Monday, 31 December 2007

The lighter side

I would not want people to think that I spend the whole time moaning about the government’s fiscal policy. The trouble is that I started this blog at the time when there had been announced a number of ill-considered policies. But, hey, let’s not say it is all doom and gloom.

As a tax practitioner I have to say that HM Revenue & Customs’ online filing system has been working well this year, at least for Self Assessment Tax Returns. I do not use the online filing for other purposes sufficiently to judge. I think that the user interface for HMRC’s own software is a lot improved and easier to understand, though I use commercial software for Self Assessment. That system uses FTP (I think that is what it is called) and when I started with it a couple of years ago it was very fussy and would reject returns for silly reasons such as characters it objected to. However, as I said, it all works well now, so well done to HMRC for this.

Then again, one has to laugh at some clients who deliver their papers over the Christmas period and expect feedback before the New Year. Yes, of course we poor souls have to work over the holiday, but that is on behalf of clients who delivered their papers at the end of November and early December. If only life were that easy. Receive each set of tax return papers, spend five minutes putting it all together and preparing a return, bill the client and go back to sleep. Actually we work rather hard and aim to give the clients a great service which is value for money, but we cannot manage too many quick changes in telephone boxes. I cannot even think offhand where there is a convenient telephone box in our area.

What I hope for 2008 is that we will have a new era of cooperation with HMRC to get the compliance done, and that there will a better understanding of tax agents’ issues on the part of HMRC (which might develop eventually from the “Working Together” programme) and that we can on our part stop blaming HMRC for everything and lay it on their political masters if we must. It would be nice if HMRC did not call taxpayers “customers” when they cannot take their business elsewhere. Dave, are you listening?

In the meantime, I must get back to working miracles for my clients and doing everything yesterday (it would be great if we could process all the information before we received it) and hope we advisers get a bit more appreciation. I appreciate others when they go beyond their duties. I would thank some staff in HMRC if one were allowed to know their full names as one often isn’t, but there have been one or two, even a few recently who were very helpful. At least they are all very polite (but then so am I).

Happy New Year to all HMRC staff, to anyone who happens to find this blog, and of course to all Rabbit’s friends and relations.

© Jon Stow 2007

Saturday, 29 December 2007

Domicile puzzles

Then again, what are we to make of the so-called reforms relating to the taxation of non-domiciled residents in the UK? This was one of the policies the Government has pinched from the Tories following the policy announcements at the Conservative Party conference. The Tory proposal proved that the Government does not have the monopoly on misguided (did I hear you say daft?) policies. So why borrow this one except to trump the Opposition?

During its ten years in office the Government has discussed several times changing the rules concerning non-domiciled persons, which in simple terms are those whose background or family history might suggest their natural homeland is not one of the countries comprising the United Kingdom. For a more detailed explanation see here. A study was made in 2005 and there was a consultation, but we had started to suppose that the Treasury saw the whole issue as a political hot potato.

Briefly, unlike domiciled resident individuals who are liable to UK tax on their worldwide income and capital gains, non-dom residents have up to now been taxable on their UK income of course but not their overseas income and gains except to the extent of the amounts actually remitted to the UK. It had been the view of many that if taxation of worldwide income and gains were extended to non-doms many of our richer guests including oil billionaires would take themselves and their spending power elsewhere; hence there had been no amendment to the rules since the first review was announced way back in 1949.

The new rules effectively bring most non-domiciled residents into a regime of being taxed on worldwide income unless they pay annually to HM Revenue & Customs £30,000 plus whatever tax is due on remittances as before. Of course the super-rich will go for this unless they see this as an unprincipled betrayal and leave the country. Those who will be hit are the non-doms of moderate income who have brought their labour and investment to the UK, perhaps employing people in their factory, workshop or restaurant; those who hope to retire in their homeland or elsewhere. Of course there are long-term resident (seventeen years plus) non-doms who already knew that if they died within the UK their worldwide estates would be liable to inheritance tax.

The Government talks a lot about fairness. One might say that it is not fair that some taxpayers of a particular class pay less tax than others with similar income. Is it fair that the very wealthy can buy off HMRC with a £30K bribe or paying annual protection money? Is the Treasury reduced to acting like the Mafia or an East End gang? Worse, is this not another example of the total lack of coherent fiscal policy? What on earth is going on?

© Jon Stow 2007

Saturday, 15 December 2007

Dickering Darling delays amending capital gains reforms

What are we to make of Alistair Darling's delay in the announcement of any amendments to his proposals on capital gains tax “reform”? He told the Commons on Thursday that he was postponing any decision on change until the New Year.

In my view, commentators tend to hang too much on what might be motive. There was, I am sure, genuine concern from the Chancellor and the Government that they had put their foot in it and made a serious misjudgement, and I am sure that that Treasury Civil Servants will have felt the wrath of their political masters over this matter. There was of course quite a “Clever Dick” or maybe “Clever Alistair” element in the Pre-Budget Report last October, which was a real “rabbits out of the hat” performance of the type we usually associate with the Budget itself. Of course, many Budget tricks have little impact and are designed for show. Unfortunately in many ways, the particular announcements made in October do have genuine impact and we all know a couple were designed to trump the policies announced by the Conservatives at their conference.

The reform of the position concerning treatment of non-domiciled taxpayers (or non-taxpayers) is not very intelligent any more than was the Tory proposal, but I will return to that another time. The Inheritance Tax change also borrowed from the Tories is hardly a give-away except in the sense that it will save some legal fees related to will making.

But back to capital gains tax. The Government proposals sweep away a raft of complications in calculation of gains, some of which have been in place since 1965, and yes, they will be simpler to administer or for taxpayers and their advisers to calculate gains. However, it is hard to see why the taper relief for business assets is being replaced by a flat rate, therefore increasing the effective rate of tax for most sellers of such assets from 10% to the 18% flat rate, an increase in tax of 80%, while at the same time reducing tax on investment gains from between 30% and 40% to the 18% flat rate. It is fine for investors, of course, but seems to involve little insight in an understanding of the realities of the change on the part of the Treasury. Why 18% anyway, which is a strange rate? Maybe someone was fond of the construction industry income tax flat rate for subcontractors which was in force until April this year, and wanted to keep the number on the tax tables somewhere.

Of course, many buy to let and other property investors will be delighted with an 18% rate. Investment in property has been booming under the current Government since the late nineties. My own theory as to the reason (partly because it was my wife's and my reason) is that this is the result of:

  1. the disastrous consequences for the pension industry and people's pension funds of the removal of the dividend tax credit refunds (Gordon Brown's first Budget in 1997)

  2. the other pension disasters brought on by subsequent funding problems for many pension schemes,

  3. the regulatory failures such as Equitable Life (where many lost some tens of thousands) which whilst it was not entirely the Treasury's fault, it played its part.

So I believe that the popularity of property investment amongst the less wealthy is as a result of Government policy. Now, with interest rates so high, many are subsidising their mortgages to a degree, and few are making any income profit on lettings where they borrowed anything like the maximum. Income losses are the norm, though many will hang on (those who can afford it) for their hoped for capital gain down the line. The trouble might be those who cannot afford to pay the mortgages and will try to cut and run. That could cause the whole market to lose confidence, which has the potential for disaster.

So, back to the capital gains issue as it affects small business owners who may wish to sell, and the prospect of paying 18% tax after 5th April 2008 rather than 10% on their gains. Why the delay in announcing changes? Well, I am sure it is nothing more sinister than the Treasury not knowing what it is doing. People say”why is Government policy so against small businesses?”. Well, I don't think the Government is against small businesses. It simply has no policy, or at least no long-term thought-through policy with regard to small business in general.

I also think that ideas tend to come from different places.. The 18% capital gains tax trick comes from the Treasury Civil Servants (I speculate) who do not understand the old system and were anxious to have something they could understand, though they did not appreciate the consequences of their changes. The income-shifting document on which I commented last week is much more driven by HM Revenue and Customs, anxious to make up for the Arctic Systems defeat and to prove that their leadership knows what it is doing. This is coupled with HMRC's deep suspicion of small businesses, which it feels are mostly on the fiddle. Having had brief exchanges earlier this year with a certain someone who has had a recent promotion in the upper echelons of HMRC following the tax credit data loss debacle, I have the distinct impression that this suspicion is extended to the small businesses' tax advisers too. We were told we should be more helpful. In the good old days we tax practitioners worked in partnership with the Revenue to get things right (all right, there were some naughty schemes for the very rich, but most small businesses were a long way from being able to take advantage). Oh, the days when we could talk to someone in the Revenue who had a file, someone who would telephone to clear up a query, when it was all so much less confrontational!

We tax advisers should not all be tarred with the same brush, and neither should business owners in general.

What to do about business asset capital gains tax? I would have had a new acquisition base point of 5th April 1998 and abolished taper relief except for business assets, and I would be surprised if the cost to the Treasury would have been all that much, though I accept that part of the motive for the change announced was a tax raising exercise. Probably we will get some sort of retirement relief, maybe £100,000 exempt and then 18% flat rate. If we just have a £100K lower rate band that will be a stupid fudge which will not win the Government any friends (and it needs friends).

I just hope that whether under this Government or a future administration HMRC and the Treasury policy makers and planners do put together a coherent strategy for managing business taxation, and that Ministers take responsibility for their actions and for their failures. Here is an irony: Paul Gray as Chairman of HM Revenue & Customs did fall on his sword over the lost CDs crisis, even though this was not his personal responsibility. He deserves great credit for that, and I would love to see honour, principle, competence and vision, rather than suspicion, drive fiscal policy.

© Jon Stow 2007

Sunday, 9 December 2007

Income shifting: the Government’s paper published in December 2007.

The document “Income Shifting: a consultation of draft legislation”

is the Government’s response to the defeat of HM Revenue& Customs in the Arctic Systems case, Jones v Garnett, which concerned a “husband and wife” company where the wife received a substantial distribution of profit as dividend by virtue of the share in the company for which she had subscribed. The Revenue had sought to assess the husband on the wife’s share of the income under settlements legislation dating from the 1930s.

Despite the so-called consultation period, this is another example of legislation on the hoof, which is likely to be bad legislation, difficult to understand for tax payers, difficult to interpret for advisers because of the grey areas likely to be thrown up and pretty impossible for HMRC to police. I can see many enquiries initiated on scant evidence, vast amount of taxpayers’ money being wasted, and lots of professional fees incurred without much increase in the tax uptake by HMRC.

Firstly, the consultation period is all too short and ends on 28th February 2008 only shortly before the next Budget and at best a couple of months before publication of the 2008 Finance Bill. At least one recent consultation, that before last year’s “interventions” contacting taxpayers over the telephone or in writing concerning supposed problems in their Returns indicated that HMRC had already made up its mind and that engaging the professions, CCAB or otherwise, was in reality a sham. This is of course as a result of politically driven policy and reflects the attitude of Ministers and their political appointees. I do not wish this to be seen as another example of Revenue-bashing. It just seems to me that in being expected to implement ill thought out legislation and indeed to understand their duties at all in this respect, the HMRC on the ground are almost as much victims of policy as the vast majority of basically honest small business owners and their poor advisers, and it does show how out of touch our political masters are.

The document avoids mention of married couples, families or civil partnerships as specific targets, whereas surely these are the classes of individuals at which the new legislation is aimed. This is quite extraordinary in my view.

We cannot expect that there will be much reasoned opposition when the Finance Bill is discussed. Debate is often curtailed and MPs’ eyes probably glaze over when tax is mentioned, except in the context of headline tax rates, which we know disguise the true burden of taxation (vide the FA 2007 cut in the basic rate of income tax from 2008-09, which essentially will make no difference at all to the majority of individual taxpayers with the loss of the starting rate of 10%; indeed there are some who will be worse off).

In the context of lack of reasoned debate, one suspects that few politicians will get past page 4 of “Income Shifting: a consultation of draft legislation” where Box 1.1: Examples of income shifting” (the only one illustrating the circumstances of a married couple) suggests that Nina, by paying all her profit through dividends to herself rather than half to Charlie, her non-working husband, has avoided paying income tax of £6,039, and if she had been a sole trader she would have paid £15,414 for 2007-08. Well, yes, but the example fails to mention that the company would still have paid 20% corporation tax, viz. £12,000 tax however the profits had been distributed as dividends.

Whilst I am of course cherry-picking the nonsense here, this example is in the introduction, and is disingenuous – yes, it is spin and disguises the reality, which is that £12,000 tax has been paid as opposed to nothing, which this example appears to suggest.

In Part 3 of the document there are a number of examples of what will be deemed income shifting as well as some that will not. Of course this is far beyond where the politicians will read. One can see the logic of some (in Treasury terms anyway and assuming that they are starting from a reasonable premise just for a moment), but there are worrying misunderstandings about the way life works and indeed the way families work (OK, an out-dated concept).

Example B (P.24) says:

B.74 This example illustrates a scenario that would be covered by the income-shifting legislation. Despite each partner providing equal labour for the business, a tax advantage is obtained through a division of income between the partners that does not reflect what they would be entitled to in a normal commercial arrangement. This is because of the differing levels of capital they have introduced to the business.

B.75 Individual 1 and individual 2 form a partnership and start trading as a local grocery. Individual 1 introduces £200,000 of capital into the business, which is used to acquire the shop premises and stock. Individual 1 and individual 2 both work full time in the business and develop it together. Neither individual 1 nor individual 2 bring any special skills into the business. Trading profits for the year are £80,000, which are split between individual 1 and individual 2 equally (i.e. each partner receives £40,000).

B.76 The new legislation would apply in this case because income has been shifted. The profit share received by individual 1 and individual 2 do not reflect the balance of labour and capital put into the business. The arrangement whereby individual 2 is entitled to an equal share of the profits and a return on capital of the business even though individual 2 has not contributed any capital appears to be non-commercial. Individual 1 has forgone income that individual 1 may have otherwise received in relation to the capital contribution (i.e. a return on individual 1’s capital).

I hope you will forgive any stereotyping in the next paragraph or so, but suppose Mr. Patel is given £200,000 by his father. He works in a grocer’s shop for a while, where he meets Mrs Patel to be, the daughter of the owner. They get married, and Mr. Patel uses his £200K to by a decent corner shop business. They have some acumen which they have acquired selling goods for others, but neither has a special skill which could be defined, beyond an eye for business. They run their shop as a partnership, sharing the profits equally; after all they both work hard and the shop is open from 7AM selling newspapers, sweets and the dreaded tobacco products until 11 at night when they might sell a little alcohol.

Is it really fair that because Mr. Patel originally bought the shop and business with his money, he should be taxed on a larger share of the profit than his wife? After all, they work so hard and probably could not manage individually with the long hours and having during slack periods to pay someone at least the minimum wage. Again, is this fair? HMRC thinks it is. I don’t.

Mrs. Giles-Hunter inherits a farm from her father. She has been running the farm for some time effectively as an employee before her father’s death, but it is very large and a great deal of work. At the Young Farmer’s Ball she met a young man named Hunter, who is experienced in farming, but being the second son will not inherit his father’s farm. They get married, and move into Mrs. Giles-Hunter’s farmhouse, and they run her farm together with a formal partnership agreement. They both have equal skill as farmers through experience, they increase their profits (no mean feat these days) and they share the fruits (the profits) equally. Because it is Mrs. Giles-Hunter’s farm and for legal reasons she cannot give half of the land to her husband, should a larger share of income be attributed to her because essentially the business is based on her capital?

Are we really going to deny families proper reward for their joint endeavours, which are in many instances what bind them together as a unit? My last example might cause some difficulties under the current rules and of course one might try to separate the land from the buildings, machinery and goodwill for the exercise, but to try to assess one person unequally when the other works equally hard seems nonsensical and out of touch.

The paper says that the income shifting legislation does not mean that businesses will have to maintain additional records, yet from the farm to the corner shop, one might think that timesheets would have to be completed to show the amount of work contributed by individual partners or directors. Without them there may be a large problem in that HMRC enquiries especially for the less well represented deem taxpayers guilty until proved innocent. Of course HMRC largely relies on professional advisers to do the self-assessment job for them, notwithstanding the relative contempt shown for these advisers and their conduct in the higher echelons of HMRC (and I have pretty much heard this attitude from the horse’s mouth).

In reality professional advisers will be better placed to implement the new rules then HMRC, which will continue to bark up many wrong trees, and one really has to wonder whether their projected tax yields even if true will show the Treasury any profit given the costs of recovery if HMRC has any significant involvement through the enquiry system. The general cost assessment contains a number of arbitrary statements without justification of the basis. There is of course no talk of redistributing the presumed increased yield amongst other cash-strapped taxpayers.

The new raft of legislation will not be based on “fairness”, and “the right amount of tax”, two favourite Treasury mantras, or on preserving family unity and values. Rather we see old-fashioned paranoia exhibited by out of touch Civil Servants and politicians who have forgotten that what drives Britain, “the nation of shopkeepers” is a continuing sense of talent and entrepreneurship which is overlooked in the current climate of low taxes for big business only, and the Stalinist attempt to regulate the lives of every individual who dares to have expectations of rewards for their efforts.

Adam Smith would be sorry to discover that the Government is no longer influenced by shopkeepers. Indeed it has rather taken against them.

© Jon Stow 2007