Tax Avoidance - the Current UK Approach - Watson, Farley & Williams

Corporate tax feature from Watson, Farley & Williamspublished in the November 2011 issue of The In-House Lawyer:Tax avoidance: the current UK approach

CORPORATE TAX Watson, Farley & Williams LLPTax avoidance: thecurrent UK approachThe coalition government’s focus on combating tax leakage has made taxavoidance a topical issue and in recent years the courts have heard numerousanti-avoidance cases. Sarah Gatley clarifies the current position and outlinesregulatory plans for the futureIn the current economic climate, the UKgovernment is keen to combat tax leakageand tax avoidance continues to be a topicalissue. Tax avoidance is increasingly reportedin the press following the emergence ofprotest groups, such as UK Uncut, which hasorganised action against companies that itconsiders to be involved in tax avoidance.There have been numerousanti-avoidance cases in recent years andthis article considers some of those casesand the approach taken by the UK courts totax avoidance. It also reviews HM Revenue& Customs’ and the government’s ongoingprogramme of reforms designed to tackle taxavoidance. The introduction of the Disclosureof Tax Avoidance Schemes regime hasaffected the way that HMRC deals with whatit perceives as tax avoidance, ensuring thatit is able to shut down offending schemespromptly. Furthermore, the governmentis actively considering the possibility ofimplementing a general anti-avoidancerule (GAAR), which in addition to variousongoing consultations on anti-avoidancelegislation, creates an uncertain and difficultenvironment for those wishing to organisetheir affairs in a tax-efficient manner.This article will not attempt to define taxavoidance, tax mitigation or tax evasion, asthose concepts would require an article tothemselves.DEVELOPMENT OF ANTI-AVOIDANCECASE LAWThe recent approach to dealing with taxavoidance by both HMRC and the courtshas provoked much discussion among taxpractitioners advising on tax mitigationarrangements. The courts have hearda raft of tax avoidance cases involvingvarious creative schemes, often with similarelements such as the circular movementof money, self-cancelling transactionsor the insertion of numerous steps thatseem to serve no commercial purpose,other than to secure a reduction in tax.Over the last 30 years, when consideringtax avoidance schemes, the approach takenby the courts has varied significantly, andthere often seems to be no consistencyin their approach. Consequently, the courts’attitude towards tax avoidance seemsuncertain.This article seeks to consider some ofthe more recent anti-avoidance cases – itis not intended to provide a detailed reviewof all anti-avoidance case law. Rather, thisarticle endeavours to highlight some of thediffering approaches adopted by the courtstowards tax mitigation arrangements,while attempting to determine whethera cohesive judicial attitude towards taxavoidance is discernable.The cases discussed below all involvescenarios in which the judiciary has had toconsider the tax treatment applicable tovarious transactions designed to mitigatethe effects of taxation. The circularmovement of money is a common threadin several of the cases, although theapproach by the courts to dealing with taxavoidance varies and, it would seem, thecircular movement of money is not alwaysfatal to the success of an arrangement.Commerciality of a transaction may alsobe important when considering whether atransaction is acceptable, although, againcommerciality alone is not always sufficientfor an arrangement to succeed.Prior to W T Ramsay Ltd v Inland RevenueCommissioners [1981] (discussed below), thecourts adopted a more literal approach tothe construction of legislation in the contextof tax-sensitive transactions. Consequently,the courts often refused attempts byHMRC to reclassify arrangements andremove the advantageous tax effects oftransactions structured to comply witha literal interpretation of the relevant taxlegislation, (see for example IRC v Duke ofWestminster [1936]). However, Ramsayheralded the beginning of a new approachto how the courts deal with cases involvingtax avoidance. Following Ramsay, the courtshave seemed more prepared to considerParliament’s intention when determining howtax legislation should be interpreted. Thishas enabled the judiciary both to reclassifytransactions according to their real legaleffect, for the purposes of applying thelegislation to them, and to interpret statutelaw having regard to its intended purpose.This has led to what some commentatorsrefer to as the judiciary’s ‘purposiveapproach’ to statutory interpretation.W T RAMSAY LTD v INLANDREVENUE COMMISSIONERS [1981]In this watershed case, the House of Lordsaccepted that in certain circumstances,www.inhouselawyer.co.ukNovember 2011 The In-House Lawyer 3

CORPORATE TAX Watson, Farley & Williams LLPdepending on the facts, it may beappropriate to recharacterise a transactionin order to eliminate unacceptable taxavoidance. In Ramsay, the taxpayercompany sought to create an allowable lossto offset against a chargeable gain it hadmade on a sale and leaseback transactionby using two loans. It sought to create theloss without actually suffering any financialdetriment, by entering into a series oftransactions whereby both a loss, whichwas allowable for tax purposes, and amatching gain, which was not chargeable totax, were created.In its judgment, the House of Lordsheld that the judiciary was not bound toconsider individual steps in a series oftransactions, where the steps were soclosely associated with each other as toform a single composite arrangement.When applying the tax legislation to thefacts in such circumstances, the courtswere entitled to have regard to the effectof the transactions as a whole and werenot bound to have regard to individualcomponents of the arrangements. Inparticular, Lord Wilberforce confirmed thatthe courts were not confined to adoptinga literal interpretation of tax legislation.However, it should be noted that Lord Fraserof Tullybelton expressly confirmed that hewas not suggesting that the legal form of atransaction should be disregarded in favourof its supposed substance.Following Ramsay, where tax avoidancearrangements have involved artificial stepsdesigned to enable such arrangementsto fall within the ambit of particular taxlegislation, the courts have demonstrateda willingness to disregard such artificialsteps and recharacterise the arrangementsby considering the reality and effect of thearrangements as a whole. Consequently,transactions that have been motivated bythe desire to avoid tax, that involve artificialsteps, have increasingly found themselvesvulnerable to reclassification when thecourts have considered the legal effect ofthe composite transaction. However, this isnot always the case.The approach taken in Ramsay hasbeen adopted in numerous anti-avoidancecases and commentators often refer toRamsay as having developed the doctrineof a ‘purposive approach’ to interpretingtax legislation. However, subsequentcases have confirmed that there is no suchconcept as the ‘Ramsay doctrine’.Some of the notable anti-avoidance casesthat followed Ramsay are highlighted below.FURNISS v DAWSON [1984]A family attempted to defer a capital gainarising on the disposal of their companyby means of various steps involvingexchanging the shares prior to the disposal.The court considered that the transactionsshould be treated as a single compositetransaction and the scheme failed.ENSIGN TANKERS LEASINGLTD v STOKES [1992]This case concerned a claim for capitalallowances in respect of expenditure thatwas incurred by a limited partnership setup to finance films. The limited partnershipcontributed approximately £3m and thebalance of approximately £11m wasfinanced by means of limited recourse loans.Capital allowances were claimed on £14m.The case considered what ‘incurred’ meant.In adopting a purposive approach to thelegislation the House of Lords held thatthe partners were only entitled to capitalallowances on the money that they hadactually expended and not on the full £14m.One of the key issues in Ensign was thecircularity of monies.MACNIVEN v WESTMORELANDINVESTMENTS LTD [2001]This was a House of Lords decision in whichthe taxpayer was successful. The caseinvolved a property holding company thatwas suffering from financial difficultiesand which accepted loans from its majorshareholder, a pension fund. The companycould not repay the loans, and consequentlythe pension fund made further interest-freeloans, which were immediately used to repaythe accrued interest to the pension fundon the earlier loans. It claimed that thesepayments should be treated as chargeson income. HMRC sought to argue thatthe interest had not been paid. The Courtconsidered whether the payment had theeffect the taxpayer intended or whether,due to the circularity of the payments, andby reviewing the transaction as a whole theinterest should not be treated as havingbeen paid.BARCLAYS MERCANTILE BUSINESSFINANCE (BMBF) v MAWSON [2004]This case represented another victory forthe taxpayer (although HMRC won at firstinstance), with which those readers in thefinance leasing industry may be familiar.BMBF purchased a gas pipeline under theIrish sea from the Irish Gas Board (BGE) andleased it back to BGE. BGE subleased thepipeline to its wholly owned subsidiary,which assumed direct liability to BMBFto pay the rent due under the headlease.BGE’s obligations to BMBF were secured bya deposit with BMBF’s parent. The depositwas indirectly sourced by the £91m receivedfrom BMBF for the purchase of the pipeline.BMBF had borrowed £91m, with which it paidfor the pipeline, from Barclays Bank.HMRC argued that the transactioninvolved the circular movement of moneyand that when the legislation wasinterpreted as Parliament intended it toapply, no allowances should be granted.Following the earlier Court of Appealdecision, the House of Lords rejectedHMRC’s arguments and, in interpreting therelevant legislation, concluded that therequirements of the Capital AllowancesAct 1990 were met and that the companywas entitled to the full capital allowances.In reaching its decision, the House ofLords highlighted the importance ofstatutory interpretation and of carryingout a thorough analysis of the relevant taxlegislation. In BMBF, the Court held that thetransactions complied with the relevantstatutory provisions and therefore, furtheranalysis was not required.BMBF is also important because theHouse of Lords considered that thecircularity of money in the transactionwas irrelevant when determining how theprovision of the legislation in question shouldbe construed. However, subsequent caseshave not always ignored the circularityof money when interpreting legislationaccording to Parliament’s intentions.ASTALL & ANOR v HM REVENUEAND CUSTOMS [2009]In this case involving an individual, thecourt found in favour of HMRC. It providesa useful example of how the courtshave moved away from the narrow rulesof statutory construction when thatapproach to interpretation would producean unacceptable result and alternatively,have chosen to adopt a more purposiveapproach to interpreting tax legislation.While the courts’ approach in such casesis interesting, it is not helpful to taxpayersseeking clarity.4 The In-House Lawyer November 2011www.inhouselawyer.co.uk

CORPORATE TAX Watson, Farley & Williams LLPTOWER MCASHBACK LLP 1 & ANORv REVENUE AND CUSTOMSCOMMISSIONERS [2011]This was another decision that involvedcircular movements of money with the aim ofclaiming capital allowances and was decidedin HMRC’s favour. The Supreme Court heldthat although capital expenditure wasincurred, only some of it was attributableto plant and machinery. The remainingexpenditure was part of a payment loopdesigned to inflate the allowances beingclaimed, which did not have any real linkwith the plant and machinery acquired.Accordingly, only part of the expenditurequalified for capital allowances.The Supreme Court adopted a similarapproach to Ramsay and confirmed thatMawson and Ensign Tankers are still good law.MAYES v REVENUE AND CUSTOMSCOMMISSIONERS [2011]This case represented another taxpayervictory. Mr Mayes was one of a number ofparticipants in a tax avoidance schemeknown as SHIPS2. The participants in thescheme were all UK-resident taxpayers withhigh earnings or significant capital gains. Thepurpose of the scheme was to minimise thetax liabilities of the participants. The schemeinvolved the taxpayers purchasing secondhandlife assurance policies and surrenderingthem in order to obtain a deduction forincome tax and capital gains tax purposes.The scheme depended on theimplementation of seven pre-determinedsteps. HMRC accepted that all the stepswere genuine, but argued that steps threeand four, when applying the legislation,should be ignored, on the basis that theyconstituted a singly, wholly self-cancelling,pre-planned transaction for tax avoidancepurposes which had no commercial purpose.Following conflicting decisions by both theSpecial Commissioners and the High Court,the Court of Appeal dismissed HMRC’s appealand held that the High Court was correct toallow Mr Mayes’ claim for relief.Of all the recent cases, the decisionin Mayes is perhaps the most difficult toreconcile with the cases that have gonebefore it.DEUTSCHE BANK GROUP SERVICES(UK) LTD v HM REVENUE & CUSTOMSCOMMISSIONERS [2011]This First Tier Tribunal decision was heardalongside the case of UBS AG v HM Revenue‘Of all the recent cases, the decision in Mayes vRevenue and Customs Commissioners [2011] is perhapsthe most difficult to reconcile with the cases that havegone before it.’& Customers Commissioners [2010], which fall within certain widely drawn descriptionsraised similar issues. Both cases involved (known as hallmarks). The aim of the regimea scheme to pay bonuses in the form of is to provide HMRC with information aboutrestricted shares, which aimed to avoid potential tax avoidance arrangements at antax and national insurance contributions. earlier stage than previously and has beenIn applying a purposive interpretation to and continues to be effective in enablingthe legislation, the First Tier Tribunal found HMRC to expedite the process of shuttingthat the legislation did not apply and so the down and preventing arrangements itscheme failed.considers unacceptable tax avoidance.On 22 June 2011, HMRC issued anAND MOST RECENTLY…informal consultation paper, whichTwo of the most recently reportedproposes changes to the DOTAS ‘hallmarks’anti-avoidance cases include Explainaway applicable to the disclosure rules relatingLtd & ors v Revenue & Customs [2011] to direct taxes. Comments were invitedand Schofield v HMRC [2011], the latter of by 31 August 2011. The paper focuseswhich involved a capital gains tax avoidance on three key areas: employment incomescheme. The Upper Tribunal confirmed that schemes, offshore schemes and lossfour option contracts forming part of the schemes. With respect to employmentavoidance scheme constituted a single, income schemes and offshore schemes,composite transaction and so the scheme the paper considers the introduction of afailed to achieve the desired tax advantage. new hallmark. With regard to loss schemes,Akin to earlier case law, the Upper Tribunal the paper considers widening the existingapplied existing case law, to disallow the loss hallmark, as it views the existing onescheme on the basis of the circularity of the as too narrow.transaction. The Tribunal focused on the Being an informal consultationultimate outcome of the scheme, therefore document, it does not outline the proposalsmaking it more difficult for taxpayers in any detail. However, it does signal HMRC’scontemplating such schemes to avoid a intention to bolster and extend the DOTASchallenge by HMRC by contriving to design regime, which it hopes will ultimately detera tax avoidance scheme to appear more users of such schemes.commercial.The courts have shown a willingness CODE OF PRACTICE ONto consider Parliament’s intention when TAXATION FOR BANKSdetermining how the tax legislation should On 9 December 2009, following abe interpreted in cases involving taxconsultation process, the governmentavoidance. However, the approach taken published a Code of Practice on Taxationby the courts is not always consistent, for Banks (the Code). The Code stateswhich makes tax planning for legitimate tax that banks can undertake tax planningmitigation both complicated and uncertain. to support their business operations, butthis should not be used to achieve taxTHE DISCLOSURE OF TAXresults that are contrary to the intentionsAVOIDANCE SCHEMES (DOTAS)of Parliament. Paragraph 2.2 of theThe DOTAS regime was introduced in 2004 Code requires the bank to have a formaland requires promoters, and in some cases, documented strategy and governanceusers, of certain tax planning schemes process for taxation matters. The boardto notify HMRC of the arrangements or of directors or a senior person will beproposals. Schemes are notifiable if they responsible for the policy being followed.www.inhouselawyer.co.ukNovember 2011 The In-House Lawyer 5

CORPORATE TAX Watson, Farley & Williams LLP‘The government intends to take a more strategicapproach to dealing with tax avoidance and has outlinedan “ambitious” package of measures designed to dealwith tax avoidance.’Paragraph 3 states that:HMRC’s new strategy has generally beenmet with support from the tax profession.‘… the bank should not engage in taxplanning other than that which supports CONSULTATION DOCUMENT ‘HIGH RISKgenuine commercial activity’.TAX AVOIDANCE SCHEMES’In May 2011, following the proposals outlinedParagraph 3.3 states that:in the aforementioned document on tacklingtax avoidance, HMRC published a consultation‘… remuneration packages for bank document entitled ‘High Risk Tax Avoidanceemployees, including senior executives, Schemes’. Comments were due by 31should be structured so that the bank August 2011. In this document, HMRC detailsreasonably believes that the proper proposals to introduce legislation to removeamounts of tax and national insurance the cash-flow benefits from those who usecontributions are paid on the rewards of high-risk tax avoidance schemes. Accordingemployment’.to the consultation document, a high-risk taxavoidance scheme is one that uses contrivedIt is possible that the publication of the arrangements to seek tax advantages inCode will dissuade banks from attempting circumstances where they are not intendedto implement aggressive tax avoidance to be available and which HMRC believes doesschemes, particularly with respect to the not deliver the advertised tax advantages.remuneration of employees.This concept reflects judicial decisions intax avoidance cases. It is proposed thatGOVERNMENT PAPER FORthe legislation will list specific high-riskTACKLING TAX AVOIDANCEtax avoidance schemes, so that certainAs part of the 2011 Budget, theconsequences can be attached to usinggovernment published a document entitled those schemes. Those using a listed scheme‘Tackling Tax Avoidance’, which explains would be required to report its use to HMRC.that the government intends to take aThe government wants to ensure thatmore strategic approach to dealing with tax a person who uses a listed scheme thatavoidance. The paper outlines an ‘ambitious’ does not work is not better off financiallypackage of measures to deal with the issue, than a person who does not use this typeincluding a new anti-avoidance strategy, of scheme. It is intended that this willthe first announcements of reviews in be achieved by removing the cash-flowhigh-risk areas of the tax system, options to advantage of using such schemes. Thereduce the cash-flow advantage from using cash-flow advantage will be removed byavoidance schemes and targeted responses providing that users of such schemes will beto specific avoidance risks.subject to an additional charge on amountsHMRC’s new anti-avoidance strategy will that are underpaid. This charge can befocus on three core elements:avoided by users paying any disputed taxupfront. The additional charge will be set1) preventing avoidance at the outset at a rate that will remove the cash-flowwhere possible;advantage of not paying the tax upfront.2) detecting it early where it persists; and CONSULTATION ON TAX TREATY AVOIDANCEAt the 2011 Budget, the government3) countering it effectively throughannounced its intention to introducechallenge by HMRC.legislation in the Finance Bill 2012 to countertax avoidance schemes that exploit theprovisions of double taxation agreements(DTA). Accordingly, on 1 August 2011, HMRCpublished a consultation and draft legislationon tax treaties anti-avoidance. The purposeof the draft legislation was to ensure thatindividuals, companies and other personscannot benefit from the provisions of a DTAwhere the claim to such benefit is part ofan arrangement whose main purpose is toreduce a liability to UK taxation. However,on 9 September 2011, the government,prior to the consultation period ending,announced that it had decided to dropits proposed legislation as a result of theresponses it had received to consultation.Following the withdrawal, the ExchequerSecretary to the Treasury, David Gaukeissued a written ministerial statement inwhich he explained that the responses sofar received ‘have made it clear that theproposed legislation, as drafted, could causesignificant uncertainty for compliant UKbusinesses and overseas investors about itsintended scope and its practical effect.’ Thestatement does not rule out further actionin this area, although at this stage, given theAstall & Anor v Revenue and Customs[2009] EWCA Civ 1010Barclays Mercantile Business Finance(BMBF) v Mawson [2004] UKHL 51Deutsche Bank Group Services (UK) Ltd vHM Revenue & Customs Commissioners[2011] UKFTT 66 (TC)Ensign Tankers Leasing Ltd v Stokes[1992] 1 AC 655Explainaway Ltd & Ors v Revenue &Customs [2011] UKFTT 414 (TC)Furniss v Dawson [1984] 55 TC 324IRC v Duke of Westminster [1936] AC 1 HLMacNiven v Westmoreland InvestmentsLtd [2001] UKHL 6Mayes v Revenue and CustomsCommissioners [2011] EWCA Civ 407Schofield v HMRC [2011] UKUT 306 (TC)Tower MCashback LLP 1 & anor v Revenueand Customs Commissioners [2011] STC1143UBS AG v HM Revenue & CustomersCommissioners [2010] UKFTT 366 (TC),W T Ramsay Ltd v Inland RevenueCommissioners [1981] STC 1746 The In-House Lawyer November 2011www.inhouselawyer.co.uk

CORPORATE TAX Watson, Farley & Williams LLPresponses and the difficulty of introducing it,such legislation is unlikely.INTRODUCTION OF A GAARIn December 2010, the governmentasked Graham Aaronson QC, a leading taxbarrister, to chair a study programme intothe introduction of a GAAR. The study groupis considering whether a GAAR is possibleand if so, the form that it would take.In June 2011, HMRC published aprogress summary compiled by thestudy group setting out its progress todate. In its progress summary, the studygroup noted that it has considered andreached a consensus on the strengths andweaknesses of the current judicial approachto the interpretation of tax statutes andthe application of those statutes to taxavoidance schemes.According to the progress summary,the study group has reached consensuson what would be the potential advantagesof a GAAR for the UK, and what concernsa GAAR would need to address andallay. The work done by the study grouphas enabled it to develop a contractualframework of principles that would need tobe embodied in a GAAR, which couldthen be enacted.The study group will now considerwhether it is possible to develop furtherthe framework it has produced into a set ofstatutory rules. Consequently, it currentlyremains uncertain whether a GAAR will beimplemented. The study group is due todeliver its final report by 31 October 2011,so it will shortly be known whether thestudy group considers that a GAAR can, andshould, be developed and then enacted.It should be noted that GAARs alreadyexist in most European jurisdictions and inCanada, New Zealand and Australia, withvarying degrees of success. Each of theseGAARs have their own characteristics,some with clearance systems. To date, ithas not been decided whether any GAARthat is introduced in the UK would have aclearance system.At this stage, it is difficult to predict theform a GAAR would take and its practicaleffect. It may be that by having a GAAR, taxlegislation could be simplified. In recent yearsthere has been a trend for governments toenact emergency legislation to close downtax avoidance loopholes. This action hasresulted in a raft of complicated and oftenill-thought out anti-avoidance provisions intax legislation. It is arguable that a GAARcould provide a simplified anti-avoidancemechanism, which would avoid the need forcomplicated emergency legislation.There have been discussions of theGAAR taking a principles-based approach.That has the advantage of beingall-encompassing, but may result incontinuing uncertainty. A more prescriptiveGAAR, although creating greater certaintyfor taxpayers, may not have the desiredeffect of deterring those intent oncircumventing the tax system. Whateverapproach is taken, it is hoped that a GAARwill provide certainty and will not merelybe an additional power enabling HMRC tointimidate taxpayers.SUMMARYRamsay heralded the start of a new approachto the way the courts deal with casesinvolving tax avoidance. Following Ramsay, thecourts have shown a willingness to considerParliament’s intention when determining howtax legislation should be applied.There have been numerous casesinvolving tax avoidance, some withsurprising outcomes, and as a result, theapproach the courts will take is not alwaysclear. The introduction of a GAAR may, it ishoped, increase certainty for taxpayers byproviding a clear framework for tax planning.Outside of the courts, there are numerousconsultation documents on anti-avoidance,and all of these factors make for an uncertainenvironment for those seeking to undertaketax mitigation arrangements.By Sarah Gatley, solicitor,Watson, Farley & Williams LLP .E-mail: sgatley@wfw.com.www.inhouselawyer.co.ukNovember 2011 The In-House Lawyer 7