How do we solve a problem like avoidance: a prologue

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.