What’s the deal with… the Panama Papers furore?

One of the least surprising disclosures from the “Panama Papers” – the leaked documents from the law firm Mossack Fonseca – was the revelation that most of us do not understand the difference between tax planning, tax avoidance, and tax evasion.

Welcome to Panama

Tax planning, which can involve the use of companies based outside the UK, is perfectly lawful. It is the legal use of the tax system to reduce taxes. Indeed the tax system is designed to encourage certain behaviours by making certain arrangements deliberately more tax efficient than others.

Tax evasion, on the other hand, is not legal. It is the escaping of a liability to pay tax by illegal means.

Tax avoidance is the “grey area” where legitimate planning is perhaps taken beyond the spirit of what was intended. Outright deception would be evasion but deliberate obfuscation may fall short of this.

For example, if a freelancer earns £20,000 per annum and fails to declare their earnings to the Revenue, he or she will be evading tax. If they invest their earnings in an ISA they will be seeking to avoid tax. Or, to offer another example, gifting an amount equivalent to the “nil rate band” into a discretionary trust has been a common way of reducing an individual’s liability to inheritance tax in recent years. These forms of tax planning, perhaps because they are so common, have attracted nothing like the levels of outrage that we saw in the wake of the Panama Papers.

What marks out the revelations from the Panama Papers from more “run of the mill” tax planning is that they concerned the use of tax havens. Tax havens – usually islands, such as the Caymans or British Virgin Islands or, closer to home, the Channel Islands – are jurisdictions where tax is typically lower than it is at home and even in many cases nil. Tax havens may also combine the benefits for the tax payer of low or non-existent rates of tax with enhanced levels of secrecy around ownership of assets.

Mossack Fonseca’s clients made prolific use of offshore trusts and shell companies. Offshore trusts help to hide the identity of the owner of assets, typically shares or property. The trustees will be professionally appointed trustees unrelated to the beneficial owner. Shell companies are set up as ordinary companies but exist for the sole purpose of holding assets and, again, they obscure the identity of the true beneficial owner. The company’s management team will be unconnected with the beneficial owner of the company’s assets.

It is true that tax havens, offshore trusts and shell companies may be used for nefarious purposes, such as to facilitate money laundering or terrorist financing, but this is not true in the overwhelming majority of cases, where their use is legitimate albeit may constitute tax avoidance.

The furore from the Panama Papers has increased pressure on the Government to stop the use of tax havens as a means of avoiding tax. Jurisdictions like the British Virgin Islands are Crown dependent overseas territories which means that they are self-governing but that it is also possible for the UK Government to impose tax rules on those territories – although the economic consequences for those territories if it were to do so would be potentially devastating.

Since the Panama Papers the Government, in conjunction with EU partners, has announced measures to share information about the true owners of complex shell companies and offshore trusts and the Prime Minister has reiterated his intention to seek a public register of beneficial ownership in jurisdictions like the Caymans.

The issue of tax avoidance was already something of a political “hot potato” before the release of the Panama Papers with the controversy surrounding Google’s modest tax contribution to the UK coffers and with a number of well-known celebrities having been revealed to have used tax avoidance schemes to minimise their tax liability.

In fact, the current Government had, even prior to the Panama Papers, already taken steps to address tax avoidance. In April this year, provisions of the Small Business, Enterprise and Employment Act 2015 came into force requiring UK companies (and limited liability partnerships) to disclose details of “persons with significant control” (as defined in some detail in the legislation) – although the legislation does not extend to companies in offshore tax havens.

Also, the Government introduced a “General Anti-Abuse Rule” (GAAR) in its 2013 Finance Act, the purpose of which is to counteract “tax advantages from tax arrangements that are abusive”. The GAAR was introduced to strengthen the Revenue’s anti-avoidance strategy and to tackle abusive avoidance, and sits above other parts of UK tax legislation. An arrangement will be abusive under the GAAR if, having regard to the circumstances, entering into the arrangements or carrying them out cannot reasonably be regarded as a reasonable cause of action to take in relation to the relevant tax provisions. Adjustments are made to counteract an abusive tax advantage.

With the GAAR and new rules on UK corporate transparency already in place, the Government is clearly wishing to be seen to be doing something. Whether the Panama Papers forces its hand to do even more remains to be seen.

Simon Concannon is head of tax at Walker Morris