Avoidance Of Doubt

Tax avoidance looks like being a hot topic in the upcoming election campaign, with the parties all squabbling (somewhat hypocritically in some cases - Messrs Cameron and Hodge, I'm looking at you here) over the moral high ground to condemn it as a "bad thing".

What might help the debate of course is if some of them understood what it was.

I think we're pretty much all agreed that tax evasion (basically, lying outright to reduce your tax liabilities by hiding income for example) is naughty. It's an offence that you're likely to end up in court for and potentially get a custodial sentence.

Tax avoidance however, is much trickier to define. In its simplest form, it's doing something in a particular way so you pay less tax than you would have done if you had structured it differently. It is planning your tax affairs so more money ends up in your pocket and less in the taxman's. So why has it got such a bad name, given it seems to be just simple common sense? After all, none of us wants to pay more tax than we have to, do we?

The current journey for the Outrage Express seems to have started with the multinationals like Google, Amazon and Starbucks. As is common with the majority of companies, they want to get as much profit as possible so they can pay it to their shareholders. One way to do that is to base yourself somewhere that has a low rate of Corporation Tax. Less tax paid means more money to distribute to your investors.

However, if a company has a permanent establishment in the UK such as Starbucks does, then in short it pays tax in the UK on the profits it makes in the UK. Not a good thing, if the rates of tax here are higher than where your parent company is based. So many companies employ what is known as transfer pricing.

This is where one arm of the company (e.g. Starbucks UK) will buy goods or services from another arm elsewhere (say Starbucks US). The more Starbucks UK pays for these things it buys, the lower the profit it makes and the company it buys it from (usually in a territory with a lower tax rate) makes a higher profit but pays less tax on it.

Transfer pricing is not new. It's been around as long as there have been multinationals. It's also covered by a pretty complex set of rules, and HMRC have a dedicated unit set up to inspect and police transfer pricing transactions. As long as the price Starbucks UK is paying is reasonable however, there's sod all they can do about it. Starbucks UK reduces its profits and pays less UK tax, with that tax being paid elsewhere within the worldwide group instead.

It may not be "fair". It may well be avoidance, but under existing UK and international law it is not illegal.

Neither, for that matter, is going to live somewhere with a lower income tax rate than the UK so you pay less tax on your UK income. Countries have what are known as Double Taxation Agreements which determine who gets first crack at taxing what income, based on where you live. The principle is that nobody should be taxed twice on the same income in different countries, which I think we can all agree is a pretty fair system.

So there will be occasions where someone receives significant income from a UK company but because they are not living in the UK themselves they pay very little UK tax on it. That money will be taxed elsewhere. Again, this may not seem "fair". It may well be avoidance, but under existing UK and international law it is not illegal to arrange your affairs in such a way so you pay less tax.

"What about us poor saps that don't have the money to pay fancy accountants and avoid tax?", I hear you cry. "Why should the super-rich be the ones who get to benefit while we're getting screwed to the floor by HMRC?"

Well for a start, tax avoidance is not purely the playground of the super-rich. Not by any stretch of the imagination.

Do you know someone who runs their business through a limited company, and pays themselves a small salary but then tops it up with dividends out of the profits? They're structuring their affairs in a way that minimises their tax liability. In the broadest definition of the term, they're avoiding tax. 

Ironically, I bet a large number of the MPs and journalists reminding us what a bad thing tax avoidance is have their freelance work go through a personal service company like this.

Do you put your savings in an ISA, rather than in an ordinary bank or building society savings account? You're structuring your affairs in a way that minimises your tax liability. In the broadest definition of the term, you are avoiding tax. 

Have you ever paid a tradesperson in cash, so they don't have to charge you VAT? By the broadest definition of the term, you're complicit in tax evasion - something the likes of Starbucks, Google and Amazon aren't even so low as to stoop to.

A lot is going to be said about tax avoidance over the coming months, much of it clouded in a fog of apoplexy and social responsibility. Before falling for it hook, line and sinking tax liabilities, it might be worth considering what the term actually means and who participates in it.