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The Supreme Court’s first ever GAAR decision
In December 2011, the Irish Supreme Court delivered its judgments in the first case before it on the Irish general anti-avoidance rule (the “GAAR”). Although the GAAR was introduced in 1989, the decision in O’Flynn Construction Ltd and others v Revenue Commissioners is the first time the Supreme Court has considered it.
The Supreme Court held, by a three to two majority, that the transactions carried out by the taxpayer infringed the GAAR. The court upheld the argument of the Revenue Commissioners that the use of specific relief provisions by the taxpayers amounted to a misuse or abuse of those provisions, having regard to the purpose for which the relief was provided.
Background to the GAAR
The GAAR was introduced in 1989, soon after the Supreme Court had declined to follow the doctrine of fiscal nullity enunciated by the House of Lords in its decisions in Ramsay v Revenue Commissioners and Furniss v Dawson . The Irish GAAR is modelled on the Canadian GAAR and contains similar, although not identical, provisions. In fact the differences between the Canadian and Irish provisions, and in particular, the differences in statutory interpretation, were specifically highlighted in both the majority and dissenting judgments in the O’Flynn case.
Facts of the O’Flynn case
The taxpayers in the O’Flynn case sought to avail of the export sales relief, since defunct in Ireland, whereby profits earned from qualifying exports would be exempt from corporation tax. Simplified greatly, the taxpayer developed a scheme – which involved over 40 steps – whereby a construction company, lacking a background in export sales, paid a tax free dividend out of its distributable reserves by availing of bought-in export sales relief.
The nub of the case was whether the transaction fell within an exception for transactions which were:
“undertaken or arranged for the purpose of obtaining the benefit of any relief, allowance or other abatement provided by any provision of the Acts and that transaction would not result directly or indirectly in a misuse of the provision or an abuse of the provision having regard to the purposes for which it was provided”.
In short, was the use of the export sales relief provisions by taxpayers not involved in export a misuse or abuse of the relief having regard to the purpose for which the relief was provided?
Decision of the court
The majority decision of the Supreme Court held that the taxpayer’s scheme was a tax avoidance transaction which did amount to a misuse or abuse of the export sales relief scheme. While the decision in the case clearly indicates that the courts will give teeth to the GAAR, it is clear that the particular facts of the case are extreme and the GAAR is judicially accepted to be inapplicable to “legitimate tax mitigation of a genuine commercial transaction”. Furthermore, the majority judgment placed limits on the ability of the courts to discern “purpose” of the legislation (it may not be possible to discern purpose, whether for constitutional reasons or simply because the provisions are so detailed and technical).
One important aspect of the judgment in O’Flynn was the Supreme Court’s analysis as to how the principle of statutory interpretation should be applied in Irish GAAR cases, which was a point of disagreement between the majority and minority judgments.
The essence of the disagreement in relation to statutory interpretation lies in the importance accorded to the background to the GAAR. The majority judgment clearly moves away from a literal approach to statutory interpretation and places great reliance on the background to the GAAR. This reliance on background is a new departure in Irish tax law and it is not clear how the background will be discerned (and which background facts will be considered relevant) in reaching an interpretation of a particular provision.
Comparisons with other jurisdictions
It is interesting to note that Ireland, Canada, New Zealand and Australia, all of whom share a common law heritage, have each adopted a GAAR, and there are some signs that the UK government is considering the same route. However, while the Irish GAAR is partially modelled on the Canadian GAAR, the Supreme Court in O’Flynn specifically rejected an invitation to adopt the Canadian courts jurisprudence on the Canadian GAAR. Foreign jurisprudence is, therefore, only likely to be of limited impact in Ireland. Clearly, for instance, in the recent case of Copthorne Holdings Ltd. v Canada the Supreme Court of Canada took a different approach to the Irish Supreme Court when it upheld a literal approach:
“the terms abuse or misuse might be viewed as implying moral opprobrium regarding the actions of a taxpayer to minimize tax liability utilizing the provisions of the Income Tax Act in a creative way. That would be inappropriate. Taxpayers are entitled to select courses of action or enter into transactions that will minimize their tax liability (see Duke of Westminster).”
In New Zealand, the correct principles to be applied in cases involving the GAAR were clarified in Ben Nevis Forestry Ventures Ltd & Others v CIR . In that case, the Supreme Court of New Zealand held that it is the task of the courts to apply a principled approach which gives proper overall effect to statutory language that expresses different legislative policies.
The New Zealand courts have recognised the potential conflict between specific provisions and general anti-avoidance provisions and the majority judgment in Ben Nevis makes it clear that the court should seek to balance conflict between the specific and general provisions as best as possible but have noted that “the courts should not strive to create greater certainty than Parliament has chosen to provide”.
While the majority judgment in O’Flynn noted that “the process of legislation and its application may often involve drawing the lines in contested cases”, it did not appear that the exercise of balancing the specific and general provisions was a difficult exercise for the court in O’Flynn due to what the court perceived as being the wholly artificial nature of the transactions. However, the Irish courts will undoubtedly be faced with a more difficult task of drawing such lines in future cases.
Really these cases, together with the somewhat tortuous efforts of the UK judiciary to craft an intellectually robust, but sufficiently certain, test of impermissible tax avoidance, illustrate the difficulty of balancing the competing interests of taxpayer certainty versus an equitable and fair tax system. There are signs of a judicial awareness of this difficulty in O’Flynn and the Supreme Court states, on more than one occasion, that the GAAR is inapplicable to “legitimate tax mitigation of a genuine commercial transaction”.
Targeted anti-avoidance rules
The Supreme Court in O’Flynn also considered the position where a particular tax provision contains its own targeted anti-avoidance rule (“TAAR”), and noted that in such a case the GAAR is unlikely to apply. However, the exact interaction between a GAAR and a TAAR remains unclear.
Availability of reliefs
Prior to O’Flynn, the Irish position, based on case law, was that the availability of a tax relief depended upon clear and unambiguous language. Just as the literal approach did not favour the Revenue Commissioners and led to the introduction of the GAAR, nor did the literal approach always favour the taxpayer where a relief was sought. Given that the judgment in O’Flynn now envisages a purposive approach, there may now be circumstances where a taxpayer may benefit from such an approach when claiming a relief.
Impact of the O’Flynn decision
The judgment has raised uncertainty as to what background can be taken into account as a matter of statutory interpretation, and even doubt as to when background will be relevant at all. On the other hand, the courts did uphold the ability of taxpayers to engage in tax planning, and identified the function of the court as being to decide upon where the line should be drawn between permissible tax planning, and impermissible tax avoidance.
The experience of other jurisdictions demonstrates that it may be difficult to achieve absolute certainty, or even a general level of clarity, when considering a GAAR. As the Supreme Court of Canada in Copthorne Holdings Ltd. v Canada noted:
“The GAAR does create some uncertainty for taxpayers. Courts, however, must remember that s. 245 was enacted “as a provision of last resort.”
The O’Flynn decision, while a victory for the Revenue Commissioners, produces a nuanced view of the impact of the GAAR, reiterating the view that tax planning is a legitimate activity in the course of a commercial transaction and introduces a new uncertainty by referring to the background as being relevant to the interpretation of legislation.
© Matheson 2012
This article first appeared in International Tax Review (1 April 2012).
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