Today I mean to look at the first of the proposals in Progress’ Tackling Tax Avoidance Charter which is to:

‘Name and shame’ companies and individuals engaged in tax avoidance. This would both have a powerful deterrent effect and help to change the culture among those people who see tax avoidance as legitimate and desirable rather than the abrogation of civic duty that it really is.

The attractions of this course are manifest.

• Few people, today, would agree with Lord Oliver, speaking as a Law Lord, in Craven v White that:

the fact that the purpose of a scheme is tax avoidance does not carry any implication that it is in any way reprehensible or other than perfectly honest and respectable.

• The specialist tax tribunal is often confronted with applications for appeals to be held in private and – these days – almost never accedes to them. One can, thus, say that the notion that one has the right to privacy in relation to ones, controversial, tax affairs is already in heavy retreat.
• Naming in shaming is bound to have a powerful deterrent effect. As US Supreme Court Judge Louis Brandeis observed, “Sunlight is the best disinfectant”. And so it is in this field – as anyone who has picked up a newspaper recently will tell you.

The attractiveness of the outcome ought not, however, cause you to close your eyes to the difficulties of getting to it. These problems might best be explained by comparing what is proposed to that which already exists.

Section 94 of the Finance Act 2009 enables HMRC to publish the names of “deliberate” defaulters. The operation of the provision was considered by HMRC in October 2010 in a well argued paper which revealed that naming and shaming deliberate defaulters was a powerful tool which would work and which raised the stakes for would be tax evaders.

So far so good. However, the operation of section 94 is subject to two (relevant) limitations. First, it applies to those who engage, broadly, in evasion (rather than avoidance). And, second, names are published only once the subject (in effect) accepts that s/he or it is a deliberate defaulter.

So what do these limitations tell us about the call to name and shame tax avoiders?

First, whilst there is a settled understanding of what constitutes tax evasion, there is no equivalent for tax avoidance. This is no mere matter of semantics.

Amongst commentators there is profound and genuine disagreement as to what avoidance actually is (a matter I have explored in several of my previous blog posts – see in particular that of 11 June 2013). And this is not (or not just) a question of how you describe tax avoidance; there’s an even more important (prior) question about what avoidance actually is.

The consultation group which considered and devised the General Anti Abuse Rule wrested at some length with these questions. And the concepts and language they ultimately adopted to resolve them (which can be found here) are so complex as to be described as unworkable by many. I disagree; I think the GAAR will prove highly effective but the fact remains that tax avoidance is conceptually and definitionally extremely complex.

Second, unlike “deliberate” default, “tax avoidance” is not a term of legal art. So, again unlike “deliberate” defaulter, there is no ‘other’ legal conclusion to which the label “tax avoider” might be attached.

What are the consequences of this?

You would need not merely to work out what tax avoidance is and then define it (my first limitation) but you would also have to create, and fund, a mechanism to determine whether a particular transaction satisfied that description.

And basic considerations of fairness would dictate that if you were to be ‘named and shamed’ by HMRC you would  need an opportunity to contend before an independent tribunal that you had not engaged in tax avoidance. And HMRC would have to spend money defending their decision. And that money, because expended only upon pinning a label to someone, could not lead directly to the recovery of tax. It might, in other words, fairly be considered ill-spent.

It is not easy to see a wholesale solution to these difficulties. But there is a limited one.

Tax law does, from time to time, badge transactions as “abusive” (the GAAR) or as having a main tax avoidance object (any number of targeted anti avoidance rules (“TAARs”)). Legislation could, relatively easily, be introduced that those engaging in transactions caught by the GAAR or a TAAR should be named and shamed. Such a measure would not go quite as far as Progress propose – it would not catch all tax avoiders – but it would catch a fair number and achieve much of the deterrent effect that Progress seeks.

A short diversion from yesterday’s plotted course.

Compass today released its alternative spending review. The plan includes closing the structural deficit by raising £85bn in extra tax including £32.5bn from “Clamping down on tax avoidance” (see page 8). This figure is borrowed from HMRC’s calculations of the tax gap (see “Further Details on Eliminating the Structural Deficit” in the Compass Plan). But a perusal of HMRC’s own calculations show that only £5bn of the tax gap is attributable to avoidance. The vast majority is linked to various types of criminality – under or non reporting, criminal frauds, the black market – or simple non-payment. In these areas the tax gap is wide and persistent. There is no magic wand to be waved.

As I argued in my blog post of yesterday:

“A (completely wrong-headed) belief has grown up that £32bn per annum of prospective income – i.e. the so-called tax gap – is just lying around waiting for the Labour Party to come back into power and pick it up.”

I went on to argue that perpetuating this belief was damaging because it undermined the party’s inclination seriously to address the lingering public perception that the Labour Party can’t be trusted with the economy.

Compass rightly recognises the need to tackle that perception:

Earning the trust to spend money wisely in the future is paramount for any progressive party or coalition, including the Labour Party who have a particular problem in that many voters think it was not careful enough with the public finances when in Government.

Unfortunately its alternative spending review is a rather retrograde step.

Recent internal debate in the Labour Party around its spending plans has helped to move the party back into the centre-ground from the tax-and-spend hinterlands. However, that debate has focused on the “spend” bit; there has been no real soul-searching in relation to the party’s position on the “tax” bit.

This absence is both surprising and damaging.

It’s surprising, because, unlike spending, where the Tories have a natural head-start, fairness in the tax system is much more obviously Labour territory.

It’s damaging, because a (completely wrong-headed) belief has grown up that £32bn per annum of prospective income – i.e. the so-called tax gap – is just lying around waiting for the Labour Party to come back into power and pick it up. And this belief undermines the commitment of many of the party faithful to tackling the “spend” bit.

But perhaps worse still, the absence of a sensible debate – or perhaps more accurately the focus on insensible debate – is a missed opportunity to articulate a set of effective and actionable principles for a sensible approach to taxation around which the Party, the electorate and even the business community might cohere.

The most recent attempt to galvanise the party into action is Progress’ ‘Tackling Tax Avoidance Charter‘. But as I have observed before, it has both the strengths and the weaknesses of Margaret Hodge: it’s a powerful call but to unworkable action.

Over the coming days, I will look at each of the Charter calls. But I start with its introduction:

“This month the G8 will be discussing international action against tax avoidance. While this is hugely important, it is not an excuse for inaction at home, where HMRC estimates  a ‘tax gap’ of at least £32bn exists. At a time of squeezed incomes and public spending cuts, it’s simply unfair a group of global corporations and wealthy individuals are avoiding paying their fair share.”

This introduction – an otherwise sensible call for fairness – perpetuates a number of unhelpful fictions. In fact, of the £32bn tax gap, “only” £5bn is attributed by HMRC to tax avoidance. And I am aware of no evidence at all that global corporations are disproportionately responsible for this £5bn of “avoidance” – indeed I am not even aware of any suggestion that they are. And, although I know other commentators disagree, I argue tax avoidance transactions before the specialist tax tribunals day in and day out and I have no doubt that the General Anti-Avoidance Rule (the “GAAR”) will have an enormous effect in shrinking that part of the tax gap attributable to tax avoidance.

I don’t make these points (and those I will make in the days to come) because I think there’s no need for action on tax avoidance. I don’t make them because I don’t think £5bn matters. I don’t make them because I mean to defend global corporations. I make them because I would like to see Progress as a useful participator in the debate around closing the tax gap. And I think it ought to set it sights higher than making noise.

We all know a little about the tax gap. It’s £32bn right? A fairly big number. It’s just under 5% of government spending – or about half the budget of the DfE – or about 50% more than we spend on primary health care. So it’s quite important.

Over the course of this week, I’m going to look at three things connected to the tax gap. First, what is it? It’s probably not what you thought it was. And the Real Tax Gap may, in fact, be a lot bigger than £32bn. Second, where does the tax gap arise? There are real surprises here. It’s only once you know where it arises that you can begin to formulate practical policy to close it. Third, to what behaviour is the tax gap attributable? Again, an appreciation of this last point is critical to identifying the practical measures one must take to close the tax gap.

But first, what is the tax gap?

According to HMRC (see paragraph 1.1):

“The tax gap is defined as the difference between tax collected and the tax that should be collected (the theoretical liability). The theoretical tax liability represents the tax that would be paid if all individuals 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).”

Two points about this explanation.

First, the “tax that should be collected” is not (or not just) the tax that tax legislation says should be collected. That number’s smaller than £32bn. It’s tax satisfying both of two conditions (1) the legislation says it should be collected and (2) HMRC thinks Parliament intended the legislation to collect. This is interesting recognition that the law doesn’t always do what HMRC thinks it should.

Second, the tax gap is a function of the difference between the tax that is collected and the tax that the law (both in letter and in spirit) says should be collected. In other words, it doesn’t include tax that you and I might think should be collected but the law does not presently collect. That’s quite important so let me say it again. If Google’s tax affairs were compliant with the letter and the spirit of the law then the tax that you and I might (sensibly) think they should pay in the UK will not be captured in the tax gap.

So the tax gap on a different measure – i.e. between what the tax law should sensibly collect and what is actually paid – might be a number really quite a lot a bigger than £32bn. Call this number the Real Tax Gap.

Now I am but a mere technician. But occasionally released, blinking at natural light, from the stacks. But if I was campaigning for an effective tax system, I might begin by defining some parameters that would enable me to model the size of the Real Tax Gap.

Last week Progress launched its Tax Avoidance Charter. It chose, to chair the launch event, a politician, Margaret Hodge, who, as Chair of the Public Accounts Committee, has made the subject her own. The strengths of Ms Hodge are the strengths of the Charter. But her weaknesses are its weaknesses.

I’m going to examine those strengths and weaknesses over a series of blog posts. My posts are intended better to inform the educated but inexpert reader about the issues at stake. Because we need a more nuanced debate about tax.

We need a debate which does justice to the critical importance of tax policy in the functioning of the economy – the shaking and tightening of the reins on discrete areas of economic activity – and the centrality of tax equity to any sensible formulation of the social compact between haves and have-nots. Occasionally, I’ll shy at some interesting obstacle but largely I’ll try to stay the tax avoidance course.

But first, by way of introduction, what are the strengths and the weaknesses to which I have referred?

First, the strengths. Real credit must be given to Ms Hodge for pushing questions of tax equity up the political agenda – and to the Charter for seeking to formulate certain policy goals around tax equity. This re-fashioning of tax as a moral issue is undoubtedly having an effect at all levels – a diminished level of activity amongst those who generate tax geared investments; the willingness of wealthy individuals to buy them; the propensity of parties to litigate them; and even the judicial inclination to uphold them. Looked at through this end of the telescope, Ms Hodge’s desire – along with that of Progress – to tackle ‘tax avoidance’ transactions is whole-heartedly to be applauded.

But what of the weaknesses? These, too, can be found if one looks through the other end of the telescope. All of those outcomes identified as positives in the previous paragraph can also be seen as negatives – or having negative consequences: inactivity on the part of those who mediate the supply of cheap capital to prospective entrepreneurs; a disinclination of investors to invest in capital starved sectors of the economy; an inhibiting lack of clarity about the terms under which relief might be available; and an erosion of the rule of law. 

The question which of these two accounts of the effects of the debate around tax avoidance is right admits of no universal answer. Both are right and both are wrong. It all depends – and what it depends on is a question of classification. 

There is – and this is nub of the matter – no easy way to determine what is “tax avoidance”.

Every time you invest in an ISA, or put money into your pension, your behaviour is guided by considerations of tax efficiency. Governments, rightly, encourage people to put money aside for a rainy day, or to reduce their dependence on the state in their retirement. No one would say that was ‘bad’ tax avoidance. Most would not call it tax avoidance at all. 

Let’s move a step along the spectrum. Let’s say you’re an individual who’s prepared to invest in the British film industry. Government recognises that film performance is uncertain but that a strong film industry makes an important contribution to the wider economy. So it creates a tax relief to encourage individuals to invest. You make an investment of 20 and you attract the relief prescribed by government. Unacceptable avoidance or not? 

Now a step further. You’re a wealthy individual who’s interested in investing in the British film industry. But the relief on 20 isn’t enough to attract you to invest. A film maker comes to you and says, we already have 80 of the 100 we need to make the film. We’ll put up the 80 we already have as security to enable you to borrow 80 and you can then put that borrowed money plus 20 of your own into the film. So you’ll get more relief. Avoidance now?  

What about if, in the above scenario, you’ll pay income tax on all your earnings from the film, including the money you use to repay your loan? What about if, in the above scenario, HMRC publishes material which states that you’ll obtain the relief in the scenario described? Tax avoidance? What about if a government funded film body goes to investors and invites them to invest with 80 of borrowed money?

And what about if some years after making the investment you enter into a further transaction which means you don’t pay tax on the income from the film. One might readily agree that that transaction is avoidance – but does it change the character of the initial investment in the film industry?

Of course identifying which if any of the above transactions is ‘avoidance’ is merely one of what label to put on it. Badging it as ‘avoidance’ tells you little about its intrinsic nature. And, crucially, the question whether it amounts to ‘avoidance’ is one amenable of subtle distinctions.

This theme of a continuum between ‘good’ transactions – for example, where the tax system seeks to motivate individuals to act in particular ways and individuals do so act – and ‘bad’ transactions is one I will return to in later posts. But appreciating that there is a continuum is critically important when one starts to think about the Tax Avoidance Charter: how it might be applied in practice and what effects it might have for business on the ground.