1. There is, of course, already a tax-geared penalty regime which applies to the GAAR, namely, that in Schedule 24 of the Finance Act 2007 for under-declared liabilities to tax. However, the trigger for that regime is the existence of a degree of culpability on the part of the taxpayer for that under-declaration. There will, of course, be instances where the fact that the taxpayer’s return (showing, say, tax of 20) culpably fails to include a tax saving (of, say, 80) arising in consequence of abusive behaviour that is later counteracted by the operation of the GAAR. However, the circumstances where the taxpayer will be culpable for not showing the right tax (100) on his return may be limited given that (a) he will have been advised that the behaviour generates a tax saving (of 80) and is not abusive and (b) there is some scope for policy decisions by HMRC to affect whether the GAAR is in fact operated.
2. Where the GAAR operates it restores the taxpayer to the position he would have been in had he not engaged in the abusive tax conduct (in the example above, his tax liability is restored to 100). However, professional fees, any economic costs, and the remote possibility of Finance Act 2007 penalties aside, the effect of the GAAR will simply be to restore him to the position he would have been in had he not engaged in the abusive behaviour at all.
3. Discouraging abusive behaviour, therefore, requires that it carry a risk over and above the taxpayer being restored to the status quo ante (i.e. a tax liability of 100). The answer is a special penalties regime. An appropriately drawn regime will encourage taxpayers to interrogate their advisers as to whether there is a risk that proposed planning will be abusive. It will also encourage advisers to be more cautious about suggesting abusive planning. I am aware of no reason of principle why one should not discourage abusive planning through the use of penalties.
4. A penalties regime will also likely have what one might describe as a modest penumbral effect. In other words, it will not merely discourage practices caught by the GAAR but it will discourage practices that might be caught. And the higher the penalty, the stronger the discouragement.
5. Whilst this is bound to have short term positive fiscal impacts, it must also be recognised that the penumbral effect could act as a discouragement to taxpayers to engage in acceptable or pro-purposive tax planning. (I assume this to be an undesirable consequence although others might disagree).
6. One might reasonably assess the penumbral effect to be modest given that the GAAR is tightly drawn. Moreover, one can certainly modulate the extent of the penumbral effect through the rate at which one sets the penalty. The other mechanism that one might adopt is arrangements whereby one mitigates the penalty according to whether the taxpayer had good reason to consider the arrangements not to be abusive. A similar mechanism has been adopted to mitigate, for example, the effects of Follower Notices.
7. Addressing these points in turn, I consider the GAAR (importantly, as presently drawn) to be tightly focused. An experienced adviser approaching the question ‘Is this planning abusive?’ with an appropriately open mind is, I consider, likely to be able to reach a reasonably accurate assessment of the answer. Putting the matter another way, I consider the quality of the GAAR in its present form is likely to have as its consequence that the introduction of penalties is likely to have a limited, and in some measure desirable, penumbral effect.
8. Where there is a penumbral effect, that effect will be strongest on arrangements which are abusive but are nevertheless not caught by the GAAR. As others have observed, the GAAR operates only when arrangements are (putting the matter somewhat crudely) clearly abusive. This is the consequence of a policy call having been taken by Parliament about where to strike the balance between maximising legal certainty and maximising the reach of the GAAR, a policy call articulated in the language used in, for example, section 207(2) Finance Act 2013. The penumbral effect will be strong where the arrangements are (again crudely) probably abusive but there is nevertheless some doubt about whether they are. This particular penumbral effect may be regarded as desirable.
9. As to the size of the penalty, plainly it must be tax-geared i.e. a function of the amount of tax the abusive practice purports to ‘save’ (80 in the example). Plainly also it must appropriately risk the abusive behaviour. Different people will reasonably arrive at differing assessments of what the right level of risk is. My personal view is that 100% is not unreasonable and it also has a symbolic attractiveness. The effect will be that the taxpayer with an initial liability of 100 who engages in abusive behaviour reducing his tax bill to 20 will, when counteracted and penalised, face a final liability of 180.
9. As to mitigation, there will always be cases where an application of a tax geared penalty will lead to genuine injustice. One will also want to encourage taxpayers engaging in behaviour that might be abusive to tell HMRC. And one will wish to incentivise taxpayers to come clean if they have engaged in abusive behaviour.
10. However, the scope of mitigation should be narrowly drawn.
11. I consider a discount of 50% should be given where the taxpayer discloses on his tax return that he has engaged in conduct that may be considered abusive (so the disclosing abusive taxpayer’s liability is 140).
12. I consider a discount of 25% should be given where the taxpayer who does not initially disclose later discloses (160). This discount is not high. However, it must be smaller than that for the person who discloses on his tax return otherwise one fails to incentivise the taxpayer not to make an initial disclosure – and to wait and see whether HMRC refers his transactions to the GAAR Panel.
13. As to injustice, one must recognise (a) that in certain circumstances the taxpayer may quite reasonably rely on his adviser (b) there are powerful commercial incentives for advisers to give over-optimistic advice about tax risk (professional fees are often a function of whether a taxpayer enters into arrangements rather than whether he seeks advice on them). One has regard to these competing considerations, it seems to me, by mitigating for injustice only where the taxpayer can demonstrate that he took a genuine interest, appropriate to the tax saving, in whether the arrangements in question were or were not abusive. Although this may be a matter of detail which is downstream of these brief thoughts, one may wish to stipulate particular factors that a tax tribunal will accept as demonstrating the presence of a genuine interest including whether the taxpayer took advice from a specialist unconnected to the promoter of the arrangements.
Postscript: I’d suggest readers might have a look at this Schematic which sums up what the GAAR does – and how a GAAR specific penalties regime might affect its operation.