For A General Anti- Avoidance Principle

Section one

Why do we need a General Anti-Avoidance Principle?

The TUC estimated in 2008 that tax avoidance might cost the UK government up to £25 billion in lost revenue a year.

We are aware that the figure we published is disputed by those who use different definitions of tax avoidance and different methodologies for calculating the tax gap to the one we used, including H M Revenue & Customs. Despite that we think that all objective observers agree that tax avoidance is the cause of a serious loss of revenue to the UK Exchequer each year and that this is an issue that needs to be tackled at a time when the alternative to doing so is the closing down of public services and the dismissal of public sector employees.

Some of the tax avoidance we have identified can be tackled by specific targeted legislation. For example, the domicile rule could be abolished using specific legislation. That however is not true in all cases. Tax avoidance by its very nature is in very many cases the deliberate exploitation of gaps and loopholes within UK legislation (and in some cases not just tax legislation: the exploitation of gaps between tax and accounting regulation and tax and company law is also now commonplace). It also exploits the gaps in UK legislation and that of other territories. Indeed, we believe this to be a major contributory factor in the loss arising as a result of corporate tax abuse.

Some argue that if there are such gaps and loopholes then this is the fault of government and that if such loopholes exist then the government should expect smart tax lawyers and accountants to exploit them on behalf of their clients. We do not agree. No law can anticipate all circumstances that can arise and no law can be written in such way that there is never any doubt as to its interpretation: the very nature of language ensures that such doubt will always exist. In addition, the sheer complexity of the modern commercial world means that it is inevitable that there will gaps in the legislation that mirrors that complexity.

It is because there are these inevitable uncertainties that we think a General Anti-avoidance Principle (GAntiP) should be incorporated into UK law.

This paper explains the logic of our argument and suggests the outcomes that we think might arise as a result of the introduction of a General Anti-avoidance Principle into UK tax law.

Section two

What's the tax issue?

This briefing assumes that

A person who evades tax seeks to circumvent payment of a tax liability by means they know to be criminal;

A person who avoids tax seeks to minimise a tax liability using a process they know might be considered an abuse of the law, albeit one which they reasonably expect will not result in a criminal liability arising;

A person who is tax compliant seeks to settle a tax liability in the location where it can be best determined to be due, at the time when it is likely that a legislature wished it to be paid and only after claiming deductions and reliefs that were clearly intended to be provided given the economic substance of the transactions undertaken by the taxpayer.

These assumptions are critical to the understanding of a GAntiP because they result in the presumptions that:

The intention of the taxpayer is known to them;

Intention can be evidenced, e.g. through documented statements of intent prior to adopting a course of action or, where that is not available, from an assumption that an outcome in tax equates to evidence of intent;

The issue of intent is vital when considering a General Anti-Avoidance Principle: intention is what most clearly differentiates tax avoidance and tax compliance. Rare cases apart, however, intent has not been an issue of concern in UK tax law to date. The focus of tax enforcement has been upon the outcome of transactions. A consideration of intent would add an additional focus into the management of tax compliance by both HM Revenue & Customs and taxpayers. This new focus would mean that only those taxpayers who could be sure that they could document either the fact that they were tax compliant or that, in the event of dispute, it had been their intent to be tax compliant, would enjoy an easy relationship with taxation authorities.

As a result of this change in emphasis that a GAntiP would require such a measure is not just a small change in legislation intended to plug gaps in the tax system. That is what a General Anti-Avoidance Rule (GAAR) might do. But that also explains why GAARs do not work: they seek to cover limitations in the drafting of tax legislation without addressing the underlying culture of tax avoidance. This is bound to fail.

A General Anti-Avoidance Principle on the other hand, which is what we propose, changes the whole approach to tax management in a way that we think will substantially enhance the reputation of UK business, reduce risk for investors in UK companies (many of whom are prospective pensioners and trade union members) and also raise new tax revenues when this is essential if businesses are to make an appropriate contribution to the current financial crisis.

As such a GAntiP goes to the core of the crisis in business taxation in the UK - striking at the seemingly perpetual and ongoing disputes that dog relationships between UK business and HM Revenue & Customs as the latter try to deduce from the consequences of the behaviour of the former just what their real intentions were, usually in the face of absolute denial of any intent to save tax. Because a GAntiP would explicitly put the intention to behave in a tax compliant fashion firmly onto the boardroom agenda of every business and into the relationship between every accountant and their client in the UK that second guessing would be rendered unnecessary - documentation to prove intent would be required. Tax would never be the same again as a result, and that is the outcome we seek.

Section three

What a General Anti-Avoidance Principle would do

The idea behind a General Anti-Avoidance Principle is simple: it would say that if one or more steps are added into a series of transactions with the sole or principle aim of securing a tax advantage (which is defined as a saving in tax) then that step in the transaction is ignored when it comes to calculating the tax due on the transaction. In other words, it tackles pre-meditated attempts to subvert the intention of the tax system that might artificially exclude income from account for tax or that provide tax reliefs that do not reflect the substance of the transactions otherwise undertaken.

Transactions this might tackle include:

Income shifting between spouses;

Recategorisation of the payment of labour reward from companies as dividends, so avoiding national insurance;

Seeking to recategorise income as gains;

Shifting income between countries to avoid taxation in ways not anticipated by transfer pricing legislation;

Artificial transactions to utilise losses, commonplace in companies.

An example of a possible GAntiP is (a slightly modified version of) the one proposed in the House of Commons in July 2009 by Michael Meacher MP and Dr John Pugh MP, which had two clauses and said

1. If when determining the liability of a person to taxation, duty or similar charge due under statute in the UK it shall be established that a step or steps have been included in a transaction giving rise to that liability or to any claim for an allowance, deduction or relief, with such steps having been included for the sole or main purpose of securing a reduction in that liability to taxation, duty or similar charge with no other material economic purpose for the inclusion of such a step being capable of demonstration by the taxpayer, then subject to the sole exception that if the step or steps in question are specifically permitted under the term of any legislation promoted for the specific purpose of allowing such use, such step or steps shall be ignored when calculating the resulting liability to taxation, duty or similar charge.

2. In the interpretation of this provision a construction that would promote the purpose or object underlying the provision shall preferred to a construction that would not promote that purpose or object.

Section four

A change in the jurisprudence of tax

The second clause in the proposed GAntiP noted above indicates the second, essential change in tax law that we believe must accompany the introduction of a GAntiP. This is a change to the jurisprudence or philosophy of tax law.

Tax law in the UK does not work in the same way as much other law. There are two options available on how tax can be interpreted in the UK. Interpretation can either be based upon the principles inherent in a piece of legislation or in accordance with the strict construction of that legislation. These two alternatives underpin what are called respectively the principles of equitable and legal interpretation of the law.

It has been commonplace for tax to be charged in accordance with 'legal' interpretation. For example, it was decided in a legal opinion given in the House of Lords in the United Kingdom in 1869^[5] that:

If the person sought to be taxed comes within the letter of the law he must be taxed, however great the hardship may appear to the judicial mind to be. On the other hand, if the Crown, seeking to recover the tax, cannot bring the subject within the letter of the law, the subject is free, however apparently within the spirit of the law the case might otherwise appear to be. In other words, if there be admissible, in any statute what is called an equitable construction, certainly such a construction is not admissible in a taxing statute.

This principle remains enshrined in most British tax law and appears to heavily influence taxation thinking in general. It also encapsulates the philosophy that underpins the entire tax avoidance industry. This is because that ruling - which remains valid today - has implicit within it the following assumptions:

That the right to hold property is sacrosanct and that taxation violates that property right. As such tax may only be charged when specifically sanctioned irrespective of the equity of the resulting payment, or absence of payment of taxation;

The letter of the law can be determined without reference to the intent of those who created it or the context which gave rise to it, even if the circumstance in which it is used was not envisioned by those who created it;

That it is equitable as a result that some will, or will not, fall out of the charge to tax on the basis of the strict interpretation of the meaning of words which could not have been envisaged by those who passed them into law and whether or not (as is explicitly noted in the legal opinion, above) the resulting charge to tax is equitable or just.

The alternative approach to interpretation of the law with regard to taxation is the equitable basis, which is purposive. It may be summarised by an Australian law of 1901^[6]on legal interpretation which said:

In the interpretation of a provision of an Act, a construction that would promote the purpose or object underlying the Act (whether that purpose or object is expressly stated in the Act or not) shall be preferred to a construction that would not promote that purpose or object.

In this context interpretation 'looks through' the strict structure of the words in the law to determine their just and equitable meaning, and uses that meaning in deciding upon the application of the law.

Equitable construction of the law is therefore considered an essential element of any set of principles for taxation that, in our opinion, successfully recognises the rights of the citizen and the mutuality of obligation inherent in the relationship between the citizen and State, and between states. It is also for that reason an essential component of a GAntiP, which is why it was reflected in the draft of such a Principle noted above presented to the House of Commons in 2009 and, unfortunately, rejected by the government at that time.

Section five

How we would gain from a General Anti-Avoidance Principle

There are three advantages to the existence of a GAntiP.

The first is that it will in due course allow a government to pass purposive legislation that seeks to prevent tax avoidance, as far as is possible. This is legislation that states the intention of the law that is being created and devolves responsibility for the detailed rules that actually make it work to the status of regulations. This offers a number of advantages:

Few politicians fully understand the details of the tax laws that they are asked to pass; it is much more likely that they will understand and be able to discuss purposive taxation law;

The purpose of law will be clearer: taxpayers will have greater chance of understanding and complying with the law;

The detail of regulation can be devolved to those with appropriate expertise;

An appeal arrangement will be needed to ensure that those who claim that regulation does not accord with the purposive legislation can be heard, and can have the claimed conflict ruled upon. This is a necessary and appropriate judicial over-ride for the administrative function of the State which is almost always responsible for the detail of tax legislation;

Where a government intends to use legislation or regulation in a way that was not anticipated it will be obvious, and appeals against use of the law in that way should succeed. There will, therefore be greater obligation on governments to disclose their intent as to how they propose to use the legislation available to them and to not subsequently change it, which should increase certainty for taxpayers.

The second advantage is that the provisions of the GAntiP can be used to attack existing avoidance arrangements, and do so in a way that does not (as a GAAR does) look for legal interpretation that fails but that does so instead by looking at the failure of the tax avoidance arrangement on the basis of a just and equitable interpretation of the law. In other words, the spirit of the law will be incorporated into tax law for the first time and the opportunity to close the tax gap arising from its abuse will, at long last, be available.

This change will result in the Duke of Westminster case of 1936, which has long been used as the justification for untold tax abuse, being consigned to its overdue grave. In that case the House of Lords asserted "Every man is entitled to do what he can to order his affairs so that the tax attaching under the appropriate Acts is less than it otherwise would be", but this would no longer be true if there was a GAntiP in UK law and the purpose of the law was flouted.

Thirdly, the taxpayer will be in a much better position as a result of the introduction of a GAntiP. They would know that tax avoidance does not pay, and therefore steer well and truly clear of it. The risk of many taxpayers, who enter into schemes created by tax advisers that the taxpayer does not really understand, would be reduced considerably as a consequence. The resources currently dedicated by so many tax professionals and companies to tax avoidance would be released for more productive use in society. The tax yield would rise because of an increase in the wellbeing of society and a reduction in tax abuse.

In combination a GAntiP, purposive legislation, equitable interpretation of the law, and the resulting clear framework of the responsibilities for all parties in the tax system provides the following benefits:

Clarity as to the purpose of the law;

The opportunity to adopt a principles and intention based approach to the management of taxation;

An enhanced prospect of practical compliance with legislation designed to achieve that purpose;

A fairer method for appraising culpability when errors occur;

The chance for a taxpayer to object to inappropriate regulation through use of the Court system;

Greater certainty within any tax system.

It is these benefits that a GAntiP is intended to promote.

Section six

How much tax might be raised?

It is, frankly, impossible to say precisely how much tax would be raised by the introduction of a GAntiP. Whilst disputes rage about how much is lost at present to tax avoidance it is harder still to assess how much might be recovered from a GAntiP when the inevitable behavioural responses it is intended to promote are taken into account in making any such assessment.

However, an estimate should be made, and it is very clear that HM Revenue & Customs and HM Treasury do think a GAntiP would have positive impact on the government's revenues because that was their basis for objecting to the tabling of a such a Principle by two backbench MPs in July 2009: backbench MPs are procedurally not allowed to table revenue raising measures.

As the TUC has shown, measures proposed by HM Treasury between February 2008 and July 2009 were intended to stop at least £1 billion in tax avoidance. Much of this was detailed, complicated, legislation targeted at very specific abuses. It can safely be assumed that these measures tackle just the tip of the iceberg in tax avoidance abuse - representing the schemes where resources and parliamentary time can be dedicated to stopping such arrangements. It is highly likely that at least as much abuse might be preventable each year as a result of introducing a GAntiP when tax avoidance is, in the opinion of the TUC, costing as much as £25 billion per annum.

There are however, many further savings to be achieved from this change, as noted above. The first would arise because a great many tax avoidance schemes would simply fall by the wayside and never get into use if there was a GAntiP: the chance of their failing would increase significantly and so they would not be promoted. It is quite reasonable to think this might save at least £1 billion in tax a year.

Most important of all, perhaps, though would be the benefit for UK businesses and those who invest in them. If the risk of tax being reported incorrectly in the accounts of quoted companies is reduced because they cease seeking to tax avoid then the risk of investing in them will be reduced. This reduction in risk increases the likely rate of return from investing in them with long term benefits for UK pension fund members.

We believe that this combination of benefits must at a minimum deliver billions of additional tax revenues matched by at least as much benefit for shareholders in the UK and elsewhere from enhanced certainty in their well being and that this is more than sufficient to justify introducing a GAntiP now.

Section seven

Why do this now?

There are in our opinion a number of good reasons for introducing a General Anti-Avoidance Principle now. These are

We are profoundly concerned that tax avoidance is reducing the necessary contribution UK business should be making to the Exchequer at a time when all should be sharing the burden of paying for the UK's recession brought on by the crisis in UK banking in 2007 - 08.

We believe that the culture of tax management in the UK needs to be radically transformed. Tax is not a 'burden'. It is a contribution paid by all towards the building of a better society. In saying this we agree with the US judge who said 'Taxes are what we pay for civilised society'. In that case they need to be managed in a more civilised, non confrontational and just way that is intended to achieve the aims of society. A GAntiP seeks to do just that.

We need to reduce the risk of tax avoidance creating uncertainty in the reporting of the profits of quoted companies which can have negative impact upon the assessment of their performance which in turn impacts on the returns earned by members of pension funds.

If a GAntiP could achieve these combined goals it would be a considerable achievement.

Section eight

Glossary

The language of the tax gap and all issues relating to it is confusing for many lay observers of this issue. For those in doubt the terms we use in this briefing have, in our opinion, the following meanings:

Tax evasion is the illegal non payment or under-payment of taxes, usually resulting from the making of a false declaration or no declaration at all of taxes due to the relevant tax authorities, resulting in legal penalties (which may be civil or criminal) if the perpetrator of tax evasion is caught.

Tax avoidance is seeking to minimise a tax bill without deliberate deception (which would be tax evasion) but contrary to the spirit of the law. It therefore involves the exploitation of loopholes and gaps in tax and other legislation in ways not anticipated by the law. Those loopholes may be in domestic tax law alone, but they may also be between domestic tax law and company law or between domestic tax law and accounting regulations, for example. The process can also seek to exploit gaps that exist between domestic tax law and the law of other countries when undertaking international transactions.

The tax avoider faces uncertainty when pursuing their activities. That uncertainty focuses mainly on their not really knowing the true meaning of the laws they seek to exploit and taking the chance that either a) they may not be discovered to be tax avoiding or b) that if they are the interpretation placed on the law that they seek to exploit is favourable to them. Their risk of penalties arising as a result of their actions depends upon what the outcome of these risky situations might be.

Tax compliance is different from tax avoidance and tax evasion because it is defined as seeking to pay the right amount of tax (but no more) in the right place at the right time where right means that the economic substance of the transactions undertaken coincides with the place and form in which they are reported for taxation purposes. The significant difference between tax avoidance and tax compliance is the intent of the taxpayer. A tax avoider seeks to pay less than the tax due as required by the spirit of the law. A tax compliant tax payer seeks to pay the tax due (but no more).

Tax planning is a part of tax compliant behaviour. It is not a part of tax avoidance. Tax law reflects the complexity of modern life and the multitude of choices and options available to all taxpayers when legitimately seeking to structure their affairs. This necessary offer of options within tax legislation creates the opportunity for choice on the part of the tax payer and means that determining the right amount of tax (but no more) that they seek to pay does necessarily requires the exercise of judgement on occasion.

So long as the exercise of that judgement seeks to ensure that the taxpayer makes choices that exercise options clearly allowed by law and that they do not exploit unintended loopholes created between laws then that process of a taxpayer choosing how to structure their affairs is the process of tax planning, which is a legitimate, proper and socially acceptable act.

As example, a taxpayer choosing to save in an ISA (Individual Savings Account) is exercising an option made available to them in law that is entirely tax compliant so long as all the published conditions for saving in that way are met. As a consequence no one can accuse a person using an ISA of tax avoidance. Those who say they are tax avoiding can safely be said to be wrong.

---

See the last section of this report for an explanation of the technical terms used in this briefing

http://www.tuc.org.uk/touchstone/Missingbillions/1missingbillions.pdf

The term GAntiP was created by Prof Judith Freedman of Oxford University and is used to distinguish a General Anti-Avoidance Principle from GAAP (Generally Accepted Accounting Principles) and GAARs (General Anti Avoidance Rules).

For further explanation see http://en.wikipedia.org/wiki/Jurisprudence

Partington v. Attorney-General (1869), L.R. 4 E. & I. App. 100, per Lord Cairns at p. 122.

Section 15 AA of the Acts Interpretation Act, 1901 downloaded 4 December 2006 from http://www.austlii.edu.au/au/legis/cth/consol_act/aia1901230/s15aa.html

IRC v Duke of Westminster [1936] AC 1

http://www.tuc.org.uk/extras/stemmingtheflood.pdf

http://www.tuc.org.uk/touchstone/Missingbillions/1missingbillions.pdf

Oliver Wendell Holmes, Jr. (1841-1935) American jurist, Supreme Court Justice
Compania General De Tabacos De Filipinas v. Collector of Internal Revenue, 275 U.S. 87, 100, dissenting; opinion (21 Nov 1927)