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KEY POINTS
- Does Finance Bill, clause 55 infringe the Adam Smith tax principles?
- Is the existing relevant anti-avoidance legislation ineffective?
- What does 'always having had effect' actually mean?
- Does retrospective legislation infringe human rights?
Like Gordon Brown and Alistair Darling, Adam Smith had Scottish connections. He lived between 1723 and 1790 and is often described as 'the founding father of modern economics'.
His maxims concerning the levying of taxation continue to hold considerable sway with economic policy makers (or at least that was our broad understanding until the Chancellor's recent Budget statement). Briefly, Adam Smith's maxims include the following:
- The subjects of every state ought to contribute towards the support of the government, as nearly as possible, in proportion to their respective abilities.
- The tax which each individual is bound to pay ought to be certain, and not arbitrary.
- Every tax ought to be levied at the time, or in the manner, in which it is most likely to be convenient for the contributors to pay it.
- Every tax ought to be so contrived as both to take out and to keep out of the pockets of the people as little as possible over and above what it brings into the public treasury of the state.
No doubt we can all think of numerous examples over the years when Chancellors of either political persuasion have appeared to some of us to have flouted each of these maxims. No doubt even the best of us will sometimes struggle to remain wholly objective in such cases.
Likewise, no doubt, the Chancellors concerned could defend their position with great aplomb. Furthermore, in any long piece of written work like the present Finance Bill, it is probably inevitable that the odd error will creep in somewhere.
However, clause 55 of the Finance Bill as first published struck us as particularly at variance with Adam Smith's maxims, as well as being badly drafted and unjust.
A snag in conveying this to most people, perhaps, is that one group who are most likely to be upset are property developers, who are probably not high on the general public's list of occupations that are deserving of sympathy — largely because, when successful, they can make lots of money. This does not seem to us to be sufficient reason to treat them grossly unfairly.
The latest attack
According to HM Treasury's explanatory notes on the Finance Bill, the clause is one of several measures in the Finance Bill introduced to stop what had become a common piece of tax planning, used particularly by property developers.
The explanatory notes tell us that this planning involved the establishment of offshore trusts (of which the UK individuals are both settlors and beneficiaries) and partnerships (of which the foreign trustees of those trusts are partners).
The partnerships acquired rights to receive the UK individual's income. However, the terms of the trust were such that, as beneficiaries of the trust, the UK individuals retained beneficial entitlement to the income.
The users of the 'scheme' claim that, under the terms of the relevant double taxation treaty, the UK is not entitled to tax the partnership income of the foreign trustees.
As that income is precisely the same income as that received by the UK individuals as beneficiaries of the trust, they argue that the UK is not entitled to tax the UK individuals on it.
Legislation was introduced in Finance (No 2) Act 1987 which sought to provide that a double taxation treaty did not affect UK residents' liability to UK tax on their share of income or gains from a foreign partnership.
The 'scheme', as HMRC term it, tried to get round this by claiming that the foreign trustees are the partners rather than the UK individuals and it is this element that clause 55 of the Finance Bill seeks to undo. In part, the 'scheme' relied on the judgment in a case called Padmore (see Padmore v CIR (No 1) 62 TC 352 and Padmore v CIR (No 2) [2001] STC 280).
A side issue — for the purposes of this article — is that it is debatable whether the clause achieves its intended aims. The clause introduces a new subsection (4) into ITTOIA 2005, s 85 which says that 'for the purposes of this section the members of a firm include any person entitled to a share of income of the firm'.
It is debatable whether the beneficiary of a trust whose trustees are members of a partnership are in fact caught by this at all.
Is there an avoidance scheme?
A further side issue is whether it is correct to talk of the arrangement — as the explanatory notes do — as being an 'avoidance scheme'.
The planning was only capable of working if the property development activity were genuinely carried on from the overseas jurisdiction. This therefore seems to us to be tax planning, not avoidance.
However, let us assume for the moment that the clause were to achieve its aim, and let us also for the moment ignore niceties about the way in which HMRC increasingly appear to term tax planning as avoidance, and indeed avoidance as evasion.
The clause has in it the following sentence. 'The amendments made by subsections (1) and (3) are treated as always having had effect' (our italics).
Several authorities have said to us that in their view this is simply very poor drafting. What for example is 'as always having had effect' supposed to mean? Does it perhaps mean that the amendments to the legislation had effect before the relevant legislation itself ever existed? Would the Doomsday book be far enough back?
It has also been suggested to us that, to the extent this is an obvious attempt to give the amendments retrospective effect, it is vulnerable to a challenge on Human Rights Act principles, despite the statement by the Chancellor at the beginning of the Finance Bill that in his view it is compatible with Convention rights.
Even if that were not the case, in our view it falls foul of several of Adam Smith's maxims and is also grossly inequitable on common sense and moral grounds.
Infringing the maxims
An underlying assumption, presumably, is that since someone has entered into an arrangement which happens to involve non-resident trustees and a partnership based in some lower tax jurisdiction, they must then be fat cats and ought to pay more tax. This assumption may be wrong, in which case it may infringe Adam Smith's first maxim above.
One suspects that perhaps a further assumption could be that property developers are similarly tarnished in the minds of the general public and HMRC as fat cats.
However, the fact is that an economy needs to have some people carrying out property development, which is a high risk activity; therefore we would suggest requiring some possibility of high returns.
If such people are driven out of business, the public may eventually suffer out of all proportion with any net gains to the public purse from a tightening of the tax regime, in which event Adam Smith's maxim 4 would seem to be infringed.
There is an element of speculation as regards our comments about Adam Smith's maxims 1 and 4. However, there seems to be no doubt at all that this measure falls foul of maxims 2 and 3.
There seems to us to be no question that this has added to the uncertainty and arguably the arbitrariness of our tax system. No one could have known a few years ago that they would have been affected retrospectively by this amendment to the legislation.
Furthermore, if someone were to find himself having to pay more tax now as a result of something he did a few years ago that is now caught by a retrospective change to the legislation, it is very hard to see how it can be said that the tax is levied at a time or in a manner likely to be convenient for him to pay.
Retreat to higher ground
The authors would suggest that this element of retrospection and uncertainty in planning their affairs will have the effect of driving a number of major companies out of the UK and, as highlighted in recent articles in the national press, we understand that several FTSE100 companies have already decided to pack up and leave. More may follow.
There is a further issue which is that having gone to the trouble of negotiating a double tax treaty with an overseas jurisdiction, it is debatable whether this country does itself any favours if it later on uses its internal tax legislation to negate the impact of the treaty for its own tax residents.
Consequently, if Alistair Darling were minded to try to defend this measure, we would be fascinated to hear this defence, and suspect Adam Smith would turn in his grave straining his ears to listen, too.
Barry Brinsmead and John Hiddleston are senior tax consultants with the Vantis Group. John Hiddleston, head of tax technical, Vantis, can be contacted at john.hiddleston@vantisplc.com, or on 020 7549 8057.
