Last week I considered the inefficiencies, from an official perspective, of targeted anti-avoidance provisions as a means of preventing avoidance that the Government considers to be aimed at defeating the purpose of tax legislation. I also looked at the legislative approach to supplementing this legislation.
The proposed general anti-abuse rule will act as a potentially powerful addition to the official anti-avoidance armoury and will supplement the already effective and widely applied Disclosure of Tax Avoidance Schemes legislation. The Dotas legislation is aimed at ensuring that HMRC/Treasury know about the schemes that are to be promoted and can, through the issue of a scheme reference number to each type of scheme, identify through the tax return system which taxpayers have entered into schemes which have reference numbers. The penalty system associated with non-compliance with Dotas encourages disclosure.
But Dotas and targeted anti-avoidance legislation, prompted by information gained under Dotas or not, appears to be insufficient to effectively (enough) combat the seemingly endless flow of avoidance schemes and that is why the GAAR is thought to be necessary. Before looking at that, though, we should remind ourselves of how the judicial system can help to supplement targeted anti-avoidance rules. The basic position is that HMRC assesses tax according to the legislation. HMRC merely applies the legislation – although it may not seem like that is all it does.
And as most of the tax legislation is specifically (as opposed to “purposively”) drafted it encourages an approach to avoidance that is based on the form rather than the substance of legislation. The starting point for such avoidance then is that it can be legally defended and is thus effective as it is in accordance with the form or letter of the law.
But then the Government considers the effect (of the avoidance) and the outcome may well not be what it intended. The scheme in question may extend a relief or allowance much further than was intended or it may appear to sidestep a charge to tax – all within the strict letter of the law. Often, this will be done, in the view of HMRC, through the insertion of steps or transactions that have no commercial purpose other than the avoidance of tax.
And that is where recourse to the judicial system, tribunal and court, comes in. HMRC will typically assess the taxpayer to tax and the taxpayer will resist leading the case to be heard first at tribunal and then, if necessary, through the appeals system, in the courts.
The essence of the HMRC case will sometimes be founded on a “substance prevailing over form” argument.
This was, for example, the case in the now well-publicised Eclipse 35 case.
The defeat for the taxpayer in front of the first-tier tribunal provides further evidence that the judicial system can support and impose a purposive approach to interpreting tax legislation.
So, what were the facts? Eclipse 35, a film investment partnership whose members include Sir Alex Ferguson, Sven-Goran Eriksson and several chief executive officers and hedge fund managers, was barred from claiming £117m in tax relief on a complex £1bn deal with Disney.
The partnership licensed the worldwide rights to the films Enchanted and Underdog for £503m before then licensing the rights back to Disney. The 289 members of Eclipse 35 claimed tax relief on the interest on the loans taken out to fund the deal which, if successful, would have led to an average of £404,000 in tax relief on an investment of £173,000.
However, the tribunal found that Eclipse was “not trading” and therefore the members could not claim tax relief.
So, why did the tribunal find that Eclipse 35 was not trading? The acquisition and sub-licensing took place almost simultaneously. Therefore, the Tribunal decided that “on any commercially meaningful basis, Eclipse had no “customer” and did not offer to provide any goods or services by way of business”.
It was explained that “Eclipse 35 did sub-license the rights to the distributor but it had acquired the self-same rights a moment previously from Disney and had acquired them on terms whereby they would be so sub-licensed”.
This case shows that the tribunals are willing to look critically at the activities being carried out in order to determine whether or not a trade is being carried on and, in cases such as this, whether the tax avoidance purpose is legitimately and effectively achieved.
Tony Wickenden is joint managing director of Techical Connection
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