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The spirit of tax law

21 January 2013 By Hugo Dixon

When is it OK to avoid tax? And when should taxpayers refrain from actions that will cut their bills, even if their actions are perfectly legal?

As the European economy remains sluggish, the public mood has turned against those who seem to be paying less than their fair share of tax. Last week, for example, saw Goldman Sachs abandon an idea to switch UK bonus dates to cut its employees’ tax bills and an escalation in the row about Greek tax cheating.

The cases are, of course, very different. In Greece, tax evasion – which is against the law – is rife. The International Monetary Fund’s latest review on the country, published on Friday, says that the “losses to the state from tax evasion are enormous”. It estimates the black economy is 25 percent of GDP.

Three years after its financial crisis began, Greece has made little progress in cracking down on tax cheats. Although Athens did adopt a strategy of focusing on priority areas, the IMF says implementation has been stalled in part because the tax administration remains unreformed: “Anti-corruption efforts have been minimal, and efforts to remove underperforming staff have met stiff resistance.”

But the rot extends beyond corrupt tax officials. In recent months, Greek politics has been transfixed by the scandal over the so-called “Lagarde List”, which contains the names of more than 2,000 Greek citizens who had bank accounts at a Swiss HSBC branch. Christine Lagarde, then France’s finance minister, passed the list to George Papaconstantinou, her Greek opposite number, in 2010.

Insufficient effort was made to investigate whether tax had been paid on the money in these Swiss bank accounts. At some point, the original list was even “lost”. Further fuel was added to the fire when it emerged that three of Papaconstantinou’s relatives didn’t appear on a copy of the list that did survive. Parliament last week voted to investigate him. The former Greek finance minister says he did not remove his relative’s names, saying he is the victim of “a crass and blatant attempt at incrimination”.

Whatever actually happened to the “Lagarde List”, Greece is at the extreme end of the spectrum of tax cheating in Europe. But even in the UK, where tax evasion is less common, the zeitgeist has changed. Individuals and companies have come under attack by politicians, officials and the media for tax-reduction schemes which are either in the grey zone or perfectly legal.

One practice is the habit of people providing their services through companies they own rather than being classified as employees, which incurs higher tax. Last year the government discovered that 2,400 civil servants were being engaged in this way and tightened the rules. There has also been a row over how Starbucks cut its UK corporation tax. After a torrent of criticism, the coffee chain agreed to pay more UK tax.

Now Goldman has buckled to pressure after it emerged it was considering shifting the date that it was to pay some bonuses to take advantage of the fact that the top rate of income tax will fall from 50 percent to 45 percent. Mervyn King, governor of the Bank of England, described the idea that Goldman would do this as “depressing”.

Goldman misjudged the public mood and made a hasty U-turn. That was clearly the right thing to do to protect its reputation, given the hostility to the banking industry and the fact that banks were all directly or indirectly bailed out by taxpayers during the financial crisis.

But what Goldman had been considering was not illegal. Under UK tax law, bonuses that are part of a contractual entitlement have to be paid on the due date. But companies are free to pay discretionary bonuses whenever they wish. Indeed, many businesses will be delaying their bonuses this year to take advantage of the lower tax rate.

Taxpayers should, of course, abide by the spirit as well as the letter of the law. Indeed, there is even a UK code of practice for the banking industry which says precisely this.

But it is hard to argue that “bonus-shifting” even contravenes the spirit of the law. The government, after all, knew that this was likely to happen. When the top tax rate of 50 percent was introduced in 2010, many companies accelerated their bonuses to avoid the higher rate. Last year, the government estimated that 16-18 billion pounds of income, not all of it bonuses, had been brought forward in this way. It also factored such income-shifting into its estimate of what would happen when the tax rate was cut.

If parliament had really wanted companies to refrain from such behaviour, it should have said so. But it didn’t. The Conservative-led coalition government even took apparent pleasure from the fact that the previous Labour government, which introduced the 50 percent tax rate, got its maths wrong.

The key ethical principle that taxpayers should adopt is that they will abide by both the spirit and the letter of the law. But, as the Goldman case shows, this doesn’t necessarily protect one from being pilloried. Public attitudes about what is fair when it comes to avoiding tax are hardening. Companies in the public eye should therefore add a further practical principle: abide by the spirit of the times.


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