15 May 2015
PwC was accused of mass tax avoidance promotion but the line between avoidance and evasion is difficult to define
Earlier this year, the House of Commons Public Accounts Committee (PAC) decided that PwC had engaged in promoting tax avoidance schemes for its clients.
The verdict of the politicians was clear: it was ‘promotion of tax avoidance on an industrial scale.’ Margaret Hodge, Chair of the PAC believed that PwC’s earlier comments that it did not ‘mass-market tax products’ was ‘misleading’. These are damning comments from a House of Commons Committee and even more so for a leading global professional services firm. There are, however, questions surrounding why the PAC chose to single out PwC for such criticism and whether PwC had actually done anything wrong, other than legally minimise tax liabilities for its clients.
The issue of tax avoidance is currently receiving substantial public scrutiny in many countries from politicians, governments and the media. For many decades, tax avoidance operated quietly in the shadows and away from the glare of publicity. This is no more: tax avoidance by companies now receives widespread attention. Tax avoidance is based on legally minimising tax liabilities by adopting various forms of tax planning strategies. In contrast, tax evasion is illegal and is intentionally not paying tax when there is a clear legal requirement to do so.
Often however, the dividing line between avoidance and evasion can be difficult to define. In fact, the cynical view is that the difference between avoidance and evasion is only the thickness of a prison cell wall. It is not just the legalities of tax minimising schemes that is exercising the politicians’ minds. Even legal tax avoidance planning is now increasingly being subject to investigation – especially the ethical basis of adopting schemes that are deemed as being at the more aggressive end of the tax management spectrum.
Earlier this year, the PAC’s anger was aimed at large accountancy firms who advise multinational companies ‘on complex strategies and contrived structures which do not reflect the substance of their businesses and are instead designed to avoid tax.’ However, as a result of leaked documentation of tax advice to its clients, the PAC particularly sought evidence from PwC. The PAC was concerned that some of the tax schemes PwC designed for its clients were allegedly based on ‘artificially diverting profits to Luxembourg through intra-company loans’. This was the practice the PAC regarded as ‘promoting tax avoidance on an industrial scale.’
Margaret Hodge’s recent anger with PwC can be traced back to a 2013 PAC report. At this time, PwC’s head of tax informed the Committee that ‘we are not in the business of selling [tax avoidance] schemes’. Last year however, journalists obtained documents showing that PwC had been actively involved in negotiating advance tax rulings for ‘many hundreds’ of companies with the Luxemburg authorities. Pointing to the evidence arising from these overseas tax avoidance schemes, the PAC recently concluded that these tax schemes by PwC displayed all the ‘characteristics of a mass-marketed tax avoidance scheme’. Even more damning for the accountants, the PAC stated that the earlier PwC comments that it did not mass-market, produce or promote tax products were ‘misleading.’
More generally, and as a warning to other firms of accountants, the PAC warned that the tax industry has demonstrated that it ‘cannot be trusted to regulate itself.’ The Committee members accepted PwC acted in line with its own internal code of conduct but then warned that the code does ‘little more than shroud the way PwC exploits flaws in international tax law.’
The PAC’s 2013 report highlighted the worrying extent of the role large accountancy firms play in tax avoidance. The Big Four accounting firms generate annually over £2 billion of income and employ over 9,000 staff on tax planning in the UK alone. The global reach of these large firms however is even more cash generative, exceeding $25 billion from worldwide clients. At the time, the Big Four firms informed the Committee that they no longer sold ‘the type of very aggressive avoidance schemes’ that they sold over a decade ago.
More recently however, the PAC believes that the accounting firms now seem to have been advising on other forms of tax avoidance for clients. This includes designing complex business operating models across different countries which allow companies to exploit the lowest international rates of taxation. The PAC found that even though the Big Four firms have their own internal guidelines ‘on where the line between tax planning and aggressive avoidance lies’, it does not seem to stop them ‘selling schemes with as little as a 50% chance of succeeding if challenged in court.’
The PAC did not spare the government from criticism either. It claimed that the Big Four have enjoyed a close relationship with government which creates ‘a perception that they wield undue influence on the tax system which they use to their advantage.’ The PAC used the example that the Big Four frequently second staff to the government to ‘provide technical advice on changes to tax laws’ to improve ‘the quality of legislation’.
The PAC was informed that this relationship may give rise to a perception that these accountants can influence legislation in order to benefit their larger clients – perhaps to the disadvantage of smaller UK businesses. More pointedly, the Committee described the situation as more a case of ‘poacher, turned gamekeeper, turned poacher again’. This mixture of roles can arise when Big Four staff advise government on tax legislation and then later go back to their firms and advise their own clients on how they can use those same laws to reduce the amount of tax they pay.
The PAC concluded that the UK’s tax system is just ‘too complex’ and needs a ‘more radical approach to simplification’. In addition, the PAC claimed there was ‘no clarity’ over where accounting firms distinguish between acceptable tax planning and aggressive tax avoidance. The PAC warned it was inappropriate for staff from the Big Four to be seconded to the government to advise on tax legislation and then return to advise their own clients. Finally, the PAC called for ‘greater transparency’ about companies’ tax affairs which would increase the pressure on multinational companies ‘to pay a fair share of tax in those countries where they operate.’ The PAC was also particularly concerned about PwC negotiating the advance tax rulings with Luxembourg authorities for hundreds of companies.
The verdict of the PAC was clear: companies ‘do not need to conduct any business of substance in the countries where they shift profits to in order to avoid tax.’
The PAC’s recent report called for HMRC ‘to do more to challenge the nature of the advice’ that is provided by accounting firms to their clients. The PAC recommended that companies’ tax liabilities ‘reflect the substance of where companies conduct their business, and to introduce a new code of conduct for all tax advisers’.
The PAC even warned that HMRC needs to take ‘urgent action’ otherwise ‘this irresponsible activity’ will continue to be unchecked and cause ‘harm to both the public finances and the reputations of the companies involved.’
In spite of the PAC’s critical comments, there is another side to this story. It is not just PwC that has engaged in devising tax avoidance strategies for their clients – many of the other large international firms are doing the same; as are many smaller firms of accountants who are acting for their own clients. These accountants are acting upon the instructions of their clients and have a duty of professional care to act in the best interests of their clients at all times. After all, tax avoidance in itself is not illegal – and it is only when some types of tax mitigating schemes become excessively aggressive that there is the possibility of breeching tax legislation. The problem is that with the complexity of UK tax legislation, it is not at all clear when tax planning becomes unacceptably aggressive tax avoidance.
In practice, the practical, legal and ethical nature of adopting tax planning and avoidance strategies is considerably more complex than some politicians care to recognise.
John Stittle is Senior Lecturer at the University of Essex