The recent publication of the Paradise papers has reminded us of the gulf between the politicians and tax authorities on the one hand, and some savers and their advisers on the other. It is common now in political discourse to condemn both tax evasion and tax avoidance in the same sentence as if they are similar things. The old distinction between tax evasion, which is a crime, and tax avoidance which can be good financial planning, is being steadily eroded.
These days a saver has not merely to ask if any particular investment and its tax consequences is legal but also does it meet the government wish to make sure the saver pays enough tax. The more careful government advocates now make a third distinction, offering aggressive tax avoidance as something to be rooted out whilst ordinary tax avoidance is acceptable. It is this distinction which investors and their advisers now need to comprehend.
The self-same governments that condemn tax evasion and avoidance in one breath have set up regulated structures for investment advisers which require the advisers to give best advice and to take into account the tax circumstances and the cashflows of their clients. It is arguable that in the UK it would not be good advice if the adviser failed to point out to the client that they can hold a portion of their savings in ISAs which mean they avoid income tax on interest and dividends and avoid capital gains tax (CGT) on gains. Advisers would be expected to discuss with their client whether saving for a pension would also be a good way of investing for the future. After all, the pension fund pays no income tax on dividends received and no CGT on gains made. The individual pays no tax on income invested in a fund up to a limit, and gets one quarter of the money out in later life entirely tax free. These are widely used and accepted ways of avoiding and deferring taxes.
Globally, governments are worried about the way some large companies switch revenue to low tax jurisdictions
Governments have also offered tax breaks to influence behaviour. They say they want people to save or to invest, and offer reductions or exemptions to tax to do so.
Some say it is still reasonable to do anything to save tax that is legal. It is surely, they argue, up to governments to change the tax law to levy more tax if they object to some of the ways individuals and companies take advantage of tax law. Governments no longer accept that approach. There is now a system of having to report planned tax avoidance schemes to the Inland Revenue which may wish to take pre-emptive action to stop any particular loophole. The court of the media and public opinion can also swing into action and find that various legal schemes are nonetheless unacceptable, causing embarrassment and the need to change tack for the better off individuals or companies who have taken advantage of the schemes on offer.
Most of the matters highlighted in the Paradise papers, so far, were cases where people and companies had used offshore funds but were paying UK taxes on the income and gains in the normal way. Many investments are currently packaged in the form of offshore funds to attract global investors, but each holder has to obey the tax laws in his or her own tax jurisdiction. It is of course a different matter if people are using offshore trusts or companies to change the tax authority that the income or gain falls under. This brings into question more difficult issues about who controls a given trust and where it is truly domiciled, or where a company actually earns its revenue and income and where it should pay business taxes.
Globally, governments are worried about the way some large companies switch revenue to low tax jurisdictions, away from higher tax places where they have earned the revenue. Only international tax action can tackle this matter. There will always be arguments between different tax authorities as they seek to maximise the amount of a multinational’s revenue and profit booked to their area for tax, with the other countries arguing that they deserve a bigger share. Some companies may be pushing the margins too far by putting large revenues into small country tax havens. Others are merely trying to come to fair and accurate judgement about how much value and turnover they do earn in any given country, given the complications of long supply chains with value added in several places before selling to a final customer.
Investors now have to recognise the sensitivity of these issues. Portfolio investors can still take advantage of mainstream tax breaks and will get advice on how to do so. They need to be more careful about fancy schemes, and to see that the companies they are investing in sometimes also have difficult questions to answer about where they pay tax and how much tax they pay.
Tax has just got a lot more taxing. Investors should expect more aggressive behaviour by tax authorities as they battle to beat revenue loss and to maximise the take under their control.
The above article was first published by Charles Stanley on 7th November 2017