The Morality of Tax Avoidance. The Journey Back.

In his evidence to the Public Accounts Committee, Tim Levy, Director of Future Capital Partners, one of the two largest film investment companies that had grown up to enable investors to access statutory film relief, estimated that by 2002 the size of the market had grown to over £2bn per annum of expenditure. A written answer by the then Paymaster General Dawn Primarolo (and recorded in a Parliamentary briefing paper) showed that the tax cost of supporting the British film industry through statutory tax reliefs rose from £10m in 1997-98 to £560m in 2005-06. Because of the different things they are discussing, these two sets of figures are broadly consistent.

Clearly this was too much, and the legislative rowing back began in the 2002 Budget. That Budget introduced measures to “protect the tax base and root out tax avoidance.” That assertion proved a touch optimistic. The tax cost of statutory film reliefs virtually trebled in the following three years. But further legislative steps were taken and eventually, belatedly, the reliefs returned to the fiscal obscurity from which they had sprung.

A full account of the history of the legislative measures introduced by Parliament to “root out” tax avoidance and the responses by the various film investment companies to those measures is for the purist. It would reveal a shift on the part of those companies from accessing statutory film relief to statutory loss relief to statutory interest relief along with statutory capital allowances. It would also show ‘soft’ finance, assets being purchased at inflated values, all too generous commissions to IFAs, and other features tending to signal ‘bad’ tax avoidance.

There is much of interest in this account. If you want to draw the all-important line between ‘bad’ and ‘good’ tax avoidance – an ambitious exercise attempted by many but with little conspicuous success – you’ll find it in that account.

But that’s not an exercise for me. I have acted in (indeed, am acting in) most if not all of the film relief cases to come before the courts in recent times. Professionally, whilst they are on-going I cannot discuss them or their facts. And anyway, the story I want to tell is that of why it was that people engaged in transactions which are today badged as ‘bad’ tax avoidance. I don’t need to draw the line to tell the story.

But it is in the detail of that account that the truth lies. If there’s nothing wrong with good tax avoidance and everything wrong with bad tax avoidance, and you want to throw stones at the bad, you can only take sight if you have the facility to distinguish it from the other. And you would have had that facility without the benefit of the hindsight you now enjoy.

The features that are, now, typically identified by tribunals as ‘offensive’ were certainly not thought to be such at the time. In a previous post, I identified a number of common features of these arrangements which are today cited by tribunals, courts and commentators as signalling egregiously bad tax avoidance: the presence of borrowing to ‘ramp up’ the amount of tax relief available to the investor; the presence of guaranteed income streams to repay that borrowing; the fact that the structure of the arrangements together with the availability of the tax relief renders the commercial performance of the underlying film all but commercially irrelevant.

However, as I observed in that post, all of those features were said by Government at the time to be perfectly acceptable. All of those features are present in two cases in which I acted (Halcyon and Micro Fusion) in which the Court of Appeal said the arrangements succeeded. And none of those features was signalled or clearly signalled by the draftsman in his journey back from a more generous statutory relief regime to be especially offensive.

So, I return to my starting point. How is it that people found themselves engaged in transactions badged today as bad tax avoidance? Is their participation in those transactions a reliable indicator of poor moral fibre?

To conclude that it was, you would have to assume that an individual possessed the sophistication to draw the line between good and bad tax avoidance. You would have to assume that he was able to make the judgement despite the fact that each of Parliament, the courts and the Government were signalling to him at the time as acceptable features he now knows to be unacceptable. And you would have to assume he was able to make that judgment in the face of what his advisor was telling him.

Of course, you might just stand back and say, that’s all very well, but perhaps he should just have steered clear of the whole thing unless he was sure he was on the right side of the line. And perhaps that’s a fair judgment. Remember it next time you drive through an orange light.



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The morality of tax avoidance. A cautionary tale.

“Tax avoidance rocketed in the late 1990s,” according to an unnamed senior HMRC expert. And the question ‘Why?’ engaged a number of technical commentators this morning. 

There is a very strong candidate explanation as to why. And, of course, if you’re engaged in making tax policy, you’re keenly interested in what it was that happened at that particular moment in time. Knowing the answer to that question might help you damp the fuse of any future rocket. But I’m not interested in the explanation so much as what an account of the increase in tax avoidance might tell us about why people seek to avoid tax – and the morality of doing so. But the two tales are intertwined.

First, I need to start with a key distinction. Not all tax avoidance is ‘bad’. If I choose to pay money from my earnings into my pension scheme, I will not be taxed on those earnings: the tax code encourages me to make payments into my pension scheme by enabling me to do so out of untaxed income. So I will have arranged my affairs so that I pay less tax and I will have avoided tax – but few would regard this as objectionable. If the tax code offers me a reward for behaving in a certain way – because it serves some broader societal purpose such as encouraging people to save for their old age – and I behave in that way, why should I not enjoy the reward?

However, if, for example, I could contribute money into my pension scheme, get the tax relief, and then borrow it back from my pension fund at a zero-rate of interest, that would be anti-purposive. I would be getting to the other side without having to pay the ferryman. The money would not be there for me to spend in my old age. 

So, pro-purposive good. Anti-purposive bad.

This is all, now, pretty much agreed across the spectrum of commentators. People might disagree about whether Government should offer a particular relief but if Government does then there’s nothing immoral in you availing yourself of it in the way in which Parliament intended. The Fair Tax Mark is seeking investment and offering a relief (Enterprise Investment Scheme relief) which its Technical Director thinks should not exist. But it would say, if the relief exists there’s nothing wrong with people accessing it.

Working out whether the use of a relief is pro-purposive or anti-purposive? Less easy. But more on that later.

In 1992, Government decided it wanted to encourage investment in British films. So it introduced a new relief: if you used 100 to purchase a film, you could, in effect, set 33 off against your other income in each of tax year one, year two and year three. If you were a 40% taxpayer, you would (in effect) get a tax credit worth 13.3 in each of those years. This might not be enough to tempt you to invest in films – they are inherently very risky. So Government also said that the film company could sell you the film for 100 and then rent it back from you for a guaranteed stream of income worth, say, 92. That way, the film company would get 8 to put towards the cost of making the film. And you would get three tax credits of 13.3, plus income worth 92 for your 100. 

Now that’s not quite as good a deal as it looks, because that 92 of income is taxable so its net value in your hands is 92 – (40%) = 55. So you’re still down 5 (100-55+13.3+13.3+13.3) plus you only get the second and third 13.3s in the second and third years.

So in 1997, (under a Labour administration by the way) the Government announced you could get all of those 13.3s in your first year. And this was enough to tip the balance. You could borrow, say, 80 and put up 20 of your own money. You’d get a tax credit of 40 in your first year so you’d be 20 up in that year alone. You’d get taxed on 92 as it came back to you (so it would be worth 55) but you’d invest the 20 you were up and make up the extra 5 and then some. You wouldn’t need to worry about repaying the borrowing – this would be done from the rental stream of 92 which the film-maker would pay a bank to guarantee.

Now, so far so good. In published documents – I have them and I am perfectly happy to post them on line if anyone wants them – Government through HMRC encouraged this investment. In exactly the form I have described (the numbers are slightly different but the principle absolutely as stated). And the British Film Commission went out and encouraged foreign film makers to make their films in the UK on the back of the fact that they could make a 100 film here for only 92.

Just pause there. This was pro-purposive investment in films. Encouraged by the Government. And the result was that this sort of arrangement became respectable. Analytically, in tax terms, it was no different from putting money into your pension.

The result was that an enormous tidal wave of money came into British films. Because of the way in which the reliefs were structured, investors were, in effect, financially indifferent to the quality of films that were made. They made money from the arrangements irrespective of whether the films flew or bombed at the box office. 

Now several billions of pounds later, Government worked out that the reliefs weren’t really operating as they had intended. They were badly designed and too expensive. And the wholly unsurprising consequence of indifference to quality was the production of turkeys: remember Sex Lives of The Potato Men? I thought not – and that was, relatively speaking, one of the better ones: it at least got made and got a cinema release. So over a period of about a decade, Government slowly rowed back from what it had started in 1997. 

But it was difficult. You had a whole class of Film Investment companies which had grown up to put these deals together (the big ones generally founded around the late 1990s). You had IFAs who had made a lot of money introducing their clients to these deals. And you had a class of perfectly respectable, moral, law abiding individuals who had grown accustomed to arrangements of this nature.

Arrangement of this nature. Geared investments? encouraged by Government. Guaranteed income streams? encouraged by Government. Indifferent to the performance of the film because protected by the tax relief? encouraged by the structure of the tax relief. All of these features perfectly respectable – both legally and morally – at the time.

Like the launch of the reliefs in the first place, the process of rowing back from them was equally flawed. It left many of those moral and law abiding citizens genuinely in the dark about whether they were participating in pro- or anti- purposive arrangements. But subtle nuances – even important ones – don’t play well with an audience in the mood for blood. 

But the story of the trip back is for another day.

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