Last week I considered the high-profile media attack on tax avoidance in the UK. I will look at the perceived need for, and the progress towards, a general anti-abuse rule in the UK in a forthcoming article.
As I noted previously, the history of UK tax avoidance has predominantly been about supplementing existing legislation with so-called targeted anti-avoidance legislation, or assessing the taxpayer under existing anti-avoidance provisions and relying on the judicial system to enforce a ‘purposive’ or ‘substance over form’ interpretation so as to achieve the desired outcome.
I will look first at the legislative approach. There have been many examples of this over the past few years. Good examples in this year’s Budget are the two specific provisions in relation to life assurance policies.
The first of these provisions was aimed at countering perceived avoidance using ‘cluster policies’ (segments) where there would typically be some manipulation of premiums and benefits between segments designed to:
- give the policyholder an entitlement to a stream of cash payments from the plan with no immediate tax charge; and
- defer the possible tax charge until the latest possible time by ensuring all of the investment growth on the plan accrued to just one (the last to be encashed) policy segment.
The Budget proposals aimed to prevent this planning from working in the future through new legislation that would remove any scope to defer income tax in this way by recognising the economic position and treating all such interdependent policies as a single policy for the purposes of the chargeable event legislation.
It is important to note this new provision in no way affects policies that are properly structured as genuinely independent policy segments and have no artificial allocation of premiums and benefits between them. In this respect, the Government has stated: “Standard industry arrangements which divide a sum invested across a number of identical but genuinely distinct and economically self-contained policies will not be affected.”
The second proposed legislative change to counter (officially) perceived abuse targets the ability to use past chargeable event gains made under a policy (that were not subject to tax when made) to later reduce exposure to income tax for the policyholder.
The change would apply where chargeable event gains have arisen earlier in the life of a policy or contract but the gains were not chargeable to tax under the income tax rules for these products (because, for example, the earlier gains were attributable to a person who was not a UK resident).
Under the law as it stood before this amendment, it would seem a chargeable event gain arising (perhaps due to a part encashment) was deductible from the final gain regardless of whether any tax was due on the earlier gain.
A large policy excess (for example, an amount taken significantly in excess of the accumulated 5 per cent allowances) taken from an offshore bond when the policyholder was non-UK resident would not have given rise to a UK tax charge, despite an excess.
If the offshore bond was encashed when the policyholder was a UK resident then the previous gain under the policy, despite no tax having been paid, could be set against the final gain. In the right circumstances, this could give rise to a substantial deficiency to set against other taxable income.
The new measure removes this opportunity. An amendment to section 491(2) ITTOIA 2005 restricts any offset of earlier gains to gains that have been taken into account in calculating the total income of the policyholder.
Both these changes take effect in relation to relevant policies and contracts made on or after March 21, 2012, and for pre-existing contracts where certain events (for example, a variation resulting in an increase in the benefits secured, any assignment of the policy or the holding of the policy as security for a debt) take place on or after March 21, 2012.
The point, in relation to this look at the legislative approach to supplementing or introducing anti-avoidance provisions, is that this new legislation was introduced to supplement a significant body of existing chargeable event legislation that was clearly insufficient to prevent the avoidance that was legitimately taking place through the use of these arrangements.
When the legislative approach to avoidance by the introduction of targeted anti-avoidance provisions is used, the legislation is generally effective from the date the change is announced with no retrospection. In some cases, as for these two provisions relating to life assurance policies, provision is made to bring pre-existing policies into the new legislation if certain events or alterations take place on or after the date of change.
There are exceptions, though. For example, as a sign of the Treasury’s growing impatience with ‘loophole exploitation’ in relation to stamp duty land tax avoidance, it has been stated that if the recently drafted anti-avoidance legislation on SDLT inadvertently leaves open ways of exploitation then any new legislation will apply retrospectively.
This is an example of the need to make very clear statements of ‘official intent’ because of the potential inefficiency of targeted anti-avoidance legislation without the backing of a GAAR and when faced with a highly innovative avoidance industry.