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Defending the indefensible

13 October 2009 / Mike Truman
Issue: 4227 / Categories: Comment & Analysis
It’s time to stop defending artificial pre-packaged avoidance schemes, says MIKE TRUMAN


  • No equity in a taxing statute?
  • Stephen Timms speech emphasises attack on ‘tax cheats’.
  • FA 2009, s 67, preventing use of employment liabilities relief for tax avoidance.
  • Enact the Brightman principles from Ramsay line of cases?

I wasn’t going to be a tax adviser. In February 1977, when I went to law college in Chester, I was going to be a solicitor specialising in criminal law. It was what I had been most interested in during my law degree, and I’d even taken an optional course in the English penal system.

What concerned me most was the well-known moral question of how you defend someone you are sure is guilty. There are good arguments for why such defendants should have proper representation, but it did bother me.

Then, during the solicitors’ finals (as they then were), I studied Revenue Law for the first time, and found it really interesting. Not only that, but it didn’t seem to have the same moral and ethical problems; no one wanted to pay tax, everyone had to, it was up to the government to get the rules right so that people paid what they ought to, there is no equity in a taxing statute. So that’s why I ended up joining the Inland Revenue and then later moving out to private practice.

I don’t believe any longer that there is no equity in a taxing statute, and I’m certain our political lords and masters don’t. The profession needs to come to terms with the fact that tax planning (to use the most neutral term) cannot continue as it has done in recent years, and that we have to decide which areas of it are defensible.

Depending on your point of view, that can either be because you think the dividing line is moral and ethical, or that you take the purely practical point of view that tax planning is under sustained attack and we need to concentrate our defence forces, but either way something has to change.

Tax cheats

The clearest sign of this is a speech that I referred to in last week’s issue, given nearly a month ago by the Financial Secretary to the Treasury, Stephen Timms, to an international conference on tax analysis.

He said that he wanted to set out why he thought that these were particularly ‘interesting times’ to look at tax administration; ‘interesting times’ presumably taking the same menacing meaning as it does in the old Chinese saying about living in them. His introduction continued with this blunt statement:

‘We’re in a different world now, and I want it to become increasingly clear to taxpayers and tax agents that for tax cheats, the game is up.’

That term ‘tax cheats’ looks like a marker, and will probably be a phrase that is used again. It neatly encompasses (and blurs) in the public mind tax evasion and artificial tax avoidance; cheating implies doing something that you are not meant to do, but which you are able to get away with.

It does, however, seem to me to leave scope for non-artificial tax planning, beyond simply claiming reliefs in the way that they were intended to be claimed. The difficulty is deciding the boundaries – where does legitimate planning become illegitimate cheating?

Stephen Timms gives a clear picture of where he thinks the problem lies:

‘[T]here is a minority of tax agents who ... seem to think we play a game with them and their clients. Every budget and pre-budget report we set out measures to improve efficiency and equity in the tax system. They then look for ways to convert them into avoidance schemes. In turn, we point out these are ineffective, or we close them down again at the next legislative opportunity.’

He calls this behaviour ‘corrosive to the business environment’ and leading to ‘mutually assured complexity’ in the tax system. That reference to complexity caused by successive iterations of legislation and loophole discovery is an issue I picked up in the Hardman lecture I gave in 2007, particularly in relation to the case of D’Arcy [2008] STC 1329.

The problem is not just that each new piece of legislation is picked over in an attempt to create avoidance schemes, it is also that each new piece of anti-avoidance legislation creates the possibility of an unintended interaction with another piece of similarly complex legislation to produce (as in that case) an unexpected tax loophole.

Far from solving the problem of artificial tax avoidance, tax complexity actually creates the opportunity for it.


To put the issue in some context, let’s look at one of the anti-avoidance provisions in this year’s Finance Act. Section 67 introduced a targeted anti-avoidance provision denying relief for employee liabilities under ITEPA 2003, s 346 if the payment was part of a tax avoidance scheme.

So how on earth can a payment by an employee arising from a claim that he was personally liable to pay damages because of something that happened in relation to his employment possibly be part of a tax avoidance scheme?

The relief was, after all, originally introduced to protect directors from being taxed on insurance premiums paid to cover them against claims for negligence.

Apparently the scheme went like this. Say you had just received a large bonus, and you did not want to pay tax on it. The scheme provider would set you up with another employment with (let’s say) company A. The only activity company A would carry on is some sort of financial trade involving a couple of transactions; stock lending is the example HMRC gave when it first explained the scheme.

The contract between company A and the counterparty to the financial transaction, company B (which would also be part of the scheme) would provide that if certain aspects of the transaction were not carried out correctly you would personally be liable, as an employee of company A, for a large amount of damages, which would just happen to equal the bonus that you had received from your real employment.

You would then, very deliberately, default on those obligations and become liable to pay the damages. A further entity in the arrangement, C, would then lend you the money to pay them, and you would claim tax relief for having done so.

However, C would never require the repayment of the loan, and since it is simply part of the structure there is no real loss suffered by anyone, least of all you. Presumably the money is either simply passed back from B to C.

Sham transaction

Now I have never asked who was marketing these schemes, so I don’t know who I am about to offend … This is one of the grubbiest, most squalid little bits of cheapskate packaged tax avoidance that I have seen in a long time – only exceeded by the schemes which tried to misuse the relief for transfers of shares to charities by artificially ramping up the prices.

While it may not meet the technical legal definition of a ‘sham’, because I am sure that all the liabilities created would have been legally valid, if you showed it to the hypothetical reasonable taxpayer on the top deck of the 155 to Clapham, he or she would have no hesitation in describing it as such.

There is no real employment, merely a technical one. A relief which was intended for liabilities created by genuine errors is being used for an ‘error’ which was deliberately engineered and intended from the start.

And finally, a relief which is needed for those who have really had to pay out money is now being put at risk by misuse to create a deduction for those who have suffered no loss at all. As Stephen Timms put it:

‘It is right for those who pay their fair share [of tax] to resent – to see, in fact, as morally wrong – the actions of a small minority, who use their resources to create a new set of rules for themselves. Who think they can pay tax on a “do it yourself” basis to rob public services of vital resources.’

The future

So what is the answer? Stephen Timms proposes ‘not just new powers but clearer norms for behaviour too. Not simply rules imposed by government, but commitments embraced – put forward even – by responsible taxpayers’.

The danger in the profession not getting involved in such an agreement of norms is that straightforward tax planning may get swept up in the definition of unacceptable behaviour as well. We need to make the case for the right of taxpayers, given two ways to structure a transaction, to choose the one that results in the lowest tax bill, provided that structure is a genuine one.

The first step in doing that might be to re-establish some basic principles about tax avoidance which have been true for most of my working life in tax. From 1981 to 2004 it was accepted that, if a set of transactions involved money going round in a circle, or if steps were introduced into such a composite transaction with no commercial effect, then they equally had no tax effect.

We are now told that this was merely a way of describing the principle of purposive statutory construction, and applying it to tax. The result is that no one is really sure when a transaction will be caught and when it will not, and a large number of taxpayers are being encouraged to take the risk and see if they can reduce their tax liabilities to almost nothing through the use of such schemes.

So if the principles as set out by Lord Brightman worked pretty well in the past, why not actually enact them now as a form of general anti-avoidance rule (GAAR)?

Because to think that some sort of GAAR isn’t on the way at some time over the next few years seems to me to be similar to thinking that Portsmouth are going to win the Premiership during the same period – it’s not entirely out of the question, but it is highly unlikely.

If we want to preserve the right of taxpayers and their advisers to pursue reputable, non-packaged, tax planning, we need to accept that the writing is on the wall for the aggressive packaged schemes.


Issue: 4227 / Categories: Comment & Analysis
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