The difference between tax avoidance and tax evasion is that avoidance seeks to minimise the tax paid, generally by legal means, for example ordering one’s affairs through bespoke planning advice.
Evasion, on the other hand, is knowingly not paying tax; for example, hiding income-producing assets or bank accounts offshore to conceal them. We often witness evasion that has been brazenly dressed up as allowable avoidance. It is this behaviour that encourages HMRC to suspect planning/avoidance motives in vanilla tax structures and has contributed to the swathes of negative media concerning tax avoidance.
In the 1936 Duke of Westminster case, Lord Tomlin stated: “Every man is entitled, if he can, to order his affairs so that the tax attaching under the appropriate Acts is less than it otherwise would be. If he succeeds...he cannot be compelled to pay an increased tax.”
Exploiting the rules
Tax is imposed by law and it is possible to take advantage of deductions, reliefs and different tax rates to ensure a lower tax bill. However, many avoidance schemes are artificial in the way they operate. Instead they are used to exploit or bend the rules in an advantageous way not intended.
There are some laws that remain mechanistic in the way they operate. In this case, a literal construction of that law, which examines each step in a series of linked transactions, without regard to the wider scheme, might be appropriate.
- Tax is imposed by law and it is possible to take advantage of reliefs to ensure a lower bill.
- In 1981, the House of Lords decision in W T Ramsay Limited vs CIR meant the meaning of tax legislation had to be considered in context.
- Disincentives to tax avoidance include the naming and shaming of scheme promoters.
Lawmakers are increasingly ensuring that statutes build in purposive provisions, as opposed to mechanistically operating laws. These provisions clearly define the purpose of a particular tax, relief or exemption, based on the behaviours it is intended to drive.
Where the purpose is clear and the facts show that the intended purpose has been disregarded – for example, because a scheme has been entered into mainly for tax avoidance – it can be expected that HMRC will challenge this.
The courts may then decide to deprive the taxpayer of the artificial advantage they had sought through entering the scheme. This approach is not new. In 1981, the House of Lords decision in W T Ramsay Limited vs CIR was hailed as an intellectual breakthrough, but for most it just put tax law on the same footing as all other law. This meant it required the words to be considered in the context and scheme of the relevant legislation as a whole, with regard to the purpose of the statute.
This purposive construction allows courts to ascertain the legal nature of any transaction and to consider the tax consequence accordingly. If it emerges that a series or combination of linked transactions are intended to operate as such, then the court can consider that series or combination. If there is an artificial ‘allowable’ tax loss created, which is designed to be offset against a real chargeablegain, the self-cancelling transaction can be ignored.
Dozens of cases followed Ramsay, where purposive interpretation and its extent has been considered. Advisers seeking to avoid a step looking pre-ordained, introduced artificial elements of risk or built-in contingencies that sought to provide a lack of certainty of outcome. But HMRC and other governments then ensured laws were introduced, which focused on the substance of the transaction rather than its mere form.