I have been contacted by Matthew Bloch who sent me a blog he'd written. Matthew sounds like a pretty successful entrepreneur. He was shocked by the tax deal his accountant tried to sell him, with a kick back for the accountant attached.
With his permission I reproduce his blog here, making the one simple point that this is why we need a general anti-avoidance principle, and that I am not confident that such schemes will be blocked by a general anti-avoidance rule - especially of the sort now proposed by this government:
"A couple of weeks ago, the very day that Jimmy Carr was on the front page of the Times, our company accountant had arranged me & Pete a presentation with a tax-avoidance specialist, or “profit extraction” service.
I didn't really get a say in participating, so sat through this woman's presentation, slightly open-mouthed. It was fascinating, apparently scandalous and we declined to take part. But according to a poll on moneysavingexpert.com, 58% people would go to any legal length to dodge tax, so here's to you guys, knock yourselves out!
This is what she described to us, a scheme for removing profits from a UK company, largely tax-free. I think I am describing this correctly, but if I don't, I it's because something was being hidden from me, or I'm getting my terminology wrong. I'd be glad to take clarifications or corrections.
For this dodge you will need a) an individual who wants to receive their tax-free cash (that's you), b) a company from which to pay the money, c) an arbitrary investment fund (or “basket”), and d) a casino bank.
You go to the bank, and strike two deals:
1) you buy a spread bet, betting that the investment will go up in price by a small and fairly sure percentage. This costs you a stake of e.g. £7,000, for a £100,000 payout;
2) you sell an option to the bank at the same time, contracting to pay the beneficiary £100,000 if the investment performs, to the same condition as the bet. The bank pays you£4,000 for the privilege of becoming the beneficiary of that option.
So you're now personally £3,000 down — that's is the bank's commission. Nobody pays any taxes on these transactions, which are fundamentally risky. Individually, they're to nobody's obvious benefit.
The casino bank is on the hook for a spread-bet that is very likely to pay out. But the bank also has a position over you by being the beneficiary of the option you sold them. If the bet pays out, so must the option, which would leave everyone back where they started (except for the commission).
The dodge is: you're able to assign the obligation for this option to your company. That's a benefit to you, because you would no longer owe the bank in the event of a pay-out.
However — this is now a large potential liability for the company. Because it's a liability, nobody sane would take it off you for free, right? Your company is providing a “benefit in kind”, as if it had bought you a holiday or car, and you'd have to be taxed on that at an equivalent cash price. You can't just give money away (that would be tax evasion, which this isn't). How should we value this gamble?
Apparently, the “proper” way to value the option (the £100,000 liability) is the Black Scholes model. Its model calculates the benefit to the employee at a value of only £6,000. Really, it does. So after the transfer is done, your company not you is on the hook for this £100,000 liability, and this has only “cost” you £6000 as a taxable benefit (so e.g. you might pay £2400 at 40%).
At the end of the bet period (90 days), the performance of the investment is evaluated, and the spread-bet & option conditions are very likely (though not certain) to be triggered.
When that happens, the casino bank pays out £100,000 to the individual. Winnings on a bet attract no income tax, so you receive the full amount — hurrah!
The company pays out £100,000 to the casino bank. But it's not a dividend on profits any more, it's a bad investment that can be written off altogether. It's completely tax-deductible, so there is no corporation tax to pay on it.
So the end position is that £100,000 has been transferred from the company to the individual. Through lies and smoke, this transfer has been valued at only £6000, i.e. the apparent value of the option assignment, not the eventual payout.
One wrinkle: if the performance of the investment didn't meet the bet criteria, you have to start again and re-place the contracts, and wait another 90 days. This means it costs e.g. another £3000 in fees to the bank. I was assured that this has only ever happened once in the history of the scheme. If there wasn't risk, it wouldn't be a bet. And that wouldn't be “proper”.
The certainty of the bet is set at a level that the tax planners (and — apparently — HMRC) consider “proper”. I heard assurances (from a circle of people paying each another to say so) that it was “proper”, including a tax barrister. She actually said “of course if we'd bet against a rise of 1.75% that would clearly be a scam, which is why we put the bet level at 2.35%”. My question, “so it's literally 0.6% away from being a scam?” got laughter but no response.
I thought this artificial loss would fall under the description of tax avoidance established by the Ramsay Principle. Could I see their independent legal opinion of the scheme? They had one, but I wasn't allowed to see it unless I signed a non-disclosure agreement. Which would have ruined this post.
The firm assures me they have a £500,000 fighting fund, in a trust, against an investigation they think of as “inevitable”. That's only to cover their clients' costs in defending an investigation — this is mere advice, and they can't guarantee we wouldn't have to pay the tax. But that would be years down the line (i.e. implicitly, after we are long gone from the business, and if HMRC were being properly funded instead of cut to the bone). And for their pearls, the firm only wants £13,000.
The scheme doesn't even demand large sums, just a limited company where you can withdraw a few tens of thousands of pounds, a cooperative casino investment bank, and a strong desire to leech off the entire rest of society. I was told this firm's clients are putting tens of millions through their scheme, and they've even declared and explained it to HMRC “because we've got nothing to hide”. ”Proper” was the word I kept hearing — a cast-iron assurance that there were solid, well-researched and slightly technical reasons that not paying tax was OK.
It's not. I don't get why disclosure shouldn't get the scheme instantly shut down. I don't get why we have a tax & legal system that makes this complex dodge even possible. I don't get why our own accounting firm thought it was ethical to take kickbacks from this firm to sign their own clients up. And I'd hope that one day, people who take advantage of these schemes gets shamed as publicly as Carr did, because they're the UK's real scroungers.
[thanks to generous sxc.hu users svilen001, mzacha, nazreth and kkiser for their stock imagery]"
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So on £100k, the person saves £25k in tax on dividends, but then pays away £3k to the bank and £13k to accountant, so gets £9k net. That sounds like a pretty bad return for someone to take the risk of having to pay the tax back in the future (plus interest).
I don’t think you’ve understood the scheme
The MoneySavingExpert poll is quite an eye opener. They had over 21,000 votes, and of those:
10% said they would break the law to reduce thier tax
45% that they would push the law as far as possible
31% that they would “do what they could to reduce tax without taking the mickey too much”
14% said they would only use Government approved schemes like ISAs and pensions to reduce their tax.
I suspect only the last group would fall within your definition of tax compliant, but you may disagree.
MoneySavingExpert is not a financial website. It is a website to help people save money through communicating good deals (e.g. money off vouchers, discounts etc). I am not sure the cross section of its users would be particularly right-wing or wealthy.
I’d be interested in your observations on the poll. But as we don’t often get public surveys on people’s attitudes to tax, I think it does merit some consideration.
Can you provide a url?
I can’t find it
http://www.moneysavingexpert.com/poll/22-06-2012/would-you-avoid-tax-if-you-could
I’m simply disgusted – this is totall amoral. I thought I had read somewhere that the Black Scholes model of valuation had been discredited? Are HMRC aware of it? I agree that it is another example to make the case for a “proper” anti-avoidance rule!
The money is not invested, it is gambled. If derivatives are “financial weapons of mass destruction.. what are financial spread bets” They’re another facet of the huge financial “ponzi” parasite which has invaded the worldwide economy.
The economic equivalent of a Tarantula Wasp.
I’m trying not to think that the outcome for its victim, the worldwide economy, will be the same as it is for the spider!
Thanks to Matthew and then you for sharing this with a wider public, Richard. What a marvelous illustration of how utterly corrupted a whole sector of our society has become, and how complicit in this are government agencies and individuals (whether voluntarily or without the power to resist).
On a related point, you’ll no doubt have seen MP John Mann’s response to the naming of the parliamentary investigation into banking. Anyone who say Tyrie being interviewed by Jon Snow on Ch4 News last week would have been left with no doubt about exactly where this ‘investigation’ will go. What Tyrie (and his City puppet masters) are not in control of, of course, are the investigation of the US authorities. It’ll be interesting to contrast Tyrie’s report and conclusions with that of people who understand what an investigation actually is.
In the good old days there was many a scheme like this in other forms. In the small print was a guarantee that if something went wrong there was always a place for you in your local Workhouse.
This is just a scam. The spreadbet is paying 25 to 1 (4,000 to 100,000). The accountant might say it nearly always pays out, but I think most gamblers will tell you that 25 to 1 shots don’t come in very often. I think the fact that the accoutants make £3K for each time it doesnt come off is very telling……
And every time it doesn’t come off the company profit increases by £4K, which i presume is taxable.
The words “spread bet” are enough to put me off – not least because I can visualise cases like that of Max Bialystock in The Producers, where frantic efforts have to be made to reduce profits to meet the bet!
“springtime for Hitler, and Ernst and Young…”
The whole thing stinks – first of all I doubt that regulated investrment banks can enter into spread betting – and secondly I very much doubt that under Black Scholes that an option that was so likely to result in a final payout of £100,000 would be valued at only £6,000. I would also have my doubts that the company would ever get a tax deduction for the investment/gambling loss on a transaction with a related party. I wonder if this scheme has been properly disclosed to HMRC as well. If there are any qualified lawyers/accountants peddling this scheme they probably should be reported to their professional bodies straightaway – the size of the upfront fee gives a pretty big hint as to what is going on.
I agree with Stephen – it feels like there is something slightly missing in the description. If the option is almost guaranteed to pay out £100,000 then £7,000 can’t be a realistic market value for it. OK, fair enough – so the bank is in on the deal and is issuing an option at a below-market price in partial exchange for the assignment of benefit. However, the Black-Scholes valuation surely would not be £6,000 in that case, as Stephen says.
I suspect that this scheme might be a way to extract fees from gullible/greedy company owners rather than a genuine tax avoidance scheme. (of course there are lots of “genuine” tax avoidance schemes which are just as convoluted and artificial as this, but I can’t quite see how this one would work).
Incidentally this doesn’t necessarily mean the referring accountant is in on it – there are plenty of accountants who wouldn’t know the difference.
Or it may be that there is a detail missing from the writeup that explains the apparent discrepancy – I don’t want to unfairly accuse anyone of dishonesty.
Three cheers for Matthew Bloch.
I can’t see how the company could expect to get a tax deduction either. It is important to note that case law on discovery would require an explicit full detailed disclosure in the company tax computation of this arrangement. Sellers of dodgy schemes should make that clear and provide the wording, if they don’t its another hallmark of a scam merchant. If no disclosure is made HMRC could reopen this up to 20 years hence.
There is case law on the taxability of gambling wins in a situation where a gambler controls the odds. In this scenarion where the Black Scholes formula is being rigged that would be worth a punt for HMRC. It would be interesting to see how many punters/ gamblers actually lose the bet.
I bet the counsels opinion is not worth the single side of paper its probably written on.
This is one of those scenarios where the sellers and bank concerned should be getting a dawn visit from HMRC. Lets keep our fingers crossed! Matthew why not go the whole hog and name and shame your accountant, the scheme peddler and the bank. Pity the counsel’s name is not known, he should be named too but I’d imagine shame would be in short supply there. It might be an idea to get in touch with David Cameron, he finds this kind of thing morally repugnant.
I agree that the referring accountat many not be in on it – but surely professionalism to any degree would suggest that he should be raising a few basic questions before the scheme was presented to his client.
I notice that the ICAEW in today’s FT is quoted as saying that no one has referred any tax advisers to it for the last three years for pushing tax avoidance schemes that go beyond their members public interest duty. Perhaps this one and the K2 scheme should be referred to them – if only to keep acountants honest.
My guess is that the ICAEW are watching – so perhaps they should do their duty in the public interest, without waiting for any prompting?