Tax Research UK

Prem Sikka is in the Guardian saying:

The Lehman insolvency examiner’s report once again shows that the public should be sceptical of the audited accounts published by giant corporations. Accountants disarm journalists, critics, regulators and the general public by claiming that the accounts are fairly presented in accordance with some generally accepted accounting principles (GAAP), but the Lehman report shows that they are based in carefully rejigged accounting practices (CRAP).

He’s expanded on my theme.

Good man.

Richard Murphy Accounting

I’ve been doing a little grubbing around Lehman and its repo accounting.

Report is widespread that the “repo 105” deal that caused the alleged misstatement of Lehman’s balance sheet took place in the UK.

Now it so happens that my information is that Lehman UK reported using UK GAAP i.e. under UK accounting standards.

But, under UK accounting standards a repo is treated as an on balance sheet transaction.After all, it is a sale of an asset matched by an agreement to repurchase it. The transaction has not changed the real structure of the balance sheet as far as UK GAAP is concerned, so the transaction is effectively ignored for reporting purposes. That’s because the risk and reward of ownership of the underlying assets has not changed – they remained with Lehman.

Oddly, as far as I can tell IFRS delivers the same result as far as I can see.

So how come Lehman reported with the benefit of the repos being reflected in the consolidated accounts?

The answer is that US GAAP does not reflect the risk and reward model. It simply asks if there is a sale and then applies a hurdle test. As Prof Mike Page of Portsmouth University wrote on the blog this morning:

Further research on US blogs seems to suggest that SFAS 140 was crucial to scheme. I have, as yet, not been able to track down a full text of it but other comment suggests there may be a ‘bright line’ that allows a Repo to be treated as a sale if it is for more that 105% of current market value. The exact conditions aren’t set out in online summaries. Given the size of the law suits, what is in the UK (and doubtless some offshore) subsidiaries financial statements may be vital to what US investors might have known about the transactions. I think this is going to be one of the most fascinating accounting cases for a long time. As Richard pointed out, the role of fair-value is likely to be important as the notion of ‘market value’ must have been pretty elastic for a lot of the stuff that was apparently put through these Repo transactions.

That’s the hurdle.

And it seems that the Lehman “repo 105” might have been named in honour of that hurdle – over which it jumped.

Some – such as the FT – have suggested that opinions on whether the hurdle had been jumped could be obtained in the UK, but not in the US. Maybe that’s true. But maybe also it was not essential.

The reason is that the resulting misstatement from use of repo 105 will, if I’m right,  not be found in the accounts of  any of the underlying regulated entities within the Lehman group – all of which were stated in accordance with required GAAP. Rather the misstatement was only to be found in those rather vague entries in the books of account of a group of companies called the consolidation journals.

This takes some getting one’s head round for the lay reader. Basically you have to understand that the glossy published accounts of a group of companies – most especially a multinational corporation – are a work of fiction. As my friend Prem Sikka has often said, most should qualify for the Booker Prize.  That’s because of three things:

1. There is no entity anywhere that undertakes the transactions recorded in these accounts. The transactions are actually undertaken by a range of other entities – maybe thousands of other entities, which are then added together.
2. Except they’re not added together. All the intra-group balances are excluded and all the intra-group trades are excluded. This would not be worrying until you realise that between 60% and 70% of world trade is intra-group – and none of it appears in the consolidated accounts of multinational corporations – which makes clear how misleading they are.
3. There is also the possibility that profits and losses can be recorded in the consolidation alone – and balance sheets changed in the process – with the resulting transactions never appearing in the books of any actual company and therefore beyond the reach of taxation and regulation. These are the secretive ‘consolidation journals’. In the wrong hands these provide massive opportunity for abuse.

The real question about Lehman then is not just where did the abuse happen that helped bring it down – but did it happen in the ether of the consolidation alone – in the pure make believe world unrelated to reality that is a set of books and records to which no company lays claim in its own books and records?

I think that might be true.

In which case three things follow:

1. We need country-by-country reporting which requires the accounts of an multinational corporation to be grounded in a place – not floating in an ether above it;
2. We need, as I have suggested, to review the whole nature of limited liability reporting and what it means in groups;
3. we need to review accounting even more urgently.

And, finally, someone needs to work out how to prosecute fraud never recorded in the books of a company but nonetheless reported upon in a set of accounts. There’s a challenge, if this is true.

Richard Murphy Uncategorized

RSM Tenon calls for doc amnesty extension - Accountancy Age.

A couple of months ago HM  Revenue & Customs announced a tax amnesty especially for doctors.

Now Accountancy Age notes:

Richard Murphy Tax evasion

The most astonishing document has been published by a body called Swiss Banking, who appear to represent the collective body of bankers in that country. Dated in December 2009 it’s only just come to my attention.

What is astonishing about it is the extraordinary arrogance of their proposals which will, they think, let them keep Swiss banking secrecy intact. To do so they are proposing a withholding tax in Switzerland on interest income, dividends, payments from funds, on capital gains and wealth. The object they say is:

to ensure that the assets deposited by foreign-domiciled clients with Swiss banks are compliant with the income tax laws of their relevant tax domicile. At the same time the purpose is to protect the privacy of these clients.

Switzerland offers to collect the flat rate tax on income paid on balances of foreign domiciled clients for countries that wish to avail themselves of the service. This tax is deducted by the paying agent (the bank) and credited to the tax authorities of the client’s tax domicile.

In return, Switzerland demands undiscriminated access to the financial markets of these countries under prevailing national law.

This needs some serious unpacking.

First: let’s be quite clear about the taxes that are proposed. They are flat taxes, about which the Swiss banks are eulogistic in their praise. Most of the rest of the world is not so enthusiastic, of course. The reality is that flat taxes are deeply regressive, and highly avoidable, as my own work on them has shown. As they say:

The model is generally also open to parties with progressive rates of tax, but on condition that a uniform rate is applied. A progressive taxation system would be technically virtually impossible to implement.

Second, let’s be clear that the Swiss determine the rate according to this model. They say it would coincide with the EU withholding rate – which will be 35% soon – but there’s no guarantee of that.

Third, they demand that:

The payment of the flat rate tax by the client is definitive, meaning that the client’s assets held with a bank in Switzerland have then been definitively assessed. The client no longer needs to declare the assets concerned in his/her/its annual tax return. The client receives (on request) an annual tax statement from the paying agent showing the tax amounts deducted.

There are massive further technical problems inherent in the proposals – which are naive on these technical issues to a degree that is quite extraordinary, but let’s stop at this point and realise what the Swiss bankers are demanding. It is this:

1. That the Swiss be allowed to set the prevailing current flat tax rate on all sorts of investment income for any state that enters into an arrangement of the proposed sort with Switzerland.
2. That progressive taxation on investment income be banned in those partner states as a consequence because they would be unenforceable. That would be because Switzerland could always undermine higher rates and there would be no penalty on anyone making use of Swiss banks rather than local banks and as such local banking would collapse if there were to be higher rate or progressive taxes in any state entering into such a deal with Switzerland.
3. That any state entering into such an agreement with Switzerland must forego its own right to set its own tax rates henceforth – not least because Switzerland wants to apply this tax rate to some forms of company and other entities as well.
4. That any state entering into such an agreement forego its right to demand tax returns that are full, complete and accurate from its residents.
5. That any state entering into such a deal forego the right to ask its taxpaying population about why they have funds in Switzerland – and whether the capital transferred there should have been taxable in the home jurisdiction or not – so foregoing all prospect of ever making investigation of tax evasion.

I have to assume that those proposing this arrangement are aware of what it means. It would be patronising to thin otherwise. But in that case there are three things to say.

First, it’s hard to take their technical competence seriously. They clearly do not understand the complexity of the issues they are addressing – which the EU has been tackling for many years with regard to the European Union Savings Tax Directive and which the Swiss seem to just brush aside.

Second, the staggering implicit assault on the tax sovereignty of other states within these proposals is breathtakingly naive and politically brazen at the same time.

Third, it is astonishing that in all this the obvious intention is to dismiss the issue of banking secrecy as a simple one of non-taxation of income arising in Switzerland. The key issue of how the funds get there in the first place is completely swept aside – it is demanded that states ignore this issue.

I have said time and again that secrecy jurisdictions are profoundly political constructs. This is inherent in my definition of them, which is:

Secrecy jurisdictions are places that intentionally create regulation for the primary benefit and use of those not resident in their geographical domain. That regulation is designed to undermine the legislation or regulation of another jurisdiction. To facilitate its use secrecy jurisdictions also create a deliberate, legally backed veil of secrecy that ensures that those from outside the jurisdiction making use of its regulation cannot be identified to be doing so.

This is an almost perfect example of that definition being seen in practice.

We could just dismiss it. The reality is though that these people are serious: they really think this should be done.

That’s why they’re a threat to democracy itself. When bankers use the abusive legislation of a state they have captured to seek to undermine the right of people in other states to set their own tax rates, determine their own fortunes and determine their own criminal justice systems we can more readily appreciate the scale of their assault on society as whole, which is why we have to fight back.

And don’t think these are fringe organisations. The members of the organisation promoting this include UBS, Credit Suisse, Barclays, HSBC, Lloyds and RBS.

Be worried. Be very worried.  These people really do want to rule the world – and that’s no joke.

Richard Murphy Banking, Corruption, Ethics, Switzerland, Tax evasion

Vince Cable speech to Liberal Democrat Spring Conference | The Liberal Democrats: Latest News Detail .

From Vince Cable’s speech this weekend:

We want a Green New Deal. Investing in jobs by improving our homes and building more social housing. And we will set up an infrastructure bank to invest in big projects like railways and renewable energy.

And:

And fairness is crucial.

The public will accept austerity for a time if the burdens are fairly shared.

They will not accept it from a government that imposes hardship on the majority while rewarding rich cronies, grovelling to tax exiles and non-doms and ignoring the widening inequalities in income and wealth.

There are Lib Dems with whom I have no common ground. And thankfully there are those with whom I do.

Vince is in the second camp.

Richard Murphy Green New Deal

FT.com / Columnists / John Kay - Think before you tear up an unwritten contract.

John Kay destroys the ideas behind shareholder value in one column. As he notes:

In my own work, I used the term architecture to describe competitive advantages derived from structures of implicit contracts with suppliers, employees and customers. Marks and Spencer exemplified the use of such relational contracts.

I had barely formulated this thesis, however, when the company began to put strain on these relationships, in the interests of shareholder value. If the success of M & S demonstrated the power of relational contracting, the company’s decline illustrated a process that swept across business – and above all the financial sector – from the 1980s. The substitution of transaction-oriented dealings for relationship contracting added to profitability in the short run; but in the long run it eroded relationships that had been the underlying source of much of that profitability.

But the whole is better than this part.

Highly recommended.

Richard Murphy Economics

Tyngewick Gawcott: Success in Doctoral Studies.

Too good not to note:

At a recent research forum the following success index for PhD studies was proposed:

PhD Success Formula

S= (HW + 3M + NR/4)xC/A
___________________
(1 + FM + FB/10 + S)

Where: HW= Hours worked on thesis

M = meetings with supervisor

NR = number of references

C= Average number of cups of tea/coffee per day +1

A=Average units of alcohol per day + 1

FM = ln(Number of family members)

FB= Number of Facebook friends

S= Number of Sports teams supported + 4 x Number of sports played regularly.

While this is clearly an early attempt at a descriptive index related to probability of success it indicates the need for further research to improve the functional form and parameterisation. One commentator has already suggested that comsumption of illegal drugs should be added into the measurement of A, for example.

Thanks Mike.

Now I know where I went wrong.

Richard Murphy Economics

My latest column in Forbes is here, looking at the issue of EU hedge fund regulation.

As I argue:

Like it or not international finance needs rules and they need to be consistent. Creating competitive advantage by manipulating the rules does not mean there are winners or losers as a consequence – it means there is no game and only losers. Rules are not anti-competitive. Even Friedman recognized that they make free competition possible.

Brussels is saying that real people–the people of Greece and maybe the E.U. itself–are losing out right now as a result of lax financial regulations largely set by London and Washington. The two financial capitals are signalling that they don’t care, but they should. Unless regulations are levelled upwards so that international finance is a game all can partake in to mutual benefit, there would be no game at all–and that would be a protectionist disaster.

One that the so called free marketeers seem to desire.

Richard Murphy Regulation

Island ‘has important role to play’ » Business » This Is Jersey.

JERSEY will have an important role to play in solving the global financial crisis, an audience of UK lawyers was told in London last week.

And, as a result, Jersey Finance chief executive Geoff Cook said that he had great confidence in Jersey’s future.

Mr Cook, who was speaking at an event at the Law Society Common Room, said that reputable international finance centres would play a vital part in helping to resolve the world’s financial crisis.

The fantasy of those involved in finance in Jersey continues.

Richard Murphy Jersey

It’s been a hectic couple of days – hence low volume blogging.

That’s been an opportunity missed regarding Ernst & Young (E&Y) and Lehman. It’s also been an opportunity for reflection.

The reality is that there is nothing surprising about what E & Y have done. It seems that a senior partner from an audit form joined a client, devised an off-balance sheet accounting ruse, cleared it with his former colleagues, who then signed it off for audit purposes, and it was used thereafter without further question arising to deliberately misrepresent the true nature of the balance sheet of the entity.

That sounds shocking expect for one thing – this is what happens day in, day out, the whole world over.

This is what securitisation was about.

This is what a lot of offshore is about.

Derivative trading is often intended to achieve such goals – and most finance directors have no clue what they’re doing when engaging in them, and nor do their auditors.

In issues as straightforward as deferred taxation the balance sheet is knowingly and deliberately misstated by companies and auditors with the connivance of auditing and accounting regulators – in this case to overstate a liability that will in most cases never be settled – all to achieve a political objective of conning the world into believing that more tax is being paid than is ever settled..

In the case of fair value accounting myths were created that there were markets in assets for which there was no effective trading.

The E & Y / Lehman case is not an isolated incident. It is indicative of a pandemic of abuse by the accounting profession.

It’s an abuse that starts at the very top. The International Accounting Standards Committee Foundation – the body ultimately responsible for ensuring that accounts showing a true and fair view are prepared says in its constitution that its main objective is

to develop, in the public interest, a single set of high quality, understandable and enforceable global accounting standards that require high quality, transparency and comparable information in financial statements and other financial reporting to help participants in the world’s capital markets and other users make economic decisions;

Note the “and other users” – something that is then blatantly ignored by the International Accounting Standards Board when it says that the main users of financial statements are “present and potential investors, lenders and other creditors in making decisions in their capacity as capital providers”. They then conclude that because investors are providers of risk capital to the entity, financial statements that meet their needs will also meet most of the general financial information needs of other users.

And despite this extraordinary claim, and attention on one small group of users alone, the Big 4 have also engineered that they have almost no liability to providers of capital in the exercise of their duties.

The consequence was always going to be a disaster: it’s a disaster that is unfolding.

Treating that disaster as specific would however compound the error: the problem is systemic. It has to be tackled that way.

The key issues are, I suggest, in no particular order:

1. Why we gave up control of accounting disclosure to the accounting profession

2. Why we gave up control of auditing regulation to the auditing profession

3. Why we allowed the definition of an audit to be limited to confirmation of compliance with an accounting framework and abandoned the true and fair override

4. Why we allowed the users of financial statements to be considered the providers of capital alone

5. Why we don’t demand financial statements that meet the needs of other major user groups including:

   a. Employees

   b. Suppliers

   c. Customers

   d. Regulators

   e. Tax authorities

   f. Civil society groups

   g. People at large

6. Why we limited auditor liability so much

7. Why we allowed the concept of limited liability to be porous when it comes to failure and yet so restrictive when it comes to sharing information and reward

8. Why we allow limited liability within limited liability i.e. subsidiaries have limited liability distinct from parent companies

9. Why we consider group accounts the only useful perspective on corporate activity

10. Why we allow off balance sheet accounting

11. Why we still allow auditors to undertake other commercial activities

12. Why we don’t increase company registration fees to ensure auditors can always be fairly remunerated from a communally managed purse

13. Why we allow companies to not file accounts on public record

14. Why we accept a lack of transparency on group structures

15. Why we don’t demand full accounts on public record from all entities created under law wherever they are in the world, whether they be companies, partnerships, all variations on these, trusts, charities, foundations and other such entities. Such information to include full information on ownership, entitlement to assets, establishment, constitutions, management and accounts.

16. Why we allow companies to be struck off public registers without questions being asked and substantial fees being paid in lieu of accounts.

17. Why fit and proper tests aren’t conducted for all persons incorporating and owning companies.

Of course the list goes on, and on. So it should.

Now is the time for the most fundamental review of what the limited liability entity is, why we allow it, what its rights and obligations are and how we regulate it.

Surely this time we appreciate the need to do this?

Don’t we?

Richard Murphy Auditing, Big 4