Tax avoidance schemes are growing in number and complexity. In response, the government is implementing a new strategic approach with a new general anti-avoidance provision. But how did we get to this stage?
The current anti-avoidance system in the UK hinges on three elements:
- The interpretation of tax legislation by the courts in respect of tax-avoidance transactions.
- Specific anti-avoidance legislation or targeted anti-avoidance rules (TAARs).
- Rules requiring the disclosure of tax-avoidance schemes (DOTAS).
The courts’ interpretation of tax legislation with regard to tax avoidance has only relatively recently moved from a strict, literal approach, which allowed easier exploitation of loopholes, to one that considers the purpose of the legislation and whether it is intended to apply to a particular avoidance transaction or series of them. The turning point towards the purposive interpretation of tax law is represented by Ramsay v IRC(1982). The tendency has since then been consolidated in many other cases in which the courts have denied attempts to avoid taxation which would have been otherwise successful if a literal interpretation of the law had been adopted. A possible problem connected with the change in the courts’ interpretation approach is widely acknowledged as the risk of stretching the interpretation of tax provisions well beyond their intended scope to include legitimate tax planning.
Specific anti-avoidance legislation in the UK has been considerably growing in size and complexity in recent years, in line with the government’s attempts to stem ever more sophisticated, aggressive and artificial avoidance arrangements. Currently there are more than 300 TAARs in the UK tax legislation; some are familiar to tax practitioners and clients, like those in respect of transactions in securities, transfer pricing, IR 35, transactions with connected persons, gifts with reservation etc, while others are much more obscure.
The rules for the DOTAS require early disclosure to HM Revenue & Customs (HMRC) of certain tax avoidance arrangements that fall within specified descriptions, or hallmarks, prescribed by the Treasury. HMRC can then evaluate the scheme and ask the government to amend the relevant legislation to block the scheme.
In March 2011, together with Budget 2011, the government published a document on tackling tax avoidance that set out how it was progressing towards the implementation of its new strategic approach to tax avoidance. The key elements of the new approach were to:
- Maximise opportunities to make the tax system more watertight against avoidance.
- Review areas of the tax system that had been under repeated avoidance attack to develop sustainable solutions.
- Create new generic defences against avoidance, going beyond closing identified loopholes, including considering the case for a general anti-avoidance rule (GAAR).
Among the concrete steps taken to implement the new approach was the review of high-risk areas of the tax code that have needed frequent amendment over recent years to close loopholes or that have seen repeated avoidance attacks. The first two areas chosen were income tax losses and unauthorised unit trusts. The consultation documents for both areas were published in June 2011 and the progress made under the review was announced at Budget 2012.
The government also set up a study group in December 2010, headed by Graham Aaronson QC, to explore the case for the introduction of a GAAR in the UK. The study group also looked at the scope and design of a GAAR. On 21 November 2011 the government published the report, written by Aaronson, recommending the introduction of a GAAR in the UK that is targeted on flagrant, abusive and artificial schemes. The report also included an illustrative draft of a general anti-abuse rule.
In particular the report does not recommend the introduction in the UK tax system of a broad spectrum general anti-avoidance rule, as that could undermine the ability of business and individuals to carry out sensible and responsible tax planning. What the study group does recommend is a moderate rule targeted at abusive arrangements, which will be able to deter and, if necessary, counteract contrived and artificial schemes that represent a blatant attack to the UK’s tax regime. As such the rule should not apply to the centre ground of responsible tax planning, whose boundaries will need to be established, possibly by resorting to independent advisory panels when in doubt. It is predicted that once the effectiveness of an anti-abuse rule becomes established, it will then be possible to start a reduction and simplification of the existing targeted anti-avoidance rules.
The report also recommends that the initial introduction of a GAAR should only apply to the main direct taxes - income tax, capital gains tax, corporation tax, and petroleum revenue tax. It should also cover national insurance contributions under separate legislation but not VAT, which is subject to separate anti-abuse rules derived from EU law.
The draft general anti-avoidance rule included in the study group’s report incorporates a number of principles, or safeguards, to ensure that the centre ground of responsible tax planning is effectively protected from the application of the rule. The safeguards include an explicit protection for reasonable tax planning in the text of the rule, an explicit protection for arrangements entered without any intent to reduce tax, placing on HMRC the burden of proving that an arrangement is not reasonable tax planning, and the institution of an independent advisory panel to establish whether HMRC would be entitled to use the rule to counteract an arrangement and requiring that the application of the GAAR should be authorised by senior HMRC officials.
The government announced its formal response to the report at Budget 2012 and set out its plans for further, formal public consultation.
The announcement about a GAAR, together with the update about the review of income tax losses and unauthorised unit trusts, the announcement of further tax areas to be subject to review and other targeted anti-avoidance rules, make Budget 2012 heavily geared toward anti-avoidance and a crucial step in the implementation of the government’s new strategic approach to tax avoidance.