Learning Outcomes
After studying this article, you will be able to explain the main anti-avoidance provisions relevant to UK corporation tax, including the General Anti-Abuse Rule (GAAR), Targeted Anti-Avoidance Rules (TAARs), and key international measures. You will be able to apply the double reasonableness test, identify when specific anti-avoidance rules apply, and recognise how these provisions interact in practical scenarios for SQE1 assessment.
SQE1 Syllabus
For SQE1, you are required to understand the anti-avoidance framework for corporation tax, including the main statutory and international provisions, and how they operate in practice. In your revision, focus on:
- The scope and operation of the General Anti-Abuse Rule (GAAR) and the double reasonableness test
- The role and application of Targeted Anti-Avoidance Rules (TAARs), including those on close company loans and transfer pricing
- International anti-avoidance measures, such as Controlled Foreign Companies (CFC) rules and the Diverted Profits Tax (DPT)
- The interaction between GAAR, TAARs, and international rules in countering tax avoidance schemes
- The practical consequences for companies and the approach of HMRC to abusive arrangements
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.
- What is the purpose of the General Anti-Abuse Rule (GAAR) in UK corporation tax, and what is the double reasonableness test?
- How does the TAAR on loans to participators in close companies operate, and what is its intended effect?
- What is the Controlled Foreign Companies (CFC) regime designed to prevent, and how can it affect a UK parent company?
- When might the Diverted Profits Tax (DPT) apply to a multinational group, and why is its rate higher than the standard corporation tax rate?
Introduction
Corporation tax anti-avoidance provisions are a core part of the UK tax system, designed to prevent companies from reducing their tax bills through artificial or abusive arrangements. The main tools are the General Anti-Abuse Rule (GAAR), Targeted Anti-Avoidance Rules (TAARs), and international measures such as the Controlled Foreign Companies (CFC) regime and the Diverted Profits Tax (DPT). These rules work together to ensure that companies pay the correct amount of tax in line with the intention of the law.
The General Anti-Abuse Rule (GAAR)
The GAAR is a statutory rule that allows HMRC to counteract tax advantages arising from arrangements that are considered abusive.
Key Term: General Anti-Abuse Rule (GAAR)
A statutory rule that enables HMRC to deny tax advantages from arrangements judged to be abusive, based on a double reasonableness test.
The Double Reasonableness Test
The GAAR applies if an arrangement cannot reasonably be regarded as a reasonable course of action in relation to the relevant tax provisions. This is known as the double reasonableness test.
Key Term: Double Reasonableness Test
The test under GAAR asking whether it is reasonable to regard the arrangement as a reasonable course of action, considering all circumstances.
If an arrangement is found to be abusive, HMRC can make adjustments to counteract the tax advantage. The GAAR covers corporation tax, income tax, capital gains tax, inheritance tax, and other major taxes.
GAAR Advisory Panel
The GAAR Advisory Panel provides opinions on whether arrangements are abusive, giving guidance to both taxpayers and HMRC.
Key Term: GAAR Advisory Panel
An independent panel that issues opinions on whether a tax arrangement is abusive under the GAAR.
Worked Example 1.1
A UK company sets up a subsidiary in a low-tax jurisdiction. The subsidiary has no staff or real activity but receives large royalty payments from the UK company, reducing UK taxable profits.
Question: Would this arrangement likely be caught by GAAR?
Answer: Yes. While international structuring can be legitimate, if the subsidiary lacks substance and the arrangement is designed solely to avoid UK tax, it is likely to be considered abusive under the double reasonableness test.
Targeted Anti-Avoidance Rules (TAARs)
TAARs are specific statutory provisions aimed at particular types of tax avoidance. They operate alongside GAAR to address known avoidance risks.
Key Term: Targeted Anti-Avoidance Rule (TAAR)
A statutory rule aimed at countering specific tax avoidance strategies, such as loans to participators or transfer pricing.
Loans to Participators in Close Companies
A close company is a company controlled by five or fewer shareholders or by its directors.
Key Term: Close Company
A company controlled by five or fewer shareholders (participators) or by its directors.
If a close company makes a loan to a participator (such as a director-shareholder), a tax charge arises under s. 455 Corporation Tax Act 2010.
Worked Example 1.2
XYZ Ltd, a close company, lends £50,000 to its director-shareholder. The loan is not repaid within nine months of the end of the accounting period.
Question: What is the tax consequence for XYZ Ltd?
Answer: XYZ Ltd must pay a tax charge of 33.75% of the loan amount (£16,875) under s. 455. This charge is repayable if the loan is repaid, but it discourages tax-free extraction of value.
Transfer Pricing
Transfer pricing rules prevent companies from shifting profits by setting artificial prices in transactions with connected parties.
Key Term: Transfer Pricing
Rules requiring transactions between connected parties to be priced as if they were between independent parties (arm's length).
If a UK company pays inflated prices to an overseas subsidiary, HMRC can adjust the prices to reflect arm's length terms, increasing UK taxable profits.
International Anti-Avoidance Measures
Global groups often seek to reduce tax by shifting profits to low-tax countries. The UK has rules to counteract this.
Controlled Foreign Companies (CFC) Rules
The CFC regime targets profits diverted to foreign subsidiaries controlled by UK companies.
Key Term: Controlled Foreign Company (CFC)
A non-UK company controlled by UK residents, whose profits may be attributed to the UK parent for tax purposes.
If a CFC's profits arise from artificial arrangements to avoid UK tax, those profits can be taxed in the UK.
Diverted Profits Tax (DPT)
DPT is a separate tax at a higher rate (25%) designed to deter profit diversion from the UK.
Key Term: Diverted Profits Tax (DPT)
A UK tax at 25% on profits diverted from the UK by large multinational groups using artificial arrangements.
DPT applies where a group avoids a UK taxable presence or exploits tax mismatches to reduce UK tax.
Worked Example 1.3
A multinational group sells products in the UK through a local agent, but claims that profits are earned by an offshore company with no real UK presence.
Question: How might DPT apply?
Answer: If the arrangement is found to artificially avoid a UK taxable presence, DPT can be charged at 25% on the diverted profits, even if corporation tax does not apply.
How the Rules Interact
GAAR, TAARs, and international rules work together. A single arrangement may be challenged under more than one provision. For example, a profit-shifting scheme might be caught by transfer pricing rules, CFC rules, and GAAR if it is abusive.
Exam Warning
Some arrangements may fall under both GAAR and a TAAR. HMRC may use all available tools to counteract tax avoidance. Always consider the interaction of rules in exam scenarios.
Case Law and Practical Application
Key cases illustrate how anti-avoidance rules are applied.
Worked Example 1.4
In HMRC v Hyrax Resourcing Ltd [2019], a scheme paid employees via offshore trusts, claiming payments were loans and not taxable.
Question: Was this arrangement effective?
Answer: No. The tribunal found the arrangement was abusive and HMRC applied GAAR to counteract the tax advantage, treating the payments as taxable income.
Key Point Checklist
This article has covered the following key knowledge points:
- The General Anti-Abuse Rule (GAAR) allows HMRC to counteract abusive tax arrangements using the double reasonableness test.
- Targeted Anti-Avoidance Rules (TAARs) address specific avoidance risks, such as loans to participators and transfer pricing.
- International measures, including CFC rules and DPT, prevent profit shifting and base erosion by multinational groups.
- GAAR, TAARs, and international rules can apply together to counteract tax avoidance.
- Practical examples and case law demonstrate how these rules operate in real scenarios.
Key Terms and Concepts
- General Anti-Abuse Rule (GAAR)
- Double Reasonableness Test
- GAAR Advisory Panel
- Targeted Anti-Avoidance Rule (TAAR)
- Close Company
- Transfer Pricing
- Controlled Foreign Company (CFC)
- Diverted Profits Tax (DPT)
