Where to draw the line? Guest Post by Rebecca Benneyworth

Jolyon’s approach to what the profession would regard as aggressive tax avoidance has, I believe, moved the debate on quite significantly. There is still a considerable way to go, but the discussions on his blog on badging tax risk show that a consensus looks viable.

However, while there is considerable agreement on some of the aggressive schemes we might encounter, I am also concerned about the much greyer areas of tax advice that we, the tax profession, might find that the wider public take a very different view of.

In considering reliefs, Jolyon has written several times about pro-purposive use and anti-purposive use. One being an appropriate use of a relief, which Government intended, the opposite being tax avoidance as a minimum. However, there are other situations where a very attractive tax result might be achieved for a client in much simpler circumstances; situations which are not susceptible to the same analysis, and about which the public might take a different view.

An example

Let’s think about a sole trader with total profits for tax purposes of £40,000 and no other income. His total tax and national insurance contributions on that income this year will be £9,743, leaving him with net pay of £30,257. If we were to advise him to form a limited company, and from the same profits draw a salary of £7,956 (equal to the NIC entry point) and the balance of profits after corporation tax as a dividend, his tax bill (there is no NIC payable) will reduce to £6,409, and net pay increases by 11% to £33,591. I am not comparing these two situations with those of the “man on the Clapham Omnibus” who is salaried at £40,000 a year with a much lower take home pay, as our business man has uncertainty about his income, and other factors to take into account. However, whether he trades as a sole trader or a limited company, the profit outcome is likely to be broadly similar (subject to some administrative costs). Not only that, but our company director is in a far superior position regarding state pension, as he is credited with an earnings related element in addition to the basic state pension entitlement, despite having paid no NIC at all.

Bigger numbers – bigger difference

Why not scale this up? Another sole trader has profits of £100,000 a year. As a sole trader his current year tax and NIC liability would be £34,701, leaving net pay of £65,299. If he decides to trade through a limited company (which he might do for entirely non-tax reasons) and takes the same profit extraction route as described above, his overall tax liability falls to £29,177, a saving of £5,512. This overall saving at 8% is smaller in percentage terms than the example above. However, having taken advice he has given 50% of the shares to his wife, protected by the outcome in Jones v Garnett. The overall tax bill now falls further, to only £19,984, a total saving against a self employed position of £14,717, and an increase in overall net return of 22%.

I am not for one minute arguing that I believe that this is unacceptable behaviour – indeed I would probably be negligent for not suggesting it - but maybe some people think that it is. Is the mischief limited company status? I don’t think so, because if the director chose to take all of the profits by way of salary his tax bills would be significantly larger – indeed they would be higher by reason of employer’s NIC in addition to employee contributions.

So is the problem the method selected for extraction of profits? What if his needs are modest and the profits are almost all retained in the company, bearing tax of only 20%? If he retains, say £25,000 of profit in the company, his tax bill falls to £23,563 as a sole shareholder – a saving of £11,317 against his position as a sole trader, and to £18,409 as a joint shareholder, saving £16,292. Some will still argue that this is unacceptable, but the fact is that the valid choices made about how to structure a business and how the profits are extracted has a major impact on the tax charge.

Bad or not?

What does HMRC or Government think about these situations? They have been well known about since Jones v Garnett but after some initial suggestions to address that case we have heard nothing further. We now have the GAAR but given this sort of planning is well known about it looks like the GAAR is not in point. So it is all right then?

I do think this is an important area for this debate to consider. It would disturb the lay reader who might consider that professional tax advisers are at fault for suggesting it. And yet we are only doing what every other tax adviser would do – and should do if they are not to be held negligent. However at present HMRC has shown little or no to appetite to tackle this type of bread and butter planning.

What could or might be done? I promised Jolyon a blog about “how we got here” – meaning the way that we arrived at the current tax rules, but it proved difficult to establish an overall theme. What I did observe was that Governments of the last 50 years have had very differing agendas and the constantly moving tax rules to reflect those views. Taxing unearned income at a premium of 15% for some considerable time, as “bad” income. Taxing companies which distributed most of their profits at a greater rate for some time, and then in a complete volte face, imposing additional tax on company profits which were not distributed (many will remember close company apportionment calculations).

The first step would be to reach an agreement about whether we regard these wide variations in tax burden on essentially the same income as an acceptable outcome of choice, or an unfair advantage. Then we might think about what comes next.