Smoke and mirrors: a taxpayer's guide
Willem Buiter's blog of 26 March elegantly makes the case that beyond the usual cock-up explanation of the financial collapse - mistakes on all sides, misunderstanding, singular stupidity, inertia that was practically comatose - there is increasing evidence that downright wrongdoing played a significant role. The charge sheet runs from carelessness through negligence, to immorality and gross fraud. Prof. Buiter sets out three examples:
1. UBS will pay $780m and hand over details of many of its US customers to the US government in a deal to avoid being arraigned for conspiring to defraud the IRS of taxes. The bank admits helping thousands of clients evade taxes and indeed it marketed its services for precisely this purpose. Prof. Buiter believes any bank that promotes tax evasion should be shut down and its executives sent to the salt mines.
2. Bernie Madoff ran a $50bn Ponzi scheme in the heart of Wall Street. Whilst there is currently no evidence of a wider conspiracy, he finds it hard to believe that nobody at all colluded in this fraud.
3. Barclays Bank have taken £7bn of new capital from Middle Eastern funds at a price higher than that offered by the UK government. It is preparing to sell its successful iShares business in order to raise cash to pay the premiums for the UK's Asset Protection Scheme. This is not obviously in the shareholders' best interests. Barclays also recently obtained a court order to ban the publication in the UK of documents describing the banking group's tax avoidance schemes. He suspects Barclays are concerned lest the government probe into their highly complex structure and accounting and raise questions about both their balance sheet and their tax status. Whether this is true or not, it is clear that Barclays' tax advice business is extremely lucrative.
Prof. Buiter goes on to say that bank insiders have too often exploited their monopoly of information to gorge themselves at their shareholders' expense and, now that the shareholders have been sucked dry, have sunk their teeth into the still succulent taxpayer. He is frustrated and puzzled at the absence of civil or criminal action against bank board members, whether from shareholders, regulators, or governments.
I have great sympathy with Prof. Buiter's view that much of the behaviour we have too often er... not witnessed, is plainly immoral. The huge resources deployed to massage books and organise tax affairs are also fundamentally unproductive, since they largely end up as non-consumed assets of the already wealthy, earning or declaring a financial return but unlikely to enter the real economy. And it is indeed mystifying that no boards have yet been sued. On the contrary, some boards have complained when the UK Treasury decided not to bail out their losses.
And yet.... The famous judgment of Lord Tomlin from 1936 was that "Every man is entitled if he can to order his affairs so that the tax attaching under the appropriate acts is less than it otherwise would be." In short, legal tax avoidance is one of the fundamental tests of British-ness (Gordon Brown, take note). Of course, other countries enjoy this pastime too. Importantly, the judgment also means that the rule of law should apply in the determination of a subject's tax affairs, just as it should in other cases. It is therefore not in itself wrong that banks or others should employ brainy people to work out what is possible under highly complex and sometimes inconsistent rules. We should not allow outrage to trump due process.
With increasing sophistication and internationalisation of business, Tomlin's principle has been softened over the years. HMRC (the UK's tax office) now expects to look through transactions to the commercial reality. Those whose sole purpose is the avoidance of tax may be set aside. Transactions have to be at proper arm's length prices. Sometimes this leaves the taxpayer haggling with HMRC instead of working out a liability according to clear rules. All very Pythonesque when you'd rather be away managing your business.
But this hasn't caught the big fish and probably never will. Global finance and the super-rich will beat the tax offices because they can always muster larger, better equipped forces and design cleverer structures that will outlast any tax office's capacity to investigate. Corporations have the wonderful additional excuse of "We can't tell you about this transaction because it's commercially sensitive." Too right.
The pervasiveness of bad faith (that is, mere) tax avoidance is behind the emphatic calls from President Sarkozy and Chancellor Merkel for firm, immediate action against tax havens. "We must end this immoral system," said Sarkozy. But it will be hard to agree on the blacklist, let alone take action. China, interested in the status of Hong Kong, Singapore, and Macao, objected immediately. Within only the EU, Britain (with the Channel Islands, Isle of Man and many remoter dependencies), Ireland (with the Dublin IFSC), and Luxembourg (the whole country) will be concerned. The very pervasiveness of tax dodging will make it extremely hard to do anything.
Tax is like a parking ticket: something it's socially normal to play a game over and try to avoid paying. This is a deeply ingrained view, reinforced by the ridiculous complexity of tax systems. The extreme reluctance of politicians to discuss general tax rises, and the constant "what's in it for me" approach to tax announcements show how weak the social solidarity argument for tax-paying has become. This in turn links back to Prof. Buiter's recently expressed concern that the politics in the UK and the US mean we cannot assume today's fiscal stimuli will be paid for out of future taxation.
I doubt anything can be done about our obsession with avoiding tax. Beefing up the taxing authorities is an arms race that can never be won, though there may be value in recruiting a couple of hundred serious high fliers to deal with the biggest corporations and richest individuals. Long term, one might think about:
- increasing the discretion of taxing authorities (though that may only make the avoidance schemes more complicated and more international);
- enshrining a constitutional principle that every person shall be expected to pay a fair amount of tax;
- putting greater onus on auditors to flag up uncertainties within complex structures;
- making auditors officers of the state rather than of the client company;
- concentrating taxes on things that are less easily manipulated than numbers in company accounts, perhaps through wider VAT or property residence;
- radically simplifying tax systems and reducing the number of taxes and tax jurisdictions.
In the meantime, if you're a small fish and want to pay even less tax than Barclays, here are the basic rules:
1. Keep it complicated. Find ways to split and re-amalgamate money flows, use companies, friends and relations, mix up ownership of assets and income. This all wastes time and gives you opportunities to secrete funds and introduce unclarity. Unclarity is key to tax avoidance, because you then move from rule application to haggling. That's good for you.
2. Make it international. Some nice angles here. For example, if you marry a foreigner you trust you can use that person's domicile to good effect. Using several jurisdictions is an opportunity to learn about accounting and disclosure rules around the world. You can also read up on tax arbitrage, where the same expense can be claimed as a taxable deduction in more than country. This is also where transfer pricing - fixing the price of services one of your companies provides to another - to optimise your tax bills comes into its own.
3. Don't own or earn anything. You may need a lawyer or accountant to show you how to do this. A good method is to use intermediaries who have nothing to do with you. There's a Panamanian company whose directors are a couple of Swiss lawyers you've never met. They happen to send money to your Spanish spouse's company in Guernsey and switch investments just when you might have done, had they been your investments, which of course they aren't.
4. Pay cash. So much more confidential, and always impresses. I once worked on the audit of a thoroughly shady business whose chairman asked the taxman what the discount for cash was. Now that's cool.