Tax Authorities Playing Games

Posted May 12, 2013

After being distracted by UKIP last week, I am happy to return to the subject of taxation and the way in which developed countries appear to be more aggressively pursuing tax owed by citizens and residents. Firstly I would start with FATCA. By way of background, the Foreign Account Tax Compliance Act (FATCA), which is being phased in from this year, is part of the effort by the US government to prevent money laundering, and reduce tax evasion. Under FATCA, Foreign Financial Institutions (FFIs could be any financial institution based outside of the US) can either report on the activity of American account holders directly to the IRS or to their own government who will in turn collate and pass on the data to the IRS under the terms of an Inter-Governmental Agreement (or IGA).

In principle, the real advantage of the IGA is with territories where Data Protection legislation prevents FFIs from remitting data directly to the IRS. Furthermore, the IGA route can reduce the complexity and the cost faced by FFIs in remitting data to the IRS. Otherwise, it may be just as easy for FFIs to remit data directly to the IRS. Failure to comply means that FFIs face up to 30% withholding fines on their US source income, so either way, FFIs are very motivated to comply.

In December last year, a committee of MPs here in the UK accused Amazon, Google and Starbucks of an “immoral” use of secretive jurisdictions, royalties and complex company structures to avoid paying tax on British profits. The Commons Public Accounts Committee also criticized HM Revenue & Customs for being “way too lenient” in negotiations with corporations which pay little or no corporation tax. It called on the government to draw up laws to close loopholes and name and shame companies that fail to pay their fair share.

The UK press was all over Amazon which uses a Luxembourg based unit to pay a rate of less than 12% on foreign profit (less than half the average corporate income tax rate in its major markets). Starbucks was also attacked for its practice of paying fees (such as royalties) to other parts of its global business which allows it to declare that it lost money for the 15 years it has operated in the UK. Google was also targeted for avoiding UK tax by channeling non US sales via Ireland and Bermuda allows it a tax rate of 3.2% on non-profits.

At first when I saw the extent of the backlash here in the UK, against the aggressive but very legal tax avoidance strategies of large American companies, I wondered if this betrayed some tension in the ‘special’ relationship between the US and the UK. Was the UK responding to the onerous FATCA-driven reporting requirements which may threaten the attractiveness of Britain and its overseas dependencies as off shore centers?

My hypothesis was disproven when, over the past couple weeks, the news began to report that a UK-led G7 agreement was being thrashed out to promote a FATCA like sharing of information among its members. In the run up to this G7 meeting, a subgroup calling itself the G5 (the UK, France, Germany, Italy, Spain) signed an agreement on automatic banking information exchange to identify individuals and companies who may be avoiding tax using overseas accounts. To cement this deal, the UK has got its overseas territories to agree to share information on all confidential banking information.

Could the answer to this sudden preoccupation with tax transparency be nothing more than cash strapped nations hoping to collect as much of the tax revenue owed as possible? Maybe it’s as obvious as that? It would be interesting to see what happens to the leaked 2.5 million documents (including 1000 British names) on off shore financial activities leaked to the tax authorities in the UK, the UK and Australia.

As I was telling a friend this week, this industry is bigger than most people recognize. The best talent from any tax authority is attracted by higher wages in the private sector. The private sector advises the government on tax policy. So the tax avoidance industry is designed to be a step ahead of any law. Remember the 2010 50p tax rate introduced by Gordon Brown? A very strange thing happened. In 2009-2010, more than 16 000 individuals in the UK declared more than £1 million in income. After the 50p tax rate was introduced, that number fell to 6 000. After the tax rate was cut to 45p, the number of people declaring an annual income of more than £1 million rose to 10 000.

Seems to me that the real winner in this never-ending game of cat and mouse is the tax planning industry.