We all know that tax evasion is criminal and that tax avoidance, if it is not a shame, is lawful. But what of tax avoidance? This is an expression coined by Mickey van der Walt, a former Commissioner for Inland Revenue. In principle, tax avoision does not exist. A transaction is either lawful or unlawful but the charismatic van der Walt, who had a vast and intimate knowledge of the South African tax system, was aware that some taxpayers and their advisers were inventing schemes that had a veneer of respectability but, on closer inspection, would cause the tax architect to blush in front of the judge when the matter came to trial.
Of course, this situation is not unique to South Africa. Various parties in the United Kingdom have been attempting to obtain from Her Majesty’s Revenue and Customs (HMRC) an estimate of how much revenue is lost each year to evasion and avoidance. For three years, HMRC declined to answer but recently, faced with a court order served in terms of the Freedom of Information Act, it disclosed that 42 billion a year is lost through evasion and avoidance. In addition, it is estimated that 12 billion is lost through VAT fraud. Because of understaffing, income tax and VAT inspectors recover barely 4 billion a year – less than 10% of the income tax loss.
In a rather startling disclosure, hidden away in the voluminous notes published after the Chancellor’s Budget speech on 12th March 2008, HMRC estimates, using a “detailed methodology”, that 50% of all fees for tax work charged by accountancy firms in the UK relates to advice on tax avoidance. Whether this is accurate is impossible to say. HMRC estimates that the big four accountancy firms in the UK earn 1 billion a year between them for tax avoidance advice. But how does the HMRC know this?
The O’Donnell Review, which led to the merger of the separate Revenue and Customs Departments in 2005, set three objectives for the new department – an improvement in customer focus (a euphemism par excellence) an improvement in cost efficiency and the closure of tax gaps.
In consequence, HMRC then commissioned a study of the tax practices of 148 of the biggest companies in Britain. Interviews were requested with the tax managers of those companies. Perhaps not surprisingly, 45 companies immediately declined to take part and, of the remaining 103, 66 companies diplomatically said they would be happy to participate but annual leave and commercial pressures prevented them from doing so. Let’s be truthful. Would you accept an invitation to have tea with a crocodile? Based on qualitative research interviews with the remaining 37, HMRC arrived at the evasion/avoidance estimates and formed an opinion on the extent of tax avoidance advice provided by their auditors.
Some of the questions asked of those 37 companies that agreed to participate included:
- how easy has it been for the group to reduce its tax bill through the adoption of tax management tactics and schemes?
- what drives, and what inhibits, initiatives in these areas, and has the group changed its receptivity, in either direction, to such initiatives?
- what are the likely responses that the group would make to a noticeable reduction in a competitor’s effective tax rate?
- for companies with a United States connection, what effect has SOX (Sarbanes Oxley) had on tax decisions, and what pressures from outside the UK impact on those decisions?
- several companies have noted concern around a perceived hardening of the government’s position on tax planning methods that affect corporation tax. Do you agree that this has become more difficult?
- what has been the influence of that trend on the way your company handles corporation tax? Has it:
- eliminated tax planning? or
- led to a search for new solutions with the same objective?
- if changes to the law prevented existing tax planning, would the company simply search for new alternatives to adopt?
- what difference, if any, would it make if the tax on which penalties are calculated was before group relief and losses, i.e, unlike now, penalties could not then be avoided by offsetting group relief or losses against culpable tax?
All the interviews were tape-recorded and transcripts were produced for analysis. HMRC concluded, not surprisingly, that it was reasonable to suppose that the companies with the most ambitious tax planning strategies were also the least interested in being interviewed and that the study simply omitted them for lack of access and co-operation. But it went on to say that a broad spectrum of other views was canvassed, ranging from the risk-averse through the complacent to a few deliberately tax-aggressive businesses.
The most consistent criticism of HMRC arising from the study, was the amount of time and effort that is usually required to respond to questions that arise (often repetitively) from an examination of a company’s tax returns. Answering detailed queries was particularly contentious in the light of a perceived asymmetry. Companies felt they were obliged to respond and reply far quicker than HMRC would in turn reply to them. Doesn’t that sound familiar?
The British Government itself is not immune from allegations of tax avoidance. CDC plc, formerly the Government’s Commonwealth Development Corporation, which was formed to assist poor Commonwealth countries by investing in their infrastructure, recently disclosed in its audited financial statements that on worldwide profits of 365 million the company paid income tax of only 5 million, or 1.4%. CDC is exempt from UK tax and from all anti tax avoidance legislation, and it is estimated that by skilful transfer pricing the company has avoided paying income tax of 100 million to various poor and developing countries.
Is the British Chancellor of the Exchequer blushing? Shamefully, it’s not likely. But, as it was then, Chancellor Gordon Brown, now as Prime Minister, has so very much more about which to blush!
Penelope Webb is a former tax partner in a large international accounting firm.