The VAT rate will increase within months. The only question is 'by how much?'

There has already been plenty of media speculation about a prospective rise in VAT whichever party is returned to power after the election. No one wants to confirm this move - because they fear the backlash and being blamed for not winning the election.

The Chancellor has no excuse. The Treasury will have advised him of his options re spending cuts and tax rises. He will have to lay out his plans in next month's Budget. George Osborne's team will also have had conversations with the Treasury as part of the plans for a possible transition. It seems likely that there is a clear need to increase taxes. I will leave the economists to dispute the timing and depth of spending cuts that may also be required.

I will also leave aside the precise numbers and how much can be raised through tax rises.

What I want to do here is to simply highlight WHEN tax rises generate money for the Exchequer. And I'll just focus on those key taxes that contribute the most money each year.

Income tax
Assume a second Budget in June or July - part way through the current tax year that starts on 6 April 2010. It is customary to determine tax rates before the start of the tax year. But let's assume instead that income and corporation tax rates were to be raised in respect of earnings and profits of the tax year 2010-2011.

Remember that the PAYE system, which only affects employees and pensioners, is 'cumulative' in the way that allowances, reliefs and taxes are allocated. A tax change half way through the year results in 6 months worth of the annual tax effect hitting taxpayers in one go. Not good news and, I would have thought, all but inconceivable. At least, not without the introduction of complex adjustments that could throw out many computerised payroll systems.

Still, even if income tax rates were increased for 2010 and a solution was found for the PAYE issues summarised above, what about the self employed and the higher rate tax payable by those with investment or rental income? When would they pay the additional tax? Well, it's not due for payment until 31 January after the end of the tax year - so that would be 31 January 2012. And that's if income tax rates are increased with immediate effect. Such a change would clearly not contribute a major reduction in the deficit this year.

And the impact of a rise in income tax rates is further delayed if any increase is deferred until 2011-2012.

Corporation tax (CT)
CT rates for the 2010-2011 financial year could, in theory, be revised mid year and the resultant complaints could be ignored. But again this tax is paid after the end of a company's accounting period. Assume a year end of 31 December 2010. Any increased CT would only be payable late in 2011. And all those companies with 31 March accounting dates would only pay such increased CT at the start of 2012. So, as with income tax rises, this will not do much for the current year deficit. And the impact is further delayed if any increase is deferred until 2011-2012.

National Insurance (NI)
Most classes of NI are payable along with income tax for the year in question. Thus pretty much the same issues arise as for income tax (see above). The only class of NI that could have material sort term impact is the 'tax on jobs' - employers' NI. An increase of 1% has already been announced to take effect from 6 April 2011. And part of that rise was announced in 2008.

Capital Gains Tax (CGT)
I'll write separately about the rate of CGT. For now let's just note that, like income tax, it is payable on 31 January after the end of the tax year. Thus, even if the rate for 2010-2011 was increased from 18%, this would only have an impact on the tax payable on 31 January 2012.

VAT
We have already seen two changes to the VAT rate in the last 18 months. Firstly a reduction to 15% and then an increase back to 17.5%. Both such changes had an almost immediate impact on the Government's tax receipts. There is no other way to do this.

So VAT will have to rise later this year. The only question in my mind is by how much? I suspect 20% as it's a convenient figure but better minds than mine are welcome to suggest alternatives.

The average rate of VAT in the EU is almost 21%. Only Luxembourg and Cyprus have a standard VAT rate lower than the UK. Each 1% rise in the rate of VAT should generate £4-5 billion of additional income for the Treasury. A rise to 20% would still leave the UK slightly below the average rate across the EU, and could generate almost £12 billion for the economy, the equivalent of around 3p on income tax. And let's remember that we all dismissed the 2.5% reduction from 17.5% down to 15% as being unlikely to have a meaningful impact on spending. And when we reversed the cut and put up VAT by 2.5% to 17.5% did everyone cope? Might this always have been the plan, to use such a rise as a test-run for the impact of a rise to 20%?

What do you think?

Official: You can't rely on HMRC guidance

To be fair we have known this for some time. The Courts and the the Tribunal (and previously the Commissioners) will always focus on the wording of the law. HMRC's statements of practice, concessions and guidance notes are as they are described 'on the tin'. They are intended to be helpful but they are not the law.

The judgment in a recent Tribunal case reinforced this position. The facts of the case are not relevant to this blog post - other than to note that the taxpayers, Parnalls Solicitors, had sought, to rely on HMRC guidance notes when arguing their case.

In a concluding statement the Tribunal judge, Roger Berner stated:

"Mr Harvey referred us to a number of extracts from HMRC publications and other materials in support of an argument that HMRC were guilty of inconsistency in arguing the case against the Appellant. We do not consider that these were material to our decision, which depends on the law as we have found it and not on any interpretation which might be attributed to HMRC. We do not therefore refer to such materials in our decision, and we make no comment on their validity or otherwise."

HMRC's guidance can be helpful. It may be right, but it may be wrong. And it is of no relevance when it comes to arguing a point of law. In practice any appeal starts with negotiations directly with HMRC. At this stage, if their guidance is helpful by all means refer to it. But such arguments cease to be relevant once your appeal gets to the Tribunal.

Tax on TV: Sort your paperwork or watch The Business Inspector on Channel 5

If only all small business owners had time to watch TV and would choose to watch a new 4 part series: The Business Inspector, a new programme, that premieres on 10 March. It's sponsored by HMRC!

Although HMRC are not referenced in the programme they are co-producing it and have paid £370,000 for the privilege. Their objective: To raise awareness among small businesses that they need to keep good records.

I well remember the campaigns about record keeping that were run by the then Inland Revenue in the mid 1990s. This was during the reign of the cartoon Hector the Inspector when the self assessment system was first introduced. I only threw out the old cassette and old video last month during a tidy up. Might have been fun to have compared the messages with the new programme. I wonder how the relative investments compare and what the current sponsorship is REALLY expected to achieve.

"STOP giving tax advice - or face a charge of deliberate wrongdoing"

Of course no one needs to stop giving tax advice. And I think it's irresponsible to suggest that such a situation will ensue. But that is what some people are doing after reading the Draft legislation on deliberate wrongdoing by tax agents published by HMRC on 8 February.

The good news is that HMRC have bowed to pressure and are extending the deadline for responses to 28 April. The original deadline of 3 March (just 23 days after publication) was quite disgraceful as it gave far too little time for effective consideration and reasoned responses.

Over the last few days I have rejected the wilder fears from certain accountancy commentators that tax advice is to be banned; and at the same time I have flagged the issue for the IFA and will-writing communities, for the reasons I have set out below.

The first point to note is that the draft legislation goes WAY beyond the aspirations of the consultation document issued in December (Working with Tax Agents: The next stage). As drafted the legislation means that all Tax Agents would be potentially subject to tax geared penalties for giving advice that results in a reduction in someone's tax liability. This is clearly a nonsense and I'm sure it will be changed. As such I favour formal representations to HMRC by the widest possible range of tax agents.

In this context the draft legislation also extends the accepted meaning of 'tax agent' to include voluntary sector advisers (eg: CAB, TaxAid, TOP) and those in the financial services and will writing professions. It also extends to all employees as well the principals in firms/businesses.

I have enormous sympathy with HMRC's ambitions and am a supporter of many of the objectives set out in the Working with Tax Agents consultation documents. I can also see exactly what they were seeking to do with this legislation. Whether the parliamentary draughtsman was inadequateley briefed, chose to extend the potential scope of the rules or was asked to do so we may never know.

I have long deplored the extent to which we are already taxed by legislation and only untaxed by concession and discretion. The anti-terror laws are already used in circumstances way beyond their original intent. The original assurances given that they would not be misused are worthless. Sadly it is much the same with tax law - as those who have negotiated with HMRC will confirm all too readily. There are already too many examples of where, having been asked to trust HMRC not to abuse their powers, that trust has itself been abused.

We have also seen with the health and safety laws (in particular) that law abiding citizens end up taking things to extreme to ensure that they don't get close to crossing the line. Tax law is very different of course and to an extent HMRC want to discourage tax agents from 'planning up to the edge'. But the draft legislation is too widely drawn and too open to abuse by HMRC.

It has evidently been drafted in a hurry and needs to be revised in a number of places - not least to make clear that it can ONLY be applied to counter the real targets rather than only 'in particular' those targets. It is this prospect of wider application that is the biggest worry in my view. I confidently expect that HMRC will bow to pressure and common sense and revise the drafts now they realise how much wider it could be applied than they originally intended.

However, until the draft is amended, it says what it says and the more people who point out that it is much too widely drawn the better.

Gaines-Cooper judical review residence case won by HMRC

Many readers of this blog may be confused by today's media stories about a tax case involving Robert Gaines-Cooper. The Times report is typical: Entrepreneur faces £30m tax demand after residency ruling leaves thousands exposed.

If you didn't know any better you might assume that the Court of Appeal had just decided against Mr Gaines-Cooper. It's certainly true that the Court of Appeal found him to have retained his residence in Britain during what he claimed to be a period of non-residence - dating back to 1976.

Here's the thing though. I wrote about the Court of Appeal's decision in this case back in October 2008! - Gaines-Cooper loses in Court of Appeal - Residence rules revisited

So how is it that his appeal seems to have been heard again by the Court of Appeal?

What the papers have omitted to note is that the most recent case was a Judicial Review. In effect a challenge to the way in which the decision had been made, rather than the rights and wrongs of the conclusion reached. Here the main focus was whether HMRC had failed to correctly apply the tests in the IR20 leaflet. The Court found in favour of HMRC. Quelle suprise!

Whatever the merits of Mr Gaines-Cooper's arguments there are few tax advisers who seriously expected the Judicial Review to succeed. Beyond this case the newer residence rules have been enshrined in what is now HMRC6: Residence, Domicile and the Remittance Basis.

The only good news is that there are moves to establish a statutory residence test that would largely remove the worries about how much discretion HMRC have in future to determine the facts long after the event.