Tax Jurisprudence – Choice Principle
Dr Benjamin Poh
Citation:  LR 379
Tax Jurisprudence – Choice Principle
This article analyses how the choice principle as part of the common law tax jurisprudence, has been eroded and narrowed by judges in common law countries, in view of the evolving interpretation of the General Anti-Avoidance Rules (“GAAR”). The Revenue authorities may invoke GAAR to defeat tax planning schemes carried out by the taxpayers and this creates dilemmas to tax advisers in giving specialist tax advice to taxpayers. It is time for the Malaysian government to provide clarity and consistency in the application of the GAAR so as to create certainty for taxpayers to plan their tax affairs without offending the GAAR.
Choice principle is a legal concept, whereby taxpayers are free to arrange their tax affairs according to the choices provided in the tax statute. However, the principle has been eroded and narrowed by judges in common law countries, in view of the evolving interpretation of common law and statutory GAAR. Tax avoidance is a tax offence in some countries with statutory GAAR. Recent decisions by the courts in common law countries, mostly agreed that aggressive tax planning schemes carried out not in contemplation of the legislative intentions of Parliament and without economic substance are against the common law and statutory GAAR. These decisions may provide impetus to the Revenue authorities to invoke GAAR, as a weapon to raise countries’ revenues to achieve fiscal objectives set by the governments at the expense of the taxpayers. The invocation of GAAR is more likely today in view of the current worldwide financial crisis. The GAAR may also be used by the governments to curb international tax avoidance schemes in response to the Organisation for Economic Co-operation and Development ( “ OECD ”) Base Erosion and Profit Shifting Projects and to further the governments’ fiscal and economic reforms to regain the countries’ international competitiveness. In Part I, the author will *380 review the initial recognition of the choice principle in common law tax jurisprudence and its erosion over the years by the courts. In Part II, the author will discuss two approaches to tax statute interpretation adopted in Australia and New Zealand. In Part III, the author will discuss major concerns the taxpayers and advisers face in carrying out tax planning schemes, in view of the courts’ evolving interpretation of common law and statutory GAAR. In Part IV, the author will review the UK’s approach to common law GAAR and her rationale of enacting a statutory GAAR. In Part V, the author emphasises why the Malaysian government should look into its statutory GAAR and commit to providing clarity and consistency in the application of the statutory GAAR.
Part I: The evolving interpretation of the choice principle under common law
The choice principle was well recognised by judges in common law countries since Lord Tomlinson’s famous dictum “ every man is entitled if he can to order his affairs so as that the tax attaching under the appropriate Acts is less than it otherwise would be”.1 What his Lordship meant is that every taxpayer is given a choice to arrange his or her tax affairs according to the provisions of the tax statute (or so-called the legal form), so as to mitigate his or her overall tax liability. However, the principle was subsequently qualified by the House of Lord ’s decision in WT Ramsay Ltd v IRC ,2 where the complex series of transactions carried out to reduce tax liability without any economic substance were considered as unacceptable tax avoidance schemes. In Furniss v Dawson ,3 Lord Brightman said that if certain types of transactions were inserted into a series of transactions mainly for tax purposes, without any economic substance, they would be ignored for tax avoidance purpose. This, his Lordship said:
First, there must be a pre-ordained 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 …
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 will depend on the terms of the taxing statute sought to be applied.
Concerned about the inconsistency in the interpretation of common law GAAR and economic substance in tax avoidance cases after Ramsay , Oxford law professor, Judith Freedman commented4 in her article on tax avoidance, *381 “ the line drawn between legitimate tax planning in Barclays Mercantile Business Finance Ltd v Mawson  UKHL 51 and illegitimate tax avoidance in IRC v Scottish Provident Institution  UKHL 52 is based on the judicial view of the intention of Parliament, but that view does tacitly include the issue of whether the legislation can have imposed upon it an intention to look at legal concepts only or whether it can be applied to the transaction in question so as to take account of economic substance. The approach here is wider than a normal purposive construction. It is arrived at partly by looking at the legislation in context, in the normal way, but in part by a review of the nature and manner of carrying out the scheme in question so as to reach an assessment of its economic substance”. This concern has led the UK government to enact a statutory GAAR on July 17, 20135 (after numerous consultations as discussed in Part IV of this article), to assist taxpayers and tax advisers to differentiate between legitimate tax planning and illegitimate tax avoidance schemes.
Part II: Legal form versus economic substance and purposive approach
Australia, New Zealand, Hong Kong, Singapore and Malaysia have similar statutory GAAR. The courts in these countries tend to interpret their GAARs according to the UK judicial doctrine of GAAR. The legal form versus economic substance and purposive approach to interpretation of the tax statute is a hotly debated issue in common law courts. Each approach has its supporters and dissenters. Those who adopt the legal form approach to interpretation of the tax statute, consider compliance with legal requirements as set down in the tax statute to be paramount to tax planning. This approach creates certainty for taxpayers to plan their tax affairs by relying on particular tax provisions of the tax statute. However, the Revenue may oppose the legal form approach to tax statute interpretation and urge the court to adopt the economic substance and purposive approach by invoking the judicial doctrine of GAAR, to push the court to inquire whether the tax plans and transactions were actually carried out with economic substance and are consistent with the legislative intentions of the Parliament. This approach is conceptually superior, but it creates uncertainty for taxpayers relying on particular provisions of the tax statute to plan their tax affairs.
In the Australian case of WP Keighery Proprietary Limited v Federal Commission of Taxation ,6 Dixon CJ, Kitto and Taylor JJ gave their views on the choice principle, “ Whatever difficulties there may be in interpreting s 260 (the Australia statutory GAAR), one thing at least is clear: the section intends only to protect the general provisions of the Act from frustration, and not to deny to taxpayers any right of choice between alternatives which the Act itself lays open to them ”. The choice principle was subsequently expanded in several Australian High Court cases *382 namely, Mullens v Federal Commissioner of Taxation ,7 Slutzkin v Federal Commissioner of Taxation ,8 Cridland v Federal Commissioner of Taxation ,9 Federal Commissioner of Taxation of the Commonwealth of Australia v Gulland.10 These cases show that the application of the choice principle and the GAAR, was to give effect to the principle of statutory construction expressed in the maxim generalia specialibus non derogant . In other words, the Australian courts view the GAAR as being a general provision of the tax statute, that cannot be simply invoked by the Revenue to frustrate the choices given to a taxpayer under particular tax provisions to plan his tax affairs, so that his tax liability is less than it otherwise would be under the tax statute.
Nevertheless, the New Zealand courts preferred the economic substance and purposive approach to tax statute interpretation. In the tax avoidance case Commissioner of Inland Revenue v Challenge Corporation Ltd ,11 the Privy Council inquired whether the taxpayer had incurred economic costs (e.g. reducing his income or incurring expenditure) to obtain a tax advantage. If yes, then it is a tax mitigation plan; if not, it is a tax avoidance plan.
The main criticism of this approach: the line between tax mitigation and tax avoidance is often difficult to draw, as the taxpayer can incur economic costs, but if viewed as a whole of the entire scheme, especially if the scheme involved related parties, that economic cost may be artificially created to serve the end purpose of obtaining a tax advantage. In another tax avoidance case, Ben Nevis v Commissioner of Inland Revenue ,12 the Supreme Court of New Zealand said that any tax plan carried out by taxpayers to obtain tax advantages, must be consistent with the legislative intentions of Parliament and with economic substance. If not, it is a tax avoidance plan.
The economic substance and purposive approach is conceptually sound and will discourage aggressive tax planning schemes in practice. However, it will create uncertainty for the taxpayers relying on particular tax provisions to plan their tax affairs in practice. This approach also challenges the court to discern the legislative intentions of Parliament by going through the history and purpose of the tax legislations. The intentions of the tax legislations may be obscure and inconsistent, due to numerous debates by members of Parliament, amendments by the Finance Minister after numerous consultations and drafting of the legislations. In addition, the court must also assess whether the tax plans were carried out in an artificial or contrived way without any economic substance. This may sometimes very much depend on *383 his or her value judgments and the prevailing social attitudes towards tax avoidance scheme at a particular point of time.
In Comptroller of Income Tax v AQQ (and Another Appeal) (“ AQQ ”),13 the Singapore Court of Appeal preferred the economic substance and purposive approach over the legal form approach to tax statute interpretation. In this case, the taxpayers carried out a series of corporate restructuring exercises and financing arrangements to extract available dividend tax credit (ss 44 and 46 of the Singapore Income Tax Act) in a number of companies within a group, to take advantage of the existing corporate imputation tax system before the single-tier corporate tax system was implemented in Singapore. The main issues of the tax appeal were whether the corporate restructuring exercises, dividends distribution to AQQ (the holding company of the subsidiaries after restructuring) after offsetting the interest incurred on the financing arrangements, with tax credit to be refunded by the Revenue, were considered as tax avoidance schemes. Initially, the Income Tax Board of Review said that the taxpayer’s corporate restructuring exercises, dividends distribution and financing arrangements were artificial and contrived, and fell within the statutory GAAR under s 33 of the Singapore Income Tax Act. However, the High Court allowed the taxpayer ’s appeal on the corporate restructuring exercises and dividends distribution schemes but held that the financing arrangements were implemented in an artificial and contrived manner. Ultimately, the Court of Appeal decided that all the three schemes should be viewed as a whole and said that the schemes were not carried out for bona fide commercial reasons and without economic substance, and therefore that the schemes fell within the statutory GAAR. By reading the following diagram on the financing arrangement, the end result of these financing arrangements was that AQQ obtained $225 million from N Bank, and the entirety of this sum was effectively returned to N Bank on the same day, albeit following a circuitous route. The payment of interest expenses did not incur any real economic costs within the group as a whole:
*384 In AQQ , the court had lifted the corporate veil of the group by ignoring the principle of separate legal entity and applied the doctrine of economic substance to assess whether the arrangements fell under the purview of GAAR. However, in the author’s view, the court did not really answer the question of whether the intentions behind ss 44 and 46 should not be utilised in the way arranged by AQQ , and whether the doctrine of economic substance was ever intended by the Parliament to disallow deduction of interest expenses incurred in a manner arranged by AQQ . This decision will definitely create uncertainty to the taxpayers and tax practitioners, at the mercy of judicial creativity and attitudes towards the application of GAAR according to the particular facts and circumstances of a case.
Part III: Tax advisers’ dilemmas
Malaysia ’s statutory GAAR is very similar to s 33 of the Singapore GAAR, s 260 of the Australia GAAR (Australia has changed its statutory GAAR now contained in Part IVA of the Income Tax Assessment Act 1936) and s 99 of the New Zealand GAAR (New Zealand has changed its statutory GAAR now contained in subpart BG 1 and GA 1 of the Income Tax Act 2007 ). The most immediate concern to tax advisers in Malaysia is whether the tax planning advice given according to specific provisions of the Income Tax Act 1967 (“ITA 1967”) in Malaysia could trigger the invocation of GAAR by the Inland Revenue Board after the AQQ case.
Currently, there is no public ruling issued on GAAR, although a number of tax avoidance cases have been challenged in the Malaysian courts. One of the hallmark cases is SB Sdn Bhd v Ketua Pengarah Hasil Dalam Negeri .14 The case was mainly about the use of s 44(6) on donations made by one subsidiary to its parent under the ITA 1967 and the Revenue’s rights to invoke GAAR under s 140 to override s 44(6) . Extensive discussion on s 140(6) (a deeming provision that will trigger statutory GAAR) by the Special Commissioner of Income Tax (“SCIT”) on whether the *385 donation had been made at arm’s length basis. The answer was negative, as the donations were given out of a subsidiary company’s substantial profits for a number of years to its parent entity, a tax-exempt foundation. However, the decision was overruled by the Court of Appeal on appeal. The Court of Appeal adopted the approach taken by the Privy Council in Commissioner of Inland Revenue v Challenge Corp Ltd15 and held that the donations were real and actually incurred rather than a pretence, and therefore it was a tax mitigation plan instead of a tax avoidance plan. The author is of the view that the Malaysian judiciary will choose the approach taken in Ben Nevis and AQQ as this is in line with the purposive interpretation as promoted by s 17A of the Malaysian Interpretation Acts 1948 and 1967. If SB Sdn Bhd were to be argued in the court after the decisions of Ben Nevis and AQQ , the appeal outcome might be different. This is because, in substance, the donations paid out by one subsidiary to its parent were in fact circulated within the group without actually flowing out to any independent third party.
Tax advisers in Malaysia might face dilemmas in advising their clients to mitigate tax liability by using specific provisions of the ITA 1967. This is because tax advisers might have difficulty in discerning the legislative intentions of Parliament, and may be uncertain about the court’s views on the economic substance of the whole scheme if the tax plan is brought to court in future as a result of GAAR invocation. If tax advisers keep their clients uninformed about the tax planning opportunities because of their uncertainty about the legislative intentions and the court’s views, will they be sued for professional negligence? In the UK case, Hossein Mehjoo v Harben Barker & Anor ,16 the accountants were sued for negligence by not advising a non-domiciled individual of the possibility of tax planning opportunity involving offshore bearer warrants. The High Court held that the tax advisers were negligent in not advising the non-domiciliary to use such a scheme and said that any reasonably competent accountant holding himself out as having expertise in advising non-UK domiciles should have recommended the tax planning scheme. The Court of Appeal overruled the High Court’s decision and held that the accountant’s terms of engagement only provided for general tax planning advice on the best use of reliefs, rather than specialist tax planning advice. Therefore, the accountant was not negligent. This would be good news for tax advisers holding themselves out as general tax planning advisers; but bad for tax advisers providing specialist tax planning service. If one were to hold himself out as a specialist tax adviser, he has to justify his opinions based on the facts and laws in court so as to avoid being sued for professional negligence, and it is advisable that specialist tax advisers should have bought sufficient professional indemnity insurance to cover any future lawsuit in court.
Part IV: UK approach to statutory GAAR
The Malaysian government may learn from the UK’s experience on enacting a statutory GAAR and use it as a guidance for reforming its existing GAAR framework.
The following extract17 summarises the historical background of introducing statutory GAAR in the UK:
UK tax law is specifically targeted rather than purposive: in tackling the exploitation of loopholes in the law, governments have legislated against individual avoidance schemes as and when these have come to light. Often the response has been the creation of new schemes to circumvent the law, which in turn has seen further legislative action – an “arms race” between the revenue authorities and Parliamentary counsel on one side, and on the other, taxpayers aided and abetted by the legal profession. Over the past twenty years many commentators have suggested having legislation to counter tax avoidance in general: by providing certainty as to the tax consequences of any transaction, a “General Anti-Avoidance Rule” (GAAR for short) might dissuade the most egregious efforts to avoid tax, encourage taxpayers and legal counsel to redirect their energies to more productive activities and allow the authorities to simplify the law without fear of it being systematically undermined.
In the late 1990s the Labour Government consulted on a GAAR before deciding against the idea. By 2003, evidence of the scale of tax avoidance – particularly schemes targeted at individuals working in the financial sector – rekindled interest in a GAAR, though in its 2004 Budget the Labour Government announced a new “disclosure regime” as an alternative, whereby tax avoidance schemes would be required to be disclosed to the revenue departments. This note looks the debate on the case for a GAAR over these years.
In its first Budget in June 2010 the Coalition Government stated it would explore the case for a GAAR, and in November 2011 published the report of a study group, led by Graham Aaronson QC, to advise on this question. Mr Aaronson argued in favour of a “ moderate” rule “targeted at abusive arrangements ”. The Government confirmed its plans at the time of the Autumn Statement in December 2012. Provisions in the Finance Bill 2013 for the new General Anti-Abuse Rule were agreed, without changes, and the new rule came into force on 17 July 2013.
Graham Aaronson, QC commented about the UK GAAR:18
I have concluded that a GAAR which is appropriate for the UK must be driven by an overarching principle. This is that it should target those highly abusive contrived and artificial schemes which are widely regarded as *387 intolerable, but that it should not affect the large centre ground of responsible tax planning. Critically, I consider that this overarching principle must be supported by the simple proposition that where there can be reasonable doubt as to which side of the line any particular arrangement falls on, then that doubt is to be resolved in favour of the taxpayer so that the arrangement is treated as coming within the unaffected centre ground.
The key features19 of the UK GAAR are summarised below:
The burden of proof that a taxpayer has entered into abusive arrangements will be with HM Revenue and Customs (“HMRC”).
The courts can take into account any relevant material in applying the GAAR. There is a broad carve-out from the GAAR in so far as a transaction/arrangement may be established practice at the time it was entered into.
HMRC is required to consult a newly-appointed Advisory Panel as to whether the GAAR should apply. The Panel will consist of experienced tax professionals and will provide views on whether a course of action was reasonable (a so-called single reasonableness test). It should be noted, however, that HMRC is not bound by the views of the Advisory Panel since the Panel is not sitting in a judicial capacity.
There will not be a pre-transaction clearance procedure which would allow taxpayers to determine whether the GAAR applies to their circumstances.
If the GAAR is invoked successfully, a taxpayer’s liabilities will be adjusted on a just and reasonable basis.
While there are no penalties associated with application of the GAAR, if the GAAR is invoked and a taxpayer is not considered to have taken due care with their tax affairs (e.g. self-assessment), then penalties may be applied under the relevant regime.
Currently, the UK HMRC has developed a number of guidance20 relating to tax avoidance for taxpayers’ reference and assessment, if they intend to carry out any tax planning or mitigation plan:
Part A – Purpose and status of the guidance (mainly stating the purpose and status of GAAR).
*388 Part B – Summary of what the GAAR is designed to achieve and how it operates to achieve it.
Part C – Specific points (clarifications on what constitutes a tax advantage, tax arrangement, abusive tax arrangement, counteraction of tax advantages).
Part D – Examples (examples of legitimate tax planning and abusive tax avoidance).
Part E – GAAR procedure (counteraction, consultation and representation procedures).
Part V: Time to clarify our GAAR
Tax legislation is a complicated piece of legislation affecting many aspects of a country; these include governments’ budgets, fiscal policies, international competitiveness, industry practices, and how businesses and individuals plan their tax affairs in practice. Though certainty in tax laws are difficult to achieve in practice, but clarity and consistency in applying tax law are paramount to individuals and businesses in practice.
The Malaysian government has entered into various trade and tax treaties with its major trading partners and endeavoured to adopt the best practice endorsed by the OECD countries. It’s time now for our government to re-look the current GAAR framework and clarify the situations in which GAAR might be invoked by the Inland Revenue Board; and provide further guidance to the public, rather than leaving this decision to the Malaysian judiciary. The UK’s journey from common law GAAR to statutory GAAR has sent us a clear message that unclear positions will only create inconsistency in judicial precedents, which will create uncertainty for taxpayers to plan their tax affairs according to the existing tax legislations.
Malaysia’s Inland Revenue Board can issue guidelines on GAAR by providing some examples of legitimate and illegitimate tax planning, and voluntary disclosure on tax planning schemes without penalty. Certain critical indicators may be provided in the guidelines for the court to assess whether certain tax plans and transactions are artificial without economic substance, such critical indicators may include the manner of the scheme entered into, form and substance of the scheme, length of period of the scheme, financial position of related parties after the scheme is carried out, agreements whether consistent with the function, risk and return of the contracting parties, etc.
With a clear, fair and efficient system of tax administration on GAAR, the Malaysian government will be able to attract more private and foreign direct investments into Malaysia in view of the current financial crisis and minimise unnecessary resources spent on tax litigations between taxpayers and the government in future.
*379 Tax Jurisprudence – Choice Principle
*. Advocate and Solicitor, High Court of Malaya, specialising in tax and commercial litigation and private wealth advisory. He is a Chartered Accountant of Singapore and Malaysia, CFA Charterholder, RICS Chartered Surveyor and Fellow of Chartered Tax Institute Malaysia. He holds a PhD in Tax Law from Washington School of Law, MBA (with Merit) degree from Manchester University and LLB (Hons) from London University. He can be contacted at firstname.lastname@example.org. The above article was initially published by the Chartered Tax Institute of Malaysia in Tax Guardian Vol 7/No. 4/2014/Q4 Issue and was revised by the author on August 15, 2020.
- IRC v Duke of Westminster  AC 1.
-  AC 300;  STC 174.
-  AC 474.
- Professor Judith Freedman, “Interpreting Tax Statutes: Tax Avoidance and The Intention of Parliament”, (January 2007) Law
Quarterly Review 70.
- Antony Seely, “Tax Avoidance: A General Anti-Abuse Rule”, House of Common Library, 2014, p 1.
-  100 CLR 66.
-  135 CLR 290.
-  140 CLR 314.
-  140 CLR 330.
-  160 CLR 55.
-  AC 155.
-  NZSC 15.
-  MSTC 70-030.
-  MSTC 3771.
-  STC 548.
-  EWCA Civ 358.
- Antony Seely, “Tax Avoidance: A General Anti-Abuse Rule”, House of Common Library, 2014, p 1.
- Graham Aaronson, “UK GAAR Study”, The National Archives, 2011, p 28.
- Dixon Wilson, “The UK’s New General Anti-Abuse Rule (GAAR)”, Dixon Wilson, 2013, p 2.
- Parts A to D has been approved by the GAAR Advisory Panel with effect from April 15, 2013.