The UK presents a tax conundrum. Our tax system and legislation is the longest in the world, standing at 10 million words spread over 22,000 pages. That’s the equivalent of more than 60 copies of Dan Brown’s the Da Vinci Code back-to-back. Unfortunately, this isn’t necessarily an indication of a robustness either. 

Instead of our tax laws being rewritten, they are formulated through a series of updates following annual budget announcements by the Chancellor of the Exchequer. Consequently, much like the laws of this country, there is potential for a high level of bureaucracy which is not only time consuming to navigate, but also extremely complicated, and it can also lead to loopholes. 

This presents a problem not just for business owners who don’t necessarily specialise in tax, but also poses challenges for accountants and tax advisors, and even HMRC who are supposed to be the authority on this matter. 

Few, if any, tax advisors can truthfully say they know every page of tax legislation. Being so big means it’s in all likelihood, an impossible task for any individual. Furthermore, being so complicated makes it very challenging for HMRC to enforce collection. The complexities can, and often do, lead to mistakes, which can cost SME business owners a lot in terms of time and money. 

Chris Thompson, Partner at Wellers, explores the complexities of the UK taxation and what should be done to simplify the system to benefit SME business owners.

How the system is exploited by multi-nationals

Being so large and complex means the UK tax system is potentially open to abuse. The more rules you have means the more loopholes for clever tax advisors take advantage of and reduce the tax liability of large corporates. They do this by exploiting avenues of legislation to pay the least amount of tax possible in a manner the government potentially never intended. This is known as tax avoidance. 

As an example, many companies such as Starbucks, Google, and eBay (to name just a few) have, over the years, managed to pay very little tax relative to their vast quantities of sales. They have achieved this by declaring low profits to reduce their corporate tax liability. This is accomplished through a combination of strategies that makes use of their presence in multiple countries. 

In essence, corporation tax is paid on the profits generated in the UK. This means for tax purposes each country is treated separately and that is something some tax advisors utilise. To reduce their UK taxable profits, they increase their costs through strategies such as:

1. Funding UK based operations from overseas head offices through loans. This is, in effect, borrowing money from a company in the group. Consequently, it requires interest payments back to the head offices, with the rate of interest set by the controlling entity. These inter-company interest charges then help absorb some of the profits made in the UK.  

2. Some businesses create franchises and base their royalty and licensing agreements in a low tax jurisdiction. This allows them to charge operations based in the UK for use of their brand. It may be charged as a percentage of sales thereby shrinking earnings. 

3. Historical losses, that raked up when they originally set up operations in the UK, are carried forward for tax purposes. These are then used against subsequent profits to help reduce their tax liability.       

These strategies play the international tax system to ensure that these very large international groups shift profits in order to pay corporation tax in the jurisdiction with the lowest rate. Multi-nationals have the resources to pay for this tax advice. However, individuals and SMEs don’t by and large. The result being they pay more on a proportional basis meaning there is inequality as a consequence of the tax system.   

How to reform UK taxation 

Global tax reforms agreed by 130 countries in the Summer of 2021 are looking to introduce a minimum global profit tax rate of 15% and tax profits based on the place of sale, not the place of residence. For individuals and SMEs, a solution could be to simplify, and potentially, rewrite the book. If you look at how tax in the UK compares to other regions such as Hong Kong, you would be shocked. 

As cited by financial writer, Dominic Frisby, in his book, Daylight Robbery, in Hong Kong the highest rate of income tax is just 17%. There is no capital gains tax, no inheritance tax, no tax on dividends, and no VAT. The rate of corporation tax is also lower than ours, at just 16.5%. Despite this, Hongkongers are almost 25% better off than Brits when GDP per capita is adjusted by purchasing power parity. What’s even more impressive, is its entire tax book is just 350 pages long. That isn’t even as long as one copy of Dan Brown’s the Da Vinci Code. 

Conclusions 

Over the years, Governments and politicians have added layer upon layer to the tax book as they sought to close loopholes to existing and new tax legislation. To counteract some of this, tax reliefs and allowances have also been brought in. On top of this, VAT, capital gains tax, inheritance tax, national insurance, and the taxation of pensions have become incredibly convoluted and difficult to understand. 

The complexity of UK taxation has been recognised in part, and in 2010 an Office of Tax Simplification was introduced to offer independent advice to the Treasury to make things easier to understand. However, there has been little change in the 11 years since.  

Given the evidence, it is impossible to see how adding more layers to an already overly complex set of laws, is only going to make the situation better. Quite the opposite, it will become even harder to understand. 

Depending on how it is done, an overhaul of the current system would not only make it easier for accountants to make sense of, but it also means business owners and entrepreneurs can be confident of their tax profile and not getting their liability wrong. HMRC’s job could be easier too and that in turn could improve the tax take and reduce the tax gap.

In the meantime, it is important that business owners and entrepreneurs work closely with their accountant to ensure that their finances accurate so as to prevent mistakes which could lead to costly fines.