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Tax and Financial Planning for Individuals

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23 August, 2013

Research tends to inform us that as individuals we pay much more in tax then we actually need to. However, when it comes to tax planning, it is difficult in the current climate to know where the line between “acceptable” and “unacceptable” tax planning is drawn. This feature does not attempt to suggest where that line is or should be, but to draw attention to the issue of tax planning by highlighting some key developments in this area covered by our sister publication, Tax-News.com.

Tax Wastage

For the vast majority of people, paying tax is a compulsory, rather than an optional, exercise for salaried individuals. In fact, in most circumstances, we don’t have a choice anyway; the taxman will automatically take income tax and social security contributions out of our pay before we even see it via tax withholding mechanisms. There are however, plenty of legitimate means available to obtain relief from taxation, for example if you are paying into a pension, are building up a savings pot, are investing in things like property or small businesses, or you are a small business owner yourself. Indeed, in many cases we are encouraged by Governments to take advantage of these schemes. Yet, grumble as most of us do about the inevitability of taxation and the amount we are expected to pay, most of us it seems fail to take advantage of these targeted tax relief schemes.

In the United Kingdom, an annual survey by unbiased.co.uk, the umbrella website for the country’s independent financial advice industry, attempts to measure the amount of tax that Britons pay unnecessarily. And its latest results are quite shocking. According to the unbiased.co.uk/TaxCalc research, 68% of British taxpayers do nothing to reduce their liability to tax, despite the availability of many schemes to help them do this. The report predicts that, overall, GBP4.6bn (USD7.2bn) in tax will be overpaid to HM Treasury in 2013, with each Brit set to pay on average GBP153 in unnecessary tax this year. These amounts are largely the result of people’s failure to take advantage of tax privileged Individual Savings Accounts (ISAs), and tax relief on pension contributions, capital gains tax and inheritance tax. The research shows that nearly 4.3m people not currently paying into a pension but potentially considering it are currently leaving GBP2.6bn of income tax relief on pension contributions unused. Moreover, the latest tax authority figures reveal that, based on the average yearly pension contribution of GBP3,010, those who are paying into a pension scheme could boost their pension pot by as much as GBP602 each and GBP2.6bn collectively, simply by taking advantage of tax relief on pension contributions.

The complexity of national tax codes has something to do with the amount of tax that is unnecessarily paid by individual taxpayers. In the United States for instance, Congress has made nearly 5,000 changes to the Internal Revenue Code since 2001, and around 90% of taxpayers now use the help of a paid tax professional or tax software to help complete their tax returns. With penalties for non-compliance high, but with few people absolutely certain what the rules are, it is natural that taxpayers will err on the side of caution when paying their taxes. However, many US taxpayers are losing out as a result. Research from the US Government Accountability Office suggests that as many as 2.2m Americans may not be taking advantage of income deductions that they are legally entitled to, with the result that each of these taxpayers overpays tax by an average of USD438.

Tax Avoidance

Although tax relief schemes are usually aimed at fulfilling some specific policy intent, for example to encourage us to save for our old age, donate to charity, start a business or invest in certain economic activities, we have been receiving mixed signals from Governments since the start of the financial crisis. Thirsty for revenue, not only are Governments curtailing some tax reliefs, but they are also policing them more closely, sceptical that everyone who uses them is doing so for legitimate reasons. Furthermore, there has been a dramatic increase in anti-avoidance legislation in many places over the last few years, and we are being constantly reminded by tax authorities to pay all the taxes that we legitimately owe or face dire legal and financial consequences.

Encapsulating governments’ often schizophrenic attitude to (legitimate) tax shelters, the German Finance Ministry recently gave itself a congratulatory slap on the back after publicising a report showing that the cost of tax breaks granted by the federal Government has fallen to its lowest level since 1999. This report showed that the revenue shortfall from tax benefits will drop to around EUR15.5bn (USD20.7bn) in 2014, down significantly from the EUR18.6bn recorded in 2010.

Similarly, last month, the French Government unveiled plans to cut spending on tax breaks (les niches fiscales) for individuals and companies by EUR3bn next year, including by removing the income tax shelter benefiting families, known as the "family quotient."

In the United States, there is a determination among tax reformers in Congress to eliminate as many “tax expenditures” as possible as they attempt to force through a clean sweep of the US tax code. A recent study concluded that cancelling the charitable tax deduction alone would provide an additional USD39bn in tax revenue freeing up money to lower individual income tax rates. Indeed, so full of “pork” (aka special interest tax breaks) has the US tax code become that nobody is absolutely certain how much these tax breaks cost anymore, although the Joint Committee on Taxation recently put the figure at USD1 trillion in revenue foregone by the federal Government annually.

Governments are also throwing a lot more resources at cracking down on “aggressive” tax avoidance and tax evasion. For instance, it was announced last May that the Canadian Revenue Agency (CRA) would benefit from an additional CAD30m (USD30m) in Government funding over the next five years as part of the CRA's crackdown on international tax evasion and aggressive tax avoidance practices.

However, this figure is dwarfed in comparison to the GBP917m given by the United Kingdom Government to HM Revenue and Customs (HMRC) to undertake new enforcement campaigns, which have culminated in the creation of almost 50 taskforces targeting certain “high risk” professions like private doctors and dentists, plumbers and online traders. HMRC said in a report issued in December 2012 that its compliance yield has doubled in six years from GBP7.4bn in 2005-06 to GBP16.9bn in 2011-12. And the tax authority is also more likely to take individuals suspected of tax evasion to court: in 2012-13, 339 people were charged with criminal offences (by the end of October 2012) with 285 brought before the courts and 260 convicted, representing a conviction success rate of 90%.

Safe Versus Aggressive Tax Avoidance

Of course, tax evasion, a criminal offence in most countries, is a world away from legitimate tax avoidance provided by the sort of tax relief schemes we mentioned earlier in the feature. But even tax planning techniques previously considered “safe” now might put you on the tax authority’s radar in many jurisdictions. It is highly unlikely that you will be challenged by placing money into tax-privileged savings accounts like ISAs in the UK or Tax-Free Savings Accounts in Canada. However, using more complex sorts of tax reliefs might lead to scrutiny by the taxman. Film finance schemes are a good example, and tax authorities will want to know whether an investor has a genuine intention to fund a movie or television production, or is motivated solely by reducing his or her tax bill. This has been an issue in the UK, where a number of celebrities and wealthy investors were recently found to have utilized complex schemes involving film tax relief to substantially to reduce their liability to income tax, and in January 2013, HMRC wrote to investors in film production partnerships with details of a "settlement opportunity," following a number of tax tribunal cases in which HMRC successfully argued that particular schemes existed primarily to avoid tax.

Marketed Tax Schemes

In the current climate, a reasonably good indicator of whether a tax relief scheme will attract the unwanted attention of the tax inspectors is whether it has been “marketed” by a firm of professional tax advisors, for hunting these schemes down has been central to Governments’ efforts in combatting aggressive tax avoidance.

In the US, one well-reported example occurred in March 2013, when accountancy firm Ernst & Young agreed to pay the Internal Revenue Service USD123m after it admitted "wrongful conduct" in connection with its participation in four tax shelters. In conjunction with a number of firms, banks, and investment advisors, E&Y was alleged to have developed, marketed and implemented four tax shelter products between 1999 and 2002. These products were then utilized by approximately 200 high net worth clients.

The UK Government has also been pretty hot on this issue, and on August 12, 2013, announced a consultation on a new regime for tax advisers who promote "high-risk" tax avoidance schemes. HMRC proposes specific statutory information powers applicable to high-risk promoters, defined as promoters whose schemes have a negligible probability of working, or which rely on non-co-operation with HMRC or on concealment or “misdescription of elements” in order to succeed.

Some high profile banks and financial advisors are now reluctant to sell tax planning advice in response to bad PR. For instance, in February 2013, it was reported that Barclays was to close the bank’s tax planning unit after a sustained period of bad publicity for the bank. The head of investment banking, Rich Ricci, said at the time that the tax advisory arm of the business had "generated negative media and political attention" and stressed that the bank needed to take a "fresh look" at the products and services it offers.

General Anti-Avoidance Rules (GAARs)

Increasingly, Governments’ are deploying general anti-avoidance rules (GAARs) in their quest to sort the wheat from the tax avoidance chaff. In theory, GAARs are supposed to simplify this task: by providing a single checklist of what constitutes unacceptable tax planning, taxpayers should know where they stand, while tax authorities should spend less resources on pursuing tax avoidance cases, in the process freeing up the courts. However, where the line between acceptable and unacceptable is drawn is highly subjective, and if the boundaries of a GAAR are set too wide, these rules can cause a lot more problems than they solve.

For past few months, this dilemma has occupied the thoughts of lawmakers, tax experts, taxpayers and the tax authority in the UK, which has recently introduced a general anti-abuse rule. Indeed, the description “abuse” was carefully chosen, reflecting the Government’s desire to target the rule more narrowly towards tax avoidance of the more aggressive kind, although many doubt whether it will achieve this objective.

India’s proposed GAAR is seen as a prime example of a badly-drafted avoidance rule, and the Government has repeatedly postponed the introduction of a GAAR precisely because it was felt that it gave far too much power to the tax authorities, placing as at it did the onus on taxpayers to prove why a particular tax scheme should not be considered impermissible tax avoidance.

GAARs certainly aren’t flawless, and they can fall behind the times with the result that they need updating occasionally. This was demonstrated in Australia in 2012 when the Government introduced new legislation to ensure the continued effectiveness of the country's general anti-avoidance rule. Talking about the changes to the rule, known as Part IVA under Australia’s income tax law, Assistant Treasurer Mark Arbib said: "As well as directly attacking illegitimate tax avoidance, Part IVA also plays an important role in deterring the potential abuse of the tax system by the broader tax-paying community. Without Part IVA there would be significant scope for taxpayers to simply plan their way around the intended operation of the tax law, significantly undermining its integrity."

The United States doesn’t have an anti-avoidance rule as such, but an economic substance doctrine used by the courts was codified into law in 2010 and effectively serves as a GAAR. The economic substance test is a judicial doctrine that has been used by judges to deny tax shelters when the transaction generating these tax benefits lacks an underlying economic purpose. However, the courts have not applied the doctrine uniformly, and President Obama’s health reform legislation clarifies the manner in which the principle should be applied by the courts.

Although Governments seem to be quite fond of GAARs, there is little evidence to suggest that they have provided an effective solution to the problem of determining legal or illegal tax avoidance. Indeed, the UK has had a GAAR of sorts for a number of years in the form of a programme called Disclosure of Tax Avoidance Schemes (DOTAS), and the very fact that the Government is frequently legislating to close tax loopholes and publicising new efforts to tackle tax avoidance suggests that GAARs are no panacea.


Generally, the increased privacy and lower taxes provided by investing offshore still make this form of tax minimisation strategy attractive. And, despite the bad press that offshore has had over the past few years, especially since the financial crisis, for a resident of a “high-tax” jurisdiction, it isn’t a crime to keep money in an offshore bank account, hold assets in an offshore trust or form an offshore corporation as long as these assets are declared. Unfortunately though, if there is one thing guaranteed to get the taxman breathing down your neck, it is the suggestion that you might have links to assets held offshore.

Just about all of world’s major economies now have some sort of programme in place either to encourage people to declare their previously undisclosed offshore income under a relaxed penalty regime, or to aggressively root out those who refuse to acknowledge the existence of offshore arrangements.

Many Governments use both the carrot and stick approach to offshore tax compliance. The United States is one example. In January 2012, the US Internal Revenue Service decided to re-open the offshore voluntary disclosure program after reporting continued strong interest in the scheme from taxpayers and tax practitioners following the closure of two previous initiatives. On the other hand however, President Obama, and certain, mainly Democratic, members of Congress, would like to crush offshore with an iron fist. A number of aggressive compliance proposals have been contained in each of Obama’s budget proposals, and these have echoed proposed legislation by anti-offshore hawk Carl Levin, a Democratic Senator representing Michigan.

The United States already has fairly onerous reporting rules for those with overseas income, such as with the Foreign Bank Account Report (FBAR) programme. However, the Obama Government has succeeded in building on the FBAR rules with new legislation known as FATCA (the Foreign Account Tax Compliance Act), which was enacted in 2010 and is due to commence in July 2014. FATCA is intended to ensure that the IRS obtains information on financial accounts held abroad with foreign financial institutions (FFIs) by US taxpayers. Failure by an FFI to disclose information on their US clients, including account ownership, balances and amounts moving in and out of the accounts, will result in a requirement to withhold 30 percent tax on US-source income.

The UK has also employed – with mixed success – an often bewildering array of offshore declaration schemes, such as the so-called New Disclosure Opportunity and the Liechtenstein Disclosure Facility. Additional disclosure opportunities arranged in 2013 between the UK and the Crown Dependencies (Guernsey, Jersey and the Isle of Man) are expected to generate an additional GBP1bn (USD1.5bn) in tax revenue over the next five years, HMRC has said. The UK Government is also rolling out its own version of FATCA with its dependent territories, many of which are classed as tax havens, and ahead of the G8 Summit in June 2013, the Treasury announced that these jurisdictions had agreed to sign up to the OECD multilateral convention on information exchange. And in December 2012, Chancellor George Osborne announced a comprehensive tax compliance plan which included extra money for HMRC to go after offshore-based avoidance and evasion.

In June 2013, the Canadian Government announced the introduction of tougher foreign income declaration requirements, as part of its crackdown on international tax evasion and so-called "aggressive” tax avoidance. Under plans announced in Finance Minister Jim Flaherty’s latest Budget, Canadians holding overseas property costing over CAD100,000 (USD95,220) will have to provide additional information to the CRA. Earlier that month, Revenue Minister Gail Shea revealed that the Canadian Government is now in possession of information on individuals with offshore assets, and is reviewing this “voluminous” information with a view to taking necessary legal action against them.

With the banking havens of Liechtenstein and Switzerland in its back yard, so to speak, Germany has also been at the forefront of efforts to lift the veil of banking secrecy, and back in April 2013, Chief Executive of Germany's Federal Financial Supervisory Authority (BaFin) Raimund Röseler announced plans to more closely scrutinize the offshore business activities of German banks. The German authorities have been particularly interested into getting hold of information about German nationals with assets held in Liechtenstein and Switzerland, and there has been a steady flow of illegally-obtained information over the Alps since a major tax evasion scandal involving the former boss of Deutsche Post erupted in 2007. In the most recent example of this trade in stolen information, Lower Saxony's Finance Minister Peter-Jürgen Schneider said in June 2013 that the federal state fully intends to make further use of data obtained illegally, to track down suspected German tax evaders with undeclared bank accounts held abroad.

Meanwhile, Australia has long had a programme in place to tackle what the Australian Tax Office (ATO) calls the “abusive use of secrecy havens” under the banner of Project Wickenby, which was launched in 2006. By December 2012, 28 people had been sentenced under the project.

It is not just individual nations that are clamping down on offshore tax avoidance and evasion either:  an increasingly extensive network of information sharing regimes is springing up to enable tax authorities to assist one another in this campaign. At the level of the European Union, there is the Savings Tax Directive, which the European Commission is currently attempting to expand in legal scope and jurisdictional reach. Five EU Member States collectively known as the G5 are also piloting and developing a multilateral tax information exchange initiative based on FATCA intergovernmental agreements which is intended to tackle international tax evasion in a way that minimizes costs for both businesses and governments. Further afield, it was announced in May 2013 that the tax administrations from the United States, Australia and the United Kingdom have developed a plan to share tax information involving trusts and companies holding assets on behalf of residents in jurisdictions worldwide. And numerous tax information exchange agreements have been signed over the last four years between offshore jurisdictions and onshore Governments.


Few people want to pay more tax than they legally owe, but the reports by unbiased.co.uk and the US Government Accountability Office show that the majority of us still pay quite a bit more than we have to. But the further one takes tax planning strategies to reduce income for tax purposes, the more attention we are likely to get from the tax authorities, especially in the current climate of budget deficits and tax scandals in the media. So what’s the answer? Although the boundaries between acceptable and unacceptable tax avoidance are as blurred as ever, there is still a place for sensible tax planning. For those of us with financial tax affairs, this remains a relatively straight-forward exercise. The situation for people with more complex finances is less clear cut, but the best course of action remains to engage the services of a reputable and independent tax advisor.


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