Reality and income tax 'mismatched'

Tax experts and politicians have outlined a series of changes to legislation and Government policy needed to tackle tax avoidance.

Richard Murphy, a chartered accountant and director of Tax Research UK, said the solution lies in introducing a principle which allows HM Revenue and Customs to strip out "artificial steps" and address the underlying economic "mismatch" between earnings and taxation.

Under the K2 tax scheme Jimmy Carr employed, salaries are transferred to a Jersey-based trust which then lends the money back to investors. Because the loan can technically be recalled, it is not subject to income tax.

Pointing to the scheme, Mr Murphy said: "There is a mismatch between economic reality and the way (income) is being taxed. When that happens the Revenue should be able to say: we are going to ignore all the artificial steps and instead tax the income."

Introducing a tax avoidance rule, as opposed to a principle, would not go far enough, he said.

"Whenever you put a rule in place the accountants find a way to break the rules. What we have to say is: rules are not good enough.

"It is important that we have a fair and identifiably fair tax system in the UK to collect tax due, to re-balance the economy, to get us out of this mess and to finance the future.

"We need a principle that lets us say (tax avoidance) is wrong."

Earlier this week Michael Meacher, Labour MP for Oldham West and Royton, lodged a Private Members Bill in Parliament he said was aimed at outlawing financial transactions aimed at tax avoidance.

Writing on his blog, he said: "It will transfer the burden of proof, from HMRC having to prove that a transaction was really a disguised tax avoidance device, to a company having to prove that it had a genuine purpose.

"If HMRC believed for good reasons that it was really for tax avoidance purposes, they could declare that the transaction was null and void and it would be for the company, if they so chose, to challenge that decision in court."

The Bill would avoid the delay in introducing a rule to block schemes such as K2, he said.

"My Bill will also have the important corollary that not only would the tax avoidance device be declared null and void at the outset, but the accountant and lawyer originators would be liable for prosecution for seeking to pervert the will of Parliament, and if prosecuted and found guilty, would be subject to a deterrent penalty to discourage any similar repeat offence."

Richard Teather, senior lecturer in tax at Bournemouth University and author for the Institute of Economic Affairs, said the solution to tax avoidance lies in the simplification of the UK tax system and removal of tax relief programmes, rather than introducing an anti-tax avoidance principle.

"The problem with giving tax reliefs is that people will use them and get tax relief," he said.

"It's very hard to blame people when the Government is giving out these tax breaks to encourage investment. It is far better to scrap all these tax reliefs and just have a simple arrangement that everybody gets taxed the same."

Schemes, such as K2, could become a thing of the past if the interest rate was raised. Under the terms of the agreement, investors would have to pay annual interest to HMRC on the loans received from K2 rather than a one-off lump sum in income tax.

Therefore, the amount of tax avoided would eventually be met in interest, he said.

"In the long term, the Revenue is not losing out.

"You can do very little tweaks to the system that still give people flexibility. All you have to do is tweak the interest rate and those schemes stop being attractive and people stop using them."

Matthew Sinclair, director of the TaxPayers' Alliance, said: "Britain's increasingly complicated tax code creates loopholes which those with clever accountants can exploit, and means that HMRC has to focus on administering dysfunctional rules rather than chasing those who break them.

"That is why Ed Miliband is right when he says we need the Government to do more than say this extreme tax avoidance is wrong. They need to change the rules so it is harder, riskier and less worthwhile.

"With simpler taxes that apply the same single rate to all income, from shareholders' dividends to workers' wages, we can ensure everyone pays no more or less than their fair share.

"A comprehensive overhaul of our tax system is now vital, not just to create the conditions for stronger economic growth but also to restore its legitimacy."