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Is tax avoidance unethical?

Tax avoidance has hit the headlines again. At the Liberal Democrat conference last week Nick Clegg and Danny Alexander were both forthright in their condemnation of tax avoidance which they likened to benefit fraud. Perhaps predictably, in contrast, the Daily Telegraph editorial commenting on this attack stated that tax avoidance was “perfectly legitimate”. Whose view is correct?

By way of a timely illustration of the practical significance of this debate, Lord Ashcroft, the Conservative Party peer, was to be the subject of a Panorama programme on Monday night as a result of a transfer of £17 million indirect interest in his main British company into a trust fund for his daughter. This transfer was made on the last day before Lord Ashcroft lost his non-domicile status and therefore provided permanent protection of the assets from UK inheritance tax. The programme was pulled at the last minute, apparently as a result of clarification of the position by Lord Ashcroft.

Patrick Wooddisse, Head of TLT's Tax & Estate Planning team, comments "Apart from a clear failure to understand the technical tax issues on which they comment with such authority, what is most striking about these controversies is the looseness of the terminology used by senior politicians and journalists."

There are three key definitions, which have been established in legal circles since a judgment by Lord Templeman in 1986, that need to be understood. Firstly “tax evasion” means dishonestly taking steps to conceal a tax liability. This is a criminal offence which is clearly unethical. Secondly, at the other end of the spectrum, “tax mitigation” involves taking steps to plan your tax affairs in accordance with the law as it was intended to work when it was enacted by Parliament. For example, you can defer tax by investing in an ordinary offshore bond. It is difficult to see how this could be regarded as unethical or comparable with benefit fraud. In the middle, and at the heart of the controversy, is “tax avoidance”. This occurs when tax liability is reduced as a result of application of the law in a way that was not intended by parliament. Typically this involves a "tax loophole" whereby, on a strict reading of the legislation, circumstances can be created artificially which prevent an intended tax charge from arising. It is clear that the law cannot cover every eventuality and it is therefore inevitable that people will test inconsistencies or ambiguities in legislation to see whether it can result in them avoiding tax which parliament had intended that they would pay. A good example would be the "home loan" scheme which involved a combination of loans and trusts as a means of removing a family home from the inheritance tax net. It was heavily marketed and widely adopted until legislation was introduced to counter it in 2004.

This raises a number of questions. Firstly, is what Lord Ashcroft was doing tax avoidance or tax mitigation? Until we have seen the Panorama programme, we do not know. However, if he was simply transferring funds into a trust whilst he legally held non domicile status then that would clearly be within the intention of Parliament when it enacted the Inheritance Tax Act, since the legislation explicitly permits this. Whether senior political figures have higher responsibilities than the rest of us is another matter but, strictly speaking, it would be inaccurate to describe this as tax avoidance.

Secondly, is tax avoidance as bad as benefit fraud or is it acceptable? Most people agree that there needs to be some form of a social contract between individuals and the state, whereby the state will provide services which the individuals will contribute to by way of taxation. Therefore there is a duty for us to behave responsibly whilst conducting our tax affairs. On the other hand, many would argue that HMRC have become increasingly ruthless in their pursuit of tax revenue and that the Government’s use of retroactive legislation (whereby arrangements that were made in good faith before the legislation was put in place can be taxed punitively), mean that the Government have effectively taken the gloves off and that normal rules have been suspended.

Patrick continues, "Given that tax avoidance is legal, we see it as up to our clients to take their own moral stance on this. The only consistent advice that we would give is that, from a pragmatic perspective, it is clear that the wind is blowing against the more extreme examples of tax avoidance and that the Government are likely to introduce harsh retroactive measures against any aggressive schemes that are implemented. Therefore we would question whether it really is in your best interests to attempt aggressive tax planning which might result in significant short-term legal fees and ultimately a more serious tax liability for the client. If in doubt about this, ask anyone who was sold a home loan scheme and then faced tax charges and professional fees unwinding it. Significantly there is continuing discussion about whether the Government will introduce a general anti-avoidance rule which will give them discretion to ignore any schemes which appear to be outside the intention of parliament. The net result will be further uncertainty within our tax system which cannot be good for anyone."