Contents

1. Tax and Human Nature: The Good, The Bad and The Ugly – James Paull

2. The UK: DAC6 – A Welcome Break – Andrew Parkes

3. The US: LLC’s Again – Here But Not There – Miles Dean and Andrew Parkes 

4. The UK: IR35 and Personal Services Companies – James Paull

Tax and Human Nature: The Good, The Bad and The Ugly

It’s the time of year when many British taxpayers will be sitting back having filed their self assessment tax return and written a metaphorical cheque to the exchequer. Some will be wondering about the pit into which their hard-earned funds have disappeared, consoling themselves with the good uses to which they are being put and bemoaning those that they consider a waste of money. Others will consider the range of taxes that they pay throughout the year, not just on their tax returns, and will probably find some are fair and will pay (reasonably) happily whilst deeply resenting others. The majority will no doubt be considering how their return is going to look in future years, given the widely touted rises coming down the line.

An interesting side effect to consider is the extent to which the tax system (and in particular the rate and types of taxes paid) drives behaviour and vice versa. Although humans like to think of themselves as rational and reasonable, all are, to a greater or lesser extent, subject to unconscious biases which can shape the way they think without them realising it. This is true of individual taxpayers as well as those responsible for designing and operating the legislation. It is also true of those who sit in the middle and report: the mainstream media as well as, increasingly, social media.

Looking at the societal landscape over the last 12 months, it’s easy to see the distortive effect that cognitive biases can have on the country as a whole. Fears of Covid-19, fanned by regular reporting of increases in cases and tragic reports of loved ones lost, have seen resources flow into the combat of Covid, at the expense of many other areas of society, including other areas of healthcare, generally accepted as of crucial importance. One does not have to give an opinion as to whether this is a good or bad thing to accept that it has undoubtedly happened. A knock-on consequence of this is the long trailed tax rises, in whatever form they materialise, which brings consideration of behavioural impacts into even sharper focus.

So, given this capacity for distortion of behaviour, how does this feed into the tax system and to what extent can the tax system be instrumental in shaping behaviour? To what extent are we at risk of further distortive behaviour in the near future? In analysing the different interplays between tax and behaviour, we think there are three broad categories into which the effects can be placed: the good, the bad and the ugly.

The Good

In our view, the single most important characteristic for a tax system is that it should engender a feeling of legitimacy amongst the population so that it requires a minimum of policing and a degree of voluntary acceptance. Although almost no one actively desires a higher level of taxation, most people understand and accept the need for a system of some sort as a mechanism for paying for public services.

In his Wealth of Nations, published in 1776, Adam Smith suggested four broad conditions of good taxation: fairness, certainty, convenience and efficiency. Fairness relates to ability to pay and making reasonable demands on these individuals; that individuals feel that they are not being asked to bear an excessive share of the burden. Certainty relates to the importance of understanding why and how specific taxes are levied and convenience and efficiency relate to ease of compliance, timing of taxes, costs of collection and minimising economic distortions. If a system has these characteristics, then it is thought to be a good and legitimate system. To us, this seems a reasonable basis for judging the quality of the tax system today.

All tax systems will distort behaviours to a greater or lesser extent, but it tends to be when the boundaries of perceived fairness have been pushed beyond a certain point that these distortions become more acute. A recent example of this was the introduction of a 50% additional income tax rate in 2010. This was felt by many to be a step too far and as advisers we experienced an increased appetite from clients to look at tax planning. Many taxpayers looked to accelerate income to a period before the increase took effect and others looked at the possibility of investing for capital gains rather than taking income. In a few cases, the more draconian step of leaving the UK altogether was taken, although in our experience not to the extent that was anticipated by opponents of the tax rises. Of course, everyone has their limit. As it turned out, these rises did not raise material revenue, in part because of the distortions discussed above, and the rate returned within three years to 45%, which it appears is probably just the right side of the line. Lessons should be learnt from this when considering whether to move CGT rates closer or equal to income tax.

Although a good system of taxation should require minimal policing, it is clear that there will always be those who do not pay their fair share. This requires resources to bring delinquents to heel. Although HMRC devotes increasing resources to catching evaders, it has been helped by the growing societal abhorrence of tax evasion and some cases of aggressive tax avoidance. On occasions, the media has been instrumental in shining a light on cases of evasion or egregious avoidance and the outing of high profile individuals using tax havens or artificial structures to deliver single digit effective tax rates has definitely helped to ensure that reputational concerns impact appetite for tax planning in a way they may not have done a few years ago. This is a double-edged sword, however, as it has resulted in a blurring of the boundaries between sound tax planning and tax evasion (as to which, see the “ugly” section below).

On a more micro basis, there are a number of instances where taxation has been used effectively to encourage “good” behaviours. This is seen as an exception to the principle of avoiding economic distortions. An obvious example is the plastic bag tax. In the short period since its introduction, it is a relative rarity to see supermarket shoppers not having brought their own bags with them. In its clearly stated aim of reducing the number of single use plastic bags ending up in landfill, it must be seen as a success. Similar success has been seen in the context of the graduation of vehicle excise duty rates by reference to carbon dioxide emissions levels. This acts as a nudge to remind buyers of the relative environmental impact of the car which they are buying and, in some cases, might push the buyer to a cleaner car. The link between increasing alcohol and tobacco taxes is less clear cut, perhaps in part due to the habit forming nature of the substances but perhaps also as a result of the lack of transparency as to how much tax is being paid on a particular item. Is it too cynical to suggest that this might also be as a result of the significance of the contribution of these duties to the Exchequer (£8.8bn in 2019/20)?

The Bad

In difficult times, there will always be a case for tax rises to pay for increased public spending. Although these are never going to be popular, it is nevertheless important to ensure any rises pass Smith’s good taxation principles (see our article on tax rises to pay for Covid, here).

Getting these wrong can lead to excessive distortions of behaviour so, in our view, it is essential to analyse the behavioural risks. This will identify what the potential negative behavioural impacts may be and assess how likely they are. Does it require simple steps to avoid the consequences or more draconian measures? It is also important to balance this against the potential revenues that can be raised from a specific tax increase. The Laffer Curve is a well known illustration that tax rises do not necessarily result in increased tax take. It does not always appear that tax rises have been well thought through from this perspective, even if the rises were proposed with the best of intentions.

There also seems to be an increasing trend for “tax policy by opinion poll” where the Treasury appears to be briefing the press as to potential tax rises, and gauging public reaction before deciding to proceed with the change under consideration. On the face of it, there is something in this if the result is to build a consensus. However, more often it removes certainty (one of the key tenets of a good tax system) and causes knee-jerk reactions from taxpayers who feel forced into action they would not otherwise have taken, when in many cases the Government ultimately shelves the proposal.

The Ugly

Unfortunately, there are some behaviours which the tax system brings out that show the less flattering side of human nature.

Tax rises on ideological grounds are unlikely to meet the fairness test and are very likely to prove counterproductive. This is of no concern to the ideologue, but it should be of concern to taxpayers in general. It usually takes the form of an increased burden on the wealthy and high earners and runs the risk that it will drive this relatively small, but usually pretty mobile group, to up sticks or to engage in planning they might not otherwise have done. It also acts as a disincentive to potential inward investment and high earning immigrants coming to the UK. If this happens, the burden falls on those who remain.

In no way should it ever form part of deliberations as to tax rises/cuts or how this is likely to impact the political position of the party proposing them. Sadly, this has not always been the case and, if press reports are to be believed, it continues today.

Another unedifying behavioural trait is supporting tax rises if it is someone else who will have to pay them. A recent YouGov survey relating to the possibility of a wealth tax found that 61% were in favour of a blanket wealth tax, if property and pensions were excluded. There are a number of reasons why this might be the case, but it would be naïve to think that this was not in part down to people thinking they would not then need to pay it, ignoring that it would materially reduce the tax take and force the burden largely onto entrepreneurs with valuable illiquid shareholdings in so doing. The same could be said for the proposals in relation to equalising CGT and income tax rates.

As mentioned above, the mainstream media can and does play a valuable role in policing unacceptable behaviours in relation to tax. However, this can and does go too far with a seemingly wilful conflation of tax evasion and avoidance, revenues and profits. A recent headline in the Daily Mail proclaimed: “Netflix paid just £3.2m of corporation tax on £13.2m of profits”. The clear implication was that it was avoiding tax when the effective rate being paid was an entirely respectable 24%. Of course, it is legitimate to ask as to how this level of profit has been arrived at but no attempt was made to do so other than to imply spending large sums on original programming was a way of avoiding tax. It is unlikely in the extreme that such high profile companies are evading tax (see Andrew Parkes’ previous comments on Netflix here).

They may well have complex legal structures, and clearly operate globally, but it is the role of the legislator to use the tools in their armoury to counter this, not for the mainstream media to stoke up ill-informed outrage which is then amplified through social media.

Many of the usual suspects have experienced large share price growth and routinely use equity to reward their employees. They will have been entitled to a deduction for these gains (on which employees will have paid income tax, and the employer NIC) as a matter of course, without the need for aggressive tax planning. This doesn’t make a good story or clickbait, but it does help in destroying trust in large business which brings many benefits to the UK, including generating material tax revenues through income tax, NIC and VAT.

In summary 

The interaction of the tax system with human nature is extremely complex. It tends to bring out some of the best and some of the worst in behaviours. There are no easy answers. The number of competing agendas means that it will never be possible to please all of the people all of the time. However, when a theory has survived for almost 250 years, it’s usually because there is something in it. Perhaps all stakeholders should pause to consider this when framing their behaviours in relation to tax and ignore the rest of the noise.

If you would like to discuss any of the issues raised in the above article, please contact:

James Paull
Head of Incentives Group
M: +44 (0)7961 118 994 or
E: james.paull@uk.Andersen.com

The UK 

DAC6 – A Welcome Break

When most people were curled up in front of the TV after overeating Christmas leftovers, HMRC were proving that they can and do sterling work throughout the year, by giving most, if not all, UK advisers a very welcome present for the start of the New Year.

Member States of the EU have been helping each other with cross-border tax demands, service of notices and exchange of information since the 1970s but recently they have supercharged what they expect each country to exchange with each other, whether it is useful information or not.

The latest expansion was in respect of certain cross-border advice given to EU residents. If the advice fell within the requirements, known as “DAC6” (aptly named because it is obviously the 5th amendment to the Directive for Administrative Co-operation), then the adviser has to make a report to their tax authority, giving details such as what the advice was about and who it was given to.

DAC6 required details of transactions that were implemented on or after 25 June 2018 and although the date that the first reports had to be made had been delayed due to Covid, the fateful day was fast approaching – 30 January 2021!

However, for UK advisers, Brexit came to the rescue – not often you will see that phrase. With the UK’s withdrawal from the EU, it was no longer a party to the DAC and although the legislation already enacted by the UK was sufficient to allow HMRC to collect the information, it was not enough to allow HMRC to send it to the EU’s database, post Brexit. Plus, the EU would not allow HMRC access to any other countries’ information on the database.

Further, due to the volume of reports, it would be impossible for HMRC to use the usual exchange of information routes to send the information to other countries. Therefore, on 29 December 2020 regulations were made that reduced the scope of the UK’s domestic legislation to only cover the part of DAC6 that overlapped with the OECD’s Mandatory Disclosure Rules (MDR).  The UK DAC6 rules will eventually be replaced with ones specifically for the MDR. These rules cover the potentially more serious transactions within DAC6, those where a person is trying to hide their identity or their funds. Both are hallmarks of money laundering and areas where there will be sufficiently low enough numbers for HMRC’s Exchange of Information Team to deal with them on a bilateral basis.

The reason for the rejoicing is that the way the amendment to the regulations was done, it actually removed the need to make any disclosures under DAC6 for the other areas. These can now be quietly forgotten about, or some of them can. Before anyone gets the idea that advisers are celebrating some sort of reprieve for tax avoiders, it is worth pointing out that this is the removal of an extra unnecessary administrative burden. The UK’s DOTAS rules overlap with DAC6 and disclosures will still rightly be needed for avoidance schemes, where DOTAS is well understood and these disclosures can already be shared with other countries. Also, for DAC6, HMRC’s guidance is somewhat vague and unhelpful, although that does reflect the fact that the terms used in the DAC itself are themselves vague, undefined and open to different interpretation by different Member States, so any guidance is going to be difficult to write.

However, there is one category of advisers who may now be faced with a headache. Although with Brexit, UK advisers are no longer within the scope of the DAC their EU clients are, and under DAC6 the UK adviser’s responsibilities now fall on those clients if no EU adviser is involved. For example, if a UK firm has a client in, say, France and was originally going to make a report under DAC6, that responsibility now falls on their French client.

If you have any queries regarding the DAC or the UK’s ability to exchange information, please contact Andrew Parkes who was one of the UK’s Delegated Competent Authorities (and has the certificate to prove it):

Andrew Parkes
National Technical Director
M: +44 (0)7522 229 589 or
E: andrew.parkes@uk.Andersen.com

The US

LLC’s Again – Here But Not There

Since it was published, our article on US Limited Liability Companies (LLC) and the UK Supreme Court’s decision in Anson has led to a number of queries from both UK and US taxpayers who either are, or want to use a US LLC in their structures.

As a follow up to the article we thought we would outline some of the basics for the use of a US LLC, as it is not always “bad news”.

Seems like a good idea 

Probably the biggest advantage and often the reason for using a LLC, is that it is American. Like customers all over the world, Americans often like dealing with entities that are familiar and home grown. LLCs hit this spot, whereas a UK limited company, for example, may well put some potential customers off.

However, with a US entity you have to deal with the IRS, some of whose agents carry guns; always a sobering thought! This is not the case with a LLC, unless you “check the box” to make it taxable. Under US law, a LLC is either disregarded or a partnership depending on whether it has one or more members (shareholders to you and me). This means that if the LLC does not have an actual US business, it will not have to deal with the IRS at all. For example, if a business has no presence in the US, selling to US customers via a UK website and shipping the goods from the UK then it is highly likely that it will not have any sort of business that is subject to US Federal Taxes.

The UK though, still treats the LLC as a company allowing for profits to be reinvested, or held, after being charged at the lower corporation tax rate. It does have to register with Companies House, filing accounts even though the US legislation does not require them.

Maybe… 

Often though, a UK taxpayer is being asked to invest in a US business alongside US investors. This is where the problems start, unless  the LLC is just holding non-income producing assets (unlikely, we know) then it may not matter.

Imagine that the company has been set up to invest in US land, and the investors have got it right, buying in a downturn and, without doing anything to the land, it is now riding high. If our UK investor sells their investment in the LLC, the UK will treat them as selling “shares”, whereas the US will treat them as selling the land. The whole Anson saga was whether the UK and the US were taxing the same income and this looks similar. However, as ever with tax, the devil is in the detail and here the UK/US Double taxation agreement will treat the “two” assets as if they were one. Or rather, the OECD commentary to Article 23 requires the UK to give credit for the US tax as it is a conflict of qualification.

But perhaps not 

Back to the detail though, if the LLC sells the land whilst the UK investor retains their shares, then you may get real double taxation. Again, the US will see the investor as selling their share of the land, but the UK will see the LLC doing so. From a UK point of view, the UK taxpayer still owns their asset, the interest in the LLC, it is just now “backed” by cash held by the LLC and not the property.

This is the same problem with any income of the LLC. The US will see the UK investor as having earned the income, whilst the UK will see the LLC and HMRC will refuse double taxation relief in respect of any US tax when that income is distributed to the UK investor.

Anson to the rescue?

We would say not. Mr Anson won his case of course, but it was a finding of fact and the Supreme Court acknowledged that a different First Tier Tribunal could have found differently on the same facts. This, plus both the Upper Tier and the Court of Appeal finding for HMRC, means it is a shaky decision and you wouldn’t bet your house on a decision going your way.

Also, HMRC have been quite canny with how they have handled it. By stating that they will continue to treat LLCs as companies, they keep UK Plcs happy, given groups are likely to have significant problems if LLCs all disappeared in a puff of smoke.

However, by saying that they will consider each Anson claim on a case by case basis they get to pick their battle. If the LLC is a small one, based in Delaware (or somewhere with a LLC act very close to Delaware) and with an operating agreement close to the one in Anson, HMRC can “let it go” without really risking anything. Conversely, if there is enough money at stake, the LLC is in a State with very different law to Delaware and the operating agreement is also different, HMRC has the cover to launch Anson Round 2. If the First Tier is less sympathetic, say it is an avoidance scheme and not a real commercial situation as with Mr Anson, suddenly the score is 1-1.

In effect, the question then becomes the one Mr Clint Eastwood asks in one of his famous roles “Do I feel lucky?”

If you are thinking of investing in the US and have any queries regarding UK taxation, please contact Andrew Parkes or Miles Dean:

Andrew Parkes
National Technical Director
M: +44 (0)7522 229 589 or
E: andrew.parkes@uk.Andersen.com

Miles Dean
Head of International Tax
M: +44 (0)7785 770 431 or
E: miles.dean@uk.Andersen.com

The UK

IR35 and Personal Services Companies

One of the few positives from the Covid-19 pandemic is the focus that it has compelled businesses to take, with regards to establishing new ways of working. The overnight shift for many businesses to a remote working model, together with the necessity of managing the employee cost base as effectively as possible, has resulted in many businesses shifting to the use of temporary workers or consultants. The attractiveness of consultants has perhaps been boosted by the number of experienced professionals looking to work in this way. From a commercial perspective, the business case for using consultants has never been more compelling.

However, every silver lining has a cloud, and this particular cloud takes the form of the off-payroll working rules, which have applied to public sector bodies since April 2017 and after a short Covid related reprieve, will apply to medium sized and large businesses with effect from 6 April 2021.

Use of consultants 

There are a number of benefits to using consultants, some of which have been brought to the fore as a result of upheavals over the last 12-18 months. We’ve set out below just a few of the key benefits:

• the use of consultants means you get the right person for the job without having to train up an existing employee;

• consultants can bring fresh ideas to the business, based on experience in other organisations;

• consultants are typically flexible and can fit into the way your organisation works;

• they do not typically expect benefit packages;

• they are not subject to employment law rules, so can be let go in a cost effective way if the needs of the business change or the cultural fit is not right; and

• self-employed workers are not subject to payroll taxes, so there is lower administration as well as direct cost savings through not attracting employer NIC.

Tax considerations 

It is the last of these benefits that has meant that consultants have long been in the sights of HMRC. There is case law dating back to the 1960s considering the issue of when a worker should be treated as an employee for tax purposes and when they are truly self-employed. There has followed a raft of legislation under the general umbrella of “IR35” where the worker is engaged through an intermediary. Initially, the intermediary targeted was a personal service company (usually wholly owned by the employee or jointly with a spouse) although this has expanded to managed service companies and workers employed through agencies.

The key issue underpinning the operation of these rules remains the employed/self-employed distinction. There is no statutory test for this. There are a number of factors which operate to determine this relating to the contractual relationship between engager and worker and how the engagement operates in practice. Factors to consider include, control, bearing of financial risks, mutuality of obligations between engager and worker and the availability to use a substitute. It is necessary to consider these factors on a case by case basis and to keep them under review. A change in the way of operating could result in a change in the tax status of the arrangement.

Off-payroll working: April 2021

Initially, the IR35 rules operated to place the onus of any reporting on the intermediary. However, the off payroll working rules will, with effect from 6 April 2021, apply to medium sized and large businesses so that the responsibility for PAYE/NIC withholding (if any) will shift to them. For small businesses, the existing IR35 rules will continue to apply.

Whether a business is small is determined by reference to employee population, turnover and balance sheet. There are transitional rules for businesses ceasing to be or becoming small, which can delay the requirement to operate in accordance with the off payroll reporting rules. Careful attention should be paid to these to ensure that the reporting takes place at the right time.

How to navigate

Clearly the shift in the compliance burden to the end user means that there are increased risks of getting the analysis wrong. It is therefore important to make sure that not only are you comfortable that the contractual arrangements put your workers on the right side of the employed/self-employed line, but also the way in which the engagement is carried out.

It is equally important to check that this remains the case as the engagement progresses. Educating line managers as to what can and cannot be asked of workers is important to reduce these risks.

We recommend that businesses put in place a process to identify where contractors are being used, gathering information on how they are operating, analysing the nature of the engagement and documenting it, dealing with the contractor in relation to the determination (including if the contractor disagrees) and ongoing monitoring. HMRC has confirmed in its February 2021 compliance guidance that it will support businesses in becoming compliant and not seek to levy penalties in the first 12 months of the new regime, save in the case of deliberate non-compliance.

HMRC has put together an online tool called Check Employment Status for Tax (“CEST”) which asks a number of questions about the arrangement and gives a view on the status of the relationship for tax purposes. HMRC has confirmed that it will stand by a CEST determination as self-employed if the questions have been answered accurately and continue to subsist. However, there is a concern that the tool reflects HMRC’s interpretation and may be more employment biased than case law (albeit that the vast majority of cases have, when put through CEST, generated the same result).

It may be tempting to decide that the use of contractors now sits in the “too difficult” box and so any new engagements take the form of employment contracts. There are certainly a number of organisations that are taking that view, but before doing so, we recommend analysing whether there are any ways the existing or future contractor arrangements can be modified to fall on the right side of the line, once the new regime comes into force. There are material benefits on offer and giving some thought to addressing the risks could allow these benefits to be accessed at relatively little cost.

Other tax issues for PSCs

Workers operating through PSCs should not assume that IR35 is the start and end of their considerations relating to tax. Although these rules will be front and centre of concerns, there are other pitfalls which can befall PSCs, such as potential application of the settlement provisions or disguised remuneration rules. Particular care is needed where ownership of the PSC is shared with a spouse or other family members.

Conclusions

For the right circumstances, there remain a lot of benefits to operating with consultants, including significant potential costs savings. It would be a shame if, at a time when these benefits are needed more than ever, over prudence meant that some or all of these potential savings were left on the table.

If you would like to discuss any of the issues raised in the above article, please contact:

James Paull
Head of Incentives Group
M: +44 (0)7961 118 994 or
E: james.paull@uk.Andersen.com