I do not apologise for the fact that what follows is complicated — tackling Barclays won’t be easy.

Equity or law?

If we are to tackle the abuse that Barclays Bank, and no doubt others, are perpetrating as a result of their structured finance activities that have given rise to massive taxation savings then there is no doubt that we will have to change the way in which the law of taxation should be interpreted in UK courts.

There are two options for interpreting taxation law. Interpretation can based upon the principles inherent in legislation or upon the strict construction of legislation.

The legal systems of the world vary considerably, as do the jurisprudential systems that they use. These two possibilities do, however, accord with the broad categorisation of determining obligations in accordance with the principles of either equity or law. For these purposes “equity” is the name given to the set of legal principles which supplement strict rules of law where their application would operate harshly. The intention is to achieve "natural justice." In contrast the "law" refers to laws enacted by Parliament or established by "common law", the latter being based on precedents set by judges when they decide cases.

It has been commonplace for tax to be charged in accordance with “law”. For example, it was decided in a legal opinion given in the House of Lords in the United Kingdom in 1869[1] that:

If the person sought to be taxed comes within the letter of the law he must be taxed, however great the hardship may appear to the judicial mind to be. On the other hand, if the Crown, seeking to recover the tax, cannot bring the subject within the letter of the law, the subject is free, however apparently within the spirit of the law the case might otherwise appear to be. In other words, if there be admissible, in any statute what is called an equitable construction, certainly such a construction is not admissible in a taxing statute.

This principle remains enshrined in most British tax law (in particular) and appears to heavily influence taxation thinking in general. This decision has implicit within it the following assumptions:

1. That the right to hold property is sacrosanct and that taxation violates that property right. As such tax may only be charged when specifically sanctioned irrespective of the equity of the resulting payment, or absence of payment of taxation;

1. The letter of the law can be determined without reference to the intent of those who created it or the context which gave rise to it, even if the circumstance in which it is used was not envisioned by those who created it;

1. That it is equitable as a result that some will, or will not, fall out of the charge to tax on the basis of the strict interpretation of the meaning of words which could not have been envisaged by those who passed them into law and whether or not (as is explicitly noted in the legal opinion, above) the resulting charge to tax is equitable or just.

The alternative approach to legal interpretation with regard to taxation is purposive. It may be summarised by an Australian law of 1901[2] on legal interpretation which said:

In the interpretation of a provision of an Act, a construction that would promote the purpose or object underlying the Act (whether that purpose or object is expressly stated in the Act or not) shall be preferred to a construction that would not promote that purpose or object.

In this context interpretation ‘looks though’ the strict structure of the words in the law to determine their just and equitable meaning, and uses that meaning in deciding upon the application of the law.

Human Rights are based upon principles. They are concerned with justice and the equitable treatment of all people. In that context a purposive or equitable approach to the interpretation of law is essential if miscarriages of justice contrary to the spirit of equity, noted to be possible in the UK legal decision of 1869, are to be avoided.

Equitable construction of the law is therefore considered an essential element of any set of principles for taxation that recognise the rights of the citizen and the mutuality of obligation inherent in the relationship between the citizen and State, and between states.

The consequences of an equitable approach to taxation law for a Code of Conduct

Much of the debate on taxation focuses on three issues:

1. How to reduce tax evasion;

1. To what extent, if any, tax avoidance may be considered legitimate;

1. What behaviour on the part of a taxpayer is considered compliant, and therefore acceptable.

This is unfortunate, because the words evasion, avoidance and compliant are being used as nouns. This requires them to be precisely defined to be of use, especially if a strict legal usage of the word is to be used for interpretation. Such a definition is not, however possible because of the complexities inherent in all language and because any definition may not stand the test of time.

For example, to evade tax means that a person has acted illegally to secure a tax advantage in the form of a reduced liability to pay tax. However, what is and is not illegal in tax law varies over time. For example, an action which may be quite acceptable in one country is quite commonly not in another, or may be acceptable in a country at one time, and because of a change in the law may not be at a later stage. In practice this means that whilst the principle of evasion can be described, it is difficult to define what is meant by the term unless the context and time of the evasion is known. Even then the ambiguities of language always make the transition from the state of tax evasion to tax avoidance porous, in contrast to the pragmatic description of the difference offered by a Chancellor of the Exchequer of the United Kingdom who famously said that it was ‘the thickness of a prison wall’[3].

Overcoming this limitation in language is essential if any Code of Conduct for Taxation is to have practical application. This is easier if the terms evasion, avoidance and compliance are considered to be verbs. This is possible if the terms describe approaches to the management of taxation, and not the specific transactions that result from that activity. In other words, the test of acceptability of a transaction is primarily an ex ante rather than an ex post test, albeit that the possibility that error in execution of the transaction resulting in an unacceptable legal outcome occurring even when the motivation is sound cannot be excluded (but should not be subject to significant penalty, if any at all). This contrasts with almost universal current legal practice where investigation is ex post i.e. outcomes are all that matter.

Using this understanding:

1. A person who evades tax seeks to limit a tax liability by means known to be criminal;

1. A person who avoids tax seeks to minimise a tax liability by any means believed possible, even if it is apparent that the law of one or more states may be abused (worked round, or avoided) in the process, but without criminal liability arising;

1. A person who is tax compliant seeks to settle a tax liability in the location where it can be best determined to be due, at the time when it is likely that a legislature wished it to be paid and only after claiming deductions and reliefs that were clearly intended to be provided given the economic substance of the transactions undertaken by the taxpayer.

This approach differs radically from conventional thinking. It presumes:

1. That the intention of the taxpayer is known to them;

2. Intention can be evidenced, e.g. through documented statements of intent prior to adopting a course of action, the validity of which is at least in part accepted on the basis of a relationship of trust which a Code of Conduct would seek to encourage;

3. This evidence is reliable if:

a. The evidence is systematic i.e. the procedures used to produce it are a part of the management process for taxation used by the taxpayer, or by the taxpayer in association with their agent;

b. There is no evidence that outcomes persistently fail to match documented intent which would suggest the evidence was fabricated;

4. That only in the absence of documented intent, or in the presence of persistent failure of realisation of intent would an ex post test of culpability with regard to tax be the primary test of intent, and therefore culpability for error.

The result would be a transformation in the way in which taxation compliance is appraised. The emphasis would shift from attention to outcomes alone to an additional focus upon the management of taxation. Only those who could be sure that they could document compliance would enjoy an easy relationship with taxation authorities. Those whose behaviour indicated the intention to avoid, or evade, would be much more likely to be subject to scrutiny. This risk based approach would be dependent upon effective appraisal of management systems by both the taxpayer and tax authorities, and on a risk appraisal being an inherent feature of the tax return process. This would take the form of a self-scoring declaration submitted with any tax return and intended to assist identification of all compliant tax payers. Failure to correctly complete such a return would, of course, give rise to automatic penalties for the taxpayer. Incentives to comply would therefore be high.

Using this approach there is no doubt where Barclays would stand: it would fail the compliance test. As the evidence published has shown, it well documented its intention to avoid tax. The consequences will be explored in my next blog.

The point to make now is this: we could enact this change in the basis of the interpretation of law now and apply it to all future tax cases. It is then likely that Barclays’ activities could then be ruled illegal in court without requiring retrospective legislation since they would fail an equitable construction test of the sort Australia enacted in 1901.

[1] Partington v. Attorney-General (1869), L.R. 4 E. & I. App. 100, per Lord Cairns at p. 122.

[2] Section 15 AA of the Acts Interpretation Act, 1901 downloaded 4 December 2006 from http://www.austlii.edu.au/au/legis/cth/consol_act/aia1901230/s15aa.html

[3] Dennis Healey is reputed to have said this, and claims to have done so but no date on which he is supposed to have done so is known. See http://en.wikipedia.org/wiki/Tax_evasion accessed 8 December 2006