Untitled

CHAPTER 11

TAX AVOIDANCE

11.1 INTRODUCTION

11.1.1 During his 1995 Budget speech, the Minister of Finance drew attention to the high level of tax avoidance, much of it implemented by means of sophisticated financing structures. The Commission was requested by the Minister to investigate the question of tax avoidance.

11.1.2 In complying with this request, the Commission has given particular attention to:

the need for a general tax anti-avoidance provision;
the efficacy of the existing legislation contained in section 103 of the Income Tax Act ("the Act"); and
the desirability or otherwise of the imposition of penalties in the case of avoidance.

11.2 THE MARGO COMMISSION

11.2.1 As this matter was investigated less than a decade ago, it is useful to analyse that examination by the Margo Commission of Inquiry.

11.2.2 The Margo Commission adopted the view that antiavoidance legislation was beneficial in countering tax avoidance schemes and hence that both general avoidance measures and specific provisions should be included within our legislation. However it noted that section 103 of the Act suffered from two particular deficiencies:

the test of abnormality presents difficulties for Revenue in that if a particular form of transaction is widely used for tax avoidance purposes, it may gain a commercial acceptability to the extent that its utilisation becomes normal; and
there was no disadvantage from the taxpayer's point of view in embarking even upon tax avoidance schemes with little probability of success against a challenge by the Commissioner in terms of the provisions of section 103.

Accordingly the Margo Commission recommended that this defect be remedied by providing for an arrear interest payment if the taxpayer were successfully challenged in terms of section 103 provided that the total liability for interest should not exceed the amount of tax involved.

11.2.3 A further difficulty with the normality test is that there is ambiguity as to whether it is objective, that is whether there exists an objective test to be applied despite the context of specific circumstances.

11.2.4 The first difficulty raised by the Margo Commission was based upon the interpretation placed on section 103(1)(b) of the Act by the Appellate Division in the cases of CIR v Louw and Hicklin v SIR. As Trollip JA noted in Hicklin's case:

...thus what may be normal because of the presence of circumstances surrounding the entering into or carrying out of an agreement in one case may be abnormal in an agreement with the same nature in another case because of the absence of such circumstances. The last observation is that the problem of normality or abnormality in such matters is mainly a factual one. The court hearing the case may resolve it by taking judicial notice of the relevant norms or standards or by means of the expert or other evidence produced therein by either party.

In Louw's case Corbett JA noted:

In such a case should the court in applying the normality yardstick take account of the special relationship between the erstwhile partners and the company which they have formed, or ignore it and apply the yardstick as though the company were a stranger? I do not see how the court can ignore the special relationship and yet give proper effect to the concluding words of section 103(1)(ii), viz. "under a transaction operation scheme of the nature of the transaction, operation or scheme in question".

11.2.5 Given that the four requirements of section 103(1) of the Act are cumulative, the ability of a taxpayer to circumvent section 103(1) by producing expert evidence to establish the relevant standards of normality of a particular transaction can undermine the efficacy of that section. The approach in Hicklin & Louw was followed by Fagan J in a more recently decided but unreported case before the Cape Special Income Tax Court. Of course it might be argued that this decision is incorrect and the approach to tax avoidance adopted by Melamet J should be followed. However, the latter judgment is a clear example of a kind of judicial intervention, probably last seen in the approach in Ferera v COT, where McDonald JP said that "tax avoidance was an evil" which meant that the courts must not by the interpretation of the avoidance provisions deprive them of their efficacy.

11.2.6 In dealing with the comparison between the House of Lords' approach to tax avoidance most recently expounded in Ensign Tankers Leasing Co Ltd v Stokes and that developed in ITC 1496, The Taxpayer commented:

Deciding this question in favour of the partnership the court said that the question was not why the taxpayer was trading but whether he was trading. If the sole purpose of the transaction was to obtain a tax advantage it was not logically possible to postulate the existence of a commercial purpose. However, it was possible to have a situation in which a taxpayer, whose sole motive was the saving of tax, invests with others in an ordinary trading activity conducted by them for a commercial purpose and with a view of making a profit. The court considered this test to be an objective one. The adoption of this approach helps to prevent a court from collapsing the distinction between abnormality and purpose in order to conclude that it was not possible to have a genuine partnership once the purpose of the partners was to save tax rather than to conduct a trade. Once the requirements of abnormality and purpose are distinguished, then it would appear that the Ensign Tankers judgments have application in South African, that is, that the activities of the partnership should be assessed objectively in order to decide whether the partnership is truly engaged in a trading operation.

11.2.7 As the Act is presently drafted, it is submitted that the Court's construction in the aforementioned case does not provide a legally correct solution to a more efficacious tax anti-avoidance provision and the criticism of The Taxpayer is accordingly justified.

11.3 COMPARATIVE EXPERIENCE

11.3.1 The formulation of an adequate anti-avoidance section has also strained the ingenuity of the Revenue authorities in other jurisdictions. The Commission investigated a number of jurisdictions to evaluate comparative legislation and case law in order to formulate the need for, and efficacy of, a general anti-avoidance provision.

New Zealand

11.3.2 Section 99 of the New Zealand Income Tax Act of 1976 provides that every arrangement made or entered into whether before or after the commencement of the Act, shall be absolutely void as against the Commissioner for income tax purposes if, and to the extent that, directly or indirectly, its purpose or effect is tax avoidance. Tax avoidance is defined to include:

directly or indirectly altering the incidence of income tax;
directly or indirectly relieving any person from liability to pay income tax;
directly or indirectly avoiding, reducing or postponing any liability for income tax.

Liability includes the potential or prospective liability in respect of future income. Once the purpose or effect has been proved, section 99(3) provides that when an arrangement is void in accordance with this section the assessable income of any person affected by the arrangement shall be adjusted in such manner as the Commissioner considers appropriate so as to counteract any tax advantage obtained by that person from or under that arrangement. Arrangement is defined to mean "any contract, agreement plan or understanding (whether enforceable or unenforceable) including all steps and transactions by which it is carried into effect."

11.3.3 In Challenge Corporation v CIR, Lord Templeman commented as follows about this section:

Section 99 does not apply to tax mitigation where the taxpayer obtains a tax advantage by reducing his income or by incurring expenditure in circumstances in which the taxing statute affords a reduction in tax liability.

Section 99 does apply to tax avoidance. Income tax is avoided and the tax advantage is derived from an arrangement when the taxpayer reduces his liability of tax without involving him in the loss of expenditure which entitles him to that reduction. The taxpayer engaged in tax avoidance does not reduce his income or suffer a loss or incur expenditure but nevertheless obtains a reduction in his liability to tax as if he had (our emphasis).

11.3.4 Section 99 is drafted so as to ensure that it is not a requirement that tax avoidance should be the sole or principal purpose. So long as it is not merely an incidental purpose or effect, the section can be applied.

Australia

11.3.5 Part IVA of the Australian Income Tax Assessment Act contains a similar provision. There are essentially three requirements that need to be satisfied before the provisions of Part IVA will take effect. Firstly there must be a scheme which is defined as any agreement, arrangement, understanding, promise or undertaking whether express or implied and whether or not enforceable or intended to be enforceable by legal proceedings. The second requirement is that the taxpayer shall obtain a tax benefit in connection with a scheme as defined. The definition of tax benefit is contained in section 177C. Broadly there are two kinds of tax benefits envisaged by this section. Section 177C(1)(a) provides that the obtaining of a tax benefit shall be read with a reference to any amount not to be included in the assessable income of the taxpayer of a year of income where that amount would have been included, or might reasonably have been expected to have been included in the assessable income of the taxpayer of that year of income if the scheme had not been entered into or carried out. Section 177C(1)(b) provides for an alternative concept of tax benefit, namely a deduction being allowable to the taxpayer in relation to a year of income where the whole or part of that deduction would not have been allowable or might reasonably be expected not to have been allowable to the taxpayer in relation to that year of income if the scheme had not been entered into or carried out.

11.3.6 The critical question for decision is, but for the scheme, would the taxpayer have obtained a deduction or might it have even been expected that he would have obtained such a deduction?

11.3.7 The third requirement for the application of Part IVA is to be found in section 177D which provides that where the taxpayer obtains a tax benefit in connection with the scheme and, having regard to a large number of matters therein referred to, it would be concluded that the person or any one of the persons who entered into or carried out the scheme or any part of the scheme did so for the purpose of enabling the relevant taxpayer to obtain a tax benefit in connection with the scheme or of enabling the relevant taxpayer or other taxpayers each to obtain a tax benefit in connection with the scheme. Section 177A(5) extends the notion of purpose by providing that a reference in this Part to a scheme or part of a scheme being entered into or carried out by a person for a particular person shall be read as including a reference to a scheme or a part of a scheme entered into or carried out by the person for two or more purposes of which that particular purpose is the dominant purpose. Where reference is made to the purpose of enabling the relevant taxpayer to obtain a tax benefit it is enough that the sole or dominant purpose is to enable the relevant taxpayer to obtain a tax benefit.

11.3.8 Paragraph (b) of section 177D provides eight alternative tests which Revenue can consider in deciding whether the scheme was entered into for the purpose of enabling the taxpayer to obtain a tax benefit. These tests are summarised as follows by Australian commentators:

The manner in which the scheme was entered into or carried out. This test would seem to relate to the background of the scheme and the alternative purposes which could be attributed to the taxpayer in entering into it. Schemes of a nature which are used by many taxpayers as a result of representations by entrepreneurs would seem to fall clearly within this test. Where a scheme was entered into by a single taxpayer on a basis which could be regarded as an expansion or variation in the manner of carrying on business it would seem that this test would not be satisfied. In between these two alternatives there would be multiple situations in which the emphasis would be placed upon one point and then perhaps on another.
The form and substance of the scheme. The form would refer to the legal form in which the scheme was carried out, whereas the substance of the scheme would relate to the eventual effect of the scheme as opposed to the legal formalities.
The time which the scheme was entered into and the period of time during which the scheme was carried out. Again this test seems to be aimed at those schemes which are retailed as oneoff situations and a business-like transaction carried out for a substantial period of time would appear to be able to satisfy this test.
The result which would be achieved by the scheme. This test relates to the result which would arise out of the normal operation of the Act, excluding the possible application of Part IVA and would be considering the position of the tax benefit in relation to the position that would arise if the scheme had not been entered into.
Any change in the financial position of the relevant taxpayer arising out of the scheme. This test would relate to the many schemes which have involved paper losses and against which special legislation has been enacted in sections 82KH to 82KL inclusive. In these particular cases the expenditure alleged to have been made, which is an allowable deduction, is greater than the actual loss incurred. In many of these schemes the financial position of the taxpayer improved. If, however, a taxpayer incurs expenditure which is an allowable deduction or alternatively does not receive assessable income, one would expect the scheme to result in a diminution of the assets of the taxpayer entering into that scheme.
Any change in the financial position of any other person. This test is to be contrasted with test (e) which relates to the taxpayer, whilst this test relates to any person. The person does not need to have any connection with the taxpayer of a business or family kind, and a professional relationship could result in the Commissioner having the first factor towards establishing the application of Part IVA. The independence of the person who benefits from the scheme visavis the taxpayer would have some importance because if expenses are incurred and the taxpayer concerned gains no benefit from those expenses, one would normally expect that to be looked upon as a normal business relationship with the deductibility being determined under the normal provisions of the Act without the application of Part IVA.
Any other consequences for the relevant taxpayer or any other person connected with him. This test relates to a consequence other than a change in the financial position of the parties covered by tests (e) and (f). A benefit may be obtained without being in a financial form, and the gaining of such a benefit could result in the Commissioner taking that as a feature which would be relevant in determining whether the provisions of Part IVA apply.
The nature of any connection between the relevant taxpayer and a person contemplated by test (f). This test relates to the connection between the taxpayer and a person who benefits from the operation of the scheme. The connection may be of a business, family or any other nature.

11.3.9 Part IVA was considered for the first time by the Australian High Court in FCT v Peabody. Firstly, the court held that although section l77F was couched in discretionary language, "the existence of the discretion is not made to depend upon the Commissioner's opinion or satisfaction that there is a tax benefit or that, if there is a tax benefit, it was obtained in connection with a Part IVA scheme. Those are posited as objective facts." The court then went on to find that the scheme under attack had to be examined in its overall context. Notwithstanding that aspects thereof might be designed to achieve a tax benefit, if the entire scheme had a commercial purpose and could be justified on a commercial basis, section 177F was inapplicable.

11.3.10 The finding of the court confirms the difficulty in the formulation of a test for tax avoidance which can isolate with precision both the tax purpose of a scheme and the tax infection of the methods employed in such a scheme so as to enable Revenue to curb tax avoidance practices.

Canada

11.3.11 Section 137 of the Canadian Income Tax Act provides that no disbursement which artificially reduces the income of a taxpayer shall be taken into account in determining tax liability. The section then provides that in computing income for the purposes of this Act no deduction may be made in respect of a disbursement or expense made or incurred in respect of a transaction or operation that if allowed would unduly or artificially reduce the income. The Canadian court in Stubart Investment v The Queen interpreted this section as follows:

Where the facts reveal no bona fide business purpose for the transaction section 137 may be found to be applicable depending on all the circumstances of the case.
In those circumstances when the section does not apply the older rule of strict construction of a taxation statute prevails but will not assist the taxpayer when:

the transaction is legally ineffective or incomplete; or
the transaction is a sham within the classic definition thereof.

The formal validity of a transaction may also be insufficient where:

the express provision of the allowance, deduction or benefit sought to be gained clearly indicates legislative intent to restrict such benefits to rights accrued other than to the establishment of the arrangement adopted by the taxpayer purely for tax purposes; or
where the provisions of the Act necessarily relate to an identified business function; or
where:

... the object and spirit of the allowance or benefit provision is defeated by the procedures blatantly adopted by the taxpayer to synthesize a loss, delay or other tax saving device, although these actions may not attain the heights of "artificiality" in s.137. This may be illustrated where the taxpayer, in order to qualify for an "allowance" or a "benefit", takes steps which the terms of the allowance provisions of the act may, when taken in isolation and read narrowly, be stretched to support. However, when the allowance provision is read in the context of the whole statute, and with the "object and spirit" and purpose of the allowance provision in mind, the accounting result produced by the taxpayer's actions would not, by itself, avail him of the benefit of the allowance.

11.3.12 In short, the court adopted a business purpose doctrine for testing the tax effectiveness of a transaction where the language, nature and purpose of the provision of the tax law under construction would indicate a function, pattern or design characteristic solely of business transactions, prior to a deduction or allowance being granted.

11.3.13 It should be noted that even in Canadian law where express purpose was not included in the section, the essence of tax avoidance turned on the purpose of the taxpayer in entering into the transaction as defined in the legislature.

11.3.14 Shortly after the Stubart case, the Canadian legislature introduced a General Anti-Avoidance Rule commonly known as GAAR. A transaction or series of transactions that but for GAAR would result directly or indirectly in a tax benefit is considered to be an avoidance transaction unless the transaction may reasonably be considered to have been undertaken or arranged primarily for bona fide purposes other than the purpose of obtaining a tax benefit. The tax benefits may be in the form of a reduction, avoidance or deferral of tax or other amount payable under the Act, such as interest penalties, remittance of source deductions or an increase in a refund of tax or other amount.

11.3.15 Where a transaction is carried out for a combination of bona fide non tax purposes and tax avoidance, the primary purposes of the transaction must be determined. Where a transaction results in a tax benefit and has been carried out primarily for tax purposes, GAAR is inapplicable if it may be reasonably considered that the transaction or series thereof would not result directly or indirectly in a misuse or abuse of the particular provision. Hence GAAR relies upon the business purpose cum abuse of rights doctrine.

Hong Kong

11.3.16 In 1987 the Financial Secretary said that section 61A of the Hong Kong Revenue Ordinance would be employed as a general tax anti-avoidance section to attack sales of income streams and similar deliberate tax avoidance schemes which could not be attacked under the specific anti-avoidance sections in the Act. It should be noted that section 61A had no retrospective effect.

11.3.17 The section was modelled on the Australian Part IVA but it represents a simple, more decided and understandable attempt at drafting a more directed section, arguably one that would have been more successful in a Peabody context (see paragraph 11.3.9 above).

11.3.18 Section 61A provides as follows:

1) This section shall apply where any transaction has been entered into or effected after the commencement of the Inland Revenue (Amendment) Ordinance 1986 (other than a transaction in pursuance of a legally enforceable obligation incurred prior to such commencement) and that transaction has, or would have been but for this section, the effect of conferring a tax benefit on a person (in this section referred to as "the relevant person"), and, having regard to

the manner in which the transaction was entered into or carried out;
the form and substance of the transaction;
the result in relation to the operation of this Ordinance that, but for this section, wold have been achieved by the transaction;
any change in the financial position of the relevant person that has resulted, will result, or may reasonably be expected to result, from the transaction;
any change in the financial position of any person who has, or has had, any connection (whether of a business, family or other nature) with the relevant person, being a change that has resulted or may reasonably be expected to result from the transaction;
whether the transaction has created rights or obligations which would not normally be created between persons dealing with each other at arm's length under a transaction of the kind in question; and
the participation in the transaction of a corporation resident or carrying on business outside Hong Kong;

it would be concluded that the person, or one of the persons, who entered into or carried out the transaction, did so for the sole or dominant purpose of enabling the relevant person, either alone or in conjunction with other persons, to obtain a tax benefit.

2) Where subsection 1) applies, the powers conferred upon an assessor under Par X shall be exercised by an assistant commissioner, and such assistant commissioner shall, without derogation from the powers which be may exercise under that Part, assess the liability to tax of the relevant person

and if the transaction or any part thereof had not been entered into or carried out; or
in such other manner as the assistant commissioner considers appropriate to counteract the tax benefit which would otherwise be obtained.

3) In this section 

"tax benefit" means the avoidance or postponement of the liability to pay tax or the reduction in the amount thereof;

"transaction" includes a transaction, operation or scheme whether or not such transaction, operation or scheme is enforceable, or intended to be enforceable, by legal proceedings.

11.3.19 Although the section is comprehensive, the test for the manner in which the transaction was entered into does not appear to have met the difficulties of the normality test of section 103(1). See in particular paragraph (f).

11.4 SUBSTANCE OVER FORM THE UNITED KINGDOM APPROACH

11.4.1 Given the difficulty of drafting an adequate and effective anti-avoidance provision, the question arises as to whether any general anti-avoidance provision should be included in income tax legislation at all.

11.4.2 In this regard, the United Kingdom experience is important, in that the absence of a general anti-avoidance section has stimulated judicial activism in the guise of a "substance over form" doctrine.

11.4.3 For approximately forty years the English courts followed the approach adopted by the House of Lords in IRC v Duke of Westminster:

Every man is entitled if he can to order his affairs so that the tax attaching under the appropriate Acts is less than it otherwise would be...

11.4.4 Then in 1981 in IRC v Ramsay, Lord Wilberforce laid down four general principles to be applied to tax avoidance schemes:

When construing fiscal legislation the courts are not confined to literal interpretation. The taxpayer will be taxed according to clear statutory words but the Act itself must be placed in context and the purpose of the Act should be taken into account.
The taxpayer can arrange his affairs to reduce his liability to tax. He is still to be taxed according to the legal effect of the transactions into which he has entered. Lord Wilberforce was here reaffirming the ratio of the Westminster decision.
The Commissioner will find as a matter of fact whether the transaction is the genuine one or a sham.
If the document or transaction is genuine the court should not look for some underlying substance (citing Westminster's case). One does not look at the transaction distinct from its context. It may be an ingredient of a wider transaction as a whole. When the Commissioners are deciding whether the transaction is a genuine one or a sham they may look at the series of transactions and determine their effect as a series. In other words this constitutes a limit imposed by the Ramsay court on the Westminster doctrine.

11.4.5 This tougher approach to tax avoidance continued in IRC v Burmah Oil Co Ltd and culminated in Furniss v Dawson. In Furniss' case the taxpayer owned shares in two family companies (called together Opco) and he wanted to sell these shares to W B Co. If he simply sold these shares he was liable for capital gains tax so he incorporated a company Greenjacket Company on the Isle of Man. Greenjacket Co bought the shares from the taxpayer in exchange for shares in Greenjacket Co. Greenjacket Co sold the Opco shares to W B Co. The money paid for the shares belonged to Greenjacket Co. When the taxpayer transferred the shares to Greenjacket Co in exchange for shares in that same company there was capital transfer tax but no capital gains tax because this was classified as a company reconstruction. The base cost for the Greenjacket shares was equal to the base cost of the Opco shares and therefore there was no chargeable gain. The House of Lords disregarded the sale of the shares to Greenjacket (albeit that it was genuine) on the ground that it was a step inserted without a commercial (business) purpose and treated the series of transactions as a sale by the taxpayer to W B Co and thus liable to capital gains tax.

11.4.6 The House of Lords decision came as a rude shock to those taxpayers who thought that the ratio of Burmah Oil and Ramsay could be restricted to the facts of those cases. Lord Wilberforce had warned that Ramsay's principle was "the new approach" and "the emerging principle". However, it was believed that the new attitude was restricted to situations where losses and tax relief were fabricated, where commercial reality was lacking and where the main objective of the transaction was the avoidance or reduction of the liability to taxation. However the basis of the emerging principle was explained by Lord Bridge of Harwich in the House of Lords:

But in another sense the present appeal marks a further important step, as a matter of decision rather than mere dictum in the development of the court's increasingly critical approach to the manipulation of financial transactions to the advantage of the taxpayers.

The House of Lords was intent on extending the approach in Ramsay and Burmah Oil. Thus it reprimanded the court a quo in Furniss v Dawson, Lord Brightman saying:

It is difficult to escape the impression that the High Court and the Court of Appeal were determined at all costs to confine the Ramsay principle to the sort of self-cancelling arrangement which existed in that case and to resist what they conceived to be a deplorable inroad into the sacred principles of Westminster case.

11.4.7 The state of United Kingdom tax avoidance law immediately after the House of Lords decision in Furniss v Dawson could be summarised thus:

It is still perfectly legal for any taxpayer to order his affairs to reduce his tax liability. As Lord Bridge of Harwich said in the House of Lords in Furniss v Dawson:

Of course, the judiciary must never lose sight of the basic premise expressed in the celebrated dictum of Lord Tomlin in IRC v Duke of Westminster that every man is entitled if he can to order his affairs so that the tax attaching under the appropriate Acts is less than it otherwise would be.

A subject is to be taxed only upon the clear words of an Act of Parliament but, in determining what "clear words" are, one is not in the case of the fiscal statute limited and confined to a literal interpretation. One must look to the context and scheme of the relevant Act and its purpose should be considered. This was pointed out by Lord Wilberforce in Ramsay's case.
The Commissioners are to find as a matter of fact whether or not a document or transaction is genuine or a sham. If the document is genuine the court cannot go beyond it to find some supposed underlying substance. But where there is a series of documents or transactions before the Commissioners, if it can be seen that a document or transaction was intended to have an effect as part of a series of transactions or as an ingredient of a wider transaction intended to be entered into as a whole, there is nothing in the Westminster principle to prevent it from being so regarded.
Not all series of transactions are to be construed within and determined under the Ramsay principle. Lord Brightman expressed the point as follows:

The formulation by Lord Diplock in Burmah expresses the limitations of the Ramsay principle. First there must be a preordained 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 shares in the operating companies by the Dawsons to Wood Bastow. It did not in Ramsay's. 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 would depend upon the terms of the taxing statute sought to be applied. The formulation, therefore, involves two findings of fact: first whether there was a preordained series of transactions, i.e. a single composite transaction; second whether that transaction contained steps which were inserted without any commercial or business purpose apart from a tax advantage. Those are facts to be found by the Commissioners.

11.4.8 However in 1988, the House of Lords began to retreat from the Furniss v Dawson approach. As Lord Oliver said in Craven v White:

It has been urged, in the course of the argument, that in Dawson this House crossed the Rubicon and that your Lordships should not be astute to confine the bridgehead thus created. That event, of course, constituted a declaration of war upon the republic of Italy and I confess that I do not find the analogy drawn from so partisan an exercise an altogether happy one. I do not, however, quarrel with the general proposition, but before embarking even upon a reconnaissance into a republican territory it is at least desirable to test what the bridge will support by an analysis of the means by which the crossing was effected. The first essential, therefore, appears to me to be to analyse the true basis and the legal justification for the decision in Dawson in order to see whether it does in fact rest upon or establish some wider principle of law which justifies the appellants' claim to recover tax from the respondents upon gains from which, no doubt, they benefited but which did not in fact directly accrue to them. The second is to construe the relevant statute and to apply it to such facts as have been found or as may properly be inferred.

11.4.9 Lord Oliver found the true basis of Furniss v Dawson in the approach adopted earlier by the court to the question of motive. Thus:

... it is this reference to the motive of the taxpayer in engaging in a particular transaction which represents the significant alteration in approach which raises immediately the question why the taxpayer's motive for an action, otherwise lawful and effective, should lead to its being disregarded...It does not, I think, arise from a moral judgment which the court is called upon to make...the fact that the purpose of the scheme is tax avoidance does not carry any implication that it is in any way reprehensible or other than perfectly honest and respectable... The reason...is simply this, that the absence of any commercial motive underlines the artificiality of the interrelated transactions and entitles the court to disregard them because they are not intended to produce anything other than an artificial fiscal result. It is this aspect of motive which assumes great importance in Dawson... there appears to be introduced in the speech of Lord Scarman [in that case] a moral dimension by which the court is to identify what he described as "unacceptable tax evasion" ...On the face of it this might be taken to suggest that the long accepted distinction between tax avoidance and tax evasion is to be elided and that the fiscal effect of a transaction is no longer to be judged, as in Ramsay and Burmah, by the criterion of what the taxpayer has actually done, but by whether what he has done is "acceptable". Your Lordships are thus invited not simply to analyse the transaction, to construe the statute and then to apply it to the analysis of what the taxpayer has really done, but to construct a general catchall formula for rendering ineffective any step undertaken with a view to the avoidance or minimisation of tax on an anticipated transaction or disposition. That is an invitation to legislate.

11.4.10 From the foregoing it would appear that the history of United Kingdom tax avoidance jurisprudence reveals the extent to which judicial activism creates substantial uncertainty, allowing a judiciary, unaccountable to the electorate, to make major fiscal policy decisions.

11.5 THE APPROACH TO THE FORMULATION OF A NEW ANTI-AVOIDANCE PROVISION
FOR SOUTH AFRICA

11.5.1 The comparative legislation and experience referred to above would appear to be useful in three particular respects:

The uncertainty of the English jurisprudence coupled with an open invitation to judicial activism and judicial legislation supports strongly the retention of a general anti-avoidance section. This would operate as a curb on unbridled judicial activism.
A business purpose test could be used in certain circumstances to qualify the normality formulation presently contained in section 103(1).
Complex provisions like the Australian Part IVA and even the Hong Kong section 61A are no more successful than anti-avoidance legislation which is based on more general provisions. In the light of the body of jurisprudence developed in respect of section 103(1), it is preferable to use this as a starting point and to make the necessary amendments thereto so as to combat the widespread use of aggressive tax avoidance techniques. The repair of the defects in the existing provision is to be preferred to the total scrapping thereof.

11.5.2 For a number of years commentators have noted that the abnormality requirement is the "Achilles heel" of section 103(1). Stewart writes as follows:

While transactions which the section is designed to catch are in their developing stages, they might readily accede to the description of abnormal and so fall within the provisions of the section but once they become firmly established business practices the applicability of the section is more doubtful.

11.5.3 In approaching this matter of formulating a general anti-avoidance provision in South Africa, the Commission was guided by the following principles:

The anti-avoidance legislation is only intended to operate where the specific legislation contained in the Act is ineffective. It would be highly undesirable if the general anti-avoidance legislation were to operate in a manner which discouraged proper drafting of specific legislation. Parliament should, as a general principle, be specific in the formulation of its tax laws and general anti-avoidance provisions should only be designed to be used in exceptional cases.
Adherence to the principle stated above would promote equity and certainty and facilitate orderly planning of the taxpayer's affairs.
The existing anti-avoidance provisions have been the subject matter of much commentary and judicial decisions. It would therefore be preferable to retain the existing provisions, remedying the defects which have been identified by the Commission, rather than starting afresh.
Safeguards of an administrative nature, for example, the obtaining from the Commissioner of his reasons for exercising an opinion pursuant to the anti-avoidance provisions, are of fundamental importance to the taxpayer. However, it is unnecessary to incorporate such safeguards in the anti-avoidance provisions since those safeguards exist in the Constitution and are thus available to the taxpayer. (See in particular in this regard sections 23 and 24 of the Constitution).

11.5.4 Section 73 of the VAT Act has attempted to deal with these difficulties. Section 73 provides that whenever the Commissioner is satisfied that any scheme (whether entered into or carried out before or after the commencement of the Act, and including a scheme involving the alienation of property):

has been entered into or carried out which has the effect of granting a tax benefit to any person; and (our emphasis);
having regard to the substance of the scheme; (our emphasis);

was entered into or carried out by means or in a manner which would not normally be employed for bona fide business purposes, other than the obtaining of a tax benefit; or
has created rights or obligations which would not normally be created between persons dealing at arms' length; and

was entered into or carried out solely or mainly for the purpose of obtaining a tax benefit;

the Commissioner must determine the liability of any tax and the amount thereof as if the scheme had not been entered into or carried out or in such manner as in the circumstances of the case be deemed appropriate for the prevention or diminution of such tax benefit.

11.5.5 It would appear that the reference in subsection b(i) to a business purpose other than the obtaining of a tax benefit defeats possible submissions that the obtaining of a tax benefit can be a business purpose, no matter that such tax benefit is normally taken into account in determining the means employed or the manner in which a scheme for bona fide business purposes is entered into or carried out. Nonetheless the alternative provision, namely the creating of rights and obligations not normally created between persons dealing at arms' length could well admit of a relative test as outlined in Louw and Hicklin's cases for what objective yardstick exists to determine whether parties are dealing at arms' length other than the test of an arms' length transaction in relation to a similar transaction or scheme. It is thus submitted that section 73 of the VAT Act is an improvement on section 103(1) of the Income Tax Act, particularly in so far as transactions are carried on during the course of trade. In the application of this test the definition of trade in section 1 can be used to define the ambit of the section.

11.5.6 Wherever a transaction is entered into outside of the context of trade as defined in the Act, sub-paragraph b(ii) of section 103 of the Act is the more appropriate test. For example this would cover the act of placing assets into a trust by an individual estate owner or a similar estate planning activity. In the context of non trading activities, the relative test in the said sub-paragraph b(ii) is more suitable since the transaction has not taken place in a business context.

11.5.7 Concern has been expressed about the use of the business test as a basis for the normality requirement in that transactions which for example, utilise a tax incentive, granted by the legislation to encourage the very transaction in question, could be a victim of the provision. This is an understandable concern and consideration could be given to a similar provision adopted by Canada, which has it that the anti-avoidance provision is not to apply where it may reasonably be considered that the transaction would not result directly or indirectly in a misuse of the provisions of the Act or an abuse having regard to the provisions of the Act, read as a whole.

11.5.8 The Commission therefore recommends that the existing anti-avoidance provision contained in section 103(1) of the Act should not be deleted but rather that its principal defects be remedied, as follows:

where the transaction occurs in the context of trade, a business purpose test should be substituted for the normality test; and
where the transaction occurs in a non-business context, the existing normality test should continue to apply;
the provisions of section 103(1) must not apply where it may reasonably be considered that the transaction would not result directly or indirectly in a misuse of the provisions of the Act or an abuse having regard to the provisions of the Act, read as a whole.

11.5.9 The Commission recommends that the new provision should not apply retrospectively but, in the manner of section 61A of the Hong Kong Ordinance, only apply to transactions entered into after the implementation of the new section.

11.5.10 The constitutional safeguards in terms of section 23 of the Constitution (the right to information) and section 24 of the Constitution (the right to administrative justice, including the right to be provided with reasons for administrative decisions) should allow for a greater measure of certainty in Revenue decision making and hence allow the courts to test the justification of the use of section 103(1) more accurately.

11.5.11 The nature of the anti-avoidance section, requiring administrative decisions, necessitates a consideration of the effect of section 24 of the Constitution. In particular the Commission considers that in the light of section 24, the onus to prove tax avoidance should be upon Revenue, save that if the first three requirements are proved (ie. the existence of a transaction, the effect of which is to save or postpone tax and the transaction is abnormal), the existing presumption in favour of the purpose being to avoid tax (section 103(4)) could be retained.

11.6 THE IMPOSITION OF PENALTY INTEREST WHERE ANTI-AVOIDANCE PROVISIONS ARE SUCCESSFULLY INVOKED

11.6.1 The Commission considered the Margo Commission's recommendation regarding the imposition of interest which should be charged with retroactive effect on the amount of the tax where a taxpayer has been successfully challenged in terms of section 103, provided that the total liability for interest should not exceed the amount of tax involved.

11.6.2 The Commission has also taken note of the Government White Paper which commented on the Margo Commission Report regarding this particular recommendation as follows:

In the submissions received by the Department of Finance many complaints were received respecting this recommendation. It is felt that a rigid rule for the imposition of interest in section 103 cases is not needed. From paragraph 27.28 it seems clear that the Commission has blatant cases in mind. In other cases the taxpayer may genuinely feel that he has not overstepped the mark. Section 89 quat of the Income Tax Act, as amended in 1986, provides for the payment of interest where inadequate provisional tax payments have been made, except where the taxpayer's taxable income does not exceed R20 000 in the case of a company or R50 000 in the case of a person other than a company. If the taxpayer has reasonable grounds for believing that an amount should not have been included in his income, the Commissioner may direct that interest shall not be paid on the tax attributable to the amount in question. It is considered that the provisions of section 89 quat are adequate.

11.6.3 Although the Commission has taken cognisance of the argument that there is little disadvantage caused to a taxpayer by the successful invocation of section 103(1), it agrees with the conclusion of the White Paper for the reasons set out hereunder. A taxpayer should be allowed to arrange his/her or its affairs to best advantage within the ambit of the Act. In short, avoidance is not to be equated with evasion. A general tax anti-avoidance provision has been included to allow Revenue to counter tax avoidance practices which would otherwise fall within the form of the Act. It is and must remain a discretionary section and given its inevitable uncertainty should be treated carefully in the context of a Rechstaat. To penalise a taxpayer by an effective retrospective imposition of interest in respect of what could otherwise be a reasonable act on the part of the taxpayer would indicate a distorted appreciation of the distinction between evasion and avoidance. If a taxpayer acts unreasonably, section 89 quat can be employed; but the principle that a taxpayer is entitled to plan his or her affairs within the context of existing law in order to reduce his or her tax liability should be respected as a fundamental principle of a tax regime committed to the rule of law.

11.7 ANTI-AVOIDANCE PROVISIONS AGAINST TRAFFICKING IN ASSESSED LOSSES

11.7.1 The general anti-avoidance provisions against trafficking in assessed losses are contained in section 103(2) of the Act.

11.7.2 Recently two important decisions of the Appellate Division have interpreted those provisions, namely:

Commissioner for Inland Revenue v Ocean Manufacturing Limited; and
Conshu (Proprietary) Limited v Commissioner for Inland Revenue, 1994(4) SA 603.

11.7.3 Following the original decision of the Conshu case in the Special Tax Court the Commissioner issued Practice Note No. 20 dated 25 June 1993, reading as follows:

1. Concern has been expressed that the opening words of subsections 103(1), 103(2) and the wording of subsection 103(5)(a) of the Act gives the Commissioner the right and in fact impose an obligation on him to invoke those provisions in relevant circumstances and to re-open any assessment irrespective of the period that has expired since the date of the assessment.

2. The view of Inland Revenue is that the raising of additional assessments in terms of these subsections is subject to the restrictions imposed by the first proviso to section 79 of the Act. Additional assessments may therefore not be raised after the expiry of three years from the date of the assessment unless the Commissioner is satisfied that the amount which should have been assessed to tax was not so assessed or the fact that the full amount of tax chargeable was not assessed, was due to fraud, misrepresentation or non-disclosure of material facts.

11.7.4 The Commission recommends that the provisions of section 103(2) be amended to embody the provisions of the aforementioned practice note.

11.7.5 Furthermore, any amendments to the Act permitting group taxation would require consequential amendments to the Income Tax Act.

11.8 RECOMMENDATIONS

11.8.1 The Commission recommends that section 103(1) of the Income Tax Act be amended as set out hereunder, it being recorded that the draft below has been included to illustrate the principles which are being recommended by the Commission rather than to be prescriptive of the precise wording to be adopted:

(a) section 103(b)(i) be amended to read as follows:

"(b)(i) was entered into or carried out:

(aa) in the case of a transaction in a business context, by means or in a manner which would not normally be employed for bona fide business purposes, other than the obtaining of a tax benefit; and

(bb) in the case of any other transaction, being a transaction not falling within (aa), by means or in a manner which would not normally be employed in the entering into or carrying out of a transaction, operation or scheme of the nature of the transaction, operation or scheme in question; or";

(b) the following proviso be inserted at the end of section 103(1):

"provided that the provisions of this section shall not apply where it may reasonably be considered that the transaction would not result directly or indirectly in a misuse of the provisions of the Act or an abuse having regard to the provisions of the Act, read as a whole." [para. 11.5.8]

11.8.2 This new provision should only apply to transactions entered into after the implementation of the new section. [para. 11.5.9]

11.8.3 The Commission recommends that section 103 be amended to embody the principle contained in Practice Note No. 20 dated 25 June 1995; that is, that the raising of additional assessments in terms of section 103 is subject to the restrictions imposed by the first proviso to section 79 of the Act, so that additional assessments may not be raised after the expiry of three years from the date of assessment unless the Commissioner is satisfied that the amount which should have been assessed to tax was not so assessed or the fact that the full amount of tax chargeable was not assessed, was due to fraud, misrepresentation or non-disclosure of material facts. [paras. 11.7.3-4]