2007 May » Tax Research UK

Does the ICAEW understand reporting?

May 312007

I mentioned recently that the ICAEW had issued a report called ‘Reporting with Integrity’. In it they said:

there’s no clear and accepted understanding of what [integrity] means in practice

Which gives little confidence in the progress accountants have made in more than 100 years of their professional existence.

There’s worse in the report though. Put simply the document assumes reporting takes place. As the report notes:

This report argues that integrity is important not only in its own right but also because it:
‚Ä¢ helps establish trust;
‚Ä¢ underpins high quality information that people can rely on;
‚Ä¢ enables markets to develop and allocate resources more efficiently;
‚Ä¢ delivers value to individuals, organisations and nations by supporting the achievement of desired outcomes; and
‚Ä¢ inspires public policy responses when there is a loss of confidence in markets.

I won’t argue with that.

But what this does undermine are two things. The first is the long history of accountants fighting every proposed new disclosure asked of companies if required by statute. This is best typified that most accountants support the view that small companies in the UK and that’s more than 90% of them) do not need to file such vital information as their profit and loss account on public record.

The second is the long standing support that the accounting profession provides to tax havens where secrecy is the hallmark of their trade. These tax havens by doing so, and by using the definition of integrity used, undermine:

‚Ä¢ trust;
‚Ä¢ the provision of high quality information that people can rely on;
‚Ä¢ markets, which may allocate resources inefficiently as a result;
‚Ä¢ the delivery of value to individuals, organisations and nations; and
‚Ä¢ confidence in markets.

Nowhere does the report address these issues. Words like ‘public record’ and ‘offshore’ do not exist in it.

Put simply, unless the ICAEW is planning to come out against minimal disclosure, offshore and secrecy this report is a charade. It walks round the elephant in the reporting room – which is the fact that in too many cases reporting is not required at all, and that accountants are complicit in this. That reveals a fundamental lack of integrity. I’ll be asking the ICAEW that they intend to do about this. Please don’t hold your breath whilst waiting for a response.

The IASB misses the point on small company accounting

Accounting 2 Responses »

May 302007

I’ve been writing about the inappropriateness of accounting standards that have been established for smaller enterprises in the UK and elsewhere for more than a decade now. Usually my approach has been based on two arguments. The first is that the UK standard, (the Financial Reporting Standard for Small Entities) has in all its forms to date been based on the idea that if you take UK Accounting Standards and cut out the bits that are unlikely to be relevant to smaller entitles then the remainder can be deemed fit for purpose for smaller businesses.

This has always seemed self-evidently wrong in both theory and practice, even when the UK standards in question had some suitability for the quoted companies for which they were really designed. The reason is simple. The process incorporates the false assumption that small businesses are simply smaller versions of big ones. That’s not true for reasons that will, at least in part, be noted later.

My second argument has been that there are issues in small business accounting that never arise in large companies and that any standard based on larger entity accounting is bound in consequence to ignore many issues that are of great significance to smaller businesses, not least because of the different legal forms in which those enterprises are conducted.

I remain of the view that both these arguments are right and if they apply to the UK FRSSE then they certainly apply just as much to the proposed International Financial Reporting Standard for Smaller Entities (the IFRSSE, to use an inelegant term). That’s not least because the logic underpinning the development of the IFRSSE is based in no small part on that used to produce the UK FRSSE, which is the only precedent of its type. The logical failing of the UK standard are in consequence replicated in full in international one.

Except it’s not quite as simple as that. As I become increasingly familiar with the philosophy (if you can call it that) of International Financial Reporting Standards and the IASB that promotes them I realise that the IFRSSE is even more flawed than its UK precedent. The reason is simple to explain: the consequences are more worrying.

The principle inherent in UK accounting standards is that there is a unitary board of a company that has a mutual responsibility for the actions of the entity. They are obliged to report on that activity to those who own the enterprise and who have the power (at least in theory) to hold them to account for their actions. That report is prepared for the benefit of those owners even if at cost to the entity itself, with the auditors in consequence having a duty to critically appraise the conduct of the board in the exercise of its responsibilities. This implies that:

1. The company is owned by persons who it is assumed are distinct from it (i.e. a limited liability format is assumed to exist);
2. The owners appoint persons to act as stewards on heir behalf (the Board);
3. Those stewards might delegate their powers to managers (or not; the choice is there’s) but the responsibility and accountability rests with that board none the less;
4. The board are therefore responsible for the management of the company;
5. They are also responsible for reporting on it, and cannot divest themselves of that power, whatever they would wish.

In summary this assumes that the board are responsible to the owners, owing to them a duty of care in a relationship of stewardship. This stewardship model of the corporation was chosen because it was assumed that there would be an ongoing, long term relationship between the parties.

Unfortunately, the relationships that underpin this model of the corporation are rarely found in smaller entities. In those entities there may be complete fusion between ownership and the Board. That must be the case for a partnership or sole trader. As a result the reporting responsibility is confused in these entities and the model appears to fail, despite which the UK FRSSE still applies. It is little better in the case of a small limited company where it is usually the case that there will be close relationships between the Board and the shareholders, and quite often they are synonymous.

That being said though there does remain one key element in the assumption underpinning UK GAAP that does translate to the smaller entity. The assumption of the ongoing, long term relationship between the owners and the entity remains valid because that is the expectation (if not the reality) for many of those who start small businesses. Some may be looking to make a quick buck but the majority will not. They will be investing heart, soul, body mind and credit card limit in an enterprise which represents in consequence much more than a financial asset. The human capital invested in creating the enterprise is frequently considerably greater than any financial outlay. It is wholly unaccounted for but is clear indication of the commitment inherent in such enterprises. In that sense the model does, to some degree work because that long term relationship is also assumed to underpin UK accounting standards.

But that is not the assumption inherent in the IFRSSE, being the cut down version of IFRS that it is. The inherent logic of IFRS is that it should supply what is called ‘decision useful information’. This is a concept that appears to have been imported into IFRS from the USA even though IFRS do not apply there. Under the influence of American members of the IASB there has been a shift towards the US Generally Accepted Accounting Principles (GAAP) in IFRS and away from the UK / European model. What is little appreciated though is that the logic of US and UK / European GAAP are fundamentally different.

Whilst it is true that US GAAP is, like UK GAAP based on the logic of the incorporated entity the US incorporated entity is very different from its UK counterpart. Each US state has its own rules of incorporation, but it’s also true that a significant number of all US corporations are registered in Delaware and it is that model that therefore dominates US thinking. The Delaware corporate model assumes a completely different relationship structure than does the UK model. For example it assumes that:

1. The owners of the entity have few obligations and almost no rights. They may not have to disclose their identity, might not have the right to receive any information (including accounts), will have very limited rights to vote, and the audit report (if there is one) is not addressed to them;
2. The Board’s main role is to delegate the task of running the company to managers. Those managers actually take responsibility for the entity. The Board does not have responsibility for that task unless they happen also to be managers;
3. If auditors are appointed they report on management to the Board unlike the UK model where the duty is to report on the Board to the shareholders.

In this model the shareholder is far removed from the company, and has little reason for interacting with it. The result is that in US GAAP the shareholder is assumed to have just one decision to make, which is to buy, hold or sell their shares. Nothing else matters. The need for information to actually indicate how the entity is managed, what it is seeking to achieve and its prospect for doing so is simply ignored because the shareholder has no chance of influencing that behaviour. This is fundamentally different from the stewardship model that underpins UK GAAP. This assumes a long term relationship; the US model assumes a transient shareholder relationship.

The last thing that exists between the owner of small enterprise and the entity they own is a transient relationship. And for the vast majority of smaller entities (even those of some size) the least likely transaction into which they well enter will be one where they issue shares or even approve a sale of them. In most small entities the people who start the company (in whatever form it is run) will be those who own it when it is wound up.

This is immensely important. If the whole logic of IFRS is to ensure that a user of the information produced can decide whether to buy or sell shares in the entity of which they might be a part owner and this almost never happens in smaller entities then the entire logic of the accounting process in IFRS, and by implication IFRSSE, is completely alien to the needs of smaller entities. In which case discussing the detailed provisions that are suggested by the standard, in all its three hundred or more pages is irrelevant.

There is only one possible response to the IASB proposal. That is to say it misses the target because it starts with a flawed conception of what a smaller entity is, what its information needs are and how they can be met. In which case the proposed standard must be reworked from scratch.

KPMG Switzerland – adding up the wrong numbers

KPMG, Tax Havens Comments Off

May 292007

I’ve just come across a report from KPMG Switzerland:

Given the much-debated issue of taxation in Switzerland, KPMG conducted a survey of all cantonal tax offices to find out how many people were subject to lump-sum taxation and what proportion of overall tax revenue they paid.

They discovered:

as net contributors, people subject to lump-sum taxation pay as much on average as the comparable category of top earners who are taxed by normal standards

This is a serious misrepresentation of the truth. Those taxed by ‘normal standards’ were assessed on their income. Those who paid lump sums were not. They did not disclose their income. They may have paid as much per head on average as those in the equivalent top group of assessed tax payers, but that’s not the point. The point is:

1) These 4,221 people chose not to be assessed on their income. Presumably, therefore, their income was higher and they chose this option to save tax;

2) These people came to Switzerland to take advantage of this offer. They should have paid tax elsewhere. No account is taken of the tax lost elsewhere as a result of Switzerland stealing these tax revenues due to other countries;

3) The social impact of having some people not taxed on income when the majority of the population have to do so is not assessed. You can be sure it encourages tax evasion by others.

KPMG should, I hope, be capable of critical thinking. Why is it that they work so hard to hide that ability in their press releases? A little more analysis would really do them some good.

Andrew Dilnot thinks small businesses are bad businesses

Uncategorized Comments Off

May 292007

Andrew Dilnot was director of the Institute of Fiscal Studies for many years. Now he’s Principal of St Hugh’s College Oxford and the university’s pro-Vice Chancellor.

This evening he made a complete fool of himself as the after dinner speaker at the Oxford Centre for Business Taxation’s dinner. He took it upon himself to address his comments to Alastair Darling, who was not present, of course. He suggested that that a Chancellor should not make policy for presentation purposes, have a reason for all policy and think through the consequences of that policy before enacting it. In principle that might be sound, but it was delivered with a political subtext that was as unwelcome as it was unfunny and which confirmed (again) the lack of objectivity of this place, and the IFS come to that.

But worst of all, he used as example of an ill thought out policy the 0% corporation tax rate small businesses enjoyed for a period in the UK. I agree with him, this was poorly thought out. But it’s his analysis that led him awry. He said he presumed this policy was created because it was assumed that small businesses were either a) new or b) entrepreneurial or c) this was actually a disguised social policy for the poor engaged in such activity. His claim was that the reality is much simpler. Small businesses, he suggested are simply bad at what they do. They have to be or they would not be small.

I’m sure that I wasn’t the only one who thought that he should a) not make statement for presentation purposes b) have a reason for all he says and c) think about the consequences before doing so.

What made this especially odd was that his opening “funny” referred to his annual speech to new students in his college. He apparently assures them that now thy have arrived in Oxford they no longer need to try to be cool. They can just be nerds, because that’s what Oxford wants. Well, I can tell you, his college has certainly got one.

ATTAC Jersey

Jersey, Tax Justice Network Comments Off

May 252007

No, I’m not asking you to get aggressive.

But you may want to look at the May Newsletter of TJN’s partner in Jersey, called ATTAC.

Jersey – trying to have it both ways

Corruption, Guernsey, Ireland, Isle of Man, Jersey, Trusts Comments Off

May 252007

This week Jersey has tried to be all thing to all people. First it tells the US Senate how compliant its finance industry. Then it bangs it’s drum about winning the ‘Offshore Finance Centre of the Year Award’. Look at this stuff from the associated press release:

In winning the prestigious award, Jersey beat off competition from other international finance centres including Dublin, Gibraltar, Guernsey, the Isle of Man and Luxembourg, who were all short listed.

The judges commented that they were impressed by the innovation Jersey has shown during the past year, identifying opportunities and introducing initiatives to keep up with the fast pace of change occurring in offshore centres. These initiatives included the introduction of Incorporated Cell Company Structures, a review of the Island’s trust law and the introduction of the Listed Fund Guide.

Let’s be clear what the finance industry thinks of incorporated cell company structures:

Protected Cell companies have — in concert with other entities — been used to construct what has been called “an impenetrable wall” against creditors and prying eyes. Whilst these claims can only be tested by time, this novel use of a PCC for asset protection and financial privacy is an interesting approach and a valuable piece of intellectual property.

And,as the correspondence between Jersey’s own ministers and civil servants leaked to the Observer showed, Jersey’s new trust laws are so open to tax abuse they’re even worried they might be used against Jersey itself. To put it another way. They’re designed to allow sham trusts.

This is precisely why Jersey is on the list of abusive, secretive and threatening tax havens before the US Senate. Along with the other contestants.

PS But note where the award ceremony was held:

The Victoria Park Plaza Hotel, London.

Right there in the biggest finance centre of all.

JITSIC is growing

Corruption, Tax compliance, Tax management Comments Off

May 252007

If you don’t know JITSIC is the Joint International Tax Shelter Information Centre. There has been one of these to date, in Washington. Now it is growing. The following press release was issued by HMRC this week:

The Commissioners of the Australian, Canadian, UK and US tax administrations have decided to open a second JITSIC centre – in London, UK – in Autumn 2007. Japan has accepted an invitation to join JITSIC, and a representative of the National Tax Agency will be present at the London centre.

The Commissioners have also made plans for the future development of JITSIC, along with a measured expansion to cover North America, Europe and Asia – broadening the focus of its activities, further sharing best practice on risk assessment and other key areas of interest, and particularly increasing the transparency of cross-border transactions in order to create a level playing field for taxpayers who are voluntarily compliant.

I welcome that. For all the reasons noted this is great news for taxpayers who are tax compliant. Cooperation pays.

Shareholder opposition to IFRS 8 is global

Accounting, IFRS 8 Comments Off

May 242007

The International Corporate Governance Network has expressed its concern about IFRS 8. It has said in a letter that:

IFRS 8 as currently drafted carries a heavy implication that management processes and decisions alone are sufficient to secure sufficiency in financial reporting.

By specifically referring to management, rather than boards, IFRS 8 is perhaps as much a corporate governance standard as an accounting standard. If there is any risk that with IFRS 8, financial reporting can amount to a “paper passing” exercise decided by management under the sanctity of IFRS 8, then the matters should be addressed by the EU in
adopting IFRS 8, but hopefully the issue could also be addressed by the IASB as well.

The risk with IFRS 8 is not about strong companies, but about those that have management who are not delivering, or have something to hide, which could then be passively assented to by non-executives and auditors due to the prescription of the standard allowing it.

When the letter is signed by the head of equities at Calpers you know IFRS 8 is in trouble. Calpers is the California Public Employees’ Retirement System. In May 2007, it owns $240 billion worth of stock, bonds, funds, private equity and real estate. It is the largest pension fund in the United States.

I think someone should be listening. As I say in Accountancy Age today (no link yet):

This is about more than IFRS 8. What is happening here is a question of whose interests accounts are prepared for and what exactly accounting standards are meant to do.

Falling off the hedge

Economics Comments Off

May 242007

You can tell there’s a financial crisis coming. The world is so awash with cash that the FT reports that:

A hedge fund investing in old violins has been pledged $11m (£5.5m) in the latest sign of investor willingness to put money into offbeat assets that were previously the exclusive domain of collectors and enthusiasts.

Florian Leonhard, a London-based violin dealer and restorer, is aiming to start investing the Fine Violins Fund once it has raised $50m, with a target of returning 8 per cent to 12 per cent a year.

I’ve got nothing at all against fine violins. But this attempt to commoditise anything and everything is a sign of a market in need of a fundamental correction.