Introduction to Taxation and Objectives of Taxation Flashcards
What is Tax
It’s a compulsory payment to the government based on income, expenditure or capital assets. There is no direct return for the payment
The 6 Objectives of Taxation
Public Goods - Funds NHS, police etc, so they’re generally free to use
Income & Wealth Distribution - Reduces wealth inequality (depending on government)
Social Welfare (Merit Goods) - Funds essential services like healthcare
Economic Stability - Manage inflation, spending and stimulates growth
Regulation - Discourage harmful behaviour (tobacco tax)
Trade Harmony - Previously aligned with EU VAT rules
What’s the History and Evolution of Taxation
Past (200+ ago) - Taxes based on physical assets like hearth tax (fireplace), land tax, window tax (bricked windows)
Shift - From asset based to income/ spending based taxation
Modern Taxes - Main source of tax comes from income (employment) through National Insurance Contributions, consumption through VAT
Classification of Taxes by Tax Base
(Profit based)
Income Taxes (IT) - Paid by individuals on their wages, property, business profits
Corporation Tax (CT) - Paid by companies on their profit (for corporate structure)
(Asset value based)
Capital Gains Tax (CGT) - Tax on profit from selling assets
Inheritance Tax (IHT) - Tax on estates when they die above a threshold
(Based on Spending)
Value Added Tax (VAT) - Tax on goods/service (in the UK, a significant source of revenue for gov)
Excise Duties - Taxes on specific goods (alcohol, fuel, tobacco)
Classification by How the Tax is Raised (Who is legally responsible to pay tax to gov)
Direct Taxes - Taxes paid directly by the individuals/ businesses (IT, CT, CGT, IHT)
Indirect Taxes - Collected by businesses instead and passed to government (VAT, a hidden tax, you pay the tax but government collects it to gov)
Classification of Distribution of Tax Burden
Progressive Taxes - Higher income = higher % paid in tax (UK Income tax)
The marginal tax rate is higher than the average tax rate
Proportional - Same % for all regardless of income level (Stamp duties, tax paid on assets like property, flat tax, not income based)
Regressive Taxes - Lower Income = Higher tax burden
Marginal tax rate is less than the average tax rate (VAT, low income ppl spend their income on goods/services subject to VAT)
5 Desirable Characteristics of a Tax System (Adam Smith’s Canons of a Good Tax) ECCEF
Equity (Fairness) - Everyone should contribute to the support of Gov, reducing tax avoidance
-Horizontal: Similar individuals are taxed similarly (hard to define similar, earned/ investment, timing)
-Vertical: Different incomes taxed differently (hard to decide what levels are different at what rates
Certainty - Tax obligations have to be clear and predictable with timing and manner for both parties (direct more than indirect)
Convenience - Taxes should be easy to pay (e.g. UK’s PAYE, tax deducted before wages)
Efficiency - Minimal collection/ admin costs, system shouldn’t distort economic decisions for tax payer
Flexibility - Tax system should adapt to economic changes (UK tax revenue increases with wages)
-be wary of quick decision to avoid a negative economic reaction
Equity in Taxation - Two Traditional Approaches (BA)
Benefit Approach - Pay tax in proportion to benefits received from public services (more you benefit, more you pay)
-hard to measure benefit
Ability to Pay Approach - Higher earners pay more taxes (progressive system, vertical equity)
- equality of sacrifice, £1 tax for £25K isn’t the same for £10K
What’s the Tax Gap (Why does it Matter)
It’s the difference between expected tax revenue (HM Treasury) and the actual tax collected
It matters because:
-it reduces funding for public services
-shifts burden to compliant taxpayers, which undermines equity
-erodes trust in the tax system
2022/23 - 4.8% total tax due (£36bn)
Tax Gap by Tax Type
VAT: 36% (largest share; indirect tax leakage)
IT/ NIC/ CGT: 41%
CT: 11%
Excise Duties: 9%
Other: 3%
Tax Gap by Culprit Group
Small Medium Enterprises: 44% (largest contributor)
Large businesses: 27%
Individuals: 13%
Criminals: 16%
Tax Gap by Behaviour
Hidden economy (cash in hand, undeclared work - 17%
Criminal Attack (Fraud claims) - 16%
Legal Interpretation (Disputes over tax law meanings) - 13%
Non-payment (unpaid tax) - 12%
Failure to take care (errors on returns) - 12%
Evasion (falsifying records) - 12%
Avoidance (exploiting loopholes) - 9%
Error - 8%
What’s Tax Avoidance
It’s using a legal loophole to reduce taxes
Can be done through offshore management businesses
Consequences are fines/ reputational damage
It’s aggressively frowned upon
What’s Tax Evasion
It’s a deliberate fraud (illegally hiding income, from HMRC)
For example, undeclared cash earnings, fake losses
Consequences are criminal charges and imprisonment
It’s universally condemned
What’s Tax Planning
Its arranging your business structure or timing of events to minimise tax liabilities
For example, using a limited company structure or disposing assets in separate tax years to enable annual exemption to be claimed
5reasons why the Tax Gap Exist
Complex laws - Errors + disputes over interpretation
Hidden Economy - Cash transactions (17% of gap)
Loopholes - An avoidance scheme (e.g. K2, off shore earnings)
Non Compliance - SMEs (44%, struggle with admin
Criminal Activity - Fraud (16%)
What are the 5 Implications of the Tax Gap (TRUDG)
Trust decline - Public perception worsens
Revenue loss - less funding for public services
Unfairness - Compliant taxpayers have to pay more (undermining equity)
Distortion - Avoiders gain competitive edge
Government Intervention - Changing laws, enhance collection efficiency, stricter HMRC enforcement
(COPID) The 5 Fundamental Ethical Principles (ICAEW/ International Standards)
Confidentiality - Protect client info unless legally obliged to disclose, e.g. spouse demanding partners tax details = refusal
Objectivity - Avoid bias/ conflict of interest, e.g. cant advise both divorcing spouses
Professional Behaviour - Comply with laws, avoid actions discrediting the job, e.g. advising illegal tax evasion is a breach
Integrity - Honesty and straightforwardness in all dealings, e.g. if client asks to underreport income, decline
Competence/ Due Care - Maintain expertise and act diligently, e.g. misapplying tax laws due to lack of knowledge is negligence
Ethical Threats and Mitigations (SSAFI)
Self Interest - Your financial/ personal bias
- disclose those interest; undergo independent review
Self Review - Auditing your own work leads to over trust
-must separate teams for audit advice
Advocacy - Overpromoting a client leads to lost objectivity
- must clarify role as an advisor, not advocate
Familiarity - Close relationship with client leads to leniency in reviews
- must rotate client teams and get second opinions
Intimidation - Pressure to act unethically
-document the threat, alert seniors
Professional Conduct in Relation to Taxation (PCRT) for Tax Planning (4)
Lawful - No exploitation of loopholes (schemes like K2)
Transparent - Disclose arrangement to HMRC
Client Specific - No ‘one size fits all’ avoidance
Parliament’s Intent - Avoid artificial arrangements contrary to policy goals
5 Steps to Resolving Ethical Conflicts
Identify - Facts, parties and ethical issue
Assess - Relevant principles (confidentiality vs public interest)
Consult - Internally/ legally
Document - Decisions and rationale
Act - Refuse involvement if unresolved (withdraw)
What do you do if a Client asks to alter tax return
Refuse, then report if there is evidence of evasion
If you refuse to report, you violate the principles of integrity and professional behaviour
If HMRC requests confidential client data?
Only disclose if your are legally compelled to
Failure to act corrects violates the confidentiality principle
If you advise competing clients
Decline as an advisor or implement strict confidentiality
Failure to do so violates the objectivity principle
If a client has overpaid HMRC (error)
Notify HMRC, then repay the excess
Failure to do so violates integrity
3 Consequences of Ethical Failures
Professional - Fees and suspension and expulsion
Legal - Prosecution for aiding evasion
Reputational - Loss of trust from firms and individuals
