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  • The UK tax system in five infographics, and what we can learn from the fact they are boring

    The UK tax system in five infographics, and what we can learn from the fact they are boring

    The chart above shows the composition of the UK tax system – the contribution made by each of the different taxes.

    It must have seen dramatic changes over the last forty years:

    Not really:

    Or, over a longer period, and as a % of GDP:

    The same data, but normalised so it shows the share of overall taxation:

    Obvious conclusions:

    • The conventional wisdom that tax has moved from taxing income (income tax/NI) to taxing consumption (VAT) is correct – but only to a degree. The decline in income tax/NI is small, and the increase in VAT has been almost matched by a decrease in other indirect taxes/duties
    • The conventional wisdom that corporation tax has been slashed (the “race to the bottom“) is wrong
    • The complaint that business rates are at historically high levels is wrong
    • The idea that the EU forced VAT on us, and changed our tax system forever, is also wrong. VAT replaced the various sales taxes, and caused a massive drop in excise duties. The combined total of VAT/sales taxes/duties hasn’t materially changed since the 60s.
    • Council tax/poll tax/rates revenues look much the same, despite the very significant changes over this period

    How does it compare with the rest of the OECD?

    That looks like this:

    Comparisons are easier if we normalise, and order by the total % of tax collected in income tax and social security/national insurance:

    We need to be cautious about these comparisons. There are services which are paid for out of general taxation in some countries, but paid for directly by individuals in others. The obvious large example is healthcare in the US – about 55% of which is paid for by businesses and individuals rather than the Government. A smaller but still significant example is local services: some (e.g. rubbish collection) are paid from council tax in the UK, but by direct fees in some Continental countries.

    With that large caveat, what can we conclude from these charts?

    • The tax system most similar to the UK is Portugal, which I find surprising – although Portugual collects somewhat more in VAT and other indirect taxes, and the UK collects somewhat more in capital/land taxes
    • Amongst the countries similar to the UK – large developed economies with relatively generous welfare states, the UK has the smallest overall tax as a % of GDP, the smallest overall tax % collected from individuals/wages, and the largest from capital/land taxes.

    We shouldn’t exaggerate these differences. There are obvious large variations in total tax as a % of GDP between countries, but it’s remarkable how – aside from a couple of outliers – the differences in tax composition between countries is relatively small.

    Another way to look at this is to plot the % of tax on the wages of the average worker (i.e. income tax, and employee/employer’s national insurance only) against the level of state spending in each OECD country:

    It’s notable that there’s no country in the world which taxes the average worker less than the UK, but has higher government spending.

    We should therefore be sceptical of anyone who claims that we can radically change the balance of taxation and [eliminate corporate tax][tax corporates more and people less][tax land more and everything else less]. International experience suggests our options are limited to fiddling at the margins here and there or, more courageously, choosing to significantly increase or decrease the size of the state, and therefore decrease or increase most people’s taxes, and the public services they fund.

    Footnotes

    1. Sources are here for most of the taxes, here for local government taxes and here for vehicle excise duty (the latter being a forecast, not an outturn) ↩︎

    2. Thanks to the IFS who did all the work here – I just bundled similar taxes together and plotted it ↩︎

    3. Ignoring minor taxes; there are dozens, and they make the chart unreadable. ↩︎

    4. Again ignoring minor taxes. ↩︎

    5. Thanks to the OECD for the wonderful global revenue statistics database. I just categorised similar taxes together – but had to push the taxes into a smaller number of categories than for the UK-only charts above, or cross-country comparisons became impossible. ↩︎

    6. I’m bundling employer and employee SS/NI together, because all the evidence is that, in the long term, employees bear the economic burden of employer labour taxes, i.e. because a business will generally keep its overall labour costs constant as taxes increase, so take-home wages fall (Again, in the long term) ↩︎

    7. Chile! ↩︎

    8. This is now updated using the latest OECD data for 2022. I’ve removed Ireland because of the well-known problems with Irish GDP data, and excluded Chile because it is so great an outlier that it makes the chart hard to read. ↩︎

    9. Don’t knock it! -almost everything I write is about fiddling at the margins ↩︎

  • In which country do employees pay the highest tax on their income? Is it the UK?

    In which country do employees pay the highest tax on their income? Is it the UK?

    How does the UKtax on employment income compare with other countries? It’s a simple question – but not straightforward to answer.

    One way is to look at different tax rates. But the rates alone are misleading. The biggest missing element is: when do the rates apply? The 37% top rate of Federal income tax in the US kicks in at $523,600. The top UK rate – now again 45% – applies from £150k. So saying the UK rate is just a bit higher than the US rate misses the most important question: how much tax do people actually pay? What is the effective tax rate on any given income?

    So I wrote some simple code to calculate and chart the effective rate of tax. on an employee – or the “tax wedge” for different multiples of the average wage in each country. See my previous post introducing this approach for more detail and a complete list of caveats and limitations. The updated code is here.

    Here’s the chart comparing UK tax (before and after the mini-budget) with the rest of the OECD, looking at incomes going up to 5x average wage. For context: the average (mean) UK wage is about £37k, so the top end of this chart goes to a touch under £200k.

    Click the chart for an interactive version that lets you select/deselect different countries (which prevents it becoming unreadable):

    The generous UK personal allowance means that a Brit on an average income pays less income tax/national insurance than most anyone in the developed world. The basic rate and national insurance however are high enough to accelerate our rate towards other countries. The introduction of the higher rate is hard to spot on the chart, because it is (more or less) accompanied by a reduction in national insurance (and these figures don’t model child benefit or other features that can create horrible marginal rates in the UK around the £60k point). Things do kick off at the 2.7x point/£100k, as the phase-out of the personal allowance escalates the effective rate.

    What if we look at tax on higher incomes? Let’s go up to 20x average wages, so about £500k in the UK. Again, click the chart for an interactive version:

    All in all, the UK has a rather average level of tax on high earners, compared with the rest of the OECD. And for employees the rate caps out at just over 50% once we take employer’s national insurance into account (as we should).

    Does anyone actually pay these really high rates?

    Usually, the only high earners who pay these rates are employees. For others, the rates are often much less. In the UK the rates drop to 47% (partners in partnerships), 45% (rent), 38.1% (dividends), 28% (capital gains on real estate) or 20% (capital gains on securities). And the evidence is that really higher earners tend to be in these categories (or can plan their way into these categories).

    Employment tends to be heavily taxed because it’s so easy to do. Those poor, poor bankers get all the flak, but pay a lot of tax. Their private equity cousins pay about half as much. And the same’s true almost everywhere… call me cynical, but I’m doubtful there are many Austrian millionaires actually paying a 68% effective rate.

    So if, as a political or economic matter, we want to increase taxation on high earners, I’d suggest that the focus shouldn’t be on changes that increase the 50% rate (which already looks high) – better to focus on the others.

    Can it really be true that the UK taxes average income significantly less than most other countries?

    It’s something almost nobody believes – but it’s nevertheless true. If you don’t believe my chart, here’s the OECD comparison for average incomes:

    It shouldn’t be a surprise that the countries with more extensive welfare states than the UK have higher rates of tax on the average worker. By contrast, some of them tax higher earners more; some don’t. The thing is, whilst the level of tax on the rich is of huge political significance, it is not very significant to the public finances. The 45p rate which the Tories abolished-then-didn’t raises £2bn. Income tax as a whole raises £228bn. NHS spending is £136bn.

    If we want a Scandinavian level of public services, then most people have to pay similar levels of tax to most people in Scandinavia. Sorry about that.

    Footnotes

    1. excluding Scotland – that’s very similar but a bit higher… although Scotland’s actual freedom of manoeuvre here is very limited ↩︎

    2. This is an update of previous posts with updated data, better code, and more footnotes ↩︎

    3. based on data from the wonderful OECD tax database, updated for the Budget changes and the return of the 45p top rate ↩︎

    4. The effective rate is total tax paid divided by total gross income. Not to be confused with the marginal rate – the tax rate on the next £ you earn ↩︎

    5. The calculation realistically has to include employer national insurance and social security. Yes, it’s paid by the employer, and isn’t visible on our wage slip, but evidence suggests it is mostly borne by workers (i.e. because the employer has an amount they’re willing/able to pay as wages, and employer NICs come out of that). ↩︎

    6. i.e. because realistically you don’t compare taxes on £100k in the UK with £100k in Costa Rica; you should compare taxes on three times the average wage in the UK with three times the average wage in Costa Rica. The OECD adopts a consistent methodology for calculating average wages using national accounts, but a limitation of this approach is that it results in the mean not the median wage. For most purpose this is much less useful, but for this purpose it remains a useful way to meaningfully compare tax rates across different economies… as ever, I’m open to other suggestions ↩︎

    7. Yes, that is a lot higher than the usual figures we see because, as above, it’s the median not the mean, and it’s the average wage not average income ↩︎

    8. I crashed WordPress trying to embed this. Any better suggestions would be appreciated! ↩︎

    9. Including employer national insurance – for which see the footnote above… we may not recognise it, but it’s nevertheless tax that employees bear economically ↩︎

    10. Yes, I avoided tax for years, but in my defence it’s just the way partnerships have always worked ↩︎

  • The UK should cut the top 90% rate of income tax

    The UK should cut the top 90% rate of income tax

    Well-intentioned bodges to the UK income tax system have created anomalously high marginal tax rates for people earning between £50-60k and £100-125k. The marginal rate typically hits 68% but can reach 90%. This is complicated, unfair and a disincentive to work; it could also plausibly be holding back growth. Any government serious about fixing the tax system should start here.

    There is an updated article on marginal rates here.

    The marginal rate

    If you want to know your take-home pay, then it’s your effective rate of tax that’s important – total tax you pay, divided by gross wage (more on that here).

    The marginal rate of tax is different and more subtle – it’s the percentage of tax you’ll pay on the next £ you earn. Irrelevant to where you are now, but highly relevant to your future, because it affects your incentive to work more hours/earn more money. Economists say everything happens at the margin.

    The marginal rate of tax in the UK for high earners in theory caps out at 47% (45% income tax and 2% national insurance) once you get to £150k. I’m not terribly convinced this disincentivises anyone to work. But people earning much less than £150k can have a much higher rate, principally due to two effects:

    • Child benefit is £1,133 per year for the first child and £751 for the rest. It starts to be phased out by a special tax – the “high income child benefit charge” – if your salary hits £50k, and you get no child benefit at all once the gross salary of the highest earner in the household hits 60k.
    • The personal allowance – the amount we earn before income tax kicks in – starts to be phased out if your salary hits £100k, and is gone completely by £125k.

    These phased withdrawals create very high marginal rates.

    UPDATE: marginal rates are further increased by student loan repayments. See more below.

    The calculations

    I’ve put together a quick spreadsheet. For a family with three kids, the marginal tax rate for a given salary looks like this:

    That bump between £50k and £60k is a 68% marginal tax rate, meaning that, for every additional £1,000 you earn gross, you take home £320.

    Looking at it another way: imagine you’re working a reasonably modest 1,500 hours a year and earning £50k gross, so about £38k take-home. That’s £33/hour before tax, £25/hour after tax.

    How would you like to work another 200 hours a year for the same pay? Sounds good. But after-tax you’ll be earning £10/hour. You may well not think that’s worth your while. And, if you need childcare, the additional childcare could easily cost you more than the additional pay.

    The bump between £100k and £125k is the withdrawal of the personal allowance, and results in a 62% rate between £100k and £125k. Not quite as dramatic as the 68%, but still well over the psychologically important 50% mark – and that rate lasts for a significant £25k.

    Let’s go higher

    Because it’s linked to child benefits, those high marginal rates just get bigger the more children you have. I have friends with six children. Congratulations, Steve, because you can win a marginal tax rate of 91%.

    Why stop there? With eight children you get a top marginal rate of 106% – so if you earn £50k gross, your after-tax pay is £38k. If you earn £60k gross, your after-tax pay is £37k. That’s insane. Hopefully, nobody is actually in that position, but a sensible tax system doesn’t create such results, even in theory.

    Update: A clever anonymous coder has made an interactive version of this chart, where you can spawn as many children as you like, and see how high the marginal tax rate goes: here.

    Let’s go even higher

    To keep the two charts above readable, I’ve omitted the marriage allowance. This lets a non-working spouse transfer £1,260 of their unused personal allowance to their partner, if they’re earning less than the £50,270 higher rate threshold. So it’s worth £252. Unlike the other allowances, it’s not withdrawn in a phased way – it disappears if the £50,270 threshold is hit. That gives us this beauty:

    Earn £50,200 gross, your take-home is £37,887. Gross £100 more salary, your take-home pay is £214 less. You have to gross £800 more to actually make more money – take-home pay of £7 more, to be precise.

    The small size of the marriage allowance means its effect vanishes pretty quickly. But it does combine with the child benefit claw-back to create a zone of extremely high marginal rates which persists for some time:

    • Earn £52,200 gross, your take-home is £38,274 – that £2,000 of extra pre-tax income ends up as only £387 of additional money in your pocket.
    • Earn £55,200 gross, your take-home is £39,223 – the £5,000 of extra pre-tax income has given you only £1,336 post-tax.

    That is not much incentive for someone earning £50,000 to increase their earnings.

    What about student loans?

    Student loans are really just a complicated hidden graduate tax. For someone starting university before 2012, you pay 9% of your salary over £20,184, until the loan is repaid. Of course, the effect on individuals – even those on the same income – will vary widely, depending on how much loan they borrowed, how long they’ve been earning, and how their salary ramped up over time.

    We can model it with some simplifying assumptions. Let’s say everyone on the chart is 30 years old, graduated nine years ago, and their salary ramped up in a straight line from £20k to where it is now. The marginal rates then look like this:

    I’d be cautious about citing these figures, given how dependent they are on the assumptions. However, it’s reasonably clear that graduates suffer from startling marginal rates. Please have a play with the spreadsheet if you’re interested.

    What about [another stupid feature of the tax system]?

    The tax-free childcare scheme creates an insane marginal rate at £100,000.

    The basic scheme is that the Government will stump up for 20% of your childcare costs, up to £2,000 per child. You qualify if you and your partner’s earnings hit £7,904, and it’s completely withdrawn if one of your salaries hits £100,000. The result? An infinitely negative marginal tax rate at £7,904 and another brilliantly infinitepositive marginal tax rate at £100,000.

    That £100k spike is absolutely not a joke – someone earning £99,999.99 with three children will lose an immediate £6k if they earn a penny more. They then don’t recover to their previous post-tax earnings until their gross salary hits £119k.

    You can see this more clearly if we plot gross vs net income:

    There are other similar effects: the thresholds around student maintenance loans for one. But I’m going to stop here for the sake of my sanity…

    Why does this matter?

    It’s complicated and unfair for people hitting these thresholds. The way the child benefit withdrawal applies means that it catches lots of people out. The high marginal rates act as a disincentive to work. Across the whole economy, I’m absolutely not an economist, but it seems plausible these effects act as a brake on growth.

    The human side looks like this, one of many similar messages sent to me today:

    If we’re looking for ways to fix the tax system, then this should be right at the top of the target list. Regardless of where we sit on the political spectrum.

    The solution

    One solution is simply to scrap the personal allowance and child benefit tapers (and the marriage allowance to boot). Problem is, that would be fairly expensive, on the face of it, costing somewhere around £5bn to repeal both, although the widespread awareness of these issues amongst the people affected, and use of salary sacrifice, additional pension contributions, etc, makes me wonder if the actual (dynamic) cost might be materially less.

    Realistically the most likely source of funding is playing around with rate thresholds, for example reducing the point at which the additional rate kicks in. There are certainly other alternatives; but the important thing is that we really, really, shouldn’t have a tax system that can have a 68% marginal rate, let alone a 90% marginal rate.

    Oh, and the other lesson: please please, politicians and HM Treasury, don’t introduce any more tapers into the tax system. Thank you.

    The caveats

    All the calculations are in this spreadsheet. The key assumptions/caveats are:

    • Income tax/NI as for tax year 2022/23, from November 2022 (so the lower NI rate)
    • One earner in a household, who is over 21 and not an apprentice, not a veteran, and under the state pension age
    • Ignores benefits aside from child benefit (although benefits are notorious for creating very high marginal rates; to some extent that is unavoidable)
    • Doesn’t include the thresholds around student maintenance loans.
    • Doesn’t include tapering of pensions annual allowance (starting at £240k)
    • Doesn’t include effects of the pension cap – that can create high marginal rates, but as it’s linked to the total size of your pension pot, the rate is very dependent on an individual’s specific position.

    Any corrections, additions or comments would be much appreciated. Some kind people have offered to add in universal credit taper. It’s an incredibly important issue, but I’m reluctant to do this given that I have no understanding of the benefits system myself. I’d be delighted if others adapt the spreadsheet to do this.

    Many thanks to James Wiseman on Twitter for his original calculation, and credit to William Hague for his article that sparked this train of thought.

    Footnotes

    1. For more on this, and some international context, there’s a fascinating paper by the Tax Foundation here ↩︎

    2. Strictly the marginal rate is infinite – it caps at just over 300% in my spreadsheet because the resolution of the calculations is £100. Also I didn’t have a monitor large enough to show an infinite line. ↩︎

    3. Corrected to fix a bad mistake/bug in the spreadsheet ↩︎

    4. Now I’ve added the student loan calculations, I regret doing this in Excel, because it becomes unwieldy. Really needs implementation in proper code. Any volunteers? ↩︎

    5. it’s not infinite – I forgot that you can’t divide money forever. For a couple with three kids, claiming the full £6k, the marginal rate will tend to £6k/1p = 60,000,000% ↩︎

    6. For the chart, the spreadsheet assumes the higher earner in a family pays a maximum of 20% of their gross wage on childcare; if you don’t like that assumption you can change it ↩︎

    7. See also this excellent OTS report here ↩︎

    8. Fixing student loans is much harder, and tied into a series of policy questions where I don’t feel I have expertise to comment. Really not sure what to do about tax-free childcare. A taper would be better than a £100k hard stop. ↩︎

    9. Back of a personal allowance napkin: 500,000 taxpayers earn £120k, value of personal allowance is £5k, so approx cost £2.5bn. Back of a child benefit taper envelope: the child benefit taper was expected to bring in £2.5bn of revenue when introduced in 2013. Since then, child benefit has gone up about 10%, and nominal earnings about 30%. Implying costs of around £2.5bn today. The marriage allowance should be small beer by comparison with either figure. Needless to say, these are hugely approximate estimates; I’d be grateful for anything better anyone can suggest! ↩︎

  • Time for solicitors who’ve falsely claimed their libel letters are “confidential” to put things right

    Time for solicitors who’ve falsely claimed their libel letters are “confidential” to put things right

    The SRA will be cracking down on solicitors who send libel threats that they assert are confidential, and can’t be published – when they’re not and they can. The SRA has now made it clear that these solicitors should give serious consideration to writing to past recipients of these threats, and withdrawing incorrect assertions of confidentiality.

    When solicitors send journalists and bloggers letters threatening a libel action, or demanding a retraction, it’s common practice for them to claim that their correspondence is “without prejudice” and/or “confidential”, and can’t be published (or even referred to). It’s a testament to the success of this tactic that I’d no idea this was going on, until I received a letter of exactly this kind.

    The small problem is that these letters will almost never be “confidential”, mostly will not be “without prejudice”, and even if they are “without prejudice”, that doesn’t prevent publication. This is not one of those cases where lawyers in good faith can disagree, and the law is complicated and uncertain – it is simply nonsense. More on the reasons for this here.

    This isn’t a small thing. The Government rightly says that aggressive dubious libel claims – strategic lawsuits against public participation (SLAPPs) – are a threat to free speech and a free press. But SLAPPs only work in darkness – give them the light of publicity and the strategy falls apart. The people writing these letters know that – that’s why they make the phony assertions of confidentiality. If we can end the phony assertions, the SLAPPers will know that any libel threat risks a Streisand effect that will just give more publicity to whatever accusation they’re trying to censor.

    I wrote to the Solicitors’ Regulatory Authority back in July, asking them to end the practice of solicitors making phoney claims of confidentiality in libel letters, and received this excellent response:

    As part of our work, we are currently developing further specific guidance to the profession on the topic of SLAPPs, highlighting the issues arising from our casework. Further to your letter, we plan (amongst other things) specifically to address the practice of labelling correspondence as “private and confidential” and / or “without prejudice”, and to address the conditions under which doing so may be a breach of our requirements. We think that this approach will help solicitors to comply with our existing standards and regulations and to use those labels only when appropriate. We can update you as and when we publish this guidance. 

    We are also to carry out a thematic review of a targeted sample of firms, looking at the steps taken by firms to address the issues raised in our Conduct in Disputes guidance. The outcomes of this review, as well as our enforcement work and the work currently being done by the government on reform of the law relating to SLAPPs, may in due course inform further updates to our guidance. 

    That begged the question: what happens where a solicitor has previously sent a letter to a journalist, or a small-time blogger, which wrongly claimed to be confidential? Solicitors are required to behave in accordance with the SRA Principles: to act with honesty, integrity, independence, and to uphold the rule of law. That means not making statements which you know are false; but it also means that you have a duty to correct a false statement (even if you didn’t know it was false at the time you made it).

    I therefore wrote to the SRA last month, asking them to include in their guidance a requirement for solicitors to proactively correct false claims of confidentiality:

    The SRA has now replied, saying that they will consider adding that to their guidance; and, importantly, adding that where a firm has made a false assertion of confidentiality, whether or not they’ve subsequently withdrawn that assertion will be taken into account when and if the SRA comes to consider a complaint against that firm:

    When the SRA guidance comes out, if it’s as clear as I expect it to be, that should trigger a wave of SRA complaints by everyone who’s received a letter with a phony confidentiality claim – whether they’re a national newspaper or a blogger with a readership of a dozen.

    Those solicitors who’ve sent these letters should be giving serious consideration to proactively writing to past recipients of these letters, and withdrawing their false assertions. They should do this because it’s right. They should also be very concerned about the consequences – for their firms, and for them personally – if they don’t.

    Photo by Kristina Flour on Unsplash

    Footnotes

    1. I am a tax lawyer, and not an expert in confidentiality – although like most commercial lawyers I have a reasonable knowledge of the law – but I have spoken to lawyers who have real expertise in the law of confidence/confidentiality ↩︎

    2. And to be fair, I expect most cases will be in this category. Solicitors love their templates, and many core elements of a letter they send today will be based upon something that was first put together many years, or even decades ago. So I expect most solicitors sending out these letters did so in good faith, not appreciating that they were asserting something that was wrong as a matter of law. However now they are alerted to the point, and they are aware (or should be aware) that these assertions are false ↩︎

  • When tax cuts cost you money – the effect of previous stamp duty reductions

    When tax cuts cost you money – the effect of previous stamp duty reductions

    This chart shows house prices having a heart attack.

    The big spike in June 2021 just happens to coincide with the last month of the £500k stamp duty “holiday”. Buy a £500k property in June 2021: £0 stamp duty. Buy in July 2021: £12,500. So a nice 2.5% saving. Shame about the 5% price hike in June 2021. Overall, buyers lost out.

    Then another spike before the end of the £250k nil rate band in October. Buy a £500k property in September 2021: £12,500 stamp. Buy it in October: £15,000. A 0.5% saving – again swallowed by house price increases.

    These look like irrational results: buyers would have been better off waiting til the holidays ended. But humans are irrational creatures.

    And these prices stick – March 2021 to December 2021, the net effect of the heart attack is a 6% increase (when looking at the chart, remember it’s a chart of house price inflation, not absolute house prices).

    Previous stamp duty holidays had less dramatic effects: there’s good evidence that the 2008/9 stamp duty holiday did lead to lower net prices, but 40% of the benefit still went to sellers, not buyers. There’s also been some research on the 2021 holiday, but it was completed too soon to catch the September heart attack.

    So all of this suggests stamp duty holidays are a bad policy, an inefficient way of helping buyers, and that they perhaps even trigger price rises greater than the tax saving.

    A permanent stamp duty change shouldn’t, at least in theory, have as dramatic an effect – a chunk of the benefit would still be swallowed up in higher prices, but we wouldn’t see the heart attack. In the real world, however, I expect we will – partly because some people (rationally) won’t believe the stamp duty reduction is permanent, and partly because some people will (irrationally) excitedly jump on the stamp duty reduction.

    The bigger point is that, from a distributional point of view, stamp duty cuts are a way to hand money to those who already have it.

    And the bigger conclusion: stamp duty is a terrible tax. As the Mirrlees Review put it:

    Stamp duty land tax, as a transactions tax, is highly inefficient, discouraging mobility and meaning
    that properties are not held by the people who value them most…

    I’d scrap it, and replace the £12bn of revenue with increased council tax on high-value properties (not hard, when council tax raises £42bn). Fairer, more efficient, more redistributive, not a bloody transaction tax, and might even help dampen down the property market. More on this to follow.

    Footnotes

    1. Or are they? A smart person suggested to me that a rational buyer might prefer to pay £525k with no stamp duty than £500k plus £12.5k stamp duty, because their mortgage lets them spread the £525k over 25 years; the stamp duty has to be funded in cash. That’s a very cool explanation, but doesn’t make this good policy! ↩︎

    2. Which if you haven’t read, you should ↩︎

  • Can we “windfall tax” energy companies’ capital appreciation?

    Can we “windfall tax” energy companies’ capital appreciation?

    The EU Tax Observatory have just published an excess profits tax proposal which would tax listed energy companies on 33% of the increase in their market capitalisation in 2022. EU headquartered companies get fully taxed. Non-EU headquartered companies get taxed pro-rata to their sales in the EU.

    So, for example, if the UK was to implement such a tax then BP and Shell, whose market cap has increased by c£150bn so far this year, would pay £50bn in tax.

    This is a highly unusual proposal, and therefore interesting from a tax policy standpoint. I’m very conscious of the “not invented here” problem in tax policy, and I don’t want to bash this proposal just because I view my, simpler and more conventional, windfall tax proposal as preferable. However, there are five issues with this proposed tax which illustrate why conventional tax designs are often more effective. These kinds of design choices are going to be critical when (and I think it is a “when”) ambitious windfall taxes become a political inevitability.

    1. Breaching the norms of international taxation

    There is much to criticise about the norms of international taxation, but one thing is inarguable: the further a tax departs from these norms, the more likely there are to be geopolitical complications. The various digital services taxes causes ructions and the threat of a trade war, even though the amounts raised were extremely modest.

    Imposing a very unusual €10bn+ tax on national champions such as Saudi Aramco, Equinor, Exxon and BP seems much more provocative than the digital services taxes, and is therefore very likely to trigger complaints that the tax is contrary to international norms. Others can comment on the likely geopolitical consequences with more authority than I can.

    2. Potential breaches of WTO/GATS

    As a practical matter, complaints about taxes breaching international norms often take the form of arguments that the taxes are contrary to WTO/GATS. Often this is theoretical (on the part of academics) and rhetorical (on the part of politicians) rather than leading to an actual WTO challenge; we certainly saw this dynamic playing out for the digital service taxes.

    Here there would be two arguments:

    • The excess profits tax breaches the EU’s national treatment (NT) obligations under GATS, because it is (in its effect) discriminatory in disproportionately applying to non-EU companies. This is precisely the same point that has been made about digital services taxes.
    • The tax breaches the EU’s most favoured nation (MFN) obligations under GATS, because it applies to listed companies but exempts unlisted companies, even where the companies are in essence carrying on precisely the same business.

    These are complicated issues, and I won’t go into them further here – other than to note these points are political as much as technical/legal.

    3. The design problem with snapshot taxes

    As a general principle, there are problems with “snapshot” taxes, applying to a taxpayer’s position at a particular moment in time. The results can be arbitrary; they can also be easily manipulated.

    If we pre-announce an excess profits tax that applies to the end 2022 market capitalisation, then I don’t think it’s impossibly cynical of me to expect depressed revenue projections, profit warnings, takeover offers, and other events before year end which just happen to mean that shares in energy companies take a mysterious and temporary dip at the end of 2022. To put it more neutrally: people respond to incentives, and energy companies will have a very large incentive to depress their share price by year-end.

    We could prevent manipulation/avoidance by keeping schtum for now as to the precise details of the tax, waiting until the current crisis passes, and then applying the snapshot date (and other mechanics) retrospectively. This is one of the reasons why I said in my windfall tax blueprint that the best windfall taxes are retrospective.

    That still leaves the problem of arbitrariness. That is inevitable when, on a day-to-day level, share prices are famously random. What if market cap falls just before the snapshot date, and then recovers just afterwards? What if, conversely, market cap peaks just beforehand, and then falls back to 2021 levels afterwards (very possible, if more gas supplies come online than expected)? Do companies get refunds? What if the delta between the price on the snapshot date, and the price when the tax falls due, is so great that raising enough capital to pay the tax is impossible?

    The snapshot problem would be less serious if we were taxing something that companies “had” – like profits or property. The result would still be arbitrary, but a company could always afford to pay the tax. Here we would be taxing something that is, for the company, mostly notional, and so we risk the company not “having” it when the tax falls due.

    So I would say it’s preferable from a tax design perspective for windfall taxes to be retrospective, and to tax things that have economic reality for the taxpayer – like actual cash money/profits.

    3. Legal conflict with double tax treaties

    The double taxation treaty between France and the UK prevents France from taxing UK companies on their capital gains (save in certain circumstances, not relevant here). So would it stop France taxing BP/Shell under this proposed excess profits tax?

    The definition of taxes covered by the treaty is wide, and I would say clearly covers the proposed excess profits tax:

    The capital gains article looks like this:

    Article 14(5) would prevent France from taxing BP/Shell, because their gains are taxable only in the UK, provided they are gains “from the alienation of any property”. Are they? On its face you’d say “no” – nothing is being sold/alienated. However, the OECD Commentary to the Article specifically envisages taxes on unrealised capital appreciation. Logically it probably has to, as if tax treaties only covered realised gains, then a country could sidestep treaty restrictions by taxing unrealised gains.

    So in my view it’s likely the treaty would prevent France taxing BP or Shell. This is not beyond doubt – one could argue that this is not a capital gain *of* the company in question; however, I would say that is not a requirement of the treaty.

    Similar issues would arise with the French treaty with the US, Norway, Saudi, etc; and the German treaties, and so on – although the argument is particularly strong for the treaties which refer explicitly to “capital appreciation” – many do not.

    Applying the proposed tax to non-EU businesses is therefore going to be legally challenging.

    4. Potential legal conflict with the Capital Duties Directive

    The Capital Duties Directive prohibits indirect taxes on a variety of transactions relating to companies’ capital. It used to be an obscure, sleepy little Directive, until it was applied to nullify UK stamp duty/SDRT on issuances into clearance services and depositary receipts, and cost the UK perhaps £5bn. So the Capital Duties Directive is now a famously terrifying Directive, which the CJEU interprets exceptionally broadly:

    It is therefore in my view probable (but far from certain) that the CJEU would prohibit the proposed tax (on the basis that the tax is an indirect tax on the capital of companies admitted to a stock exchange).

    Conclusion

    This is not a complete list – there are potentially other difficulties with the tax, for example EU law discrimination arguments (of the type discussed by Ruth Mason and others), and the potential incentive for EU energy companies to migrate to outside the EU, so they become taxed at a lower rate.

    However my conclusion is simple: the more important a tax, and the more money you seek to raise, the more important it is for the design of the tax to be as conventional as possible.

    Image by DALL-E – “a picture of an oil rig paying tax, digital art”

    Footnotes

    1. which it almost certainly won’t ↩︎

    2. Which is an aid to interpretation, and isn’t quite binding, but comes very close to that in practice ↩︎

    3. because the CJEU is a very inconsistent, and highly political, court ↩︎

  • Did the world’s biggest meat firm avoid millions in tax?

    Did the world’s biggest meat firm avoid millions in tax?

    The Guardian says ABP avoided millions in UK tax – that’s probably wrong.

    One of the frustrating things about the media is their unwillingness to accurately call out very aggressive tax avoidance by individuals, contrasting with a completely slapdash approach to accusing companies of tax avoidance.

    Exhibit A, courtesy of the Guardian:

    The ABP Food Group are accused of tax avoidance by having a £63m 5% loan into a UK company, ABP UK, from a Dutch company, Trojaan. But Trojaan is funded by 0% loans from other companies (including in Jersey). So, says the Guardian and their experts, this is “aggressive tax avoidance” to reduce ABP UK’s tax bill.

    Does it smell like avoidance?

    We can run a quick sense check. What’s the value of this “aggressive tax avoidance”? £63m x 5% x 19% (tax rate) = £600k. ABP is a €4bn global company. Why would it avoid £600k of tax? That’s a drop in the ocean of its UK profits. So on its face, the story doesn’t really make sense. You don’t need any tax expertise to work that out, just basic math.

    Would the avoidance actually work?

    It’s not obvious it would. The UK has had rules for over a decade now which prevent a business magicking debt into the UK if the group doesn’t actually have external debt. The current iteration of this is the “corporate interest restriction“. This (very broadly) caps interest deductibility at the lower of (1) 30% of UK EBITDA, and (2) the amount of external debt the group has worldwide.

    So if all that’s going on is the stuff in the Guardian article – the group has no external debt, but lends £63m into the UK at 5% interest, then the corporate interest restriction will kibosh any relief on that interest.

    Of course, the Guardian may be missing the full picture, and the group may have plenty of external debt, in which case this rule may not apply (but the 30% EBITDA cap still would). But that’s okay – if the group as a whole has external debt, then passing some of that debt to ABP UK via a series of intra-group loans is perfectly natural, and not tax avoidance at all. (And I’m guessing that’s what’s actually happening)

    What about the ABP Dutch company that has €118m profit but pays only €1.1m in tax? Could be Dutch tax avoidance, but more likely this is a transfer pricing adjustment, and reflects another adjustment being made elsewhere (e.g. Ireland) – so the group is “flat” overall. Again – sense check – we shouldn’t expect large taxable profits in a Dutch company that’s just man-in-the-middle of a bunch of intra-group lending.

    So there is no particular reason to think UK tax avoidance is going on – the numbers are too small, and the “scheme” is one that’s countered by legislation.

    Why did the Guardian think otherwise?

    Because they didn’t speak to anyone with knowledge of UK tax avoidance – they quote a US tax professor and a UK campaigner with no tax expertise. That’s disappointing – there are literally thousands of people who know about this stuff.

    Are you sure there’s no avoidance going on?

    No, which is why I say the story is “probably” wrong.

    A smart person on Twitter suggested a possible “double dip” structure, with ABP getting a tax deduction on its bank loan and also on the on-lending into the UK. For obscure technical reasons I think that wouldn’t work, but I’m aware some people take the contrary view… however I very much doubt anyone would go to that trouble for a measly £600k tax benefit.

    There is a wider point here – ABP UK is (probably for historic reasons) an unlimited company, and unlimited companies aren’t required to file accounts, which limits our ability to see what it’s up to. That’s now an anachronism, and should change.

    But – call me old-fashioned – I prefer not to accuse someone of “aggressive tax avoidance” when I don’t actually have the evidence.

    Footnotes

    1. No, nobody in particular comes to mind ↩︎

    2. insert tired joke about arts graduates working at the Guardian ↩︎

    3. really I can’t stress enough how complicated these rules are, and how over-simplified a summary that is ↩︎

  • The non-dom rules: how to raise £2bn more tax, and make the UK more competitive

    The non-dom rules: how to raise £2bn more tax, and make the UK more competitive

    Thanks to a new paper, we can put numbers on the non-dom regime – the assets it covers, and the income/gains they generate, and taxpayer responses to losing non-dom status. So, armed with this data, how should we reform the non-dom regime?

    I’ve written before about the UK non-dom regime. We realistically need some kind of simplified tax regime for new arrivals, but the non-dom regime is of little practical use to normal people arriving in the UK (even highly paid ones), but of huge value to the exceedingly wealthy.

    There is a new paper from Arun Advani, David Burgherr and Andy Summers which lets us put some numbers on all this. They estimate abolishing the non-dom rules would raise at least £3.2bn of income tax and capital gains tax revenue. That would be reduced by £210m if we keep the rules for the first year after someone arrives in the UK, and £860m if we keep the rules for the first three years.

    So, informed by this, how would I reform the non-dom rules?

    I’d burn the whole thing to the ground:

    • End the “domicile” concept, which is complex and uncertain – and with all things complex and uncertain, that makes life harder for honest taxpayers and easier for tax avoiders and tax evaders. Replace it with a simple statutory test. For example: if you’ve never been resident in the UK before, then we have a new temporary non-resident scheme which applies for your first few years.
    • End the over-generous 15 year timespan. Three years is plenty. We want to give people time to land on their feet and adapt. We don’t need a semi-permanent class of UK residents with a raft of generous tax exemptions.
    • End the complexity of the remittance basis. Simply exempt temporary non-residents from all UK tax on their worldwide income and gains, subject to a lifetime cap of say £2m (to prevent the UK becoming a stepping stone in ultra-high net worth tax planning).
    • Inheritance tax should follow that. Exempt temporary non-residents from inheritance tax on their foreign assets. Everyone else fully subject to inheritance tax. And only fair we rationalise the treatment of those leaving the UK – perhaps taper down inheritance tax over seven years for those who cease to be resident.

    So this potentially raises £2bn more in income tax and capital gains tax, plus probably at least £500m in inheritance tax. It gives us a very generous treatment for new arrivals, giving them time to land on their feet. And it’s actually available and useful to all, not just the very advised.

    However, we need to go further:

    • If all we do is end the non-dom rules, then the very wealthy, and very well-advised, will be surprisingly unaffected. Why? Because they’ll have put their offshore assets into offshore trusts. How do we achieve this? I’m open-minded. We could push people to close the trusts, e.g. by taxing them say 5% of a trust’s asset value each year. Or we could tax the trusts just as if the settlor still owned the trust property. Plenty of other options. The important thing is that there’s no point reforming the non-dom rules if we don’t also close down excluded property trusts.
    • There are thousands of non-doms who have offshore property/assets which they can’t bring into the UK without a remittance charge. We could keep the old remittance rules for these assets – but that would just pile complexity on top of complexity. Instead, I’d say to them: okay, we’re going to tax all of your offshore income and gains going forward. But all your historic assets, income and gains? You’re now free to bring it into the UK without remittance tax. That may strike many non-doms as a good deal.

    Obviously this is a high level road map and not a detailed proposal. There is a lot of complexity here, particularly around trusts, which is why it’s important that reforms are the subject of detailed thought. By which I don’t mean consultation – there should be consultation on the precise mechanics, but the principles, once decided upon, should be set in stone. All the endless complexity shouldn’t distract us from the basic point: the non-dom rules are broken, unfair, and should go.

    Passport image by Caspar Rae on Unsplash

    Footnotes

    1. We can do a back-of-the-napkin calculation to estimate the order of magnitude as follows: the paper estimates non-doms have £10.9bn in foreign income and gains, implying assets of well over £100bn. It should be reasonably straightforward to apply an actuarial model to age cohorts and estimate how much of the £100bn+ will be owned by people dying whilst resident in the UK in any given year, but for the moment let’s assume it’s 5%. Then apply the rate of IHT to that – not 40% but 10%, the actual effective rate for the very wealthy. So the napkin says: £100bn of assets x 5% x 10% = £500m. The assets will be much more than this (meaning a bigger number), dynamic effects very considerable (meaning a smaller one), but this should give us the right number of zeroes ↩︎

    2. These are (very broadly) excluded from UK tax if the settlor (the person creating the trust) was a non-dom at the time it was created. ↩︎

  • Impact on Scotland of the abolition of the 45p additional income tax rate

    Impact on Scotland of the abolition of the 45p additional income tax rate

    If the Scottish Government doesn’t follow the Tories’ abolition of the 45p additional rate, I expect its revenues from Scotland’s own 46p rate will fall by half. Here’s why.

    In 2017, the Scottish Government raised the additional rate from 45p to 46p. They called this the “top rate”. On paper, the differences between Scottish and rest of UK (rUK) rates should have raised £378m. A year later, HMRC estimated the actual figure was £239m. The top rate alone would naively have raised £27m – the actual figure was £5m.

    Why? “Behavioural response”. That could mean a variety of things:

    • Taxpayers “avoiding” tax in the broadest sense of the word, for example by making additional pension contributions, investing in venture capital trusts, or taking other entirely uncontroversial steps to reduce their taxable income.
    • Taxpayers actually moving house (their place of residence) to escape the Scottish rates. It doesn’t seem very likely that high earners would go to that trouble just to save 1%, but at the margin it may affect choices, particularly if taxpayers expect more Scottish tax increases in the future.
    • Another marginal effect will be people taking the reasonable position that they’re resident in England, not Scotland, when the facts support that, but they wouldn’t have bothered before.
    • People slightly adjusting their behaviour so they’re resident in England, not Scotland; in many cases this may just amount to spending a few more days outside Scotland.. You might call this “avoidance“. But if it’s real, not not fictitious, it can’t be challenged.
    • People lying that they’re resident in England when they’re actually resident in Scotland. Tax evasion – but probably hard for HMRC to detect.
    • Simple tax evasion as people fail to declare revenue. Again doesn’t seem very likely to me that such small rate differences would make anyone tip into criminality. Most high income tax payers are employees, who can’t realistically evade tax.

    Whatever the reason – these are pretty impressive behavioural responses to a small change. Much more than I would have guessed – and it surprised HMRC too (the table above shows they anticipated a 20% response). The response to the top rate is extraordinary – 80% of the income you’d expect, on paper, to arise, simply disappeared.

    So we can expect at least a 40% behavioural response to the new gap of 5p between the UK and Scottish rates on high incomes. Possibly 80% or more if the previous history of the top rate is any guide. And we may start seeing a real response (people moving house, rather than just changing where they claim residence). A prudent ballpark estimate would be that Scottish revenues from its 46p top rate will fall by about half; they may disappear entirely (or even become negative).

    Of course this doesn’t mean the Scottish Government will simply fall in line with the rest of the UK, and abolish its top rate. They may well take the view that half the revenues are better than none (particularly if it doesn’t expect a real response, i.e. an actual economic cost to Scotland of people moving). And the political signalling of the additional/top rate has always been much more important than the (modest) revenues it collects. £2bn across the whole UK is chicken feed, in the context of about £200bn from income tax as a whole. £5m across Scotland is less than chicken feed.

    The moral of the story – the interdependence of the Scottish and rUK economies means that differential tax rates are a Really Bad Idea. An independent Scotland would find its tax policy in practice heavily constrained by the tax policy of rUK.

    Inevitable caveat: I haven’t covered the effect of the rate changes on the Barnett formula, because I know nothing about it…

    Photo thanks to chris robert on Unsplash

    Footnotes

    1. Spoiler: if they did, they were correct. ↩︎

    2. The rules around allocating taxpayers to Scotland or rUK are here ↩︎

    3. With the usual exception for stuff that can’t move, e.g. land. ↩︎

  • The mini-Budget – is it true that the UK taxed high income more than other countries?

    The mini-Budget – is it true that the UK taxed high income more than other countries?

    In his Budget speech, the Chancellor said that the UK had a higher rate of tax on high incomes than Norway. Is that true? How does the UK compare to others; and how was that changed by the Budget?

    How does the UK tax on high incomes compare with other countries? It’s a simple question – but not straightforward to answer.

    One way is to look at the highest marginal rate of tax on high incomes. That looks something like this:

    But the rates alone are misleading. The biggest missing element is: when do the rates apply? The 37% top rate of Federal income tax in the US kicks in at $523,600. The top UK rate – now 40% – applies from £50k. So saying the UK rate is just a bit higher than the US rate misses the most important question: how much tax do people actually pay? What is the effective tax rate on any given income?

    We can answer this given data for rates (taken from the wonderful OECD tax database), updated for the Budget changes, and calculate the overall effective rate of tax. on an employee – or the “tax wedge” for different multiples of average income in each country. See my previous post introducing this approach for more detail and a complete list of caveats and limitations. The updated code is here.

    Here’s the chart comparing UK tax (before and after the mini budget) with the rest of the OECD, looking at incomes going up to 20 x average income. You can click on it for an interactive version that lets you select/deselect different countries:

    It turns out the Chancellor was correct – the UK did have a higher rate of effective tax on someone earning 20x the average income (£500k), but (from April 2023) no longer will.

    All in all, the UK has a rather average level of tax on high earners, compared with the rest of the OECD. By contrast, the UK taxes average income significantly less than the average. That’s something almost nobody believes – but it is nevertheless true. If you don’t believe my chart, here’s the OECD comparison for the average income:

    It shouldn’t be a surprise that the countries with more extensive welfare states than the UK have higher rates of tax on the average worker. By contrast, some of them tax higher earners more; some don’t. The thing is, whilst the level of tax on the rich is of huge political significance, it is not very significant to the public finances. The 45p rate which the Tories just abolished raised £2bn. Income tax as a whole raises £228bn. NHS spending is £136bn.

    If we want a Scandinavian level of public services, then most people have to pay similar levels of tax to most people in Scandinavia. Sorry about that.

    Footnotes

    1. The calculation realistically has to include employer national insurance and social security. Yes, it’s paid by the employer, and isn’t visible on our wage slip, but evidence suggests it is mostly borne by workers (i.e. because the employer has an amount they’re willing/able to pay as wages, and employer NICs come out of that). ↩︎

    2. i.e. because realistically you don’t compare taxes on £100k in the UK with £100k in Costa Rica; you should compare taxes on three times the average income in the UK with three times the average income in Costa Rica ↩︎

  • Nadhim Zahawi – why did he say he didn’t benefit from an offshore trust, when we know he did?

    Nadhim Zahawi – why did he say he didn’t benefit from an offshore trust, when we know he did?

    I’ve told Zahawi’s lawyers I’m going to accuse him of lying to Kay Burley in his Sky News interview back in July. Amazingly, he’s refusing to respond – no explanation, no defence, nothing. It’s the behaviour of someone with something to hide.

    The backstory: Zahawi founded YouGov. But the 42.5% founder stake in the company (that you’d expect him to have) was held by a Gibraltar company – Balshore Investments – held by an offshore trust owned by his parents. More on that here.

    Why would anyone do anything so weird? The obvious answer: he put the shares in Balshore to avoid UK tax, but has arrangements behind the scenes to get cash from Balshore.

    In his Sky News interview, Zahawi denied that he benefited from Balshore:

    But this document shows a £99k gift from Balshore to Zahawi:

    My expectation is that this wasn’t a one-off – the only thing special about the £99k is that Zahawi got sloppy, and so it ended up being publicly disclosed. My bet is that there’s more out there. Possibly £26m more.

    So why on earth did Zahawi deny receiving any benefit from the trust? I put this to his lawyers, Osborne Clarke:

    They – amazingly – refused to defend or explain Zahawi’s false denial:

    Zahawi’s assertions that he’s paid all his tax, hasn’t avoided tax etc etc… they all fall flat when we know his central claim that he hasn’t benefited from the trust is false.

    At this point it doesn’t look like an accidental omission – in my opinion, it looks like deliberate deception… a lie. If Zahawi told the same lie to HMRC, then this wouldn’t be tax avoidance – in my view it would be tax evasion. Astonishing for a senior cabinet minister.

    At this point, I just couldn’t believe that Zahawi and his lawyers were so not-bothered that he’d been caught out in a lie. I put the point to them again… and still they refused to comment:

    If Zahawi doesn’t want me to infer things from his failure to explain what looks very much like a lie, then I’m afraid he’s going to be disappointed. Having structures that make no sense, making false statements about your tax affairs, and refusing to explain or defend those statements, is consistent with tax avoidance… but, in my experience and opinion, it’s also consistent with tax evasion.

    And so is the Balshore arrangement. The more I think about the structure, the less it looks like tax avoidance. The problem is, there are lots of rules that stop you simply giving your shares to an offshore trust, and then taking money from the trust. HMRC aren’t that dumb. You’ll end up paying the tax. The structure only saves tax if you keep everything hidden from HMRC. But if Zahawi did that, then he wasn’t avoiding tax at all… it was simple tax evasion.

    It seems incredible that someone who is now a senior cabinet minister would have acted dishonestly. But there is a longstanding allegation of criminal behaviour by Zahawi – reported in 1999 but only denied in 2020 (and never the subject of a libel claim).

    Zahawi is probably hoping everyone has forgotten about his tax affairs, and it will all go away. I haven’t, and it won’t.

    More to follow soon.

    Footnotes

    1. And it is super-weird. I’ve spoken to dozens of QCsKCs, tax lawyers, accountants, entrepreneurs and others about this. Everyone has the same reaction: that’s really weird. Zahawi’s explanation – that his father was instrumental in the establishment of YouGov, and so it was only natural he got the shares – is bizarre on several levels. ↩︎

    2. See page 36 here ↩︎

    3. Zahawi denies that the £26m profit Balshore made from YouGov was used to fund his £26m of loans. But he also denied receiving any benefit from the trust, and we know what that denial was worth. ↩︎

    4. There are a large number of different views out there on how precisely the structure would get taxed, but literally everyone I’ve spoken to thinks that it would have been taxed; whether under the settlement rules, the usual trust rules, transfer of assets abroad, remuneration rules/loan charge, purposive disregard of Balshore entirely… take your pick ↩︎

  • The myth of the corporate tax “race to the bottom”

    The myth of the corporate tax “race to the bottom”

    It’s often said there’s been a race to the bottom in corporate tax, with tax competition resulting in corporations paying less and less over the last few decades. The most recent claim was by the IPPR, which I commented on here.

    These claims are wrong, at least when it comes to the UK: the UK corporate tax rate plummeted over the last 20 years, but the actual tax collected, as a percentage of GDP, stayed broadly the same. See the chart above or the OBR piece here.

    Why? Because a company’s corporate tax liability is the tax rate multiplied by its taxable profit. The UK definition of “taxable profit” – often termed the “tax base” – has expanded over the same period that the rate fell. Either by accident or design, the two effects broadly countered each other. This means that the average effective tax rate (i.e. tax paid divided by profits) is largely unchanged:

    Unfortunately, the ONS doesn’t publish that chart going back further than 2010 – but we can calculate a reasonable proxy for effective tax rate using the ONS data for corporate gross operating surplus. That results in this chart, which needs to be read with many many caveats, but nevertheless is a good indication that the long-term trend is indeed that the headline rate (purple) plummets, but the effective tax rate (yellow) does nothing much at all.

    So the stories people tell of [brave tax-cutting Chancellors][evil tax-cutting Tories] are all wrong, and are because people are looking at the (mostly irrelevant) purple line. The yellow line – reflecting the tax actually paid – tells us that corporate tax wasn’t cut at all – it just changed in lots of very complicated and opaque ways. Great.

    What about other countries?

    I’ve quickly pulled together some data from the OECD’s fantastic corporate tax database, and have made an interactive chart that lets us compare corporate tax rates and revenue across the OECD. Click this image:

    The OECD sadly only has tax rate data going back to 2000 – I added the earlier UK tax rate data myself. But you can zoom and focus on 2000-2020, then click on the right hand side to select/deselect individual countries.

    The code and underlying spreadsheet is here..

    Unfortunately, I can’t find useful international gross operating surplus data, so can’t compare effective tax rates across the OECD. If anyone can find that data, please let me know.

    So what?

    I can play with the interactive chart all day but – fun as it is – it’s just cherry-picking.

    The question we really want to answer is: is there evidence across the OECD that falling rates drove falling revenues over the period 2000-2018?

    I’ll post more on this soon.

    Footnotes

    1. With some noise from “incorporation” – sole traders establishing companies to save tax, which tends to reduce income tax/national insurance and boost corporation tax – but not enough to make a difference to this analysis. ↩︎

    2. This comes from the excellent OBR piece. Well worth a read ↩︎

    3. The two big ones: (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. ↩︎

    4. If anyone can point me towards pre-2000 tax rate data I’d be most obliged. ↩︎

    5. If you have feedback on the quality of my incredibly amateurish coding then please do add comments on our official code feedback page here ↩︎

    6. The OECD data only goes back to 2008 ↩︎

    7. Just promise me you won’t look at the US chart, because pass-through taxation (company profits taxed in the hands of owners/shareholders) means US corporate tax statistics can’t easily be compared with other countries’. ↩︎

  • How to design a £30bn windfall tax on the energy sector

    How to design a £30bn windfall tax on the energy sector

    If we wanted to raise significantly more than the Government’s £5bn Energy Profits Levy, how would we do it?

    This is a further explanation and expansion of points I make in Panorama’s programme on the energy crisis, broadcast on 5 September, and follows my previous post discussing two serious flaws in the Energy Profits Levy – the relatively modest “windfall tax” the Government introduced in May.

    The politics

    I’m not going to get into the rights/wrongs of windfall taxes, other than to note that the political case for a more ambitious tax may be hard to resist if energy companies make £170bn of “excess profits” over the next two years, when at the same time it seems increasingly likely that the Government is going to spend £18bn or even £29bn keeping energy prices down for consumers.

    The design challenges

    The big problem is: how do we define an “excess profit”? The apparent Treasury leak of the £170bn figure didn’t bother to say.

    It was relatively easy for the last two big UK windfall taxes.

    • In the late 70s and early 80s there was a perception that the banks had made a windfall profit from low or zero interest deposit accounts, at a time when interest rates were at historic highs. So in the second Budget of the new Conservative Government, on 10 March 1981, the Chancellor introduced what was the “Special Tax on Banking Deposits”. This was a very simple tax, with the principal charging provisions fitting on one page. It simply took the average balance of zero-interest bank deposits held by banks during the last three months of 1980, and taxed that at 25% – so directly taxing the windfall, and raising approximately £400m.

    Note the important common features: one-off taxes, applying to clearly identified windfalls, and doing so retrospectively. These are good design features which we should seek to copy. The retrospective element is counter-intuitive – normally we’d say retrospective taxation is undesirable, even wrong, but in this case retrospection is essential both to enable the windfall to be clearly identified, and prevent avoidance/distortions.

    The difficult question in this case is: how do we identify the windfall?

    Three sophisticated approaches that won’t work

    Here is the heart of the windfall, the European gas futures price:

    It’s this that feeds into electricity prices generally, because the marginal price of electricity is set by gas. There is an excellent explanation of this here.

    In principle, we could calculate what energy company profits would have been in a parallel universe where energy prices hadn’t changed since January 2022. Then deduct that from the actual profits, and tax the difference. Fantastic, but for the minor detail that this is impossible – no complex business has systems/accounts that enable a calculation of this type to be made (i.e. because energy prices don’t go straight to the bottom line as revenue – energy prices are also a cost for most energy companies, and both costs and revenues are often hedged, energy is often sold on the basis of fixed prices, etc etc etc). If you ignore these complexities and just tax the immediate revenue impact of the increase in prices, then you end up with the Spanish windfall tax, which was something of a disaster.

    That suggests we need to look at profits, not prices, and apply some kind of revenue trend approach, for example saying that 2021 is the baseline profit, and any increase in 2022 is excess profit which we’ll tax. But that’s extremely random, and really just punishes companies who had a poor 2021. If Shell and BP go on to make identical profits in 2022, it can’t be right that we tax BP more, just because in 2021 Shell’s profit was higher.

    Alternatively, we could follow the approach adopted by the various wartime excess profit taxes which looked at the average profit during a prior period. This was proposed as a way of taxing excess profits resulting from the pandemic, but to my mind is a bad fit for the energy sector, given the cyclical nature of energy company profits (exacerbated by their very poor performance in the 2020 pandemic):

    I wouldn’t altogether discount this approach, particularly if we look across a very long period (say 20 years), but even then the result would be highly contingent on the precise period chosen (and where it cuts across the economic cycle), and therefore somewhat arbitrary. The extensive caselaw on the UK’s wartime excess profits duty (which shaped a surprising amount of modern tax law) is testament to quite how arbitrary and uncertain such taxes can be.

    Other more sophisticated excess profit tax approaches have been proposed, e.g. categorising individual sources of profit, but they don’t seem very applicable to the problem we’re trying to solve.

    A lovely idea that can’t work

    Most of the large profits from the current crisis are being made elsewhere in the world – particularly in Gazprom, Saudi Aramco, and a plethora of US energy companies. Some people (okay, the Lib Dems) have suggested we tax those companies’ UK subsidiaries.

    The difficulty with this is that in most cases all, or almost all, the profit is made outside the UK – so we have nothing to tax. Gazprom is an interesting exception – it has a UK trading arm with a reasonably significant market presence – and that’s probably why the Lib Dems name-check it specifically. The minor problem is that the company isn’t doing so well these days.

    More radical ideas that are legally complex

    Another suggestion has been to tax listed energy companies on their capital appreciation. This has a number of difficult legal issues, and in particular potential conflicts with tax treaties and EU law. I discuss this further here.

    A simple approach that should work

    So the best solution may be the simple one of imposing a special top-up tax on the profits of energy companies from 26 February 2022 to whenever it is that market prices settle down. I’d tentatively set out the following design features:

    • The tax should be on the consolidated accounting profit of all UK-headquartered energy production/generation/trading companies, and the profit of UK subsidiaries of foreign-headquartered energy companies. Certainly not limited to the big two listed giants – Shell and BP – but to all large businesses in the sector – including nuclear, wind and solar generation.
    • A properly fair and sophisticated tax would separate out the profits of energy generation companies in the group from other companies, and only tax the former. This leads to endless complexity and unfairnesses, so this should be a rough and unsophisticated tax that simply applies to the entire consolidated group profit of groups that make a majority of their profit from energy generation or trading, or oil/gas extraction.
    • The tax should be retrospective, introduced only after prices return to normal. The basic form of the tax (a tax on global accounting profit) would be announced now, together with an indication of the target revenue yield, but little more in the way of details. That minimises avoidance and other distortions, and enables the final form of the tax to fit with the windfalls that have actually been made.
    • There would need to be large penalties for any company or individual seeking to evade paying the tax by extracting profits in advance of the windfall tax, leaving no cash for HMRC to collect.
    • We should consider taxing companies global profits, not just UK profits. We don’t normally do this – but that’s not because it’s a high point of principle… it’s because foreign profits are normally taxed in other countries. If other countries aren’t taxing excess profits, we shouldn’t feel shy about taxing them ourselves. And if other countries do introduce similar taxes to tax excess profits, those taxes should be creditable against the tax of UK-headquartered companies.
    • Why consider taxing foreign profits in this case? Because I fear that the UK profit would not be a large enough tax base to raise the necessary sums. If that is wrong, that is excellent – it is problematic to tax foreign profits, and preferable not to do so. The great thing about a retrospective windfall tax is that we should know with reasonable certainty what the tax base looks like at the point that the tax is drawn up, and it is at this point that such decisions should be taken.
    • The other pragmatic reason not to tax UK companies on their foreign profits is that it incentivises businesses to relocate. Relocation risk would be reduced if other countries introduced similar taxes (as seems likely). However, the critical element is for the Government to make a credible promise that there would be no repeat of the tax (just as there was in 1981 and 1998; these promises were kept).

    If the actual windfall profit ends up being around the supposed leaked Treasury figures, then it’s not unrealistic to think such a tax could potentially raise £30bn over two years.

    However, it’s important to stress that we shouldn’t start taxing a windfall before a windfall has actually been made. Right now, BP and Shell had a very good Q2, and a decent Q1 (ignoring BP’s huge loss from the forced sale of its Russian business). Let’s see what happens next. When it comes to windfall taxes, there’s no time like the past.

    Footnotes

    1. Which is one reason to be suspicious of the leak, and of the figure ↩︎

    2. Thanks to R for their help with this – the chart is from here ↩︎

    3. And its profits were a fairly modest £300m even before it started running into trouble ↩︎

    4. Amended to clarify that I am not just focussed on oil/gas ↩︎

    5. See: the bank levy – not a model anyone should adopt ↩︎

    6. That means, for example, that the usual tax rules that exclude gains/losses on sales of subsidiaries wouldn’t apply, which I think is the correct result here. Imposing a windfall tax on BP that ignores its very real Rosneft losses would be unfair ↩︎

    7. I think I do mean “evade” here and not “avoid” ↩︎

    8. I would allow such losses to be deductible in the proposed windfall tax, as they’re part of the IAS consolidated accounting profit – but I can see a case for excluding them, given that companies could control the timing of disposals to avoid tax. One option would be to tax/relief gains/losses from 26 Februrary 2022 up to the date the tax is announced, but not afterwards ↩︎

  • The £5bn flaws in the UK oil and gas windfall tax

    The £5bn flaws in the UK oil and gas windfall tax

    In May, the Government announced the Energy Profits Levy – a windfall tax on UK oil and gas companies. It has two significant flaws, which together mean the tax will raise almost £5bn less than it could have done.

    This post is an explanation and expansion of points I make in Panorama’s programme on the energy crisis, broadcast on 5 September (and reflects further thinking since I recorded the interview a few weeks ago). I’ve another post looking at how a more ambitious windfall tax could raise £30bn.

    Flaw 1 – this windfall tax misses some of the windfall

    The Energy Profits Levy was announced on 26 May 2022 and applies from 26 May 2022. For most taxes that wouldn’t be surprising. But for a windfall tax it’s odd, because windfall taxes are usually retrospective – i.e. taxing a windfall that’s already been made.

    This chart at the top of this post shows the oil price over the last five years – the shaded red section shows the oil price breaking $100/barrel, at the point of Putin’s invasion of Ukraine. The red line shows the point at which the windfall tax starts to apply… it’s clear that this windfall tax misses a large chunk of the actual windfall.

    If the tax had applied from 24 February it would have raised an additional sum of approximately £1.5bn..

    Flaw 2 – the investment allowance is pure deadweight cost

    The windfall tax is charged at 25% of oil and gas profits. So a company with £100m of windfall tax profits would pay £25m tax.

    But the government was sensitive to claims that a windfall tax would deter investment, and so introduced an 80% allowance for capital expenditure and, in addition, a 100% first year allowance.

    Many tax reliefs are introduced to encourage more of a Good Thing. Those reliefs always have a “deadweight cost” – the cost of giving relief to something that would have happened anyway, as well as a benefit (the Good Things that we will now get more of).

    What are the benefits and deadweight costs of the investment allowance?

    Calculating the benefit

    The investment allowance works like this: if a company has oil and gas profits of £100m, and invests £50m in qualifying capital expenditure, it gets a deduction against its windfall tax profits of up to £90m (i.e. 180% of £50). So its windfall tax profits are reduced to £10m, and its tax only 25% of this – £2.5m.[/mfn]Needless to say, these are all highly simplified examples.[/mfn] That £50m investment has cost the company only £27.5m

    First thought: wow, what a fantastic incentive that is sure to generate lots of new investment!

    Second thought: hang on, the windfall tax isn’t around for very long – it ends 31 December 2025. So for any oil and gas investment to be incentivised by the investment allowance, the project needs to move from drawing-board to breaking ground in 30 months. My understanding from industry contacts is that very few, if any projects will do this.

    It’s even worse than that – 31 December 2025 is the “sunset date” – the tax will be phased out earlier if oil and gas prices return to “historically more normal levels”. A tax relief that lasts for an unpredictable amount of time is not a tax relief many people will be banking on.

    These points suggest there will be little or no upside from the investment allowance – the only projects that will materially benefit from the investment allowance will be those that were already planned.

    A more general point: giving 100% investment relief (aka “full expensing”) is a good idea, even an excellent idea, but it absolutely can’t be part of a temporary tax regime. And another important point: there is evidence that investment reliefs are ineffective in times of economic uncertainty.

    Calculating the deadweight cost

    The deadweight cost is the cost of giving the investment allowance to investments that are already in the pipeline. We have a good idea of what the pipeline looks like, thanks to the ONS’s projections for North Sea capital expenditure (made prior to May 2022). We can pick out the qualifying items from this, and calculate the cost of giving them the 25% allowance:

    Click to download the spreadsheet

    This gives an estimate of the deadweight cost of £3.2bn. That will be a low-end estimate, because it ignores a number of factors, each of which would increase the actual deadweight cost:

    • The calculation completely ignores the 100% first-year relief, as I have no data on the proportion of the capital expenditure which is first-year expenditure; any suggestions would be appreciated (although I expect the proportion will be small, given the long life of most oil/gas equipment).
    • I ignore leasing expenditure, and this is not separately shown in the ONS forecast – will be an element of operating expenditure. This is likely a bigger effect. There is also an obvious avoidance route of recycling existing assets into leases to claim the allowance (although in principle HMRC out to be able to counter that).
    • I’m not taking account of deferral effects – i.e. where investment planned for early 2022 was pushed back into late 2022 to benefit from the investment allowance. These are likely limited, as industry had little warning of the tax.
    • Similarly, I don’t take account of acceleration effects, e.g. investment already planned for 2026 being moved up into 2025 to claim the relief – that will likely be more significant.
    • Finally, there is now a large incentive to reclassify items so they benefit from the relief.

    So, overall, it’s fair to say that the two flaws result in a loss of around £5bn of tax revenue.

    Footnotes

    1. Data from Yahoo Finance. A more serious analysis would probably be looking at natural gas futures pricing, but that’s way outside my expertise… this chart suffices for the basic point that the windfall tax kicks in well after the windfall starts ↩︎

    2. I estimate this by taking the £5bn yield the Government expects in its first ten months, and then pro-rating that across an additional three months ↩︎

    3. i.e. because it is out of pocket £50m plus £2.5m tax; if it hadn’t invested at all it would have had £25m tax; hence the investment actually cost £52.5m minus £25m. It’s actually less than this once we take into account all the many, many, other reliefs against ringfenced oil/gas corporation tax, but I want to focus solely on the design of the windfall tax. ↩︎

    4. See here, and go to Supplementary fiscal tables – receipts and others, tab 2.14 ↩︎

  • The end of secret libel letters?

    The end of secret libel letters?

    Last month, the Chancellor of the Exchequer instructed lawyers to write to me, accusing me of libel and requiring me to withdraw my allegation that he had lied. They claimed their letters were confidential, and warned me of “serious consequences” if I published them. This was tosh. I did not retract, and I published the letters.

    I’d been aware of SLAPPs – “Strategic Lawsuits against Public Participation” – where a wealthy and/or famous person uses the threat of libel proceedings to shut down debate. I hadn’t been aware of what turns out to be the widespread practice of libel lawyers claiming their letters were confidential and/or “without prejudice” and couldn’t be published. In most cases this is not true.

    It may come as a surprise to many people, but solicitors are not allowed to tell fibs. The Solicitors Regulatory Authority requires solicitors to behave in accordance with the SRA Principles: to act with honesty, integrity, independence, and to uphold the rule of law. Intimidating people into not publishing letters they are perfectly entitled to publish is the very opposite of these Principles.

    So I wrote to the Solicitors’ Regulatory Authority, asking them to end the practice of solicitors making phoney claims of confidentiality in libel letters.

    I’ve now received a response. It is excellent:

    As part of our work, we are currently developing further specific guidance to the profession on the topic of SLAPPs, highlighting the issues arising from our casework. Further to your letter, we plan (amongst other things) specifically to address the practice of labelling correspondence as “private and confidential” and / or “without prejudice”, and to address the conditions under which doing so may be a breach of our requirements. We think that this approach will help solicitors to comply with our existing standards and regulations and to use those labels only when appropriate. We can update you as and when we publish this guidance. 

    We are also to carry out a thematic review of a targeted sample of firms, looking at the steps taken by firms to address the issues raised in our Conduct in Disputes guidance. The outcomes of this review, as well as our enforcement work and the work currently being done by the government on reform of the law relating to SLAPPs, may in due course inform further updates to our guidance. 

    Silence is integral to the SLAPP strategy. A small-time blogger says something you don’t like. You get your lawyers to write them a letter warning them off. The blogger deletes their blog, and nobody has any idea what happened. The SRA now has a fantastic opportunity to end this, and to force libel lawyers and their clients to step into the light. If you want to threaten someone with libel: fine. But you’ll have to face the consequences of everyone knowing what you’re up to.

    Footnotes

    1. This is not a theoretical example; after my experience I was inundated with messages from bloggers who had been at the receiving end of SLAPP letters ↩︎

    2. Actually not fine; I tend to think libel law should only apply to the most serious of deliberate lies ↩︎

  • Nine questions the Chancellor is ducking

    Nine questions the Chancellor is ducking

    I’m going to keep this as a running list of the key questions Nadhim Zahawi is ducking.

    Any one of the questions could be enough to justify an HMRC investigation. All of them together? And linked to the Chancellor of the Exchequer? Words fail me.

    And bland statements from Zahawi that he’s paid all his taxes don’t count, particularly when previous bland statements have been clearly false.

    Here’s the list:

    1. Why were Zahawi’s founder shares in YouGov issued to Balshore, a Gibraltar company held by a trust controlled by Zahawi’s father?

    Significance: the obvious answer is: tax avoidance. In which case, we can expect gains/income of the trust to have been taxable (one way or another). See here.

    Zahawi answer 1: because his father/Balshore provided startup capital. Untrue. My analysis of how we know this here. Zahawi’s lawyer’s attempt to defend his position here – they say £7,000 was startup capital, which is nonsense. We’re not even sure the £7,000 was provided in 2000 – it could have been two years later.

    Zahawi answer 2: because Zahawi had no experience of running a business at the time, he relied heavily on the support and guidance of his father, who was an experienced entrepreneur, and helped him with living expenses. This may well be true to some degree, but seems very doubtful it is true enough to justify all the founder shares going to Zahawi’s father, not least that it contradicts the known history of YouGov. I set out all the problems with this here.

    Of course Zahawi vociferously denies that the shareholding was motivated by tax avoidance, but without a convincing answer to why the shareholding looks so weird, tax avoidance is the explanation most people (experts and laypeople alike) will jump to.

    Status: unresolved.

    2. If Zahawi’s story is true, and his father did provide valuable services to YouGov in exchange for the shares, wasn’t there VAT on those services?

    Significance: this means YouGov would have had to account for about £140k of VAT. I very much doubt they did. So, if Zahawi is telling the truth, his company unlawfully failed to file correct VAT accounts.

    A persuasive answer to this would be “of course there wasn’t VAT, because Zahawi’s father didn’t provide valuable services to YouGov”. But of course that completely undercuts Zahawi’s answer to question 1.

    Status: I and others have asked Zahawi’s team this question – there’s been no response. More here.

    3. Why did Zahawi deny that he benefited from his parents’ trust, when we know that he received at least one gift from it?

    Significance: Zahawi gave clear answers to Sky News, and those answers were false – he did receive a gift in 2005 (and I expect on other occasions too). Why isn’t this a resigning issue?

    More here.

    Status: no further explanation has been forthcoming.

    4. Did Zahawi unlawfully fail to pay tax on the gift from the trust?

    Significance: When a company owned by a foreign trust makes a gift (a “capital payment”) to a UK resident, it’s taxable for the UK resident. Even if everything Zahawi says is true, this tax was due. I doubt very much it was paid. If that’s right, then the Chancellor of the Exchequer has unlawfully failed to pay his taxes. This feels significant.

    The reason why I expect the tax wasn’t paid is that a rational tax avoider anticipating tax on the gift would have structured the arrangement differently, so there was no tax. The most obvious solution would be a direct gift by Zahawi’s father to Zahawi, not involving the trust. The various amateur features of the structure suggest that in fact they didn’t anticipate the tax – in which case it probably wouldn’t have been paid.

    This isn’t avoidance – it’s just an unlawful failure to pay tax that was due. It’s not evasion unless the failure to pay tax was deliberate – but much more likely it’s just down to incompetence.

    Status: no response from Zahawi other than a bland statement he’s paid all his taxes. That’s unacceptable – this is a simple question: “did you pay tax on the gift?”

    5. What other gifts/loans did Zahawi and his companies receive, funded by the YouGov shares, from the trust and its subsidiaries?

    Significance: the more Zahawi benefited from the YouGov shares, the more the structure looks like tax avoidance.

    Status: all we have is Zahawi’s denial that he ever received a benefit from the trust. But we know that is false.

    6. Did Zahawi unlawfully fail to pay tax on his interest payments to Gibraltar?

    Significance: a UK person paying interest to Gibraltar has to pay a 20% UK tax on each interest payment (“withholding tax”). Has Zahawi paid this tax on the interest he’s paid to Berkford since 2011? If not, the Chancellor of the Exchequer has unlawfully failed to pay his taxes.

    Zahawi acquired the Oakland Stables in Warwickshire in 2011 for £875,000. At the time, it was reported that he acquired the property with a secured loan from Berkford Investments Limited, which I believe to be owned by the same trust as Balshore. Zahawi has said this was a commercial loan, bearing interest at 8%. These interest payments should have been subject to a 20% UK tax (“withholding tax”).

    Again, a rational tax avoider would not have structured the arrangement in this way. Common approaches would be to use a Jersey company, rather than Gibraltar, or alternatively to create a Luxembourg or Ireland subsidiary under the Gibraltar company. Gibraltar companies are rarely, if ever, used in tax planning because of (amongst other things) the withholding tax issue. So my expectation is that Zahawi and his family didn’t anticipate this issue, and therefore didn’t pay the tax.

    Again, this isn’t avoidance – it’s just an unlawful failure to pay tax that was due. And it’s not evasion unless the failure to pay tax was deliberate – more likely it’s just down to incompetence.

    Status: no response from Zahawi other than a bland statement he’s paid all his taxes. Again, this is unacceptable. It’s a simple question: “did you pay 20% UK withholding tax on all your interest payments to Berkford?”

    7. Why is the Oakland Stables loan not visible in Berkford’s accounts?

    Significance: this is very odd, and begs the question as to whether there is something unusual about the loan. Or it could just be a massive accounting failure in Berkford.

    Status: no response from Zahawi.

    8. Was Zahawi’s mother running the offshore company Berkford whilst in the UK, making it UK tax resident?

    Significance: If an offshore company is “centrally managed and controlled” in the UK then that company will be tax resident in the UK, and so taxed on all its worldwide income and gains. On its Land Registry documents, Berkford provided a UK address – the flat where Zahawi’s mother lived at the time. 

    Since Zahawi’s mother was a controller of the trust holding Berkford, was she in fact running Berkford making it UK resident and fully subject to UK tax? If so, that probably wouldn’t create liability for her, but the company could have a large tax bill.

    Status: newly identified by Marcus Leroux.

    9. How can we have a Chancellor of the Exchequer who appears to have avoided tax, may have unlawfully failed to pay tax, and refuses to answer questions?

    I’ve no answer to this one.

    Footnotes

    1. Note that it may be no cash VAT would have been due, because YouGov could have recovered the VAT ↩︎

  • The many holes in inheritance tax, and how to fix them

    The many holes in inheritance tax, and how to fix them

    Bob

    Bob is a 70-year-old with £5m of investments which he wants his children to inherit. But he’d like to avoid the £2m of inheritance tax.

    He asks his tax adviser for advice on how to avoid the tax, and is expecting a long complicated memo, proposing a tax avoidance scheme involving seventeen companies, three tax havens, two trusts, and large fees.

    What he actually gets is written on a postcard:

    • Step 1: Sell your existing investments and replace them with shares listed on the Alternative Investment Market. Either assembling a diversified selection yourself, or paying someone else to do it.
    • Step 2: Make sure to live at least two years.
    • Step 3: Drop dead, happy in the knowledge you’ve avoided inheritance tax.
    • There is no Step 4.

    Jane

    Jane is a 70-year-old who owns a £5bn vacuum cleaner company, which she wants her children to inherit. But she’d like to avoid the £2bn of inheritance tax.

    She asks her tax adviser how to avoid the tax. The answer she gets is surprising: nothing. Her estate will have no inheritance tax liability whatsoever on the £5bn business.

    Why does this work?

    There is a complete exemption from inheritance tax – business property relief – where (broadly) you own a business, and have held it for at least two years. So Jane is straightforwardly exempt from inheritance tax.

    Surprisingly, the exemption extends to most AIM shares, which qualify for complete exemption from inheritance tax after two years. Given AIM companies are small/mid-cap, the obvious downside is that your portfolio suddenly becomes more volatile (although not as much as you might think). But Bob probably sees that as a small price to pay for avoiding a 40% tax hit.

    Does this actually happen?

    Oh yes. Here’s the HMRC analysis of the effective rate paid by different value estates. The effective rate for the wealthy is 10%:

    Why are these exemptions so generous?

    The road to tax hell is paved with good intentions (and also flapjack).

    Inheritance tax can be unfair for small family businesses. Imagine a small shop, making a profit of £50,000/year. That business is plausibly worth £500k. So when the owners die, their children – who expect to inherit the business – have a £200k bill. A larger business could deal with this by borrowing, or bringing in outside investors – but for a small business that’s much more difficult.

    So most countries with inheritance/estate taxes have exemptions for private businesses.

    The UK does that with business property relief. But BPR goes much further than it needs to:

    • First, the exemption has no limit. What makes sense for the cornershop doesn’t really make sense for a £1bn business – but the exemption covers it just the same.
    • Second, the exemption doesn’t apply to shares in listed/quoted companies, for the very good reason that you can easily fund the tax by selling the shares in the market. But shares in alternative markets like AIM aren’t considered “quoted” for this purpose, even though you can easily fund the tax in precisely the same way.

    Inheritance tax is just full of this sort of thing, which is why it’s so broken – see my previous blog.

    How to fix it

    That’s easy. Exemptions and reliefs should do what they’re supposed to do, and no more. If we are trying to protect small private businesses then business property relief should only cover small private businesses. Cap the relief at a generous but sensible level (£1m?). Exclude all forms of listed security. Job done.

    Given the high cost of BPR, this could raise a serious amount of money, and could fund a reduction in what is (by international standards) quite a high tax rate. The same should be done with agricultural property relief.

    And by reducing both the rate of IHT, and the perception the rich don’t pay it, we might make the tax less unpopular, and therefore preserve its long term future.

    Cemetary photo by John Thomas on Unsplash

    Footnotes

    1. This is an updated version of my previous piece – ‘how to avoid inheritance tax’ ↩︎

    2. Won’t there be CGT on the sale? Probably not much. £1m of the investments are in an ISA. As for the rest, like any tax-obsessed investor, you’ve been managing CGT as you go, crystallising gains to use your annual allowance, and using your wife’s annual allowance (i.e. total gain sheltered = £25k * years invested). You’ll have a bit of gain, but it’s a price worth paying. ↩︎

    3. probably with the £1m capped relief still available to the original owner of the business, before it was listed, if they continue to hold the listed shares ↩︎

  • Ending secret libel letters

    Ending secret libel letters

    This morning I wrote to the Solicitors’ Regulatory Authority, asking them to end the practice of solicitors sending libel letters demanding that allegations of wrongdoing are retracted, but insisting that the letters are confidential and cannot be published, or even mentioned.

    This follows the letters I received from Osborne Clarke, acting for the Chancellor of the Exchequer. More context here, and legal background to the bogus “confidentiality” claims here.

    My letter is below – if you click on the thumbnails they should expand. Alternatively, there’s a PDF here.

    Footnotes

    1. Embarrassing “without privilege” typo corrected, courtesy of Heather Self ↩︎

  • Why publish “without prejudice” and “confidential” correspondence?

    Why publish “without prejudice” and “confidential” correspondence?

    This is a slightly wordy explanation that I’ve written primarily for lawyers who are curious why an experienced lawyer would publish “without prejudice” correspondence. The main post is here.

    The short answer is: because it wasn’t really “without prejudice” or “confidential”. If I write you a letter, and say the letter is an elephant, that doesn’t make it an elephant.

    Without prejudice?

    We generally want lawyers to negotiate to reach settlements, rather than taking everything to a time-consuming and expensive court hearing. “Without prejudice” is a longstanding rule designed to facilitate that. The Civil Procedure Rules summarise it as:

    In other words, if I’m suing someone for £100m, and offer in a “without prejudice” letter to settle for £1 then, if we later get to court, the defendant can’t point to my £1 offer and say it suggests I don’t believe in my own case. The court will generally refuse to accept my letter as evidence. It is probably also improper for the defendant’s lawyer to publish my letter – it’s certainly bad manners.

    The Osborne Clarke email goes further than “bad manners”, and says:

    “It is up to you whether you respond to this email but you are not entitled to publish it or refer to it other than for the purposes of seeking legal advice. That would be a serious matter as you know.”

    This is poppycock – indeed it’s more than poppycock, it’s an improper attempt to intimidate someone without the rest of the world finding out about it.

    But you can’t just slap “without prejudice” on any old letter – there has to be a genuine attempt to settle a dispute. As Lord Griffiths said in Rush & Tomkins v. GLC:

    The “without prejudice” rule is a rule governing the admissibility of evidence and is founded upon the public policy of encouraging litigants to settle their differences rather than litigate them to a finish … The rule applies to exclude all negotiations genuinely aimed at settlement whether oral or in writing from being given in evidence.

    That’s the key: there must be a dispute, and the correspondence must be – “genuinely aimed at settlement”. So actually my £1 offer above might not be “without prejudice”, because the recipient could well claim it wasn’t “genuine”.

    There are several reasons we can be confident the “without prejudice” doctrine doesn’t apply to this letter:

    • This wasn’t a genuine attempt to settle a dispute. The way a normal settlement offer works is that, if the settlement isn’t accepted, you proceed to litigation. In fact here, when I rejected Zahawi’s “offer” (that I retract my claim about Zahawi), their next letter said they’re not suing me. So there was no dispute, and this wasn’t a genuine attempt to settle it. It was a bluff, aimed at getting me to retract.
    • There wasn’t even a dispute. The “without prejudice” letter claims that I said Zahawi “was lying about the extent of involvement of [Zahawi’s] father in the very early days of YouGov when it was set up in 2000.”. That is not correct – I said no such thing. Osborne Clarke’s second letter correctly identifies what I actually said – that Zahawi’s first explanation – that his father contributed startup capital – was a lie. So the “without prejudice” letter relates to a matter that was never under dispute.
    • I said explicitly I would not accept without prejudice correspondence.

    I am therefore confident that the first letter was not in fact a “without prejudice” letter, it is not improper for me to publish it, and it could be adduced as evidence in court (in the laughably unlikely event this matter ever goes to trial).

    Confidential?

    Here’s the second Osborne Clarke letter.

    They really, really, don’t want me to publish it:

    “You have said that you will not accept without prejudice correspondence and therefore we are writing to you on an open, but confidential basis. If your request for open correspondence is motivated by a desire to publish whatever you receive then that would be improper. Please note that this letter is headed as both private and confidential and not for publication. We therefore request that you do not make the letter, the fact of the letter or its contents public.”

    Slapping “confidential” on a letter doesn’t stop the recipient publishing it. You need two things: contents that are actually confidential, and then a duty of confidence must be agreed or implied.

    We can dispose of the second point immediately. Obviously I hadn’t agreed to treat their correspondence as confidential, and there’s no reason to imply that I had; in fact they imply the opposite (that I may publish the letter). So no duty of confidence exists.

    The first is more subtle, but here’s the problem: there is nothing confidential in the letter. Imagine they’d written “Look, Zahawi’s first explanation was wrong, and we admit that. But his press secretary had just been eaten by a rhinoceros, and the intern was so traumatised they put out any old nonsense. We still haven’t tracked down his family, so please treat this as confidential.”

    Now that could have been confidential information. But nothing in the actual letter is confidential. They say nothing that the world doesn’t know already about Zahawi’s unconvincing explanations for his tax affairs.

    Oh, and there’s a further problem. Even if the letter was confidential, and a duty of confidence could be established, there is a defence if I can establish a public interest in publishing. Here I would say that publishing the fact the Chancellor is seeking to silence an allegation of dishonesty against him is absolutely in the public interest.

    Wider implications

    I believe the tactics Osborne Clarke used here are fairly common in the libel world – abusing “without prejudice” and confidentiality to ensure that libel threats are not reported. These aren’t real libel claims – they’re strategic lawsuits against public participation (SLAPP).

    The Solicitors’ Regulatory Authority already warns lawyers about the potential for SLAPP misconduct. I will be writing them to ask that they expand their guidance to make clear that only in rare cases will a libel letter before claim be without prejudice and/or confidential. More generally, lawyers should not make assertions that their letters cannot be published unless they have a very clear and stated basis for doing so.

    I should add that I am not making an SRA complaint against Osborne Clarke – my sole aim is for the SRA to ensure that SLAPP defendants are not misled into thinking that they cannot mention the purported claim against them to third parties.

    I’m leaving comments on this post open for now, but will police them more than usual, for which my apologies.

    Footnotes

    1. This is a very smart point that I’d missed, but was picked up by a litigator – thank you Chris! ↩︎

  • The Chancellor’s secret libel letters

    The Chancellor’s secret libel letters

    The Chancellor of the Exchequer, Nadhim Zahawi, has been sending threatening letters, drafted by expensive lawyers, to people investigating his tax affairs. The letters are designed to intimidate, and say they are confidential and can’t be published. One was sent to me. I am publishing it.

    Update: The Times has the story here. For those who prefer PDFs, I’ve uploaded the first Zahawi letter here, my response here, and the second here.

    The letters

    The public have a right to know if the Chancellor of the Exchequer – the person responsible for HMRC and tax – created a tax avoidance scheme to avoid £4m of his personal tax. At this moment I expect HMRC is considering whether to launch an investigation… it’s hard to imagine a worse conflict of interest than the Chancellor being investigated by tax inspectors whose conduct he can influence.

    And the public definitely have a right to know if the Chancellor sends letters to prevent the media and others from writing about his tax avoidance.

    I believe in transparency. I think it’s improper for lawyers acting in the shadows to curtail legitimate public debate about important public figures, particularly when there are allegations they’ve been dishonest. So I told the Chancellor’s lawyers I’d only accept open correspondence. They persisted in sending me letters that claim to be confidential. They aren’t. They contain no confidential information, and I never accepted a duty of confidence – indeed I explicitly rejected it. I don’t believe the Chancellor ever really intended to pursue a claim. The public interest is so obvious, and so strong, any libel claim would be farcical.

    The letter they sent me says, rather artfully, that it’s not actually a threat to sue for libel. But it comes from a libel lawyer, and tries to prevent me publishing it. Similar letters have been sent to others in recent weeks, and I understand Zahawi has done this before – using lawyers to silence people writing about his tax affairs.

    I’ve considered very carefully whether I should publish the correspondence. I’ve considered the matter with others and spoken to several legal ethics experts. All support my view that in the circumstances of this case there is no legal or ethical reason not to publish the letters, and a powerful public interest in publishing. So that is what I’m doing. And I will be writing to the Solicitors Regulatory Authority to ask them to make clear that lawyers should never assert that letters of this kind are confidential unless there is a proper and reasoned basis for such an assertion (which is is clearly absent here). More here on why I am confident this is both lawful and proper.

    The background

    For the last couple of weeks, I’ve been writing about how, when Nadhim Zahawi co-founded YouGov, his 42.5% founder shareholding ended up with a Gibraltar company, Balshore, owned by a secret offshore trust controlled by his parents. I said it looked like tax avoidance. I am a tax expert. And every other tax expert I’ve spoken to agrees – accountants, solicitors, QCs, and retired HMRC inspectors.

    Zahawi provided an explanation for this: that his father had provided “startup capital”. But he hadn’t. He may have provided £7k for some of the 42.5% but (according to documents filed by YouGov) another investor paid £285,000 for 15% of the shares at the same time. Clearly £7k didn’t justify 42.5%. I published my conclusion – there were three possibilities: I’d made a mistake; YouGov had filed a series of wrong documents; or Zahawi was lying. I invited Zahawi to respond. He didn’t – instead he switched to a new explanation – that his father had provided so much assistance, and Zahawi was so inexperienced, that it was only fair for YouGov to give his company (Balshore) the shares.

    I couldn’t understand why he provided that first explanation, and then dumped it and alighted on a new one (itself not very credible). I couldn’t think of any explanation except deliberate deception – so I called it what I thought it was: a lie. It’s this that has Zahawi so unhappy. The latest defence piles on more of what look like falsehoods. They suggest the false explanation was given only once, when I know it was given to at least three people. Zahawi’s lawyers confuse the words “capital contribution” and “startup capital” (they surely know the difference). They muddle Zahawi’s first explanation with his second. I think they know they have no real argument, and no serious libel claim. Which is why, instead, they have focused on silencing me – with bullying letters from the shadows. But I’m not going to play that game.

    This is not the only false statement from Zahawi.  On 11 July he told Sky News he didn’t benefit from an offshore trust and wasn’t a beneficiary of it. In fact he was – in 2005 Zahawi absolutely received a gift from Balshore. This was a benefit and he was a beneficiary – in both everyday English and technical tax law. I have not called this a “lie” because Zahawi may just have been confused. But for him not to correct his past statement is unacceptable.

    And Zahawi’s tax avoidance may have triggered a raft of further taxes: value added tax in 2000; trust taxation on gifts and capital gains in subsequent years; and withholding tax on his many interest payments to Gibraltar. I’ve asked Zahawi’s lawyers if he paid these taxes. Their response – he doesn’t want to get into a debate when he has an important job to do. But a large part of that job is being in charge of the tax system. And it’s not a debate, it’s a simple question: did the Chancellor fail to pay tax that was due? The public has a right to know.

    The documents

    Here’s the initial Twitter DM I received from Zahawi’s lawyers, Osborne Clarke. Note my reply that I won’t accept “without prejudice” letters (a “without prejudice letter” is often sent by lawyers negotiating a settlement; it can’t subsequently be put before a court, because that would dissuade people from trying to settle disputes). The opposite is an “open” letter.

    Their response was to send me a (supposedly) without prejudice letter – the very thing I’d said I wouldn’t accept:

    I responded as follows:

    I then received this response:

    I hope it’s clear from the above why I believe publishing the letters is the right thing to do. I explain in more detail here why Osborne Clarke’s assertion that I can’t publish these letters is wrong in law.

    I’m leaving comments on this post open for now, but will police them more than usual, for the predictable tedious legal reasons – sorry.