With the passing of the 2013 Finance Act, the UK government has unveiled its latest defensive measure with which it intends to counteract aggressive and socially unconscionable tax avoidance measures undertaken by businesses and individuals in respect of a wide array of taxes, including income tax, corporation tax and capital gains tax.

Background

The UK General Anti-Abuse Rule (the “GAAR”) represents a new fundamental rule which underpins all present and future rules relating to the taxes with which it is concerned. Its implementation signals a departure from the prevailing UK practice over the last 50 years of developing an exponentially growing and litigator-friendly corpus of targeted anti avoidance rules (“TAARs”) that were introduced in order to counteract perceived foul play in the managing of tax affairs of business and individuals.

As a preliminary thought it is worth recognising that the GAAR, being an effort on the part of government to move the debate on from the appropriately acronymed TAAR regime developed over recent decades, is a conclusive statement by the UK Government that the concept of taxation is no longer considered (in the case of income tax) in its original light as a controversial confiscation of the fruits of the collective British sweated brow in order to support the effort to protect the peoples of Europe from le Grande Armée and (amongst other complaints) the imposition of a Napoleonic tax code.

Until the landmark 1982 case which produced the Ramsay principle according to which UK courts moved away from a strictly literalist interpretation of tax rules, legislation permitting such governmental appropriation was accorded the strictest interpretation by the courts in order to protect the subjects of the UK against Parliament’s 1689 claim of right to exercise exclusive control over the raising and spending of public revenue. Against such a combative backdrop, an impenetrable haystack of TAARs were counteracted where possible by a growing industry of accountants, lawyers and financial advisers exploiting loopholes and gaps in the legislation to the financial benefit of their clients. The very establishment of the UK Office for Tax Simplification in 2010 is the clearest indication yet that such a procedure for creating and interpreting tax legislation has not produced an optimal taxation system for the UK.

The state justification for the levying of taxation, having moved on from the supply of bayonets for the Peninsular Campaign to the supply of the many modern public services provided by the state for the benefit of its people, a more generalist rule such as the GAAR is clearly a better fit for a modern tax system which since Ramsay has been interpreted by the courts in a less literal and more purposive manner. The courts act nowadays, as described in the Hong Kong Arrowtown case (and approved by the House of Lords in Mawson), with an “unblinkered approach to the analysis of the facts”.

GAAR Engagement

The GAAR will be engaged in situations whereby the following four questions are all answered in the affirmative in relation to a taxpayer’s tax affairs:
1. Is there an arrangement (whether legally enforceable or otherwise) which gives rise to a tax advantage?
2. Does the tax advantage relate to a tax to which the GAAR applies?
3. Is the obtaining of a tax advantage one of the main purposes of entering into the relevant arrangement?
4. Is the tax arrangement “abusive”?

In such cases, the 2013 Finance Act provides that adjustments are to be made to the taxpayer’s tax liability that are “just and reasonable”.

The remainder of this article will consider one aspect of the fourth and potentially most litigious aspect of the GAAR applicability test, namely how the concept of “abusive” is to be applied to tax arrangements, and whether the “double reasonableness” safeguard introduced in the GAAR legislation is appropriate to prevent HMRC using the GAAR aggressively to target taxpayers from carrying out perfectly normal tax mitigation practices.

An important acknowledgment, prior to consideration of “abusive” within the meaning of the GAAR, is that the report by Graham Aaronson QC published on 11 November 2011, which was commissioned by the UK Government and tasked with the study of whether a general anti-avoidance rule could be framed so as to be effective in the UK tax system, recommended the introduction of a general anti-abuse rule and not a general anti- avoidance rule. This is a welcome and important distinction, which has been accepted by HMRC and the UK Government in the GAAR legislation. The UK legal system has developed a long and established practice of allowing its taxpayers to undertake responsible and fair tax planning, which Aaronson described as the “large centre ground’. The consequences to businesses and individuals in the UK of losing the ability to undertake effective and responsible tax planning would outweigh any benefits of having a looser general anti-avoidance rule. The GAAR is instead intended to target only those schemes which Aaronson described as “highly abusive, contrived and artificial schemes which are widely regarded as intolerable”.

Double Reasonableness

In order to ensure that the GAAR was targeted only at those most insidious tax arrangements, Aaronson proposed that a safeguard against the application of the GAAR to centre- ground responsible tax planning exercises, a “double reasonableness” test”, be applied to the consideration of the abusive (or otherwise) nature of a tax arrangement. Its appearance in the Finance Act 2013 is as follows:

‘Tax Arrangements are “abusive” if they are arrangements the entering into or carrying out of which cannot reasonably be regarded as a reasonable course of action in relation to the relevant tax provisions, having regard to all the circumstances…’

But, as the foundation of the GAAR concept, is the “double reasonableness” test an appropriate and practical one?

From a taxpayer safeguard viewpoint, the double reasonableness test does not ask whether, objectively, the carrying out of a particular set of tax arrangements is a reasonable course of action. Instead, it asks a judge to decide whether, amongst the potentially myriad range of views which may be held by the taxpayer, HMRC or any other entity, corporeal or otherwise (including the judge himself), it is reasonable that the tax arrangements can be regarded as a reasonable course of action, even if that judge in question does not himself hold that course of action to be a reasonable one.

Note that in cases where a single person can be regarded by a tribunal as having a reasonably held view that a particular tax arrangement represents a reasonable course of action then even an overwhelming number of equally reasonably held views that the tax arrangement in question is not a reasonable course of action will fail to provide a foundation for a successful the GAAR action. In such instances the GAAR will not apply as the high threshold for double reasonableness will not have been met. Instead, GAAR being drafted such that the benefit of the doubt falls squarely with the taxpayer, such tax arrangements will be deemed to form part of Aaronson’s GAAR- excluded “centre ground”.

There are two levels of reasonableness tests which a particular tax arrangement must fail to meet in order to potentially fall within the application of GAAR. These will be referred to for the remainder of the article as “primary” and “secondary” reasonableness tests.

in order to ensure that the GAAR was targeted only at those most insidious tax arrangements, Aaronson proposed that a safeguard against the application of the GAAR to centre-ground responsible tax planning exercises, a “double reasonableness’ test”, be applied to the consideration of the abusive (or otherwise) nature of a tax arrangement.

Primary Reasonableness

In order to succeed in the GAAR action, at a fundamental level HMRC must demonstrate (and note where the burden of proof lies) that a particular tax arrangement cannot reasonably be regarded as “a reasonable course of action in relation to the relevant tax provisions”. There being no particular definition of “relevant tax provisions”, a wide array of tax laws may be applicable in determining relevance to a particular tax arrangement and its consequences.

Clearly therefore the commercial and/or personal choices offered to the taxpayer by the “relevant tax provisions” in question are of interest in determining primary reasonableness. To take a basic hypothetical example, the UK currently sets stamp duty for the purchase of shares in a limited company at 0.5% of the consideration payable by the acquirer of those shares. If a selling company has a single asset, being a residential house worth £1 million, then all other things being equal, an acquirer is not acting unreasonably in selecting to purchase the share capital of the Company for £1 million (incurring a stamp duty liability of £5,000) as opposed to acquiring the land for £1 million (incurring a stamp duty liability of £40,000). This is because the applicable taxation laws offer clear choice of action to a taxpayer, with different taxation outcomes depending on his/her choice. To follow the more taxpayer friendly process of acquiring shares worth £1 million would be to follow precisely the letter and spirit of the rules relating to stamp duty.

According to the HMRC’s published GAAR Guidance, it would be unreasonable for a buyer of land in the above example (A) to claim that no stamp duty is payable by the buyer in accordance with the 2003 Finance Act transfer of rights provisions because he has sold the land to a connected party B (connected party transactions being exempt from stamp duty). Here, B has acquired land from a seller via A and taken advantage of a legislative gap, thereby escaping £40,000 of stamp duty which B would have paid had he bought land directly from the seller. Clearly the policy decision behind both the transfer of rights provisions and the connected party rules are to prevent bona fide purchasers from paying double stamp duty. Each of those independent rules were not established to cumulatively ensure that no stamp duty is payable by sufficiently wily taxpayers.

A taxpayer using a convoluted and unusual procedure to effect a simple acquisition, in order to avoid tax liability would not be exercising a reasonable exercise of choice in relation to the relevant tax provisions in a GAAR action because, and herein lies the difficulty for potentially abusive tax arrangements, GAAR as an overarching principle will almost always be a “relevant tax provision” to be taken into account in assessing reasonableness.

The GAAR’s status as an overarching principle of UK taxation acknowledges that taxation is an essential element of the honouring of the State’s perceived commitment to the provision of public services to its subjects, and that everyone must pay their “fair share”. The UK Government, by placing the policy rationale behind a legislative tax provision (including the GAAR) front and centre of the analysis of primary reasonableness, has made a clear statement that at the level of abusive tax arrangements there will no longer be a way “around” the legislation.

A common criticism of a reasonableness test is that it is a subjective test. “Reasonableness” being in the eye of the beholder, further safeguards must be in place in order to achieve a fair and just analysis of the abusive nature (or otherwise) of tax arrangements. Enter the “secondary reasonableness” aspect of the double reasonableness test…

Secondary Reasonableness

As noted above, a tax arrangement shall only fall foul of the GAAR if the arrangements in question cannot be reasonably regarded as a reasonable course of action. Key to the understanding of how well this rule may operate is therefore an appreciation of precisely how to measure whether a view, one way or another, falls to be regarded as a reasonable view for the purposes of the GAAR.

Whether a view on tax arrangements falls to be treated as “reasonable” for the the GAAR purposes is to be judged against the regard which the court must have to the widely drafted “all the circumstances”, including:

• policy objectives of the GAAR legislation and relevant legislative provisions; By identifying precisely who can hold a reasonable view on reasonable courses of action in relation to tax arrangements (i.e. those who understand that the “game”, in abnormal cases of tax arrangements, is over and can base their view on the GAAR legislation), the double reasonableness test does provide a helpful guide as to the range of parties from which a judge can source a GAAR- based on the view that a particular tax arrangement is “reasonable”. The subjective nature of reasonableness tests is therefore avoided to a fair extent.
• indicators of abusive tax arrangements and indicators of non- abusive tax arrangements specified in the Finance Act 2013; and a common criticism of a reasonableness test is that it is a subjective test
• specific regard to be had to certain sections of HMRC’s GAAR Guidance, the first iteration of which published with effect from 15 April 2013 which has been approved by an independent GAAR Advisory Panel established in order to provide a further independent safeguard against the possibility of “mission creep” (i.e. HMRC extending the potential use of the GAAR to attack Aaronson’s protected centre ground of tax planning).

It is the first of these three “circumstances” which is of most relevance for this analysis. As noted above, as an overarching tax principle, the GAAR will almost certainly always be a “relevant tax provision” for the taxes to which it applies. Crucially therefore, in order for a person’s view on a tax arrangement to be held out as one which is reasonable for the GAAR purposes, that person must subscribe to the policy objectives of the GAAR itself (and courts are given the specific authority by the legislation to take into account “principles” and “policy objectives” of tax provisions by reference to materials which would not normally be admissible under traditional rules of evidence and legislative interpretation, including extra-parliamentary government policy statements and ministers’ stump speeches for example.)

Thus an eminent tax law professor, who would otherwise be considered to be an expert on taxation law and capable of holding a perfectly reasonable view on the reasonableness of a particular tax arrangement, will be completely outside the tent of acceptable views from which a judge in a GAAR case can source “reasonably held views” if that professor subscribes to a principled notion that subjects of the UK are entitled to arrange tax affairs taking the law as it is written with no further reference to uncertain or debatable concepts such as the policy objectives of the law.

As an overarching principle the GAAR will embed itself into every tax provision to which it applies’

Conclusion

The UK’s GAAR rules provide for further benchmarks to be met by HMRC in seeking to enforce the GAAR claim against a taxpayer, and certainly there is far more analysis which could be undertaken on GAAR’s merits which cannot be conducted in this article. It will be fascinating to see how judges deal with the double reasonableness test in action and how the independent GAAR Advisory Panel’s influence over enforcement of the GAAR plays out in the new regime’s infancy.

As an overarching principle the GAAR will embed itself into every tax provision to which it applies. Parliament has emphatically rejected the historic approach taken by Courts which were initially hesitant to interpret tax rules purposively (for an example of the Courts’ former role as a bulwark against HMRC’s “shovel in the stores” see the 1929 Ayrshire Pullman case).

Taxpayers are no longer able to trust that their wiles and professional advisers’ high-risk tax schemes will minimise tax liability. Tax schemes which are intellectually justified without reference to GAAR are at serious risk of falling foul of the new generalist rule and face potential counteraction.

Looking ahead to a future in which Parliament has picked up its ball and gone home, perhaps in the event that the GAAR operates successfully both taxpayer and HMRC alike will be more comfortable with what behaviour is indicative of Aaronson’s centre ground, allowing the UK Treasury’s Office for Tax Simplification to get on with the job of untangling the UK’s 11,000 pages-plus tax code representing one of the most complicated tax regimes on the planet.