Principles of tax policy - Treasury Contents

Written evidence submitted by the Law Society of England and Wales

1.    The Society is pleased to be asked to comment on the Mirrlees Review, a detailed consideration of the economic theory and evidence on which a tax system operating in the 21st century should be based. The Review contains many ideas and points of discussion. It is still at a draft stage and will not be finalised until the spring. The Society has therefore restricted our comments to a few key areas and our comments can, at this stage, only be very general. The Society would be happy to assist with any development of Mirrlees Review proposals in the future.

2.    The Society should also like to take the opportunity to say that many improvements to the UK tax system can be made in advance of structural reforms of the type proposed by Mirrlees. The Society has previously made a number of suggestions to improve tax law and would urge that these also receive consideration.[47]


3.    The Mirrlees Review states that:

"By international standards, the UK system has fewer loopholes and opportunities for avoidance than some. For most people, for most of the time, the tax system works: it is not overtly intrusive and does not require vast effort to comply."[48]

4.    The Society would urge the Government to keep these comments in mind when proposing substantial reforms or adjustments. In our experience, it is ill-thought out policies which cause the most difficulties experienced by taxpayers and their advisers, particularly so when policy is made and then reversed.


5.    The Society agrees with the arguments put forward in the Mirrlees Review that the case for some form of integration of income tax and national insurance contributions (NICs) has become overwhelming.

6.    As identified in the Review, the advantages of integration would be increased administrative simplicity and transparency in the UK tax system and consequently reduced compliance and collection costs. Complete integration would inevitably result in an increase in the "headline" rate of income tax and could therefore expect to be unpopular with the electorate. This would be particularly so given the general attachment to the "contributory principle" - the widespread belief that there is a link between the payment of NICs and state benefits received - albeit that that link is virtually broken.

7.    As an alternative, a more limited reform could be accomplished by aligning the tax bases of income tax and NICs.

8.    The treatment of state pensions, which are currently exempt from NICs, could be a particularly controversial area since those in receipt could well argue that such pensions should be received free of the NIC element of the merged tax as the pension had been "paid for" during working life. The Mirrlees solution - of an intermediate tax rate for such income - seems sensible at first blush, but rates might have to be low. A high rate could be seen as imposing disincentives on saving for retirement.

9.    A difficult question remains with regard to the treatment of employers NICs since the rate rise required to transfer the burden of this element of NICs to employees might be too high. Mirrlees considers a separate employer tax as a solution but notes that this would be distortive as it would only apply to employment income. These distortions can already be seen in the current system where businesses can reduce employer NICs by, for example, re-structuring as a partnership. (Partners are usually self-employed for NICs purposes so no employers NICs are payable in respect of the individual partner's profit shares.) Such distortions would either have to be accepted or additional taxes introduced on self-employed income and, possibly, returns on capital.

10.  The Society considers that the Mirrlees proposals for a single integrated benefit, eliminating the high marginal tax rates (90% or more on low earners) and ending the current practice of tapering personal allowances have some merit. Any revision to the present system would, of course, create "winners" and "losers".


11.  The Mirrlees Review considers a number of economic models of saving and proposes, inter alia:

—  Taking bank and building society accounts out of tax altogether.

—  Introducing a rate of return allowance (RRA) for substantial holdings of risky assets.

—  Taxing capital income and capital gains above the RRA at the same rate as earned income with reduced rates for dividends and capital gains on shares to reflect corporation tax already paid.

—  Maintaining the current system of pensions taxation but ending employers exemptions from NICs on pension contributions and replacing the tax free lump sum.

—  Introducing a comprehensive lifetime wealth transfer tax.

12.  The Society is not able to comment on the pros and cons of these proposals from an economic perspective, although the Society assumes some level of saving for some purposes (eg retirement) should be encouraged, as should investment that will lead to economic growth. Whatever the economic rationale, the Society recommends that any reforms should be both simple to implement and easily understood by savers and investors. It should also be straightforward for investors to comply with their obligations and for the tax authorities to monitor compliance. Any reforms should be for the long-term as the set up and withdrawal of allowances in quick succession undermines investor confidence and discourages take-up.


13.  The proposals here are perhaps the most radical in the whole of the Mirrlees Review involving the abolition of Stamp Duty Land Tax (SDLT), reform of Council Tax and the creation of new taxes - a housing services tax on domestic property and a land value tax for business property. Perhaps unsurprisingly the Society urges caution here. The Society would prefer that Government undertakes to remedy some of the obvious flaws in existing systems - for example the "slab" rate structure for SDLT - rather than engage in wholesale replacement of taxes.


14.  The policy questions behind corporate taxes are well known. Should companies be taxed at all? If so, should taxes be based on corporate profits or on turnover? How should taxes on companies and shareholders be integrated? Again these are not issues where the Society can usefully add to the discussion in the Mirrlees Review. The Society does, however, have some comments on the Mirrlees Review proposals for the introduction of an Allowance for Corporate Equity (ACE).

15.  ACE is intended to level the playing field between borrowing, retained profits and equity finance by providing a tax deduction for the cost of equity finance. It was first proposed for the UK 20 years ago[49] although there seems to have been little appetite for its adoption.

16.  It seems to be commonly agreed that ACE systems reduce the corporate tax take because they narrow the tax base. Indeed the Mirrlees Review states that the introduction of ACE would "almost certainly"[50] result in lower corporate tax revenues. Any Government which decided to introduce this system would need to consider whether it intended to re-coup this revenue loss from the corporate sector. The Society would comment here that international groups in particular have generally been hostile to real, or perceived, unfavorable tax changes. This has been aptly demonstrated in the recent years by the high profile departures of international headquarter companies from the UK in the light of the discussions surrounding the reform of the taxation of foreign profits.

17.  The Society believes that a number of countries have tried ACE-like systems. Some have then abandoned them although the Society understands Belgium currently permits Belgian companies to calculate a deductible "notional interest" expense based on the company's aggregate equity amount as determined from the company's accounts. The Society notes that the European Commission opened infringement proceedings against Belgium in 2009 on the basis that this notional interest regime violates the free movement of capital because it does not permit deductions in relation to foreign branches or foreign real estate.

18.  If the UK were to go down the ACE route, policy makers would need to decide whether they wanted to implement a full or partial system as well as cope with the restrictions imposed on its structure by EU law. It is possible, for example, that a system providing a tax deduction for dividend payments and other distributions might achieve at least some of the objectives claimed by ACE more simply. Transitional issues would need to be addressed - for example, would ACE apply to existing equity or only that created after introduction? How would group shareholdings be treated? The interaction with the UK's Substantial Shareholding Exemption (SSE) would need to be considered, as would the taxation of international groups and the use of funds raised to finance overseas acquisitions and businesses.

19.  The ACE system envisaged by the Mirrlees Review appears to contemplate distinct rules for debt and equity and would therefore encounter difficulties in determining the correct tax treatment of "hybrid" instruments which have characteristics of both debt and equity. A deduction or an allowance for the cost of corporate capital might have to be considered to alleviate such issues.

20.  Finally, the introduction of ACE into the UK would only have the full advantages hoped for by the Mirrlees Review if the tax treatment for shareholders of debt interest, dividend income and returns on capital were equalized. This would necessarily require radical reform of the taxation of personal income and gains.


21.  The Mirrlees Review recommends removing nearly all exemptions (such as on financial services), zero rating (such as on childrens clothes) and reduced rating (such as on domestic fuel) and compensating those who lose out through the tax and benefits system. Such a change may be controversial.

22.  The UK's current willingness to zero rate or exempt entirely from VAT certain goods and services raises difficult boundary issues - the Jaffa Cake dispute is a notorious example. Removing exemptions and standardizing rates (as permitted by EU law) will reduce these issues but will increase the number of collection points - the times at which VAT must be charged and may be re-claimed. VAT will remain a complicated tax to administer and HMRC's administration and compliance systems must be fully prepared for the increased workload produced by any extensions in scope.

23.  The Society is pleased that the Mirrlees Review acknowledges the practical difficulties in imposing VAT on financial and insurance services. Given that removal of this exemption would require change in European law and international co-ordination the Society awaits more detailed proposals before commenting on this aspect of the Review.

24.  The Society notes that the European Commission has independently launched a wide-ranging review of the VAT system[51] and raised similar questions. The Society is mindful of the pressure on Member States' exchequers and suggest that to obtain agreement of all member States to radical changes to the VAT system may prove challenging.

January 2011

47   Law Society Tax Good Governance and Better Law Making - a manifesto for improving tax law (2010). Back

48   Mirrlees Review "Tax By Design" Chapter 1 page 8. Back

49   By the IFS Capital Taxes Group in 1991. Back

50   Op cit Chapter 18 page 20. Back

51   The Future of VAT: Towards a simpler, more robust and efficient VAT system (2/12/2010). Back

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