The Influence of Tax Avoidance and Evasion on International Taxation Rules - Assignment Example

The Influence of Tax Avoidance and Evasion on International Taxation Rules Overview of the Tax System in the UK Every year the Chancellor presents the Budget to fix the cost to provide public services like education, health and social security and the extent of taxes the government has to collect from individual citizens and business entities for raising money to spend primarily on the public services. Key taxes collected by the government are elaborated in the following table: Income Tax on earnings, pensions and benefits (taxable incomes) Income Tax on savings and investments Tax on certain types of transaction (buying or selling things or giving them away) Tax on buying goods and services • earnings from employment • profits from business • state and private pensions • allowances (jobseeker, carer, incapacity benefit) • profits from partnerships • savings and investments • bank and building society interest • dividends from shares • income from property and rent • capital gains if assets are sold or given away as gifts • stamp duty while buying property or shares • inheritance tax on estates after death • value added tax (VAT) on everyday purchases • fuel duty on petrol, diesel and LPG • excise duty on alcohol and tobacco • general betting duty • National Insurance contributions (NICs) - social security benefits It is said that there are only two certainties in life - death and taxes. Certain taxes apply only to certain people. Groups of individuals having income above a certain limit, qualify for income tax and self-employed individuals can claim back much of the value added tax. The tax system also includes exemptions, reliefs, thresholds and allowances for the benefit of citizens and businesses. How Taxes are calculated and collected The tax system shifts the trouble of manage tax affairs to individuals. Tax payers get a tax-free personal allowance and they have to pay income tax on anything over this allowance. The more is the earning, the higher is the amount of tax they pay. The amount of National Insurance paid by individuals also depends on their earning. For employees whose employer operates PAYE (Pay As You Earn), taxes and NICs are deducted from their salaries or wages. Self-employed individuals are responsible for paying their own taxes and NICs and have to file their Self-Assessment tax returns. Taxes are deducted at source for Savings Bank and building society interests and dividends and dividends i.e. taxes are deducted before they're paid to the employees. Citizens get a special tax-free allowance for capital gains and they only pay capital gains Tax on anything over this allowance in one go by filing Self-Assessment tax returns. Other taxes, like value added tax i.e. VAT, and various duties on fuel, alcohol, tobacco and betting are charged at flat rates and are included in the price for the goods or services. The "PAYE" System Full-time employees use the 'Pay as You Earn' (PAYE) system to pay taxes and National Insurance Contributions (NICs). In PAYE system taxes and NICs are deducted at source. The pay slip contains the record of the tax deducted at source (TDS) and NICs deducted at source. NICs are used for funding social security or welfare state schemes such as pensions and national health schemes (NHS). It is the individual's responsibility to notify the taxman that they are earning money and pay appropriate taxes. They have to fill in the P46 tax form to enable their tax code that explains your allowances for the year. They are liable to be prosecuted by the Revenue and Customs if they deliberately conceal facts of their employment or income. The Role of OCED in International Taxation The challenge of achieving tax compliance is facing the governments all over the world. There are costs that have to be paid and benefits that can be reaped in what is called as Globalisation or Internationalisation of taxation policy administration. A move towards a borderless world was initiated opening up new opportunities for taxpayers to decrease their overall tax liabilities. On December 14, 1960, a convention founding the "Organisation for Economic Co-Operation and Development" (OCED) was signed by the UK and 19 other countries, thereby pledging full dedication to achieve the Organisation’s fundamental aims. The OCED provides member country surveys, comparative statistical and economic data and tools to analyse and monitor their economic, social and environmental policies. The OCED Secretariat conducts peer reviews, research and analysis for member countries and offers its expertise as consultancy covering the full economic and social spectrum, which is not possible for any one country alone. Many countries have made their tax systems attractive to investors because of competition. However, some anti-competitive tax practices undermine fair and just competition and public confidence in tax systems. OECD has formed a global forum along with and non-OECD economies to address harmful tax practices. This forum will work together to improve transparency and establish effective exchange of information. The OECD's Centre for Tax Policy and Administration settles international tax standards such as OECD Model Tax Convention and Transfer Pricing Guidelines. OCED also resolves politically sensitive issues including non-OECD economies, such as developing a taxation framework for eCommerce and the harmful tax competition project. OECD monitors fiscal policies of member countries enabling macroeconomic projections. OCED does economic surveys and reviews tax systems of member and non-member countries. This is an in-depth analysis, which provides options for reforming the tax system to national authorities to increase efficiency; enhance equity and improve enforceability of their economic policies. OCED publishes a country-specific synthesis surveys presenting the challenges facing tax policy makers and provides them policy recommendations to use taxes to help create a cleaner environment and encourage sustainable development. OECD makes assessment and surveillance of tax structure policy, which involves comparing tax design and policies for member countries and their impact analysis over the economic efficiency and income distribution and presents country-specific recommendations. For tax administrators, implementing tax policy in an increasingly globalised world has become a challenge. The OCED Committee on Fiscal Affairs established the Forum on Tax Administration to tackle strategic management of tax administration issues. OCED guides and recommends how to adapt international tax arrangements to a new global environment, how to tax enterprises operating in different countries, and how to make tax systems simple and fair, how to administer tax systems effectively. To solve social and economic problems, the policymakers worldwide are looking for effective and fair tax systems. OCED addresses these challenges and helps shaping the tax system of the 21st century. World trade consists of transfer of goods and services within multinational companies in different countries. OECD has issued Transfer Pricing Guidelines on the right arm's length principle to determine tax liability in each country and avoid double taxation. Similarly OCED has devised the Model Tax Convention and set up the worldwide network of tax treaties for providing clear consensual rules for taxing income and capital in case of cross-border investments and to avoid double taxation. OECD prepares internationally comparable statistics and economic surveys. It engages in monitoring, assessing and analysing national tax systems and policies and their effect on labour, capital and product markets. OECD's taxation wing provides a broad range of activities and services including international tax evasion, harmful tax practices, unfair eCommerce, and international environmental taxation policy. A borderless world helps global trade and economic development. But it also provides opportunities for dishonest taxpayers. OCED provides an international forum to help governments of member as well as non-member countries to ensure that taxpayers do not escape their tax liabilities and take necessary action against them if they do. OCED uses exchange of information tool in fighting the increasing non-compliance of tax laws in a borderless world. The OCED Committee on Fiscal Affairs is working to improve exchange of legal as well as factual information. OCED helps member countries in cross-border consumption taxes like VAT/GST for revenue collection throughout the world. OCE helps member countries tackle malpractices like bribery and corruption that hamper democratic processes, good governance, sustainable development and fair business practices. In 1996, the OECD provided recommendations on tax deductibility of bribes to foreign public officials to put an end to claiming bribes to foreign public officials as tax deductible expenses. When two states claim conflicting rights to tax an individual or company, it gives rise to cross-border tax. With the increase in cross-border trade, more and more people work abroad, as such frequent disputes over cross-border tax become a problem. The OECD’s Committee on Fiscal Affairs has modified the OECD Model Tax Convention to serve as a basis for most negotiations and arbitration between countries on tax matters. OECD provides arbitration to solve cross-border disputes over taxation to companies and individuals from member countries if other attempts to resolve disagreements fail. This helps multinational companies investing outside their home country and for individuals living and working in more than one country. International Tax Enforcement Arrangements New measures to extend the scope of HMRC's powers are to be introduced extending its ability to enter into international agreements, which will cover both direct and indirect taxes. At present, rules exist for direct taxes only. The new single power will the UK to make arrangements with another country that will cover agreements on the information exchange for tax administration and enforcement including powers for mutual assistance in tax collection. The effective date for the new measures will be when the Finance Bill receives Royal Assent. This will allow HMRC to obtain information from all the treaty partners of the UK regardless of domestic tax interest. HMRC's powers will be amended to obtain information and take recovery action on behalf of an overseas tax authority permitting the arrangements to cover both direct and indirect taxes. Under existing EU legislation, the UK is able to do this with existing Member States. These new powers will allow the UK to exchange information and seek assistance for the collection of indirect taxes with non-EU member countries. In case of conflict of international law, it is well established in English law that the courts will not enforce the tax law of another country. But due to the mutual assistance directive, it is not required for EU-member states to supply information that is contrary to its domestic legislation. Therefore this may allow introducing the enforcement of tax laws of another territory. The provisions in the Finance Bill 2006 allow the UK to make arrangements relating to international tax enforcement with another territory covering exchange of information, seizure of documents, and recovery of debts. The provision authorises HMRC under authorized agreement, to disclose information to overseas tax authorities and also permits other government departments to disclose information to HMRC, which allowed to be shared with overseas tax authorities. Amendments are made to the information gathering powers of HMRC to obtain information about liabilities to any foreign tax included in the agreement. New provisions enable the HMRC to recover foreign tax debts covered by the agreement closely resembling the present MARD rules implementation. They help the UK in making agreements with other territories about mutual assistance in the enforcement of taxes and tackle international tax evasion and tax avoidance. In addition, they enable the UK to endorse the 1988 Council of Europe – OECD Convention on Mutual Administrative Assistance in Tax Matters. Tax Avoidance and Tax Evasion Normally the politicians and revenue administrators in the UK condemn tax avoidance. According to Denis Healey, former UK Chancellor of the Exchequer, "The difference between tax avoidance and tax evasion is the thickness of a prison wall." Tax avoidance is using the law selfishly in order to reduce taxes. Some examples of tax avoidance are setting up a charitable trust or foundation to change tax status, establish an offshore company, trust or foundation in low tax jurisdictions etc. In contrast tax evasion is evading taxes by illegal means. Some examples of tax evasion are deliberate misrepresentation or concealing the facts and true figures to the tax authorities in order to reduce their tax liability, dishonest tax reporting, declaring less income or profits, or overstating deductions. Tax evasion is a common crime in almost all the countries in the world, which impose fines or imprisonment on the guilty parties. In short, tax evasion is an illegal attempt to avoid taxes while tax avoidance is an attempt to use the law to reduce taxes. The government has made continuous efforts to tackle tax recently. It expects to raise about £4.5 billion in revenues this year. The government has been announcing measures to reduce tax avoidance and protect revenues since 2002 Budget. The authorities still have some means of avoidance that are seen as unacceptable even if they satisfy the law. This has complicated the traditional difference between illegal tax evasion and legal tax avoidance or planning. The government is threatening to use retrospective legislation in some areas to ensure that taxpayers fairly contribute their share towards the social security. This Paymaster General has made this statement on the basis of employment liabilities. Recently they have come up with the tax avoidance disclosure regime, the most important legislative development in tackling avoidance. This principle cannot be easily applied to business taxation because profits from a business are an inherently difficult tax base to define and identify and have become global in nature in today’s scenario. This has made it difficult to achieve a coherent policy that demands businesses to pay their taxes fairly without undue avoidance and at the same time aiming for a globally competitive tax system. Adopting an ongoing approach on targeted anti-avoidance provisions may contribute to the former objective, but it will project hindrance to the other of a competitive tax system. The government's current approach may help to increase immediate revenue needs and it may also contribute to an insight of greater fairness and anti-avoidance awareness in some areas. However its long-term effects may be less beneficial in other areas of the tax system. From the government’s perspective, it has succeeded to some extent because there is an increase in the number of disclosures. The government can block measures deployed to halt arrangements that it views as unacceptable. The authorities are drawing the attention of senior executives to the risk of being engaged in unacceptable tax avoidance. This seems to have helped to increase the revenues in the short run, but because of that the UK is likely to become a less attractive location for global companies and internationally mobile individuals. It is required from the government that it adopts a more satisfactory approach towards tackling tax avoidance issues. This would require a fundamental overhaul of tax policy than it has been implemented in the UK for many years. In the short term, we can expect more rounds of anti-avoidance measures in the Budgets to come. Influence of tax avoidance and evasion on international tax rules Tax avoidance means immorally taking advantage of the loopholes in tax law system and seeking alternative but credible interpretation. On the other hand, tax evasion is a crime in almost all countries that subjects the guilty party to fines or even imprisonment. Mechanisms of Tax Avoidance and Tax Evasion International tax avoidance and evasion take advantage of the foreign economy links and affect various taxations such as consumption, labour, capital income, trade pricing, etc. Migration reduces labour income tax base depending upon the type of migration. In temporary migration, there is small loss of tax revenue but is useful because migrants are expected to return with useful skills. Tax-driven international capital movement is another channel of tax avoidance and sensitive to tax changes. The tax competition influences taxes upon the localization of firms, the investment expenditures of existing firms, and the geographical placement of the income of multinational companies. Tight integration of international capital markets offers further tax avoidance mechanisms to personal capital income. It is easy to avoid domestic taxation of interest income by moving funds abroad instead of investing them in domestic financial institutions resulting in cross-border interest flows escaping taxation altogether. Another important channel of tax avoidance is income shifting in a tax system in which labour income is taxed differently from income from other sources i.e. transforming income from one category to another to achieve lower taxation or avoid taxation thereby losing tax revenue through this mechanism. The manipulation of transfer prices between entities of multinational companies is a typical channel of international income shifting. A company may sell goods and services cheaper to particular foreign firms thereby transforming income generated in one country into official income in the other country. Debt shifting is considered as a supplementary channel of tax avoidance. An MNC can reallocate its debt from a low-tax country to a high-tax country, so that it gets the benefit of more valuable interest deduction. Further internal debt arrangements within the MNC can attempt to employ non-market interest rates to exploit the tax-influenced advantages. Some countries have rules to prevent such arrangements and to prevent tax avoidance. They do it through "thin capitalization" (a very high debt- asset ratio). Other tax avoidance mechanisms are cross border shopping if taxes are lower compared to the home country, under declaration of Income, false claiming of expenses and credits, deliberately not filing returns or not registering with the tax administration, dumping and diverting transit goods into domestic economy. Money laundering is also becoming a concern where individuals or firms project untaxed profits as loans. Effects of tax evasion and avoidance Tax evasion and avoidance have the potential of wear down the tax base leading to low tax revenues and resulting in increased domestic borrowing by government to finance the budget deficit. If the government increases borrowings from the domestic market, it leads to higher interest rates resulting in discouraged investment. Tax evasion like dumping kills local industry leading to unemployment and slow economic growth. Tax evasion poses social or welfare implications by constituting additional social costs such as taxpayers investing efforts and money to conceal tax evasion and tax authorities bearing the costs of auditing in order to detect tax evasion. Tax enforcing, tax concealing and cheating prove costly to the individuals involved and the society as a whole, since these resources are wasted in doing non-productive work consequently imposing excess burden of taxation on the society. Practically it is problematic to study the efficiency costs of tax rates and fines because of the difficulty in accurately measuring tax concealment and tax evasion detection efforts, difficulty in getting field data from taxpayers who will not reveal illegal tax evasion voluntarily. Actions to Limit Tax Evasion, Avoidance and Competition The Organisation for Economic Co-operation and Development (OECD) has urged its member states to unilaterally stop "harmful tax competition and take actions to counter tax evasion, avoidance and competition. These actions include strengthening tax administration, consolidating tax collection, computerizing internal processes and hasten operations, sharing of information, following penalty structure, educating the taxpayers, treating tax evasion as an economic crime, removing discretionary powers in tax administration, reviewing the tax legal structure regularly to seal loopholes for tax evasion and avoidance, and enhancing investigation reinforcement in tax administration. The OECD has urged its member states to multilaterally take actions to counter tax evasion, avoidance and competition. These actions include setting up trading blocks like COMESA, EAC, SADC etc., cooperation among Revenue Authorities in a region e.g. East African Revenue Authorities Technical Committee) and KRA/TRA/URA Consultative meetings on anti Smuggling activities across borders, enforcing double tax agreements, encouraging MOUs between countries, exchanging information, and assisting collection of tax by different tax authorities. The OECD has urged its member states to internationally take actions to counter tax evasion, avoidance and competition. These actions include enforcing double tax agreements and transfer pricing rules, adopting anti-money laundering bills (untaxed profit brought as interest free loans), and monitoring tax havens activities. 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