The proposal has prompted considerable debate; if you consider recent UK tax cases, would the application of a GAAR have resulted in a different decision? And what light is shed by those cases on the operation of a GAAR? To what extent would a taxpayer (if a GAAR is introduced) be, in the often quoted words of Lord Tomlin in Duke of Westminster v Commissioners of Inland Revenue [1936] AC 1: "..entitled, if he can, to order his affairs so that the tax attaching under the appropriate Acts is less than it otherwise would be…."?
The meaning of "reasonable tax planning"
The much anticipated report of Graham Aaronson QC and his study group on a potential GAAR for the UK tax system was published on November 21 2011. The report recommended the introduction of a "moderate" GAAR as an overriding statutory principle, which does not apply to responsible tax planning and is targeted at abusive arrangements.
In the financial climate now such a sentiment will be seen by many to be laudable and indeed necessary to bridge the tax gap. However, difficulties arise in attempting to identify the "egregious" arrangements from the centre ground of responsible tax planning. The report was accompanied by draft legislation and guidance notes which seek to achieve this unenviable task.
The draft legislation counteracts "abnormal arrangements" which, but for the GAAR, "would achieve an abusive tax result….and which are contrived to achieve such a result". Responsible tax planning is safeguarded by excluding arrangements which "can reasonably be regarded as a reasonable exercise of choices of conduct afforded by the [tax legislation]". To this extent it would seem that the Westminster principle survives the GAAR in a diluted form , that is, a taxpayer is entitled to order his affairs as he sees fit to minimise his tax liability provided such ordering is "reasonable".
This aspect of the draft legislation and guidance notes has attracted much comment and criticism. The report itself acknowledges the difficulty in determining where to draw the boundaries of reasonable tax planning. The report tries to mitigate any inherent uncertainty by placing the burden of proof on HM Revenue and Customs (HMRC) and establishing an advisory panel to assist HMRC. However, the absence of a specific clearance system has drawn significant criticism.
In practice
The real remit of the GAAR can only truly be considered in context. Indeed, the report proposes that the advisory panel's conclusions in each case are published (anonymised) to enable taxpayers and HMRC to "calibrate their understanding of where the dividing line falls between responsible tax planning and abusive tax schemes".
The report itself does not include examples of arrangements which are to be considered as "reasonable tax planning" or "egregious" arrangements. However, the report does refer to the deficiencies of the arsenal of mechanisms for targeting tax avoidance by reference to the SHIPS 2 scheme in Mayes v HMRC [2011] EWCA Civ 407 which the courts had felt unable to defeat. The SHIPS 2 scheme enabled UK taxpayers, through a seven step route, to create an artificial tax loss to offset other tax liabilities. The recommendations of the report appear, at least in part, motivated by this decision; accordingly, it is likely that the SHIPS 2 scheme would be likely classified as an "egregious" arrangement subject to counteraction. But what of other recent decisions? Would they have been decided differently had the GAAR been on the statute books?
Lloyds TSB Equipment Leasing (No1) Ltd v HMRC [2012] UKFTT 47 (TC) was a recent decision of the UK First Tier Tribunal (Tax Chamber) concerning the now-repealed overseas leasing rules. For the taxpayer to succeed in its claim for capital allowances (tax depreciation) on the cost of two ships, it had to establish that the ships were being used for a "qualifying purpose".
The ships would be used for a "qualifying purpose" if (relevantly) the ships were being let on time-charter in the course of a trade by a UK taxpayer and the main object (or one of the main objects) of the time chartering (or any related transaction) was not the obtaining of capital allowances.
The taxpayer acquired two ships and granted a finance lease of each ship to a joint venture company. The joint venture company, in turn, granted a bareboat charterparty of each ship to a UK company within the K-Line group of companies (K-Euro). Pursuant to certain time charters, K-Euro then made the ships available to non-UK end-users.
HMRC denied the taxpayer's claim to capital allowances on the basis that the ships were not being used for a "qualifying purpose" - that is, the grant of the bareboat charterparties and the time charters via the interposed K-Euro were transactions entered into with the main object of obtaining capital allowances.
The tribunal held that it was not fatal to the taxpayer's claim to capital allowances that it had taken steps to ensure or bolster the likelihood of obtaining those allowances, including taking extensive tax advice on the matter (which the tribunal characterised as due diligence). The tribunal acknowledged most taxpayers will have a range of different objectives when entering into any transaction, and considered that in making its determination of which are main objectives a key, or the key, factor is the commercial basis or justification for entering into those transactions. The tribunal considered that this would assist in throwing light on what the true objectives are and what their relative significance is.
The tribunal considered that K-Euro's participation was to pursue commercial objectives - that is, the acquisition of two ships, financed in a cost-effective manner (the cost of finance being reduced by the capital allowances taken elsewhere). The tribunal quoted Lord Upjohn in Commissioners of Inland Revenue v. Brebner [1967] AC 18:
"No commercial man in his senses is going to carry out a commercial transaction except upon the footing of paying the smallest amount of tax that he can."
Accordingly, the tribunal did not consider the objective of obtaining capital allowances as a main objective of the transactions for letting the ships on charter; the Tribunal instead saw the commercial objective as paramount. A triumph of logic and common sense.
Determining what reasonable is
The report acknowledges as the Tribunal did in Lloyds, that the UK tax rules offer, and indeed in many cases positively encourage (such as is the case in the context of capital allowances), the opportunity for taxpayers to reduce their tax liabilities. This, the report stated, is clearly not something to be criticised or counteracted by a GAAR (presumably in the absence of abnormal features).
This would seem to be an indication, that structuring a commercial transaction to obtain the benefit of capital allowances would not automatically constitute an "abusive tax result" - which, though encouraging, still begs the question as to whether the arrangements in Lloyds would reasonably constitute "reasonable tax planning"?
On the basis of the Tribunal's findings that the transactions in Lloyds were principally motivated by commercial objectives, these arrangements should also be regarded as a "reasonable exercise of choices of conduct". This can be contrasted with the circumstances of Mayes which lacked a commercial objective other than the securing of an artificial tax loss and would seem to rightly fall on the side of "egregious" arrangements as a purely tax driven transaction.
Simon Gough (simon.gough@dlapiper.com) is a partner and Kelly Lovegrove (kelly.lovegrove@dlapiper.com) is an associate in the London office of DLA Piper