Oral evidence - Draft Finance Bill 2016

Members present

Lord Hollick (Chairman)

Lord Bilimoria

Baroness Drake

Lord Forsyth of Drumlean

Lord Kerr of Kinlochard

Lord Teverson

Lord Turnbull

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Examination of Witnesses

Frank Haskew, Head of Tax Faculty, Institute of Chartered Accountants in England and Wales, John Cullinane, Director of Tax, Chartered Institute of Taxation, and Chas Roy-Chowdhury, Head of Taxation, Association of Certified Chartered Accountants

Q1 The Chairman: Gentlemen, welcome to this first meeting of the Finance Bill Sub-Committee. Some of us on this side of the table are familiar faces and most of you on that side of the room are also familiar faces. Thank you very much for joining us today. We are looking into two or three of the changes that have been proposed in the Finance Bill. Perhaps I can start off with the personal savings allowance. Very significant changes were announced in the 2014 and 2015 Budgets. The draft Finance Bill introduces a new personal savings allowance and abolishes the tax deduction scheme for interest. It is quite far-reaching and, for some of us, rather baffling. Do you see these changes as simplifications of the personal tax system? Do you have any concerns about their practical implementation or, should I say, do your members have any concerns about their practical implementation? Mr Roy-Chowdhury, would you like to start?

Chas Roy-Chowdhury: Thank you. It is very nice to see you all. Thank you for the opportunity to speak on the Finance Bill draft clauses. We do not think it is simplification. We think if the £1,000 allowance or exemption was across the board rather than across different tax rates, that would be simplification. As it stands currently, the basic rate taxpayer has a £1,000 exemption, the 40% taxpayer has £500 and the 45% taxpayer has nothing. We think the cliff-edge effect is unnecessary and is going to cause complexity. Certainly where you are completely out of paying tax altogether, that is fine, but where you are going across from one rate to another, it is going to create complexity unnecessarily.

The Chairman: How would you propose to remedy that?

Chas Roy-Chowdhury: It should be £1,000 all the way across, so that everybody has the same and there is no cliff edge; it does not matter which rate of tax you pay, you have the same allowance.

Frank Haskew: Effectively, what we are saying is that it would be much easier if the amount was a straightforward exemption, so that that amount was taken off your taxable income and then you computed your tax liability based on that net figure.

John Cullinane: Yes. I think the term “allowance” is a bit of a misnomer for the reasons my colleagues have given. It is not strictly taking it out of taxable income. It is leaving it there, so it will impact on your total taxable income. That will impact what rates of tax you pay, which will impact other things, such as whether you have personal allowances withdrawn at a certain income level. Then, depending on where you are, it will feed back to how much is simply not taxed. It is almost like two or three, depending on how you look at it, different 0% bands, so it is quite convoluted in concept.

For the vast majority of people, who are clearly basic rate taxpayers, effectively they will no longer pay tax on their interest income. I am sure they will be pleased about that. At the moment they probably do not have much of a compliance burden in respect of that, because it is taken off them by the bank, and in the future it will not be and they still will not have a compliance burden. However, the people at the margins between these rates are affected by the complexity. It will certainly be over 1 million people who will still pay some tax on the interest income, so the compliance burden will probably increase rather than reduce.

The Chairman: Increase rather than reduce?

John Cullinane: Yes.

Chas Roy-Chowdhury: May I add to what John is saying? I think there is a real problem with the fact that people are going to have to self-assess. Basic rate taxpayers who are not in self-assessment at the moment are probably going to have to self-assess. We have the simple assessments coming up later on. We also have the quarterly filing coming in from next year. Interest is paid annually, so how is that going to work regarding what people need to work out for their tax return purposes or this filing purpose? It seems as though there is a whole can of worms being opened up unnecessarily in the guise of simplification, which it is not really achieving.

Frank Haskew: For practical purposes, for most basic rate taxpayers receiving interest income or dividend income, that is really the end of the matter, due to the fact that you get a deduction of tax or a tax credit, which satisfies your liability. At the moment, in practical terms, basic rate taxpayers have nothing to worry about, whereas under this system, potentially, they will have much more to worry about and might have to pay some tax as a result.

Q2 Lord Forsyth of Drumlean: When I was preparing for this session and looked at all the changes, I found myself trying to work out how I would have to organise my savings and dividends and other income in order to minimise my tax bill. I do not know if that is frowned upon by the Chancellor, but I suspect that is what most people will do. What is not clear is whether, with the combination of this measure and the point you made about not having an allowance that applies across the three tax rates, some people are going to end up, unless they organise themselves, with very high marginal rates of tax in excess of 60%. Would it be possible to provide the Committee with some examples of how all these changes might have an effect? For example, there is the business that you mentioned a few moments ago of it being looked at on a quarterly basis; you could find yourself then going over the threshold. I think people are going to play games with it in order to minimise their tax, are they not?

Chas Roy-Chowdhury: Yes.

Lord Forsyth of Drumlean: The sums involved are quite substantial. I am really asking you whether it is sensible in the context of simplification to have different thresholds for different allowances applying. I produced the tax simplification report for the Chancellor in 2006, and one of the things we recommended was setting up an Office of Tax Simplification, which has been done, and getting rid of allowances and having lower rates, which at that time the Chancellor was in favour of. This seems to me to be taking us back into a morass. Is that right?

Chas Roy-Chowdhury: Yes, I think that is right. What I would say is that at the moment the Government have a sure thing in getting the financial institutions to deduct tax. Now they are going to be relying on individuals to declare how much tax they need to pay. We talk about the tax gap all the time. Is that really the road we want to go down by creating another problem regarding the tax gap where people are not aware of how much tax they should be paying, if anything, and they get it wrong? Yes, I think it is creating complexity, both for the Government in knowing where they stand regarding tax take and for individuals not knowing where they stand and mis-declaring taxpayers. They may have vehicles where they get dividends and interest and they do not know until the end of the year what that is going to be and, therefore, again, what do they file, with quarterly filings coming in from next year? There is a whole array of different areas that do not seem to have been properly thought about, and there has been no consultation before the announcement. It seemed like a great idea before the election, because this was when this was first announced, and then thinking through the details has kind of come afterwards.

Q3 Lord Turnbull: Are we getting towards a more generalised scheme of giving people an allowance and then for higher rate taxpayers taking it away, and certain tax allowances being dealt with in the same way, but when we come to dividends, we have a £5,000 allowance and then a series of rates which you are then taxed at and higher rate taxpayers and additional rate taxpayers pay the highest rates? Am I right in saying that those two regimes are operating using different methodologies?

Chas Roy-Chowdhury: Yes.

Frank Haskew: Yes.

John Cullinane: Comparing the two, the dividend one is simpler and, to the extent that that is the case, one does not understand why that same principle could not be applied to the interest.

Lord Turnbull: It seems to me that in order to know what to take off you need to know the answers to all the sums, but you cannot know the answer to all the sums until later.

John Cullinane: There is a bit of iteration about it, yes. That is correct.

Frank Haskew: You should be able to work out your tax liability with a sheet of paper, the rate of allowances and a calculator. I think citizens are entitled to expect that. The fact is once all these changes go through it is almost algebra and you are going to need software, and most people will not understand it.

Going back to your point, Lord Forsyth, we have had some examples of how the dividend rules, which were prepared by our former chairman, are working. Obviously we can send these to you. When you look at them, you will see that they are incredibly difficult for people to understand. We struggle as tax practitioners with this. We have had quite a lot of arguments about how the rules work. If we are having trouble with it, I think it is going to be very difficult for the ordinary citizen to understand how their tax is being calculated.

Lord Turnbull: Are there kinds of interest that are not in this scheme? Is interest on bonds and gilts in the scheme or not?

Frank Haskew: The rules on savings income refer back to savings interest within the Income Tax Act 2007. We had a question this morning about peer-to-peer loans, which is becoming a major issue. The question was whether they are subject to the savings income exemption and the answer was, “We do not know”.

Q4 The Chairman: I think this raises another point. With peer-to-peer lending, do you get a return from the intermediary? If you buy a foreign sterling-denominated bond or a bond issued by a UK company that happens to be issued by an overseas subsidiary of it, do you get an annual return? I suppose the follow-up from that is, given that complexity, which can sometimes lead to an opportunity for people to play games, or maybe to pay less tax than they should be paying—not always for reasons of trying to evade tax—is the net result of this arrangement possibly to reduce the tax take to HMRC?

John Cullinane: I do not have to hand what the figure was, but it was certainly estimated to reduce the tax take, because, obviously, the broad swathe of basic rate taxpayers were suffering from tax being withheld by the bank. It was not a compliance burden to them, but they were getting net interest, not gross interest. Now, to the extent they are below that threshold, they will get it gross, so there was budgeted to be a reduction in the tax take.

The point that was made earlier that this came out without any consultation is the key point, because when these ideas, which might sound quite good and appealing, are discussed by a limited number of people, albeit expert, within the context of a massively complicated code already, there are all sorts of interactions with other features and ramifications they do not work out at the time. What happens if people have trusts and what happens in the example you have just given? I do not think it will open the floodgates to avoidance, because at the end of the day it is only £1,000, and that only applies at the basic rate, so it is £200, and people are pretty much being given that anyway, but it will add a lot to the complexity of the system.

The Chairman: Lord Turnbull, would you take us on to dividends?

Q5 Lord Turnbull: I have one more general question. One of the criticisms that has been made is that changes are being made piecemeal. Normally you would have expected that a destination and some principles about that destination would have been described, and then, “Here are the steps that lead you to that destination”. Do you think there is a destination? How far are these changes consistent with that and how far are either bits of it inconsistent or even taking us further away from that destination?

John Cullinane: We do not really know what the destination is, because there is not a road map. If you compare it with what the Government did in the area of corporation tax rates, they said, “We are going to try and bring the rate down over the years. Having said that, we are going to do this, that or the other on avoidance so that people pay what they are supposed to”, so there was a clear strategy set out, whereas that is not the case here. You do not know whether they have done this and that is the end of it, or whether the £1,000 will go up over time, or quite what the intention is.

Chas Roy-Chowdhury: I think John is absolutely right. There is no road map as there was for corporation tax and as there will be next year for business tax. We are seeing ad hoc tax changes right across the piece. We are hearing announcements being floated in the media about things such as pensions and tax changes. There are all sorts of changes which are being sounded out in the media rather than a proper holistic road map being put out there so that we can discuss, debate and actually feed into the process. There was no consultation on the policy issue of quarterly filing, only around how to implement the policy. I think it would do a lot of good in all these different areas of tax policy if we could properly debate and discuss them before they are announced and before they are put out to the general public when they cannot be drawn back.

Frank Haskew: Could I follow that up? Shortly before the last election we had an event attended by a government Minister and a shadow Minister, and we said, “Why don’t we have a personal tax road map as we have for corporation tax?” Interestingly, the Government Minister concerned and the shadow Minister both said that they would not consider a personal tax road map. The thinking seemed to be that the figures—if you like, the amounts of money coming in from personal tax, and presumably national insurance—were so large that there was no appetite at all to lose any control about how personal tax policy might be developed.

Lord Turnbull: You can keep control of the money by the size of the allowances and the rates. The structure does not necessarily commit you to reducing tax over time or at any particular speed.

Frank Haskew: I would entirely agree with that, Lord Turnbull, but that area seems to be kept very close to the policymakers and not shared.

Q6 Lord Turnbull: If I come to dividends, it is the same kind of question. It is described as the last knockings of the imputation system from 1970 or 1971, or something like that, so it has been a long time dying. Should we regret that? Although in some ways it looks illogical to tax a company and then out of the post-tax income of the company tax the recipient, it is actually a much simpler scheme. On paper this looks a much simpler scheme, but do you see problems with it?

Chas Roy-Chowdhury: I think again there are huge complexities. It is a nil-rate band and should be referred to as such. It is not an allowance or anything else; it is a nil-rate band. Again, it is all about raising revenue. It is all about anti-avoidance around people taking remuneration in the form of dividends to escape national insurance. It has created a lot more complexity. Basic rate taxpayers, once they get over the £5,000 nil-rate band, will be subject to tax and self-assessment, where they have not been in the past. Again, it is possibly going to draw a whole raft of new people into self-assessment. There is going to be a situation again where you have quarterly reporting, or quarterly filing, or whatever it is going to be, where people are going to get it wrong and are going to have to rely on business to supply the information on a timely basis and on a quarterly basis, even where they have overseas holdings. There is a whole range of knock-on effects and impacts that have not been properly thought through.

Lord Turnbull: Is getting rid of tax credits not a benefit?

John Cullinane: You can view the dividend so-called allowance as two things. First of all, portfolio shareholders—people who happen to have a few shares and get a few dividends in large companies they otherwise have no real relationship with—are being taken out of tax altogether, so there will not be this complicated situation of being theoretically taxed but having a credit. You can see that. Then on the other side, for people who either control or together with a number of other people control a company, the Government clearly wanted a rough-and-ready way to get closer to a position where, whether people were sole traders or had companies and took the dividends out, they were paying something more comparable overall. You can see what they are trying to do there. You can see that is rough justice, as it were, rather than all these calculations of tax credits. I can see a simplification argument for the broad concept.

However, they have not introduced those two regimes by trying to distinguish between the portfolio shares and the ownership shares. They have done it by saying it is £5,000. If you had done it the other way round and said that when a company pays a dividend to those individuals controlling it, then they have to withhold some tax, you could have done it by withholding tax, but because you are saying it is only a question of the overall amount, the onus is on the taxpayer to keep tabs on what is coming in from all over place. I think the compliance burden for those affected is probably going up.

Lord Turnbull: In my case I only have a few shares, and the company gives you an end-of-year statement showing how much tax, the dividend and the tax credit. Is that going to go? Will you be sent a note saying, “The dividend you have is such-and-such”, and then you have to make your peace with the tax authority, whether it is at the 7% rate or the 38% rate?

John Cullinane: I think this is similar to the last change. It is rather working against the grain of where they are trying to get to with digitalisation, which is to have more done automatically, or by third parties, and less onus on you to have to work out complicated calculations for yourself. It is throwing more into the area of your own calculations and it is making those calculations more complicated.

Q7 Lord Forsyth of Drumlean: Before we leave the dividend issue, can I be sure that I understand this? Higher rate taxpayers are going to be paying at 32.5% and additional rate taxpayers at 38.1%. Going back to what I asked right at the beginning about people trying to organise themselves, the income will be treated as taking you towards the threshold. Is there not a danger that people are going to manipulate their equity ownership so that they avoid dividends that are going to take them over the threshold? Is that kind of thing not going to happen?

John Cullinane: Yes, people are very alive to the differences between the rate that a sole trader would pay and the rate that would be paid on that business if it were incorporated. When we had the small company rate of zero everybody incorporated and people did those calculations quite finely. I suppose the Chancellor’s defence on this one is that the situation was very complicated and depended on the circumstances, but, generally speaking, the overall tax take was lower if you were incorporated, and this is largely redressing that balance—leave employment out of it, but as between self-employment and incorporation.

Lord Forsyth of Drumlean: I was thinking you would not want to have a share that gave a high yield. You would not want to have Glaxo. Will it not distort people’s holdings?

Frank Haskew: Yes.

Chas Roy-Chowdhury: Investment, that is right. Why would you want the dividend where you are going to pay a higher right of tax as opposed to a capital gain?

Lord Forsyth of Drumlean: Not only the dividend; it may take you into a huge tax liability.

Chas Roy-Chowdhury: Absolutely.

Frank Haskew: We are likely to see changes in investment tactics and that will have knock-on consequences.

Q8 Lord Kerr of Kinlochard: Following up on Lord Forsyth’s first question, I did not hear, or perhaps I missed it, whether you can give us some worked examples of the increased complexity. A rather brilliant note I read in preparing for this session suggested that the combination of different elements in an individual’s tax return, if he was a recipient of interest, could mean, if he was a middle-income, higher rate taxpayer, that he was facing a marginal rate as high as 60%, with a combination of all these things. If that is the case, could we see one or two worked examples of how that goes?

Frank Haskew: We could certainly forward those to the Committee, yes.

The Chairman: That would be helpful.

Lord Kerr of Kinlochard: Following up on Lord Turnbull’s question, if one no longer receives the dividend voucher, if one no longer has the interest on a bank account deducted at source, what will be the effect on the Exchequer’s take? It seems to me that if one’s tax return is pre-populated with numbers and they underreport, the temptation will be not to correct it.

Chas Roy-Chowdhury: Yes.

Lord Kerr of Kinlochard: In the case of bank interest, if it is not there on the tax return, one has, rightly up to now, assumed that the bank is deducting it. Will the temptation not be—or perhaps not the temptation, but will the fact that you have not had to fill it in before, because it was already done for you by the bank, not take you in the direction of underreporting as well? Is there not a danger that the Exchequer is going to lose?

Chas Roy-Chowdhury: That is the point I made earlier. I think the tax gap is going to be affected by these changes, because the ordinary taxpayer has, as you quite rightly say, been used to the tax being deducted at source and now they are going to have to declare it. If they are relying on pre-populated tax returns or quarterly filing returns, why would they doubt what is put in there by HMRC? They probably were not even aware that their tax was deducted at source from interest. Now they are getting it gross, they probably will not be aware there has been a change. Unless there is a huge educational piece that goes on with this, for the ordinary person in the street there is going to be a tax gap impact and there is probably going to be a cash-flow impact, which makes me think that quarterly reporting is all about bringing in quarterly tax as well, to compensate for this.

Lord Kerr of Kinlochard: In practice, this is happening this year because the first tax year this comes in is the one we are in right now.

Chas Roy-Chowdhury: It is 2016-17. From 6 April.

Lord Kerr of Kinlochard: Do you think the Government are doing enough to explain these changes to people? I confess that until I started preparing for this inquiry I had no idea.

Frank Haskew: I think our view is they probably are not doing enough. It is a major change. Effectively, it is shifting the burden from the banks, and potentially companies, on to the individual taxpayer. That is a major shift. We have had a tried-and-tested system of tax deduction in this country for a long time, which I think works for most people and, effectively, enables them to be fairly confident about their tax position. We are now going to move away from that. I do not think that most ordinary taxpayers really understand where this will lead to. I think there is a real need for education here for taxpayers to understand what it will mean for them. We are already receiving reports that the banks are struggling to explain how this is going to work. We are only a few months away from this actually coming in.

John Cullinane: The starting point of calling these things allowances when they are not does not help with the education. You have ISAs and other elements and other terminology in the piece as well.

Lord Kerr of Kinlochard: I think the only thing that the public understand and are puzzled about is the fact that the ISA allowance is not going up. The ISA seems to me to be an extremely popular savings vehicle, almost as popular as the defunct savings certificates used to be. I think the average higher-income taxpayer deeply regrets the fact that children’s savings certificates do not exist as a way of passing on money and is puzzled that the Government have frozen the limit on the ISA. I do not think that he has grasped at all the complications of the personal savings allowance and the tax deduction scheme for interest, and so on. I do not think any of that has got through. It seems to me there is an education task which is quite important and quite urgent.

Chas Roy-Chowdhury: That is right. We find that in every Budget, or several Budgets a year—and it is happening now with Autumn Statements—there are a number of changes which seem to happen and which are left-field. You do not expect them, or you do not expect them to land in the way you do when you see the draft legislation. It really goes back to having a road map and, if not a road map, a discussion—let us try and do things properly in tax rather than making the complex tax system ever more complex.

Q9 Lord Bilimoria: Clause 71 introduces a new power for HMRC to assess individual tax liabilities using information supplied by third parties, such as banks. How does this change the individual’s current responsibilities under self-assessment? To what extent will ordinary taxpayers have the ability and information to check and, if necessary, dispute HMRC’s tax bills?

Chas Roy-Chowdhury: Again, it is all around greater complexity. These are going to be people who presumably are not filling in self-assessment returns. Regarding the obligation on the taxpayer, my understanding from reading the draft legislation is that they will no longer need to put their hand up with a self-assessment return and notify HMRC. That is one obligation that will then disappear if they get a simple assessment. The point is they can receive more than one simple assessment, because it could be that HMRC at the start of the 2016-17 tax year gets certain information—one bit of information about dividends or interest—and sends out a simple assessment, and then later on it gets more information, so there could be multiple simple assessments that the same taxpayer could receive in a tax year, which is highly onerous and highly complicated. I imagine most taxpayers will merely say, “Yes, it must be right”, and they will not have the ability to check. Again, where are we actually going with all this? It is layers and layers of complexity that again are bringing more people into self-assessment.

Lord Bilimoria: Before you go on, as it is the first question I am asking formally, I should have declared my interests. My interests are as in the register of Members’ interests, and also I am a Fellow of the Institute of Chartered Accountants in England and Wales. I am a member of the alumni council of Ernst & Young and I have this month taken over, which may not be in the Register of Interests, as the chair of Cambridge University Judge Business School. Please do carry on.

Frank Haskew: What HMRC is introducing with Clause 71 is a not unreasonable power to make it easier for a taxpayer, who is probably not within self-assessment, for their affairs to be dealt with. I think it is a reasonable principle, particularly with the move to digital, and I think that is understood. We are at the very early stages of all this. We do not know where the digital agenda will end up. There is still a lot of confusion as to how those provisions are going to work in practice. If your affairs are anything out of the ordinary, or slightly complicated, you are probably not going to be a person for whom simple assessment will work. There are going to have to be further discussions on the whole process and who is going to be within it and how it is going to work. Obviously, we will be taking part in those discussions, but it is very early days for these provisions and, as Chas said, the provisions they are looking to introduce already seem quite complicated, which seems to be a feature of the UK tax system in any new measures introduced.

Chas Roy-Chowdhury: The only thing I would say before John comes in is that what we usually find with anything new in tax is they come in very light touch, but they will not stay light touch. Even if we are talking about this simple assessment coming in—a few lines, very easy for people to check, no penalty regime, no interest charges—it is not going to stay that way. Five years down the track, which is what we need to think about, how is this going to evolve? We need to be careful about the seeds we are now sowing.

John Cullinane: At the very basic level, as Frank says, it is a good idea, because if you take an old-age pensioner, the state pension is taxable, but the department does not take on itself the job of withholding the tax that is imposed on everybody else. Many pensioners have to report the state pension on their tax return when the state clearly knows how much pension they have had. In that type of situation, or a situation of a third-party provider, the basic idea to get the information off that third party at source and then to make an assessment based on that makes sense. Given that the system is very complicated and the third-party provider only knows their piece, I think the issue will be how it will be got right as you move on that model towards the digitalisation world. It is a bit like comparing the people who have to do tax returns, where, when they sign their tax return, they may find it difficult and complicated but they know they are on the hook for trying to get it right, and when you get a PAYE code, where I suppose you feel you ought to get it right but the sense in which it is your responsibility is diminished because you naturally think, “The employer and the HMRC know a lot about me between them, surely, they have it right”. Whether people will then under-declare or over-declare, on balance, who knows? In many cases, they will be impelled to accept more errors against themselves, or not even notice, than the other way, because one way round they are subject to penalties if they get it wrong.

In this particular area it is not at all clear whether the individual would be exposed to a penalty if they felt that the assessment was inadequate and they had kept quiet. Many people simply will not know. They might have a suspicion, but they will not know because it is too complicated. I am not calling for harsh penalties. That is an oddity in our system. As I say, it is not 100% clear, but I cannot believe, once digitalisation is up and running, that people who end up in under-declaration situations will be let off penalties merely because things have come from third-party providers, but as of now that is a little unclear.

Lord Bilimoria: Later we are coming on to the Office of Tax Simplification and the whole idea of simple assessments. To be clear, was this really necessary? Could the HMRC not deal with this under existing powers?

Chas Roy-Chowdhury: Yes, that is our view. It may well seem like a good idea at the moment, but I do not think it is going to stay that way. If they are getting a whole lot of information and their IT systems are getting better and more clever and more holistic and able to capture everything there is out there about the taxpayer, why do they need to go down this road for the very lowest-level taxpayer? It does not seem an appropriate or necessary measure.

Frank Haskew: The self-assessment regime is quite a complicated regime once you are into it. This is an attempt to have almost “self-assessment lite” for people who have slightly easier tax affairs. The principle of that is not unreasonable, but whether we are going about it right, having self-assessment lite for people with very simple affairs who probably do not warrant self-assessment, is a moot point.

John Cullinane: I do not know if it would be a good idea. I am sure HMRC could deal with it simply by not raising an assessment at all and, if people have suffered tax at source, they keep quiet. I am not sure I would criticise them for, as it were, seeking to codify it in legislation rather than leaving that under the carpet. You would not get the opportunity to inquire into what they are doing. I do not criticise that basic idea of having this sort of provision in the formal system.

Lord Bilimoria: May I have one more question on this? Does HMRC have the resource to provide the sort of customer support this will require?

John Cullinane: No.

Frank Haskew: We could certainly provide the Committee with a recent survey that we did of HMRC and its service standards. The anecdotal evidence is that in the last few months it has improved, but the fact is that over the last few years the service levels have fallen off a cliff. HMRC is in a very difficult position when the Government are constantly changing the rules. We need some stability and certainty in the tax system for HMRC to be able to operate it correctly. By its very nature, if you are changing things all the time you are going to get more phone calls and more inquiries, which puts huge pressures on HMRC.

John Cullinane: And then there are the annual cuts.

The Chairman: If you could provide us with that sort of feedback that would be really helpful.

Frank Haskew: Yes.

John Cullinane: The trouble with service levels is that the vast majority of taxpayers and commentators think about them against the background of the way things have happened traditionally. People fill in their tax return. They are maybe a little worried that they have not filled this bit in correctly or that bit in correctly, so they might phone up and ask, and then they might wait a long, long time to get an answer, and they probably will not get an answer from somebody who knows about the issue that has concerned them. The HMRC strategy, approved and required, in a sense, by the Government, is not to gear themselves up to be able to provide those answers on the phone; it is to provide a framework of guidance, and so on, and for the taxpayers to fend for themselves. That is where they are trying to get to with the level of resourcing that has been provided. It is a little unfair to criticise HMRC. There is an odd policy mix where you have that trend towards digitalisation, which is a little bit of the modern world and how your utility company tries to deal with you, and many other big organisations that you are the customer of, versus a set of rules that is vastly more complicated than any electricity tariff and a little bit bewildering to people, however well it is described in guidance.

Q10 Lord Forsyth of Drumlean: I am confused about how it will be decided who is covered by this regime. How will you work it out? It is the point that Mr Cullinane made about elderly people. Reading this, I am thinking of elderly relatives who get in a complete panic about their tax return. If they get a letter from HMRC saying, “You have to pay £1,200”, and they have dividend and other income, how are they going to work out whether that is right or not? It is probably quite good news for accountants, but who is actually going to be involved in this regime? How can we be sure about the quality of the data? Am I right in suspecting that quite a lot of the people who will be involved in this are elderly people, particularly if they are going to get more than one letter in the year? My mother-in-law starts panicking about her tax return now and it is not actually due until the end of the year. Is this an issue or am I imagining it?

Chas Roy-Chowdhury: You are absolutely 100% right. It is the same thing with quarterly filing. There are those people who are digitally excluded. I would mention my 82 year-old mother. She is not on the internet. She has no idea about different rates of tax and things such as that. The underlying concept is all right for people such as us who are working, who have internet access and who are participating in the workplace. There needs to be a reality check around trying to bring more and more people into the tax return system, if you like, for want of a global term. We need to look at where we are going with this, because it is going to affect a lot of elderly people who are not going to be able to fend for themselves. They will not want their neighbour looking over their shoulder to help them with their financial situation or their sons or daughters helping them. There needs to be a better way of doing it.

It is a different world for the elderly. There is a whole raft of people out there who are trying to take advantage of them, and we do not know who may then try and “help” them, as it were. We need to be very clear where we are going with this agenda of trying to make everything digital. I know the numbers with digital access will increase over time, but at the moment there are a lot of people who will not be able to take advantage of this and will not be able to give the Government that kind of digital landscape they are trying to work towards.

Lord Forsyth of Drumlean: Does the information come on computer then, or is it in the post?

Chas Roy-Chowdhury: My understanding is that it is part of the digital agenda, but I am not sure of the underlying detail.

Lord Forsyth of Drumlean: What does that mean?

Chas Roy-Chowdhury: Yes, by computer.

John Cullinane: You can use the example of the state pension. Certainly when I helped my mother with her tax return, the pension figure on the assessment would always be a pound or two different from what you calculated. The information must have come from somewhere. I do not believe somebody sat in an office increasing it or reducing it by a pound. Under the current system there have been a lot of feeds that the Revenue is getting independently. I can completely understand the basic thought of why make people assess themselves when they have the information anyway, and I can also understand them wanting to put a statutory framework around this, but it is doing that in the context of a system that is being made ever more complicated and of the digitalisation agenda. I entirely see they have to move with the times and improve the efficiency with which they deal with this.

Lord Forsyth of Drumlean: If this information comes by computer, do you have to be computer literate?

Chas Roy-Chowdhury: Yes.

Lord Forsyth of Drumlean: What about elderly people living in rural areas where their internet is slow and all of those kinds of issues?

Chas Roy-Chowdhury: We made all these comments around quarterly filing to the Minister. We have said all this. We have also talked about people who are illiterate and all these sorts of things. However, the policy has been decided and it is the implementation of the policy that is up for grabs.

Q11 Lord Turnbull: I want to make a very quick point. The big picture is that for 60 years the Inland Revenue worked on the basis that it wanted to get the money before you got it and this self-assessment was a settling up at the margins, and if you had a bit of gift aid, you could get money back, and sometimes you had to pay a bit more. This is not only going to increase the number of people, but the amounts at stake are going to be much larger than they used to be because far less is being taken off at the start. In a world in which you are trying to improve relations between the tax authorities and the public, this seems to be a recipe for increasing the acrimony, because it is not a few tens here and there or a few hundred here and there, it could be a few thousand here and there. This seems a very poor way of improving relations with the taxpaying public.

John Cullinane: I do not think that is strictly true though of the simple self-assessment proposal in isolation. That is merely to codify the Revenue’s ability to deal with something on the basis of what a third party has at least provided information on. I think that particular change has merit about it.

Lord Turnbull: You are then told that you receive this amount of interest or this amount of dividend or whatever, as opposed to your pay packet and what you previously had. You always knew that you had paid something on account, and therefore the amount that could be in dispute would be that much less because you had always paid the first 20%. That is no longer going to be true and they are going to say, “You received all this”, but the amounts will be of a size that you will feel you have to check it. You will be very poorly placed and they will not tell you exactly who paid it to you and when they paid it to you. It looks to me as if it is taking 60 years of history backwards.

Frank Haskew: I think that is true, but we need to remember that PAYE is still the large area where tax is being deducted, and that is going to continue. There are still going to be huge amounts of income tax and national insurance coming in every month under PAYE. By comparison, the amounts coming in under interest on dividends are considerably less than that.

Baroness Drake: Could I pursue Lord Forsyth’s point on digital transition and digital engagement? The self-employed population has increased exponentially over the last few years. There is a debate in the Commons today, because people are saying that a significant part of this population has neither the means nor the ability to engage digitally and, as I understand it, the Treasury has said that they can engage verbally. I do not know quite how you do that. It would be quite interesting, because it is clearly topical and is out there in the Commons. It would be useful to have your views as to what you think the challenges are around, in particular, the self-employed, particularly those on more modest incomes.

Chas Roy-Chowdhury: We fed into this debate that is going to start at 4.30, I believe, and that was the meeting we had with the Minister a couple of weeks ago. It is around digital capability where people can file four times a year. It is not meant to be a tax return, but I am sure eventually it will be, and then probably a fifth time to make the four returns tie up and, therefore, give a true and fair view of their income. Some of those small businesses are illiterate. We gave an example of the type of paperwork that accountants receive from those types of clients. They will not even know how to file or put the paperwork together. It is all about keeping records on a regular daily basis. Do the Government want businesses to do business or merely be bookkeepers and record keepers, and that is all they do, rather than going out there hiring people, making their businesses work and making a success of the UK economy? That is a very short summary, but it is around those kinds of areas. There does not seem to be an understanding of how to work out a profit for filing or work out an income for filing and how you do that on a quarterly basis. It does not work in that way. From an accounting point of view, you work out the accounting profit that you use ultimately as a basis for filing a tax return. How do you do that in a quarterly return? There are all sorts of questions around that. We have already mentioned interest, which is paid annually. How do you gather the interest details on a quarterly basis? There is a whole range of things that have not been fully thought through and are going to be steamrollered through regardless.

Q12 Lord Teverson: Could I follow up on one small thing? The perfect system for this, as the Government would see it, is that they are able to collect all that information anyway and present it to you electronically and you will say, “My goodness, I didn’t realise you knew all that about me; yes, that is right”, and it goes like that. Clearly, that is not going to be the case. You mentioned particularly the self-employed. What other areas are beyond the Government’s capture for this population of people? Is it foreign earnings or something else? Give us an idea of the proportion of things that will be missing, coming a bit back to Lord Turnbull’s point about things catching up later and there being a big discrepancy at the end of the year?

John Cullinane: There are changes in the economy. The PAYE system works best with people having one full-time job for life, or as close as you can get it, so there is not a lot of chopping and changing and a great deal of predictability, and then it can operate very efficiently. If the economy moves on and people either become, or are forced to become, more flexible, it becomes a lot more complicated. If you look at when buy-to-let first became an investment, there was a lot of talk of tax evasion by buy-to-let landlords. I expect many people in that position had never had an obligation to file a tax return before, because it was the first time they had something that was not deducted at source. I think it is probably a question of being alive to developments in the economy and trying to find a framework for the new and developing areas, rather than leaving people to fend for themselves, and scaling back the deduction-at-source arrangements where they already exist.

Chas Roy-Chowdhury: I think it will be the overseas areas as well: overseas rental income, overseas dividends or overseas interest. Those will fail to be captured, at least fully.

Frank Haskew: In the Government’s plans for quarterly reporting, they have made it clear that one of the policy concerns, particularly in the SME sector, is that businesses are not keeping proper business records and that therefore there is an underpayment of tax. That is the justification for this, to which I think the push-back quite strongly is that it is a different issue entirely. If you have a problem with business records, then that is a problem that needs to be addressed, and is a totally different issue from quarterly reporting and digital information. The fact is that if you have poor records, you could still be uploading quarterly information which is completely wrong. I think the two are very different and at the moment they seem to be conflated: that somehow digital reporting will answer all the business records problems. We do not see how that can be the case.

Lord Teverson: Some self-employment is very lumpy income. Particularly if you are consulting and you are a private service company, you might have a big invoice that comes in a couple of times a year, which your expenses and costs do not mirror. What happens with that? Presumably, that is an issue as well.

Frank Haskew: Effectively, you are going to have a position of collecting big data. How is that big data going to reconcile to the annual tax return position that you have? It seems almost inevitable that you are going to have to do your quarterly uploading of information and still have to reconcile it at the year-end.

Chas Roy-Chowdhury: I would add that the idea behind the quarterly filing is that those businesses that go in first are going to be the least capable. It is going to be a bottom-up approach, so those who are digitally excluded or illiterate or very small or the most vulnerable are going to be in the system first. Rather than those who are most capable going in, they are going to be in there last. The bottom of the pyramid is going in first and the top of the pyramid is considered to be all right and may never go in.

Lord Teverson: Most of the questions that I was going to ask have already been covered. One bit that has not is: what does experience internationally tell us about this? Are we in the vanguard? Are we trailblazing here or have other economies and treasuries gone there before?

Frank Haskew: Australia is going through a very similar process at the moment. We saw the representation being made by the Australian institute in an almost identical consultation, and it was saying exactly the same things as us. There are these international pressures going on to move this way, but internationally they have not thought through how businesses actually operate. There is a lack of understanding about how businesses operate and translating that into digital tax terms.

John Cullinane: We could probably provide some information on what is available from international comparisons. I agree with Frank that you will not find they are a road map from somebody who is just that bit ahead of us on a similar journey. The issues for the self-employed that you outline are genuinely very difficult to work out and, even under the existing rules, if you get a lot of income one year, the Revenue will assess payments on account for next year on the assumption that it will always be the same, and so people have to know to appeal against those. Things that sound perfectly reasonable when they are introduced at a high level cause issues, and to some extent that is a genuine problem they have.

Q13 Baroness Drake: I have one question on taxation. One purpose of the changes to dividend taxation was to address the situation where private companies were paying less tax and national insurance because they were paying through dividends. To what extent do you think these changes will address that problem? What do you think might be some of the behavioural responses to this mechanism in those companies?

Frank Haskew: It will certainly go some way to addressing tax-motivated incorporation. There is no doubt about that because, effectively, it shifts the balance. Regarding policy, you will probably see a shift more towards people not paying dividends out and accumulating income within the company and potentially then looking to liquidate at some stage, for instance, or doing some other transactions. We also have some quite complicated rules coming up about company distributions in the current Finance Bill clauses. At the moment it is difficult to say, but it certainly will go part of the way to addressing that problem.

Q14 Lord Forsyth of Drumlean: Can I ask about the Office of Tax Simplification, which I certainly thought was quite a good idea? As originally envisaged, it would be a body that would look at the tax system and say, “Can we get rid of these allowances? Can we alter these aspects to make it simpler and fairer and flatter?” That is what the Chancellor used to say when we were in opposition. Looking at the number of recommendations, it is a minority that actually get implemented. What do you think has prevented more of these recommendations from being adopted, given the Government’s mantra that they want to simplify taxation? The Finance Bill puts the office on a statutory basis. I am bound to say that I am not sure I see the point of that or if it is going to make it more effective in carrying out its functions. Or am I missing something?

John Cullinane: Tax simplification is not an important enough priority. That is the basic issue. In general, I think the OTS has done a good job. It probably could have improved its average if it had made only minor tinkering recommendations, but it has tried to deal with some chunky issues, and they are difficult to get through.

Lord Forsyth of Drumlean: Can you give an example?

John Cullinane: The whole area of employers’ national insurance. Effectively, you are taxing something pretty close to everyone. There is income tax on earnings, but there are all sorts of differences. They are looking at some quite big issues, underlying which there are huge revenue flows, so it has not set itself the easiest task. Overall, I have been pretty impressed with it, but the real issue is, even if it had a 100% record in dealing with the stock of complexity that has built up, more and more is being piled on every year to dwarf it, as we have seen in some of the clauses we have talked about here. For example, under the statutory provisions for the OTS, it is going to have to do an annual report on its own work, not on the state of simplicity versus complexity of the whole system, and not coming forward with their ideas on other ways in which it could be addressed. It is a little bit of a Maginot line.

Lord Forsyth of Drumlean: Putting it on a statutory basis, it ought to have the power to put up its hand and say, “Hang on a second, this is not a smart idea”.

Frank Haskew: When the Office of Tax Simplification was first set up, the late Lord Howe made a comment that he tried to simplify the tax system, but it was a bit like painting Brighton pier when it was being extended to France. His analogy is so true. For instance, in 2011 we had a 400-page Finance Bill. That was shortly after the Office of Tax Simplification had prepared its report on tax reliefs, and 100 pages were removed from the tax code by the Office of Tax Simplification. I did a quick tally this morning and, in the last Parliament, the Government introduced 2,839 pages of tax legislation. That was their total at the end of it.

Lord Forsyth of Drumlean: Net?

Frank Haskew: No, sorry, that is gross. The OTS certainly reduced that by 100 at the beginning. We did not have any figures after that, but I suspect it was relatively small. The fact is we have had almost 3,000 pages added to the UK tax code, and that was on top of, I think, 9,000 when we started. It is very difficult to simplify a tax system meaningfully when you are faced with that level of extra legislation. The Government said right at the beginning of that Parliament that the pace of change would slow and, in fact, that is by far the biggest number of tax pages added in one Parliament we have ever had.

Chas Roy-Chowdhury: The Government do not take simplification seriously enough. Before the OTS was set up, we advocated the idea of a tax policy committee, similar to the Monetary Policy Committee, which has much more of an independent remit. That was not what was set up. The OTS does its work based on what it is allowed to do by the Minister, so we think going to a statutory basis would help. Two years ago, we had a situation where this Committee was looking at draft legislation around partnerships at the same time as the OTS was looking at simplifying partnership tax. There was a whole raft of new partnership legislation coming in when the Government had already given the go-ahead for the OTS to look at simplifying partnership tax. It seems bizarre that the Government say one thing, and this is not joined up, and then do something else which shoots the OTS in the foot. I think the OTS has done as much as it can within the scope and remit it has, but I do not think the Government take simplification seriously enough. They want to have that badge of honour, “We believe in simplification”, but everything we have discussed today shows otherwise.

Lord Kerr of Kinlochard: I think the Office of Tax Simplification is an excellent idea, but surely what you are describing is bound to happen in this area and the good it can do is bound to be very limited if its role is not ex ante, if its role is ex post, if it is simply dealing with the existing tax regime and suggesting ways in which it could be simplified, because there is inertia in any system and the existing regime is as it is because somebody thought one particular element in it was a good idea and it accreted over time. Surely it has to have an ex ante role in looking at proposals before they are put into Finance Bills and considering whether they should be in there or not. In this case, is it not particularly odd that, apparently, it does not have any role in regard to the administration of tax? We are talking here about whether it is wise to be doing a major change in the personal taxation of dividends and interest savings at the same time as you are having a major change in the administration of tax, moving, as one must, to a digital system, so-called simple assessments, and all the problems that we are talking about. Surely any organisation with a remit for simplification would say you have to separate these two things. One might also say it is not a very good idea to be making such a “complex” simplification of the regime. One might also comment on whether it is a good idea to do it at the same time as one changes the administration. Am I right that it has no ex ante role and it has no role in relation to administration?

John Cullinane: I think you are right on the first point. On the second point, although they have been trying to develop what a proper measure of simplification is, I agree totally with Frank on his figures and I also agree, by and large, that is pretty representative of how much more complicated the system has become. In isolation, the number of pages is probably not the be-all and end-all of it. You could have something that added a lot of pages, but was a simpler experience for the taxpayer. I think the OTS is alive to that and does take that into account. I think that is okay. The source of the problem is this continual piling on of complexity, as Chas and Frank were saying earlier, often without any consultation. Often the most complicated things that come out are the ones without any prior consultation. I would imagine the OTS would not necessarily want an obligation to vet everything, because then it would be totally bogged down, but some kind of ability to comment on it. Certainly that is where the focus needs to be in the process of generating new, complicated stuff all the time.

The Chairman: Thank you very much indeed. Can I finish up with one point? You have painted a picture of complexity, some baffling changes, a greater burden on taxpayers to actually comply with the new regime, and rather sparse resources of HMRC to help with that. That all sounds like a financial burden that is being transferred to the taxpayer. Would you agree?

Chas Roy-Chowdhury: Outsourced, yes.

Frank Haskew: Yes.

The Chairman: Somebody said earlier that may be good news for accountants, but overall that is probably not something we should welcome.

Frank Haskew: It is not good news for the taxpayers of the UK.

Chas Roy-Chowdhury: I think that is not the kind of work most accountants really want to pick up.

The Chairman: Thank you very much indeed for your helpful answers. We look forward to the further information you are going to provide us. Thank you very much indeed.

Examination of Witnesses

Paul Johnson, Director, Institute for Fiscal Studies, and Professor Judith Freedman, Professor of Taxation Law, Said Business School, University of Oxford

Q15 The Chairman: Professor Freedman, Mr Johnson, thank you very much indeed for joining us this afternoon. You came in at the tail end of the previous session where I was summarising what we had heard from the representative bodies. That was that the tax changes are baffling, complex and transfer the burden—and, indeed, some additional cost—to the taxpayer. That seems to sit rather oddly with the comment that the IFS made, which is that the changes, referring particularly to the personal savings allowance and tax deduction scheme for interest, were improving the “efficiency of the tax system” and that the PSA would be “a big simplification”. You do not seem to quite agree with the weight of the evidence that we have just heard.

Paul Johnson: It will be different for different people, but for the large majority, who will not now have to pay tax on interest income, that will look more straightforward. There are significant numbers, of course, at the moment who are taxed at source who do not reclaim that which they are entitled to reclaim, and this will at least get around that. There is clearly a minority with significant amounts of interest income who will now need to declare this separately, and certainly if you are a non-taxpayer or a basic rate taxpayer, for whom that was previously dealt with automatically, this will be more complex. Regarding the weight of numbers of people affected, literally only those who are currently paying tax because it is charged at source and not reclaiming it I suspect will outnumber those for whom this will add complexity.

The Chairman: So the tax-free allowance takes a lot of people out, but those just above the tax-free allowance now have to do rather more?

Paul Johnson: Yes. Again, the majority of those affected will be higher rate taxpayers who will have tax returns in any case. It will add a little bit of complexity to their tax return. Some gain and some lose with regard to complexity, but the judgment we were making was that the significant number who will gain, at least numerically, outweigh the minority who will lose in complexity.

The Chairman: Winners and losers.

Paul Johnson: As ever.

The Chairman: Professor Freedman, would you agree with that?

Professor Judith Freedman: That is logical. It depends whose perspective you are looking at it from. The worry is that the simplification is only in the administration. If you step back and try to understand the system—if I were to explain it to my students—it looks more and more complicated: it is not very logical and you have all these little different bits of savings allowances and personal allowances and dividend allowances. To actually sit down and understand the system, and how much you are paying and why, is difficult. I think we have reached the stage where most people just fill in the forms, rely on the software and hope it is about right. It is a judgment whether that is a good way to run a tax system, but I think it would be quite nice for everyone to be able to understand why they are paying the tax they are paying.

Paul Johnson: I agree with that. If you add the various changes to savings taxation that we have seen over the last few years—as you know we have got the interest allowance, a dividend allowance now, a capital gains allowance—you can take £28,000 of income and capital gains now. If you do it precisely right, without paying any tax at all—obviously that will create some kind of behaviour to try to achieve that—and if you add on to that the complexity that has been layered into the pension tax system, and maybe there will be more of that coming in the Budget, the amount of time people will have to spend getting their savings decisions right, given the way the tax system is structured, is only going up.

The Chairman: Do you see these changes as part of a coherent approach with a sense of direction and a road map so that savers and taxpayers can now begin to see what the overall strategy is, or do you think it is just a series of individual measures, one heaped on top of another?

Paul Johnson: It is slightly hard to see what the road map might be. Elements of the system are becoming more generous in the sense of moving bits of it towards the ISA treatment. ISAs have been made significantly more generous and flexible. We now have a sort of ISA treatment of the first £1,000 or £500 of interest income. Effectively, we have something like an ISA treatment of dividend income, the first £10,000 of capital gains tax. For the majority of people with modest returns, we are moving a little towards that kind of treatment, but then you are adding additional tax to higher payments of dividends, so that is away from that kind of treatment of savings income. As I said, really importantly in here, you have to think about the taxation of pensions in this context, and clearly that is becoming both less generous and more complex over time. Exactly what it is aimed at, I do not know. I could construct this argument which says that we are producing something which is more like ISA treatment for more people and their savings, but whether that is what is intended, I honestly do not know.

The Chairman: Do you see the changes that are being made leading to savers having to reshape their portfolio to take advantage of some of the new tax allowances? In other words, there is an opportunity, but also a complexity in understanding. Is that how you would see it?

Paul Johnson: For sure. It will do exactly that, because, as I said, you can take advantage of a different set of allowances, which relate to different kinds of savings income, and people will do that. When you are looking at the dividends taxation, the incentive to split between partners in a couple is obviously significantly increased in that sense. Again, if you are a higher earner, because of the pension tax changes, the incentive to put less into a pension and more into something that is going to create dividends or capital gains is clearly increased. Yes, this will, for sure, result in people altering their portfolios in order to maximise their tax advantage.

Professor Judith Freedman: That has to be right. The newspapers are already full of advice columns, even for people at the lower end of the income scale , on whether they should keep their money in the bank or in shares and rely on the new savings allowance and taxation of dividends rules, or whether they should go into ISAs. That is quite a difficult decision and there are already newspaper columns on that.

Q16 Lord Forsyth of Drumlean: I wonder if I could ask Professor Freedman a general question. I have always thought that it is important that people should be able to know what tax they are likely to have to pay, either at the end of the year or during the course of the year. The changes which are being introduced to the treatment of dividends and savings tax, and the changes in the thresholds, mean that people may very well not actually know where they are going to be at the end of the year and they are going to be informed digitally, whether or not they have got a computer, that they are due X, Y, Z. Is that not a fundamental shift away from what we have always had within our tax system?

Professor Judith Freedman: I think the intention is for people to be able to find out more by having their personal account and being able to log on. I think there is an assumption behind some of the literature I have seen that everything is very static and that people behave in a very simple way if they have very low incomes. Actually, people on low incomes do not necessarily behave in a simple way. In fact, they may have fluctuating income and are perhaps even more likely than people on higher incomes to have fluctuating income. I do not think that the idea that you can foresee and understand tax better if you have simple tax affairs, if you have low income, is necessarily correct.

Lord Forsyth of Drumlean: I was not so much thinking about low incomes. Paul Johnson said there are more people. I am thinking of people who find themselves moving from one level of marginal rate of tax to another.

Professor Judith Freedman: That is for sure, yes.

Lord Forsyth of Drumlean: And people getting caught by the combination of all these allowances suddenly finding a marginal rate of tax of more than 60% and not realising that. They are called allowances but they are not really allowances at all. That seems to me to be a very undesirable change.

Professor Judith Freedman: I agree. The interaction between these allowances, or whatever one calls them, and the rates of tax, the schedules, and the withdrawal of those allowances as you get up the rate schedule, is very confusing, and you cannot really know how much tax you are going to have to pay until you crunch the numbers.

Q17 Lord Forsyth of Drumlean: I was supposed to ask you about the changes in dividends. I understand that the thinking behind the changes that are being proposed is to address the position of people setting up service companies in order to minimise the amount that they have to pay in income tax and national insurance by paying themselves dividends. Do you think that these changes will achieve this result? Do you think that there will be further changes needed to deal with the unexpected consequences of these changes?

Professor Judith Freedman: It helps in some ways and hinders in others. As Paul said, it encourages people to split their income between family members to keep below the £5,000 sum. There will simply be different tax planning around it, I suspect. In a fairly crude way it charges people more tax if they have set up a tax-motivated company, so in a fairly crude way it does a kind of catch-up. It discourages people from converting their labour income into income from capital; ie into dividends. It does that across the board, whatever kind of company you have. It is very crude in its effects. I can see why they have done it, it is quite clever in a way, but I do not think it will stop tax-motivated incorporation, as it is described by the Treasury. I would question whether what is called tax motivated incorporation is always tax motivated anyway. I do not think the new dividend rules will remove the IR35 problem. I do not think they will simplify in the sense of making it obvious that one should operate in an unincorporated form, because there are lots of other reasons for setting up companies.

Lord Forsyth of Drumlean: Do you think it will change people’s investment strategy? Will they want to buy shares that have lower dividends or things of that kind? Do you think people will try and game the system?

Professor Judith Freedman: It depends on the person. The vast majority of people will hold most of their shares in ISAs and it will not make any difference to them. Other people will hold their shares through other vehicles where it will not make any difference.

Lord Forsyth of Drumlean: The vast majority of people, of course, do not pay the vast majority of the tax.

Professor Judith Freedman: For wealthy people, who have more than that amount of dividend income, yes, they will tax plan, I am sure.

Baroness Drake: If I could go back to the coherent strategy point, I think the observation was it is difficult to see one, but there are winners and losers depending on your view of who should win and lose. There is now a range of different tax incentives. Do you think people will understand them? Do you think they will be able to make a coherent assessment of what is out there? What do you think will be the overall responses to this additional complexity in the system?

Paul Johnson: I can only speculate. There will be different groups, as we have just discussed. There will be a small group of very high-wealth individuals, who, in principle, will be paying significantly more as a result of the dividend changes. I am fairly sure those will be well advised because you need quite a lot of money to be in that situation and, as we have just discussed, being advised, they will make changes to minimise tax. For the majority of us, who are not in that happy position, I suspect there will be a lot of uncertainty about how this impacts. My guess is that most people will remain in ISAs, even though for most people now an ISA is not going to be terribly valuable because you do not pay capital gains and you do not pay dividend tax on quite a large amount of returns out of an ISA. If it is more expensive in charges to have money in an ISA than out, they will be losing relative to what might have been possible.

Again, it is really important to see this alongside other changes to pensions, and indeed to buy-to-let properties, where, because this will treat small amounts of interest income, but significant amounts of dividend income, alongside capital gains more generously than it has in the past, one would expect a greater part of the portfolio to be held in that form. The overall direction of change, which is for those with higher levels of dividends, those with large amounts going into pensions and so on, is the amount of money that goes into owner-occupied housing may go up, which is the only bit that has not been touched by any of these changes.

I suppose one worry that I have is that an unintended consequence of putting all these things together is that owner-occupied housing looks increasingly like the best bet from a tax point of view and, therefore, the price of that is pushed further.

Q18 Baroness Drake: The Government are clearly keen to set the pace at moving to digital accounts and clearly that is quite an aggressive agenda. Would you suggest any changes to the personal taxation system that could enhance that transition to digital accounts? In your view, are there particular areas that stand out that, if simplified, would assist that transition?

Paul Johnson: I am no expert on the digital accounts, but, as with most areas of the personal tax system, one’s eye is immediately drawn to the national insurance system and the fact that is still administered entirely separately for different jobs and between self-employment, employment and incorporation, and creates complexity in every imaginable dimension of thinking about this. So long as you have a different treatment between income tax and national insurance, and different treatment of national insurance between different forms of income, and, if you have more than one job, different treatments again, I would assume with digital returns, as with everything else, that is going to be one of the big problems. Judith may have more sense of that.

Professor Judith Freedman: I wonder about that question because we should be thinking what is our ideal system and then backing that up with the new technology, rather than saying, “Here is the new technology; let’s devise a system that works with the technology”. I think that is one of the worries about the way we are bowling ahead with digital and thinking, “We’ve got to do this because we need the digital account” and “We’ve got to do the other because we need the digital account”, instead of first thinking, “What do we actually want to achieve with our tax system?”

Q19 Lord Teverson: I did not declare my interests. I am a fellow of the Chartered Institute for Securities and Investment. I absolutely agree with your point that some of the less well-off people are the ones with the most complex jobs. Certainly down in the far south-west of the country, which is one of the poorest, the feeling is that everybody has to have at least three jobs, so it tends to work that way. Can I come back to the strategic area of government policy on taxation? A number of people would say there is a tendency to introduce significant tax changes on a very piecemeal basis rather than what one might call a coherent long-term plan, even over the period of a Parliament. Obviously beyond that it can be more difficult. Do you agree with that, or can you see that there are specific strategies going on at the moment that are at least coherent in a broader sense?

Professor Judith Freedman: I suppose some people might have coherent strategies in mind, but it can be hard to discern them.

Lord Teverson: Would you say they have been clearer in the past? I can remember times in the 1980s when you had an impression that it was going in one direction. Is that looking back rosily in history?

Lord Forsyth of Drumlean: No, you are right.

Professor Judith Freedman: I think we have had periods where there has been a clear aim to do certain things. There is now a clear aim to reduce corporation tax rates, for example.

Lord Teverson: Yes, that is true.

Professor Judith Freedman: There are some clear aims, but it is not always clear why we are reducing the corporation tax rate, for example. We have had road maps which have been successful. The corporation tax road map was considered to be quite successful. We are going to have a business tax road map apparently, but the question will be whether that road map comes from a wish to have a coherent way forward or whether everyone is casting about for things to put into the road map. I do not know yet which it is. Even when you have a road map, rabbits are pulled out of the hat which throw the road map, and that has always been the case. I do not think it has necessarily got that much worse. Ever since I have been working on tax, people have been saying the same thing. Maybe there are some rose-coloured spectacles around.

Paul Johnson: If I want to really depress myself I will go back and look at the article that was written when the IFS was founded in 1969 by our founders, which bemoans the way in which tax policy was made back then, and many of the things they complained about are still true. I think it is a desperate failing of the way that we make tax policy, relative to most other policy, where there are strategies coming out of departments’ ears and lots of consultation on good and bad policies. Regarding the high-level direction of tax policy, we get none of that essentially. We have no sense of where we are going on taxation of housing, pensions, or indeed savings, until it is sprung on us. I think some of this is terribly damaging.

The change year after year after year in taxation of long-term vehicles such as savings and housing is clearly damaging; the new continued increases in stamp duty on the one hand, or reductions in pension tax relief on the other, or changes in buy-to-let. Some of that may be entirely sensible, but it needs to be thought through as a whole, particularly if in one year, for example, you are going to change the rules around annuitisation and tax relief for pensions, and the next year think about the whole structure of pension taxation. My sense is that the one was decided and then the other was thought about, rather than thinking about all those in the round. I do think a lack of long-term strategy is a significant problem and significant cost.

It is a political cost as well, because we have seen both the last Labour Government and coalition Government bring in policies which make no sense and then have to go through the political pain of repealing. One can think of 0% corporation tax rates and very low rates of capital gains tax under the last Labour Government. One can think of pasty taxes and other types under the coalition Government. Not having that strategy is not only economically damaging, obviously it is not politically helpful either.

Lord Teverson: How could those sorts of instances you are thinking of, Mr Johnson, have been improved? Were they areas that were not properly consulted on, or were they consulted but there was a political motive that effectively meant that these things had to happen anyway? How does that improve?

Paul Johnson: Those sorts of things were just sprung. They were not consulted on at all. The worst type tends to be that which comes out of nowhere in a Budget announcement. I think you have to have a sense of the direction you want to take the capital gains system, or the business tax system, or the housing tax system, and give people a sense of that direction, putting your policies into that framework. Clearly, you are never going to get fully away from things being announced on Budget Day, because it is an exciting thing to do, but being clear that what you are announcing is consistent with a long-term direction is less likely to make mistakes, and will make it easier for people to plan in some sense of where that is going to go.

Lord Teverson: Is that possible in a political environment? We can get better at it, can we?

Paul Johnson: I think it is possible to do more than we do at the moment. Not all countries do it in quite the same way that we do. For example, there have been periods when we have gradually got rid of mortgage interest relief or the married couple’s allowance, or what have you, where it has not been announced exactly where we are going, but it has been pretty clear what the direction of travel has been. In the 1980s, I think one did see some clear sense of direction. I do not see evidence that recent Chancellors have had that in mind.

Lord Bilimoria: You made the point about the lack of a road map and said that even with the corporation tax it is not clear why they are doing that. Is it not quite clear why the corporation tax is being reduced?

The Chairman: We should be back in about six minutes.

The Committee suspended for a Division in the House.

The Chairman: I am sorry for the length of that but it was quite a crush. Lord Bilimoria, would you like to repeat your question?

Lord Bilimoria: Thank you. I resume my question. My understanding is it was being explained why there is an advantage to have a low corporation tax for the benefit of the economy, industry and foreign direct investment. In the same way, do you believe that why income tax rates are the way they are, or entrepreneurs’ relief or capital gains tax, should be articulated very clearly? Surely the objective is not to raise as much tax as possible, but to make the economy more competitive?

Professor Judith Freedman: Obviously the Government’s aim is up to them. If their aim is to be more competitive, you then have to analyse what makes you more competitive, not just assume that reducing the corporation tax rate will be the thing that makes you most competitive. It may be that there are other priorities that business might have for competitiveness. That is what I meant. You need to look at the tax rate in the context of a wider debate about capital allowances, for example, and other issues, because it may be that you can have a very low tax rate and still not be competitive because of some other tax factor.

Paul Johnson: I think it is very important in that debate to recognise there has been not only a cut in the main rate of corporation tax but a very big shift in the structure of tax as it affects business. Proportionately, business rates have become much more important over the last eight or nine years. Business rates are not a terribly good tax. They create problems for particular parts of the economy. As Judith said, whilst we have reduced the headline rate of corporation tax, we have reduced capital allowances and so on. Both business rates and lower capital allowances reduce the incentive to invest while the lower rate of corporation tax achieves exactly what it was supposed to, which is international competitiveness for attracting high profit, internationally mobile profits and business, as does the patent box. There is a trade-off. To be fair, the Government have fairly explicitly taken one route down that trade-off, but I do not think we spend enough time discussing the fact that there is a trade-off. The amount and sort of business taxes that businesses pay is changing really substantially, and I think more than has been properly debated.

Lord Bilimoria: So this should be highlighted much more and explained much more clearly.

Paul Johnson: I think it should, yes.

The Chairman: Baroness Drake, did you want to come in on this as well?

Baroness Drake: You started to anticipate it, because I was going to ask about the structural changes in the tax take. It came up previously why the Government may be reluctant to have a road map, particularly in the area of personal tax and national insurance. As the source of tax revenue shifts, that may produce a political resistance to having road maps in certain areas because of the importance in the tax take and the political nature of the tax take it comes from. What you are suggesting is there is benefit in looking at the structural changes in the tax take and having a more open debate about which lever is most effective.

Paul Johnson: Very much so. That structural change in the tax take is most evident in the business side. If you look at the personal side, VAT has become slightly more important over the last few years, particularly as a result of the increase in the main VAT rate. Income tax and NI remain the two biggest—NI is more important than it was relative to income tax 20 or 30 years ago—but the changes are pretty gradual at the moment.

Baroness Drake: I thought personal tax and NI had risen quite significantly as a proportion of the tax take over the last 10 years. Is that not the case?

Paul Johnson: As corporation tax has gone down, the personal tax and NI proportionately have risen. I meant I do not think the relationship between income tax and NI has changed dramatically recently.

Q20 Lord Bilimoria: Can we move on to the OTS? The draft clauses in the Finance Bill on the OTS broadly give statutory effect to the current operating model. Professor Freedman, you have written of the need for a radically different model, an office of tax policy, which might have an independence and influence similar to the Office of Budget Responsibility. Can you explain why this is better and what you have in mind?

Professor Judith Freedman: The first problem with the Office of Tax Simplification is the name. Just looking at simplification without looking at policy more broadly is always going to end up with people having to work on the margins. If you cannot look at underlying policy then there are limits to how much you can simplify. In fact, the Office of Tax Simplification has found that. In many of its reports it has gone further than just fiddling at the edges and has talked about policy. I think the emphasis on simplification is oversimplistic, if you like. You cannot only look at simplification.

The other problem is that it is not independent. It is funded by the Treasury and, even now that it has been established by statute, the funding is purely at the whim of the Treasury. The appointments of all the people involved are by the Chancellor. There is a sense in which it is neither one thing nor the other, because it is not part of the Treasury, so it may not have access to some of the information that the Treasury or HMRC has, but it is not outside the Treasury either and completely independent. In the statute, they have established that they can look at issues that the director of the OTS wishes to raise, not only things the Chancellor asks them to look at, but they are entirely dependent on the Chancellor for the funding. They do not have a devolved budget like the Office for Budget Responsibility. They could raise something, want to look at it, and then be starved of the resources to do that.

Lord Bilimoria: Would you agree that many people say the Office of Tax Simplification is an oxymoron? There have been thousands more pages of tax law added over the last Parliament, and tax reliefs that were reduced by the OTS, for example, but then if you take the new reliefs introduced there has been a net increase. It seems to me that it is having the opposite effect of what was intended.

Professor Judith Freedman: Well, that is not their fault. I think that they are being given a really difficult task, because you cannot simplify tax simply by looking at a few little bits and pieces; you have to look at the whole system and look at it long term. All too often, the Office of Tax Simplification is given tasks and required to report within a year, and you cannot simplify like that. They also do not have enough staff, or the right sort of staff, to do any kind of radical work, which is what I am arguing they need to do.

Lord Bilimoria: Mr Johnson, what is your view on that?

Paul Johnson: I agree with that. On the plus side, it does mean that there is a focus on some of the administrative issues in tax, which if not quite within the Treasury is almost within the Treasury. The amount of external input that the OTS has ensured that it has got has been significantly more than existed without that. The issues are rather as Judith says. You cannot overstate the point that thinking about simplification without thinking about the structure of policy is extraordinarily hard, if not impossible. What are the things that create complexity? They are the fact that we treat self-employment income differently from employment income, differently from corporate income. In that world, complexity is inevitable. If you have an Office of Tax Simplification looking at simplification without being able to address those things, it is only ever going to be able to get so far. For one, that is clearly important.

Secondly, how do you make something like this have a real impact on the policy-making process? Again, as Judith says, I think you need to be clear. Is it a powerful voice within the Treasury having that effect, or is it something external such as the OBR? It is a little bit stuck in between. I do not know how effective and powerful a voice it is within the Treasury, but unless it is a very effective and powerful voice within the Treasury—and I suspect it is not as effective and powerful as the baronies that are running each directorate within the Treasury—it is going to have a more limited impact. We need to decide which of those things it is doing.

Thirdly, of course, it is by construction allowed only to look at historical policy, as it were, and is not involved in all this new additional complexity that you are describing, which is inevitably going to lead to exactly the question that you asked, which is they may be tidying up some mess that was made a few years ago but some more mess is being made without their input.

Q21 Lord Forsyth of Drumlean: Perhaps I should declare an interest: I chaired the Tax Reform Commission in 2006 for the Chancellor and the Prime Minister, while we were in opposition, and it recommended setting up an Office of Tax Simplification. The idea was that the shadow Chancellor was committed to having a lower, flatter, simpler tax system. That was the declared policy. The idea was to set up a body which would make recommendations that would enable him to achieve that through areas such as, for example, removing allowances and reducing rates, looking at merging national insurance and income tax, and so on. These were all approved while we were in opposition. Clearly the resource point is an important point and, if it is going to be put on a statutory basis, should one not expect there to be resources to enable the organisation to help the Chancellor—if those are still his objectives—to achieve them? More importantly, do you think that part of the difficulty with what you are suggesting, Professor Freedman, is if you had an independent body it would take away from the freedom of the Chancellor? The Treasury is never going to agree to that. Perhaps there is an oxymoron, but is there not an opportunity, properly resourced and brought in at an early stage in thinking about ideas that occur to the Chancellor in his bath, to look at these from the point of view of tax simplification? Is that not something which could help, given the resources, if the Government were committed? That is the first question. The second question is, why do you think so many of the recommendations have not been taken up?

Professor Judith Freedman: To start with, some of the recommendations have been taken up. They may not be very exciting ones.

Lord Forsyth of Drumlean: Most have not.

Professor Judith Freedman: Some have, and there have been some administrative advances, so I do not think we should be wholly negative about what they have done. The big recommendation, and the one that I think is the most important, which is to merge tax and national insurance, is so difficult and so intensely political that, having made that proposal, it has now been taken back off into the Treasury. That was almost inevitable.

Lord Forsyth of Drumlean: That is one of about 400.

Professor Judith Freedman: Many of the other recommendations are small. I think more than you are saying have been taken up, or maybe it just takes time. It takes time for them to filter into the thinking of the Treasury. Quite a lot of things have been taken up, but not always in the way that they were intended. Cash accounting, for example, was picked up, taken up, but then implemented in a way that was never intended by the Office of Tax Simplification. One of the problems is follow through. Once they have made the recommendation, it can just disappear and they may not know what is happening with it. It may be taken up, but not taken up very well.

Lord Forsyth of Drumlean: As at March 2015, 60 big picture recommendations had been made and 342 other formal recommendations; 16 had been accepted of the big picture recommendations and 150 of the formal recommendations. Why have a dog and bark yourself?

Professor Judith Freedman: Some of them may still be wafting around in the Treasury, and some of them are interconnected. There have been a lot of partnership recommendations, for example, which take time to analyse. I think the problem is the other way round— everything is supposed to be happening very quickly, and if you really want a body to think carefully about tax you should not be expecting it to happen overnight; you should be giving them time. We should not be looking for quick fixes. One of the problems is that when one is involved with the Office of Tax Simplification, one is asked to find quick fixes. I am on one consultative committee only, so I only know about that. I am on the Consultative Committee on Small Company Taxation. Rather than being able to go away and do two years of research, which is what I think we should do, we are being asked to come up with things quickly for next March. That is not the way to do big reforms.

Q22 Lord Kerr of Kinlochard: I should declare a vanity-of-human-wishes interest too, like Lord Forsyth. I was amanuensis to two Chancellors, and they both thought long and hard, Mr Johnson, about your idea that the most obvious simplification, getting rid of complexity and regressivity in the personal taxes, would be to combine national insurance contribution and income tax. It is obvious. They both thought about it and both rejected it, though they were very powerful Chancellors; they felt it should happen, but could only happen at a time of high growth when there was a giveaway Budget because although the nation would undoubtedly be a gainer, there would be lots of losers on the way. The suggestion you have made is not going to happen, because we are not at such a time now—growth is not very high, there is a deficit to reduce, and so on. Have you any other ideas that might actually be implemented on the simplification dossier?

I have an organisational question too. Of your two models—the genuinely independent outside the Treasury, high-profile operation, and the powerful body inside the Treasury, headed by some senior mandarin, like Lord Turnbull used to be—it seems to me it has to be the second. The Office of Tax Simplification will not work until it has an ex-ante role, until it is allowed to look at the future direction of travel and the Budget measures that are intended, and is allowed to say which of them it likes and which of them it does not like, and is allowed to suggest some. If it is simply dealing with the existing statute book and saying how it could be changed, it is obviously going to have a fairly marginal role, it has to be ex ante. No Chancellor is going to have an independent, high-profile figure limiting, as he would see it, his Budget options. A powerful colleague is not going to be allowed to play that role, so it has to be a Lord Turnbull figure, a sinister, grey man sitting alongside him who is going to play this role. Question two is do you agree with me on that?

Question three is, if you do, is it fair on Angela Knight to ask her to take on that role? Clearly she is adept and skilful at the presentation of policy, but is she a natural Andrew Turnbull?

The Chairman: There is no need to give a specific answer to that.

Paul Johnson: I am not sure that I can comment on how similar Angela and Andrew are.

Regarding the premise of your second question, you have to be right, but I think I am going to be greedy and say you could have both in some sense. I think it is important that there is a powerful person within the Treasury whose role it is to look very specifically at the structure of the tax system and its long-term simplification, and to some extent that clearly ought to be taken by the managing director responsible for that at the moment. It is interesting that, nevertheless, the OTS has added to that process. It has added to it by bringing in people with some very specific kinds of expertise, by particularly being outward-looking and having a bit of a focus on simplification specifically. I think you can big that up by having an éminence grise, or however you want to describe it, within the Treasury playing that role, possibly with a more formal and powerful set-up than is the case at the moment.

I think this would have to be a step even further from Government than the OBR, whether it is within Parliament or externally, having some serious long-term work that is not under the control of the Chancellor looking at some of the changes that might be available in a slightly less constrained political sense. This is a role we and some of the professional bodies take to some extent. Judith reminded me this morning that the last time there was any external official commission on taxation was 1955, and that is quite a long time ago for this to have been looked at officially, but outside of government. Maybe after 60-odd years it is about time to think again.

Professor Judith Freedman: There have been calls for another royal commission, but then we would have the same problems as they have had in Australia, where they have had many commissions and it may be nothing happens. Many of the things that the 1955 Royal Commission recommended have not happened yet.

Paul Johnson: Perhaps we could leave it a little longer.

Professor Judith Freedman: I am not sure about that. I think it would be asking a lot of the Office of Tax Simplification, as it is currently constituted, to look at everything that is coming up, because it simply would not have the time and the resource. It is more than that—it is not just resources. There is a time constraint, because once it has been announced and gone into the Budget there is not much you can do about it. That is why I think you have to have much longer term thinking, and that can be outside because it is not committing anybody to anything, but it would feed into the thinking of the Treasury. Obviously, ultimately, the decisions are going to be political, guided by the wise people in the Treasury, but they would have more to call upon if they had that longer term work going on. I am not suggesting that my proposed Office of Tax Policy could dictate policy—clearly it could not, that would be unrealistic—but I still think it is useful to have that work going on and to be there for people to call upon and be able to say to Chancellors, “This work has been done. These people have looked at this idea and it will not work for these reasons”.

Lord Kerr of Kinlochard: Of course I agree with you. I think the most effective simplification that I have seen was Lawson in 1984 on corporation tax, where the aim was to encourage investment while making a bonfire of allowances, and, therefore, a five-year guaranteed programme of reduction in rates was written into the Budget. I have to admit, all the Andrew Turnbulls of the Treasury thought that was completely crazy and it was a disaster to tie your hands five years out. Chancellor Lawson went ahead and did it, and it worked extremely well. Perhaps it can only be done by a Chancellor.

The Chairman: I think it is time we heard from Lord Turnbull.

Q23 Lord Turnbull: Returning to 1984, I think the grizzled figure you are looking for is Arthur Cockfield, who was given this kind of role, although Lord Stern, when he came back from the World Bank, thought he would have a go at creating a kind of global look at the tax system and it quickly became apparent that Gordon Brown had no interest in it whatever.

Can I come back to this rather cheery assessment of the measures at the start? I think you were saying there are more people benefiting than not, and a lot of the people who are benefiting are people basically getting another £200, some bank interest—it could be children, the elderly or whoever—who are not getting taxed on that and probably not reclaiming it and so they benefit. If you take a different metric, it is not the number of people who benefit, because they never dealt with the tax people in the first place and are not dealing with them now. Looking at the number of people who have to be involved with their tax returns in a way that they did not before, I wonder whether the assessment is quite as cheerful, because under this new system you will be told that a lot of the money that previously would have been deducted has now got to be settled, so at this second stage more money will be at stake. It is not simply a kind of settling-up system any more, it is actually taking the tax off, none of which has so far been paid on account. That raises the stakes for people. Previously, you got the money from the banks, paid net, and you knew you had nothing more to do with it. Now you will get a list of all the people that have paid you interest and you have to work out, “Who are they? I don’t remember that one”. Even if they end up not paying and challenging it, they have to start looking at their return. Then you have all these allowances: an interest allowance, a dividend allowance, an ISA allowance, a CGT allowance, a pension allowance. They all have different amounts and different rules. Some of them get tapered; some of them get taxed at higher rates. It seems to me that the whole thing is incredibly messy and not getting any clearer.

Paul Johnson: I do not disagree at all. I would say several things. The first is I am sure that there are a significant number of people who were claiming back interest who now no longer need to, and a significant number who were not and who are now going to be paying the right amount of tax. That is a clear move in a simpler and better direction. It is also worth saying, of course, that higher rate taxpayers were not getting everything deducted at source, so they have to declare that anyway. Higher taxpayers are not massively additional.

As I said at the beginning, for sure, the number of these different allowances which add together in different ways is going to make planning much more complicated. As someone said earlier, which I think is quite important, the point at which you now shift over from basic rate to higher rate in a whole number of ways is becoming a very expensive moment. The biggest thing is you lose the married couple’s allowance immediately, so you are facing several hundred per cent tax at the point at which you move from the basic to higher rate. You are also having your £1,000 interest fall to £500, so you have an additional hit there, and once you get to £50,000, of course, you are having your child benefit taken away. So you are having all sorts of additional marginal rates layered on top of each other, and once the higher rate threshold hits £50,000 that will all come in at the same point. So becoming a higher rate taxpayer is going to become a very expensive part of your life, particularly if, as the press have speculated, you can no longer get relief on your pension contributions at your marginal rate, if that comes in. The cost of becoming a higher rate taxpayer is going to become very high indeed. For that group, this is definitely hard work.

Lord Turnbull: The point we have reached in the policy, both in the amount of taxation and the ease of handling it by houses, and the fact that inheritance tax is being eased further there, means that everything is channelling into that conclusion, and tomorrow this Committee gets into that world. If you are looking at an ideal, various great men of economics, Meade and Mirrlees, and so on, have tried to design the principles. Are we getting any nearer what they would regard as a rational basis for taxation?

Paul Johnson: Not really. Regarding treatment of interest income, taking most of that out of tax is moving to a more rational treatment, because you are avoiding the double taxation of interest income for most people, but clearly not for those who have large amounts of interest income.

Lord Turnbull: Not double taxation; that is interest, and possibly not all interest.

Paul Johnson: Yes.

Lord Turnbull: But you are still paying tax on dividends.

Paul Johnson: Sure, that is why I said specifically interest.

Lord Turnbull: And then tax on the return on that.

Paul Johnson: If you look at the recommendations from the Mirrlees review, one of its recommendations was specifically to take bank and building society interest income out of tax, because you do not get excess returns on that, so you do not have to worry about people making excess returns which remain untaxed. Then for other forms of savings income, you either go for the expenditure tax system, such that you put the money into the savings before you pay tax and then pay tax at the other end, or you put in place what Mirrlees referred to as a rate of return allowance, such that you save out of taxed income and then only pay a tax on anything above the normal return that you might get, and that is what allows you, at least in principle, to match the marginal rates on returns.

Lord Turnbull: Do you still entertain hopes that by the end of this Parliament we might be a little nearer that point?

Paul Johnson: Not very strong hopes. You could make the argument again—and I do not think the Chancellor has put it this way and I would not put this argument very strongly—that the new system for taxing dividend income, because it increases the tax on high levels of dividend income, is moving you slightly closer to the point at which the marginal rate of tax on that dividend income over £5,000 a year is a bit closer to the marginal rate of tax on labour income. Obviously, on the first £5,000 it is a lot less, so it is a very kind of messy move in that direction, but I could just about make an argument that that was a move in that direction. I think Judith is less positive about it than I am.

Lord Turnbull: I have one more question for you, Professor Freedman, but do you want to comment on that?

Professor Judith Freedman: On the dividend point, it is clear that it is achieving kind of simplification in such a very messy way that you cannot really see that is what is being achieved, but I can see why they have done it, because it is a crude way of achieving higher taxes on certain types of dividend, which was what Mirrlees proposed. The chapter that I helped to write proposed that we should increase the tax on some dividend income.

Lord Turnbull: We are clearly moving towards many jobs, more people are becoming self-employed, their income is complicated. Is the way in which small businesses, sole traders, and so on, are being taxed going to get any simpler?

Professor Judith Freedman: I do not think so, although that is what the Office of Tax Simplification is currently tasked with looking at. It is tasked with looking at the taxation of small companies. At the same time, there is another committee looking at IR35 (that is, personal service companies). There is another committee looking at tax and national insurance. There are three different committees looking at those things. The other thing is that BIS is also looking at how we define employment. There is not only a problem of whether we have joined-up tax policy, but whether our tax policy is joining up with what is going on in other government departments. That is a further complication. There is a great awareness that we need to do something about that, but I am not sure that there are any easy answers out there; the only really easy answer is the one we have already said is very difficult, which is merging tax and national insurance.

Q24 The Chairman: One area where the Chancellor has set his road map out very clearly is corporation tax. He has also made it clear, repeating it over the weekend, that we have a much lower tax here than many countries, but he does expect companies that are here and operating here to pay that tax. If you apply the 19%/20% tax on profit achieved by Google in this country, according to their filings in the United States, then the £130 million that was paid for the 10 years would be roughly what they would probably pay in one year, let us say somewhere between £100 million and £150 million. What advice would you give the Chancellor to achieve his objective of making sure these companies actually pay the lower rate of corporation tax that he wants?

Professor Judith Freedman: I do not have any inside information about that particular case. I think that great steps are being taken by HMRC to tax companies in the way that they should be taxed under the law. A lot of the settlements that we look at are based on past law. The law is changing going forward. With some of the comment from Google, we saw that it is expecting to pay more tax in the future because of the way the law is changing. The UK has taken quite a strong role in trying to get the BEPS project—Base Erosion and Profit Shifting—under way. We have to change the law before we can change the amount of tax we can collect. You cannot look at the gross figures and work out from them how much tax should be collected, because that depends upon what the tax law says.

The Chairman: Mr Johnson?

Paul Johnson: As with all these things, there is a trade-off. There is a whole series of things going on when you have got what appears to be a low rate of tax overall. A lot of it is entirely deliberate, such as capital allowances and R&D tax allowances, and so on, and those are designed into the system. You could decide to undersign them, but very often that has negative consequences. One of the biggest choices facing the Chancellor—and I certainly would not advise him necessarily to take the most radical view here—is how far he goes down the line of reducing the amount of interest deductibility that is available. That is one of the things he is consulting on at the moment and one of the recommendations, but not mandatory recommendations, out of the BEPS process. That could make quite a big difference to the whole structure of the UK corporation tax system, if you limited that significantly, but at the cost probably of overtaxing a number of companies and reducing the incentive to invest. That is a big trade-off, because it would also reduce the amount of potential avoidance cross-border that you get there. He is going to have quite a difficult choice to make on where he comes down on that.

Professor Judith Freedman: That is one of the changes that is arising from the BEPS programme. The other change is the way we look at transfer pricing, and so on. We are going to see a number of changes going forward.

The Chairman: Do you think he has the tools to achieve his objective?

Professor Judith Freedman: Not yet. It may be that BEPS will not completely solve the problem. I very much doubt that BEPS will completely solve the problem, but it may improve things. A complete solution would need probably much more radical change, maybe getting rid of corporation tax altogether, but calling it something else and basing it not on profits at all but on sales; that is what everybody seems to want to tax companies on—their sales or transactions rather than their profits. That would be a very different tax. If you have a corporation tax, and it is a corporation tax on profits, then it is profits you have to look at and not revenues.

Paul Johnson: Another thing that he needs to look at to some extent is the patent box as a result of some of the BEPS changes. Not as much as some other countries do. The patent box is a very interesting illustration of where he is putting the balance. It is nothing other than a tax competition measure aimed at attracting the declaration of certain kinds of internationally mobile profits in this country by offering a very low rate of tax. Again, there are choices and trade-offs over that and I think we get some fairly clear indication of where the Chancellor sits on that.

The Chairman: Do you think that has been effective?

Paul Johnson: Frankly, I do not think there was ever any chance that it was going to be effective in the sense of increasing the amount of R&D that goes on in the UK, because it is not particularly associated with where R&D happens, and, even if it were, the tax comes at the point at which you are already making substantial profits rather than earlier on, which is when you would need the subsidy or the tax break. It may prove to be effective at bringing that income into the UK regarding tax competition, which is what it was aimed at.

Lord Forsyth of Drumlean: Picking up Professor Freedman’s point, with the growth of the internet and its importance in retail, do you think it makes sense to have a system that relies on profits as opposed to volume of sales for tax purposes? That is the fundamental problem with the Googles and the Amazons, and all the rest.

Professor Judith Freedman: You may need to look specifically at e-commerce and have some special tax for that. That has been rejected by the OECD at the moment. It thinks it needs to be dealt with as a whole. It may be that we have to change the tax base. Maybe we have to look to some more VAT, which is, after all, a transactions tax. We may have to consider whether a profits tax is the right tax. There will be certain types of activity which you can only catch with a profits tax, so we should not be so focused on those activities where sales seem important that we forget about the other activities where we want to catch things where there are no sales.

Lord Forsyth of Drumlean: So you think we need both?

Professor Judith Freedman: We probably need to balance those if we want to catch all those different types of activities.

Lord Forsyth of Drumlean: Following up on the Chairman’s question about Google, do you think where there is a wide public interest and we are dealing with companies, there ought to be more transparency about how these numbers are reached?

Professor Judith Freedman: We had this debate before when we allegedly had deals going on in the past, and we had a process set up within HMRC, the Assurance Commissioner, to deal with that. I think I am on record as being a bit dubious about whether that process was going to be robust enough. The current debate suggests to me that maybe we need to think more about that institution. We probably do need some kind of institutional check on what is going on and maybe it needs to be somewhat different from the way in which the current system has been constituted. We cannot all second-guess every single settlement that is reached, because we simply do not have the know-how or the information.

Lord Forsyth of Drumlean: Perhaps to the nearest billion.

Professor Judith Freedman: I would like to feel that we could trust the systems that we have set up because we do have to have a system where it is possible for settlements to be reached; you cannot litigate everything. The idea that there is a precise, right amount of tax is also very misleading, especially when you are talking about valuations and pricing. There has to be some judgment in the process to make it work. We have to rely on the people that we employ to exercise that judgment, but we do need systems of checks and balances. We have an Assurance Commissioner, who will undoubtedly have had to approve this agreement.

The Chairman: Thank you very much indeed for your evidence this afternoon. Thank you also for the discussion we have just had on a very topical issue.