Tuesday, 9 April 2013

How the K2 tax avoidance scheme works case study


There are a lot of rash statements being made about whether or not the K2 tax avoidance scheme used by Jimmy Carr was "legal”. The implication being that if it was not,it was a bad thing to do obviously. And if it was "legal", well that is OK then, even if Prime Minister David Cameron says it was "morally wrong".

Unfortunately, tax is a bit more complicated than that.  Tax evasion is the illegal thing. It happens when people deliberately do not pay the tax they should. It is criminal. Tax avoidance is the arrangement of a taxpayer's affairs in such a way as to pay the least amount of tax legitimately.

A fine line? Some would say so.

How the K2 tax avoidance scheme works

The investigation into individual tax avoidance in the UK said comedian Jimmy Carr used an offshore wealth management scheme so called K2. 
K2 is used by more than 1,000 high earners and was described by Prime Minister David Cameron as "very dodgy." Here is the basic premise of how it operates:

• UK earners 'quit' their job

• They then sign new employment contracts with offshore shell companies

• The offshore companies 'rehire' their new employee to the UK but take their earnings

• The offshore company pays the employee a much lower salary each month, but 'loans' them several thousand pounds

• These loans can be written down as tax liabilities, thus substantially reducing tax payable to the Government . This is how the K2 tax avoidance scheme works. High earners using the K2 Scheme do not keep as much money as is being portrayed.

This is how the K2 tax avoidance scheme works in general terms the actual workings may be slightly different to those described here. The Prime Minister described this way of avoiding tax as “Very Dodgy”. The question is why is it dodgy? It is not illegal or even close to being illegal because it is declared to HMRC every year.

What it is, is very difficult to close down.

If you were to say the government should tax the loans, then everybody would have to pay tax on their mortgage and any other loans that they took out. This has the government in a very difficult position and the only way they can deal with it is by embarrassing people that use this and similar schemes.

This is how the K2 tax avoidance scheme works for individuals and companies and lets not forget the UK is the fourth highest taxed country in the world.

Loophole 

HM Revenue and Customs (HMRC) is referring to K2 in the category of tax avoidance, so let us concentrate on that. Just because a scheme is classed as tax avoidance does not mean it is all right.

Usually, it has to be registered with HMRC, so they can check if it complies with tax rules. If HMRC decides it is not acceptable, then the taxpayer would have to hand over all the unpaid tax along with interest and, possibly, penalties.

Basically, officials treat the underpayment of tax as a mistake. It could be that the scheme takes advantage of some obscure loophole. In that case the tax people would get the Treasury to change the law, but the scheme's users would get away scot free until such an order was made. So the Jimmy Carr ruse is not being talked about by the authorities as illegal, but that does not mean he - and the others who are or were signed up to it - will not have to pay back the tax.

HMRC's (HM Revenue & Customs) line is that K2 is being investigated. Another phrase being bandied about is "tax abuse" which, confusingly, can be applied to both evasion and avoidance. A tax avoidance scheme which HMRC finds to be a blatantly artificial construction to dodge tax could be an abuse.  There will soon be a General Anti-Abuse Rule to deter this sort of dodging. Some accountants say it will "kill it stone dead", others that it will just lead to more complicated disputes. 

How tax shelter schemes work





The K2 tax scheme, a Jersey-based accountancy arrangement, is used by 1,100 people. It works by transferring salaries into a Jersey-based trust, which lends investors back the money. As the loan can technically be recalled, it is not subject to income tax. Jersey is self-governing, with its own financial, legal and judicial systems. It has no VAT in place and sets its own income tax. And low taxation is the reason why the affluent flock to the tiny island.

Income tax is a flat-rate of 20 per cent. Britain, in contrast, charges top earners 50 per cent, although this will fall to 45 per cent next April. Jersey's s Goods and Service Tax (GST) - equivalent to the UK’s 20 per cent VAT - is also far lower at 5 per cent. But beyond that, non-residents have also benefited. An accountancy industry has thrived in what critics say is a lax regulatory environment – finance makes up 41 per cent of its economy compared to, say, 4 per cent for hospitality.

But ‘tax havens’ worldwide, from Bermuda to Liechtenstien, have come under pressure to clean up their act as the cash-strapped U.S. authorities and EU governments try to claw back tax lost to avoidance schemes. Jersey rejects the criticism saying it is a ‘transparent and cooperative jurisdiction’. It calls the perception of it as a tax haven an ‘ancient myth’.
Winston Wambua

International Offshore Specialist
 
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Email: winstonk@live.com
 
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