Tax avoidance and tax evasion have been hot topics in the press recently, with companies such as Starbucks, Amazon and Google hitting the headlines after appearing before Margaret Hodge and her public accounts committee.
A very important piece of legislation relating to tax avoidance and tax evasion recently received Royal Assent and that is the general anti-abuse rule which is contained in the 2013 Finance Bill. Rather than considering tax avoidance or evasion, the GAAR legislation defines what are, for its purposes, tax arrangements that are abusive.
The GAAR rejects the approach taken by the courts in a number of historical cases to the effect that taxpayers are free to use their ingenuity to reduce their tax bills by any lawful means however contrived those means might be and however far the consequences might diverge from the real economic position. The GAAR guidance gives examples of this such as Ayrshire Pullman Motor Services and Ritchie v Inland Revenue Commissioners (1929) and Inland Revenue Commissioners v The Duke of Westminster (1936).)
The guidance explains that with reference to cases such as Ayrshire and the judgement by Lord Clyde, Parliament – in enacting the GAAR legislation – has taken the position that taxation is not a “game” where taxpayers can indulge in any ingenious scheme in order to eliminate or reduce tax liability.
With the operation of the GAAR, Parliament has imposed an overriding statutory limit on the extent to which taxpayers can go in trying to reduce their tax bill. The limit is reached when the arrangements put in place by the taxpayer to achieve that purpose go beyond anything which could “reasonably be regarded as a reasonable course of action.”
The primary policy objective of the GAAR is to deter taxpayers from entering in to abusive arrangements and to deter would-be promoters from promoting such arrangements. If they are not abusive they are not in the scope of the GAAR.
HMRC also launched a consultation paper entitled, Raising The Stakes on Tax Avoidance, on 12 August. This focuses on tax avoidance and suggests new proposals which HMRC believes will make it significantly harder to market tax avoidance schemes in the first place. These proposals include identifying publicly “high-risk” promoters of avoidance schemes, isolating them from mainstream advisers, using information powers to get early information about their products and making it clear to their customers who they are dealing with.
Legitimate tax planning
In many circumstances there are various different courses of action that a taxpayer can quite legitimately choose between. The GAAR is carefully constructed to include a number of safeguards that any reasonable choice of action is kept outside the target of the GAAR.
For example, a taxpayer may decide to invest in an Isa to take advantage of the tax benefits of doing so or might give away assets to a son or daughter without retaining benefit in the gifted asset, with a view to reducing the amount of inheritance tax payable on their estate. Or they might invest in an enterprise investment scheme or venture capital trust to benefit from the investment opportunity while at the same time receiving various tax benefits. Always remembering not to let the tax tail wag the investment dog.
Unfortunately, experience has shown the Government that tax incentives and reliefs can be abused. Where taxpayers set out to exploit some loophole in the tax laws by entering in to contrived arrangements to obtain a relief but incurring no equivalent economic risk, then they will bring themselves in to the target area of the GAAR.
I think it worth highlighting at this point that many of the established rules of international taxation are set out in double taxation treaties. These cover, for example, the attribution of profits to branches or between group companies of multi-national enterprises, and the allocation of taxing rights to the different states where such enterprises operate. The mere fact that arrangements benefit from these rules does not mean that the arrangements amount to abuse, so the GAAR cannot be applied to them. Accordingly, many cases of the sort which have generated a great deal of media and Parliamentary debate in the months leading up to the enactment of the GAAR cannot be dealt with by the GAAR.
However, where there are abusive arrangements which try to exploit particular provisions in a double tax treaty, or the way in which such provisions interact with other provisions of UK tax law, then the GAAR can be applied to counteract the abusive arrangements.
Operation of the GAAR
It is important to appreciate that the GAAR is designed to counteract the tax advantage which the abusive arrangements would otherwise achieve in the absence of the GAAR achieve. This means that it will usually be necessary to determine whether the arrangements would achieve their tax avoiding purpose under the rest of the tax code – the non-GAAR tax rules – before considering whether the arrangements are “abusive” within the meaning of the GAAR.
However, there may be some arrangements which appear to be so blatantly abusive that it would be appropriate for HMRC to invoke the GAAR without first completing the exercise of determining whether the arrangements would achieve their intended tax result under the rest of the tax rules.
It is therefore not possible for a taxpayer to object to the use of the GAAR simply because all other means available to HMRC to tackle what it considers an abusive arrangement have not been utilised. There may be cases where abusive schemes would succeed in the absence of the GAAR, which is the very reason why the GAAR has been introduced.
There may also be arrangements which cannot be described as “abusive”, but which nonetheless HMRC regards as seeking to achieve some tax advantage and as falling outside the range of acceptable tax planning. The fact that the GAAR would be inapplicable in those situations does not inhibit HMRC’s right to challenge such cases, relying where appropriate on other parts of the tax code applied in accordance with the legal principles developed by the courts in recent years.
The GAAR applies to tax arrangements which are abusive
In broad terms the GAAR only comes in to operation when the course of action taken by the taxpayer aims to achieve a favourable tax result that Parliament did not anticipate when it introduced the tax rules in question and, critically, where that course of action cannot reasonably be regarded as reasonable. To ensure that, in effect, the taxpayer is given the benefit of any reasonable doubt when determining whether arrangements are abusive, a number of safeguards are built into the GAAR rules. These include:
- Requiring HMRC to establish that the arrangements are abusive, so that it is not up to the taxpayer to show that the arrangements are non-abusive.
- Applying a double reasonableness test. This requires HMRC to show that the arrangements “cannot reasonably be regarded as a reasonable course of action”. This recognises that there are some arrangements which some people would regard as a reasonable course of action while others would not. The double reasonableness test sets a high threshold by asking whether it would be reasonable to hold the view that the arrangement was a reasonable course of action. The arrangement falls to be treated as abusive only if it would not be reasonable to hold such a view.
- Requiring HMRC to obtain the opinion of an independent advisory panel as to whether an arrangement constituted a reasonable course of action, before they can proceed to apply the GAAR.
When is a tax arrangement abusive?
There are a number of key elements in this provision:
- The concept of a reasonable course of action in relation to the relevant tax provisions;
- Comparing the substantive results of the arrangements with the principles on which the relevant tax provisions are based, and with the policy objectives of those provisions;
- Seeing whether there are contrived or abnormal steps;
- Seeing whether the arrangements are intended to exploit any shortcomings in the relevant provisions; and
- The double reasonableness test – whether the arrangements cannot reasonably be regarded as a reasonable course of action.
The GAAR recognises that some parts of the tax legislation reflect a clear policy of providing tax relief or other specified outcomes for certain courses of action – for example, to invest in pension scheme. So reasonable steps taken to achieve the outcomes envisaged by those rules, or to prevent benefits under those rules from being inappropriately denied, will be a reasonable course of action in relation to those rules.
It is possible that there could be a reasonably held view that the tax arrangements were a reasonable course of action, and also a reasonably held view that the arrangement is not a reasonable course of action. In such circumstances the tax arrangements will not be abusive for the purposes of the GAAR.
But it is important to note that some person’s view that the tax arrangements are a reasonable course of action, whether the view of a QC, an accountant, solicitor or anyone else, will not inevitably lead to the conclusion that the arrangement is not abusive.
It will be necessary to test that view to see whether that view itself can be regarded as reasonable, having regard to the purposes of the GAAR legislation and the factors that it requires to be taken into consideration.
The double reasonableness test is the crux of the GAAR test. It does not ask whether entering in to or carrying out the arrangements was a reasonable course of action in relation to the relevant tax provisions. Instead it asks whether there can be a reasonably held view that entering in to or carrying out the tax arrangements in question was a reasonable course of action.
Just and reasonable counteraction
It could be the case that the taxpayer might have carried out any one of several alternative non-abusive transactions to achieve the same non-tax purpose if the abusive one had not been carried out. In this scenario the just and reasonable counteraction would be to select the transaction which a taxpayer would most likely carry out in such circumstances and to adjust the tax consequences on the basis that this alternative transaction had been carried out. It is important to note that the most likely alternative transaction would not necessarily be the one which would result in the highest tax charge.
The GAAR legislation does not include any specific provisions imposing or dealing with penalties. However, under the general principles of self-assessment, a taxpayer has a duty to submit a correct tax return.
Accordingly, if it would be “reasonable” for a taxpayer to believe that he or she has entered in to an abusive arrangement that would be counteracted by the GAAR, then the self-assessment return must make an appropriate adjustment to reflect the fact that the GAAR would be applicable. Failure to do so could leave the taxpayer open to penalties for failing to take reasonable care in completing the tax return.
In practical terms this means that it is possible for penalties to be imposed for breach of the self-assessment requirements in cases where a taxpayer has completed the self-assessment return on the basis that a tax-avoiding arrangement has succeeded in reducing the tax bill, when it should have been obvious that the arrangement was abusive and would be caught by the GAAR.
The challenge for IFAs
It is crucial to highlight the need to keep in mind the premise underlying the GAAR and the recent consultation paper from HMRC, which rejects the proposition that taxpayers have unlimited freedom to use their ingenuity to reduce their tax bills by any lawful means.
The GAAR now compares the substantive results of arrangements with the principles on which the relevant tax provisions are based, and with the policy objectives of those provisions. It means that there is a new way of legislating that will have a profound and far-reaching effect, as HMRC has confirmed it is adopting the FCA principle of an outcomes-based approach to abusive tax planning.
The challenge for IFAs is that the publicity surrounding tax avoidance means that there has been, in the minds of certain clients at least, a blurring of what might potentially be done in terms of tax planning. Consequently, there is a possibility of clients not taking up the opportunity to use perfectly legitimate structures, permitted by legislation including the GAAR, to avoid taxes either now or in the future.
In terms of legitimate tax planning and tax avoidance, my view is that the professional financial adviser has never been more important.
Andy Gadd is head of research at the Lighthouse Group