The double standard on how we treat tax avoidance (leniently) as opposed to how we treat welfare fraud (very harshly) came under the spotlight again yesterday. The good news is that our courts seem to be cracking down on the tax avoidance problem, and are closing a few of the more glaring loopholes. The Court of Appeal finding in favour of Inland Revenue on the Aleseco tax avoidance case is a genuine cause to celebrate. Basically, here’s how the tax avoidance deal worked:
Inland Revenue won the case against Aleseco of Australia in the High Court in 2011, arguing that the kitchenware supplier avoided tax by using a form of interest-free loan from its parent in the early 2000s, called optional convertible notes. The notes were a common cross-border way to convert debt to equity and minimise tax. The High Court ordered Alesco to pay $8.6 million in tax and penalties.
The Court of Appeal has supported the High Court’s view, saying the only reason Alesco advanced $78 million to its New Zealand unit interest-free for 10 years under the convertible notes was to avoid tax by claiming expense deductions for interest payments that did not occur.
Other firms with foreign parents have been using the same ruse, including Telstra, MediaWorks and Qantas. Yet another way in which the transformation of our economy into the branch office of a set of offshore firms is causing this country grief. It is not simply that the bulk of the profits are being repatriated offshore. Clearly, these parent/subsidiary relationships have also exposed us to tax avoidance scams as well, which have raided our revenue base and fuelled the austerity cuts in jobs and services felt by ordinary New Zealanders. One of the really interesting features of this situation is the scale of it:
The tax department estimates more than $300 million in tax and penalties is at stake.
OK, now compare that to the alleged scale of welfare fraud, which according to Victoria University research by Dr Lisa Marriott last year, is costing us $39 million a year – or about one seventh of the estimated revenue loss caused by this one version of tax avoidance alone.
Last year, tax evaders cheated the country of between $1 and $6 billion, while welfare fraud cost $39 million. “The problem of tax evasion is at best case scenario 25 to 50 times the financial amount of welfare fraud, and at worst case scenario potentially 100 to 150 times the amount,” says Dr Marriott.
The problem is not simply that the amount being lost – and subsequent damage done to our ability to fund public services – is far, far greater from tax avoidance. For a bizarre set of reasons, tax avoidance by relatively affluent white collar tax specialists doesn’t seem to carry anything like the same social stigma as when poor people cheat on welfare – even though the behaviours are immoral in both cases. Tax evasion is not giving government the money one rightfully owes, while welfare fraud is taking money from government to which one is not entitled. Anecdotally, one could theorise that tax avoidance is less likely to be driven by primal needs for food and shelter than in many instances of welfare fraud. Yet for some reason, the courts are usually far tougher on those who cheat on welfare than those who fiddle their tax obligations. As Marriott says:
“For tax evaders, the average offending is about four times as much, but have about a third of the likelihood of receiving a custodial sentence.”
The numbers tell the story. For tax evaders, the average offending is $270,000, and those found guilty have only a 22 percent, or one-in-five chance, of being jailed. For welfare fraudsters, the average offending is $70,000, and those found guilty have a 60 percent chance of being jailed.
Presumably, this crackdown on welfare fraud is meant to deter les autres. Belatedly, the courts now seem to be grasping the notion that it is important to deter tax avoidance as well – given that this kind of activity does more damage to the economy, compromises the ability of government to deliver adequate social services, and feeds public cynicism. Bet your bottom dollar…if it was welfare recipients who had devised a complex ruse to deny circa $300 million of what was legitimately owed to New Zealand, it would be front page news. Talkback radio would be running red hot. So far though, this story has been largely confined to the business press on RNZ and elsewhere, amidst the usual whining that this time IRD and the courts have gone too far – and that this legal ruling in favour of IRD will deter foreign investment. To which most of us would reply “Great!” Because we need this kind of foreign investment like we need a hole in the head.
Thankfully, RNZ located tax consultant Grant Macalister of the WHK business services, who shot down the “This will deter foreign investment” argument, and his comments are included in this RNZ podcast, which is pretty essential listening.
What the courts are beginning to do – in accord with guidelines laid down by the Supreme Court – is create a climate that will limit the ability of foreign firms to rip New Zealand off with the impunity of yore. What we now have to ensure is that the current government doesn’t change the tax laws back again, in order to frustrate the courts and restore business as usual – under the guise, say, of “clarifying the will of Parliament in these matters.”