Learning Outcomes
After studying this article, you will be able to explain the difference between tax avoidance and tax evasion, outline the purpose and operation of the General Anti-Abuse Rule (GAAR), apply the double reasonableness test to identify abusive tax arrangements, and recognise the practical implications of anti-avoidance provisions for income tax in SQE1 scenarios.
SQE1 Syllabus
For SQE1, you are required to understand anti-avoidance provisions in the context of income tax. Focus your revision on:
- the distinction between tax avoidance and tax evasion and their legal consequences
- the statutory basis, scope, and application of the General Anti-Abuse Rule (GAAR)
- the meaning of "abusive" arrangements and the double reasonableness test
- how HMRC may counteract abusive arrangements and the process for challenging GAAR decisions
- the practical impact of anti-avoidance rules on tax planning and legal advice
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 difference between tax avoidance and tax evasion?
- What is the General Anti-Abuse Rule (GAAR) and what types of arrangements does it target?
- How does the double reasonableness test operate under GAAR?
- What steps can HMRC take if it considers a tax arrangement to be abusive under GAAR?
Introduction
Anti-avoidance provisions are a key part of the UK income tax system, designed to prevent taxpayers from exploiting the law to obtain tax advantages not intended by Parliament. The General Anti-Abuse Rule (GAAR) is the main statutory tool for tackling abusive tax arrangements. For SQE1, you must be able to distinguish between lawful tax planning and arrangements that cross the line into abuse, understand how GAAR operates, and apply the relevant tests to practical scenarios.
Tax Avoidance vs Tax Evasion
It is essential to distinguish between tax avoidance and tax evasion. Tax avoidance involves arranging affairs to reduce tax liability within the law, such as claiming reliefs or allowances. Tax evasion is illegal and involves deliberately concealing income or providing false information to HMRC.
Key Term: tax avoidance
Arranging affairs to minimise tax liability using legal means, such as reliefs or allowances, but sometimes in ways not intended by Parliament.Key Term: tax evasion
Illegally reducing tax liability by concealing income, falsifying records, or failing to declare taxable income.
The General Anti-Abuse Rule (GAAR)
The GAAR is a statutory rule introduced by the Finance Act 2013 to counteract abusive tax arrangements. It applies to income tax, capital gains tax, corporation tax, inheritance tax, and other major UK taxes.
Key Term: General Anti-Abuse Rule (GAAR)
A statutory rule allowing HMRC to counteract tax advantages arising from arrangements considered "abusive" under the Finance Act 2013.
Scope and Purpose
GAAR is intended to prevent taxpayers from obtaining tax advantages through arrangements that, while technically within the law, are considered abusive because they defeat the purpose of tax legislation. It does not target ordinary tax planning or reasonable use of reliefs.
What is an "Abusive" Arrangement?
An arrangement is "abusive" if it cannot reasonably be regarded as a reasonable course of action in relation to the relevant tax provisions, having regard to all the circumstances.
Key Term: abusive arrangement
A tax arrangement that cannot reasonably be regarded as a reasonable course of action, considering the purpose of the relevant tax law.
The test for abuse is known as the double reasonableness test.
Key Term: double reasonableness test
The test asks whether it would be reasonable to conclude that the arrangement is not a reasonable course of action in relation to the relevant tax provisions.
The Double Reasonableness Test
The double reasonableness test is central to GAAR. It requires HMRC (and, if challenged, the courts) to consider whether it would be reasonable to regard the arrangement as a reasonable course of action, given the purpose of the tax law. If not, the arrangement is abusive.
How GAAR Operates
If HMRC believes a taxpayer has entered into an abusive arrangement, it may:
- Identify the arrangement and consider whether it is abusive under the double reasonableness test.
- Refer the case to the GAAR Advisory Panel for an independent opinion.
- If the arrangement is found to be abusive, HMRC may make "just and reasonable" adjustments to counteract the tax advantage.
- The taxpayer may appeal HMRC's decision to the tax tribunal and courts.
Arrangements Caught by GAAR
GAAR applies to arrangements that are:
- contrived or artificial
- lack genuine commercial purpose beyond obtaining a tax advantage
- exploit loopholes or inconsistencies in tax law
It does not apply to straightforward use of reliefs or allowances as intended by Parliament.
Worked Example 1.1
A taxpayer enters into a series of circular transactions with no commercial purpose except to create an artificial loss, which is then used to reduce their income tax liability.
Answer: HMRC may apply GAAR, as the arrangement is artificial and abusive. The loss would be disallowed, and the taxpayer's liability adjusted.
Worked Example 1.2
An individual claims a relief for pension contributions made in the normal course of saving for retirement.
Answer: GAAR would not apply, as this is a reasonable use of relief as intended by Parliament.
HMRC's Powers and the GAAR Advisory Panel
If HMRC decides to apply GAAR, it must refer the case to the independent GAAR Advisory Panel. The Panel issues an opinion on whether the arrangement is a reasonable course of action. While not binding, the Panel's opinion is highly persuasive.
If HMRC proceeds, it can make counteracting adjustments to the taxpayer's liability. The taxpayer may appeal to the First-tier Tribunal and higher courts.
Exam Warning
GAAR is not intended to catch ordinary tax planning or use of reliefs. It is aimed at arrangements that are clearly abusive, not merely aggressive.
Practical Implications for Legal Advice
Legal practitioners must ensure that tax planning advice does not cross the line into abuse. When advising clients:
- Consider the commercial purpose of the arrangement.
- Assess whether the arrangement is reasonable in light of the purpose of the tax law.
- Warn clients of the risk of GAAR counteraction if arrangements are artificial or contrived.
Revision Tip
When answering SQE1 questions, focus on whether the arrangement has genuine commercial substance and whether it aligns with the purpose of the tax provision.
Key Point Checklist
This article has covered the following key knowledge points:
- The distinction between tax avoidance (legal) and tax evasion (illegal).
- The statutory basis, scope, and purpose of the General Anti-Abuse Rule (GAAR).
- The meaning of "abusive" arrangements and the double reasonableness test.
- How HMRC applies GAAR and the role of the GAAR Advisory Panel.
- The importance of commercial substance and legislative intent in tax planning.
Key Terms and Concepts
- tax avoidance
- tax evasion
- General Anti-Abuse Rule (GAAR)
- abusive arrangement
- double reasonableness test
