Ensuring the integrity of tax systems
Over the past decade tax authorities around the world have worked assiduously to improve the gathering of tax information. The period has been marked by a series of both multilateral initiatives, such as the work of the OECD Global Forum, and unilateral initiatives, such as the US Foreign Account Tax Compliance Act. The focus throughout has been on tackling the issue of tax evasion by the hiding of funds from tax authorities.
This work on greater transparency continues, but in a range of major jurisdictions the issue of tackling what is seen as unacceptable tax avoidance is becoming a major focus of debate. At the heart of the debate are questions about fairness in the sharing of national tax burdens and concerns over the funding of budget deficits.
Over the past 30 years, the OECD average top tax rate has dropped sharply, from 65.7 per cent in 1980 to 41.7 per cent in 2010. There are strong economic arguments in favour of the trend towards lower top tax rates, but many wealthy individuals pay effective tax rates well below the current headline rates. This has attracted the attention of politicians and media alike.
In the US, the effective tax rate paid by the wealthiest has become a major political issue, not least as a result of the ‘Buffett Rule’ proposals from the Obama administration. In many countries, governments are pushing through unpopular austerity agendas. In these circumstances, campaigns against the use of abusive tax avoidance schemes by the wealthy are gathering strength.
In law, the rule for tax advisors is clear. Tax evasion – hiding taxable income from the tax authorities – is criminal. Tax avoidance – planning your affairs to minimise your tax bill – is legal. But if the principle is clear, the distinction between tax avoidance schemes that achieve their intended tax result and those that do not depends on the decisions of the courts. In many jurisdictions, judges now adopt a purposive view of tax legislation to ensure that artificial schemes designed to defeat the purposes of the legislation do not succeed. Advisors who promote such schemes may reasonably be accused of mis-selling.
Many countries have general anti-avoidance rules to combat artificial schemes. Canada and Australia are prominent examples. Elsewhere, the UK and India are actively considering similar legislation, with retrospective provisions in the case of the Indian proposals. While such legislation is often politically popular, it needs to be drafted extremely carefully to avoid introducing damaging levels of uncertainty and subjectivity into national tax systems. The potential revenue gains from anti-avoidance measures need to be balanced against the impact that bad drafting has on confidence, economic growth and, ultimately, tax revenues.
The judicial and legislative approach to abusive schemes raises significant challenges for advisors and their clients. The most pressing is that there are few precise definitions of what constitutes abuse or is ‘unacceptable’. The response is often that any experienced tax professional can recognise such tax schemes when they see one. Legislation often attempts to capture this sentiment via some form of ‘reasonableness test’, but what can appear reasonable in one context – perhaps a parent keen to avoid funds falling into the hands of a spendthrift child – can appear quite unreasonable in another.
The lack of any solid definition of what constitutes abuse is a particular problem for STEP members, who are often engaged in drawing up long-term plans for families. We have entered a world in which it takes only one bad headline to move a particular form of tax plan – however poorly understood by those commenting on it – from the ‘acceptable’ to the ‘abusive’. A good example of this has been witnessed in recent months in the UK, where, in the view of the government, large donations to charity suddenly seemed to move from socially praiseworthy to being an abusive tax dodge – before common sense eventually prevailed.
Another danger is that what counts as normal tax planning in one jurisdiction might be seen in a different light in another. Alongside the growing number of jurisdictions taking action unilaterally against abusive tax planning, we are also seeing a growing number of multilateral initiatives.
“Onerous anti-avoidance measures should not be seen as a substitute for well-designed tax systems”
The EU Commission, for example, has announced a programme of work aimed at addressing the problem of ‘harmful tax competition and revenue loss and unfair competition deriving from aggressive tax planning’. Mutually agreed consistent definitions and language should be a key element of any such multilateral initiatives.
STEP recognises that a fair tax system must include effective measures to counteract abuse. Equally, however, there must also be a clear balance between taxpayers’ obligations and taxpayers’ rights.
Much of the current debate about abusive tax avoidance in essence reflects moves to ensure that the obligations on taxpayers are more rigorously enforced. It is unfortunate that the issue of how to preserve a balance with taxpayers’ rights – such as the right to certainty in tax laws – receives relatively little attention from those campaigning against tax abuse.
To assist the debate and help develop a more consistent international approach, STEP has been working for some time with Confédération Fiscale Européenne and Asia-Oceania Tax Consultants’ Association to construct a survey of taxpayers’ rights and obligations in a broad range of different jurisdictions. There is an international consensus on many important points and the ultimate aim of the work is to synthesise this consensus into a model ‘Taxpayers’ Charter’ that reflects current international best practice.
In the meantime, STEP is proposing a five-point programme that it believes could strengthen national tax systems and help in the fight against abusive tax avoidance:
- It is important to recognise that abusive tax schemes usually exploit gaps and inconsistencies in the tax system. Such gaps and inconsistencies normally reflect complexity. It is regrettable that in many jurisdictions the drive for tax simplification has run out of steam, or even gone into reverse. Governments and tax professionals alike should refocus on working towards simpler tax laws.
- Too often tax legislation is introduced that tax professionals quickly identify as adding to the risk of abuse. Equally, anti-abuse legislation is often introduced that either adds disproportionately to compliance costs or fails to tackle the real problems. Both these problems can be avoided by governments engaging in effective and open consultation before legislating.
- It is important to recognise that complex anti-avoidance legislation, such as the general anti-avoidance rules now being widely introduced, should be the last line of defence. Onerous anti-avoidance measures should not be seen as a substitute for well-designed tax systems. Governments need to ensure that the measures they introduce to meet the public’s demand for action on abusive tax avoidance schemes fit in with the core principles of good taxation. Introducing tax measures that create uncertainty, penalise international capital flows or impose high compliance costs can create huge inefficiencies and costs on economies.
- Tax advisors have a responsibility to give their clients clear warnings of the risks of engaging in schemes that might be considered abusive. Everyone needs to recognise that clients engaging in such schemes will be challenged by the tax authorities and will receive little sympathy in court. They may also be vulnerable to widespread adverse publicity – as recent high-profile examples in a string of major jurisdictions have demonstrated.
- International professional bodies such as STEP have a key role in promoting an informed debate about abusive tax conduct and, in particular, helping to develop a consistent approach internationally to what is a complex topic. Most professional advisors would agree that a level playing field should be an important goal of the various multilateral initiatives on tax avoidance that are starting to take shape. The professional bodies played a key role in helping to develop a cooperative rather than combative multilateral approach to improving information gathering. To ensure a similar cooperative approach to tax planning, it will be important to ensure professional advisors are engaged at an early stage in the developing debate at both a national and an international level.
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