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Dividend tax: From 'gifthorse' to 'loophole'
by Susie Hughes at 10:15 22/04/04 (Political News)
The political battlelines were drawn on the dividend tax and other new measures affecting freelancers and small businesses during the Finance Bill's Second Reading. It emerged that Opposition members were prepared to attack the new dividend tax (IR591) on the basis that the Government had lauded the introduction of the zero corporation tax rate as a 'gifthorse', only for it to change to a 'loophole' 18 months later leaving small businesses in an uncertain and disruptive situation.
The Second Reading of a Bill gives politicians the first opportunity to debate the wider principles of the legislation rather than the detailed provisions, which is carried out in the forthcoming Committee Stages of the Bill.

However, Conservatives and LibDems spent some time focusing on the damage being done to the small business sector with the dividend tax; IR35; Section660 and other measures. The Government also recognised this was going to be an issue during the next few months and reinforced its determination to tackle tax avoidance and evasion, particularly with reference to small businesses and owner-manged companies.

This theme has already attracted considerable debate on Shout99 (see: When a tax 'avoider' becomes an 'evader') and some Conseravtive members did point out that 'avoidance' and 'evasion' are different issues. Shout99 had been approached by the Opposition to provide information and experiences from its members and many of the points we have summarised on behalf of the Shout99 network were used in the debate.

Tax avoidance and evasion
The debate was opened for the Government by Treasury Minister, Paul Boateng, who laid his card on the table with regard to the Government's position, indicating that they will be using investment in public services as a justification for tackling tax avoidance.

He said: "Promoting enterprise and competition is important, but it must be underpinned by fairness. Our objective continues to be ensuring stable public finances and world-class public services, which are served by a fair tax system in which everyone pays or claims for what is due. To protect revenue for investment in the public services that the country wants and needs, we are determined to tackle tax avoidance and evasion.

"We have therefore introduced a number of legislative changes to close loopholes that have been exploited for tax avoidance, and we are taking steps to target low rates of corporation tax on small businesses that are reinvesting to ensure that distributed profits are subject to a minimum corporation tax rate of 19 per cent. We are protecting the zero rate as an incentive for businesses to invest for growth, enterprise and productivity.

"We have also introduced new requirements to disclose the use of direct tax and VAT avoidance schemes."

Small owner managed businesses
The Opposition then have an opportunity to oppose formally that the House declines to give the Bill a Second Reading and therefore prevent its passge to the next stage. However, in practice this is a debating tool as there is little chance of a Bill being clocked in its entirity at this stage.

Interestingly, the motion to oppose the Bill focussed on small businesses. Opening for the Opposition, Conserviative Treasury spokesman, Howard Flight move that:

  • That this House declines to give a Second Reading to the Finance Bill because the provisions contained in its 574 pages increase the burden and complexity of taxation, particularly on small owner managed businesses; do nothing to increase the savings rate or improve United Kingdom productivity; and will lead to a further decline in the competitiveness and relative attractiveness of the United Kingdom as a location for investment.

Fiscal distortion
Flight continued by reminding that Government, and in particular, the Paymaster General, that they had actively encouraged small businesses to take advantage of incorporation through the zero tax rate, only to do a complete U-turn on the provision.

He said: "As we stressed in the Committee proceedings on the Finance Act 2002, the introduction of the zero corporation tax rate introduced a fiscal distortion that favoured incorporation for small businesses, as opposed to remaining sole traders. As we warned, that led to a massive shift to incorporation, which the Government estimate would cost 420 million in lost tax this year alone. The Government have chosen to tax the distributed profits of small companies, which would otherwise fall within the zero band, at 19 per cent., to deal with that. Again, that will create significant compliance and legislative burdens for small businesses, with complications relating to undistributed prior year profits carried forward, and hit especially the smallest companies, which often find it difficult to retain profits.

"The Law Society commented that the extent and complexity of the provisions are disproportionate to the amount of tax involved. The Treasury Committee stated that it is puzzled about why, unlike other commentators, neither the tax authorities nor the Treasury appear to have anticipated the inevitable incentive to incorporation for small businesses.

"The Paymaster General (Dawn Primarolo) will remember that she pointed out in Committee that small businesses would not look a gift horse in the mouth. She clearly expected the provisions to encourage small businesses to incorporate, but now we are told that it was not a gift horse after all. Consequently, small businesses now end up with a complex tax charge.

Section660 - stealth tax
Howard Flight also took issue with Section660, the tax on businesses owned by family and friends, which has caused considerable concern and outrage among professional bodies and small businesses.

Mr Flight said: "On another subject relevant to owner-managed businesses, clause 86 seeks to remove the ability of small owner-managed businesses to be held jointly, and the husband and wife to remain taxed on a 50:50 basis.

"That flies in the face of the provisions that were specifically made in 1990, when independent taxation was introduced. Outside the Finance Bill, aggressive new interpretation of section 660A, universally criticized by the accounting profession, seeks to introduce another stealth tax, to tax as the husband's income dividends from the proportion of owner-managed companies that were historically owned by the spouse. The parliamentary debates and Budget press release relating to the Finance Act 1989 made it clear there was no such intention thus to interpret section 660A.

"What is fundamentally wrong with these initiatives, essentially designed to extract more taxation from small, owner-managed businesses, is that they impose complicated rules on small businesses, which are costly to administer, potentially penal, and will possibly lead to mistakes. At the end of the day, the earnings are not large. As a constituent wrote to one of my colleagues:

  • "I am sick of this Government messing up so many areas of my life. I am fed up with their taxes, anti-family stances and sheer arrogance. They meddle in so many areas where they just do not see the ramifications."

"I am surprised that the Inland Revenue has not previously attacked artificial tax avoidance schemes, which have been widely marketed, well before they have become widely used, and I understand the Government's objectives in the Bill. However, I ask the Chief Secretary to make a commitment that the Government will now publish the prescribed Treasury regulations, mentioned in clause 290, which will define "notifiable arrangements". Without that, we cannot know whether, as the Treasury Committee warned, the arrangements will create undue compliance burdens for tax payers and their advisers, or undue administrative burdens for the tax authorities."

Evasion/avoidance
He also flagged up the Government's tendency to muddle tax evasion with tax avoidance.

Mr Flight said: "I also warn the Government of the dangers of confusing tax evasion and tax avoidance. In those European Union economies where that happens, the outcome has been to make tax evasion socially acceptable. Ultimately, there also needs to be a degree of consent on the part of those asked to pay the taxes levied on them. As the senior partner of Grant Thornton pointed out, many of the Government's problems in their attempts to tackle tax avoidance are of their own making. Moreover, to avoid the new rules imposing excessive and uneconomic burdens on business, they also need to draw a clear line between "offensive" tax avoidance schemes and normal corporate tax planning; otherwise, provisions could have the effect of requiring any transaction on employment or a financial instrument that could have been accomplished in a less tax-efficient manner to be reported. That would impose wasteful time and cost burdens on both business and the Inland Revenue.

"Clause 298 lacks adequate clarity about when lawyers are bound by their duties of confidentiality to a client and when they will be obliged to report under the new rules.

"It is also notable that, although the Bill contains major anti-avoidance measures, there is a marked absence of Government initiatives to tackle tax evasion and the growing black economy, or for that matter, the 7 billion incorrectly paid out in state benefits as the result of one in five Department for Work and Pensions decisions being wrong, as recently reported by the Public Accounts Committee. Moreover, in the Chancellor's drive to leech the tax system, he might apply his ingenuity to improving the collection of 14 billion of uncollected tax last year, as the recent National Audit Office figures revealed. That partly reflects the growing unwillingness of the rising generation to be bothered with the demands of ever more time consuming, bureaucratic compliance in their private lives."

Fiasco
Next was the turn of David Laws to lay out the stall for the Liberal Democrats. He too made much of the fact that the dividend tax was an action to solve a perceived problem of the Government's own creating, which everyone else had foreseen.

Mr Laws said: "Our other perpetual complaint about the tax system, especially under this Chancellor, is its complication and the rapid introduction of a series of ill-thought-out subsidies, often without any calculation of whether they will have any economic advantage. There are examples in every Budget under this Chancellor, and in this year's Budget we witnessed the fiasco of the zero per cent. corporation tax rate. The Chancellor had to introduce a new 19 per cent. tax rate this year to try to deal with the problem of lost revenue that resulted from many people incorporating.

"That fiasco was entirely foreseeable and, indeed, was foreseen by many people who gave evidence to the Treasury Committee a couple of years ago and by the Institute for Fiscal Studies. It was also widely discussed and debated in the House. A year or so ago, I attended an event in my constituency organised by local accountancy groups that were trying to encourage people to incorporate and pointed out the great advantages that the Government had opened up as a consequence of the zero per cent. tax rate.

"The tax accountants led, as one would expect, with an explanation of how the measure worked in practice and what their charges were. As a political representative, I was asked only one question - that surely the loophole was too good to last and that once the Government realised they were losing Revenue they would close it and people who had paid their money to accountancy firms would be no better off. I am afraid that I naively said that even this Government would not be so short-termist and short-sighted to end the tax relief within 18 months, particularly before a general election.

"That is the last time that I shall defend the Treasury's long-termism, as business men now ask me how the Government could change their mind so rapidly. Under the Bill, the Government will raise almost 1 billion over the next couple of years by withdrawing all the reliefs that had previously been introduced. It would have been far too embarrassing, however, for the Chancellor to have to announce in the Budget that he was withdrawing the zero per cent. tax rate. That would sound like an anti-business measure, so he presented it as a further reform to stop tax avoidance. The introduction of a new 19 per cent. rate will further complicate the system and, as a result, the tax accountants who were at that meeting will earn even more money from people going back to them for advice.

Messed around again
He continued with a proposal to delay the implementation of the measure: "It is not for me to suggest how the Government can get out of the mess that they have got themselves into, but I shall make a constructive suggestion before concluding my speech. The Government will issue a discussion paper on the tax rates paid by incorporated and unincorporated smaller businesses later this year, and it will lead to changes in 2006. We do not want people to adjust to the latest change in the tax regime, only to be messed around again in 2006 when the Government change the whole system.

"The Government should aim to put off that penal increase in taxation. They should accept that the loss of tax revenue is their fault and was entirely predictable. They should not introduce changes in the tax system for small businesses in 2006 until they have thought them through. It was fair to characterise the Budget as somewhat dull and the Finance Bill as long. What is not in the Bill concerns us, and should concern the Government too. There is nothing about the fairness and simplicity of the tax system, nothing to address the public expenditure issues facing the Government, and there is complacency about the major macro-economic challenges facing them.

Assault on small businesses
Other MPs then have the opportunity to make specific points. Michael Jack, Conservative MP for Fylde and a long-term campaigner for small businesses dealt with aspects of the Finance Bill which he described as the Government's assault on small businesses.

He said: With IR35, section 660A, and now other elements of the Finance Bill, they seem to be hammering hard on these small engine room businesses for the British economy. Why does that group seem to have been singled out for particular treatment, when a more considered review might have been the best way forward? Such people are the entrepreneurs of the future and the engine rooms of the service economy, yet they seem to be getting a bad deal in the Finance Bill.

Tax rises
The Second Reading debate concludes with winding-up statements from the Opposition Paymaster General, Mark Prisk, a former freelancer; and his opposite number for the Government, Dawn Primarolo.

Mark Prisk predicted that despite all the gimmicks and giveaways, and the spin and the gloss of the Budget day speech, the unvarnished truth is that, over the next 12 months, the nation's tax bill will rise by almost 8 per cent....and almost 8 per cent. more the year after....with the burden of tax to reach its highest level for more than a quarter of a century by 2008.

He said: "Our taxes had been rising steadily under Labour even before the Bill. The net effect of the previous seven Budgets and Finance Bills equates to an extra 5,000 per household per year. That is 60 stealth tax rises in seven Budgets, and this year, the Chancellor has slipped in six more stealth taxes. In this Bill, there is a new tax on small companies, a tax on UK businesses for transfer pricing, a tax rise on red diesel, a tax hike on other road fuels, a new tax on trusts and a sixfold tax rise on company vans.

"The complexity of our tax system stems largely - although not wholly - from a Chancellor who constantly meddles and tinkers with each and every tax, duty and charge. Every year we get a raft of new schemes, every Budget produces different rates and credits and every Finance Bill brings more and more rules."

Dividend tax: lame gifthorse
He continued: "Let us take the new tax on small companies, as set out in clause 28. In 2002, the Chancellor cut the corporation tax starting rate from 10 per cent. to zero. Indeed, the Paymaster General actively promoted the change. She said in the Standing Committee that small businesses would not look a gift horse in the mouth. Thousands of businesses took her at her word and incorporated. Indeed, her encouragement was so magnificently successful that 300,000 firms incorporated.

"Unfortunately, that was far more than the Treasury had budgeted for. Suddenly, the Paymaster General's gift horse was beginning to look a little lame. So, in the Budget last month, the whole policy was reversed, with a 19 per cent. tax rate being imposed on many of the smallest companies. Indeed, we are now told that this was not a gift horse at all, but a loophole. What remarkable genius. Only this Government - perhaps only this Paymaster General - could miraculously transform a gift horse into a loophole in 18 months. That is a remarkable achievement.

"Yet the Government were warned of their error at the time. The recent Budget report by the Treasury Select Committee states:

  • "We are puzzled as to why, unlike other commentators, neither the tax authorities nor the Treasury anticipated that this would be the likely effect".

"The Committee's report that goes on to say that the cost to the taxpayer was an estimated 670 million in lost revenues.

"In a sense, the cost to business is probably far greater. There are the professional costs of accountancy advice and changing accounts, and the costs of the time lost in that process. But perhaps the greatest price to the UK economy is the uncertainty that this incompetent meddling has created. How are businesses meant to plan ahead when the tax system keeps changing? How can companies invest when they do not know how their investments will be taxed? Perhaps most important of all, what assurances can the Paymaster General give that some of the reliefs and many allowances in this Bill that she and her colleagues have applauded will not also soon be suddenly denounced as loopholes?

"Conservative Members fully accept that seeking to evade legitimate tax liability is illegal and should be dealt with accordingly, but there is a world of difference between illegal tax evasion and tax avoidance or planning. Indeed, I understand that that was once the Labour party's view. Preparing for the debate, I came across a fascinating document, Labour's policy paper "Tackling Tax Abuses, Tackling Unemployment" - a snappy title. It was written when the Chancellor was still the shadow Chancellor. Under the heading, "How avoidance can be countered", it states:

  • "The taxpayer is entitled to take advantage of the law to minimise his or her tax bill."

It goes on
  • "as a matter of principle we believe that the citizen is entitled to know where he or she stands before the tax law."

It concludes:
  • "It is the complexity of the present system that has encouraged the growth of a flourishing avoidance industry."

"For once, I agree with the stated policy - as it must have been then - of the Labour party and its supporters, but what is the Paymaster General's view? Does she agree with the Chancellor's view then, or with his actions now? Does she accept that people are entitled to ensure that they pay only the tax that they owe? Does she understand that ceaseless change leaves taxpayers unclear about where they stand? Will she agree in her reply that the more complex the tax law, the greater encouragement there is for tax avoidance?"

Dawn Primarolo
The task of ending the debate and summarising and responding to the points made by MPs from all parties fell to the Paymaster General, Dawn Primarolo, best known in the freelance community as the architect of IR35, who, at the time, angered the freelancing community by referring at their actions as 'cheating honest tax payers'.

In reference to Michael Jack's points about tax avoidance, Ms Primarolo said: "I want to touch on his points with regard to avoidance and whether Parliament has got it wrong. That is a crucial debate, on which the hon. Member for Hertford and Stortford (Mark Prisk) touched in his closing remarks. In 1997, Lord Nolan described avoidance as

  • "when a taxpayer reduces his liability to tax without incurring the economic consequences that Parliament intended to be suffered by any taxpayer qualifying for such a reduction in his tax liability. Tax avoidance is a course of action designed to conflict with or defeat the evident intention of Parliament".

"Of course, we would expect all individuals and companies to want to make the most efficient use of the tax system and its reliefs, but we have seen systematic, abusive schemes that give relief for economic activity that was never undertaken or multiple reliefs for the same action that was never intended.

"The debate in Committee - on which I hope the right hon. Gentleman (Michael Jack) will serve - will enable all hon. Members to draw a clear distinction between legitimate tax planning, avoidance and evasion and allow us to discuss how we should respond to these challenges in fairness, treating all taxpayers on an equal basis."

Next steps
As expected, the motion to oppose Second Reading was defeated and the Bill was given its Second Reading. It will now pass to the Committee Stage for a detailed analysis of the proposed legislation and the opportunity to put forward amendments to the specific clauses.

The full text of the debate is available here: Finance Bill: Second Reading

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Susie Hughes Shout99.com 2004

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Dividend tax: From 'gifthorse'... Susie Hughes - 22/04
    Taxation is Theft pF - 22/04
       Needs qualification New Dawn - 23/04
          Re: Needs qualification pF - 23/04
    Re: Dividend tax: From 'giftho... steh - 23/04
       Answers New Dawn - 23/04
    Re: Dividend tax: From 'giftho... jobyrne - 24/04
       Probably never..... joe-hill - 24/04
          Wait and see thelonegunman - 26/04
             Re: Wait and see Joe Smith - 4/05

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