Understanding Judicial Doctrines of General Anti-Avoidance Rules (Part I) (Published in Westlaw Asia Law Review Article Citation: [2020] LR 406)

Understanding Judicial Doctrines of General Anti-Avoidance Rules (Part I)

Dr Benjamin Poh

Citation: [2020] LR 406
*406 Understanding Judicial Doctrines of General Anti-Avoidance Rules (Part I)


Part I of this article will review the earlier common law judicial doctrines of the General Anti-Avoidance Rules (“GAAR”) developed in the US and UK. These doctrines have been adopted by the common law courts today including the Malaysian judiciary, to combat against aggressive international tax planning or avoidance schemes with little commercial justification and economic substance. In Part II of this article, the author will discuss two recent hallmark cases on GAAR that were decided by the Malaysian Court of Appeal, its implications for tax planning in Malaysia and the necessary tax reforms that the government should focus on.


The financial crisis in the year 2008 had caused severe impact on tax revenue of major advanced countries. As a result, the US and Western European countries had to make substantial tax reforms and implement austerity programs to regain their financial standing and fiscal position. Similarly, the Organization for Economic Co-operation and Development ( “ OECD ”) countries had committed to reform the international taxation framework via the Base Erosion and Profit Shifting ( “ BEPS ”) project, to combat against multinational enterprises’ aggressive international tax planning and to collect their fair share of tax revenue so as to improve their national fiscal position.

The OECD defines BEPS as “ tax planning strategies that exploit gaps and mismatches in tax rules to artificially shift profits to low or no-tax locations where there is little or no economic activity. Although some of the schemes used are illegal, most are not. This undermines the fairness and integrity of tax systems because businesses that operate across borders can use BEPS to gain a competitive advantage over enterprises that operate at a domestic level. Moreover, when taxpayers see multinational corporations legally avoiding income tax, it undermines voluntary *407 compliance by all taxpayers ”. The BEPS project advocated 15 action plans to tackle international tax planning or avoidance schemes. The 15 action plans are similar to domestic Specific Anti-Avoidance Rules (“SAAR”) and GAAR as found in any domestic income tax laws and regulations used to tackle tax avoidance schemes without commercial justification and economic substance.

Historically, governments have employed SAAR to tackle international tax avoidance schemes, but such approach was not satisfactory. This is because business and financial practices are changing fast and detailed tax rules such as the SAAR, could not anticipate and cover every eventuality. The rising of the tax planning industry armed with smart and creative tax lawyers, accountants and private bankers trying to exploit the tax loopholes within the SAAR, was relatively successful, even though some of these tax planning schemes are with little commercial justification and economic substance. Therefore, governments are more likely to invoke GAAR as a tool to protect their revenues from abusive tax plans.

Nevertheless, judicial interpretation of GAAR in common law countries are not consistent for cases involving tax avoidance and planning schemes. Understanding the judicial doctrines of GAAR will enable tax practitioners to assist their clients to plan their tax affairs efficiently and effectively and to meet the thresholds laid down by the court.

The origin of the US economic substance doctrine

The US “economic substance” doctrine was first found in the hallmark case of Gregory v Helvering .1 In this case, the taxpayer was the sole owner of a corporation called “United”. United owned stock in another company called “Monitor”. The taxpayer subsequently incorporated a new company called “Averill” and transferred the stock in Monitor to Averill, to convert ordinary income on the stock into capital gain. Subsequent to the transfer, Averill was liquidated and the stock was sold immediately. The taxpayer argued that the gain from the sale was a capital gain. The taxpayer treated the transaction as a tax-free corporate reorganisation under s 112 of the Revenue Act 1928.

The Commissioner of Internal Revenue argued that there really was no “business reorganisation” as the taxpayer who controlled all three corporations, was simply following a legal form to give the appearance of a reorganisation so that she could dispose of the Monitor shares without having to pay substantial income tax on the gain that otherwise would have been deemed to have been realised.

*408 The US Supreme Court agreed with the Revenue’s argument, and stated as follows:

Putting aside, then, the question of motive in respect of taxation altogether, and fixing the character of the proceeding by what actually occurred, what do we find? Simply an operation having no business or corporate purpose – a mere device which put on the form of a corporate reorganisation as a disguise for concealing its real character, and the sole object and accomplishment of which was the consummation of a preconceived plan, not to reorganise a business or any part of a business, but to transfer a parcel of corporate shares to the petitioner. No doubt, a new and valid corporation was created. But that corporation was nothing more than a contrivance to the end last described. It was brought into existence for no other purpose; it performed, as it was intended from the beginning it should perform, no other function. When that limited function had been exercised, it immediately was put to death.

In these circumstances, the facts speak for themselves and are susceptible of but one interpretation. The whole undertaking, though conducted according to the terms of [the statutory provision], was in fact an elaborate and devious form of conveyance masquerading as a corporate reorganisation, and nothing else. The rule which excludes from consideration the motive of tax avoidance is not pertinent to the situation, because the transaction upon its face lies outside the plain intent of the statute. To hold otherwise would be to exalt artifice above reality and to deprive the statutory provision in question of all serious purpose.

The UK choice principle doctrine

However, four months later, a similar tax avoidance case was decided differently by the UK House of Lords. In IRC v Duke of Westminster ,2 the Duke of Westminster had a number of household servants. The UK Income Tax Act 1918 did not allow a deduction of wages of household servants, but allowed a deduction of annuity payments made in pursuance of a legal obligation other than remuneration of servants. The Duke accordingly entered into deeds of covenant with each of his servants under which he undertook to pay each of them annuity sums for a period of seven years. The payments were made to the servants irrespective of whether any services were performed by the servants. However, it was established by evidence that the understanding between the Duke and his servants was that they followed the provision made for them by deed, and would not assert any right to remuneration. In this way, the Duke converted his non tax-deductible wages obligation into a tax-deductible annuity obligation.

Lord Tomlin agreed with the Duke’s tax planning scheme and said, “ 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. If he succeeds in ordering them so *409 as to secure this result, then, however unappreciative the Commissioners of Inland Revenue or his fellow taxpayers may be of his ingenuity, he cannot be compelled to pay an increased tax. This so-called doctrine of ‘ the substance ’ seems to me to be nothing more than an attempt to make a man pay notwithstanding that he has so ordered his affairs that the amount of tax sought from him is not legally claimable”.

The modern approach to statutory GAAR interpretation Gregory v Helvering3 laid down the US substantive, purpose-based, anti-tax avoidance principle. Whereas IRC v Duke of Westminster4 took a narrow and literal approach to tax statute interpretation on tax avoidance plans. However, the modern approach to tax statute interpretation on tax avoidance plans used by leading common law countries is more in line with the US substantive and purpose-based approach. This modern approach consists of a few key judicial doctrines of GAAR as discussed below.

Sham transaction doctrine

The sham transaction doctrine is applied when a taxpayer claims tax benefits based on having taken certain steps but did not complete those steps, or the legal transactions do not accurately reflect or capture the transactions’ underlying economic reality. It is sometimes considered by the tax authorities or the courts as “ artificial transactions” arranged for the purpose of obtaining tax benefits. The legal transactions, as documented, are in fact different to the implemented legal transaction which the parties adhere to. This doctrine is not easily employed to defeat tax avoidance plans in the modern day, as the courts are reluctant to frustrate a legal transaction and declare it to be “ artificial ”. This is because the legal effects of a transaction should be well respected in law, even though some features of the transaction may seem abnormal and which may reflect the unique commercial requirements between the parties.

Substance-over-form doctrine

Under the substance-over-form (or legal substance) principle, the facts must be assessed according to commercial substance and not just its legal form. In other words, the substance of the transaction, rather than its legal form, is the main determinant of the tax consequences. What this method and the step transaction doctrine discussed below have in common is that, the court will look beyond its legal form and apply the doctrine to the facts in a proper and realistically manner. When assessing the validity of a transaction and its tax effects, it is important to consider the underlying commercial and economic reality of the transaction.

*410 Business purpose doctrine

The business purpose doctrine (or bona fide purpose doctrine) is employed by the court to seek an understanding of the motivations behind the transactions, whether the main purpose of the transactions is for tax avoidance or other commercial justification. In other words, the court requires that transactions are mainly driven by business or commercial justification rather than by tax consideration. The court will always employ this doctrine with the substance-over-form and step transaction doctrine, to assess whether a series of transactions are pre-arranged and inserted into a composite transaction without any economic and commercial substance, other than with the main purpose of avoiding tax.

Step transaction doctrine

The step transaction doctrine was developed by common law judges to enable them to assess a series of interconnected transactions as a single composite transaction. Under the step transaction principle, even if one or more of the whole series of transactions are bona fide, these transactions may be disregarded and several related transactions can be treated as a single composite transaction. The doctrine is intended to prevent the possibility that two transactions might achieve the same financial result, but be taxed differently, solely due to the form that the legal steps had taken. Usually, the court will employ the three tests below for purposes of determining whether or not it is appropriate to invoke the step transaction doctrine, and only one of the three tests is required to be satisfied:5
(1) The “binding commitment test” examines if at the time the first step was entered into, there was a binding commitment to undertake the later step. The purpose of this test is to promote certainty in tax planning. As it is the most rigorous limitation test of the step transaction doctrine, it is seldom used and applies only where a substantial period of time has passed between the steps that are subject to scrutiny. It is important to note that if there is a time in the series of transactions during which the parties are not under a binding obligation, the steps cannot be examined using the binding commitment test, regardless of the parties’ intent.
(2) The “end result test” examines whether or not separate steps constitute pre-arranged parts of a single transaction intended to reach an end result. This test is most often invoked in connection with the step transaction doctrine.
(3) The “mutual interdependence test” examines whether or not separate steps are so interdependent that the legal relations created by one step *411 would have been fruitless without a completion of the series of steps. In other words, this test concentrates on the objective relationship between steps, rather than on their “end result ”. Accordingly, it can be considered that in a certain way the mutual interdependence test and end result test supplement each other.6

In Ramsay Ltd v IRC ,7 Lord Wilberforce applied the step transaction doctrine and said that:

While obliging the court to accept documents or transactions, found to be genuine, as such, it does not compel the court to look at a document or a transaction in blinkers, isolated from any context to which it properly belongs. If it can be seen that a document or transaction was intended to have effect as part of nexus or series of transactions, or as an ingredient of a wider transaction intended as a whole, there is nothing in the doctrine to prevent it being so regarded; to do so is not to prefer form to substance, or substance to form. It is the task of the court to ascertain the legal nature of any transaction to which it is sought to attach a tax or a tax consequence and if that emerges from a series or combination of transactions, intended to operate as such, it is that series or combination which may be regarded.

Economic substance doctrine

The doctrine of economic substance is the latest and advanced concept developed by common law courts to attack sophisticated tax avoidance plans involving independent third parties which acted as an intermediate indifferent party in the whole tax plan. In the context of GAAR, the economic substance doctrine requires the court to perform an economic analysis of the transactions to discern whether the transactions undertaken by the parties involved, make economic and commercial sense, other than for the main purpose of tax savings.

Besides looking at the legal substance in determining whether the legal arrangements are effective and executed as planned, the court would look at whether the economic position of the taxpayer would be altered as a result of the transactions. In other words, a transaction lacks economic substance if it did not expose the taxpayer to any economic risk or offer the taxpayer any opportunity for profit, that was meaningful in relation to the resulting tax benefit.8

The court will consider several critical factors9 when invoking this doctrine, such as whether there will be a reasonable expectation of pre-tax profit when *412 the transactions were undertaken;10 whether there are any supervening market forces such as market risk or other non-tax considerations that could intervene in the planned execution of the transactions involved; whether there are any tax indifferent intermediary involved and in this regard, as was observed by Lord Diplock in IRC v Burmah ,11 “ The kinds of tax-avoidance schemes that have occupied the attention of the courts in recent years … involve inter-connected transactions between artificial persons, limited company, without minds of their own but directed by a single master-mind ”; and whether the transactions have all the usual commercial features and are clearly an “ordinary business transaction” with economic substance. The economic substance doctrine is effective in commercial tax shelter plans where the transactions intend to produce a pre-tax loss (e.g. pre-tax profit minus transaction costs) and no commercial person would enter into the transaction without the tax benefit.


For years, the tax fraternity and the courts in common law countries have fought difficulties and challenges in interpreting statutory GAAR whenever a case has an element of tax avoidance. Malaysia like other common law countries has faced similar difficulties and challenges in interpreting its statutory GAAR. In Part II of this article, the author will review two recent hallmark cases brought before the Malaysian Court of Appeal on GAAR. These two cases are Sabah Berjaya Sdn Bhd v Ketua Pengarah Jabatan Hasil Dalam Negeri12 and Syarikat Ibraco-Peremba Sdn Bhd v Ketua Pengarah Hasil Dalam Negeri .13 The author will review some challenging issues that might arise when interpreting the statutory GAAR under s 140 of the Income Tax Act 1967. Lastly, the author will provide some key pointers for GAAR reform, so as to keep in line with the international tax jurisprudence and trends, following the implementation of the OECD BEPS project.

*406 Understanding Judicial Doctrines of General Anti-Avoidance Rules (Part I)

*. 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 pcslegal.group@gmail.com. The above article was published by the Chartered Tax Institute of Malaysia in Tax Guardian, Vol 10/No. 3/2017/Q3 Issue.

  1. (1935) 293 US 465.
  2. [1936] AC 1.
  3. (1935) 293 US 465.
  4. [1936] AC 1.
  5. US: CA, 2002, Andantech LLC v Commissioner, 83 TCM (CCH) 1476, 1504, 2002 TCM (RIA) P 2002-097, at 543-544.
  6. Dr Patricia Lampreave, “An Assessment of the Anti-Tax Avoidance Doctrines in the United States and The European Union” (March 2012) IBFD Bulletin for International Taxation, p 155.
  7. [1982] AC 300.
  8. Jinyan Li, “Economic Substance: Drawing the Line Between Legitimate Tax Minimization and Abusive Tax Avoidance” (2006) 5(1) Canada Tax Journal 45.
  9. Ibid, pp 46-51.
  10. Long Term Capital Holdings v United States, 330 F Supp 2D 122 at 139 (D Conn 2004).
  11. [1982] STC 30 at 32, HL.
  12. [1997-2002] AMTC 2079; (2000) MSTC 3771, CA.
  13. [2017] AMTC 69; (2014) MSTC 30-084, CA.
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