as income.  Indeed if Mr Lynch is right when he says that the “loans” [his parenthesis] were never intended to be paid back, they were never loans at all; they were pretend loans, as a fundamental attribute of a loan is that it has to be repaid.  Pretending something is a loan in order to mislead HMRC is not tax avoidance; it is fraud! In which case Mr Lynch and, I assume Mr Osborne, are not championing tax avoiders; they are championing tax evasion!

There is no doubt that the loan charge is retrospective.  Parliament does not like retrospective legislation, but the previous Labour government made clear in 2004 that future legislation to combat PAYE and National Insurance avoidance schemes would be applied retrospectively to 2004.

Mr Lynch does not want these tax avoiders to be made bankrupt.  Nor do I.  Nor actually does HMRC; it wants the tax that has been avoided and interest for the period that the country has been deprived of use of the money.  The loan charge is in fact fairly generous as it effectively allows tax relief for the fees paid to the promoter, which would not have attracted tax relief at all had HMRC attacked the scheme when it was entered into.  Furthermore, HMRC have been pleading for people to come forward and settle the tax before next April, because they can then agree a time to pay arrangement.  Curiously Mr Lynch mentions none of this.

What he seems to want is for those tax avoiders to be let off the amount they owe because they have spent the money.  Most people would find that an extraordinary proposition.  It was not their money to spend; it was our money, us the compliant taxpaying public.  I do not recollect the Evening Standard ever having asked for tax to be excused in relation to celebrities who were faced with heavy tax bills because they entered into other tax avoidance schemes that did not work.

Mr Lynch does not explain why he believes that those who do not try to avoid their tax (or more accurately in many cases, are not able to try to avoid their tax) should contribute to the running of the country but those who seek to avoid their responsibility to do so should be absolved from having to pay.  It is hard to see how such a proposition equates with fairness – if indeed Mr Lynch thinks that fairness ought to apply in tax matters.  Perhaps Mr Osborne will allow him a little more space to explain this to the compliant taxpayers amongst his readership.

Of course, if “freelancers” have used tax avoidance to obtain a higher standard of living than they were entitled to, they are going to have to tighten their belts to find the money to pay the back-tax.  But why should we be sympathetic to that?  There are millions of people who would like a better standard of living, but most do not seek to achieve that by avoiding their responsibility to contribute to the running of the country.

ROBERT MAAS