The so-called loan scheme tax charge imposed by HM Revenue & Customs mainly on those who had, in my opinion, undoubtedly engaged in tax avoidance whilst supplying services as sub-contractors through limited liability companies has attracted much attention in the last couple of days, not least because of the alleged involvement of Douglas Barrowman, husband of Tory peer Michelle Mone, in the promotion of such schemes.
Let me stand back from the political heat. Let me also stand back from the emotions around the charge, which represents an honest attempt to recover tax from those who set up structures to avoid it, however innocent or mistaken their actions might be claimed to be.
Instead, let me suggest three things. The first is that it has always been appropriate for HMRC to seek to recover tax in these cases, and since the biggest savings went to those they are now seeking to recover tax from, it is appropriate that they pay most of the tax due.
Second, let me add that HM Revenue & Customs was and still is incompetent in the management of these cases. It should have acted more quickly because the problem was apparent by about 2005. It should have acted more decisively.
And it should, when its own inaction became apparent, have been decidedly lenient with penalties and interest on people who were, to be candid, too often conned into using these schemes.
They should have also looked for recovery, at least of the employer's NIC, from the employers who obviously also benefitted from these arrangements.
And questions about the false promotion of these arrangements and the resulting penalties due for doing so should obviously have been much higher up their agenda.
The fact that none of these things happened is a clear sign of failure on HMRC's part, and ministers should now be intervening to prevent miscarriages of justice on interest and penalties, although not I suggest when it comes to tax.
Thirdly, and actually more important than all this, though, is the fact that ministers have never done anything to address the obvious problems of tackling small business activities through the use of limited companies that were designed in the Victorian era and are obviously unsuited to modern needs, most especially when much of the tax and corporate case law surrounding their use was established for large entities. Nor have HMRC. This is the real scandal. I suggest.
I first said so in August 2007 after a case on a not-terribly unrelated issue. What I said then was that the whole structure of small business taxation needed reform to make it suitable for the twenty-first century. In 2009, I was told HMRC had seriously considered my proposal but deferred it because of the global financial crisis. No one has ever been back to the issues, but I offer the following written in 2007 again because I still think that urgent reform of small business taxation in the UK is required to make it fit the economic facts of what happens in these concerns, which it does not at present.
If action had been taken when I proposed it, most of the loan charge issues would not now exist. I think that is worth noting.
I have written about the Arctic Systems case, and as a result was challenged to produce a suitable response. That I have now done. The full paper is available here. The summary says:
This paper analyses the way in which the owners of many small limited companies reward themselves and members of their families out of the income that their labour generates for those companies. This is particularly relevant in the light of the recent House of Lords ruling in what is known as the 'Arctic Systems' case. The paper shows that many of these arrangements do constitute tax avoidance because the rewards paid do not much the underlying economic substance of the transactions that are taking place.
In the interests of promoting tax justice for all taxpayers HM Revenue & Customs have a consequent duty to promote new arrangements that will encourage tax compliant behaviour in this sector. Tax compliance is defined as paying the right amount of tax (but no more) in the right place at the right time where 'right' means that the economic substance of the transaction accords with the declaration made for taxation purposes.
The paper does then show that this problem is almost insoluble whilst these businesses are operated through the medium of small limited companies which were not designed for and are unsuitable for the type of activity they undertake.
As a result this paper proposes that:
1. A change in company law to allow the re-registration of small limited companies as LLPs. An LLP is tax transparent: its income is taxed as if it belongs to its members even though it is a legal entity that is separate from them for contractual purposes;
2. The introduction of new capital requirements for the incorporation of limited companies undertaking trades, and over time forced re-registration of those that do not meet that standard as LLPs;
3. The introduction of a new investment income surcharge at rates broadly equivalent to national insurance charges that would have the benefit of reducing the incentive to split income, restore the taxation balance between income earned from all sources and allow a reduction in the base rate of income tax without adding substantially to the burden of administration for taxpayers since those liable will, in the vast majority of cases, already be submitting tax returns;
4. Create new, economically justifiable and verifiable standards for splitting income in LLPs so that the risk of legal challenge to such arrangements will be substantially reduced whilst recognising the significant role that the partners of those who supply their services through owner managed corporate entities play in the undertaking of that activity.
If this were done then:
a. The administrative burdens for many small businesses would be reduced;
b. The certainty of the arrangements under which they can operate would be increased;
c. The rewards that they rightly seek to pay to those who contribute to the management of these companies from within domestic relationships will be rewarded, but within appropriate constraints;
d. The attraction of freelance status in tax terms would be retained;
e. The current injustice that sees income from labour more heavily taxed in the UK than income from capital would be eliminated in large part without prejudicing the required favoured status of pensioners;
f. The incentives for tax planning would be reduced, so simplifying tax administration;
g. The tax yield might either rise, or a reduction in the tax rate might result.
The challenge in creating such a system is significant because it requires cooperation across government departments, but far from insurmountable. It is part of the challenge of creating an enterprise culture that meets the needs of the UK in the 21st century, and that is a challenge that any government needs to meet.
As I note at the end of the paper, suggestions and comments are welcome. But please do read the paper first and not just the summary.
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There are several tax areas that have been problematic for many years, but successive governments have lacked the political will and frankly courage necessary to grip them.
Examples include council tax, which is stuck in the 1990s and unsurprisingly local authority finances are in a complete mess. Another is the artificial distinction between the same small business activity conducted by an individual through employment, self-employment, or a small company.
Taxpayers were sold loan schemes just like they were sold film schemes. The promoters took their fees and got away scot free while the taxpayers were left with massive tax liabilities.
I have sympathy with each individual’s circumstances, suddenly getting a tax demand they were not expecting and can’t pay, and HMRC sometimes seem to act in an unnecessarily aggressive manner. But the idea that some people could take all (or almost all) of their earnings in the form of a “loan” (that would never be repaid) but would somehow be tax free forever… Well, too good to be true comes to mind. Almost as bad is if the lender does ask for the loan to be repaid years later.
The loan charge legislation simply says that either the accrued loans have to be repaid, or they are treated as earnings. The case law was all over the place, but with the legislation on disguised remuneration, and a renewed focus on the reality of arrangements after the Rangers case, we are back where we should be. You can’t have your earnings and not pay tax on them.
Agreed
Some years ago I had a conversation with an old friend who over the decades had worked providing the same service and gradually changed his status from PAYE employed, to self-employed and then most recently to become an Ltd company. As you do with old friends I started to pull his leg that in his new found status tax-dodging would now be the next step.
His reply, in serious mode, was that given all the opportunities for tax avoidance legally provided by his new status, illegal activity would be unnecessary.
As you say Richard reform is urgently needed, the current situation is farcically unequal.
I saw the super impressive Dan Neidle on news night last night talking about the investigation he has undertaken into the affairs of Mone’s husbands company. He clearly believes HMRC and customers have been defrauded. Let’s hope it comes to court and there is a conviction.
Again I’m going to say that none of this incompetence – it is by design, because the ‘political will’ is being deliberately put into doing the wrong thing.
Why?
Because from politicians down to the HMRC and to other public services, they have been bought by the people who benefit.
This was always Thatcher’s plan – to create a cabal of low taxed wealthy individuals who would mobilise and fund political life to ensure that daily life and the economy would serve them best the most. And this would also protect her legacy.
Thus we have socialist mobilisation for the rich – bailing out of the banks, DAVOS, Tufton Street, the Mont Pelerin Society (there are loads of examples) and sticking together.
But if you are a worker or a trade unionist, even an environmentalist – no – you are not allowed to mobilise at all – the power of socialism and solidarity is not allowed to you – only the rich.
No – you’ll be pitted against your neighbour for the pitiful handouts you’ll be left with instead and exploited to the day you die.
That is where this country is at the moment in my view.
“There are several tax areas that have been problematic for many years, but successive governments have lacked the political will and frankly courage necessary to grip them” (Andrew).
There is a deeper problem, I think. Taxation as a solution to most problems is beset by an intrinsic flaw.
First, more money and professional skill is brought to bear to find loopholes for vested interests to exploit and capital owners to protect, than is ever applied in drafting the original law.
Second, the law or tax authorities take an eternity to address the loophole, or never do; and almost all governments connive to avoid facing or tackling the problem, or wish to provide the full resources of the state to break the vicious circle.
Third, Government is so far from understanding the issues, it is terrified of where opening ‘the can of worms’ may lead.
Fourth, most voters do not understand the issues, and switch off as soon as the word ‘tax’ arises; Government prefers to let sleeping dogs lie, given the electorate is obviously unmoved by it all; and the funders of political parties have the largest stake in the tax status quo ante (they like to rail against the injustice of tax, while exploiting the lucrative loopholes).
Fifth, taxes are opaque and, over centuries of accretion the tax system has become an impenetrable monster, out of the control of government; which is terrified even to look too hard at the problem, still less fix it.
John
The biggest problem is that most so-called tax professionals have not the slightest idea about the macroeconomics of tax, anxd nor do politicians.
Richard
It was pointed out that in the past Tax Avoidance schemes were not offered by ‘mainstream’ business’s – Accountants, banks, lawyers etc.
Perhaps Governments need ‘lean on’ professions and business’s that offer business and financial advice not to get involved with them.
The Loan Charge is targeted at those who attempted to avoid tax, this was and is not illegal.
HMRC retrospectively applied the Loan Charge. As Jacob Rees-Mogg argued in Parliament on Wednesday, who of us is safe if government can decide to change the law after the event. HMRC have done so not only for the seven years they rule we must keep records but as far back as 1999.
Politely, anyone who claims they have received a loan knowing that no one will ever ask for its repayment is, or was, in my opinion, making a false representation to HMRC as to the nature of the transaction they have/had undertaken. I always thought these arrangements were evasion. It was very foolish to think otherwise. You decide what that makes you.
Your reply did make me look in the mirror. My involvement in the Loan Charge was immoral, taxes are, or should be there for the common good, the NHS. Within a few months I realised my position was untenable and withdrew from the scheme and am paying the tax to HMRC.
The reason I write again is that I don’t want my comment to colour anyone’s view of, I believe, many of the 60,000 plus people affected by the Loan Charge who were innocently involved. Many were advised by professionals such as accountants and did not know what they were involved in until they received a letter from HMRC. More than 250 MPs from all parties are members of the Loan Charge APPG. They are so because they have talked to constituents whose lives have been ruined by the Loan Charge, people who work for the NHS and other service roles. Many were told the only way to get the job they had applied for was to use such a scheme. Ten people have committed suicide. Ordinary people, made extraordinary by debts of hundred of thousands of pounds have lost their homes and families. Meanwhile the scheme organisers have gone free, why isn’t HMRC pursuing them with the same vigour as the Loan Charge victims?
I am sorry, but I do not agree.
Everyone had the choice to say this looks and feels dishonest and go to an honest adviser who would not go near it with a barge pole.
Let’s not get too sympathetic with those who bought the idea they could save tax and did not question the ethics.
The problem is exacerbated by the British tax culture. In Britain too much is made of the distinction between tax avoidance and tax evasion. The distinction is a real one, but misleading. Tax avoidance and evasion are much closer than piety allows. It is easy to look at Treasury approved tax avoidance schemes, like ISA’s and sink into a feather bed of self indulgent faux righteousness about the nature and implications of wholesale tax avoidance. It feeds the false premiss that tax avoidance may be taken as a form of personal, fiscal moral piety. It is virtuous. Pay the least tax possible is an entitlement, if not a duty.
It is an insidiously inviting proposition. The least tax, may prove no tax at all; without self-reproach or thought to consequences as a general rule. The absurdity of the proposition, if applied universally is obvious; but avoided – like the taxation. It is bound, necessarily, if applied as a general principle, that the poorest alone will pay the most tax, relative to their ability to pay it and inability avoid it; and in the end inevitably the richest will benefit the most, by far; the fact that as group they may pay more tax simply begs all the important question. And that is how it has transpired, in the foul mess Britain now finds itself lost within.
The problem is that seeking personal tax advantage may involve seeking out loopholes to be exploited in the law. Large tax gains, we should surmise probably require the boldest approach to the loopholes. The piety, we too easily forget is solely in the eye of the beholder. In Britain, however the intellectual assumption of ideological neoliberalism is that all tax is a form of theft (it is perhaps neoliberalism’s ironically over extravagant, wanton rebuttal of Kropotkin’s excess); it has become part of the fabric of conventional political wisdom; and it is possible for the individual to persuade him/herself that the law endorses the implausibility. , whatever the consequences may be. It is, thus a proposition that poisons the well.
ISAs are not btax avoidance. They are explcitly permitted
Tax avoidance is not
What we need to promote is tax compliance. This is seeking to pay the right amount of tax (but no more) in the right place at the right time where right means that the economic substance of the transactions undertaken coincides with the place and form in which they are reported for taxation purposes.
Richard, I know perfectly well that ISAs are permitted, but as a matter of fact they avoid tax in the clear sense that, outside the ISA investment, the tax would be payable. In the plain meaning of the language, I would submit that is the “avoidance” of tax; and crucially here the plain meaning is likely to be understood by most people, which i think underlines the point I am trying to make. It influences the broad understanding of tax and avoidance in the culture (including the understood political culture).
Tax avoidance is permitted. It seems to me (if I understand you), that you are therefore placing a weight on the meaning of the word “explicit”, that I am not sure it can bear; but that is likely to be lost on the general public; which is my more general point.
Perhaps I am missing something.
Sorry, but if tax avoidance implies used the law – and it does or there is no point using the term – ISAs come nowhere near being tax avoidance.
Why does this matter? Because if you say ISAs are ok then you imply all avoidance is, and it is not.
So your plain language usage is deeply misleading, at best.
Why does it matter? Because I am not at all certain that public understanding of the term “avoidance” is the same strict interpretation as your understanding; I can of course see the there is a clear distinction you wish to make, but I find the explanation of it opaque. I was attempting to make a wider point about the social and political culture that establishes how taxation and its operation is viewed in Britain; and it is the culture, above all that establishes how people behave, and the importance that is attached to the issue; not least the approach to legislation by both lawmakers and law users. This is not solely determined by the technicalities.
I am content to leave it there.
We will have to agree to disagree
John –
It’s not often that I disagree with you, but I’m totally with Richard on this one. Which isn’t to say that I disagree with your central point regarding the relationship the Great British Punter has with taxation – that’s broken and always has been, because people see tax as a dead cost. Nobody likes the idea of shelling out for no return, which is how people and businesses view tax. I hate to say it, but at least the comfortable fiction that Tax pays for schools and hospitals etc. allows people to see some purpose to taxation that they can get behind… my worry is that the truth will get them to disengage with taxation even more.
I DIGRESS!
What I can’t accept is the assertion that ISAs are in any way tax avoidance mechanisms – they simply are not. The are savings accounts which the government incentivise people to use by removing the tax burden from the interest. There’s a clear difference in my mind between that and, for example, the loan charge. 2 clear differences, actually.
Firstly, there’s the purpose. The type of arrangements implemented by the oh-so-very clever minds behind unrepayable loans were put in place with the very clear and primary objective of minimising the end user’s tax liability. There is no other reasonable explanation for such an arrangement of affairs (although doubtless some “Ramsay-Proofing” has taken place in their construction). On the other hand, the primary objective of an ISA is to encourage people to save money. That encouragement is provided through the incentive of a reduced (zero) tax charge, but that’s just the nudge to get people to save, which is what the government wants.
Secondly, there’s the intention. Parliament intends tax to be charged on earned income. Unrepayable loan schemes use a series of steps which are designed to circumvent that intention. That’s what tax avoidance is. An ISA on the other hand, is a savings product which does not attract a tax charge. That, equally, is the intention of parliament. The holder of an ISA does not need to do anything other than save in order to benefit from the tax incentive. The users of avoidance schemes have to undertake a series of steps which will achieve a relief from tax that was never intended by parliament.
To me there is clear blue water between ISAs and tax avoidance schemes. One is a fabricated arrangement designed solely to avoid tax. The other is a savings account the government wants us to use.
If you characterise an ISA as tax avoidance, then anything built in to the core of a product which results in a reduction in tax that might otherwise be due could be equally characterised. Before long, you’d have to accept that discounts offered by shops during the January Sales are tax avoidance, because they reduce the amount of VAT that would have been charged at full price. No, I’m not splitting hairs, it is exactly the same logic.
That’s why I agree with Richard on this.
Thanks