Do you like paying tax? That’s a tough question. Some people see the value in paying their fair share of tax and some people despise having to do so. But what is the difference between tax evasion and tax avoidance?
The moral dilemma
The moral and political arguments surrounding how much tax an individual should pay could encompass more than one lively debate over a bottle of wine. Tax can be a taboo topic, especially if your own tax affairs are in the spotlight. In Norway, your annual tax returns are a matter of public record. Every November, the Finnish media publish the names of about 10,000 of the country’s biggest earners plus hundreds of celebrities and sports stars, making headlines with lists of the top 10 biggest taxpayers.
Let’s agree that people don’t trust politicians to spend tax money wisely, and politicians don’t trust people and corporations to pay the tax they owe.
But what about your average Joe and Jane? Could you find yourself on the wrong side of prison bars, or in a journalist’s crosshairs? Being judged either by the law courts or the court of public opinion is something most people would do anything to avoid.
The tax ladders
When it comes to your personal tax affairs, there are tax allowances, tax exemptions, as well as tax-free, tax-advantaged, tax efficient and tax-deferred options. There are quite a few planning options available, if you look hard enough.
The starting block is with NS&I. Premium Bond winnings are 100% tax-free.
On the next rung of the ladder is the ISA. An ISA is a tax-free investment option. No income tax on income or dividends, no capital gains tax (CGT) on any investment growth, and all proceeds and money taken out is 100% tax-free whatever your personal tax band.
Next comes pensions. Income tax relief when you contribute: tax-free growth while you save. Then up to 25% of your pension pot can be taken tax-free.
These are tax-free and tax-efficient savings vehicles, and it is difficult to see these being problematic. The government is trying to get people to save and make provision for their later life so that they will not have to fall back on state benefits.
The amount you can save each year via these two routes is restricted annually, and in the case of pensions there is a lifetime limit. These limits are policed very efficiently.
Moving up the ladder, there is the slightly greyer term of tax avoidance. This is the legal use of laws to reduce your tax burden. Using trusts, transferring assets to your spouse and, if you have your own company, paying yourself a dividend rather than a salary are all legitimate ways of avoiding tax. All taxpayers can reduce their personal tax burden using the legal options open to them.
Regarding more complex practices, two famous public cases that come to mind are Jimmy Carr and the members of Take That, who were found by HMRC and the courts to be using ‘aggressive’ tax avoidance schemes. The schemes they were using were not illegal, but HMRC did demand some payment of missing taxes as the schemes were “in violation of the spirit of the tax code.”
Jimmy Carr said that “the law should become clearer by eliminating any loopholes instead of leaving it up to people to decide what is morally right.” Does he have a point? Perhaps, although as fast as the government can legislate, accountants and lawyers design ever more inventive solutions.
David Cameron was one of Carr’s biggest critics saying, “Some of these schemes we have seen are, quite frankly, morally wrong.” Yet only four years later, he found himself being linked to the Panama Papers.
In David Cameron’s case, his father Ian was a client of the Panamanian law firm Mossack Fonseca and a director of an offshore trust. Mossack Fonseca set up offshore shell companies for clients so they could pay lower rates of corporation tax. This is because the country where the company is registered has a low (sometimes 0%) rate of corporation tax. These countries become known as tax havens. None of this is illegal, just frowned upon by some. Countries that are tax havens prefer the term offshore financial jurisdictions.
Out of interest, the Cayman Islands, Bermuda and the British Virgin Islands (BVI) are all British overseas territories.
Sunny places for shady people
We now come closer to the top of the ladder and onto tax evasion. Tax evasion is deliberately misrepresenting the true state of your affairs in order to pay less tax.
There are a lot of businesses that use shell companies and trusts in offshore financial jurisdictions. Because they often have higher levels of secrecy, these countries are also used for laundering the proceeds of drug dealing, human trafficking and the wealth of despots and dictators.
Vince Cable used the term “Sunny places for shady people.”
Not all tax havens are in sunny climes. Every country wants to collect their fair share of tax, but many countries are in on the ‘game’. If we consider that money laundering, and all the associated crimes that go along with it, could be tackled by being open and by sharing information, then the lack of information-sharing and secrecy is probably one of the worst parts of being considered a tax haven.
The USA is one of, if not the most aggressive country in the world when it comes to chasing down its citizens for tax. However, the Financial Secrecy Index puts the US second (after Switzerland) in terms of scale and secrecy. An interesting contradiction.
Most havens are signing up to a new information-sharing scheme for banking. But the USA is reluctant to join the club. The UK, if it were to be considered one group with its tax haven network of crown dependencies (including the Cayman Islands, BVI, Bermuda and Jersey), is potentially the largest tax haven in the world.
Most people are not murderers, drug dealers, multinational corporations or imposing sovereign states. If it’s not illegal, should you care what other people think? That opens a moral can of worms. Would people still drop litter if they knew their face would appear on the evening news for doing so? For most people the answer would be no, and thinking about how you feel about being “named and shamed” can help when making decisions about whether something is right or wrong.
What can you do to avoid being accused of being a hypocrite, or worse a tax evader? Keep it simple. You can often achieve what you need to with the help of a good financial planner and by using ISAs, pensions, investment accounts and investment bonds. As an extra boost you may require some straightforward trust planning to help look after your children and/or grandchildren. After that, you should have most of your needs met. If you need to go further, philanthropy is a good place to go; and then, perhaps, we’ve come full circle to simply paying tax.
In the case of some of the more elaborate schemes that have been challenged by HMRC, they’ve only been around for a few years so if someone’s trying to sell you a new, creative, exciting scheme, you may want to wait until it’s been proven.
If you’re not sure, ask HMRC for guidance. Secrecy and not sharing information are, as mentioned, a large part of the problem so if you have any questions be open and honest.
If you would like a second opinion on the tax-efficiency of your financial affairs, please contact us. One of our chartered financial planners will be happy to help.
At Capital we like the saying: “You must pay your taxes. But there’s no law that says you have to leave a tip.”