February 2021 Tax Alert


Revised Inland Revenue guidance on tax avoidance – Happy New Year?

Tax Alert - February 2021

By Campbell Rose and Virag Singh

On 17 December 2020, Inland Revenue issued a draft interpretation statement - Tax Avoidance and the interpretation of the general anti-avoidance provisions section BG 1 and GA 1 of the Income Tax Act 2007 (Draft IS). In addition three QWBAs were withdrawn (QB 14/11, QB 15/01 and QB 15/11), with aspects of the QWBA’s being reconsulted on through PUB00305 QB 1 and PUB00305 QB 2.

When finalised, and from its publication date, the Draft IS will replace Inland Revenue’s current equivalent statement (IS 13/01), which was published in June 2013 (Current IS).

Much of the Draft IS comprises a comprehensive and unobjectionable summary of general anti-avoidance principles established by the courts over the years, including particularly in Ben Nevis and Penny & Hooper, and drawing from more recent decisions such as Alesco and Frucor.

The Draft IS has changed the emphasis in the analysis in a number of areas. There is an increased emphasis on the “ultimate question” that needs to be addressed under the Parliamentary contemplation test, an increased emphasis on the consideration of artificiality and contrivance, and a reduced emphasis on confirming the facts, features and attributes that Parliament would contemplate being present (or absent) when permissible tax advantages arise under relevant specific provisions (although this is still accepted as being useful).

In this article we have briefly commented on these changes in emphasis and other areas of the Draft IS that we consider would benefit from further reflection by Inland Revenue. We have also highlighted certain parts of the Draft IS that serve as useful reminders of key principles, and some additional elements that could be usefully included (although at 137 pages, the Draft IS is already a weighty tome!).

The rise of artificiality and contrivance

The Draft IS starts its analysis by noting – uncontroversially – that the focus when applying the general anti-avoidance provision is on answering the “ultimate question” posed by the Supreme Court in Ben Nevis when it established the Parliamentary contemplation test: whether the impugned arrangement, viewed in a commercially and economically realistic way, makes use of the specific provision in a manner that is consistent with Parliament’s purpose.

In examining the factors that the courts have taken into account in applying this test, the Draft IS then characterises as “particularly significant” whether the taxpayer has gained the benefit of the specific provision in an artificial or contrived manner, or by pretence. This seems to be driven by the Supreme Court in Ben Nevis describing artificiality and contrivance as a “classic indicator” of a use of a specific provision that is outside Parliamentary contemplation. While artificiality and contrivance was discussed at length in the Current IS, it has a heightened level of emphasis in the Draft IS and features prominently in the Commissioner’s revised approach to the application of section BG 1 (including the associated flowchart).

The significance of the commercial and economic effects

In discussing the commercial and economic effects of documents and transactions, the Draft IS lists at paragraph 1.87 factors that are seemingly ‘bad’. This includes:

  • a tax advantage obtained from a deduction for expenditure, when the commercial reality is that the expenditure is of a capital or private nature; and
  • a benefit of a non-assessable receipt when the commercial reality is that they have received income.

The inclusion of these two factors is interesting in that they do not have any clear origin in decided cases (relevant case law is summarised in Appendix 2). These capital/revenue-related dimensions of what is effectively an economic substance approach were not specifically addressed in the Current IS. They reflect the increased emphasis on answering the “ultimate question” based on the arrangement viewed in a commercially and economically realistic way, however, as clearly stated in the Draft IS (and as noted below), it is important to note that this does not involve a comparison of the arrangement entered into with a hypothetical alternative which is economically equivalent.

The fall of facts, features and attributes

The Current IS has a significant focus on the facts, features and attributes that Parliament would have expected to be present to give effect to its purpose for the relevant provisions. The Draft IS has significantly reduced the emphasis on this aspect of the analysis focusing more on the “ultimate question” itself along with the commercial and private purposes (non-tax purposes) of the arrangement. The Draft IS notes that in answering the “ultimate question”, “in some cases”, it can be “useful” to consider whether there are any facts, features or attributes that Parliament would contemplate being present (or absent) when permissible tax advantages arise under the specific provisions.

In our view identifying the facts, features and attributes that Parliament would have expected as described above is an important part of the analysis and this change in emphasis should be revisited. This enquiry sets the scene for any general anti-avoidance analysis by assisting to establish what is Parliament’s purpose for the relevant provisions in the context of the ultimate question. Of course, in a particular case artificiality or contrivance may have distorted the application (or non-application) of specific provisions. In such a case, it is necessary to establish whether this artificiality or contrivance directly affects the presence or absence of the relevant facts, features and attributes.

Answering the “ultimate question”

Under the Current IS, the consideration of non-tax purposes is confined predominantly to determining whether a tax avoidance purpose or effect is merely incidental. In the Draft IS, these purposes are also focused upon in determining the “ultimate question”, as part of the core tax avoidance analysis. The purpose or effect of an arrangement is required to be determined objectively and the subjective motive, intentions or purposes of the parties is irrelevant. However, contemporaneous evidence and consistency of factual narrative are critical for taxpayer credibility in this respect.

The Draft IS confirms that the core tax avoidance test does not involve postulating a counterfactual and asserting that, because the taxpayer’s arrangement was different from the counterfactual, its tax outcomes cannot have been contemplated by Parliament. In practice we are often seeing Inland Revenue staff adopting counterfactuals as a dominant element of their avoidance analysis, so it is helpful that the Draft IS itself states that an analysis free of “impermissible” counterfactuals is “the approach the Commissioner will take”. Equally, a taxpayer cannot postulate a counterfactual arrangement that they would otherwise have entered into that would have resulted in the same or a similar tax effect. The avoidance analysis is undertaken in relation to the particular arrangement entered into by the parties.

In a similar vein, the Draft IS also valuably notes that the inference or conclusion that the general anti-avoidance provision applies must be reasonable i.e. the inference must be one that is:

  • open on the evidence and the facts established from the evidence;
  • logical and cogent;
  • not mere speculation; and
  • not an intuitive subjective impression of the morality of what taxation advisers have established.

The Draft IS helpfully reconfirms that the general anti-avoidance provision cannot be used to fill a legislative gap, the analytical approach is firmly grounded in the words of the relevant statutory provisions, and that in appropriate circumstances, using legislated options (with no additional problematic features) solely for tax purposes is acceptable.

Missing in action

The Draft IS (and the related QWBAs) suffer from little to no new practical examples of the application of the general anti-avoidance provision. These are critical to ensuring voluntary compliance. Inland Revenue should have plenty of material to include from the field and its Disputes Review Unit, so that scenarios towards the middle and not extreme ends of the spectrum (i.e. ironically, more closely aligned to commercial and economic reality) should be part of the finalised statement.

At the same time as issuing the Draft IS, Inland Revenue has also withdrawn three Questions We’ve Been Asked (including QB 15/01 regarding debt capitalisation), and is reconsulting on two revised QWBAs with examples of how the analysis is to be applied. In our view the debt capitalisation scenario in QB 15/01 should also be revised as although there are specific rules dealing with debt forgiveness, they do not apply to debt capitalisation nor do they apply where forgiveness is not pro rata to ownership interests. Debt capitalisation is still taking place in practice and so continued guidance on this is important.

There is no discussion of White v CIR, the only avoidance case in recent history where the court ultimately found for the taxpayer and the decision was not appealed. Nor does the Draft IS address the Court of Appeal’s comments in Roberts v CIR regarding the appropriateness of referencing extrinsic material (Policy Officials’ discussion documents etc) when it discusses the relevance of these materials to understanding the background to a specific provision.

As noted above, the Draft IS applies from the date of publication but in our view the revised analysis should at least be considered alongside the Current IS in respect of audits, disputes, ruling applications etc. already in progress notwithstanding the fact that it may not materially impact the conclusions reached by Inland Revenue.

Finally, depending on timing of when the Draft IS is finalised and when the Supreme Court’s judgment in Frucor is available (once that hearing has taken place), the statement may need to be updated to reflect any appropriate revisions as a result.

Submissions on the draft statement close on 31 March 2021. If you would like to make a submission or to understand the impact of the draft statement in more detail, please get in touch with your usual Deloitte advisor.

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