I spent a fascinating afternoon yesterday with Prof Dan Ostas of the University of Oklahoma. We weren't near a prairie. Instead we sat by the river in my home city of Ely and chewed the cud on various issues relating to accounting, tax and business ethics. Dan is supremely qualified to partake in such discussion. He has doctorates in both economics and law, but in both cases his studies focused on the philosophy of the subjects in question.
As the afternoon went on and we had set out our own positions so that we might understand each other better Dan asked me a fascinating question. His premise was that even if we could accept that some business people lacked ethics because they claimed (however inappropriately) a duty to profit maximise overcomes any other principle; and even if we could accept that some lawyers might take such a literal approach to the law so that they could argue (again, however inappropriately) that only the formal construction of its language guided their principles, surely we could not excuse the accountant who argues that legal form determines the appropriate construction of law on any issue, including tax, when there is not an accountant who has been trained since the 1970s who has not know that substance dominates form when it comes to accounting principles.
Let me explain what this means with an example. That example is leasing. In any lease contract an asset is hired by its legal owner to another person who makes use of that asset for their own beneficial purposes throughout the hire period. There is no reader of this blog who has not, I suspect hired an asset at some point in their life. Let's take an example of a commonplace hire: it's the white van to which most of use need occasional resort to move some essential item or other.
If we hire that van for a day, a weekend or even a month it's very obvious where the risks in the transaction in which we are partaking lie. We have the risk arising from the use of the asset whilst we hire it. That's why we insure it during that period. But what we know is that the risk of break down, for example, is that of the care hire company, and that they have to replace it if anything goes wrong. We simply have a right to use the van. The hire company very obviously retains its ownership, and most of the risks arising from that ownership, bar our careless driving, which we insure. Let's be unambiguous then that this cost of hire is very clearly a cost that any person, if they were running a business, would consider a straightforward business expense to go straight to the profit and loss account. And that, for the record, is how accounting requires that it be treated.
But now suppose we lease the van for three years from new. And suppose we cannot return it during that period. And we have to maintain and insure it during that time. And we even have an option to buy it outright at the end of the hire contract for a pre-agreed price. This is still a hire contract. We have not bought the van, even if we might eventually do so. It has a legal owner quite distinct from us, and we have to pay them, come what may, even if they can take the van back if we fail to do so. The near entire value and risk of ownership of that van have passed to us during the three years that we hire it. And accounting says that if this is the case then the asset is to be treated as if the person renting the van actually does own it. They must put it on their balance sheet at its full market value. Over the three years that they own it they must write its value off, down to the agreed value at the end of the contract at which they may (or may not) buy it. The full value of van is matched by a supposed loan that is also recorded on the balance sheet, to be repaid in cash over three years, or by cancellation of the contract and return of the vehicle to its legal owner at the expiry of the rental period. And the sum that will be paid in rent in excess of the depreciation charge is treated as an interest payment to the asset owner.
Now all those accounting entries for this van are a legal fiction. The reason is that the person renting the van does not own it: someone else does. But the accounts say they do own it. And the legally is not true, but in substance it is because all the major risks of ownership have passed to them. The legal owner is just a financier; that is all. The result is that the person hiring the van depreciates even though in legal terms it is not theirs and they say they pay interest when the reality is they pay rent. Accountants ignore the literal lethal truth and substitute a form of accounting that reflects the substance of what has happened and which means that whether the van was leased or hire purchased the accounting treatment should be near enough identical.
In that case every accountant knows that the legal form of contracts can be nonsense. They have to do so: it is implicit in the whole accounting framework in which they operate. But in that case can a tax accountant - having an identical professional qualification to the auditor who signs off sets of accounts - honestly say that it is their professional duty when advising on tax to comply only with the letter of the law, when they know that the result will not necessarily reflect the economic substance of the transactions into which they are suggesting a client enters. That was Dan's question.
My answer was simple, and straightforward. I said the accountant could not rely on the letter of the law. Their code of professional ethics and the regulations of their own profession (because accounting standards are, in effect, self determined by the accounting profession) require them to know that by doing so they can create outcomes that clearly conflict with proper reporting. And we now know that it is the goal of tax authorities around the world to make sure that tax profits are reported where their substance arises. This means that they must be reported in the right place, at the right time, and be subject to the correct tax code so that appropriate tax might be paid in the name of the correct taxpayer who suffered or enjoyed the actual economic consequence of the transaction being reported. Anything else is clearly contrary to the principles of the OECD's Base Erosion and Profit Shifting programme; to the multitudinous array of tax anti-avoidance legislation provisions and to the rules now implicit in targeted and general anti-avoidance principles for tax purposes, all of which seek to ensure that economic substance and not legal form is taxed. And there is no professional accountant on earth who cannot know the difference.
Having explained all this Dan then asked his follow up question. “Was it possible, then, that an accountant in Cayman, or wherever, could really with a clear conscience advise the use of a structure that did artificially relocate the place in which a transaction was recorded, or even advise the placement of an income stream in a structure when it was apparent that the structure was itself nothing more than a fig-leaf to disguise the true interests in the transaction?” And my answer was again straightforward, that of course no accountant could do this with a clear conscience: that was simply not possible.
“So'” Dan asked “are those accountants who do so greedy, stupid or wilfully corrupt?”
This was again easy to answer. A professional person does not have the defence of stupidity available to them, at least on something as glaringly obvious as this, especially if they chose to advise on it: they had a duty to be professionally competent, including knowing both the rules and ethics of their profession. So that option was off the table.
Greed, I said obviously came into it. But then, the pursuit of profit is not permitted by professional ethics if the two are in conflict, so that option was also ruled out as a defence.
And nor could the accountant say it was their own ethics that matter; it is public ethics that do because their profession is bound to act in the public interest.
And that left only wilful corruption as an explanation.
I could not offer Dan another alternative. And as he put it “Of all the people in the game somehow you'd think it was the accountants who'd get these things right, surely?” And then I drew his attention to my report written with Saila Stausholm of Copenhagen Business School on the office locations of the Big 4 firms. Each has at least 35 offices in tax haven locations.
Now you tell me: is that wilful corruption or not given that there is almost no economic substance to any of the transactions recorded in these places, and they must know that? And if it is is not, how not?
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Today in Jersey self praise is being dished out by the bucket full from the Crown Officers because over 1.3 billion euros has been repatriated to Italy from Jersey trusts. The money arose from the Riva brothers sell off of the Ilva steel plant assets after it was closed down by the Italian government having caused 400 deaths with its toxic emissions. In fact the money was sent back last year but Jersey is still spinning this tale of corruption as one of good news and cooperation that has allowed the Italian steel industry to be revived and many jobs created! As always no lawyers or Jersey accountants have appeared in the dock – perhaps the euros arrived here in a hired whiter than white van? As always shall the professional bodies for the accountants, lawyers and presumably bankers be taking any action or even asking questions?
I will take a look
I don’t have enough knowledge of global accountancy qualifications or ethics to be able to comment on the accountants who operate in the tax havens. But surely the accountants who send the transactions to the tax havens are complicit in the legality, or otherwise, of those transactions? They must know that what they are doing is facilitating the corrupt practices of others, which in turn makes them corrupt, and therefore they should be held to account within the jurisdictions in which they operate.
But when you look at the way in which the UK economy is set up, financial services brings in a huge slice of GDP. I’m not sure that you could find a government who would want to scare that away. And when you have such cosy links between government and financial services firms you probably won’t find many individual MPs who would want change the status quo either.
I agree
but there’s no harm pointing this out
The answer is simple.
Power corrupts but money power corrupts absolutely.
We fetishize wealth in the West and increasingly elsewhere. You’re nobody unless you want to be rich apparently.
Accountants are human and want to be rich too, and their proximity to ‘the money’ means that they too can be co-opted into the values of those who are rich and wish to remain so.
So accountant’s morality and ethics are always at risk of being bought out by the interests of a system that they should be regulating. Lawyers are prone to this sort of thing too. Money talks.
People who accumulate wealth for wealth’s sake are a threat to society. They decouple from the world as their money replaces humanity.
In your book ‘The Joy of Tax’ you make it clear that tax destroys the value of money and that a sufficient tax on the rich ensures that they never have too much money to get into mischief with or even undermine democracy or corrupt people like accountants, lawyers and others.
Bring it on I say.
You are in good company. You say “people who accumulate wealth for wealth’s sake are a threat to society”. Both Plato and Aristotle agreed with that.
Lawyers do not confuse justice with the law. The “substance” for a lawyer is usually decided by a judge; or the decision of a Court, which provides all the “conscience” sufficient to satisfy a lawyer; it is not a personal choice, or if it is, he/she is probably better out of the profession.
What is the comparable “substance” for an accountant? To answer “principle” would to me seem insufficient; it will not stand the pressures (of interpretation) that will be placed on it, from all sides. Where and how is “substance” established in accountancy? What is the objective test of “substance” in accountancy? A statement of principles is not enough. Substance needs some, eh, substance…..independent existence.
In accountancy, where is it?
Part of the problem remains for me that we tax activities that are prey to the ingenuity of lawyers and accountants to create models of tax avoidance; indeed it is perhaps their most lucrative activity. We should not tax entities that are mere creations of the human mind. A new intellectual entity will simply be created that does the same thing free of tax (in principle this is not a surprise, nor can much be done about it). In the 18th century all the best minds in finance guaranteed, cast-iron, in law, the monopoly of the Bank of England; until someone invented the ‘cheque’. By the time that it even dawned on the best minds what was happening, the monopoly was dead and banking had changed forever.
Let me refine this.
Lawyers know that they can offer opinion, however implausible, knowing that a judge must balance opinion to come up with a normative, but societally acceptable, view of what the law might be.
This lets us build a model of what substance is. The lawyer when acting as advocate can offer any opinion they like, knowing that it will be corrected if inappropriate.
The lawyer, acting as adviser, has a duty to tell their client what is acceptable i.e. their job is to appraise alternative arguments and effectively act as judge, and to then suggest what law is likely to be societally acceptable in the normative paradigms currently existing.
These two roles are fundamentally different, and any lawyer should know it. One allows a formalistic approach to the law, another a pragmatic one (or if you wish, equitable one)
The difficulty for us is that lawyers in tax think they always act as advocates: they do not
Accountants are not advocates. They are advisers. They, therefore, have a duty, professionally, to determine what is the prevailing normative view of society within which their client must operate to be compliant with the law. It is this that they have failed to do.
Substance is the prevailing normative view based on pragmatic interpretation of law and practice in the current environment
“Substance is the prevailing normative view based on pragmatic interpretation of law and practice in the current environment”.
I have no problem with the intention of that statement, nor any of the refined distinctions you have made. It defines a social norm rather than “substance”. This is not my point. Social norms are powerful expressions of culture; but the power of culture is largely informal, deeply complex and often unconscious. Hence we have had equal pay for women for many decades; but we do not have equal pay. Informal culture trumps formal acceptance (form over substance).
“Substance” requires a test; a reliable, and I would say substantive (free-standing) core of evidence that requires no special scrutiny to understand or interpret, or that provides a large degree of interpretative flexibility that serves principally to defeat clarity (and a back door for unstated social norms to be reasserted). Court decisions (whether serving justice or not) at least supply a test.
‘Prevailing normative views based on pragmatic interpretations of the law’; under severe pressure and rigorous scrutiny will, I believe, simply serve to become more and more indeterminate (especially where responsibility and severe consequences may follow from the determination) and will not in my view provide the precision that is required; it is an intellectual will-of-the-wisp.
OK
I’ll keep musing on it