Sunday, 2 October 2016

UK Taxation

BFTF has been thinking about a number of questions related to taxation recently, and has also read the a very interesting book called, “The Great Tax Robbery” by Richard Brooks, journalist and ex Tax Inspector. It's a big topic, so hoping to make things manageable by breaking it down into a few sections:

Why do we need taxation?
How much tax is paid and in what forms?
Is income tax paid equitably?
Who is avoiding taxation?
A short history of UK taxation
Who is avoiding taxation?(again)
What should be changed?
Some notes and examples

Have tried to break down the topic into a few key questions and hoping that the end result – this post – has something of value here for you, dear reader.


Why do we need taxation?
“I like paying taxes. With them I buy civilisation” American Supreme Judge Oliver Wendell Holmes Jr, 1927

“There is nobody in this country who got rich on his own — nobody. You built a factory out there? Good for you. But I want to be clear. You moved your goods to market on the roads the rest of us paid for. You hired workers the rest of us paid to educate. You were safe in your factory because of police-forces and fire-forces that the rest of us paid for. You didn't have to worry that marauding bands would come and seize everything at your factory — and hire someone to protect against this — because of the work the rest of us did. Now look, you built a factory and it turned into something terrific, or a great idea. God bless — keep a big hunk of it. But part of the underlying social contract is, you take a hunk of that and pay forward for the next kid who comes along.” Elizabeth Warren 2011


How much tax is paid and in what forms?
A 2016 HMRC report shows that current tax receipts are around £533 billion per year and shows how the composition of the overall tax take has changed over time:
UK Taxation Trends 1981-2016

In addition, a report by the Institute for Fiscal Studies provides a little more detail and also comments that, in the medium term:

“the UK taxman looks set to: (i) be more reliant on the highest-earning income tax payers; (ii) collect more revenue from VAT and less from other indirect taxes, notably fuel duty; (iii) raise less revenue from both council tax and business rates; and (iv) raise substantially less revenue from corporation taxes.”

Breakdown of UK Tax Receipts 2015-16

The report also shows how total tax take has varied between 35.5 and 37.5% of GDP since 1997.


Is income tax paid equitably?
“If anything, taxes for the lower and middle class and maybe even the upper middle class should even probably be cut further…But I think that people at the high end, people like myself, should be paying a lot more in taxes. We have it better than we’ve ever had it.” Warren Buffet

HMRC data shows how much income tax comes from low and high earners, it can be seen that the top 1% pay a surprisingly large proportion of the tax collected by government and that the proportion of income tax coming from this group has increased over time (part of a long term trend).

Breakdown of Income Tax Receipts by Income Percentile

It is worth noting that this increase could be due to high earners being taxed more, high earners earning more or low-middle income workers earning less.

The IFS comments that :

“The trend towards a lower proportion of income tax payments from the bottom 50% of income tax payers, and higher payments from the top 1%, is a continuation of a much longer-term trend. In 1978–79… The trend pre-2007 was overwhelmingly driven by the distribution of pre-tax income. Inequality increased considerably, such that the larger burden on richer taxpayers mostly reflected their higher share of total incomes.11 Post-2007, the trend has been largely as a result of explicit policy choice.”

This is reflected in a report report by the High Pay Commission, which points out that CEO earnings increased by over 200% between 2000 and 2009, while other workers only saw increases of 45%.

Perhaps also worth mentioning this BBC article on high earners who DO pay their full share of tax; an this interesting article on the questions raised by tax data and how it is presented; and this Full Fact article on high earner tax.


Who is avoiding taxation?
This is where “The Great Tax Robbery” comes in with a lot of pertinent information, we’ll come back to this later after looking at some context in the shape of a short history of UK taxation.


A short history of UK taxation
“The Great Tax Robbery” also talks a lot about the history of taxation (and tax avoidance) in the UK. Here are some of the points that caught BFTF’s attention:

1692 to 1963 : The Land Tax- A tax on the value of land – and idea that has increasing support today

1872 : Tax (which was a maximum of 10%) evasion running at 40%. The practice of transferring bonds abroad to avoid tax on dividends, already present.

1907 : Lloyd George’s “Peoples Budget” described as one to “wage implacable warfare against poverty and squalidness”. Top rate of income tax still only 7.5% Direct Taxes (Income, Land) overtake indirect taxes as governments primary source of income.

1914 : Most British residents became taxable on their worldwide income – this was the start of the “tax avoidance” industry. Todays HMRC definition is that tax avoidance involves transactions that have tax implications which are “unintended and unexpected” from the legislators point of view.

1918 : The costs of WW1 has pushed Income Tax to 30%, with an additional 22.5% surtax for high earners and an “excess profits tax”. This latter tax caused first large scale corporate (as opposed to individual) tax avoidance activities, resulting in anti-tax avoidance laws. MP’s recommended extending these laws to income tax, by giving the HMRC the “power to ignore, for the purposes of assessment, any fictitious or artificial transaction entered into for the purposes of evading or avoiding income tax”. The Chancellor Austen Chamberlain said No.

1930s : Emergency tax rises to pay for re-armament rose to 98% for highest earners.

Re-armament for WW2 resulted in a rise in taxation

Post war : Chancellors Sir Stafford Cripps and then Hugh Gaitskell maintained a wall around Britains corporate tax base

1960s : With top tax rates still above 80%, high earners were taking advantage of complex tax schemes. For example, a plan was developed to allow Julie Christie to shelter $100k from an effective tax rate of over 90% in 1965. The plan involved a network of companies and trusts, and 35 separate transactions, all signed off on a single sitting. These schemes generally aimed to release the money back to the individual over period of years, at levels that would attract much reduced tax rates.

Britain’s overseas territories were increasingly becoming “shop fronts for tax dodging”, combining secrecy, lack of tax and minimal regulation on the one hand with the protection of the UK on the other.

1964 : Companies “income tax” replaced by “Corporation Tax” and “Capital Gains Tax” introduced – both aimed at eliminating forms of tax avoidance. Tax rates still very high (40% on average earnings, over 95% on some personal incomes)

1973 : Rossminster, a bank with a strong line in tax avoidance products was selling products like the "non deposit scheme”, which worked like this :

The scheme provides a loan to the client, say, £10k
The client immediately pays all the interest back, say, £1k (but offsets these against other income)
The client then sells the loan to another Rossminster company at less than face value, say £9k (this is not taxable)
The whole thing would be signed off in a single sitting at Rossminsters offices.

1974 : Labour Chancellor Denis Healey began outlawing many of the tax avoidance schemes, leaving interest tax relief only for mortgages – but Healey focused on individuals, not companies, who continued to be able to enjoy interest payment tax relief .

1978 : Healey banned a particular form of tax avoidance retrospectively, the first time this had been done. Healey's junior minister Joel Barnett commenting that “one’s abhorrence of retrospective legislation” had to defer to “ones abhorrence of people literally taking hundreds of millions of pounds away from every other taxpayer who is having tax deducted from them”

Denis Healey

1979: Incoming Conservative government abolishes exchange controls, allowing companies to easily move large amounts of money into tax havens. And British banks set up “off shore deposit takers” in the UK’s crown dependencies for clients who wanted to avoid UK taxes.

1981 : A House of Lords judgement in a tax case concluded that schemes which aimed to produce a non-taxable gain and a tax-deductible loss should be looked at in their entirety, not as a set of separate transactions. This approach was known as the “Ramsay Principle

1984 : Chancellor Lawson legislates to stop tax profits being sent to tax havens, but according to Brooks, the legislation was “full of loopholes requiring remedial action in almost every subsequent finance bill.”

1990s : Tax law was completely overhauled so that it could deal with financial concepts such as derivatives. Unfortunately, the resulting legislation, according to Brooks was very complex and had many overlapping areas

1999 : Brown abolished “Advance Corporation Tax”. This was a tax on company dividends that was hard to avoid and meant that companies had to pay 20% on their dividends from profits anywhere in the world (which they could then offset against corporation tax). With its removal, companies were incentivised to reduce taxable profits.

2002: The year of the “Hartnett Review” which signalled a wish to be an “enabler as well as a regulator” and achnowledged only “a small number” of companies of having “aggressive” tax plans.(see also here)

2004 : Labour introduced the “disclosure” scheme whereby tax schemes had be declared in advance. According to Brooks, this “proved the most effective single anti-tax avoidance measure on record”, preventing some £12.5bn (and 62 different schemes) in its first five years of operation.

In addition, some income tax and national insurance avoidance schemes were now shut down retrospectively, but retrospective taxation was not extended to corporate tax schemes.

2005 : The Inland Revenue and Customs & Excise were merged to form HMRC. There were some 25,000 job cuts in an “efficiency” drive that, according to Brooks “even the Treasury and HMRC managers knew would cost the Exchequer far more than in lost tax than it saved in staff costs”

And Gordon Brown made a speech to the CBI which said regulation by government would be “not just a light touch but a limited touch”

According to Brooks, multinational companies had two main complaints :

1) They didn’t like having to bring the tax on overseas profits up to UK levels when bringing those profits back to the UK

2) They didn’t like the “controlled foreign companies” laws (brought in by Lawson in 1984) as these taxed profits that were sent to tax havens.

By 2009, lobbying by multinationals had achieved both of these desired aims.

Customers trying to withdraw savings from Northern Rock, 2007

Brooks has commented:

“..just 600 staff in the Revenue's large business service handle 700 groups of companies. By contrast, a single sale and leaseback project by Tesco took 90 lawyers to organise…”

Adding that :

“Many believe that hiring more inspectors is sensible, because last year the large business service recovered 92 times its costs. A "special investigations section" fighting the most complex avoidance cases had yielded 450 times its costs.”


As we are now getting back to modern times, lets focus again on :


Who is avoiding taxation?
2010/11 : HMRC spent £3.5bn to collect £446bn (0.8% collection fee) – cf charities which typically spend 15-25% on fundraising.

2010/11 : Prosecutions per £1bn of fraud :
Direct taxes : 5,
Indirect taxes (e.g. customs duties) : 50
Tax Credits : 140
Welfare Benefits : 9000

2011 : The Osborne austerity budget was also the budget where the government announced the complete removal of the 1984 laws on taxation on British multinationals overseas profits, allowing companies to use tax havens with impunity and reducing their tax bills, according to the treasury, by some £7billion over 4 years.

A tax advisor told Brooks that “nobody in the private sector could believe what they [the government] did…it was just so stupid”

George Osborne

MP’s noted with concern that Hartnett was the only HMRC board member who had a background in tax. The legal arm was headed by someone who confessed to being “not what you would call a tax lawyer”, and neither were his directors.

2011 was also the year that the HMRC tax deal with Switzerland, which was claimed to bring in tax revenues from Brits holding tax evading accounts there – but only if the accounts were still open 18 months later in May 2013. No get out clauses there then. Unsurprisingly the deal brought in less than 15% of the projected tax take of £3.1billion.

2011 also the year that Dave Hartnett, HMRC’s most senior tax inspector sat down with finance director of Vodaphone and reached an agreement on the tax required on 10 years of the company’s offshore financing arrangements. Vodaphone had set aside £3bn to cover the tax and interest costs of just 5 of these years but was only asked to pay £1.25bn. A result Vodaphone described as “very good”. Ministers said that the details of the deal could not be revealed due to “confidentiality laws”. This was not true. HMRC was perfectly able to divulge the details to Parliament.

Vodafone tax report in 2015 was still…well… you decide on the right adjective...

As large companies honed their tax avoidance activities, the proportion of their profits that they paid as corporation tax flatlined, even as profits rose dramatically:

UK Corporate Profits and resulting Corporation Tax paid

Data for above here : www.hmrc.gov.uk/stats/tax_receipts/tax-receipts-and-taxpayers.pdf, or it would be if the government hadn’t dumped most of the historical data and files from government online resources. So much for open government.

The flatlining of large companies tax recipts left small companies, who did not have the resources to set up complex tax dodges, picking up the bill – small companies provided ~35% of corporation tax in 2011, up from just 15% in 2000.

2011-2015 : Coalition government cut the number of professional tax inspectors from 3550 to below 3000.

2012 : The coalition government limited personal tax relief to 25% of income

2013 : Hartnett, having left the HMRC, became a consultant to the tax firm Deloitte


What should be changed?
Brooks make a number of recommendations on how to reduce the level of tax avoidance.

The most effective deterrent, according to Brooks, is greater openness. Multinationals must publish the tax they pay in each country they operate in. Similarly, users of tax avoidance schemes should be placed on public record.

International Tax rules are set largely by the OECD and should be amended to allow governments to tax companies on their real presence in the country, rather than the artificial one created by contrived transactions between parent and subsidiary companies

The EU should remove the “fundamental freedom” rights from tax motivated company structures and real sanctions should be imposed on countries who act as tax havens.

Tax havens around the world should have to release details of trusts etc to the beneficiaries home - countries – and tax havens should be forced to stop “turning a blind eye” and wilfully avoiding collection of this information.

Minimum tax levels on companies should be based on dividends paid to shareholders (similar to the system scrapped in 1999 under Labour)

Penalties for tax avoidance schemes should be significant, based on the amount of tax avoided and made public.

The system of tax legislation needs to be changed, as currently tax avoidance advisors dominate the discussion. Other parties need to be significant parts of the debate.

The current approach to large companies and wealthy individuals where by taxation is decided in a “relationship” needs to change and be replaced by implementation of the law.

The cull of staff in HMRC needs to be stopped an reversed, so that they can effectively do their jobs. This would raise hugely more in recovered taxes than it would cost in salaries.


Some notes and examples
Lastly, some notes on a few tax related items...

PFI
Ah yes, PFI, a system of financing public infrastructure initiated under the Conservatives, but turbo charged under the 1997 Labour government as a way of delivering on promises to revitalise public services without breaking promises to hold to the previous Conservative governments spending limits.

By 2005, some £50billion of PFI deals for schools, hospitals and other infrastructure had been signed under Labour, with repayments to the private PFI companies of some £7.5billion per year stretching out 30 years into the future (to a total of over £200billion)

The treasury had accepted the conclusions of KPMG that, when assessing whether a PFI deal offered better value than the government building the infrastructure itself, it should be assumed that the PFI company will pay tax on its profits.

And this tax can make the difference between a PFI deal being viable or not.

But, in practice, many PFI companies simply do not pay any significant amounts of tax, not least by often locating parts of the deal in a tax haven.

Gordon Brown

The Developing World
Countries in the developing world badly need the tax receipts that tax avoiding companies, often multinationals, are avoiding paying them, often with no transparency.

One way of combating this would be to introduce country by country reporting of profits, and taxes.

Luxembourg
Luxembourg is a country that has become synonymous with tax avoidance. This is because, although the country has an official tax rate of 29% (in line with EU laws), in actual practice it allows multinational companies to reduce this to 1% or lower.

If a country seeks to recover the tax that companies have syphoned into Luxembourg, the companies can claim that this would be in breach of EU “fundamental freedom” laws.

If you even have cause to wonder how Luxembourg manages to have the highest per capita GDP in Europe, part of the answer may be the taxes that should have been paid in the UK but are, instead, being paid at a lower rate in Luxembourg.

How companies use trademarks to reduce tax.
Back in 1997 the drinks company Grant Met (who owned the Johnnie Walker whiskey brand) merged with Guinness to form Diageo. The merged firm then moved the ownership and trademark of Johnnie Walker to Holland via a complex set of transactions which had the result of allowing Diageo to use the value of the Johnnie Walker brand (some £6billon) against its taxes for a number of years.

Diageo used similar ruses for other brands and were able to pay no UK tax in 2009 and 2010.

Thin Capitalisation
A way of reducing tax liabilities by loading up a company with debt and then offsetting the tax against this. Practiced by many companies. One example is the takeover of Manchester United Football Club, which the then Conservative tax spokesman David Gauke commented thus “the current structure of our tax system appears to encourage the situation whereby a successful and profitable business like Manchester United becomes loaded down with debt as a consequence of a leveraged buy-out… This may be a tax efficient structure but it is difficult to see how this is good for long term interests of the club, good for football or good for the country”

Some example of companies who avoid taxation – and whose behaviour does not form part of the official calculations of the “tax gap” (the gap between tax collected and tax that should have been collected)

Diago and their whiskey trademark trickery in the Netherlands.

Boots who, in 2007, were bought out and loaded up with debt (and its tax deductible interest payments) which allowed the Swiss Controlled group to reduce its tax payments by £4.2billion over 6 yrs.

Barclays
Barclays, the leading player in tax avoidance around 2004. As it took years for the Inland Revenue take even one of these cases to court, Brooks comments that “an unholy truce was reached: every year Barclays would divulge the rudiments of its many schemes, against a few of which the taxman would take up the cudgels while nodding through the remainder”. No wonder Barclays had over 150 subsidiary companies in the tax haven Cayman Islands alone.

All of the schemes were signed off with legal advice from the law firm Slaughter & May

None of this stopped Barclays chief executive stopped John Varley from telling MP’s that “I don’t recognise this statement that we have undertaken tax avoidance schemes”

Image Sources
D-day, Denis Healey, Northern Rock, Osborne, Brown

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