John Mackay Tax Avoidance and Mitigation It has been said that tax is the cost of civilisation and thus a necessary "evil". Accordingly those who choose to reduce their tax bills are undermining the attempts of a civilised society to organise itself for the benefit of all. It has been recently said, by Dawn Primarolo MP, that taxpayers who contribute their fair share of taxes have a right to expect that others will also do so. Accordingly those who seek to find ways to save tax are almost considered enemies of the state and if high profile may well find their personal details splashed across newspapers or the subject of television "investigations", as has happened with famous retailers and hedge fund managers. Not paying tax tends to be described as either evasion, avoidance or mitigation of tax. In the UK we have historically thought that the difference between evasion and avoidance was the thickness of a prison cell wall. Evasion is not paying the tax you lawfully owe - usually by concealing income or capital. The UK "black economy" has been estimated at 5-10% of GDP. This is an economy driven by unreported cash or barter transactions and ranges from the odd job man to large organised gangs. Many years ago we would have been content to say other ways to reduce your tax bill were avoidance and legitimate from a legal view. In doing so we were indebted to a 1936 tax case involving the Duke of Westminster, who changed the method of paying his domestic staff from wages to tax deductible annuities. In finding for the Duke a Law Lord commented that every man was entitled to order his affairs so his tax is less that it otherwise would have been. This gave a legal basis to tax avoidance. Taxpayers could carry out transactions, which if legally correct would be accepted by the courts. With the existence of high tax rates there was a great deal of demand for tax saving schemes. It is no surprise that very creative minds were attracted into this industry and in the seventies there arose a supplier of schemes - Rossminster. This was an organisation that combined ingenious tax minds with financing to offer packaged tax schemes. It challenged the very basis of taxation by effectively making it a voluntary charge. Those who were prepared to pay could walk in off the street, pay their fee, and walk out again with their tax disappeared. The schemes themselves were likened to plays in that they were so well packaged the parties became like players who walked on stage played their part and walked off again. The schemes tended to involve a great number of steps all completed in a relatively short time. However such schemes could only save tax because the courts would not adopt a substance over form approach and tax the economic end result nor would they characterise extremely artificial steps in the schemes as shams and deprive them of legal effect. With the civilisation of the UK threatened and the courts facing an overwhelming case load as the Inland Revenue sought to litigate the numerous Rossminster schemes; the Law Lords in 1981 moved the goalposts. In a famous judgment they formulated the Ramsay doctrine which meant that schemes with inserted "tax" steps would be taxed by reference to the end result achieved as if a single composite transaction had happened. The Ramsay doctrine has been refined over time and we are at the stage where the Ramsay approach has been subsumed into a wider purposive approach to interpreting tax law. This has given rise to the concept of mitigation. This is a form of tax saving where the taxpayer takes the benefit of a tax effect, exemption or relief offered by Parliament and falls within the circumstances to which that effect, exemption or relief is directed. From a Government perspective the Ramsay case and its evolution was helpful but did not halt the growth in tax schemes. Harking back to earlier Rossminster days the suppliers of schemes became much more organised about the packaging and mass marketing of schemes. Very much helped by modern means of communicating. The demand remained high even with reduced direct taxes. Post the 1984 Big Bang the large City institutions with burgeoning employer National Insurance costs, because of their highly paid employees, sought ways to reduce costs and in the difficult years make bonus pools go further. The growth in highly paid fund management businesses, such as hedge funds, which have very high income streams, further increased the number of taxpayers seeking to reduce their tax costs. New schemes were created and mass marketed. It became clear that it was beyond the Revenue to control such activities. Tax law was being re-written in a very codified manner, like computer software. This meant that the collection of rules that prescribed the tax universe had flaws, gaps and unintended effects. Unlike software there are no pilot tests of tax law. Imperfections bred schemes which allied to demand and organised sellers once more created an avalanche of tax investigations and litigation. Also in the business tax area much of the tax law was being made subservient to general accounting principles. Therefore control shifted to the accounting bodies. Perhaps due to funding issues and loss of revenue, perhaps due to exasperation, whatever the reason patience snapped at the Treasury. Rather than introduce a general anti-avoidance rule allowing courts to look through tax orientated schemes, the UK followed the US approach and now requires advisers to disclose tax schemes to HM Revenue & Customs at a very early stage in their proposal to potential clients. In addition Dawn Primarolo stated in December 2004, that law blocking schemes, in particular those saving tax on employment income would be made retrospective back to the date of her announcement. One could also be forgiven for thinking, that like the US, there may also be a bit of shaming and naming as a further disincentive to avoid tax. It is clear that the fairness and morality arguments are being pushed in support of the effort to stop perceived avoidance. We are now in world where tax planning should be thought of as acceptable or unacceptable. The primary arbitrator of that is the Government as it requires and receives ever more disclosure of schemes and introduces correcting legislation. The judges have been relegated by the Treasury's adoption of a US approach. What of the high income retailers or hedge fund managers? Living abroad remains within the realms of acceptable tax planning. You need to live abroad for five years to escape capital gains tax - but only one year for income tax. As for the rest of us do we feel more civilised? Clearly we will have our own views on this, but the manner in which the Government has sought to bypass its own restrictions on political funding may indicate otherwise.

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