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]
INTRODUCTION
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.
TAXATION OF
EARNINGS
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".
REFORMING THE
TAXATION OF
SAVING
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.
TAX ON
LAND AND
PROPERTY
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.
CORPORATE 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.
VAT
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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