Tax Avoidance

1
Tax Avoidance

• SDT A1.118
• Development of judicial attitude
• 1997 - General anti-avoidance rule mooted
• 1999 - Deferred indefinitely
• 2004 - Disclosure of avoidance schemes

2
TAX AVOIDANCE

• Social attitudes (influencing judicial attitudes)
• tax seen more as a social obligation rather than
  confiscation by the state
• scale and sophistication of tax avoidance
• failure of anti avoidance legislation

3
JUDICIAL ATTITUDE - 1949
Tax avoidance is an evil but it would be the
beginning of much greater evils if the Courts
were to overstretch the language of the statute
in order to subject to taxation people of whom
they disapproved Lord Normand
4
JUDICIAL ATTITUDE - 1984
Difficult though the task may be for judges it is
one which is beyond the power of the blunt
instrument of legislation Lord
Scarman Furniss v Dawson
5
The Joint International Tax Shelter Centre is
already rising to the challenges posed by
international tax avoidance in its increasingly
cunning and complex forms. The understanding
gained and exchanged will materially benefit
every taxpayer who prefers to play by the
rules. HMRC Press Release September 2007
6
SCOBLE (1902)

• purchaser of a railway had the option to pay by
  what was called an annuity
• the annuity was in effect the price expressed in
  instalments with interest added
• purchaser deducted income tax from the annuity
  payments - the seller challenged that deduction
• held that capital element did not constitute an
  annuity
• simply by calling something by a certain name in
  a legal document did not change its true nature

7
DUKE OF WESTMINSTER (1935)

• gardeners wages replaced with deeds of covenant
  in order to give tax relief to the Duke
• most of the gardeners were made aware that
  although the legal right to claim wages continued
  they were not expected to exercise it - they
  acknowledged this in writing
• taxpayer won - both the Court of Appeal and House
  of Lords refused to ignore the legal substance of
  the deeds

8
DUKE OF WESTMINSTER

• a typical employee previously earning 60s. per
  week received 38s. under the deed and although
  entitled to draw 60s. wages drew only 22s.
• Lord Atkins dissenting judgement is both
  scathing and powerful
• it is interesting to speculate on how our tax
  system would have developed had Atkin's prevailed

9
LORD ATKIN'S CONCERNS

• in the event of an employees death could his
  estate claim the the wages previously foregone
• what effect would any minimum wage legislation
  have on the new reduced wages
• was not the employee liable to tax on the wages
  voluntarily foregone

10
FLOOR v DAVIS (1978)

• taxpayer and two sons-in-law controlled a company
  (IDM)
• they agreed, subject to contract, to sell to KDI
  (an American company)
• to avoid CGT they firstly sold their shares to
  FNW (specially created) in exchange for an issue
  of pref shares
• FNW then sold the IDM shares to KDI for cash
• FNW issued further shares including some giving
  rights to the majority of its assets on
  liquidation to a Cayman company, D
• FNW went into voluntary liquidation

11
FLOOR v DAVIS

• case decided (against the taxpayer) on various
  technical provisions
• one judge in Court of Appeal (Lord Justice
  Everleigh) would have taxed the transaction on
  the basis that it was a pre-destined composite
  transaction - this dissenting judgement was later
  approved (in Ramsay)
• House of Lords reached their decision on the
  technical arguments - no view expressed on
  composite transactions

12
I see this case as one in which the Court is not
required to consider each step taken in
isolation. It is a question of whether or not the
shares were disposed of to KDI by the taxpayer. I
believe that they were. Furthermore, they were in
reality at the disposal of the original
shareholders until the moment they reached the
hand of KDI, although the legal ownership was in
FNW. I do not think that this conclusion is any
way vitiated by the Commissioners of Inland
Revenue v Duke of Westminster. Lord
Everleigh
13
RAMSAY (1981)

• series of self cancelling transactions designed
  to produce a deductible loss and a non taxable
  gain - loss used to shelter real gain
• held that the courts role was to ascertain the
  legal nature of any transaction for which a tax
  consequence was sought and if there were a series
  of transactions which was designed to operate as
  such then regard would be had to the effect of
  that series
• on that basis the scheme could be treated as
  nullity for tax purposes

14
Each of the appellants purchased a complete
pre-arranged scheme, designed to produce a loss
which would match the gain previously made and
which would be allowable as a deduction for
corporation tax (capital gains tax) purposes. In
these circumstances the court is entitled and
bound to consider the scheme as a
whole Lord Fraser of Tullybelton
15
RAMSAY PRINCIPLE

• there must be a pre-ordained (but not necessarily
  pre-contracted) series of transactions
• that composite transaction may or may not include
  the achievement of a commercial end (eg Ramsay
  did not - Furniss did)
• there must be step(s) inserted which have no
  commercial purpose other than the avoidance (or
  deferral - see Furniss) of tax

16
FURNISS v DAWSON (1984)

• taxpayer owned shares in two companies which were
  about to be sold
• agreement in principle reached to sell the shares
• on advice the taxpayers decided to sell the
  shares firstly to an Isle of Man company
• contracts entered into on the same day for the
  Isle of Man company to buy (in exchange for a
  share issue) and then to sell the shares
• held that capital gains tax was payable
• important extension of Ramsay principle to a tax
  deferral (as opposed to avoidance) scheme

17
In answering the statutory question To whom
was the disposal made? the fact that the shares
were routed through Greenjacket was
irrelevant. Lord Hoffman in Westmoreland,
commenting on Furniss
18
RAMSAY POST FURNISS

• that the arrangements were, at the time the
  intermediate transaction was carried out,
  pre-ordained to produce a given result
• that that transaction had no purpose other than
  tax avoidance (including deferral)
• there was at that time no practical likelihood
  that the pre-ordained transactions would not take
  place (thus meaning that the inserted transaction
  had no independent life)
• the pre-ordained transactions did take place

19
CRAVEN v WHITE (1988)

• Use of Isle of Man company similar to Furniss
• taxpayer won 32 House of Lords
• too much uncertainty about outcome to regard as
  pre-ordained
• different to Furniss (seen as effectively a
  tripartite agreement)
• accepted by the majority judges as close to the
  line

20
IRC v BOWATER DEVELOPMENT

• Split of land between five group companies to
  minimise DLT
• accepted that no purpose other other tax
  avoidance
• sale to anticipated purchaser faltered but
  eventually some 18 months later was concluded
• Commissioners decide that at time of
  fragmentation chances of purchaser being able to
  sign contract were nil
• Ramsay test therefore not met

21
BAYLIS v GREGORY

• Similar facts to Furniss
• no firm purchaser at time of sale to Isle of Man
  company
• eventual sale by Isle of Man company took place
  some 22 months later
• Ramsay test therefore not met

22
COMPOSITE TRANSACTION
"A step in a linear transaction which has no
business purpose apart from the avoidance or
deferment of tax liability will be treated as
forming part of a pre-ordained series of
transactions or of a composite transaction if it
was taken at a time when negotiations or
arrangements for the carrying through as a
continuous process of a subsequent transaction
which actually takes place had reached a stage
when there was no real likelihood that such
subsequent transaction would not take place and
if thereafter such negotiations or arrangements
were carried through to completion without
genuine interruption." Lord Jauncey of
Tullichettle
23
MCGUCKIAN (1997)

• family company had large distributable reserves
• adopted a scheme whereby the shares were sold to
  a non resident trust set up for the benefit of
  the taxpayers and a large dividend was declared
• the trustees sold their right to that dividend to
  a UK company set up by the advisers
• held that following Ramsay the scheme could be
  regarded as a composite transaction and the
  dividend was taxable as if received directly
• there is a suggestion also that Ramsay can be
  used even if specific anti-avoidance legislation
  is in point

24
MCGUCKIAN

• see Lord Steyns judgement for an analysis of the
  development of the judicial approach to tax
  avoidance
• move from literal to purposive
• Duke of Westminster regarded as very narrow -
  allowing taxpayer to rely on literal construction
  regardless of purpose
• tax law left behind
• old step by step approach to avoidance schemes -
  so long as not a sham Courts could not look at
  overall effect

25
STEYN contd

• Ramsay seen as the breakthrough particularly
  Lord Wilberforces judgement
• Courts cannot stand still - if scheme intended to
  be implemented as a whole it should be
  interpreted as such
• the new approach is a matter of statutory
  construction - it is not a question of changing
  or ignoring the statute
• virtually ignores Craven v White (only mentions
  Goffs dissenting judgement)

26
DTE FINANCIAL SERVICES v WILSON

• scheme to avoid NI and defer PAYE on bonus
  payments to directors
• various offshore trust interests were created
  which eventually resulted in an interest in a
  trust being assigned to each director and cash
  being paid to them
• Special Commissioner dismissed the technical
  arguments that the payments fell within PAYE as
  such but accepted that the concept of fiscal
  nullity applied thus making them liable to PAYE

27
DTE

• not disputed that the emoluments were liable to
  Schedule E
• not disputed that there was a NI avoidance and
  PAYE deferral scheme
• Revenue accepted that the arrangements were not a
  sham
• held, following the Ramsay principle, that the
  company should be treated as having made a
  payment direct to the employee to which NI and
  PAYE should have been applied

28
MACNIVEN v WESTMORELAND

• W owned by tax exempt pension scheme
• W did not perform well and had to borrow heavily
  from pension scheme
• large arrears of interest payments
• actual payment required to obtain tax relief in W
• pension scheme lent money to W to enable interest
  payments to be made
• W would have value as a tax loss company
• did Ramsay apply to counteract tax advantage

29
Comment on Hoffmans reasoning
If the legal position is that the tax is
imposed by reference to a legally defined
concept, such as stamp duty payable on a document
which constitutes a conveyance on sale, the court
cannot tax a transaction which uses no such
document on the ground that it achieves the same
economic effect. On the other hand, if the legal
position is that tax is imposed by reference to a
commercial concept, then to have regard to the
business substance of the matter is not to
ignore the legal position but to give effect to
it. Lord Hoffmann held that what Lord
Wilberforce was doing in the Ramsay case was no
more... than to treat the statutory words loss
and disposal as referring to commercial
concepts to which a juristic analysis of the
transaction, treating each step as autonomous and
independent, might not be determinative.
Tax Journal 19/2/2001
30
Where Ramsay works

• Treat a loss arising from complex financially
  self cancelling transactions as not being a loss
  within the CGT legislation Ramsay, Burmah etc
• Regard a disposal from A to B to C as being from
  A to C Furniss v Dawson
• Treat a dividend received from a company as still
  constituting income even where it had been routed
  through an intermediary and relabelled as
  capital McGuckian

31
My Lords, I confess that during the course of
this appeal I have followed the same road to
Damascus as Peter Gibson LJ. Like him, my initial
view, which remained unchanged for some time, was
that a payment comprising a circular flow of cash
between borrower and lender, made for no
commercial purpose other than gaining a tax
advantage, would not constitute payment within
the meaning of s 338. Eventually, I have found
myself compelled to reach the contrary
conclusion. LORD NICHOLLS OF BIRKENHEAD
32
In the present case, WILs obligation to pay the
accrued interest to the trustees was discharged
by satisfaction. Thus, if the Revenue are to
succeed,payment in s 338 must bear some other
meaning. Ultimately, applying in full the
purposive Ramsay approach to interpretation, I
can find no justification for giving payment in s
338 some other meaning. Moreover, I am unable to
see what that other meaning could be. LORD
NICHOLLS OF BIRKENHEAD
33
The key question Could the Courts ignore the
payment on the grounds that it was funded by the
lender who probably would not have lent the
further funds unless it knew that the money would
be immediately returned to it?
34
As is well known, the Ramsay case was concerned
with a tax avoidance scheme designed to
manufacture a capital loss to set off against a
capital gain. The question before the House was
whether a transaction by which the taxpayer
company acquired certain shares for 185,034 and
almost immediately sold them for 9,387, gave
rise to a loss within the meaning of the Act.
Both the acquisition and sale of the shares
formed part of a preplanned series of
transactions by which the alleged loss was
exactly balanced by a gain which was alleged to
fall within an exemption from the charge. The
aggregate effect was that the taxpayer suffered
no loss except the payment of a fee to the
promoters of the scheme. It was not disputed that
the transaction included a genuine purchase and
sale. Hoffman
35
Why the taxpayer won

• The liability giving rise to to the tax deduction
  was a real liability
• the tax deduction was delayed by the requirement
  for payment to be made
• s338 required that payment had been made, not
  that a loss had been incurred although had a loss
  not been incurred the transaction could indeed
  have been attacked!

36
I readily accept that many expressions used in
tax legislation (and not only in tax legislation)
can be construed as referring to commercial
concepts and that the courts are today readier to
give them such a construction than they were
before Ramsay. But that is not always the case.
Taxing statutes often refer to purely legal
concepts. If a transaction falls within the legal
description, it makes no difference that it has
no business purpose. Having a business purpose is
not part of the relevant concept. If the
disregarded steps in Furniss v Dawson had
involved the use of documents of a legal
description which attracted stamp duty, duty
would have been payable. Hoffman
37
Ingram v IRC 1985 STC 835

• Series of transactions designed to reduce stamp
  duty
• Taxpayer argued that stamp duty charged on
  instruments not transactions so court should look
  only at each document in isolation
• Court held that they were entitled to ascertain
  substance of transaction to decide how much duty
  was payable

38
Assignation of right to receive rent for 5
years (for 25m)
Rabobank
JLP (property holding company)
JL (trading company)
Payment of rent (6 x 5m)
39
IRC v John Lewis Properties plc 75 TC 131
JLP was perfectly entitled for the avoidance of
tax to structure its commercial transaction with
the bank so that in place of an income receipt of
rent it received a capital sum. There is no broad
economic equivalence test entitling the court
to treat a capital item as income because it is
the economic equivalent of incomethe transaction
produced in the hands of JLP, in place of an
income stream, an up-front capital sum the price
was not merely (as in McGuckian) the banks
receipt of the rents from the lessees
re-labelled it was a distinct sum paid out of
the resources of the bank under a transaction
which had commercial reality in these
circumstances it is not open to the court to
recharacterise the price as income. LIGHTMAN J.
in the High Court
40
The hallmark of tax avoidance is that the
taxpayer reduces his liability to tax without
incurring the economic consequences that
Parliament intended to be suffered by any
taxpayer qualifying for such reduction in his tax
liability. The hallmark of tax mitigation, on the
other hand, is that the taxpayer takes advantage
of a fiscally attractive option afforded to him
by the tax legislation, and genuinely suffers the
economic consequences that Parliament intended to
be suffered by those taking advantage of the
option. Lord Nolan in CIR v Willoughby 70 TC 57
41
It has been put to me that we should now
introduce a general anti-avoidance rule. I do not
at this stage intend to introduce this but I will
today close loopholes in partnerships, finance
leasing and VAT and make it a requirementas in
the USAthat accountancy firms and those
promoting schemes register them with the Inland
Revenue. Chancellor, 17 March 2004
42
The Inland Revenue and Customs Excise have
begun discussions with the tax administrations of
Australia, Canada and the United States to
establish a joint task force to increase
collaboration and co-ordinate information about
abusive tax transactions. They plan to share
expertise, best practices and experiences within
the framework of the four countries' existing tax
treaties. Representatives of the four
administrations will be meeting in Washington
shortly to finalise plans for this
initiative. 17 March 2004
43
The rules for disclosure of tax avoidance
schemes require promoters and users of certain
tax schemes to notify them to HM Revenue
Customs. They are targeted at tax avoidance
schemes and not at everyday tax planning and
advice. HMRC THE END