The coalition government’s focus on combating tax leakage has made tax avoidance a topical issue and in recent years the courts have heard numerous anti-avoidance cases. Sarah Gatley clarifies the current position and outlines regulatory plans for the future
In the current economic climate, the UK government is keen to combat tax leakage and tax avoidance continues to be a topical issue. Tax avoidance is increasingly reported in the press following the emergence of protest groups, such as UK Uncut, which has organised action against companies that it considers to be involved in tax avoidance.
There have been numerous anti-avoidance cases in recent years and this article considers some of those cases and the approach taken by the UK courts to tax avoidance. It also reviews HM Revenue & Customs’ and the government’s ongoing programme of reforms designed to tackle tax avoidance. The introduction of the Disclosure of Tax Avoidance Schemes regime has affected the way that HMRC deals with what it perceives as tax avoidance, ensuring that it is able to shut down offending schemes promptly. Furthermore, the government is actively considering the possibility of implementing a general anti-avoidance rule (GAAR), which in addition to various ongoing consultations on anti-avoidance legislation, creates an uncertain and difficult environment for those wishing to organise their affairs in a tax-efficient manner.
This article will not attempt to define tax avoidance, tax mitigation or tax evasion, as those concepts would require an article to themselves.
Development of anti-avoidance case law
The recent approach to dealing with tax avoidance by both HMRC and the courts has provoked much discussion among tax practitioners advising on tax mitigation arrangements. The courts have heard a raft of tax avoidance cases involving various creative schemes, often with similar elements such as the circular movement of money, self-cancelling transactions or the insertion of numerous steps that seem to serve no commercial purpose, other than to secure a reduction in tax. Over the last 30 years, when considering tax avoidance schemes, the approach taken by the courts has varied significantly, and there often seems to be no consistency in their approach. Consequently, the courts’ attitude towards tax avoidance seems uncertain.
This article seeks to consider some of the more recent anti-avoidance cases – it is not intended to provide a detailed review of all anti-avoidance case law. Rather, this article endeavours to highlight some of the differing approaches adopted by the courts towards tax mitigation arrangements, while attempting to determine whether a cohesive judicial attitude towards tax avoidance is discernable.
The cases discussed below all involve scenarios in which the judiciary has had to consider the tax treatment applicable to various transactions designed to mitigate the effects of taxation. The circular movement of money is a common thread in several of the cases, although the approach by the courts to dealing with tax avoidance varies and, it would seem, the circular movement of money is not always fatal to the success of an arrangement. Commerciality of a transaction may also be important when considering whether a transaction is acceptable, although, again commerciality alone is not always sufficient for an arrangement to succeed.
Prior to W T Ramsay Ltd v Inland Revenue Commissioners [1981] (discussed below), the courts adopted a more literal approach to the construction of legislation in the context of tax-sensitive transactions. Consequently, the courts often refused attempts by HMRC to reclassify arrangements and remove the advantageous tax effects of transactions structured to comply with a literal interpretation of the relevant tax legislation, (see for example IRC v Duke of Westminster [1936]). However, Ramsay heralded the beginning of a new approach to how the courts deal with cases involving tax avoidance. Following Ramsay, the courts have seemed more prepared to consider Parliament’s intention when determining how tax legislation should be interpreted. This has enabled the judiciary both to reclassify transactions according to their real legal effect, for the purposes of applying the legislation to them, and to interpret statute law having regard to its intended purpose. This has led to what some commentators refer to as the judiciary’s ‘purposive approach’ to statutory interpretation.
W T Ramsay Ltd v Inland Revenue Commissioners [1981]
In this watershed case, the House of Lords accepted that in certain circumstances, depending on the facts, it may be appropriate to recharacterise a transaction in order to eliminate unacceptable tax avoidance. In Ramsay, the taxpayer company sought to create an allowable loss to offset against a chargeable gain it had made on a sale and leaseback transaction by using two loans. It sought to create the loss without actually suffering any financial detriment, by entering into a series of transactions whereby both a loss, which was allowable for tax purposes, and a matching gain, which was not chargeable to tax, were created.
In its judgment, the House of Lords held that the judiciary was not bound to consider individual steps in a series of transactions, where the steps were so closely associated with each other as to form a single composite arrangement. When applying the tax legislation to the facts in such circumstances, the courts were entitled to have regard to the effect of the transactions as a whole and were not bound to have regard to individual components of the arrangements. In particular, Lord Wilberforce confirmed that the courts were not confined to adopting a literal interpretation of tax legislation. However, it should be noted that Lord Fraser of Tullybelton expressly confirmed that he was not suggesting that the legal form of a transaction should be disregarded in favour of its supposed substance.
Following Ramsay, where tax avoidance arrangements have involved artificial steps designed to enable such arrangements to fall within the ambit of particular tax legislation, the courts have demonstrated a willingness to disregard such artificial steps and recharacterise the arrangements by considering the reality and effect of the arrangements as a whole. Consequently, transactions that have been motivated by the desire to avoid tax, that involve artificial steps, have increasingly found themselves vulnerable to reclassification when the courts have considered the legal effect of the composite transaction. However, this is not always the case.
The approach taken in Ramsay has been adopted in numerous anti-avoidance cases and commentators often refer to Ramsay as having developed the doctrine of a ‘purposive approach’ to interpreting tax legislation. However, subsequent cases have confirmed that there is no such concept as the ‘Ramsay doctrine’.
Some of the notable anti-avoidance cases that followed Ramsay are highlighted below.
Furniss v Dawson [1984]
A family attempted to defer a capital gain arising on the disposal of their company by means of various steps involving exchanging the shares prior to the disposal. The court considered that the transactions should be treated as a single composite transaction and the scheme failed.
Ensign Tankers Leasing Ltd v Stokes [1992]
This case concerned a claim for capital allowances in respect of expenditure that was incurred by a limited partnership set up to finance films. The limited partnership contributed approximately £3m and the balance of approximately £11m was financed by means of limited recourse loans. Capital allowances were claimed on £14m. The case considered what ‘incurred’ meant.
In adopting a purposive approach to the legislation the House of Lords held that the partners were only entitled to capital allowances on the money that they had actually expended and not on the full £14m. One of the key issues in Ensign was the circularity of monies.
MacNiven v Westmoreland Investments Ltd [2001]
This was a House of Lords decision in which the taxpayer was successful. The case involved a property holding company that was suffering from financial difficulties and which accepted loans from its major shareholder, a pension fund. The company could not repay the loans, and consequently the pension fund made further interest-free loans, which were immediately used to repay the accrued interest to the pension fund on the earlier loans. It claimed that these payments should be treated as charges on income. HMRC sought to argue that the interest had not been paid. The Court considered whether the payment had the effect the taxpayer intended or whether, due to the circularity of the payments, and by reviewing the transaction as a whole the interest should not be treated as having been paid.
Barclays Mercantile Business Finance (BMBF) v Mawson [2004]
This case represented another victory for the taxpayer (although HMRC won at first instance), with which those readers in the finance leasing industry may be familiar. BMBF purchased a gas pipeline under the Irish sea from the Irish Gas Board (BGE) and leased it back to BGE. BGE subleased the pipeline to its wholly owned subsidiary, which assumed direct liability to BMBF to pay the rent due under the headlease. BGE’s obligations to BMBF were secured by a deposit with BMBF’s parent. The deposit was indirectly sourced by the £91m received from BMBF for the purchase of the pipeline. BMBF had borrowed £91m, with which it paid for the pipeline, from Barclays Bank.
HMRC argued that the transaction involved the circular movement of money and that when the legislation was interpreted as Parliament intended it to apply, no allowances should be granted.
Following the earlier Court of Appeal decision, the House of Lords rejected HMRC’s arguments and, in interpreting the relevant legislation, concluded that the requirements of the Capital Allowances Act 1990 were met and that the company was entitled to the full capital allowances. In reaching its decision, the House of Lords highlighted the importance of statutory interpretation and of carrying out a thorough analysis of the relevant tax legislation. In BMBF, the Court held that the transactions complied with the relevant statutory provisions and therefore, further analysis was not required.
BMBF is also important because the House of Lords considered that the circularity of money in the transaction was irrelevant when determining how the provision of the legislation in question should be construed. However, subsequent cases have not always ignored the circularity of money when interpreting legislation according to Parliament’s intentions.
Astall & Anor v HM Revenue and Customs [2009]
In this case involving an individual, the court found in favour of HMRC. It provides a useful example of how the courts have moved away from the narrow rules of statutory construction when that approach to interpretation would produce an unacceptable result and alternatively, have chosen to adopt a more purposive approach to interpreting tax legislation. While the courts’ approach in such cases is interesting, it is not helpful to taxpayers seeking clarity.
Tower MCashback LLP 1 & anor v Revenue and Customs Commissioners [2011]
This was another decision that involved circular movements of money with the aim of claiming capital allowances and was decided in HMRC’s favour. The Supreme Court held that although capital expenditure was incurred, only some of it was attributable to plant and machinery. The remaining expenditure was part of a payment loop designed to inflate the allowances being claimed, which did not have any real link with the plant and machinery acquired. Accordingly, only part of the expenditure qualified for capital allowances.
The Supreme Court adopted a similar approach to Ramsay and confirmed that Mawson and Ensign Tankers are still good law.
Mayes v Revenue and Customs Commissioners [2011]
This case represented another taxpayer victory. Mr Mayes was one of a number of participants in a tax avoidance scheme known as SHIPS2. The participants in the scheme were all UK-resident taxpayers with high earnings or significant capital gains. The purpose of the scheme was to minimise the tax liabilities of the participants. The scheme involved the taxpayers purchasing second-hand life assurance policies and surrendering them in order to obtain a deduction for income tax and capital gains tax purposes.
The scheme depended on the implementation of seven pre-determined steps. HMRC accepted that all the steps were genuine, but argued that steps three and four, when applying the legislation, should be ignored, on the basis that they constituted a singly, wholly self-cancelling, pre-planned transaction for tax avoidance purposes which had no commercial purpose.
Following conflicting decisions by both the Special Commissioners and the High Court, the Court of Appeal dismissed HMRC’s appeal and held that the High Court was correct to allow Mr Mayes’ claim for relief.
Of all the recent cases, the decision in Mayes is perhaps the most difficult to reconcile with the cases that have gone before it.
Deutsche Bank Group Services (UK) Ltd v HM Revenue & Customs Commissioners [2011]
This First Tier Tribunal decision was heard alongside the case of UBS AG v HM Revenue & Customers Commissioners [2010], which raised similar issues. Both cases involved a scheme to pay bonuses in the form of restricted shares, which aimed to avoid tax and national insurance contributions. In applying a purposive interpretation to the legislation, the First Tier Tribunal found that the legislation did not apply and so the scheme failed.
And most recently…
Two of the most recently reported anti-avoidance cases include Explainaway Ltd & ors v Revenue & Customs [2011] and Schofield v HMRC [2011], the latter of which involved a capital gains tax avoidance scheme. The Upper Tribunal confirmed that four option contracts forming part of the avoidance scheme constituted a single, composite transaction and so the scheme failed to achieve the desired tax advantage. Akin to earlier case law, the Upper Tribunal applied existing case law, to disallow the scheme on the basis of the circularity of the transaction. The Tribunal focused on the ultimate outcome of the scheme, therefore making it more difficult for taxpayers contemplating such schemes to avoid a challenge by HMRC by contriving to design a tax avoidance scheme to appear more commercial.
The courts have shown a willingness to consider Parliament’s intention when determining how the tax legislation should be interpreted in cases involving tax avoidance. However, the approach taken by the courts is not always consistent, which makes tax planning for legitimate tax mitigation both complicated and uncertain.
The Disclosure of Tax Avoidance Schemes (DOTAS)
The DOTAS regime was introduced in 2004 and requires promoters, and in some cases, users, of certain tax planning schemes to notify HMRC of the arrangements or proposals. Schemes are notifiable if they fall within certain widely drawn descriptions (known as hallmarks). The aim of the regime is to provide HMRC with information about potential tax avoidance arrangements at an earlier stage than previously and has been and continues to be effective in enabling HMRC to expedite the process of shutting down and preventing arrangements it considers unacceptable tax avoidance.
On 22 June 2011, HMRC issued an informal consultation paper, which proposes changes to the DOTAS ‘hallmarks’ applicable to the disclosure rules relating to direct taxes. Comments were invited by 31 August 2011. The paper focuses on three key areas: employment income schemes, offshore schemes and loss schemes. With respect to employment income schemes and offshore schemes, the paper considers the introduction of a new hallmark. With regard to loss schemes, the paper considers widening the existing loss hallmark, as it views the existing one as too narrow.
Being an informal consultation document, it does not outline the proposals in any detail. However, it does signal HMRC’s intention to bolster and extend the DOTAS regime, which it hopes will ultimately deter users of such schemes.
Code of Practice on Taxation for Banks
On 9 December 2009, following a consultation process, the government published a Code of Practice on Taxation for Banks (the Code). The Code states that banks can undertake tax planning to support their business operations, but this should not be used to achieve tax results that are contrary to the intentions of Parliament. Paragraph 2.2 of the Code requires the bank to have a formal documented strategy and governance process for taxation matters. The board of directors or a senior person will be responsible for the policy being followed. Paragraph 3 states that:
‘… the bank should not engage in tax planning other than that which supports genuine commercial activity’.
Paragraph 3.3 states that:
‘… remuneration packages for bank employees, including senior executives, should be structured so that the bank reasonably believes that the proper amounts of tax and national insurance contributions are paid on the rewards of employment’.
It is possible that the publication of the Code will dissuade banks from attempting to implement aggressive tax avoidance schemes, particularly with respect to the remuneration of employees.
Government paper for tackling tax avoidance
As part of the 2011 Budget, the government published a document entitled ‘Tackling Tax Avoidance’, which explains that the government intends to take a more strategic approach to dealing with tax avoidance. The paper outlines an ‘ambitious’ package of measures to deal with the issue, including a new anti-avoidance strategy, the first announcements of reviews in high-risk areas of the tax system, options to reduce the cash-flow advantage from using avoidance schemes and targeted responses to specific avoidance risks.
HMRC’s new anti-avoidance strategy will focus on three core elements:
- preventing avoidance at the outset where possible;
- detecting it early where it persists; and
- countering it effectively through challenge by HMRC.
HMRC’s new strategy has generally been met with support from the tax profession.
Consultation document ‘High Risk Tax Avoidance Schemes’
In May 2011, following the proposals outlined in the aforementioned document on tackling tax avoidance, HMRC published a consultation document entitled ‘High Risk Tax Avoidance Schemes’. Comments were due by 31 August 2011. In this document, HMRC details proposals to introduce legislation to remove the cash-flow benefits from those who use high-risk tax avoidance schemes. According to the consultation document, a high-risk tax avoidance scheme is one that uses contrived arrangements to seek tax advantages in circumstances where they are not intended to be available and which HMRC believes does not deliver the advertised tax advantages. This concept reflects judicial decisions in tax avoidance cases. It is proposed that the legislation will list specific high-risk tax avoidance schemes, so that certain consequences can be attached to using those schemes. Those using a listed scheme would be required to report its use to HMRC.
The government wants to ensure that a person who uses a listed scheme that does not work is not better off financially than a person who does not use this type of scheme. It is intended that this will be achieved by removing the cash-flow advantage of using such schemes. The cash-flow advantage will be removed by providing that users of such schemes will be subject to an additional charge on amounts that are underpaid. This charge can be avoided by users paying any disputed tax upfront. The additional charge will be set at a rate that will remove the cash-flow advantage of not paying the tax upfront.
Consultation on Tax Treaty avoidance
At the 2011 Budget, the government announced its intention to introduce legislation in the Finance Bill 2012 to counter tax avoidance schemes that exploit the provisions of double taxation agreements (DTA). Accordingly, on 1 August 2011, HMRC published a consultation and draft legislation on tax treaties anti-avoidance. The purpose of the draft legislation was to ensure that individuals, companies and other persons cannot benefit from the provisions of a DTA where the claim to such benefit is part of an arrangement whose main purpose is to reduce a liability to UK taxation. However, on 9 September 2011, the government, prior to the consultation period ending, announced that it had decided to drop its proposed legislation as a result of the responses it had received to consultation. Following the withdrawal, the Exchequer Secretary to the Treasury, David Gauke issued a written ministerial statement in which he explained that the responses so far received ‘have made it clear that the proposed legislation, as drafted, could cause significant uncertainty for compliant UK businesses and overseas investors about its intended scope and its practical effect.’ The statement does not rule out further action in this area, although at this stage, given the responses and the difficulty of introducing it, such legislation is unlikely.
Introduction of a GAAR
In December 2010, the government asked Graham Aaronson QC, a leading tax barrister, to chair a study programme into the introduction of a GAAR. The study group is considering whether a GAAR is possible and if so, the form that it would take.
In June 2011, HMRC published a progress summary compiled by the study group setting out its progress to date. In its progress summary, the study group noted that it has considered and reached a consensus on the strengths and weaknesses of the current judicial approach to the interpretation of tax statutes and the application of those statutes to tax avoidance schemes.
According to the progress summary, the study group has reached consensus on what would be the potential advantages of a GAAR for the UK, and what concerns a GAAR would need to address and allay. The work done by the study group has enabled it to develop a contractual framework of principles that would need to be embodied in a GAAR, which could then be enacted.
The study group will now consider whether it is possible to develop further the framework it has produced into a set of statutory rules. Consequently, it currently remains uncertain whether a GAAR will be implemented. The study group is due to deliver its final report by 31 October 2011, so it will shortly be known whether the study group considers that a GAAR can, and should, be developed and then enacted.
It should be noted that GAARs already exist in most European jurisdictions and in Canada, New Zealand and Australia, with varying degrees of success. Each of these GAARs have their own characteristics, some with clearance systems. To date, it has not been decided whether any GAAR that is introduced in the UK would have a clearance system.
At this stage, it is difficult to predict the form a GAAR would take and its practical effect. It may be that by having a GAAR, tax legislation could be simplified. In recent years there has been a trend for governments to enact emergency legislation to close down tax avoidance loopholes. This action has resulted in a raft of complicated and often ill-thought out anti-avoidance provisions in tax legislation. It is arguable that a GAAR could provide a simplified anti-avoidance mechanism, which would avoid the need for complicated emergency legislation.
There have been discussions of the GAAR taking a principles-based approach. That has the advantage of being all-encompassing, but may result in continuing uncertainty. A more prescriptive GAAR, although creating greater certainty for taxpayers, may not have the desired effect of deterring those intent on circumventing the tax system. Whatever approach is taken, it is hoped that a GAAR will provide certainty and will not merely be an additional power enabling HMRC to intimidate taxpayers.
Summary
Ramsay heralded the start of a new approach to the way the courts deal with cases involving tax avoidance. Following Ramsay, the courts have shown a willingness to consider Parliament’s intention when determining how tax legislation should be applied.
There have been numerous cases involving tax avoidance, some with surprising outcomes, and as a result, the approach the courts will take is not always clear. The introduction of a GAAR may, it is hoped, increase certainty for taxpayers by providing a clear framework for tax planning.
Outside of the courts, there are numerous consultation documents on anti-avoidance, and all of these factors make for an uncertain environment for those seeking to undertake tax mitigation arrangements.
By Sarah Gatley, solicitor, Watson, Farley & Williams LLP .
E-mail: sgatley@wfw.com.
Astall & Anor v Revenue and Customs [2009] EWCA Civ 1010
Barclays Mercantile Business Finance (BMBF) v Mawson [2004] UKHL 51
Deutsche Bank Group Services (UK) Ltd v HM Revenue & Customs Commissioners [2011] UKFTT 66 (TC)
Ensign Tankers Leasing Ltd v Stokes [1992] 1 AC 655
Explainaway Ltd & Ors v Revenue & Customs [2011] UKFTT 414 (TC)
Furniss v Dawson [1984] 55 TC 324
IRC v Duke of Westminster [1936] AC 1 HL
MacNiven v Westmoreland Investments Ltd [2001] UKHL 6
Mayes v Revenue and Customs Commissioners [2011] EWCA Civ 407
Schofield v HMRC [2011] UKUT 306 (TC)
Tower MCashback LLP 1 & anor v Revenue and Customs Commissioners [2011] STC 1143
UBS AG v HM Revenue & Customers Commissioners [2010] UKFTT 366 (TC),
W T Ramsay Ltd v Inland Revenue Commissioners [1981] STC 174
