Could some tax beancounter help me out here?

Ritchie\’s tax gap estimations. Just how wrong are they?

As we know, he\’s said that £12 billion is avoided by companies playing dodgy games.

He measures this by looking at the headline rate of tax, subtracting the tax rate actually paid and calls the difference the tax gap.

As I\’ve been saying for some years now, this has a fault in it. That it does not take account of the allowances that Parliament deliberately puts into the tax code to get companies to do what Parliament wants companies to do.

Clearly, one of these is the R&D tax credit. Which, in2010-11 was, according to HMRC, a tax expenditure of £860 million. So there\’s 7% of the tax gap in just that one allowance. For absolutely no one is going to say that using the R&D allowance as the R&D allowance is in fact tax avoidance.

There are other allowances of course. And this is where I need the help, not being expert in these figures. An obvious allowance is capital allowances.

The cost of capital allowances in 2009-10 was £19 billion (of which the annual investment allowance accounted for £1.5 billion.)

Now what does that actually mean? That capital allowances against corporation tax were £19 billion, meaning that we\’ve no tax gap at all as against Ritchie\’s £12 billion?

Or is only that £1.5 billion from corporation tax? Or some other number entirely, somewhere in the middle?

The real question being, we know there are allowances which reduce Ritchie\’s estimation. For his method of estimation did not include such allowances. But how big is that allowances number and thus how small is the tax gap?

12 thoughts on “Could some tax beancounter help me out here?”

  1. The annual investment allowance is just one of the capital allowances. It gives relief to plant bought in that year. There are also writing down allowances for plant bought in previous years, not yet fully relieved against profits.

    But note that the capital llowances figure shown in the report relates to income and corporation taxes.

    That is, companies, partnerships and individuals are all included. What you need is the split of that £19 billion.

    As an side, it’s pretty terrifying that annual investment allowances are only £1.5 billion…

  2. The £19 billion estimate for capital allowances is the reduction in the tax liabilities tax liabilities for the years shown and taking into account the proceeds of sale or disposal of written down equipment.

    The Annual Investment Allowance is one of the capital allowances and gives a 100% deduction for qualifying expenditure in the year in which it is made up to £100,000.

    None of this is exactly tax planning although Mr Murphy seems to think that expenditure on capital goods should not be allowable against taxes on profits, but he is probably in a minority of one there.

    Capital allowances do give a tax “advantage” in so far as the tax allowances are usually made faster than the assets are written off in the accounting books of the tax payer in accordance with their usual depreciation policies (but not necessarily so) but this is hardly the sort of item that should be included in any “tax gap”.

  3. @ Alex

    And my understanding is that the ‘tax advantage’ has to be accounted for as a liability on the balance sheet as deferred taxation – thus taking account of the timing difference.

    This reduction is tax paid cannot be distributed as dividend because the deferred tax provision reduces the retained profits – further undermining the case that capital allowances for plant are a form of tax avoidance.

  4. The problem is that accounting profit and taxable profit are not the same thing. In getting from accounting profit to taxable profit you would need to add back depreciation then deduct capital allowances. So whether taxable profit is higher or lower will depend on the difference between depreciation and capital allowances. However, the problem however will be potentially widespread : there are all sorts of adjustments that are required to get from accounting to taxable profits. Other examples are the substantial shareholding exemption and double tax relief. I’m sure there are many more…

  5. “As an side, it’s pretty terrifying that annual investment allowances are only £1.5 billion…”

    But that is not a measure of the amount of investment, but simply the amount of tax that was reduced by the availability of the allowance. Many small firms will have spent more than £100,000 (£100k = a few large trucks and a bit more) while others may have very little taxable profits in the year that they are spending and growing.

  6. “As I’ve been saying for some years now, this has a fault in it.”

    *A* fault?! Surely “many obvious faults”

  7. @Shiney: Well yes sort of if you think that the whole purpose of business is to milk the company for the benefit of shareholders. Accelerated capital allowances/deferred taxes do give the company an effective interest free loan from the government, even if they can’t distribute it to shareholders. But I would say that is fair enough because if the equipment is bought from a manufacturer then the sales price will be treated as turnover in the accounts of the manufacturer, giving rise to tax on the profits, but only treated as capital expenditure in the books of the purchaser and thus allowable over several years.

    To the extent that equipment purchases are from companies within the UK tax net, the Treasury does not lose out from capital allowances.

  8. The Annual Investment Allowance is the 100% allowance for small(ish) levels of capital investment.

    Both that and the normal capital allowances are available for companies, sole traders and partnerships, so it doesn’t help you split out the company bit.

    To make it more difficult, I think the £19bn is the total tax reduction claimed through capital allowances. What you want for the tax gap is the extent to which that is greater than it would be if they just allowed accounting depreciation.

  9. The main differences between taxable and accounting profits are (i) accounting profit is overstated because depreciation is calculated on the historic cost of assets but then charged in currency debased by inflation and *some* of capital allowances (the Annual Investment allowance) is in the same sort of £ as the cost; (ii) some expenses (e.g. entertaining customers by giving them cup of coffee) are disallowed for tax purposes, (iii) lots of weird accounting conventions such as notional interest cost of deferred payment in shares.

  10. @Alex5

    I am aware of how the AIA works.

    My point was that there is not much capital investment going on, which means that any recovery is not going to happen in the foreseeable future.

  11. “I am aware of how the AIA works.”

    Good

    “My point was that there is not much capital investment going on, which means that any recovery is not going to happen in the foreseeable future.”

    Well do the maths. £1.5 billion is the value of the tax reduction, so gross that figure up by the tax rate, then allow for the fact that the allowed expenditure may only be a fraction of the expenditure by those firms, and then allow for the fact that many firms may not be paying much corporation tax with losses brought forward, and suddenly your £1.5 billion tax figure could be about £15 billion of capital expenditure, and that from the end of business that tends to be less capital intensive.

    Energy, transport and heavy industrial companies that spend the most per unit of turnover tend to be larger companies.

  12. @ Alex
    We all hope you are right but
    @ John Millar
    Some recovery will come when investment picks up without waiting for the returns therefrom

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