July 2012 (122) – Tax Planning and Morality

In the wake of the LIBOR scandal perpetrated by banks and revelations in The Times about dodgy tax avoidance schemes in which high profile entertainers have been involved, it is appropriate for all professional bodies to review their codes of practice so that the concept of morality is exposed.  It is not enough simply to live within one’s interpretation of the law, or within regulations imposed by others; we must live within our own moral compass as well.

It is unfortunate that judges themselves have laid the foundations of the tax planning industry which relies purely on complying with a particular interpretation of the law, known commonly as tax avoidance. For example Lord Upjohn said in a particular tax case “No commercial man in his senses is going to carry out commercial transactions except on the footing of paying the smallest amount of tax involved”.  And the famous Judge Learned Hand said “There is nothing sinister in so arranging one’s affairs as to keep taxes as low as possible.  Everybody does so, rich or poor; all do right.  Nobody owes any public duty to pay more than the law demands; taxes are enforced exactions, not voluntary contributions!”

Running with this judicial permission to create ever more devious means of complying only with what the law demands, as interpreted by the taxpayer and his advisers, the tax avoidance industry forgot about its moral compass, if it ever had one.  Court cases have more recently adopted a purposive approach to the interpretation of the law, and governments have introduced mounds of legislative provisions to counter what they consider abusive tax planning.  The introduction of disclosures of tax avoidance schemes has helped tax administrations focus on anti-avoidance legislation, but all this really does is create a mountain of tax law which only tax professionals can interpret!  Quite clever really – advise clients on tax planning schemes, let them be discovered by tax administrations (who cares that the clients have to pay the tax they were supposed to in the first place plus interest and huge penalties), and then advise clients again on interpreting new and ever more complex legislation imposed to prevent these and other schemes from being effective.

An example of this is indeed the recent exposure of a particular scheme which in its simplicity works like this. Client“I am due a large bonus and don’t want to pay tax on it”. Adviser”I can arrange for this to be paid into a structure which then gives you a loan.  Would you like to pay tax on the bonus or pay no tax because you receive a loan?” Client“I would prefer the no tax option please.  But what about repaying the loan?  How will I do that?” Adviser“Aah, here’s the clever part.  The loan gets transferred to another entity which never asks you to repay the loan”  Client“Sounds too good to be true – where do I sign?”

Well it is too good to be true, and the client’s gut feeling should have warned him not to get involved.  But greed overtook both common sense and morality.  And throughout my career, I have had so many people coming to me with schemes to reduce their tax burden, from seemingly innocuous partnership arrangements where tax losses are created in excess of amounts invested, to SDLT avoidance schemes – and I always advise that there are two issues which are relevant.  The first is that these schemes invariably fail once discovered since they rely on an interpretation of the law which was not the intent of the legislators; and the second is that they cannot be morally justified. If a tax is due and payable and you live within a particular country which imposes such a liability, then it should be paid.  Consider the Greek economy for example:  if Greek tax residents paid just half of the taxes that are due and payable, then the Greek bailout would not have been required and more important, the austerity measures now adopted could have been avoided.  Seeing our own European neighbours searching for the means merely to subsist as a result of their government failing to collect taxes that are due highlights the issue I am discussing here.

But does this mean that minimizing the tax burden is morally wrong in itself? Certainly not – tax is a cost like any other which must be considered when making an investment.  And if this and other costs are too high, the investment won’t be made. For example, a group of investors want to develop a business in the US through a partnership; personal tax rates at federal and state levels would create tax liabilities which would be prohibitive even if prospective profits could be achieved.  Instead they operate through a non-US low taxed corporate entity which licenses the technology required and finances the entire operation through arm’s length interest and royalty arrangements, resulting in an overall tax rate of half what it would otherwise have been.

Another example: a sportsman is employed by a company which has limited ability to fund a pension scheme with sufficient money to provide an adequate income subsequent to his retirement.  Taking into account the short working life as a sportsman, he becomes employed by a non-resident company which has no proscription as to the amount it can fund into a pension scheme.  Of course, the pension is taxable in the country of which he is resident at the time, but this opportunity may provide not only a deferral but indeed a minimization of tax that would otherwise have been payable on an arising basis.

And a final example: A multi-national company wishes to invest in a renewable energy plant in an under developed country which offers a 5 year tax holiday to stimulate its domestic economy. On repatriation of the profits, the multi-national is subject to domestic tax – so tax is simply shifted from the country that actually needs tax revenue but foregoes it in order to stimulate its economy, to a developed country which doesn’t have the same requirements.  The multi-national is advised to invest through a subsidiary which has a double tax treaty with the under developed country which has a so called tax sparing clause.  This means that effectively the tax holiday is preserved by using a deemed credit to offset the tax that would otherwise be due in the subsidiary’s country.  The subsidiary can now use gross (tax free) profits for reinvestment into further renewable energy plants in other countries.

These examples show that tax planning may not be immoral if the knowledge of international tax practitioner is harnessed for justifiable purposes.  I and my colleagues should no longer rely on the obiter dicta of past judgments in tax cases, nor should we use our semantic creativity to justify structures which the public would generally conceive as being unacceptable tax avoidance.  It is time for a change.

It is time for ITSAPT to be launched.  Regular readers will know that ITSAPT is the acronym for my book International Tax Systems and Planning Techniques, but it also means something – it’s apt means it is appropriate, appropriate for today’s environment. I have been developing the ITSAPT website at www.itsapt.com for the past 3 months to populate it with ‘knowledge’ articles which will help entrepreneurs and their professional advisers to plan their international tax and structural affairs in a tax efficient and properly justifiable manner.  And to do this successfully, I have entered into a joint venture with a conference and publishing group which plans to take my concept and develop it into a worldwide organisation offering specialist information in an easily accessible manner.  This will be accomplished through an intuitive and comprehensive website, several conferences around the world each year, a members’ bulletin board, links to sites where further information can be obtained to enable businesses to be efficiently structured, a non-intrusive social network, webcam training and much more.

We will be launching the ITSAPT website in its developed form in September 2012.  I would be pleased to hear from anyone who feels they may like to become ITSAPT members and will offer free membership for 6 months to the first 50 individuals who respond to this newsletter.  They will also be invited to a launch party to be held early next year which will demonstrate how ITSAPT can become the organization that entrepreneurs and their professional advisers would want to join in order to develop their relationships and their knowledge of how to structure and build international businesses.

And just one further reminder that the early bird registration for the ITSAPT Conference on November 8th 2012 expires on 31 July 2012.  The topic is Structuring International Real Estate Transactions and the day will be presented through case studies and a conference with tax counsel on a development project, followed as always by a cocktail party where delegates will be able to discuss relevant issues with the panel of speakers.  The program can be seen on the ITSAPT website under www.itsapt.com/conference

Kind regardsRoy Saunders