Schemes could fall through GAAR net

IN JUNE 2010 the UK government said that tax policy was broken and promised to fix it.

In its first Budget the coalition government said that it wanted to make the tax system simpler and more stable in response to complaints from business. In a document called “Tax Policy Making: A New Approach”, David Gauke, exchequer secretary to the Treasury, said that he wanted a “more considered approach” to designing taxes.

“Consultation on policy design and scrutiny of draft legislative proposals should be the cornerstones of this approach,” he said. “The government will always need to maintain flexibility to make changes to the tax system. But in doing so, it should be transparent about its objectives, and open to scrutiny on its proposals.”

Earlier this week, in a highly unusual move, the Treasury made retrospective changes to block one of two “aggressive” tax avoidance schemes used by Barclays, which it said tried to avoid £500m in tax.

The first scheme was set up to exploit corporation tax rules that apply to releases of debt. Normally a debtor company is taxed on the profit that arises when a liability is released for less than the amount borrowed, but special rules apply to connected companies. The Treasury is also blocking future use of a second scheme that sought to claim tax credits through the Authorised Investment Fund when tax has never been paid.

Going retro

The Treasury says that the retrospective changes to tax law about debt buybacks were a last resort because the abuse of the rules was so blatant. However, backdating the changes appears to undermine the Treasury’s earlier promise of a more consistent approach to tax policy. Is political expediency – the taxman showing it is tough not cosy on big businesses tax avoiders – overriding a key principle of the tax system?

Richard Woolhouse, CBI head of tax and fiscal policy, says: “In general, retrospective changes to the tax system are extremely unhelpful as they increase uncertainty and undermine business planning.”

However, tax experts aren’t too worried. They reckon that the retrospective tax change is meant to act as a high-profile deterrent to other businesses. They don’t expect a spate of backdates changes to tax law.

“[The retrospective tax change] is not a game changer,” says John Whiting, tax policy director at the Chartered Institute of Taxation. “The significance is in HM Revenue & Customs (HMRC) trying to get people to realise that it is still in control.”

And if, as expected, the government introduces a “general anti-avoidance rule” (GAAR), there should be even less of a need for retrospective tax changes.

In November last year, a report by Graham Aaronson QC recommended a “narrowly focussed” GAAR, which he said would deter “abusive” tax avoidance and reduce legal uncertainty surrounding schemes.

The GAAR would explain what types of avoidance schemes are “abusive” and covered by the rule. If HMRC can show that an avoidance scheme is covered by the GAAR it would, in theory, make tax disputes quicker to resolve, particularly if they go to court.

Striking a balance

The challenge for HMRC is writing a GAAR that is simple to understand and precise. It should apply to only the most dodgy avoidance schemes and shouldn’t penalise legitimate avoidance schemes or tax planning.

Getting the right balance can be tricky. Richard Barron, head of taxation at the Institute of Directors, says that Canada’s GAAR has been criticised for being too wooly. “If a GAAR is too vague and it goes to court, the court tends to interpret ambiguities [in the GAAR] in the taxpayer’s favour,” he says.

According to Kevin Cummings, partner at Berwin Leighton Paisner, the Treasury’s announcement, countering two very different types of transactions, is an early example of the type of problem that will be faced if a GAAR is introduced.

While there might be no real difficulty about applying a GAAR to artificial transactions designed to secure tax repayments, where no tax has actually been paid, others might feel that buying back debt at a discount without tax on the “paper profit” is reasonable tax planning and therefore outside the scope of the GAAR.

“The two types of transaction are precisely at polar extremes of tax planning. One is aggressive, while the other is entirely commercial and not tax motivated,” Cummings says. “In a world where Graham Aaronson’s GAAR operates, the government will find it increasingly difficult to counter arrangements it finds ‘abusive’ but most sensible business people do not.”

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