Accounting » Tax Research UK

Explaining the accounting of why the UK only has debt of £650 billion right now

Accounting, Banking, Economics, Uncategorized 28 Responses »

Feb 022012

I have noted that when my explanation of why the UK owes much less debt (see also here) than the Tories claim was posted on the Liberal Conspiracy web site some of the right wingers who inhabit that space suggested I could not consolidate accounts. As a result they claim my conclusion was wrong: they said the debt owed by the government could not be cancelled by the fact that the debt was owned by the Bank of England because I ignored the liabilities of the Bank of England to repay the cash it had used to buy the government issued gilts. Well, they are, of course wrong and let me explain why the accounting behind my claim is exactly right.

Let’s start with the government issuing a gilt for £100 million. It creates a loan (the gilt) for £100 million that is a credit in its accounts and it then has £100 million in cash (a debit balance).

In accounting terms this looks like this:

Government Accounts
Cash
Dr £’m	Cr £’m
100



Government Accounts
Gilt Loans
Dr £’m	Cr £’m
	100

Then it spends that cash on buying an asset (or a lot of assets!). The accounting then looks like this:

Government Accounts
Cash
Dr £’m	Cr £’m
100	100



Government Accounts
Fixed Assets
Dr £’m	Cr £’m
100

Now there’s no cash. The £100s balance out to nothing. The accounts balance though. There’s an asset of £100 million balanced by a liability of £100 billion for the gilt. There’s just no cash left.

Now let’s suppose the Bank of England does a quantitative easing programme, as of course it has. Let’s look at the double entry of that.

First it creates the cash:

Bank of England
Cash
Dr £’m	Cr £’m
100

Bank of England
Promise to repay account
Dr £’m	Cr £’m
	100

Remember that this is a bank making cash out of thin air. It has effectively ‘printed’ cash. So it has created £100 million in cash, which is a debit entry in its books. What’s the matching liability since you can’t have anything but double entry in the accounts? Well, it is, of course, a liability and for ease I’ve called it the ‘promise to repay account’. Why? Because that’s what it says on a bank note: the Bank of England promises to pay it. It’s that promise that represents the liability. The fact that if someone went to the Bank of England and asked for repayment of their £10 note they’d be given another one does not change the promise to pay. £10 is owing – but it’s payable with the money that’s just been printed. That’s what legal tender means: it’s cash made out of thin air. The liability will not be paid: it’s pure gain, but that’s what happens when you make cash out of thin air. This then is a very different liability from the government’s gilt. That will be repaid, in cash. And it carries interest. The Bank of England will never repay on its promise and the liability carries no interest.

Now let’s suppose that the cash that has been created is used to buy the gilts the government has issued. It’s pretty simple double entry. It looks like this:

Bank of England
Cash
Dr £’m	Cr £’m
100	100

Bank of England
Promise to repay account
Dr £’m	Cr £’m
	100

Bank of England
Gilt asset account
Dr £’m	Cr £’m
100

The cash has gone: it has been paid to the previous owners of the gilts. The two 100′s balance out to zero. That cash has now entered the economy and left the Bank of England. That is how the cash enters the economy in a quantitative easing programme.

The net result is that now the Bank of England owns £100 million of gilts (the debit balance) matched by a liability of £100 million in the ‘promise to pay the bearer’ account which will in reality never be paid.

Now what I have then suggested is that we should consolidate the resulting accounts of the government and Bank of England since the government owns the Bank of England. Let’s look at what the accounts look like before we consolidate. The government accounts now look like this:

Government Accounts
Fixed Assets
Dr £’m	Cr £’m
100


Government Accounts
Gilt Loans
Dr £’m	Cr £’m
	100

The government has £100 million of assets and owes £100 million in gilts.

The Bank of England accounts look like this:

Bank of England
Promise to repay account
Dr £’m	Cr £’m
	100

Bank of England
Gilt asset account
Dr £’m	Cr £’m
100

The Bank owns £100 million of gilts and has made a promise to pay £100 million.

Now let’s be clear about what happens when you consolidate: you cancel out trading between the consolidated parties but as I have ignored interest for ease there is no trading to get rid of here. And second you cancel assets and liabilities owing between the consolidated entities, which are the government and Bank of England in this case. What is cancelled out? Well it’s the gilts: they are debt after all. The government owes £100 million to the Bank of England in this example but since the Bank of England is owned by the government then it is like owing debt to itself – or if you like, it’s like a husband owing a wife when they agree they really share all their property in common. So it can simply be cancelled out.

The net result is that the accounts really look like this. The two gilt accounts balance each other out to zero and we’re left with:

Government Accounts
Fixed Assets
Dr £’m	Cr £’m
100

Bank of England
Promise to repay account
Dr £’m	Cr £’m
	100

So the government has now got assets paid for with a promise to pay – it’s printed the money to pay for the asset. It’s used the subterfuge of owning the Bank of England and printing money to achieve the result but let’s not deceive ourselves, this is the result. But, as I have explained, it can do that precisely because there is both no risk of inflation now because of the state of the economy and because the economy needs that cash – there is a shortage of cash at present that is threatening to close down economic activity and create deflation if this new cash were not created by the Bank of England now.

So, what’s the conclusion? First, the double entry works: the critics are simply wrong. They forgot there’s an asset. Incidentally, it doesn’t also actually matter if it was spent on the running costs of the NHS instead for double entry purposes; there would still be a debit. I use an asset to indicate it’s better that liabilities are matched by assets and that the current account be balanced if possible. That’s the logic of the Green New Deal. But I stress, either way my double entry works and my critics are guilt of doing single entry accounting – which is always a mistake.

Second, the economic logic is right: the national debt has to be stated net of quantitative easing gilt repurchases or the figure is simply mis-stated.

Third, this radically changes the whole economic narrative, completely. But that’s another blog. The point here is that technically I have to be right.

Having said which, I know the assets repurchased may not have been paid for at the price they were issued at: I accept that’s leakage in the matter but it does not change the fundamentals of the argument one iota, it just means that the banks pick up some subsidy on the way (which fact will, I suspect surprise no one). But we still have not got debt of £1 trillion. Very soon we’ll have national debt of less than £700 million and what is more we’re only borrowing about £35 million or so a year on average.

And we need to recognise that if we’re to have an honest economic debate.

The tax profession, tax havens and fraud: an ongoing saga

Accounting, Corruption, Secrecy jurisdictions, Tax Havens 7 Responses »

Jan 132012

As the Telegraph reports:

The Treasury has closed a tax avoidance scheme that could have cost £1.5bn after a tip off that artificial trading companies were being set up in tax havens.

Wealthy individuals were planning to use a long-standing “post-cessation trade relief” – designed for tradesman and professionals to offset legitimate costs against their income – to artificially reduce their tax bills.

It is understood that tax experts planned to raise fake expenditure requests from a tax haven that could be claimed against by individuals in the UK.

David Gauke, Exchequer Secretary, said the schemes would have put a “significant” amount of money at risk.

“It is unacceptable, at a time when we are trying to bring down the deficit, that there are those who try to avoid paying the tax they owe,” he said.

David Gauke and I don’t often agree: on this one we do.

Let’s not beat about the bush, what was proposed here was fraud.

Who proposed the fraud? Tax professionals did.

Where were they going to locate the fraud? In tax havens.

How were they going to get away with it? Because tax haven secrecy – the total opacity on the ownership, control and accounts of offshore companies that they provide – would have let them do so.

And you winder why I and the Tax Justice Network campaign against tax havens? They remain what they always have been, a home for fraud assisted by a pinstripe mafia of lawyers, accountants and bankers.

Remove limited liability from those companies who act anti-socially

Accounting, Corporation Tax, CSR 23 Responses »

Jan 112012

I’d love to say the following idea was mine, but it wasn’t, so I’m going to give credit for where it came from, in a letter to the Guardian today:

Shareholders in a limited company that goes bad are liable for no more than the money they have already paid for their shares – the company’s creditors stand the loss, not the owners of the company, the shareholders or the directors. This is not a right, but a privilege we grant so that people will be ready to invest in new enterprises without fear of taking on unlimited liabilities.

We don’t have to privilege all companies, directors and shareholders over their creditors in this way – there’s no human right to it. We could instead say that liability is only limited if the highest-paid executive’s remuneration does not exceed, say, 30 times the median employee’s salary. It would be a brave shareholder, individual or institutional, that permitted any executive’s remuneration package to approach the point where they, the shareholders and directors, might be found personally liable if things go wrong.
David Harington
Worcester

I have long argued that the right to limited liability is a privilege that carries obligations, including the duty to pay tax and to file accounts. I haven’t argued often, and certainly not in the case of public companies, that the privilege of liability should be withdrawn as a sanction.

I think that’s been an omission on my part. We should be much more straightforward in saying that limited liability is a privilege to be used for the benefit of society, and with care, and that if obligations to society are not respect then it should simply be withdrawn with the shareholders and not society at large then having the duty to remedy the defect. When should that happen? Let me suggest the following occasions for a start:

1) When excess pay is allowed, as noted above.

2) When accounts are not filed on time, for any reason.

3) When corporation tax returns are not filed, for any reason. Of course these are not public documents now: they soon would be if this was the case.

4) Three months after any set of accounts is filed showing the company to be insolvent unless action to remedy the defect has been taken in the meantime.

That will concentrate minds I think.

Now which MP would like to propose it as a private member’s bill?

At the core of the crisis for the elderly in this country is the greed of a few in the City of London

Accounting, Banking, City of London, Economics, Pensions 4 Responses »

Jan 092012

Ian Fraser is a journalist for whom I have a lot of time, and respect. I warmly endorse a blog he wrote this weekend on the subject of this week’d edition of The Economist in which he wrote:

I was surprised and disappointed when I opened my copy of The Economist on Friday morning.

The magazine is running a feebly-argued propaganda piece headlined “Save the City” as its cover story. The piece vaunts the “skills” that are to be found in the City of London and seeks to persuade us that having a powerful financial sector is critical to the future health of the UK economy and that the “Square Mile” must therefore be cherished and preserved at all costs. The cover image harps back to the Blitz, as if Hitler’s Lufwaffe is once again poised to carpet bomb a key part of our heritage.

Outside PR puff sheets like HBOS’s absurd “Deal Leaders” of 2005-08 and the Pravda-style advertorials inserted into newspapers and magazines to launder the images of evil dictatorships, I’ve rarely read such a farcical or misleading article.

That’s harsh criticism, but true.

There’s much to note in the piece, but I’d highlight this:

The magazine’s “Save the City” leading article is one-sided, snide, racist, xenophobic, and makes massive omissions. It doesn’t even start to acknowledge the multifarious failures of the financial sector, or the damage it has wrought on the UK economy in recent years. The article fails to mention the massive risks posed by “crony capitalism” and “regulatory capture”, including wilful blindness to fraud, and even includes the words –

“Finance—the funnelling of savings to their best use—is a vital industry. Britain is very good at it, leading the world in various financial markets, including foreign exchange and over-the-counter derivatives. “

Who wrote this garbage I wonder?

Yes, the City did once fulfil the function of efficiently allocating capital, but that stopped some ten to 20 years ago when the ‘zero sum’ game of financial speculation for the self-enrichment of the participants took over.

As I have said before the City has, with a few exceptions, become the cuckoo in the nest of the UK economy.

It has become gigantic skimming machine/casino. In addition to making taxpayer-underwritten bets, however absurd, it largely serves to diminish the savings and pensions of UK citizens, though outrageous fees, spurious and unwarranted trading and an intermediated structure that favours the interests of the people that work in its own, often-conflicted institutions (plus the people in their various suppliers including brokerages, law firms, accountancy firms, investment and actuarial consultancies, etc, etc) over and above the long-term interests of savers and the needs of the wider economy.

Of the City’s many crimes this destruction of an effective pension mechanism for the UK – where the future prospects of millions are literally traded away for the current gratification of a few in the Square Mile is perhaps the greatest. It is unsung, it is unchallenged and it is ongoing. And it’s time the politicians of this country changed that, because at the core of the crisis for the elderly in this country is the greed of a few in the City of London.

Fill marks to Ian for highlighting it.

Tony Blair’s opacity is a long way from anything good capitalism would demand

Accounting, Ethics, Uncategorized 17 Responses »

Jan 082012

The Telegraph and Observer both have commentary on the publication of Tony Blair’s accounts today and I’m quoted in both. That’s because a couple of years or so ago I won a prize from the Guardian for fathoming out why he structured his business affairs in seemingly bizarre and inexplicable fashion and so I a seem to have become the person to quote on the subject.

My original analysis is here. It’s not light reading. The key point was a simple one though, and that is that Blair adopted a massively opaque structure to ensure that much of his activity is hidden from view in an arcane and rare corporate structure called a limited partnership (which is not the same as a limited liability partnership) and by exploiting legal but dubious legal loopholes he has ensured contrary to the spirit of the law that it does not need to file its accounts on public record even though all its members are limited liability entities. It is the clear intention of the law that they should be published in that situation, but his lawyers or accountants found a way round that.

That has always raised the question, why does he need that secrecy?

Now further questions have arisen since in the pile of companies he owns is a management services company – which seems to supply most of its services to the limited partnership and is paid more than £10 million for doing so. Its total income in its 2011 accounts was £12 million, it had costs of £10.9 million and paid tax at a fair rate on the resulting balance of profit. But what papers have picked up on is the fact that in a management services company you would logically expect most costs to be for people – since they’re the management that’s being supplied, after all. But as the The Observer notes, largely quoting me:

Windrush Ventures Ltd spent almost £3m on staff, rent and other services but had total administration costs of almost £11m. “Just what is this company doing?” Murphy asked. “You would expect total costs to be around double the costs of employing staff. But in this case total administrative costs are £10.9m. That’s a very high ratio indeed.” He added: “We have no idea where this money is coming from or how it’s being spent. The structure seems designed to impose a veil of secrecy over its accounts.”

More than £7 million of those admin costs seem hard to explain in a management company. It would be a might lot of consultancy if that’s what’s being bought. And if it is – why is that the case, and who is benefiting? I think those are fair questions for a person in the public eye making his money as a result of public office.

As the Telegraph notes Blair’s defence is:

The Windrush accounts are prepared in accordance with the relevant legal, accounting and regulatory guidance.

It’s profoundly disappointing that he relies on such a legalistic defence. It’s up to him how much transparency he provides and he has op[ted for the absolute minimum he can get away with. When the debate now is about good capitalism he shows he is a long, long way from being anywhere near the demands for accountability that imposes. And that is why it’s fair to raise the issue.

If regulation is to work ‘chums’ can’t regulate ‘chums’. Getting tough is necessary

Accountancy, Accounting, PWC, Regulation 3 Responses »

Jan 062012

I’ve already mentioned the derisory fine dished out to PWC that’s in the news this morning. Then I noticed this in the FT:

The £1.4m ($2.2m) fine that an accounting industry tribunal has levied on PwC is doubly notable. First, because it is the largest ever of its kind. Second, because it is disgracefully small. PwC, auditor to JPMorgan Securities, failed to tell City watchdogs that the broker was riskily lumping billions of clients’ money with its own. This represented “very serious” misconduct, according to the tribunal. But the three worthies, led by Richard de Lacy QC, lacked the backbone to impose an appropriate fine.

Do you want evidence that ‘chums’ can’t regulate ’chums’? Then this is it.

This type of cosy regulation is a neoliberal, market based conceit. It’s time for it to go.

The three lessons from the Olympus debacle

Accounting, Auditing, Corruption, Secrecy jurisdictions, Tax Havens, Uncategorized 5 Responses »

Nov 092011

The unfolding story at Olympus is quite extraordinary.

What seems to have happened, based on reports that I’ve read, is that fraudulent fees paid at the time of acquisition of new investments were filtered through tax havens to support the valuation of investments previously made on which losses had been incurred. The precise details of the shenanigans are, of course, not yet known but it seems likely that this process has been going on for at least 20 years. Three observations seem pertinent at this moment.

The first is to note that a situation where an overly strong board of directors with weak or non-existent nonexecutive directors, none of them accountable to effective shareholder scrutiny gives rise to a situation where corruption and abuse is far too easy. We should not be complacent and think that this applies to Japan alone. This is also an accurate description of the UK quoted company environment where boards are almost entirely unaccountable, whether to non-executive directors (almost all of whom are recruited from the same small coterie of people) or to shareholders, where institutions dominate. Since, however, those institutions show no willingness to act on behalf of those whom they are supposed to represent, but do instead align their self-interest with the City of London and in turn with the companies they are supposed to be monitoring, we have no effective governance of these arrangements in the UK either, so we have no reason to take comfort from this situation by pretending it is peculiar to Japan alone.

Second, and inevitably, questions will be asked about the role of Ernst & Young as auditors, and rightly so. How can such a situation have persisted for so long in the accounts of a major company? Surely the time has come when the competence of these firms has been proven to be non-existent and massive reform of the audit environment is put on the international agenda to ensure that a suitable financial architecture but the 21st-century is created?

Thirdly, and very obviously, it’s obvious that the use of disguised ownership facilitated by tax haven entities made this whole arrangement possible. How many times do we have to say that these structures exist to facilitate corruption, abuse, fraud, and tax evasion before the world’s major states take action to close them because of the costs they impose upon the ordinary people that democratic governments are meant to represent? The cost of the Olympus failure will inevitably fall upon its shareholders, many of whom will in turn be pension funds. The argument that tax havens impose cost upon these people is surely proven now, and yet the counter-argument is persistently put forward by those who argue that these places facilitate international trade and the free movement of capital. There’s no doubt they might facilitate the free movement of capital, but only in the pursuit of abuse, fraud and the debasement of shareholder worth.

In that case the time to demand that every country require that the beneficial ownership of every single corporation that it allows to be created be put on public record, and be proven beyond doubt, has surely arisen. This fraud proves yet again that the company registries of the world are a simple mechanism for the facilitation of such fraud because of the lax standards of regulation that they impose. We cannot any longer tolerate this abuse and sustain effective capital markets. The choice is either that capital markets fail, or that transparency and accountability is required, not just in the major centres, but within every single jurisdiction in which limited liability entities are allowed to trade, or companies must automatically be banned from engaging with companies located in those places. That is the only option that is tenable. And now is the time for reform.

Time for the UK’s finance directors to answer the question “Why do you use tax havens?”

Accounting, Country-by-country, Secrecy jurisdictions, Tax avoidance, Tax Havens 11 Responses »

Oct 212011

Michelle Perry is a financial journalist who I have spoken to on and off for a decade. I note she’s just taken up a new role as editor of CFO World and in that capacity has written an editorial I want to publicise, because I think it important. Issued in response to Action Aid’s report on tax havens, using methodology I developed, she says:

There were numerous responses to ActionAid’s report earlier this month that 98 of the FTSE 100 companies use tax havens located as far as the Cayman’s to islands closer to home like Jersey. What wasn’t surprising were the polarised views. Tax issues rarely produce indifference.

No public defence was made by the influential, but media-shy, group of 100 finance directors. But the group did respond to me by email (not in person) to say that the Hundred Group are “absolutely committed to acting with integrity and transparency in all tax matters”.

The statement went on to say that the UK’s top companies continue “to make a substantial contribution to the UK public finances”. It quoted the annual study of total tax contribution – a survey set up six years ago to counter criticism of corporate tax avoidance. The survey shows that the Hundred Group member companies contributed £56.8 billion (or 11.9 percent of all government tax receipts) in the year to 31 March 2010.

The response to that is always, I suggest “So what? How do we know that’s the right sum?”. Perry seems to agree. She continued:

It’s true, of course, business does contribute significant sums in taxes to government. However the taxes cited in this report tend to be a combination of those borne and those collected.

It’s important not to blur the lines here. It’s this very point that many companies dislike. They do not like to feel that they are working as an unpaid, unglorified tax collectors for a government whatever its colour.

But in reaction to ActionAid’s research I do not feel this is a valid response. In fact it does not respond to the research, but redirects attention and shirks the issue.

We can not have a debate about tax or tax havens – their validity or not – until these companies and more to the point these finance chief acknowledge freely and publicly that they use them and why they use them. It may turn out that these reasons are wholly valid but until they state them, we cannot have a grown up debate about this burning issue.

We need to have this debate so that the companies can regain a value in the eyes of society and until we do large corporates will continue to be seen, wrongly, by a large majority of the British public, as a parasite of the taxpayer.

This is the perfect opportunity to speak openly and freely on these matters.

I should apologise for such a lengthy quote. But I think this a really significant argument and I applaud Michelle Perry for making it.

Might I suggest that the next step is to ask for country-by-country reporting?

Reacting to the draft EU Accounting Directive on country-by-country reporting

Accounting, Country-by-country, Europe, Uncategorized 2 Responses »

Oct 032011

I have now published (at the request of those who supplied them to me) the drafts of the EU Accounting and Transparency directives as they apply to country-by-country reporting. Of the two the Accounting Directive is much the more detailed and since the two are meant to be consistent it it to the Accounting Directive (AD) that I will refer.

Chapter 9 of this draft contains the issues of relevance for this is the draft AD itself rather than the preamble and notes to it.

Highlighting what I think are some of the key issues, the following jump out:

1) The AD applies to all large companies in the extractive industries and forestry.

2) Government is very widely defined to mean a government, regional government and a government agency.

3) Project level reporting is currently included – as requested by Publish What You Pay.

4) Large undertakings are required to file an annual report on payments made by them in aggregate across all their subsidiaries operating in a jurisdiction to the government of that place and its agencies.

5) Payment includes payments in kind.

6) Only taxes relating to the extractive industries are covered. sales and payroll taxes are excluded, although sales taxes are likely to be minimal anyway.

7) Materiality is defined in terms of the recipient country not the paying company.

It is not entirely clear that the report is part of the annual accounts and it is not clear whether it has to be audited, but the reference to Chapter 2 of Directive 2009/101/EC implies that this is the case because I can’t see what else it could mean since it does not seem to add this new report to the list of disclosures required there but adds it into those disclosures – and that can only be in the accounts.

9) Reporting exemptions are offered but thankfully will be very hard as written for any company to use.

10) The EU is reserving the right to define materiality specifically.

So that’s the good news.

Now the problems:

1) Defining an extractive industries company will be a nightmare.

2) I suspect project reporting to be a major obstacle – but welcome it.

3) There is a real problem that only tax payments are to be included. Let’s not for a minute pretend that this is as a result country-by-country reporting because it is not. It’s just disclosure data that will be very hard to interpret because no one will know what sales and profits are, for example, in the countries in question meaning that very little meaningful interpretation of the data disclosed form an accounting perspective will be possible. I’ll address this in more detail, later.

4) More broadly, I welcome the fact that the AD seems to require reporting whether or not the EI company is actually extracting resources in a territory or not – meaning that, for example, profits taxes appear to have to be reported everywhere, although I am troubled that tax havens will not be covered since a non-payment can’t trigger disclosure under the rules noted and that is a major omission.

5) There is no requirement in here to demand some other very basic disclosures we have asked for including:

- a list of every country in the company operates

- a list of its subsidiaries by territory

6) No reserves data by country is required, meaning a massive information source critical to civil society in many developing countries is omitted from disclosure.

7) The data demanded appears to be cash flow data. This imposes serious cost on companies and is inconsistent with the accounting basis used by companies themselves. More logically accounting data requiring profit and loss account charges due by category of liability reconciled with opening and closing liabilities due and total payments made in aggregate would have been of much ore use as this then becomes accounting data.

But most problematically, this is not accounting data. So, for example, without sales data the rate of royalty paid cannot be checked and consistency over time cannot be appraised. Likewise without profits data whether or not taxes due on profits are reasonably stated cannot be appraised. And if data is not required for all territories – such as tax havens – then the risk of profits being artificially relocated from developing countries to such places cannot be appraised.

I do of course welcome this development but it is a very long way short indeed of meaningful accounting disclosure that will really hold these companies to account. In that sense this is a profound disappointment: the message that capital must be held to account for what it does not just in developing countries but on its flow into and out of such places has bot been heard as yet. That’s worrying.

Country-by-country reporting has come a very long way since I published the first version of it in January 2003 but it still has a long way to go as well. The campaign has to go on – and pressure has to still be brought to bear on the EU to get these reforms through, with improvements if possible.

My thanks to all who are bringing that pressure to bear in Publish What You Pay and elsewhere: their efforts have been quite extraordinary, and will be in the months to come too, I know.

NB: published in haste and maybe subject to revision later