Archives For tax

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By Jason Piper, tax and business law manager, ACCA

History tells us that if communities are going to grow beyond a particular size then they will have to rely upon a level of infrastructure spending which can only be provided by the state. Philanthropy and altruism, on the part of private resource owners, get us only so far when it comes to providing sufficient quality and quantity of the pure public goods needed to support the sort of society that has developed over the last few thousand years.

There’s a lot of debate internationally at the moment on whether you can ‘tax yourself into prosperity’ with opinion clearly divided on whether it is possible. At one level, the concept seems to be nonsense. Taxation diverts privately controlled resources into state hands. Simply moving funds from one pot to another like this can’t possibly increase the overall level of funds available, can it?

It is what the various controllers of this revenue might do with those resources if placed in their hands that makes all the difference. After all, a bucket full of water can be left to stagnate by someone with no interest in gardening, or taken by a green-fingered neighbour and used to water their crops. By the same token, if a government can clearly identify resource owners who aren’t generating prosperity with their funds and take it from them to be put to some other use which might enhance prosperity, then it is possible that the tax system could be a mechanism towards that end. (nb that’s a really big “if” on identifying who can best use resources, and it’s keeping a lot of economists busy trying to work out how, or even whether, we could do it).

Taxation is an idiosyncratic and asymmetric process. At its core, it is about taxpayers more or less (mostly less) voluntarily surrendering resources which they could have used directly for their own benefit, to be used instead ‘for the benefit of society.’ That means clear parameters have to be created to help guide policymakers when they’re exercising this unique power, and perhaps even more importantly, to evaluate their success after the event.

Whether we agree with what a particular policy is trying to achieve is an individual value judgement. Regardless of this individual view, we can form an objective picture of whether the policy has been executed effectively, and measure the impact of the changes on the tax system.

When evaluation is done, changes should be assessed on the three core tenets of the tax system – simplicity, certainty and stability. While there is likely to be some compromise on at least one of those factors in any new measures, policymakers need to understand why they are proposing the changes, and what they could do differently to ameliorate any negative impacts without diluting the ultimate policy impact.

Tax is difficult…

accapr —  1 December 2014 — Leave a comment

By Jason Piper, ACCA Technical Manager, Tax and Business Law

Tax is difficult because the world is complicated. Trite though that sounds, it is unfortunately the simplest way of expressing the inevitable outcome of a huge bundle of conflicting factors. One of the most fundamental issues is that tax is always expressed as an amount of money, but is at the same time used as a mechanism to influence underlying behaviours in line with society’s ‘values’.

Whether you think of monetary labels as the price or the value of something may depend on your level of cynicism, but those amounts are only ever an equivalent for whatever the underlying “thing” is worth. It follows that how we define and process those numerical expressions is fundamental to calculating tax liabilities so the ‘value’ of a business’s activities, as reflected by its tax contribution, is seen through that filter.

Take a factory producing bicycles. The actual taxes paid by the operators of the business will certainly be far more sensitive to the accounting treatments of the factors of production than to the quality of the bicycles, the treatment of the workers or the environmental impact of the whole operation. Whether the ownership of the factory is leasehold or freehold, and whether the workers are employees or independent contractors makes no direct difference to the number of physical bicycles it can produce – and yet those different legal descriptions can radically alter the tax outcomes.

In the long run it’s as likely, if not more so, that the success or failure of the venture will depend more upon the abstract legal considerations than it will the quality of the bicycles or its treatment of the workforce and environment– even though you could make a good argument that it’s actually those aspects of the factory’s operations that society ought to be more interested in.

For the vast majority of individuals things are generally simpler. There’s far less in the way of accounting to be done; all that matters is the tax treatment of the cash amounts of earnings that hit their bank accounts in the year and valuations usually arise only in the context of “benefits in kind”. (It’s probably a given that all employees consider the monetary value their employers put on them to be far too low, but that’s another issue).

The other main tax individuals pay in most countries is sales taxes or VAT – but these are almost entirely dealt with and accounted for by the businesses selling the goods to them, and the complexities that arise bypass the consciousness of consumers altogether. A recent change in VAT treatment of a popular consumer product in the UK hasn’t even resulted in a noticeable change in the retail price, despite the 20% shift in margins for supermarkets.

The issues arise because society tries to use the application of the tax system to enforce its values directly (rather than just raising the revenue to fund other measures). Differentials in tax treatment inevitably end up cruder than the world they’re trying to operate on. There’s a myriad shades of difference between a factory employing local disadvantaged and disabled people to build environmentally friendly water filters for developing economies and a fully automated cigarette rolling plant that deposits its waste products straight into a local river.

It may look simple to use the tax system to distinguish between those two extremes, but then comes the difficulty of drawing the black and white line between tax/no tax on infinite shades of grey. Somewhere after all the tax system has to draw the line, because tax is a binary choice between “this dollar is yours to spend as you will” against “this dollar is taken by the state and you no longer have a say in its use”, and it’s around those tipping points that the uncertainty will crystallise. Set that in the context of accounting standards so complex that even experts can’t agree on them, and tax codes so long that no one dare claim to be expert on all aspects of them, and it can hardly be a surprise that we can’t work out what the tax system does do, let alone what it ought to.

Read ACCA’s certainty in tax paper here

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By Jason Piper, tax and business law manager, ACCA

Among the themes covered in the ongoing debates around BEPS and international tax, there’s been a strand of discussion around “tax competition” – the practice by governments of attempting to make their jurisdiction look more attractive than others by reducing the tax burden on businesses.

The argument runs that by encouraging a move away from taxation of business, tax havens and rich countries are imperilling developing countries who need tax revenues.

But if making your tax system “competitive” costs you money, why would anyone bother? Perhaps because the indirect consequence is that you make more out of the VAT, PAYE and simple GDP effects of inward investment than you lose by reducing the tax due on any profits that the company may book in your jurisdiction.

For that to work though, you need a number of conditions to be true. In particular, you need to have effective collection mechanisms for VAT, and a secure taxpaying base of employees. You need to be comfortable that you have the economic capacity to service the increased production and demand for the GDP growth to have value.

For most developed countries that is very much the case. They typically collect 30-40% of GDP in taxes, and less than 10% of that comes from corporation tax – so 3-4% of GDP is collected as corporation taxes. But in developing countries, the level of GDP collected as tax falls to 10-20%, while the proportion of overall taxes attributable to corporation tax rises to nearer 20%. So we’re still looking at around 2-4% of GDP collected as corporation tax.

And that means that the economics of “tax competition” doesn’t work for a developing country; it would need to have twice the GDP impact per pound of corporate profit untaxed to get in the same level of VAT or employee income tax as recompense – yet proportionally the amount of tax that developing countries should typically be able to extract from the international businesses who might invest in them should be far higher. The reason that big business goes to developing countries is typically natural resources – and those resources are not typically mobile. If business wants them, there’s only the one jurisdiction they’ll be coming from, so the local government should have business in a firm grip when it comes to extracting tax revenues.

And there’s another twist. Remember those percentages of GDP collected as tax? Well, it’s generally reckoned that a nation needs to devote around 15% of its GDP to government in order for government to be stable. Or in other words, if you as a business are looking at investing into a market where less than 15% of GDP gets collected as tax, then you’ve got more to worry about than just business rates and form filling; there’s a good chance that the whole infrastructure will be unstable. Whether that’s political instability, or a lack of roads on which to transport your produce, there’s going to be additional risk factors to play into your analysis of whether the investment is sound.

And therein lies the challenge for a business decision maker. In a developed country, with a high level of maintained infrastructure and political stability, corporate tax is a pure cost to be managed down. The net marginal benefits accruing from payment are nil, while the government may even be prepared to forego those taxes in order to attract your business; official resistance to corporate tax minimisation is likely to be low.

In a developing country, taxes paid to central government may have a very real benefit to business, for the simple reason that without them the whole investment may become worthless in very short order. Tax is not so much a deduction from profits as a cost of sales; it’s an essential element in allowing those profits to be earned in the first place.

To be fair, this probably isn’t something that big business needs to be told. They know full well that however valuable the resource in a mine might be on paper, it’s worthless if they can’t safely extract and process it. Political stability is a key element of their risk analysis. If the people at the top of multinationals weren’t smart enough to have worked this stuff out for themselves, they wouldn’t be there.

But there’s a lot of other people who haven’t spent a lifetime making difficult decisions based on complex yet incomplete information. And if they end up running tax administrations, then there’s a risk that they might consider tax holidays for big business to be a good way forward to attract international investment – when in fact, it may be the very last thing they need, and the very last thing that a rational business would ask for. What’s sauce for the goose may not be sauce for the gander, or indeed the value burger of your choice. When it comes to domestic tax policies in respect of international investment, it most definitely is horses for courses.

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By Jason Piper, technical manager, tax and business law, ACCA

Certainty is considered by many businessmen to be a useful characteristic when they are trying to make decisions. The ability to predict outcomes is key to the process. Equally, uncertainty introduces unknowable risk, and for the majority of decision makers this will naturally reduce their incentive to follow that particular course. And ultimately, if every possible course of action results in uncertain, unacceptable risk then the outcome will be inactivity – in economic terms, stagnation.

For business decision makers, the uncertainty which surrounds the outcome for tax purposes when the bogeyman of ‘tax avoidance’ is invoked has often been compared to the famous quantum mechanics thought experiment of Schrodinger’s Cat. For those who are not familiar, the cat is sealed (alive) into a box containing a mechanism controlled by radioactive delay which has exactly a 50% chance of triggering, and killing the cat, before the box is opened again to check on the cat’s welfare. Until the box is opened, we cannot know whether the cat is alive or dead.

But that’s exactly the situation taxpayers find themselves in with principles-based anti-avoidance approaches. The application of such methodologies is notoriously difficult, and will ultimately amount to ‘I know it when I see it – but I have to see it to know it’. That is to say, we cannot be certain as to whether a particular scenario falls foul of the principles rule until it is tested against the rule by the courts. Until then, the tax liability is in the same conceptual limbo as the cat – and with it the business decision maker.

Until the case is tested, the business will not know how much cash it will have left at the end of the fiscal year to reinvest, or pay to its employees as salary. Which is why the Schrodinger’s Cat situation would be an anathema to the cautious business decision maker. The outcome of the transaction could not be known in advance – and once the outcome is known, it is potentially irreversible, with catastrophic consequences for the cat.

In order to try to resolve this difficulty, many jurisdictions have introduced general anti-avoidance rules in one form or another. The argument is that in practice, taxpayers might actually see a net increase in certainty in the system by introducing the meta-law of purposive interpretation as a matter of statute. The truly compliant taxpayer remains in the same state of certainty as without the rule; under neither the strict letter of the tax provisions nor the principles-based rule will their dealings be condemned as ‘illegal’. And with the principles-based system to back up the strict letter, uncertainty is also resolved for the most egregious of schemes – they know with certainty that the proposed structures will fail, because they look wrong. There is no need to go through the complex observation process of interpreting every element of the structures, documentation and returns to see if they comply with the strict wording of the legislation in the view of the particular judge hearing the case.

From the perspective of the compliant this approach might seem to have much to recommend it. But we’re no longer here just looking at Schrodinger’s Cat, the ‘single particle’ uncertainty analysis. There are two boxes, one labelled “underlying tax law” and the other labelled “overarching anti-avoidance rule”. We’ve got two particles to predict, and we’re into the territory of quantum entanglement. That’s the bit about how you can establish the state of one half of a pair of related subatomic particles simply by observing the other – until you’ve observed either though, the system (like Schrodinger’s Cat) is effectively unresolved.

Resolution of the wave form is dependent upon both the strict law and the purposive rule. But if we can predict with absolute certainty the outcome of one ‘observation’ then we know both, and there is no need to stick the cat in the box. For example, a ‘clearly egregious’ case will fail on principles, so there is no need to analyse the strict law position. The net level of uncertainty in the system has been reduced. The limits of uncertainty are now restricted to those few cases where we can predict neither the legal, nor the purposive, outcome.

But the interpretation of intent, of the spirit of the law, is not fixed, and as a result neither are the boundaries of the uncertainty. The defence of principles-based GAARs is that we have ‘certain uncertainty’ – but the risk of populist information of the system is that we have ‘uncertain uncertainty’ in respect of application of the rule, a position no better than that we already inhabit. Business should know whether it’s going to get the cream, or pay the price of being too curious, before ever entering into a transaction. But if the range of uncertainty is itself uncertain, then more and more businesses are going to find themselves in the box, anxiously awaiting their fate. And that is simply not a place they should be.

Post script: There is of course one further wrinkle to all this, which is that the box may never get opened even once you’ve put the cat into it* (David Quentin discusses the issues well here). But the uncertainty about that is more a function of revenue authority enquiry resource than it is underlying tax policy, and while it may be every bit as in need of resolution, the question of whether governments should fund their tax collection authorities properly is hopefully not quite so difficult to answer.

*We’re assuming an otherwise immortal cat. Or perhaps a cat flap round the back that we can’t see. No cats were harmed in the performance of this thought experiment.

aligning stakeholders

By Chas Roy-Chowdhury, head of taxation, ACCA

In the past week I have given evidence at two committees in the Houses of Parliament, discussing the GAAR and the tax conduct of banks.

The House of Lords Economic Affairs Finance Bill Sub-Committee spoke about plans to introduce the General Anti-Abuse Rule later this year, as a means to combat tax abuse.

There is still general confusion between tax avoidance and tax evasion – put simply, avoidance is legal, evasion is illegal.

We have been saying for some time that a General Anti-Abuse Rule is not needed because genuine tax abuse can be caught through the regulations we already have in place to combat it.

If businesses are not paying enough tax, this doesn’t mean they are abusing the system and so a GAAR would not be appropriate.

The tax system needs to be looked at. The taxpayers need to understand fully how much tax they should be paying. A simple tax system needs to be put in place so that everyone involved in the tax paying/advising process knows exactly the right calculations and no mistakes can be made.

We were one of the first to put forward the idea of a Tax Policy Committee which essentially the Government took on board and created the Office of Tax Simplification (OTS). We think the OTS has done a sterling job and should now be expanded significantly and its independence and pro activity should now be guaranteed under statute.

I also gave evidence at the Parliamentary Commission on Banking Standards Joint Committee, which was a panel discussing banking tax practices.

Having a special tax regime for banks is not the best way forward to get businesses to adhere to a particular framework of doing things.

In both cases it seems the answer is a simpler tax system so everyone can understand exactly what they need to pay and cannot get into any legal difficulties without realising it. It would also reduce the ability, or the ‘want’ to ‘tax plan’. If the system is complex then advisers and intermediaries can, and indeed must, be aware of all the alternatives within it.

Let’s see what the Government’s plans will do.