Lyon & Turnbull

Scottish Revenue | Bill Pagan | March 2014

Where do we start? Not with the Referendum!

Scotland already has devolved powers over Business Rates and Council Tax.  In addition, there will be a Scottish rate of Income Tax (SRIT), but this will be administered by HMRC: Scotland will have power only to adjust all the Income Tax rates paid by “Scottish Taxpayers” by the same percentage – up or down!  This is therefore a purely fiscal tool, not a tool for social engineering, to the disappointment of the Scottish Government (SG).

The creation of Revenue Scotland, a non-ministerial department which will report to the Scottish Parliament,  does not depend at all on the Independence Referendum to be held this September.  Regardless of the outcome of the Referendum, Scotland will, from 1st April 2015, be given outright control over two new taxes:  the Land and Buildings Transactions Tax (LBTT), and Scottish Landfill Tax (SLfT). These two taxes will replace existing UK taxes, LBTT replacing Stamp Duty Land Tax (SDLT), and SLfT its UK namesake.  The logic of giving Scotland control over these taxes is that both relate to land, transactions in which, or activities in which, are readily identifiable as taking place on one or other side of the border.

The legacy of aggression

Not a reference to Bannockburn!  SDLT has been the subject of sophisticated and aggressive tax planning, much of which has been targeted by HMRC as abuse.  Recently introduced rules for Capital Gains Tax, and the Annual Tax on Enveloped Dwellings (ATED), are responses to the perceived abuse of UK tax rules through the medium of companies.  SDLT is one of the taxes to which the Disclosure Of Tax Avoidance Schemes rules (DOTAS) and the UK’s General Anti Abuse Rule (GAAR) both apply.  It is not surprising that SG plans to give Revenue Scotland equivalent tools to prevent perceived abuse of their LBTT and SLfT legislation.
The SG approach is even stricter than the UK approach.  Before the UK GAAR can be applied, two separate tests have to be satisfied: firstly, that entering into the particular arrangement is itself unreasonable in the context of the specific Tax; secondly, that the arrangement must itself lack commercial substance.  Only then will any perceived Tax advantage be counter-acted. In Scotland, it will be sufficient if either of these tests is satisfied - and the Scottish test is no more than “artificiality”, whereas the UK test is “abuse”.

More fundamentally, the UK GAAR is an anti-Abuse measure; the Scottish equivalent – as son of GAAR, nicknamed “McGAAR” -  will be an anti-Avoidance weapon.  Neither offers a clearance procedure, though the Scottish system promises the opportunity to make informal approaches – a sort of unofficial DOTAS perhaps?
For the ordinary case, where there is no need to rely on McGAAR,  the Bill provides the expected rules for disciplining taxpayers on matters such as failure to file returns or filing them late, or late payment or non-payment of tax, with the usual provisions for interest and penalties.  It is not necessary to legislate for the creation of tax crimes, for example “tax fraud”, because these will be covered by the Scottish Common Law approach to crime:  Scottish courts have never been shy of recognising crime for what it is, with or without a detailed label.  They know wrong-doing when they see it!

Casting the UK asunder?

Since starting the consultation on tax rules in Scotland, SG has published its White Paper on Independence.  Whatever one’s views on the fundamental question of Independence, there is much to agree with – just as the SG approach to governing Scotland under the present rules is acknowledged even by its opponents as having much to commend it.  It is hard for example to disagree with the White Paper’s four principles for a new tax system for Scotland, namely simplicity, neutrality, stability, and flexibility. 

These are presumably seen by SG as the 21st century’s equivalents of Adam Smith’s four maxims:  certainty, convenience, efficiency and proportionality (the ability to pay).   This fourth maxim is reflected in one major difference between SDLT and LBTT which is that the UK’s “slab” rates of tax, where as soon as a threshold is reached the whole transaction is taxed at a higher rate, will be replaced under Scottish LBTT by a progressive scale of tax, making it less likely that LBTT will be a major deterrent to a first step on the housing ladder.  Sadly, simplicity has not been embraced:  there was the opportunity for the LBTT legislation to be drafted from scratch, without many of SDLT’s complexities. Unfortunately, this was not done, and the LBTT legislation has borrowed so much from its predecessor, SDLT, that simplicity was impossible - so McGAAR is seen as necessary.

Draftsmen feel the draught

Any need for a GAAR is a failure of draftsmanship. The author pointed this out when giving evidence to the Economic Committee of the House of Lords last spring in the context of its discussions on the introduction of the UK GAAR.  While he got a sympathetic hearing, it was acknowledged that this is wishful thinking!  McGAAR will come – and will be in place not only for LBTT and SLfT but for any other taxes which may be devolved to Scotland by the UK in future.  Such devolving of taxes does not require primary legislation, merely the agreement of both Governments followed by secondary legislation.  McGAAR will of course be available also to cover whatever Taxes an independent Scotland may impose should the September Referendum result in a “Yes” decision. The Law Society of Scotland (LSS), after much discussion, came out in favour of McGAAR on the basis that it might in future permit simpler legislation. Dum spiro spero!

Legislative parenthood

The present powers of SG are of course all conferred by UK legislation.  It is Westminster’s  Scotland Act 2012 which permits SG to invite the Scottish Parliament to legislate Revenue Scotland into existence, and states that the two new Scottish taxes are to come into effect in April 2015. The Scottish Parliament’s Revenue Scotland and Tax Powers Bill provides the overall framework within which Revenue Scotland is to operate: it is Scotland’s Taxes Management Act, which is the reason its chapters have to cover the complete code of tax collection. 
The Bill is on a scale which, sadly, we have got used to in the context of UK taxes: it runs to 225 sections and five long schedules, and it takes 10 sections to deal with McGAAR.  For McGAAR to be applied, either of two conditions must be met:  Condition A is that the arrangement is not a reasonable course of action, and Condition B is that the arrangement lacks commercial substance. There is a short list of things which might be deemed to lack commercial substance. There is also a short list of things which will be included in the definition of “tax advantage”, including reduction and deferment of tax, not merely full avoidance.  All these items are listed only as “included” - there is no question of the lists being treated as comprehensive.  If Revenue Scotland considers that McGAAR should apply, the perceived tax advantage is counteracted by a notice to the taxpayer, and the adjustment may be made by a tax bill under any devolved tax.

A rifle or a blunderbuss?

McGAAR is clearly of the blunderbuss variety.  There is an alternative, namely the Targeted Anti-Abuse/Avoidance Rule (TAAR).  This approach has been used in some specific UK tax legislation, indeed some have argued that the UK GAAR is actually a TAAR because it targets only abuse and not mainstream planning.  SG claims to have used the TAAR approach already, citing the provisions in the LBTT Act which counter-act avoidance of tax on the conversion of leases.  But when something as specific as this is legislated against is it not just an example of good draftsmanship?
The point is of interest chiefly because it is an indicator of SG thinking.  Avoiders beware!  But tax is charged only when a law says that it shall be charged, and if the Rule Of Law is not to be ignored in the field of tax (as some argue it has been in the UK’s anti-terrorist legislation) there must be limits on the operation of McGAAR.  No government should be allowed to impose taxes by wishful thinking rather than by detailed legislation.  As an aside, in a post-conflict situation, an occupying power is not permitted to meddle with the host country’s tax system, one reason being that otherwise it could simply provide that all tax rates, on capital and revenue, should be raised to 100%, turning tax into confiscation. 

Let’s hope Scotland never experiences occupation or confiscation – or for that matter rates of tax on income approaching the top UK rates of the early 1970s, when Estate Duty was charged at 75% on estate over a mere £500,000 and some investment income was taxed at a rate of more than 100%.  Scotland has a learned and robust Court of Session, which already has a good record in tax decisions.  A recent example of a Scottish judgement with UK-wide influence (though not being binding on courts south of the border) is that of Lord Drummond Young on the approach to interpreting tax statutes, referred to by SG in its explanation of Scottish tax policy.   In the Aberdeen Asset Management case in 2013, it was held that there were two principles, firstly that statutory wording is to be interpreted by normal rules including the context and purpose of the legislation; and secondly that where there is a series of transactions they must be examined as a whole.  This second approach is included in the current draft McGAAR legislation which goes as far as to say that even elements of a series of transactions which are not legally binding may be taken into account.

I disagree with my assessment . . . . . . 

While it is hoped that disappointed taxpayers will first ask for an Internal Review by Revenue Scotland, or failing that for formal Mediation, the Bill provides for the setting up of separate Scottish Tax Tribunals. These will be the First-Tier Tax Tribunal for Scotland, with a mixture of “ordinary and legal” members, and the Upper Tax Tribunal for Scotland, with “legal and judicial” members.  There is the right of appeal from the First-Tier Tribunal to the Upper Tribunal, but only with the consent of one or other Tribunal, and only on a point of Law.  There is then the right of appeal, again with the need for consent and only on a point of Law, from the Upper Tribunal to the Court of Session, which for these purposes is designated by the traditional title of “Court of Exchequer”.  Finally, there is the opportunity to apply for Judicial Review, nominally to the Court of Session but actually to the Upper Tribunal, in which case it has to recognise that it is taking on higher responsibilities.   In effect, given that Court of Session judges are likely to be assigned to the Upper Tribunal, it will thus be the ultimate overseer of the operation of the Scottish tax system and of McGAAR.

SG has stated the admirable intention that there will be both the culture and the practice of “getting it right first time”, and with the first two taxes, LBTT and SLfT, both with McGAAR in support, this may, at least initially, not be as optimistic as it at first sounds.

Ambitions and reality

SG have made it very clear that it is their intention, whether or  not Scotland embraces independence, that all of tax evasion, tax avoidance, and “unacceptable” tax planning will not only be targeted, but that what has traditionally been considered “acceptable” tax mitigation will be seen by society as improper.  It is a strong message, and one which is more likely to be effective in a small country where there are fewer taxes, and fewer people, to police. 

There are opportunities too for streamlined administration of taxes, grasped in relation to both the new Scottish taxes:  the Scottish Environment Protection Agency (SEPA), whose staff already visit Landfill sites under its environmental mandate, will oversee the returns for, and collection of, SLfT;  and Registers Of Scotland (ROS), whose register effects transfer of valid titles to land and buildings in Scotland , will do the equivalent for LBTT.  Wherever possible, returns and payments will be electronic, though this will not be compulsory in all cases. These initiatives reflect the opportunities available with a fresh administrative start and the close working relationships which can be established, in a small country, among the national Government, the professions, and the commercial interests affected by legislation - on all devolved subjects, not just taxes.  Like most Governments, SG has stated the clear ambition that its taxpayers will have confidence in the Scottish tax system, and feel it is fair.  Whether taxpayers do feel they are fairly treated is however often determined not so much by the system as by the rates of tax imposed.

A military analogy to end with:  “will this battle plan survive the first contact with the enemy?”  It should, at least the first contact.  Whether SG’s hope for a responsible – even patriotic! – approach from Scottish taxpayers will be fulfilled in the longer term and with additional taxes is for later review.
 
Bill Pagan, retired senior partner of Pagan Osborne, chairs the Law Society of Scotland’s Private Client Tax Committee, and in that context regularly meets officials of both UK and Scottish Governments, including the senior staff appointed to the embryo Revenue Scotland.  He is a well-known speaker on Tax and Trusts, and a guest lecturer on the University of Edinburgh post-graduate Legal Diploma course.

 

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