UK: General Anti-Avoidance Rule - A New Dawn for Tax Planning?

Last Updated: 22 March 1999
Following the Chancellor of the Exchequer's proposal in the July 1997 Budget to introduce a general anti-avoidance rule ("GAAR") into UK tax legislation, the Inland Revenue published a consultative document on 5 October 1998 giving details of how the Government considers a GAAR would operate. The Chancellor has further announced in the November 1998 Pre-Budget Statement that appropriate legislation to enact the GAAR could be set out in the Finance Bill next year.

In addition to any political benefit gained by the Government in being seen to be tough on tax avoidance, the introduction of a GAAR should satisfy senior officials at Somerset House who have been frustrated by the inventiveness of the tax profession in detecting and utilising tax loopholes, sometimes through implementing complex and artificial tax avoidance schemes. The introduction of a GAAR could enable the Inland Revenue to challenge tax avoidance schemes without the uncertainty of litigating against tax driven transactions through the courts.

The consultative document proposes that the GAAR at first will apply only to direct taxation of companies. Customs & Excise are seeking to combat VAT avoidance through the introduction of a series of specifically targeted mini-GAARs to combat tax avoidance in particular business areas. The draft of the first Customs mini-GAAR, targeting VAT avoidance in the construction industry, was published on 20 January 1999 and incorporates many of the features of the direct tax GAAR.

The purpose of the GAAR is expressed as deterring and counteracting tax avoidance, which is widely defined as including not paying tax, paying less tax or paying tax later than would otherwise be the case. The burden is placed on the Inland Revenue to establish that the sole or main purpose of a transaction, or one of its main purposes, is tax avoidance by a company. As only one of the main purposes of a transaction needs to be tax avoidance, many commercial transactions structured in a tax efficient manner could be caught by the proposed GAAR.

Once the Inland Revenue have established that a transaction is caught, it is left to the taxpayer company to demonstrate that the transaction represents "acceptable tax planning" - namely a transaction which exploits tax benefits in a manner envisaged in tax law, or which falls within one of the safe havens established by existing anti-avoidance legislation.

The consultative document proposes that a list of acceptable transactions will be published. While these general clearances would assist in structuring tax planning, they would also provide the Inland Revenue with a powerful weapon if they wished to "black ball" a tax avoidance scheme without the need to litigate against future users of the scheme or publishing specific anti-avoidance legislation.

If a company cannot show that a transaction falls within the scope of "acceptable tax planning" the draft rules propose that the Inland Revenue should have the power to re-characterise the transaction. If the transaction has legitimate commercial purposes, the Inland Revenue would be able to tax in accordance with the "corresponding normal transaction", namely the transaction which would have been carried out if the transaction had not been tax driven. Where no normal transaction exists, the transaction would be disregarded for tax purposes, although this does not preclude the taxation of any enduring legal consequences generated by the transaction which actually occurred.

The consultative document proposes that the GAAR will be introduced in tandem with a system to enable companies to obtain advance clearances for transactions. Companies will be able to reduce any commercial uncertainty by clearing in advance with the Inland Revenue any transactions where tax mitigation is a major consideration. A key concern is that the Inland Revenue's current resources may be inadequate to support the proposed clearance procedure with the result being a backlog of applications which could render the GAAR unworkable in practice. Paradoxically, a clearance procedure may also make it more difficult to insist upon complex indemnities which pass the tax risk of a transaction. If the party being asked to give the indemnity could insist instead on a clearance being obtained, it will be in a strong position to refuse to give the indemnity if the other party is not prepared to risk making a clearance application.

While the consultative document proposes the provision of a powerful weapon to the Inland Revenue to counter tax avoidance, doubts remain whether the enactment of the GAAR is essential. Companies and their advisers are accustomed to the introduction of specific anti-avoidance legislation to counter perceived tax abuses, and, over the course of the 1990s, the UK's tax regimes for corporate debt and financial instruments have been overhauled in an attempt to eliminate tax asymmetries. With the Courts proving hostile to artificial tax avoidance schemes, the balance in the tax avoidance battle appears to have swung in favour of the Inland Revenue. In this environment, while the GAAR, if enacted, could deter the implementation of artificial tax avoidance schemes, it may be at an unacceptable cost of uncertainty for the majority of companies undertaking legitimate tax planning in commercial transactions.

For further information please contact Adam Blakemore, e-mail: Click Contact Link , 2 Park Lane, Leeds LS3 1ES, UK, Tel: +44 113 284 7000

This article was first published in the Spring 1999 Hammond Suddards Tax Newsletter Update

The information and opinions contained in this article are provided by Hammond Suddards. They should not be applied to any particular set of facts without appropriate legal or other professional advice.

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