LECTURE 1: Introduction to Tax

Question 1

What is tax?

Answer 1

A compulsory levy, imposed by the government, or other tax raising body, on either income, expenditure or capital assets, from which the taxpayer receives nothing directly in return.

Question 2

INCOME TAX

Answer 2

A direct tax on the income of individuals and trusts.

Question 3

CORPORATION TAX

Answer 3

A direct tax on the profits of limited companies and unincorporated associations.

Question 4

CAPITAL GAINS TAX

Answer 4

A direct tax on property of individuals and trusts.

Question 5

INHERITANCE TAX

Answer 5

A direct tax on transfers of property by gift or on death.

Question 6

VALUE ADDED TAX

Answer 6

An indirect (or expenditure) tax on goods and services.

Question 7

DIRECT TAX

Answer 7

Levied directly on the person who is intended to pay the tax.

Question 8

INDIRECT TAX

Answer 8

Borne by a person other than the one from whom tax is collected.

Question 9

Who administers the UK tax system?

Answer 9

Her Majesty’s Revenue and Customs (HMRC). Most of the day-to day work is carried out by Officers of Revenue and Customs.

Question 10

What are Officers of Revenue and Customs responsible for?

Answer 10

• The issue of Tax Returns
• The calculation of tax
• The checking and repair of tax returns
• Collection of tax
• Representing HMRC in appeals

Question 11

Where are appeals against tax assessments which cannot be resolved between the taxpayer and the Officer of Revenue and Customs referred to?

Answer 11

• the Tax Chamber of the First Tier Tribunal, then
• the Finance and Tax Chamber of the Upper Tribunal, then
• on a point of law only, the Court of Session (Scotland), then
• the Court of Appeal, and ultimately
• the Supreme Court

Question 12

What are the two main source of tax law?

Answer 12

Statute

Case Law

Question 13

What are the main tax acts? (statute)

Answer 13

• Capital Allowances Act 2001
• Income Tax (Earnings and Pensions) Act 2003
• Income Tax (trading and other income) Act 2005
• Income Tax Act 2007
• Corporation Tax Act 2009 and 2010
• Taxation of Chargeable Gains Act 1992
• Inheritance Tax Act 1984
• Value Added Tax Act 1994
• Taxes Management Act 1970

HMRC also produce Statements of PRactice, Extra Statutory Concessions, press releases and leaflets. They are not legally binding.

Question 14

What are the objectives of the tax system?

Answer 14

• To raise revenue required to provide public goods.
• Redistribution of income and wealth - UK has progressive system of tax, not everyone pays the same rate of tax.
• To regulate the economy - tax system encourages us to be environmentally friendly, want to encourage us to save money, tax relief for pensions.
• To provide harmonisation - moves to harmonise the tax system across EU, EU VAT scheme, corporation tax.

Question 15

What four canons of taxation did Adam Smith propose in his book The Wealth of Nations (1776)?

Answer 15

• Equity (fairness)
• Certainty (about tax liabilities)
• Convenience (retiming and method of payment
• Efficiency (cost of collection is small in proportion to revenue raised and distortionary effect on the behaviour of tax payers is avoided)

Question 16

EQUITY

Answer 16

Adam Smith: “the subject of every state ought to contribute towards the support of the government as nearly as possible in proportion to their respective abilities; that is in proportion to the revenue which they respectively enjoy under the protection of the state.”

Practical problems arise if the tax system is perceived as inequitable, e.g. an increase in avoidance and evasion.

Question 17

HORIZONTAL EQUITY

Answer 17

Treating equal people in equal circumstances in an equal way.

Question 18

VERTICAL EQUITY

Answer 18

Treating different people in different circumstances in a different way.

Question 19

AVOIDANCE

Answer 19

The manipulation of one’s affairs within the law in order to reduce tax, referred to by accountants as “tax planning” or “tax mitigation”.

Generally, the UK tax law allows a taxpayer to use the letter of the law to his or her best advantage, but there are some legal arrangements which are so artificial that the courts will see them as being more akin to evasion.

The increasing legal complexity which is necessary to reduce avoidance also reduces comprehensibility.

Question 20

EVASION

Answer 20

The illegal manipulation of one’s affairs to reduce tax.
Although by its very nature very little is officially known about it, studies suggest that it’s fairly widespread, particularly in certain areas.

Question 21

What are the effect of evasion?

Answer 21

• Both (non-) compliance costs to the private sector in taking advantage of opportunities available, & administrative costs to the public sector trying to hinder them.
• Traders who evade taxes have a price advantage over honest traders.
• Increase in the amount of tax required from those who do pay.

Question 22

Why are avoidance and evasion on the rise?

Answer 22

Become more attractive as tax rates rise. It becomes worthwhile to take greater risks and to spend time and money on seeking advice and performing complex tax planning.

Question 23

CERTAINTY

Answer 23

Per Adam Smith:

• “the tax which each individual is bound to pay ought to be certain, and not arbitrary.”
• the certainty of what an individual ought to pay is, in taxation, a matter of so great importance that a very considerable degree of inequality… is not so great an evil as a very small degree of uncertainty.”

Certainty is often aligned with simplicity. A simpler tax system should enable taxpayers to be more certain about the calculation of their liabilities.

The Office of Tax Simplification (OTS) gives independent advice to the government on simplifying the UK tax system.

In order to simplify the system and to counter the more aggressive avoidance schemes, a General Anti-Abuse Rule (GAAR) has now been enacted.

Question 24

CONVENIENCE

Answer 24

Deduction of tax at source, including PAYE, is an attempt to aid convenience. However, there are costs to businesses of collecting the taxes.

Question 25

EFFICIENCY

Answer 25

i.e. cost of collection is small in proportion to revenue raised and distortionary effects on the behaviour of taxpayers is avoided.

Question 26

What can cost of collection be split into?

Answer 26

1) Administration costs: costs to the public sector
Adam Smith (1776) referred to the “great number of officers” required to levy the tax.
Easy to measure, but must include wages, salaries, materials and all overheads, and to be meaningful should be expressed as a percentage of revenue collected.

2) Compliance Costs Costs to the private sectors.
The “hidden costs of taxation” (CT Sandford, Institute for Fiscal studies 1973)

Compliance costs include money spent on accountants & tax guides, taxpayers’ time spent in complying, and also mental costs to the taxpayer, per Adam Smith “certainly equivalent to the expense at which every man would be willing to redeem himself from it”. They also include costs to 3rd parties (family, friends) and costs to businesses of acting as unpaid tax collectors.

Question 27

POLL TAX

Answer 27

everyone pays a fixed sum

Question 28

PROPORTIONAL TAX

Answer 28

everyone pays tax at a given rate

Question 29

PROGRESSIVE TAX

Answer 29

bands of tax, rate of tax increases as income increases.

Question 30

AD VALOREM TAX

Answer 30

varies according to value or price

Question 31

UNIT TAX

Answer 31

charged per unit, e.g. per packet of cigarettes

Question 32

HYPOTHECATED TAXES

Answer 32

taxes raised to provide designated benefits

Question 33

TAX BASE

Answer 33

what, broadly, the tax is levied on, e.g. income, expenditure or wealth