The commonly understood position has been that tax evasion was illegal and tax avoidance was lawful. That very much oversimplifies the reality.
What is Tax Evasion?
Is tax avoidance legal? Before you consider that, what is unlawful. Tax evasion is illegal. Tax evasion is the activity of deliberately avoiding tax, typically through dishonestly declaring income, gains, losses and expenses on any tax return that needs to be filed.
It includes failure to file returns and report on such matters when required to do so. Therefore even if you do nothing you can still be considered a tax cheat and culpable to be prosecuted for the offence of Cheating the Public Revenue. You can if indicted and convicted sent to prison.
What is Tax Avoidance?
At its most simplistic tax avoidance is arranging ones affairs to minimise the amount of tax to be suffered. In many instances there is deemed to be nothing wrong with this and it is legal.
However, more aggressive tax avoidance arrangements may not be so successful in their avoidance of the liability to tax. HMRC considers that tax avoidance is bending of the rules in its definition of tax avoidance.
What is Aggressive Tax Avoidance?
Typically aggressive tax avoidance is the arrangement of transactions designed to defeat a liability to a tax charge. A common feature of such arrangements is that the transactions appear to have no commercial rationale or purpose other than to avoid tax.
Tax Avoidance Cases
The Ramsay Principle involved an approach to looking at the whole of a transaction as opposed to its various parts.
Ever since WT Ramsay Ltd vIRC, the courts have tended to assume that tax legislation in particular are concerned with the characterisation of the entirety of transactions which have a commercial unity rather than the individual steps into which some transactions may be divided. This approach does not deny the existence or legality of the individual steps but may deprive them of significance for the purposes of the characterisation required by the statute.
In the Burmah case, a series of circular payments which left the taxpayer company in exactly the same financial position as before was not regarded as giving rise to a “loss” within the meaning of the legislation.
In Furniss, the transfer of shares to a subsidiary as part of a planned scheme immediately to transfer them to an outside purchaser was regarded as a taxable disposition to the outside purchaser rather than an exempt transfer to a group company.
In Carreras the transfer of shares in exchange for a debenture with a view to its redemption a fortnight later was not regarded as an exempt transfer in exchange for the debenture but rather as an exchange for money.
In each case the court looked at the overall effect of the composite transactions by which the taxpayer company in Burmah suffered no loss, the shares in Furniss passed into the hands of the outside purchaser and the vendors in Carreras received cash.
On the true construction of the relevant provisions of the statute, the elements inserted into the transactions without any commercial purpose were treated as having no significance.
It is going too far however to say that transactions without commercial sense and for the purpose of tax avoidance will always fail to avoid tax. It therefore follows that the answer to the question, Is Tax Avoidance Legal? is not always no.
MacNiven shows the need to focus carefully upon the particular statutory provision and to identify its requirements before one can decide whether circular payments or elements inserted for the purpose of tax avoidance should be disregarded or treated as irrelevant for the purposes of the statute. It was said by Lord Nicolls:
“My Lords, I confess that during the course of this appeal I have followed the same road to Damascus as Peter Gibson LJ. Like him, my initial view, which remained unchanged for some time, was that a payment comprising a circular flow of cash between borrower and lender, made for no commercial purpose other than gaining a tax advantage, would not constitute payment within the meaning of section 338. Eventually, I have found myself compelled to reach the contrary conclusion.”
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