GOVERNMENT CONSULTATIONS on Labour’s shelved tax initiatives are like the proverbial London buses. This month, ministers will publish proposals for a statutory residence test and an informal consultation on a general anti-avoidance rule (GAAR) will begin. Led by Graham Aaronson QC, whose name conveniently incorporates the initials, the team will report back in October.
The Institute of Chartered Accountants of England and Wales is taking the consultation seriously, devoting its Wyman Symposium this month to the subject. But since 1998, when it was last mooted, courts have shown themselves to be more willing to look at the reasons behind a transaction when deciding if it constituted tax avoidance.
On his TaxBuzz blog, Mark Lee has paraphrased “seven commandments” that Aaronson has laid down for a GAAR: thou shalt not create more uncertainty; thou shalt not increase HMRC discretion; thou shalt not increase the burden on taxpayers or on HMRC; thou shalt not damage the competitiveness of the UK for international business; thou shalt adopt drafting that is intelligible and generally acceptable to all interested parties; thou shalt not catch transactions that would be regarded as legitimate tax planning; thou shalt incorporate the rule in the legislation.
These all seem very sensible, and we will wait and see if Aaronson’s team can put this into practice. But there seems to be a tension between the need to reduce uncertainty while not increasing the burden on HMRC. So is it possible to have a GAAR that fulfils the commandments while not catching the innocent fish? And, more importantly, is one needed?
The Ramsay principle
There is, if not certainty, then a line in the sand at the moment. Adam Craggs, partner at Reynolds Porter Chamberlain, says that case law found over the past 30 years negates the need for a GAAR. “There is less need for a GAAR as HMRC is able to secure victory through taking a purposive approach in construing the relevant statutory provisions,” he says.
This purposive approach – that is, courts interpreting the purpose of the legislation, not just its wording – towards tax stemmed from the case of farming company Ramsay in 1981, over the generation of artificial capital losses to maximise its capital allowances. Out of this case came the principle that, where a transaction has no commercial purpose apart from the avoidance of tax, tax must be charged as if the transaction had not taken place.
This principle was reaffirmed in the Barclays Mercantile and Scottish Providence cases, both of which the House of Lords ruled on in 2004. To simplify greatly, the Lords ruled that in the Barclays Mercantile case, a transaction that was worked to make the most of its capital allowances was a real one, and thus constituted acceptable aggressive tax planning. In Scottish Providence, a similar scheme used a transaction to maximise capital allowances, but the Lords said it was artificial, and therefore was unacceptable tax avoidance. In basic terms, transactions can be manipulated to reduce liabilities, as long as they are real.
The issue has been brought back into the spotlight – just as Aaronson was beginning informal consultations – by the Tower MCashback case.
HM Revenue & Customs appealed against decisions by the upper tribunal and Court of Appeal that found in favour of the company, a software development partnership. The case centred around capital allowances on software that the company paid inflated prices for on an interest-free loan.
This practice was in accordance with capital allowance legislation, the Court of Appeal said. As there was no doubt the software had been purchased, this was acceptable.
However, the Supreme Court said that it was required to consider what had been spent on the software in reality.
Daniel Feingold, a barrister at Strategic Tax Planning, said that Tower MCashback simply reaffirmed “the line in the sand” drawn up by Barclays Mercantile and Scottish Providence.
This has given courts greater scope to decide what is acceptable and unacceptable tax avoidance and take into account the spirit as well as the letter of the law.
“What has been happening is that, in the past, advisers were very clever in putting together and formulating schemes that took a literal view on the law,” Craggs says. “There was little courts could do about it. Parliament had to play catch up to close these loopholes.”
Thanks to Ramsay, Tower MCashback et al, the courts can take a purposive approach and review the true nature of a transaction – which is one of the main selling points of a GAAR.
But this is all very well for lawyers. What about advisors, who are dealing with tax schemes day in, day out without knowing the crucial minutiae of the cases involved? Would putting the court’s current position into cold, hard legislation be useful?
The profession as a whole is unsure about a GAAR, but the merits are well documented. Richard Mannion, partner at Smith & Williamson, says: “The system has become so complicated and partly because of the desire to stop every manoeuvre. So, if you had a GAAR, would it not make the tax system simpler and would than not be a good thing?”
A GAAR would no doubt bring about greater simplification, one of the watchwords of the government. The concern over the 59 pages of disguised remuneration shows “we are not in a satisfactory position”, says John Whiting, tax director of the CIoT. “This should make anyone think, is there not a better way of doing things?” This would allow us to get rid of a whole raft of poorly drafted anti-avoidance legislation, he adds.
Simplicity comes at a price, Mannion says, “and that price is worth paying.”
Lack of certainty
The “price” that Mannion refers to could be the lack of certainty.
James Roberts, partner at Barlow Lyde & Gilbert, makes the point that “accountants are stuck in the middle of the battle” between HMRC and taxpayers. They must advise clients and their advice may well be relied upon by the taxpayer or HMRC when the efficacy of the tax planning comes under later scrutiny. Following the Prudential ruling, which reaffirmed that accountants’ advice does not fall under legal privilege, it is therefore not shielded from public gaze.
“And so the more open and flexible the GAAR, the less black and white certainty will exist, and the greater the potential dilemma for the accountant in advising on specific action that the client may be considering taking.”
The most popular way of dealing with this dilemma is clearance personnel within the Revenue itself, who would be able to inform advisors whether their schemes fall on the acceptable side of tax avoidance according to the GAAR, in whatever form it is implemented.
Implementing a GAAR with a clearance team is the “holy grail”, says Mannion. But there is probably more chance of finding the real holy grail than HMRC establishing a clearance team. Trevor Johnson, senior technical editor at CCH and a previous president of the Association of Taxation Technicians, says that this is where we got to in 1998, and HMRC was against it then. “People would think you might as well get clearance” he says. “HMRC would expect to charge for granting clearances. The CIoT suggested that if the GAAR was going to increase revenue, the costs of clearance should be borne by HMRC,” he adds.
But at a time of HMRC budget cuts, and a target of an extra £7bn a year to be raised through closing the tax gap, the taxman would be unlikely to sign up for this model.
As Feingold suggests, it would likely require 50 people, legally qualified. Importantly, the experiences of Canada and Australia show that “there will still be litigation to test its scope”, he adds.
Without a clearance system – and, arguably, even with one in place – the GAAR will not create certainty. The worst case scenario is that businesses will be fearful that every transaction they partake in could fall under the GAAR, and have no-one to clarify this. Accountants will not want to definitively state either way, and it will end up being debated by counsel in the same way it is now.
The “mini GAAR”
One of the main reasons, if not the only reason, that a GAAR could be required is because of poorly drafted legislation, with the 59 pages of disguised remuneration rules being a case in point.
It is all too easy to say that legislation should be better drafted. But there is one rule of thumb that will improve matters, although may not necessarily be popular with advisors.
Jason Collins, a partner at McGrigors, points out the limits to the Ramsay approach. He says that HMRC “tends to approach Ramsay as if it were a broad spectrum antibiotic which negates all forms of tax planning” – paraphrasing Lord Hoffman’s ruling in the McNiven case. However, he adds this only comes into play if the particular legislation permits the courts to look into the reality, which only applies in broad-brush legislation.
“The status quo is that planning around prescriptive legislation or legislation which creates legal ‘fictions’ will tend to succeed and it is HMRC’s responsibility to make sure its legislation does not contain loopholes,” he said.
Prescriptive legislation allows loopholes. But a “mini GAAR” – as James Bullock, another partner at McGrigors, puts it – in each piece of anti-avoidance legislation would allow courts to look at the reality of the transactions. This will not help with certainty for advisors. But equally, tax scheme users will know whether their scheme falls on the anti-avoidance radar.
This is not an ideal scenario, but neither is the current position, and a GAAR, no matter how well drafted, will by its very nature create some element of doubt in any piece of tax planning. It is up to Graham Aaronson and his team to prove this wrong and navigate these choppy waters safely.
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