There’s a rare old ding dong going on between Nichola Ross Martin and Richard Murphy about whether cash accounting is a good or bad thing. I agree with Richard that Nichola’s argument is based on fuzzy logic and poorly articulated assumptions. But Richard’s riposte also falls short. He says:
There’s almost no logic to Nichola’s argument, starting from the fact that everyone knows that large numbers (but I accept not all) of these businesses do suppress receipts to pay less tax. As evidence I offer the fact that the tax refund after an investigation is almost unknown in this sector.
The evidence Richard puts forward amounts to a self-fulfiling prophecy. The whole premise of a tax investigation is that HMRC inspectors have some inkling the client’s accounts may not be all they appear. Therefore, Richard’s argument is not evidence but an extrapolation based upon a faulty assumption.The assumption depends on the reality that ‘everyone’ avoids/evades tax in an unscrupulous manner.
To take this one logical step further – who is ‘everyone?’ If Richard means to include tax practitioners, then it is a damning indictment of the profession and its ability to persuade clients to do the right thing. I’d like to see the evidence. When I was at university, it was drummed into me that ‘everyone’ has a very specific meaning. Unless there is strong empirical evidence to support that position then everything else falls. For the logical reason that there is no science in unsupported sweeping statements.
That is not to say Richard is wrong. Anecdotally I agree. But anecdote is not enough. If you want to present scientific argument then please root it in logically sound theory that is evidence supported. It is a reason why Richard’s ‘Tax Gap’ has had such an important impact on international taxation. It is research based with a logical argumentative flow.
Then there is the issue of scale. The last figures I saw – so if I am out of date please correct – indicated that the average ‘take’ from HMRC compliance investigations is £5,000. That’s a piffling amount, even for a very small business turning (one of) the reported poverty levels of £16,000 pa, given that investigations typically go back 6 years and the figure include interest and penalties.
Again, drawing from experience, the smaller the business, the less incentive to avoid. Why? Because these are traders on the edge between survival and extinction. For many professionals (by volume), these are their bread and butter. Why are we not thinking about how to support and nurture these businesses through best practices instead of demonising them? If Richard is correct then it follows the human condition is driven by greed that has to be controlled. Welcome to 1984. It is a dismal and hopeless view of the world.
I believe I’m also correct in thinking that HMRC says it wishes to concentrate on the more costly abuses. If so, then might HMRC be persuaded as to the value of a simpler system for VSBs? I think so because it allows HMRC to deploy investigative resources to the places of greatest abuse. Which is better, an inspector bringing another file to conclusion for <$5K or several hits at TaxDodger plc at £50 million a pop. There are other problems with Richard’s argument.
If Richard is correct about ‘everyone,’ then by his tax justice driven logic, ‘we’ should apply arbitrary uplifts in income that reflect what ‘we’ think the client ‘should’ be making. This is because it is socially justified. There is nothing wrong with this logic. But it is wholly out of whack with reality. BTW – if anyone wishes to refute this logic, the next post I have on reserve should assist in the understanding. Back to the plot.
It is why HMRC investigators start when considering gross profit calculations in easy targets where they have a lot of data like pubs, clubs and take out establishments. Notice by the way I’m highlighting cash based businesses. For the reason they are the easiest and most frequent (by volume) to come under suspicion. It is HMRC who are the taxpayer’s police. Not professionals.
The hard fact is professional accountants are not in business to dispense, arbitrate or take decisions based upon social conscience. They are in business to serve their clients best interests according to the laws and regulations by which they are bound. The fact that the framework within which tax accountants operate is socially blind is not their concern.
Richard also queries how to:
Tackle the obvious issues of tax avoidance, such as banking cash the day after the year end?
Tackle up front loading of payments?
I have argued before but it is worth reiterating:
Upfront loading provides a one off timing difference that creates a false sense of where the business is at, let alone the tax consequences. No professional worth his salt is going to stand for that because once you go down that road, it is incredibly hard to back out.
In my experience, clients are not sophisticated enough to understand this technique without help from their advisors. Where is Richard pointing the finger? The same general theory applies to businesses who use the normal ‘accruals’ basis. Hold back invoicing, inflate stock, shovel all inbound invoices into the accounts. Again, where is the finger really pointing?
As an aside, I have handled cases where refunds were obtained. Usually on the basis of faulty expense claims combined with incorrect handling of pensions contributions as a deduction in calculating the final tax bill. So it is not ‘virtually unknown.’ Rare or at very best unusual.
Mike Truman weighs in with a thoughtful and balanced response where he expresses what I think most practitioners are seeking – a simplified system of accounting that satisfies the needs of the taxing authorities:
I am beginning to wonder whether part of the problem might be the terminology: perhaps we should not be talking so much about cash accounting but rather a simplified tax regime for smaller businesses, which incorporates cash reporting, but which does not pretend to be creating a set of financial statements at all.
Mike points up the French system of which I have personal knowledge. While he is technically correct in the way the system operates, he misses four important points:
- France has a very high rate of business failure – something around 65% of new businesses fail within the first three years. Most evidence suggests it is the way the taxing authorities and advisors fail to provide proper guidance around tax and more important social security deferment. One friend of mine nearly went bankrupt because of this. Through no fault of his own.
- Second, France has a very high rate of tax evasion. Informal estimates put the figure of self-emplyed ‘black’ income as high as 35%. It is considered a national sport. As it is in Spain and Germany.
- Third, France is faced with a massive social problem. The French cherish their social services. Again, based on personal experience, the French health system is both comprehensive and caring. I absolutely never resented paying for the services provided. But they too are being taxed into the ground. What the UK sees as a stealth tax system the French have been living with for years. And hating it.
- Small French businesses rarely employ people directly. the oncost is horrific – like 43-62% of basic salary. It has been a contributing factor in the consolidation of farmlands into the hands of wealthy corporations. It is also seen as a contributing factor in the failure of successive French governments to foster sustainable growth.
In any debate about these topics, there is almost always a level of hyperbole and politicking. I say this serves no useful purpose. Anyone I know who is invested in this debate will surely agree that the ‘system’ as expressed in law is broken.
By all means propose a system of tax justice. I welcome it. As a past practitioner paid to help clients avoid every penny possible and recognising the corrupting actions it leads to, I am four square behind Richard in demanding a fairer system. Because as John Christensen said to me in private email:
From where I have sat these past 30 years, some of the finest minds in Britain (and elsewhere) have been devoted to undermining the integrity of the tax system on behalf of their wealthy clients and themselves, and to the detriment of the middle and lower income earners.
But let’s take people from where they’re at and not where we want them to be. Approach the issues in a logical manner based on empirical evidence rather than gut feel. It is what this profession thrives upon. Be persuasive and not strident. Discuss rather than lambast.
I too am an idealist. But with a thick pragmatic streak.
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