Should we ask questions like a 2 year old?RSS icon

Written by David Henderson on Monday 7 January 2013

I was looking forward to the point at which my son would enter the ‘why?’ stage of his development. I optimistically thought it would be great fun to explain to him why the sky was blue, how a combustion engine worked or how to sail a boat against the wind. But I hadn’t been expecting his undeterrable quest for answers would fall on topics I hadn’t considered. His favourite line of investigation goes like this:

Who built our house? Builders.
What were their names? It was 65 years ago, I don’t know their names.
What were the names of the other builders? The ones that did the kitchen were called Frank and Del.
Why? That’s what their parent called them.
Why? ….

The recent revelations surrounding the corporate tax avoidance methods employed by some multinational organisations will have left most people slightly puzzled. If this type of activity is possible and even legal under current law, what difference is regulation like FATCA going to make? Let’s use the questioning technique of a 2 ¾ year old to find out:

Is FATCA about collecting tax? No, it’s about collecting information.

Why are they collecting the information? To find mismatches.
What’s a mismatch? Where two people give different answers to the same question.

What question? “ How much income have you earned?”

Who are they checking it with? The people who received the income and the companies who paid it to them.

Why do they want to check it? Because they’re worried the taxpayers might not tell the whole story and evade tax.
What does “evade tax” mean? Tax evasion means not paying the tax you owe and it’s illegal.

So will FATCA help tell the whole story? Yes, if the company paying the income has enough information to know they should report it.
What if there isn’t enough information to work out if the account should be reported? The account holder will be asked to self certify the correct information.
Will a tax evader’s self certification be accurate? Unless they have a significant change of heart it seems unlikely.
Wouldn’t a false self certification be illegal? Yes, but we’re talking about tax evaders, they are already breaking the law.
So will this help collect more tax? It might raise some additional revenue, but seems unlikely to catch the really big fish who use clever methods to avoid having to pay much tax in the first place.
What’s the difference between avoidance and evasion? Tax avoidance is legal, tax evasion is illegal.
What is avoidance then? Tax avoidance is ensuring that all the laws around tax are used to the advantage of the taxpayer.
Like what? Like investing money in a ISA to avoid income and capital gains tax or sacrificing salary into a pension for individuals to avoid income tax and national insurance.
Why are there laws to allow that? To encourage particular behaviours like saving to help people provide for themselves in retirement.

Are there many of these laws? Lots. Many of them are aimed at companies to encourage foreign investment or new businesses that help grow the economy.
They sound good. Actually a lot of people are upset by big multinational corporations using these laws to avoid paying tax. It is felt they push the ethical limits of the laws, in what has sometimes been labelled aggressive tax avoidance.

Oh. Tax is complicated isn’t it?

On balance it does seem like a good idea for tax authorities to have something to check taxpayer declarations and returns against, after all when it comes to collecting tax if you look after the pennies etc. And clearly the financial services industry is in a position to provide these reports. But catching serious tax evaders and aggressive avoiders is still a law enforcement responsibility and can’t be forced on to the Financial Services industry to save governments money.

Perhaps the most fruitful area for tax collection would be for policy makers to focus on areas being exploited by aggressive tax avoidance; this will require international effort and agreement as FATCA has proven. After all if governments are serious about collecting the taxes that they believe are due to them they need to go further than the equivalent of asking taxpayers if they have been naughty! It might work on a 2 ¾ year old, but when millions or billions of pounds are at stake a smarter approach is surely required.

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