Soon after he was appointed shadow Chancellor last September, John McDonnell announced a “wholescale review of the tax system” and, more specifically, of HMRC. Last Thursday, almost a year later, the first-stage report of the HMRC review was published (apparently available only on Scribd).
The report describes itself as commissioned by Labour and conducted independently by a team led by Professor Prem Sikka of the University of Essex. Many of the team members are academics, but I can only assume it is a piece of consultancy work rather than purporting to be an academic paper. Certainly it does not stand up to scrutiny as a robust piece of academic work: that is evident from even a cursory reading, and any peer-reviewed journal would surely give it short shrift.
The report covers a lot of ground (the whole of HMRC’s work in just 37 pages), but an examination of just one area – the GAAR (General Anti-Abuse Rule) – suffices to illustrate the point.
Most of the material on the GAAR is at the very end of the report, in the section on recommendation 13 – that the GAAR be re-written. This in itself is problematic, as one might expect the conclusion would be reached on the basis of at least some kind of review of the evidence. Instead, the only references to the GAAR in the chapters leading up to the recommendations are more in the nature of ad hominem comments rather than compelling evidence.
It may be, however, that the report is simply badly structured, so it’s worth looking within the recommendation itself to see whether its rationale becomes clearer.
The first argument seems to be this:
“The principle behind GAAR should be to discourage organised tax avoidance by focusing on the economic substance rather than just the legal form of a transaction. This way, it can be argued that many of the transactions are a sham, because they have no economic substance and are merely designed to avoid taxes and should thus be ignored.”
Leaving aside what is meant by “organised tax avoidance” (by analogy with “organised crime”?), the first sentence is broadly unobjectionable. But the second betrays a shocking lack of knowledge of tax (or indeed general) law, by confusing tax avoidance with the concept of sham.
I happen to have some direct experience of the very high legal threshold required to show that arrangements are a sham, being one of the very few tax inspectors ever to have taken a case involving sham in a tax context through the courts, and won: Hitch v Stone. In a nutshell, to prove sham it must be shown that the parties never actually intended to enter into the legal obligations that the documents purport to create. The problem is that, with tax avoidance, the parties generally do intend to enter into the legal obligations as per the documents; but these are essentially a paper trail, with no economic substance. If sham were the test for a general anti-abuse or anti-avoidance rule, the rule would virtually never apply. No doubt this is the opposite of what the authors of the report intend, but it’s a good illustration of the dangers of sloppy terminology.
Moving on in the report, there’s then a reference to the fact that “transforming income into capital through artificial transactions” may not be caught by the current GAAR. It’s likely the answer to whether this would be caught rather depends on what kind of scheme is being considered. However, the report doesn’t shed much light on this, as it goes on to give a completely unrelated illustration which seems to come from the world of aggressive tax planning by multinationals, of the kind that the OECD Base Erosion and Profit Shifting (BEPS) project has been attempting to address, and which has little to do with transforming income into capital.
The next deficiency identified in the report is that the new rule will only apply prospectively, to transactions that took place after it was enacted. If this is a deficiency, one must assume that the authors are instead advocating retrospective legislation. While this can have its place in egregious circumstances, wholesale retrospection runs into grave problems such as the Human Rights Act, and would be particularly problematic in this instance now that a penalty is associated with the application of the GAAR. Assuming the report is not intended as support for the Conservative Manifesto policy of repealing the HRA, it isn’t clear to me how this issue would be addressed.
There is then a fleeting reference to one aspect of the current GAAR that could legitimately be identified as deliberately narrowing its scope: the so-called double reasonableness test. There would have been more merit in making this the main focus of concern, and building the case for a re-write on that foundation. However, given the GAAR was enacted in July 2013 and (quite naturally, as I’ve explained) applies only to transactions after that date, and given the lag between transactions taking place and the submission of tax returns, it really is far too early to assess how effective the narrowly focused GAAR has been. I would therefore argue that any calls for a rewrite are premature; though equally (as I argued in last month’s blog on the recent government condoc) it’s premature to use the GAAR as a building block for other provisions until such an assessment has been made.
Rather than addressing these points fully, the report returns to the issue of “sham” – boldly declaring that the new GAAR “must catch all sham transactions” – which, as I’ve explained, is a nonsense.
Finally, it addresses the question of membership of the GAAR panel, which it claims shackles HMRC’s attempts to apply the new rule. The bold recommendation on panel membership is that it should be made up of retired judges; to which I say “be careful what you wish for”. The history of tax avoidance over the last 80 years, since the landmark case of Duke of Westminster in 1936 paved the way for tax avoiders, has been one of great reluctance by judges to impose tax based on anything other than the strict letter of the law.