The Hindu Business Line : Tax secrets may well hide in the reporting gaps and crevices

CAPTAINS of industry have been lobbying with the Finance Minister for one sop or the other. There are no great hopes that all their wishes will fructify in the forthcoming Budget, yet a general impression, as in many other countries, is that corporates come heavily under the taxman's axe.

"The tax charge in a set of company accounts is one of the last corporate myths," writes Richard Murphy FCA on www.thetaxgap.com. "Tax accounting is complex. It involves knowledge of: Tax; tax rates; accounting; cash flow; deferred tax; provision accounting. After that, it still requires a considerable amount of judgement and experience to understand the result," he explains.

The agenda of Tax Gap is to check the validity of the `wide variety of claims' about the burdens of taxation in the context of UK companies, as follows: Tax burden is increasing; burden of other taxes too on companies is rising; and there is no such thing as the `tax gap', meaning "the difference between what society expects them to pay in tax and what they actually pay".

The first report on this theme was out on January 15, 2006, and it is titled `Mind the Tax Gap'.

The 53-page report is based on "a review of the accounts of the 50 largest companies in the UK (the `FTSE 50'), as valued by the London Stock Exchange in March 2005".

For this, 238 sets of financial statements during the period 2000 to 2004 were studied and `30,000 pieces of data' extracted on accounting, general trading and employment issues, and `hundreds of thousands of calculations' performed.

A similar exercise may be necessary closer home too.

Tax gap defined: The report cites a few definitions of tax gap. It is "the difference between what taxpayers should pay and what they actually pay on a timely basis," according to the US Internal Revenue Service (IRS). "By their reckoning, the US tax gap is about $330 billion a year." The UK's taxman, HM Revenue & Customs (HMRC) defines thus: "The tax gap measures the amount of tax we ultimately fail to collect, or, alternatively the amount of uncorrected non-compliance."

Tax gap is a broad economic problem consisting of twenty (gasp!) component gaps, says the report. These include: Revenue gap ("what a tax authority expects to raise in tax given current levels of economic activity, and what it actually raises in taxation revenues"), proportionate gap ("proportion of income paid in tax by the best off in a society, and the proportion of income paid in tax by the worst off in a society"), poverty gap ("after tax incomes of the rich and the poor in a society"), reporting gap (hinging on disclosures), expectation gap ("the headline or declared tax rate for companies, and the rate of tax they actually pay"), and responsibility gap ("duty of care towards a country that a taxpayer is expected to show when declaring their taxation liabilities, and the duty they actually display in their actions"). The rest are about gaps in trust, transparency, corruption, efficiency, and so forth.

Companies are not paying due tax! What are the report's findings? One, the top 50 companies paid "an average of 5.7 per cent less corporation tax than expected rates from 2000 to 2004". Two, "this `expectation gap' increased from 4.2 per cent in 2000 to 7.6 per cent in 2004". Three, over 5 years under study, "these companies have thus paid £20 billion less tax on their profits than expected rates would suggest appropriate".

Four, in 2004-05 alone, the estimated `expectation gap' (from the top 50 companies) constituted around £4.6 billion in lost tax revenue (which was 60 per cent of the tax due in the UK). And five, "extrapolating across all UK companies, the report finds that the likely total UK `expectation gap' may be as much as £9.2 billion a year: about 28 per cent of corporation tax receipts in 2004-05."

How does the gap happen? After examining published accounts, the report suggests the following significant reasons: One, "many companies declared tax liabilities on their profit and loss accounts which suggest that they are paying tax at higher rates than those required by UK law.

This is misleading because those provisions include significant charges for deferred tax, much of which is not paid, and because pre-tax profits declared on profit and loss accounts are not the basis used for calculating a company's taxation liabilities."

That is a common problem, as you know, because accounts for tax purposes are different from those drawn up for satisfying company law. What the report highlights is that deferred tax provisions of the top companies has been increasing by £3 billion a year since 2002, with no indication that this tax will ever be paid. "£36 billion of deferred tax is owed in all by the companies surveyed and they provide no indication of when this might be due. This has in effect allowed companies to enjoy the benefits this sum as if it were an interest-free loan from governments with no set date for repayment."

If that gap disturbs you, here's more: "Too many other explanations for companies not paying the tax that is expected of them are hidden within their accounts in ways that prevent interpretation." The report calls this `reporting gap'; which is the gap "between the information that a reasonable user of a set of accounts needs to understand the tax that a company should pay, and the information they get that explains the tax that the company does pay".

So, if you always fret at your inability to figure out the published accounts, you aren't alone.

Citing the popular debate on how the United Nation's Millennium Development goals are to be financed, the report notes that since the world needs £28 billion a year to wipe out poverty, "if all UK companies paid the tax that was reasonably expected of them they could, by themselves contribute one third of the sum required to change the world forever."

Accountants' role in tax injustice

ANOTHER must-read report is `Tax us if you can', a September 2005 briefing paper from Tax Justice Network (www.taxjustice.net). "The one per cent of the world's population who hold more than 57 per cent of total global wealth use these havens to escape taxation. The sheer scale of the lost tax revenue this implies for governments around the world — some $255 billion each year — beggars belief," says the site.

The 78-page document is sub-titled, `the true story of a global failure', and it focuses on revenue loss arising from the use of tax havens. Tax havens are a root cause of tax injustice, declares the report. "Accountants have played the largest part in promoting tax injustice. Much of the planning that has created the current environment of tax injustice took place within the British commercial and legal environment in which accountants rather than lawyers tend to be at the forefront of tax advice," charges the report.

"Accountants have increasingly organised themselves into transnational companies or partnerships, largely driven by the need to be able to audit their transnational client companies under the statutes of most developed countries."

Of interest are: A map of hotspots that the report shows, plotting tax havens across the world; "the leaked Instructions to the Offshore Invoicing at Volcafé"; and the glossary of terms.

Organised gangs in fraud

A POSTING dated January 16 on www.accountingweb.co.uk reads `Organised gangs commit majority of Tax Credit frauds'. It has a link to a Q&A on www.publications.parliament.uk. "HMRC uses a number of sophisticated tools to help detect claims, which are fraudulent or wrong and wherever possible, this compliance activity is aimed at preventing these claims from being paid," says Dawn Primarolo, Paymaster General, in the UK House of Commons.

"In 2004-05 HMRC intervened on 17,164 incorrect claims before the tax credit payments were made where fraud or error was suspected. Between April to end of November 2005 HMRC have made 38,924 such interventions, of which HMRC estimate over half have been as a result of organised attacks. From October 2004 to end of November 2005 HMRC also identified and stopped 22,284 tax credit claims in payment, where organised fraud was suspected."

The next poser to the Chancellor of the Exchequer reads, "How many under 16-year-olds fell pregnant in (a) London and (b) each London borough in each year since 1997?" Answer is that the information requested falls within the responsibility of the National Statistician.

AccountSpeak@TheHindu.co.in

D. Murali

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