Tax Break

John Fisher, international tax consultant

Archive for the month “March, 2012”

Greatest Britain

"Call me mummy"

What makes Britain great?  There is, of course, no single answer (and the French would suggest there is no question), but the nation that gave the world its principal parliamentary system, its principal international language and (sorry, Yanks) its principal sport must have something in its national DNA that sets it apart from all the rest.

It seems to me that a major factor is Britain’s innate conservatism as described and promoted by the 18th century philosopher and politician, Edmund Burke. British society doesn’t change – it evolves. And evolution produces strength, step-by-step. There have, of course, been potholes in the road over the years – most notably the Civil War and Protectorate of Oliver Cromwell in the 17th century – but, let’s face it, after a few years of that miserable puritan they brought back Charles II whose head had fortunately not been cut off along with his father’s. When things went haywire again a quarter of a century later, the King (the last James we are likely to see) was booted across the water and  none other than John Locke, the very man who challenged the divine right of kings in his “Two Treatises of Government”, was charged with schlepping the new king and queen from Holland.

Even the buses evolve

There was a marvelous example of British evolution a few months back that, typically, went almost unnoticed. One Friday morning an announcement was made in Perth (the Aussie one) – which is just about as far as you can get from Buckingham Palace without jumping on a spaceship – that henceforth the first born of the monarch (etc) will be the heir to the throne irrespective of gender. In a stroke, countless centuries of common law and statute were set aside and Britain and its Commonwealth moved on (I am aware that political correctness dictates that I should be talking about the United Kingdom – but, frankly, I am a bit ambivalent towards Northern Ireland).  And what about Decimalization 40 years ago? After watching sterling evolve over centuries into the quaint system of pounds, shillings (20 in a pound) and pence (12 pence in a shilling) – instead of changing the currency they just dropped the shillings and recast the pence. To maintain an element of originality in the change, instead of using a normal date (like January 1 used for introduction of the Euro) they went for the totally obscure February 15 1971 – which could, at least, have been identified as the middle of the month – in any month other than February.

Which brings me to the central point. I have a hunch  (but not an ounce of evidence) that we may be heading for another of those evolutionary changes in the next few years.

Just enough room for a cucumber sandwich and a bottle of claret

Last week, in the month of March as from time immemorial,  Chancellor of the Exchequer George Osborne presented the Government’s budget for the coming fiscal year.  The Government’s fiscal year starts April 1 but, for the purpose of income tax the year starts on April 6. Why April 6? The story is simply wonderful.

New Years Day used to be recognised in Britain as March 25. That date represents Lady Day when, according to Christian tradition, the Archangel Gabriel informed the Virgin Mary she was going to conceive (count nine months and you get to Christmas Day). The Treasury understandably collected its taxes based on the year commencing March 25.  When, in 1582, Pope Gregory XIII  instituted his calendar replacing the old Julian version European countries gradually adopted it. The Protestant English, however, gave him the two finger salute and hung on until 1752 when, in addition to adopting the Gregorian calendar New Year’s Day was moved to January 1. The tax year was left untouched but for one small point. Adoption of the Gregorian calendar required an eleven day leap forward in the date (there were riots reported at the time of people claiming they had been robbed of part of their lives). Not prepared to give up on tax revenue, the Treasury moved the collection period forward by the said eleven days – meaning that the new tax year would start on April 5. As part of the calendar change leap years are generally skipped at the turn of the century – in 1800 another day was added bringing the start to April 6; in 1900, the Treasury was magnanimous and left the date alone; 2000 was a leap year, so we will never know what Gordon Brown might have done.

April Fool! Alternative view of British evolution

It is hard to see how this system can go on forever. I recently had to do some foreign tax credit calculations for a client invested in real estate in the UK – I felt like getting out an abacus (and hitting someone over the head with it). I would assume that one of these years when the economy is doing well and a government is in the middle of its term there will be a quiet announcement from somewhere like the Isle of Skye (if it is still part of Britain) that the next tax year will start on April 1 – but then everyone will probably assume it’s an April Fools joke. Happy New Year.

Czech mate

I have just sold Czechoslovakia and this is the receipt

Slovakia spent most of the twentieth century as the hapless side-kick in a Vaudeville double act that was incessantly down on its luck thanks to British and French betrayal, German invasion, Soviet domination and Soviet invasion. When Czechoslovakia finally broke up peacefully in 1993 the junior partner had an uphill battle to establish itself. But establish itself, it did.

The masterstroke came in 2004 when the center-right government announced that henceforth the country would be subject to a Flat Tax – a 19% rate for corporate profits (but not dividends), business income, employment income  and VAT. Slovakia was not the first former Eastern Bloc country to adopt a Flat Tax – that distinction belonged to Estonia as far back as 1994 – but it was considered to be a model of success and did wonders for the reputation of Arthur Laffer and his Curve that showed the relationship between the tax rate and government revenue. The election of a centre-left government earlier this month is slated to spell the end of the Flat Tax.

The concept of a Flat Tax is a simple one – adopt a relatively low rate of taxation with a very broad tax base. The tax is defined as a Proportional Tax – you pay a fixed proportion of your income –  as opposed to the more common Progressive Tax – where marginal tax rates increase with income.

The big advantages of Flat Taxes are that they encourage foreign direct investment and sustainable economic growth while, at the same time, being more transparent, easier to administer and providing less incentive for tax evasion. The absolute opposite of this is probably the US Tax Code of which President Richard Nixon’s Treasury Secretary William Simon once commented that he wished for a system that “looked like someone had designed it on purpose”.

Marx getting a firm grip on western civilization

The biggest objection to Flat Taxes is that they do not meet the common or garden definition of “Social Justice”. Karl Marx (still venerated in North Korea and Cuba) popularized “from each according to his ability to each according to his need” and that epithet has managed to stick to the tax systems of countries whose attitudes to socialism range  from passionate love to passionate hate. But the old windbag of Highgate Cemetery did not have a monopoly on the meaning of “Social Justice” –  I believe, like Irving Berlin, that the world would not be in such a  snarl, had Marx been Groucho instead of Karl –  and there are good, if less popular, arguments for the social justice of proportional taxes.

In any event, the Occupy Movement and its various offshoots, have ensured that vote-hungry governments hammer the rich and the banks without reference to the effect on GDP and the ultimate welfare of those they seek to avenge. In the   1960’s a British Labour politician was embarrassingly caught traveling First Class on a train; he explained ingeniously- if ironically – that his party’s ambition was for everyone to travel First Class.

It looks like Slovakia is suffering from a political reality which could do very nasty things to its economy. Unlike the profligate Eurozone countries of Southern Europe, Slovakia did not get itself in a total mess over the last few years (at least not Euro -wise).  Along with everybody else, however, it has agreed to limit its budget deficit ( 3% of GDP this year, down from 4.6% in 2011). In order to achieve that it needs to either decrease government spending or increase taxation – economic growth will not close the gap in the immediate future. GDP is amongst the lowest in the Eurozone and government spending is still relatively modest –  so it is down to taxation.

But the question is – what taxation?  The  Flat Rate system in Slovakia is not a pure system – although the individual tax rate is 19% there are personal allowances a personal income deduction for non-working spouses and pensions and charitable contributions. On the other hand there are punitive social security taxes. Overall this is referred to as a marginal flat tax (or sometimes a progressive average tax rate). What seems to be clear is that whatever the reason – and some commentators have stressed the relative importance of factors other than the tax rate – the system has worked and as one top international tax expert once told me “If it ain’t broke don’t fix it”.

Will Fico take the fizz out of the Flat Tax?

The plan of Robert Fico and his center-left Smer party, just returned to power after a brief stint in opposition, is reported to be to introduce a 25% higher rate for high earners and jack up the corporate tax rate to 22% for companies with significant profits. This all fits in nicely with populist social justice arguments but risks destabilising the very system on which impressive foreign investment has been based. A former finance minister has urged him to look to taxes that do not directly affect competition – singling out excise, environmental and property taxes.

The pity really is that countries like Slovakia have to fall in with Europe’s austerity package at all. The previous government fell over its support for the European Financial Stability Fund designed to address the European Sovereign Debt Crisis of which Slovakia was not guilty. It is lucky for Europe that Mr Fico and his predecessor did not take a leaf out of  British Prime Minister Neville Chamberlain’s book. Explaining his sell-out of Czechoslovakia to the House of Commons in 1938 he said:  “How horrible, fantastic, incredible it is that we should be digging trenches and trying on gas masks here because of a quarrel in a far-away country between people of whom we know nothing”. Anybody know the way from Bratislava to Athens?

Vive L’ Hollande

The quiet ones are the worst

The swashbuckling  Alexandre Dumas  coined the phrase “cherchez la femme” (literally: look for the woman) that has haunted French culture ever since. In the run up to the French Presidential election it is generally agreed that, had Dominique Strauss-Kahn not fumbled in the wrong pocket of his bathrobe  for the gratuity for the chamber maid of his New York hotel room, he would now be  a shoo-in to the Elysee Palace and the rest of Europe would be nodding approval at the  election of a former head of the IMF. Instead, Europe is aghast at the prospect of an old-style left-wing candidate (more of that nonsense below) who is about as exciting as a stale baguette and, whilst by all accounts of high intellectual ability, brings  recollections of Lyndon Johnson’s comment about that other President-by-mistake,  Gerald R Ford – “He cannot fart and chew gum at the same time”.

HE left HER!

But, however daft and outdated many of Francois Hollande’s policies are, and however unlike Maurice Chevalier and Alain Delon this slightly owlish chap is – judging by the two women in his life, there has to be some magnetism somewhere. Although he seems to have never got round to paying for a wedding licence, the mother of his four children is none other than the delectable Segolene Royale who is best remembered for losing the presidency the last time to little Sarkozy. Not satisfied with his lot, he started up with a drop-dead-gorgeous Paris Match journalist two years before he finally split up from Royale and it is Valerie Trierweiler  who is expected to become First Lady (or First Mistress, or whatever they call girlfriends in the Elysee Palace).

And SHE took HIM!

Among Hollande’s policies are: the renegotiation of the latest Eurozone treaty which is what has led European leaders from Merkel to Cameron to refuse photo-ops with him; the batty idea to return the retirement age to 60 from 62; and, battiest yet, a proposal to tax people making over € 1 million at a new 75% rate earning him the nickname “Monsieur 75%”.

The background to the 75% top rate is not economics. In 2012 everybody knows that punitive rates (and that does not even take into account wealth tax and social taxes that get dumped on top) do not bring in significant revenue. No. Mr Hollande is out to take revenge on the rich, especially the demonic financial sector- as he speaks you can hear the cart rattling into the Place de la Concorde, the hapless aristocratic occupant being pelted by the rabble as he approaches his doom at the hands of Madame La Guillotine.

Apart from the effect on the incentive to work, mad tax rates on the highly paid simply cannot work in the European Union. Shortly after making his madcap announcement Hollande traveled to London to canvass the 300,000 plus French living there ( London is the 6th largest French city). The French no longer buy left wing panic mongering about life beyond France’s borders, normally accompanied by Gitanes smoke and the fruity aroma of  un bon vin rouge; instead they master English and go abroad.

The one policy that might have prevented a wholesale decamping from Gaul is the imposition of an Exit Tax – the crystallization of  a capital gains tax liability on assets on the day of departure irrespective of  if, and when, the asset is disposed of and the capital gain realized. The European Union has been playing with this concept for years – most recently in the November 2011 European Court of Justice decision in the National Grid Indus case. The problem with exit taxes is that they tamper with a basic freedom of the EU – The Freedom of Establishment . On the other hand, the EU is concerned not to deny members the right to a balanced allocation of taxing rights (territoriality). As such, the Court considered the imposition of an immediate Exit Tax as not “proportionate” – instructing that, if an exit tax is to be imposed, the assessee should have the option to pay the tax at a later date when the asset is realized.

The French government, in fact, prophesied this situation when advancing new exit tax legislation in 2011. The legislation applies to shareholdings in companies, does not require immediate payment if breaking residence for another EU country and – in the event that the asset is not sold within 8 years – eliminates the liability. As one commentator noted, the new exit tax does not appear to have had any effect on slowing emigration.

Thank heaven for little girls

Of course, the peculiarities of the French election system could see Mr Hollande crowned but unable to enact his manifesto. If the elections to the National Assembly, a month after the second round of the presidential election, return a right wing majority (the current composition is heavily tilted to the right) , the Fifth Republic will enter into its fourth period of Cohabitation – a President and Prime Minister from opposing parties sharing government.  Mr Hollande has already proven himself a master of Cohabitation – cohabiting successfully with Ms Royale and Ms Trierweiler – so he is well placed to make a go of things at the national level.

Washington the dream factory

Who were Rodgers and Hammerstein trying to kid?

Last year, the Oscar for Best Actor was awarded to someone who feigned inability to speak coherently. This year, the same award went to someone who chose not to speak. The 2012 Academy Award for Best Supporting Actor went to that prize’s oldest recipient best known for playing a singing sailor whose most memorable line, nearly 50 years ago, was whistling his children to attention that they might greet the evergreen Julie Andrews who tried to con everyone into thinking she was a nun.

I think it was Founding Father Benjamin Franklin who adopted the ancient line “Speak little, do much” and Hollywood appears to finally have caught on. The candidates for US President, on the other hand, have clearly not taken a leaf out of Hollywood’s book and now, in the wake of that Muppet Show cast vying for the Republican Nomination whose “Pin The Tail on The Donkey” approach to corporate tax rates I dealt with in a previous post, President Obama has now weighed in with a load more useless verbage on the subject.

Measured by the higher level of  tax in his proposal – 28%, the relevant bits of the president’s Federal Budget Proposal for 2013 are, by definition, more responsible than those of his competitors. But, other than talking vaguely about a broadening of the tax base to cover the drop from 35% and ensure a fairer, leaner system, he was a bit short on the facts. He wants to close loopholes but, given that there are interest groups jealously guarding every one, he does not say which ones. He wants to encourage manufacturing with a 25% rate but does not note that some of the biggest loopholes are in that sector. He wants to encourage relocation of activities back to the US from abroad and proposes a minimum tax on overseas profits of which he provides no details.

Go on. Admit it. You thought the last President of Chile was a General.

Non Americans (that’s me, folks) find all this lack of detail strange. Among the 34 members of the OECD (the rich nations’ club) the only nation other than the United States to run a pure presidential system is Chile – the French have a hybrid approach that includes a prime minister who has the support of the National Assembly, and everybody else runs some form of parliamentary system.  As such, in countries that still call football football, when the Head of Government comes up with a budget there is usually a fighting chance that, at least most of it, will be passed since, overall, he has the confidence of the parliament. That is what we Old World people understand Heads of Governments are supposed to do. Otherwise we could employ a secretary to announce legislation and save a lot of time,money and teeth whitener.

Not in the US. When President Obama made his Budget proposal it was a request to Congress and there is not the faintest risk of it becoming law – in other words he could join the dream world of the irresponsible opposition even though he is the incumbent. Pure Hollywood.

There are, of course, certain anomolies in the US system. The president has to ask Congress to declare War which makes a lot of sense, considering the amount of expense and gore a silly mistake can cause. BUT, he does have the power to turn out the lights on all of us by messing around with those secret codes in the briefcase always carried by a military man at his side.

Her typing wasn't half bad either

On second thoughts, I think I will keep taking the US president seriously. As much as I value the professional abilities of my secretary, if she had her “finger on the button” I would be nervous every time she went for the remote control to adjust the airconditioning.

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