Widening the anti-abuse net

September 17, 2013

EY´s Russell Aubrey tracks the shift towards a harder stance against tax avoiders.

UK Chancellor George Osborne once denounced aggressive tax avoidance as “morally repugnant”. Could he be not far off the mark? Or is the act merely sound business practice?

Be that as it may, governments have in recent years sharpened their focus on tackling “tax abuse”. The globalization of business and mobility of capital have challenged tax administrators worried that multinational companies may manipulate complex multi-jurisdictional tax rules to reduce their tax burden.

Backed by groups such as the Organisation for Economic Cooperation and Development (OECD) and the G-20, governments have shared more information with each other, widened disclosure requirements, and conducted joint tax audits to rein in aggressive tax planning.

Tax evasion is illegal, but there has always been a grey area surrounding its cousin — tax avoidance. How do you draw the line between tax evasion and legitimate tax planning?

Countries are now taking a bolder tack in catching taxpayers, by either proposing or adopting a broader general anti-avoidance rule (GAAR) to challenge perceived abusive tax avoidance.

GAAR is a set of principles embedded within a country’s tax code designed to distinguish between genuine commercial transactions and those that exist only for the sole purpose of avoiding tax. GAAR gives the tax authority the mandate to deny taxpayers the tax benefits of artificially contrived transactions.

Anti-avoidance rules in tax law are not new – Australia was the first to introduce them almost a century ago in 1915. GAAR was only applied sparingly and in the most extreme of circumstances.

However, against a backdrop of dropping tax revenue, countries seeking to recover taxes have become more assertive in either threatening to apply or actually applying GAAR against taxpayers. Some are even testing the judicial limits of their once dormant anti-avoidance statutes.

This unfolding trend has alarmed businesses. China collected CNY24 billion in taxes from 207 concluded GAAR cases in 2011, trumpeting this as a justification for continuing to develop its GAAR approach. India, which is proposing to introduce GAAR is even contemplating applying GAAR retroactively.

If governments continue to rely on the catch-all properties of GAAR, this could hamper the ability of businesses to plan and execute transactions with a high degree of certainty.

Elements of GAAR

Anti-avoidance rules tend to focus on the substance of a transaction. When that is absent or insufficient, the tax authority may bring GAAR into the equation to reject claims for tax benefits that are regarded as artificially contrived.

Because of GAAR’s subjective approach, which often looks beyond the form of a transaction to its underlying substance, purpose or intent, interpretation of GAAR provisions is often subject to much debate. The number of litigations based on GAAR has increased around the world, some involving the first court examinations of long established but rarely challenged statutes.

How the court cases play out over the anti-avoidance provisions has also led some governments to fine-tune their GAAR approach. If the courts have a tendency to side with the taxpayers, governments may push to enact a stronger GAAR or more targeted provisions. For example, after losing the landmark Vodafone case, the Indian government pushed to change an existing law that would allow the tax authority to challenge similar transactions dating back 50 years.

Countries adopt different approaches to their GAAR regimes. Some have independent panels to provide oversight of the tax authority’s use of GAAR while others may have explicit treaty override protections.

Governments usually try to achieve one or more of the following objectives with their GAAR regime:

  • Codify judicial rulings on what they feel constitutes avoidance or abuse
  • Target transactions that may comply with a technical interpretation of the law but that generate tax benefits that may be inconsistent with the spirit of the law
  • Define what is an artificial scheme, transaction or arrangement staged to confer a tax benefit
  • Apply a substance test as a filter for determining whether a transaction is legitimate
  • Provide the tax authority with a mechanism to disregard a transaction or eliminate the tax benefits claimed
  • Allow the imposition of penalties or interest where there are violations

Living with GAAR

With the growing implementation of new or strengthened GAAR regimes, how can taxpayers defend themselves?

How an organization manages GAAR depends on its overall risk appetite. What then is an acceptable level of risk for a transaction?

As a best practice, the corporation should put together a tax corporate governance framework that includes a documented process for approval and sign-off for significant transactions. The framework should embed protocols for escalating material transactions or those that are likely to attract the attention of the tax authority.

Taxpayers also need to monitor developments on tax enforcement and keep at hand detailed and up-to-date information so that transactions can be measured against each jurisdiction’s most current rules.

The presence of a GAAR regime does not mean a complete stop to all tax planning. Rather, taxpayers should conduct tax planning deliberately, taking into account all angles to protect the business from a GAAR challenge.

To build a solid defense, taxpayers need to maintain sufficient documentation to justify and support decisions taken.

This article was originally published in EY´s You and the Taxman, issue 02, 2013.

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