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In the post-GAAR world, practitioners are increasingly likely to eschew any form of tax planning which involves artificial steps. However, as practitioners retreat from the world of artificiality, we might pause to ponder the paradox that HMRC remains ensconced in it.

Any suggestion that ‘artificiality’ is a modern concept is false. The well worn path of jurisprudence, particularly since Ramsay, implanted alarm bells into the minds of practitioners that any artificially inserted steps were likely to render a scheme ineffective for fiscal purposes.

But something has certainly changed since the introduction of GAAR and the sea change in British public opinion against tax avoidance. The result is that practitioners, with clients less likely to cheerlead elaborate and synthetic schemes, are increasingly retreating from the world of artificiality. The modern, prudent practitioner will extirpate any artificial elements from a transaction.

What is most striking however is not the retreat of practitioners from this make-believe world, but that HMRC joined them in it, and remains there.

If aggressive tax avoidance schemes are concerned with the insertion of artificial steps, then this is equally true of the tax laws utilised by HMRC to combat them: herein lies the paradox.

Let us take two examples. First is TCGA 1992 s 87, the ‘matching’ provisions of which attribute gains of offshore trusts to resident beneficiaries when a capital payment is made. The ‘fiction’ in this instance is that there has been an actual disposal.

Second is the controlled foreign companies (CFC) legislation, which imputes the income of foreign corporations to controlling resident shareholders irrespective of whether an actual distribution occurred.

In either case, HMRC’s need to insert artificial steps is a consequence of the rules of international taxation, which limit tax jurisdiction to three recognised grounds. These are:

  • residence jurisdiction (taxing residents);
  • source jurisdiction (taxing property with a domestic situs); and
  • nationality jurisdiction (taxing domiciliaries or nationals).

As a consequence of these rules, where foreign entities receive income or dispose of foreign-situs assets, HMRC has no jurisdiction to tax.

HMRC circumvents these rules by inserting artificial steps – deemed disposals or fictive distributions – which, in substance, facilitate the extension of its tax jurisdiction to offshore trusts and companies.

Of course, HMRC would deny any suggestion that s 87 and the CFC rules are an illicit extension of its jurisdiction under international law. But what cannot be denied is the absurdity at the heart of such legislation – that gains and income of foreign residents can be artificially reallocated to residents.

Critics of HMRC may invoke the new diverted profits tax as a further example, which taxes the profits of non-resident companies based on fictions, including that a branch operation, in certain circumstances, can be treated as a permanent establishment.

There is a fair argument that in order to combat artificial tax avoidance schemes, HMRC needs to be equally creative: if you can’t beat them, join them. However, as practitioners retreat from artificiality, there remains the question of whether HMRC will embrace it further.

In an era when the ‘tax gap’ dominates Budget day debates, there must be a temptation to introduce legislation enabling HMRC to extend its jurisdiction by presupposing increasingly fictitious events. After all, if some of the recognised international rules of tax jurisdiction have already been breached by the UK, then what is to prevent HMRC from indulging further in artificial means of combating aggressive avoidance?

This is the danger at the heart of the paradox, and is no longer the way to go.

On some readers, this paradox may impute nothing more than a gentle feeling of irony. Others might reflect that if taxpayers are to expect any form of certainty in tax planning, then the adherence to fixed rules over the incongruities of the world of artificiality might be more conducive to the rule of law going forward. Particularly when that world is less inhabited by taxpayers than it once was.n