No - ISAs are not a form of tax avoidance

Kirsty Wark on BBC's Newsnight has just put it to Vince Cable that:

"at one level, using ISAs is tax avoidance."

She was suggesting that Nick Clegg and Danny Alexander had made a mistake by referring to plans to challenge both tax avoidance and tax evasion. Except that they were deliberate in their choice of words. There was no mistake.

Throughout my 25 year career as a tax adviser I stuck to the old adage that tax avoidance is legal and tax evasion is illegal. When I started to be troubled by the morality of tax avoidance I gave up giving tax advice.

As former British Chancellor of the Exchequer Denis Healey memorably explained:

“The difference between tax avoidance and tax evasion is the thickness of a prison wall”.

This distinction remains true today. But something has changed. As Nick Clegg stressed, the Coalition Government wishes to stamp out (as did the previous administration) tax avoidance that is:

"perfectly legal but morally questionable"

For Kirsty's benefit - and that of anyone else who is confused, let's be clear. It is self evident that investing in in an ISA (Individual Savings Account) is not 'morally questionable' and thus not under attack. As long as all the published conditions for saving through an ISA are met it is simply good tax planning to make use of the facility to save money in a tax-free structure (ISA) specifically intended for this purpose. So perhaps we do need to be able to distinguish acceptable and unacceptable tax avoidance.

In this connection I again refer back to a post on this blog from over two years ago: Distinguishing Tax Evasion, Tax Avoidance and Tax Planning.*

* The distinction was first made by Richard Murphy and I note that he has more recently published a new tax briefing on the subject. Whilst I may not agree with his politics or all of his views, I think on this he may be right.

Doesn't everyone try to avoid or evade taxes?

In the light of recent announcements to limit tax avoidance and tax evasion I am forced to ask an uncomfortable question: Doesn't everyone try to avoid or evade taxes?

Well maybe not 'everyone' but certainly a large majority. I'm thinking of those who, for example:

• Are self employed and are keen not to have to pay tax on all of their trading income (perhaps taking 'cash in hand');
• Are employees and are keen to receive benefits, gifts and bonuses without them being subject to tax;
• Are receiving a pension and do some work 'on the side'
• Claim personal expenses as deductions from their taxable income (profits) when they 'put it on the business' despite the primary 'non-business' rationale for the expense;

All of the above constitute 'tax evasion' of one sort or another. It's just that many people tend to assume that it's something that only the rich and famous do and for much larger amounts of course. (And don't get me started on the MPs again!)

Again, many ordinary people are keen to avoid tax (legally). This may simply be a question of wanting to do all they can to avoid falling within 'tax traps' and thus avoiding that tax otherwise payable if they are within the rules for:

• IR 35 (the freelance contractors tax)
• Inheritance tax
• The new top rate 50% income tax (which can create an effective liability of 60% in some situations)

And the financial pages and websites are full of adverts tempting us to avoid or reduce our tax bills. Where should the line be drawn? Last year I wrote a piece here: Tax avoidance - what are you allowed to do? A simple guide. And two years ago I wrote a piece: Distinguishing Tax Evasion, Tax Avoidance and Tax Planning.

Many of those supposedly targeted by the Coalition Government's new initiative will continue to accept advice that they can reduce their tax bills using tax avoidance schemes that are within the letter of the law. They will be unfazed by the suggestion that such tax planning is 'legal but morally questionable'.

And everyone else will continue to do what they can to keep their own tax bills low. To the extent that this is simply sensible tax planning there should be no problems. I wonder though whether accountants ever come under pressure to overlook, what we might term, amateur tax evasion by their clients?

£900m to tackle tax avoidance and tax evasion

During his speech at the Lib Dem party conference yesterday, Danny Alexander said that:

"Tax avoidance and evasion are unacceptable in the best of times but in today's circumstances it is morally indefensible."

He announced that £900m will be made available for a:

"package of new measures to crackdown on tax avoidance and tax evasion".

Speaking earlier on the BBC's Andrew Marr Show, Nick Clegg criticised Labour for not doing more to clamp down on tax loopholes that he described as

"perfectly legal but morally questionable".

I said last year that I thought the tide was turning. See: Tax cheats need to think again.

Now Danny Alexander has referenced tax avoidance and tax evasion as if they were one and the same activity. And Nick Clegg implicitly referenced legal tax avoidance as being 'morally questionable' and liable to be blocked.

HMRC still has the same desire to introduce anti-avoidance legislation as under the previous Government. The difference now is that they are under even greater pressure to close the 'Tax Gap' and yet they have fewer resources than ever before to do this. But they need to be seen to be clamping down on 'rich' tax avoiders and evaders, to at least the same extent as they clamp down on benefit cheats.

The £900m will apparently include measures such as:

• a fivefold increase in the number of criminal prosecutions against tax evasion;
• a crackdown on offshore evasion with the creation of a dedicated team of investigators to catch those hiding money offshore;
• a much tougher stance on evasion and avoidance by those liable for the 50 per cent tax band;
• further investment in in-house collection capacity to increase HMRC’s internal debt collection rates; and
• more registration checks to stop people claiming tax repayments when they are not due.

These are all worthy activities but will the £900m really make a difference in the face of continued cuts? I really hope so but sadly it's far more likely that this is simply a 'spin' story to placate the Lib dem conference. Time will tell.

The Tax Gap is big - probably bigger than HMRC have admitted

HMRC have published their second (annual?) publication concerning the Tax Gap. This contains HMRC's estimate of the difference between total taxes paid and those that should have been paid if all individuals, partnerships and companies complied with both the letter of the law and HMRC’s interpretation of the intention of Parliament in setting law (referred to as the spirit of the law).

The total Tax Gap is estimated to have been £42bn in 2008-09 as compared with £38bn in the previous report - although that figure was restated as £40bn in the 2010 report due to a desire to present comparative figures to the nearest £5bn. The split of the Tax Gap across different taxes is revealed in this chart:

Of course the very idea of trying to estimate what is not being reported is fraught with difficulties. And HMRC's document admits this with statements such as:

"All of the tax gap estimates shown are subject to error.The main sources of error are random errors due to sampling and systematic errors due to assumptions used to derive the estimates. Where possible the range within which the true estimates would be expected to lie has been estimated. However for some taxes and components it has not been possible to provide a robust estimate of the error margin."

Whilst the report explains how the figures have been computed it does seem likely to underestimate the true Tax Gap. This must be due either to inadequate expert scrutiny within HMRC, incompetence or a deliberate effort to reveal how inadequate have been previous efforts to estimate the Tax Gap.

The report colour codes figures to distinguish how the figures have been computed:

Established methodology, estimate updated annually

Developing methodology, estimate updated annually - Used, for example, to estimate IT, CGT and NIC avoidance by individuals

Experimental methodology, not updated annually and illustrative indicators for gaps with no direct measure - Used, for example, to estimate IHT avoidance.

One critic of HMRC's calculations, Richard Murphy, explains some of the inadequacies on his Tax Research blog:

That Inheritance tax avoidance and evasion is £0.1 billion when this tax is so widely known as an ‘honesty box’ tax – requiring for a start retrospective declaration of gifts made in the seven years prior to death – of which the executors may well be wholly unaware?

That tax avoidance of income tax, Capital Gains Tax, and national insurance combined is just £1.4 billion when George Osborne admitted that avoidance of CGT alone was more than £1 billion in his June budget speech? So there’s almost no income tax avoidance at all then?

That the 20 million or so people who do not receive tax returns each year – including every single person who trades in the shadow economy – between them evade just £0.3 billion in income tax – when the World Bank says that the UK shadow economy is 13.5% of GDP?

He has also suggested that the real Tax Gap must be more than double the official figures. He estimates are also worked out carefully and suggest that tax evasion costs Britain £70bn and that tax avoidance costs us £25bn. He notes, for example that if the Tax Gap for VAT is estimated to be 16% of the VAT that should have been accounted for, then this suggests in turn that 16% of turnover that should have been subject to VAT has not been reported. I don't wholly agree with this simplistic approach but I do entirely accept that HMRC's figures probably UNDER-estimate the full extent of tax avoidance and tax evasion.

Equally, according to the FT, David Gauke, exchequer secretary, has said by reference to the official figures that:

“The tax gap number is staggering and this government is committed to taking the necessary action to bring it down – taking steps to reduce tax avoidance and evasion, including by the richest people in our society, so that everyone pays their fair share and we reduce the tax gap over the coming years.”

And this brings us onto my next blog post by reference to Danny Alexander's speech at the Lib Dems Conference.

Evan loves tax

The BBC's Evan Davis has a series of programmes at 9am each morning on Radio 4 this week in which he explores our vexed relationship with tax.

I caught part of yesterday's episode during which Evan interviewed:

John Whiting twice - once in his capacity as Technical Director at CIOT (and an ex PwC partner giving tax advice) and later as "interim head" of the new Office for Tax Simplification.

Dave Hartnett (before last week's media frenzy) - who explained his distinction between tax avoidance and aggressive (and implicitly unacceptable) tax avoidance - which results in HMRC petitioning Government to change the rules.

Lord Howe and Lord Lamont - two ex-Chancellors

Each episode is available on BBC iplayer for a few more days if you care to listen.

The PAYE tax system is now working as it should...

I was invited to appear on BBC 3 Counties radio twice yesterday to explain some of the facts behind the big PAYE tax news story. Sadly I could not get phone reception at either of the appropriate times but here are extracts from the notes I made in preparation for the interviews. I would never have been able to cover all of these points of course:

• No - this is not a deliberate attempt by HMRC to sting taxpayers as part of a 'let's collect as much money as we can' approach [A suggestion put to me by the researcher who had called]. More people are due refunds than appear to owe money to the taxman anyway.

• The new PAYE computer system has brought these errors to light. There have always been unders and overs as the PAYE system isn't perfect. This year we know about them all and the new system makes it more likely they will be resolved faster than in previous years. So in some ways its a good news story. HMRC changing their systems to try to get things less wrong than in the past!
  

• References to a figure of 10m people due tax rebates are wrong. HMRC have said 4.3m have overpaid in the last 2 years and 5.8m in earlier years. This is likely to be many of the same people.
  

• The PAYE tax system has been creaking for years. Not designed for people who change job more than once a year or who have more than one part time job at a time.

• Many of the people who owe money do so because they have a company car that was not properly taken into account in their tax code. And they probably know this and hoped they would get away with it.
  

• References to employers using the wrong tax code for an employee are a touch unfair. Employers use the tax codes issued by the taxman. If it's wrong it's because the taxman didn't have or didn't use the right information. Often the taxpayer hasn't told the taxman everything they need to know.

• Tax Codes are not something that the taxman and employers can work out between themselves. The taxman tells the employer what to do based on information given to them by the worker.
  

• PAYE is a simple idea - Pay as you Earn. It's a way of paying tax by instalments but it can only get to the right figure every year if your affairs are very straightforward. In most cases there will be unders and overs that get sorted out by an adjustment to your tax code the following year. This happens to millions of people every year. It always has done and always will do.
  

• To get everyone's tax spot on each year we would all have to file annual tax returns. In fact most people on PAYE don't do this. They can if they want to though....

• The previous Government added layers of complexity to the tax rules and calculations which the PAYE system was not capable of easily dealing with. (Tax codes can only charge 40% and not 50% tax if someone liable to the top rate has a second job, so they will always underpay tax through PAYE on that second job)

• Where you owe less than £2,000 any unpaid tax will normally be collected by adjusting your tax code for next year. So again, it's good news. If you do owe tax, instead of being asked to pay it back straight away you'll be given loads of time and the repayments will be spread over 12 months.

• Only a small proportion of the 1.4m PAYE taxpayers who owe money will be able to use what is being misleadingly called a 'loophole' to avoid repayment of any tax they have underpaid. It's a concession and not a statutory right. ESC A19 only authorises HMRC to write off the debt if the taxpayer can prove they have provided all relevant info and HMRC has evidently not used it AND taxpayer could reasonably have expected their tax deductions to be right.
  

• The taxman may well ask for a full tax return for the year before agreeing to write off a tax debt. Do you have any undeclared casual earnings, investment income or rental income?

• If your affairs are complicated or you have any undeclared sources of income, do take professional advice from a specialist tax adviser before contacting the tax man.

• You may also want to speak to a tax specialist if you are willing to pay for one-off advice rather than an accountant to help you every year.

Postscript: In the event I went on the show this morning and in 4 minutes of airtime I think I made 4 or 5 of the above points!

Tax planning schemes

I was intrigued to see this in the newsletter of a substantial firm of accountants recently:

Certain niche promoters of tax planning arrangements have recently chosen to increase the extent to which they promote directly to businesses, rather than, as historically has been the case, to advisors such as ourselves for evaluation.

We undertake due diligence on such proposals on a regular basis and, with a few honourable exceptions, find that we are unable to recommend them. This is because of concerns over, for example, the robustness of the tax law analysis, the conviction and strength of supporting opinions, the cost vs benefit ration, the evidence of success when faced with HMRC enquiry, the professionalism of documentation and implementation, and not least of 'after-sales' care.

The direct promotion of schemes to businesses reminds me of just such a situation I encountered almost 20 years ago when I was the tax partner at a large firm of accountants. The FD of a client company told me that the owners had been made aware of a scheme that would enable them to extract monies tax free from the company. The promoters had appealed to the owners' greed and their belief that their 'large firm of accountants' were overly cautious when it came to dealing with (what was then) the Inland Revenue.

We checked out the paperwork and Counsel's opinion and expressed doubts as to the prospect of the scheme achieving the desired outcome. Our advice was ignored and the directors paid thousands of pounds to the promoters. I left the firm a couple of years later and only heard quite recently that my advice had in fact been spot on. Ten years down the line the Directors accepted the Revenue's arguments. The scheme didn't work after all. The promoters kept their fees as is often the way.

The reason that some promoters now try to go direct to clients is because an increasing number of accountants are becoming more cynical. And are becoming more effective at helping clients to understand the risks inherent in a pre-packaged scheme - and, when they do this the clients' reaction is typically:

“Now I understand it properly, why would I want to go into a scheme like that?”

Previous posts that address similar issues:

• "Raise the white flag" - Are tax schemes worth the effort any more?
• "Give me pure tax evasion any day"
• HMRC challenge sideways loss relief tax avoidance
• HMRC confuse tax avoidance and tax evasion again
• Beware of HMRC spotlights - EBTs now included
• Were you wasting time advocating this tax scheme?
• The beginning of the end for structured tax avoidance schemes?
• Bending vs breaking tax rules