Cash from the black hole: Gordon's plan to make everyone pay a fair share

Not enough tax is being collected in Britain to cover all the Chancellor's spending plans. Super-rich foreigners and multinationals may be in the taxman's sights, say Tim Webb and Jason Nissé - while, opposite, Paul Lashmar goes on the trail of the missing VAT billions
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The Independent Online

Do big businesses andrich individuals pay enough tax? The perception is that they don't and that this is something Her Majesty's Revenue & Customs' new chairman, David Varney, should be sorting out.

It is a fact that wealthy individuals living in the UK who have "non-domicile" status, such as the owner of Chelsea football club, Roman Abramovich, or the steel magnate Lakshmi Mittal, get a particularly good deal. Mike Warburton, a senior tax partner at accountants Baker Tilly, says: "Properly advised, there is no reason non-domiciled residents need to pay any tax at all."

Tax avoidance is not illegal, but the Chancellor's tolerance is wearing thin. In his last Budget, Gordon Brown outlined new measures to crack down on tax avoidance, particularly by UK-based international companies exploiting loopholes to pay low tax rates on foreign earnings. Making the rich pay more tax fits in not only with his socialist principles, but his ambitious spending plans, too. The faltering state of the economy has put him under even greater pressure than usual to raise more revenue.

Mr Brown estimates that corporation tax receipts will total £47.8bn in the current financial year, up by more than a third on his estimate for the previous year. With economists predicting growth of just over 2 per cent for this year, David Cruickshank, head of UK tax at Deloitte, thinks the Chancellor's estimate is unrealistic, to say the least. Other tax experts privately believe that closing the loopholes is a thinly disguised attempt to raise taxes. So how much tax does UK plc and the Roman Abramoviches resident in Britain actually pay? And what will be the impact of the Chancellor's efforts to squeeze them?

The headline rate of corporation tax has been falling steadily for years. Under the Conservative government of Ted Heath in 1973, the top rate was 52 per cent, but this has fallen steadily to 30 per cent today, Mr Brown himself shaving 1 per cent off the rate in 1999. Other Western countries - such as the Netherlands and even recession-hit Germany - have done the same, as globalisation forces governments to be as attractive as possible to business. But companies are complaining that the overall tax burden - including VAT, national insurance contributions and indirect costs such as environmental legislation - is actually going up. Add to this the fact that, in Mr Cruickshank's words, "the Government always thinks it is losing more money than it actually is", and its resultant aggressive attempts to claw this money back, and relations between the Treasury and UK plc have never been more frosty.

The Treasury has made its most significant changes to the tax regime in the past year. From last autumn, tax advisers must disclose any new scheme to HM Revenue & Customs (HMRC) before it is implemented. This gives the Treasury advance warning, allowing it to legislate if necessary to close the loopholes. In this year's Budget, the Chancellor said that the new disclosure rules had particularly highlighted tax avoidance on international transactions. Two important new measures introduced as a result target arbitrage, where companies with overseas operations exploit the differences in tax rates in different jurisdictions to pay the least possible tax. Companies' use of cross-border financial instruments to lower the cost of borrowing will be restricted.

More worrying for business is the Treasury's retrospective legislation, allowing it to target legal tax schemes that already exist. For example, recently introduced rules governing the borrowing of money by venture capital funds will apply not just to new funds, but to existing ones as well.

Such legislation is causing consternation within the business community. Loughlin Hickey, the head of tax for Europe, Middle East and Africa at KPMG, says: "The concern is that the Government is giving up on the due process, saying 'We can't keep up with all the new schemes we keep finding, so let's ban it retrospectively'."

Mervyn Woods, the head of tax at the CBI, is also worried about the lack of consultation before the measures were announced: "There is concern at boardroom level at what the Government is aiming at. It is damaging the perception of the UK as a place to do business."

But when it comes to targeting non-domiciled wealthy individuals in the UK, the Chancellor is not so sure he should proceed aggressively. A non-domiciled resident is defined as someone living in the UK whose father was born in another country. The Treasury estimates there are 100,000 such people living in the UK (some tax experts believe there could be 250,000). Three-quarters are employed, earning a total of £8bn annually, or an average of £133,000 each. Most of them live in London.

The relaxed tax laws for non-domiciles go back to the days of the British Empire, when the state was trying to attract businessmen from the colonies to live in Britain. Mr Warburton estimates that a tenth of the richest people in the UK are non-domiciles. Many other wealthy individuals are married to non-domiciles, who legally own their spouse's assets to avoid paying tax. The assets of retail tycoon Philip Green's Arcadia Group are held outside the UK and controlled by his wife, Tina, who is a non-domicile.

The Treasury has been conducting a half-hearted review of non domiciles' tax status, keen to be seen to be tackling the issue by Labour backbenchers, on the one hand, but mindful of the economic consequences of a change to the rules on the other.

As Paul Knox, a tax director at Ernst & Young, points out: "The Treasury is in a quandary. Whatever the political justification, they have to ask whether changing the rules is in the best interests of the UK economy."

Any review could see a lot of wealthy individuals leaving the country. While they may not pay much tax, they employ staff and spend a lot of money here, contributing to the overall economy. The Tories threatened to review non-domicile rules in 1993, but had to withdraw the plans because of protest from Middle Eastern residents.

The Treasury is nevertheless chipping away at the non-domicile rules. HMRC has announced a review of the use of non-bearer shares, a means by which non-domiciles move assets offshore without paying tax.

Then there is the issue of dual-employment contracts, which enable non-domiciles who do a lot of work abroad to be paid outside the UK. In a recent Tax Bulletin, HMRC said it had received "new legal opinion" about the legality of these arrangements.

It is not in the interests of tax advisers and taxpayers to be in perpetual conflict with the Government. Ultimately, they know they cannot win. Companies may choose to locate overseas, but many do not have that option. With this in mind, senior partners from the biggest accountancy groups have extended an olive branch to the Treasury, with the idea of introducing a voluntary code of conduct to foster greater collaboration between government, tax advisers and taxpayers.

Mr Hickey from KPMG says: "Unless we come together, there will be never-ending conflict and legislation. Let's look for alternatives."

But others are more sceptical. Mr Cruickshank points out that foreign companies, in particular, may not wish to participate in this type of voluntary scheme, which would fall apart as a result. The Treasury has not dismissed the idea, but is not showing any signs of embracing it yet. Clearly, the Government's support is vital. As Mr Hickey says: "It takes three to tango."

Labour backbenchers - such as the Grimsby MP Austin Mitchell - are becoming impatient about what they see as the lack of action on the issue of low taxpayers. Mr Brown and Mr Varney must balance the need for political appeasement against the fear that plucking these golden geese could harm the UK economy.

Follow that camel: VAT villains take Customs for a carousel ride

The Government could have built 10 new "super hospitals", 100 ordinary hospitals, 250 secondary schools and 1,000 primary schools with the Value Added Tax (VAT) stolen by organised gangs since it has been in power. This astonishing calculation shows why experts are saying that fraud is bringing into question the effectiveness of the whole VAT system in delivering revenue.

Officials at Customs - which has just merged with the Inland Revenue to form Her Majesty's Revenue & Customs (HMRC) - have admitted they have been losing £1bn-£2bn a year to VAT fraud but sources say the real, more embarrassing, figure has passed £20bn in total since major VAT fraud re-emerged after 1997. HMRC claims it is bringing the fraud under control.

A former senior Customs officer and fraud expert, David Raynes, said organised crime gangs have moved from drugs and other crimes into lucrative and relatively risk-free VAT fraud: "We have to be clear: VAT fraud involving mobile phone and computer-chip shipments is completely out of control in the UK. There is no end to it."

A renewed attack by VAT fraudsters has been so effective as to distort the UK's monthly trade figures, according to figures released by the Office for National Statistics this week.

The ONS said the distortion could have been caused by "missing trader fraud" when traders import goods such as mobile phones VAT-free, sell them on for a sum including VAT, and then disappear before passing the VAT on to the Revenue. This produced strange results - such as trade with Dubai soaring from £204m in May to £529m in June and a £144m increase in trade with Russia.

A spokesman for the ONS said: "Something is wrong which is distorting the balance of EU and non-EU trade, but we can't put any numbers on it. This is organised crime."

Well-informed criminal sources say that a series of VAT trials in the spring that were disastrous for Customs - especially the expected adverse ruling in the "Bondhouse" case, where the investigation of an alleged massive fraud in a London warehouse has gone badly wrong - emboldened criminals to launch a new assault on VAT in May.

Graham Gunning, a VAT Partner of Ernst & Young, said the figures bring Customs' performance into question. "They may have limited resources, but based on the evidence, either they are not doing enough or what they are doing is misdirected."

The figures also revealed that the fraudsters have moved away from the EU, where controls have tightened, and are using other countries, primarily Dubai and Russia, Mr Gunning said.

Mobile phones and computer chips "exported" to countries such as Dubai go round in a "carousel", and each time the gangs collect the 17.5 per cent VAT when the goods pass through the UK. The same goods go round as many as six times, experts say, and while there is no real economic activity, they boost export figures.

According to sources in Dubai, a criminal industry has developed there to facilitate UK VAT fraud. Factories run by known Pakistani businessmen can illegally change the individual identifying numbers of mobile phones. This means that every time a phone goes round the carousel it reappears looking like a new phone.

Mr Raynes said: "Investigators are being rather unfairly pilloried over some of these mobile phone/computer chip cases. The rules and the administration of the tax are fundamentally flawed. Actually, VAT as a tax system is fatally flawed," he said.

Customs investigators said the frauds were enormously complicated and difficult to document in court. Sixty trials are in the pipeline but many have been delayed by a year or more while Customs meets the requirements of the new legal rulings.

Customs belatedly woke up to the extent of VAT fraud in 2000, by which time the practice was rampant. Small-time British criminals suddenly began buying luxury mansions with helicopter pads and collections of classic cars.

Mr Raynes said that one reason fraud has become so widespread was that Customs had traditionally required little documentation to register for VAT, but each registration could potentially be used to milk millions of pounds from the Exchequer.

"Customs wanted to encourage people to register for VAT. When I was in Customs, I said we needed to tighten up," Mr Raynes said. "All of this was ignored and overruled at the time of the Lord Rayner review in 1982. Lord Rayner was the head of M&S at the time. I unfavourably compared a detailed M&S credit application with the limited requirements of VAT registration. Nothing much has changed."

"The UK is not the only country badly affected by this type of fraud. The loss in Germany, for example, amounts to €21bn [£14bn]," Mr Raynes said. "The whole basis on which VAT-registered businesses are controlled within the EU is deeply flawed. It has been thus for over 25 years. EU-wide political action is needed to close the loopholes."

Mr Gunning said controlling this type of VAT fraud was primarily a domestic rather than an international problem: "The money is stolen when it is passed between UK-based companies." He believes that the Government needs to change the system so that honest companies purchasing mobile phones or computer chips do not give the dishonest UK seller the VAT, as happens now, but use a self-accounting mechanism for VAT to prevent money from going missing.

Customs has difficulties estimating how much VAT is lost to fraud. In the year 2003-04, it estimated the "VAT gap" - the amount of VAT not gathered for all reasons, including fraud - was around £7bn. VAT revenues were £115bn for the year.

Meanwhile, Customs has tried to take a low-key response to this week's figures: "HM Revenue and Customs are well aware of this type of fraud and have been successfully tackling it since 2000. As often happens when tackling organised crime, our success has prompted changes to the fraud including, in this case, changes to the underlying pattern of trading. We are analysing recent trade data to determine if this impacts on balance of trade figures," it said.