Anti-Avoidance Legislation in the United Kingdoms Taxation System - Case Study Example

Anti-Avoidance Legislations in the United Kingdom’s Taxation System Introduction Recently, the United Kingdom and other countries within the G20 unit sought to improve their individual and corporate tax regimes. Apparently, tax regimes used by the United Kingdom before 2005 were not only complex but also distorting to individuals and corporate entities. As a result of distortion and complexity within the tax system, cases of both involuntary and deliberate tax avoidance and tax evasion became rampant. Presently, the UK tax legislating body and the UK tax enforcement agency strives to create a level platform for individual and corporate tax payers. Apparently, the synergistic effect of tax evasion and tax avoidance is responsible for the widening tax gap. Technically, the substantial difference between actual tax collected and theoretical tax estimates raises concerns. For example, According to Griffith, Miller and O’Connell (2011), the UK tax gap in 2011 stood at £35 billion; approximately 4% of the UK’s GDP. Probably, UK tax systems contain undesirable characteristics which discourage both corporate and individual taxpayers from complying. Particularly, tax legislations and compliance enforcements may possess considerable loopholes that make it easy for taxpayers to either avoid or evade their tax responsibilities. In the United Kingdom, Her Majesty’s Revenues and Customs is the primary enforcer of tax legislations. Essentially, the HMRC is tasked to ensure that the right amount of tax is paid by taxpayers, and at the right time. In this context, the HMRC owes the British citizens the responsibility of tax administration. On the other hand, legislations pertaining to tax regulations are primarily conducted by the House of Commons. Presently, the members of House of Commons are known to make tax policies that are closely aligned with current business practices, and income trends. Caldwell (2008) mentioned that in an effort to minimize distortions and complexity of tax systems, the legislative assembly engages in thorough consultation with taxpayers prior to enactment of legislations. Apparently, reforms in tax legislations are least in areas where tax avoidance and tax legislations are uncommon. Contrarily, legislative reforms are common in fields where avoidance and evasion of tax responsibilities are commonly reported. According to Hasseldine and Holland (2011), the main purposes of anti-avoidance legislations in the UK today include but not limited to improving the taxpayers’ experience and willingness, enhancing cost management, and facilitating prevalence of professionalism and integrity in UK tax systems. Examples of Anti-Avoidance Legislations Based on empirical findings, the level and magnitude of tax compliance in the United Kingdom depend on influential parameters like social norms, personal ethics, fairness, and legal deterrence. Apparently, income tax is the leading source of revenue to the UK’s taxation agency; HMRC. Another main source of revenue to the UK government is corporate tax. According to a report by House of Commons (2011), income and corporate taxes make up approximately 58% of the government’s annual total revenue. In the past, evasion and avoidance of income tax responsibilities were common. In an effort to enhance attractiveness and fairness of tax regimes, the House of Commons together with the HMRC enacted and enforced legislations that provided for certain personal allowances and reliefs for income tax. For example, tax reliefs were extended for payment of interests on loans. Commonly, one aggressive tax avoidance strategy employed by income tax payers is taking of direct loans from their employers. Technically, companies are allowed to lend money to employees. However, income generated by the employees enjoys tax relief from HMRC because the loaned employees are already pay interests to employers on their borrowings. In an effort to curb this aggressive tax avoidance practice, the legislative assembly asserted that tax reliefs are valid only if the loans were taken for the following purposes; partnership investments, co-operative investments, purchase on shares on any UK resident company, and purchase of plant and machinery. Combs, Dixon and Rowes (2014) added that by 2013, any personal loans from employers taken for purpose other than the four mentioned above were not extended relief claims. Besides the anti-avoidance legislation on income tax reliefs, the UK’s legislative assembly also seeks to curb tax irresponsibility within the corporate sector. In an effort to increase profitability, corporate entities are notoriously known to engage in tax evasion and avoidance practices. According to Hasseldine and Holland (2011), corporate tax avoidance and evasive practices are invariably influenced by an organization’s ethical disposition, motivational postures adopted by both the taxation environment and then revenue authority, and deterrent provisions within applicable anti-avoidance acts. Currently, corporate entities are increasingly hiring specialist tax lawyers and financial advisers. Hiring of professional tax specialists is primarily meant to increase the corporate tax avoidance powers. During implementation of previous tax legislations, HMRC noted that strict application of deterrent provisions reduced economic suitability of the United Kingdom for domestic and foreign corporate investors. In response, an anti-avoidance legislation widely adopted within the UK’s corporate taxation sector is the patent box regime. A report by House of Commons (2011) indicated that a tax rate of 16% was charged for corporate income generated from patents. After the corporate tax anti-avoidance legislations of 2009, HMRC reduced tax rates of income from patents to 10%. In addition, substantial tax reliefs were extended to expenditures within the research and development departments. Technically, the patent box regime is meant to increase favorability of tax legislations in the UK. Expectedly, increase in favorability of tax legislations will serve the purpose of improving the motivational postures of UK’s taxation field, thus enhancing corresponding improvement in ethical dispositions demonstrated by corporate taxpayers. Pros and Cons of the Anti-Avoidance Legislations Income Tax Legislations Within the income tax sector, an influential characteristic of a tax system is vertical equity. Vertical equity entails measurement and determination of who pays tax at what rate. For example, personal allowances in previous anti-avoidance legislations applied for persons with incomes below £600. With respect to the new anti-avoidance legislations, personal allowances apply for persons earning below £10600. In addition, exemption of tax responsibilities for persons with loan repayments is an element of horizontal equity which serves the purpose of stimulating desirability of the UK’s income tax regime. As aforementioned, compliance of tax regulations by individuals depends on personal ethics, and social norms. According to Caldwell (2008), individuals’ willingness to honor tax responsibilities and obligations is significantly influenced by the equity aspect, particularly vertical and horizontal equity in tax systems. Technically, increasing the personal allowance level eliminates the need for tax avoidance practices. In addition, exemption from tax liabilities for specific loans discourages tax avoidance. In this context, the favorable anti-avoidance legislations prevent tax avoidance practices, thus saves the regulatory agency time and money that would have been otherwise be used in enforcement of non-compliance violations. Unfortunately, the anti-avoidance legislations on income tax are not without shortcomings. Primarily, it was thought that complex and tight tax legislations exacerbated tax avoidance and evasion practices. According to Gracia and Oats (2012), the low personal allowance level adopted in previous legislations discouraged the honoring of taxpayer’s fiscal obligations. In addition, reliefs on loan repayments featured as an effective legislation stimulating factor for compliance. However, avoidance and evasive practices increased despite presence of such lenient relief legislations on loan repaying taxpayers. In addition, increase of minimum taxable personal allowances increased the tax avoidance power of individual taxpayers. Griffith, Miller and O’Connell (2011) mentioned that the increase in threshold of taxable income from £600 to £10600 reduced the number of taxable income earners by 430,000. Instead of clamping down on avoidance of income tax, the new regulations reduced the number of taxable Britons. Worse still, the remaining population of taxable income earners continued to exploit tax avoidance avenues, especially the relief on loan repayments option. Eventually, the anti-avoidance legislations within the income tax sector increased favorability of the tax system, but reduced revenues generated from income tax. Corporate Tax Legislations As predicted by empirical findings, the British patent box regime of 2009 would incentivize continued proliferation of patents within the United Kingdom. Admittedly, the most profitable corporate entities in the United Kingdom derive substantial portions of their income from patented operations. According to Murphy and Palin (2013), a tax reduction to 10% on income from patented operations not only encourage tax compliance, but also attract additional foreign corporations into the UK’s commercial environment. Probably, companies that would benefit from the patent box tax regime legislation include entities within the medical field, information and technology corporations, and research and development firms. Hill and Sims (2013) mentioned that based on relevant statistics, the average tax rate for patented incomes adopted by most European nations remained at approximately 15%. In this context, the United Kingdom feature as one of the European nations with lowest tax rates for income from patented operations. Undeniably, this tax incentive for patented operations not only protects new innovations, but also raises entry barriers for generic companies. In this case, the patent box regime will make the United Kingdom a preferable environment and destination for patent-driven corporations. In the presence of such incentives, tax avoidance and evasion within the corporate tax sector will diminish. According to Hill and Sims (2013), the low taxation rate contained within the patent box regime makes UK’s taxation field more favorable and competitive in comparison to other Western countries. Despite increasing the economic competitiveness of United Kingdom, the anti-avoidance legislation on patent box regime is only suitable for patent-rich businesses. According to Hill and Sims (2013), the British corporate tax environment will have to create and sustain other tax regimes that would prevent overseas immigration of patent and intellectual property companies. Undeniably, legislations pertaining to more tax reductions and incentives on intellectual property corporations will increase the already widening tax gap. Currently, other European nations like Luxembourg and Belgium offer tax legislations that enhance development and use of not only patents but also copyrights in business. For example, patent box regime in Luxembourg applies for additional non-patented properties like trademarks, internet domains and artistic copyrights. Murphy and Palin (2013) mentioned that the UK patent box regime applies to research and development projects and patented incomes only. In this case, competitiveness of countries like Luxembourg is enhanced by inclusion of non-patented intellectual properties in the patent box regime. Undeniably, the UK’s patent box regime is an anti-avoidance legislation aimed towards the right direction. However, patented operations thrive from cumulative efforts of other patents and intellectual properties. In this case, it would be difficult to gauge the actual magnitude of incomes attributable to primary patented operations. In addition, incentives offered in other European nations will eventually erode the competitive advantage ushered in by the British patent box regime. Case Example: HSBC Tax Scandal Apparently, tax avoidance and evasion practices are not theoretical concepts confined to finance and accounting classrooms, but happen in actual commercial environments. In 2010, the world’s second largest bank HSBC Holdings was engaged in a major tax evasion scandal in the history of UK’s banking system. Based on facts surrounding the HSBC case, the London based bank helped approximately 100,000 clients to evade taxes in their respective countries. At the center of the controversy are the British government, and the revenue agent HMRC. Kinston and Roberts (2015) mentioned that allegedly, the HSBC chairmanship, the British government, and the British revenue agency colluded to assist rich clients in evading taxes. The worst part of the scandal is that the British Prime Minister David Cameroon had appointed the former HSBC executive director Mr. Green to become a trade minister in his government. In addition, Her Majesty’s Revenue and Customs conducted a thorough investigation into the HSBC scandal, but failed to provide a conclusive report about the tax evasion claims. Apparently, the British tax authority did not detect any violation of anti-avoidance legislations by the giant financial institution. Kinston and Roberts (2015) agreed that were it not for the combined efforts of French and United States tax authorities, the HSBC scandal would have gone unnoticed or unmentioned by the UK tax authorities. At this juncture, one can as; why were the grave violations of UK’s anti-avoidance legislations by HSBC unnoticed or unreported by the HM Revenues and Customs? Understandably, the goal of most individual and corporate taxpayers is to minimize their tax liability burdens. In an effort to minimize their burdens, these taxpayers will exhaustively exploit every loophole within a taxation system. Undeniably, the UK’s taxation system, especially its anti-avoidance legislations are not without loopholes. In their book, Lymer and Oats (2014) insinuated that the boundaries of tax compliance regulations used by the HM Revenues and Customs were not solidly demarcated. Primarily, the UK’s legislative assembly, together with the nation’s revenues enforcement agency HMRC used tax regulations that were clear, friendly, impartial, and honest towards taxpayers. For example, the British taxation system asserts that in the investments of trusts and insurance schemes, income withdrawals should be made under the category of dividends and not under salaries. In an effort to hide the nature of their incomes, most clients of HSBC hired professional financial advisers and lawyers in planning and exploiting loopholes through the use of trusts and insurance schemes. Kinston and Roberts (2015) mentioned that under the UK tax legislations; income from dividends is highly taxed compared to salaries. However, the tax system provides no anti-avoidance policies on the use of salaries instead of dividends during income withdrawals. Consequently, clients of HSBC who received high income in form of dividends avoided their tax responsibilities by reaping big through tax breaks reserved for salaries. In an effort to maintain favorability and fairness within its tax system, the UK’s HM Revenues and Customs relied on the consensual understanding and genuine goodwill of its taxpayers in ensuring compliance with tax regulations and anti-avoidance legislations. Eventually, HMRC unknowingly perpetrated the planning and execution of tax evasion practices by HSBC through income splitting strategies. Possible Solutions Admittedly, formulation of anti-avoidance legislations is a tricky business, especially when a nation is committed to creating and maintaining a fair tax system. In an effort to facilitate clarity and honesty of tax legislations, certain regulatory boundaries may be left with loopholes. In addition emergence of popular tax evasion practices like income splitting between dividends and salaries increase the culpability of honest and innocent tax systems like the UK’s HM Revenues and Customs. Apparently formulation of anti-avoidance legislations by the UK government relied on widely held interpretations of tax regulations. According to Combs, Dixon and Rowes (2014), the legislative assembly, in good faith, either ignored or dismissed the alternatives associated with imprecisely defined tax laws. In this case, legislative practices should be conducted in a manner likely to eliminate unnecessary indeterminacy of tax regulations. Typically, dishonest taxpayers will always dig for and exploit deeply situated loopholes within a nation’s tax system. Phyllis (2013) agreed that during legislation, simulated deliberations on possible transgression alternatives of tax rules should be considered, and appropriate compliance mechanisms enacted to deter selection of such alternatives by taxpayers. Reference List Caldwell, B. T. (2008) Taxation and Legislations: 21st Century Issues and Challenges. Cardiff: Nova Publishers. Combs, A, Dixon, S, & Rowes, P. (2014) Taxation: Incorporating the 2013 Finance Act. London: Rutledge. Gracia, L. & Oats, L. (2012) Boundary Work and Tax regulation: A Bourdieusian View. Accounting, Organizations and Society Review 37, 304-321. Griffith, R. Miller, H. & O’Connell, M. (2010) Corporate Taxes and Intellectual Property: Simulating the Effect of Patent Boxes. Journal of Economic & Social Research 41 (2), 59-72. Hasseldine, J. & Holland, K. (2011) Market for Corporate Tax Knowledge. Critical Perspectives on Accounting Review 22, 39-52. Hill, W. & Sims, R. (2013) Opening Pandora’s Patent Box: Global Intellectual Property Tax Incentives and their Implications. Intellectual Property Law Review 53 (3), 371-404. House of Commons. (2011) Principles of Tax Policy: Eight Report of Session 2010-11 – Report, together with Formal Minutes, Oral and Written Evidence. London: The Stationery Office. Kinston, D. & Roberts, R. (2015) The Lion Wakes: A Modern History of HSBC. New York: Profile Books Publishing. Lymer, A. & Oats, L. (2014) Taxation: Policy and Practice. London: Fiscal Publications. Murphy, D. & Palin, R. (2013) Tax Heavens: How Globalization really Works. Pittsburg: John Wiley & Sons Publishing. Phyllis, L. L. (2013) Tax Avoidance and Anti-Avoidance Measures in the United Kingdom. London: Greenwood Publishing Group. Read More