UK: The World According To GAAR

Last Updated: 29 May 2012
Article by James Quarmby

Last month's Tax Engine was, even by my standards, a little bit of a rant. I'm normally only that bad after a particularly tiring martini or after a slow, frustrating drive though country lanes stuck behind a tractor or a Nissan Micra. Actually, I don't mind the tractors so much as at least they have a job to do, whereas the problem with Micra drivers is that they have nothing to do, which is why they drive so pathetically. Anyway, this month's Tax Engine is straight down to business - no funny business, no chit-chat and no Nissan Micras.

So, the august body charged with investigating a General Anti Avoidance Rule (GAAR) has reported its findings. Graham Aaronson QC says, helpfully, in his introduction that 'a broad spectrum general anti-avoidance rule would not be beneficial for the UK tax system'. He correctly identifies the many good reasons why such an approach would be harmful. He has, instead, opted for what he calls a 'moderate rule' with all sorts of safeguards to protect us from the dangers he identifies from a 'broad spectrum' approach.

So far, so reasonable. But, when I look at the draft legislation he has proposed, the problem is, it's difficult to see much evidence of a moderate approach. It all looks horribly broad.

The details

The rule will only cover income tax, CGT, corporation tax and petroleum revenue tax. It will also apply to subordinate legislation and, crucially (in my view), double tax treaties. It's interesting that it does not include inheritance tax.

The scope

The rule will only apply to 'abnormal arrangements' which would achieve an 'abusive tax result'. On first reading, this sounds entirely reasonable – until you start examining these definitions further.

Abusive tax result

This is hilariously widely drafted. Essentially it is a tax advantage which is neither 'reasonable tax planning' nor an 'arrangement without tax intent'. Forget the latter – anyone who seeks tax advice of any kind will not be able to rely on that protection.

Reasonable tax planning

This is one of the 'safeguards' and is defined as a 'reasonable exercise of choices of conduct afforded by provisions of the Acts'. There is no further definition and the guidance notes show just how limited this safeguard actually is. An example given in the notes of a reasonable choice is a decision as to whether to capitalise a company by way of loan or share capital. It's easy to see therefore just how narrow those 'reasonable choices' are meant to be. I have more to say on choices later on.

Abnormal arrangements

There is at least a reasonable attempt to define abnormal in this context. Basically, it is an arrangement which is only entered into for tax planning purposes and which carries one or more 'features'. The umbrella definition of an 'abnormal feature' is one which is designed to avoid or exploit particular provisions of the Acts, or indeed to exploit inconsistencies or shortcomings in the Acts. There then follows a list of features which may be considered abnormal.

The problem is that the list of features is very wide and will catch virtually any tax planning device, other than the simple 'choices' referred to above. For instance, one of the features is the inclusion of a person, transaction or document which would not be included were it not for the tax planning motive. Any experienced tax planning professional will tell you that most tax planning involves the inclusion of a person, document or transaction! If it did not then there is little reason for clients to come to us in the first place. Another feature is the location of an asset, place of residence of a person which would not be so located were it not for the tax planning motive.

I want to give a simple example here: Mr A is a resident non-domiciled person. He wishes to acquire and hold UK investment properties. He is advised to fund an offshore trust, which in turn capitalises an offshore company which then purchases the UK properties. Due to the way in which our current legislation works, any gains made on the disposal of that land will escape UK CGT unless and until a benefit is paid to the Mr A (or any other beneficiaries) in the UK. Is this reasonable tax planning? I would argue yes, but let's look at the features. Here we have the inclusion of transactions and persons which aren't actually 'necessary' - Mr A could just acquire the land directly but instead he creates a complicated trust and an offshore company structure. He also decided to locate those entities in Jersey. That's two factors satisfied already and you only need one for it to be abusive. Since the objective is to avoid CGT we also have an abusive tax result. So, this transaction is caught if the purpose of the transaction is to avoid or exploit the application of the Acts. We would argue that the taxpayer is simply charting a sensible course through our complex tax legislation to achieve a lower tax burden. After all, there is specific legislation dealing with the taxation of beneficiaries of offshore trusts, so this is not a scenario that parliament didn't anticipate. Would HMRC agree with this? One would hope that it would, given the purported aims of the Report. But would this answer change if Mr A bolted on a bit of income tax planning? What if the trust lent funds down to the company at market interest rates? The company lets out the property, claiming the interest as a deduction against its rental profits. Here we have an additional feature - again only created in order to obtain a tax advantage and one which would 'result in deductions being taken into account for tax purposes which are significantly greater that the true economic cost or loss'.

In this example, there is no true borrowing cost, yet we are getting a deduction. This is surely 'abusive' and it seems to fall squarely within the motive test and thus represents an abnormal feature. I'm on a roll here. The property is subsequently sold a few years later, giving rise to a massive capital gain. The gain is subsequently 'washed out' by making a distribution offshore to Mr A of an amount equal to the gain. He keeps that money offshore but the trustees in the next tax year make substantial distributions to his children in the UK. The children escape a charge to CGT because of the distribution we manufactured in the previous tax year. Is this 'abusive'? - according to the rules yes. Does it 'exploit' the application of the Acts? We say no, but what does HMRC think?

The draughtsmen of this rule will have you believe that they only wish to catch highly artificial and abusive tax planning schemes and yet when you read the rules it is clear that the net is cast much wider than that. The high-minded ideals in the GAAR report will swiftly be forgotten by HMRC Inspectors when they have this powerful legislation in front of them.

Procedural issues

In an attempt to prevent HMRC from having too much power, the GAAR cannot be used unless it follows the correct procedure. However, this just means that HMRC has to make a case to the Advisory Panel demonstrating why it believes, on the balance of probabilities, that the arrangement is an abusive one. The Advisory Panel is supposed to be an independent body and the burden of proof is on HMRC.

But worries have already been expressed about the concept of an Advisory Panel. This is not a judicial body - it's a sort of 'star chamber', one member of which will be an HMRC employee! I have to ask - what is the point of having a system of complex tax laws and courts to interpret and uphold those laws if we are simply going to usurp them with an un-elected panel of 'advisors' who operate beyond our rules of evidence and procedure? This is arguably a serious erosion of our civil liberties and one which is most unwelcome.


In short, there won't be any. This means that all taxpayers will live in a twilight zone, unsure if their tax planning will, at some point, be leapt upon and torn apart by HMRC . Furthermore, given the unsatisfactory way in which HMRC (over)use their investigative powers, taxpayers will not even have the comfort of knowing that once the enquiry window into a return has passed that they will be safe. HMRC are quite adept at alleging negligence on the part of a taxpayer in order to re-open old years of assessment. If taxpayers wish to avoid this fate then I suspect they will have to guess which transactions may be caught by the GAAR and then specifically point out to HMRC on the return what those transactional are and why they may be caught. Otherwise, HMRC will not be barred from using its powers of discovery to open up old tax returns.


Many of my colleagues in the tax profession have cautiously welcomed these proposals, some have even praised them. Maybe they were reading a different report to mine. All I see is an erosion of taxpayer's rights - legislation which can and probably will be used by HMRC to hound taxpayers who have been clever enough to find a way through our ridiculously complex tax legislation. This is not a report to be welcomed - it must be torn up into a thousand pieces and burnt. The ashes should then be put into a decorative urn and, once a year, there should be a cricket match between HMRC and the Chartered Institute of Taxation. The winner gets to hold the urn for a year. I think you will agree an entirely unique idea without compare.

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