Racing around in circles on tax

Lewis Hamilton has been in the headlines for his tax planning rather than his driving, named in the BBC’s “Paradise Papers” reports as having imported his private jet through the Isle of Man to save £3 million in VAT.

If you want an unintentionally funny tax story, do read the BBC’s piece on this. “It was still dark when the private jet began its descent. Inside, its decor was sumptuous…the island that the plane was heading towards hadn't yet woken up.” Melodramatic prose, private jets, fast cars, exotic islands, shadowy international finance – I think the writer must be angling for a job on the next James Bond script.

But once you cut through the purple prose and outrage, what this shows is the stupidity of governments trying to fiddle with the tax system.

Hamilton bought his jet, according to the stolen files, mostly for business purposes (presumably flying between race courses and training grounds), plus a minority of personal non-business uses.

VAT was invented by a Frenchman, so not surprisingly it has, at its heart, an elegant logic. Also, not surprisingly, that fundamental simplicity is overlaid by a huge amount of bureaucratic complexity.

But fundamentally, the way VAT is supposed to work is that someone in business charges, and pays to the tax authority, VAT on all their sales, their income. They can then reclaim the VAT on all their business expenses and business-related purchases. That way the net VAT paid by the business is on its “value added”, the difference between its sales and its purchases. That’s why it’s called Value Added Tax.

If the EU’s VAT system stuck to this basic principle, Hamilton would have been allowed to reclaim part of the VAT on his jet, the proportion that related to his business rather than private use. If he used it two thirds of the time for business and one third for private flights, he could have reclaimed two thirds of the VAT. Yes, there would have been a bit of wrangling with the tax authorities over which flights were business-related, probably some cross-referencing of flight logs and race schedules, but basically the same business-use principle that all self-employed people are familiar with when HMRC check their expenses.

But at some point some bureaucrat or politician decided that the basic VAT principle of reclaiming VAT on business purchases should be abandoned when it comes to aeroplanes.

Without, it seems, any good reason other than political envy, the EU decided that VAT reclaims would be prohibited for private planes, even when they were legitimately used for business flights, unless they were used solely by an airline.

So that’s how the VAT scheme used by Hamilton and others worked. His advisers set up an airline for him (charter flights count as an airline business, even though the airline’s only customers were Hamilton and his businesses); the aeroplane was imported into the Isle of Man, Hamilton’s company paid the VAT due, and immediately reclaimed it again because the plane was to be used by his charter airline company. There was a bit more complication, but that’s the fundamentals.

Now, did Hamilton do anything wrong here?

There certainly wasn’t anything illegal; everyone agrees that the law was followed to the letter.

But it’s also difficult to say that he “should” have paid that VAT and “should” not have been able to reclaim it. The jet was being used primarily for legitimate business reasons, and the basis of VAT is that businesses “should” be able to reclaim VAT on their business purchases.

Yes, Hamilton does, according to the leaked documents, also use the plane partly for his own private non-business flights. But what the outraged BBC journalists don’t mention is that he will have to pay his charter company for those flights, at the proper price, and that will be taxable income of the charter company, subject to tax in the ordinary way.

So what is the problem? Why is there outrage, other than envy at the rich and successful and a desire for the government to grab ever more money? Yes, an artificial scheme has been entered into, but only because the EU first put an artificial restriction on the business VAT reclaim.

One technicality has cancelled out another technicality, the law has been obeyed, and VAT has been paid and refunded as it was designed to.

This is essentially the same as the “flat tax” argument that I have been making in Adam Smith Institute reports for years. Rather than over-complicate the tax system, with hugely bureaucratic and interfering rules where some types of income get tax breaks and some don’t, and some types of expenditure get special tax allowances but others are penalised, let us just treat everything the same, have an easy system and keep the rates as low as possible.

It would have been far better to have a simple system where VAT just does what it is supposed to, without trying to use tax for social engineering. It would also show that the UK is open to business rather than merely trying to extract every last pound of tax.