Comedian Jimmy Carr has woken up this morning to discover details of his tax affairs splashed across the front pages of the national press. He is a leading player among the users of a tax avoidance scheme (“K2”) marketed by Peak Performance Accountants (“PPA”). This is a scheme designed on a fairly well-known basis, marketed by other tax boutiques as well as PPA, whereby income is routed into a trust (in the case of K2 based in Jersey), which lends the money back to the taxpayer. Because this loan is technically repayable, it is not taxed as income in the hands of the taxpayer.
The quotes from Roy Lyness of PPA are particularly instructive, and illustrate both the difficulty that HMRC has in keeping up with abusive tax avoidance and the reason why we urgently need the General Anti-Abuse Rule (“GAAR”) on which HMRC is currently consulting.
HMRC has previously pinned its anti-tax avoidance strategy on the Disclosure of Tax Avoidance Schemes (“DOTAS”) regime, whereby publicly marketed tax avoidance schemes have to be disclosed to HMRC in advance and are allocated a reference number to be included on taxpayers’ self-assessement returns when they have used the scheme.
I have previously identified one problem with DOTAS, which is that bespoke schemes designed in-house by one particular company are not covered. However, this story reveals a more fundamental problem, which is one of limited HMRC resources. There is widespread disclosure of tax avoidance schemes under DOTAS, and HMRC simply cannot keep up with identifying which are the widely used ones and which will never see the light of tax avoidance day.
Thus HMRC is still always playing catch up with the abusive tax avoiders, and it is in this context that the GAAR assumes such importance. Whereas previous anti-avoidance legislation has been targeted, thus restricted to combatting specific abuses and by definition retrospective in its effect, the GAAR is intended to be pro-active in defining specific schemes as abusive, and thus to catch them from day one of their implementation.
So the key question is, would the GAAR as currently formulated catch the K2 scheme? Because if not, the GAAR would need some urgent reformulation, as the K2 scheme strikes me as precisely the type of abusive tax avoidance that it is intended to catch.
And so to the Consultation Document outlining the proposed terms of the GAAR, and a step-by-step analysis of how HMRC would determine if it should be applied to the K2 scheme. Numbers refer to the clauses in the draft GAAR legislation included in the Consultation Document:
1(3)(a) The scheme is an income tax avoidance measure, and income tax is one of the taxes covered by the GAAR.
2(1) It is reasonable to conclude that the obtaining of a tax advantage is the main purpose of the arrangements.
2(2) Can it be reasonably regarded as a reasonable course of action to re-direct the fruits of a taxpayer’s labour to a trust which then has discretion to lend those monies back to the taxpayer if the trustees so choose? If we assume an arm’s-length transaction is taking place, with no prior instructions issued to the trustees, I would submit that no sane individual would take that risk with all of their earned income. This is sufficient to render the K2 scheme ‘abusive’ in the context of clause 2(2) of the draft GAAR legislation.
2(4) Looking at the indications of abusive tax arrangements, it appears clear that (a) and (d) apply in this case, the latter on the assumption that the trustees are not paying market value for acquiring the rights to the taxpayer’s income.
3 A tax advantage is being obtained by avoidance or reduction of an assessment to tax (c) and avoidance of an obligation to account for tax (f).
4 It would thus be open for HMRC to adopt counteraction of the tax advantage obtained on a just and reasonable basis. It appears to me that such a just and reasonable basis would be to ignore the existence of the trust and to tax the income directly on the taxpayer. There is strong legal precedent for this in the cases stemming from the Ramsey principle, which showed that uncommercial steps in a series of transactions can be ignored for tax purposes in appropriate circumstances.
Thus in my view the GAAR would successfully apply to counter the K2 scheme. Which brings me to a key question raised in the Consultation Document; what should be the transitional provisions for introduction of the GAAR?
In my view the economic situation in the UK is not such that we can afford to ‘pussy foot’ around with this issue. My view, strongly expressed in my response to the Consultation Document, is that taxpayers have been well aware since the Budget on 21 March 2012 that a GAAR was going to be introduced, and the study of the Aaronson Committee outlining its proposals for the introduction of a GAAR has been available since November 2011.
Thus anyone who has chosen to enter into or continue with a potentially abusive tax avoidance scheme since 21 March 2012 has known that they were taking action that would potentially fall foul of a GAAR, and in my opinion it is therefore entirely reasonable to apply the GAAR, once it is introduced in April 2013, to transactions taking place on or after 21 March 2012 (it may be for technical reasons that HMRC would prefer to apply dates of 1 and 6 April 2012, given that these dates are the commencement of the corporation tax and income tax year respectively). This would be the only transitional provision applicable, and would thus have the merit of simplicity of application.
Whether HMRC and the Treasury believe this to be practically possible remains to be seen, but I think it would send the strongest possible message that George Osborne was sincere in condemning abusive tax avoidance, as well as giving the GAAR a flying start in maximising the tax take from implementation of the planned legislation.
Finally, in my view the real beauty of the GAAR is that it puts an end to what Roy Lyness refers to as “(going) round the block”, and the abusive tax avoiders’ “game of cat and mouse” with HMRC. And that, I submit, would be a great result for the future financial health of this country.