Tax avoidance schemes: impact of purposive interpretation of tax laws

At the moment tax avoidance is addressed in three main ways -
(i) Purposive interpretation of tax statutes by the Courts;
(ii) Specific anti-avoidance legislation; and
(iii) Rules requiring the disclosure of tax avoidance schemes.
Purposive interpretation Purposive interpretation of tax statutes is a relatively recent development. The ground-breaking speech of Lord Wilberforce in the Ramsay1 Courts tended to interpret tax statutes in a strict, literalist, manner. As Lord Loreburn LC put it2 -
"But still more important, in the present context, is the special constitutional convention which jealously safeguards the exclusive control exercised by Parliament over both the levying and expenditure of the public revenue. It is trite law that nothing less that clear, express and unambiguous language is effective to levy a tax."
Adding to the difficulty of confronting tax avoidance, which this strict interpretation imposed was another principle which required courts, in the cases where the statutory language was ambiguous, to opt for the interpretation which favours the taxpayer -
"It is quite clear that if in a taxing statute words are reasonably capable of two alternative meanings the Court will prefer the meaning more favourable to the subject".3
The turning point came (but was not immediately recognised as such) with the speech of Lord Wilberforce in Ramsay, where he stated -
"A subject is only to be taxed on clear words, not on the "intendment" or on the "equity" of an act. Any taxing act of Parliament is to be construed in accordance with this principle. What are "clear words" is to be ascertained upon normal principles; these do not confine the Court to literal interpretation. They may, indeed should, be considered the context and scheme of the relevant act as a whole, and its purpose may, indeed should, be regarded....."
This has developed in subsequent cases, and the current approach to the interpretation and application of taxing statutes is succinctly summarised by Ribeiro PJ in the Arrowtown case in the Hong Kong Court of Final Appeal4 in a passage which was explicitly endorsed by the House of Lords in BMBF v Mawson5 -
"The driving principle in the Ramsay line of cases continues to involve a general rule of statutory construction and an unblinkered approach to the analysis of the facts. The ultimate question is whether the relevant statutory provisions, construed purposively, were intended to apply to the transaction, viewed realistically."
By using purposive interpretation, and looking beyond the literal language of the particular provisions to seek the true meaning from their wider context, the Courts have frustrated many attempts to avoid tax which, pre-Ramsay, would have succeeded.
As a general proposition it may be regarded as a very positive development. However, the view of a large number of tax professionals is correct that in some cases the courts, under the guise of purposive interpretation, have been prepared to stretch6 the interpretation of tax legislation in order to thwart tax avoidance schemes which they regard as abusive.
It is still early to determine the value of the Disclosure of Tax Avoidance Scheme (DOTAS) scheme as a whole. However, it is plainly a useful source of information for Revenue. That, of course, has to be weighed against the additional burden which DOTAS places on taxpayers, and the additional complexity which consequential anti-avoidance legislation adds to the already vast body of tax legislation. There will also inevitably be instances where counteracting legislation comes too late to deal with early users of particular schemes: by their nature, these schemes are often complex, and Revenue have to apply a great deal of intellectual effort in determining whether the scheme would be effective under existing rules and, if not, precisely what changes to the rules are needed to deal with them.
There is no doubt that the combination of purposive interpretation, specific anti-avoidance rules and DOTAS substantially reduces the scope for tax avoidance. Accordingly, the UK context is very different from that which was applied in other common law jurisdictions, such as Australia and Canada7, when General Anti-Avoidance Rules, (GAARs) were first introduced there.
The critical question is whether it is effective enough in preventing the sort of tax avoidance schemes which many citizens and taxpayers regard as intolerable. If it is effective enough, this would be so, even though it is possible that a well-designed GAAR could, in time, lead to simpler tax legislation and would reduce the temptation to stretch the interpretation of tax legislation.
Regrettably, however, it is clear that purposive interpretation, specific anti-avoidance rules and DOTAS are not capable of dealing with some of the most egregious tax avoidance schemes. Such schemes focus on prescriptive tax rules, which are not susceptible to contextual interpretation. A recent example is the "SHIPS 2"8 scheme, which gave UK taxpayers a seven step route to creating an artificial tax loss, which could be used to set off against their other tax liabilities. In the High Court Proudman J sympathised "with the instinctive reaction that such an obvious scheme ought not to succeed"9. However given the prescriptive nature of the statutory rules in question she was unable to find a purposive interpretation sufficient to defeat it.
The Court of Appeal10 reached the same conclusion. In the present context it is particularly pertinent to note the comments of Thomas LJ and Toulson LJ. Thomas LJ11 said.
"I agree with the judgement of Mummery LJ which sets out with great clarity why the appeal and cross appeal have to be dismissed. However, for the reasons given by Toulson LJ, my concurrence is reluctant. The higher-rate taxpayers with large earnings or significant investment income, who have taken advantage of the scheme have received benefits that cannot possibly have been intended and which must be paid for by other taxpayers. It must be for the parliament to consider the wider implications of the decision as it relates to the way in which revenue legislation is structured and drafted."
Toulson LJ12 said - "I also agree. On the corresponding deficiency issue, I add a brief summary to explain the reason for my reluctant concurrence in a result which instinctively seems wrong, because it bears no relation to commercial reality and results in a windfall which the parliament cannot have foreseen or intended."
Many would like to agree with Thomas LJ that it would be appropriate for the parliament to consider the implications of that decision. SHIPS 2 shows the inadequacy of the existing means of combating highly artificial tax avoidance schemes.
1. Ramsay v IRC [1982] AC 300 at 323.
2. Vickers Sons & Maxim Ltd v Evans [1910] AC 444 at 445.
3. Salmon LJ in Fleming v Associated Newspapers [1971] 44 TC 382 at 398.
4. Collector of Stamp Revenue v Arrowtown Assets Ltd (2004) 6 ITLC 454.
5. [2004] UKHL 51, [2005] IAC 684, paragraph 33.
6. "Stretching" statutory language in this context has been recognised in the recent Supreme Court judgement in HMRC v DCC Holdings [2010] UKSC 58. Lord Walker, delivering the judgement of the Court, at paragraph 25 noted - "argument has focused, in particular, on whether and how far the words in section 84(1) [FA 1996]....can be stretched (or need to be stretched) in order to avoid the absurd result of....".
7. The Canadian GAAR was introduced in 1987 in response to the Stubart case, where the Supreme Court rejected the general application of a business purpose test (which some saw as emanating from Ramsay) . Likewise the Australian GAAR was introduced against a background of highly literalist interpretation of tax statutes.
8. Mayes v HMRC [2011] EWCA Civ 407.
9. [2010] EWHC 2443 (CH), [2010] STC 1, paragraph 45.
10. The judgement of the Court of Appeal is final. Permission to appeal to the Supreme Court was refused on 1st November 2011. 11. (at paragraph 100) 12. (at paragraph 101)
(The writer is an advocate and is currently working as an associate with Azim-ud-Din Law Associates)