Memorandum submitted by The Chartered
Institute of Taxation
This paper sets out the matters which the CIOT
considers should be dealt with in the next Budget and Finance
This year, we focus our attention on the rapidly
increasing complexity of the tax system and the burdens this imposes
on businesses large and small, and on individuals trying to complete
their tax returns. The system has become so complex that we believe
that it is in danger of serious malfunction due either to the
inability of the tax authorities to administer it effectively,
or to the inability of taxpayers and businesses to understand
their rights and obligations under it, or both. Accordingly, we
think that a fundamental review is required leading to the repeal
of unnecessarily complex provisions and the simplification of
Above all, there is an urgent need for the Government
to stop making the system even more complex.
As noted above, there is a growing recognition
that the tax system has become so complex that it has got completely
out of hand. Complexity in the tax system arises from:
narrowly targeted tax charges and
reliefs which take up a lot of space in the statute book to tax
or relieve only a restricted class of beneficiaries;
provisions hedged with complex conditions;
small differences in a tax charge
or relief for different, but similar, situations;
the manner in which the legislation
differences between the text of UK
legislation and the EU directives which are being given effect;
legislation which remains unconsolidated
for long periods (a particularly acute example being Stamp Duty,
first introduced in 1891 and not comprehensively consolidated
It is a common complaint that some legislation
is drafted in a manner which reduces even the simplest scheme
to a quagmire of incomprehensibility (eg the reduced rate of VAT
for building conversions introduced by FA 2001). Parliamentary
Counsel must keep the users of legislation at the forefront of
his/her mind when drafting legislation. The legislation must be
clear and precise, but it must also be readable. There have been
far too many examples of user-unfriendly legislation in recent
We are concerned that the system has become
so complex that individual taxpayers have great difficulty in
understanding how their tax liabilities are calculated, and the
Inland Revenue are struggling to cope with the volume of work.
One change which we have urged on the Government
in previous years is the simplification of the income tax rate
structure. In particular, there seems no point in having a lower
rate and a basic rate only two percentage points apart. The consolidation
of these two rates into a unified rate is the single most important
change which would simplify the calculation of income tax liabilities
for individuals and reduce the 32-page tax calculation guide by
several pages. The starting rate is a source of further complexity,
since investment income which suffers tax deductions at source
has the "wrong" rate deducted, leading to numerous small
As regards Capital Gains Tax, the replacement
of indexation relief by taper relief in 1998 and the amendment
of the definition of business assets in 2000 have added enormously
to the complexity of the computation of gains on assets acquired
before 6 April 1998. Given that Capital Gains Tax, which was introduced
in 1965, was rebased in 1982, the opportunity should have been
taken to rebase it again in 1998. There would be no need to rebase
for companies, so the cost to the exchequer would be minimal.
A further rebasing is now long overdue.
Other suggestions for simplification are set
out in separate papers.
Tax Law Rewrite
We welcome the review and "simplification"
of tax law being undertaken by the Tax Law Rewrite project, but
are aware that the project's remit is to rewrite existing legislation
with no major changes to the law itself. When the project's work
identifies areas where a change in the law would produce a straightforward
real simplification, we would like to see such changes in law
being directly considered in the next Finance Bill. We are aware
that such areas are specifically identified from our own involvement
in the consultation process but there is little evidence of their
feeding through to any Finance Bills.
Codification of the law relating to intellectual
property and other intangibles
Given that considerable progress has been made
in designing the new system, we trust that the legislation will
appear in the Finance Bill 2002.
The boundary lines between the reduced, standard
and zero rates, and between those rates and exemption from tax,
have become enormously complex. What is particularly worrying
is that the resulting liability boundaries arise in trade sectors
where there are many small businesses: property development, building
services and catering. We consider that a thorough review is necessary
to simplify both the liability boundaries and the manner in which
the legislation is written. We cite three areas where there is
Sale and letting of land and buildings
This is one of the most complex liability provisions
in VATA 1994.
Sales and lettings may be taxed at the standard
rate or zero rate or be exempt from tax. Furthermore, exemption
from tax may be waived in some (but not all) situations so as
to give rise to a charge to tax at the standard rate. Under current
legislation, it is necessary to distinguish some 38 different
factual situations in relation to freehold sales and 70 factual
situations in relation to lettings. In addition there are some
13 special situations where rights, interests and licences are
taxed at the standard rate ((a)-(m) of Item 1 in Sch 9 Group 1).
Further factual situations will arise when an order is made following
enactment of the urban regeneration provisions in FA 2001. This
is clearly an area where some simplification is necessary.
Construction, alteration and renovation of buildings
Certain supplies relating to the construction
and alteration of buildings are zero rated. There are three "Items"
in Sch 8 group 5 and these are amplified by 24 "Notes".
There are a further three "Items", supplemented by 11
"Notes", in Sch 8 group 6. These zero ratings are qualified
by the provisions of Sch 10 paras 1 and 5-8.
Certain supplies relating to buildings are charged
at the reduced rate under new Sch 7A Groups 2, 3, 6 and 7 VATA
1994. Group 3 contains 10 Items, amplified by 5 Notes.
Other supplies are standard rated.
Once again, therefore, there are a large number
of different factual situations which need to be taken into account
in determining the rate at which services are taxed. The difficulty
is increased by the appalling manner in which the reduced rate
legislation was drafted in FA 2001. Quite how small jobbing builders
are supposed to find their way around the resulting maze is something
of a mystery.
In principle, food of a kind used for human
consumption is zero rated under Sch 8 Group 1. There are two classes
of exception. The first class excludes food supplied in the course
of catering, food supplied for consumption at the place where
it is supplied and hot takeaway food. The second class excludes
food of a specific description divided into seven classes ("the
excepted items") to which there are exceptions which are
again divided into seven classes ("the items overriding the
The resulting liability boundaries have given
rise to a considerable body of case law without providing definitive
boundaries between food which is zero rated (because it falls
outside the exceptions, or within both the exceptions and the
items overriding the exceptions, without falling into the first
class) or standard rated (because it falls within the excepted
items without being included in the items overriding the exceptions,
or because it falls within the first class).
The payroll burdens
The increasing use of the tax system to deliver
the Government's social policies continues to place additional
burdens on employers. This burden has been increased markedly
in recent years by the addition of:
statutory sick pay and maternity
collection of student loan repayments;
working families tax credit;
construction industry scheme;
personal service company legislation;
administration of stakeholder pensions
for all but the very small businesses.
For example, the difficulties experienced with
statutory sick pay featured in the original Bath Report, but nothing
has been done to remove or reduce them. The difficulties experienced
with maternity pay are illustrated in the DTI's Green Paper issued
last December. Problems with the personal services company legislation
have already been discussed at length.
As regards P11D returns, the complexity of the
new car benefits rules will add considerably to the overall burdens
associated with payroll operations, only partially offset by the
removal of the need to ascertain employees' business mileage.
We believe that these payroll burdens have become
oppressive for small businesses and are in need of urgent action.
We look forward to seeing the results of the review announced
in the recent paper "Enterprise and the Productivity Challenge"
and hope that it will address some of these issues.
The "cliff-edge" VAT registration problem
The 1998 consultation on registration limits
highlighted what has become known as the "cliff-edge"
problem. This arises when a taxpayer selling mainly to the public
crosses the registration threshold. Prices must be increased by
17.5 per cent if the taxpayer is to recoup the VAT which he/she
must account for to Customs and Excise. A price increase of this
level is often impractical as the taxpayer's prices would be out
of line with those of unregistered competitors and he/she would
lose custom if he/she did so.
Thus, a smaller price increase (or even no increase)
is made with the result that the taxpayer pays all or part of
the VAT out of his/her own pocket. The ability to recover input
tax is largely illusory as service traders such as hairdressers
incur very little.
The consultative document foreshadowed in the
Pre-Budget Report (November 2000) and re-affirmed in the Budget
(March 2001) was published on 18 June 2001. While we welcome the
flat rate scheme in principle as a means of simplifying the compliance
problems of small businesses, we regret that it does nothing to
alleviate the cliff-edge problem. Indeed, the problem is described
in the consultation document as "an ongoing cash flow and
compliance burden on businesses which small firms can find especially
difficult" (see Easing the Impact of VAT: Consultation on
a Flat Rate Scheme for Small Firms (June 2001) para 2.9, emphasis
supplied). As indicated above, the cliff-edge problem is a tax
burden problem, not a cash flow one.
The introduction to the consultation document
states that the Government is "committed to do more to help
small businesses manage their entry into the VAT system"
(para 1.2). The true cliff-edge problem is a genuine disincentive
to the expansion of small businesses, particularly those in the
service sector, and to anyone wishing to emerge from the shadow
economy. We urge the Government to introduce measures to alleviate
Disposals of substantial shareholdings
The consultative document on large business
taxation is a good illustration of the effectiveness of the consultative
process if all parties are receptive to different views. The original
proposals for deferral would have been very difficult to operate
in practice given the need for complex anti-avoidance provisions.
The proposed use of the exemption method in this consultative
document is a clear statement that for policy to be effective
it must be simple in its implementation; if not, taxpayers will
be unable to rely on it in their decision making process and the
purpose of the policy will be frustrated.
Double taxation relief
The rules governing relief for underlying tax
are now enormously complicated. Further, the problem of "tainting"
has not been dealt with despite extensive discussion. The subject
of DTR on company dividends needs a proper review. The discussion
in the above consultative document should be used as an opportunity
to debate publicly detailed economic and structural aspects of
our credit system. Clarity in the taxation of foreign dividends
is key to the continued globalisation of UK business.
Quarterly instalment payments
The present system, which is based on estimates
of current year profits, is unworkable in principle, since no
company is able to predict its profits and capital gains in advance.
It involves the Revenue acting in a quasi-banking role and undermines
the principle of being able to compute tax liabilities on the
basis of facts rather than speculation and then to pay the right
amount of tax at the right time. We think that the system of QIPs
should be based on the liability of the preceding accounting period.
Dependent subsidiary legislation
A growing number of our members have expressed
serious concerns as to the operation of the dependent subsidiary
legislation (s79, FA 1988). Broadly, the legislation counters
the potential for manipulation of the value of employee shares
by artificially increasing the value of the subsidiary company
in question (for example, by trading with it on a non-commercial
basis). The legislation imposes income tax charges on the employee
shareholders in question.
However, the legislation extends its effect
more widely than the mischief that it seeks to counter. For example,
in circumstances where all of the conditions for exclusion from
the effects of the legislation are in principle satisfied, unlimited
tax liabilities may nevertheless arise to employees purely by
reason of a failure by the directors of the parent company to
certify within two years of the end of the accounting period that
this is so. In practice, many of those caught by this rule, and
in particular those with foreign parent companies, are simply
not aware of it until it is too late. The effects of the legislation
are therefore extremely harsh and represent a disincentive for
business to operate in the UK. The removal of the penal effect
on the unwary, while preserving the deterrent effect of the legislation,
is likely to be straightforward and would create a simpler and
fairer environment for business and encourage wider employee share
Gains on employee share options, and section 144A
We recommend that the legislation that deals
with gains realised by employees in respect of shares and share
options be made more practical and less penal. Indeed, there is
a strong case for section 144A to be repealed altogether.
The section has its origins in the days when
the "notional payment" rules only really applied to
payments made through exotic national insurance avoidance schemes.
The tight time limits and harsh penalties (creating an income
tax charge of up to 56 per cent) associated with this section
could therefore be justified.
Now that this section applies to shares and
to share options that are part of normal commercial arrangements,
the penal provisions are out of place. In addition, the tight
time limit that applies to this section is not practical for payrolls
that operate on a monthly basis.
Abolition of the Schedular system for companies
This is something which we have advocated in
another paper. This may be distinguished from the Government's
proposal to base the tax liability of small companies on accounting
profits, since the main benefits would lie with the elimination
of the complex loss set-off rules for different types of income.
In meetings with the Revenue, it has become
clear that the technical change which would reduce significantly
compliance costs for large and medium-sized businesses would be
the removal of the limit (currently £12,000) on capital allowances
for so-called expensive cars and the corresponding limit for leased
cars. The opportunity to implement this change presents itself
in April 2002, with the introduction of the new system for computing
benefits on company cars. This change would ensure that standard
fleet cars are not subject to a restriction on the timing of capital
allowances or to a disallowance of rentals which involves the
preparation of copious back-up schedules for car fleets. The problems
would, of course, disappear if accounting profits were used as
a measure of taxable profits.
We have argued elsewhere for the general abolition
of withholding tax on interest and royalties.
Forex, financial instruments and loan relationships
The CIOT has not had the opportunity to consider
the consultative document issued on 26 July 2001 on corporate
debt, financial instruments and foreign exchange gains and losses.
It is key that when reviewing the ultimate form of the new legislation
the position will not be worsened rather than improved. In particular
there are many unsatisfactory features of the current legislation
which create uncertainty and which will worsen the overall legislation
if extended wholesale.
Tax nothings and the capital/revenue distinction
Once the major substantial shareholdings and
intellectual property reforms are enacted, the Government should
announce a review of business expenditure which goes completely
unrelieved in the tax system, such as payments to escape onerous
leases. There seems no policy reason why such expenditures should
not attract relief once payments to escape onerous debt or royalty
obligations clearly do so.
Gifts of shares and securities to charities
In line with the Government's objectives of
encouraging charitable giving, we think that the provisions of
section 587B ICTA 1988 should be extended to include unquoted
shares and securities.
VAT PROBLEMS AFFECTING
Directly effective EU legislation
Some provisions of Directive 77/388/EEC (the
Sixth Directive) have not been implemented, or have been incorrectly
implemented, in the UK legislation. In consequence, taxpayers
must rely on the courts or tribunals applying the principle of
"direct effect" so that relief is given by reference
to the terms of the Sixth Directive rather than by reference to
the terms of contrary UK legislation. We give four examples.
First, in relation to the exemption of insurance
services in VATA 1994 Sch 9 Group 2: Items 1-3 of Group 2 were
overridden in Card Protection Plan Ltd v Customs and Excise Comrs
 STC 174, HL, and Item 4 in Century Life plc v Customs and
Excise Comrs  STC 38, CA, by art 13B(a) of the Sixth Directive.
Secondly, in Prudential Assurance Co Ltd v Customs
and Excise Comrs (2001) VAT decision 17030, the tribunal held
that VATA 1994 Sch 9 Group 5 Item 9 was unduly restrictive vis
a" vis art 13B(d)(6) of the Sixth Directive by restricting
the exemption of management services to those performed by the
"operator" of an authorised unit trust scheme or trust
based scheme. In Business Brief 6/01, 18 April 2001, Customs and
Excise announced that they "do not accept that businesses
are entitled to exempt sub-contracted management services"
and have appealed to the Court of Session.
Thirdly, in relation to the place of supply
provisions in VATA 1994 s9: the Sixth Directive was given effect
by the court in Customs and Excise Comrs v Chinese Channel (Hong
Kong) Ltd  STC 347.
Fourthly, in Ashworth v Customs and Excise Comrs
 VATTR 275 the tribunal held that what is now VATA 1994
Sch 9 Group 1 Note 10(a) is "an excessive exercise of the
power given by art 13B(b) [of the Sixth Directive]" insofar
as it excludes from exemption the grant of a lease in a dwelling
used as the tenant's principal private residence.
Failing to amend defects pointed out by the
courts and tribunals means that the UK legislation says one thing
when the courts and tribunals apply something else. This situation
amounts to a denial of rights in two distinct senses. First, rights
should be accessible within the means of the least resourced.
This means that rights should be clearly identified in the UK
legislation. It should not be necessary to resort to the directives
or the jurisprudence of the EU Court of Justice in order to identify
rights. This is an unnecessary and unjustified complication which
increases compliance. Secondly, some taxpayers are misled by the
UK legislation and thereby fail to claim rights because they believe
that there are none to claim. In consequence, they are denied
the relief which they are due. We find it unsatisfactory that
the legislature frequently fails to enact EU rights affirmed by
the courts and tribunals. We contrast the prompt legislative action
normally following duties which are similarly affirmed. Making
a press announcement (the only response to the CPP case so far)
is a wholly insufficient response given that the legislation can
be amended by statutory instrument.
The legislation makes comprehensive provision
for the content of VAT invoices and the circumstances in which
they must, or must not, be issued. It has long been recognised
by the tribunals that the VAT charged on a VAT invoice can be
reduced or eliminated by way of a credit note in order to correct
a genuine mistake or overcharge or to give a proper credit (British
United Shoe Machinery Co Ltd v Customs and Excise Comrs 
VATTR 187). However, the legislation is almost entirely silent
on the question of form. VAT Regulations SI 1995/2518 reg 38 requires
the VAT Account to be adjusted when the consideration for a supply
is decreased and reg 31 requires credit notes received, and copies
of credit notes issued, to be retained. However, a credit note
is required to be issued only when the reduction arises in connection
with a change in the rate of tax and the matters to be recorded
on a credit note are specified only in relation to the credit
notes so issued (reg 15). In practice, it is necessary to follow
what appears to be an extra-statutory procedure (set out in Notice
No 700 Part 7) in all other respects.
In Schmeink & Cofreth AG & Co v Finanzamt
Borken (case C-454/98)  STC 810, ECJ, the EU Court of Justice
observed that "the Sixth Directive does not contain any provisions
relating to the adjustment by the issuer of the invoice of VAT
which has been improperly invoiced. . . . In those circumstances,
it is for the member states to lay down the conditions in which
improperly invoiced VAT may be adjusted" (paras 48, 49).
Credit notes play an important role in commercial
accounting. It is unsatisfactory that such important documents
are governed by extra-statutory procedures. We consider that the
position should be governed by legislation.
Other VAT registration problems
In the meantime, there is one further matter
concerning registration which deserves a closer look. Taxpayers
are liable to register for VAT purposes if they meet any one of
eleven different factual circumstances. The relevant legislation
is set out in no less than four schedules of VATA 1994 (see VATA
1994 Schs 1, 2, 3 and 3A). We note that Schs 2 and 3 were introduced
by FA 1992 and Sch by FA 2000. The four schedules are drafted
along similar lines and there is a considerable overlap in their
The legislation is inordinately long for what
is, in practice, a relatively straightforward process. While we
have no problem with the eleven criteria governing compulsory
registration, we question the need for four parallel registration
systems. We consider that a useful simplification would be achieved
by means of a single system.
We urge the Government to review the decision
to deny exemption to pension funds, etc in respect of their share
of Schedule A profits etc from investment LLPs. A property investment
via an LLP is no more objectionable than a direct joint ownership
or an investment as a limited partner in an ordinary partnership
or as a unit holder in a property unit trust. Given the bulky
nature of property investment (unlike investment in stocks and
shares), the use of an LLP appears to us to be entirely reasonable
provided that the interests in the LLP are not actively dealt
in on a market.
Our recent papers on Stamp Duty reform have
drawn attention to the need for exemptions for the incorporation
of a business as a going concern, company reconstructions generally,
etc. We firmly believe that this tax, as presently levied, is
harming our competitive ability in the global market.
We trust that proper notice of Budget day will
be given next year. This will enable organisations to arrange
their customary meetings and seminars based on the Budget. It
will also enable bodies such as the CIOT to plan their timetable
for response and consultation.
It would also help if a comprehensive list of
all items released on Budget day is published, together with details
of where they can be found. This would enable practitioners and
the public to ensure that they are in possession of all relevant
information. Also, the Budget pack should contain all relevant