I wrote a blog in Saturday which read as follows (to save you he time of going to read it):
I was asked yesterday by a pretty experienced tax journalist how I defined the difference between tax planning and tax avoidance.
“That”, I said “is easy. It's getting legal opinion.”
What did I mean? Simply that if you are tax planning then you either reduce your tax risk ( which happens by getting things right, rather than taking the risk of getting them wrong) or at the very least you arrange your affairs in ways that you know will not create tax risk for you. There are obvious examples: paying money into a pension, for example does not create tax risk, and nor does putting money into an ISA within allowed limits.
Tax avoidance, on the other hand always, and without exception, increases your tax risk. That is because you are doing something about which there is uncertainty. in that case, many tax advisers would suggest that you got a tax barrister's opinion to confirm that your action was legal, as defence against any counterclaim from HMRC. Examples might be claiming allowance for expenses where it is not certain that these are due in law, or using an offshore structure when the motive could be questioned. In all such cases the taxpayer's risk is increased by undertaking the transaction. That is what tax avoidance involves.
NB: I'm grateful to tax barrister David Quentin for this incredibly powerful, and simple, insight into the difference between the two categories of behaviour.
I was both amused and bemused by the reactions to this blog.
First of all, let me reiterate that I think that the arguments on risk that David Quentin has made are right: indeed, it is very hard for me to see how anyone could object to them, yet object they have. The almost inevitable claims about the legality of tax avoidance have arisen in response as if this is a foregone conclusion when we know that in a great many cases tax arrangements are deliberately created to exploit positions of uncertainty in tax law and that no one can know whether or not legality can be assured in these cases. That is, of course, why a barrister's opinion is sought but let me clear so as to what the purpose of that opinion is for those who do not know. It is not to eliminate the doubt about the law that clearly exists, and is being exploited, because a barrister cannot do that; only a court can. The barrister's opinion is there simply to prevent the risk of tax penalties being paid if the scheme is later found to be outside the law. It is an insurance policy, not an opinion that the barrister provides. That fact only reinforces what I am saying.
It also reinforces the fact that I'm distinguishing tax risk from legal risk, although most commentators appear to be completely unaware of the difference. Tax risk is a much broader concept the legal risk. As tax barrister Jolyon Maugham put it in a blog when discussing risk relating to submission of a tax return that includes tax avoidance :
Now, one of three things can happen: first, the tax return might not get checked; second, the tax return might get checked and HMRC might agree that the Big Idea works; third, the tax return might get checked and HMRC might decide that the Big Idea doesn't work (and the courts might agree).
It is immediately obvious that tax risk is bigger than legal risk, although few who have commented would appear to realise that. This isn't the place to discuss every aspect of tax risk, which does of course start with a decision on the part of the taxpayer as to whether they wish to even try to comply with the law, or not, which is, of course, akin to the decision to tax evade, or not. What would, I should have thought, have been obvious to most commentators is that are a great many decisions taken with regard to tax long before complex questions of legality arise.
There is, as noted, first of all the decision as to whether the taxpayer is concerned with legality at all: since HMRC admit that more than 40% of self-employed tax returns do, on average over the last few years, significantly understate income it is very obvious that for many people this is either a matter of indifference, or a decision consciously taken.
At the other extreme, and probably much more commonplace, are the sorts of clients who I used to seek to serve who are, when it comes to tax, decidedly risk averse. They seek a tax risk profile that avoids any confrontation with HMRC. I stress, there are more reasons than legal risk for doing that. Firstly, there is the issue of doing 'the right thing'. Despite the impression given by many tax accountants and lawyers, vast numbers of people want to not just be compliant with the law, but be very clearly operating well within it. But this is not the only reason for seeking to be legally compliant, although for some it is undoubtedly enough in itself. Others adopt this course of action for entirely rational reasons because it reduces the risk of the cost of tax investigation, the stress associated with that (which is usually very high) and the uncertainty that it will give rise to, particularly if they are running a business where their efforts on much better concentrated on making profit than avoiding tax ( if only most accountants realised it, but don't because they have no idea how to make money for their clients). In this case these decisions are not about legal risk, because in truth a great many tax investigations do not come down to matters of law, they resolve around matters of fact. Of course, the law provides a framework for interpretation of those facts, but when the law is well known a tax risk profile is determined by other factors, including, for example, how facts are presented. This is an issue that often relates to the quality of books, records, and other documentation a is, that e to support a claim that the taxpayer makes. To pretend that law is the only factor in these situations relating to tax risk is just wrong.
And then, between these extremes there are those who are willing to take rate tax risk. But, even then, as Jolyon Maugham points out, the risks taken into account in these situations are far from being purely of a legal nature. The probability of being investigated will, implicitly, become part of any such equation, and there will be, like it or not, implicit odds assumed on whether or not HMRC will have the resources and willingness to pursue an argument, whether they think it right or wrong. Way down the line there will be legal risk, and for that, there will be, of course, the assurance that the barrister's opinion might provide that at the very least the cost will only be the tax that was always due plus some interest.
In other words, to presume that decisions relating to tax avoidance relate very largely to legality is wrong. Legal risk comes way down the line when it comes to appraisal of these issues. The other factors are much more significant. But, what is also true, is that in making those earlier decisions the complexity of the issues being considered means that the vast majority of people will not apply what economists may consider a rational thought process, weighting each factor with its own individual risk and valuation. That would, anyway, in practice be impossible: valuations will not be known relating to each aspect of the decision, and risk factors cannot be allocated with the precision required for such decision-making. As a consequence heuristic reasoning will be used. And there will never be, as Daniel Kahneman would argue, a backstop of ' slow thinking' to support this process. Instead as Gerd Gigerenzer would argue, there are just heuristics. These are the rules of thumb that we use to make critical decisions when information overload would otherwise prevent us taking any action at all.
And that is what I offered to the journalist when I discussed this issue with them last Friday. When asked what was the difference between tax planning and tax avoidance I offered a heuristic logic that in my opinion works. As I've noted above, when it comes to tax avoidance the vast majority of people do not seek a barrister's opinions to reassure themselves on the state of the law. If you really think that Chris Moyles read the barrister's opinion on whether he was or was not trading in second-hand cars, I suspect you are mistaken. The reason for securing that opinion was as an insurance policy against risk. The risk that he was taking was created by deliberate exploitation of uncertainty in the law.
There is no such risk in tax planning: when a person tax plans they operate so clearly within the parameters of the law that the prospect of legal challenges is so small as to be completely capable of being ignored. In that case the heuristic logic that I presented was entirely sound and works in at least 99% of cases, or more. In that case it pass a fitness for purpose test, and that is why I offered it. What is more, it precisely encapsulates that risk exists in tax avoidance and has a cost, both is which are key characteristics of it.
Arguments such as ' tax avoidance is legal' do not pass this test. It is only tax planning that does definitely comply with that legality test: it exists in the space that is unambiguously within the law. Tax avoidance does not do that: it explicitly exists in the space where the law is unknown. The requirement to get counsel's opinion simply confirms that this uncertainty exists.
But I stress that when sating this I am not saying as a result that obtaining counsel's opinion confirms the existence of tax avoidance. That is not what I said.
Nor am I saying that the absence of counsel's opinion says that tax avoidance is not taking place: not everyone buys an insurance policy even when they can foresee the risk.
But, if you want to tell the difference between tax planning and tax avoidance, which is what I was asked, then the advice of a prudent person that tax counsel's opinion may be needed is sure indication of its existence and as a heuristic that works remarkably well.
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“HMRC admit that more than 40% of self-employed tax returns do, on average over the last few years, significantly understate income”
Can you provide the link to where HMRC say hat?
Last tax gap report, declarations of self employed people with self employed income
HMRC’s figures show the majority of returns with under-declared income have under-declared liability of less than £1,000 with around 1/3 less than £500. Hardly “significantly understated”.
Have you noticed how small most self employed profits are?
‘that’, not ‘hat’ !
“There is no such risk in tax planning: when a person tax plans they operate so clearly within the parameters of the law that the prospect of legal challenges is so small as to be completely capable of being ignored.”
So non-Doms keeping income off-shore (paying the remittance basis charge if necessary) and people who might transfer ownership of a UK based business to their non-Dom wife who lives abroad so dividends can be paid without further tax charges are definitely not involved in tax avoidance?
Similarly, a business basing itself in a low tax location and selling into the UK cannot be involved in tax avoidance.
The situations described are clearly within the parameters of the law.
If you think there is no risk in either of those I am amused, or worried for you
So if there is risk involved in this, then why haven’t HMRC taxed Philip Green on his wife’s dividends, why haven’t HMRC taxed Amazon on more profit? Both of these examples have been going for years.
Because they can’t, that’s why, as there is nothing in UK tax law which allows them to tax them. If they could tax them on additional income don’t you think they would have done so by now?
Because we know avoidance is legal
Not paying tax does not mean it is not avoidance
Perhaps you could outline the risk.
For non-Doms keeping income off-shore, for example.
A non-Dom arrives in the UK. He leaves income arising in his home country outside the UK.
I’d be relying on part 14 ITA 2007 to claim the remittance basis and am confident no tax arises. I wouldn’t seek counsels opinion, not least because HMRC’s RDR1 wholly agrees with my stance.
But you know different? Please explain.
If you have seen a non-dom who has never remitted that’s fine
Most do, and get it wrong
“If you think there is no risk in either of those I am amused, or worried for you….”
Doesn’t seem to have deterred at least one business owner…who made some serious savings on tax…
….by extremely careful and assiduous tax planning he saved a substantial sum on a £1.2bn dividend.
That wasn’t planning
Look at the deal and you’ll see why not
“That wasn’t planning
Look at the deal and you’ll see why not”
Why don’t you explain to us why it “wasn’t planning”.
Transferring ownership of assets from husband to wife is pretty basic tax planning and wholly uncontentious.
Living outside the UK and so not being taxable in the UK on dividends is again pretty basic stuff.
Someone on their first year of tax studies could come up with that plan.
Sometimes your arguments seem to consist of nothing more than you saying you’re right because you say you are.
Oh yes
Via a complex offshore structure
Shall we stop being silly here?
I suspect it’s right that if a tax opinion is obtained for a transaction involving individuals then that’s a good sign there’s tax avoidance going on.
When it comes to large corporate and financial transactions then things are different. The numbers involved are just so large, and those involved so risk-averse, that tax opinions are issued by the law firms involved as a matter of course. Nobody would, for example, underwrite even the simplest corporate bond issue without a legal opinion that covers the tax consequences, even though in most cases the tax analysis is well understood. There are also, of course, straightforward commercial transactions where the tax consequences are unclear and judgments have to be made.
The other point to make is that Quentin is quite wrong that there is no category of “ineffective legitimate tax planning”. I and my colleagues spend most of my time worrying that we might accidentally put our clients into that category…
Oh come on…..
Yes I can get to the ISA for a person without datable income and unused CGT allowance but yon gave to work hard to get there
Can you rephrase that in English please?
“the heuristic logic that I presented was entirely sound and works in at least 99% of cases, or more.”
Are you saying that:
A)99% of tax avoiders get a legal opinion (and 99%of non avoiders do not) or
B?99% of those who get an opinion are avoiding tax (and 99%without an opinion aren’t avoiding)?
No
I am saying that in 99% of real world cases where someone is deciding whether something is tax avoidance or not the potential need for a legal opinion is enough to indentify that avoidance is taking place
What is so very hard about understanding that?
Well mainly that you eke restating the heuristic with small (but important) differences. For example:
* This comment adds a definition of the scope (“real world cases where someone is deciding whether something is tax avoidance or not”, however that is supposed to be defined), although you have subsequently adopted a different one (tax-motivated transactions).
* You have moved from a straightforward test of ‘did they get a legal opinion’, to ‘is there a potential need for a legal opinion’ (so now our journalist user needs a heuristic to determine if it is there is potential need for a legal opinion.)
* Yo now omit any statement about what it tells you that a case does not satisfy the criterion (are you removing it, or is it implicit). If I look at someone who buys an ISA, does the heuristic tell me that (because no opinion is required), this is not avoidance, or is it silent on the matter?
All this matters because without it, we can’t tell what the heuristic is, and so can’t judge its usefulness.
the heuristic was offered in response to a particular question and in my view works well in that context
But some disagree, largely by trying to apply it to a differ question or situation
It was ever thus
Again, you are talking about individuals and I am talking about corporate clients entering into large financings, acquisitions, etc. Often these kinds of commercial transactions have a highly complex tax treatment, and it’s easy to accidentally walk into a major problem that makes the whole deal uneconomic. My reputation and livelihood are on the line if I get it wrong.
If your post is meant to be limited to individuals and small companies then I agree with the point you’re making. If you think the same is true for large companies then you are quite wrong.
There are fewer cases around “ineffective legitimate tax planning” than there used to be, because in recent times HMRC has focussed on avoidance schemes. But a good recent example is the Howden Joinery Group case. A perfectly commercial transaction where the intended tax result was not achieved (rightly so, in my view).
Actually, I think that is true for large companies too
We know tax avoidance is a major motive in these cases
And yes I have done M&A and VCT deals without ever once getting an opinion
The fact is, companies (especially large ones) seek legal opinion all the time, on a range of matters (employment law, tax law, and contract law). Governments seek legal opinion all the time for heaven’s sake.
Often it is nothing to do with avoidance or breaking the spirit of the law. It’s more to do with covering their backsides: the sums of money at stake or the principles involved are so important they would be negligent if they failed to seek legal advice.
To say all these organisations (companies, governments, charities) are somehow pushing the limits of the law in seeking legal opinions is clearly nonsense.
I never said a legal opinion proved the existence of tax avoidance
I said if you’re differentiating tax planning and avoidance the potential need for one does
Please don’t say I said things I never claimed. It just makes you look a little desperate
I don’t know whether you were acting for smaller companies, or it was some time ago – but it’s not the way the world works now. Every public bond issue has an accompanying legal/tax opinion. Few (if any) concern tax avoidance.
OK: but that proves my point – they are about insurance, not opinion in that case
And that was why tax avoidance has such an opinion
It doesn’t disprove my theory. There is neither tax avoidance or planning maybe in these cases – therefore my rule simply does not apply
You are trying to infer arguments I never made
You say that in 99% of cases where someone is deciding whether avoidance is taking place, the existence of an opinion suggests avoidance. Yet I see hundreds of transactions a year, all of which are very complicated and all of which involve opinions. Your “heuristic” says 99% of them involve avoidance. In fact, none of them do. Your “heuristic” therefore fails.
No
Because no one is looking for avoidance in them, you say
So the question I answered is not posed and so of course the heuristic does not apply
You really are flogging a wholly irrelevant line of argument
Richard,
Might I suggest that a good way to express this is by saying that the heuristic applies to tax-motivated transactions (or tax-motivated steps inserted into other transactions) only?
I’ve been pondering this since your original post without quite deciding one way or another but, with that clarification, I think it’s a very useful rule of thumb indeed. I’ll be sure to give it a whirl next time I’m asked about the distinction by someone down the pub! 😉
Z
Accepted!
I thought the context made that obvious but I forget pedants need the obvious spelt out
If that’s the case, isn’t this “test” completely circular?
You say that in 99% of cases, obtaining a legal opinion indicates the presence of avoidance. But you say you can only apply the 99% test if you have first established that there is (or there might be) avoidance going on.
So much for an “incredibly powerful insight”.
Oddly, a great many would disagree with you
But, don’t let that worry you
@Chris H
You are mis-stating the population the test applies to, which is (as Zacchaeus put it) ‘tax-motivated transactions’, which doesn’t limit it to avoidance (or even potential avoidance). Essentially, it differentiates between avoidance or tax planning.
You are right that it is less applicable than the original post on this suggested though. If, for example, a hypothetical multinational coffee shop bases it’s coffee traders on Switzerland, and insists that it’s for business reasons, you need some other method to apply first (obviously if and when you work out if it *is* tax motivated! the heuristic kicks in).