Tax Avoidance Schemes – The Ugly Face of Creative Accounting

1. Tax Avoidance Schemes – The Ugly Face of Creative Accounting

a. How it works. “Itsascam” strips £40million from it’s staffing costs budget and donates the sum to a trust, registered in Jersey, called, “Itsmyturn”. The entire payment is tax-deductible. “Itsmyturn” transfers the £40million to another Jersey registered but British tax-resident company called, “Menowok”. “Menowok” purchases £40million shares in, “Imherenow”. “Imherenow”, in late March each year awards non-recurring shares, to the value of £40million to employees of, “Itsascam”. The shares earn instant dividends equating to the outstanding salary and/or bonuses due.

b. Dividend income attracts tax at 25% providing a 15% reduction in the top rate of tax due (25% if the top rate of tax is increased by labour government) for each employee. On £40million HMRC loses £6million. “Itsascam” also makes a £6million saving through the tax deductable donation to the “itsmyturn” Trust. Total loss of tax due to HMRC £12million each year. It is thought there may be at least 6000 companies in the UK operating tax avoidance schemes similar to the foregoing. Total tax loss to HMRC, £70-90billion.

2. Tax Avoidance – The PA Holdings Tax Avoidance Bonus Scheme (Private Eye Edition 1240 Expose)

a. Michael O’Higgins was appointed to one of the most senior positions guarding taxpayers’ money in 2006 after 10 years as managing partner at the management consultancy, PA

Consulting. He ran the public services, which earns a fortune advising on everything from health services to ID cards.

b. In 1999 his firm received a call from Bill Field, a tax avoidance specialist with accountancy firm Ernst & Young who had a cunning plan for all PA staff to dodge tax on their substantial annual bonuses. The call would lead to an intricate tax avoidance scheme that has only now been exposed in a tax tribunal.

c. “The proposal,” explained the tribunal, “was to re-route bonuses awarded to employees so that they were paid as dividends” (which would be taxed more lightly). But the greedy tax dodgers also wanted the payments tax deductible for PA Holdings Ltd so they would slash its tax bill too, which ruled out simply paying dividends from the company.

d. Field came up with a ruse to pull off a double whammy. At the end of 1999, PA made a tax-deductible payment of £24m to a Jersey trust, Mourant, which then handed the money to a Jersey-registered but British tax-resident company called Ellastone Ltd. In return Mourant took shares in Ellastone; and in March 2000 awarded them to deserving PA employees who immediately became entitled to dividends that happily equated to their bonuses. The wheeze earned Ernst & Young a tidy £355,000, plus unspecified further payments when the scheme was repeated in the following two years.

e. HMRC insisted that for all the scheme’s cleverness, the payments to PA staff should still have been subject to PAYE like any other bonuses. As HM Revenue & Customs’ QC Malcolm Gammie put it:

“Assume that North, East, South and West enter a room and sit at a table. North (the employer) holds cash that he has already said he will share (as an annual bonus) with West (his employee). The common understanding and intention of all concerned is that North will hand the cash to East, East will hand the cash to South and South will hand the cash to West. If the question is asked, has North paid West his annual cash bonus, the answer is quite clearly yes … The answer does not change just because North produces a pack of cards so that the cash can pass from North to East to South to West under the cover of a card game … This was effectively the ‘game’ that was played by the Appellant (North), the Trustees (East), Ellastone (South) and employees (West).”

f. Alas, the tribunal did not agree, allowing the PA consultants to avoid tax on the strict letter of the law. O’Higgins admitted that his own bonuses, much of them earned from the taxpayer in the first place, had been funnelled through the scheme. Over three years the sum runs into millions. And that is not the limit of his raid on the public purse that he now protects.

g. While O’Higgins was a managing partner, the tribunal found that “PA went out of its way to ‘sell’ the arrangements to employees”. He would also sit on the board of the company behind the scheme, PA Holdings Ltd, for two years while it disputed it with HMRC.

h. All of which sits a little oddly with O’Higgins’ other taxpayer-funded job as non-executive director of the Treasury, “shaping the vision, strategy and priority” of that department – which perhaps ought not to include big-time tax avoidance.

i. HMRC appealed the ruling and the matter was the subject of a ping-pong tussle lasting over 12 years.

3. Court Case Lifts Lid on Tax Avoidance in Bonus Scheme

a. Lord Justice Moses, hearing the last of many appeals ruled, “PA Consulting decided that its employees should receive a bonus, the trustees identified which of the employees, from the list provided by PA Consulting, should receive a bonus and those employees received a bonus. That was the beginning and end of the matter. It is, in my view, the beginning and end of these appeals”.

b. The case before the Appeal Court concerned PA Holdings (PA), a UK-based international management consultancy company. In the late 1990s, the company wished to pay its employees discretionary annual bonuses. It adopted arrangements whereby the employees who would have been paid bonuses were instead awarded shares in a specially created company and received dividends. It argued that the cash the employees received was dividend income that was subject to the dividend tax rates and not to the basic or higher rates of income tax. It also contended there was no liability to national insurance contributions (NICs) in respect of these payments. HMRC disagreed with that analysis.

c. The Court of Appeal decision on the income tax avoidance scheme that paid bonuses to employees in the form of share dividends holds implications for tax planning strategies, and could result in HM Revenue & Customs (HMRC) and the Treasury renewing their efforts to crack down on such schemes.

d, Although this case concerned an aggressive NIC and income tax avoidance scheme, there are implications for more mainstream tax planning strategies. The recharacterisation of dividend income as employment income could affect individuals using service companies to avoid NIC.

4. Summary

a. All political parties are well aware of the urgent need to reduce the annual UK financial deficit and this is reflected in recent conference statements. The Labour Party seems intent on soaking the rich, just a little whilst the Tory’s would squeeze the poorer members of society. Removing the attractiveness of the many tax avoidance schemes would eliminate any need to add further austerity measures to those presently in place.


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