New general tax avoidance rules: Government guidance provides comfort for some common corporate tax structuring

Pat Dugdale

This year’s Finance Act will include the new general anti-abuse rule (GAAR).  This seeks to counteract tax advantages arising from “abusive” tax arrangements and is expected to come into force in July 2013.  The draft legislation is supplemented by guidance notes which are vital to the understanding of the relatively short and conceptually unfamiliar GAAR legislation, and in particular what is “abusive”. 

The GAAR is intended to restrict arrangements at the extreme and “egregious” end of the tax planning spectrum, so that the mere fact that a transaction is tax-driven will not cause it to fall foul of the GAAR.  The GAAR guidance includes helpful examples of some relatively common corporate transactions which would not generally be caught and these are listed after the description of the GAAR below.

The GAAR will apply to most UK taxes, income tax, capital gains tax, petroleum revenue tax, inheritance tax, stamp duty land tax and the new annual tax on enveloped dwellings.  It will not apply to stamp duty or SDRT, nor to VAT which has its own abuse of law doctrine. It will be extended to apply to National Insurance contributions by separate legislation.

The draft legislation preserves the criticised “double reasonableness” test but seeks to achieve a greater measure of certainty by specifying circumstances to be taken into account in determining what is or is not reasonable. Tax arrangements will be abusive if they are arrangements “the entering into or carrying out of which cannot reasonably be regarded as a reasonable course of action in relation to the relevant tax provisions, having regard to all the circumstances” including:

  • whether the substantive results of the arrangements are consistent with any principles on which those provisions are based and the policy objectives,
  • whether the means of achieving those results involves one or more contrived or abnormal steps, and
  • whether the arrangements are intended to exploit any shortcomings in those provisions.

In particular, tax arrangements may be abusive if income, profits or gains are less, or deductions or losses are greater, for tax purposes than they are for economic purposes or if the arrangements result in a claim for repayment or crediting of tax which has not been paid and is unlikely to be paid.

The rationale behind the double reasonableness test is that there may be scope for differing views on whether a transaction is a reasonable course of action; there may be reasonably-held views for and against the reasonableness of a certain course of action, in which case the GAAR cannot apply even the particular tax inspector or judge dealing with it considers it unreasonable.  

Tax arrangements perceived to be abusive can be counteracted by the making of adjustments (on a just and reasonable basis) to the tax in question or to any other tax to which the GAAR applies. Corresponding amendments can then be made to the tax liabilities of other persons, but only by way of tax relief or reduction.

However, there are some safeguards to prevent over-zealous application of this new weapon in HMRC’s armoury. HMRC must give notice to the taxpayer who then has an opportunity to make representations, followed by referral to the GAAR Advisory Panel which will represent a spread of interests including business people and tax professionals but, crucially, no HMRC representatives. The Panel will consider the arrangements and give one or more opinions (depending on whether the members of the panel have reached a consensus) as to whether the arrangements can reasonably be regarded as a reasonable course of action in relation to the relevant tax provision. The burden of proof is on HMRC which must show that there are abusive tax arrangements and that the counteraction is just and reasonable. HMRC, the courts and tribunals will not be obliged to follow the opinions of the Advisory Panel, but must take them into account together with the published guidance.  The Advisory Panel’s other function will be to revise and amend the guidance from time to time.  It will not publish its opinions in full but will publish summaries of the principles underlying the decisions at periodic intervals.

The draft guidance is helpful, particularly Part D which shows how the tests for abusiveness would be applied in various situations. It confirms that arrangements which have become standard tax or business practice should not be treated as abusive; these include:

  • putting special, arguably artificial, provisions into consideration loan notes to ensure that they qualify as non-QCBs (typically done in order to ensure that the rolled-over gain on the sale of the shares is not taxed if the buyer becomes insolvent and the notes are not repaid);
  • arranging for a loan note to be listed in order to bring it within the Eurobond exemption from withholding tax even though it will not be widely held (Government proposals to restrict the use of the Eurobonds exemption intra-group have been scrapped); and
  • on a return of funds to shareholders, giving choice as to whether the funds come out in capital or income form, e.g. so-called B share schemes.

It is also considered reasonable to take tax into consideration in making commercial decisions; cited examples of reasonable tax planning include:

  • deciding to operate a business through a company rather than a partnership in order to take advantage of lower taxation on retained profits;
  • financing a business largely with debt rather than equity to obtain deductions for interest;
  • selling shares rather than assets to pay less SDLT or other taxes;
  • disclaiming capital allowances in order to preserve reliefs for a later accounting period;
  • deferral of the tax point for a transaction to a new financial year to take advantage of lower tax rates; this can be done by delaying the time at which a contract becomes unconditional, or by use of an option as an interim measure (although it is possible that cross options or artificial conditionality might be regarded as abusive);
  • using intra-group equity funding and loan back to obtain relief for carried forward loan relationship deficits which would otherwise be trapped in a group company; and
  • a borrower deliberately engineering itself within the “late paid interest” rules to avoid the usual accruals basis for interest deductions.

However, there will now be a limit on the extent to which taxpayers can use their ingenuity to reduce their tax bills. The guidance emphasises that even in the case of the examples mentioned above, the introduction of unusual contrived features could be regarded as abusive. For example, while use of non-QCB loan notes is generally acceptable, it would be otherwise if the only reason for their issue was that the seller intended to emigrate and asked for loan notes rather than cash to defer the tax point of his disposal to a time when he was no longer UK resident.