Labour pledge to tackle tax avoidance is vital, but it will need to get tough with the industry

The Labour Party has put tackling tax avoidance firmly on the election agenda, with its manifesto highlighting it as a way of reducing the deficit.

Its ten-point plan to raise £7.5 billion a year says it will review the operations of Her Majesty’s Revenue and Customs (HMRC), attack the informal economy, reform the UK’s Overseas Territories and Crown Dependencies, close loopholes that enable corporations to shift profits from the UK to low or no tax jurisdictions, tackle the tax gap (of avoidance, evasion and tax arrears) and impose penalties on those engaged in tax avoidance. However, Labour does not provide any information about how it arrived at the estimate of £7.5 billion.

The above is an extensive list and poses considerable challenges. But they are worth surmounting because the future of social democracy is at stake. The UK may be losing anything between £35 billion and £120 billion a year in tax revenues – so in some ways £7.5 billion is a drop in the ocean of what’s possible. Political parties need to be more adventurous in tackling tax games through investment in infrastructure and penalties for the tax avoidance industry.

Investing in tax infrastructure

The tax avoidance industry gambles on the idea that HMRC will not have enough resources to investigate and prosecute complex avoidance schemes. Chasing tax avoiders requires forensic and technical skills, but it is also labour intensive. Since 2005, HMRC has lost nearly half of its staff. Wage freezes mean that staff morale is low and many skilled workers are poached by big accountancy firms – the organisations that design and market tax avoidance schemes.

Due to chronic staff shortages and chronic under investment in tax tribunals, there is a backlog of some 27,246 tax cases waiting to be heard by tax tribunals. Some cases run for a decade or more. Unsurprisingly, many cases are settled behind the scenes with sweetheart settlement deals or are just dropped.

The economic case for this is very strong. Available evidence suggests that in 2013/14, every £1 invested in large business investigations yielded £97 in extra tax revenues. Each additional £1 investment in enforcing compliance by local businesses and wealthy individuals brought £18 of additional tax revenues.

In flux? HMRC in need of support.www.gov.uk

Beyond legal charades

The tax avoidance industry is very subtle in its operations. Court cases become mostly framed around “what the law means” (such as this recent judgement).

Investigations by the US Senate Permanent Subcommittee on Investigations shows how lawyers and accountancy firms work closely together to help clients avoid taxes for hefty fees. For a fee, lawyers provide favourable legal opinions to soothe client anxieties. Some US lawyers have since gone to prison for being a party to schemes.

When the cases do eventually reach courts, the matter gets tied into legal knots. At great public expense, tax tribunals and courts must work through them – often eventually declaring avoidance schemes and contrived interpretations of legislation to be unlawful. The company or wealthy individual taxpayer party to the scheme then pays the tax due plus interest and maybe a financial penalty.

But there is virtually no penalty on the tax avoidance industry. The designers and marketers of the schemes are not investigated, prosecuted or fined, and HMRC rarely seeks to recover any of the legal costs. So the industry has economic incentives to craft more schemes and the whole process begins again. The recent case of Andrew Chappell vs HMRC makes the point, it being only the eighth HMRC victory against tax advisory firm NT Advisors.

So if Labour is serious about clamping down on tax avoidance, it will have to craft legislation that imposes costs on the industry that profits from it. It would need to shut down habitual offenders. Partners of accountancy firms and other organisation peddling tax avoidance schemes would need to be made personally liable for fines and other penalties. As an additional pressure, it would need to ensure that any organisation associated with tax avoidance does not receive any public contracts. But so far it has been very hazy on the details.

Disclosure

Prem Sikka is director of the Association for Accountancy and Business Affairs (AABA), a not-for-profit organisation