PROTECTING THE REVENUE – SOME COMMON INTERNATIONAL ISSUES
Justice G.T. Pagone
International Tax Law – University of Padua
Lectio Magistralis
27 September 2017
There has been much discussion in recent times about the need to protect the base upon which countries collect revenue.  The OECD and G20 published a report in 2015 on Base Erosion and Profit Shifting.  It listed 15 actions which were directed in part to deal with challenges to taxing regimes from the digital economy, in part to deal with profit shifting by large multinationals, and in part to protect the revenue base through international co‑operation. 
The concern to protect the revenue base, and its international consequences, is not new.  Bilateral treaties, whether based on the OECD model, or otherwise, have long recognised the dual risks of double taxation and of tax avoidance.  The treaties, and the OECD model, have tried to balance the competing claims of different countries to impose tax upon those who come within their jurisdictions.  Sometimes the same economic gain has been at risk of being taxed more than once by competing claims by different countries.  The bilateral agreements have sought to express agreement at an international level about which country can impose which tax and upon what basis it may be imposed, without the enterprise being taxed twice or avoiding tax altogether.  Sometimes the different bases for taxation between countries have also lead to anomalies and have provided some taxpayers with opportunities for tax avoidance.
The more recent concerns about base erosion have also looked at the digital economy as creating new risks of erosion of the basis upon which revenue is collected.  A simple transaction, for example, of buying a book, which might once have been done at a local shop in one country with the profit from the sale taxed in the place of purchase from the local store, may now regularly be done over the internet from a distant place with a difference between where the profit is earned and which country may claim to tax the transaction.  The digital economy has developed and expanded in ways that were unimaginable not very long ago.  It has also brought new opportunities for profit to be shifted to low tax jurisdictions as part of the inevitable global planning of large multinationals as they use their global resources efficiently and with an eye to be tax effective.  Large global enterprises have a legitimate interest in knowing how they will be taxed in the countries in which they have economic activity, and also have a legitimate claim that they not be taxed disproportionately in one country in respect of gains that may to some extent be referrable to profits made in another jurisdiction.  Large global enterprises face genuinely complicated questions about how to allocate their profits and costs throughout the group, with consequences for the amount of tax payable by them in the various jurisdictions in which they operate.  The allocation of worldwide costs throughout a large multinational company, as well as the global allocation of licence fees, financing costs and intellectual property rights, are all relevant elements which together make up the gains of a worldwide group in respect of which different countries may have different and competing claims about taxable gains and tax deductions.  
Domestic tax laws give effect to the international agreements for the allocation of taxing rights and the prevention of tax avoidance.  General anti‑avoidance rules are intended to preserve the integrity of the domestic taxing regime but must sometimes do so with an eye to international dealings and international arrangements.  Australia has recently made changes to its general anti‑avoidance rule in part to give effect to the concerns about base erosion and profit shifting.  In 2015 Australia extended its general anti‑avoidance rules in a way that was said to be designed to counter base erosion by international entities “using artificial or contrived arrangements to avoid the attribution of business profits to Australia through a taxable presence in Australia”.  More amendments were made to the anti‑avoidance rule in 2017 by the creation of a new tax on “diverted profits” at a rate of 40% to deal with what was described as “taxpayers who transfer profits to offshore associated entities using arrangements entered into or carried out for a principal purpose of avoiding Australian tax”.  These amendments were made in the context of existing laws to protect the revenue base from tax avoidance.  Australia, like other countries, has long had provisions designed to protect its revenue base from tax avoidance but they were thought to be insufficient for the times and in need of extension.  What is new about the amendments is the way in which they seek to deal with what is seen as the avoidance of domestic tax by international corporate activity in which multinationals organise their global affairs to achieve a domestic Australian tax effect which the Australian parliament believes to be unacceptable.  The new provisions use some of the concepts already found in existing transfer pricing provisions, but locate them within anti‑avoidance rules.
It is important to remember in any discussion about tax avoidance that we are dealing with lawful transactions which are otherwise effective to achieve what they intended under the general taxing laws.  Tax avoidance is to be distinguished from (a) sham transactions which are legally ineffective, (b) tax evasion which involves some element of fault or illegality not present in tax avoidance, and (c) transactions which simply fail to achieve their intended fiscal purpose under the general taxing laws.  Anti‑avoidance provisions generally assume that the ordinary tax provisions allowed what the anti‑avoidance provisions will disallow.  Anti‑avoidance rules, in other words, come into effect when the ordinary tax provisions have allowed the tax benefits of a transaction which would otherwise be effective but is nonetheless considered to be an avoidance of the provisions.  There is often, therefore, a tension to resolve when formulating tax avoidance provisions to determine a predictable, reliable and defensible measure as the basis to disallow something which the ordinary tax provisions would allow.  An idea which is often found in such provisions is that they are directed to transactions which are seen as what an abuse or a misuse of the provisions relied upon.  The basis for the application of general anti‑avoidance provisions is often made to be whether what a taxpayer has done can be seen as a misuse or an abuse of a provision.  The subjective motive of avoiding tax, however, is usually not thought to be a measure, or even relevant to a measure, of impermissible tax avoidance.
Economic Substance Doctrine:  USA
The economic substance doctrine enunciated in Gregory v Helvering depended upon the view that to uphold the taxpayer’s transaction as effective would have been to sanction an abuse or a misuse of a provision which the taxpayer had relied upon.  In that case the taxpayer had claimed that certain transactions amounted to a corporate “reorganisation” within a provision of the Revenue Act of 1928 which gave certain distributions a tax advantage.  In that case the United States Supreme Court decided that the transaction was not entitled to the benefit which applied to a corporate reorganisation because what was said to be a “reorganisation” was found to lack economic or business substance, and, therefore, that to have held, otherwise would have been to allow a misuse of the provision.  
The opinion of the United States Supreme Court, as well as that of Learned Hand in the Court of Appeals, made clear that the basis of the decision against the taxpayer was that the purported “reorganisation” was not what the legislature had contemplated as a “reorganisation” notwithstanding the transaction’s apparent compliance with the statutory words.  The Courts accepted that a taxpayer’s conduct may be motivated to avoid tax without adverse consequence, but the Court held that what was put forward as a corporate “reorganisation” was not within the provision’s contemplation of a “reorganisation”.  Critical to that conclusion was that the transaction found on the facts, and claimed to be a “reorganisation”, was not what might be expected to be found as a “reorganisation” when the provision ordinarily applied.
The reasoning in the Courts’ opinion depended fundamentally upon principles of legislative interpretation and not upon the application of a separate rule about tax avoidance.  The Court in that case decided that the rule relied upon by the taxpayer could not be interpreted as the taxpayer had done.  The United States did not have a statutory general anti‑avoidance rule to strike down tax avoidance arrangements and the much later legislative enactment clarifying the economic substance doctrine depends upon the common law as enunciated by the Court and upon construction of the primary taxing provisions.  It is important to bear in mind, therefore, that the courts were not creating law when deciding the case, but were applying the existing statutory provisions.
The conclusion in Gregory v Helvering that what the taxpayer had done did not amount to a “reorganisation” within the contemplation of the words in the section, however, was not based upon a literal construction of the words.  The courts’ opinions accepted that the section’s literal terms may have been satisfied by the taxpayer but that what had been done could not be seen to fall within what the section intended.  That conclusion depended upon an objective comparison between what the section intended and what the taxpayer achieved.  Learned Hand’s conclusion against the taxpayer fastened upon the absence of economic or business reality in what was said by the taxpayer to have been a “reorganisation”:  
We agree with the Board and the taxpayer that a transaction, otherwise within an exception of the tax law, does not lose its immunity, because it is actuated by a desire to avoid, or, if one choose, to evade, taxation.  Anyone may so arrange his affairs so that his taxes shall be as low as possible; he is not bound to choose that pattern which will best pay the Treasury; there is not even a patriotic duty to increase one’s taxes …  Nevertheless, it does not follow that Congress meant to cover such a transaction, not even though the facts answer the dictionary definitions of each term used in the statutory definition … [T]he meaning of a sentence may be more than that of the separate words, as a melody is more than the notes, and no degree of particularity can ever obviate recourse to the setting in which all appear, and which all collectively create.
The opinion of the Supreme Court on appeal placed emphasis upon the absence of business or corporate purpose to a transaction which otherwise appeared to come within the words used by the legislature:
Putting aside, then, the question of motive in respect of taxation altogether, and fixing the character of the proceeding by what actually occurred, what do we find?  Simply an operation having no business or corporate purpose – a mere device which put on the form of a corporate reorganisation as a disguise for concealing its real character, and for the sole object and accomplishment of which was the consummation of a preconceived plan, not to reorganise a business or any part of a business, but to transfer a parcel of corporate shares to the petitioner …  The rule which excludes from consideration the motive of tax avoidance is not pertinent to the situation, because the transaction upon its face lies outside the plain intent of the statute.  To hold otherwise would be to exult artifice above reality and to deprive the statutory provision in question of all serious purpose. 
The conclusion that “the transaction upon its face” was said to fall outside the plain intent of the statute required a consideration of “what actually occurred.”  It also required, of course, a consideration of how the section was otherwise expected to operate.  It was in the comparison of the two that the Court concluded that what actually occurred did not match the business or corporate outcomes expected in the intended application of the relevant provision.  An abuse or misuse of the provisions was seen not in the taxpayer’s subjective intention, or in the taxpayer securing a tax advantage, but in the objective comparison of how the section operated as used by the taxpayer with how the section could objectively be expected to operate:  the objective features expected in the latter were not actually present in the former.  The motive of the taxpayer was irrelevant because although the motive might explain why the transaction occurred the transaction fell outside the operation of the section because it did not achieve what the section contemplated.  The transaction was ineffective because it lacked the objectively ascertainable business or corporate operation that could be expected of transactions of the kind contemplated by the provision.  The reason for the Court’s view that to permit reliance upon the section in the circumstances would “exalt artifice above reality and […] deprive the statutory provision in question of all serious purpose” was found in a comparison of what was done with what could be expected to be seen in the intended legislative operation of the provision.

Abuse in the Canadian GAAR
A similar approach can be seen to underlie the position taken in Canada, although Canada has not relied only upon principles of statutory interpretation to deal with tax avoidance but has enacted a specific provision to disallow tax benefits which come within a legislative general anti‑avoidance tax rule.  The rule assumes that a transaction would otherwise have been effective to obtain a tax benefit but provides that it may be disallowed under the general anti‑avoidance rule.  
A transaction caught by the Canadian general anti‑avoidance rule must be both an “avoidance” transaction and an “abuse or misuse” of the provision relied upon.  Section 245(3) of the Income Tax Act, RSC (1985) denies tax benefits to tax avoidance transactions as defined, but s 245(4) excludes from the operation of the general anti‑avoidance rule those transactions which are not also an abuse or a misuse of the provision.  Section 245(4) provides:
245(4)	Subsection (2) applies to a transaction only if it may reasonably be considered that the transaction

(a)	would, if this Act were read without reference to this section, result directly or indirectly in a misuse of the provisions of any one or more of
(i)	this Act,
(ii)	the Income Tax Regulations,
(iii)	the Income Tax Application Rules,
(iv)	a tax treaty, or
(v)	any other enactment that is relevant in computing tax or any other amount payable by or refundable to a person under this Act or in determining any amount that is relevant for the purposes of that computation; or
(b)	would result directly or indirectly in an abuse having regard to those provisions, other than this section, read as a whole.
In Canada Trustco Mortgage Co v Canada the Canadian Supreme Court explained that in determining whether the general anti‑avoidance rule applied to a transaction there needed to be considered:  (a) whether there was a tax benefit arising from the transaction; (b) whether the transaction was an avoidance transaction because it was not arranged primarily for bona fide purposes other than to obtain the tax benefit; and (c) whether the avoidance transaction was an abuse or a misuse of the provisions.  Each needed to be satisfied for the general anti‑avoidance rule to operate.  
The finding of a transaction as an avoidance transaction depends upon a consideration of the purpose for which the transaction was entered into and, in particular, upon whether the transaction had been undertaken or arranged primarily for bona fide purposes other than to obtain the tax benefit.  The focus of that enquiry is the transaction itself.  The requirement concerning whether the transaction was abusive, however, depends upon an enquiry into whether the transaction, albeit an avoidance transaction, was also to be regarded as abusive in the sense that the taxpayer was relying upon a specific provision “in order to achieve an outcome that those provisions seek to prevent.”  The focus of that enquiry is the “contextual and purposive interpretation” of the relevant provision “and the application of the properly interpreted provisions to the facts of a given case.” 
In Canada Trustco the Court explained that the application of the abuse and misuse text in s 245(4) imposed a two part enquiry:
The first step is to determine the object, spirit or purpose of the provisions of the Income Tax Act that are relied on for the tax benefit, having regard to the Act, the relevant provisions and permissible extrinsic aids.  The second step is to examine the factual context of a case in order to determine whether the avoidance transaction defeated or frustrated the object, spirit or purpose of the provisions in issue.
In that case the Court concluded that deductions which had been claimed by the taxpayer from a sale and lease back transaction, albeit an avoidance transaction, was consistent with the object and spirit of the taxing provisions relied upon by the taxpayer notwithstanding that there may not have been real financial risk or economic cost.
In Copthorne Holdings Ltd v Canada the Supreme Court subsequently upheld the application of the general anti‑avoidance rule to a company amalgamation in which the amalgamated corporation redeemed a large portion of its shares and paid out the aggregate paid up capital attributable to the redeemed shares to its non-resident shareholder who treated the payment as a return of capital rather than as taxable income.  The abuse or misuse of the provision in that case was found in the comparison between the outcome achieved by the taxpayer and what could be expected in the ordinary course of the application of the provisions.  In delivering the judgment for the Court Rothstein J wrote:
I am of the opinion that the sale by Copthorne I of its VHHC Holdings shares to Big City, which was undertaken to protect $67,401,279 of PUC from cancellation, while not contrary to the text of s 87(3), does frustrate and defeat its purpose.  The tax-paid investment here was in total $96,736,845.  To allow the aggregation of an additional $67,401,279 to this amount would enable payment, without liability for tax by the shareholders, of amounts well in excess of the investment of tax-paid funds, contrary to the object, spirit and purpose or the underlying rationale of s. 87(3).  While a series of transactions that results in the “double counting” of PUC is not in itself evidence of abuse, this outcome may not be foreclosed in some circumstances.  I agree with the Tax Court’s finding that the taxpayer’s “double counting” of PUC was abusive in this case, where the taxpayer structured the transactions so as to “artificially” preserve the PUC in a way that frustrated the purpose of s 87(3) governing the treatment of PUC upon vertical amalgamation.  The sale of VHHC Holdings shares to Big City circumvented the parenthetical words of s 87(3) and in the context of the series of which it was a part, achieved a result the section was intended to prevent and thus defeated its underlying rationale.  The transaction was therefore abusive and the assessment based on application of the GAAR was appropriate.
The “double counting” of the paid up capital by the transaction was seen as a misuse of the relevant provision.
Parliamentary Contemplation Test in New Zealand
The general anti‑avoidance rule in New Zealand does not expressly include a concept of abuse or misuse like that found in the Canadian legislation, but the New Zealand Supreme Court has interpreted the New Zealand provisions by reference to similar concepts.  In Ben Nevis Forestry Ventures Limited v Commissioner of Inland Revenue the New Zealand Supreme Court adopted a test for the application of its general anti‑avoidance rules to a transaction which required consideration of the purpose contemplated by Parliament when enacting the provision which the transaction was said to have avoided.  In the joint judgment of Tipping, McGrath and Gault JJ their Honours said:
When, as here, a case involves reliance by the taxpayer on specific provisions, the first enquiry concerns the application of those provisions.  The taxpayer must satisfy the court that the use made of the specific provision is within its intended scope.  If that is shown, a further question arises based on the taxpayer’s use of the specific provision viewed in the light of the arrangement as a whole.  If, when viewed in that light, it is apparent that the taxpayer has used a specific provision, and thereby altered the incidence of income tax, in a way which cannot have been within the contemplation and purpose of Parliament when it enacted the provision, the arrangement will be a tax avoidance arrangement.
The inquiry called for in that context is similar to the Canadian abuse test and to the economic substance doctrine of the United States.  The New Zealand Parliamentary contemplation test also calls for an inquiry into whether the specific transaction entered into by the taxpayer was the kind of transaction which the Parliament could have been expected to contemplate by the provision relied upon by the taxpayer.  
The New Zealand Supreme Court indicated that the enquiry into whether a tax avoidance arrangement exists is broad and not confined.  In Ben Nevis it was said:
The general anti-avoidance provision does not confine the Court as to the matters which may be taken into account when considering whether a tax avoidance arrangement exists.  Hence the Commissioner and the courts may address a number of relevant factors, the significance of which will depend on the particular facts.  The manner in which the arrangement is carried out will often be an important consideration.  So will the role of all relevant parties and any relationship they may have with the taxpayer.  The economic and commercial effect of documents and transactions may also be significant.  Other features that may be relevant include the duration of the arrangement and the nature and extent of the financial consequences that it will have for the taxpayer.  As indicated, it will often be the combination of various elements in the arrangement which is significant.  A classic indicator of a use that is outside Parliamentary contemplation is the structuring of an arrangement so that the taxpayer gains the benefit of the specific provision in an artificial or contrived way.  It is not within Parliament’s purpose for specific provisions to be used in that manner.
In considering these matters, the courts are not limited to purely legal considerations.  They should also consider the use made of the specific provision in the light of the commercial reality and the economic effect of that use.  The ultimate question is whether the impugned arrangement, viewed in a commercially and economically realistic way, makes use of the specific provision in a manner that is consistent with Parliament’s purpose.  If that is so, the arrangement will not, by reason of that use, be a tax avoidance arrangement.  If the use of the specific provision is beyond Parliamentary contemplation, its use in that way will result in the arrangement being a tax avoidance arrangement.
The Parliamentary contemplation test is not without its difficulty, but its underlying purpose is to provide a predictable and objective foundation for determining when a taxpayer may rely upon a provision to secure its benefit without falling foul of the general anti-avoidance rules.
The Ramsay Approach in the United Kingdom
The United Kingdom has enacted a general anti-avoidance rule in recent years, but the courts have previously been called upon to decide cases said to involve tax avoidance, and the jurisprudence that developed before the recent statutory provisions has not been overruled and continues to be relevant.  The approach adopted in W T Ramsay Ltd v Inland Revenue Commissioners was, like the US economic substance doctrine and the New Zealand Parliamentary contemplation test, also based upon statutory interpretation rather than a separate statutory rule.  The United Kingdom did not have a separate general anti‑avoidance rule when Ramsay was decided and, like the Supreme Court of the United States, was required to interpret and apply the ordinary taxing provisions according to their terms.  The principle first articulated in Ramsay was, therefore, said by Lord Wilberforce to be within the function of the courts to apply strictly and correctly the legislation enacted by Parliament. In that context, his Lordship said of the approach to construction which was adopted:
That does not introduce a new principle: it would be to apply to new and sophisticated legal devices the undoubted power and duty of the courts to determine their nature in law and to relate them to existing legislation. While the techniques of tax avoidance progress and are technically improved, the courts are not obliged to stand still. Such immobility must result either in loss of tax, to the prejudice of other taxpayers, or to Parliamentary congestion or (most likely) to both. To force the courts to adopt, in relation to closely integrated situations, a step by step, dissecting, approach which the parties themselves may have negated, would be a denial rather than an affirmation of the true judicial process.
The question in Ramsay was whether there had been a disposal of an asset giving rise to a taxable loss. The specific issue of statutory interpretation was whether the particular transaction came within the intended terms of the statute where the disposal was brought about by a series of steps, each of which the parties necessarily intended to be effective according to their terms, but where their ongoing practical and economic effect, apart from tax, had been intentionally negated as part of the composite arrangement.  The House of Lords held in Ramsay that the transaction did not come within the intended contemplation of the statute and dismissed the taxpayer’s reliance upon a provision where the facts (at the conclusion of all of the steps of a composite set of transactions) revealed an absence of the things one might ordinarily have expected to find where the provision would ordinarily apply.
The principle enunciated in Ramsay, and sometimes known as the doctrine of fiscal nullity, was not without difficulty or criticism in subsequent cases and by commentators.  The principle was subsequently formulated by Lord Brightman in Furniss (Inspector of Taxes) v Dawson as follows:
First, there must be a pre-ordained series of transactions; or, if one likes, one single composite transaction. This composite transaction may or may not include the achievement of a legitimate commercial (i.e. business) end. The composite transaction does, in the instant case; it achieved a sale of the shares in the operating companies by the Dawsons to Wood Bastow. It did not in Ramsay. Secondly, there must be steps inserted which have no commercial (business) purpose apart from the avoidance of a liability to tax – not “no business effect”. If those two ingredients exist, the inserted steps are to be disregarded for fiscal purposes. The court must then look at the end result. Precisely how the end result will be taxed will depend on the terms of the taxing statute sought to be applied.
This formulation attempted to give formal legal structure and predictability to an approach that might otherwise have been too loose to apply.  In Furniss Lord Brightman tried to provide more precision to the approach which had been adopted in Ramsay by focusing upon the composite nature of transactions which included steps that had no business purpose apart from the avoidance of a liability to tax, but the formulation by Lord Brightman was subsequently said by Lord Walker to have obscured the clarity of Lord Wilberforce’s insight.  
The dicta in Furniss was criticised as having given rise to the view that the principle enunciated in Ramsay had created new jurisprudence applicable to taxing statutes to the effect that transactions or elements in transactions which had no commercial purpose were to be disregarded.  In Barclays Mercantile Business Finance Ltd v Mawson (Inspector of Taxes) it was said that drawing such a conclusion from the cases went too far.  In that case it was said that it was necessary first to decide what transaction came within the relevant statutory description and next to decide whether the transaction in question came within that description. Lord Nicholls explained that the approach taken in the earlier decisions depended on statutory interpretation, saying: 
The essence of the new approach was to give the statutory provision a purposive construction in order to determine the nature of the transaction to which it was intended to apply and then to decide whether the actual transaction (which might involve considering the overall effect of a number of elements intended to operate together) answered to the statutory description. Of course this does not mean that the courts have to put their reasoning into the straitjacket of first construing the statute in the abstract and then looking at the facts. It might be more convenient to analyse the facts and then ask whether they satisfy the requirements of the statute. But however one approaches the matter, the question is always whether the relevant provision of the statue, upon its true construction, applies to the facts as found. As Lord Nicholls of Birkenhead said in MacNiven v Westmoreland Investments Ltd [2003] 1 AC 311, 320, para 8: “The paramount question always is one of interpretation of the particular statutory provision and its application to the facts of the case”.
In Barclays it was held that the taxpayer was entitled to the capital expenditure allowance under s 24(1) of the Capital Allowances Act 1990 (UK) notwithstanding that some transactions may have had no commercial purpose apart from the tax benefit secured. In that case a company (BGE) had built a pipeline and incurred expenditure which it did not expect to absorb for some time. Transactions were entered into, including a sale and leaseback, which enabled another company to enjoy the capital expenditure allowance and to pass on a benefit to BGE.
The basis of the Ramsay principle was statutory interpretation, but its application concerned something about the effect of some aspect of a transaction being to nullify the non‑tax consequences of other aspects of the transaction for all purposes other than tax.  The terms of the principle were traced in a later case to the acceptance by Lord Wilberforce of the argument put by the Revenue in Ramsay. In Schofield v HM Revenue and Customs the Chancellor (with whom Hallett and Patten L.JJ agreed) explained: 
The argument for the Revenue, as recorded on page 314, was that 
"Where the taxpayer enters into a preconceived series of interdependent transactions deliberately contrived to be self-cancelling, that is to say, to return him substantially to the position he enjoyed at the outset, and incapable of having any appreciable effect on his financial position, no single transaction in the series can be isolated on its own as a disposal for the purposes of the statute." 
This argument was accepted by Lord Wilberforce, with whom Lords Russell of Killowen, Roskill and Bridge of Harwich agreed, and by Lord Fraser. 
On page 323 Lord Wilberforce set out the argument for the taxpayer in opposition to that of the Revenue, namely the subject was to be taxed by clear words and if a transaction is genuine the courts cannot go behind it and continued: 
"This is a cardinal principle but it must not be overstated or overextended. While obliging the court to accept documents or transactions, found to be genuine, as such, it does not compel the court to look at a document or a transaction in blinkers, isolated from any context to which it properly belongs. If it can be seen that a document or transaction was intended to have effect as part of a nexus or series of transactions, or as an ingredient of a wider transaction intended as a whole, there is nothing in the doctrine to prevent it being so regarded: to do so is not to prefer form to substance, or substance to form. It is the task of the court to ascertain the legal nature of any transaction to which it is sought to attach a tax or a tax consequence and if that emerges from a series or combination of transactions, intended to operate as such, it is that series or combination which may be regarded." 
At page 326 Lord Wilberforce added: 
"I have a full respect for the principles which have been stated but I do not consider that they should exclude the approach for which the Crown contends. That does not introduce a new principle: it would be to apply to new and sophisticated legal devices the undoubted power and duty of the courts to determine their nature in law and to relate them to existing legislation. While the techniques of tax avoidance progress and are technically improved, the courts are not obliged to stand still. Such immobility must result either in loss of tax, to the prejudice of other taxpayers, or to Parliamentary congestion or (most likely) to both. To force the courts to adopt, in relation to closely integrated situations, a step by step, dissecting, approach which the parties themselves may have negated, would be a denial rather than an affirmation of the true judicial process. In each case the facts must be established, and a legal analysis made: legislation cannot be required or even be desirable to enable the courts to arrive at a conclusion which corresponds with the parties' own intentions."
The Ramsay approach required the transactions to be analysed to determine whether their effect achieved the non‑tax consequences which the taxing provisions contemplated.  The statutory interpretation foundation of the approach directed attention to the non‑tax outcomes for which the taxing provisions were intended, and then required an analysis of the transactions to determine whether what was achieved by the transaction was anything more than the tax outcome.  A description of the transactions as “self-cancelling” may explain the attempt in Furniss to reformulate the principle but was an unnecessary element in understanding the principle itself.  The self-cancelling nature of the transaction may be a sufficient reason in one case for concluding that a taxpayer’s reliance upon a provision was not as the provision was intended to operate but the principle of construction was broader.  In every case the question is whether the section was intended to apply as the taxpayer has purported that it does. In each such case the question will require a comparison between the taxpayer’s outcomes and those which would be expected by operation of the section.  
The United Kingdom subsequently adopted a general anti‑avoidance rule to apply in addition to the common law rules of statutory interpretation.  The United Kingdom adopted a general anti-avoidance rule in Part 4 of the Finance Act 2013 after an independent report headed by Mr Graham Aaronson QC and the release of a government consultation document published on 12 June 2012.  The target of the general anti-avoidance rule was expressed to be “artificial and abusive tax‑avoidance schemes which, because they [were] often complex and/or novel, could not have been contemplated directly when formulating the tax legislation”.  The general anti‑avoidance rule adopted in England also depends upon a taxpayer’s misuse or abuse of a statutory provision.
The provisions seek to achieve the aims of combatting tax avoidance, substantially in line with those proposed in the Aaronson Report, by authorising the revenue to counteract abusive arrangements on a just and reasonable basis subject to a number of safeguards. The statutory targets (before consideration of any of the safeguards) are arrangements “which cannot reasonably be regarded as a reasonable course of conduct” as judged by reference to the relevant provisions, the substantive results and any other arrangements forming part of the arrangements.  The UK model is targeted at arrangements having consequences that Parliament would not have countenanced had it foreseen the arrangement, and the tax consequence claimed.  The UK model is, therefore, directed to abuse of statutory provisions by analysing the transaction and looks to the presumed intentions of Parliament rather than to a purpose of, or imputed to, the participants.
The primary safeguard for taxpayers in the UK provisions is the “double reasonableness test”.  The UK general anti-avoidance rule applies only where conduct “cannot reasonably be regarded as a reasonable course of action”.  The double reasonableness test is designed to ensure that the general anti‑avoidance rule will be limited to counteract “only artificial and abusive schemes”.  One of the reasonableness requirements in the test looks to the course of action and asks whether it is reasonable, the other looks to the observer and asks whether the otherwise “unreasonable” course of action would nonetheless be regarded as reasonable.
An essential aspect of the UK general anti-avoidance rule is the existence of a “tax advantage”.  A broad definition of tax advantage was adopted in the legislation, but implicit in the definition in the legislation is that the tax position obtained by a transaction is to be contrasted with something else.  The existence of a tax advantage will therefore need to be determined by identifying something against which to compare what was done.  In Inland Revenue Commissioners v Parker Lord Wilberforce said in respect of a different, but potentially comparable, definition of “tax advantage”:
The paragraph, as I understand it, presupposes a situation in which an assessment to tax, or increased tax, either is made or may possibly be made, that the taxpayer is in a position to resist the assessment by saying that the way in which he received what it is sought to tax prevents him from being taxed on it; and that the Revenue is in a position to reply that if he had received what it is sought to tax in another way he would have had to bear tax. In other words, there must be a contrast as regards the “receipts” between the actual case where these accrue in a non-taxable way with a possible accruer in a taxable way, and unless this contrast exists, the existence of the tax advantage is not established.
The appropriate comparator was contemplated in the Aaronson Report to derive from the “arrangements that would have occurred absent the relevant tax purpose” (emphasis added).  In other words, it will require the identification of a hypothetical fact based upon a prediction about what would otherwise have happened. 
The concept of abuse is central to the operation of the UK general anti-avoidance rule.  “Abusive” is defined in s 207(2) as follows:
Tax arrangements are “abusive” if they are arrangements entering into or carrying out of which cannot reasonably be regarded as a reasonable course of action in relation to the relevant tax provisions, having regard to all the circumstances including –
(a) whether the substantiating result of the arrangements are consistent with any principles on which those provisions are based (whether express or implied) and the policy objectives of those provisions;
(b) whether the means of achieving those results involve one or more contrived or abnormal steps; and 
(c) whether the arrangements are intended to exploit any shortcomings in those provisions.
Although different from the jurisprudence concerning abuse in the US, Canada and New Zealand, and different from the concept of specifically permitted choices in s 177C(2) in the Australian general anti-avoidance rule, the underlying concept is similar and calls for an inquiry into whether the way a taxpayer sought to use a provision is the way the provision was intended to be used.
Anti-avoidance rule in Australia
The general anti‑avoidance rule in Australia since 1981 is in Part IVA of the Income Tax Assessment Act 1936 (Cth).  The provisions are lengthy and complex but they depend upon the Commissioner of Taxation determining to cancel a tax benefit to which the part applies.  The Commissioner’s power to make a determination to cancel a tax benefit depends upon there being a scheme to which Part IVA applies.  Section 177D(1) provides that Part IVA applies to a scheme if “it would be concluded” that a person who entered into or carried out a scheme, or part of a scheme, did so for the purpose of enabling one or more taxpayers to obtain a tax benefit in connection with the scheme.  The section lists eight matters to which regard must be had to reach that conclusion but they do not include the subjective motive or reasons.
The general anti-tax avoidance rule in Australia before 1981 had been in s 260 of the 1936 Act and depended fundamentally upon finding that a transaction was entered into predominantly for the purpose of tax avoidance.  Those drafting the provisions that came to be in Part IVA in 1981 sought to give statutory expression to a principle from the decision of the Privy Council in Newton v Federal Commissioner of Taxation in which their Lordships had said:
In order to bring the arrangement within the section you must be able to predicate – by looking at the overt acts by which it was implemented – that it was implemented in that particular way so as to avoid tax.  If you cannot so predicate, but have to acknowledge that the transactions are capable of explanation by reference to ordinary business or family dealings, without necessarily being labelled as a means to avoid tax, then the arrangement does not come within the section.  Thus, no one, by looking at a transfer of shares cum dividend, can predicate that the transfer was made to avoid tax.  Nor can anyone, by seeing a private company turned into a non-private company, predicate that it was done to avoid Div 7 tax…  Nor could anyone, on seeing a declaration of trust made by a father in favour of his wife and daughter, predicate that it was done to avoid tax …
This test required a consideration of the particular contract, agreement or arrangement which the Commissioner had identified as caught by s 260 to determine whether its objectively ascertainable purpose was to avoid taxation.  The inquiry was not into the actual motive or purpose of the participants but, rather, into whether the objectively ascertained explanation of the arrangement undertaken in the particular way it had been undertaken was to avoid tax.  In its most essential element the test might be thought to depend upon an inquiry into whether what produced the tax advantage had some purpose other than the tax advantage.  In that inquiry the actual purpose or motive of the participants was irrelevant to whether the general anti-avoidance rule applied.
The application of s 260 did not expressly require, nor depended upon, an express consideration of whether the transaction was an abuse or misuse of the statutory provisions relied upon by the taxpayer.  There developed, however, jurisprudence which excluded from the operation of s 260 those transactions which could be said to have been choices permitted by the legislature.  In W P Keighery Pty Ltd v Federal Commissioner of Taxation the High Court held that s 260 did not apply to a corporate taxpayer which had rearranged its affairs to become a public company to avoid undistributed profits tax imposed upon private companies under the then provisions of Division 7 of the 1936 Act.  Dixon CJ, Kitto and Taylor JJ said in a joint judgment:
The very purpose or policy of Div. 7 is to present the choice to a company between incurring the liability it provides and taking measures to enlarge the number capable of controlling its affairs.  To choose the latter course cannot be to defeat, evade or avoid a liability imposed on any person by the Act or to prevent the operation of the Act.  For that simple reason the attempt must fail, and the Commissioner cannot rely upon s 260 in order to treat as void any more extensive set of facts, for an attempt to do so could not stop short of including the incorporation of the appellant company itself.
The “choice principle”, like the abuse or misuse doctrine, sought to make the general anti‑avoidance rule depend upon whether the avoidance was effected by something contemplated by the taxing statute.  
The restriction of the choice principle was a significant feature in the enactment of Part IVA in 1981 and found legislative expression in s 177C(2).  By that provision there is excluded from the operation of Part IVA those tax benefits which are “attributable” to something “expressly provided for” in the taxing statute, provided however, that the scheme giving rise to the tax benefit had not been for the purpose of creating the conditions necessary for the tax benefits to be obtained.  Section 177C(2) expressly provides that something which is obtained by a taxpayer as a tax benefit (and which, therefore, might otherwise be a tax avoidance scheme to which the Act applies) may nonetheless be excluded from the operation of the general anti‑avoidance rule.  The structure adopted by Part IVA makes the exclusion depend upon a consideration of, first, whether a taxpayer has obtained a tax benefit within the meaning of s 177C(1), secondly, whether the obtaining of the tax benefit was “attributable” to a specifically provided statutory allowance, and thirdly, whether the scheme through which the tax benefit was obtained was one for the purpose of creating the conditions necessary for the allowable event to arise.  The intent, and effect, of the provisions is, however, to exclude from the operation of the general anti‑avoidance rule a scheme which is productive of a tax benefit even if it otherwise would be regarded as an avoidance transaction as long as it was one specifically provided for by the legislature.  The inquiry into whether the scheme was entered into or carried out for the dominant purpose of enabling a taxpayer to obtain a tax benefit need not be asked if, whatever the result of the inquiry might have been, the scheme is one which was a choice expressly provided for by s 177C according to its terms.  
International Tax Avoidance Arrangements
There are many targeted anti‑avoidance rules to be found as well as transfer pricing rules directed to substituting an arm’s length price for a non‑arm’s length price between related parties to international transactions.  It might, however, be thought that there was still some gap in the application of the general anti‑avoidance rule to international transactions.  It might be thought, for instance, that the general anti‑avoidance rule required specific application to arrangements which had been directed to the avoidance both of foreign tax as well as domestic tax.  
The 2015 amendments extending the anti‑avoidance provisions in Australia were directed at schemes entered into by “significant global entities” which are defined, broadly, as members of multinational corporate groups with annual global income exceeding A$1 billion.  The amendments were described in an Australian Tax Office document as being “designed to counter the erosion of the Australian tax base by multinational entities using artificial and contrived arrangements to avoid the attribution of profits to a permanent establishment in Australia”.  New provisions were introduced into Part IVA to extend the general anti‑avoidance provisions to schemes described as those “that limit a taxable presence in Australia”.  Section 177DA was extended to apply Part IVA to a scheme having as its features: (a) a foreign entity making a supply to an Australian customer of the foreign entity, (b) activities being undertaken in Australia directly in connection with the supply, (c) some or all of the activities being undertaken by an Australian entity which is an associate of or which is commercially dependent on the foreign entity where the activities are undertaken at or through an Australian permanent establishment of the Australian entity, (d) the foreign entity deriving ordinary income or statutory income from the supply, and (e) some or all of that income not being attributable to the Australian permanent establishment of the foreign entity.  
The extension to the general anti‑avoidance rule is made to depend upon it being concluded that a person who entered into or carried out the scheme having those features did so for a “principal purpose” that included a purpose of enabling a taxpayer to obtain a tax benefit in Australia or both to obtain a tax benefit and to reduce one or more of their foreign tax liabilities, or to enable a taxpayer and another taxpayer each to obtain tax benefits in Australia or both to obtain a tax benefit and to reduce one or more of their foreign tax liabilities.  The conclusion to be reached is expressed by language suggesting an objective determination rather than an inquiry into subjective motives or reasons.  The matters to which regard must be had in reaching that conclusion include those ordinarily provided for in Part IVA, but they include also the extent to which the activities that contribute to bringing about the contract for the supply are performed and are able to be performed by the foreign entity, another entity, or other entities, as well as the result, in relation to the operation of any foreign law relating to taxation, that would be achieved by the scheme but for the operation of Part IVA.
The application of this provision was intended to have, however, a lower threshold test than the sole or dominant purpose test in s 177D and, therefore, to apply more easily.  The general anti-avoidance rule had been made to depend upon it being concluded that a tax benefit was the “dominant purpose” of one of the participants, but in the case of the extension made by s 177DA it is sufficient that the purpose be “a principal purpose of, or more than one principal purpose that includes a purpose of” one of the relevant participants enabling the relevant taxpayer to obtain the tax benefit or the other tax effect.  An aspect of this provision that distinguishes it from the more general provision is that it can apply where the purpose of what was done, objectively ascertained, may be to obtain both a domestic Australian tax benefit and also a reduction in a foreign tax liability for the taxpayer or another taxpayer.  The words “or more than one principal purpose” suggest that more than one principal purpose may exist for entering into a scheme and that “principal” in this context may not mean strictly “first or highest in rank” but, rather, “among the most important, prominent, leading, main”.  The fact that the purpose is described also by the word “a” principal purpose rather than as “the” principal purpose also suggests a lower threshold than dominant purpose.  
The “diverted profits tax” provisions introduced in 2017 have some resemblance to transfer pricing provisions and included a new tax and additional changes to the general anti-avoidance rule in Part IVA.  The provisions are directed to “significant global entities” and permit the Commissioner to impose a new tax at a penalty rate of 40% where the new provision of s 177J in Part IVA applies to a scheme rather than to make a determination to cancel the tax benefit.  The Diverted Profits Tax Act 2017 gives the Commissioner a new statutory power to make a diverted profits tax assessment which the taxpayer must pay within 21 days.  The taxpayer then has a 12-month period of review during which it can provide the Commissioner with information disclosing reasons why the assessment should be reduced.  The taxpayer may shorten the period by written notice.  If, at the end of the period, the taxpayer is dissatisfied with the assessment, it may challenge it by making an appeal to the Federal Court of Australia.  However, the taxpayer will generally be restricted in any appeal to adducing evidence that was provided to the Commissioner during the period of review.
The Commissioner’s ability to impose the new tax depends upon the general anti‑avoidance rule in Part IVA applying because of s 177J.  That section identifies the schemes to which Part IVA is made to apply by the extended provisions and does so in language consistent with the earlier provisions as well as with those which had been introduced in 2015.  The section depends, like s 177DA, upon a taxpayer obtaining a tax benefit where the conclusion would be drawn that a principal purpose of one of the relevant participants entering into or carrying out the scheme was to enable a taxpayer to obtain a tax benefit, or to enable the taxpayer to obtain both a tax benefit and a reduction of foreign tax liability, or of enabling the taxpayer and another taxpayer to do so.  The provisions can only apply to a taxpayer which is a “significant global entity” which is defined to mean an entity having an annual global income of AUD$1 billion or more in an income year.  The taxpayer obtaining the diverted profits tax benefit must have an associate which is a foreign entity and which participates in, or is connected with, the scheme by which the taxpayer obtains the tax benefit.
The extended operation of the general anti-avoidance rule to diverted profits tax, however, is restricted in various ways.  A number of entities are specifically excluded, such as managed investment trusts, complying superannuation entities and foreign pension funds.  The provisions also contain a negative test based upon a standard of reasonableness which is designed to limit its operation.  Section 177J will not apply where it is reasonable to conclude that any one of three tests is satisfied, namely, the $25 million income test, the sufficient foreign tax test, and the sufficient economic substance test.  The $25 million income test is designed to ensure that the general anti-avoidance rule will not apply in relation to a diverted profits tax benefit if the aggregate of certain amounts does not exceed $25 million.  The sufficient foreign tax test is designed to exclude s 177J from applying if it is reasonable to conclude that the increase in the liability for foreign income tax was equal to or exceeded 80% of the corresponding reduction of the Australian tax liability.  The sufficient economic substance test was designed to ensure that the diverted profits tax will not apply in relation to a relevant taxpayer if it is reasonable to conclude that the profit made as a result of a scheme reasonably reflected the economic substance of the entity’s activities in connection with the scheme.  For this purpose, regard may be had to the taxpayer’s transfer pricing documents including OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrators as approved by the Council of the OECD.
G.T. Pagone
Melbourne, September 2017