Evasion and Avoidance

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27 June, 2012

Following up on my recent comments on piracy, recent news reports have forced me to learn the subtle difference between "tax evasion" and "tax avoidance". Apparently "evasion" is when you don't pay the taxes you're required by law. "Avoidance" is when you don't pay the taxes you're required by law, but structure your property or income in such a way that you don't pay (much) tax. It sounds like a pretty clear distinction, but the application can be dubious.

The Times recently reported on a widely used scheme that is so banal, so transparent, that one can hardly see it as representing anything other than a fig leaf to cover the authorities' wish not to to tax the wealthy and powerful. The way it works is, extremely wealthy individual X doesn't like his salary from company Y being taxed by government G, as though he were just an ordinary citizen. So he comes to an agreement with Y that they will stop paying him a salary, and instead pay an offshore shell company K2 for his services. So far so good. Y now pays no tax, because he has no income, but for obvious reasons this is not entirely satisfactory. Poor Y, who is now starving in a garret with no visible means of support, appeals to the good will of K2 (which has made such a great profit from Y's tax aversion) for a loan. They're a soft touch, and they loan him essentially all the money they've earned on his case, telling him, "Pay us back when you can." He never pays it back, but they never lose hope. Loans are not taxable, of course, unless they are written off.

Of course, one key part of this scheme is that the shell company is based in Jersey, confirming the fundamentally corrosive effect of these tax havens. But then, this only underlines the point I made above: these fake sovereign entities exist merely to hide governments' reluctance to tax the wealthy and powerful behind a veil of secrecy impenetrable to irritating democratic institutions.

The prime minister has attacked a popular comedian who has benefited from this scheme, but only as "morally wrong" suggesting that it was legal albeit unsavoury. Nearly all of the news reports I have seen describe this scheme as legal. This is a ridiculous advance capitulation in the propaganda war. Of course this scheme isn't legal. It's not legal to take salary and pretend that it's a loan. Even if you can structure it to make it look like a loan, there is still mens rea. As an analogy, I could announce my willingness to forgo a £50,000 salary from my employer, and my employer could choose to express its gratitude for my generosity by giving me a cash gift of £50,000. Gifts are not taxable, so I've benefited there. Lucky me! Of course, this is so easy that there are rules in place determining who is deemed to be a reasonable recipient of a gift. But even if there were no rule, because no one had yet thought of this dodge, my action would not be legal. A gift is defined by the intention of the giver, and my employer did not have that intention. Many crimes are defined by the state of mind of the perpetrator.

When they say these schemes are legal, what people really mean is that demonstrating that they are illegal in any individual case would be difficult or impossible. That makes it sound like the proverbial "perfect murder" of detective fiction. (Imagine a detective novel for accountants where the crime is tax evasion rather than murder. The novel could be written entirely in the form of spreadsheets.) Poisoning someone doesn't become legal just because you are able to stage it to look like an accident or suicide; and nonpayment of income tax doesn't become legal because you've staged your salary to look like a loan.

The Guardian quotes a salesman of the K2 scheme saying "he believed it would take tax inspectors years before they put a rule in place to block the scheme, according to the Times. "We expect the process to take at least three years to get a proper ... rule in place. We say 'make hay while the sun shines'." Again, it's not clear why a rule needs to be in place.

In part, this is just pointing out how the game is rigged by constraining the resources of the tax authorities. Clearly hiring more (and cleverer) tax inspectors would bring in more money than they would cost. The current staffing levels are determined in part by the wish to preserve the impunity of the very wealthy, but also made politically palatable by perverse notions of fair play. I've noticed this as well in people's discussions of traffic law enforcement: It strikes people as unfair for the police to apply clever tactics to catch and fine speeders, and doubly unfair if the local government seems to be profiting from the enforcement.

This being Britain, there is a party political side to it. Apparently, Cameron came under pressure to also condemn a popular singer who participated in a similar tax (avoidance/evasion) scheme, but happens to be a staunch Tory supporter (recently awarded an OBE). According to the Guardian, "Privately, senior Tories are concerned that Cameron's comments on Carr were a tactical mistake because they gave journalists a green light to investigate the tax affairs of Conservative ministers, MPs and donors." (Why do journalists need to be given a green light? Surely they're capable of acting on their own initiative...) And then there's the embarrassing fact that Cameron père (aka Ian) earned his substantial fortune designing tax avoidance schemes.

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