By Jason Piper, technical manager, tax and business law, ACCA
Certainty is considered by many businessmen to be a useful characteristic when they are trying to make decisions. The ability to predict outcomes is key to the process. Equally, uncertainty introduces unknowable risk, and for the majority of decision makers this will naturally reduce their incentive to follow that particular course. And ultimately, if every possible course of action results in uncertain, unacceptable risk then the outcome will be inactivity – in economic terms, stagnation.
For business decision makers, the uncertainty which surrounds the outcome for tax purposes when the bogeyman of ‘tax avoidance’ is invoked has often been compared to the famous quantum mechanics thought experiment of Schrodinger’s Cat. For those who are not familiar, the cat is sealed (alive) into a box containing a mechanism controlled by radioactive delay which has exactly a 50% chance of triggering, and killing the cat, before the box is opened again to check on the cat’s welfare. Until the box is opened, we cannot know whether the cat is alive or dead.
But that’s exactly the situation taxpayers find themselves in with principles-based anti-avoidance approaches. The application of such methodologies is notoriously difficult, and will ultimately amount to ‘I know it when I see it – but I have to see it to know it’. That is to say, we cannot be certain as to whether a particular scenario falls foul of the principles rule until it is tested against the rule by the courts. Until then, the tax liability is in the same conceptual limbo as the cat – and with it the business decision maker.
Until the case is tested, the business will not know how much cash it will have left at the end of the fiscal year to reinvest, or pay to its employees as salary. Which is why the Schrodinger’s Cat situation would be an anathema to the cautious business decision maker. The outcome of the transaction could not be known in advance – and once the outcome is known, it is potentially irreversible, with catastrophic consequences for the cat.
In order to try to resolve this difficulty, many jurisdictions have introduced general anti-avoidance rules in one form or another. The argument is that in practice, taxpayers might actually see a net increase in certainty in the system by introducing the meta-law of purposive interpretation as a matter of statute. The truly compliant taxpayer remains in the same state of certainty as without the rule; under neither the strict letter of the tax provisions nor the principles-based rule will their dealings be condemned as ‘illegal’. And with the principles-based system to back up the strict letter, uncertainty is also resolved for the most egregious of schemes – they know with certainty that the proposed structures will fail, because they look wrong. There is no need to go through the complex observation process of interpreting every element of the structures, documentation and returns to see if they comply with the strict wording of the legislation in the view of the particular judge hearing the case.
From the perspective of the compliant this approach might seem to have much to recommend it. But we’re no longer here just looking at Schrodinger’s Cat, the ‘single particle’ uncertainty analysis. There are two boxes, one labelled “underlying tax law” and the other labelled “overarching anti-avoidance rule”. We’ve got two particles to predict, and we’re into the territory of quantum entanglement. That’s the bit about how you can establish the state of one half of a pair of related subatomic particles simply by observing the other – until you’ve observed either though, the system (like Schrodinger’s Cat) is effectively unresolved.
Resolution of the wave form is dependent upon both the strict law and the purposive rule. But if we can predict with absolute certainty the outcome of one ‘observation’ then we know both, and there is no need to stick the cat in the box. For example, a ‘clearly egregious’ case will fail on principles, so there is no need to analyse the strict law position. The net level of uncertainty in the system has been reduced. The limits of uncertainty are now restricted to those few cases where we can predict neither the legal, nor the purposive, outcome.
But the interpretation of intent, of the spirit of the law, is not fixed, and as a result neither are the boundaries of the uncertainty. The defence of principles-based GAARs is that we have ‘certain uncertainty’ – but the risk of populist information of the system is that we have ‘uncertain uncertainty’ in respect of application of the rule, a position no better than that we already inhabit. Business should know whether it’s going to get the cream, or pay the price of being too curious, before ever entering into a transaction. But if the range of uncertainty is itself uncertain, then more and more businesses are going to find themselves in the box, anxiously awaiting their fate. And that is simply not a place they should be.
Post script: There is of course one further wrinkle to all this, which is that the box may never get opened even once you’ve put the cat into it* (David Quentin discusses the issues well here). But the uncertainty about that is more a function of revenue authority enquiry resource than it is underlying tax policy, and while it may be every bit as in need of resolution, the question of whether governments should fund their tax collection authorities properly is hopefully not quite so difficult to answer.
*We’re assuming an otherwise immortal cat. Or perhaps a cat flap round the back that we can’t see. No cats were harmed in the performance of this thought experiment.