What Everyone Needs to Know about Tax. Hannam James
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any taxes. That's half again more than the basic cost of the Lego and it doesn't even include employers' national insurance.
You can see what's happening here. Lots of different taxes – income tax, employers' and employees' national insurance contributions and VAT – accumulate without the government ever having to admit what the total amount of pain is going to come to. Keeping the tax system complicated suits the government and, if I'm honest, it suits tax accountants like me as well. That's not because accountants are all helping their clients avoid taxes, it is just that calculating what you owe is so difficult that even the smallest of businesses need professional help to get it right.
VAT is an example of a tax that the government tries to keep invisible. When we look at a price tag, it already includes the VAT. The way taxes are collected through PAYE and the VAT system makes sure that, as an individual earner, you rarely have to hand over any money yourself. It is all done for you by your employer and businesses. The happy result (for the Treasury, at least) is that none of us have the foggiest how much tax we actually pay. That means, to some extent, all taxes are ‘stealth taxes’.
There are no taxes quite so stealthy as the so-called green taxes pushing up our heating bills. Nonetheless, increase any tax enough and people start to notice. You may remember the fuel protests back in 2000. These were sparked off by increases of the duty on petrol and diesel.
Chapter 2 of this book is all about VAT, excise duties and green taxes: the taxes you pay on spending. We'll also see how tax gets in the way of free and fair trade, especially if you are a Third World farmer trying to sell your produce into the European Union.
And yet more taxes
As well as raising money, the government likes to use the tax system to encourage what it sees as virtuous behaviour. For example, it wants to promote thrift and provides incentives for us to save. We'll look at ISAs, pensions and other tax-efficient ways of locking your money away in Chapter 3. However, all these encouragements for us to save mean that the idle rich, who already have plenty of money in the bank, can get away with paying very low taxes indeed. They don't even need to resort to complicated avoidance schemes or to become a tax exile.
Capital gains tax applies on profits you make from investing in shares and other assets. Admittedly, you don't have to pay capital gains tax on your main residence when you sell it. But you do have to pay stamp duty when you buy your house, not to mention inheritance tax when you die in it. There is also council tax while you are living there, whether you own your home or not. We'll look at all these taxes onproperty in Chapter 3 as well.
Taxes on businesses
Company taxation has become a vexatious question. Are multinational companies like Google and Starbucks paying their fair shares? It sometimes seems that if the government went after them, the rest of us would have to pay a lot less.
It's true that some multinationals pay little tax in the UK, and the rules have recently been tightened up to deal with this. Remember, though: Google and Starbucks are American corporations so they should pay most of their tax in the USA. In any case, if we tax companies more, that doesn't let ordinary people off the hook. They still end up paying because company taxes are stealth taxes too. Companies all have customers, employees and shareholders. If you have a pension, life insurance policy or an ISA, you probably own shares in some big companies. Any tax on business has to be passed on to real people, so taxing companies is just another way of taxing you, but several levels removed so you are largely unaware of it. In Chapter 4, I'll clear up some of the common misconceptions about corporation tax and explain why many economists now realise that business taxes should be kept as low as possible.
That said, the international tax system is way behind the times. In the modern globalised economy of e-commerce and the internet, ideas (called ‘intellectual property’ in the jargon) are the most valuable things around. But because they are so mobile, taxing ideas is hard work. In Chapter 4, we'll also look at how governments have offered tax breaks for intellectual property to stay put, and how multinationals can move it around the world to keep their tax bills down. Luckily, in the last couple of years, there has been an international effort, initiated by the British government, to ensure that multinationals pay the right amount of tax.
Avoiding taxes
With all these taxes around, it is hardly surprising that some people try so hard to avoid paying them. But this is not often a good idea. The taxman is likely to take you to court if he thinks you are playing the system. And the courts are not sympathetic towards tax avoiders. At least tax avoidance is only likely to cost you money. Tax evaders can end up in prison. By the way, evasion and avoidance are very different beasts. If you evade taxes, you are using fraud to pull the wool over the taxman's eyes. It's illegal and you could be prosecuted. Tax avoidance means using clever ideas to exploit loopholes in the law. It's legal but opinion is divided on the extent to which it is morally defensible. Tax planning is doing what you would have done anyway (if tax wasn't a consideration) but doing it in a way that means you pay less tax. In many cases, the government encourages us to do this because it wants to incentivise certain kinds of behaviour. Most people consider tax planning acceptable, especially when they are doing it themselves. Few of us want to voluntarily pay more tax than we have to. Having a personal pension or an ISA are both examples of sensible planning. That said, the boundary between avoidance and planning is subjective. Not everyone agrees about where it is. Chapter 5 looks at these issues in more detail.
Avoidance is possible because the tax system is awesomely complicated. But simplifying things is much harder than you would hope. So, we'll wind up the fifth chapter by looking at why tax reform is so difficult and why the law is so convoluted.
I started working as a tax accountant over 20 years ago. During the intervening period, I have had the privilege of advising some of the most prestigious and exciting companies in the world. However, you won't read about any of them in these pages. Rather than risk inadvertently giving away confidential information (or even appearing to do so when I haven't), I've steered clear of my own clients. The information in this book is either publicly available or an inference based on what's publicly available. By that, I mean material you can find on the internet (if you know where to look) or in published books. Where I have discussed real-world examples, I've done my best to verify what I've said through official documents. Facts and figures given in the text are current as at 1 January 2017.
I'd like to thank Jonathan Richards, Christopher Barton, Andrew Drysch, Rachel Phillipson and, most of all, my wife Vanessa for their helpful comments on the manuscript. Any remaining errors are entirely my responsibility. Thanks also to John Grogan as well as to Stephen Mullaly and his team at Wiley for all their hard work in turning this book into a reality.
Finally, all the opinions expressed in this book are mine alone. I don't expect that anyone will agree with all of them.
Chapter 1
Taxes on your income and earnings
Income tax and national insurance
Income tax: when you think about tax, that's probably the tax you're thinking about. It was introduced by the Prime Minister, William Pitt the Younger, as a temporary measure in 1798 to fund the Napoleonic Wars. Legally, it's still temporary. Every year, Parliament has to vote for income tax to apply for another twelve months. If ever MPs failed to do so, the government would run out of money and have to shut down.
We all know that the basic rate of income tax is 20p in the pound and the higher rate is 40p. These headline figures are the UK's ‘marginal rates of tax’. When tax experts talk about the marginal rate of tax, they mean the rate you pay on each extra pound of income that you earn. Just looking at income tax, the first £11,000 you earn is tax free so the marginal rate up to this amount is nil. Then it increases to 20 %, the basic rate. When you earn over £43,000 the marginal income tax rate goes up to the higher rate of 40 %. So, if you are paid £20,000 a year, your marginal