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  • Carried interest – the £600m loophole that doesn’t actually exist

    Carried interest – the £600m loophole that doesn’t actually exist

    Private equity fund managers pay only 28% tax on their income – the “carried interest loophole”. This wasn’t created by legislation, but by an impressive piece of lobbying in 1987 which resulted in an agreement between the industry and HMRC. A new analysis shows that the 1987 agreement is unlawful; there is no loophole, and the correct legal position is that most fund managers should pay tax at the full marginal rate of 47%. An interest group could start judicial review proceedings to require HMRC to apply the law correctly. But it would be much better for the Government to clarify the law.

    The new analysis is in a peer-reviewed paper authored by Dan Neidle and published in the British Tax Review, the leading academic journal for UK tax analysis. The FT is carrying the story here, with comments from HMRC and other tax experts.

    UPDATE: There is now a short response from Macfarlanes, who currently chair the private equity industry’s tax committee. The response neatly illustrates the problem the industry has: it correctly notes that trading is a difficult grey area (the correct technical position), but then jumps a few paragraphs later to absolute certainty (unsupportable as a technical matter). I responded in slightly more detail here.

    What is carried interest?

    Instead of receiving a salary, profit share, bonus, etc, private equity executives take a stake in the funds that they manage – called “carried interest“. It’s an unusual kind of stake, because they pay almost nothing for it. The private fund will then typically acquire a mature business, and aim to make it more efficient and then sell it at a profit. If that succeeds, then the carried interest can become incredibly valuable, with the management team receiving 20% of the profit. As the profits are often very large, and the team is pretty small, carried interest can make you seriously wealthy. At least £3.4bn of carried interest was shared between about 2,000 people in 2021/22 – and the true figure is likely significantly more.

    What’s the loophole?

    When I was an overpaid lawyer, I paid 47% on most of my income. Overpaid bankers pay about 53%. But overpaid private equity fund managers only pay 28%. One of the pioneers of the UK private equity industry famously said that he paid less tax than his cleaning lady.

    Why? Because the private equity industry claims that carried interest in a typical private equity fund is taxed as capital, not as income. And whilst income is taxed at a marginal rate of 47%, capital gains are taxed at only 28%.

    The loophole is worth around £600m a year to private equity fund managers.

    Why would Parliament create such a loophole?

    It didn’t.

    Most loopholes are created when Parliament accidentally leaves a small chink in tax legislation that a careful taxpayer can carefully squeeze through. This one is different – it was created by an impressive lobbying effort by the private equity industry back in 1987. The industry said that if it didn’t get the low tax result it wanted, then it would move offshore. And the Government blinked.

    The FT published an illuminating history of the background to these discussions; you’ll see that it’s heavy on policy justifications, and light on technical tax justifications.

    As a result, the Inland Revenue agreed a statement with the British Venture Capital Association saying that typical private equity funds were not “trading” for tax purposes, with the consequence being that carried interest was taxed as capital. Since then, the Inland Revenue has faithfully followed the BVCA statement, and private equity funds rely on it as a matter of course.

    People often call it the “carried interest loophole”.

    Is the loophole good tax policy?

    Over the last few years there have been many proposals to scrap this favoured treatment of carried interest, and it seems this is now Labour Party policy. The debate is somewhat predictable: campaigners say the loophole is unfair; the industry says that if they have to pay tax at the same rate as everyone else, they’ll fly off to Zurich.

    I confess I don’t find the debate over whether the loophole should exist very interesting. So I’ve been wondering about a different question. Things have moved on since 1987, and these days HMRC can’t give certain taxpayers special favours – it has to follow the law. And, if you follow the law, and ignore the 1987 agreement, does the carried interest loophole actually exist?

    My view is that it does not.

    Why doesn’t the loophole exist?

    Because, on a proper analysis, the way most private equity funds work means that they are probably “trading” for tax purposes, and so carried interest cannot be “capital”. The premise of the 1987 BVCA statement is incorrect.

    The analysis in the BTR paper is somewhat detailed, but essentially it’s that investment is a passive activity – a mutual fund which buys a portfolio of stocks/shares is investing. A classic venture capital fund is also likely to be investing. But most UK private equity isn’t venture capital – most funds are “leveraged buyout funds”. Their typical activity is buying an entire business in a complex M&A process, actively managing it to maximise its value, and then selling it a few years later (in another complex M&A process). Then doing this again and again. In my view that course of activity is likely trading.

    There’s much more detail on the argument in the paper, linked above. It’s important to note that I’m not saying all private equity funds are definitely trading; I’m saying that most classic LBO funds are probably trading, and therefore that HMRC should be investigating each one on a case-by-case basis before accepting that carried interest is taxed as capital.

    This is not a very radical conclusion. One of the oddities of the tax world is that, whilst the private equity world operates on the assumption none of its funds are trading, in other contexts tax lawyers take a much more cautious view of what “trading” means.

    And it’s not just my view – it’s also the view of most (but not all) of the other tax experts I spoke to when writing the paper (and has support from the prominent tax specialists the FT spoke to in this article). And the paper passed peer review by two (anonymous) tax experts, including a leading tax KC.

    What does that mean for HMRC?

    HMRC appears to regard itself as bound by the 1987 BVCA statement. But the courts have repeatedly held that, whilst HMRC has some discretion in how it applies the law, it cannot depart from the law. It is not able to treat carried interest as capital if it is not in fact capital.

    So what HMRC should be doing is individually assessing whether each private equity fund is trading and, if it is, taxing the “carried interest” at 47%.

    What happens next?

    There are three ways this plays out:

    1. Everyone carries on as before, and we all pretend that private equity funds aren’t trading.
    2. Someone judicially reviews HMRC to require it to follow the law. I explain in the paper why in my view such a judicial review would have good prospects for success. I understand it’s now quite likely this will happen.
    3. The Government decides that a major industry can’t operate under such tax uncertainty, and legislates to either clearly tax carried interest as capital, or clearly tax it as income.

    The sensible outcome is option 3. We shouldn’t be taxed on the basis of lobbying and concessions, and tax policy shouldn’t be driven by litigation. The Government should act.

    Footnotes

    1. Carried Too Far? [2023] B.T.R., No. 1, © 2023 Dan Neidle and Thomson Reuters, trading as Sweet & Maxwell, 5 Canada Square, Canary Wharf, London, E14 5AQ – the article is also on Westlaw here if you have a subscription ↩︎

    2. Full disclosure: I was a tax lawyer for 25 years, frequently advising on the question of whether an entity was carrying on a trade or investing; but I never advised a client on the availability of capital treatment for carried interest. As with everything I write, this article and the BTR article include no client-confidential information. ↩︎

    3. It’s sometimes said that the private equity executives pay the same price for their carried interest as outside investors, but the key difference is that they don’t have to commit any subsequent funding. That makes a huge difference in practice. See, for example, the example in paragraph 7.2 of this document. where outside investors commit £100m to a fund, but the investment managers pay just £10,000 for their carried interest, which could eventually give them 20% of the fund returns. That’s usually justified on the basis that the carried interest starts out as pure “hope value”. But one thing’s for sure – if I offered £11,000 for the carried interest they wouldn’t give it to me. It is inextricably linked to the labour of the private equity managers – which is another reason why the status quo is so anomalous. ↩︎

    4. That’s because many private equity managers are non-doms, and one of the effects of the BVCA statement is that there’s no UK trade, and so (to the extent their management activity is conducted outside the UK), they can hold their carried interest offshore and not be taxed on it. There are no stats on non-dom gains. ↩︎

    5. because they are employees, with their earnings subject to employer’s national insurance, the burden of which falls on employees in the long term ↩︎

    6. A pedant would say that, unless she was very well remunerated, his cleaning lady paid tax at the basic rate of 20%. However, Ferguson was writing at a time when standard private equity structuring (the “base cost shift”) meant that in practice fund managers enjoyed an effective CGT rate in the single digits. That game was ended in 2015. ↩︎

    7. Normal capital gains are taxed at 20%, but ever since 2015, carried interest has been taxed at the special rate of 28% ↩︎

    8. You can argue whether it is truly a “loophole”, but “carried interest loophole” is a common term and I’m using it for clarity ↩︎

    9. The source for the £600m figure is this FOIA, which shows £3.4bn of gains in the most recent tax year. The difference between CGT and income tax/NI on £3.4bn is £600m. Determining the actual revenue that would be raised if the loophole disappeared is complicated. This is a “static” figure, and would be reduced if private equity managers responded by leaving the UK. On the other hand, there could be additional revenue from the loss of the remittance basis for non-dom fund managers (as their carried interest would be income from a UK trade and hence UK situs) ↩︎

    10. People usually cite the 2003 Wilkinson case as authority for this proposition, but the Al Fayed case from 2004 is much more entertaining. ↩︎

    11. The uncertainty goes to more than the treatment of carried interest – if UK-managed private equity funds are trading then that could adversely affect their investors too. In some rare cases their foreign investors could become subject to UK tax on their profits (if the investment management exemption or treaty exemptions don’t apply). In other cases UK institutional investors could have a bad tax outcome, e.g. pension funds’ usual tax exemption might not apply. The position for this result risks damaging the UK private equity industry and so, however the Government decides carried interest should be taxed, any legislation should explicitly protect the position of investors (including, in my view, investment management executives who acquire “normal” interests in the fund, as opposed to carried interest). ↩︎

    Comment policy

    This website has benefited from some amazingly insightful comments, some of which have materially advanced our work. Comments are open, but we are really looking for comments which advance the debate – e.g. by specific criticisms, additions, or comments on the article (particularly technical tax comments, or comments from people with practical experience in the area).

    It would be great to have comments on the technical points here, and not on the different question of how carried interest *should* be taxed as a policy matter.

  • Penalising the poor: HMRC charged 400,000 with penalties when they had no tax to pay

    Penalising the poor: HMRC charged 400,000 with penalties when they had no tax to pay

    This is now out of date. Our more recent report is here.

    Between 2018 and 2020, almost 400,000 people earning less than £13,000 received a penalty for not filing a tax return on time. Very few of them had any tax to pay (the tax-free personal allowance was around £12,000). But, by failing to submit a tax return, they were fined at least £100, and often thousands of pounds. For most of those affected, the penalty represents more than half their weekly income.

    This paper illustrates the scale of the problem. We believe the law and HMRC practice should change, and we make three key recommendations.

    UPDATED with some of the personal stories people sent us. You can submit your own story here.

    The full report is here in PDF form. A web version follows below. The original FOIA is here and the spreadsheet with the full data is here. .The BBC’s original report is here, and the new report from The Sun is here. And the first comment below this article is extremely well-informed, written by someone who I know has huge personal experience advising in this area.

    Background

    Self assessment

    Most people in the UK aren’t required to submit a tax return – where a person’s only income is employment income and a modest amount of bank interest, then in most cases a tax return isn’t required.

    For this reason, out of the 32 million individual taxpayers[1] in the UK, around a third (12 million people) are required to submit a “self assessment” income tax return[2].

    Tax returns must be filed online by 31 January, or three months earlier (31 October) for people submitting paper forms. 

    Penalties

    If HMRC has required a taxpayer to submit a tax return, but he or she misses the deadline (even by one day), then a £100 automatic late filing penalty is applied.

    After three months past the deadline, the penalty can start increasing by £10 each day. After six months, a flat £300 additional penalty can be applied, and after twelve months another £300. By that point, total penalties can be £1,600.[3] Those advising taxpayers on low income commonly see clients with over £1,000 of penalties (and sometimes thousands of pounds if multiple years are involved). Filing appeals for late payment penalties often makes up a significant amount of their work.

    Until 2011, a late filing penalty would be cancelled if, once a tax return was filed, there was no tax to pay. However now the penalty will remain even if it turns out the “taxpayer” has no taxable income, and no tax liability.

    Appeals

    Anyone receiving a late payment penalty who has a “reasonable excuse” for not paying can make an administrative appeal to HMRC, either using a form or an online service.[4] If HMRC agree, then the penalty will be “cancelled”. If HMRC don’t agree, then a judicial appeal can be made to the First Tier Tribunal, but this is very rare for late filing penalties. All the “appeals” discussed in this report are administrative form-based appeals.

    The data

    Data provided to Tax Policy Associates by HMRC under a Freedom of Information Act request clearly demonstrates that late filing penalties are being disproportionately levied on those on low incomes, most of whom in fact have no tax to pay.

    The chart below shows the percentage of taxpayers in each income decile who were charged a £100 fixed late filing penalty in 2018/19. The green bars show where penalties were assessed but successfully appealed. The red bars show where the penalty was charged.

    And this is the data for 2019/20, a less representative year:[5]

    The charts clearly show taxpayers in the lowest three income deciles receiving a disproportionate number of penalties – 210,000 in 2018/19 and (likely less representative) 167,000 in 2019/20.

    But the critical problem is that almost none of these taxpayers have any tax to pay.

    We know this for two reasons.

    First, the personal allowance was £11,850 in 2018/19 and £12,500 in 2019/20, and anyone earning less than that had no income tax liability. Taxpayers in the lowest three income deciles earn less than £13,000 – so very few will have tax to pay.

    Second, this is confirmed by the data on penalties issued for late payment (as opposed to late filing). The first three deciles pay almost no late payment penalties[6]. This won’t be because they are more punctual at paying than they are at filing; it will simply be because they almost always have no tax to pay.

    The impact of penalties on the poor

    A £100 fixed penalty is a large proportion of the weekly income of someone on a low income (indeed over 100% of the weekly income for someone in the lowest income decile), but inconsequential for someone on a high income:

    And, whilst the data shows the numbers of people receiving £100 fixed penalties for late filing, many of the same people will have received late filing penalties which are much higher – up to £1,600 for one year, and more than that where a taxpayer fails to file for more than one year.

    The human cost

    Since publishing our initial report, we’ve been inundated with people’s stories, often very distressing.

    These are vulnerable people, at a low point in their lives – and the same difficulties which meant they missed the filing deadline mean they often won’t lodge an appeal, and may take months before they pay the penalties (racking up additional penalties in the meantime).

    Here are a representative sample:

    Will the 2025 changes change the position?

    The income tax self assessment penalty rules will likely be changing from 6 April 2025.

    From that date, a one-off failure to file will not incur a penalty; rather it will result in a taxpayer incurring a “point”, and only after two points (for an annual filer) or four points (for a quarterly filer) will a penalty be issued. [7]

    At the same time, the fixed penalty amount will increase to £200.

    This might overall reduce the penalties imposed on low earning taxpayers (for example if they are currently missing the filing deadline by a few weeks, and then filing), but it could equally well worsen the position (if they are missing multiple deadlines, and particularly if they don’t open correspondence). At this point we have insufficient data to say. However we can say that insufficient consideration appears to have been given to the impact on the low paid when the new rules were drawn up.

    Conclusions

    We believe that the Government, HM Treasury and HMRC are acting in good faith, and have to date been unaware of the disproportionate impact that penalties have on the low paid.

    In light of the data revealed by this report, we have three recommendations:

    1. Cancellation

    Fixed rate late submission penalties should be automatically cancelled (and, if paid, refunded) if HMRC later determines that a taxpayer has no taxable income. Most likely that would be after a subsequent submission of a self assessment form; but no further application or appeal should be required.

    Similarly, there should be an automatic abatement of penalties (by, say, 50%) if HMRC determines that a taxpayer has a taxable income but it is low (for example less than £15,000).

    In both cases, an exception could be made where HMRC can demonstrate that the failure to file was intentional (i.e. for truly exceptional cases, and not applied by an automated process).

    Whilst it is possible that some cancellations could be achieved under HMRC’s existing “care and management” powers , we expect that creating a general cancellation and abatement rule falls outside those powers, and therefore may require a change of law.

    This is not a radical proposal; before 2009 penalties were automatically capped at the amount of a taxpayer’s tax liability. UPDATE: It’s well worth reading the first comment below, from the respected retired tribunal judge Richard Thomas, for more background on this.

    2. Monitoring

    HMRC should start monitoring late submission penalties across income deciles, (using other sources of data, i.e. not limited to those provided to us) to provide a more complete picture of the impact on the low paid, including the level of penalties paid (i.e. not just the data on £100 penalties presented in this report).

    And how many penalties are never paid by these deciles and get written off? We expect a fairly high proportion – in which case all that is being achieved is stress for the recipients of the penalties, and administrative cost for HMRC.

    Armed with that data, HMRC should aim to reduce the disparities identified in this report, and report annually on its progress.

    3. Rework processes

    The data reveals that there is a significant population of self assessment “taxpayers” who are being required to complete an income tax self assessment, are charged a late submission penalty, but turn out to have no tax to pay.

    HMRC should analyse this population with a view to determining:

    • how many of these are taxpayers who in retrospect should not have been required to submit a self assessment return at all,
    • whether that could have been determined in advance, on the basis of the information HMRC possessed at the time,
    • if it could be determined in advance, what additional processes should be put in place by HMRC to prevent such taxpayers being required to submit a self assessment in the future, and
    • if there are small changes which could impact this population’s tax compliance, for example changing envelope labelling (although it may be this work has already been done)

    Methodology

    Source of data

    HMRC provided data to Tax Policy Associates following a Freedom of Information Act request.

    The data shows penalty statistics by income decile of self assessment taxpayers. In the years in question there were 11.3 million self assessment taxpayers, and therefore each decile represents 1.13 million people.

    Note that the income deciles are different from the usual national income deciles, as self assessment taxpayers have different (and, on average, lower) incomes than the population as a whole.

    Limitations

    The most important limitation is that, whilst we had asked for income level to be computed by reference to previous self assessments filed by taxpayers, HMRC’s systems were unable to do this (at least within the limited budget available for responding to FOIA requests).

    The data is therefore based upon the income level revealed when a taxpayer did eventually submit his or her return. That means, if a taxpayer did not submit a return at all for the relevant year, they do not appear in this data. In fact, the majority of taxpayers fall in this category – HMRC only has income data for 44% of taxpayers receiving a late filing penalty for 2018/19, and for 30% of taxpayers receiving a late filing penalty for 2019/20.

    It is plausible that the “never filing” taxpayers are more likely to be low/no income taxpayers (without the time/resources to file) than higher income taxpayers. If that is right then the data we report is under-estimating the impact of penalties on low-income taxpayers. However, this is speculation; further data is required.

    Data

    The complete dataset follows below.

    “PF1” is the £100 fixed penalty for missing the self assessment deadline; LPP1 is the 30-day late payment penalty. “Pre” are penalties originally assessed. “Post” are penalties which are actually charged (the difference between “Pre” and “Post” being cancelled penalties, usually as the result of a successful administrative appeal).

     2018/192019/20
     PF1LPP1PF1LPP1
    DecilesPrePostPrePostPrePostPrePost
    1st (£0 to £6k)9.2%6.3%0.3%0.2%7.5%4.6%0.2%0.1%
    2nd (£6k to 10k)5.1%3.8%0.2%0.1%4.1%2.7%0.2%0.1%
    3rd (£10k to £13k)4.2%3.1%0.3%0.2%3.2%2.1%0.2%0.1%
    4th (£13k to £18k)3.5%2.6%3.3%3.0%2.6%1.7%2.8%2.6%
    5th (£18k to £23k)3.1%2.3%3.8%3.5%2.3%1.6%3.6%3.3%
    6th (£23k to £30k)2.8%2.1%4.4%4.1%2.1%1.4%4.1%3.8%
    7th (£30k to £40k)2.6%1.9%4.6%4.2%2.0%1.3%4.4%4.0%
    8th (£40k to £52k)2.3%1.7%4.8%4.3%1.9%1.3%4.8%4.3%
    9th (£52k to £88k)3.6%2.5%6.7%5.7%2.4%1.6%5.4%4.7%
    10th (above £88k)3.7%2.9%5.3%4.4%2.9%2.1%4.5%3.6%

    Acknowledgments

    Many thanks to HMRC for their detailed response to our FOIA request on penalties and income levels, and to their openness and responsiveness to our follow-up queries.

    Many thanks to all those who responded with their personal experiences of penalties, and to the tax professionals who provided technical input and insight (many of whom spend hours volunteering to help people in this position).

    [1] See the projection for 2022 here: https://www.gov.uk/government/statistics/income-tax-liabilities-statistics-tax-year-2018-to-2019-to-tax-year-2021-to-2022/summary-statistics

    [2] See HMRC figures at https://www.gov.uk/government/news/fascinating-facts-about-self assessment

    [3] i.e., £100 + 90 x £10 + £300 + £300. The way in which penalties escalate does not seem rational, and will be improved from 2025 – see page 9 below. Technically all penalties after the first £100 are discretionary, but in practice they appear to be applied automatically in most cases.

    [4] See https://www.gov.uk/government/publications/self assessment-appeal-against-penalties-for-late-filing-and-late-payment-sa370. Strictly the appeal should be made within 30 days of a penalty being notified, but in practice we believe HMRC rarely holds taxpayers to this deadline.

    [5] The pandemic meant that HMRC extended the filing deadline to 28 February 2021.

    [6] Another factor is that some of the late payment penalties applied to those on low income will have been held over from a previous, higher earning, year. Hence the proportion in the lowest three deciles with tax to pay will be lower than suggested by this chart.

    [7] See HMRC policy paper: https://www.gov.uk/government/publications/interest-harmonisation-and-penalties-for-late-submission-and-late-payment-of-tax/interest-harmonisation-and-penalties-for-late-payment-and-late-submission

    Comment policy

    This website has benefited from some amazingly insightful comments, some of which have materially advanced our work. Comments are open, but we are really looking for comments which advance the debate – e.g. by specific criticisms, additions, or comments on the article (particularly technical tax comments, or comments from people with practical experience in the area). I love reading emails thanking us for our work, but I will delete those when they’re comments – just so people can clearly see the more technical comments. I will also delete comments which are political in nature.

  • OECD corporate tax trends since 1965

    OECD corporate tax trends since 1965

  • The tax scandal within the Post Office scandal, and how to fix it.

    The tax scandal within the Post Office scandal, and how to fix it.

    The hundreds of victims of the Post Office scandal are finally receiving compensation for the appalling treatment they received – including malicious prosecution, jail and asset seizures. But much of the compensation could be taken in tax, the Post Office settlement offers don’t properly explain this, and victims could end up in default to HMRC. It’s a scandal on top of a scandal, and the Government should act.

    UPDATE: as of 19 June 2023, it looks very much like this has now been solved

    UPDATE 14 March: the Government responds, and says they’ll fix the “compression” effect where postmasters receiving multiple years of lost income in one go get pushed into a higher tax bracket. But no sign of a general exemption. Disappointing.

    UPDATE 27 Feb: the Post Office has finally responded in a letter to The Times – but much too slow, no acknowledgement of responsibility, and an inadequate compensation principle. These people have lost much more than money, and the compensation should reflect that. And it should certainly compensate for additional tax they suffer as a result of receiving multiple years’ income in one year. These practicalities are quite aside from the moral case for a complete tax exemption.

    UPDATE 23 Feb: Regulations have been published creating a tax exemption for wrongly convicted postmasters, and those who claimed under the GLO settlement. But not yet anything for the people discussed in this piece, who are claiming under the Historical Shortfall Scheme or the Suspension Remuneration Review. There are hundreds.

    UPDATE 22 Feb: Times column by me here. And a very fast, and promising, response from Kevin Hollinrake MP (the responsible Minister) here.

    The Post Office scandal

    Between 2000 and 2013, the Post Office falsely accused more than 700 branch managers of theft.Some went to prison. Many had their assets seized and their reputations shredded. Marriages and livelihoods were destroyed, and at least 33 have now died, never receiving an apology or recompense. These prosecutions were on the basis of financial discrepancies reported by a computer accounting system called Horizon. The Post Office knew from the start that there were serious problems with the Horizon system, but covered it up, and proceeded with aggressive prosecutions based on unreliable data. It’s beyond shocking, and there should be criminal prosecutions of those responsible.

    The tax problem

    Many of the victims of the scandal are now entering into settlement agreements with the Post Office (under the “Historical Shortfall Scheme“), and receiving compensation. The Daily Mail (which previously played an important role in bringing the scandal to public attention) reported on Thursday that much of this compensation is disappearing in tax, and has kindly shared with me the terms of one settlement (with the relevant victim’s permission).

    My conclusion is that the Mail is right. I fear that the tax impact of the settlements on the victims has not been thought-through and, as a consequence, much of the compensation will disappear in tax. There are two big issues:

    No tax advice

    • The tax treatment of compensation is a complicated area, but the victims are being left to their own devices. The Post Office settlement offers suggest victims may wish to obtain tax advice, but don’t cover the cost, and the settlement agreements seem to have been structured in a way that creates an unnecessarily bad tax result for the victims.

    Compensation for loss of earnings is fully taxable

    • Much of the payments are compensation for loss of earnings. This is taxable in the same way as normal earnings, and the Post Office will operate PAYE. The problem is that, unlike normal earnings, multiple years are being taxed at the same time, pushing the victim into a high tax bracket. For example: a postmaster earning £30k ordinarily takes home about £25k after tax. But if that same postmaster receives ten years’ worth of earnings in one payment, of that £300k they’ll take home not £250k, but £170k. The “compression” of many years of income into one year costs them £80k. That’s an unjust result..
    • There were two ways to deal with this: (1) structure the compensation in a way that reflects the main harm suffered and also isn’t taxable (for example as damages for defamation or an economic tort), or (2) increase the compensation to make up for the additional tax. This is the approach a court would adopt when calculating damages – the ‘Gourley principle‘ – putting a claimant into the same after-tax position they would have been in had there been no breach.. Neither of these steps appears to have been taken.

    The large interest element is fully taxable

    • Because the compensation is covering events from many years ago (20 years in some cases), a large amount of the compensation is interest (often a six-figure sum). This will be fully taxable for the victims. 20% of the tax will be withheld by the Post Office. The remainder (another 20%-25% of tax) will be payable by the victims on their self assessment return. They are not being warned about this and may receive a nasty surprise. I am very concerned that some of the victims won’t obtain tax advice, won’t declare the interest on their tax return, and so could fall into default with HMRC. That would be an unconscionable outcome.
    • The settlement offer mentions tax on interest, but the wording appears to be standard “boilerplate” which in the case I saw (and I expect many others) is incorrect and misleading:
    • Why “incorrect”? Because, even if this individual had no other income, it is mathematically impossible that they’d be entitled to a refund of the 20% tax withheld, and mathematically certain they will have significant additional liability. I don’t understand why anyone thought this text was acceptable. It is actively misleading.
    • What it should say is something like: “we’ve deducted income tax at the basic rate of 20%; given the compensation amounts you are receiving, you will have additional liability of somewhere over 20% which you will need to declare and pay in your self assessment. We will cover the reasonable costs of you obtaining tax advice from one of the following firms…”
    • The more fundamental point: it’s fair for interest to be taxed when it’s a financial return; not when it reflects the time passed since an injury was suffered. For this reason, interest on personal injury damages/compensation is exempt from tax. The Post Office’s victims have suffered injuries similar in many ways to personal injury, but this exemption won’t apply. And then there’s, once more, the effect of compressing many years’ income into one year. That seems unjust.

    Some of these problems could be fixed going forwards: ensure claimants receive proper tax advice (before and after the event), paid for by the Post Office, and ensure that the settlements appropriately account for tax considerations. The GLO scheme will be able to take account of these issues, and certainly should do.

    But it’s too late for the hundreds of settlement agreements that have already been signed, and there’s no obvious solution to the interest on future settlements/payments being taxed. A better solution is needed.

    The solution

    There is a simple solution – this year’s Finance Bill should include two clauses:

    1. All the victims of the scandal should be exempt from tax on compensation payments they receive (whether under the original GLO, the Historical Shortfall Scheme, the Suspension Remuneration Review, the GLO scheme or otherwise). The exemption should be retrospective to the first date that settlements were made. This has already been announced for postmasters with quashed convictions, but needs to apply to all victims.
    2. All compensation should be calculated as if the exemption does not exist. The Post Office does not appear to have followed the Gourley principle in its settlements to date, but the creation of an exemption could enable it to reduce settlements still further in the future. So it’s important to prevent this.

    If this cannot be achieved then the Post Office should, at an absolute minimum, take responsibility for what appear to be serious failings in its past settlements. It should make sure that the Gourley principle applies (to compensate for compression effects on both damages and interest), and pay for victims to receive proper tax advice (both before the settlements and when they come to file their tax returns). The Post Office should do this out of goodwill. If it does not, then it will potentially be open to past settlements being reopened, on the grounds that it made false statements in its settlement offers.

    And, needless to say, future settlements (under either scheme) should give full consideration to the tax impact.

    Why should the Post Office victims be treated differently from others receiving compensation?

    This is a highly unusual situation. We have large numbers of people who, many years ago, suffered a grave injustice at the hands of a company wholly owned by the Government. The Government, therefore, has a special responsibility to ensure that they do not suffer more injustice. This principle was acknowledged by the Government back in December 2022, when it announced it would legislate so compensation payments were disregarded for benefits purposes, and in September when it announced that postmasters with quashed convictions would pay no tax on their compensation. The same principle should apply to all victims of the scandal – including those under the Historical Shortfall Scheme or the Suspension Remuneration Review.

    And there are other precedents. Settlement payments for the Thalidomide scandal were (very belatedly), exempted from tax. Compensation payments for missold pensions were exempted from tax

    Many thanks to everyone who helped with this piece, particularly Ray McCann, Judith Freedman and M. And thanks, as ever, to J. Without their technical tax expertise and practical advice, I could not have written this piece. All mistakes, however, are mine.

    Thanks to Tom Witherow at the Daily Mail for highlighting the issue and bringing it to my attention. And credit to Jac Roper (who I don’t know) for an article she published last year raising the point, but which I missed at the time.

    Photo by Stable Diffusion, “a photo of a statue of lady justice holding a cash register”.

    Footnotes

    1. When I wrote this article I was significantly understating the number. We don’t have the full figures, but it is likely around 3,000. ↩︎

    2. Not to be confused with the Royal Mail – the Post Office wasn’t privatised and is owned wholly by the Government. Primary responsibility for the scandal rests with the Post Office alone, but successive governments (since the 2000s) share responsibility for not responding to early reports in Private Eye and Computer Weekly ↩︎

    3. I have relied heavily upon other tax professionals who have provided input on these points – they are much more expert in these matters than I am – but, as ever, any mistakes are mine and mine alone. ↩︎

    4. The cost of reasonable legal advice is covered – see paragraph 44 of this document, but tax advice is not covered, and the claimant firms involved may not have the capability to provide complex tax advice ↩︎

    5. A small compensation for this will be that many of those affected will be past retirement age, and so won’t pay national insurance – that will save them around £9,500 of tax ↩︎

    6. Is that tax avoidance? In some circumstances changing a document to achieve a different tax result absolutely is. However in this case, given it is a fair way to view the compensation, and results in a more just outcome, I’d say the answer is “no”. Loss of earnings is perhaps the least significant harm the victims suffered. And structuring the compensation in this way would also be technically hard for HMRC to challenge (in the unlikely event they’d want to). ↩︎

    7. In this case, using the same example figures, it would mean increasing the compensation from £300k to somewhere around £440k. ↩︎

    8. My original draft said we should also consider denying the Post Office tax relief for its compensation payments. That was the approach in 2015 when the banks were making large compensation payments for their past misconduct. However, on reflection, this would be a token gesture – the Post Office cannot afford to meet the existing claims, and is having to be funded by the Government. Denying tax relief would just necessitate more Government funding – we’d be pointlessly throwing money in a circle. ↩︎

    9. See section 148 Finance Act 1996. See also the way that “Financial Assistance Scheme” payments for members of insolvent defined benefit schemes were taxed as if the payments were made in previous years, rather than compressed into the year of payment – the quote at section 6.2 of this House of Commons Library document explains it ↩︎

    Comment policy

    This website has benefited from some amazingly insightful comments, some of which have materially advanced our work. Comments are open, but we are really looking for comments which advance the debate – e.g. by specific criticisms, additions, or comments on the article (particularly technical tax comments, or comments from people with practical experience in the area). I love reading emails thanking us for our work, but I will delete those when they’re comments – just so people can clearly see the more technical comments. I will also delete comments which are political in nature.

  • Why the 25% corporation tax increase is a bad idea which I support

    Why the 25% corporation tax increase is a bad idea which I support

    Updated: raising corporation tax to 25% will take the effective rate to the highest it’s ever been in the UK, and one the highest in the developed world. That’s bad – but the alternatives are worse.

    The Johnson government increased corporation tax from 19% to 25% from April 2023. The mini-Budget reversed this. Then Jeremy Hunt’s Autumn Statement reversed the reversal, taking the rate back to 25% from April. Not a hugely stable environment for business. But how should we assess the merits of the increase to 25%? Should we reverse the reversal of the reversal?

    The standard argument for the increase goes something like this:

    “We’ve been cutting corporate tax for 25 years, it’s gone too far, and it’s time to go back to 25%. After all, the rate was 33% in the 80s, and is now 19%, so 25% is still a pretty good deal.”

    That argument is usually accompanied by this chart, showing the headline rate falling dramatically:

    This is rather less persuasive if we look at the corporate tax actually paid – here’s an overlay showing UK corporation tax receipts (in red) as a % of GDP:

    The rate fell. The revenues bounced around with the business cycle, but fundamentally didn’t change much, if at all.

    Could it just be that corporate profits rose, so the declining rate multiplied by increased profits kept revenues broadly constant? We can test that by dividing corporation tax revenues by the corporate “gross operating surplus” in the national accounts, which gives us a reasonable proxy for the overall effective tax rate. Again we see that the plummeting headline rate does not lead to much, or perhaps any, reduction in the actual effective rate (particularly bearing in mind that the 2020 figures are depressed by Covid).:

    How can the tax take remain the same when the rate has fallen so dramatically? Because of a series of technical changes that meant that, at each stage when the rate went down, the tax base (the definition of “profits” to which the rate applies) expanded. Tax = rate x base. So, through accident or brilliant HM Treasury design, nothing much changed.

    The rate increase to 25% is, by contrast, accompanied by nothing that reduces the tax base. It will therefore simply represent a 1/3 increase in the amount of tax companies pay, making our chart look like this:

    And UK corporate tax will, as a % of GDP, become one of the highest in the developed world – of large economies, only Japan and Canada’s would be higher:

    So I am convinced that raising corporate tax is a bad idea. The problem, however, is that the 25% increase was “banked” in government accounts, and the cancellation of the increase in the mini-Budget was unfunded. The £16bn+ it costs would therefore have been distributed opaquely throughout society through inflation and/or higher interest rates. I don’t regard that as good tax policy.

    Alternatively one could keep the rate at 19% by cutting spending, or raising taxes elsewhere – that would certainly be a rational position to take (whether you agree with it or not), but it’s an argument that I don’t hear anyone making.

    And, finally, you could argue that increasing the rate to 25% will actually bring in no more revenue, because profits will drop – in other words, the 25% is past the “revenue maximising point”. The problem with this is that there’s no evidence for it in the response to previous rate reductions.

    So taking the rate to 25% feels like the least bad of several bad ideas. I therefore unenthusiastically support it.

    Footnotes

    1. Two big caveats: (1) GOS is not the same as accounting profit, and in particular excludes depreciation (so the chart understates ETR), (2) the tax stats are for cash collected by HMRC in a tax year, which used to lag profits by around a year, and now mainly doesn’t – neither factor should affect the overall trend, but both will create/mask considerable noise. With some work they could be corrected, and I’d love it if someone did that. ↩︎

    2. I’ve added a trendline which shows a slight increase over time, but I’d be hesitant to draw too many conclusions given the large fluctuations across the business cycle ↩︎

    3. Another factor is that a wave of incorporation by small businesses has artificially inflated corporation tax revenues, but at the cost of (greater) reductions in income tax. This effect, however, is too small to impact the trends visible in the charts above – it’s about £1bn. ↩︎

    4. It would have gone higher than this, because this chart doesn’t include the effect of the bank surcharge, which at 8% would have meant banks would have been be paying 33% on their profits. However, controversially but sensibly, the increase to 25% was accompanied by a reduction in the surcharge to 3% ↩︎

    5. And Canada, like Australia, is driven by the high tax revenues from mining/oil/gas ↩︎

  • Did Ian Lavery MP pay tax on the unexplained £140,000 he received from his former union?

    Did Ian Lavery MP pay tax on the unexplained £140,000 he received from his former union?

    As inews has reported, Ian Lavery MP has refused to confirm whether he paid tax on £140,000 of irregular and uncommercial payments from his former union. He says all his tax affairs are up-to-date, but refuses to comment on the specific question of these payments. That is the same answer I received from Nadhim Zahawi back in July, and it’s not good enough.

    I should say up-front: credit for this story goes to David Parsley from inews and the senior tax accountant who worked with him. I stand behind the story, and provided some assistance. Please read the inews story for full background.

    Normally we wouldn’t think to ask if someone paid tax on their income, and it wouldn’t be remotely fair or sensible to ask this kind of question of every MP, or everyone in a public position. However this £140,000 is different.

    The background

    The Certification Office for Trade Unions & Employers’ Associations reported back in 2017 on financial irregularities in the Northumberland NUM, of which Mr Lavery was General Secretary. The BBC reported on it, as did the Guardian.

    Here’s a short summary of what happened – but the Certification Officer report, and inews report, are well worth reading in full:

    • Mr Lavery received a “redundancy payment” when as a legal matter he was not made redundant – he left the union because he became an MP.
    • There was a peculiar arrangement whereby the union compensated Mr Lavery and his wife for the underperformance of an endowment policy that Mr Lavery and his wife (not the union) had invested in.
    • Mr Lavery received loan write-offs of £91,545 – this is highly unusual for an employee.
    • The union (in the words of the Certification Officer’s report) “in effect purchased a share in its General Secretary’s home”, again contrary to usual commercial and trade union practice.

    This was all in 2005-2013. No proper explanation or justification has ever been provided for these arrangements. The Certification Officer did not appoint an inspector to fully investigate (because he thought there would be insufficient financial records to facilitate an investigation). No prosecution was brought (or, as far as I am aware, contemplated). I will let others judge the propriety of the arrangements, and focus on the tax consequences.

    The tax treatment of the payments

    The experienced accountants working with inews say the loan write-offs and “redundancy payments” should have been fully taxable. I have reviewed the documentation and agree with this conclusion.

    Note that there is usually an exemption for the first £30,000 of redundancy payments, but the point is that these were not actually redundancy payments at all – Mr Lavery left his employment to become an MP, and was succeeded as general secretary by Denis Murphy (the former MP for Wansbeck – this was an unusual “job swap”). Note the description in the filed AR21 annual returns for the union:

    A redundancy, by contrast, is when a job ceases to exist. Calling it a “redundancy” does not make it a redundancy, any more than calling my sister a grapefruit makes her a grapefruit. This was either a reward for his previous work as general secretary, or part of a quid-pro-quo for Mr Lavery’s job swap with Denis Murphy. In either case, the payments were general earnings, subject to income tax and national insurance in the usual way. The union, which Mr Lavery ran at the time, should have applied PAYE.

    The loan write-off was more straightforward: fully taxable, no applicable exemptions, and with the income tax payable by Mr Lavery personally (not by PAYE).

    In my experience, when people fail to follow correct legal procedures for payments, and/or the payments do not make commercial sense, they often also fail to follow correct tax procedures. That’s true whether the failures are accidental (for example a result of administrative chaos), or intentional. I don’t know which was the case here, and the Certification Office report doesn’t reach any conclusions as to the parties’ motivation.

    There are several possibilities:

    1. Mr Lavery paid tax on the payments in full at the time (or the tax was collected by PAYE) and nobody did anything wrong
    2. Mr Lavery did not pay the correct tax at the time, and/or the union did not correctly operate PAYE, but the tax was paid subsequently, e.g. as a result of an HMRC enquiry, potentially with “carelessness” or “deliberate” penalties applying.
    3. Mr Lavery/the union did not pay the correct tax at the time, and still has not.
    4. I and the senior tax accountant are both wrong, and the payments weren’t taxable. In that case I will happily issue an apology to Mr Lavery and make a donation to charity.

    It is reasonable to ask Mr Lavery which of these scenarios we are in. The question is whether the true nature of the payments was disclosed to HMRC (for example the fact that the “redundancy” payment was not a redundancy payment).

    Was Mr Lavery under HMRC investigation?

    Mr Lavery used the word “enquiry” when speaking to inews, and said HMRC conducted a “desktop review”, but did not explain what that involved. On the other hand, he told the BBC that he has “never been under investigation” by HMRC.

    These words all have slightly different meanings:

    • An “enquiry” is the process that lets HMRC challenge someone’s tax return within twelve months of it being filed. HMRC does this by giving the taxpayer notice in writing, i.e. a taxpayer should always be aware of an enquiry.
    • If HMRC realises it missed something in a tax return, but has passed the twelve month deadline, then HMRC is out of luck.
    • But if HMRC discovers information which was not disclosed in a tax return, and suggests the tax was incorrect, they can raise a “discovery assessment”. The deadline for this is usually four years after the end of the tax year, extended to six years where a taxpayer or their advisers have been careless, and twenty years where the taxpayer’s non-disclosure was deliberate
    • HMRC will review someone’s affairs internally before deciding whether to commence an enquiry or discovery assessment, and that will usually involve correspondence with the taxpayer or their advisers

    I think, in the usual English meaning of the word, all of the above would class as an HMRC “investigation”, and that’s how tax advisers would use the word too. So it’s not clear to me how Mr Lavery could have had dealings with HMRC well after the event (2005-2013) unless he was under investigation. Most likely because HMRC were considering whether to raise a discovery assessment – but even the six year time limit would have been challenging at that point.

    Why it’s reasonable to expect an explanation

    It was the unusual and uncommercial nature of the YouGov and Balshore structure which made me wonder if Mr Zahawi failed to pay all the tax that was due – and it turned out he had not. The unusual and uncommercial nature of the payments to Mr Lavery raises the same questions. The amounts are much less than Mr Zahawi’s but the principle is the same: we expect our representatives to pay the tax that’s due, in the same way millions of ordinary taxpayers do.

    The other thing that’s the same is Mr Lavery’s response. inews asked him a very simple question. He should have an equally simple answer: tax was fully paid, and here are the tax returns to prove it. Giving us the same non-answers as Mr Zahawi provided is not good enough.

    Mr Zahawi may agree that, in retrospect, it would have been better if he’d provided a proper explanation at the time.

    I hope Mr Lavery takes the opportunity to provide us with a proper explanation now.

    Thanks to the tax lawyers, tax accountants, employment lawyers and trade unionists who assisted with this report – but most of all, thanks to David Parsley for breaking the story.

    Footnotes

    1. corrected – first version said £90,454 ↩︎

    2. corrected – first version said 2005-2012 ↩︎

    3. Technically it’s more complicated than that, as Andrew ably explains in the comment below, but for practical purposes most people call it an “exemption” and I’ll do that here. ↩︎

    4. It seems that at some point an argument was made that Murphy was not a “general secretary” but a “secretary” – that is not consistent with the annual returns ↩︎

    5. For completeness, the deadline can also be: twelve years for certain offshore cases, and 20 years for a failure to notify of liability (i.e. you never completed a return at all), or where the matter relates to a tax avoidance scheme ↩︎

    Comment policy

    This website has benefited from some amazingly insightful comments, some of which have materially advanced our work. Comments are open, but we are really looking for comments which advance the debate – e.g. by specific criticisms, additions, or comments on the article (particularly technical tax comments, or comments from people with practical experience in the area). I love reading emails thanking us for our work, but I will delete those when they’re comments – just so people can clearly see the more technical comments. I will also delete comments which are political in nature.

  • The abolition of VAT on ebooks was a £200m handout to publishers

    The abolition of VAT on ebooks was a £200m handout to publishers

    The UK charged 20% VAT on ebooks until May 2020, when it was abolished following a lobbying campaign by the publishing industry. They claimed that consumers would benefit from lower prices. Our analysis shows that this didn’t happen – publishers retained the VAT saving for themselves, costing the country £200m.

    Background

    Books have always benefited from 0% VAT. Ebooks were subject to 20% VAT. An EU law change in 2018 permitted the UK to reduce the rate of VAT on ebooks, which the UK initially resisted. Following a lobbying campaign from the publishing industry, the UK scrapped VAT on ebooks in March 2020. The cost to the Exchequer was £200m.

    The Axe The Reading Tax Campaign (run by the Publishers Association) said that removing VAT from ebooks would result in lower prices for consumers:

    Removing the VAT from ebooks and epublications would mean that people who buy them would benefit from lower prices

    Did it?

    Our conclusions

    We analysed the detailed ONS sampling data of ebook pricing, compiled as part of the consumer price index. We found no significant change in ebook pricing around the time of the VAT cut. Full details of the ONS analysis are below.

    This is the key chart, showing the change in average pricing for the 23 months before and after the VAT cut, for both ebooks and other comparable products:

    The VAT cut means that ebook publishers could have cut their prices by 17% and made the same profit. They didn’t. Over this period there were 8%+ price reductions for comparable products – computer game and app downloads – where there was no VAT cut. There were no overall price reductions for ebooks.

    We also analysed individual pricing data for the 30 best-selling ebooks on Amazon UK in 2020 (as Amazon is by far the most significant ebook retailer). Only (at most) four out of thirty showed a sustained price reduction which could plausibly have been attributed to the May 2020 VAT cut. That likely overstates the effect. Full details of price movements on these ebooks are below.

    VAT was also cut for electronically delivered newspapers and magazines – that’s not something we’ve looked into in this report.

    Perhaps there was a benefit to consumers, but that was hidden by increased costs/inflation?

    This is often the excuse for a failure to pass on VAT cuts, but it doesn’t wash here – this is an unusually clear effect:

    • These are ebooks. The usual fluctuations in price of inputs such as e.g. paper are irrelevant.
    • This was a big cut in VAT at one moment in time. It would be easy to spot the effect, if there was one.
    • Inflation over the period was low, much lower than the VAT cut, and was concentrated in other areas, e.g. energy prices.
    • There is an easy comparison with other downloaded products, which have a similar cost base and supply/demand factors.

    Perhaps the cost of paper was rising, so book prices increased, and publishers felt ebook pricing had to follow book pricing?

    There’s no evidence of that. Paperback fiction pricing dropped slightly across the period we looked at (1%); non-fiction pricing rose slightly (5%).

    Who benefited?

    Amazon dominates the UK ebook market. Precise up-to-date figures are hard to come by, but its UK market share in 2015 was estimated as 95%; that has now come down, perhaps to the level of its global ebook market share of around 67%.

    However, ebook prices are set by publishers, not Amazon. The publishers lobbied for the VAT cut. In May 2020 they could have reduced their prices by 17% and received the same post-VAT income. They didn’t.

    Amazon generally retains a royalty of around 30%, so we can say that of the £200m annual cost of the VAT abolition, Amazon received about £60m and publishers/authors about £140m.

    To put these figures in context, the publishing industry’s UK profit in 2021 was probably around £200m. Even after increased author royalty payments, this looks like a very significant enhancement to publisher profitability.

    What does this mean?

    Our conclusions above are unlikely to surprise either consumers or tax policy specialists. They reflect what we found when we analysed the impact of the January 2021 abolition of VAT on tampons. We believe they also accord with common sense.

    Professor Rita de la Feria is Chair in Tax Law at the University of Leeds, and probably the world’s leading academic expert on VAT. Professor de la Feria has previously written about how special interest groups (publishers, in this case) lobby for favourable VAT changes, and has kindly reviewed a draft of this report. She says:

    “These results are consistent with previous empirical studies on VAT cuts carried out in many countries and as regards a wide range of products: VAT cuts tend not to be passed through fully to consumers. So, decreasing VAT tends to help businesses, not consumers. It is also important to note that, even if the cut had been passed [to consumers], a tax cut on e-book sales would increase the regressivity of the tax system, as we know that those products are overwhelmingly consumed by those on higher incomes. So, it represents in effect a tax cut on the richest, at the time when we should be protecting the poorest.”

    Despite this evidence, we risk repeating the ebook experience, this time with sunscreen. An MP tabled an Early Day Motion. The House of Commons is debated cutting VAT on sunscreen . The Government has sensibly noted that any VAT cuts may not be passed onto consumers. The House of Commons Library has published a research paper citing our tampon pricing research.

    We hope MPs will review the evidence of the impact of well-intentioned VAT cuts, and stop lobbying for VAT cuts that will benefit industry rather than consumers.

    Methodology – analysis of ONS data

    We followed the same methodology we used for our “tampon tax” report last year – a python script analysed ONS inflation data to track price movements in ebooks and other comparable products. That approach is explained in detail in our tampon tax report, and all the code and data for our ebook analysis is on our Github. We welcome comments and criticisms.

    This interactive chart (full screen version here) shows how ebook pricing changed across the point when the 20% VAT was abolished. It’s clear there was no change at all:

    The chart is normalised to April 2020 – i.e. we call the April 2020 prices 100%, and everything else is relative to that. Inflation (CPI) was low at the time (you can add that into the chart as well). We stop at two years because, after March 2022, inflation starts to dominate, and render this kind of analysis much more difficult.

    There was an immediate 3% drop in ebook pricing from April 2020 to May 2020, when the VAT cut took effect. However the volatility in pricing means that does not give a true picture of the effect of the cut. The volatility is considerable, with a 70% increase in Autumn 2019 and then more-or-less a reversion to the previous trend.

    There is an even higher level of volatility for the two best comparators – mobile phone apps (green) and computer game downloads (orange):

    So it is sensible to look at averages across the 23 month period before and after the May 2020 VAT cut:

    This shows almost no change in ebook pricing. Over the same period, the price of physical books rose by 5%, as did computer software; the price of music downloads increased by 2%; computer game downloads and mobile phone apps had åverage price reductions of over 8%. Of course none of these other products experienced any VAT change.

    CPI rose by 8% across that period, mostly post-pandemic and then immediately after the Russian invasion of Ukraine, but that was largely driven by price increases in housing, energy, fuel and transport.

    We would conclude from this that there is no evidence of any price reduction in ebooks.

    Methodology – pricing data for the top 30 ebooks sold on Amazon UK in 2020

    To sense-check the ONS results, we looked at historic ebook pricing tracked by the wonderful website eReaderIQ for the top 30 ebooks from Amazon’s 100 bestselling books in 2020 (skipping over those where eReaderIQ doesn’t have data, e.g. because no ebook was available on April 2020). All charts are taken from eReaderIQ, with their kind permission.

    It is important to note that this approach has no statistical validity as, whilst we have pricing data for each book, we don’t have data on the number of sales of each book, total Amazon UK ebook sales, or total UK ebook sales. Furthermore, looking at individual books may give a false impression of price cuts which do not reflect the market as a whole.

    So why look at individual book pricing at all? Because if, for example, we saw most of the top 30 books consistently having a 20% price cut around May 2020, that would call into question our findings from the ONS data. We do not see this. Only four books out of the top 30 show a sustained price reduction consistent with the May 2020 VAT cut. That likely overstates the effect, because these changes could be coincidental; only one book demonstrated the “correct” 17% price cut on the “correct” date.

    It’s important to note that Amazon does not set prices. Amazon may have profited from the VAT cut, but it was publishers who chose not to pass the benefit onto consumers.

    1. The Boy, The Mole, The Fox and The Horse:

    15% price cut in May 2020 – kept at that level. This is consistent with the VAT cut being passed to consumers.

    2. The Thursday Murder Club:

    15% price cut, but only for four months – then back up.

    3. Where the Crawdads Sing:

    No change.

    4. Pinch of Nom Everyday Light:

    No change.

    6. Pinch of Nom: 100 Slimming, Home-style Recipes:

    No change.

    11. Girl, Woman, Other

    20% price cut on 1 May 2020, but returning to the previous price on 1 June.

    15. The Mirror and the Light

    20% price cut in May 2020, sustained. Potentially consistent with the VAT cut being passed to consumers.

    16. Good Vibes, Good Life

    17% price cut on 30 April 2020, sustained. That could be an example of the 17% price benefit being passed to consumers; although given it was a newly launched book, it could also be a post-launch price reduction.

    17. Normal people

    55% price cut in May 2020, but only for a month.

    19. Why I’m No Longer Talking to White People About Race

    No change.

    20. The Beekeeper of Aleppo

    17% price cut in May 2020, but only for six weeks.

    21. The Silent Patient

    Lots of variation, but no sustained price cut (and that trend continued right to February 2023).

    24. The Family Upstairs

    20% price cut, maintained for a year, then back to where it was.

    25. Cook, Eat, Repeat:

    No price cut.

    26. Wean in 15

    No price cut.

    27. The Fast 800 Recipe Book

    No clear trend.

    32. This is Going to Hurt

    No clear trend.

    35. Nadiya Bakes

    No price reduction.

    36. Blood Orange

    No price reduction.

    38. Troubled Blood

    No price reduction.

    40. Shuggie Bain

    No price reduction.

    43. The Boy At the Back of the Class

    No price reduction.

    45. Happy: Finding joy in every day

    No price reduction.

    46. Hinch Yourself Happy

    15% price reduction for ten weeks, then mostly reversed, trending to a 5% price reduction.

    47 Ottolenghi FLAVOUR

    No price reduction.

    48. The Green Roasting Tin

    30% price reduction in mid-May 2020. Potentially consistent with the VAT saving being passed to consumers (although the higher amount suggests there could have been another factor here).

    51. Kay’s Anatomy

    17% price cut in May 2020, reversed after six months.

    52. The Midnight Library

    17% price cut in May 2020, reversed after six weeks, stabilising at a 5% price cut.

    53. The Sentinel

    No price cut.

    54. The Fast 800

    No clear trend.

    Many thanks to the ONS for publishing all their CPI data, and being so responsive to our queries. Thanks to eReaderIQ for permitting us to use their ebook pricing tracking data and publish their tracking charts.

    Thanks to G and R for their review of an early draft of this report, to J and C for industry insights, and to Professor Rita de la Feria for her comments and her previous work in this area.

    Image by Stable Diffusion: “cinematic photo of an electronic book, masterpiece, highly detailed, trending on artstation, 4k”

    Footnotes

    1. Historically, EU law permitted reduced or 0% VAT on books, but required ebooks to be subject to the full rate – so 20% in the UK. That was changed in October 2018, permitting Member States flexibility in what rate they applied. ↩︎

    2. In July 2019 many EU states reduced the rate of VAT on ebooks. The UK didn’t follow until March 2020, when the then-Chancellor Rishi Sunak announced that the UK would cut the rate to 0% from end 2020. Then in April 2020 he announced the cut would be accelerated to May 2020. ↩︎

    3. Technically this was a reduction in VAT from 20% to 0%, which is different from an exemption (and more favourable, because it means retailers/publishers can claim a refund of VAT on their inputs/expenses). In the interests of clarity we will use terms like “scrapped” and “cut” because we think that is easier to understand, and the further technical consequences of a 0% rate are not relevant to this report ↩︎

    4. VAT was also cut for electronic newspapers/magazines, but that’s outside the scope of this report ↩︎

    5. See page 66 of the March 2020 Budget Red Book, item 15 ↩︎

    6. We set the cut-off at 23 months because inflation tends to dominate after Q1 2023 ↩︎

    7. Why 17% and not 20%? Because a £10 ebook before May 2020 represented a £8.33 price plus £1.67 VAT. After May 2020, the publisher could charge £8.33 and receive the same net proceeds – that’s a 17% price cut to the consumer. ↩︎

    8. Overstates because these changes could be coincidental; only one was the “correct” percentage price cut at the “correct” date; also the prices of individual books tend to fall after they are published. The ONS data samples the ebook market as a whole, and so is not prone to these problems. ↩︎

    9. Publishing industry UK revenue was £3bn in 2021, with a profit margin of about 6% (that figure is a rough estimate from industry sources) ↩︎

    10. It is interesting that, just as with the tampon data, there is an apparent price increase immediately prior to the VAT cut. The July spike in UK ebook pricing coincides with the moment when many other EU member states cut VAT on ebooks. However for now we are putting this down to a coincidence rather than any intentional pricing manipulation. ↩︎

    11. We consider apps and computer game downloads the best comparators because, like ebooks, pricing is set by publishers. By contrast, music download pricing is subject to a more complex negotiation between platforms and publishers; subscriptions are (for obvious reasons) less volatile ↩︎

    12. We have a 23 month cut-off because inflation effects start to dominate once we get into Q2 2023 ↩︎

    13. We would discourage anyone from scraping the website to try to research pricing further; for the reasons we mention we don’t think this could achieve statistical validity; it would also abuse a fantastic service ↩︎

    14. i.e. because many books will decline in both sales and price the longer they remain on the market, and so tracking individual books (as opposed to the market as a whole) may given a false impression of price cuts (a type of cohort effect). ↩︎

  • ebook VAT abolition – pricing evidence

    ebook VAT abolition – pricing evidence

  • Is it right that Shell and BP made $70bn profit in 2022 but pay little tax in the UK? Yes. And also, no.

    Is it right that Shell and BP made $70bn profit in 2022 but pay little tax in the UK? Yes. And also, no.

    UPDATED with BP profit announcement and further thoughts

    Only a small proportion of Shell and BP’s profit is made in the UK, so we should be unsurprised that only a small amount of their huge profits are taxed in the UK. But when energy companies make “windfall profits”, at the expense of the rest of us, there is a case that normal principles shouldn’t apply, and the windfall should be taxed.

    Shell

    Here are Shell’s unaudited financial statements for 2022:

    $65bn of pre-tax profit – more than twice that for the previous year – and $22bn of tax. That’s a 34% effective rate – which we’d normally say is around what we’d expect (much higher than a normal company, because oil/gas extraction tends to be subject to special taxes).

    Nothing surprising.

    No figures yet on how much of that $22bn of tax will be paid in the UK, but it’s likely very small. Why? Because only 5% of Shell’s business is in the UK. The rest is abroad, and we don’t tax that.

    Before 2009, the UK *did* tax foreign profits, but with a complex tax credit system to stop anything being taxed twice. Why did the UK abandon that, and move to an “exemption” system where we almost never tax foreign profits? A mixture of:

    1. A series of daft CJEU decisions made it difficult and perhaps impossible in practice to operate a credit system without breaking EU law.
    2. The credit system was *very* complicated, and it’s unclear it ultimately raised more tax.
    3. For these reasons, other countries had dropped the credit system, and the UK government wanted to be “competitive”

    So there is nothing surprising about only around $1bn of the perhaps $22bn total Shell tax bill being paid in the UK. Nothing to see here. Move along.

    Except…

    These are not normal times. This is not a normal level of profit. Shell made twice as much profit in 2022 as in 2021, but not by being twice as clever. Shell simply is benefiting from the same high energy prices which are hurting households and businesses across the world. There is an obvious political case for rebalancing that equation, and redistributing some of Shell’s winnings back to the people who lost the great 2022 energy game (us).

    Often these kinds of populist political arguments have large economic and tax policy downsides. In this case, it’s different. Shell’s profits aren’t just normal profits – they’re “economic rent”. Shell is – by pure accident – making a return which doesn’t just exceed its costs, but exceeds the normal return it would expect for the risks that it runs. In other words: a “windfall”.

    Standard economics and tax policy says we absolutely *should* tax economic rents that arise by accident. And because those profits arise by accident, that shouldn’t deter investment, or create economic distortions. Here’s what the Mirrlees Review – the bible of conventional tax policy – says:

    I’d conclude:

    • Shell is making a windfall profit.
    • The fact Shell’s effective tax rate remains a fairly typical 34%, when its profits are super-normal, tells us that the windfall profit (Shell’s economic rent) is not in fact being taxed.

    BP

    Looks like a bumper year for BP:

    But, looking at BP’s quarterly results in detail, that reported $28bn profit is the “underlying replacement cost profit” – a non-GAAP figure (i.e. not a standard accounting definition of profit). The standard GAAP figure shows a $15bn pre-tax profit, then $17bn of tax – so a post-tax *loss*:

    How can actual profit be negative, but underlying profit be $28bn? Largely because of BP’s forced sale of Rosneft, which lost them around $25bn (which goes into the $30bn figure I’ve circled above).

    The Rosneft loss is absolutely a real economic cost for BP, but there’s no tax relief for it (in the UK or, I expect, anywhere else). So it massively reduces BP’s profit, but doesn’t reduce BP’s tax bill. Which is why there’s $17bn of tax on a $15bn profit.

    But let’s pretend the Rosneft loss didn’t exist, and do the same calculation we made for Shell – is BP paying an appropriate level of tax on that underlying $28bn of profit?

    $16bn of tax on $28bn of profit = a 61% effective tax rate. That’s much higher than Shell’s 34%, and also much higher than BP’s typical effective tax rate (which averages at around 40% in recent years, but that disguises some wild variations).

    Why is the rate so high? I’m not sure. I can’t see any details of the tax calculation in the BP papers published today, although it does indicate that only $2bn comes from the increase in the UK windfall tax/energy profits levy. Update: a commentator below suggests the reason may be a Q3 negative mark-to-market on gas hedges resulting in a P&L loss that’s disregarded for tax purposes, therefore increasing the ETR. That seems plausible to me.

    I’d conclude from this:

    • Did BP make a massive windfall profit from its underlying energy business? Absolutely yes.
    • But did BP also make a massive “reverse windfall” loss from Rosneft? Again, yes.
    • It doesn’t seem fair to tax the windfall profit as if the loss wasn’t real. Because it was.
    • Even if it hadn’t made the big Rosneft loss, it’s still unclear whether we could say BP isn’t paying an appropriate level of tax on its windfall/economic rent.

    So what to do?

    The UK is already somewhat taxing windfall profits with its “energy profits levy”, which takes the total tax on UK oil and gas production to 75%. That tax is badly flawed, but that’s not the main problem here: UK oil and gas is only a small part of Shell’s revenues (and a larger, but still quite small, part of BP’s revenues).

    Mostly Shell’s rent is being untaxed because it’s not the UK’s to tax, and other countries are not taxing it. The windfall taxes that have been introduced have been relatively modest.

    Which prompts the thought: if nobody else is taxing Shell’s economic rent, perhaps the UK should? A temporary and absolutely one-off return to worldwide taxation for a one-off windfall tax.

    The UK has had successful windfall taxes in the past, and many people would say this is a clear case of a set of exceptional circumstances resulting in a one-off profit that isn’t deserved, and should be taxed. And a proper windfall tax is retrospective: we wait and see just how much of a windfall the energy companies made, and then tax it after the event – which prevents any possibility of avoiding the tax.

    There are two significant counter-arguments:

    First, that energy prices are naturally cyclical, and so energy companies make big losses in bad years (2020) and big profits in good ones (2022):

    The sheer scale of Shell’s 2022 profits make that a less persuasive argument.

    Second, that if the UK take so extraordinary a step then we should expect BP, Shell and other large multinationals to run away, and move their holding company and headquarters elsewhere. That is much less of a risk if other countries introduce worldwide windfall taxes – that might yet happen, although the windfall taxes announced to date have tended to be territorial. But the really key question is whether people see any extraordinary new windfall tax as a one-off, never to be repeated, or the start of a series of similar taxes. The two previous UK windfall taxes: the 1981 bank deposit tax and the 1998 utility windfall tax, were promised to be exceptional one-offs, and those promises were kept. How credible would such a promise be today?

    A retrospective worldwide tax on UK headquartered energy companies would unprecedented, highly controversial, and is not without risk – but in these serious times it should be given serious consideration.

    I’ve written more about how such a tax could be designed.

    Comment policy

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  • Is VAT stopping 26,000 businesses from growing? More on the VAT growth brake.

    Is VAT stopping 26,000 businesses from growing? More on the VAT growth brake.

    Tax Policy Associates has new data suggesting that around 26,000 businesses are stalling their growth for fear of hitting the VAT threshold.

    This chart deserves more attention:

    It shows the number of businesses at each turnover level in 2018/19. You’d expect a reasonably smooth curve, falling from a large number of small businesses on the left side, down to a smaller number of larger businesses on the right. But we don’t see that at all – we see a massive cliff edge right on the £85,000 VAT registration threshold – the point at which they’d need to charge 20% VAT.. The FT covered this here – apologies for not writing it up sooner.

    What does that mean? It means that companies are holding back their turnover – slowing and stopping growth – to avoid having to charge VAT.

    That looks much worse than the data HMRC published for 2014/15, which I commented on here..

    Worse in two ways: more bunching before the threshold, and a steeper decline afterwards. About 3,500 companies per £1k turnover band go “missing” (compared to about 2,000 in 2014/15) and about 4,500 sole traders (around 3,500 in 2014/15). Why? I don’t know. One plausible cause is the significant limitations placed on the VAT flat rate scheme after 2015-16.

    Why do we see the cliff-edge effect? Because businesses don’t want to have to charge VAT – and have to raise prices by up to 20%.Compliance hassle is also a factor, but evidence suggests much less important than the cold hard cash cost.

    So they suppress their turnover. If the 2022 Warwick paper is correct, this is decelerated growth rather than failure to report income/VAT evasion. I wrote about that more here.

    How? For example: plumbers don’t take on an apprentice. Contractors stop working in February. Accountants work separately rather than combining into one business. What effect is this going to have on overall UK productivity? I’m not an economist, but it doesn’t feel fantastic…

    We can approximately measure the effect by measuring the size of the “bulge” before the cliff in the chart, and counting the number of firms in it:

    That’s about 26,000 businesses whose growth has been stalled by the VAT threshold.

    I continue to think that this is one of the most critical UK tax policy problems.

    How does the UK’s registration threshold compare with everyone else?

    The UK has the highest registration threshold in the world:

    When the threshold is as low as $30,000, it becomes unrealistic for businesses to suppress their growth to keep below it. Only the most micro of micro businesses won’t charge VAT, and everyone else is on a level playing field.

    Why is this a problem?

    One way to view this is that the UK is losing out on VAT revenue. I think that is to miss some much more important issues.

    It doesn’t seem fanciful to think that some of the 26,000 firms that are holding their growth below the VAT threshold might have thrived if they’d gone beyond it. Hired more employees, grown from micro companies into small, then medium, then – who knows? – become large businesses. What is the impact on macroeconomic growth of some companies’ growth simply stalling?

    And could this be part of the productivity puzzle? The effect of staying below the threshold is that businesses never grow past one employee… but there is good evidence that businesses with more employees are more productive. There is an excellent article making exactly this point from the Adam Smith Institute (they seem to have been the first people to write about the issue – full credit to them).

    I’d love to see an economist undertake some analysis on whether there is a material macroeconomic impact from the effects shown by the HMRC and Warwick data.

    What’s the solution?

    Here are three bad solutions:

    • Raise the threshold dramatically. That doesn’t remove the problem; it just moves it to a higher turnover level. It would also be extremely expensive – every £1,000 of increase in the threshold costs approximately £50m in lost VAT revenues.
    • Reduce the threshold to an OECD average. That in principle fixes the problem, but at that cost of requiring every small/micro business to apply VAT at 20% overnight. That doesn’t seem wise or politically realistic.
    • Reduce the threshold a bit. I fear even (say) a £5,000 cut in the threshold is too politically difficult, and it would just move the problem elsewhere.

    And a boring solution, which is probably what’s happening at the moment:

    • Freeze the £85,000 registration threshold over time. Inflation is 10% this year; if we then assume 4% average inflation for the next ten years, then in real terms the threshold will be £52,000 by 2034, and £35,000 by 2044. So a partial solution – but if the current cliff edge is a real economic problem, waiting twenty years to solve it feels like an inadequate response.

    What we need is a way to eliminate the dramatic “cliff-edge” effect that takes less than twenty years, doesn’t just move the cliff-edge elsewhere, and is neutral in government revenue terms. And one benefit of Brexit is that we have the freedom to change VAT however we like.

    Here’s one potential idea:

    Instead of a dramatic threshold, that takes VAT from zero to 20%, let’s smoothly phase it in. So, for example, at £30,000 VAT would be applied at 1% (and input tax recoverable at 1%), with the rate increasing bit-by-bit until by £140,000 VAT would fully apply at 20% (with the intention that the overall effect is revenue-neutral). The OTS proposed further investigation of such a system back in 2019, but I don’t believe it went any further.

    This would once have been impractical, given that the complications it creates for business customers of a business applying (say) 7% VAT. But all VAT returns will soon be digital – so that element now feels like a relatively trivial technical problem, rather than a difficult human one.

    I shouldn’t understate the challenges. One particularly difficult element is how you decide in advance what rate a business should charge. Easy(ish) for an established business with a consistent quarterly turnover. Hard for a new business, or one that’s growing or shrinking unpredictably.

    You could sidestep that difficulty, but achieve an economically identical result, with a rebate system. Everyone charges 20% VAT from (say) £30,000 of turnover, but 19% of that is rebated for £30k businesses. The rebate drops as turnover increases, vanishing entirely at (say) £140k. If you pay the rebate quarterly in arrears then that removes the need to predict future turnover – that does, however, create a three-month cashflow problem for small businesses, and trying to solve that problem just runs into the predictability issue again. Rebate systems also can create tricky issues with cross-border supplies – how do we give foreign suppliers a rebate? And if we don’t, how can we avoid distortions and unfairness (and potentially WTO/GATS difficulties)?

    And we shouldn’t minimise the political difficulties with any proposal which increases prices/reduces profit for £30k-£85k businesses. I don’t expect the immediate beneficiaries (the £85k-140k businesses) would call many demonstrations in support. So it would take a brave Government, which recognises a potential brake on growth and is willing to court unpopularity to release it.

    I’d love to see this issue becoming part of the public tax debate. I can’t lie: solving it will be really hard, and require input from people with expertise that I don’t begin to have. Specifically, economists need to confirm the intuition that this is a serious problem for the UK economy, and compliance specialists (in HMRC and the private sector) need to work up a solution that doesn’t cause more problems than it fixes. It’s possible we end up concluding that the current situation is bad, but any radical solution would be worse, and we just have to sit tight for ten/twenty years and let inflation erode the VAT threshold to something sensible.

    All of this would need very serious thought, and I am absolutely not saying I have all the answers. Very possibly I have none of the answers. I do, however, believe I have a question.

    Comment policy

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    Footnotes

    1. The HMRC FOIA response is here, and our analysis preadsheet here. ↩︎

    2. from the OTS review of VAT in 2017 ↩︎

    3. I’m having to eyeball that, as we don’t have the raw data for 2014/15, only the chart ↩︎

    4. An obvious response is “Brexit”, but I don’t think that can be right. Brexit certainly made things more complicated for cross-border sales, but only after legally effective exit on 1 January 2021. Some firms adapted their business models ahead of 2021, but those were generally larger firms. And in this case it would be odd for small firms to suppress their turnover (i.e. make less money!) or hide income (commit criminal tax evasion!) before it gave them any advantage. So I can’t immediately see why there would be any Brexit effects as early as 2018/19. However, there could be significant Brexit effects from 1 January 2021, meaning that the effect could plausibly be much worse today than it was in 2018/19. ↩︎

    5. Many thanks to Damian McBride on Twitter for suggesting this. The flat rate scheme was restricted for good reason – it was being widely abused – but it would be good to have some assurance that the cure is better than the disease… right now I don’t know ↩︎

    6. “up to” because many businesses will be able to recover significant input VAT. For example, if I run a restaurant with £100k of turnover, £20k of ingredient costs (plus VAT) and £30k of rent (plus VAT) then I’ll owe HMRC 20% of £100k but be able to recover 20% of £20k and 20% of £30k. My net VAT bill is therefore £20 – £4 – £6 = £10. So becoming VAT registered is actually costing me 10% of my turnover, not 20%. Contrast with e.g. if I’m a tax consultant operating out of my house with few VATable expenses – my VAT cost is then likely close to 20%. Of course they could instead eat some of the VAT cost in the form of reduced profits – but in most cases their profits will be too small to cover more than a teensy bit of the VAT cost ↩︎

    7. The chart doesn’t include the US because, whilst many States apply sales taxes with thresholds as high as $500,000, they’re conceptually very different from VATs. The rates are much lower (averaging around 6%), they don’t apply B2B, and the tax bases are relatively limited. Singapore also isn’t on the chart, as it’s not an OECD member – it has a high GST registration threshold of SGD 1m/year, but that’s much easier in a country where the tax/GDP ratio is less than half the OECD average ↩︎

    8. I am also assuming politicians can resist heavy lobbying to stop the freeze. You may feel that is like assuming a spherical cow. ↩︎

    9. mostly ↩︎

    10. See paragraph 1.29 here ↩︎

  • Three wrong takes on the Zahawi affair

    Three wrong takes on the Zahawi affair

    I wanted to try and scotch what I think are three wrong takes on the whole Zahawi business. So a quick few words:

    This was David vs Goliath, and David won!

    No – Zahawi and his advisers made the tactical mistake of accidentally SLAPPing someone with plenty of financial resources, time, litigation experience, and plenty of contacts and friends in the legal, tax and media worlds. I’m sure Zahawi spent a small fortune on advisers – but my team would probably have cost ten times as much (had they charged me). Goliath accidentally started a fight with a bigger Goliath.

    That hides the unpleasant truth that the basic SLAPP strategy remains sound. In reality, when Goliath picks on David, Goliath will almost always win. That’s how our libel laws work, and it’s a disgrace.

    The lamestream media missed this story because they were useless/corrupt!

    I only started looking at ministers because of the weird FOIA experience Jim Pickard (FT) and I had. in June/July 2022. I only started looking at Zahawi because of the astonishing Anna Issac (Independent) report that Zahawi’s finances had been investigated by the NCA and HMRC and the Michael Savage and Jon Ungoed-Thomas story (Guardian) soon after that a “red flag” had been raised by the Cabinet Office over Zahawi’s appointment.

    Zahawi’s initial explanations were disproved thanks to investigative work from Billy Kenber and George Greenwood (Times).

    Zahawi’s attempt to sue me was then covered in The Times and briefly became widely shared on social media.

    But it then became a very hard story to cover. I continued to dig, sending correspondence to Zahawi’s lawyers and ultimately referring them to the Solicitors Regulatory Authority. It was complicated, relied upon believing my rather technical claims, and was in the teeth of firm denials from Zahawi and legal threats from his lawyers.

    There was also something of an overdose of political news at the time. So it had little attention in the press or, for that matter, in social media.

    But still, some papers covered it, particularly the specialist legal press. Catrin Griffiths at The Lawyer was fearless. And Laith Al-Khalaf and Sabah Meddings wrote, and the Sunday Times devoted space, to a lengthy profile of me, focussing on Zahawi. The Economist had a very kind piece. Much harder for the broadcast media, given the “due impartiality” rules and the additional scrutiny they are under.

    Probably Zahawi’s combination of litigation and stonewalling would have made the story die a slow, quiet death, but then Ashley Armstrong at The Sun blew the doors off with the scoop that, at the same time Zahawi was sending lawyer letters and denying everything, he was actually negotiating a secret settlement with HMRC. Followed a week later by Anna Issac (again! but now at the Guardian) with another scoop: Zahawi had paid 30% penalties.

    After that, everyone was on the story – newspapers, broadcast media, BBC, ITV, Sky News etc. Acres of coverage, and large numbers of journalists delving further into Zahawi’s background.

    So without the work of newspaper journalists, I wouldn’t have started looking at Zahawi, wouldn’t have been able to conclude that Zahawi was not telling the truth, wouldn’t have even suspected that a settlement had been made (with penalties!) and certainly the whole thing wouldn’t have reached a mass audience.

    This isn’t a story of media failure – it’s a story of effective scrutiny from all corners of the media, in the teeth of denials and legal threats.

    HMRC lied to Neidle and Pickard when they said no Minister was under enquiry

    The timeline is still very unclear, but it appears that Zahawi was under investigation for more than a year prior to his appointment as Chancellor. However, it does not seem he was under enquiry – an enquiry being a formal status that lets HMRC freeze limitation periods and require delivery of documents. Very possibly HMRC had made a discovery assessment. Either way, it seems likely that HMRC’s response to me was accurate. I didn’t ask if a Minister was under “investigation” because there is no formal legal concept of an “investigation” and HMRC would, rightly, have said that it was therefore too imprecise a question for them to answer.

    Comment policy

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  • Worse than careless? The Zahawi cover-up.

    Worse than careless? The Zahawi cover-up.

    Everyone is talking about the £3.7m of tax that Nadhim Zahawi “carelessly” failed to pay. Perhaps not enough people are talking about the cover-up: all the times Mr Zahawi said his taxes were in order, when he surely knew they were not.

    UPDATE: this was written on 24 January. Now, on 29 January, we have Sir Laurie’s conclusions, and it appears that Zahawi must have known he was under investigation long before the “early July” timeline in his statement to the Telegraph. Hence the below is a dramatic understatement – we can add to it the many times Zahawi denied he was under investigation.

    The statements

    Here are ten of Zahawi’s statements, with links to original sources:

    Many, perhaps all, of these statements must have been false and/or misleading at the time Mr Zahawi made them, and he must have known that. This was the cover-up.

    How can we be sure these statements were false/misleading?

    There are still lots of gaps in our knowledge, but we know this for sure about the timing:

    And we know this for sure about Mr Zahawi’s relationship with Balshore and the trust and his tax:

    • Balshore held the YouGov shares, and we know they were eventually sold for around £27m (there were dividends on them as well; we don’t know the total amount).
    • Mr Zahawi absolutely received £99,000 from Balshore in 2005 (we know this from an accidental corporate error, which led to a disclosure in the IPO documents)
    • Mr Zahawi received, directly or indirectly, the proceeds from the disposal of the YouGov shares, or was entitled to those proceeds (otherwise he would surely not have been taxed on them). In plain English – he benefited from the Balshore structure. In technical tax terms, he was likely a beneficiary of the trust.
    • The existence of the settlement obviously means that, prior to the settlement, Mr Zahawi had failed to pay tax that was due. The fact he admitted to “carelessness” means it was not just a technical error – there was a failure to take reasonable care.

    The above facts – which nobody has contested, are simply not consistent with the ten Zahawi statements above.

    The Ministerial Code requires Ministers to be honest and truthful.

    Judge for yourself if Mr Zahawi was honest and truthful.

    Comment policy

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  • What the Zahawi statement tells us, and what we still don’t know

    What the Zahawi statement tells us, and what we still don’t know

    UPDATE: this was written right after Zahawi issued his statement on 21 January. The timeline in that statement is contradicted by Sir Laurie Magnus’ conclusions in his letter to the Prime Minister, but I won’t update this piece. Suffice to say that it’s now clear Zahawi knew he had a serious tax problem well before he became Chancellor in July 2022 and, when I started analysing the Balshore structure that same month, it seems likely that HMRC were well ahead of me.

    The Telegraph is carrying a statement from Zahawi.

    I gave an interview to BBC Breakfast this morning:

    And the following is my detailed response, and reflects discussions with other tax experts – tax solicitors, KCs, tax accountants, and retired HMRC officials.

    My commentary on the statement

    As a senior politician, I know that scrutiny and propriety are important parts of public life. Twenty-two years ago, I co-founded a company called YouGov. I’m incredibly proud of what we achieved. It is an amazing business that has employed thousands of people and provides a world-beating service.

    I agree. YouGov, and Zahawi’s role in founding it, is an amazing British success story. He should be proud of it.

    When we set it up, I didn’t have the money or the expertise to go it alone, so I asked my father to help. In the process, he took founder shares in the business in exchange for some capital…

    The “some capital” is a lie. It’s backing down from his initial claim that “startup capital” was provided – it’s now merely “some”. But it’s still not true. The facts are that his father/Balshore provided no capital at the time, and paid a nominal £7,000 two years later (with a Companies House form backdated – and by 2002, £7,000 was a triffling amount to the company). When I first called this a lie, Zahawi’s lawyers threatened to sue me for libel. When I pointed out the backdated form, they went silent, and never responded on the point. I don’t understand why Zahawi continues to raise a point that even his lawyers backed away from.

    … and his invaluable guidance.

    This was Zahawi’s fallback explanation, after I disproved the “capital”. The problem is that it contradicts all the published history of YouGov, everyone The Times talked to, and was denied by YouGov itself (in an official statement given to The Times). I wrote more about this here.

    Twenty-one years later, when I was being appointed Chancellor of the Exchequer, questions were being raised about my tax affairs. I discussed this with the Cabinet Office at the time.

    Following discussions with HMRC…

    The timeline jumps here. It misses the small detail of me saying I thought he’d failed to pay £3.7m in tax, him sending lawyers to threaten me and half of Fleet Street with libel writs, and him issuing denials that anything was wrong.

    When exactly did he realise that I was right, his denials were wrong, and approach HMRC?

    It also misses the timeline of when the “taxable event” happened – the thing that resulted in him having the large tax bill. This was either all or almost-entirely-all much more recent than twenty-one years ago. The big gain on the YouGov shares was in 2017/18. This is not ancient history – it’s when Zahawi was a successful and wealthy man, who you would expect to have very competent tax advisers.

    The tax return for 2017/18 was due by 31 January 2019, and could have been amended to reflect the disposal at any time up to 31 January 2020 (assuming it was not filed late). So we are talking about events of only 3-4 years ago. 

    … they agreed that my father was entitled to founder shares in YouGov, though they disagreed about the exact allocation.

    Unclear quite what that means – it goes to the technical basis for taxing him. Obviously, his father was “entitled” to the shares, because he owned them, as a result of Zahawi’s generous decision in 2000 to arrange for YouGov to issue them to Balshore for free.

    Perhaps this is suggesting the arrangement was a settlement, with Zahawi a beneficiary as to x% and his father to y%? But that’s a point of technical detail which goes down a long rabbit hole, and I won’t go further into here. The various technical ways in which Zahawi could have been taxed are fascinating, but which one was actually used doesn’t affect my conclusions – it’s also possible that neither HMRC nor the settlement needed to conclude this, and just stated an amount.

    They concluded that this was a ‘careless and not deliberate’ error.

    If it was deliberate, he’d be prosecuted for criminal tax evasion. HMRC “concluding” it wasn’t criminal isn’t a ringing endorsement.

    “So that I could focus on my life as a public servant, I chose to settle the matter and pay what they said was due, which was the right thing to do.

    This implies it was some obscure technical point, which could have gone either way, and he chose to pay up. That isn’t what happened. 30% penalties don’t get charged for being on the wrong side of obscure technical points. He was “careless”.

    What does that mean? Well, it’s easy to not be “careless”: instruct proper advisers, give them all the information relevant to your tax return, follow their advice, and check your tax return (as best as you reasonably can). Then, even if your advisers turn out to have been complete idiots, the law and HMRC will agree that you weren’t careless.

    So we now know for a fact Zahawi didn’t do this.

    We can’t know for sure what went wrong but, under the circumstances, my view (and that of most other experts I’ve spoken to) is that the most likely scenario is that he received somewhere around £27m, didn’t obtain proper advice, and didn’t declare it to HMRC.

    That settlement almost certainly contained a written admission by Zahawi of default – that he had failed to meet his obligations. That is HMRC standard practice, published here.

    Additionally, HMRC agreed with my accountants that I have never set up an offshore structure, including Balshore Investments

    Games with words. We know his father set it up.

    We know Zahawi likes these games. When The Sun reported the story, he said he didn’t have “lawyers” negotiating the settlement with HMRC. He now admits there was a negotiated settlement, but it was actually “accountants”.

    I regard these kind of games as an attempt to deceive – as a lie – and I expect most people in and outside politics will have a similar view.

    and that I am not the beneficiary of Balshore Investments.

    More games. Balshore Investments is a company. Nobody is a beneficiary of Balshore Investments.

    The question is: is he a beneficiary of the trust? He has denied this in the past. His lawyers denied it to me as recently as 1 December 2022. There’s clear evidence it’s not true, and that he received a gift from Balshore on one occasion. By sheer luck, a corporate goof meant that this was disclosed in the YouGov 2005 IPO papers. It seems likely there were other gifts. Perhaps these are more games, and Zahawi is using “beneficiary” in a way I do not understand.

    This matter was resolved prior to my appointments as Chancellor of the Duchy of Lancaster and subsequently chairman of the party I love so much. When I was appointed by the Prime Minister, all my tax affairs were up to date.

    If true, this means he negotiated and signed a settlement with HMRC when he was Chancellor of the Exchequer. The phrase “conflict of interest” seems insufficient.

    When Winston Churchill was Chancellor, he famously summoned the Chairman of the Board of the Inland Revenue, and had him devise a tax avoidance scheme to convert his income into capital, so it escaped tax (there was no CGT at the time). Times have changed. And Zahawi, whilst an impressive figure in many ways, is not Churchill.

    Key outstanding questions

    1. When did Zahawi become aware he had unpaid tax, and how? Was it sparked by my July report?
    2. Why did he respond to me, and others reporting on his tax affairs, with libel threats rather than simply saying there were questions he was looking into?
    3. What were the income/gains on which he is taxed? My expectation is that this is around £27m originating in Balshore’s gain on the YouGov shares, returned in some form – directly or indirectly – to Zahawi.
    4. If that’s right, why did he repeatedly deny benefitting from Balshore and the trust?
    5. Why didn’t he declare the £27m (or whatever the precise figure was) to HMRC? It was a huge figure. About a third of his net wealth at the time.
    6. When did he/his advisers approach HMRC for a settlement?
    7. If it was at a time when he was Chancellor, how was the obvious conflict of interest declared and handled?
    8. Was the settlement under COP 9 – the procedure where HMRC suspects tax fraud? This can end in a contractual settlement of precisely the kind Zahawi entered into, i.e. if HMRC conclude they suspect but can’t prove fraud. Osborne Clarke, Zahawi’s lawyers, have told me that HMRC did not apply COP 9.
    9. In the experience of advisers who work in this area, a 30% penalty implies Zahawi and his advisers did not provide full and complete cooperation. Why was that?
    10. Settlements usually contain a written admission by the taxpayer that they had failed to meet their legal obligations – i.e. that their taxes were, prior to the settlement, in default. Did his?
    11. If it did, then why has he repeatedly said that he has always reported, and paid, the tax that is due?
    12. When was the settlement finalised?
    13. Why did he attempt to mislead The Sun, by saying he didn’t have “lawyers” negotiating the settlement?

    I’m ignoring the many technical questions about the nature of the arrangement and how it was taxed – they’re less important now. I’m also ignoring some of the other questions around Mr Zahawi’s tax affairs, in particular the £30m unsecured loans into Zahawi & Zahawi (the company established by Nadhim and his wife, and now solely in her name). The loans come from an unknown party – but the nature of these loans means its likely someone closely connected to him.

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  • It’s wrong to say Nadhim Zahawi evaded tax. It’s also wrong to say he didn’t. Here’s why.

    It’s wrong to say Nadhim Zahawi evaded tax. It’s also wrong to say he didn’t. Here’s why.

    It’s increasingly likely that Nadhim Zahawi should have paid £3.7m in tax at some point after 2005, but didn’t. What are the legal consequences? Did he evade tax? As lawyers always say: it depends.

    UPDATE at 1pm: the Guardian is reporting that Zahawi paid 30% penalties. I’ve updated the below to reflect that

    Here’s my handy tax avoidance/evasion infographic:

    Where does Zahawi sit on this chart? Going through each one:

    • 1. Normal tax planning. This isn’t that. It doesn’t look normal, and a contractual settlement isn’t normal. But I guess in principle the Sun’s report could be wrong, and all my instincts and expertise (and that of the many other experts I collaborated with) could be dead wrong. Consequence: I apologise to Zahawi, make a donation to a charity of his choice, and then eat my hat.
    • 2. Successful tax avoidance scheme. I always discarded this possibility – the structure just doesn’t work. The fact Zahawi appears to have approached HMRC to settle suggests that both Zahawi’s advisers and HMRC agree with me. But it’s just about still possible that I could be completely wrong. Consequence: I apologise to Zahawi, and make a donation to a charity of his choice.
    • 3. Failed tax avoidance scheme. Zahawi was fully advised on the structure by a reputable law/accounting firm, and honestly believed it worked. The advisers were idiots, but he couldn’t know that. You might think Zahawi acted immorally, but that’s a value judgment – legally he’s squeaky clean. This feels somewhat unlikely to me, as the structure is so amateur. But it’s possible. Consequence: the tax is due, with interest. Very possibly no penalties. Zahawi should sue his advisers.
    • 4. Non-compliant. Zahawi winged it, took no advice (except perhaps from his father or friends), and blundered into a situation where a pile of tax was legally payable, but he didn’t know that. This is very plausible, and forgivable, when a startup is founded – i.e. YouGov back in 2000. In my view it’s much less plausible once Zahawi started receiving serious sums of money from the structure – perhaps £25m or more. Surely at that point you’d obtain advice? Consequence: tax, plus interest, plus penalties of 10% to 100% (and possibly 200%) – depending on the precise facts
    • 5. Tax evasion. Zahawi knew the YouGov proceeds were taxable, but dishonestly failed to pay or report the arrangements to HMRC. Or he was so reckless about it that it amounts to dishonesty. Consequence: tax, plus interest, plus penalties at the top end of that 10% to 100% range (maybe even 200%). Prosecution for tax evasion and potential jail time.

    So I don’t think it will be scenarios 1 or 2.

    I expect we will find out pretty soon if it’s scenario 3 – failed tax avoidance scheme. If advisers are at fault, then Zahawi will surely say so. That doesn’t let Zahawi off the hook for his behaviour after I revealed the avoidance. If Zahawi indeed paid a 30% penalty then we can probably discard this scenario.

    Otherwise, it’s scenario 4 or 5. And here’s the key point: the only difference between the two scenarios is Zahawi’s state of mind twenty years ago. If/when the facts are clearer, and if/when we get an explanation from Zahawi, we may be able to assess the plausibility of Zahawi blundering vs Zahawi being dishonest. But it’s very unlikely we will ever know for sure… and very unlikely HMRC would be able to establish dishonesty beyond “reasonable doubt”.

    Journalists should put this question to Zahawi: “did HMRC apply their investigation of fraud procedure, COP9?” If they did, then HMRC thought tax evasion was absolutely a possibility, but didn’t proceed with a prosecution. I’ll talk more about that below.

    Another important point: it’s my opinion that Zahawi has been dishonest in his response to my original report. If he knew for a fact his tax affairs weren’t in order, but put out statements saying they were, then that was dishonest. But it does not necessarily follow from this that he was dishonest in not paying his tax – he could have been hiding out of embarrassment that he had blundered so badly.

    So how should this be reported?

    I would say:

    “If the Sun report is correct, and Nadhim Zahawi reached a contractual settlement with HMRC over his YouGov arrangements, then that means that he originally failed to pay tax that was due. At this point we don’t know why.”

    It’s misleading to say he avoided or evaded tax, and misleading to say definitively that he didn’t. We just don’t know enough. There is no need to use the words “avoidance” or “evasion” at all. If Zahawi doesn’t like the implication, then Zahawi can provide an explanation.

    Why is there one rule for the rich, and one for the rest of us?

    There isn’t. Except there kind of is.

    The frustrating thing is that it’s much easier to prove dishonesty/tax evasion in simple cases. A shopowner fails to declare a chunk of their sales to HMRC, and does so regularly, keeping two sets of books. What explanation is there, other than dishonesty? Ditto some benefit fraud.

    But a wealthy individual fails to declare cash in an offshore bank account, opened in the name of their dog? They can argue they forgot and got confused, and a jury might believe them. Without the dog detail, it’s even easier.

    And another thing that’s frustrating to many of us: when HMRC finds tax evasion, standard policy is not to prosecute unless there are very aggravating factors. HMRC will often charge penalties, and reach a contractual settlement agreement, backed by a promise from the taxpayer that they have fully disclosed everything. This is what HMRC’s Code of Practice on fraud investigation, COP9, says:

    HM Revenue & Customs (HMRC) investigation of fraud statement The Commissioners of HMRC reserve complete discretion to pursue a criminal investigation with a view to prosecution where they consider it necessary and appropriate. In cases where a criminal investigation is not started, the Commissioners may decide to investigate using the Code of Practice 9 (COP9) investigation of fraud procedure. Under the investigation of fraud procedure, the recipient of COP9 is given the opportunity to make a complete and accurate disclosure of all their deliberate and non-deliberate conduct that has led to irregularities in their tax affairs. Where HMRC suspects that the recipient has failed to make a full disclosure of all irregularities, the Commissioners reserve the right to start a criminal investigation with a view to prosecution. The term ‘deliberate conduct’ means that the recipient knew that an entry or entries included in a tax return and/or accounts were wrong, but the recipient submitted it/them anyway, or that the recipient knew that a liability to tax existed but chose not to tell HMRC at the right time. In the course of the COP9 investigation, if the recipient makes materially false or misleading statements, or provides materially false documents, the Commissioners reserve the right to start a criminal investigation into that conduct as a separate criminal offence.

    And that’s what happened with Lester Piggott – he confessed to undeclared cash in offshore bank accounts, paid the tax and penalties, and then it later turned out he had other offshore bank accounts he hadn’t disclosed. At which point the Inland Revenue prosecuted.

    Current HMRC practice has the considerable advantage that lots of tax, and penalties, is swiftly collected without the time, cost and uncertainty of a long trial. And in the worst cases, there clearly are prosecutions. But many of us think there should be more visible prosecutions of wealthy tax evaders – it would strengthen the rule of law, and everyone’s faith in the integrity of the tax system.

    But right now there is no reason to think Nadhim Zahawi has been treated any differently from anyone else. We can reassess that if/when we know the details of the settlement.

    But Nadhim Zahawi committed tax evasion! Jail him!

    Please think about the company you are keeping.

    Comment policy

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    Footnotes

    1. It’s inevitably an oversimplification. Any comments on how to improve the content or design would be gratefully received… the Tax Policy Associates infographics department has stopped returning my phone calls ↩︎

    2. Legend has it that the Revenue found out because, when he wrote them a cheque for the tax due on the three offshore accounts he’d ‘fessed up to, it was drawn on a fourth, completely undisclosed, bank account. ↩︎

  • Nadhim Zahawi – the whole story

    Nadhim Zahawi – the whole story

    UPDATE: this was written on 19 January, and I haven’t updated it. We subsequently learned (thanks to the Guardian) that Zahawi had been charged a large penalty. And we now know, thanks to Sir Laurie Magnus, that HMRC started investigating Zahawi well before the start of this timeline, and that Zahawi knew about that by April 2021. This timeline therefore is too kind to Zahawi: his deceptions were more serious than I knew on 19 January. It is also not kind enough to HMRC; it seems likely that, but the time I started analysing the Balshore structure, HMRC were already onto it.

    There’s a very lengthy backstory to Nadhim Zahawi’s HMRC settlement, and lots of people have been asking me to summarise it. Here goes:

    23 June 2022: I fired a Freedom of Information Act request at HMRC to establish if any Ministers are under HMRC enquiry. I was initially told at at least one was; HMRC now tell me none are. (This is important later.) Mentioned in the later FT story here.

    5 July 2022: Nadhim Zahawi becomes Chancellor of the Exchequer

    6 July 2022: The Independent reports that Zahawi had been the subject of an investigation by the NCA, the SFO and HMRC. Zahawi denied this – but how would he know if he was being investigated? Then the Guardian reports that the Cabinet Office had raised a “red flag” about Zahawi’s tax affairs before his appointment as Chancellor. This was pointedly not denied by the Cabinet Office. That caught my interest. I pulled all the publicly available documents on Zahawi’s business activities and started looking through them.

    7 July 2022: I spot a filing error in the accounts of an unrelated company, Crowd2Fund Limited, which proves that Balshore Investments Limited, a Gibraltar company previously linked to Zahawi, is held by a trust controlled by Zahawi’s parents.

    9 July 2022: I conclude that, when Zahawi established YouGov in 2000, he arranged for the founder shares that would have been his to go to Balshore. It paid nothing for the shares. The only plausible reason for this is tax avoidance. I check my conclusions carefully and speak to tax accountants, solicitors, QCs and retired HMRC inspectors, as well as entrepreneurs familiar with startup formation. I’m stunned by the unanimity of opinion: this stinks.

    10 July 2022: I publish. I’ve calculated the tax I think Zahawi avoided – it’s mostly the gain on the YouGov shares which would have been subject to CGT had Zahawi held them, but is tax free in Gibraltar. The figure is £3.7m (a lower bound; I make some conservative assumptions).

    11 July 2022: Zahawi is interviewed by Kay Burley. He says: “There have been claims I benefit from an offshore trust. Again let me be clear, I do not benefit from an offshore trust. Nor does my wife. We don’t benefit at all from that.”

    13 July 2022: Zahawi’s people have been claiming Balshore got the shares because his father provided startup capital. I go through all the documents and accounts again, and am satisfied this is false. I say so, and challenge Zahawi to correct me if I’ve gotten it wrong. I know his people see this.

    14 July 2022: Zahawi’s people respond by seamlessly jumping to a new explanation: that Balshore got the YouGov shares because Zahawi “had no experience of running a business at the time and so relied heavily on the support and guidance of his father, who was an experienced entrepreneur”. There is nothing in any documentation I could find, or in the publically known history of YouGov, to support this story.

    16 July 2022, 8am: An investigation by The Times suggests the new explanation is false – YouGov itself, and people present at its founding, say his father wasn’t involved in the business. Zahawi is able to rustle up two people who say they met his father and he was helpful. I’m pretty helpful – nobody hands me a 40% shareholding in their startup.

    16 July 2022, 8.40am: I conclude this all means Zahawi’s first explanation, that his father provided startup capital, was a lie. It is provably false, and the ease with which he slipped to a new explanation suggests it was deliberately false. I tweet this.

    16 July 2022, 5pm: I receive a Twitter direct message from Osborne Clarke, Zahawi’s libel lawyers, asking to speak. I tell him to put anything he has to say in writing, and that I won’t accept “without prejudice” correspondence (which is normally kept private):

    16 July 2022, 7pm: I receive an email from Osborne Clarke, labelled “without prejudice”. It tells me I cannot publish or even refer to it, and that would be a “serious matter”. It requires me to retract my allegation of lies by the end of the day, or they will write to me on an “open basis” (which usually means: they will send a “letter before action” threatening to sue me). The email is a confused mess, accusing me of saying Zahawi’s second explanation was a lie, when in fact I said his first explanation was a lie. Seems like pure bluster. No need to react.

    17 July 2022: I do some more analysis. A chance company law error means YouGov IPO documents disclosed that a £99,000 dividend from Balshore was redirected to Zahawi. His claim to not have benefited from the trust is false. The obvious inference is that there were many gifts; it’s just happenstance we see this one. A forensic accountant working with me identifies almost £30m of unsecured loans going into Zahawi’s property company. Another obvious inference: some of this may be the YouGov profits coming back to Zahawi.

    19 July 2022, 8am: I receive a letter from Osborne Clarke. This time it addresses what I actually said, but tells two fibs. First, it says that Balshore paid £7,000 for the shares in 2000. I’m reasonably confident it didn’t – two years later a back-dated Companies House form was filed and £7,000 paid (see page 4 here; the accounts are consistent with that). Second, it claims that £7,000 was “startup capital” – just daft. Why is he saying things that clearly aren’t true? Why are his lawyers repeating them? Again I’m warned I can’t publish the letter.

    19 July 2022, 9am: I realise what the letter doesn’t contain: a statement that Zahawi’s taxes have been fully reported and paid to HMRC. I publish my analysis from the 17th.

    20 July 2022: I keep hearing that other people are receiving threatening letters from Osborne Clarke, containing warnings not to publish. Time to think about whether these warnings are true. I’m not an expert in confidentiality law, but I know enough to get by, and their claim feels like nonsense. And it’s outrageous that Zahawi thinks he can not only use libel law to shut people up, and do it in secret. I call a contact who is a leading expert in confidentiality law, and he snorts with derision down the line. I call a few more, just to be cautious – lots of snorting.

    22 July 2022: I publish the Osborne Clarke letters, and explain why legally I am entitled to. The Times reports it. This goes slightly viral. The Tax Policy Associates website normally gets a few thousand readers a day – today we got 400,000. Turns out people don’t like the Chancellor of the Exchequer secretly stopping people writing about his tax avoidance.

    25 July 2022: I write to the Solicitors Regulation Authority, asking them to end the practice of libel lawyers sending threatening letters which they falsely claim can’t be published (or even mentioned).

    1 August 2022. At this point I’ve reached an impasse. I think I’ve proven that Zahawi has lied about the YouGov structure – that and everything else makes me reasonably certain that he has avoided around £3.7m in tax. But there’s been little media interest. Why? Partly Zahawi firing out libel threats. But I think mostly that we’ve been overwhelmed by politics, and scandal, and this just didn’t break through. All I can do is keep plugging away.

    24 August 2022. I ask Zahawi, through his lawyers, why there are so many inconsistencies in his story. And specifically, why he told Kay Burley he doesn’t benefit from the trust, when we know he received £99,000 from it. They duck the question. But they tell me Zahawi’s taxes are “fully declared and paid in the UK”.

    6 September 2022: Zahawi steps down as Chancellor.

    We now know that, at about this time, his accountants probably approached HMRC to settle his unpaid YouGov taxes – likely the same taxes I said he’d tried to avoid. Why now? Because settlements take time. If everything was finalised in early January, then he must have approached HMRC in early Autumn. And for several weeks before that (at least) his accountants must have been preparing their approach.

    So we can’t be sure exactly when – but it’s likely that at some point around this date, Zahawi knew that his tax was not fully declared and paid, and that what I’d written in July was in substance correct.

    13 September 2022. More evasion from Osborne Clarke. But one clear statement: “Our client’s taxes are fully declared and paid in the UK”.

    15 October 2022. A second libel threat from a second set of lawyers acting for Zahawi. I posted an innocuous tweet referring to the Independent report that Zahawi had been investigated by the NCA and HMRC. The threat looks like an automated mailshot – it doesn’t refer to my previous correspondence with Zahawi, and doesn’t seem to realise I am a tax lawyer. It’s amateur hour.

    29 November 2022. A great response from the SRA. They issue a warning for solicitors to stop sending libel letters which falsely claim to be confidential, and say they can’t be published. It’s not a change in practice, it’s a statement of what has always been the case – lawyers can’t lie.

    1 December 2022: yet another evasive non-response from Osborne Clarke to my questions. But again one clear statement: “[Zahawi’s] taxes are properly declared and paid in the United Kingdom”:

    (At this point it seems highly likely that Zahawi was deep into settlement discussions with HMRC, and therefore he knew that this statement was false)

    2 December 2022. Given the clear statement from the SRA, I refer Zahawi’s lawyers, Osborne Clarke, to the SRA. Lying and bullying should have consequences.

    3 December 2022: At this point the Zahawi story looks dead. His strategy of saying nothing seems to have won out.

    15 January 2023. Everything changes. An absolute scoop from Ashley Armstrong in The Sun on Sunday. Zahawi paid millions in tax to settle a dispute. There’s a hilarious non-denial denial from Zahawi that he “never had to instruct any lawyers to deal with HMRC on his behalf”. Later that day, that line is dropped – he doesn’t deny the story, he just refuses to comment.

    The obvious conclusion: Zahawi responded to my July analysis by instructing accountants to seek a “contractual settlement” with HMRC before an enquiry could be raised. This isn’t a dispute in the usual sense (“taxpayer says X, HMRC says Y”). It’s an admission that tax that was due wasn’t paid. These settlements are confidential. Zahawi was trying to make it all go away, quickly and quietly.

    16 January 2023. There is now a flurry of press interest. The Times. The FT. BBC online. LBC. Five Live (starts at 2:41:07). Radio 4 pm (starts at 46:44). The Independent. Sky News. More.

    Zahawi puts out a statement: his taxes are “properly declared and paid in the UK”. This can only be true in the most hyper-literal sense: today, his taxes (maybe) are properly declared in the UK. When he approached HMRC for a settlement, they certainly weren’t.

    18 January 2023, 12pm: Rishi Sunak is asked about Zahawi’s settlement at Prime Minister’s questions. I’ve the highest regard for Sunak’s probity. I know people who worked with him – they’ve no doubt as to his intelligence and his honesty. So it’s disappointing to hear this. No, Zahawi has not “addressed this matter in full”.

    18 January 2023. 10:30pm: Zahawi provides a clear statement to Newsnight (report starts at 13:25) that his tax affairs “were and are fully up to date”. No more games with tenses.

    Zahawi claiming that his tax affairs "were and are fully up to date"

    If/when the settlement details come out, we will know for sure this was a lie. And we’ll know that all the denials his lawyers issued to me were a lie – because at the very time they were made, Zahawi was negotiating a settlement to quietly cover up the fact he’d avoided millions in tax.

    Comment policy

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    Footnotes

    1. For completeness, the story doesn’t mention me because I asked Jim Pickard to keep my name out of it, and he kindly obliged – it felt too political for where I wanted Tax Policy Associates to be. The original FOIA application was mine, but Jim worked with me on interpreting it and responding to it, and deserves credit for the story that started the path that led to my Zahawi findings. ↩︎

  • Did Nadhim Zahawi pay up to avoid an HMRC enquiry over YouGov?

    Did Nadhim Zahawi pay up to avoid an HMRC enquiry over YouGov?

    That’s the obvious inference of this astonishing story in today’s Sun. On the face of it, this confirms my investigation in July that concluded Zahawi had avoided around £4m in tax by arranging for his founder shares in YouGov to be held by a subsidiary of his father’s offshore trust.

    Zahawi denies the Sun’s story, but in a curiously specific way: he “never had to instruct any lawyers to deal with HMRC on his behalf”.

    If the Sun is right, what would have happened?

    It’s reasonably clear there wasn’t a pre-existing enquiry into YouGov – Zahawi explicitly denied this and (more convincingly) around the same time I received confirmation from HMRC (in response to an FOIA request) that no ministers were under enquiry.

    So I would speculate that, when my investigation broke in July, Zahawi instructed accountants to look into his old YouGov structure. They told him that he was bang to rights; he then made a disclosure to HMRC with the aim of making swift payment in full to avoid an enquiry. If so, that might help explain the apparent speed with which a settlement was reached. Typically an HMRC enquiry involving a large amount involves years of negotiation, and HMRC has strict governance processes that they must comply with. I had expected HMRC would respond to my story by starting an investigation, and then by opening an enquiry around the end of 2022 – but if Zahawi had convincingly paid up in full by then, no enquiry would ever be opened.

    That is, however, just speculation. The payment could relate to some other matter – perhaps the mysterious NCA/HMRC investigation which was reported by the Independent, which (according to the Guardian) caused a “red flag” to be raised when Zahawi was appointed Chancellor. Zahawi denied this – but it was always a meaningless denial, because there’s no reason he would know he was under investigation. It was telling that the Cabinet Office, who could convincingly deny the “red flag” story, did not do so.

    Or the Sun could be wrong. That feels unlikely – it’s a big risk for them to run the story unless they were sure. I’ll keep an open mind – let’s see if we get any more convincing denials out of Mr Zahawi.

    UPDATE: new story from the Independent, with the interesting addition that Zahawi’s spokespeople don’t seem to be denying the story. They just repeat his usual boilerplate about his taxes being properly declared and paid. That rather begs the question of whether they’re only properly declared and paid because he approached HMRC to disclose a previous under-payment of tax)

    So what’s going on? If this was a boring ordinary course self assessment payment of tax then presumably Zahawi would say so?

    And if it wasn’t… what was it?

    More to follow.

    Comment policy

    This website has benefited from some amazingly insightful comments, some of which have materially advanced our work. Comments are open, but we are really looking for comments which advance the debate – e.g. by specific criticisms, additions, or comments on the article (particularly technical tax comments, or comments from people with practical experience in the area). I love reading emails thanking us for our work, but I will delete those when they’re comments – just so people can clearly see the more technical comments. I will also delete comments which are political in nature.

  • Donald Trump’s companies failed to file their accounts – but the scandal is that this is normal

    Donald Trump’s companies failed to file their accounts – but the scandal is that this is normal

    Updated to correct my claim that there are few if any prosecutions for failure to file. There are in fact several thousand in most years. That amazed me. So there isn’t a non-prosecution scandal. There’s a scandal of hundreds of thousands of late filings, and serious policy question as to how to fix this.

    Donald Trump’s Scottish hotel and golf businesses have failed to file their accounts for 2021:

    What does this mean?

    There’s an automatic late filing penalty of £150. Not much, but more than Trump paid in US Federal income tax in 2020.

    More interestingly, if a company fails to file accounts on time, it’s a criminal offence for the directors, with a potentially unlimited fine:

    In this case there’s just one director, Eric Trump. Donald Trump stood down as director after he was inaugurated – although if (as must be possible) he is still directing things behind the scenes, then he will be a “shadow director” and also potentially criminally liable.

    There’s a defence if the directors can show they “took all reasonable steps” to file. The most common reason – and the one I’m betting is the case here – is simple disorganisation/ineptitude. That will not qualify for the defence. What would? Most often some kind of difficulty getting the auditors to sign off on the accounts. Perhaps because a difficult technical problem has arisen (unlikely with such a relatively simple business as this one). Perhaps – more interestingly – because there is a question whether the business remains a going concern.

    It’s pretty common for small companies to miss filing deadlines. Much less common for large businesses – and when I worked on big ticket corporate M&A and financings, these kind of failings were a “tell” that there were financial or governance problems.

    We’ve no way of knowing what the reason is for the Trump companies’ delinquency. The tax writer Rebecca Benneyworth spotted that it looks like the Trumps had already extended the filing deadline from 30 September to 31 December. That was probably an automatic three-month Covid extension – but that’s usually a one-off, and wouldn’t explain the late filing now. That could be down to disorganisation or chaos just as much as it could be evidence of a real problem. Chaos seems the safe bet.

    Update: thanks to The National for spotting that the Trumps filed their past accounts by post, not online. So it’s possible they posted the 2021 accounts right at the end of the year, but before the deadline, and Companies House just hasn’t gotten round to them yet. And also possible that the postal strikes delayed a filing that was actually posted before the deadline. I’ll withdraw/update this post if either turns out to be the case Further update – initial indications are that this is not the reason. More to follow.

    There is one thing we can know for certain. The Trumps won’t be prosecuted. Over 200,000 companies file late, and pay the £150 penalty. I gather in some circles late filing is considered normal, or even tactically advantageous.

    Yesterday I wrote this: “But it is almost unheard of for a director to be prosecuted. Of course it is more accurate to say: over 200,000 companies file late because it is almost unheard of for a director to be prosecuted.”

    But a lawyer (an old contact of mine) with considerable experience in this area has made clear that I am completely wrong. There are in fact a large number of prosecutions. Companies House publishes the full statistics, but they are hard to find – see Table 6 here. The upshot is that there are several thousand prosecutions in a normal, non-Covid year:

    On the surface, it looks like about a 50% conviction rate, but that’s not right – about half the charges are withdrawn… and I understand from my contact, that’s because the accounts have been filed. Account for that and adjournments, and (unless I’m mistaken) the conviction rate looks close to 100%.

    Much less going on in Scotland:

    I don’t understand why this is. There are about 20x fewer Scottish companies than in England & Wales (see tab 9 of the linked spreadsheet), but about 100x fewer prosecutions. Northern Ireland has about 1/3 of the number of companies as Scotland, but around the same number of prosecutions.

    So my conclusion that the Trumps are likely safe is surely correct, but my reasoning was completely wrong – and I apologise for having unfairly denigrated what looks like a busy and effective Companies House prosecution service (at least in England & Wales).

    The mystery

    I said there was a scandal of non-enforcement, and it looks like I was dead wrong. Instead we have a mystery – why do so many companies file late when in fact there is a non-zero prospect of prosecution?

    • Are the prosecutions not well known? (Possible, given I spoke to six experienced lawyers and only one was aware of them).
    • Is it a mistake to drop prosecutions if the directors belatedly file the accounts? The prosecutions are said to be dropped because they are “no longer in the public interest”. That is debatable. I would say the public interest is not just in making a particular director file their own accounts, but in deterring late filed accounts across the board. In essence, the prosecution policy has changed the offence from “failing to file by the due date” into “failing to file”. That does not seem right to me.
    • Do these two factors combine so that, rationally, a director can happily file late and accept the low risk of a prosecution, knowing that the prosecution will almost certainly be discontinued once they do file?

    I’m not sure what the reason is. But I am sure there’s a problem – because late filing prejudices people dealing with the companies (who often rely on filed accounts to judge creditworthiness) and facilitates financial crime.

    Here’s a suggestion for a policy response:

    • Does Companies House do enough to make people aware of prosecutions for failure to file accounts? (given my error on this, I would of course say “no”…)
    • Investigate late filing in more detail – who is filing late, how late are they filing, and what the reasons are
    • Analysis of prosecutions. Who is being prosecuted? Is it really in the public interest that prosecutions are dropped when accounts are belatedly filed?
    • Is it correct that Northern Ireland and (particularly) Scotland prosecute fewer offences? If so, why?
    • Does the automatic £150 penalty need to be increased for larger companies? It’s tempting to make it a percentage of turnover, but that could easily become disproportionate. 0.1% of turnover for the Trump companies would be a not-so-large £7,000, but for Sainsbury’s (a silly example to make the point) would be a ridiculous £38m
    • It’s ridiculous that so many companies still file on paper. That includes giants like HSBC and Tesco. The reason is that (as a number of people have now told me) Companies House’s online submission service only works for very simple cases. That’s inconvenient for those companies; it also means that Companies House records are much more difficult to analyse electronically (which is inconvenient for the rest of us).

    It would be quite wrong for a small company missing the filing deadline by a day to face prosecution. And it would be equally wrong to selectively prosecute Trump, particularly given that Scotland appears to prosecute basically nobody.

    But I remain of the view there is a problem – I’m just much less certain about the solution than I was yesterday.

    Photo by Max Goldberg, licensed under the Creative Commons Attribution-Share Alike 4.0 International license

    Footnotes

    1. The ultimate sanction is for a company to be struck off. If the failure to file continues, then Companies House will send a written warning; then another warning; then they’ll begin the process of striking the company off. ↩︎

    2. I am saying “almost” because it’s possible there have been some prosecutions, but I’m not personally aware of any ↩︎

    3. I should have known this. In my defence, I’ve only ever personally filed for very simple companies… but I should not have extrapolated that to other companies without checking. My bad. ↩︎

  • Why VAT may be a brake on UK growth, and how to fix it

    Why VAT may be a brake on UK growth, and how to fix it

    UPDATE: new data suggests the situation is now much worse than suggested in this article. Please see our latest report for the details.

    This chart should keep the Chancellor up at night. It shows the number of businesses by turnover band.

    You’d expect a reasonably smooth curve, falling from a large number of small businesses on the left side, down to a smaller number of larger businesses on the right. But we don’t see that at all – we see a massive cliff edge right on the VAT registration threshold. Businesses don’t want to have to charge VAT – and therefore either raise prices by up to20% or reduce their profits by the same amount (and the admin hassle is likely also a factor, but I expect a much smaller one). So they suppress their turnover.

    This isn’t news – and it got some coverage at the time. But a new paper from the CAGE research centre at Warwick puts beyond doubt that this one of the most critical UK tax policy problems.

    New evidence

    The CAGE team analysed a huge dataset of companies from 2004-2015, with sophisticated controls to minimise confounding effects. They find an even clearer effect than the simple OTS chart above. Here’s a chart showing the proportion of firms that are growing for given levels of turnover:

    The ‘0’ point on the x axis and red line running through it) is the VAT threshold. Look how growth peaks immediately before that point and then slumps right on the threshold.

    By contrast, shrinking firms show the kind of smooth curve we’d expect:

    The smooth shrinkage curves also suggests that the growth cliff-edge is real, and not being driven by failure to declare turnover (i.e. criminal tax evasion). If firms did evade tax to keep below the threshold, then we’d expect to see the same effect in reverse, with a cliff-edge for shrinking firms (so, for example, a firm with £90k of revenue would fail to declare £5k of that, to slip below the threshold before it’s entitled to do so). But we don’t see any evidence of that.

    The Warwick team goes further, and look at the impact on rates of growth on turnover and cost:

    We can see the brakes being put on – with turnover and cost growth slowing down just before the threshold, but then returning to a higher level afterwards. The fact it happens to cost as well as turnover is important, because this again suggests the effect is real and not just turnover being kept “off the books” (you can’t keep costs off the books without conspiring with your supplier).

    How do firms manage their growth?

    We can get a sense of this in research which HMRC commissioned from Ipsos MORI in 2017. The findings were stark:

    If 20% admit to restricting their turnover, I expect the real proportion is significantly higher.

    And this accords with the anecdotal evidence I hear from everyone I ask about the subject – whether SME consultants, accountants, coffee shop-owners, builders, builders’ clients… it’s common knowledge that small businesses depress their revenue, most typically by not expanding, not taking on apprentices, and/or cutting back on hours when approaching the threshold. Such as:

    Anecdote is not data, but given we already have the data, I find the consistency of the anecdotes compelling.

    Are there similar effects elsewhere in the world?

    Surprisingly little work has been undertaken in this area, and none that I can find elsewhere in the OECD. However, there has been a detailed analysis of Thai VAT returns, which can be neatly summarised by this chart:

    and this chart, from a preliminary analysis of Indian VAT returns:

    A similar effect to the UK, albeit more dramatic. Note how the Indian and Thai charts show a much more pronounced peak before the threshold than the UK chart. I would speculate this is because of increased tax evasion compared to the UK – i.e. businesses not just decelerating growth as they approach the threshold, but failing to report sales that would take them over it.

    How does the UK’s registration threshold compare with everyone else?

    The UK has the highest registration threshold in the world:

    When the threshold is as low as $30,000, it becomes unrealistic for businesses to suppress their growth to keep below it. Only the most micro of micro businesses won’t charge VAT, and everyone else is on a level playing field.

    Why is this a problem?

    One way to view this is that the UK is losing out on VAT revenue. I think that is to miss some much more important issues.

    It doesn’t seem fanciful to think that, some of the firms that are staying below the VAT threshold might have thrived if they’d gone beyond it. Hired more employees, grown from micro companies into small, then medium, then – who knows? – become large businesses. What is the impact on macroeconomic growth of some companies’ growth simply stalling?

    And could this be part of the productivity puzzle? The effect of staying below the threshold is that businesses never grow past one employee… but there is good evidence that businesses with more employees are more productive. There is an excellent article making exactly this point from the Adam Smith Institute.

    I’d love to see an economist undertake some analysis on whether there is a material macroeconomic impact from the effects shown by the HMRC and Warwick data.

    What’s the solution?

    Here are two bad solutions:

    • Raise the threshold dramatically. That doesn’t remove the problem; it just moves it to a higher turnover level. It would also be extremely expensive – every £1,000 of increase in the threshold costs approximately £50m in lost VAT revenues.
    • Reduce the threshold to an OECD average. That in principle fixes the problem, but at that cost of requiring every small/micro business to apply VAT at 20% overnight. That doesn’t seem wise or politically realistic.

    And a boring solution, which is probably what’s happening at the moment:

    • Freeze the £85,000 registration threshold over time. Inflation is 10% this year; if we then assume 4% average inflation for the next ten years, then in real terms the threshold will be £52,000 by 2034. So a partial solution – but if the current cliff edge is a real economic problem, waiting ten years to solve it feels like an inadequate response.

    What we need is a way to eliminate the dramatic “cliff-edge” effect that takes less than ten years, doesn’t just move the cliff-edge elsewhere, and is neutral in government revenue terms.

    Here’s one potential solution:

    Instead of a dramatic threshold, that takes VAT from zero to 20%, let’s smoothly phase it in. So, for example, at £30,000 VAT would be applied at 1% (and input tax recoverable at 1%), with the rate increasing bit-by-bit until by £140,000 VAT would fully apply at 20% (with the intention that the overall effect is revenue-neutral). The OTS proposed further investigation of such a system back in 2019, but I don’t believe it went any further.

    This would once have been impractical, given that the complications it creates for business customers of a business applying (say) 7% VAT. But all VAT returns will soon be digital – so that element now feels like a relatively trivial technical problem, rather than a difficult human one.

    I shouldn’t understate the challenges. One particularly difficult element is how you decide in advance what rate a business should charge. Easy(ish) for an established business with a consistent quarterly turnover. Hard for a new business, or one that’s growing or shrinking unpredictably.

    You could sidestep that difficulty, but achieve an economically identical result, with a rebate system. Everyone charges 20% VAT from (say) £30,000 of turnover, but 19% of that is rebated for £30k businesses, and the rebate dropping as turnover increases, vanishing entirely at (say) £140k. If you pay the rebate quarterly in arrears then that removes the need to predict future turnover – that does, however, create a three-month cashflow problem for small businesses, and trying to solve that problem just runs into the predictability issue again. Rebate systems also can create tricky issues with cross-border supplies – how do we give foreign suppliers a rebate? And if we don’t, how can we avoid distortions and unfairness (and potentially WTO/GATS difficulties)?

    And we shouldn’t minimise the political difficulties with any proposal which increases prices/reduces profit for £30k-£85k businesses. I don’t expect the immediate beneficiaries (the £85k-140k businesses) would call many demonstrations in support. So it would take a brave Government, which recognises a potential brake on growth and is willing to court unpopularity to release it.

    I’d love to see this issue becoming part of the public tax debate. I can’t lie: solving it will be really hard, and require input from people with expertise that I don’t begin to have. Specifically, economists need to confirm the intuition that this is a serious problem for the UK economy, and compliance specialists (in HMRC and the private sector) need to work up a solution that doesn’t cause more problems than it fixes.

    So all of this would need very serious thought, and I am absolutely not saying I have all the answers, or indeed many of the answers. I do, however, believe I have a question.

    Image by DALL-E: “a colourful set of equal-sized cubic children’s wooden building blocks with the letters VAT (in order), on a wooden table, digital art”

    Footnotes

    1. from the OTS review of VAT in 2017 ↩︎

    2. “up to” because many businesses will be able to recover significant input VAT. For example, if I run a restaurant with £100k of turnover, £20k of ingredient costs (plus VAT) and £30k of rent (plus VAT) then I’ll owe HMRC 20% of £100k but be able to recover 20% of £20k and 20% of £30k. My net VAT bill is therefore £20 – £4 – £6 = £10. So becoming VAT registered is actually costing me 10% of my turnover, not 20%. Contrast with e.g. if I’m a tax consultant operating out of my house with few VATable expenses – my VAT cost is then likely close to 20% ↩︎

    3. The one exception here is the apparently (anecdotally) common tactic of builders asking clients to buy their supplies directly, so it doesn’t go through the builder’s books and therefore take them over the threshold. This may be tax avoidance (depending on your own perspective), but in my view it’s not improper and certainly not criminal tax evasion ↩︎

    4. The chart doesn’t include the US because, whilst many States apply sales taxes with thresholds as high as $500,000, they’re conceptually very different from VATs. The rates are much lower (averaging around 6%), they don’t apply B2B, and the tax bases are relatively limited. Singapore also isn’t on the chart, as it’s not an OECD member – it has a high GST registration threshold of SGD 1m/year, but that’s much easier in a country where the tax/GDP ratio is less than half the OECD average ↩︎

    5. I am also assuming politicians can resist heavy lobbying to stop the freeze. You may feel that is like assuming a spherical cow. ↩︎

    6. See paragraph 1.29 here ↩︎

  • 5 ways to fix the UK tax system

    5 ways to fix the UK tax system

    This is a version of the article published by the Sunday Times on 1 January 2023 – it summarises some of the themes I wrote about in 2022, and some more that I’ll be writing about in 2023.

    Kwasi Kwarteng’s “fiscal event” last September was widely perceived as a disaster, but at its heart was a kernel of undoubted truth: there are features of our tax system that discourage growth — and we should fix them.

    Here are five.

    Income tax marginal rates over 60%

    The boldest, and most criticised, element of the Kwarteng mini-Budget was to scrap the 45p top rate to “simplify taxes” and “incentivise growth”. The problem with this is that, even if you accept the premises of Kwarteng’s position, 45p is not even close to the highest marginal tax rate in the UK.

    The marginal tax rate at any given income is the tax rate you pay on the next pound you earn. That’s crucially important, because it affects your incentive to earn that extra pound.

    I’ve charted the marginal rate of income tax and employee national insurance for different incomes, and it looks like this:

    This should immediately start ringing alarm bells. Why do the comfortably-off (£100-120k) pay a higher marginal rate of tax – 62%! – than those on really high incomes? Because at point the personal allowance starts to taper away – with every £1 of income earned about £100k, the personal allowance reduces by 50p.

    But we’re only getting started. What if you have three children all qualifying for child benefit? Well…

    Child benefits starts to be withdrawn at £50,000 – resulting in a marginal rate of 68% between £50k and £60k.

    Sad to say, we can make even that result look good if we throw in the effect of the Government’s much-heralded “tax free childcare” scheme. This entitles you to up to £2,000 per child. The catch is that it completely disappears if your earnings hit £100k. A couple can each earn £99,000 and they keep the benefit; but if one earns £100k they lose it (even if the other earns nothing).

    What marginal tax rate is that? Well, if you’re claiming tax-free childcare for three children, and currently earn £99,999, your take-home pay is £69,884. Earn £1 more, and your take-home pay is less – £63,942. That’s an infinite marginal tax rate, so slightly tricky to show in a chart. Instead, here’s a chart of gross vs net wages:

    The ”dip” at £100k shows the drop in post-tax income, which isn’t recovered until you earn £20,000.

    Put all of this together, and what does it mean?

    It means that people who can control their hours usually think very carefully before putting themselves in the £50-£60,000 bracket, or the £100-£125k bracket.If they’re employed, they often make additional pension contributions, use salary sacrifice schemes, or find other ways to earn the money, but not pay tax on it. If they’re self-employed they often just stop working for the year. These are not good things for the UK economy.

    And, worse still, all these tapering effects are triggered by one person’s income hitting the £50k/£100k trigger points. That means that the Smiths (who each earn £60k) are much better off than the Joneses (where she earns £120k, and he stays at home). The Smiths take home £93k after tax; the Joneses £75k. There are many reasons why the Joneses may have chosen that one of them should work and one not – it’s mystifying why the Government should slap an £18k penalty on their choice. The irony is that these accidental tax effects are so much larger than the deliberate tax policies Governments announce with much fanfare – the “marriage allowance” is worth a fairly pathetic £252/year.

    Why isn’t there outrage about this? I think in part because people earning £50k or £100k feel it’s ungrateful or, worse, unBritish to complain about paying tax. And people earning less don’t want to hear the complaints. But it’s not about whether people on high incomes should pay more tax – it’s about whether they should pay more tax in a fair rational way, or in an unfair irrational way.

    So a truly reforming Chancellor would declare war on marginal tax rates above 50%. We can do this without giving a handout to people on high incomes – the cost can be recovered by slightly increasing the top rate of tax. And the cost may be less than the Treasury historically thought, given that people are currently going out of their way to avoid paying these rates. And those on benefits also face ridiculously high marginal tax rates of up to 96% as benefits are withdrawn, creating a perverse incentive not to work (there’s outstanding work on this from the Resolution Foundation here).

    Here’s the political challenge: politicians on the Right have to accept slightly higher taxes for some high-earners, and politicians on the Left have to accept slightly lower taxes for some others. Will they?

    VAT punishing small businesses for growing

    This chart should keep the Chancellor up at night:

    Source – OTS review of VAT in 2017 – data from HMRC

    It shows, for a given £ of turnover/revenue, how many businesses there are in the UK at that level of turnover/revenue.

    You’d expect a reasonably smooth curve, falling from a large number of small businesses on the left side, down to a smaller number of larger businesses on the right. But we don’t see that at all – we see a dramatic cliff edge right on the VAT registration threshold (now £85,000). Businesses whose revenue hits the threshold suddenly have to charge VAT, meaning that – overnight – they must either raise prices or lose profits by up to 20%.

    The chart tells us that many businesses respond to this by suppressing their turnover so it never hits £85,000. A cynic would say that they do this by taking cash under the table, and not telling HMRC. But there’s recent academic evidence that the cynic is wrong – this isn’t dodgy bookkeeping… businesses are genuinely holding back their growth as they approach the £85k threshold. The data is compelling, but I hear plenty of first hand stories too – plumbers going on holiday for the rest of the tax year; electricians not hiring an apprentice; coffee shops deciding not to open up another branch.

    So here’s powerful evidence that the UK tax system has created a powerful brake on the growth of small companies…. some of which might, in time, grow into large companies.

    There are two bad answers to this problem, and one good but difficult one.

    The first bad answer is that we should raise the threshold from £85k. This is crushingly expensive, and doesn’t solve the problem… it just moves it.

    The second bad answer is that the UK has one of the highest VAT thresholds in the world, and we should reduce it to the average (around £30k). Given the sudden impact that would have on tens of thousands of businesses, this would require a Chancellor to be brave-bordering-on-suicidal.

    The good – but difficult – answer is that we shouldn’t have this kind of cliff edge threshold at all. And apps and digitalisation mean that now we don’t need to. Instead of VAT suddenly applying at 20% at £85k, what if it applied at 1% at £30k, and then slowly crept upwards, hitting 20% at £140k? We’d collect the same amount of tax, but without creating an incentive to stop growth.

    Until recently, expecting anyone to operate a system like that would’ve been delusional, but the modern digital systems HMRC has put in place make it achievable. It would take years of planning, with HMRC having to provide free apps and compliance solutions to small businesses. The challenge is less technical and more political – politicians have to sell, and voters to accept, the idea that raising tax is necessary for growth.

    Three dysfunctional land taxes

    We have three taxes on land in the UK – council tax, business rates, and stamp duty. Three parts of a very broken puzzle.

    Here’s a chart showing how much council tax is paid as a % of the value of a property:

    The more expensive the property, the less significant council tax becomes. That’s not how any tax should work. And in England, council tax is based on 1991 valuations that bear little relation to the housing market today.

    Almost as bad is the equivalent tax for businesses – business rates.

    The most common criticism of business rates – that it’s an unfair tax on retail businesses – is wrong. All the evidence shows that, in the long run, most of the economic burden of business rates falls on landlords (because rents are lower than they would be if business rates didn’t exist).

    But there are other big problems with the tax. It’s based on the “rentable value”, but the rentable value is so frequently updated that you can end up with a situation, where rents have fallen, and the business rates haven’t caught up (which is in many cases where we are now). Another problem: business rates are taxed on the rental value of a property, taking into account whether it’s been improved. That’s a disincentive to invest in improving property. The answer?

    And the final broken puzzle piece: stamp duty. It’s a good rule of taxation that we shouldn’t be discouraging transactions. Yet, as everyone who buys a house knows, that’s exactly what stamp duty does. It distorts the housing market and, by punishing people for moving in search of work, distorts the labour market too.

    How can we solve the land tax puzzle? By scrapping all three broken taxes and replacing them with land value tax – an annual tax based on the unimproved value of land. Instead of acting as a brake on investment, it would encourage it. Moving house would become a tax-free event. The economic burden would fall on landlords, not tenants.

    Land value tax has political support from economists across the political spectrum – all we need are politicians with courage to sell the idea that if we want to repeal bad unpopular taxes, then we have to create new, better, ones.

    Corporation tax

    According to the Office for National Statistics, from 1997 to 2017, the UK had the lowest level of investment (as a proportion of GDP) in the OECD:

    Is tax one of the reasons behind this?

    It’s trite economics that businesses do things they’re incentivised to do. The problem is that UK tax relief for investment exhibits the two deadly sins of tax policy: it’s really complicated, and it changes all the time. This means that you’d have to be brave or foolish to make long term investment plans on the strength of today’s tax relief rules – you can’t be sure you’ll qualify, and you certainly can’t be sure the rules will be the same when your investment actually comes to fruition. Which is another way of saying that the tax relief rules fail to achieve their purpose of incentivising investment.

    We need a radical solution. What if we didn’t have complicated rules governing what kinds of investments get tax relief, but just gave tax relief to all investment? Paid for by increasing the rate of corporate tax, so the reform was tax-neutral overall. And guaranteed to remain unchanged for the length of a Parliament – ideally with cross-party agreement that gives reasonable assurance for the longer term. Suddenly we’d create a powerful incentive to invest, made all the greater by the increased tax rate.

    This isn’t my invention – it’s called “full expensing” and it’s supported by the CBI and economists across the political spectrum. But we’d need politicians – and voters! – to accept the counterintuitive truth that sometimes tax rates have to go up to encourage growth.

    None of these issues are new. The Office of Tax Simplification has proposed reforming most of them. The problem has been that politicians prefer to duck difficult questions. Instead of adopting the OTS’ proposals, the Truss Government abolished the OTS. Let’s hope that, in an outbreak of Christmas cheer, Mr Hunt reverses that mystifying decision.

    Photo by CHUTTERSNAP on Unsplash

  • Tax Policy Associates – the plan for 2023

    Tax Policy Associates – the plan for 2023

    2022 was fun.

    Here’s the plan for 2023, in rough order of priority:

    Definitely

    • Launching in the next month, an analysis of a startling way in which tax law and HMRC are failing people on low incomes.
    • Also in the next month or so: a report into a tax avoidance scheme that’s rife in a well-known business sector, and avoided £450m of tax in the last few years, but has somehow escaped scrutiny.
    • More tax policy “blueprints” on corporate and personal tax, setting out the direction in which I think tax policy should be heading.
    • More responses to random tax stuff in the news – it’s often hard for people with actual expertise to comment publicly (whether tax professionals or academics), and the result can be that the only public comment comes from people with no technical knowledge of the subject. It’s quite wrong to say that only those with a technical tax background can comment on tax or have an opinion on tax – but it’s just dumb to report on tax with no input from anyone with tax expertise.
    • Nadhim Zahawi. We’ve just scratched the surface. More will follow – politicians shouldn’t be able to get away with lying about their tax affairs. Nothing damages public faith in the tax system as much as the perception that “they” don’t pay tax.
    • Continuing to providing tax policy assistance and advice to MPs and policymakers in all four of the main UK political parties (it’s invisible to almost everyone, but an important part of our work).

    Probably

    • How the VAT threshold strangles business growth, and how it can be fixed.
    • An academic paper on how a well-known and controversial tax break may in fact be unlawful, and HMRC’s practice ultra vires and potentially susceptible to challenge.
    • How Tax KCs facilitate tax avoidance – an alarming case study.
    • Further data-driven analyses of past tax changes – perhaps including a follow-up to our tampon tax report.
    • Working with others to push for libel law reform, and for the SRA to crack down on solicitors who act unethically.
    • Further analysis of CRS data on offshore bank accounts, and hopefully an HMRC estimate of the proportion that’s not reported.
    • Additional work on beneficial ownership and corporate transparency.

    Maybe

    • Other investigations into politicians who’ve avoided tax. It’s not our focus, and every allegation I’ve looked at to date (except one), has had nothing in it (Rees Mogg’s LLP, Jeremy Hunt, Rishi Sunak’s hedge fund days, and a handful of others that haven’t been public). But we’re always open to suggestions.
    • Big Data analytics on First Tier Tribunal cases over the last 15 years.

    Never

    • Taking on commercial work – I’m grateful for the offers, but it creates an impossible conflict.
    • Accepting donations/funding. All NGO funding comes with conditions, explicit or implicit. I want to continue to go my own way, and annoy everybody some of the time.
    • Hiring unpaid interns. I’d love the help, and goodness knows I miss the brilliant associates and trainees I used to work with. But at Clifford Chance I (and many others) pushed to end unpaid internships – they reward the well-connected and those from wealthier families, and are legally questionable. So, whilst awfully convenient, it would be hypocritical for me to take a different stance now.

    And

    • Thanks to everyone who’s supported our work – active and retired tax lawyers and accountants, academics, journalists, business people from just about every sector, and just interested people with time on their hands. I couldn’t have achieved anything without your insights, expertise and support. Particular thanks to B, M, D, J, L and S.
    • Suggestions for anything else we should be looking at are always gratefully received. Just drop us a line.

    Have a great Christmas/Channukah and New Year.

    Dan

    Photo by Jon Tyson on Unsplash