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COUNTERING TAX AVOIDANCE IN THE UK: WHICH WAY FORWARD? - PDF
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1 COUNTERING TAX AVOIDANCE IN THE UK: WHICH WAY FORWARD? Tracey Bowler Tax Law Review Committee THE INSTITUTE FOR FISCAL STUDIES TLRC Discussion Paper No. 7
2 Countering Tax Avoidance in the UK: Which Way Forward? Tracey Bowler Tax Law Review Committee February 2009 THE INSTITUTE FOR FISCAL STUDIES TLRC Discussion Paper No. 7
3 Published by The Tax Law Review Committee The Institute for Fiscal Studies 7 Ridgmount Street London WC1E 7AE (Tel: +44 (0) ) (Fax: +44 (0) ) ( (website: Institute for Fiscal Studies, February 2009 ISBN This discussion paper was written for the Tax Law Review Committee by Tracey Bowler. The views expressed do not necessarily represent the views of the Committee. The Committee has authorised its publication to promote debate on the countering of tax avoidance in the UK and to elicit comments for its ongoing work in this area. Comments should be sent to the Research Director, Malcolm Gammie, at the Institute for Fiscal Studies or
4 THE TAX LAW REVIEW COMMITTEE President Chairman Rt Hon. The Lord Howe of Aberavon CH QC Sir Alan Budd Members John Avery Jones CBE Special Commissioner and VAT & Duties Tribunal Chairman Charles Beer Tax Partner, KPMG Tracey Bowler TLRC Researcher Sir Geoffrey Bowman KCB QC First Parliamentary Counsel Robert Chote Director, IFS Bill Dodwell Tax Director, Tax Policy Group, Deloitte & Touche LLP Professor Judith Freedman KPMG Professor of Tax Law, University of Oxford Malcolm Gammie CBE QC One Essex Court TLRC Research Director Graeme Macdonald University of Kent Brian Mace Policy Director, Inland Revenue, David Martin formerly Senior Tax Partner, Herbert Smith Ian Menzies-Conacher Group Taxation Director, Barclays PLC Jane Moore Low Incomes Tax Reform Group formerly Technical Director of TaxAid Paul Morton Tax Director, Reed Elsevier His Honour Sir Stephen Oliver KCB, Presiding Special Commissioner QC and President of the VAT & Duties Tribunal Dr Christiana Pannayi TLRC Researcher Christopher Sanger Ernst & Young LLP Gordon Slater formerly Director of Taxation, Cadbury Schweppes plc Simon Sweetman Chairman, Tax and Financial Affairs Committee, Federation of Small Businesses Professor John Tiley CBE Professor of Law, Queens College, University of Cambridge John Whiting CBE Tax Partner, PricewaterhouseCoopers
5 CORPORATE SPONSORS The Association of Tax Technicians Barclays PLC The Chartered Institute of Taxation Citigroup Global Markets Limited Ernst & Young LLP GlaxoSmithKline PLC ICAEW Faculty of Taxation Imperial Tobacco Group PLC KPMG LLP PricewaterhouseCoopers LLP Reed Elsevier Group plc Schroder Investment Management Limited Scottish & Newcastle plc Travers Smith Braithwaite
6 CONTENTS Part 1: Introduction, Background and Executive Summary 1 1. Introduction 1 2. Background 2 3. Executive summary 7 Part 2: Some Underlying Issues What is tax avoidance? Boundaries Consequences of avoidance Non-legislative rule-making by HMRC 18 Part 3: Current Approaches Used to Counter Tax Avoidance The legislative approach The judicial approach The administrative approach 35 Part 4: Other Approaches to Counter Tax Avoidance A GAAR An abuse of law provision Principles-based drafting Overseas experience 48 Part 5: Conclusion Conclusion 49 Appendix A. The example of countering avoidance in the context of employee 51 share awards Appendix B. The example of countering avoidance in the context of stamp duty 67 Appendix C. The drafting of TAARs 79 Appendix D. A GAAR and its potential impact: a review of the Finance Acts in the context of a GAAR Appendix E. A summary of the techniques used to counter tax avoidance in 160 other jurisdictions
8 Part 1: Introduction, Background and Executive Summary 1 Introduction 1.1 This is a discussion paper written for the Tax Law Review Committee of the Institute for Fiscal Studies considering the ways in which tax avoidance has been tackled and could be tackled in the UK. 1.2 The paper reviews the use of the anti-avoidance techniques employed over the past 11 years. It considers the extent to which the goal of preventing UK tax avoidance has been achieved in relation to the main direct taxes (income tax, corporation tax and capital gains tax) and stamp duty on land transactions. 1.3 The background to the paper and an executive summary can be found in Part 1. In Part 2 of the paper, some underlying issues are addressed. These are issues relevant to a consideration of existing approaches to anti-avoidance as well as possible new ones, such as what is meant by tax avoidance. In Part 3, the paper moves on to consider the existing techniques for countering avoidance: first, legislative; second, judicial; and third, administrative. In relation to the review of the existing legislative approach, there is a detailed analysis of two areas of tax law in Appendices A and B: that dealing with the taxation of employee shares and securities; and the changes to the operation of stamp duty and the introduction of stamp duty land tax. There is also a review of the different forms of Targeted Anti-Avoidance Rule (TAAR) in Appendix C. In relation to the review of the judicial approach to avoidance, consideration is given to whether steps could be taken to bolster this way of tackling the problem. 1.4 In Part 4, there is a review of possible other techniques: the use of a General Anti-Avoidance Rule (GAAR), an anti-abuse law and alternative ways of drafting legislation, as well as a consideration of how other jurisdictions have approached the issue. In the context of looking at the use of a GAAR, the Finance Acts since 1997 have been reviewed in Appendix D, considering the extent to which a GAAR would have resulted in less of that legislation being enacted. A summary of the techniques used in various jurisdictions is set out in Appendix E. The conclusions of the paper are set out in Part 5. 1
9 2 Background 2.1 The Chancellor of the Exchequer announced in the October 2007 Pre- Budget Report that there would be a review designed to find out how anti-avoidance legislation can best meet the aims of simplicity and revenue protection. Over the past 11 years, the government has used various methods to counter tax avoidance with varying degrees of success. The government has recognised that the complexity of tax law has increased to the point where the burden for taxpayers in complying with the law has become a real issue. Anti-avoidance legislation plays a large part in contributing to this complexity. In addition, it is clear that highly complex legislation does not necessarily achieve the purpose of stopping avoidance: the more detailed the rules, the more opportunity there may be for those wishing to do so to find and exploit loopholes. Then yet more complexity is added in response, and so the process continues. The introduction of rules requiring taxpayers and their advisors to give advance disclosure of certain tax avoidance arrangements has contributed to this process. 2.2 It is unrealistic to expect any tax system to exist without tax avoidance. That should not be the aim of anti-avoidance measures. Instead, it is a case of finding the right balance so that taxpayers can carry on their business and lives without undue restriction (and at times can be incentivised by the tax system to act in a particular way) but also so that the need for government to raise sufficient revenues is met. In so doing, it is for government to decide what acceptable tax planning/ mitigation/avoidance is For the UK to remain internationally competitive for business, it needs a tax system that is sufficiently clear for business to be able to operate within with confidence, that is stable so that long-term decisions can be made without significant risk of tax change and that is fiscally comparable to its competitors tax systems so that financing and transactions can take place without significant additional tax cost. However, the tax environment has become increasingly unstable, with significant changes to the tax system each year, and the general approach to avoidance has resulted in legislation that is increasingly difficult for taxpayers (and HMRC) to navigate. Headlines castigate the volume of tax legislation; however, it is not just the volume that is the problem, but also the complexity of the legislation and the uncertainty and instability that are involved in constant change. 1 See further at paragraphs 4.15 and 4.16 below. 2
10 2.4 The legislative activity suggests that over the past twenty years there has been a significant increase in tax avoidance, both in the UK and internationally. 2 In the UK, various methods have been used to tackle the problem. One approach to avoidance has focused on getting better information for HMRC to tackle the avoidance; hence the disclosure rules that were introduced in This has had the result that the corporate appetite for mass-marketed tax avoidance products, where the transactions are entered into simply to generate tax benefits, appears to have reduced considerably However, bespoke structures are still being generated by or for corporate taxpayers. Taxpayers usually maintain that they are simply looking at ways to minimise their tax bill in relation to commercial transactions they undertake, as opposed to entering into a transaction solely to generate a tax benefit. Commercial transactions, executed in a tax-efficient (but possibly artificial) manner, highlight the difficulty in deciding where a transaction moves from being one of tax mitigation to one of tax avoidance. This is explored in Section 4 of this paper, which looks at what is meant by tax avoidance. 2.6 So far as individual taxpayers are concerned, there is no evidence that the appetite of high-net-worth individuals for tax avoidance has diminished, even though anti-avoidance legislation has closed down many opportunities. This remains a cause for concern by HMRC. 2.7 In 1998, the government published a consultation document on the introduction of a General Anti-Avoidance Rule (GAAR). 5 The TLRC considered the possible drafting of such a provision. 6 However, no further steps have been taken by government to promote a GAAR. Instead, the use of general anti-avoidance language has spread to many discrete parts of the tax code. The overall effect may not be significantly dissimilar from adopting a GAAR Following the 2006 Review of Links with Large Business, HMRC has taken initiatives to reduce the demand for tax avoidance products by 2 See J. Freedman, Defining taxpayer responsibility: in support of a general anti-avoidance principle, British Tax Review, 2004, vol. 4, pp and Law Administration, South African Revenue Service, Discussion Paper on Tax Avoidance, November 2005 ( 3 Part 7 Finance Act While no specific study has been undertaken, this is the general impression of members of the TLRC. 5 Inland Revenue, A General Anti-Avoidance Rule for Direct Taxes: A Consultative Document, October Tax Law Review Committee, Tax Avoidance, IFS Commentary no. 64, 1997 ( 7 The advantage, from HMRC s perspective, is that it has been able to expand significantly the use of general anti-avoidance language within the tax code but without having to concede any statutory pre-transaction clearance procedures. The inability of taxpayers to pre-clear transactions may be seen as making the UK tax system less competitive than others. Although not specifically related to anti-avoidance legislation, HMRC has taken steps to expand the scope of its non-statutory rulings procedures. 3
11 rewarding those who are assessed as low risk in relation to their tax planning by applying a lighter touch to their relationship. 8 This action may have some impact on the products market but will not remove the appetite for tax avoidance, a caution that is supported by a recent report by the Oxford University Centre for Business Taxation. 9 Such an administrative approach to the tackling of avoidance and the OUCBT report are considered further in Section 10 below. 2.9 The disclosure rules have contributed to an increasingly fragmented and reactive system, and both the government and taxpayers appear to recognise that this is not a sustainable approach going forward. Two main overlapping legislative approaches have been increasingly used as a result of the disclosures: providing extremely detailed and complex rules attempting to cater for every situation; and employing Targeted Anti-Avoidance Rules (TAARs). Both these approaches have generally been carried out on a reactive basis: as and when HMRC becomes aware of unacceptable tax avoidance, the legislation is modified or a TAAR is introduced. As a result, the tax legislation has become extremely long and complex The Tax Law Rewrite has added significantly to the length of the legislation and, in recasting the legislative material, has formulated even more of tax law as a series of detailed rules to be followed, often having little that is discernible in the way of principle or purpose underlying them. For example, in the case of income tax, Section 1 Income and Corporation Taxes Act 1988 previously stated that income tax is imposed on all property, profits or gains described in Schedules A, D, E and F. Now the section provides a list of seven parts of the legislation where the income tax charge may be found, along with a catch-all any other amounts which, under the Income Tax Acts, are charged to income tax. Any sense of purpose conveyed by the previous words has gone and a list is found in its place Length and complexity may not be ideal, but they would be acceptable if the result were a clear, efficient tax system where the line between what is within particular tax rules and what is not was clearly explained. That line is not clearly defined presently and, for the reasons explored in Section 4 below when looking at the definition of tax avoidance, may never be wholly clear. However, the answer to the question of whether a transaction will be viewed by HMRC as 8 See HMRC, HMRC Approach to Compliance Risk Management for Large Business, 2007 ( 9 J. Freedman, G. Loomer and J. Vella, Alternative approaches to tax risk and tax avoidance: analysis of a face-to-face corporate survey, OUCBT, Working Paper no. WP08/14, 2008 ( 4
12 unacceptable tax avoidance often only becomes clear when legislation is introduced to counteract the tax avoidance. The impression can then be given that HMRC is changing its view of what is and what is not acceptable. There may be several reasons for this. HMRC may simply not be aware of the extent of the particular transactions. The transactions may start off as relatively infrequent with little revenue impact and only over time become sufficiently well used and costly to warrant legislative action. The problem, though, has been the perception of a reactive approach and one that lacks principle While this paper focuses on what can be done in the UK to address UK tax avoidance, it must also be recognised that cross-border tax avoidance is an increasing phenomenon. In a world in which there is significant mobility of capital, goods, services and people, cross-border avoidance cannot be ignored. Solutions therefore need to take this into account. In one way, cross-border avoidance is one of the most difficult areas to address: one method of reducing the scope for avoidance is to reduce the tax boundaries between goods, transactions or activities that are close substitutes; 10 the borders between tax jurisdictions form one boundary that cannot be eliminated (absent global coordination of tax systems) where identical or similar goods, transactions or activities are taxed in different ways and at different rates on either side of the boundary The most difficult examples of cross-border avoidance involve what is referred to as cross-border tax arbitrage, defined by one commentator as taking advantage of inconsistencies between different countries tax rules to achieve a more favourable result than that which would have resulted from investing in a single jurisdiction. 11 This area of tax avoidance raises many difficult issues, not least whether this is really avoidance at all. 12 Consider an example where a structure is put in place to enable two different taxpayers to take a deduction for the depreciation on an asset by virtue of one jurisdiction giving a deduction to the economic owner of the asset and one giving a deduction to the legal owner of the asset. In each jurisdiction, the deduction is legitimately obtained under the relevant tax laws, but, by using two jurisdictions, those rules in combination could be said to have been abused. 10 See further Section 5 below. 11 H. D. Rosenbloom, International tax arbitrage and the international tax system, David R. Tillinghast Lecture on International Taxation, Tax Law Review, 2000, vol. 53, issue See further Eizenstat on global taxation standards, report of an address to the Coalition of Service Industries and Tax Council, Washington, 26 July 2000 ( 5
13 2.14 The whole nature of this type of tax avoidance, if that is what it can be called, is different from that of domestic tax avoidance. Specific antiarbitrage provisions were introduced in but these have not stopped cross-border tax avoidance and, indeed, were only designed to address the UK end of the problem. Subject to applying those provisions, the judiciary has little scope to limit the cross-border arbitrage. GAARs and anti-abuse laws would also be difficult to frame in such a way as to enable cross-border arbitrage to be caught by them. It is beyond the scope of this paper to look at more radical methods of dealing with the use of tax rules in cross-border contexts, such as changes to the scope of Double Tax Treaties. Setting such types of approach aside, we are therefore left with an area where disclosure and information-sharing with other jurisdictions 14 giving rise to reactive legislation may be the only sensible approach Tax avoidance activity will no doubt be affected by the current economic conditions. Some activity will be curtailed, whether because there are simply fewer transactions taking place or because taxpayers become more risk averse or concerned about reputational risk. Other activity may increase: if taxpayers are struggling to realise profits, they may more easily be tempted to take part in transactions that will increase their profit as a result of the tax saving involved. Taxpayers with tax losses and no immediate prospect of profits may look to ways of transferring the benefit of their losses to those with profits. Individual taxpayers may be expected to continue to look for ways to exploit the continuing differential individual tax rates applicable to income and capital. How this balance between tax avoidance activities being limited by current economic conditions and being increased by them will turn out is a matter for future review. 13 Sections Finance (No. 2) Act Such as the Joint International Tax Shelter Information Centre formed between the UK, US, Australia and Canada. 6
14 3 Executive summary 3.1 Tax avoidance is a highly subjective and political term and covers an enormous range of actions. It is no longer sufficient to distinguish between avoidance (a legal action) and evasion (an illegal action). The terminology has been complicated and politicised by the use of terms such as acceptable and unacceptable tax avoidance, begging the question: Acceptable to whom?. Yet it is clear that tax avoidance is a major factor in what has become known as the tax gap, i.e. the gap between what the authorities collect in revenue and what they think they should be collecting. It is suggested that tackling tax avoidance should be considered in this light as an important element in reducing the tax gap. 15 To do this, the causes of avoidance continually need to be identified. The way in which the avoidance is then dealt with will be determined by the nature of the avoidance and the costs. Those costs are not only the lost revenues arising from the avoidance, but also the costs of the anti-avoidance measures to taxpayers, the tax authorities and the economy as a whole. 3.2 Tax avoidance is a function of the tax base. In other words, it reflects the difficulty of describing in legislative terms what it is that Parliament wants to tax. In particular, it is often the case that boundaries within the system create opportunities for avoidance. To the extent that boundaries depend upon objective factors that cannot be distorted, there may be less scope for avoidance. However, if close substitutes are taxed differently, the system encourages taxpayers to choose the one that involves a lower tax cost. To the extent those boundaries are reduced, so the scope for tax avoidance is reduced. As a minimum, this involves reviewing where the boundaries exist in the current system and addressing the extent to which those boundaries can be justified and what the costs of those boundaries are. Political preferences and practical administration are likely to ensure that certain boundaries will remain within the tax system, and some boundaries, such as national boundaries, will always remain. Therefore other approaches also need to be considered after boundary minimisation. 3.3 However, this paper concludes that there is no golden bullet in terms of a legislative, administrative or judicial approach that will solve the tax gap problems caused by tax avoidance. Instead, a range of methods needs to be employed. Some already are employed by the government: for example, administrative measures such as the 15 The government released estimates for 2005 which indicated a range of between 10 billion and 40 billion, albeit recognising that these are subject to a wide margin of error: see 7
15 disclosure regime and the Risk Rating Approach and legislative measures such as TAARs. Sometimes, all that is necessary is a specific change in the law to correct a flaw in the rules. However, these methods alone have been shown over the past 11 years to be inadequate, and, at times, have been counter-productive. Each one can fulfil a function as an anti-avoidance tool, but their use needs to be carefully focused so that, once the mischief has been identified, the tool is appropriately targeted. Other methods, as yet untested in the UK, such as a GAAR and alternative approaches to drafting of tax legislation (such as principles -based drafting), can also perform specific functions. 3.4 This paper shows that each approach needs to be evaluated in terms of its appropriateness to deal with the tax avoidance occurring. So, TAARs need to be appropriately targeted and not gradually become a GAAR distributed through the tax legislation in many pieces. Principles-based drafting may be a useful tool, but only when there is a satisfactory underlying principle that can be formulated. A GAAR may have a role to play as a line in the sand and as an aid to construction by the courts, but overseas experience and the review in this paper of the Finance Acts introduced over the past 11 years suggest that a GAAR is no more the solution than any of the other approaches. 3.5 In using these anti-avoidance tools, important issues concerning the relationship between HMRC, the taxpayers and Parliament are raised and these are addressed in the paper. In particular, the more the UK moves away from detailed prescriptive legislation in the form it has historically used, the more important become the questions as to where that missing detail goes and how it can be relied upon by taxpayers. If the detail is not in the legislation, the expectation is that it will be in HMRC guidance, but the ability of taxpayers to enforce such guidance is seriously limited at present. Until such issues surrounding nonlegislative rule-making are addressed, the concern is that there will be continued resistance among taxpayers to the government adopting new anti-avoidance approaches and an increased feeling that the UK tax system is insufficiently certain for taxpayers to operate efficiently within it. 3.6 There is a range of anti-avoidance tools available to the government, as the paper illustrates. Avoidance, however, is invariably a symptom of some underlying problem in the tax system. The key therefore is to identify clearly the cause of avoidance and, having done so, to focus on how the anti-avoidance tools can be deployed in the most effective and 8
16 efficient manner to address the problem and not just its symptom. Too often, anti-avoidance legislation tackles the symptoms, so that the problem merely emerges in due course in a different form. In dealing with any avoidance, however, it is important to consider not only the immediate objective of countering avoidance but also how different methods can operate effectively in balancing the needs of the taxpayer, HMRC and government. 9
17 Part 2: Some Underlying Issues 4 What is tax avoidance? 4.1 Defining what is meant by tax avoidance is far from easy. It can be distinguished from tax evasion, which is the illegal means to reduce tax liabilities such as making false statements on tax returns. This paper is not concerned with tax evasion. Tax avoidance, in contrast, is a legal means of reducing the tax payable, the question being whether the action works technically or not. 4.2 However, increasingly the distinction between tax avoidance and tax evasion has been blurred, at least by the tax authorities, and tax avoidance has been treated with some of the disapproval previously reserved for tax evasion. 4.3 This still leaves the question of just what it is that so much effort has gone into to counteract. Highly structured tax schemes with numerous steps included for no apparent commercial purpose may quite easily be recognised as tax avoidance, but these are increasingly not the real problem: large companies have become aware of the reputational risk involved in such schemes. This may be for a variety of reasons, two of them being HMRC pursuing such schemes more aggressively and the impact of the disclosure regime meaning that schemes are often counteracted relatively quickly. 4.4 Instead, the problem has shifted for most taxpayers to issues where taxpayers are carrying out commercial transactions but choose to do so in a way to minimise tax. It is clear from the study undertaken by the Oxford University Centre for Business Taxation that, generally, corporate tax managers can be expected to consider that minimising tax costs in such situations is not a matter of reputational risk Is it tax avoidance if a company raises finance by equity rather than debt because it already has surplus losses and cannot realise the value of deductions for interest? Is it tax avoidance if an individual disposes of shares standing at a loss at the end of a year to set against the gains on other assets realised during the year? At one time, the answer to both these questions would have been a clear no, but the goalposts appear to have moved. We may have assurance that the capital gains tax antiavoidance rules do not cover the latter example, but the question remains, not least because of the questions for taxpayers in relying on HMRC guidance, discussed further in Section 7 below. The problem 16 Page 4 of J. Freedman, G. Loomer and J. Vella, Alternative approaches to tax risk and tax avoidance: analysis of a face-to-face corporate survey, OUCBT, Working Paper no. WP08/14 ( 10
18 with examples such as these is that they distract attention from tackling the more aggressive forms of tax avoidance. This paper looks at tackling tax avoidance in different ways, but it is suggested that focusing on what is the real mischief that the government wishes to tackle is a necessary first step. 4.6 More difficult examples highlight some of the other issues. Is it tax avoidance where a company that wants to buy equipment does so through a structure that generates a double tax deduction for the company s group, if this is the clear outcome that the legislation produces, even if one can assume that it is not what Parliament intended? The company s main purpose is a commercial purpose of buying equipment and financing the purchase at as low a cost as possible. 4.7 The transactions entered into by financial institutions raise other problems. The boundaries between a tax-efficient commercial transaction and a transaction designed solely to generate tax benefits can be far more difficult to discern. 4.8 Commentators spend much time debating what tax avoidance is, and that debate changes over time as governments seek to maximise their exchequer receipts in particular areas of the tax system. The OECD suggests that tax avoidance is the arrangement of a taxpayer s affairs that is intended to reduce his tax liability and that although the arrangement could be strictly legal it is usually in contradiction with the intent of the law it purports to follow. 17 The lack of precision in this attempt at a definition highlights the problems in identifying just what it is that we seek to stop in tackling tax avoidance. In addition, any reference to the intent of the lawmakers is fraught with difficulty when that intention can be far from clear in the context of highly technical provisions. 18 Also, while the lawmakers intention is cast in stone on enactment, it can be difficult for those considering Parliament s intention to ignore current attitudes, which may have changed over time. 4.9 In the context of income tax, Lord Templeman offered the following definition in the Challenge Corporation case: 19 Income Tax is avoided and a tax advantage is derived from an arrangement when the taxpayer reduces his liability to tax without 17 OECD, Centre for Tax Policy and Administration, Glossary of Tax Terms, 18 See, for example, the SDLT (stamp duty land tax) provisions discussed in Appendix B below. 19 Challenge Corporation Ltd v. Commissioner of Inland Revenue [1987] AC