Capital gains tax - Anti-avoidance provisions

Learning Outcomes

After reading this article, you will be able to explain the purpose and operation of anti-avoidance provisions in UK capital gains tax, including the General Anti-Abuse Rule (GAAR), identify what constitutes an abusive arrangement, apply the double reasonableness test, and understand the main procedural steps and practical implications for SQE1-style scenarios.

SQE1 Syllabus

For SQE1, you are required to understand the anti-avoidance framework for capital gains tax, with a focus on the following syllabus points:

  • The statutory basis and scope of the General Anti-Abuse Rule (GAAR) as it applies to capital gains tax.
  • The definition and identification of abusive tax arrangements.
  • The operation of the double reasonableness test.
  • The procedural steps for HMRC’s application of GAAR, including taxpayer safeguards.
  • The practical impact of anti-avoidance rules on capital gains tax planning and compliance.

Test Your Knowledge

Attempt these questions before reading this article. If you find some difficult or cannot remember the answers, remember to look more closely at that area during your revision.

  1. What is the purpose of the General Anti-Abuse Rule (GAAR) in relation to capital gains tax?
  2. Which statutory test is used to determine if a tax arrangement is abusive under GAAR?
  3. Give two features that may indicate a capital gains tax arrangement is abusive.
  4. What procedural safeguard exists for taxpayers before HMRC applies GAAR to a transaction?

Introduction

Anti-avoidance provisions are a key feature of the UK capital gains tax (CGT) regime. They are designed to prevent taxpayers from using artificial or contrived arrangements to obtain tax advantages contrary to the intention of Parliament. The main anti-avoidance tool is the General Anti-Abuse Rule (GAAR), which applies to CGT and other taxes. GAAR operates alongside specific anti-avoidance rules and targets arrangements that go beyond legitimate tax planning.

The General Anti-Abuse Rule (GAAR): Statutory Basis and Scope

GAAR is set out in the Finance Act 2013 and applies to capital gains tax, among other taxes. Its purpose is to counteract tax advantages arising from abusive arrangements. GAAR does not prohibit all forms of tax planning, but it does target arrangements that are considered abusive.

Key Term: General Anti-Abuse Rule (GAAR)
A statutory rule allowing HMRC to counteract tax advantages from arrangements deemed abusive, including for capital gains tax.

Key Term: Abusive Tax Arrangement
An arrangement that cannot reasonably be regarded as a reasonable course of action in relation to the relevant tax provisions, considering all circumstances.

Key Term: Double Reasonableness Test
The statutory test under GAAR that asks whether it would be reasonable to regard the arrangement as a reasonable course of action, considering the purpose of the law.

Identifying Abusive Arrangements

Not all tax avoidance is caught by GAAR. The rule applies only to arrangements that are abusive. The legislation and HMRC guidance identify several features that may indicate abuse:

  • The main or sole purpose is to obtain a tax advantage.
  • The arrangement includes steps that lack genuine commercial purpose.
  • The arrangement exploits gaps or loopholes in the legislation in a way Parliament did not intend.
  • The arrangement is highly contrived or circular, with little or no economic substance.
  • The arrangement relies on differences between UK and foreign tax rules to avoid CGT.

GAAR is not intended to affect straightforward tax planning or transactions with genuine commercial reasons.

The Double Reasonableness Test

The core test under GAAR is the double reasonableness test. This requires considering whether entering into the arrangement can reasonably be regarded as a reasonable course of action in relation to the relevant tax provisions, having regard to all circumstances including the policy and purpose of the law.

If it would not be reasonable to regard the arrangement as reasonable, it is likely to be abusive.

Worked Example 1.1

Scenario:
A taxpayer creates a series of artificial transactions to generate a capital loss, with no real economic effect, solely to offset a large capital gain from the sale of shares.

Answer:
HMRC may apply GAAR. The arrangement is likely to be abusive because it lacks commercial substance and is designed only to secure a tax advantage. The double reasonableness test would not be satisfied.

HMRC Procedure and Taxpayer Safeguards

Before counteracting a tax advantage under GAAR, HMRC must follow a statutory process:

  1. A designated HMRC officer must approve the use of GAAR.
  2. HMRC must notify the taxpayer of its intention to apply GAAR and set out the reasons.
  3. The taxpayer has an opportunity to respond and provide evidence.
  4. The case is referred to the independent GAAR Advisory Panel, which issues an opinion on whether the arrangement is abusive.
  5. HMRC considers the panel’s opinion before making a final decision.
  6. The taxpayer can appeal HMRC’s decision to the tax tribunal.

This process ensures that GAAR is applied fairly and only to genuinely abusive cases.

Worked Example 1.2

Scenario:
An individual transfers an asset to a connected offshore trust, then claims to avoid CGT on a subsequent disposal by exploiting a mismatch between UK and overseas rules.

Answer:
HMRC may challenge the arrangement under GAAR if the main purpose is to avoid CGT and the steps are artificial. The taxpayer would be notified and the GAAR Advisory Panel would review the case.

Practical Impact on Capital Gains Tax Planning

GAAR does not prohibit all tax planning. Transactions with genuine commercial purposes, such as selling an asset to fund a business expansion, are not caught. However, arrangements that are artificial, circular, or lack economic substance are at risk.

Key Term: Commercial Substance
The presence of real economic activity or purpose in a transaction, beyond obtaining a tax advantage.

Taxpayers should ensure that any CGT planning is supported by genuine business reasons and that documentation reflects the commercial rationale.

Exam Warning

GAAR is not limited to schemes that are technically unlawful. It can apply even if all legal formalities are followed, if the arrangement is abusive in substance.

Sector-Specific Considerations

GAAR is relevant in sectors where complex structures are used, such as real estate and digital businesses. For example, using multiple companies or trusts to disguise property trading as investment, or shifting intellectual property to low-tax jurisdictions without real activity, may be challenged under GAAR.

Revision Tip

When revising, focus on the features that distinguish abusive arrangements from legitimate planning: artificial steps, lack of commercial substance, and the main purpose being a tax advantage.

Key Point Checklist

This article has covered the following key knowledge points:

  • GAAR is the main anti-avoidance rule for capital gains tax and targets abusive arrangements.
  • The double reasonableness test is used to assess whether an arrangement is abusive.
  • Features of abusive arrangements include artificial steps, lack of commercial purpose, and exploiting legislative gaps.
  • HMRC must follow a statutory process, including referral to the GAAR Advisory Panel, before applying GAAR.
  • Legitimate tax planning with genuine commercial reasons is not caught by GAAR.

Key Terms and Concepts

  • General Anti-Abuse Rule (GAAR)
  • Abusive Tax Arrangement
  • Double Reasonableness Test
  • Commercial Substance
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