The rule of law, tax avoidance and the GAAR

31 July 2013. Published by Adam Craggs, Partner

Tax is in the news and making the headlines as seldom before, but the debate is not always as informed as it might be...

…with certain journalists failing to understand the complex issues involved and politicians making ill-thought out pronouncements on the perils of tax avoidance and tax evasion (generally without distinguishing between the two!) and encouraging us all to pay our 'fair' share of tax.  Recently, however, a very interesting and illuminating article was published by Patrick Way QC entitled "The rule of law, tax avoidance and the GAAR" which raises some interesting and thought provoking issues.

The rule of law

The rule of law is an ancient principle that Mr Way defines as follows:

"The rule of law requires that the government of the day exercise its powers, including its powers to collect tax, by reference exclusively to its rules, regulations and legal practices as laid down in statute and built up through case law.  The law is sacrosanct, and an individual is entitled to govern his or her affairs exclusively by reference to the law in force, particularly so far as is concerned the citizen's obligation to pay tax."

The rule of law is a matter for Parliament and wholly overrides any 'moral' aspect relating to construction of legislation and in particular concerning the construction of tax statutes.  The rule of law reigns sovereign over public opinion.

Public opinion

Public opinion in relation to tax matters has of course changed dramatically in recent years.  This has led to attacks in the press and by the Public Accounts Committee on businesses which have done nothing more than adopt and comply with the rule of law.  As Mr Way points out, however, if Parliament finds such an approach objectionable then it should change the law.  Parliament after all, is the law maker.

Benefits and disadvantages of the rule of law

Mr Way further points out the rule of law can, on occasions, benefit taxpayers.  Thus in HMRC v D'Arcy [2008] STC1329, a case involving planning combining an accrued income scheme and the sale and repurchase of gilts which resulted in the taxpayer being able to access a significant tax advantage with no corresponding economic expense, Henderson J said:

"In short, this is in my view one of those cases which will inevitably occur from time to time in a tax system as complicated as ours where a well-advised taxpayer has been able to take advantage of an unintended gap left by the interaction between two different sets of statutory provisions."

On the other hand, in Joost Lobler v HMRC [2013] UK FTT 141, a case involving partial surrenders of life policies involving taxable income arising under ITTOIA 2005, Chapter 6, Part 4, Judge Charles Hellier, in dismissing the taxpayer's appeal, acknowledged that this was a case which, unfortunately, produced a remarkably unfair result for the taxpayer.  The rule of law is not perfect, but at least it provides certainty and avoids capricious decisions.

A fair share of tax

As Mr Way points out in his article, the Public Accounts Committee and the press have whipped up a furore in relation to anybody who does not pay their 'fair' share of tax.  The problem, however, is that this expression is completely subjective and meaningless.  Firstly, there is no equity in a tax statue and it would be inappropriate to try and identify fairness in tax.  More particularly, if Parliament does not like the tax results that are achieved by taxpayers within the law, then the simple remedy is for Parliament to change the law. 

Starbucks, Amazon and Google

The tax rules that govern modern business practice are not well equipped to deal with global business structures under which companies operate with their subsidiaries located all over the globe.  What Google and others have done, as Mr Way points out, is to arrange for contracts which might otherwise be treated as taking place in the UK to be executed elsewhere, typically in Ireland, where the rate of corporation tax is lower than in the UK and US.  The companies also have valuable intellectual property rights and, under current principles relating to transfer pricing, the company that owns the intellectual property rights is entitled to charge other companies within its group a full market rate for using the brand or other intellectual property in question.

Enter the GAAR

The double reasonableness test in the GAAR,1 as Mr Way and a number of other commentators have pointed out, is unclear.  What does it mean to say that tax arrangements are "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 …".  Presumably the purpose of the double reasonableness test is to ask what a 'reasonable man' would consider is abusive, but as Mr Way points out:

"The difficulty with that is that this moves us away from the pejorative expression "abusive" to some extent, to the more benign word "reasonable".  These are two different concepts and should not be muddled together.  The key behind the word "abusive" is, of course, that the legislation is abused: this is a strong word and it means that the taxpayer uses the legislation (abuses the legislation) in a way that simply cannot have been intended.  Reasonableness does not come into it."

As Mr Way points out, it is most unlikely that the GAAR would stop an arrangement such as that entered into by Starbucks, Google or Amazon.  None of the arrangements put into effect by those companies were inconsistent with the intended result of the tax provisions in question and did not involve any particular abnormal or contrived step.  Furthermore, it is 'normal' for a multinational company to choose to acquire its goods in one central location and also to have its intellectual property similarly located in one jurisdiction, otherwise the exercise of spreading these activities across many companies would be extremely expensive.  By putting them in one single location, this makes perfect commercial sense.


As Mr Way comments, it is very difficult to see how the rule of law can match the public's apparent moral indignation.  Attempts have been made to put forward 'unitary solutions' where methods may be found to bring back into the UK net profits which have 'properly' arisen in the UK.  Using this method, UK legislation would produce some sort of formula by reference to which the UK part of a worldwide business of a group could be attributed to the UK on a fair and reasonable basis.  Another approach is the 'global solution' which might perhaps involve a single over-arching international body such as the OECD leading the charge to combat tax base erosion and profit shifting or any practices that are perceived to give multinational corporations an unfair advantage over domestic companies and citizens.  One problem with this is that a global solution may remove competition from within jurisdictions.  In this respect, the UK has benefitted by going through an exercise of reducing its corporation tax rate in order to encourage international companies to set up their headquarters in the UK, in other words, the UK is attempting to become a tax haven for foreign companies!

It must surely be the case that an adviser should place before his client all the legal options available, as a matter of good practice, including proposals for reducing his tax liability, together with appropriate recommendations and it is then for the client to take an informed decision and hope that the rule of law will prevail.

1. That came into force on 17 July 2013.

Stay connected and subscribe to our latest insights and views 

Subscribe Here