Chris Thompson, Partner at Wellers, explores the complexities of UK taxation and shares his thoughts on what should be done to benefit business owners.
The UK’s tax legislation is the longest in the world, standing at 22,000 pages. That’s the equivalent of 97 copies of Harry Potter and the Philosopher’s Stone back-to-back.
Don’t be fooled into thinking this is the sign of a robust system. Rather than rewriting parts of the tax system as things change over the years, it has instead just been updated. Consequently, this is what makes it so long and that has contributed to the high level of bureaucracy embedded in the system. It also means that it’s easy, for those with sufficient resources, to find ways of circumnavigating the system to find loopholes.
This doesn’t just present a problem for business owners who aren’t au fait with the ins and outs of the UK tax system, but also for accountants and HMRC whose job it is to provide in-depth tax knowledge. Any accountant that claims they know every page of the tax code is being somewhat economical with the truth.
UK taxation is so complicated that it’s even hard for HMRC to fully enforce. This level of convolution means it’s easy for business owners to make mistakes, potentially leading to big fines worth thousands of pounds. It also leaves opportunities for less than reputable advisors to find ways help clients avoid tax through questionable strategies that bend the rules and can backfire at a very high cost to all concerned.
How the system is exploited
Given the system is so long and complex that no one really understands it all in its entirety, it’s not hard to see why UK taxation is open to abuse. The more layers of laws there are, the more opportunities appear for clever tax advisors to take advantage and try to reduce their client’s tax liabilities. They do this by exploiting legislation to pay as little tax as legally possible. This is well known as tax avoidance.
Organisations such as Starbucks, Google, and eBay (to name just a few) have, over the years, all used methods such as these to reduce their corporation tax liability. So much so, they have paid incredibly little when compared to their sales revenue. This is achieved through a combination of strategies that makes use of their operations in multiple countries.
To date, corporation tax has only been paid on profits generated in the UK. So, for tax purposes, each division within the corporate structure is treated separately which is utilised by tax advisors. To reduce profits, they have employed strategies such as:
- Funding UK based operations from overseas head offices through loans. Essentially this means that the UK-based part of the business borrows money from the group. This method incurs interest payments with the rate set by the controlling company (the group). This inter-company interest charges are purposefully made high to help absorb some of the profits made in the UK.
- Creating franchises to base royalty and licensing agreements in a low tax jurisdiction. This allows an organisation to charge operations based in the UK for use of their brand and name. This can be charged as a percentage of sales which reduces profits.
- Carrying forward historical losses incurred when operations were originally set up in the UK. These can then be used against subsequent profits to help reduce tax liabilities.
Such strategies have played into the international tax system to ensure that large international groups can shift their profits to pay corporation tax at the lowest rate. They can do this because multi-national corporations have the resources to pay for highly intricate tax advice. Individuals and SMEs often don’t have the same access to resources, resulting in significant inequalities within the tax system.
What needs to change?
There are global tax reforms on the table which if passed, will introduce a minimum 15% global profit tax rate. These would also be based on the place of sale, rather than the organisation’s place of residence. That then may help mitigate against some of the tactics explained above. However, for individuals and SMEs, quite simply, the only way to fully solve the issue relating to tax legislation is to rewrite the book.
It’s hard to argue with this when you compare our tax code to those overseas. Take Hong Kong, for example. The highest rate of tax in the region is just 17%. There is no Capital Gains Tax, no inheritance tax, no tax on dividends, and no VAT. Its rate of corporation tax is also lower than ours, at just 16.5%. Despite the lower rates of tax, residents are almost 25% better off than their British counterparts when GDP per capita is adjusted by purchasing parity. What’s more, Hong Kong’s entire tax code is just 350 pages long. That equates to just over one copy of Harry Potter and the Philosopher’s Stone.
In Summary
Over the years, various Governments and politicians have added layer upon layer to the UK’s tax code. To counteract certain tax increases, some Governments introduced tax reliefs and allowances. This appears to have been the strategy for updating a system created in an analogue era, that is now operating in an increasingly digital and, at times, borderless world. On top of these conflicting policies, VAT, Capital Gains Tax, Inheritance Tax, National Insurance, and the taxation of pensions have become difficult to understand and get right.
In 2010 the Office of Tax Simplification was introduced to offer independent advice to the Treasury on how to simplify the taxation and make things easier to understand. However, despite this recognition of the complexity of the tax system, there has been little to no changes in the past 11 years.
- Funding UK based operations from overseas head offices through loans. Essentially this means that the UK-based part of the business borrows money from the group. This method incurs interest payments with the rate set by the controlling company (the group). This inter-company interest charges are purposefully made high to help absorb some of the profits made in the UK.
- Creating franchises to base royalty and licensing agreements in a low tax jurisdiction. This allows an organisation to charge operations based in the UK for use of their brand and name. This can be charged as a percentage of sales which reduces profits.
- Carrying forward historical losses incurred when operations were originally set up in the UK. These can then be used against subsequent profits to help reduce tax liabilities.
Such strategies have played into the international tax system to ensure that large international groups can shift their profits to pay corporation tax at the lowest rate. They can do this because multi-national corporations have the resources to pay for highly intricate tax advice. Individuals and SMEs often don’t have the same access to resources, resulting in significant inequalities within the tax system.
What needs to change?
There are global tax reforms on the table which if passed, will introduce a minimum 15% global profit tax rate. These would also be based on the place of sale, rather than the organisation’s place of residence. That then may help mitigate against some of the tactics explained above. However, for individuals and SMEs, quite simply, the only way to fully solve the issue relating to tax legislation is to rewrite the book.
It’s hard to argue with this when you compare our tax code to those overseas. Take Hong Kong, for example. The highest rate of tax in the region is just 17%. There is no Capital Gains Tax, no inheritance tax, no tax on dividends, and no VAT. Its rate of corporation tax is also lower than ours, at just 16.5%. Despite the lower rates of tax, residents are almost 25% better off than their British counterparts when GDP per capita is adjusted by purchasing parity. What’s more, Hong Kong’s entire tax code is just 350 pages long. That equates to just over one copy of Harry Potter and the Philosopher’s Stone.
In Summary
Over the years, various Governments and politicians have added layer upon layer to the UK’s tax code. To counteract certain tax increases, some Governments introduced tax reliefs and allowances. This appears to have been the strategy for updating a system created in an analogue era, that is now operating in an increasingly digital and, at times, borderless world. On top of these conflicting policies, VAT, Capital Gains Tax, Inheritance Tax, National Insurance, and the taxation of pensions have become difficult to understand and get right.
In 2010 the Office of Tax Simplification was introduced to offer independent advice to the Treasury on how to simplify the taxation and make things easier to understand. However, despite this recognition of the complexity of the tax system, there has been little to no changes in the past 11 years.
