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Comparative Regulation of Corporate Tax Avoidance

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Comparative Regulation of Corporate Tax Avoidance

INTERNATIONAL ACADEMY OF COMPARATIVE LAW

    XVIII CONGRESS

    Topic IV.E :Comparative Regulation of Corporate Tax Avoidance

I The legal system of the UK

    Although the United Kingdom is a single jurisdiction for the purposes of international law, it is actually made up of three separate jurisdictions: England and Wales, Northern Ireland and Scotland. The first two are common law jurisdictions, whereas Scotland is a mixed jurisdiction, involving elements of both common law and the civilian tradition and operating both principle and precedent within the one system. Whilst the UK is bicameral, in relation to tax legislation, as noted below, the upper chamber has a limited role.

    1 Most written constitutions emerged in the The UK has no written constitution.

    aftermath of some sort of tectonic shift in the political framework of a country, whether as a result of revolution, freedom from colonial rule or following peaceful negotiation, reflecting the need for a fresh start. Whilst there has by no means been an absence of dramatic political shift in the UK, there has been no perceived need for such a constitutional “fresh start”. Consequently, constitutional development in the

    UK has been, on the whole, gradual and incremental. As a result of the lack of a modern, written constitution, the sorts of principles which one would normally find are generally absent from the UK‟s juridical map, except to the extent they have been imported from elsewhere through the European Convention of Human Rights and membership of the European Union. Thus, there is no indigenous principle of equality, proportionality or non-discrimination to which the courts in the UK can reach.

    The separation of powers is, conceptually at least, a thread which runs through the

    2British constitution, although, as is often the case in British constitutional

    arrangements, the position in practice is more textured. There is, for example, a greater degree of overlap between the legislative and executive branches than in many constitutions, with Cabinet ministers, who are elected members of Parliament and part

     1 This is not entirely true it is (more or less) written down, just not all in the same place and it is not entirely certain whether some bits on the periphery are actually part of the constitution or not. 2st The principle has its origins in the reign of Edward 1, 1272 1307.

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    of the legislature, playing key roles in the executive. The role of the Lord Chancellor, until reform in 2005, spanned each of the three organs of state. The House of Lords, (until replacement by the Supreme Court in 2009) was at the same time the unelected second chamber and its judicial committee provided the highest UK court with its judges. Judges were appointed by the executive until the introduction of the Judicial Appointments Commission in 2006. However, despite the fact that the judiciary were not institutionally separate from Parliament, they were (and are) are regarded as having exercised (and exercising) a considerable degree of independence. Key to the understanding of the realities of the separation of powers is the principle of parliamentary sovereignty and the part played by the courts in this respect. Since the Bill of Rights 1689, which regulated the relationship between the Crown and Parliament in a constitutional monarchy, it has been practice of the courts to recognise the supremacy of an Act of Parliament. Indeed, the notion of parliamentary sovereignty itself is regarded by some as deriving from the common law: “Parliament

    3 In is sovereign because the judges acknowledge its legal and political supremacy.”

    traditional constitutional theory, law is what the Queen in Parliament enacts.

    “The principle of parliamentary sovereignty means neither more nor less than

    this: namely, that Parliament thus defined has, under the English constitution,

    the right to make or unmake any law whatever; and, further, that no person or

    body is recognised by the law of England as having a right to override or set 4aside the legislation of Parliament.”

    From where does the notion of parliamentary sovereignty derive? Political theory might point to the will of the people, but its legal basis in the UK would appear to be

    the common law, in particular from the decisions of the courts that they will not interfere with the enactments of the elected body. It has not always been thus: there was once a view that the courts could disregard an Act of Parliament if it was contrary

    5to the “common right and reason, or repugnant, or impossible to be performed”, but

    by time of the Bill of Rights 1689, it appears to have been accepted that judges would respect legislation as having a higher status than any other source of law, including the common law.

     3 W. Wade, “The Basis of legal Sovereignty” (1955) Camb. L.J. 172. 4 A. Dicey, An Introduction to the Study of the Constitution (1885) p. 39. 5 Dr Bonham’s case (1610) 8 Co Rep 113b.

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    6 and Dicey‟s strict view of parliamentary sovereignty, quoted above, has had it critics

    7in more recent times there is some evidence of a “new era of judicial assertiveness”,

    evidenced primarily by judicial statements from the very highest sources which might be regarded as implying that the courts regard themselves as retaining some residual rights to deny the authority of legislation. Lord Woolf, writing extra-judicially, said, “ultimately there are even limits on the supremacy of Parliament which it is the

    8courts‟ inalienable responsibility to identify and uphold.” Lord Steyn, in Jackson v

    9AG, expressed doubt on whether the Diceyan notion of parliamentary sovereignty was still correct,

    “The classic account given by Dicey of the doctrine of the supremacy of

    Parliament, pure and absolute as it was, can now be seen to be out of place in

    the modern United Kingdom. Nevertheless, the supremacy of Parliament is still

    the general principle of our constitution. It is a construct of the common law.

    The judges created this principle. If that is so, it is not unthinkable that

    circumstances could arise where the courts may have to qualify a principle

    established on a different hypothesis of constitutionalism.”

    However, despite such judicial utterances, judicial challenge to parliamentary sovereignty, other than those authorised under EC law and, to a more limited extent, the Human Rights Act 1998, remains at best a theoretical possibility and one which, if exercised in practice, would constitute no less than a legal revolution. So, in terms of checks and balances, the courts have declined to exercise a power or veto in relation to the legislature, although they are increasingly being called upon to protect the individual against misuse of power by the executive, and this is explored further in the tax context below.

A Tax law in the UK

Legislation

    The UK Parliament has legislative competency on tax matters across the UK. No central taxing power is devolved to Northern Ireland or Wales, although the Scottish Parliament has limited competency to raise or lower by 3% the basic rate of income

     6 Eg, W.I. Jennings, The Law and the Constitution (1959) pp 159 160. 7 P. Leyland, “The Constitution of the United Kingdom, a contextual analysis” p 224. 8 [1995] PL 57 at 69. 9 [2006] 1 AC 262. at [102]. It is interesting that the challenge in this case, which concerned the procedural legitimacy of the Hunting Act 2004, was made on the absence of due process rather than substantive grounds, reflecting a particularly British obsession.

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    1011 It has not used this power to date. Jurisdiction over local government tax only.

    finance is devolved to Scotland.

    Most direct tax law is contained in primary legislation, although power is occasionally given in primary tax legislation to enable Ministers to promulgate regulations in specific areas, particularly in the area of VAT. Regulations relating to taxation are drafted by HMRC. Delegated legislation weakens the operation of parliamentary sovereignty in the interests of legislative efficiency, although secondary legislation is subject to review by the courts as well as to scrutiny by parliamentary committees. The areas in which regulations may be made are limited, usually used to fill in detail left out of legislation. The principle that tax may only be imposed by Parliament is stringently upheld by the courts and delegated legislation which purports to give wide powers to HMRC to determine the level of taxation in a particular situation will be

    12struck down.

    On the whole tax law does not have special status. Judicial interpretation and application of substantive tax law follow no special principles and judicial regulation of the actions of tax authorities is exactly the same as any other public body. A few special features of tax law might be noted, however.

    1 Tax may only be imposed by Parliament and not by judges or by Royal Prerogative. There is no common law of taxation. This derives from the constitutional

    thcrisis in the 17 century, provoked in part by the assertion by the Stuart monarchs of the Crown‟s prerogative to tax. This crisis led to the Bill of Rights 1689 in terms of

    which Parliament was stated to be the only body with the power to impose taxation. 2 Related to the above is the convention that certain UK taxes (income tax and corporation tax, but not VAT, stamp duty or inheritance tax) must be imposed

    13annually by Parliament. The annual Budget is presented by the Chancellor of the

    Exchequer in the spring of each year and is then followed by an annual Finance Act.

     10 Scotland Act 1998 s 73. 11 Currently, there are proposals to give the Scots a greater range of tax powers: see the Government‟s

    white paper “Scotland‟s Future in the United Kingdom” at

    http://www.scotlandoffice.gov.uk/scotlandoffice/files/Scotland's%20Future%20in%20the%20United%20Kingdom.pdf 12 Commissioners of Customs and Excise v. Cure and Deeley Limited [1962] 1 QB 340. 13 This statement of the current economic and financial state of the UK includes the announcement of tax changes to be contained in the following Finance Bill. This means that, unusually for a government department, the Treasury has guaranteed access to Parliamentary time each year and ,each year, changes are implemented. In recent years, the amount and complexity of new legislation, frequently targeted at avoidance, has been the subject of considerable adverse comment.

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3 The third peculiarity of tax law is the rule that the Parliament‟s upper chamber,

    the House of Lords, is largely excluded from the process of enacting legislation in

    14relation to “money bills” and cannot block them. This is regarded as a flaw by some

    commentators. The House of Lords has the possibly of having some input to the Finance Bill debates since 2003 through a sub-committee of the House of Lords Select Committee on Economic Affairs, but this is only at a late stage, once policy has

    15been determined.

From tax policy to tax legislation

    The division of responsibilities for the development of tax policy between the tax authorities and the Treasury was blurred before changes which took place in 2005. A

    16review of the Revenue departments in 2004 concluded that any coherence in tax

    policy in the UK was despite the existing organisational structure rather than because of it. The review proposed that the Treasury be responsible for overall tax policy, with Her Majesty‟s Revenue and Customs (HMRC), a non-ministerial government

    17 department, taking a more limited role. These changes were implemented.

    Parliament does not initiate tax legislation.

    The strength of the political party in office under the Westminster model of government means that tax policy, indeed all policy, is to an unusual extent within the

    18control of that party. Formal consultation, if it is going to take place at all, is

    generally issued only at an advanced stage, once policy has been determined, and is thus normally restricted to technical implementation rather than informing policy development. In recent years, there has been much more consultation on detailed proposals although this is not as a result of a statutory obligation and continues to be

     14 Parliament Act 1911 The background to this legislation was the proposal by the Liberal Government to introduce a land tax, which was opposed by the Conservatives, who had a majority in the House of Lords, and which blocked the budget. The Act restricts the power of the House of Lords to block Commons legislation. 15 It is clear that input is intended to be limited to the technical aspects of the Bill rather than its policy but it is a task that the sub-committee has taken on board in a way which allows more serious consideration of some of the clauses of the Bill. It takes evidence from various independent persons on several matters and, although it is hard to evaluate its impact, the involvement of the Upper House is a welcome step forward. 16 The O‟Donnell Review: “The Review of the Revenue Departments”, 1994. Available at

    http://www.hm-treasury.gov.uk/bud_bud04_odonnell_index.htm (accessed 16 November 2009). 17 Commissioners for Revenue and Customs Act 2005. 18 The UK Government has a Code of Practice on Consultation available at

    http://www.berr.gov.uk/files/file47158.pdf and the specific practice in the tax context is as

    http://www.hmrc.gov.uk/large-business/consultation-framework.pdf

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    selective. At a later stage, draft legislation is sometimes circulated for comment prior to publication as a Bill although this is not especially common.

    Once policy emerges from the Treasury in the form of a draft finance Bill, there is little scope for further development during its parliamentary stages. The main debate, on the Bill, since 1967, takes place before a “standing committee” rather than being

    debated in front of the whole House of Commons. The opposition is allowed to choose some clauses to be debated in the whole House, which will be the more controversial clauses from a policy aspect. Standing committees are made up of members of parliament drawn from the political parties in proportion with their respective strengths in the House of Commons. Although the clauses of the Bill are in theory debated one by one, in practice it is only possible for a limited number to be considered in detail. Amendments can be suggested by any party, although the chance of an Opposition amendment being successful is extremely limited as the members of the standing committee tend to vote on party lines.

    Parliamentary scrutiny of tax legislation is almost universally regarded as inadequate in the UK. There are a number of reasons for this

    - the nature of the subject matter (often extraordinarily complex); - the Parliamentary timetable (unless the Act of Parliament follows the Budget within about four months, any Budgetary resolutions fall);

    - the exclusion of the House of Lords from the debates.

    The following, taken from a 2008 report to the Mirrlees Review, provides a critical summary:

    “in the UK the processes of analysis, negotiation, and marketing take place

    much more within the Executive Branch than in the legislature, or indeed in

    politicians‟ campaigns for election. The Executive has extensive agenda power,

    and Government proposals are rarely subject to significant amendment, let alone

    veto. The centralisation of revenues, lack of information and expertise in

    Parliament, rarity of coalition bargaining, and absence of any powers of

    initiative and referendum reinforces the familiar executive dominance of British

    19 politics.”

Revision of tax laws

     19 Alt, Preston and Sibieta, The Political Economy of Taxation, draft report to the Mirrlees Review,

    at http://www.ifs.org.uk/mirrleesreview/reports/political_economy.pdf.

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    Each year, changes in tax laws are made in the annual Finance Bill, although these changes are generally on an ad hoc and incremental basis and could not perhaps be described as wholesale revision. Announcements of changes to the law are often announced in advance of a Finance Act, especially in the context of avoidance schemes which become apparent as a result of the disclosure regime, discussed below. The change becomes effective immediately on announcement as, provided there is sufficient detail of the future provision in the announcement, it is considered that the fact that the legislation will be retrospective to the date of announcement (or other date of implementation) does not give rise to significant detriment to the taxpayer. There are often two Finance Acts in the year of a general election, but apart from this, amending legislation normally takes place annually.

    There appears to be no appetite in the Treasury for wholesale revision and there is no body in the UK, such as a Tax Law Commission, which might be charged specifically to make proposals for tax reform. Moreover, Finance Acts are excluded from a system of post-legislative scrutiny introduced in 2008, by virtue of which the responsible Department must submit to the relevant Commons departmental Select Committee a Memorandum on how an Act of Parliament is working, 3-5 years after Royal Assent.

B The enforcement of tax law

    The enforcement of tax laws takes place under legislative powers given to HMRC,

    20 one of the largest government departments.

    Self assessment for individuals was introduced in the tax year 1996-97 with corporate self assessment operational in relation to accounting periods ending after 1 July 1999. Although the personal and corporate systems are similar in many respects, there are

    21some important differences and it is proposed here to focus on the corporate system. The process starts with HMRC issuing a brief notice requiring a company to deliver a

    22return. If no notice is received, the company has an obligation to give notice that is

     20 In particular, the Taxes Management Act (TMA) 1970 and the Commissioners of Revenue and Customs Act 2005. 21 The various obligations on payers to deduct tax at source (the cumulative system of deduction of tax on employment income, the tax deducted for interest at source and tax credits attached to dividend income) means that many individuals have no untaxed income and are not required to make a return unless they are specifically required to do so by HMRC. 22 FA 1988 Schedule 18.

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    23 chargeable to corporation tax within 12 months of the end of its accounting period,and this will trigger the issue of a notice requiring a return.

    The return, which must normally be made within 12 months of the end of the accounting period, must be accompanied by computations and a copy of audited accounts for the accounting period. If no return is made, penalties are levied for

    24failure to make a return. Corrections may be made to the return by the taxpayer

    within 12 months of submission. HMRC will amend any obvious errors in the return such as arithmetical errors.

    The system is described as “process now, check later”. Initially the form is simply processed, with any obvious errors identified by HMRC and notified to the taxpayer. Whether or not the return is one which will be looked into further depends on a variety of factors.

    25A new compliance checking regime was introduced from 1 April 2009, rationalising

    information gathering powers across several taxes by providing common authorisation levels, appeals and penalties. No longer are HMRC required to open a formal enquiry before exercising certain information gathering powers, although the these powers may only be used where “reasonably required by the officer for the

    26purposes of checking a tax position”. The taxpayer can appeal against the issue of a

    notice requiring further information, and notices requesting information from third

    27parties will normally require the prior permission of the Tribunal.

    As well as, or instead of using the new regime, HMRC might engage in the more

    28formal process of opening an enquiryinto a return. Whilst HMRC do not have to

    give any reasons for opening an enquiry into a tax return, most returns which are subject to an enquiry are those identified at being at risk of under-reporting tax (how

    29this is done is not made public), although a small proportion of enquiries, affecting

    about 1 in 1000 taxpayers, are opened on an entirely random basis. HMRC say this in their guidance:

     23 FA 1988 Sch 18 para 2. 24 FA 1998 Sch 18 paras 17 20. A new system which will apply to several taxes is contained in FA 2009 Sched 55 and 56 , although this is not yet in effect. 25 FA 2008 Schs 36 39. 26 FA 2008 Sched 36 para 1. 27 FA 2008 Sched 36 para 3. The tribunal is the first judicial tier, described in more detail later. 28 TMA 1970 ss 9A 9C. 29 See http://www.taxationweb.co.uk/tax-articles/general/hmrc-enquiry-selection.html for an account of

    a former HMRC employee on the factors which were taken into account.

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    In general something will have triggered a check. For example, it is usually

    that the figures entered on a return appear to disagree with each other, such as a

    very small business suddenly makes a very large claim for VAT or one with a

    large turnover declares a very small amount of tax. The only way HMRC can

    30 find out whether the return is correct is by making a check.

    31Enquiries must be started within a year after the return was delivered. They are fact

    finding journeys, with the opening of an enquiry triggering various additional information seeking powers. If, on completing the enquiry, HMRC believe that tax has been understated, it will make amendments to the return or issue a discovery

    32assessment. If the taxpayer disagrees with the amendment or assessment, it must let HMRC know within 30 days. At that point, a negotiated settlement might be possible. If it is not, there is on more opportunity for the taxpayer to have the matter dealt with at an administrative level, as he can ask that the decision be reviewed by another

    33official of HMRC.

    If the taxpayer is not satisfied with the outcome of the review, or if it does not wish to seek a review, an appeal to the First Tier Tribunal can be lodged within 30 days of the assessment or review decision. In the context of tax avoidance schemes, appeals will normally concern a dispute over whether the scheme has the effect which is being claimed by the taxpayer.

Burden of proof

    The taxpayer bears the burden of proof of showing that an assessment is wrong:

    “If on appeal it appears … that the appellant is overcharged … the

    assessment … shall be reduced accordingly, but otherwise the assessment …

    34shall stand good.”

    The test is the civil one of the balance of probabilities rather than the criminal “beyond reasonable doubt”. The balance of probabilities is a flexible standard,

     30 http://www.hmrc.gov.uk/agents/enquiries.htm. 31 TMA 1970 s 9A. 32 A discovery assessment is on issued by HMRC when they believe they have discovered that tax has been underpaid: TMA 1970 s 29. “Discovery” includes coming to a new conclusion on facts already known to them. This includes subsequent scrutiny of an assessment by an HMRC expert in tax avoidance: R (on the application of Patullo) v HMRC [2010] STC 107. 33 TMA 1970 s 49B, 49C and 49E. 34 TMA 1970 s 50(6).

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    weighted according to the likelihood of what it is that the party is seeking to establish. Lord Hoffmann expressed this in the following characteristically idiosyncratic way,

    It would need more cogent evidence to satisfy one that the creature seen

    walking in Regent's Park was more likely than not to have been a lioness than to

    35 be satisfied to the same standard of probability that it was an Alsatian.”Tax Appeals

    The substantive appeal system in the UK starts with two layers of tribunals, followed by, potentially, two further UK appellate courts. Where the complaint is of procedural unfairness rather than a dispute as to law, there is the alternative route of seeking judicial review of a decision of HMRC.

    The tribunal system in the UK was formerly fragmented across many areas of law, eg tax, employment, social security and immigration, with different rules operating in each area. This system was reformed into a unified structure by the Tribunals, Courts and Enforcement Act 2007 (TCEA), which operates under a common set of procedural rules whilst keeping a degree of expertise in the Tribunal members by

    36having different chambers. There are two layers of tribunal: the first tier and the upper tribunal. Most substantive appeals against a decision of HMRC will start in the First Tier Tribunal (Tax Chamber) which is staffed by tax judges although, in complex cases, the case may go straight to the Upper Tribunal (Finance and Tax). Appeals from the First Tier will normally be to the Upper Tribunal. The right of appeal from the First Tier to the Upper Tribunal may only be exercised with permission from the First Tier Tribunal or the Upper Tribunal. The decisions of the Upper Tribunal set precedents for the First Tier tribunal.

    An application for permission to appeal will first involve the Tribunal in a

    37consideration of whether to review the original decision.

    Appeal from a decision of the Upper Tribunal may be made to the Court of Appeal (England and Wales) or the Court of Session (Scotland) and from there to the Supreme Court (the successor to the House of Lords). Appeals may only be made on

     35 Secretary of State for the Home Department v Rehman [2001] UKHL 47 at 55. 36 The tax chamber commenced on 1 April 2009. 37 TCEA ss 39 and 40.

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