Last week, the Solicitors’ Regulatory Authority (“SRA”) published a Regulatory Settlement Agreement (“RSA”) – effectively the result of a plea bargain between solicitor and regulator – in which LZW Law Limited accepted it had failed to act in its clients’ best interests and had acted in transactions in which there was a significant risk of conflict between the interests of two or more clients.

The RSA arose from an investigation into LZW’s participation in certain schemes – once commonplace, now less so – which had as their intention the avoidance of stamp duty land tax on certain (typically residential) purchases. LZW’s financial interest in those schemes was modest: it charged each (and there were 203) client between £250 and £500 for the extra work involved in effecting the scheme. The lion’s share of the profits on those schemes – typically calculated by reference to the purported stamp duty land tax saving – would have been enjoyed by the promoters.

As others have observed, the fine paid by LZW was a relatively modest £2,000 plus costs of £6,965. The aggregate of these sums is, as can immediately be seen, substantially less than the fees earned by LZW. Others have found this difference remarkable; for what little it’s worth, I do not.

What interests me is the role of Counsel in the scheme.

The conflict of interest referred to in the RSA was between LZW’s borrower clients (those purchasing the properties in question) and its lender clients (providing the monies by which the purchases were to be effected on the strength of the security in the property). It is a common feature of stamp duty land tax avoidance arrangements that they can impair the quality of the lender’s security. Although there is no explicit finding that these arrangements had that effect, the RSA does state that LZW had failed to disclose “material” information to its lender clients (being the borrowers’ participation in the schemes).

In mitigation, LZW pointed out that it had taken advice from Counsel as to whether it was obliged to disclose to lenders the fact of its putative borrower clients having entered into SDLT schemes. To this the RSA observed:

That “However” is rather troubling. It is not said that the barrister (who, sadly, goes unnamed) is not competent to give that advice. Nor is there any finding that the barrister – instructed by LZW and owing a duty to LZW – has a conflict of interest. Indeed, one might consider that, if the SRA regarded the barrister as having had a conflict of interest, that would have mitigated LZW’s breach because the fault would have been the barrister’s rather than LZW’s.

However, if one proceeds, cautiously, from the assumption that the barrister had no conflict of interest one is left in a rather uncomfortable position. The SRA has held, in effect, that the degree to which a solicitor can rely on a barrister’s advice is dependent on whether the barrister has advised on a related tax avoidance scheme.

If this is right, we have two tiers of specialist tax barrister: those the SRA recognises the bar’s clients can fully rely on and those they cannot.

You would have to have been living in a bubble in early December not to have noticed the outpouring of anguish by a mighty handful of micro-businesses upon discovering, somewhat late in the day, that the new arrangements for VAT on electronically delivered services (AKA ‘Mini One Stop Shop – MOSS’) would interrupt their VAT-free way of life forever.  These very small businesses, often run by one or two entrepreneurs, do not account for VAT because their turnover is below the UK mandatory annual threshold for VAT registration which, at the time of writing, sits at £81,000.  The new regime, which applies from 1 January 2015, requires businesses of any size to register for and pay VAT in member states of the EU where electronically delivered services have been sold to their residents on a B2C basis.  The threshold for this is ‘nil’.  It requires all suppliers to register for MOSS and complete quarterly returns.

Micro-businesses were astonished that they would be caught in this VAT requirement despite trading below the domestic thresholds.  Whilst they managed to negotiate with HMRC a side-step of certain rules, to allow them not to have to pay UK VAT simply in order to be registered for MOSS, nothing could be done to absolve them from the requirement to account for VAT on minimal levels of sales in other EU countries.  We were told that some of these businesses would accordingly close, having been strangled to death by red tape. Some would ensure that people from outside the UK were unable to buy their products, and others would intervene manually so that their services were not electronically delivered, in order to continue with a clunkier version of the status quo.  Meanwhile, there is no discernable reaction from micro-businesses of any other EU state, where, perhaps coincidentally, the average domestic VAT threshold is much lower.

The uproar this caused was the first time in ages that anybody focused attention on the UK having a VAT registration threshold which is several times average employee earnings.  It seems almost to be accepted that this is a normal state of affairs and that micro-businesses should be able to operate in a VAT-free environment in order to shelter them from the crushing potential competition of larger operators and the general turbulence of commercial life.  But if we gaze across the channel we see a distinctly mixed picture which, nonetheless, shows how extreme our threshold has become in comparison.  France for instance has a threshold of just over €30,000.  The threshold in Germany in less than €20,000.  Austria and Belgium have a threshold of between €25,000 and €30,000.  Spain is not the only one to have a general threshold of ‘nil’.  Even Ireland, which has decided to use two different thresholds, has a services provision threshold of less than €40,000.  Why is the UK so different that it should have a threshold of around €100,000?

Specious reasons?

It is oft stated that the main reason is to protect embryonic businesses until they are large enough to bear the cost of VAT.  If that were true, then the threshold would not be based on taxable supplies alone, but would incorporate a test for overall size.  The current rules allow a significant exempt business to make minor levels of taxable supplies but still remain unregistered.  It also seems fairly obvious that a business does not magically grow the muscles to compete with genuine medium sized and large operations once it exceeds £81,000 turnover.  On the contrary, so significant is the potential difference in tax liability for any B2C operator in the UK, that the main impact of micro-businesses not having to be registered for VAT is that they can run an inherently uncommercial business model on a footing which is just about commercial, but which, if scaled up enough to incur the VAT costs, would simply not be a business proposition.  That might be a charming idea where a genuine hobby business is concerned, but one can run an activity far removed from a true hobby at a figure under £81,000.  So it appears that the VAT threshold does not so much nurture small businesses until they grow up, but creates an artificial environment where certain kinds of activity, as long as they always remain small, will survive.  It is a bonsai environment.  And it undercuts and thus weakens genuine growing businesses.

No-one mentions whether the real reason is that it costs more for government to administer and collect from micro-businesses than justifies the revenues that might arise from them.  I speculate that no-one mentions this because it would immediately spotlight an unfair comparative burden on those businesses which seek to grow their bonsai into something rather more impressive, and which are having to pay for the government’s wish not to become involved in uneconomic tax collection.  But, for the tax system to work properly, it must work relatively even-handedly, so that tax does not become a determinate of success or failure.  If we were to assume that the threshold had been set simply to save government money, the government would not be fulfilling its duty to provide a balanced tax system.  This incentivises government to allow us to think that the threshold is a ‘pro-business’ policy.

Business infantilism

The problem which this creates is significant.  Businesses that mainly work for private consumers are then faced with a major disincentive to grow beyond their infantilised state.  One or perhaps two people can make a living without ever having to charge VAT.  But if they decide to take on one or two employees, with all the attendant risks of trying to scale up, they immediately nudge into VAT territory.  Since VAT registration works rather like residential SDLT used to do before the Autumn Statement reform, namely that once you have crossed the threshold you pay tax on every penny of taxable turnover, rather than merely the excess over the threshold, the person who makes a penny more than the threshold finds himself facing an enormous tax charge.  The marginal rate on that penny is colossal.  The cost of being a penny over the line can easily be £10,000 per year (or more) and this means that the business makes a loss out of joining the VAT club until it adds more than £10,000 to the turnover it reached when it joined the club.  That is an enormous increase in percentage terms and one cannot see any reason why an organisation would wish to do it unless it had an extremely strong conviction of its ability to grow far beyond that scale.  For many businesses only a much bigger scale will ever be viable, but there are businesses where that is not true.

So, the policy of having a high registration threshold ensures that certain businesses are locked into an infantile state and that the talents of their entrepreneurs can never be tested beyond the foothills of what they might have achieved.

Furthermore, a set-up of that kind encourages the fragmentation of a business into several different legal entities in order to escape VAT registration.  If you set the threshold low enough, the threshold at which businesses have to be split in two, three, or more sections, in order to try to avoid the VAT registration requirement, becomes so low as to not be worth the effort in doing so.  Set the threshold as high as we have, and much less fragmentation is needed in order to remain below the threshold.  Whilst HMRC has weapons against fragmentation, the conditions have to be in place and it has to have noticed the issue.  The position would be more clear-cut if the threshold were lower, since it would be harder to defend a position of there being several businesses operating over such a small aggregate economic value.

Taking this point further, it is perfectly, and legally, possible for a B2C trader not to charge VAT because he can run his business below the threshold.  That means he is not regularly distinguishable from the evader – the cash-in-hand operator whose failure to account for VAT is dishonest.  If you bring the threshold down to the extent that it is almost inconceivable that an honest tradesman need not charge VAT, then the general public can have no excuse for accepting a situation where VAT is not charged.  Indeed, in that situation the minuscule businesses that might still theoretically operate below the threshold would find it worth their while to register for VAT sooner rather than later in order to avoid the stigma of appearing to be on the wrong side of the law.

Administrative burden?

Having said that, what level of administrative burden this would create?  First, I postulated that the government perhaps thought that collecting VAT from micro-businesses was not cost-effective.  That certainly might have been the case up until the inception of mandatory electronic filing of VAT returns.  We are now in a situation where the postal costs are eliminated.  It could once have been said that there were no techniques for controlling the compliance of very small traders.  Now the greater sophistication of data analysis open to HMRC must surely make that viable.  Furthermore, there is simply more of the national economy tied up in micro-businesses now than there was in the bad old days when entrepreneurialism was not thought to be a good thing.  The threshold is probably omitting a great proportion of the economy.

As for the administrative burden on the micro-businesses, of course nobody running their own business from head to toe wants another piece of red tape.  But let’s face it, business has been incurring more and more red tape over the years, and there is no logic under which an important aspect such as paying sales taxes should be regarded as being some kind of ‘last straw’ for small business.  Annual accounting reduces VAT return submission to once per year (though not under MOSS).  A flat rate scheme is available to all traders up to £150,000 which means they do not even have to keep purchase records (though, again, MOSS is different).  The most basic bookkeeping would in any case furnish the relevant information, and good book keeping is something we would want to encourage in any size of business.  It is difficult to see how the bureaucratic burden of operating VAT is of such importance that we should continue with a fiscal distortion which is so far adrift from that of most of our EU counterparts.

Even if we were to bring our figure down to £30,000, we would still be broadly speaking at a higher level then is average across the EU.  Of course, there would be a blaze of objections from micro-businesses.  They have so much to lose.  The approval of those businesses which have struggled northwards of the threshold against the odds would probably be more muted, but they would be silently grateful for the unfair fiscal competition being addressed.  But it takes a government of conviction to consider what is best for the country rather than what is best for their next stint at the ballot box.  It needs politicians who are prepared to think the unthinkable, to shed some ingrained ideas as to what is good for business, and take the bold course of action.

Or, if all of the above appears to be too self-assured, and too uncompromising, then let the economists and the politicians step forward to explain why the UK is uniquely sensible in maintaining such a high registration threshold and what it really brings to our economy and our British way of life.

Graham Elliott – Withers LLP

You can, and indeed should, follow Graham on twitter @VatDaddy