Anti Avoidance Rules - IBFD Your Portal to Cross Border … · 2015-06-30 · • Freedom of...

Victoria Falls, Zambia, 18-19 June 2015

Anti Avoidance Rules

Prof. Johann Hattingh

Faculty of Law, University of Cape Town

South Africa

‘All taxation is in the long run voluntary’

Attributed to W.E. Gladstone

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Overview

• Tax avoidance defined

• Tax avoidance & morals

• Why does tax avoidance happen?

• How is tax avoidance addressed?

• The international aspect of tax avoidance

• What is different about tax avoidance in developing

countries?

• The future

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Tax Avoidance defined

• Tax Evasion distinguished: Generally involves

fraud and deceit, e.g.

• Falsification of returns, books and accounts used to

establish tax liability;

• Deliberate conclusion of sham transactions to evade tax

otherwise chargeable on the actual transaction;

• Deliberate non-disclosure of taxable income;

• Deliberate overstatement of tax deductible expenditure.

• Tax Evasion is illegal by virtue of common or civil

law

• No necessity for legislation to outlaw evasion; fraud is

illegal.

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• Tax evasion is not always the same as illicit

financial flows: • Smuggling, money laundering, bribes, illegal trades (drugs,

gambling), etc., not primarily undertaken to evade tax, but may

involve tax evasion.

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• The concept of ‘tax avoidance’

• If the rule of law is strictly followed, then ‘avoiding’ tax is

not possible:

• If tax legislation is clear, then a transaction either results in a tax

liability or not;

• ‘Avoiding’ tax that is clearly chargeable is therefore illogical.

• But the assumptions for this argument tend to be invalid:

• Tax legislation is notoriously susceptible to different

interpretations, and therefore doubt arises about the exact tax

results of a transaction; and/or

• Freedom of contract enables a choice in the legal form of a

transaction or an entity.

• Tax avoidance connotes strategies that use these two

aspects.

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• Tax avoidance is lawfully enabled because:

(1) Taxpayers have been entitled to follow the

least onerous interpretation of ambiguous tax

legislation since ancient time (Romanist origins)

• Penal law is to be constructed contra fiscum.

(2) Taxpayers exercise freedom of contract and

commerce to opt for legally permissible

arrangement of affairs; can take into account

which option is most cost effective, incl. the least

onerous tax burden.

• Key tenant of free market system;

• Deeply rooted in the fiduciary duty of the bonus pater

familias.

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• Tax avoidance is lawfully enabled because:

(3) Governments design tax laws that offer a

lower tax burden to taxpayers in defined

circumstances: • Use of tax incentives often labelled as ‘permissible tax

planning’;

• But: in essence involves enticing taxpayers to exercise their

freedom of contract and commerce in a certain way to fall

within the defined circumstances, thus cause and motive no

different from tax avoidance in (2) above.

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Tax Avoidance & Morals

• Tax avoidance has in recent times been

presented as involving notions of morality:

• ‘impermissible tax avoidance’

• South African GAAR – SARS: ‘arrangements that fall in the

category between tax evasion, on the one hand, and legitimate

tax-planning, on the other’.

• ‘Legitimate’ tax planning? Suggests that only tax avoidance

expressly allowed by the legislation is acceptable, e.g. planning

affairs to make use of a tax incentive. Untested in courts.

• Illogical premise: Presumes there is a clearly definable and

extra-legal moral restriction on freedom of contract and

commerce.

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Tax Avoidance & Morals

• Tax avoidance has in recent times been

presented as involving notions of morality:

• ‘impermissible’ tax avoidance = moral judgement

required: Tax morality?

• What does religious / philosophical notions got to do with law?

• Ancient link between nature of tax and moral duty towards a

community, e.g. ‘tithes and offerings’.

• Problematic in modern secular nation State.

• Who’s value system determines ‘good’ or ‘bad’ taxpayer

behaviour? I.e. whether or how much must be ‘given’

(volunteered)?

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Why does Tax Avoidance happen?

What in human nature causes the urge to avoid

tax? Examples from letters to the editor of The

Times and debates in SA Parliament.

• Arguments concerning the redistributive nature

of income tax:

• ‘Bad to teach the people that they had only got to go

to the rich man’, ‘[it will] tempt him to say what is not

true’.

• Large majority of less wealthy taxpayers (or non

payers) benefit from taxation paid predominantly by

small minority of very rich.

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• On the divide between taxation and confiscation

by the State:

‘An increase in taxes or new taxes should always

involve the principle of consent by taxpayers. Taxation

imposed without consent is tyranny.’

• Gladstonian wisdom ‘All taxation is in the long run

voluntary’ – i.e. human ingenuity will always devise

lawful relief from the suffering of privation (injustice).

But:

• Does the above justify a man who thinks himself over-

taxed becoming judge in own case?

• What about the burden of indirect tax on the poor? No

legal avoidance mechanisms to escape the excise on

a pint or on tobacco?

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• Expenditure side argument: ‘Deficits ought to be met by economy of expenditure

before raising taxes.’

• ‘not a penny more, not a penny less’ ‘Every man can do anything that the law allows to

lighten the burden of taxes so long as he acts openly

and conforms to the law’.

• Formalistic attitude of courts enable legal tax

avoidance, e.g. respect for closely held companies as

separate legal persons, allowing trusts to be used for

non-familial and charity purposes.

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• ‘spirit of the law’ arguments: ‘Parliaments often fail to express the written law with

sufficient accuracy or completeness […]

Thus, the opportunity for legal tax avoidance proceeds

from this divergence between Parliamentary intent [the

spirit of the law] and written law.’

• Based on populist view of ‘law’, namely that ‘law is the

will of the people as expressed in Parliament’.

• Even if this was true, what are the method to establish

the ‘intention of Parliament’ as far as complex tax laws

are concerned?

• Modern tax legislation drafted by technicians, very

often not worked on by politicians. SA courts

nowadays reject reliance on Parliament’s intention

(because it can’t be determined with accuracy).

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• Opportunism:

‘Vast deal of ingenuity in the legal and accounting

profession ought to be forced to find exercise in modes

more profitable to society’

• Overt claims about morality and tax:

‘A prudent man will take care of his property, including

making sure it bears the smallest burden of taxation’.

‘The good citizen will bear his fair share of tax; and he

looks to Parliament to see that he does not also have to

bear the share of the “prudent man” ’.

‘Parliament must protect the honest taxpayer against the

clever.’

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• Overt claims about morality and tax:

‘It is dishonourable for the legal/accounting profession to

lend their skill to the tax dodger.’

‘The ordinary citizen can’t assess his/her tax

responsibility because the income tax legislation is

technical and obscure… the Revenue takes full

advantage of this harsh technical structure… why

should a taxpayer feel ‘ashamed’ to instruct an advisor

to also take full advantage?’

‘In the ultimate resort taxation cannot be effectively

levied except by the consent of those sought to be

taxed’

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• Overt claims about morality and tax

‘The taxpayer’s impulse to resort to tax avoidance arises

not from the desire to inflict injustice on his fellow

taxpayer, but from the conviction that he himself is the

victim of injustice committed by the State.’

Do these cover/overt moral arguments provide a

reliable framework for determining tax liability?

Is anyone seriously suggesting that Parliaments

should lay down moral codes according to which

taxpayers (and their advisors) ought to behave?

Is reforming the law not a better option?

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How is Tax Avoidance addressed?

Legislative options in a domestic setting

• The ideal solution is that all tax law should be clear,

administrators have no discretion in applying this law

(perfect separation of powers), interpreters of legislation all

follow theoretically responsible methods to apply the

legislation:

• Outcome: No need for GAAR or SAARs.

• Prerequisites: Coherent modern legislation (object/purpose clear),

highly trained civil servants, tax professionals and tax judges in legal

methods for interpretation of legislation, its principles and theories of

taxation; homogenous legal culture.

• But this is unrealistic at the most basic level: South Africa, for

instance, uses armies of drafters over time, from different legal

cultures, drafts legislation without clear object/purpose, changes the

legislation annually, so technical and complex that principle of

income tax becomes emasculated.

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• Imperfect solution: Breach separation of power.

• Parliaments are imperfect and fail to express law accurately and

completely.

• Therefore requires that discretion be given to civil servants to correct

inadequate expression of principled tax legislation:

• GAAR: affords administrators the greatest degree of discretion,

uncertain for taxpayers, open to abuse (extortion from taxpayers,

especially if tax courts are weak).

• SAARs: less use of discretion, more mechanical, can either hit or

miss the mischief, or be overbroad with unintended

consequences.

• Both leads to complexity in law, uncertainty for taxpayers and

requires significant auditing capacity by administrators.

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• Fall-back solution: Use of common / civil law doctrines that

unmask legal fraud

• The strength of the common/civil law is that it finds expression in

terms of broad principles – not confined by the reach of words in a

statute.

• Requires legally trained tax administrators, especially tax auditors

who tend by nature not to be legal professionals.

• Some examples from South Africa: • ‘Legal substance’ recognised and not deterred by ‘mere nomenclature’; known as

transactions in fraudem legis, simulated or ‘sham’ transactions (common intention by

parties to disguise the real nature so as to escape the provisions of legislation).

• Test for a sham: ‘The Court must be satisfied that there is a real intention, definitely

ascertainable, which differs from the simulated intention.’ (Zandberg 1910)

• ‘The test should thus go further, and require an examination of the commercial sense

of the transaction: of its real substance and purpose.’ (NWK 2011)

• Used far more successfully by SARS than GAAR to combat tax avoidance.

• Doctrine of ‘economic substance’ instead of legal substance not (yet) known (e.g.

contra the USA or New Zealand).

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• Prerequisites for the use of common / civil law

• Legally training civil servants, auditing staff and

professionals; requires knowledge of law of evidence.

• Properly resourced and trained tax tribunals - unlikely

to settle outside court due to admission of fraud

(easier to admit to avoidance).

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The International Aspect of Tax Avoidance

• Occurs at several levels:

• Enabled by tax treaties themselves (purely at the

international level).

• Enabled by differences between domestic regimes

applicable to the same transaction.

• Enabled by tax incentive regimes reserved for non-

residents of a particular jurisdictions.

• What may be done at each level?

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(A) Tax treaty use (or for some ‘abuse’):

• ‘Abuse’ an amorphous concept.

• International law as a source for anti-abuse doctrine

(fraus conventiones)

• Poorly develop and not universally recognised.

• Tax treaty provisions:

• SAAR: Subject to tax clauses, beneficial owner requirement,

limitation on benefits.

• Reserve application of domestic GAAR expressly in a tax treaty

• Only basis accepted by courts in Canada.

• Application of domestic GAAR to a tax treaty?

• Fraught with difficulty: Some domestic courts refuse to apply

GAAR to tax treaties (Netherlands).

• Design domestic GAAR to include international aspect

• 2015 change to Australian GAAR; triggered if ‘foreign tax

benefit’ enjoyed. 23


(A) Tax treaty use (‘abuse’):

• Courts should be inclined to apply common / civil law

doctrines regarding simulated transactions even where a

tax treaty applies because the doctrines unmask fraud.

Tax treaties never meant to allow fraud to persist.

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(B) Mismatches between domestic tax regimes

• Neutralise tax arbitrage by domestic matching rules

• E.g. hybrid mismatches, secondary rules developed under

BEPS.

• Will remain a perennial problem because

• No universal income tax base.

• Tax policy change is uncoordinated, and new (competing) tax

incentives enacted all the time.

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(C) Tax incentives reserved exclusively for non-

residents (‘aggressive tax competition’):

• Sovereignty at stake:

• There is no legal sanction to penalise a country for exercising

freedom to design its own tax system as its pleases.

• The only avenue is political / peer pressure mechanisms (e.g.

OECD peer reviews).

• Domestic solutions:

• Can penalise own residents for helping themselves to tax

incentives offered by a foreign sovereign.

• Examples: Punitive WHT; black list approach (harsh CFC rules,

e.g. Italy). Tend to be crude solution.

• Can choose to compete, e.g. Mauritius vs. South African

headquarter regimes: SA allows treaty shopping into

Africa with less substance required than in comparable

circumstances in Mauritius!

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What is different about tax avoidance in developing countries?

• Different levels of development in Africa, from

G20 members to poorest countries in the world,

meaning:

• Varying degrees of intensity in tax avoidance – dearth

of quantitative studies.

• Varying degrees of sophistication in avoidance

strategies.

• E.g. large financial industry in SA – some of the most complex

avoidance schemes in the world exposed, found only in USA,

UK and Australia. Replication in less develop economies

impossible due to absence of advanced financial markets.

• Capacity to address varies greatly (legislation, tax

administration & judiciary).

• But overall: less developed countries perhaps most

exposed due to capacity gap. 27

What is different about tax avoidance in developing countries?

Despite differences, two areas that impact choice of

means to address tax avoidance in developing

countries: Corruption and weak tax courts.

• Which suggests:

• Steer clear of GAARs, they entail the exercise of too much

discretion by tax officials.

• Always possible to fall back on common/civil law doctrines of substance

or abuse (generally better understood by judges).

• OECD’s BEPS ‘principal purpose test’ for tax treaties a bad idea. Should

rather explicitly reserve in tax treaties the existing domestic mechanisms

used to address tax avoidance.

• Make use of SAARs, complex but complex world of global

trade, as are the reasons for tax avoidance:

• OECD now for the first time doing work on model SAARs: CFC regimes,

interest deduction limits, LOB, hybrid mismatch rules. Result:

Interpretation guidance for administrators and courts.

• Appropriate in Africa? Requires law reform, and massive training effort

of civil service, incl. policy and tax administration officials, and tax

judges.

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The future

• Avoidance at the international level will continue

to flourish – despite BEPS – in the absence of

international accord between governments about

‘fair’ tax competition.

• A moral code for taxpayer behaviour in secular

States is unworkable; even more so between

States.

• Tax avoidance is embedded in the fabric of the

free market (choice) and can never be stamped

out entirely; at most governments should aim to

lower the incidence – how?

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The future

• By delivering on the reciprocal nature of all tax.

• The social contract implies two fundamental

prerequisites for taxation:

(1) A government should deliver a sense of

security to its citizens;

(2) A government should create broad based

opportunity for prosperity of all its citizens.

Why should taxpayers otherwise consent

to pay tax?

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End.

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