Under the LDF tax amnesty which has been running since 2009 – the bizarre workings of which I have discussed here – you can choose to disclose your tax evasion to HMRC and pay back taxes and interest on those taxes. You’ll also face a penalty of 10% of your unpaid taxes but you won’t face a criminal prosecution. Nope, and you might well still be better off than if you had paid your taxes. It will be the rest of us eating porridge, as the following example shows.
This state of affairs occurs, broadly, when you are able to make a return on the tax you have evaded which is higher than the rate of interest HMRC charges you on unpaid tax. Sufficiently higher to overcome the effects of the 10% penalty. It isn’t legal – but it’s risk free. I prove it, in the following example.
Happy Easter, from those wonderful folks who gave you the Liechtenstein Disclosure Facility.
To simplify, I’ll assume that tax rates and interest rates on unpaid tax in 2009 were what they are today. Today rates on capital gains tax are 28% and, on savings income, 45% (if you’re wealthy). Interest rates on unpaid tax are 3%. I’ll also assume that taxes follow the calendar year and are payable on 31 December rather than 31 January. None of these simplifications makes a material difference to my example.
Assume Mr X makes a capital gain on 1 January 2009: on an investment of £500,000 he makes a gain of £1,000,000. He then invests the proceeds earning a return of 10% per annum until 31 December 2015.
If Mr X has evaded his taxes he will have (in cash) at the end of 2009 £1,650,000, at the end of 2010 £1,815,000, at the end of 2011 £1,996,500, at the end of 2012 £2,196,150, at the end of 2013 £2,415,765, at the end of 2014 £2,657,341 and at the end of 2015 £2,923,076.
His tax liability for 2009 will be £280,000 with an interest bill (from 31.12.20-31.12.2015) of £50,400.
His tax liability for 2010 will be £74,250 with an interest bill (from 31.12.2010-31.12.2015) of £11,137.
His tax liability for 2011 will be £81,675 with an interest bill (from 31.12.2011-31.12.2015) of £9,801.
His tax liability for 2012 will be £89,842 with an interest bill (from 31.12.2012-31.12.2015) of £8,086.
His tax liability for 2013 will be £98,827 with an interest bill (from 31.12.2013-31.12.2015) of £5,930.
His tax liability for 2014 will be £108,708 with an interest bill (from 31.12.2014-31.12.2015) of £3,261.
His tax liability for 2015 will be £119,580.
So his total tax bill will be £852,882, interest payable will be £88,615 his penalty will be £73,330 (he won’t pay a penalty on his tax bill for 2015) and of his £2,923,076 he will have left £1,908,249.
If, on the other hand, Mr X complies with the law and pays his taxes he will have:
At the end of 2009 £1,650,000
At the end of 2010 (£1,650,000 x 110% – (28% of £1,000,000) – (45% of £150,000)) £1,467,500
At the end of 2011 (£1,467,500 x 110% – (45% of £165,000)) £1,540,000
At the end of 2012 (£1,540,000 X 110% – (45% of £146,750)) £1,627,963
At the end of 2013 (£1,627,963 x 110% – (45% of £154,000)) £1,721,459
At the end of 2014 (£1,721,459 x 110% – (45% of £162,796)) £1,820,347
At the end of 2015 (£1,820,347 x 110% – (45% of £172,146) £1,924,916
Plus he will have a tax bill for his interest in 2015 of (45% of £182,038) of £81,917 leaving him with cash of £1,842,945 (more than £65,000 worse off).
The critical point to note is that, in every year Mr X earns a return of higher than the rate at which HMRC charges interest on unpaid taxes, he is eating into the effect of the 10% penalty. And the longer the period over which he beats that 3% the easier it is to overcome the effects of the penalty. Putting the matter another way, the 10% penalty regime benefits successful long term and punishes unsuccessful short term evaders.
Follow me @jolyonmaugham