Income shifting – the Treasury misses the point, again

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The Treasury has published its proposals for tackling income shifting following HM Revenue & Customs' loss in the House of Lords in the Arctic Systems case.

This is one of those situations where I wrote my submission to this consultation in advance, and informed sources tell me this has been well read in the Treasury. But that doesn't mean I am happy with this consultation paper. Far from it in fact.

I think income shifting is a real problem in the UK tax system. My further research on this issue will be published early next year. But let me say for now that the problem is big. But, and this is the key issue, it is widespread. In other words, it may take place in the context of self employment but it is almost certainly more significant with regard to investment income such as that from bank deposits, share portfolios and buy-to-let properties.

So there is in this consultation paper there is an elephant sitting in the middle of each page which is deliberately ignored, but which is asking why this issue is only being tackled with regard to small business activity. The opening paragraph of the report says:

The Government believes that it is right for everyone to pay income tax on their own income. This principle, by which individuals are taxed on their income independently of others and of their personal choices, ensures that the income tax system is fair and remains progressive.

If that is true then the Government has a duty to tackle this issue with regard to investment income as well. More than that. They have a duty to close the incentive to recategorise income as being from an investment source rather than being from individual human endeavour. The biggest anomaly in our tax system is that unearned income is taxed much more lightly than is earned income because of the incidence of national insurance charges. It is this anomaly that has encouraged the abuse that hes led to income splitting. Unless it is ended the problem will persist.

This, therefore, is the fundamental intellectual flaw in this paper, and yet again one senses within it the tension between the Treasury and HMRC that is apparent in the domicile consultation paper, also published yesterday. The Treasury demands that the investment community in the City keep their favourable tax system, whilst HM Revenue & Customs gets the flack for having to try to enforce obvious iniquity upon a majority of the population.

What we really need is a principles based tax system. And that means principles underpin the design taxes as well as underpinning the regulation of compliance with the tax. I'm sorry to say that this new proposals takes us no nearer that principles base: indeed, it creates further injustice and the perception of increased unfairness in the tax system when the issue it is tackling is the right one, but is addressed in the wrong way. It's just another shot in the foot by the Treasury in that case.

All of which means I just hope Hartnett gets the top job at HMRC, for two reasons. Some say he would be wasted on the role as he is best at policy. But tax policy is the biggest weakness at the top of HMRC and the Treasury right now. Second, I think he's tough enough to say that this sort of proposals is plain daft. His two predecessors were not.