A gamble that can’t lose: how to cheat at tax

A couple of weeks ago, the very day that Jimmy Carr was on the front page of the Times, our company accountant had arranged me & Pete a presentation with a tax-avoidance specialist, or “profit extraction” service.

I didn’t really get a say in participating, so sat through this woman’s presentation, slightly open-mouthed. It was fascinating, apparently scandalous and we declined to take part. But according to a poll on moneysavingexpert.com, 58% people would go to any legal length to dodge tax, so here’s to you guys, knock yourselves out!

This is what she described to us, a scheme for removing profits from a UK company,  largely tax-free. I think I am describing this correctly, but if I don’t, I it’s because something was being hidden from me, or I’m getting my terminology wrong. I’d be glad to take clarifications or corrections.

For this dodge you will need a) an individual who wants to receive their tax-free cash (that’s you), b) a company from which to pay the money, c) an arbitrary investment fund (or “basket”), and d) a casino bank.

You go to the bank, and strike two deals:

1) you buy a spread bet, betting that the investment will go up in price by a small and fairly sure percentage. This costs you a stake of e.g. £7,000, for a £100,000 payout;

2) you sell an option to the bank at the same time, contracting to pay the beneficiary £100,000 if the investment performs, to the same condition as the bet. The bank pays you £4,000 for the privilege of becoming the beneficiary of that option.

So you’re now personally £3,000 down – that’s is the bank’s commission. Nobody pays any taxes on these transactions, which are fundamentally risky. Individually, they’re to nobody’s obvious benefit.

The casino bank is on the hook for a spread-bet that is very likely to pay out. But the bank also has a position over you by being the beneficiary of the option you sold them. If the bet pays out, so must the option, which would leave everyone back where they started (except for the commission).

The dodge is: you’re able to assign the obligation for this option to your company. That’s a benefit to you, because you would no longer owe the bank in the event of a pay-out.

However – this is now a large potential liability for the company. Because it’s a liability, nobody sane would take it off you for free, right? Your company is providing a “benefit in kind”, as if it had bought you a holiday or car, and you’d have to be taxed on that at an equivalent cash price. You can’t just give money away (that would be tax evasion, which this isn’t).  How should we value this gamble?

Apparently, the “proper” way to value the option (the £100,000 liability) is the Black Scholes model.  Its model calculates the benefit to the employee at a value of only £6,000. Really, it does. So after the transfer is done, your company not you is on the hook for this £100,000 liability, and this has only “cost” you £6000 as a taxable benefit (so e.g. you might pay £2400 at 40%).

At the end of the bet period (90 days), the performance of the investment is evaluated, and the spread-bet & option conditions are very likely (though not certain) to be triggered.

When that happens, the casino bank pays out £100,000 to the individual. Winnings on a bet attract no income tax, so you receive the full amount – hurrah!

The company pays out £100,000 to the casino bank. But it’s not a dividend on profits any more, it’s a bad investment that can be written off altogether. It’s completely tax-deductible, so there is no corporation tax to pay on it.

So the end position is that £100,000 has been transferred from the company to the individual. Through lies and smoke, this transfer has been valued at only £6000, i.e. the apparent value of the option assignment, not the eventual payout.

One wrinkle: if the performance of the investment didn’t meet the bet criteria, you have to start again and re-place the contracts, and wait another 90 days. This means it costs e.g. another £3000 in fees to the bank. I was assured that this has only ever happened once in the history of the scheme. If there wasn’t risk, it wouldn’t be a bet. And that wouldn’t be “proper”.

The certainty of the bet is set at a level that the tax planners (and – apparently – HMRC) consider “proper”. I heard assurances (from a circle of people paying each another to say so) that it was “proper”, including a tax barrister. She actually said “of course if we’d bet against a rise of 1.75% that would clearly be a scam, which is why we put the bet level at 2.35%”. My question, “so it’s literally 0.6% away from being a scam?” got laughter but no response.

I thought this artificial loss would fall under the description of tax avoidance established by the Ramsay Principle. Could I see their independent legal opinion of the scheme? They had one, but I wasn’t allowed to see it unless I signed a non-disclosure agreement. Which would have ruined this post.

The firm assures me they have a £500,000 fighting fund, in a trust, against an investigation they think of as “inevitable”. That’s only to cover their clients’ costs in defending an investigation – this is mere advice, and they can’t guarantee we wouldn’t have to pay the tax. But that would be years down the line (i.e. implicitly, after we are long gone from the business, and if HMRC were being properly funded instead of cut to the bone). And for their pearls, the firm only wants £13,000.

The scheme doesn’t even demand large sums, just a limited company where you can withdraw a few tens of thousands of pounds, a cooperative casino investment bank, and a strong desire to leech off the entire rest of society. I was told this firm’s clients are putting tens of millions through their scheme, and they’ve even declared and explained it to HMRC “because we’ve got nothing to hide”. ”Proper” was the word I kept hearing – a cast-iron assurance that there were solid, well-researched and slightly technical reasons that not paying tax was OK.

It’s not. I don’t get why disclosure shouldn’t get the scheme instantly shut down. I don’t get why we have a tax & legal system that makes this complex dodge even possible. I don’t get why our own accounting firm thought it was ethical to take kickbacks from this firm to sign their own clients up. And I’d hope that one day, people who take advantage of these schemes gets shamed as publicly as Carr did, because they’re the UK’s real scroungers.

[thanks to generous sxc.hu users svilen001 at effective.com, mzacha, nazreth and kkiser for their stock imagery]

21 thoughts on “A gamble that can’t lose: how to cheat at tax

    • I’m not that prissy. But I was surprised to have ask whether they would get a kickback from the scheme.

      • Did they tell you?

        I went to a similar presentation a few years ago where the “specialist” knew more about avoidance than tax.

        In this situation I always ask who is going to benefit the most and I can’t see how the client ever does with the risk of a tax investigation which if HMRC win means the tax has to be paid plus interest and of course the fee is never returned.

        Cowboys.

  1. Good for you. It’s rewarding to finally see the biters bitten. Also interesting to wonder how much government money goes into investigating Benefit fraud while simultaneously turning a blind eye to this kind of nonsense, but then Benefit claimants tend not to have a £500,000 fighting fund stashed away.

    • I don’t think anyone is going to care, but I thought it was worth publishing this and seeing if any finance experts thought it was interesting / feasible. Also £500,000 for all their clients? It might be in a trust, but it’s a drop in the ocean if their clients really have tens of millions going through the scheme – the advisors would just close down the firm and move on.

  2. This is very enlightening, but the part I don’t understand is… you have sold an option to the bank that is (apparently) almost certain to require you to pay out £100 000 in the near future. How can the value of this liability only be £6000? Surely it shouldn’t be that far off £100 000 minus interest? There is nothing ‘improper’ about the Black-Scholes equation, it is just oversimplified – I don’t see how it could get the value so drastically wrong if used correctly.

    Knowing very little about how this stuff works in practice (I went to a lecture course on financial maths at uni, but that’s it), my guess is that either they are exaggerating the likelihood of the bet paying out (so the scheme is less successful than they say it is), or they have been very lucky at picking investments to base the scheme on. Alternatively, they are systematically underestimating the value of the liability. The main uncertainty in the basic Black-Scholes model is the volatility of the price of the underlying investment – if they underestimate the volatility, they will underestimate the value of the liability. I don’t know if there is a standard way of calculating the volatility for tax purposes? Who is responsible for performing this calculation?

    • I think the important thing isn’t that it makes sense, but that is a justifiable valuation to HMRC, because of the very standard method used. Of course blind trust in Black-Scholes has been called the mathematical equation that caused the banks to crash. I don’t know whether the £6000 calculation is a correct application of Black-Scholes, but it’s possible the investment basket they used is volatile in a way that causes it to be valued at far less. Again, given that this is the key part of the scam, I suspect that there is a strong case for overestimating the volatility (precisely because they are presenting it as not-at-all volatile to us, the client).

      • The fundamental problem with Black-Scholes is that it can dramatically undervalue options under certain conditions – specifically, when the option is out of the money, like it is here. It’s very likely that the £4000 figure is way too low, and the bank, having bought it, could sell the option on again for closer to the true value.

        In this scheme, though, I can’t see how that actually matters – if the option pays out under precisely the same conditions as the spread bet, I can’t see how you’d get caught out.

  3. Pingback: How to cheat at tax – one entrepreneur’s report » Tax Research UK

  4. Whilst this sort of tax avoidance annoys me, I think you might have escaped a scam here. If you look at the spreadbet, it is paying 25 to 1 (4,000 to 100,000, as you don’t include the commission paid in the calculation). Your accountant might have told you it always pays out, but I think most gamblers will tell you that 25 to 1 shots don’t come in very often. I think the fact that the accoutants make £3K for each time it doesnt come off is very telling……

    • I am not sure they are odds that any genuine bookmaker would set at those stakes, at least not without the corresponding option being set up too. It’s the bank that takes the commission for their part, not our accountants or the tax dodgers.

      • Ok, fair enough, the odds are reduced to just a shade over 14′s at 7,000 to 100,000. I’m not aware of any bank (although I could be wrong) who run both spread betting and option pricing. And even if the odds are completely made up so as just to make the transacation work, then the price of the option would not be £6K under Black-Scholes.

        • The Black-Scholes calculation does seem like an oversight, another poster had pointed that out. I’ve probably burned my bridges with regards finding out any more, but I’d be interested in suggestions as to how that valuation might work (other than “we know it’s wrong, but HMRC won’t check it”, which seems possible).

          • Matthew, having gone so far in exposing this scam,why not go further and name the firm/individual’s promoting it?

            After all if all the details have already been disclosed to the Revenue, what have they to fear?

          • I’ve written that this company is selling a scam, and I’ve not got time to be sued for libel. What I would be interested in is a library of current legal & effective _techniques_, in gory practical detail. The more these schemes are exposed, the harder they should be for HMRC to ignore (especially if new people start putting them to use), and the harder it will be for tax cheat firms to stay in business.

  5. Have posted something on Richard Murphy’s website to the same effect as some of the comments above re Black-Scholes and the likelihood this is a scam.

    One other possibility is that they have vastly inflated the interest rate in doing the Black-Scholes calculation. Interest rates on direct loans between companies and their employees are explicitly regulated by HMRC and have to reflect market conditions, but it’s possible that the rates used in this type of calculation are unregulated and can be cranked up to 10,000 percent or whatever it takes to make the sums work. If so, that may well be subject to a future HMRC challenge.

  6. My current employer uses these “tax planners” and a few of our clietns have used their scheme. Its run by people who used to work at Mercury before it went bust. It was “sold” to us as a “new” idea following the 9 Decmeber 2010 action taken by the government against EBT cash loans. I didn’t like us doing EBT’s and I don’t like this scheme either…

    • Unfortunately Dave you’re in a very difficult position but if the firm you work for are chartered accountants (ICAEW) they should be aware of this recent statement by the CEO.

      http://www.ion.icaew.com/MoorgatePlace/24889

      Sadly most of my fellow members don’t see anything wrong with this type of tax avoidance, hiding behind the argument that it’s perfectly legal when to be accurate its legality hasn’t yet been tested in the courts.

      The other problem which I haven’t seen aired yet is how may accountants are completely out of step with their clients’ views on tax avoidance.

      • Well Stuart, they aren’t my employers anymore and they aren’t an ICAEW firm, nor will they ever be now I’m not there. Their general working practices are a bit dodgy too.