ANTI-AVOIDANCE PROVISIONS AN OVERVIEW by

1. ANTI-AVOIDANCE PROVISIONSAN OVERVIEW by SYED SHABBAR ZAIDI, FCA PARTNER A.F. FERGUSON & CO.

2. MAIN PROVISIONS • Transactions with associates – Transfer Pricing • Recharacterization of transactions for: • Substance Over Form • Economic Impact • Disregard of Transactions being Avoidance Scheme • Thin Capitalisation Underlying Theme is: Over and above the recorded amounts - This is a different approach. Are we ready for this ?

3. ANTI AVOIDANCE THE TASK AHEAD • Anti-Avoidance provisions and self assessment scheme, if go hand by hand would raise the issue of ‘burden of proof’ and tax liability / penalty for the ‘difference’. • This matter has yet to be decided with the tax authorities. • Even in UK-Anti Avoidance ‘Disclosures’ and ‘Reporting’ have been suspended. Lesson: A paradigm shift for tax practice. This is ‘Economics’.

4. INTERNATIONALISATION OF APPROACH • Article ‘9’ of the model treaty (OECD): • Re-writing of Books • Domestic Laws and Treaty • Economic Double Taxation • Secondary Adjustments • All these aspects are now the part of our law, e.g. Section 108 read with Rule 20 to 26 ‘Transfer Pricing. This is a different story. Now the businesses have to accept the ground reality that “Arm’s length consideration” is the part of law. Again the solution is ‘Negotiated Settlement’ rather than Litigation’. There are only two major cases on transfer pricing in UK.

5. ANTI-AVOIDANCE DISCRETION AND UNCERTAINTY • Administrator’s discretion approach / uncertainty • Is the solution to give the administrators the discretion to decide ? This would have the advantage of giving the body of taxpayers as a whole the benefit of the doubt and so a form of fairness and certainty ? • Is this not the effect of the uncertainty surrounding the new approach ? Have we failed to heed Adam Smith’s warning ? He said that:

6. ANTI-AVOIDANCE DISCRETION AND UNCERTAINTY (Cont’d) “The tax which each individual is bound to pay ought to be certain and not arbitrary. The time of payment, the manner of payment, the quantity to be paid, ought all to be clear to the contributor, and to every other person. Where it is otherwise, every person subject to the tax is put more or less into the power of the tax gatherer, who can aggravate the tax upon any obnoxious contributor, or extort, by the terror of such aggravation some present or perquisite to himself. The uncertainty of tax taxation encourages the insolence and favours the corruption of an order of men who are naturally unpopular even where they are neither insolent or corrupt. The certainty of what each individual ought to pay in taxation is a matter of so great importance that a very considerable degree of inequality, it appears, I believe, from the experience of all nations, is not near so great an evil as a very small degree of uncertainty.”

7. ANTI-AVOIDANCE DISCRETION AND UNCERTAINTY (Cont’d) • Such an approach is unfair to the administrators as well as to the individual taxpayer and taxpayers whose interests all have to be balanced. If more time and energy were devoted to tax policy much of this might be eased. However, this as is noted above is unlikely because as there would be losers and gainers it is not in the politicians’ interest to embark on this.

8. AVOIDANCE AND EVASION • This fundamental distinction is mirrored in the concept of a sham. A sham is a fraud, a pretence, something which pretends to be other than it really is. A forged document, for example, is a sham in that it tells a lie about itself. A scheme or arrangement might be highly artificial; it might have no purpose other than tax avoidance, it might or might not be effective to that end, but, provided that transactions involved are intended to be genuine, and not merely a smokescreen for the reality, it is not a sham. Now it will be readily perceived that the participants in virtually every tax avoidance scheme have not the slightest incentive to produce a sham. ….. (Cont’d)

9. AVOIDANCE AND EVASION (Cont’d) • The strategies depend for their effectiveness on the steps taken being real. And that is none the less the case if those steps are artificial and are contrived purely for the purpose of tax avoidance. Given that there is no difficulty in taking the artificial steps, there is no point whatsoever in not taking them but in merely pretending to take them. Indeed, there is every point in taking them; as otherwise the scheme certainly will not work and will depend for its de facto effectiveness on a criminal fraud which is totally unnecessary and the discovery of which will normally give rise not only to the tax, which continues to be due, being in fact collected but also the perpetrators being indicated on serious charges.

10. AVOIDANCE AND EVASION (Cont’d) • Now the learning on the nature and limits of the concept of a sham was firmly established in English law well before Ramsay. A classic case, which had nothing to do with tax, was Snook v London and West Riding Investments Ltd. The famous dictum of Diplock LJ at pages 528-802 was cited by Lord Fraser in Ramsay: “It means acts done or documents executed by the parties to the ‘sham’ which are intended by them to give to third parties or to the court the appearance of creating between the parties legal rights and obligations different from the actual legal rights and obligations (if any) which the parties intend to create”. Now: Relate this concept with ‘Declared Cost’ and Actual Cost vs. Actual Cost and Fair Value under section 111 of Income Tax Ordinance, 2001

11. THE POTENTIAL ISSUES • It is submitted that he introduction of a general anti-avoidance provision would produce great difficulties. • The issues are: • It would introduce a great deal of uncertainty into the law. It would therefore act as a deterrent to bona fide commercial transactions and “legitimate” tax planning. Taxpayers have the right to expect that the tax laws are such that they are able to plan and conduct their legitimate business and financial affairs knowing in advance with a reasonable degree of certainty what the likely tax consequences would be.

12. THE POTENTIAL ISSUES (Cont’d) • Despite the best efforts of the courts in this country and the legislators in other countries, I would submit that no-one has yet come up with a really workable distinction between “acceptable” and “abusive” tax avoidance. • Discretionary taxing powers would be placed in the hands of the tax authorities, and there would be practical difficulties in the courts exercising an effective supervisory function. • In any case, a major shift in tax-making power from the legislature to the tax authorities would be contrary to the rule of law. There are also objections to these functions being assumed by the courts.

13. ‘THIN CAPITALISATION’ • It is primarily an Anti Avoidance measure. • OFCD Model supports the view. • There is economic rationale as return on equity leads to higher tax than interest. Thus under these rules ‘Debt’ charge is disregarded. • In exact sense, in developed situations, it has duel effect. The difference is treaty as ‘dividend’ subject to withholding.