The United Kingdom taxation system

‘Every man is entitled, if he can, to arrange his affairs so that the tax attaching under the appropriate Acts is less than it otherwise would be. If he succeeds in ordering them so as to serve that result, then, however unappreciative the Commissioners of Inland Revenue or his fellow taxpayers may be of his ingenuity, he cannot be compelled to pay an increased tax.’ Per Lord Tomlin in I.R.C. (Inland Revenue Commissioner) v. Duke of Westminster 1936.

Is this an accurate statement?

Introduction

United Kingdom Taxation System

In order to maintain financial budget set by the Chancellor of the Exchequer, the UK government raises the majority of its government revenue through the collection of tax payable by the general public.

The taxation system involves individual tax-payer making payments to the Central Government, namely Her Majesty’s Revenue and Customs (HMRC), and Local Government under various categories such as personal income tax from a person’s employment, value added tax on the supply of goods and services by a taxable person in the course of business (Alan Melville, pp.470), national insurance contribution from both parties of an employment, etc. (Taxation in the UK, Wikipedia)

Income Tax

Income Tax, as one of the main tax categories, is charged on earnings from employment and self-employment, company dividends, property rental or leasing and funds received as a trustee of an organizational trust. (What counts as taxable income?)

A taxpayer is bound by law to pay income tax on the income generated from any of the sources mentioned above within the UK disregarding the individuals’ nationality, citizenship and domicile address or the place of registration in the case of a corporation treating it as a legal entity. (Taxation in the UK, Wikipedia)

Interpretation of Lord Tomlin’s Statement

The “every man" mentioned in Lord Tomlin’s statement refers to individuals with tax liabilities no matter it’s income tax liability from an employment, property rental or dividend from the shares obtained.

The “affairs" mentioned in the passage refers to the source of income or the items included in the calculation of income tax. It’s important to note this as there are non taxable item such as winning from premium bonds and income from scholarship (Alan Melville, pp.17) and tax free allowance such as personal allowance and blinded person allowance. (Alan Melville, pp. xi) (Taxable Income)

The whole of Lord Tomlin’s statement means that, “...all of those with tax burden may seek to make arrangement to minimize their tax liability within the scope of the statute law and resulting in paying less tax than before. If the individual succeed to make tax avoidance arrangement and reduced his or her tax liability, despite the Inland Revenue Commissioner might be unappreciated and the fellow tax payers who do not make such arrangement might feel unfair, the HMRC cannot force the tax reduced individual to pay an increased tax, in this case the original amount."

This assignment would be studying the case IRC v. Duke of Westminster [1935] All ER 259 (H.L.) with back-up to the case W T Ramsay Ltd v IRC [1981] AC 300 (HL) in order to find any justification on the accuracy of Lord Tomlin’s statement.

IRC v. Duke of Westminster [1935] All ER 259 (H.L.)

In IRC v. Duke of Westminster [1935] All ER 259 (H.L.), Duke of Westminster executed a deed of covalent with his fellow servants including domestic helpers, gardeners, etc. In the specific deed of covalent, the Duke promised to pay the servants some money for their services. A letter was written and sent to the servants stating that the Duke would pay them remunerations on top of additional sums, if any, as a payment for their services as domestic helpers. The Duke tried to claim such payment for a tax deduction as an arrangement for tax avoidance. (Appendix 1)

A deed is a contract- like legal document requiring a mutual agreement of more than one person which is normally used to grant a right such as the transfer of an asset or property. The main difference between a deed and a contract is that a deed is a written agreement that must be signed and sealed under witness of a third party, often an innocent party such as a solicitor; apart from the agreement must be in writing, a deed unlike a contract a consideration is not required to be enforceable and a third party beneficiary can force the deed to be executed. In some cases a deed has a double as long enforceable period as a simple contract. (Deed, Wikipedia)

A covenant is a religious term often referring to a promise to engage in specified action such as a sacred agreement between god and man. In the case of a deed, covenants often refer to all of conditions attached to the acceptance of a deed.

A deed of covenant is a legal document recording the responsibility of one personnel to pay a sum of money to another on an annual basis for a number of years no less than 6 years. The individual making the payment can apply for tax deduction at the basic rate and thus pay a net amount after tax relief. A registered company’s annual charity donation is normally an example of a deed of covenant. (Deed of Covenant)

An employment contract is a simple contract made by an employer making an offer to an employee for their labour and skills by paying them a weekly wages or a monthly salary for which would be chargeable to income tax under Income Tax (Earning and Pension) Act 2003 under the category of Income from Employment. Employment Income not just refer to salary and wages only but anything an employee can receive from an employment contract for the business rendered or tasks performed.(Alan Melville, pp85) (Income Tax Act 2003)

In this case, the problem lies on whether the deed of covenant could be seen or treated as an employment contract. As first of all, the Duke was neither paying the gardeners and the servants in neither neither a weekly wage basis nor a monthly salary basis as an employment contract would intend to, therefore there could be said to be no consideration towards the contract which is one of the key factor in the formation of a legally binding contract. (Formation of a Contract)

In the case of a deed of covenant, the payment is only tax deductible if it is an annual payment to the gardeners and servants. The Duke would only be eligible to claim tax relief for the annual payment or the amount paid for the service rendered in that specific year.

The Duke of Westminster case suggested that tax avoidance can be allowable as long as it follows the statute law established, in this case the basic principle of the format of the deed of covalent can reduce the Duke’s tax liability if it is approved and only making claim for one year of annual payment made.

The Ramsay Case

In this particular case, the taxpayer company tried to generate a capital gain by making two separate loans to a subsidiary company and altered the loan interest by reducing the first loan to nil and doubling the second loan. The taxpayer company eventually sold the doubled second loan to another company at a capital profit whilst the first loan was repaid at par. Through the sales of the subsidiary’s shares to another company, a capital loss was generated. The company applied for a tax deduction for the capital loss but refused to pay Capital Gain Tax for the capital profit saying it was a debt on a security, seeking for tax avoidance. (Ramsay Principle)

In this case, the House of Lords decided that although looking at the individual transactions, there were no sign of tax avoidance; but looking at the whole incident as a whole it was of no doubt that the taxpayer company was trying to avoid its Capital Gain Tax liability. Therefore the judges from this case made a decision of what was then known as the Ramsay Principle of the court has the power to disregard each individual transaction but look at the company’s account as a whole to determine whether tax reliefs applies.

Tax Avoidance

Tax Avoidance refers to one legal action to reduce his or her tax liability through making arrangement to claim for tax relief within the scope of the statute law while disclosing all its information to the tax authorities. (Difference between Tax Avoidance and Tax Evasion) Such arrangement might be unappreciative by the Inland Revenue Commissioner and the fellow tax payer as the taxpayer with tax avoidance arrangement has a lower tax liability than those without tax-planning arrangement from the same earning class.

As mentioned before the UK government raise its government revenue through tax collection; with people making tax-avoidance planning eligible for paying a lower amount, government would be collecting less tax income which might not be able to meet the budget set by the Chancellor of the Exchequer. Therefore tax avoidance sometimes might be seen as avoiding of one's duties to society, one way to protest against the politicians whiles one simply not supporting the government or just simply the correct and appropriate approach of every citizen to find all the legal ways possible to avoid paying too much tax. (Difference between Tax Avoidance and Tax Evasion)

Tax Evasion

Tax evasion refers to the prevention of tax liability by individuals, firms, trusts and other entities in breach of the statute law through deliberately misrepresenting their financial position to the tax authorities through not fully disclosing all of its material in order to reduce their tax liability using dishonest tax reporting (such as under-declaring income, profits or gains; or overstating deductions). (Difference between Tax Avoidance and Tax Evasion)

Tax evasion is a criminal offense in most countries and will result either being fined or imprisonment. The biggest exception would be Switzerland where tax fraud is a criminal offense while tax evasion is not. As all other criminal offense, tax evasion is an unappreciative offense in the eyes of the fellow taxpayers and the Inland Revenue Commissioner as a tax evader not just avoiding to pay too much, the individual is actually trying to avoid paying tax for which would be more unfair to the fellow taxpayers upon the tax evader’s succession.

Anti-Avoidance Provision

Although tax avoidance is a legal approach which is available as a right to all the fellow tax-payers, however allowing tax-allowance is making long-term damage to the economy as mentioned in the pressed notice namely “Protecting Indirect Tax Revenue" published with the Pre-Budget Report 2002, GBP 3 billion were lost to Custom & Exercise through VAT- avoidance. (Revenue Law, pp13) Therefore the government released some new anti-avoidance provisions targeting separately in legislation, by designing new statutory provisions to prevent the conversion of income profit into capital gain taxed at a lower rate like “Transactions in securities ITA2007 Part 13 Chapter 1", “Accrued income profits ITA 2007 Part 12 Chapter 2" and “Artificial transactions in land ITA 2007 Part 13 Chapter 3", etc. (Revenue Law, pp50) Some of these provisions are design to prevent tax avoidance involving circular, self-cancelling transactions, the 2004 Budget announced that users or promoters of some particular kind of tax avoidance schemes are required to disclose details of the schemes to the HMRC . (Difference between Tax Avoidance and Tax Evasion) (Revenue Law, pp98-100)

Argument on Lord Tomlin’s Statement

Based on the human behavior of sometimes being selfish, no one in the society would be willing to give away more than what is required by law, therefore if it is possible to minimize one’s tax burden, it is rational for tax payer to have tax-mitigation plan. Taxpayers with tax-mitigation plans are walking on thin ice there is only a thin line between tax avoidance and tax evasion, therefore the tax payer should be careful while drafting or drawing up the tax mitigation plan as now the government is trying to link between tax avoidance and tax evasion together.

On the other hand of this argument, tax avoidance should not be allowed as it is no different from tax evasion in terms of behavior except tax avoidance does not involve underreporting income, inflating deductions, or hiding money and its interest altogether in offshore accounts as tax evasion does. (Tax Evasion) As mentioned before tax avoidance is causing the government revenue to drop as less tax payments were received due to tax mitigation.

Conclusion

Based on the information gathered from background research and case analysis, with support of various statute law and provisions, the statement of ‘Every man is entitled, if he can, to arrange his affairs so that the tax attaching under the appropriate Acts is less than it otherwise would be. If he succeeds in ordering them so as to serve that result, then, however unappreciative the Commissioners of Inland Revenue or his fellow taxpayers may be of his ingenuity, he cannot be compelled to pay an increased tax.’ Made by Lord Tomlin was an accurate statement as mentioned before it is the right of each individual tax payer to minimize their tax liabilities through tax mitigation.

Appendix

“IRC v. Duke of Westminster [1935] All ER 259 (H.L.)

The Facts

The Duke executed deeds with persons then in his employ (including his gardener) in which he covenanted to pay to them certain weekly sums for a period of seven years or the joint lives of the parties. The deeds recited that the payments were made in recognition of past services faithfully rendered to the Duke and that the Duke desired to make provision for the person notwithstanding that he may continue in the Duke's service (in which event he will be entitled to remuneration in respect of such future service) or may cease to work for the Duke.

Letters of explanation (which were acknowledged by the employees) were sent to each employee informing him that he could claim full remuneration for future work but that it was expected in practice that he would be content with the provision made by the deed plus such sum (if any) as might be necessary to bring the total payments up to the level of the salary or wages he had lately been receiving.

The recipients at the time the deeds were executed were receiving fixed wages or salaries and after execution of the deeds continued in the Duke's employment and continued to receive such sums as, with the sum payable by the deed, made up the amount of the wages or salary payable before the deed and no more.

The Issue

If the amounts paid under the deed in respect of periods during which the persons were in the Duke's employ were remuneration for services, they were not deductible in computing the Duke's liability for surtax. If, on the other hand, the amounts were annual payments, they were deductible. Thus, the issue was whether the payments under the deeds were remuneration for services or not.

It was incontrovertible that the deeds were brought into existence so as to permit the Duke to reduce his surtax liability.

The Disposition

The payments were not remuneration for services. Three of the five Lords concluded that the letter was not a contract, only an expression of hope or anticipation and four of the five Lords concluded that, even if it was a contract, it was nothing more than a contract that the person's remuneration for future services will not be full remuneration but only the additional sum referred to in the letter. The fifth Lord, in dissent, concluded that the deed and letter should be viewed together as a simply maintaining the existing contract of service rather than radically altering it.

All of the Lords rejected the proposition that in revenue cases there is a doctrine that the court may ignore the legal position and regard the substance of the matter. The substance is that which results from the legal rights and obligations of the parties ascertained upon ordinary legal principles. (IRC v Duke of Westminster)"