The General Anti-avoidance Rule: its Expanding Role in International Taxation

A norma geral antielisiva: seu crescente papel na tributação internacional

João Dácio Rolim

LLM, PhD, Tax Lecturer.

Abstract

This article discusses the role of and main justifications for general anti-avoidance rules in international taxation. It analyses whether or not a GAAR may be regarded as an international general principle of law taking into account the latest developments within international organizations, including some international courts, and domestic jurisdictions, and the BEPS/OECD work. It also argues what type of GAAR or specific rules would fit more properly as a legal tool to counteract tax avoidance and its consequences. This article was originally published in INTERTAX, Volume 44, Issue 11, 2016, Kluwer Law International. 

Tax avoidance is quite challenging and the issues raised by general or specific anti-avoidance rules may “go to the foundations of a country’s tax system”1, and to the fair allocation of taxing rights among different States. In an international and comparative context tax avoidance means any arrangement or transaction made by taxpayers whose sole or main purpose is to reduce their tax burden, what may be legitimate or not depending on the economic factual circumstances and the purpose of tax laws at stake. In this sense, tax avoidance may be abusive, wholly artificial, excessive or too aggressive, and thus illegitimate depending on the fulfilment of two requirements: firstly, objective economic factors that may give or not business purpose or economic substance to the transaction must be ascertained; and secondly, it must be determined the specific purpose of the tax laws in play (the tax law that was supposedly circumvented and the tax law that should arguably be applied to the transactions)2. The above two requirements of abuse are in line with the guiding principle set out by the OECD on abuse of a tax treaty that means the main purpose for entering into transactions is to obtain a more favourable tax position contrary to the object and purpose of the treaty provisions in play3. Not surprisingly, the UN Commentaries on the UN Model Convention follows the same line of thought4. A guiding principle is set out in paragraph 25 of the Commentaries on Article 1 of the UN Model Convention as follows:

“A guiding principle is that the benefits of a double taxation convention should not be available where a main purpose for entering into certain transactions or arrangements was to secure a more favourable tax position and obtaining that more favourable treatment in these circumstances would be contrary to the object and purpose of the relevant provisions.”

Furthermore, on general anti-avoidance rules the UN Commentaries seem to be fair to state that “these two elements will also often be found, explicitly or implicitly, in general anti-avoidance rules and doctrines developed in various countries”5.

2. GAARs as rules or principles?

Before discussing the main justifications and its limits for tackling tax avoidance, it may be worth analysing first whether or not a general anti-avoidance rule can be really regarded as either a general legal principle or a just a general rule. There are two main differences between rules and principles according to Dworkin6. First, rules are all-or-nothing norms, either they are applicable in a case or they are not, whereas principles may allow some degree of optimization in their application and enforceability as they must take into account other competing principles with which they must be reconciled. Secondly, principles have a dimension of weight and importance that is lacking in rules. Sometimes rules may function as principles7.

As a matter of principle, taking into account how a GAAR is designed, whether or not covering a generality of transactions, its level of abstraction and indeterminacy, its degree of importance in the tax legal system, technically speaking any genuine GAAR may certainly be regarded as a principle of law. Furthermore, in its own right and definition, “a GAAR is a general statement of principle which seeks to thwart a broadly defined category of transactions which reduce or defer” tax liability8.

3. Justifications and limits to tackle tax avoidance

To what extent would minimization and deferral of the tax burden be justifiable and legitimate? Taxpayers have the right to legitimately organize their activities and business in the most efficient way, including a tax viewpoint. This is perfectly lawful and legitimate behaviour and a customary doctrine recognized by many countries9.

Starting from the pure liberalism point of view, “a radical separation of legal form and economic substance … [is required, and] … laws must be addressed to the generality of legal subjects, without distinction as to their social or economic position”10. This theory is considered untenable, due to its extreme inequalities at a socio-political level. Consequently, pure liberalism has given way to “welfare liberalism”, establishing an adequate and substantive social basis and providing conditions that allow formal equality to be performed11. Thus, interventionist forms supplant the liberal forms of regulation.

Although equality, ability to pay, fairness, and the concept of abuse of rights may support the adoption of general or even specific anti-avoidance provisions, these rules may damage the requirements of certainty, predictability, and protection of fundamental freedoms, which are essential elements in a liberal system. However, Picciotto again highlights that this assertion unrealistically assumes that formal rules can be defined by referring them to completely factual conditions, or objectively ascertainable circumstances. The resort to less precise standards is often made in private law (“good-faith”, “foreseeability”, “reasonableness” etc.)12. Similarly, it is reasonable to affirm that tax laws based only on specific and formal rules tend to be amended often; to the extent that they could be considered a battlefield between taxpayers and the Treasury. The optimal relationship between tax authorities and taxpayers should be fair play, capable of providing reasonable certainty, stability and predictability – the main objectives of those who support and defend liberal formalism as well. Thus, reasonable general or specific anti-avoidance rules may provide a fair relationship between taxpayers and tax authorities, avoiding abuse from both sides. There may not be a duty (fiduciary duty for those in charge of running a business) to avoid taxes where the avoidance would be pursued by wholly artificial or abusive arrangements. Another great advantage of anti-avoidance rules, depending on how they are provided and enforced, is that they give opportunities to find principles of taxation and grant them “a vital function in the interpretation of tax legislation”13.

A different perspective over tax avoidance matters considers the creation of legislative uncertainty as an essential weapon to control situations that would not be acceptable from the point of view of fairness for being rather artificial. Moreover, such situations would not be acceptable from the standpoint of the treatment of equivalent economic situations and of tax collection itself, particularly where the economic principle of neutrality underlies a general anti-avoidance rule14. “However, discretion and uncertainty are not necessary companions. Indeed, the exercise of discretion is how you offer certainty where legal definition cannot.”15 For instance, in terms of anti-avoidance measures, they may be specific or general. In this latter case, some discretion is necessarily left to fiscal authorities and judges to consider whether there is, in each case, a business purpose other than artificially avoiding taxes. In the author’s view, the revenue discretion is more appropriate where necessary to ascertain objective factors and legal issues regarding tax avoidance; however, it must be submitted to judicial review. The broader the discretion the closer the scrutiny may be necessary to avoid subjectivism, bias, arbitrariness, and a lack of sound commercial reality, particularly when dealing with business purpose requirement. Thus, the tax assessment founded on tax avoidance must observe the fundamental rights that require no excessive burden of proof and fair rebuttal, no interference with taxpayers’ right to manage their own business (except where artificial arrangements are made solely or mainly for tax purposes), no excessive penalties or guarantees, no restrictions to carry economic activities while tax assessment is under way, independent commissioners and judges, and others rights, such as an overall fair assessment that is part and parcel of due process and the rule of law.

Another interesting social and economic aspect was raised by Weeghel16, who has pointed out the public perception about aggressive tax avoidance in some countries, such as in the UK, where consumers have campaigned to boycott some multinationals for paying very low tax because of their tax avoidance schemes. As a result of that public perception, some companies became more concerned about their reputation in the UK, and searched a fair tax mark, like a fair trade label, which can be obtained by those who meet non-abusive avoidance requirements17. This would perhaps be a trend in the international scenario as long as taxpayers and other organizations be more aware of the implications of aggressive tax avoidance and of their economic and political power. The work of civil society in tackling tax avoidance has also become increasingly notable and important as shown by some specific non-governmental organizations such as the Tax Justice Network (TNJ) and the Global Alliance for Tax Justice (GATJ)18.

Having analysed in this section the main justifications for combating tax avoidances as well as their apparently opposing principles, in the next section it will be discussed whether general or specific rules are more appropriate and the main ways to ensure the proper use of tax treaties.

4. General or specific rules/principles?

Another issue regarding tax avoidance is how better to tackle it, such as fixing limits to a general judge-made abuse of law doctrine, and assessing general and specific anti-avoidance rules either separately or concurrently. It is debatable whether a system based on general principles rather than prescriptive rules may be more appropriate, depending on the legal traditions and constitutional systems of each jurisdiction19. In the author’s view a system with general principles, such as an objective abuse of rights doctrine (taking into account objective economic factors, the principle of good faith, no application of penalties, objective ascertainment of the purpose of the tax legislation at stake, and an overall fair assessment) is more appropriate to tackle tax avoidance, because it balances equity and legal certainty, whereas prescriptive rules favour legal certainty only or mostly. A combination of a general rule with prescriptive ones, for greater clarity and legal certainty, would be better depending again on what would be more appropriate to the legal system, tradition, and culture of each jurisdiction, but in line with international standards set out by international organizations such as the UN, OECD, and international courts such as the European Court of Human Rights, the European Court of Justice, and the Appellate Body of the WTO, as discussed further in the following section II. 2 and 3.

Where tax avoidance is an issue only for a specific type of transactions, such as reorganizations, mini-GAARs addressing only those transactions may be more efficient, for the sake of simplification, clarity and legal certainty. It may not make sense for a legal system to have a huge arsenal of anti-avoidance rules where taxpayers use only few transactions for tax avoidance purposes. The same can be said in relation to different types of taxes. If avoidance is a problem in the field of corporate taxation only and not in respect of VAT for instance, it would be more cost-efficient to implement a GAAR that covers income tax only. Contrariwise, if there is a substantial loss of revenue in the VAT area as well due to tax abusive transactions, it may make sense to target them via GAARs. If the all taxes within a system are actually affected by abusive behaviour of taxpayers, a GAAR covering all of them may be necessary; and for the sake of fairness, legal certainty, simplification, coherence, and consistency of the tax system that that GAAR should be the same or at the very least very similar to each other for all taxes. It would be a legal and economic contradiction and hard to explain why the same specific transaction, such as a reorganization, may have business purpose for income tax, but not for VAT purposes. This same issue of legal and economic consistency can be found in case of an international transaction where two or more tax jurisdictions are involved. If there is a business purpose for an international reorganization, that same standard must be accepted by two or more countries that are affected, as well as in case of transfer pricing rules, where under Article 9 of the UN and the OECD Model the arm’s length price should be the same and accepted by all States and taxpayers involved.

There are generally five ways to ensure the proper use of tax treaties that may be consistent with international standards. First, the application of domestic GAAR or a specific anti-avoidance rule applicable to tax treaties. Secondly, a specific anti-avoidance rule provided in the treaty itself: v.g. the beneficial owner clause, as generally applied to dividends, interests, and royalties. Thirdly, the limitation on benefits articles, generally based on ownership or control as a residence test to get treaty benefits. Fourthly, a GAAR provided in the treaty itself, such as a general beneficial owner clause, or the principle purpose test20. Fifthly, an anti-abuse doctrine as a general principle of international law (see the cases decided by the Swiss Supreme Court and Israeli Supreme Court, in section II.2.)

The BEPS project of the OECD agreed in the final report of 5 October 2015 the following minimum standards:

a) Wording in the preamble against double non-taxation and treaty shopping, and either

b) Limitation on benefits clause – LOB (an extensive or limited version) and the Principle Purpose Test (PPT)21, or

c) PPT alone, or

d) LOB and anti-conduit rules.

The above minimum standards in my view are compatible with international standards previously analysed for two reasons, as long as taxpayers can challenge their application by the competent tax authorities on proportionality and fairness grounds as discussed in the next section. First, it demonstrate a great concern for abusive tax avoidance, and secondly, it takes into account different positions of individual countries, such as the US and others that are reluctant to adopt the principle purpose test and are in favour of the LOB articles that may bring more certainty to taxpayers and may be less burdensome in terms of tax assessments and supervision.

Having discussed in this and the previous section the apparently conflicting principles that may justify to combat tax avoidance and the ways to ensure it, in the next section it will be analysed whether and how they may interact and be reconciled.

5. The role of proportionality and balancing in controlling tax avoidance

If conflicting principles are at stake regarding tax avoidance, such as legal certainty and tax equity22, they should be reconciled with each other in order to reach a fair balance protecting to an optimal extent both principles. In the author’s opinion neither of them should unconditionally prevail over the other, and the principle of proportionality is an analytical tool to reach that fair balance23. Moreover, proportionality coupled with reasonableness may balance all tax principles that justify tackling tax avoidance, mainly equity and the doctrine of abuse of rights, against other relevant principles, such as good faith, legal certainty, and predictability24. All of them are important and none of them should be absolute or exclusive. First, general or specific anti-avoidance rules should be suitable for the attainment of the desired objective (to avoid artificialities and abuses, for example); second, the necessity of the measure in a sense that it is the least restrictive of individual freedoms that could be adopted; and third, the requirement of the proportionality of the measure to the restrictions involved (balancing). Thus, if a tax measure, such as joint taxation of spouses, is too intrusive to the freedom to opt for separate taxation and discriminatory, it may be unlawful for being disproportionate. Treating the family as a tax unity may be reasonable either for tax avoidance or simplification purposes. However, joint taxation may be disproportionate where this tax treatment results in taxing spouses or civil partners more heavily than non-married couples who live together, particularly if there is an underlying policy or constitutional objective for the State to recognize, protect and encourage the family25.

Regarding the application of any gaar to tax treaties, the standards of reasonableness and the principle of proportionality may bring more certainty to taxpayers where indeterminate or open ended concepts are applied. For example, if the PPT is applied, taxpayers have to right to challenge their economic and legal assumptions, being able to demonstrate that objective (as opposing to subjective) economic factors should be taken into account, as well as a purposive and consistent application of treaty articles submitted to an independent body, either judicial or set up via arbitration.

Having discussed some conflicting justifications and opposing principles for tackling tax avoidance and concluded that the general rules to tackle it may be a more appropriate and cost-effective tool, in the next section it will be analysed whether or not it can be considered as a general principle of international law.

II. GAARs as general principle of international law?

1. Article 38 of the statute of the ICJ (OECD countries, BRICS and G-20)

Under Article 38, c, of the Statute of the International Court of Justice26, if a general principle is recognized by civilized nations, it must be applied as a primary source – not as subsidiary means – of international law27. Both domestic legal concepts and those derived from existing international practice can fall within “the recognized catchment area”28.

Thus, one fundamental legal basis for recognition of a GAAR as a general principle of international law would be its recognition in the legal system of civilized nations as it seems to be the case at the present stage. This issue of regarding a general anti-avoidance rule or doctrine as a general principle of international law has been argued for many years and some tax commentators were against it – even against the application of a domestic anti-avoidance rule to tax treaties –, whereas Vogel and Ward seemed to be a minority in favour of regarding it as such general principle29. As analysed further in this section the ultimate basis for considering a GAAR (or a similar abuse of rights doctrine) as a general principle of international law is its recognition by civilized states. Where national courts apply a domestic GAAR to tax conventions they would be applying it as a general principle of international law as well. Where there is no domestic GAAR there would still be scope for applying a general anti-abuse doctrine based on the abuse of rights in line with international recognition analysed above by interpreting the treaty itself30. Besides the purposive, contextual, and in the good faith interpretation that must be given to treaties, under Art 31, paragraph 3(c), of the Vienna Convention on the Law of Treaties31, it shall be taken into account together with the context, “any relevant rules of international law applicable in the relations between the parties.” As the International Court of Justice regards the terms rules and principles as essentially the same within international law32, general anti-avoidance rules as general principles of law of civilized nations should also be taken into consideration in the contextual interpretation of tax treaties.

Nearly all the 34 OECD countries have domestic general anti-avoidance rules or doctrines, but also all the five BRICS countries (Brazil, Russia, India, China, and South Africa) do. Furthermore, out of the G-20 only Mexico has no general anti-avoidance rule or doctrine, although it has been adopting a GAAR in its latest Double Tax Conventions into which it entered33. Needless to point out that countries with GAARs are considered civilized and represent more than 85 per cent of the worldwide gross domestic production and more than 67 per cent of world population34.

2. OECD and UN commentaries on model conventions, and domestic courts

The work of international organizations may also play a role in regarding a principle of law as a principle of international law. In this sense, the work of the OECD has been remarkable in tackling tax avoidance, in particular when it amended the OECD Commentaries in 2003 to recognize two legitimate lines of thought adopted by countries to counteract tax avoidance: application of domestic general anti-avoidance rules (GAARs) to tax treaties or from the interpretation of a treaty itself. States can deny its application to abusive transactions based on the object and purpose of tax conventions as well as the obligation to interpret them in good faith (Article 31 of the Vienna Convention on Law of Treaties)35. This view has also been taken by the United Nations Commentary which recognizes the possibility to apply domestic GAARs or doctrines to double tax conventions as well as by interpreting the treaty itself36. Some domestic courts already took the latter view as it was in the case of the Swiss Federal Tribunal in A Holdings ApS v Federal Tax Admin (2005) that “referred to an (unwritten) treaty principle that prohibits treaty abuse, which can be derived from Art. 31(1) of the Vienna Convention”37.

3. International courts rulings on tax avoidance (the ECJ, the ECHR and the Appellate Body of the WTO)

It is also worth pointing out that some international courts, such as the Appellate Body of the World Trade Organization (WTO)38, the European Court of Human Rights (ECHR)39, and the European Court of Justice (ECJ)40, recognize combating tax avoidance as a legitimate and imperative requirement in the public interest to justify some restrictions on the international fundamental freedoms and rights. This recognition, in the author’s view, makes stronger the argument in favour of regarding general measures or doctrines to tackle tax avoidance as general principles of international law. If those measures are legitimate and allow limitations on international rights, at the very least they must be considered as important and principled justifications within EU Law and the fundamental four freedoms, the international fundamental rights (ECHR), and the international trade law (WTO). Thus, counteracting tax avoidance is a legitimate objective recognized by domestic and international jurisdictions41, but anti-avoidance measures provided by law or judicial doctrine must be proportionate to that end42. In other words, they must be balanced with other interests and principles at stake, such as the fundamental freedoms43, the fundamental rights44, and non-protectionism in international trade45, in order to be less intrusive to those rights under the necessity test as part of proportionality.

4. What type of GAAR would fit as a general principle of international law?

What type of GAAR would be more appropriate to consider as a general principle of international law? It is arguable that a better type of GAAR or doctrine would be the one that requires as its first element solely (and not mainly) tax motivation46. The requirement for solely tax reasons is closer to the sham doctrine47, and generally tax avoidance is different from the definition of sham, as its second element encompasses situations where the tax motivation is the main or predominant reason to enter into a transaction.

The European Court of Justice appeared to follow in direct taxation the doctrine of sham (wholly artificial arrangements) so as to avoid only transactions that are solely tax motivated48. Whereas the objective element of abuse in direct taxation is more focused on the artificiality of transactions, the abuse for VAT purposes encompasses not only wholly artificial arrangements, but also transactions with the principal objective of tax avoidance. The Court apparently applied a more stringent test of abuse perhaps because VAT is more harmonized and must be applied harmoniously within the States, whereas in direct taxation States retain their fiscal sovereignty unless there is a disproportionate interference with the fundamental freedoms. On the other hand, the tax avoidance requirement in tandem with the fair allocation of taxing rights may differ from the autonomous tax avoidance requirement for restrictions to the fundamental freedoms in direct taxation49. Whereas the former allows Member States to tackle any abusive transaction, in which there may be some business purpose other than tax mitigation, the latter encompass only wholly artificial arrangements. The Court also made this clear in Société de Gestion Industrielle SA (SGI)50, in which Belgian transfer pricing rules that applied an arm’s length standard were upheld to protect a fair allocation of taxing rights between the States involved. These transfer pricing rules did not address only wholly artificial prices or arrangements. Thus, not only the requirement of fair allocation of taxing rights was taken together and balanced with a broad notion of avoidance51, but also the specific measures to secure arm’s length prices between related parties in cross-border transactions were closely scrutinized under a business purpose test52.

The ECHR and the AB of the WTO have also accepted tax avoidance not only when artificial arrangements were made, but also in cases of the main and substantial objective of the arrangements was tax avoidance53.

Furthermore, it is worth noting that it is the general idea of a legal conception present in different legal systems that is regarded as a general principle of international law54, and not any specific law of a particular State55. As analysed above, the general definition of GAARs comprises two elements; first, the main purpose for entering into transactions is to obtain a more favourable tax position (generally with no business purpose), and secondly, the interpretation of the treaty or tax provisions in play must not be contrary to their object and purpose (purposive interpretation of the object matter)56. “These two elements will also often be found, explicitly or implicitly, in general anti-avoidance rules and doctrines developed in various countries.”57

Finally, it would not make sense to consider “that international law has repeatedly acknowledged the principle of domestic law that a company has a legal personality distinct from that of its shareholders”58 and not consider the abuse of rights doctrine for tax purposes as a principle of international law, taking into account the GAARs existent in many civilized countries, the position of international organizations such as the UN and the OECD, some domestic courts of civilized countries, and the decisions of international courts regarding tax avoidance as a legitimate justification for accepting some restrictions on international fundamental rights and freedoms. 

In conclusion, as the international standards provided by international organizations and courts taken together with the recognition and introduction of GAARs by civilized nations, it may be logical and reasonable its recognition as a general principle of international law. Furthermore, according to international and domestic standards analysed above as well as the purposive and contextual approaches to international treaties, a GAAR that would be more appropriate as a general principle of law would be that which provides as its first element the main (not sole) purpose for entering into transactions to obtain a more favourable tax position (generally with no business purpose), and its second element an objective and purposive interpretation of double tax conventions.