Tax avoidance, tax compliance – and tax cheats

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Questions have been raised about how I define the difference between tax avoidance and tax compliance.

Following my blog on the ethics of tax avoidance it was, for example, said:

I am a little puzzled by something you have written and wonder if you explain a little further.

You say:

“‚Ķand the law does provide alternative choices in the way in which transactions can be constructed, with the deliberate intent that the tax payer take advantage of those choices and these an and do have tax consequences. So long as they are clearly complying with the law the tax payer can exercise those choices, legitimately. This is not seeking to tax avoid, it is seeking to comply with the law.”

My understanding was that what you have written above is a concise description of tax avoidance that would be understood as such by many, including, academics, HMRC and tax advisors.

In addition, if a choice is made between the alternatives envisaged by the law as being possible (and summarised by you in the extract above) then assuming disclosure by the corporation of what has been selected and the consequences of that selection (non disclosure would possibly be a case of tax evasion), “the right amount of tax” would be payable “and no more”. Therefore the corporation would be tax compliant (if I understand you definition of tax compliance correctly).

If corporations behaved in such a manner what label would you give to such behaviour? Is this for example “tax mitigation” or “tax planning”? And such behaviour is to be distinguished from something you call “tax avoidance”? Reading through previous blogs you associate tax avoidance with what appears to be the metaphor of “going round the law”. Is the substance of this metaphor the key to understanding what you mean by tax avoidance? If so, can you provide me with any guidance on what you mean by “going round the law”.

My suggestion is that if what I have suggested as tax compliant behaviour is understood to be tax avoidance by academics, HMRC and tax advisors then they are using the wrong language. Please don’t get me wrong: this is not a persona;l criticism. It is a statement of fact. If the Inuit need large numbers of words to describe snow then we need more than one word to describe the spectrum of all behaviour deigned to reduce a tax bill when the range extends for claiming a personal allowance to complex regulatory arbitrage through offshore structures.

I have explained these differences as follows:

Tax avoidance
Tax avoidance is seeking to minimise a tax bill without deliberate deception (which would be tax evasion) but contrary to the spirit of the law. It therefore involves the exploitation of loopholes and gaps in tax and other legislation in ways not anticipated by the law. Those loopholes may be in domestic tax law alone, but they may also be between domestic tax law and company law or between domestic tax law and accounting regulations, for example. The process can also seek to exploit gaps that exist between domestic tax law and the law of other countries when undertaking
international transactions.

The tax avoider faces uncertainty when pursuing their activities. That uncertainty focuses mainly on their not really knowing the true meaning of the laws they seek to exploit and taking the chance that either a) they may not be discovered to be tax avoiding or b) that if they are the interpretation placed on the law that they seek to exploit is favourable to them. Their risk of penalties arising as a result of their actions depends upon what the outcome of these risky situations might be.

Tax compliance

Tax compliance is different from tax avoidance and tax evasion because it is defined as seeking to pay the right amount of tax (but no more) in the right place at the right time where right means that the economic substance of the transactions undertaken coincides with the place and form in which they are reported for taxation purposes. The significant difference between tax avoidance and tax compliance is the intent of the taxpayer. A tax avoider seeks to pay less than the tax due as required by the spirit of the law. A tax compliant tax payer seeks to pay the tax due (but no more).

Tax planning

Tax planning is a part of tax compliant behaviour. It is not a part of tax avoidance. Tax law reflects the complexity of modern life and the multitude of choices and options available to all taxpayers when legitimately seeking to structure their affairs. This necessary offer of options within tax legislation creates the opportunity for choice on the part of the tax payer and means that determining the right amount of tax (but no more) that they seek to pay does necessarily requires the exercise of judgement on occasion.

So long as the exercise of that judgement seeks to ensure that the taxpayer makes choices that exercise options clearly allowed by law and that they do not exploit unintended loopholes created between laws then that process of a taxpayer choosing how to structure their affairs is the process of tax planning, which is a legitimate, proper and socially acceptable act.

As example, a taxpayer choosing to save in an ISA (Individual Savings Account) is exercising an option made available to them in law that is entirely tax compliant so long as all the published conditions for saving in that way are met. As a consequence no one can accuse a person using an ISA of tax avoidance. Those who say they are tax avoiding can safely be said to be wrong.

And for the sake of the record:

Tax evasion

Tax evasion is the illegal non payment or under-payment of taxes, usually resulting from the making of a false declaration or no declaration at all of taxes due to the relevant tax authorities, resulting in legal penalties (which may be civil or criminal) if the perpetrator of tax evasion is caught.

Let’s put it another way. If there is no tax to pay you can’t avoid it. Putting money in an ISA can’t be tax avoidance: the law says that this option is only available to UK taxpayers (right place) and there is no tax to pay as a result (right amount, right time).

The same with personal allowances. Anyone who says claiming them is tax avoidance is just plain wrong: parliament fully intended that people have such allowances and it is not in the business of promoting tax avoidance, which is the act of getting round the law parliament promotes.

But go to another extreme and a great deal of offshore activity is be definition tax avoidance. That’s because by definition nothing happens offshore – the substance of the transaction is never in the place in which it is recorded when working offshore and therefore cannot be paid in the right place. It’s as simple as night follows day.

The same therefore follows that offshore treasury management functions, Dutch interim holding companies, offshore holding of intellectual property and all that goes with it – plus the distance selling arrangements so beloved of IT companies using Ireland where the deal never goes near the place – are all tax avoidance.

There are other flags. For example, artificial income shifting between family members. And turning income into capital gains. Using companies to avoid national insurance is also tax avoidance. A great many uses of trusts for tax purposes represent tax avoidance.

But the use of trusts to protect children and the disabled does not represent tax avoidance. And nor does the use of limited liability per se mean that someone is doing something wrong. I use an LLP to organise my affairs but pay no less tax than I would if self employed as a result – a fact that influenced my choice, I admit.

That is the key point in all this – it is choice. Ends never justify means but looking at ends to ensure that the means used can be justified is necessary and appropriate in tax. In some cases  - like most offshore structures – it is reasonable to presume the end purpose and condemn the means. But there are also grey areas. This is shocking to the libertarian right of the corporate world who demand certainty even when surely they know that this is impossible except in their fantasy world of politics where the assumptions they make eliminate all causes of doubt that might question their abuses. For the rest of us in this middle area we have to look at motive.

It’s OK to use a limited company for commercial purposes.

It’s OK to claim the expenses the law allows if you incurred them and did so for your business.

You can use a trust to protect children or to run a charity.

No one should criticise you. It’s all don to motive – or the ends of your action.

And it’s that which lets us draw a line in the sand. Do you intend to cheat or not? Tax avoiders and tax evaders alike cheat. I stress – both are alike in motive in that they don’t want to pay tax that is due – and they cheat as a result. And it’s tax cheating that I despise, whether its ‚Äòlegal’ or not. Paying the right amount of tax at the right time in the right place (and no more) is fine. But cheats don’t do that. And that’s what annoys me. And a lot of other people. Because more morality is much more important than the law – and the cheats know that too – which is why they find it so hard to justify their actions.