{"id":25037,"date":"2014-06-09T09:46:57","date_gmt":"2014-06-09T08:46:57","guid":{"rendered":"http:\/\/www.taxresearch.org.uk\/Blog\/?p=25037"},"modified":"2014-06-09T09:59:02","modified_gmt":"2014-06-09T08:59:02","slug":"tax-risk-legal-risk-tax-avoidance-and-rules-of-thumb","status":"publish","type":"post","link":"https:\/\/www.taxresearch.org.uk\/Blog\/2014\/06\/09\/tax-risk-legal-risk-tax-avoidance-and-rules-of-thumb\/","title":{"rendered":"Tax risk, legal risk, tax avoidance and rules of thumb"},"content":{"rendered":"

I wrote a blog in Saturday<\/a> which read as follows (to save you he time of going to read it):<\/p>\n

I was asked yesterday by a pretty experienced tax journalist how I defined the difference between tax planning and tax avoidance.<\/p>\n

\u201cThat\u201d, I said \u201cis easy. It\u2019s getting legal opinion.\u201d<\/p>\n

What did I mean? Simply that \u00a0if 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) \u00a0or at the very least \u00a0you arrange your affairs in ways \u00a0that you know will not create tax risk for you. \u00a0There are obvious examples: paying money into a pension, for example does not create tax risk, and nor does putting money into \u00a0an ISA \u00a0within allowed limits.<\/p>\n

Tax avoidance, on the other hand always, and without exception, increases your tax risk. \u00a0That is because you are doing something about which there is uncertainty. \u00a0in that case, many tax advisers would suggest that you got a tax barrister\u2019s opinion to confirm that your action was legal, as defence against any counterclaim from HMRC. Examples might be \u00a0claiming allowance for expenses \u00a0where it is not certain that these are due in law, \u00a0or using an offshore structure when the motive could be questioned. \u00a0In all such cases \u00a0the taxpayer\u2019s risk is increased by undertaking the transaction. \u00a0That is what tax avoidance involves.<\/p>\n

NB: I\u2019m \u00a0grateful\u00a0to tax barrister David Quentin<\/a>\u00a0\u00a0for this \u00a0incredibly powerful, \u00a0and simple, insight \u00a0into the difference between the two categories of behaviour.<\/p><\/blockquote>\n

I \u00a0was both amused and bemused by the \u00a0reactions to this blog.<\/p>\n

First of all, let me reiterate that I think that the arguments on risk that David Quentin \u00a0has made are right: \u00a0indeed, it is very hard for me to see how anyone could object to them, yet object they have. \u00a0The almost inevitable claims \u00a0about the legality of tax avoidance have arisen in response as if this is a foregone conclusion \u00a0when 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. \u00a0That is, of course, why a barrister's opinion is sought but let \u00a0me clear so as to what the purpose of that opinion is for those who do not know. \u00a0It is not to eliminate the doubt about the law \u00a0that clearly exists, and is being exploited, \u00a0because a barrister cannot do that; \u00a0only a court can. \u00a0The 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. \u00a0It is an insurance policy, not an opinion that the barrister \u00a0provides. That fact \u00a0only reinforces what I am saying.<\/p>\n

It also reinforces \u00a0the fact that I'm distinguishing tax risk from legal risk, although most commentators appear to be completely unaware of the difference. \u00a0Tax risk \u00a0is a much broader concept the legal risk. As tax barrister Jolyon Maugham put it in a blog<\/a> when discussing risk relating to submission of a tax return that includes tax avoidance :<\/p>\n

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\u2019t work (and the courts might agree).<\/p><\/blockquote>\n

It is immediately obvious that tax risk is bigger than legal risk, although \u00a0few who have commented would appear to realise that. \u00a0This 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, \u00a0which is, of course, akin to the decision to tax \u00a0evade, or not. What \u00a0would, I should have \u00a0thought, have been obvious to most commentators is that are \u00a0a great many decisions taken with regard to tax \u00a0long before complex questions of legality arise.<\/p>\n

There is, as noted, first of all the decision as to whether the \u00a0taxpayer is concerned with \u00a0legality at all: \u00a0since HMRC admit that more than 40% of self-employed tax returns do, on average \u00a0over the last few years, \u00a0 significantly understate income it is very obvious that for many people this is either a matter of indifference, or a decision consciously taken.<\/p>\n

At the other extreme, and probably much more commonplace, are the sorts of clients \u00a0who I used to seek to serve \u00a0 who are, when it comes to tax, \u00a0decidedly risk averse. They seek a tax risk profile that \u00a0avoids any confrontation with HMRC. \u00a0I stress, there are more reasons than legal risk for doing that. \u00a0Firstly, there is the issue of doing 'the right thing'. \u00a0Despite 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. \u00a0But this is not the only reason for seeking to be legally compliant, \u00a0although \u00a0for some it is undoubtedly enough in itself. Others adopt this course of action for\u00a0entirely 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, \u00a0but don't because they have no idea how to make money for their clients). \u00a0In 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. \u00a0Of course, the law provides a framework for interpretation of those facts, but when the law is well known a tax risk profile \u00a0is determined \u00a0by 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. \u00a0To pretend that law is the only factor in these situations relating to tax risk is \u00a0just wrong.<\/p>\n

And then, between these extremes there are those who are willing to take rate tax risk. But, even then, as Jolyon Maugham \u00a0points out, the risks taken into account in these situations are far from being purely of a legal nature. \u00a0The 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 \u00a0and willingness to pursue an argument, whether they think it right or wrong. \u00a0Way 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 \u00a0plus some interest.<\/p>\n

In other words, to presume that decisions relating to tax avoidance relate very largely to legality is wrong. \u00a0Legal risk comes way down the line when it comes to appraisal of these issues. \u00a0 The other factors are much more significant. \u00a0But, what is also true, \u00a0is that in making those earlier decisions \u00a0the complexity of the issues being considered \u00a0means that the vast majority of people will not apply what economists may consider\u00a0a rational thought process, weighting each factor with its own individual risk and valuation. \u00a0That would, anyway, in practice be impossible: valuations will not be known relating to each aspect of the decision, \u00a0and risk factors cannot be allocated with the precision required for such decision-making. As a consequence \u00a0heuristic reasoning \u00a0will be used. And there will never be, as Daniel Kahneman would argue<\/a>, \u00a0a backstop of ' slow thinking' to support this process. \u00a0Instead as Gerd Gigerenzer would argue<\/a>, there are \u00a0just \u00a0heuristics. \u00a0These are the rules of thumb that we use to make critical decisions when information overload would otherwise prevent \u00a0us taking any action at all.<\/p>\n

And that is what I offered to the journalist when I discussed this issue with them last Friday. \u00a0When asked what was the difference between tax planning and tax avoidance I offered a heuristic logic that in my opinion works. \u00a0As I've noted above, \u00a0when 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. \u00a0The reason for securing that opinion was \u00a0as an insurance policy against risk. The risk that he was taking was created by deliberate exploitation of uncertainty in the law.<\/p>\n

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. \u00a0In 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.<\/p>\n

Arguments such as ' tax avoidance is legal' \u00a0do not pass this test. \u00a0It is only tax planning that does definitely comply with that \u00a0legality 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. \u00a0The requirement to get counsel's opinion simply confirms that this uncertainty exists.<\/p>\n

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. \u00a0That is not what I said.<\/p>\n

Nor am I saying that the absence of counsel's opinion says that tax avoidance \u00a0is not taking place: not everyone buys an insurance policy even when they can foresee the risk.<\/p>\n

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.<\/p>\n","protected":false},"excerpt":{"rendered":"

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
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