J Frecknall-Hughes TARC Master Class 10 October 2014

Tax Administration Research Centre Master Class, London 10 October 2014 THE WORK OF TAX PRACTITIONERS Professor Jane Frecknall-Hughes Hull University Business School Overview… Part 1: analysis The work of tax practitioners Part 2: a theory of working Part 3: judging quality Part 1, Analysis: Overview  Topicality  Definition of a tax practitioner  The nature of the taxation services market  Review of the taxation practitioner literature  A conceptual analysis of the work of tax practitioners Pt 1: Topicality Pt 1: Definition of a tax practitioner “…covers a diverse group of individuals, business structures and professional groups who provide a range of tax services for their clients Self-employed and in-house accountants, tax advisers and registered tax agents, tax agent franchises and legal practitioners in the tax area are all embraced by the term ‘tax practitioner’ ” Devos, 2012: Terms used – tax practitioner, tax preparer, tax professional, tax adviser, tax agent, tax intermediary, tax ‘structurer’, etc Roles played – tax return preparer, responder to return queries, adviser on ‘tax minimisation’, valuer/mediator, ‘servant’ of tax authority in investigation Pt 1: Definition of a tax practitioner (cont.) Responsible to: Their client (primarily) (regular or one-off) The government (as intermediary) Their firm Their profession The wider public Themselves – but rather depends on what the practitioner actually does! A tax practitioner is often referred to as ‘tax agent’ but not strictly an ‘agent’ in the true meaning of the word Pt 1: Nature of the taxation services market The market is characterised by fragmentation, though the degree varies  In the UK, tax services are provided by members of: - professional tax/accountancy bodies (CIOT, ATT, IIT (merged with CIOT), ACCA, ICAEW, ICAS, STEP, WCOTA); - the legal profession (solicitors, barristers) - former members of tax authorities in private practice - the tax authority  …working in a variety of entities: - accounting firms (Big Four, medium, small) - legal firms - specialist tax firms - tax/financial functions of, for example, MNEs - tax authority or other public sector entities Pt 1: Nature of the taxation services market (cont.) → Lack of professional monopoly and fragmented professional regulation Anyone in the UK can set up in business as a tax practitioner HMRC (2009) suggests that there are some 12,000 tax practitioners currently unregulated by any professional body The situation varies elsewhere Australia and the USA require registration of certain types of practitioner, but not others, with the USA showing variation across different states → Has resulted in lack of holistic study of the work of tax practitioners, so there is little conceptual/theoretical analysis of practitioners’ work Pt 1: Review of the tax practitioner literature Surveys (USA and Australia) suggest a significant proportion of taxpayers use practitioner services (USA now > 50%) An extensive literature (mostly US-based) suggests the following reasons: - Correct preparation of return* - Paying the least tax required (not equating to aggressive tax avoidance) but some willing to overpay to save time) - Avoidance of serious tax penalties - Reducing likelihood of investigation/audit - Increasing complexity of the tax system - Legal ambiguity over type of income received* * Linked to risk More uncertainty → less risk taking by taxpayers, but more by practitioners Pt 1: Review of the literature (cont.) There is a significant amount of literature which focuses on factors affecting taxpayers’ compliance – general import being that perceptions of probable detection and severity of penalties deter non-compliance Until recently this body of literature did not consider the likely impact of using a tax practitioner The existing studies report that tax practitioners both increase and decrease levels of compliance, explained by Klepper and Nagin (1989) and Klepper et al (1991): practitioners are “enforcers” in unambiguous contexts and “exploiters” in ambiguous ones… 10 Pt 3: An economic analysis of service quality (cont.)  Moral hazard and adverse selection conspire to reduce the availability of high quality goods: Moral hazard because sellers can maximise profits by selling poor quality products Adverse selection because such sellers will drive higher quality producers from the market Hence average quality overall reduced and market size shrinks 41 Pt 3: An economic analysis of service quality (cont.) If product quality post consumption can be determined, even if only imperfectly, there will be a reputational effect – of high quality product, fewer clients leave and word of mouth advertising, e.g., will attract new clients to the high quality firm: product quality will reach an equilibrium level and not fall to lowest level Other firms deterred from entering because high quality firms will invest in non-salvageable firm specific assets Model of how a tax practitioner chooses a particular level of service quality for compliance work can be developed from the audit service model of Simunic and Stein (1987a, 1987b) 42 Pt 3: Simunic’s and Stein’s model Model assumes:  an uncertain world in which economic agents are concerned primarily with the distribution of wealth;  that taxpayers are concerned with their distribution of future wealth, conditional on a set of tax returns; and  that tax practitioners are concerned with their distribution of future wealth, conditional upon the service itself 43 Pt 3: Simunic’s and Stein’s model (cont.) qjk = where : qjk = h { [fjk  ajk (cj, zj, sjk)], fj } taxpayer j’s perception of the quality of the tax service by tax practitioner k a function h = fjk = ajk = taxpayer j’s perceived distribution of wealth with respect to tax effects determined by tax practitioner k the tax service for taxpayer j by tax practitioner k cj zj = = a set of characteristics of taxpayer j a set of environmental factors relevant to taxpayer j sjk = fj = the inputs of tax practitioner k to the tax service for taxpayer j (tax service scope) including the quantities of such inputs taxpayer j’s perceived distribution of wealth before any 44 tax effects determined by tax practitioner k Pt 3: Simunic’s and Stein’s model (cont.) Therefore, tax service quality is some function of the difference between j’s prior (pre-tax service) and posterior (post-tax service) distributions of wealth In the model:  taxpayers are expected to revise their priors based on ajk alone – i.e., the fact that the tax service is performed by tax practitioner k  tax practitioners are expected to revise their priors based on their full knowledge of cj, zj and sjk 45 Pt 3: Simunic’s and Stein’s model (cont.) The final part of the model examines the relationship between tax service quality and tax service quantity (i.e., time spent on the tax service)  From the tax practitioner’s perspective, tax service quality and tax service quantity measure the same dimension  For example, tax service quality could be measured by the conditional probability of producing a large tax saving given a particular interpretation of existing tax law 46 Pt 3: Simunic’s and Stein’s model (cont.) However, the important aspect of Simunic’s and Stein’s (1987a, 1987b) model is that when the taxpayers are introduced who can observe neither inputs nor output directly, the equivalence between tax service quality and tax service quantity breaks down Tax service quality to consumers is a function of brand name and reputation and this user perceived tax service quality determines the level of quantity, which is necessary to maintain an existing reputation Formally, a profit maximising tax practitioner’s problem is to minimise tax service costs subject to the constraint of the user perceived quality: 47 Pt 3: Simunic’s and Stein’s model (cont.) minimise p sj subject to: h { [fj aj (cj, zj, sj) ], fj } sj >/= = IRmin qj where: p inputs; = a vector of market prices for the various tax service sj taxpayer = the inputs of the tax practitioner to the tax service for j; aj = the tax service for the taxpayer j; qj = HMRCmin the user perceived tax service quality for that tax practitioner implied by tax practitioner’s present reputation; and = some minimum required level of tax service quality necessary to comply with generally accepted HMRC requirements 48 Pt 3: Simunic’s and Stein’s model (cont.) The value of Simunic’s and Stein’s model is that it shows that a tax practitioner may choose to undertake more tax service work than that necessary to meet HMRC minimum requirements, in order to meet the reputational expectations of taxpayers The question then becomes one of determining how taxpayers form reputational expectations of the work of a particular tax practitioner or firm of tax practitioners – but no publicly available data, other than the ‘well known’ fact that most HMRC District Offices maintain a ‘black list’ of questionable tax advisers What to use? Professional designation? Generic reputation (= composite, one area affecting another)? 49 Pt 3: Ways of improving the quality of the service Market forces are unlikely to ensure high quality service Does regulation have a role to play? The usual purpose of regulation is to ‘protect the public’ – often against bureaucratic power It is unclear what this might mean in the context of tax services in relation to HMRC 50 Pt 3: Ways of improving the quality of the service (cont.) Regulation could not necessarily deal with compliance and avoidance at the same time Often calls for licensing/registration in relation to compliance McKerchar et al (2008) suggest that regulation of tax practitioners does increase compliance and the overall quality of returns – Make the tax practitioner also legal responsible for 51 the client’s submission? (Penalties → costs.) Questions? 52 References Akerlof, G.A (1970) The market for ‘lemons’: Quality uncertainty and the market mechanism, Quarterly Journal of Economics, 84(3): 488–500 Braun, P., Brzostowski, J., Kersten, G., Kim, J., Kowalczyk, R., Strecker, S & Vahidov, R (2006) E-Negotiation systems and software agents: Methods, models and applications In Intelligent Decision-Making Support Systems, eds Gupta, J.N.D., Forgione, G.A & Mora, M., pp 271–300, London: Springer Devos, K.N.H (2012) The impact of tax professionals upon the compliance behavior of Australian individual taxpayers, Revenue Law Journal, 22, 1, 1–26 (Retrieved from http://epublications.bond.edu.au/cgi/viewcontent.cgi?article=1223&context=rlj, 10 April 2013) Doyle, E., Frecknall-Hughes, J & Summers, B (2013, early online, DOI 10.1007/s10551-03-17805), Firm size and ethics in tax practice, Journal of Business Ethics Doyle, E., Frecknall-Hughes, J & Summers, B (2012) An empirical analysis of the ethical reasoning of tax practitioners, Journal of Business Ethics, 114(2): 325–339 Dubin, J.A., Graetz, M.A., Udell, M.A & Wilde, L.L (1992) The demand for tax return preparation services, Review of Economics and Statistics, 74(1): 75–82 Erard, B (1993) Taxation with representation: An analysis of the role of tax practitioners in tax compliance, Journal of Public Economics, 52(2): 163–197 53 References (cont.) Green, S (1995) Regulation of Taxation Advisers in the UK, TaxAid Research Report, London, TaxAid Charitable Trust HMRC (2009) Modernising Powers, Deterrents and Safeguards Working with Tax Agents: A Consultation Document UK: HMRC Klepper, S., Mazur, M & Nagin, N (1991) Expert intermediaries and legal compliance: The case of tax preparers, Journal of Law and Economics, 34(1): 205–229 Klepper, S & Nagin, N (1989) The role of tax practitioners in tax compliance, Policy Sciences, 22: 167–192 Martin, D., Herbig, P., Howard, C & Borstoff, P (1999) At the table: Observations on Japanese negotiation style, American Business Review, 17(1): 65–70 McKerchar, M., Bloomquist, K & Leviner, S (2008) Improving the quality of services offered by tax agents: Can regulation assist?, Australian Tax Forum, 23(4): 399–425 Simunic, D.A & Stein, M (1987a) Product differentiation in auditing: A study of auditor effects in the market for new issues, University of British Columbia Working Paper, No 1067 Simunic, D.A & Stein, M (1987b) Product differentiation in auditing: Auditor choice in the market for unseasoned new issues, Research Monograph No 13, Canadian Certified Accountants’ Research Foundation 54 References (cont.) Tan, L.M (1999) Taxpayers’ preference for type of advice from tax practitioner: A preliminary examination, Journal of Economic Psychology, 20(4): 431–447 Thuronyi, V & Vanistendael, F (1996) Regulation of tax professionals In Tax Law Design and Drafting, ed Thuronyi, V., pp 135–163, Washington, D.C.: International Monetary Fund Wall Jr., J.A (1985) Negotiation Theory and Practice, Glenville, Illinois: Scott Lovesman 55