Be careful what you wish for

Do we want a general anti-avoidance rule? DAVID KIRK thinks not
 A suitable quid pro quo for the GAAR?  Importance of a clearance system.  What is reasonable tax planning?  Effect of a GAAR on income shifting – Arctic Systems.  Corresponding non-abusive arrangements.
We are all in favour of a general anti-avoidance rule (GAAR), are we not? At least we are in public: it is very difficult at a time of financial stringency to be defending tax avoidance.
Any criticism of steps taken to counter it, particularly from tax consultants, can easily be seen as special pleading.
It is against this background that comment on the report by Graham Aaronson QC [1] has been somewhat muted, and there is a danger that the GAAR could slip in without proper scrutiny.
This would be a pity, as proper scrutiny has too often been lacking when it comes to tax legislation.
Mr Aaronson’s proposal has much to commend it. The main feature is that it is only intended to apply to the most ‘egregious’ tax schemes. He calls it a ‘general anti-abuse rule’, which conveniently abbreviates to the same ‘GAAR’.
Its essence is that it asks taxpayers to treat HMRC fairly, by playing the law with a straight bat and not relying on loopholes. Taxpayers should be asking for a quid pro quo here, which is that HMRC treat us fairly too.
A first and fundamental objection to the proposed GAAR is that it does not give us anything meaningful in return.
For example, it seems to be generally agreed that an anti-avoidance rule cannot operate fairly without a clearance system. This is something to which HMRC seem to object as they would have to find the resources to staff it.
The report suggests that because it is only targeting ‘egregious’ abuse, a clearance system is unnecessary.
This is surely unacceptable: there is no essential difference between an anti-abuse rule and an anti-avoidance rule. The one is merely a narrowly drawn form of the other.
Neither are we promised simpler legislation. Mr Aaronson speculates: ‘In time, once confidence is established in the effectiveness of the anti-abuse rule, it should be possible to initiate a programme to reduce and simplify the existing body of detailed anti-avoidance rules’.
Is he serious? He recognises a ‘particular concern’ that ‘the prospect of reducing the volume and complexity of specific anti-avoidance rules, which an anti-abuse rule would facilitate, will not be fulfilled’.
His solution: ‘Provision for a regular, say five yearly, review of progress would instil confidence that the benefits which the GAAR should bring will be delivered’.
A five-yearly review? Government moves slowly at the best of times: a five-yearly review will not impress anyone.
The clearance system and simplification go hand in hand. Having a clearance system is the only way of putting sufficient pressure on HMRC to make them want to simplify the law.
It is an essential quid pro quo for that reason too. Once the law is simplified, there will be much less need for clearance.
So if this GAAR is introduced, our representative bodies must make it absolutely clear that they will be putting relentless pressure on the government to do away with unnecessary legislation. They should have a wish-list for every budget, and be very vocal when the expected simplification does not happen.
They might perhaps start with ITEPA 2003, part 7A [2] on disguised remuneration: this extends to nearly 28,000 words  – every one of which ought to be rendered unnecessary by the GAAR. (The GAAR itself is only 1,500 words long, and commendably comprehensible by comparison.)
Purpose of tax
What of the proposal itself? Much of it will undoubtedly achieve the aim of counteracting ‘egregious’ avoidance schemes without creating the kind of uncertainty that will drive business away from our country.
Unfortunately it will not eradicate all such schemes, and in particular one rather vague provision reflects the unsatisfactory philosophical basis on which the measure is proposed. That basis is laid out in paragraph 3.3 of the report, where Mr Aaronson says:
‘My approach to taxation… is based on the premise that the levying of tax is the principal means by which the state pays for the services and facilities which it provides for its citizens.’
He contrasts this with ‘earlier days, when it was common to regard tax as a form of confiscation by the state’.
This is lazy thinking. The fact is that both these viewpoints are statements of the obvious. To those who think that, because of its confiscatory nature, the levying of tax had to be justified by the letter of the law, and the statutes that did this therefore needed to be interpreted strictly, it is patently unsatisfactory to say that this has not worked so we need a GAAR.
It is surely simpler, and more justifiable, to say that there is no reason why the ‘letter of the law’ should not incorporate a GAAR.
Furthermore, it is precisely because of its confiscatory nature that tax cannot be viewed as another way of paying for services. Some of the services that the state provides are themselves controversial, and much of the manner of their provision is appallingly inefficient.
The state cannot give what it has not first taken away, and a mentality that acknowledges where the money comes from and how it could be used if it was not confiscated is one of the necessary checks on over-powerful government in a modern society.
It is from this weak philosophical underpinning that one can see that the proposals do not always make clear what they are trying to prevent.
In many ways they are clear: there are some fearsome-looking safeguards intended to make sure that HMRC do not use the GAAR as a blunt weapon to blast away at anything that they do not like.
The list of ‘abnormal features’ that are likely to be caught by the rule looks eminently sensible. So does the fact that the burden of proof for most items in this rule lies with HMRC.
What is reasonable?
Trouble comes with one of the GAAR’s key features, which is that an arrangement is not counteracted if it constitutes ‘reasonable tax planning’.
The report defines reasonable tax planning as follows.
‘An arrangement does not achieve an abusive tax result if it can reasonably be regarded as a reasonable exercise of choices of conduct afforded by the provisions of the Acts’.
There is some rather odd use of the English language here: using ‘reasonable’ twice. Mr Aaronson is at pains to say that the GAAR is designed to let someone off the hook when, even though the judge does not regard what he does as a reasonable use of tax planning, others might.
The concept of reasonable behaviour in English law generally crops up when one is looking at a public official carrying out his duties, or in negligence cases, where more objective criteria can be applied.
This is because the failure to act reasonably can have bad consequences for innocent parties, which are easy to foresee and for which there is a direct link.
These are well understood, but there are a couple of key differences between these doctrines and Mr Aaronson’s proposals.
The first is that the consequences of unreasonable behaviour in the world of tax are indirect and difficult to establish: the only direct and foreseeable consequence of avoidance is that a very large government department has less money than it otherwise might.
One cannot go on from this to conclude that because Mr Jones did not pay his tax, Mr Smith did not get a rise in his pension.
The other difference is that, in tort and public law, we are concerned with what the reasonable person does, whereas Mr Aaronson is asking us also to concern ourselves with what the reasonable person thinks.
Inside whose mind is the judge supposed to get, to decide what is reasonable? The number of reasonable views on what is reasonable tax planning must be almost unlimited, and in any event, most reasonable people keep their thoughts to themselves much of the time.
Does the fact that a large number of businesses in the UK follow a particular model constitute evidence that it can be viewed as reasonable?
If so, is there not an incentive to mass-market ideas for avoidance? And in what numbers does tax planning have to be carried out before it will be accepted as reasonable?
This does not seem like an entirely right and proper way of looking at the concept, but how else does one judge what is a reasonable exercise of choices of conduct, without being totally subjective?
I wrote above that some of the services that the government provides were controversial: indeed, a few people regard some of them as both immoral and offensive in themselves or carried out in an immoral and offensive way.
These may be minority views, but they are not unreasonable, and it is a perfectly reasonable conclusion to draw that those holding them are entitled to use whatever legal (and I stress the word ‘legal’) means they can devise to avoid paying for these services, or paying taxes to this alien state.
A probably more widely held view is that, far from being fair that the government needs to seize more than one-third of everything that the country earns to function (on one measure it is 39%), confiscation on this scale is frankly monstrous, however the money is spent. Is such a view really unreasonable?
Who decides?
Judges who think that it is will come up against precedents. An example quoted by Mr Aaronson is Lord Loreburn, who said:
‘It is trite law that nothing less than clear, express and unambiguous language is effective to levy a tax’.
Lord Loreburn was a Liberal politician and Lord Chancellor when he gave this judgment in 1910, a year in which the government was only attempting to seize 15% of GDP, rather than 39%, to carry out its functions.
Can one really say this is unreasonable when it comes from the lips of so eminent a judge? If it was reasonable then, by what argument is it not reasonable now?
And if it is reasonable now, why is tax avoidance unreasonable? It is, after all, a process of reasoning that leads to this conclusion.
Some judges will doubtless be able to exercise their judgment on this in a genuinely impartial way. There are bound to be others who cannot.
What is a judge, faced with an application to use the GAAR, to make of all this? If this argument is correct, the GAAR is neutered at birth.
If not, the judges are forced to use their private judgment on a matter of ethics to decide whether or not something is unreasonable. I cannot believe that they will want to do this, so this section of the GAAR needs rethinking from scratch.
In practice
Let us now see how the GAAR might work in practice. Readers may recall a consultation that came out in 2007 with proposals to combat income shifting.
At its crudest, this is when someone does all the work in a business but arranges things so that their spouse gets a good slice of the income, so as to reduce the overall tax bill.
The proposals were badly thought out and did not go any further: many spouses do not do business as individuals but as a family unit, and establishing the quantum of what belongs to whom would be almost impossible.
But if there is one thing that would be messier than Parliament trying to counter income shifting by statute, it would be the courts trying to do so by precedent.
That is because, while a statute would consider all the circumstances that it wishes to address, a court only addresses the circumstances of the case in hand, and if the judges do not think the consequences through properly they will give a judgment that is a model of lucidity for that case, but makes the position no clearer for those whose facts are not the same.
Consider what might happen in the case of an IT consultant. We might, for the sake of argument, call him ‘Geoffrey Jones’.
His wife helps him in a few administrative tasks in the business, and the business is conducted through a company, which we’ll call ‘Arctic Systems Ltd’.
The company pays Mr Jones a very small salary, with the result that, although he is responsible for bringing in most (if not all) of its income, the company has large profits which it can pay out as dividends in equal shares to both of them, thus doubling up Mrs Jones’s basic rate band and saving the couple (or you might say saving him) a lot of tax.
Along comes Mr Garnett, a tax inspector, who challenges this and says that all the income belongs to Mr Jones, and should be taxed as such.
As readers will know, it was HMRC’s loss in Garnett v Jones (re Arctic Systems) [2007] STC 1536 [3] that led them to try to instate the anti-income shifting legislation referred to above.
The consequences of that legislation, had they succeeded, would have been very messy, and still would not have raised significant sums of money.
Impact of a GAAR
How would the Joneses have fared had there been a GAAR at the time of their appeal, so that HMRC would have been able to say to the court that he had achieved an abusive tax result, which ought to be struck down?
This was clearly the Revenue’s view of what he had done. An ‘abusive tax result’ is defined in Mr Aaronson’s report as an ‘advantageous tax result’ that is neither ‘reasonable tax planning’ nor an ‘arrangement without tax intent’. It also has to incorporate ‘abnormal arrangements’.
Mr Jones has certainly achieved an ‘advantageous tax result’, and the judgments show that he had a ‘tax intent’. Is this ‘reasonable tax planning’?
There are certainly many people who would regard it as such, but are they reasonable in holding that view, or can they be excluded because they have an interest in the matter?
It would be a brave judge who took on the wrath of the independent contractors’ lobby because he thought that none of them was being reasonable, but Mr Aaronson’s proposal would have required him to consider that possibility.
How does one appeal such a decision? Unless the judge has taken evidence as to what reasonable people think, which is unlikely, then in deciding whether it is a view that can reasonably be held, he is merely expressing his opinion on a matter of ethics.
A Court of Appeal judge might have a different opinion, so there would be every incentive to appeal.
Finally, are there abnormal arrangements? They may not look abnormal – indeed, because they are so widely used, they look normal.
However, that ignores the definition in the rule. One could argue that this arrangement fulfils three of the seven criteria for abnormal arrangements described in clause 7(3) of the proposed rule:
 it ‘results in receipts being taken into account for tax purposes which are significantly less than the true economic income, profit or gain’ (item (a): in his case, viewed in isolation from his wife’s);  it ‘includes a transaction at significantly less than market value, or otherwise on non- commercial terms’ (item (c), referring to his salary); and  it ‘includes a person … which would not be included if the arrangement were not designed to achieve an abusive tax result’ (item (e), referring to his wife).
So Mr Jones would be completely dependent on the definition of ‘reasonable tax planning’. Bearing in mind that two of the judges that heard the Jones v Garnett case found against the taxpayer under existing legislation, one need not be too hopeful.
It is also worth a look at the consequences of the Joneses’ arrangements being struck down under the GAAR: they have to be replaced by a ‘corresponding non-abusive arrangement’.
Does this mean a company with Mr Jones as the sole shareholder? Or should he be a sole trader? Or should he raise his salary to reflect his earning power in the open market?
The GAAR is silent on what to do if there is more than one ‘corresponding non-abusive arrangement’, and bearing in mind the general tenor of the proposals and all the other safeguards, the choice of alternatives ought to be at the taxpayer’s discretion.
This is but one example of how a GAAR could affect tax planning. There are more that other specialists are better qualified to draw to the profession’s and the government’s attention.
A long period of consultation is needed, with plenty of time for specialists in all fields of tax to give the Aaronson report proper scrutiny and see how other transactions stand up to it.
That means you, dear reader, so I look forward to seeing other areas put under the microscope in the tax media. Only in this way will a proper debate get underway that will allow us to conclude whether this general anti-abuse rule is really a good idea after all.
Categories:  Income Tax [4] Tax Topic Tags:  Comment & Analysis [5] Tags:  GAAR [6] Arctic [7]
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On January 25, 2012, posted in: Articles by