“The Thickness of a Prison Wall” – the difference between tax planning, tax avoidance, and tax evasion
By James Bailey, July 2006

This article is an extract from James' new book, "Tax Secrets for Property Developers & Renovators", available from the Property Tax Portal

 

The quotation in the title comes from the ex Chancellor of the Exchequer, Dennis Healey, when he was asked the difference between tax avoidance and tax evasion.

 

Taxation has rather murky origins – as far as I am concerned, it began when a party of Norman soldiers rode into an English village, and stole all the chickens. I suppose one of the earliest examples of tax planning (or perhaps tax avoidance, depending on your point of view) would have been hiding some of your chickens when you heard the approaching hoofbeats.

 

As things got more sophisticated, both the way taxes were charged and the ways they were avoided became more complicated. You can still see the bricked-up windows on old houses (done to avoid the 18th century Window Tax). I have also heard it suggested that the first Lurchers (delightful dogs, a cross between a Greyhound and a pastoral breed such as a Border Collie) were bred to avoid the “luxury tax” on Greyhounds – in 1823, for example, the annual tax on a Greyhound was £1, whereas for any other breed of dog, it was only 8 shillings (40p).

 

If we fast forward to the present, the way the law now stands on trying to reduce your tax bill works like this:

 

Tax Planning and the Duke’s Gardener

In 1935, the House of Lords gave their judgement in the case of the Duke of Westminster, who had set up a tax planning scheme involving his gardener (and other employees) and a Deed of Covenant – the details do not matter, as sadly that particular scheme no longer works. Their lordships said the Duke’s scheme successfully reduced his tax bill, and added that

 

“Every man is entitled if he can to order his affairs so that the tax attaching under the appropriate Acts is less than it otherwise would be”

 

This remains true today, though there have been developments since which have chipped away at this principle.

 

Anti-avoidance legislation

 

One of the reasons that the specific scheme used by the Duke of Westminster no longer works is that legislation was passed to prevent it from doing so in future. For many years, this was the only way that the Government could counter tax avoidance schemes – by identifying how a specific scheme worked, and passing legislation to ensure it was no longer effective.

 

One of the problems with this approach (from HMRC’s point of view) is that it is usually a couple of years or so behind the times, and by the time the law is on the statute book, a way round it has been invented.

 

The other problem (from the taxpayer’s point of view, this time) is that the anti-avoidance legislation can catch quite innocent transactions, or can apply in circumstances where the average taxpayer is simply unaware that the law exists, much less that it applies to him!

 

Here are just two of many examples of this:

 

  • The “Construction Industry Scheme” which requires property developers to deduct tax from certain payments to tradesmen, and keep records of payments to others
  • Section 776 ICTA 1988, which can turn what you thought was going to be a small capital gains tax bill into a large income tax bill

 

 

The “Ramsay” doctrine

 

Since the early 1980s, the Courts have developed a new way of interpreting tax legislation (the name comes from one of the earliest cases on the subject, and has nothing to do with bad-tempered TV Chefs). The Ramsay doctrine says that:

 

If a tax planning scheme involves a series of preordained steps, and one or more of those steps has no commercial purpose except to avoid tax, then that step can be ignored, and you look at the commercial reality of the transaction rather than the form it has been given by the scheme.

 

I live in Devon. If I find myself in Saltash (in Cornwall), and I want to drive to Plymouth (in Devon), I have a choice – I can drive there directly, over the Tamar Bridge, and pay a Toll of £1, or I can drive up the river to Gunnislake, and cross at a smaller bridge for nothing. If this were a tax planning scheme, and I drove to Gunnislake to avoid the Tamar Toll (and for no other reason), then HMRC could argue that the detour via Gunnislake should be ignored under the Ramsay doctrine, and I should still pay the £1.

 

This way of looking at the law came about as a result of a number of highly artificial and complex schemes to avoid tax that were being marketed at the time.

 

The Ramsay doctrine is still evolving, and it is something that cannot be ignored when considering tax planning ideas.

 

The Disclosure Rules

 

In the last few years, legislation has been passed which requires those who market certain types of complex tax avoidance schemes to disclose the details to HMRC. Anyone who then uses one of these schemes has to disclose the fact in their tax return. There are severe penalties for failure to comply with these rules.

 

This requirement to disclose such schemes has two consequences for those who decide to use them:

 

  • They can be sure that HMRC will look very closely at the scheme to see if it is technically correct, and if it is not, they will have the names of everyone who is using the scheme
  • Even if the scheme works, it is likely that legislation (sometimes retrospective) will be introduced to block the scheme – there were several examples of such legislation in the 2006 Finance Bill.

 

Tax Evasion – the other side of the prison wall!

 

Tax planning and tax avoidance are both entirely legal. Tax evasion is a criminal offence. Tax evasion always involves dishonesty in some form or other.

 

For example:

 

  • In the days of the window tax, some houses were built with “dummy” windows made of bricks, or the windows in existing houses were removed and bricked up – the tax only applied to glass windows. That was tax planning.
  • In other cases, houses were designed with one very large window where previously there might have been two or more small ones. That was tax avoidance. I remember being told of a case (though I cannot find the reference to it) where an entire course of bricks made of glass linked all the windows on one wall of a house, and it was claimed they were all one window for the purposes of the tax. The tax commissioners refused to accept this argument and the tax had to be paid. That was tax avoidance, though unsuccessful.
  • Some people bricked up their windows only when the “Surveyor” from the Inland Revenue was due to inspect the property. There was no mortar holding the bricks in place, and they were removed after the Surveyor had gone, to reveal the glass window behind. That was tax evasion, and if you were caught doing it, your window tax was doubled!

 

Tax evasion is not confined to the “black economy” where payment is in cash and the taxman is never told about it.

 

 It is likely that any “tax planning” scheme that relies on HMRC not knowing the full facts about a transaction is in fact an example of tax evasion.

This article was first printed in Tax Insider in July 2006.

 
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