Trust in me

Without mutual trust, how can the tax gap close? ALLISON PLAGER reports from the 2005 Hardman lecture.

LONG TERM,THE tax gap will widen unless there is greater trust than presently exists between tax collector and taxpayer', said Loughlin Hickey, global managing partner for tax, KPMG in his Hardman memorial lecture for the Tax Faculty of the ICAEW on 17 November 2005.
The lack of trust is prevalent, said Loughlin, i.e. 'in the tone of the public debate on tax avoidance and in meetings with taxpayers — increasingly suspicious of HMRC initiatives ranging from new legislation, HMRC membership of the Joint International Tax Shelter Information Centre and the Tax on the Boardroom Agenda initiative'. He said in meetings with HMRC and Treasury, officials are 'frustrated with the planning they see and attitudes of taxpayers and their advisers towards the problems of what they see as a funding gap and a challenge to the tax system'.
For the gap to be closed, 'there needs to be a collective acknowledgement of the problem and collective will to change behaviours'. Loughlin included advisers in all their guises, that is professional firms, but also advisers to the Government, as having a part to play in this also.

Well intentioned

'Fundamentally', Loughlin believes that people are well intentioned. But he said that people ignored or made to feel untrustworthy do not trust others.
He referred to a paper 'The Philosophy of Tax' issued in early 2005 which looks at the interaction between taxpayer and tax gatherer. The paper found that:

• if taxpayers do think the Government is not responsive to their wishes, they may attempt to evade their taxes;
• if taxpayers do not trust the Government, they are unlikely to comply voluntarily with the law;
• people are more willing to pay their taxes where they believe the tax law is fair;
• the greater the involvement in making the law, the greater the level of compliance.

Loughlin went on to discuss the tax gap. He took HMRC's position as a starting point, namely that 'the tax gap is the difference between what ought to be paid by taxpayers given a certain level of economic activity versus what is collected'. The issue of parliamentary intent was also mooted. Taking the legalistic view, Loughlin quoted Lord Hoffmann who asked 'how do we know the intention of Parliament? There is only one way to know the intentions of Parliament and that is to read the statute. So avoidance of tax assumes that you are not paying tax which, on a fair reading of the statute, you ought to have paid. But why in this case are you not liable to pay it? How can the courts give the statute a construction which means that people do not pay the tax which the statute shows that Parliament intended them to pay? The lesson, in my opinion, is that tax avoidance in the sense of transactions successfully structured to avoid a tax which Parliament intended to impose should be a contradiction in terms. The only way in which Parliament can express an intention to impose a tax is by a statute which means that such a tax is to be imposed. If that is what Parliament means, the courts should be trusted to give effect to its intention. Any other approach will lead us into dangerous and unpredictable territory'.

Democratic intent

On the other hand, Loughlin said that some HMRC officials say that by approving an income and expenditure budget, the democratically elected Parliament expresses a view on both the spending plans that are necessary for the good of a nation but also the tax revenues that they expect the nation to contribute.
As to the causes of the gap on the tax collection side, Loughlin put forward late collection, undetected or uncorrected error, tax avoidance, or tax evasion or fraud. In addition, policy failure had to be considered. He said that 'this is policy failure in the sense of not adequately anticipating taxpayer responses, for example if a change provokes businesses to withdraw or relocate or undertake transactions elsewhere, thereby reducing tax revenues'.

Trust formula

Turning to the trust gap, Loughlin took the model explained in the book The Trusted Adviser by David Maister, Charles Green and Robert Galford. This book introduced the concept of the trust equation:

Trustworthiness =  Credibility + Reliability + Intimacy
                                             Self-orientation

He interpreted credibility as meaning accuracy and completeness. This means not only the facts given or the question asked but also the context of the answer or question. Reliability meant promises followed by action, and intimacy the ability and openness to understand and acknowledge the impact of actions on another person. Thus the relationship has to be sound enough 'to empathise but be tough without destroying mutual respect and the relationship'.
Finally, self orientation could be interpreted as the motivation for action, e.g. for the tax collector this would be the obligation to administer the law fairly and for the corporate taxpayer the aim of overall corporate reputation rather than personal benefit.
Loughlin acknowledged that this was subjective, but said that it recognised 'that trust is a two way process and requires candour, personal risk and clarity on motivation for actions undertaken'. In effect, the 'trust gap could be measured as the difference between the trustworthiness of tax collector and taxpayer' and 'to close the gap requires effort and understanding on both sides'. However, 'it would also be aided by greater clarity of the overall direction of tax policy, for example in terms of promoting UK competitiveness and how the law and indeed the legislative process contributed to this'. 
Advisers have an important role. The Treasury tax policy team is important because it sets strategic policy direction and is also able to be concerned about the wider relationships between Government and business in setting a competitive landscape for the UK. Professional advisers representing taxpayers should 'adhere to the same high standards of trustworthiness that is to be expected of taxpayers'.
Overall, Loughlin said that it is necessary 'to focus on the tax gap because Governments need a sustainable revenue stream to fund spending plans approved by Parliament'. However, actions taken to deal with the tax gap could 'increase or diminish the trust gap', and equally, the trust gap influences the effectiveness of those actions.
Loughlin said that there was 'genuine concern within HMRC and Government that it is unfair if the tax burden is not seen to be fairly shared and the tax system could be undermined if the perceived unfairness continues unchecked'. But he tempered this saying that corporate taxpayers were also genuinely concerned that 'complexity and uncertainty will harm the UK as a base for investment and the tax system could be undermined by increased discretionary application of the law by the tax authorities'. He also noted that examples of bad behaviour could be found across the board, i.e. among taxpayers, tax collectors and tax advisers.

Optimistic

Despite the newness of HMRC and the Treasury tax policy team, the 'political pressure to demonstrate sound public finances', and the competition between countries competing for their share of international tax revenues and investment, Loughlin believes it is possible to move forward.
However, in order to progress, 'the assumptions around the make up of the tax gap need to be fully explained and understood to challenge efficient resource allocation'. Business people should be taken on as non-executives of the tax policy arm of the Treasury. A voluntary code of conduct relating to the behaviour of all parties concerned with the operation of tax should be devised and a forum for training together those in the public and private sectors where technical and business skills and ethics could be taught.
Loughlin said that a series of actions needed to be taken to 'appreciate and close both gaps' simultaneously. The tax gap could be closed by 'reducing the level of economic activity in the UK and ignoring the trust gap', but this could have long term impact, particularly if the trust gap widened. Likewise, closing the trust gap without treating the tax gap was not credible 'because the success of the trusted relationship will be measured by an efficient, effective and responsive tax system which provides a predictable share of funding for necessary public spending and attracts and retains wealth creating investment'.

Ground level

It is impossible to fault the theory that if there is more mutual trust between those on either side of the tax fence, taxpayers would be more inclined to ensure that they paid the correct tax on time. However, the reality is that this is unlikely to happen. There are two hurdles: human nature and money.
How can one overcome the deep suspicion with which some taxpayers and tax advisers regard tax Officers? At the basest level, it is inevitable that if a taxpayer has a bad experience at the hands of a particular HMRC Officer, that taxpayer will not look fondly at HMRC as a whole. Similarly, an HMRC Officer who finds that a particular tax adviser constantly makes errors in his clients' affairs, is likely to regard that adviser as unreliable and will not trust the information submitted by him. This is human nature.
An enquiry into a taxpayer's self-assessment tax return is not likely to generate much trust, because by definition it implies to the taxpayer that HMRC does not trust him to have completed his form properly. The problem is that a self-assessment system has to have checks, if only because taxpayers are human and can make mistakes. Furthermore, Parliament has entrusted HMRC to ensure that the correct amount of tax is assessed and collected. In the face of this trust, HMRC have to show themselves to deal with taxpayers in an equitable way, particularly perhaps when carrying out random enquiries, since in such cases there is no guarantee that hidden income is at stake. It could almost be equated to the random till checks in the supermarket when customers do their own scanning. It is quite an inconvenience to have to have a re-scan, but it is in customers' interests to check that the system is not being taken advantage of.
However, the tax system has become very complex, as for instance is reflected in the tax forms. As Loughlin said in response to a question, forms should explain clearly what they are trying to achieve, but for this to happen they would have to be even longer than they are already.

Who to trust first

Until HMRC stop writing to their 'customers' with unexplained demands for £100 and threats of legal action if immediate payment does not ensue, taxpayers are not going to feel well disposed towards the department. People who receive such demands see certain long-term residents seeming to get away with paying virtually no tax because no Government has the political will to tackle the issue of domicile. How can trust be cemented if most taxpayers who have no choice but to pay their 'fair' (favoured word of the current Government) share of tax through the PAYE system, see hugely wealthy, visible individuals pay virtually nothing?
Non-corporate distributions are another example. The Government introduced the zero rate of corporation tax on the first slice of income, despite advice from professional bodies as to the effect this would have. When the self employed did incorporate, the non-corporate distribution charge was created to temper this 'avoidance'.
Ultimately, the public's trust must be gained before Government can really expect trust to be placed in it. The public have a right to expect fair treatment, if only because it pays the Government's and HMRC's salaries. Constant tinkering with the legislation means that people do not know where they stand; just as descriptions of taxpayers as customers from a department which seems to know very little about customer service do nothing to engender trust.
 

Issue: 4036 / Categories: Comment & Analysis