29 July 2011 by

Retrospective legislation not always objectionable

The Court of Appeal (Civil Division) gave judgment on 25 July 2011 in the matter of Huitson v HMRC, pertaining to the retrospective legislation that was introduced by the revenue authorities in relation to a so-called tax avoidance scheme that was operated by the taxpayer through means of the Isle of Man.

By way of background, the taxpayer was an electrical engineer who was a resident of the United Kingdom. He worked as a self-employed IT consultant and the end-users of his services are based in the United Kingdom. From June 2001, he participated in a so-called tax avoidance scheme operated through a partnership and a trust that were located in the Isle of Man. This scheme was aimed to take advantage of the protection of the Double Taxation Agreement (Treaty) entered into between the United Kingdom and the Isle of Man. In terms of the scheme, the taxpayer provided his services to the end-users in the United Kingdom through an intermediary partnership. The partnership in turn paid the taxpayer a fixed annual fee of £15,000. Essentially the taxpayer argued that the remaining income from the scheme that was channelled back to him through an Isle of Man trust was not the subject matter of any taxation in the United Kingdom (and for that matter also not in the Isle of Man due to certain concessions made by the fiscal authorities in the Isle of Man).

Even though HMRC and the taxpayer were involved in a dispute, the legislation was amended on 21 July 2008 and that amended, with retrospective effect, the 2005 legislation. The effect of the amended legislation was that the scheme was rendered ineffectual and imposed a liability on the taxpayer to pay tax on the trust income received in the past years.

In the judgment it was indicated that a number of taxpayers make use of this scheme (about 2 500) and the amount of income at stake rose to approximately £100,000,000. It was indicated that the aim of the legislation was two-fold:

  • it sent a clear signal to taxpayers and their advisers that the legislature would take effective steps to counter any attempt to take advantage of a Double Taxation Agreement through artificial arrangements; and
  • the effect of the legislation was to avoid complex and protracted litigation.

Generally, it was indicated that one should strive for a so-called "fair balance principle". One must strike a fair balance between the general interest of the community and the protection of the individual's fundamental rights. Even though there is a need for legal certainty, retrospectivity of fiscal legislation is not in itself prohibited. Ultimately, the effect of the legislation is that it should not result in an unreasonable burden on the individual taxpayer. It was indicated that one could also take into account the fact that the purpose of the retrospective legislation in that specific instance was to restore the original intention of the legislation.

It was accepted that the retrospective legislation did not impose an unreasonable burden on individual taxpayers as the taxpayer in the specific instance entered into a tax avoidance scheme that was "wholly artificial and of doubtful efficacy". It was also indicated that the retrospective amendments prevented a windfall of more than £200,000,000 being conferred on those taxpayers who used the tax avoidance scheme at the expense of the general body of taxpayers.

It was indicated that the retrospective legislation could be justified as it was aimed to prevent taxpayers that are residents in the United Kingdom from exploiting the Treaty in a way that would enable them to reduce income tax that would otherwise have been payable on income from the exercise of a trade or profession in the United Kingdom. Ultimately, a fair balance was struck between the interests of the great body of resident taxpayers "who paid income tax on their income from a trade or profession in the normal way, and the taxpayers, like the claimant, who had sought to exploit, by artificial arrangements, the DTA, in plain contravention of the important public policy set out above".

It was also indicated that the taxpayer could not rely on the principle of legitimate expectation. It was indicated that HMRC never accepted the interpretation of the taxpayer of the provisions of the Treaty and that it was never the intention of the legislature. No legitimate expectation was created on the part of the legislature or HMRC that they accepted the relevant interpretation that was placed on the provisions by the taxpayer.

Ultimately, it was indicated that the retrospective amendments were enacted pursuant to a justified fiscal policy "that was within the State's area of appreciation and discretionary judgment in economic and social matters. The legislation achieves a fair balance between the interest of the general body of taxpayers and the right of the claimant to enjoyment of his possessions, without imposing an unreasonable economic burden on him. This outcome accords with the reasonable expectations of the taxation of residents in the State on the profits of their trade or profession. The legislation prevents the DTA tax relief provisions from being misused for a purpose different from their originally intended use. There has been no conduct on the part of the State fiscal authorities that has made the retrospective application of the amended legislation to his tax affairs an infringement of his Convention rights".

The approach adopted by the Court of Appeal in the Huitson case may have far-reaching consequences, especially to the extent that taxpayers may have entered into tax avoidance schemes so as to obtain a tax benefit. Generally, the Court has adopted an approach that one should balance the interests of the general body of taxpayers compared to the few taxpayers that sought to benefit from the provisions of the Treaty as interpreted by them. Even though the taxpayer had the protection that he is entitled to peaceful enjoyment of property which should not be deprived, the Court indicated that the effect of the retrospective legislation is justified to the extent that artificial arrangements have been entered into with a view to avoid taxation. In such instances, the State is entitled to strike a balance that would otherwise result in the general body of taxpayers having to face the burden of paying additional tax.

It is interesting to speculate whether a similar approach would be adopted should the taxpayers not have embarked on a perceived artificial tax avoidance scheme. In a South African context, retrospective legislation is commonly introduced that seeks to clarify "technical issues". In these circumstances, the right to enjoyment of property may still prevail especially to the extent that tax returns have already been submitted based on existing legislation. This is especially relevant in the context of CFC legislation and the impact on taxpayers.

Emil Brincker

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