Select Committee on Treasury Appendices to the Minutes of Evidence


Memorandum submitted by The Chartered Institute of Taxation

  This paper sets out the matters which the CIOT considers should be dealt with in the next Budget and Finance Bill.

  This year, we focus our attention on the rapidly increasing complexity of the tax system and the burdens this imposes on businesses large and small, and on individuals trying to complete their tax returns. The system has become so complex that we believe that it is in danger of serious malfunction due either to the inability of the tax authorities to administer it effectively, or to the inability of taxpayers and businesses to understand their rights and obligations under it, or both. Accordingly, we think that a fundamental review is required leading to the repeal of unnecessarily complex provisions and the simplification of other provisions.

  Above all, there is an urgent need for the Government to stop making the system even more complex.


General comments

  As noted above, there is a growing recognition that the tax system has become so complex that it has got completely out of hand. Complexity in the tax system arises from:

    —  narrowly targeted tax charges and reliefs which take up a lot of space in the statute book to tax or relieve only a restricted class of beneficiaries;

    —  provisions hedged with complex conditions;

    —  small differences in a tax charge or relief for different, but similar, situations;

    —  the manner in which the legislation is drafted;

    —  differences between the text of UK legislation and the EU directives which are being given effect;

    —  legislation which remains unconsolidated for long periods (a particularly acute example being Stamp Duty, first introduced in 1891 and not comprehensively consolidated since).

  It is a common complaint that some legislation is drafted in a manner which reduces even the simplest scheme to a quagmire of incomprehensibility (eg the reduced rate of VAT for building conversions introduced by FA 2001). Parliamentary Counsel must keep the users of legislation at the forefront of his/her mind when drafting legislation. The legislation must be clear and precise, but it must also be readable. There have been far too many examples of user-unfriendly legislation in recent Finance Acts.

Tax returns

  We are concerned that the system has become so complex that individual taxpayers have great difficulty in understanding how their tax liabilities are calculated, and the Inland Revenue are struggling to cope with the volume of work.

  One change which we have urged on the Government in previous years is the simplification of the income tax rate structure. In particular, there seems no point in having a lower rate and a basic rate only two percentage points apart. The consolidation of these two rates into a unified rate is the single most important change which would simplify the calculation of income tax liabilities for individuals and reduce the 32-page tax calculation guide by several pages. The starting rate is a source of further complexity, since investment income which suffers tax deductions at source has the "wrong" rate deducted, leading to numerous small repayment claims.

  As regards Capital Gains Tax, the replacement of indexation relief by taper relief in 1998 and the amendment of the definition of business assets in 2000 have added enormously to the complexity of the computation of gains on assets acquired before 6 April 1998. Given that Capital Gains Tax, which was introduced in 1965, was rebased in 1982, the opportunity should have been taken to rebase it again in 1998. There would be no need to rebase for companies, so the cost to the exchequer would be minimal. A further rebasing is now long overdue.

  Other suggestions for simplification are set out in separate papers.

Tax Law Rewrite

  We welcome the review and "simplification" of tax law being undertaken by the Tax Law Rewrite project, but are aware that the project's remit is to rewrite existing legislation with no major changes to the law itself. When the project's work identifies areas where a change in the law would produce a straightforward real simplification, we would like to see such changes in law being directly considered in the next Finance Bill. We are aware that such areas are specifically identified from our own involvement in the consultation process but there is little evidence of their feeding through to any Finance Bills.

Codification of the law relating to intellectual property and other intangibles

  Given that considerable progress has been made in designing the new system, we trust that the legislation will appear in the Finance Bill 2002.


  The boundary lines between the reduced, standard and zero rates, and between those rates and exemption from tax, have become enormously complex. What is particularly worrying is that the resulting liability boundaries arise in trade sectors where there are many small businesses: property development, building services and catering. We consider that a thorough review is necessary to simplify both the liability boundaries and the manner in which the legislation is written. We cite three areas where there is particular difficulty.

Sale and letting of land and buildings

  This is one of the most complex liability provisions in VATA 1994.

  Sales and lettings may be taxed at the standard rate or zero rate or be exempt from tax. Furthermore, exemption from tax may be waived in some (but not all) situations so as to give rise to a charge to tax at the standard rate. Under current legislation, it is necessary to distinguish some 38 different factual situations in relation to freehold sales and 70 factual situations in relation to lettings. In addition there are some 13 special situations where rights, interests and licences are taxed at the standard rate ((a)-(m) of Item 1 in Sch 9 Group 1). Further factual situations will arise when an order is made following enactment of the urban regeneration provisions in FA 2001. This is clearly an area where some simplification is necessary.

Construction, alteration and renovation of buildings

  Certain supplies relating to the construction and alteration of buildings are zero rated. There are three "Items" in Sch 8 group 5 and these are amplified by 24 "Notes". There are a further three "Items", supplemented by 11 "Notes", in Sch 8 group 6. These zero ratings are qualified by the provisions of Sch 10 paras 1 and 5-8.

  Certain supplies relating to buildings are charged at the reduced rate under new Sch 7A Groups 2, 3, 6 and 7 VATA 1994. Group 3 contains 10 Items, amplified by 5 Notes.

  Other supplies are standard rated.

  Once again, therefore, there are a large number of different factual situations which need to be taken into account in determining the rate at which services are taxed. The difficulty is increased by the appalling manner in which the reduced rate legislation was drafted in FA 2001. Quite how small jobbing builders are supposed to find their way around the resulting maze is something of a mystery.


  In principle, food of a kind used for human consumption is zero rated under Sch 8 Group 1. There are two classes of exception. The first class excludes food supplied in the course of catering, food supplied for consumption at the place where it is supplied and hot takeaway food. The second class excludes food of a specific description divided into seven classes ("the excepted items") to which there are exceptions which are again divided into seven classes ("the items overriding the exceptions").

  The resulting liability boundaries have given rise to a considerable body of case law without providing definitive boundaries between food which is zero rated (because it falls outside the exceptions, or within both the exceptions and the items overriding the exceptions, without falling into the first class) or standard rated (because it falls within the excepted items without being included in the items overriding the exceptions, or because it falls within the first class).


The payroll burdens

  The increasing use of the tax system to deliver the Government's social policies continues to place additional burdens on employers. This burden has been increased markedly in recent years by the addition of:

    —  statutory sick pay and maternity pay;

    —  collection of student loan repayments;

    —  working families tax credit;

    —  construction industry scheme;

    —  personal service company legislation;

    —  administration of stakeholder pensions for all but the very small businesses.

  For example, the difficulties experienced with statutory sick pay featured in the original Bath Report, but nothing has been done to remove or reduce them. The difficulties experienced with maternity pay are illustrated in the DTI's Green Paper issued last December. Problems with the personal services company legislation have already been discussed at length.

  As regards P11D returns, the complexity of the new car benefits rules will add considerably to the overall burdens associated with payroll operations, only partially offset by the removal of the need to ascertain employees' business mileage.

  We believe that these payroll burdens have become oppressive for small businesses and are in need of urgent action. We look forward to seeing the results of the review announced in the recent paper "Enterprise and the Productivity Challenge" and hope that it will address some of these issues.

The "cliff-edge" VAT registration problem

  The 1998 consultation on registration limits highlighted what has become known as the "cliff-edge" problem. This arises when a taxpayer selling mainly to the public crosses the registration threshold. Prices must be increased by 17.5 per cent if the taxpayer is to recoup the VAT which he/she must account for to Customs and Excise. A price increase of this level is often impractical as the taxpayer's prices would be out of line with those of unregistered competitors and he/she would lose custom if he/she did so.

  Thus, a smaller price increase (or even no increase) is made with the result that the taxpayer pays all or part of the VAT out of his/her own pocket. The ability to recover input tax is largely illusory as service traders such as hairdressers incur very little.

  The consultative document foreshadowed in the Pre-Budget Report (November 2000) and re-affirmed in the Budget (March 2001) was published on 18 June 2001. While we welcome the flat rate scheme in principle as a means of simplifying the compliance problems of small businesses, we regret that it does nothing to alleviate the cliff-edge problem. Indeed, the problem is described in the consultation document as "an ongoing cash flow and compliance burden on businesses which small firms can find especially difficult" (see Easing the Impact of VAT: Consultation on a Flat Rate Scheme for Small Firms (June 2001) para 2.9, emphasis supplied). As indicated above, the cliff-edge problem is a tax burden problem, not a cash flow one.

  The introduction to the consultation document states that the Government is "committed to do more to help small businesses manage their entry into the VAT system" (para 1.2). The true cliff-edge problem is a genuine disincentive to the expansion of small businesses, particularly those in the service sector, and to anyone wishing to emerge from the shadow economy. We urge the Government to introduce measures to alleviate it.


Disposals of substantial shareholdings

  The consultative document on large business taxation is a good illustration of the effectiveness of the consultative process if all parties are receptive to different views. The original proposals for deferral would have been very difficult to operate in practice given the need for complex anti-avoidance provisions. The proposed use of the exemption method in this consultative document is a clear statement that for policy to be effective it must be simple in its implementation; if not, taxpayers will be unable to rely on it in their decision making process and the purpose of the policy will be frustrated.

Double taxation relief

  The rules governing relief for underlying tax are now enormously complicated. Further, the problem of "tainting" has not been dealt with despite extensive discussion. The subject of DTR on company dividends needs a proper review. The discussion in the above consultative document should be used as an opportunity to debate publicly detailed economic and structural aspects of our credit system. Clarity in the taxation of foreign dividends is key to the continued globalisation of UK business.

Quarterly instalment payments

  The present system, which is based on estimates of current year profits, is unworkable in principle, since no company is able to predict its profits and capital gains in advance. It involves the Revenue acting in a quasi-banking role and undermines the principle of being able to compute tax liabilities on the basis of facts rather than speculation and then to pay the right amount of tax at the right time. We think that the system of QIPs should be based on the liability of the preceding accounting period.

Dependent subsidiary legislation

  A growing number of our members have expressed serious concerns as to the operation of the dependent subsidiary legislation (s79, FA 1988). Broadly, the legislation counters the potential for manipulation of the value of employee shares by artificially increasing the value of the subsidiary company in question (for example, by trading with it on a non-commercial basis). The legislation imposes income tax charges on the employee shareholders in question.

  However, the legislation extends its effect more widely than the mischief that it seeks to counter. For example, in circumstances where all of the conditions for exclusion from the effects of the legislation are in principle satisfied, unlimited tax liabilities may nevertheless arise to employees purely by reason of a failure by the directors of the parent company to certify within two years of the end of the accounting period that this is so. In practice, many of those caught by this rule, and in particular those with foreign parent companies, are simply not aware of it until it is too late. The effects of the legislation are therefore extremely harsh and represent a disincentive for business to operate in the UK. The removal of the penal effect on the unwary, while preserving the deterrent effect of the legislation, is likely to be straightforward and would create a simpler and fairer environment for business and encourage wider employee share ownership.

Gains on employee share options, and section 144A TA 1988

  We recommend that the legislation that deals with gains realised by employees in respect of shares and share options be made more practical and less penal. Indeed, there is a strong case for section 144A to be repealed altogether.

  The section has its origins in the days when the "notional payment" rules only really applied to payments made through exotic national insurance avoidance schemes. The tight time limits and harsh penalties (creating an income tax charge of up to 56 per cent) associated with this section could therefore be justified.

  Now that this section applies to shares and to share options that are part of normal commercial arrangements, the penal provisions are out of place. In addition, the tight time limit that applies to this section is not practical for payrolls that operate on a monthly basis.

Abolition of the Schedular system for companies

  This is something which we have advocated in another paper. This may be distinguished from the Government's proposal to base the tax liability of small companies on accounting profits, since the main benefits would lie with the elimination of the complex loss set-off rules for different types of income.

Company cars

  In meetings with the Revenue, it has become clear that the technical change which would reduce significantly compliance costs for large and medium-sized businesses would be the removal of the limit (currently £12,000) on capital allowances for so-called expensive cars and the corresponding limit for leased cars. The opportunity to implement this change presents itself in April 2002, with the introduction of the new system for computing benefits on company cars. This change would ensure that standard fleet cars are not subject to a restriction on the timing of capital allowances or to a disallowance of rentals which involves the preparation of copious back-up schedules for car fleets. The problems would, of course, disappear if accounting profits were used as a measure of taxable profits.

Withholding taxes

  We have argued elsewhere for the general abolition of withholding tax on interest and royalties.

Forex, financial instruments and loan relationships

  The CIOT has not had the opportunity to consider the consultative document issued on 26 July 2001 on corporate debt, financial instruments and foreign exchange gains and losses. It is key that when reviewing the ultimate form of the new legislation the position will not be worsened rather than improved. In particular there are many unsatisfactory features of the current legislation which create uncertainty and which will worsen the overall legislation if extended wholesale.

Tax nothings and the capital/revenue distinction

  Once the major substantial shareholdings and intellectual property reforms are enacted, the Government should announce a review of business expenditure which goes completely unrelieved in the tax system, such as payments to escape onerous leases. There seems no policy reason why such expenditures should not attract relief once payments to escape onerous debt or royalty obligations clearly do so.

Gifts of shares and securities to charities

  In line with the Government's objectives of encouraging charitable giving, we think that the provisions of section 587B ICTA 1988 should be extended to include unquoted shares and securities.


Directly effective EU legislation

  Some provisions of Directive 77/388/EEC (the Sixth Directive) have not been implemented, or have been incorrectly implemented, in the UK legislation. In consequence, taxpayers must rely on the courts or tribunals applying the principle of "direct effect" so that relief is given by reference to the terms of the Sixth Directive rather than by reference to the terms of contrary UK legislation. We give four examples.

  First, in relation to the exemption of insurance services in VATA 1994 Sch 9 Group 2: Items 1-3 of Group 2 were overridden in Card Protection Plan Ltd v Customs and Excise Comrs [2001] STC 174, HL, and Item 4 in Century Life plc v Customs and Excise Comrs [2001] STC 38, CA, by art 13B(a) of the Sixth Directive.

  Secondly, in Prudential Assurance Co Ltd v Customs and Excise Comrs (2001) VAT decision 17030, the tribunal held that VATA 1994 Sch 9 Group 5 Item 9 was unduly restrictive vis a" vis art 13B(d)(6) of the Sixth Directive by restricting the exemption of management services to those performed by the "operator" of an authorised unit trust scheme or trust based scheme. In Business Brief 6/01, 18 April 2001, Customs and Excise announced that they "do not accept that businesses are entitled to exempt sub-contracted management services" and have appealed to the Court of Session.

  Thirdly, in relation to the place of supply provisions in VATA 1994 s9: the Sixth Directive was given effect by the court in Customs and Excise Comrs v Chinese Channel (Hong Kong) Ltd [1998] STC 347.

  Fourthly, in Ashworth v Customs and Excise Comrs [1994] VATTR 275 the tribunal held that what is now VATA 1994 Sch 9 Group 1 Note 10(a) is "an excessive exercise of the power given by art 13B(b) [of the Sixth Directive]" insofar as it excludes from exemption the grant of a lease in a dwelling used as the tenant's principal private residence.

  Failing to amend defects pointed out by the courts and tribunals means that the UK legislation says one thing when the courts and tribunals apply something else. This situation amounts to a denial of rights in two distinct senses. First, rights should be accessible within the means of the least resourced. This means that rights should be clearly identified in the UK legislation. It should not be necessary to resort to the directives or the jurisprudence of the EU Court of Justice in order to identify rights. This is an unnecessary and unjustified complication which increases compliance. Secondly, some taxpayers are misled by the UK legislation and thereby fail to claim rights because they believe that there are none to claim. In consequence, they are denied the relief which they are due. We find it unsatisfactory that the legislature frequently fails to enact EU rights affirmed by the courts and tribunals. We contrast the prompt legislative action normally following duties which are similarly affirmed. Making a press announcement (the only response to the CPP case so far) is a wholly insufficient response given that the legislation can be amended by statutory instrument.

Credit notes

  The legislation makes comprehensive provision for the content of VAT invoices and the circumstances in which they must, or must not, be issued. It has long been recognised by the tribunals that the VAT charged on a VAT invoice can be reduced or eliminated by way of a credit note in order to correct a genuine mistake or overcharge or to give a proper credit (British United Shoe Machinery Co Ltd v Customs and Excise Comrs [1977] VATTR 187). However, the legislation is almost entirely silent on the question of form. VAT Regulations SI 1995/2518 reg 38 requires the VAT Account to be adjusted when the consideration for a supply is decreased and reg 31 requires credit notes received, and copies of credit notes issued, to be retained. However, a credit note is required to be issued only when the reduction arises in connection with a change in the rate of tax and the matters to be recorded on a credit note are specified only in relation to the credit notes so issued (reg 15). In practice, it is necessary to follow what appears to be an extra-statutory procedure (set out in Notice No 700 Part 7) in all other respects.

  In Schmeink & Cofreth AG & Co v Finanzamt Borken (case C-454/98) [2000] STC 810, ECJ, the EU Court of Justice observed that "the Sixth Directive does not contain any provisions relating to the adjustment by the issuer of the invoice of VAT which has been improperly invoiced. . . . In those circumstances, it is for the member states to lay down the conditions in which improperly invoiced VAT may be adjusted" (paras 48, 49).

  Credit notes play an important role in commercial accounting. It is unsatisfactory that such important documents are governed by extra-statutory procedures. We consider that the position should be governed by legislation.

Other VAT registration problems

  In the meantime, there is one further matter concerning registration which deserves a closer look. Taxpayers are liable to register for VAT purposes if they meet any one of eleven different factual circumstances. The relevant legislation is set out in no less than four schedules of VATA 1994 (see VATA 1994 Schs 1, 2, 3 and 3A). We note that Schs 2 and 3 were introduced by FA 1992 and Sch by FA 2000. The four schedules are drafted along similar lines and there is a considerable overlap in their content.

  The legislation is inordinately long for what is, in practice, a relatively straightforward process. While we have no problem with the eleven criteria governing compulsory registration, we question the need for four parallel registration systems. We consider that a useful simplification would be achieved by means of a single system.


  We urge the Government to review the decision to deny exemption to pension funds, etc in respect of their share of Schedule A profits etc from investment LLPs. A property investment via an LLP is no more objectionable than a direct joint ownership or an investment as a limited partner in an ordinary partnership or as a unit holder in a property unit trust. Given the bulky nature of property investment (unlike investment in stocks and shares), the use of an LLP appears to us to be entirely reasonable provided that the interests in the LLP are not actively dealt in on a market.


  Our recent papers on Stamp Duty reform have drawn attention to the need for exemptions for the incorporation of a business as a going concern, company reconstructions generally, etc. We firmly believe that this tax, as presently levied, is harming our competitive ability in the global market.


  We trust that proper notice of Budget day will be given next year. This will enable organisations to arrange their customary meetings and seminars based on the Budget. It will also enable bodies such as the CIOT to plan their timetable for response and consultation.

  It would also help if a comprehensive list of all items released on Budget day is published, together with details of where they can be found. This would enable practitioners and the public to ensure that they are in possession of all relevant information. Also, the Budget pack should contain all relevant material.

April 2002

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