JOURNAL OF THE AUSTRALASIAN TAX TEACHERS ASSOCIATION 2016 · PDF fileThe Australasian Tax Teachers Association ... Professor of Taxation Law ... Journal of the Australasian Tax Teachers

A U S T R A L A S I A N TAX TEACHERS ASSOCIATION

JOURNAL OF THE

AUSTRALASIAN TAX TEACHERS ASSOCIATION

2016 Vol.11 No.1

Edited by DALE BOCCABELLA

and ANN KAYIS-KUMAR

TheJournaloftheAustralasianTaxTeachersAssociation(‘JATTA’)isadoubleblind,peerreviewed journal. The Journal is normally published annually, subsequent to theAssociation’sannualconference.

The Australasian Tax Teachers Association (‘ATTA’) is a non‐profit organisationestablishedin1987withthegoalofimprovingthestandardoftaxteachingineducationalinstitutions across Australasia. Our members include tax academics, writers, andadministratorsfromAustraliaandNewZealand.FormoreinformationaboutATTAreferto our website (hosted by ATAX at the University of New SouthWales) atwww.asb.unsw.edu.au/schools/taxationandbusinesslaw/atta.

PleasedirectyourenquiriesregardingtheJournaltotheEditor‐in‐Chief:

ProfessorDalePinto

ProfessorofTaxationLaw

SchoolofBusinessLawandTaxationCurtinUniversity

GPOBOXU1987PerthWA6845

E:[email protected]

EditorialBoardoftheJournalofAustralasianTaxTeachersAssociation:

ProfessorDalePinto,CurtinUniversity,Perth,Australia(Editor‐in‐Chief)

ProfessorNeilBrooks,OsgoodeHallLawSchool,YorkUniversity,Toronto,Canada

ProfessorMargaretMcKerchar,UNSW,Sydney,Australia

ProfessorJohnPrebble,VictoriaUniversityofWellington,NZ

ProfessorKerrieSadiqQueenslandUniversityofTechnology,Australia

ProfessorAdrianSawyer,UniversityofCanterbury,NZ

ProfessorMirandaStewart,AustralianNationalUniversity,Australia

ProfessorNatalieStoianoff,UniversityofTechnologySydney,Australia

AssociateProfessorAndrewSmith,VictoriaUniversity,NZ

AssociateProfessorPaulKenny,FlindersUniversity,Adelaide,Australia

ISSN:1832–911X

Volume11Number1publishedDecember2016

Copyright©2016AustralasianTaxTeachersAssociation

JournaloftheAustralasianTaxTeachersAssociation2016Vol.11No.1

i

TABLEOFCONTENTS

FOREWORD

DALEBOCCABELLAANDANNKAYIS‐KUMAR..................................................................................................................iii

SOMECOMMENTSONTHEROLEOFAREVIEWER(REFEREE)OFANARTICLE

DALEBOCCABELLA................................................................................................................................................................iv

THEEVOLUTIONOFTHEAPPROACHOFTHENEWZEALANDCOURTSTOTAXAVOIDANCE

THEHONJUSTICEWILLIAMYOUNG...................................................................................................................................1

TAXANDTIMETRAVEL:LOOKINGBACKANDLOOKINGFORWARD –ATAXADMINISTRATOR’SPERSPECTIVE

JANFARRELL........................................................................................................................................................................27

ISTHECITIZEN‐CONSUMERTHEFUTURETAXPAYER?

JONATHANBARRETT...........................................................................................................................................................57

UNIVERSITYSTUDENTSANDTAXLITERACY:OPPORTUNITIESANDLESSONSFORTAXTEACHING

TONICHARDON,CHRISANNLEE,LAURADEZWAAN,YULINLIU................................................................................85

EMERGENCE,GROWTHANDMOBILITYOFEUROPEANCOMPETENCEONDIRECTTAXREGIME:ANANALYTICALANDEVOLUTIONARYREVIEW

SHAFIUKHANNIAZI..........................................................................................................................................................103

AREVIEWOFRESEARCHONCORPORATETAXAGGRESSIVENESSANDTHELEVERAGEPUZZLE

HKHIEM(JONATHAN)NGUYEN.......................................................................................................................................139

[This page is blank intentionally]


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FOREWORD

ThepapersincludedinthiseditionoftheJournaloftheAustralasianTaxTeachersAssociation(JATTA)werepresentedat the28thAnnualConferenceof theAustralasianTaxTeachers Association(ATTA).TheATTAconferencewasheldfrom20to22January2016andhostedbytheSchoolofTaxation&BusinessLaw,UNSWBusinessSchool.

Thethemeof theconferencewas ‘TaxandTimeTravel:LookingBackwardsandLookingForwards’.ManyofthepapersattheconferenceandinJATTA2016focusedonthistheme,butsomealsodealtwithother important issuesrelating to taxpolicy, taxdesignandtaxadministration.Wehopethatthepaperspublishedherewillmakeasignificantcontributiontotheliteratureonthediverserangeoftopicstheydealwith.

PlenarypresentationsanddinnerspeechesattheATTAconferenceweregivenbyProfessorDianeRing,BostonCollegeLawSchool;GregSmith,ChairmanoftheCommonwealthGrantsCommission; Jan Farrell, former Deputy Commissioner of the Australian Taxation Office(ATO);AndrewMills, SecondCommissioner of theATO;TheHonourable JusticeWilliamYoungKNZM,JudgeoftheSupremeCourtofNewZealand;RossGittins,EconomicsEditorofTheSydneyMorningHerald;andthePatronofATTA,ProfessorGordonCooper.

WewouldliketothankEditor‐in‐Chief,ProfessorDalePintoandATTAPresident,ProfessorAdrianSawyerfortheirguidanceandsupport.ThankyoualsotoallauthorsthatsubmittedanarticletoJATTA2016.Wealsothankthereviewersofarticlesfortheircontribution.Wewouldespeciallyliketothanktworeviewers(whounfortunatelymustremainanonymous)for‘comingtotherescue’atshortnoticeandprovidinginvaluablefeedbackthatcontributedto JATTA 2016. Finally, a big thank you goes to TrischaMann for her dedication to thecopyeditingtaskforJATTA2016.ShehasnowworkedonJATTAsince2014.

DaleBoccabellaandAnnKayis‐KumarSchoolofTaxation&BusinessLaw,UNSW15December2016


iv

SOMECOMMENTSONTHEROLEOFAREVIEWER(REFEREE)OFANARTICLE

Inspiredbyothers,Ibrieflysetoutmythoughtsorsuggestionsonhowareviewer(referee)couldapproach the taskof reviewinganarticle for apeer‐reviewed tax journal –oranyjournal.Thesecommentsmayhelpthosewhohavenotreviewedmanyarticles,anditmayhelppractitionerreviewersaswell.Thecommentsarealsodesignedtogetus,asascholarlycommunity,thinkingaboutthisissueandotherissuesrelatedtothepeerreviewprocess.Thecommentscannotbetakentobeexhaustive.*

Theroleofthereviewerisveryimportantinthe‘machine’thatisthepublicationofpeer‐reviewed articles. To be asked to review an article by an editor is an honour. It usuallyreflects the attainment of some standing or knowledge in a disciplinary area, and is aconcreteindicationthattheeditorisputtingsomefaithortrustinthepersontoassistwiththeeditor’sall‐importantquestionof‘topublish’or‘nottopublish’.Obviously,thisisveryimportanttotheauthorofthearticle,butalsothejournalitself.

Fromeditors’extensiveknowledge,theywillusuallyhaveareasonableideaofthesuitabilityofaparticularpersonforareviewingtask.However,editorscannotalwaysknowhowwellequipped a potential reviewer is to review an article. Accordingly, it is incumbent onreviewers, when approached, to ask themselves whether they can effectively review anarticle.Inthisregard,Isuggesttobothareviewerandeditors,aspartofthe‘soundingoutprocess’,thatthepersonapproachedtobeareviewerbegiven4–6daysto‘scanread’thearticle,andfromthatreading,makeajudgmentastowhetherhe/shecaneffectivelyreviewthearticle.Thisprocessshouldgiveeditorsmoreconfidenceinthereviewer,anditcanalsoallowforbetterplanningforthejournal.Ifthepersonapproachedcannotreviewthearticle,the editor can move onto another potential reviewer quickly, and not face the risk ofdiscovering‘anunsuitablereviewer’6–7weekslater(whenafirstreadmaybemade).

AlljournalsforwhichIhavereviewedarticles(mostlytaxjournals)workonthebasisthatthe reviewer does not knowwho the author is, and the author does not knowwho therevieweris;somecallthisdouble‐blindreviewing.Whenreadinganarticle,reviewersmaybetemptedtogivesomethoughttotheidentityoftheauthor.Forme,youmusttryveryhardnottofocusonauthoridentification;yourfocusshouldbeonthepieceofwork.Ifyouareconvincedyouknowwhotheauthoris,youhaveanobligationtolettheeditorknow,sotheeditor can make a judgment about what to do. Presumably the editor will want to beconvincedthatyoucanapproachthetaskinastrictlyobjectivemanner.(Ionceinadvertentlyestablishedtheauthor’sidentity,buttheeditordecidedtokeepmeon).

Onthedecisiontoreviewornot,itistruethatthereiscurrentlynodirectfinancialrewardforreviewinganarticle.And,fromwhatIcangather,myuniversity(andIsuspectothersinAustralia)doesnotattachanyparticularsignificancetobeingareviewer.Thatsaid,manyinstitutionswill consider reviewing as an important service item, and inNewZealand itwouldbevaluabletoincludeinaPerformance‐BasedResearchFundevidenceportfolio.

Accepting for aminute that low importance is attached to reviewing, youmay ask,whyshouldIbother?Inshort,itisaservicetoyourdiscipline,andifeveryacademicsaidnotoreviewing,ultimately,yourdisciplineasawhole,aswellasthejournal,maysuffer.Perhapsyouandyourdisciplinarycolleaguesmaysuffer.Inanyevent,the‘nobenefit’assertionis

* For further comments on the role of a reviewer (and other comments concerning ‘getting

published’), see AJ Sawyer, ‘Demystifying the Challenges Involved in Publishing a High Quality Taxation Paper’ (2014) 27(1) Accounting Research Journal 7.


v

questionable,giventhatreviewinganarticlecanbeaverygoodlearningexperienceifdoneproperly.Itforcesyoutothinkaboutthestructureofanarticle,topiccoverage,originality,contribution,andthelike–allthingsthatareatthecoreofanacademic’severydaywork.Inaddition,beingarevieweroftenmeansyouarethefirstpersonexposedtonewresearchinyourdiscipline.

Itisreasonabletoacceptonlyoneortworeviewsperyear,althoughsenioracademicswithspecialistexpertiseinanareamaybeexpectedtodomore.Ifyouaredoingmorethanthis,itsuggeststhatsomemaynotbecarryingtheirfairshareoftheloadforthediscipline.

Assumingthepersonacceptstherequest,askinganeditorfor5–6weekstoreviewanarticleisappropriate.Itisbesttomeetthedeadlinecommitmentmade,butifitbecomesapparentthereviewerwillbelate,thereviewerhasanobligationtokeeptheeditorinformed.Inmyexperience(Iamnearlyalwaysaweekorsolate),editorsappreciatebeingkeptinformed,especiallyifitallowstheeditortokeeptheauthorinformed.Itshouldnothavetobesaidthatareviewerwhoneedstowithdrawshouldtelltheeditorassoonaspossiblethatheorsheisnotgoingtocarryoutthereview,afterfirststatingtheywould.

Astothetaskofreviewing,thiswouldrequireanarticleinitself,andthereisagrowingbodyof guidance out there. Yet, academics (most frequent reviewers) rarely get anyformalguidanceortrainingonthis.Further,editorsofjournalsdonotsystematicallygivereviewersfeedback on their reviews. There are times, however, when authors acknowledgereviewersfortheirhelpfulcomments.

Imakethefollowingobservations.First,youhavetotakethereviewingtaskseriously. Ifyouplantoallocate2hourstothetask,youarenotserious;telltheeditorthatyoucannotdothereview.(Aneditorwhoistold:‘IwilllookatthisontheplaneflightbetweenMelbourneandSydney’, shoulddrop this reviewer, probably for good, if this is to be the sum total oftheirrevieweffort.)

Second, there is no magical approach or one best approach to reviewing. This is whatInormally do. I do a first read of the article, and here I am mainly focused ongainingunderstandingorcomprehension.Imakenotes,queries,etc.,onthepaperasIamreading,mainly toensureunderstanding.Dependingon thecomplexityof thearea, itcantakesometimetogainsufficientunderstanding.

I will then let it sit for 2–4 days before coming back to it. At this second stage, I willconfirmmyunderstanding,butIwillnowalsobelookingfortheusualfeaturesofagoodpiece of writing or research. Briefly, they are: (1) Does the article raise and identify aproblemoranissueofsomesignificance,andtherebysetoutaclearmotivation?(2)Hasthe issue been dealt with elsewhere? (3) Does the article deal with the problemcomprehensivelyandatasufficientlevelofdepth,ordoesthearticledowhatitclaimsitwilldo? (4)Has theauthorconsideredpreviouscontributions to theproblem?(5) Is thecontentwell‐ordered?and (6)Does the introductiongive the readera clear senseof thedirectionthearticleistaking?

Theissueofreviewerdispositionisinteresting.Somereviewerswillcometothetaskwitha‘rejection’mindset.Thatis,theyareonthelookoutforanythingthatgivesthemabasisfor saying the article is not good. Others have what has been called a ‘developmental’approachtoreviewing.Thesereviewersare lookingtoseehowtheycanhelptheauthorimprovethearticle,eveniftheyrecommendrejectionforthepresentjournal.Iwouldencourageyoutofollowthedevelopmentalreviewingapproach.


vi

Finally,itisimplicitinwhatIhavejustsaidthatthereisnoroominfeedbacktoauthorsfor‘personal’remarks,orremarksthataregeneralisedbeyondthescopeofthecontentofthearticle.Accordingly,andconsistentwithdevelopmentalreviewing,couchyourcommentstoauthorsinapositivelight,whereverpossible.

DaleBoccabellaSchoolofTaxation&BusinessLaw,UNSW15December2016


1

THEEVOLUTIONOFTHEAPPROACHOFTHENEWZEALANDCOURTSTOTAXAVOIDANCE

Paper accompanying plenary address delivered at ATTA 2016

THEHONJUSTICEWILLIAMYOUNGKNZM*

I GENERALANTI‐AVOIDANCEPROVISIONSINNEWZEALAND

Although therehavebeenanti‐avoidanceprovisions inNewZealand tax legislation since1878,1 theywerenot seriously invokedby theCommissioneruntil the1960s.2Atthistime,s108oftheLand and Income Tax Act 1954wasinforce.Itprovided:

Everycontract,agreement,orarrangementmadeorenteredinto,whetherbeforeorafterthecommencementofthisAct,shallbeabsolutelyvoidinsofaras,directlyorindirectly,ithasorpurportstohavethepurposeoreffectofinanywayalteringtheincidenceofincometax,orrelievinganypersonfromhisliabilitytopayincometax.

Thislanguagewasverysimilartothatusedins260oftheIncomeTaxandSocialServicesContributionAssessmentAct1936–1950(Cth)ofAustralia(theAustralianAct)3andtheNewZealand courts (including the Privy Council) saw the two sections as having the samemeaning.ThismeantthatthePrivyCouncildecisioninNewtonvFederalCommissionerofTaxation,4acaseconcernedwiths260,wasapplicabletos108.5

In response to judicial criticism,6 s 108wasamended in1974and, as amended,was re‐enactedass99oftheIncomeTaxAct1976(NZ).The1976ActwasreplacedbytheIncomeTaxAct1994,whichinturnwasreplacedbytheIncomeTaxAct2007.InthatAct,sBG1isthegeneralanti‐avoidanceprovision.Iamgoingtosayalittleaboutthebackgroundtos99ofthe1976Actand,indoingso,willdiscussbrieflytheprincipalrespectsinwhichitdifferedfrom s 108 of the 1954Act. One of thesewhich I shouldmention now is that the 1974amendment, and thus s 99 of the 1976Act, provided for a power of reconstruction, theabsence of which had earlier sometimes resulted in tax‐avoiding taxpayers succeedingagainsttheCommissioner.Generally,however,Idonotproposetodevoteattentiontotheshiftsinlanguagebetweentheoriginals108andthecurrentsBG1.Whendiscussingcases

* JudgeoftheSupremeCourtofNewZealand.1

2

3

4

5

6

ThelegislativehistoryisexplainedinManginvCommissionerofInlandRevenue[1971]NZLR591at594–5 (PC).TheonlyearliercaseisTimaruHeraldCoLtdvCommissionerofTaxes[1938]NZLR978(CA),wherethe Commissioner lost in the Court of Appeal on (among other things) an argument as to theapplicationofs170oftheLandandIncomeTaxAct1923.ThesharedlegislativehistoryofthetwoprovisionsissetoutinMangin,aboven1,at594–5and598.NewtonvFederalCommissionerofTaxation[1958]AC450(PC).SeePartIVbelow,textnearfootnote23.See,forinstance,thedissentingjudgmentofLordWilberforcequotedinPartV.


2

Iwill identify the particular provision7 in issue, andwhen addressing the sectionsmoregenerally,IwillrefertothemcollectivelyastheGAAR(generalanti‐avoidancerule).

II ANOVERVIEW

Inanumberoftheearlycases,thedifficultyofgivingpracticalandprincipledeffecttotheGAARinthecontextofthetaxsystemasawholeencouragedcounseltoadvanceargumentswhich,ifaccepted,wouldhavedeprivedtheGAARofsubstantialeffect.Itwasthusarguedthat:

(a) It caught only transactions which were shams (the ‘applicable only to shamsargument’).

(b) Itappliedonlybetweenthepartiestotransactions,hadnofiscaleffectand,therefore,couldnotbereliedonbytheCommissioner(the‘nofiscaleffectargument’).

(c) Itaffectedonlytaxliabilitieswhichhadaccruedatthetimeofthearrangement(the‘accruedliabilitiesonlyargument’).

Therejectionoftheseargumentsmeantthatthecourtswererequiredtoaddressdirectlythepotential tensionbetweentheGAARandtheprovisionorprovisionsreliedonbythetaxpayer.

ThescopefortensionwassubstantiallyreducedbytheexclusionforordinarybusinessorfamilydealingsadoptedinNewton.8ThisexclusionmeantthattheGAARwouldnotapplytosituationswhere tax consequences are the inevitable consequence of a straight‐forward‘ordinary’transaction,suchas,forinstance,the‘clean’transferofanincomeproducingassetfrom one person to another. On this basis,many, and perhapsmost, of the hypotheticalexamplesoftenpostulatedtoestablishtheimpracticalityofaGAARcanbebrushedaside.Theordinarybusinessorfamilydealingexclusionthusoperatedasasensiblefilterontheoperation of the GAAR. But in relation to cases not filtered out, it did not provide acomprehensiveorprincipledmechanismfordeterminingwhethertheGAARshouldprevailoverthetaxprovisionreliedonbythetaxpayer.Insuchacase,therethusremainedscopefortensionbetweentheGAARandthetaxprovisionreliedonbythetaxpayer.

If the resolution of this tension were approached as involving orthodox statutoryinterpretationprinciples,theanswermightbethoughttodependonone,otherorbothof:

(a) applicationofthemaximgeneraliaspecialibusnonderogant9asbetweentheGAARandthetaxprovisionreliedon;or

(b) schemeandpurposeanalysisastowhethertheGAARorthatprovisionprevailed.

Neitherapproach,however,providesasureroutetoaprincipledandpredictableoutcome.Whentaxavoidanceisinissue,thequestionwhethertheGAARorotherprovisionshouldprevailisalwaysparticulartothefactsofthecaseathandand,atleasttomywayofthinking,thusinvolvesapplicationasmuchasinterpretation.Insuchcasesitisalmostalwaysopento

7 Albeitslightlyloosely.Iwillrefertos108ofthe1954Act,s99ofthe1976Act(whichIwilltreatasencompassing s 108 as amended in 1974) and s BG1 of the 2007 Act (which I will treat asencompassingtheequivalentprovisionsinthe1994Act).

8 Newton,aboven4.9 ‘Generalthingsdonotderogatefromspecificthings’:BryanAGarner(ed)Black’sLawDictionary(9th

ed,StPaul(MN),2009)at752.


3

questionwhetheritistheGAARorothertaxprovisionwhichistheparticularprovision(andwhich, inaccordancewiththemaxim,shouldprevail).Aswell,withtherejectionofthesetwoarguments,thebasicpremiseoftheGAARisthatitappliestoavoidtaxarrangementswhich,butfortheinvocationoftheGAAR,wouldbeeffective.Onthisbasis,anarrangementwhichisvoidableundertheGAARisinatwilightzone;sufficientlywithintheschemeandpurposeoftheprovisionreliedonbythetaxpayertobevalidunlesstheGAARisinvoked;but insufficiently so to withstand the application of the GAAR. In such a twilight zone,orthodoxschemeandpurposeinterpretativeanalysisprovideslittleillumination.

Thereisscopefordebateastotheanalysisjustoffered.TheminorityjudgmentinBenNevisForestryVentureLtdvCommissionerofInlandRevenueproceedsonthebasisthat‘specificstatutoryallowancesundertheIncomeTaxActarenotinpotentialconflictwiththegeneralanti‐avoidanceprovision’andthatthereisthusnoneedfor‘reconciliation’.10ThatapproachappearstobeinconsistentwiththetwilightzoneIhavepostulated.Isetoutlaterinthepaperthekeypassagesfromthatjudgment.11Forpresentpurposes,itissufficientformetosaythatIthinkthatmyanalysis,rightorwrongasitmaybeintermsofprinciple,isconsistentwiththedriftofthecases, including,significantly,themostrecentNewZealandSupremeCourtjudgments.

Anotherwayofattemptingtoresolve,oratleastmitigate,thetensionbetweentheGAARandothertaxprovisionsistorestrictivelyinterprettheformer;thatisbylimitingitinrespectswhichgobeyondtheordinarybusinessorfamilydealingexclusion.Iseethislineofapproachasexemplified:

(a) reasonablywell, in the caseswhich suggest that taxavoidance involves thenon‐incurring of the economic consequences which the legislature envisaged as thecorrelativeofthetaxbenefitclaimed;but

(b) notsowell,intheviewthattaxavoidanceinvolvesthe‘crossingofaline’orotherverygeneralisedconcepts.

AfurtherapproachistoseethemischiefoftaxavoidanceastheuseofgeneralorparticularfeaturesofthetaxregimetoobtaintaxadvantagesofakindnotintendedtobeconferredbythelegislatureandtoapplytheGAARaccordingly.Thisisthe‘parliamentarycontemplation’test which the New Zealand Supreme Court has adopted. Where the taxpayer has notincurredtheeconomicconsequencesenvisagedbythelegislatureasthecorrelativeofthetax benefit claimed, the scheme will fail the parliamentary contemplation test. Theparliamentary contemplation test can thus be seen as being largely a generalisedreformulationofapproach(a)above.

Theparliamentarycontemplationtesthassomeadvantages.Asjustmentioned,itaddressesdirectlywhatmostseeasobjectionablewithtaxavoidance.Itenablestaxoutcomescloselytailoredtothefactsofthecasesathand.ItisconsistentwiththeviewthatthelegislativepurposeoftheGAARistofillingapswhichthelegislaturemayhaveinadvertentlycreated.Aswell,andassumingmytwilightzoneanalysis iscorrect, italsoavoidstheuseof inaptprinciplesofstatutoryinterpretationtoresolveasuigenerisproblemwhichinvolvesbothinterpretationandapplication.

10 BenNevisForestryVenturesLtdvCommissionerofInlandRevenue[2008]NZSC115,[2009]2NZLR

289,at[2].11 SeefinalparagraphsinPartXIand,fortheminority,finalparagraphsinPartXIII.


4

Orthodoxstatutoryinterpretationisconcernedwithmeaning.12Althoughmeaningmaybedeterminedbyreferencetolegislativepurpose,13suchpurposeisconventionallyaddressed largely objectively. When interpreting a statute a judge does not inquireas to what the legislaturemight have enacted if the facts of the case at hand werebefore it –anexercisewhich, as I will show, has from time to time been carried outin tax avoidancecases.Theparliamentarycontemplationtestthuslooksunorthodox.Aswell, thebespokeoutcomes itproduces can be viewed as contrary to the principlethat laws should be of generalapplication.

In this paper I discuss the background to the adoption by the Supreme Court oftheparliamentarycontemplationtest.Indoingso,Iwillpickuponsomeoftheideasjusttouchedon.Aswell,Iwillgivetwoexamplesoftheapplicationofthetest,onebytheHighCourtandtheotherbytheCourtofAppeal.

III MYSTARTINGPOINT–NEWTON V FEDERAL COMMISSIONER TAXATION

Fromtheearlyyearsofthelastcentury,Australianrevenueauthorities(Federalandstate) relied on anti‐avoidance provisions and this gave rise to a number of reporteddecisions. In contrast, in New Zealand, the GAAR was not seriously invoked by theCommissioneruntilthe1960s. By this stage, the Privy Council had decided Newton vFederal Commissioner ofTaxation.14Sowhen theNewZealand courts came to grapplewiths108,Newtonwasverymuchtheirstartingpoint.

As has been mentioned, Newton concerned s 260 of the Australian Act.15 Thecompaniesinvolvedintheschemehadsubstantialundistributedprofits.Ifnotdistributedbyyearend,thecompanieswouldhavebeentaxedonthem(at15shillingsinthepound).Ifthoseprofitsweredistributedasdividends,theshareholderswouldhavebeentaxedatthesamerate.Thepurposeoftheschemewastopermitthebulkofthosefundstoberetainedby the companies pursuant to recapitalisations carried out in a way which attractedcomparatively little tax. The Privy Council decision dismissed the applicable only toshams, no fiscal effects andaccruedliabilitiesonlyarguments.

LordDenningexplainedtheoperationofs260inthisway:16

Inordertobringthearrangementwithinthesectionyoumustbeabletopredicate– by looking at the overt acts by which it was implemented – that it wasimplementedinthatparticularwaysoastoavoidtax.Ifyoucannotsopredicate,but have to acknowledge that the transactions are capable of explanation byreference to ordinary business or family dealing, without necessarily beinglabelledasameanstoavoidtax,thenthearrangementdoesnotcomewithinthesection. Thus, no one, by looking at a transfer of shares cum dividend, canpredicate that the transferwasmadetoavoidtax.Norcananyone,byseeingaprivatecompanyturnedintoanon‐privatecompany,predicatethatitwasdoneto

12 Sees5oftheInterpretationAct1999(NZ).13 Section5(1).14 Newton,aboven4.15 IncomeTaxandSocialServicesContributionAssessmentAct1936–1950(Cth).16 At8.


5

avoid[therelevant]tax:seeW.P.KeigheryPty.Ltd.vCommissionerofTaxation…

Lord Denning seems to have approached s 260 on the basis that, with the exclusion inrelationtoordinarybusinessandfamilydealings,therewasnounacceptabletensionwiththerestoftheActand,inparticular,thats260,onceengaged,wouldprevailoverwhateverothertaxprovisionsthetaxpayermightrelyon.Ifthisisso,hisreferenceto,andapprovalof, WP Keighery Pty Ltd v Federal Commissioner of Taxation17 introduced a distinctlydiscordantelement.HisbriefdescriptionofthearrangementinKeighery(‘aprivatecompany[being] turned into a non‐private company’) did not do justice to the detail of anarrangement which was plainly predicated substantially, and perhaps solely, on theavoidanceoftax.Keigherystandsforthechoiceprinciplemuchreliedonbytaxpayers18andthe Privy Council’s apparent endorsement of Keighery inNewton created problems notresolved in New Zealand untilBenNevis ForestryVenturesLtd vCommissioner of InlandRevenueandPennyandHoopervCommissionerofInlandRevenue.19

IV ELMIGERVCOMMISSIONEROFINLANDREVENUE

Whens108wasfirstreliedonbytheCommissioner,anarrowapproachwasfavoured.20In1966therewas,however,adistinctchangeincoursewiththejudgmentofWoodhouseJatfirstinstanceinElmigervCommissionerofInlandRevenue.21

Elmiger concernedthe taxaffairsofapartnership involved inearthmoving.Thepartnerstransferredearthmovingmachinery to a trustwhich they controlledbutwhich,while itoperated,wasforthebenefitoftheirwivesandchildren.Thetrustwastoterminateaftersomefiveandahalfyearsanditsassetsweretoreverttothepartnersunlesstheyotherwisedirected.Asfirststruck,therentgobbledupentirelywhatwouldotherwisehavebeentheannual profit of the partnership. This resulted in the partners in their dual capacity aspartnersandtrusteesreducingtherent;but,evenso,itstillrepresentedapproximatelyhalfofwhatwouldotherwisehavebeentheprofitofthepartnership.Forpracticalpurposesthemoneygeneratedbythebusinessactivitiesofthepartnershipwassubjecttothecontrolofthepartnersanddealtwithastheywished.

WoodhouseJmadeshortworkoftheargumentthatthedifferencesbetweens260oftheAustralianActands108ofthe1954Actwerematerial.22SoheconcludedthatNewtonwascontrolling.Herejectedtheapplicabletoshamsonly,nofiscaleffectandaccruedliabilitiesonly arguments.23 He also concluded that s 108 could be invoked so as to disallow adeduction which, but for s 108, would have been allowed under s 111, the general

17

18

19

20

21

22

23

WPKeigheryPtyLtdvFederalCommissionerofTaxation(1957)100CLR66.In Keighery Dixon CJ, Kitto and Taylor JJ observed at 92: ‘Whatever difficulties there may be in interpretings.260,onethingatleastisclear:thesectionintendsonlytoprotectthegeneralprovisionsoftheActfromfrustration,andnottodenytotaxpayersanyrightofchoicebetweenalternativeswhichtheActitselflaysopentothem.’BenNevis,aboven10;andPennyandHoopervCommissionerofInlandRevenue[2011]NZSC95,[2012]1NZLR433.SeePartIXbelow.LewisvCommissionerofInlandRevenue[1965]NZLR634(SC).ElmigervCommissionerofInlandRevenue[1966]NZLR683(SC)[Elmiger(SC)].At689.At689–92.


6

deductibilityprovision,ofthe1954Act.24Indoingso,hewasnotmovedbytheindicationgivenbyDixonCJinCecilBrosPtyLtdvFederalCommissionerofTaxation25thats260couldnotbereliedontodisallowadeductionotherwisepermitted.Astothishenoted:26

Inanyeventitismyopinionthats.108ispartofthelawtobeappliedandmustbe given its appropriate place in the statute… I can seeno reasonwhy s. 111shouldactinsuchawayastooverridetheeffectofs.108,andwithallrespect,Ithinkthislastsectionwilloperatetoexcludeadeductionifthisarisesastheresultofanarrangementofthetypestruckatbys.108.

Moregenerallyheobserved:

The section is not designed to prevent ordinary commercial, or family, orcharitable dispositions. Nevertheless this is a general provision aimed atotherwise legalmethods of tax avoidance. It is designed, as I stated earlier, toforestall the use by individual taxpayers of ordinary legal processes for thedeliberatepurposeofobtainingarelieffromthenaturalburdenoftaxationdeniedgenerallytothesameclassoftaxpayer.Accordinglyitismyopinionthatfamilyorbusinessdealingswillbecaughtbys.108despitetheircharacterisationassuch,ifthereisassociatedwiththemtheadditionalpurposeoreffectoftaxrelief(inthesensecontemplatedbythesection)pursuedasagoalinitselfandnotarisingasanaturalincidentofsomeotherpurpose.

This judgmentwasupheld by theCourt ofAppeal.27 For thepurposes of this paper it issufficient to say that in dismissing the appeal the Court of Appeal largely adopted theapproachtakenbyWoodhouseJ.

TheElmigerapproachgavepracticaleffecttos108.However,itdidsoprimarilyonthebasisofNewton,effectivelyalongthelinesthatprovidingasensibleandpracticalapproachwastakentowhatamountedtotaxavoidance–thatis,whatwastrulywithinthescopeofs108– anypriorityissueasbetweens108andotherprovisionsresolveditself(infavourofs108).WoodhouseJ’sexplanationastowhys108prevailedovers111islimitedand,asexpressed,ratherconclusory,albeitthatitwasbasedonAustralianauthoritiestowhichhehadearlierreferred.

In the years that followedElmiger, s 108was often in issue in the courts. Taxpayers onoccasionsucceededbecauseoftheabsenceofapowerofreconstructionbutinmostcasesthe courts struckdown the challenged transactions.28 Save in caseswhich turnedon theabsence of a reconstruction power, application of the Elmiger approach was largelyunproblematic (albeit that there was, on occasion, a diversity of judicial opinion as tooutcome).Forthepurposesofmypaper,thesecasesareoflimitedsignificanceandthenextimportantdecisionisthatofthePrivyCouncilinManginvCommissionerofInlandRevenue,29towhichInowturn.

24 At692–3.25 CecilBrosPtyLtdvFederalCommissionerofTaxation(1964)111CLR430at438.26 Elmiger(SC),aboven21,at693.27 ElmigervCommissionerofInlandRevenue[1967]NZLR161(CA).28 The cases are reviewed in detail in the judgment of Richardson J in Challenge Corporation Ltd v

CommissionerofInlandRevenue[1986]2NZLR513(CA)[Challenge(CA)]at546–7.29 Mangin,aboven1.


7

V MANGINVCOMMISSIONEROFINLANDREVENUE

Mangin involved a ‘paddock trust’, an income‐splitting device reasonably similar to thatadoptedinElmiger.Onceagainthe‘nofiscaleffect’and‘accruedliabilitiesonly’argumentswererejected,30aswasthetaxpayer’sappeal.Thecase,however,wasfarfromanunqualifiedvictoryfortheCommissionerasisapparentfromthefollowingpassagefromthejudgmentofthemajority:31

In their Lordships’ view [LordDenning’s discussionof predication inNewton],properly interpreted,doesnotmeanthateverytransactionhavingasoneof itsingredientssometaxsavingfeaturetherebybecomescaughtbyasectionsuchass108.Ifabonafidebusinesstransactioncanbecarriedthroughintwoways,oneinvolvinglessliabilitytotaxthantheother,theirLordshipsdonotthinks108canproperly be invoked to declare the transaction wholly or partly void merelybecausethewayinvolvinglesstaxischosen.Indeed,inthecaseofacompany,itmaybethedutyofthedirectorsvis‐à‐vistheirshareholderssotoact.… ThecluetoLordDenning’smeaningliesinthewords‘withoutnecessarilybeinglabelledasameanstoavoidtax’…TheirLordshipsthinkthatwhatthisphrasereferstois,toadoptthelanguageofTurnerJinthepresentcase‘ascheme...devisedforthesolepurpose,oratleasttheprincipalpurpose,ofbringingitaboutthatthistaxpayershouldescapeliabilityontaxforasubstantialpartoftheincomewhich,withoutit,hewouldhavederived.’

Thissuggeststhatataxpayermayelectthemosttax‐effectivewayofimplementingabonafidetransaction,withtheGAARinapplicableunlessthesoleorprincipalpurposewastaxavoidance(inwhichcase,itwouldpresumablynotbeabonafidetransaction).Thiswasasubstantiallywatereddownversionof thepredication test from that adopted inElmiger(whichappliediftherewasan‘additionalpurpose’oftaxavoidance‘pursuedasagoalinitself’)32andthusleftconsiderablescopefortheoperationofthechoiceprinciple.

AlsosignificantforthepurposesofmypaperisthedissentingjudgmentofLordWilberforce.Heidentifiedfourunsatisfactoryfeatureofs108:33

(a) It fails to define the nature of the liability to tax, avoidance of which isattacked. Is this an accrued liability, a future butprobable liability, or a futurehypotheticalliability?Isitonewhichmusthavearisenbutforthearrangement,orwhichmighthavearisenbutforthearrangement,andif‘might’,probablymightorordinarilymightorconceivablymight?

(b) Itfailstospecifyanycircumstancesinwhicharrangementsetcwhichinfacthavefiscalconsequencemaybeoutsidethesection,and,ifsuchexist,tospecifyonwhomtheonuslies,andtothesatisfactionofwhom,toestablishtheexistenceofsuchcircumstances.Thetaxpayerislefttoworkhiswaythroughajungleofwords,‘purpose’, ‘or’, ‘effect’, ‘purported purpose’, ‘purported effect’ which existingdecisionshaveglossedbutonlydimlyilluminated.

(c) Itfailstospecifytherelationbetweenthesectionandotherprovisionsinthe Income Tax legislation under which tax reliefs, or exemptions, may be

30 At594–6.31 At598.32 SeeWoodhouse J’s more general observations in Part IV above, in quotation immediately before

footnote28.33 Mangin,aboven1,at602.


8

obtained.Isitlegitimatetotakeadvantageofthesesoastoavoidorreducetax?Whatiftheonlypurposeistousethem?Isthereadistinctionbetween‘proper’taxavoidanceand‘improper’taxavoidance?Bywhatsenseisthisdistinctiontobeperceived?

(d) It gives rise to a number of extremely difficult problems as to whathypothetical state of affairs is to be assumed to exist after the section hasannihilatedthetaxavoidanceelementinthearrangement….

Hethenwenton:34

InAustraliaandNewZealandtheCourtshaveendeavouredtoremedysomeofthestatutorydeficiencies.InNewtonvCommissionerofTaxation…,thisBoardgavesome fresh life to theAustralian section by instancing transactions ‘capable ofexplanation by reference to ordinary business or family dealing, withoutnecessarily being labelled as a means to avoid tax’, a suggestion profitablygeneralisedbyKittoJinthewords‘capableofexplanationbyreferencetoordinarydealing such as business or family dealing …’ (Hancock v Commissioner ofTaxation(1961)108CLR258,283)butitcouldhardlybeclaimedthattheseareindications of precision. They have in turn been ‘interpreted’ in the majoritydecisioninthiscase.Butonedifficultyleadstoanother,andtheCourtsarenowhavingtodecidehow‘ordinary’atransactionmustbetoescape.Inthepresentcase, the Judges have, not surprisingly, reached differing conclusions:Wilson Jthoughtthetransactionswereordinary:theCourtofAppealfoundthattheywereextraordinary.

…

ItisbecauseIbelievethatthelimitsofjudicialinterpretation,howeverliberalorcommonsensetheprocessmaybeclaimedtobe,arepassedwhenonecomestoattempttoapplytheNewZealandsectiontothispresentcasethatIcannotagreewith theBoard’s decision. I think thatwe have here a rusty instrumentwhichbreaksinourhandsandisnolongercapableofrepair.

IhavesetoutinfulltheproblemsidentifiedbyLordWilberforceeventhoughhis(a)wasaddressed inpart to theaccrued liabilitiesonlyargumentandhis(d) to theabsenceofareconstructive power argument. These problems were addressed (although as to (a)perhapsonlyinpart)bythe1974amendmentstos108andthusins99ofthe1976Act,towhichIamabouttoturn.Points(b)and(c)werenot,howeveraddressedbythelegislaturein1974andremainunaddressedtothisday.

VI THELEGISLATURERESPONDS

Section108hadbeenamended in1968soas tomake it clear that thesectionhad fiscaleffect.35As I havenoted, s 108was amended in 197436 and the amendedprovisionwas

34 At602.35 Byinsertingafterthewords‘absolutelyvoid’,thewords‘asagainsttheCommissionerforincometax

purposes’:sees16(1)oftheLandandIncomeTaxAmendmentAct(No2)1968.InMangin,aboven1,themajorityconcludedat595thatthismerelyconfirmedtheexistinglaw.

36 By s 9 of the Land and Income Tax Amendment Act (No 2) 1974. The immediate trigger for theamendmentappearstohavebeenCommissionerofInlandRevenuevGerard[1974]2NZLR279(CA)wheretheCommissioner’scasehadfailedforwantofapowerofreconstruction.


9

carried through into the 1976 Act as s 99. The revised section conferred on theCommissionerapowerof reconstruction.37 It alsomade it clear that itwasapplicable inrespect of arrangements affecting ‘potential or prospective liability in respect of futureincome’.38Andfinally,therewasaresponsetothemajority’sjudgmentinMangin,inthattheamendedsectiondeclaredthatitappliedtoanarrangementif:39

(a) Itspurposeoreffectistaxavoidance;or

(b) Whereithas2ormorepurposesoreffects,oneofitspurposesoreffects(notbeingamerelyincidentaleffect)istaxavoidance,whetherornotanyotherorothersof itspurposesoreffectsrelate to,orarereferable to,ordinarybusinessorfamilydealings…

It is sometimes said that this represented anabrogationof thepredication test.40 I havedistinct reservationswhether this is so. InNewton, LordDenningacknowledged that theavoidanceoftaxwasnotthesolepurposeofthearrangementsinthecasesathand.Buthethenwentontosay:41

Butneverthelessthesectioncanstillworkifoneofthepurposesoreffectswastoavoidliabilityfortax.Thesectiondistinctlysays‘sofarasithas’thepurposeoreffect.ThisseemstotheirLordshipstoimportthatitneednotbethesolepurpose.

ThisisconsistentwiththeapproachadoptedinElmigerbutnotwiththesoleorprincipalpurposeviewadvancedinMangin.IthereforeprefertoseethisamendmentasarepudiationofthisaspectoftheManginjudgment.

Althoughthe1974amendmentandthuss99ofthe1976Actdidnotaddresspoints(b)and(c)as identifiedbyLordWilberforce, theymade itclear that the legislatureexpectedtheGAARtobeaneffectivepartofthetaxsystem.

VII EUROPAOIL(NZ)LTDVCOMMISSIONEROFINLANDREVENUE

Theargumentthats108couldnotprevailagainsts111(thegeneraldeductibilityprovision)wasadoptedbythePrivyCouncilinEuropaOil(NZ)LtdvCommissionerofInlandRevenue.42Inissuewasthedeductibilityofthefullcosttothetaxpayerofacquiringitsstock‐in‐trade.Thepaymentsforwhichdeductibilitywassoughtenabledthetaxpayertoderivenotjustthestockbutalsobenefitsofanon‐taxablenaturewhichmitigatedtheeconomicburdenofthecostof thestockpurchases.Thetaxpayerwassuccessful in thePrivyCouncil forreasonswhichincludedprioritybeingaccordedtos111overs108:43

Their Lordships’ finding that the monies paid by the taxpayer company … isdeductibleunders111asbeingtheactualpricepaidbythetaxpayercompanyforitsstock‐in‐tradeundercontractsforthesaleofgoodsenteredintowithEuropa

37 Section9(2).38 Section99(1),definitionof‘liability’.39 Section99(2).40 SeeforinstanceBenNevis,aboven10,at[81]perTipping,McGrathandGaultJJ.41 Newton,aboven4,at10(emphasisoriginal).42 EuropaOil(NZ)LtdvCommissionerofInlandRevenue[1976]1NZLR546(PC).43 At556perLordDiplockforthemajority.


10

Refining…isincompatiblewiththosecontractsbeingliabletoavoidanceunders108.InrespectofthesecontractsthecaseisonallfourswithCecilBrosPtyLtdvFederalCommissionerofTaxation(1964)111CLR430inwhichitwassaidbytheHighCourtofAustralia‘itisnotfortheCourtorthecommissionertosayhowmuchataxpayeroughttospendinobtaininghisincome’(ibidp434).

ThislimitedviewoftheGAARwasinconsistentwiththatadoptedinElmigeralbeitthatthiswasnotadvertedtointhejudgment.Thissurprisinglycasualapproachtoover‐rulingearlierauthoritywassoontoberepeated,onlythistimeinrelationtothispassageinEuropa;thisoccurring in thenextcase Iwish todiscuss,ChallengeCorporationLtdvCommissionerofInlandRevenue.44

VIII CHALLENGECORPORATIONLTDVCOMMISSIONEROFINLANDREVENUE

ThisinvolvedaschemeunderwhichthetaxpayeracquiredfromMerbank(afailedfinancier)acompany(Perth)withtaxlossesandclaimedunders191ofthe1976Acttooffsetthoselossesagainst the incomeofprofitablesubsidiaries.Thatsectioncontainedaspecificbutlimited anti‐avoidance subsection (s 191(1)(c)(i)) in relation to arrangements of atemporary nature. This subsection was not engaged and the conditions for groupingspecifiedins191(whichwererequiredtobesatisfiedonthelastdayoftheincomeyear)wereallsatisfied.Theeffectof thearrangement,enteredintoneartheendofthe incomeyear,wastoallowChallengetotakeadvantageoftaxlossespreviouslyincurredbyPerth,thatis,atatimewhenithadnoassociationwithChallenge.Section191didnotmakeearlierassociationapre‐conditiontogrouping.

Itwasclearthatthewholepurposeofthetransactionwastoobtainataxadvantage.Thesame,however,wastrueofanyarrangementinvolvingthegroupingoftaxlosses,includingthosewellwithinthespirit,aswellastheletter,ofs191.Thepredicationapproachthusdidnot provide a mechanism for distinguishing between objectionable and unobjectionablegroupingarrangements.

TheCommissionerwasunsuccessfulat first instance45and intheCourtofAppeal.46ThatCourtcomprisedWoodhouseP,andCookeandRichardsonJJ.Forthepurposesofthispaper,IproposetofocusontheapproachesadoptedbyWoodhousePandRichardsonJ.CookeJagreedintheresultandlargelywiththereasonsofRichardsonJ.

WoodhousePnotedthecriticismsofs108advancedbyLordWilberforce inManginandthenwenton:47

ButtheMangincasewasheardanddisposedofbytheBoardin1970,aboutfouryearsbeforeParliamenttooklegislativestepstomeetatleastsomeofthejudicialcriticismsofs108.AndIthinktherecanbenodoubtthatwhentheprovisionwasamplified and given its present statutory form by Parliament in 1974 thedeliberatedecisionwasthentakenthat,becausetheproblemofdefinitioninthiselusive field could not be met by expressly spelling out a series of detailedspecificationsinthestatuteitself,theintersticesmustbeleftforattentionbythe

44 ChallengeCorporationLtdvCommissionerofInlandRevenue[1986]2NZLR513(PC)[Challenge(PC)].45 ChallengeCorporationLtdvCommissionerofInlandRevenue[1986]2NZLR513(HC).46 Challenge(CA),aboven28.47 At534.


11

Judges. … It can be said, I think, … that inherent in the approach taken byParliament is an assurance that some expressed judicial misgivings as to theproperroleoftheCourtconcerningtheearlierlegislationhavebeenmisplaced.MostcertainlyitwasopentoParliamenttotakethisapproachandIdonotaccepttheviewthatanyofthesupposedproblemsofconstruings99shouldpersuadetheCourtsthattheycannotberesolvedbyjudicialinterpretationandsomustbeleftforyetfurtherlegislativeattention.

He roundly rejected the choice principle48 and thenwent on to considerwhether s 191shouldprevailovers99:49

ForanumberofreasonsIamunabletoacceptthesearguments.First,itwouldbequite extraordinary, … for the draftsman to carefully prevent a tax advantagebecausetheshareholdingwas‘ofatemporarynature’andyetconsciouslydecidethatParliamentwouldwishtogiveitsblessing(andthenonlybyimplication)toamanufacturedandbarelytangibleassociationofthekindunderreview.…Ithinkitfarmorelikelythatafterdrawingexpressattentiontotheobvioustaxavoidanceimplications that could arise from shareholdings ‘of a temporary nature’ hedecidedthatallothertaxavoidancesituationsshouldproperlybeleftforattentionbys99.Itmayevenbethattheseothermatterswerenotinmindorthesubjectofanydeliberatedecision…

Thisleadstothesecondpoint.Paragraph(c)(i)couldbeconstruedasfillingtheavoidance field inso farass191 is concernedonlyon thebasis that themuchwiderprovisionsofs99wereexcludedbyanimplication.Idonotthinksuchanimportantglosscanbereadintotheparagraphandagainsttheplainlanguageofs99recognisedbycounsel…as‘acentralpillaroftheincometaxlegislation’.

Finallyitneedstoberememberedwhenconstruings99besides191thats191doesnotopenwithsuchwordsas‘Notwithstandingtheprovisionsofs99…’.IfParliament had intended that s 191 should stand quite independently of andunaffectedbytheearliersectionitwouldhavebeenasimplemattertosaysoinexpressterms.

…

FortheforegoingreasonsIthinkthats99isofgeneralapplication,thats191issubordinatetoit,andthatitisintendedtooperateasakindofprovisotootherprovisions of the Act wherever the issue of tax avoidance may seem to haverelevance.AccordinglyIamoftheopinionthattheappealshouldbeallowedandtheassessmentoftheCommissionerreinstated.

Inpart,WoodhousePwasapplyingthegeneraliaspecialibusmaximinfavourofs99.Whathedidnotspellout,however,iswhy,ifs99was‘akindofproviso’tos191,itwouldnotinvalidateeverygroupingarrangement,includingthosewithinthespiritofs191.Withwhatisnodoubtthebenefitofhindsight,Iaminclinedtoseeintheitalicisedpassagesapossibleexplanationintermsofwhatareatleasthintsofanembryonicparliamentarycontemplationtest.

48 At538–539.49 At539(emphasisadded).


12

RichardsonJwasdistinctlymoresympathetictothechoiceprinciplethanWoodhouseP.Heexpressedhisgeneralinterpretativeapproachinthisway:50

Section99…livesinanuneasycompromisewithotherspecificprovisionsoftheincome tax legislation. In the end the legal answer must turn on an overallassessmentoftherespectiverolesoftheparticularprovisionands99underthestatuteandoftherelationbetweenthem.Thatisamatterofstatutoryconstructionandthetwinpillarsonwhichtheapproachtostatutesmandatedbys5(j)oftheActs Interpretation Act 1924 rests are the scheme of the legislation and therelevantobjectivesofthelegislation.…

Certainlytheschemeandpurposeapproachtostatutoryanalysiswillnotfurnishan automatic easy answer to these interpretation problems. Tax legislationreflectshistoricalcompromisesanditbearsthehandsofmanydraftsmeninthenumerousamendmentsmadeovertheyears.Itisobviouslyfallacioustoassumethatrevenuelegislationhasatotallycoherentscheme,thatitfollowsacompletelyconsistentpattern,andthatallitsobjectivesarereadilydiscernible.Thereisforceinthethesisthatinmanyrespectsthetaxbaseissoinconsistentandcontainssomanystructuralinequitiesthatasinglegeneralanti‐avoidanceprovisionsuchass99cannotbeexpectedtoprovideaneffectivemeasurebywhichtoweightheexerciseoftaxpreferences....Nevertheless,thatemphasisontryingtodiscerntheschemeandpurposeofthelegislationislikelytoprovidethelegalanswertotherelation between s 99 and other provisions of the Act that best reflects theintentionofParliamentasexpressedinthestatute.

Heappliedthisapproachinthisway:51

Section 191 is a complex provision which has been changed, developed andrefinedbylegislativeamendmentoveranumberofyears.Basictoitsoperationisthe establishment of common shareholdings, voting power or entitlement toprofits(and,inthecourseoffullgrouping,ofanidenticalpatternofshareholding)at particular times. The only requirement in that regard applying … [at] thematerialtimewasthatthetestbesatisfiedonaparticularday—attheendoftheincome year.…A specific anti‐avoidance provision, obviously draftedwith thelanguageoftheolds108inmind,wasdirectedandconfinedtotemporarychangesofshareholdingforthepurposeoreffectofalteringtheincidenceofincometaxorrelieving any company from its liability to pay income tax by excluding anycompanyfromorincludingitinanygroupofcompaniesinrelationtothatincomeyear.

Thenatureofs191andthesefeaturesoftheschemeofthesectionatthematerialtimedonot…leaveanyroomfortheapplicationofs99tothesestraightforwardarrangementswhich did nomore than bring the loss companieswithin a newgroupsoastosatisfyalltherequirementsofs191.Itisnoanswertosaythatthepurposeofthearrangementwastosavetaxforthatisthepurposeofeveryoffsetofalossinonecompanyagainstaprofitinanother,whichistheonlyreasonforthepresenceofs191inthestatute…

Onthisanalysisoftheroleofs191inthestatutoryschemeandofthetermsoftheprovisionitselfIamsatisfiedthattotreatthearrangementscarriedthroughinthis

50 At549.The1924Actreferredtointhispassagepreceded,andwasrepealedby,theInterpretationAct

1999,referredtoinPartIIabove,textnearfootnotes13and14.51 At555(emphasisadded).


13

case as tax avoidancewithin s 99(1)woulddefeat, notpromote the legislativepurposesinvolved.Thetaxchangesachievedinthetransactionsdidnotaltertheincidenceof income taxwhich theAct itself contemplatedor affectChallenge’sliabilityforincometaxinthesenseindicatedbythestatute.

RichardsonJaddressedpriorityasbetweenss99and191ingeneralterms–thatisintermsofwhethers99ors191shouldprevailwherethepredicationtestissatisfied.Since(a)thepredication test is always satisfiedwhere tax losses are grouped and (b) the legislaturenonethelessintendedthattaxlossescouldbegrouped,thepredicationtestwasnot,initself,ananswertothetaxpayer’sargument.SoIagreewithRichardsonJthatthecasewasnotsusceptibletoresolutiononthebasisthats99alwaystrumpeds191.WhereIdifferfromhim–andagainwiththebenefitofhindsight–isthatIdonotregardthecaseasturningona general issuepriority (or subordination) asbetweenss99and191. Instead I see it asturningonwhether,onthefactsofthecaseathand,s99ors191prevailed–asuigenerisissueofbothinterpretationandapplicationandnotsusceptibletosensibleresolutionsimplyon thebasisofastraight‐forward ‘schemeandpurpose’ legislativeanalysisas togeneralprioritybetweenthetwosections.

ThePrivyCouncilallowedtheCommissioner’sappealinamajorityjudgmentdeliveredbyLordTempleman.52Thiswasexpressedintermsdistinctlyunsympathetictotaxpayers.LordTempleman summarily rejected the contention that s 99 could not apply if s 191 wassatisfied:53

Tax avoidance schemes largely depend on the exploitation of one or moreexemptions or reliefs or provisions or principles of tax legislation. Section 99would be useless if amechanical andmeticulous compliancewith some othersectionoftheActweresufficienttoousts99.

ThepositionadvancedinCecilBrosandadoptedbythePrivyCouncil inEuropawasthusrejected;albeitwithanabsenceofreferencetotheconflictingauthoritiescorrespondingtothefailureofthePrivyCouncilinEuropatorefertoElmiger.

LordTemplemanlikewiserejectedthecontentionthats191(1)(c)(i)excludedtheoperationofs99.Heparaphrasedtheargumentadvancedbythetaxpayerindeliberatelyunpersuasiveterms:54

Parliamentmusthaveintendedthatanypermanentformoftaxavoidanceoranyother form of tax avoidance except the particular form prescribed by s191(1)(c)(i)shouldbepermittedtosucceed.

Hethen,unsurprisingly,rejectedtheargument:55

IntheopinionoftheBoardthisargumentattributestoParliamentabenevolentattitudetowardstaxavoidancebycompanieswhichisunlikelyandunnecessary.

A likely explanation is that Parliamentwas indifferent to or unmindful of anyoverlapbetweenthegeneralprovisionsofs99andtheparticularprovisionsofs191(1)(c)(i) or that, in view of the well‐known difficulties encountered in theformulation and enforcement of effective anti‐tax avoidance provisions,

52 Challenge(PC),aboven44.53 At559.54 At559.55 At559(emphasisadded).


14

Parliament thought that an overlapmight be useful and could not be harmful.Parliamentmayhavehad inmind twodifferent tax avoidancepositions.Therecouldbetaxavoidanceintheintroductionintoagroupofcompaniesofacompanywhichhad alreadymade a loss; any tax advantage obtained as a result of thatintroduction would fall foul of s 99. There could also be tax avoidance in themanipulationoftheshareholdingsorconstitutionofacompanyinordertoobtaintemporarycompliancewiththeconditionsspecifiedbys191;thatmanipulationwouldfallfoulofs191(1)(c)(i).Thepossibilitythatsuchmanipulationmightalsobe frustrated by the operation of s 99 does not lead to the conclusion thatParliamentmusthave intendedtopermitpermanent taxavoidanceschemestoexploits191.Theprovisionsofs99areofgeneralapplicationand,intheabsenceofanexpressdirectionbyParliamentexcludings191fromtheambitofs99,theirLordshipsconsiderthats99mustbeappliedinthepresentcircumstances.

LordTemplemanalsogavesomeexplanationastowhys99wouldnotalwaystrumps191:56

Itwas argued that if this appeal by the Commissioner succeeds a purchase ofsharesinacompanywhichbecomespartofaspecifiedgroupwillalwaysbevoidunders99.Butapurchaseofshareswillonlybevoidinsofarasitleadstotaxavoidanceandnottaxmitigation.

In an arrangement of tax avoidance the financial position of the taxpayer isunaffected(saveforthecostsofdevisingandimplementingthearrangement)andbythearrangementthetaxpayerseekstoobtainataxadvantagewithoutsufferingthatreduction in income, lossorexpenditurewhichother taxpayerssufferandwhich Parliament intended to be suffered by any taxpayer qualifying for areductioninhisliabilitytotax.

…

Most tax avoidance involves a pretence; see the analysis inWT Ramsay Ltd vInlandRevenueCommissioners[1979]1WLR974,975(CA).InthepresentcaseChallengeandtheirtaxpayersubsidiariespretendthattheysufferedalosswhenintruththelosswassustainedbyPerthandsufferedbyMerbank.

Thejudgmentisverymuchalongthesamelinesasthecurrentparliamentarycontemplationtest. Certain economic effects were seen by the legislature as warranting the benefit inquestion. If those economic effects had been suffered, s 191 would have prevailed. ButChallengehadnotsufferedthoseeconomiceffects.Itwasthusseekingtoobtainataxbenefitincircumstancesotherthanthoseintendedbythelegislature.Therefores99prevailed,onthefactsofthecase,againsts191.

Thisdoesnotlooklikeorthodoxschemeandpurposeanalysisinthatitwasnotconcernedwiththemeaningofs191,which,inthisrespect,wasplainenough.Thepremiseofthecaseisthat,absenttheinvocationofs99,theschemewaseffectiveands191wascompliedwith.Thepracticaleffectof thedecisionwasthat,withs99engaged, theentitlementtogrouplosseswasdependentuponthecompaniesconcernedhavingbeenassociatedatthetimethelosseswereincurred;thisdespitesuchaconditionnotbeingspecifiedins191.

56 At562(emphasisadded).


15

IX INCOHERENCEANDINDETERMINACY

IntheaftermathofChallenge,theCecilBros/EuropaviewthattheGAARcouldnotbeinvokedtodisallowataxconsequencecreatedbysomeotherprovisionoftheActwasneverrevived.But theviewofWoodhouseP that theGAARwasa trumpingprovisionwas likewisenotadopted.Thechoiceprinciplewasstillinplaybutitsscopewasuncertain.Theexpression‘linedrawing’cameintovogue.Moregenerally,thelawwascharacterisedbyincoherenceandindeterminacy.

ThepositionwassummarisedbyRichardsonP(writingforhimself,KeithandTippingJJ)inthiswayinCommissionerofInlandRevenuevBNZInvestmentsLtd:57

[39] Forthereasonsdiscussedinthecases…s99astheexpandedsuccessoroftheolds108oftheLandandIncomeTaxAct1954isperceivedlegislativelyasanessentialpillarofthetaxsystemdesignedtoprotectthetaxbaseandthegeneralbody of taxpayers fromwhat are considered to be unacceptable tax avoidancedevices.Bycontrastwithspecificanti‐avoidanceprovisionswhicharedirectedtoparticulardefinedsituations,thelegislaturethroughs99hasraisedageneralanti‐avoidance yardstick by which the line between legitimate tax planning andimpropertaxavoidanceistobedrawn.

[40] Linedrawingandthesettingoflimitsrecognisetherealitythatcommerceislegitimatelycarriedoutthrougharangeofentitiesandinavarietyofways;thattax is an important and proper factor in business decisionmaking and familypropertyplanning;thatsomethingmorethantheexistenceofataxbenefitinonehypotheticalsituationcomparedwithanotherisrequiredtojustifyattributingagreater tax liability; thatwhat should reasonablybe struck at are artifices andother arrangements which have tax induced features outside the range ofacceptablepractice–asLordTemplemanputit…mosttaxavoidanceinvolvesapretence; and that certainty and predictability are important but not absolutevalues.

[41] The function of s 99 is to protect the liability for income tax establishedunderotherprovisions of the legislation.The fundamental difficulty lies in thebalancingofdifferentandconflictingobjectives.Clearlythelegislaturecouldnothave intendedthats99shouldoverrideallotherprovisionsof theActsoastodeprive the taxpaying community of structural choices, economic incentives,exemptionsandallowancesprovidedbytheAct itself.Equallythegeneralanti‐avoidanceprovisioncannotbesubordinatedtoallthespecificprovisionsofthetaxlegislation.It,too,isspecificinthesenseofbeingspecificallydirectedagainsttax avoidance; and it is inherent in the section that, but for its provisions, theimpugnedarrangementswouldmeetallthespecificrequirementsoftheincometax legislation. The general anti‐avoidance section thus represents an uneasycompromiseintheincometaxlegislation.

[42] Linedrawingrepresents the legislature’sbalancingof therelevantpublicinterestconsiderations.…

At times a conservative approach to the GAAR was proposed or applied. Thus inCommissionerof InlandRevenue vAucklandHarbourBoard58 LordHoffmann referred, in

57 CommissionerofInlandRevenuevBNZInvestmentsLtd[2002]1NZLR450(CA).58 CommissionerofInlandRevenuevAucklandHarbourBoard[2001]UKPC1,[2001]3NZLR289.


16

passing,tos99asa‘longstopforTheRevenue’.59Andalthoughthelong‐stopviewwasnotexpresslyreferredtointhelaterPrivyCouncildecision,PetersonvCommissionerofInlandRevenue,60 itmightbe thought tobe consistentwith the result.The case concernednon‐recourseloanfinancingoffilminvestments.Thenon‐recourseloanwasreferredtointhejudgmentas‘$y’whereasasthemoneydirectlypaidbytheinvestorsforproductioncostswasreferredtoas‘$x’.Ostensiblyeachinvestorhadpaidatotalof$x+yforproductioncosts.

Therewas,asonemightexpect,circularityinrelationtotheno‐recourseloanwhichdidnotrepresent‘real’money.

InallowinganappealbyPetersonfromafindinginfavouroftheCommissioner,themajorityobserved:

[44] The leverage obtained by use of a non‐recourse loan meant that theinvestorsdidnotsustainaneconomic lossafterthetaxdeduction is takenintoaccount.TheirLordshipssuspectthat it isthisfeatureoftheschemewhichhasmost exercised the Commissioner. But amoment’s reflection shows thatwhatLordTemplemanhadinmind[inChallenge]wasexpenditureorlossbeforeanytaxadvantageistakenintoaccount.…Thefactthattheinvestmentwasfundedbya non‐recourse loan did not alter the fact that the investors had suffered theeconomicburdenofpayingthefullamountof$x+y.Itwasnotandcouldnotbesuggestedthateitherloanwasontermswhichmeantthatitwasunlikelyevertoberepaid.Theinvestorshaverepaidoneoftheloansinwholeorinpart,albeitoutof the film receipts; and they incurred a liability to repay the other if the filmgeneratedsufficientreceipts,asitwashopeditwould.

[45] Thecircularmovementofmoneysometimesconcealsthe factthereisnounderlyingactivityatall.Buteachofthepaymentsinthecirclemustbeexaminedin turntoseewhether itdischargedagenuine liabilityof thepartymakingthepayment. It does notmatterwhether external fundswere introduced into thecircle orwhether chequeswerehandedover anddulyhonoured. If themoneymovementsdidnotdischargeagenuineliabilitytheintroductionofexternalfundswillnotsaveit;iftheydid,theirabsencewillnotaffectit.…OnthewayinwhichtheCommissionerputhiscase therelevantpaymentswere thosebywhichtheinvestors received the non‐recourse loan and paid it out to the productioncompany.Subsequentpayments throughthecircleofwhichthe investorswereunawareandwhichtheycouldnotcontrolorpreventdidnotalterthefactthattheyhadborrowed$yandusedittowardsthedischargeoftheirliabilitytopay$x+y to the production company, thereby suffering the loss or incurring therelevantexpenditureforwhichthedepreciationallowanceisgranted.

[46] The$x+ywasostensiblypaidasconsiderationfortheacquisitionofthefilm,andwhiletheCommissionerwasatpainstoarguethatitwasnever‘truly’paid,itwasnopartofhiscaseatanystagethatitwaspaidforanyotherpurpose.BeforetheBoardheconcededthatitwaspaidasconsiderationforthemakingofthefilm.TheirLordshipsconsiderthatthisconcession,whichwasinevitablefromthewayinwhichtheCommissionerhasconductedthecasethroughout,isfataltohiscase.

All in all Peterson represented a very tolerant approach to tax avoidance. But in themeantime,backinNewZealand,aratherdifferentapproachwasbeginningtodevelop.

59 At[11].60 PetersonvCommissionerofInlandRevenue[2005]UKPC5,[2006]3NZLR433.


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X BENNEVISFORESTRYVENTURELTDVCOMMISSIONEROFINLANDREVENUE

BenNevisForestryVentureLtdvCommissionerof InlandRevenue61 concerned theTrinityscheme.ThisinvolvedaseriesofrelatedforestryinvestmentsassociatedwithasubstantialDouglas fir forestwhichhadbeenplantedandwasgrowing in Southland.The taxpayersweremembersofsyndicatewhichtookalicencefromaTrinitycompanyoverthelandinissueandwererequiredtomakepaymentsasfollows:

(a) On21March1997,$1,350perplantablehectaretoestablishtheforest.

(b) Alsoon21March1997,$1,946perplantablehectare.Theprimarypurposeofthispaymentwastoacquirethelandin2048for50percentofitsthenvalue.

(c) Alsoon21March1997,$1,000each,inrelationtoaleaseoption.

(d) $50perannumperplantablehectarebywayoflicencefee.

(e) On31December2048,$2,050,518perplantablehectareasalicencepremium.

Inreturnforthis,thetaxpayersweretoreceivethenetstumpagederivedfromthesaleoftheforestandanoptiontoacquirethelandfor50percentofitsthenvalue.

Theprofitabilityoftheventuredependedonwhetherthenetstumpagewhichthetaxpayersshouldreceiveonthesaleoftheforestwouldcoverthecosts(includingthetimevalueofmoney)oftheirinvestment.Inrelationtotherequirementtopaythelicencepremiumof$2,050,518 in 2048, the risk of insufficient stumpage was addressed by an associatedinsurancearrangementunderwhichthetaxpayerspaidoragreedtopaytoaninsurer,CSI,perplantablehectare:

(a) in1997,$1,307;and

(b) by31December2047,$32,791.

CSIwasestablishedintheBritishVirginIslandsontheinstructionsoftheschemearchitects.AdraftbusinessplanforCSInoted:

Therealbenefitsofthedealaretaxconcessionsthatcanbeobtainednowbytheinvestorsandthefoundation.Oneoftheconditionsrequiredtogainthetaxreliefisthattheinsurancemustbeinplace.Theactualoutcomeofthedealin50yearstimeisnotconsideredmaterial.

The tax benefits sought by the taxpayers were substantial. For the 1997 year, for eachplantablehectare,thetaxpayersexpendedalittleunder$5,000andostensiblyachievedadeductioninexcessof$37,000.Forthe1998incomeyear–andleavingasidesilviculturecosts–thecorrespondingfigureswere$50(expenditure)and$41,000(deduction).

Thecasemightbethoughttohaveinvolvedaccrualissues,albeitthatthesewerenotfullyventilated in themain tax litigation, a pointwhich itself has been subject tomuch laterlitigation.62ThecasewasthusarguedastoblacklettercompliancewiththeprovisionsreliedonbythetaxpayersandtheimpactofsBG1.ThetaxpayersweregenerallysuccessfulonthetechnicalcomplianceissuesandthecasewasdeterminedundersBG1.

61 BenNevis,aboven10.62 CommissionerofInlandRevenuevRedcliffeForestryVentureLtd[2012]NZSC94,[2013]1NZLR804.


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Thetaxpayerswereunsuccessfulatfirstinstance63andappealedtotheCourtofAppeal.64Inthecourseofdeliveringthe judgmentof thatCourtdismissingtheappeal, IexpressedanapproachwhichIthoughttobethenavailableontheauthoritiesastoinconsistencybetweentheGAARandthespecificprovisionsreliedonbythetaxpayers:65

[125]Obviously,thereisaneedtorecognisethatinsomeinstancesthelegislaturemusthaveintendedtoencourageparticulartypesofbehaviour.Behaviourofthattype (being the sort of behaviour which was within the contemplation of thelegislature)cannotbewithinthegeneralavoidanceprovisionsbecausetheoveralllegislative purpose is that such behaviour should attract the tax consequencesprovided for by Parliament. Likewise, it may sometimes be obvious that thespecific taxrulesreliedonwerenot intendedtoconferthetaxbenefit in issue.Suchacase,however, is likely tobedecidedsimplybyconstruing therelevantspecifictaxrulessoastoaccordwiththelegislativeintentandwithoutanyneedtoresorttothegeneralanti‐avoidanceprovisions.

[126]Caseswhich lie in between the two extremes just identified still raise aquestion of statutory interpretation but one which, in our view, cannot beaddressedsolelybyreferencetothespecifictaxrulesreliedonbythetaxpayer.The relevant general anti‐avoidance provisions are also relevant. … Whenconstruing such specific rules and looking for their scheme and purpose, it isnecessary to keep general anti‐avoidance provisions steadily in mind. On thisbasis,itwillusuallybesafetoinferthatspecifictaxrulesastodeductibilityarepremisedontheassumptionthattheyshouldonlybeinvokedinrelationtotheincurring of real economic consequences of the type contemplated by thelegislature when the rules were enacted. Further, it also seems reasonable toassumethatdeductibilityrulesarepremisedonalegislativeassumptionthattheywillonlybeinvokedbythosewhoengageinbusinessactivitiesforthepurposeofmaking a profit. Further, schemeswhich comewithin the letter of specific taxdeductibility rules by means of contrivance or pretence are candidates foravoidance...

Aswillbeapparent,thisisverylargelyfoundedonLordTempleman’sjudgmentinChallenge,albeit expressed in termswhich are reasonably consistent with orthodox interpretationprinciples.IalsoexpressedatentativepreferenceforthemoredirectandsimpleapproachofaccordingtheGAARaprimacyoverothertaxprovisionstobe‘displacedonlywhenthereis a discernible legislative intention that a particular type of transaction’ should not besubjecttotheGAAR.66Iconsidered,howeverthatadoptionofthatapproachwasbeyondtheroleoftheCourtofAppeal,givenrecentauthority,andinparticularPeterson.67

ThecasewentonappealtotheSupremeCourtandtheappealsweredismissed.TheessenceoftheapproachiscapturedinthefollowingpassagefromthejudgmentofTipping,McGrathandGaultJJ:68

[107]When, as here, a case involves reliance by the taxpayer on specificprovisions, the first inquiry concerns the application of those provisions. The

63 AccentManagementLtdvCommissionerofInlandRevenue(2005)22NZTC19,027(HC).64 AccentManagementLtdvCommissionerofInlandRevenue[2007]NZCA230(2007)23NZTC21,323.65 Emphasisinoriginal.66 At[114].67 At[115].68 BenNevis,aboven10.


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taxpayermustsatisfythecourtthattheusemadeofthespecificprovisioniswithinits intended scope. If that is shown, a further question arises based on thetaxpayer’suseofthespecificprovisionviewedinthelightofthearrangementasawhole.If,whenviewedinthatlight,itisapparentthatthetaxpayerhasusedthespecificprovision,andtherebyalteredtheincidenceofincometax,inawaywhichcannothavebeenwithin thecontemplationandpurposeofParliamentwhen itenactedtheprovision,thearrangementwillbeataxavoidancearrangement.…

[108]…AclassicindicatorofausethatisoutsideParliamentarycontemplationisthestructuringof anarrangementso that the taxpayergains thebenefitof thespecificprovision inanartificialorcontrivedway. It isnotwithinParliament’spurposeforspecificprovisionstobeusedinthatmanner.

[109]…Theultimatequestioniswhethertheimpugnedarrangement,viewedinacommerciallyandeconomicallyrealisticway,makesuseofthespecificprovisionin a manner that is consistent with Parliament’s purpose. If that is so, thearrangementwillnot,byreasonofthatuse,beataxavoidancearrangement.IftheuseofthespecificprovisionisbeyondParliamentarycontemplation,itsuseinthatwaywillresultinthearrangementbeingataxavoidancearrangement.

XI PENNYANDHOOPERVCOMMISSIONEROFINLANDREVENUE

InPennyandHoopervCommissionerof InlandRevenue69 the taxpayerswereorthopaedicsurgeonswhopractised through companies. In each case, the companywas ownedby afamilytrustortrustsandthetaxpayerwasthesoledirector.Afterthetoppersonalrateofincometaxwasincreasedfrom33to39percentin2000,thecompaniespaid(a)salariestothetaxpayersmateriallylowerthanhadpreviouslybeenfixed;and(b)dividends(taxedat33percentorless)tothefamilytrustswhichwerecorrespondinglyhigher.

Being of the view that these arrangements constituted tax avoidance, the Commissionerrecalculated the surgeons’ incomes by attributing to each what he considered to be a‘commercially realistic salary’. The facts of the casewere remarkably similar to those inPeatevFederalCommissionerofTaxation,70albeitthat,andoddly,thejudgmentoftheHighCourtofAustraliawasnotreferredtountilthehearingbeforetheSupremeCourt.71

The taxpayers were unsuccessful in the Supreme Court for the reasons explained byBlanchardJ.Hesetthesceneinthisway:72

[33] … The structure both taxpayers adopted when they transferred theirbusinesses (orthopaedic practices) to companies owned by their family trustswas, as a structure, entirely lawful and unremarkable. The adoption of such afamiliartradingstructurecannotpersebesaidtoinvolvetaxavoidance.Itwasachoice the taxpayers were entitled to make. Nor is there anything unusual orartificialinataxpayerthencausingthecompanyunderhiscontroltoemployhimonasalariedbasis.WhatissaidbytheCommissionertoconstitutetaxavoidance

69 PennyandHooper,aboven19.70 PeatevTheCommissionerofTaxationoftheCommonwealthofAustralia(1962)111CLR443.71 As noted by Blanchard J at [38], the subsequent Privy Council decision (Peate v Commissioner of

TaxationofCommonwealthofAustralia[1967]1AC308(PC))wasreferredtoinpassinginwrittensubmissions.

72 Referencesomitted.


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isthefixingofthesalariesatartificiallylowlevelswherebytheincidenceoftaxatthehighestpersonalratewasavoided.Itcanhardlybeacoincidencethatthiswasdoneassoonasthatpersonaltaxratewasincreasedto39centsinthedollar,andnotbeforethatchangewasmadebyParliament.But,again,therewasnofailuretocomplywithanyexpressrequirementoftheActinthesettingofthesalaries,sincethereisnone.Thisisthereforeacaseinwhich,complianceinotherrespectsbeingaccepted,itispossibletomovestraighttosBG1andtoaskwhethertheuseofthestructure which was adopted when the salaries were fixed was beyondparliamentarycontemplationandresultedinataxavoidancearrangement.…

AfterreferringtoanddiscussingPeate,BlanchardJwenton:73

[47] Although theNew Zealand tax statute and somebusiness practices havechangedconsiderablyintheinterveningperiod[sincethe1960s],Parliamenthasdeliberately preserved, and in fact enlarged, the New Zealand general anti‐avoidanceprovisionwhichcorrespondedtos260inPeate.ItcontinuestohaveworktodowheneverataxpayerusesspecificprovisionsoftheActandotherwiselegitimate structures in a manner which cannot have been within thecontemplation of Parliament. The policy underlying the general anti‐avoidanceprovisionistonegateanystructuringofataxpayer’saffairswhetherornotdoneasamatterof‘ordinarybusinessorfamilydealings’unlessanytaxadvantageisjust an incidental feature.…WoodhouseP said inChallengeCorporation Ltd vCommissioner of Inland Revenue that theremust be aweapon able to thwarttechnicallycorrectbutcontrivedtransactionssetupasameansofexploitingtheActfortaxadvantages.Thatiswhattheartificiallylowsalarysettingsdidinthiscase. They reduced each taxpayer’s earnings but at the same time enabled thecompany’searnings(derivedonlybecauseofthesettingofthesalarylevels)tobemadeavailabletohimthroughthefamilytrusts.Inreality,thetaxpayerssufferednoactuallossofincomebutobtainedareductioninliabilitytotaxasiftheyhad,toadaptLordTempleman’sdictuminChallenge.

XII SUBSEQUENTLITIGATION

More recentmajor tax avoidance caseswhich did not reach the Supreme Court provideexamplesoftheapplicationoftheparliamentarycontemplationtest.

Twoofthecases involvedrepodealsenteredintobyBNZandWestpac.Atapreliminarystageofoneofthecases,Iexplainedthetransactionsinissueinthisway:74

(a) AsubsidiaryoftheBNZ(theBNZsubsidiary)wouldacquirefromacounter‐partyanequityortrustinterestinanoverseasentity(theissuer)onthebasisthatthecounter‐partywouldrepurchase that interest (at thesameprice, subject toadjustments) at a specified time (usually five years) with the counter‐party’sparent company guaranteeing performance. In economic substance, the BNZsubsidiarywasthusprovidingfundingtothecounter‐party.TheBNZsubsidiary’sinitialreturnwasintheformofdistributionsfromtheissuer.

(b) ThereturntotheBNZgroupandtheoverallbalanceofadvantagebetweenthebankandthecounter‐partyisafunctionoftheagreeddistributiontobemadeby the issuer to the BNZ subsidiary, the interest rate swap arrangement, the

73 Referencesomitted.74 BNZInvestmentsLtdvCommissionerofInlandRevenue[2007]NZCA356,[2008]1NZLR598at[7].


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guaranteeprocurementfee(theGPF)(at2.95percentofthepurchaseprice)paidbytheBNZsubsidiaryforprocuringtheperformanceguaranteefromtheparentcompanyofthecounter‐party,andthebank’sborrowingcosts.

(c) TheBNZgroupwoulddeductitscostofborrowing,theGPFandthenetcostof the interest rate swap and treat distributions from the issuer as either: (i)exemptfromtaxonthebasisthatthedistributionswerereceivedbyanoverseasownedcompany(astheBNZsubsidiary)fromanoverseascompany(astheissuerwouldbe)underthe‘conduit’taxreliefrules;or(ii)relievedfromtaxundertheforeigntaxcreditrulesonthebasisaforeigntaxcreditwasavailableforforeigntax paid by an overseas company (being the issuer) resulting in a full creditclaimedundertheforeigntaxcreditprovisions.

In both cases, the Commissioner successfully contended in the High Court that that thetransactions were devoid of commercial purpose other than the exploitation of a taxasymmetry,providedamechanismbywhichtheeconomicbenefitsofthatexploitationcouldbedividedupbetweenthebankandcounter‐partiesandshouldbeavoidedundersBG1.75Appeals against the High Court judgments were later compromised. The cases are toocomplexforme,inthispaper,todojusticetothereasoning.Thereis,however,oneaspectofthemwhichIshouldmention.

In theBNZ case,Wild J analysed carefully the conduit regime, including the pre‐existingcontrolled foreign company (CFC) and dividend withholding payment (DWP) rules.76IncomewithintheCFCrulesattributedtoNewZealandresidentswastaxedasitwasearned.IncaseswheretheNewZealandresidentwasownedbyanon‐resident,theeffectwastotaxthenon‐residentsonforeign‐sourcedincome.Theconduitregimewasintendedtomitigatethis consequence. If theNewZealand resident passed on the income to its non‐residentowner,thiswouldattractnon‐residentwithholdingtax.Itisreasonablyclearthatthosewhopromotedtheconduitregimeassumedthatthiswouldhappenandsuchassumptionis,atleast tosomeextent,reflected in the legislativerequirementsas to the ‘conduit taxreliefaccounts’whichtaxpayersmustestablish.(Itisalsoimplicitintheword‘conduit’,atleastifitistakentorefertotheincomeratherthancapitalflows.)Whatissignificantforpresentpurposesisthatbecausetherepodealswereallloss‐incurringonapre‐taxbasis,theynevergeneratedaprofitwhichcouldbepassedbacktothenon‐residentowneroftheBNZ.Sononon‐residentwithholdingtaxwaseverpaid.

Entitlementtoconduittaxreliefwasnotconditionaluponincomebeingpassedontonon‐resident owners. As well, even when such income is passed on there will necessarilysometimesbemismatchesintimeandamountbetweenthenon‐residentwithholdingtaxwhichispaidandthereliefobtainedundertheconduitregime.WildJnonethelessfeltabletoconcludethat:77

The requirements [of the regime] are consistent only with Parliamentcontemplatingthatsomeoftheconduitrelievedincomewouldinduecoursebepassedontheforeignowner.Otherwisethoserequirementsarepointless.Itisalso

75 BNZ Investments Ltd v The Commissioner of Inland Revenue (2009) 24 NZTC 23,582 (HC) [BNZ

Investments (HC)]; andWestpacBankingCorporation vCommissionerof InlandRevenue (2009) 24NZTC23,834(HC).

76 BNZInvestments(HC),aboven75,at[206]–[243].77 At[235].


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difficulttoconceiveofaforeignownernotrequiringsomereturnontheforeigninvestmentitmadethroughitsNewZealandsubsidiary.

InthisrespectthejudgmentissimilartoChallengeinthatitseffectwastomakeentitlementtoataxbenefitsubjecttoacondition(inthiscase,theeventualpassingontotheforeignowner of all or some of the relieved income) additional to the conditions stipulated byParliament.

The other case isAlescoNewZealandLtdvCommissionerof InlandRevenue.78 AlescoNZacquiredtwootherNewZealandcompanies.ThoseacquisitionswerefundedbyAlescoNZissuingaseriesofoptionalconvertiblenotes(OCNs)toitsAustralianparent(AlescoCorp)forwhichitreceived$78million.Insubstancethiswasaninterestfreeloanof$78millionwhichwastoberepaidattheexpiryof10years.ButonmaturityAlescoCorpalsohadtheoptionofconvertingthenotesintoshares.ThisoptionwasofnopracticalutilityasAlescoCorp alreadyhad100per cent ownership ofAlescoNZ and itwas therefore a distinctlyartificialfeatureofthescheme.

Under the financial arrangement rules and theCommissioner’sDeterminationG22,79 theOCNs were split into debt and equity components with $40 million of the $78 millionattributedtotheoptionand$38milliontothedebtcomponent.Thedebtcomponentwastreatedasabond issued for$38millionwitharedemptionvalueof$78million.LeavingasidetheeffectofsBG1,AlescoNZwasentitledtodeductthedifference($40m)overthelifeoftheOCNs.TheredemptionoftheadvancewouldnotinvolveanyAustraliantaxliabilityforAlescoCorpwhichwasnonethelessentitledtofulldeductibilityinrespectofthedebttakenon to fund thepayments toAlescoNZ.Therewas thusa taxasymmetrywhich theschemeexploited.

AvanillaversionofthefundingarrangementintheformofaninterestbearingadvancefromAlescoCorptoAlescoNZwouldhaveresultedintaxdeductionsforAlescoNZwhichwouldnothavebeenless,andmaywellhavebeenmore,thanthoseclaimed.Forthisreasonandgiven the tax advantages derived by Alesco Corp in Australia, it was argued that theAustraliantaxsystemwastheprimarytargetofthescheme.ArgumentsaroundtheseissueswereaddressedandrejectedbytheCourtofAppeal.TheseargumentsandthereasonstheCourtofAppealgaveforrejectingthemareinterestingbutnotmaterialtothethemeofthispaperandIthereforeleavethemtooneside.

Althoughreferabletotheneedtofundbusinessacquisitionsandinthatsense,intermsofpurpose,bonafideorgenuine,thetransactionswerecontrivedastostructure.AlescoNZsuffered no economic loss corresponding to the tax deduction claimed and the OCNdocumentationwasitselfartificialinrelationtotheoptionalconversionofthenotes.

TheCourtofAppealposedforitselfthefollowingquestions:80

[W]eareabletonarrowthescopeofdebateatthisstageoftheinquirytowhatappearstobetheonedecisivequestion:thatis,ifitisestablishedthatAlescoNZdidnot incureithera legal liabilitytopay interestoranyeconomiccostontheloan,diditsuseofthefinancialarrangementsrulesandG22toclaimincometaxdeductionsforexpenditureincurredfalloutsideParliament’scontemplationwhen

78 AlescoNewZealandLtdvCommissionerofInlandRevenue[2013]NZCA40,[2013]2NZLR175.79 AninstrumentissuedbytheCommissionertoprovideamethodforassessingincomeandcostson

debtinstruments.80 At[56](referencesomitted).


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enactingtherules?Or,expressedslightlydifferently,didAlescoNZobtainataxadvantagewithoutbearingtheinterestexpensewhichParliamentintendedtobesuffered in order to fall within the deductibility provisions? Or, expresseddifferentlyagain,shouldtheanti‐avoidanceprovisionsbeappliedinawaywhichignores the economic reality of theOCNs as contemplated by the deductibilityprovisionsandG22?

Inapplyingtheparliamentarycontemplationtest,theCourtcommented:81

[71] In our judgment, the financial arrangements ruleswere intended to giveeffecttotherealityofincomeandexpenditure–thatis,realeconomicbenefitsandcosts.Theyweredesignedtorecognisetheeconomiceffectofatransaction,notitslegaloraccountingformortreatment.Thequestioniswhetherthetaxpayerhas‘trulyincurredthecostasintendedbyParliament’.Thisconstructionisreinforcedbytherelevantaddition,inthreecriticalprovisions,oftheword‘incurred’…

[72] ThesefeaturessuggestthatParliamentdidnotintendthatataxpayerwouldbe entitled to use the financial arrangements rules as a basis for claimingdeductionsforinterestforwhichthetaxpayerwasnotliableordidnotpay.Theruleswereintendedtooperateasanetregime–thatistobringtotaxtheamountyielded after deducting the entire economic cost from a taxpayer’s entireeconomicbenefit.Intheabsenceofaliabilityataxpayerclaimingthebenefitofadeduction for interest payments would be purporting to incur that liabilitywithout suffering the economic burden. We are satisfied that the intendedpurviewoftherulesistoexcludenotionaltransactions.

TheCourtconcludedonthisaspectofthecaseinthisway:

[110]MrMcKay[whowascounselforthetaxpayer]submitsthatAlescoNZsimplychose the OCN structure as one among a range of means when carrying outeconomically rational transactions. The company was seeking to promote thegenuine commercial goal of funding the acquisition of two businesses. In thiscontextitwasfreetostructurethetransactionstoitsbesttaxadvantage.AndtheevidenceshowsthatthetaxationbenefitswereprimarilyAustralianincharacter.That is because a deduction would have been available for Alesco NZ in NewZealandwhether thecompanychoseto fundtheacquisitionsbywayof issuingnotesorbyincurringinterestbearingdebt.

[111]Mr McKay says that Alesco NZ’s choice of the OCNs had an underlyingcommercialrationale.Thecompanyadoptedthisstructureasamechanismtofundexisting financial obligations. This feature contrasts with other tax avoidancecaseswhere the transactionswouldnothavebeenentered intobut for the taxbenefits to be achieved. Alesco NZ’s acquisitions were not driven by taxconsiderations. The OCNs were an intermediate step along a pre‐ordainedcommercialpath.

[112]However,thisdistinctivefactordoesnotprotectAlescoNZ.Thequestioniswhethertheparticulararrangement,regardlessofwhetheritwastheoriginatingor intermediate step, had the purpose or effect of tax avoidance. A structurewherebytheparentprovidedfundingtoitssubsidiaryof$78mfor10yearsonaninterestfreebasis,inexchangeforthesubsidiaryissuingtoitoptionalconvertible

81 Referencesomitted.


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notes,cannotpossiblyhavebeenchosenforapredominantlycommercialpurpose.MrMcKayhasnotidentifiedone,andnorcouldhe.

[113]Thereisonlyoneavailableinference:AlescoNZadoptedtheOCNssolelyinpursuit of the goal of tax avoidance, to obtain a taxation benefit whereby theadvantage of interest deductionswas totally disproportionate to the economicburden. The benefit did not naturally attach to or was not subordinate orsubsidiarytoanidentifiableconcurrentcommercialpurposeoreffect.Norwasthebenefitmerelyincidentaltoanunderlyingcommercialpurposeoreffect; itwastheonly identifiablepurpose andeffectof adopting theOCN structure.Wearesatisfiedthat,butforthatbenefit,theOCNstructurewouldnothavebeenchosen.

XIII ANOTHERAPPROACH

Critical to theapproachestakeninthecasestodatehasbeentheunderstandingthattheGAARoperatestoavoidtaxarrangementswhich,butfortheinvocationoftheGAAR,wouldbeeffective.ThetwilightzonetowhichIhavereferred82ispremisedonthisunderstanding.

Asnotedabove,83inBenNevistheChiefJusticeandAndersonJwerereluctanttoacceptthatthereisatwilightzoneofthekindpostulated:84

[2] Wewrite separately to express reservations on aspects of the reasoningadoptedbyTipping,McGrathandGaultJJ,notessentialtotheirconclusionsontheapplicationofsBG1andtheconsequences.WedifferfromtheminbeingoftheviewthatthespecificstatutoryallowancesundertheIncomeTaxActarenotinpotentialconflictwiththegeneralanti‐avoidanceprovisionandthatthetwodonot need reconciliation. Rather, both are to be purposively and contextuallyinterpreted….IftheuseofaspecificprovisionfallsoutsideitsintendedscopeintheschemeoftheAct,theuseisnotauthorisedwithinthemeaningofthespecificprovision.…Onthisview,wedonotthinkthattherearestarkdifferencesbetweenthegeneralapproachtostatutoryinterpretationofspecifictaxprovisionsinNewZealandandintheUnitedKingdom…

…

[4] Inafiscalstatutethetermsandconceptsusedmay,dependingonpurposeandcontext,beusedinabusinessoraccountingsense.Itwouldbewrongtostartwith any preconception that ‘ordinary meaning’ or ‘legal meaning’ is to bepreferredtothemeaningatermhasinbusinessoraccounting.Similarly,wherethesubstanceofanarrangementneedstobegaugedinapplicationoftheprovisionofataxstatute,apurposiveconstructionoftheprovisionmayindicatethatitislegalsubstancewhichisinissueoritmayindicatethatthestatuteisconcernedwithbusinesssubstance.Theprovisionsofataxstatuteapplytomanydifferent

82 PartII,textnearfootnote10.83 InPartII,textnearfootnotes11and12.84 BenNevis,aboven10(referencesomitted).Thequotedtextastothe‘criticalquestion’in[5]ofthe

passagereproducedhereisfromBarclaysMercantileBusinessFinanceLtdvMawson[2005]1AC684at[32]perLordNicholls;whiletheRamsaydecisionreferredtointhesameparagraphisWTRamsayLtdvInlandRevenueCommissioners[1979]1WLR974,975(CA),discussedbyLordTempleman(seePartVIIIabove,textnearfootnote57).


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financial structures. It may use, according to the context, legal, commercial oraccountingterminology…

[5] Themeaningofanytermusedbythestatuteinaparticularprovisionmustbecontextuallyaccurate.Wedonotthereforeacceptthatwhenconsideringtheapplication of a specific tax provision, and before considering the question ofavoidance, the Court is concerned primarily with the legal structures andobligationscreatedbytheparties,andnotwiththeeconomicsubstanceofwhattheydo.Itdependsonthecontext.Thecriticalquestioniswhether‘therelevantprovisionofthestatute,uponitstrueconstruction,appliestothefactsasfound’.Those factsmustbeviewed ‘realistically’because,asLordWilberforceput it inRamsay,taxis‘createdtooperateintherealworld,notthatofmake‐believe’…

[6] Thetaxpayersherehadclaimedallowancesinrespectofamortisationofalicencefeeforuseof landforforestrypurposesandinrespectofpremiumsforinsuranceagainsttheriskthattheforestwouldnotyieldaspecifiedreturn.Itisnot necessary in the present case to determine whether these claims wereproperlymadeunderthespecificprovisionsoftheIncomeTaxAct…

Whatisproposedlookslikethefiscalnullityapproach,albeitonewhichisGAAR‐enhanced.IhavesetoutwhatwassaidbecauseIsuspectthatitreflecteddiscomfortonthepartofthejudges concerned with the parliamentary contemplation test. That test, however, wasadoptedinthemajorityjudgmentinBenNevisandintheunanimousjudgmentinPennyandHoopervCommissionerofInlandRevenue.

XIV AFINALWORD–FORNOW

As I have endeavoured to explain, the parliamentary contemplation test was largelypremisedonthejudgmentofLordTemplemaninChallenge.Soitisnotdevoidofsupportintheearlierauthorities.Itenablesthecourtstograppledirectlywithwhatmostwouldseeasobjectionableabouttaxavoidance.Thatitisnotobviouslyreconcilablewithconventionalschemeandpurposeinterpretationisafunctionoftheview–mytwilightzoneview–thattherelationshipbetweentheGAARandrestofthetaxsystemraisesissuesofinterpretationandapplicationwhicharesuigeneris.Perhapsmostsignificantly,itprovidesareasonablystraight‐forwardapproachtothedeterminationoftaxdisputes.


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REFERENCES

A CasesAccentManagementLtdvCommissionerofInlandRevenue(2005)22NZTC19,027(HC)AlescoNewZealandLtdvCommissionerofInlandRevenue[2013]NZCA40,[2013]2NZLR175BarclaysMercantileBusinessFinanceLtdvMawson[2005]1AC684BenNevisForestryVenturesLtdvCommissionerofInlandRevenue[2008]NZSC115,[2009]2NZLR

289BNZInvestmentsLtdvCommissionerofInlandRevenue[2007]NZCA356,[2008]1NZLR598BNZInvestmentsLtdvTheCommissionerofInlandRevenue(2009)24NZTC23,582(HC)CecilBrosPtyLtdvFederalCommissionerofTaxation(1964)111CLR430at438ChallengeCorporationLtdvCommissionerofInlandRevenue[1986]2NZLR513(CA)CommissionerofInlandRevenuevAucklandHarbourBoard[2001]UKPC1,[2001]3NZLR289CommissionerofInlandRevenuevBNZInvestmentsLtd[2002]1NZLR450(CA)CommissionerofInlandRevenuevGerard[1974]2NZLR279(CA)CommissionerofInlandRevenuevRedcliffeForestryVentureLtd[2012]NZSC94,[2013]1NZLR804ElmigervCommissionerofInlandRevenue[1966]NZLR683(SC)ElmigervCommissionerofInlandRevenue[1967]NZLR161(CA)EuropaOil(NZ)LtdvCommissionerofInlandRevenue[1976]1NZLR546(PC)LewisvCommissionerofInlandRevenue[1965]NZLR634(SC)ManginvCommissionerofInlandRevenue[1971]NZLR591(PC)NewtonvFederalCommissionerofTaxation[1958]AC450(PC)PeatevTheCommissionerofTaxationoftheCommonwealthofAustralia(1962)111CLR443PennyandHoopervCommissionerofInlandRevenue[2011]NZSC95,[2012]1NZLR433PetersonvCommissionerofInlandRevenue[2005]UKPC5,[2006]3NZLR433TimaruHeraldCoLtdvCommissionerofTaxes[1938]NZLR978(CA)WPKeigheryPtyLtdvFederalCommissionerofTaxation(1957)100CLR66WTRamsayLtdvInlandRevenueCommissioners[1979]1WLR974,975(CA)

B LegislationIncomeTaxandSocialServicesContributionAssessmentAct1936–1950(Cth)LandandIncomeTaxAmendmentAct(No2)1968(NZ)LandandIncomeTaxAmendmentAct(No2)1974(NZ)

C OtherBryanAGarner(ed)Black’sLawDictionary(9thed,StPaul(MN),2009)at752


27

TAXANDTIMETRAVEL:LOOKINGBACKANDLOOKINGFORWARD–ATAXADMINISTRATOR’SPERSPECTIVE

Paper accompanying plenary address delivered at ATTA 2016*

JANFARRELL

TimepresentandtimepastArebothperhapspresentintimefuture,Andtimefuturecontainedintimepast.1

I INTRODUCTION

Historiansoftenrefertothemistakesofthepastaslessonsforfutureactions.Thispaperaddresses somesignificanteventsofpast taxadministrationsandwhatwemightexpectlookingforward.

More than ever, tax regulators are being called to account to demonstrate a robuststewardship of their tax systems and to ensure that revenue collection is broadlycommensuratewitheconomicactivityandheadlineratesoftax.Politicalexuberanceagainstmultinationalsinaworldwheresomeareperceivedasnotpayingafairandcommensurateshareofcountrytaxhastakencontrolofmanypolicyagendas.Understandingthedriversandextentofsuchemergingpracticeswillnotonlyassistpresentstrategicgoals,itwillshapethefuturetaxsystem.Itfollowsthatdecisionsmadebytaxadministratorsoninterpretationissuesorconcessionsinareasofthetaxlaw,orinrelationtothehandlingoftaxrisks,candirectlyaffectfederaltaxreceiptswellintothenextdecade.

Thisarticleaddressespastevents,presentchallengesandwhatthefuturemightbringfromataxadministrationperspective.

II ROLEOFAREGULATORLIKETHEAUSTRALIANTAXATIONOFFICE(ATO)

Theultimatelitmustestofwhetherideasworkedwelliswhethertheystoodthetestoftimebyservinggovernmentandthecommunityasenvisaged.Changesinthelawthatarejudgedharshlyatthetimemay,withthebenefitofhindsight,beunderstoodasagoodsolutionthatwasjusttoounpalatableforimmediateimplementation.Achangeinattitudes,sometimefurtherdownthetrack,mightallowingtheconcepttobe(re)introduced.Historyrecallsthe

* The views expressed are a reflection of my experience working in many areas in the AustralianTaxationOffice(ATO)which includedtheroleofDeputyCommissioner,CaseLeader forthePublicGroups and International Business Line. They are personal views based onmy experience in taxadministration.

1 TSEliot.TheFourQuartets.FromtheopeninglinesofQuartetNo1:BurntNorton.Collectedpoems1909–35(1936)Faber&Faber.


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attempt,backinthemid‐1980s,toproceedwithasensibletaxproposalforanAustraliaCard,whereeverycitizenhadauniqueidentifierknowntoallgovernmentdepartments.2Thiswasanideathecommunitywasnotreadytoembrace,andtaxfilenumberswontheday;butwemayyetseeauniqueidentifierappliedforwidersocialsecuritypurposesinthefuture.MorerecentlyinAustraliawesawpolarisedopinionsaboutnewmeasuresforaminingresourcerenttaxandacarbontax.Theverysuggestionofneworincreasedtaxesisenoughtoputpoliticians(allaroundtheworld)inhotwater.3Thenotionof‘formularyapportionment’ofglobal income to ensure countries received their fair share of tax from cross‐bordertransactionswasalsokickedaroundforalongtimeandisyetanotherconceptthatdidn’tfindcommonappeal.

Thestrategicroleofgovernmentrevenueagenciesisultimatelytoprovideaservicetothepublic by effectivelymanaging and shaping the Commonwealth tax and superannuationsystems,tobenefitallAustralians–soitisavaluedpartofthecommunityfabric.4TheATOmustbe seen to act in a consistent and impartialmanner andbe subject to a balanceofinternalgovernanceandexternaloversighttoanswerquestionsonourtransparencyandaccountabilityformanagementofthetaxsystem.

The record of the ATO on its primary function as the government’s principal revenuecollectionagencystands for itself.Back in1975–76 then‐CommissionerSirEdwardCain,CBE,reportednetrevenuecollectionsof$13.47b.5Bycontrast,CommissionerChrisJordan,AO,reportedinthe2014–15AnnualReporttotalcollectionsof$336.8b–analmost25‐foldincrease,albeitonanarrowertaxbase,andjustaheadofnominalGDPgrowthoverthesameperiod,whichhada20‐fold increase.6Staffnumbersalsosteadily increasedover time toadminister a changedmix of taxes; from the 1970s base of around 11,800 overall staffoperating largely under state‐based Deputy Commissioners to around 21,300 nationallybasedstaff,overmoredispersedlocations.

2 TheAustraliaCardwasproposedin1986asanationalidentitycard.Itrespondedtoconcernsabout

wide scale tax evasion, but did not gain popular public support because of privacy concerns. ThelegislationtointroducethecardhadalreadybeenrejectedtwiceinthehostileSenateanditprovidedthetriggerforthedoubledissolutionofbothhouses,whichledtothe1987electioninJuly,andalaterdecisionofthenewGovernmentwhichwasnottoproceedwiththeAustraliaCard.

3 InanacceptancespeechfortheGrandOldParty(GOP)nominationinNewOrleansattheRepublicanNationalConventionin1988,thethenpresidentialcandidateGeorgeHWBushfamouslysaid‘Readmylips:nonewtaxes’.Thisapparentcommitmenttovoterswasbrokeninabudgetagreementin1990whendefencespendingescalatedandthenationalbudgetdeficitrosesotaxeswereincreasedinsomeareas.ThecurrentPresidentelecthasadifferentagendaforreducedtaxratesthatseemstohavefoundcommonappealforcompanies.

4 Thisalignstoavisiontobealeadingtaxadministrationknownforitscontemporaryservice,expertiseand integrity. Back in the early 1990s, the Commissioner of Taxation, Annual Report 1991–92,CommissionerOverviewat3,publishedundertheadministrationofthenCommissionerTPBoucher,hadthethemeofworking‘TowardsaWorldClassTaxAdministration’,whichremarkedonnewworkunderwaytorevitalise‘Australiantaxadministration’.

5 TheCommissionerofTaxation,AnnualReport1975–76,at18liststotalrevenueof$13.47b.Thetaxbase at that time included estate duty, gift duty, sales tax, aswell as levies for tobacco,wool, thestevedoringindustryandfruitcanning.TheHealthInsuranceLevyhadonlyjustbeenintroducedbyIncomeTaxAssessmentAct1976atabasisrateof2.5%forresidentindividualssoforthe1976–77yearthreequartersofthebasicrateapplied,namely,1.875%.Thegeneralcompanytaxratewas42.5%.

6 Nominal gross domestic product (GDP) in 1975–76 was$83,150m and in 2014–15 it was$1,609,992m, amounting to almost a twenty‐fold increase. This assumes that taxation revenue isprincipallydrivenbymovementsinnominalincomeandatanaggregatelevelnominalGDP(I)isaproxyfornationalincome.


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Therehasbeeninterestfromtimetotimeinestimatingtrendsin‘taxgaps’7forthereasonthat the tax gap represents one high‐levelmacro indicator ofwhat has been lost.Whilegenerallysound,theseindicatorssufferfromsomeinherentdifficulties,giventhattheyarebasedonestimates,assumptionsanduncertainties.Theinitialtaxgapmeasuresmaynotbeentirelyrobustbenchmarks,especiallyastherangeofaccessibledatasourcesimprovestoreduceuncertainty(forexamplebydeterminingpreciselevelsofnon‐detectionoftaxrisks)and as assumptions are discarded and replacedbyhard evidence.Notwithstanding suchimprovedknowledgeaboutthecausesofthecompliancegap,theabsoluteestimatesmayincreaseovertimeifittranspiresthatthebasicapproachhasaconservativebias.Whatallthismeansisthatweshouldexpectinthefuturetoimproveonpastefforts,buttheoutcomeofimprovementsmaynotalwaysbemeasurednumerically.

A blueprint for amodern tax administration to be efficient and effective suggests somedesirable features including adequate (operational) autonomy and adequate resourcestogetherwithastablelegalframework(forassessmentcollectionandenforcement)sothatitcanadequatelyrespondtochangingcircumstancesbutisalsoaccountableforitsactionsandsubjecttocontrolandassessment.8

FromtimetotimetheATOhasbeengivenvariousotherrolesoutsidetraditionalrevenuecollection,andithasnecessarilyshifteditsfocustoaugmentwelfaredeliveryofgovernmentinitiatives;soatvarioustimestheCommissionerofthedayalsohadotherhatstowearastheChildSupportRegistrar,theDevelopmentAllowanceAuthority,and(still)theAustralianBusinessRegistrar.9ManyoftheseinitiativessetnewadministrativechallengesfortheATO.Equally,theyrecognisedtheATOasbeingcapableofimplementationofnewfunctionsthatsupported economic growth or collected payments on behalf of other agencies.Notwithstandingtheireventualcessationortransitionoutoftheagency,theeffecthasbeentoplacegreaterdemandsontheATOworkforce,whichhasevolvedandadaptedtoeachchallenge.

7 Thecompliance‘taxgap’is,broadly,thedifferencebetweentaxesactuallypaidandwhatshouldhavebeenpaidifeveryentityorindividualorremitterwasfullycompliantwiththeirtaxobligations.Therelatedterm‘policygap’referstotaxforegoneduetotaxconcessionsthatarepartofthebodyoflaw(alsocalledtaxexpenditures),especiallythoseprovisionsthatmaybeusedtolowerthetaxleviedormayoperatetoaugmentbaseerosionandprofit‐shiftingtonon‐taxorlow‐taxjurisdictions.

8 European Commission report Fiscal Blueprints – a path to a robust, modern and efficient taxadministration (European Communities 2007) 13–16. Also refer to the OECD report, TaxAdministration2015,ComparativeInformationonOECDandotherAdvancedandEmergingEconomies(August11,2015)23–6.

9 UndertheChildSupportAct1988theCommissionerofTaxationbecameresponsibleforcollectionofchildorspousemaintenancepaymentsdueundertheChildSupportSchemeuntiltenyearslaterwhenitwas sufficiently established tomove out to theDepartment of Family and Community Services.ResponsibilityfortheDevelopmentAllowanceAuthority,establishedin1992,wasalsogiventotheCommissioner (or his delegates) as a statutory office holder responsible for management of taxincentiveallowancesundertheDevelopmentAllowanceAuthorityAct1992forconcessionsthatweredesigned to improve international competitiveness through ‘microeconomic reform’ for genuineprivatesector investment.Therewere two incentiveschemes, thedevelopmentallowanceand theinfrastructureborrowingstaxoffsetscheme.HowevertheinitialincentiveswereterminatedfornewcasesbytheTaxationLawsAmendment(InfrastructureBorrowings)Act1997astheconcessiongaverisetounintendedconsequencesandcostestimates(1993–2003)grewfrom$100mto$1.5b.Lastlythe maintenance responsibility for the Australian Business Register accompanied the AustralianBusinessNumbersingleidentifierthatgovernmentintroducedon1July1999aspartofGovernmentmeasuresforanewtaxsystemwheresome2.8mrequestsforregistrationwerereceivedinthattaxyear.


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ThemanagementofsuperannuationbeenasignificantconcernfortheATOalongwithitspartneragencies fromthe firstappearanceofsuperannuation funds in the tax law intheearly1960s.10Then,itconsistedoffairlyrudimentaryretirementvehicles.Themoremodernreformshavereactedtostudiesonouragingpopulationandassociatedwelfareburden.Thesuperannuationindustrycontrolsasignificantportionofthenation’sinvestment,11andistoobigtoignore.Complexityhasemergedthroughawideningofpolicyandtheimpositionof compulsory employer superannuation support for employees (in the superannuationguaranteeregime)andthecurrentwavesofemployees’ retirementsavingsheld inSMSFvehicles.Thedemandsongovernment,toencouragepeopletoself‐fundfortheirretirementandtodecreaserelianceonthepublicpurse,arenotlikelytowaneintothenearfuture,giventhebipartisandesiretoreducepublicdebt.

III TAXADMINISTRATIONTHENANDNOW

The institutionof theATO isnow105yearsold12 and Idon’tplan to lookback that far,althoughthishistorydoespresenttheseedsofmanypresentinitiatives,andnodoubtsomefutureones.

A ATOEmployeeExperience

IcommencedemploymentintheATOinthesomewhatmyopicdaysoffullATOassessment,when theATOmanuallychecked informationsupplied indetailedpaper taxreturns.Theworkloads consistedof high‐volumeprocessingand ‘technical scrutiny’ of claims againsttaxableincome.Wecodedthereturnsusingalphacodesforalimitedrangeofadjustments,and thiswas sent to data entry pointswhich producedmachine‐generated advice notesissuingtotaxpayerswiththeirnoticesofassessment.Apartfromtheauditsection,wehadverylimitedpersonalcontactwithtaxpayers,ateitherassessmentorreviewstage,unlessitwasour role to reviewassessingactionafter lodgmentof anobjection inorder to settleclaims,basedonanewopinionoftheadequacyofevidence.

ThelexiconweusedlastcenturyincludedATObuzzwordslike ‘ChiefAssessordirectives’and‘CanberraIncomeTaxCircularMemorandums’(CITCM)–aformofinternallybindingruling–anditwasanagewhentaxenquirycountersdistributedverbaltaxadvice.

10 SeethemajorityjudgmentofStoneandAllsopJJ inCameronBraePtyLtdvFCT,2007ATC4936at

4945,[2007]FCAFC135wherethelegislativehistoryofsuperannuation(inthecontextofs82AAE)isrecounted,notingthefirstappearanceofsuperannuationasfollows:‘[29]Thefirstdefinitionofthephrase‘superannuationfund’inthetaxlegislationappearedinthe1961Act by the insertion of s 121B into the Tax Act…[and]…was variously amended.’ The IncomeTaxAssessmentAct1936(Cth)introducedthepresents6(1)definitionofasuperannuationfundtomean(inpart)‘(a)aschemeforthepaymentofsuperannuationbenefits’.

11 AustralianBureauofStatistics,ManagedFunds,Australia,September2015,reportedthatthemanagedfundsindustryhad$2,590.6bundermanagement.

12 TheFirstAnnualReportwasbytheCommissionerofLandTaxin1912,relatingtotheoperationsoftheFederalLandTaxDepartmentinthefirstyearofexistence(1910–11)andprovidedtoParliamentbythethenTreasureroftheCommonwealth,TheRightHonorableAndrewFisher.Ofnote,undertheheading‘EvasionoftheAct’,at11,itisstated:‘Itmaybefairlystatedthat,sofarastheinvestigationsoftheDepartmenthaveyetdisclosed,thecasesofdeliberatebreachorevasionarefewinnumber.’Non‐lodgements,debtcollectionactivity,objectionsandappealsallgetcoverage.


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Weworkedinlarge,breezy,open‐planofficeswithoutairconditioningorpartitions,withonegrouptelephoneforhalfthefloorareaandaworkingdaytabulatedbytimeclock(BundyCards)foreachemployee,andarattlyteatrolleytoheraldthemorningandafternoonworkbreaks.Therewasnocapitalgainstax,nogoodsandservicestax,nofringebenefitstax,nocomprehensivethincapitalisationrulesandnotaxationoffinancialinstrumentsregimeoratax consolidation regime, so the interaction problems we now experience in the taxlegislationwerelimited.Infact,alotoftimewasspentondefiningandrefiningthebasicsoftaxlaw–theambitofincome,deductions,rebatesandconcessions.Thosewerethedaysoftargets to achieve daily output tallies, with limited time for technical scrutiny andwithmachine‐like turnoverof file stockof salaryandwage,partnership, trust, and toa lesserextentcompanyandsuperannuationreturns.

The ATO has more recently focused on the employee experience and capabilityimprovementsthroughknowledgesharing,updatingworkplaceinfrastructuretocreateanagileworkenvironmentofvirtualdesktopplatforms.Thisisdesignedtocreateasmarterandadaptableworkforce.Thepaceof technology innovationhasallowedgovernmentanenhancedabilitytousetechnologytodriveefficiencies,aswemovedawayfromtypingpoolsof dedicated people on typewriters and towards a computer on every desk. Twenty‐fiveyearsagoour‘aimwasthat...30percentofstaffwouldhaveaccesstobusinesstoolstomeettheneedsoftheofficeofthefuture.’13ThepresentATOExecutivemightjustifiablybeabletotrumpetthattheyhavewellsurpassedthatobjective.

B AttitudestoTaxAdministration

ATO attitudes to administration have certainly evolved over time – from early times of‘protectingtherevenue’,toamoreefficientandeffectiveoperationthatensurestaxpayers’willingparticipationinthetaxsystemthroughpaymentoftherightamountoftaxattherighttime,therebybuildingcommunityconfidence.14

WiththeintroductionofTheFreedomofInformationAct1982(Cth),agreaterenvironmentof openness came to Australian Public Service agencies, and the ATO published manyinternalguidancenotestomakethemgenerallyavailable,aswellasmakingothermaterialgatheredunderitsformalpowersavailableonrequest.Almostadecadeearlier,inthemid‐1970s, the Commissioner’s Annual Report had its own version of a release of (internal)informationdetailingthepeoplewhohadan‘understatementoftaxableincome’duringtheyear, including names, suburb of residential address (or town) of individuals andoccupation/business of all individuals and companies and the amount of thatunderstatement,togetherwiththeamountofpenaltyimposed,fortherelevantyears.15

Ifasignofamaturetaxsystemisthesophisticationofitsriskandcollectionmechanisms,then it might well be expected that both mechanisms will continue to feature on theimprovementcontinuumintothefuture.

Risk detectionmechanisms that were used at the turn of this century in Australian taxadministration relied heavily on data matching, with intelligence from both audits and

13 CommissionerofTaxation,AnnualReport1991–92,138,‘Goal:StafffindingtheATOasatisfyingplacetowork:BusinessToolsObjective’.

14 ATO Program Blue Print Summary 2015 <http://reinventing.ato.gov.au/program‐blueprint‐summary>.

15 SeeCommissionerofTaxation,AnnualReportsof1974–75and1975–76: Schedule1 ‘BreachesandEvasions’.


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provisionofadvice,aswellascommunitycontacts,researchinitiativesandanewlyformedAnalyticsProject.16TheATO’srisksystemsweresomewhatrudimentaryinthe1980s,justat the time foreign banks were given licences to operate in Australia. Rather thanmanagement‐initiatedaudits,specialistin‐houseeconomistswereemployedtolookatthetax performance of various sub‐segments of large and medium companies operating inAustralia,andthosethatdisplayedsignsoflowornoprofitmarginscameontotheATO’sradar.AlsoofinteresttotheATOwereinnovativefinancial instruments,thesubstanceofwhichwerenotwellunderstoodintheATOatthattime.AnattempttoaccessinformationnotfreelymadeavailabletotheATOonparticularfinancialarrangementswasdiscussedinanoften‐citedcourtcaseinwhichtheATOauditorshadcarriedoutan‘unannouncedvisit’on Citibank’s premises to seek information using the Commissioner’s general accesspower.17Thecourtsproperlypointedouttheneedfordueprocessinseekingbroadaccessandallowingclaimsforlegalprofessionalprivilegetobemade.

The ATO does indeed acknowledge the right of taxpayers to make claims for legalprofessionalprivilege,andalsoallowsanopportunitytomakeaclaimfortheaccountants’concession.18Occasionally, inmyexperience,wehavefoundthatbroadclaimstoexcludeaccess to tranchesofdocumentson thebasisofallegedprivilegearecapableofstoppingdifficultaudits in their tracks,and theATO isatpains tomakesure thatsuchclaimsareassertedonlywheretheyproperlyapply.IntheinstructivewordsofLordJusticeHamilton:

Claimingprivilegeinanaffidavitofdocumentsisnotlikepronouncingaspell,which,onceuttered,makesallthedocumentstaboo.19

IV THEADVENTOFSELF‐ASSESSMENTANDRULINGS

Whatsparkedoneofthemostsignificantchangestotaxadministrationwasundoubtedlytheintroduction of the self‐assessment system on 1 July 1986.20 In this new world of self‐assessment, income tax returns were no longer technically scrutinised by income taxassessors.Rather,taxreturnswereinputdirectlyintothedatawarehouserepositoryandthe ATO shifted emphasis to post‐assessment audit and ‘compliance improvementactivities’.21Developmentofsophisticatedrisksystemsthattappedintoasuiteofmeta‐datato drive compliance planswas inconceivable at that time, aswas the notion of the ATOprovidingelectronicpre‐filledinformationonpersonaltaxreturns.

16 CommissionerofTaxation,AnnualReport2002–03,70–71(MichaelCarmody).17 FCT&OrsvCitibankLtd89ATC4268.18 InNovember1989,theATOgrantedaconcessiontoclientsofprofessionalaccountingadvisorswhich

allowedsuchadvisorstowithhold, intheabsenceofexceptionalcircumstances,certaindocumentsfromtheATO.

19 BirminghamandMidlandMotorOmnibusCompanyLtdvLondonandNorthWesternRailwayCompany[1913]3KB850at859.

20 SeeHouseofRepresentativesHansard,63,TreasurerPaulKeating,2ndreadingofAppropriationBillNo11985–86on20August1985:‘TheGovernmenthasalsoapprovedtheimplementationofasystemof self‐assessment by taxpayers to be introduced from 1 July 1986. Thiswill greatly increase thecapacityoftheTaxOfficetoconcentrateitseffortsonthemainareasofavoidanceandevasionandincreaseefficiencyinprocessingtaxreturns.’

21 AddressbyMichaelD’Ascenzo(thenActingFirstAssistantCommissionerofTaxation)totheNationalConventionoftheTaxationInstituteofAustraliaon9May1993at2.


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The internal review that made traditional assessing production work redundant foundsimplythatchangeswereneededinthefaceofthe:

1. ‘costsassociatedtoassessbusinessandcompanyreturns’;

2. insufficient detection and treatment of general non‐compliance with tax obligations;and

3. ‘lackofjobsatisfactionforstaff’.

Atthetime,variousstakeholderassociationswereinvolvedanditwasheraldedasanewageofconsultationandopennessbytheATO–whichaformerCommissionerreferencedasallowingtheATOtoput ‘pastenmitiesaside’–akintotheBerlinwallcomingdown,andthroughsuchco‐operation,building‘amoderntaxadministration,worldclass.’22

Infactthetaxprofession,inthatdecadeandsince,hasbeenheavilyinvolvedinconsultationon many novel movements in tax legislation stemming from numerous legislativeamendmentscomingfromtheTaxLawImprovementProjectthatintroducedthe1997Actalongwithsomenewmeasures,23and themandatoryRegulation ImpactStatements thatcame into being to estimate impacts of proposals affecting business.24 In the 2000s, theintegrityof the taxsystemwassought tobe improvedbyanewconsolidationsregime,25amongotherchanges,thebiggestbeingtheabolitionofsalestaxandtheintroductionofagoodsandservicestaxonIJuly2000.

Consultation emerged as a key plank in the modus operandi of Treasury, the Board ofTaxationandtheATO.Notwithstandingitsundoubtedbenefits,thegrowthofvariouslevelsofconsultationmayperhapshavebeenover‐enthusiasticallyadoptedintheATO.26ArecentreviewofATO industry, professional and community consultation committeesunder theATO Reinvention banner noted duplication and attendant resourcing issues, and thedecision was made to reduce them from 68 to 8, and reduce the number of internalcommittees from 45 to 22, with special‐purpose and technical forums convened asrequired.27

22

23

24

25

26

27

Ibid. Footnote 10 at 8, citing the (then) Commissioner T B Boucher’s statement to the JointPublicAccountsCommitteeof29May1992.Thenew IncomeTaxAssessmentAct1997waswritten to make the lawmoreunderstandable and principlebased.Alsointhe1990swesawTaxationofFinancialArrangementsConsultationdocument(December1993)followedbyanIssuespaperin1996etc.(untillegislationemerged),theredraftingof theThin Capitalisation provisions in TLAB (No 4) 1997, the introduction ofControlled ForeignCompaniesrules(1990)totaxforeignsourceincomeofAustralianresidentsandextendingPartIVAtoincludewithholdingtaxavoidance(pers177CAinthe1996–97incomeyear).Thisfollowedthegovernment’sRegulationReviewandwaspartof,‘MoreTimeforBusiness’24March1997bytheHonJohnHoward.PervariousNewBusinessTaxSystemBillsin2002.OtherhighlightsincludedtheSimplifiedTaxSystemforsmallbusiness;the,AustralianBusinessNumberbecameoursinglebusinessidentifier;thePAYGIsystemreplacedprovisionaltax,prescribedpayments,companyinstalmentsandwithholdingtax;andlet’snotforgetcompanyheadlinetaxratesplummetedfrom36%to34%in2000–01andthento30%for2001–02.See the Report of the Commissioner of Taxation 2008–09, where the three Cs were embraced –consultation,collaborationandco‐design.GeoffLeeper,thenSecondCommissioner,People,SystemsandServices,AddresstotheNationalTaxPractitionerConference,Sydney,Wednesday,18June2014saidthat‘aconsiderableamountoftimewasinvestedintheoldarrangements,withalmost1,500externalpeopleparticipatingin230meetings


34

While core issues should invariably benefit from consultation, the futuremay not lie incommittee‐driven consultation but in more interactive, real‐time management andintelligencegatheringwherecollectiveknowledgesharingtakesplace.

TheSelf‐AssessmentPriorityTasksProject(1991)maderecommendationsthatalsoledtoanewsystemofbindingpublicrulingsandbindingprivaterulings,alongwithnewsystemsforpenaltyand interest, although the freedomof informationchangeshadstartedoffanearlierinternalrulingsprocess.28

The ATO’s Public Rulings guidance is a key service that publishes ATO technicalinterpretations.ItcameofagewithnotificationsbywayoftheCommonwealthGazette,andapanelofprofessionaltaxexpertsatthereviewandclearancestagetobringincommercialacumen and independent views. The initial, untracked/unnumbered issuance of privatebinding rulings matured considerably after implementation of quality standards andimprovements recommended after several substantial reviews.29 Guidance through theprovisionofATOviewscontinues tobeahallmarkof its service,and itassistsvoluntarycompliance.

V ASSISTANCETOTAXPAYERS,ANDCOMMUNITYEXPECTATIONS

Inourcurrentenvironment, individualtaxpayersenjoythebenefitofpre‐filledelectronictaxreturns,populatedwithfinancialinstitutiondata,dividenddata,employerinformationandotherbenefit informationusingthedownloadablee‐Taxmoduleandthenewerweb‐basedmyTax.TheATOispartofmyGov,whichnowhasmorethan4.3mlinkedclients,asasinglepointofentryforgovernmentservice.TheATOismovingtoafuturethathasadigitalinterface platform, needing very little taxpayer effort to supply information or preparedocumentationinmanycases,especiallyforworkersonalowerincome.

I can recall a time in 2004 when I was responsible for management of the Individualsbusinessline.Anofficeradvisedmehehaddevelopedaninstructionguideforanytaxpayerwhowasinreceiptofaneligibleterminationpaymenttocalculatetheconcessionalandfulltaxoutcome.Ithadmorethan70steps,withallpossiblepermutationscovered.Whilethatwasindeedaverythoroughapproach,Iaskedhimtohaveanothergoatmoresimplifiedinstructionstocoverthebasicsforself‐preparers.

ayearaspartof68ongoingcommittees.Thishasbeensignificantly reduced toeightstewardshipcommitteesplusproject‐likeconsultationforspecificissues.’SeealsosimilarcommentsfromChrisJordan,CommissionerofTaxationinhisaddresstotheATAX11thInternationalTaxAdministrationConference,Sydney,14April2014.NotetheCommissionerofTaxation,AnnualReport2014–15whichrecountsthat68matterswereconsultedonandcompleted,and53matterswereinprogress.

28 AReportonAspectsofIncomeTaxSelf‐AssessmentinAugust2004byTreasuryfurthersuggestedimprovements to theadvice system, tomake itmore responsive including theoptionofadeemednegativerulingforthoseolderthan60days,refrainingfromrulingon issuesnotdirectlyraised inprivatebindingruling(PBR)applicationsandshorterperiodsofreview.

29 For example, The Australian National Audit Office (ANAO) performance audit of July 2001, TheAustralianTaxationOffice’sAdministrationofTaxationRulings,AuditReportNo.3of2001–2002andthesubsequentANAOAdministrationofTaxationRulings–FollowupAudit,AuditReportNo.7of2004–05,TheAustralianTreasuryReportonAspectsofIncomeTaxSelf‐Assessment,August2004,7–25andthemorelimitedInspector‐GeneralofTaxation(IGT)ReviewoftheTaxationOffice’sadministrationofpublicbindingadviceinareporttotheAssistantTreasurerof7April2009;andanIGTreport,Areviewofpotentialrevenuebiasinprivatebindingrulingsreleasedon25February2008.


35

One of the ATO’s key performance indicators was the time‐cost index for business andsuperannuationfundstoprepareandcompletekeytaxforms.30TheATOstartedverylimitedqualitativeworkonthecostsofcomplianceforsmallbusinessbackin1991byfocusingonrecord‐keeping and reporting requirements. Various trends were identified, frominadequatesoftwareavailabilitytotheburdensofsalestax.Thiswasnotunusual,sincethesales tax rules had developed from a single rate tax with limited exemptions (whenintroducedin1930)toamuchlargersuiteofassessmentActsandexemptions.31Then,inSeptemberandOctober1995,undertheComplianceImprovementbannerinconjunctionwiththeRevenueAnalysisbranch,theATOconductedwider,butlimitedstudies,32whichrevealedthattheaveragetimespentbybusinesses(surveyed)ontaxactivitiespermonthwas 18–23 hours.33 However, the finding I most liked was that ‘on average, businessesconsiderthattheywouldsave94hoursperannumiffederaltaxationwereabolished’,andifallowed‘faircompensation’fortheircompliancecosts,wouldclaimapproximately$3,000(outliersexcluded).Yetontheupside,‘approximatelyhalftherespondentsagreedthattheirrequirementsofthefederaltaxsystemimprovedtherecordkeepingoftheirbusiness.’

TheTaxpayers’ChartermarkedaserviceshiftforATOoperationsonitscommencementon1July1997,asitappliedtoalltaxpayers’interactionswiththeATOandintroducedasetofservicestandardsagainstwhichadministrativeresponseswouldbemeasured.34Thegenesisof theCharter followedaJointPublicAccountsCommitteerecommendationin1993,andwas in line with initiatives of some overseas tax jurisdictions in explicitly documentingexpectationsandcommitmentsas tohowrevenueauthoritieswould treat taxpayersandvice versa. The initiative also coincided with the Howard Government’s statement thatService Charterswere to apply to all government agencies that provided services to thepublic‘tocreateamoreopenandresponsiveservicecultureinthepublicsector’.35TheATOwasnowmakinganumberofbenchmarkcommitmentstomaintainprofessionalexcellence,andtheseweretrackedthroughservicestandardsthathavebeencontinuouslymaintainedingovernancereportsagainstkeyperformancemeasures.LevelsofperformanceandATOprocesses are aspects of tax administration that remain evergreen and will no doubtcontinue to be reviewed, noting that the Inspector‐General of Taxation’s and the workprogramsoftheAustralianNationalAuditOffice(ANAO)featurestronglyinperformancereviewsoftheATO.

In the same era (late December 1996) the ATO began measuring general communityperceptionsofitsperformancefromindividualandbusinesstaxpayerswhohadhadcontact

30 TreasuryPortfolioBudgetStatements2015–16:BudgetrelatedpaperNo116at203.31 ThejointstudywiththeDepartmentofIndustry,TechnologyandCommerceandresearchedbyDrIan

Wallschutzky,AssociateProfessor inTaxation,University ofNewcastle, reviewedover12months,twelvesmallbusinesses,bothnewandwellestablished,inQld,VictoriaandNSW.

32 ChrisEvans,KatherineRitchie,BinhTran‐NamandMichaelWalpole,UNSW,27November1995,CostsofCompliance:AnInterimReport.

33 BrianGibson&IanWallschutzky,DepartmentofCommerce,UniversityofNewcastleinapaperforaTax Compliance Research Conference in Canberra in December 1993,ACase StudyExplorationofTaxation Compliance Issues in Small Business. In the study conducted from interviews of 123participants in the 12months between November 1991 and 1992, time spent on tax complianceactivitieshadincreasedfromthe12‐houraveragepermonthandtheimpactwasassessedatthattimeas‘either$7,425or$16,335dependingonhowopportunitycostwasassessed.’

34 TheJointCommitteeofPublicAccountsrecommendedintheirreportnumber326ofNovember1993,thattheATOadoptaTaxpayersChartertoaddressaperceivedimbalanceoftheCommissioner’swidepowersforincometaxcollectionagainsttherightsoftaxpayers.

35 TheHonJohnHowardMP,‘MoreTimeforBusiness,’24March1997,56.


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withtheATO,toobtainviewsaboutitsprofessionalisminrespectofareascoveredbytheCharter.36Theoutcomewasgenerallypositiveoncompetenceandintegrity,butworkonATOresponsivenessandtaxpayersrightscontinued.

CurrentsurveysrevealpositivefeedbackfromthecommunityontheATO’s‘perceptionoffairness’ surveys37 concerning individuals, and earlier resolution of tax disputes asalternatives to litigationwasalsoperceivedwell.Technologyhasallowed feedback tobeinteractiveandonline,andforanATOpresenceonFacebook/Twitter/YouTube–somethingthatcouldnothavebeendeliveredinthepast.38Inaddition,theSmallBusinessAssistwebpageprovidesreal‐timeguidanceandsupportfromanATOofficeronparticulartopics,andtheLet’sTalkForum(discussionboard)hasinteractiveconversationswithtaxagentswithtopicslikethe‘digitalbydefaultinitiative’.Theseavenuesforpositiveengagementwiththecommunityfosterswillingparticipation,inwayswewouldnothaveenvisagedintimespast.TheATOworkcoversbothinternalandexternalfacingimprovements.

VI STRUCTUREANDMODERNISATIONOFTHEATO

Our brief history of the ATO records that one of the most significant decisions was torevitaliseourcomputercapacity,tointegrateitintoouractivitiesforbettercomplianceandserviceinitiativesandtomodernisetheATO.39Typingpoolswhereofficersoncetookhand‐writtennotestobeconvertedtotypewereclosed,andworkprocesseswereredesigned.Totransition from a processing organisation to a service‐based organisation, we attendedteam‐buildingworkshopsrunin‐housebyseniortaxofficers,witharangeofvisitortrainers,fromallwalksoflife,whodemonstratedabroadrangeofskillsincludingethics,tacticsandhuman resources management. This program, funded through the Public ServicesCommission, was a new style of manager training looking at the ‘psychological andsociologicalproblems’thatmaybeexperiencedbyATOstaff,whichwasn’tfoundinanyrulebookproducedatthetime.40Inaddition,acorecompetencymodelwasdevelopedtomatch36 IndependentconsultantssuchasMillwardBrownAustralia,wereengagedbytheATOto initiatea

process to obtain service feedback, as a way to gauge effectiveness. Around 2,000 people wererandomlycontactedbytelephonewithcorequestions(from1996)andtheninDecember2000asixmonthlyProfessionalismsurveywasconductedusing9characteristicsexpecting toachievea70%satisfactionrating.RegularfeedbackisnowafeatureofthemodernATO.

37 MillwardBrownAustraliaconsultancy.38 Facebook – ATO page posts educational notes for different taxpayer communities to increase

awareness.Forexample,deadlinestolodgereturns,tipsforsmallbusinesses–itallowsthepublictocommentonthepostsaswell;YouTube–featuresvideosonvarioustaxandsupertopicsincludingranging from presentations by ATO officers on proposed legislative changes affecting foreigninvestors, through to basic educational videos on basic tax obligations targeting recentmigrants.LinkedIn–promotesvisibilityoftheATOtothelocalandglobalprofessionalworkingcommunity.YoucanfollowtheATOonthissitetoreceivecontinuallatestupdates/postsandalsobeconnectedtothosethatareworkingintheorganisation.

39 Edmonds,Leigh,WorkingforallAustralians1910–2010:AbriefhistoryoftheAustralianTaxationOfficeATO Canberra November 2010 at 196–206. The Modernisation Program is described in theCommissionerofTaxation,AnnualReport1993–94,83–9,tohavereceivedin‐principleapprovalfromGovernmentin1987for‘improvingourservicestothecommunityandmeetingthechallengesofourchangingenvironmenttowardtheyear2000.’

40 TheManagingintheNinetiesProgram(MIN)washeavyonpracticaltrainingandexperientiallearningand‘lightontheory’andresonatedwellwithmanypeoplewhowereenrolledintotheProgram.Itsaimwastohaveitrolledoutto17offices:(71stReport)CommissionerofTaxation,AnnualReport1991–92,156.


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employeeskill setswithATOwork types,and theATOsupportedaBachelorofTaxationdegreethroughtheUniversityofNSW(ATAX)forundergraduatedegreesandfrom1993forpostgraduatecourses.41

Inthe1990stheATObecameanewnationallyrunbusinessorganisationthattookoverfromthe old state‐run branch offices. I foundmyself as a national litigation appealsmanagerfielding calls on cases around the country, which was quite a learning curve. Tax LawServiceswassetupin1994toprovidetechnicalleadershipthroughouttheATOtoresolvecomplextechnicalmattersinanenvironmentwhere‘alltechnicalstaffcouldperformattheiroptimum’. Itconsistedofthreearms:LegislativeServices,whoseprimaryrolewaspolicyadviceandourwindowtogovernment;TaxCounselNetwork,whichwasateamofseniortechnical resources; and a Practice Management & Development arm, which developedtechnologicalandsupporttoolsandprofessionaldevelopmentactivities.Allthreeresultedfromthegovernment’sinvestmentintheATO’sComplianceStrategyinSeptember1992.Thethen ATO’s Second Commissioner (of Law) saw that the National Tax Practice role was‘interpreting,applying,mendingand/ordevelopingthelaw’.42

In termsof client engagement, theATOunveiled a CompliancePyramid that formed thesubjectmatterofmanyPhDthesesandresearchpapersandprovideda‘valuableframeworkforcompliancework’intheATO.43TheATOComplianceModelworkedwelltodepictthelevelsofhelpandengagementwarrantedagainstlevelsofcompliancebehaviour.Atthebaseof the pyramid, where most taxpayers converged, mutual ‘Trust and Cooperation’ wasobserved;inthemiddlethisbecame‘passive’facilitation,then‘active’facilitation,until,atthetoppointyendofthepyramid,asmallgroupofhigh‐risktaxpayerswarranted‘tougherenforcement’.44

VII TAXREFORMANDTHEATO’SCONTRIBUTION

Itisfairtosaythatsomeattemptsatmakingtaxlawlesscomplexandmoreequitableorsimplerarewelldocumentedandseemtohavetakentimetogestate.45TheAspreyReportcompletedin1975hadacentralobjectiveofbroadeningthetaxbaseandloweringtaxes.Soundslikeafamiliartheme.

The tax reform package announced in September of 1985 by then Treasurer Keatingintroducedacross‐the‐board cuts inmarginal tax rates, a new taxon fringebenefits andcapital gains tax and the taxationof income from foreign sources,with an allowance forforeign tax already paid. Cabinet decided that it was not the right time to introduce aconsumptiontax,becausetheywereadvisedthata‘yieldfromataxonservicesandamajor

41 Our three major training programs were the Australian Taxation Studies Program (ATAX), theTaxationOfficerDevelopment(TOD)program(egTOD1competencybasedtrainingforlowestgradedofficerswasdevelopedwiththePublicSectorUnion)andcontinuingprofessionaldevelopment.ATAXbeganin1991andby2002had582graduates,largelyfromtheATO.

42 PeterSimpson,thenSecondCommissionerasreportedinourstaffmagazine,TaxPeople,1994.43 MichaelD’Ascenzo,Y2Krelationships–theATOandyoupost2000,TaxationinAustralia,Vol34,No.8

February2000,421–30.44 Ibid.45 For example, the 1959 Commonwealth Committee on Taxation, chaired by Sir George Ligertwood

addressedtaxavoidancereformbutotherrecommendationswerenotpickedupuntilthenextmajorreformexercisein1972byJusticeKWAspreyandtheTaxationReviewCommittee.


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extensionofthewholesalesalestax’wouldbeinsufficienttofundtaxcutstolowincomeearners.46

WhencapitalgainstaxwasintroducedfromSeptember1985ongainsnotpreviouslytaxed,it managed to generate revenue beyond Treasury expectations.47 A number of factorscontributed to this, including the growth in the global and Australian economies in thatdecade,thescopeofthenetasdrafted,andthelackofconcessionalrates.Intheearlydays,wehadanumberofinterpretativeandtechnicalissuestodetermine,andweissuedanearlyformoftaxdeterminationtoprovidequickanswerstovexedissues.

The policy and non‐policy initiatives stemming from reviews recommending the majorinitiativeofagoodsandservicestax(GST),aswellasanewPAYGsystem,involvedlarge‐scale reforms that meant a major overhaul of ATO systems and procedures,and whichimpacted on many jobs in the ATO.48 The ensuing massive recruitment exercise, whichemployed4,000newstafftodealwiththeadditionalworkloadincallcentresandenquirycounters,islegendaryintheATO,andsuchrecruitmentisnotlikelytobeseenonsuchasignificantlevelagain.

SincethehandoveroflawdesigntoTreasury,theATOhascontributedideasandopinions,especiallyabouttheadministrativeworkabilityofproposednewlaws.Ithascourageouslypointed out likely impediments or flaws, and provided practical input on possibleimprovementstoproposedchanges.Itscorporateplanspeaksofinfluencingpolicyandlawdesignformorecertainoutcomes.49

The most comprehensive and important examination of the tax and transfer system(excludingGSTandsuperannuation)wasconductedbytheHenryReviewin2008–09,atthetimeoftheglobalfinancialcrisis.Itproducedsomeenlightenedideasforafuturetaxsystem.

Beyond tax reform, large‐scale tax changes traditionally bringwith them an increase inimplementationchallengesfortaxadministrationandpresentopportunitiesforourexpertworkforce.

Remarkably,though,withallthemediaconcentrationoncompanies’taxobligations,thetaxmix–wheretheCommonwealthderivesits(direct)revenue–hasnotchangedsignificantlyin 60 years. It has been observed that about 50 per cent is from personal income taxcollectionsand(inthelastdecade)about20percentincompanyincometax.However,tax

46 CabinetDecisionNo.6513–Taxreform.SecretarytoCabinetfilenotedated12August1985:NAA:

A13979,6513,NationalArchivesofAustralia.AustralianGovernmentpublication.47 National Archives of Australia, Australian Government. Therewere no reliable ‘statistics available

regardingthedistributionsofcapitalgainsacrossincomerangesinAustralia’althoughinformationfrom Cabinet Decision No. 5629 from 12May 1985 (at 402) suggests that early low estimates ofrevenuecollectionswerederivedfromCanadiancapitalgainsdata(bygradeofincome)bychartat405.Thesewerelaterovershadowedbyestimatedcollectionsofaround$300minrevenueovera5yearperiod:NAA:A14039,2865.

48 This occurred mainly through the Tax Simplification Taskforce in 1990, the Review of BusinessTaxationReportin1999(RalphReport)andtheANewTaxSystem(ANTS).Therewasalsoan8person‘NewTaxSystemAdvisoryBoard’establishedinJuly1999bytheTreasurertoassistwitheffectiveimplementation, to minimise transitional issues and to advise government about assistance tobusinessandcommunitysectors.

49 WhentheATOseesweaknessesinthetaxlawitadvisesgovernmentandoccasionallythisprocessofadviceandsubsequentpublicannouncementhasnotworkedaswellasintended,forexamplewhereastockpileofproposedlegislativeimprovementsisnotenacted.


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reformdoesbringchangeswithintaxbases.50Leavingasideindirecttaxes,itishardtoseetheincidenceandrelianceonpersonaltaxchangingmuchinthefuture,astheworldtrendstatistics show continuing stability in individual income tax and indirect tax as a steadysourceofrevenue.51

Tax reform is a perennial topic for academics, the business community and indeedgovernment.Thebigprojectshavebeendifficulttobringtofruitionunscathed,andgreatersuccess is sometimes found in targeted reforms – notwithstanding the exceptionalpredicaments,trade‐offsandcarve‐outsthatcanarisetoadverselyimpactonaneffectivedesignfornewtaxes,forexampletheMiningResourceRentTaxandCarbonTax.

Clearlytaxationconcessionsshouldassistthegrowthofbusinessesintheirestablishmentandearlystages,andoncetheyarematureconcessionsshouldbestemmedandafairshareoftaxpaidbybacktothecommunitythatisbuyingthegoodsandservicesofthebusiness,orallowingexploitationofresourcesinourcountry.Thechallengeofbalancingthesystemforgreatersimplicity,equityandclarityisongoing.

VIII SCHEMESTHATFRUSTRATEDTHEBESTTAXADMINISTRATORSANDONGOINGCHALLENGINGAREAS

A FrustratingSchemesofthePast

TheATO’sinvestigationoftaxavoidanceactivitiesinthelate1970stoearly1980sgrewwellbeyonditsabilityandtheextentoftaxpayerinvolvementtookeveryonebysurprise,suchthatATOresourcingbarelykeptpacewiththemonster.

The Annual Reports of the Commissioner to Parliament recount the frustration of theAustraliantaxadministrationattryingtoaddressandunderstandthe‘newandingeniousmisuseoftaxprovisions’whichwasexacerbatedbytheuseof‘evasivetactics’tofrustrateATOinvestigativeactionandfeatured‘deliberatelyconcealingthefacts’and‘makingclaimsbasedonfictitioustransactions’.52

Itisstillattimesextremelydifficulttogetthefullfactsnecessarytoproperlydeterminetaxrisks,andto theextent thatasymmetric information flowsarise that inhibitparties fromarrivingatgooddecisionmaking,itcreatesdelays.Itisimportantthattaxadministrations

50 MStewart,AMoore,PWhitefordandRQGrafton,AStocktakeoftheTaxSystemandDirectionsforReform–5yearsaftertheHenryReview,February2015,TaxandTransferPolicyInstitute,CrawfordSchoolofPublicPolicyPaper,AustralianNationalUniversityat30andChart3.4CompositionoftheCommonwealthTaxSystemsince1950(to2012).

51 OECDRevenueStatistics report 2015, summarypress release03/12/2015: ‘Corporate tax revenueshavebeenfallingacrossOECDcountriessincetheglobaleconomiccrisis,puttinggreaterpressureonindividualtaxpayerstoensurethatgovernmentsmeetfinancingrequirements,accordingtonewdatafromtheOECD’sannualRevenueStatisticspublication.Averagerevenuesfromcorporateincomesandgainsfellfrom3.6%to2.8%ofgrossdomesticproduct(GDP)overthe2007–14period.Revenuesfromindividualincometaxgrewfrom8.8%to8.9%andVATrevenuesgrewfrom6.5%to6.8%overthesameperiod’.HencetheconcentrationofthetopicattheG20countrygroupandevolutionoftheBaseErosion and Profit Shifting Project to review some international mismatched tax law that allowscorporateprofitstobeshiftedoreliminated.

52 59thReportof theCommissionerofTaxation1979–80:Management,Organization,ComplianceandPersonnelat4andTaxAvoidanceat7.


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improvethetransparencyoftransactionsthat involveworldwidefinancial flows,related‐partydealingsandthetaxationimplicationsofglobalarrangements.53

A popular method of avoidance of taxation that proliferated from the 1970s wasstripping companies of their assets (orpre‐taxprofits) prior to their tax liabilitiesbeingpaid.Thiswas described as an ‘alarming tactic’ because it was compounded by anattendant lack of provision in thecompany’s(bank)accounts forany(subsequent) taxpayments that may be assessed; it was regarded as tax evasion pure and simple.54 Inresponse,theCommonwealthParliament passed a number of related Acts in 1982, themost important of which was the Taxation (Unpaid Company Tax) Assessment Act1982, which sought to recover evaded taxes under the Crimes (Taxation Offences) Act1980. The ATO ultimately issued many notices to former owners or vendorshareholders for recoupment of tax where it was thought they were bona fideowners/directors of companies, but some found their way into the ‘bottom of theharbour’ repository of the criminally inclined. The tax evasionwas very bold, blatantand a serious threat to the equity and fairness of the taxsystem, such that theremedial legislation was given a retrospective application (to allschemes uncoveredthat were ‘practised on a wide scale entered into on or after 1January 1972’), andthe law excluded judicial review as to the assessment of the recoupment taxunder the AdministrativeDecisions(JudicialReview)Act1977.55

Famously,anopponentofthatlegislationwasSenatorDonChipp–who,speakingagainstthebillintheSenate,said:

Goodheavens;givepoliticiansthechancetolegislateretrospectivelyandwewillopenaPandora’sbox.Ifindthatquitefrightening.OnthisoccasionaPandora’sboxisopenedintheexcuseofcatchingthefilthypeoplewhocheatontax. It isdoneforanoblepurpose,onemightsay,andIagree.ButIhaveneverbeenonetosubscribe to theviewthat theend justifies themeans.Thatsortofpropositionleadsonedownatrackwhichisfraughtwithdisaster.ThatisthetrackthatAdolfHitlerwentdown.Itisthetrackthateverytyrantinhistoryhasgonedown;thatis,tomakeillegaltodaysomethingwhichwaslegallastyear.56

Notwithstanding Senator Chipp’s colourful remarks on the introduction of retrospectivelegislation,57itcanbejustifiedtoensureconsistencyoftreatmenttoallparticipants(notthefewerlateentrants).TheeramarkedachangeinthewaytheATOhandledlargetranchesofwork,andinitsawarenessoftheextentofevasionpractices.Theretrospectivityissuewill

53 TheSenateEnquiryReferenceCommittee–enquiryintocorporatetaxavoidanceInterimReportof2015,hasmadespecificrecommendationstodealwithMultinationals.

54 Ibid.55 ExplanatoryMemorandum,Taxation(UnpaidCompanyTax)AssessmentBill1982,PartI.Treasurer

HonJohnHoward.56 SeeSenateHansard,19November1982at2,592.57 SenateStandingOrder30alsoaddressesretrospectivebillsinthetaxcontext,bystatingthatifthey

are not introducedwithin 6months of announcement then the commencement datewill be afterintroduction of legislation into Parliament – effectively when the bill is made public. Treasuryreviewed thisaspect inAugust2004 in their ‘ReportonAspectsof IncomeTaxSelf‐Assessment’ andconcluded that retrospectivestartdatesareappropriate to correctanunintendedconsequence, toaddress a tax avoidance issue or to correct an undesirable behavioural change on ameasure‐by‐measurebasis.


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surelybeafeatureoflegislativechangeandtaxadministrationatsomefuturetimetoensuretransactionsfallingwithinthesameclassbeingtreatedconsistently.58

Ourinternalhistoryrecordsthatby1983,theATOhadsuccessfullyemployedanother580staff59tostrengthenoverallcomplianceactivities,andwiththeretirementofChiefJusticeBarwickfromtheHighCourttheATOwasagainsuccessfulinataxavoidancecase.60Thewaxing andwaning of contentious issues in litigated tax caseswill no doubt be anotherfeatureofataxsystemwheresignificantissuesemergetopresentuncertainty.

B FrustrationsoftheMoreRecentPast

TheHighCourtinformedus,injudgmentsonseveraltestcaseswhichtheATOconsideredamountedtoavoidanceoftaxundertheformers260,thatthegeneralanti‐avoidancelawdidn’twork–because,evidently,thetaxpayerhadachoiceoftax‐effectivearrangementsandtheATOwasnotpermittedtoreconstructthearrangementtoproduceadifferenttaxeffect.Theageoftaxavoidanceannihilationunders260wasreplacedbytheageofPartIVA.Thechanged law allowed an objective view of a particular arrangement and its surroundingcircumstances, and included countering the then‐prominent dividend stripping schemeswhichpurportedtoreplaceotherwisetaxableprofitsintothehandsofshareholdersinataxfreeform.

Itwasnotuntilabout1997thattheATOcommencedworkonwhatbecameknownas‘massmarketed schemes’, after it became aware of how pervasive they had become and howinnovative the arrangements were. Many aggressive promoters had made fees fromtargetingordinaryAustralianssuchasminers inKalgoorlie, toclaimlargedeductions forarrangements that created tax benefits. These included schemes related to afforestation,agriculture,franchises,employeebenefitandfilms,wherelargetaxrefundswerepromisedforverylittleequityoutlayandnon‐recourseloanssupposedlyfundedbyfuturerevenueflows.Itwasalltoogoodtobetrue,quiteuncommercialinnature,andcertainlyineffectiveunderthetaxlaw.61

58 NotetheFullFederalCourtdecisioninIOOFHoldingsLtdvFCT&Anor[2014]FCAFC91,anappealfromaprivaterulingchallengingwhether itwasentitledtodeductions forrights to future income(RTFI)inrespecttosharesinAustralianWealthManagement,whereitwasheldthattherewasno‘accrued right’ to have the matter determined according to the law that existed before theConsolidationprovisionswereamendedtoremovethedeductionforRTFI,inTaxLawsAmendment(2012MeasuresNo.2)Act2012.

59 LeighEdmonds,WorkingforallAustralians1910–2010:ABriefHistoryoftheAustralianTaxationOffice,172–3.Seealsothe59thReportoftheCommissionerofTaxation1979–80whereat4thePublicServiceBoardapprovedanadditionof400stafftothestaffceilingforthatyearand180inthefollowingyear.

60 TheHighCourtrefusedspecialleavetoappealagainsttheFullFederalCourtcaseofLearyvFCT80ATC 4438, where counsel for the taxpayer had argued before the Full Federal Court thatnotwithstandingamaterialadvantagehadbeenobtainedbythetaxpayerpaying$10,000totheOrderofStJohn,thetaxpayershouldnotbedeprivedofagiftdeduction.Atthetime,thiswasasignificantcasefortheCommissionertowin.

61 The ATO applied the general anti avoidance provisions to many schemes, a Senate enquiry wasconductedandtheOmbudsmaninvestigatedtheBudplanarrangementsafterinvestorcomplaintsandforthebenefitof‘affectedinvestors,taxadvisersandfinancialplanners’.Refertothepubliclyreleasedreports of the Commonwealth Ombudsman under s 35A of Ombudsman Act 1976: ‘The ATO andBudplan’ofJune1999;and‘ATOandMainCamp;ReportintotheinvestigationintotheATO’shandlingofclaimsfortaxdeductionsbyinvestorsinmass‐marketedtaxeffectiveschemesknownasMainCamp’.RecommendationswereadoptedbytheATOandsomelegislativemeasureswerealsointroducedsuchasalimitonprepaymentsrelatedtotaxshelters.


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By30June2001,theATOhadfinaliseditsviewson176investmentschemesinvolvingsome40,000 taxpayers caught up in one or more of the arrangements.62 The administrativereactiontotheissueswas,onceunderstood,toreducetheinterestrateondebts,startaprintadvertising campaign with warnings and fact sheets, and look at dispute resolutionmechanisms. I was part of the widely held settlement panel that approved terms ofsettlementofferedtoindividualinvestorsonsomearrangementstoresolvedisputes,andguidelineswerepostedonourwebsite.

HadtheATObeenabletodetectandcomprehendsomeearlywarningsigns,orhadtherebeensystematicintelligencesignallingmaterialchangestohigh‐riskrefundsorinstalmentvariation patterns as theywere occurring – then the acknowledged slow administrativeresponsestotheextensiverisksmayhavepermittedreal‐timeassessments.Today’sSmarterData initiativesaredesigned toassistwith riskpatterns,butback thenweusedProductRulings,introducedinJune1998tocreateanavenuetoadviseourviewsattheearlystagesofprospectus‐basedofferings,toallowarrangersandprospectiveinvestorssomecertainty.Most of the litigation challenges by promoters to these arrangements found the ATOultimatelysuccessful.63

ThisdarkeraofaggressivetaxplanningledtotheCommissionerreleasingTaxpayerAlertsor early warnings about the administrative treatment of tax schemes that we hadencounteredandwerelikelytotakeactionagainst.Morecomprehensively,theATOshifteditsfocustopromotersanddeterrenceofthisbehaviour;henceadecisionhadtobemadewhether to bring in a taxpayer disclosure system for participants in an (identified) taxscheme, or whether a targeted deterrent should be aimed at those promoting thearrangements.Thelatterwasviewedaspreferableatthetime,soin2006apenaltyregimetodeterthepromotionoftaxexploitationschemeswaspresumedtobethemoreeffectiveapproach,especiallywiththeabilitytoseekvoluntaryundertakingsfromthepromoterorcourtinjunctions.64Inresponsetotheneedtoprovidemoreguidance,theATOemployedtargetedadvicematerial,Don’tTaketheBait,andfactsheetsforInvestorsTaxPlanning–Investigatebeforeinvesting–togivesimple,cleartipstoinvestors.

IX ATOPRESENCEONTHEINTERNATIONALFRONT

Todaywemarvelthatwealthcanbemaderapidlybyyoungentrepreneursdevisingdigitalservicestoamassaudience.Thescaleofsuchvaluecreationwithglobalactivitiesdefiesthetraditional conceptsof ‘source’ and ‘residence’ andcreatesnew issues to solve.Thenewwords to describe the attendant loss of country revenue by groups using global tax‐advantagedpositionscannotbelabelledwiththeoldnomenclature,soanewtermiscoined,‘baseerosionandprofitshifting’.Withmuchglobalattention,theOrganisationforEconomicCo‐operationandDevelopment(OECD)hasprogresseditsworkonbaseerosiontopics,andhas pursued the development of guiding principles aimed at achieving greater tax

62 CommissionerofTaxationAnnualReportof2000–01at49.63 Forexample,theBudplanschemecaseofHowland‐Rose&OrsvFCT2002ATC4200wheretaxbenefits

weredeniedby thecourt,anddenialofresearchanddevelopmentexpenses in theAdministrativeAppealsTribunalcaseofBrody&OrsvFCT2007ATC2493.

64 TaxationLawsAmendments(2006MeasuresNo.1)Act2006.Thegovernmenthassignalleditsintenttoprogressanewdisclosurereportingregimeforaggressivetaxplanningschemestoapplytotaxandfinancialadvisors.AMay2016TreasuryconsultationPaper,OECDProposalsforMandatoryDisclosureofTaxInformation,closedforcommentinJuly2016.


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transparencyandconsensusmeasuresthatcanbeadoptedbycountriesintheirdomesticlaws.Itisanticipatedthattheimplementationofimprovedavenuestoexchangeinformationbetween jurisdictions, and proposed multilateral instruments to efficiently implementtreatychangeswithouttheneedtorenegotiateamyriadofbilateraltreaties,willaugmentinternationalcooperationbetweencountriestocombattreatyshoppingandotherformsoftreatyopportunism.65Thereisinherentgoodsenseinfindingsharedsolutionsforcommonlyencounteredproblems,intheworldoftax.

Looking back to overseas postings in the 1970s, the ATO had representatives in twolocations,LondonandinWashingtonDC.66Thiswasatastagewhenjustninedoubletaxagreementshadbeennegotiated.IwaspostedtoWashingtonDCin2005–07toadesignatedtaskforcetoassistwithouroverseaswork.Iwasco‐locatedwithothercountries,andtherewasmore focusontaxrisk.Duringmyposting,asmallUS‐based international task forcesharedexpertisetoreviewinternational‘taxshelter’cross‐borderarrangements67throughthe lensesof primarydrivers ofbank secrecy jurisdiction concerns, tax lawmismatches,financingarbitrage,useofstructures,concessionsoffered,lossesandtheadequacyofthetaxadministration approaches to detect and deter the promotion of schemes. This was allexecuted inanenvironmentwhichwasstrictlysubject toourrespective treatyexchangelimitations. Itwas an initiative of its time, and served its purposewell for participatingcountries to build stronger collaboration and understanding of the shared global taxchallenges.

AtpresentthepostingisforonerepresentativelocatedattheOECDinParisprovidingafull‐time representational role and contributing to international programs of work. Morecommonly,inthecurrentageofcommunication,wearebetterplacedtoholdinternationalconference calls with our overseas revenue agency colleagues. Conference calls areconductedbetweenseparateteamsrepresentingeachcountry,withappointeesperformingthe roleofCompetentAuthority to ensure the treaty rules areobservedand toorganiseinformationflows.

The development of joint participation with other international revenue agencies wasestablishedthroughthequaintlynamedSGATAR,PATA,andCATARgroups.68Inthinkingback on our contribution to these forums, my experience was that they consisted ofrewarding, albeit rudimentaryworkwithdeveloping countriesatone level, and tomoresophisticatedexchangesoftaxriskanalysispracticeswiththemoreadvancedeconomies.Havethingschangedthatmuch?Well,tome,findingconsensusoncross‐bordertaxworkrequires diplomacy – not unlike the well‐quoted description of what was required forsuccessinforeigndiplomacy:

Thereisnothingdramaticinthesuccessofadiplomatist…suchvictories…aremadeupofaseriesofmicroscopicadvantages:ofajudicioussuggestionhere,ofanopportunecivilitythere,ofawiseconcessionatonemomentandafarsightedpersistenceatanother...[that]noblundercanshake.69

65 BEPS Action Item 15 re a proposed OECD multilateral instrument to basically assist with treatyamendmentsfortheBEPSactionitems.

66 Thencalled‘Counsellor(Taxation)’inWashingtonDCandan‘ATORepresentative’inLondon.67 ReferexplanationinAustralianGovernmentATOComplianceProgram2010–11at27.68 Study Group on Asian Tax Administrations (SGATAR), Pacific Association of Tax Administrators

(PATA)(nolongerexists)andCommonwealthAssociationofTaxAdministrators(CATAR).69 LordSalisbury,ForeignMinisterinUKGovernment,19thcenturyquote.


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CollaborationbymembercountriestoproduceguidanceonOECDprojectgroups,inthepre‐BaseErosionandProfitShifting(BEPS)environment,epitomisedthisworldofdiplomacy.Myexperiencewas in anOECD study, as co‐leadwith a civil servant fromHerMajesty’sRevenue & Customs (UK), which had started to review ways to achieve better taxtransparency for banks in early 2008. Banks that were consulted initially negotiatedjudiciouslyonthetermsofreferenceforthestudy,tokeepitfocusedoninvestmentbanking.However,theglobalfinancialcrisisdescendednotlongafterthestudygotunderway,whichinonesensegaveitgreaterimpetus;yetitsoonattractedacautionaryconcernatanotherlevelassomebanksbeganteeteringtowardscollapse.Theintendedpracticalguidancefortax examinations by revenue administratorswas overtaken by bailouts andother globalevents,suchasnewfinancialregulationstakingprecedence.70

Inthemodernworld,taxadvocacygroupcampaignsandmediaheadlinesrevealintelligenceleakedindocumentsfrom‘whistle‐blower’ informantsthatenabledpublicationofhiddensourcesofincomeandpreviouslywellshieldedglobaltaxavoidanceorevasionpractices.ThisgreatlyassistedtheG20LeaderstoformulateCommuniquestoacknowledgetherisksofbaseerosiontomoderntaxsystemsandtheconsequentrisktotheireconomies.Itgavetaxpriority,thusallowingthepaceofworkandoutputstoprogressatamuchfasterpacethanwehaveeverexperiencedinourhistory.

X AREASOFRECENTINTEREST

A ProfitShifting

Onthesameoperativedateasthenewgeneralanti‐avoidancerule(GAAR)cameintoeffect(PartIVA,27May1981),thethenTreasureralsoforeshadowedlawtocounterthepracticeknownastransferpricing,wherepartiestoaninternationaltransactiondonotdealwitheach other at arm’s length and locate profits outside Australia (for example with highexpensesinAustralia)andtherebyavoidAustralianincometax–soundslikeprofitshifting.

Transfer pricing of goods, services and intangible property is an area of law involvingcomplexlegalandeconomicconceptsandinwhichwehavebeenreliantonexpertstoguideusthroughmethodologiesonarm’slengthpricing.Thecourtsandtribunalshavenotalwaysembraced the economic conclusions that either the ATO or the taxpayer relies upon, asadvisedbyitsexperts.71

Morethan30yearslaterwehavebroughtinmoreworkablelawstodealwithmodern‐daytransferpricingofgoodsandservices,butthewholechangingworldofdigitalcommercewill ensure that it is a topic of attentionwell into the future of the global world of tax

70 ThereportwascommissionedbytheForumforTaxAdministration(FTA)attheJanuary2008Cape

Town meeting. The booklet was published by the Organisation for Economic Co‐Operation andDevelopment booklet: Building Transparent Tax Compliance by Banks, 2009. The study teamcomprisedtheAustralianTaxationOffice,HMRevenue&CustomsintheUKandtheOECDSecretariat.Assistancecamefrom12otherFTAcountriesandtwoexperiencedbankingpersonnelsecondedtothestudyteam.

71 RefertoJusticeDownesoftheAATinRocheProductsPtyLtdvFCT[2008]AATA639whodeclinedtoaccepttheexpertsviewofcertain‘appropriatemark‐ups’and‘medians’ininter‐quartilerangesandintheabsenceof(inhisview)arationalbasisfordistinguishingprofitmarginsbetweencomparableand non‐comparable drugs, he determined a separate gross profit margin for prescriptionpharmaceuticalsbasedonotherevidence.


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administration.Theabilityofcompaniestochoosepreferredjurisdictionsinwhichtolocatetheirvaluechain,sourcea functionoradoptariskhasenabledsomeenterprisestoshiftprofitsandaccesssignificantworldwidereductionsintheeffectiveincidenceoftax.Futuretax administrations, however, although assisted by administrative safe harbours andinterpretativeguidance,willcontinuetotrackthecomplexitiesofinternationaltransactionstoassesstaxcompliancerisks,ifdisclosuresarenotcomprehensiveandreliable.

Anytimetheambitof theGAARprovisionsareextendedweseea flurryof interest,as ittraditionallybringsinafresheraoftaxinterpretationandcommentfromtaxprofessionals.ThismaybeafeatureofchallengesbytheATOtoperceivedabusiveglobalmultinationals’taxpositions,andIexpectthenewmultinationalanti‐avoidancelaw(MAAL),applyingtotaxbenefitsofsignificantglobalentities(effectivefrom1January2016),willbenodifferentinsettingnewparametersoftaxlawcontroversy.72TheMAALmeasuretargetsmultinationalentitiesthatuseartificialandcontrivedarrangementstoavoidattributionofprofitsandsodonotreturnasufficientproportionofprofitfromAustraliansales.DialoguewiththeATOisencouragedbyaffectedentities,anditisexpectedthattheywillrestructuretheirbusinesschains to conformwith and apply forATO rulings tobe assured their operationsdonotbreachthesenewlaws.73

Thecommunityhasseenagreaterleveloftransparencyinwhopaystheirfairshareoftax,and through advocacy groups and the media will be more vocal in holding companiesaccountableifnot.74TheATO,likeotheradministrations,seekstostaycurrentbyreviewingthetaximpactoftaxpayers’commercialandfinancialdealingssowecanspotthetrends,provide certainty in our views, and assure the community we are fulfilling our role insignalling acceptable levels of tax to profits.75 Notwithstanding these efforts to effectunilaterallawchangesandagreementtominimumstandardsofmultilateralrules,thefuturechangingtechnologicalenvironmentwillsurelypresentitsownchallengestotheabilityoftaxadministrationstoaddressglobal(non‐symmetrical)taxstructuringandtransparency,andwillcontinuetorequiresomedegreeofinternationalcoordinationandcooperationtokeeppacewithinnovativearrangements.

B High‐WealthIndividuals

Another memorable watershed for the ATO was the establishment of the High WealthIndividualsTaskforce.InAustraliainthe1995–96taxyear,theATOtrailblazedthesegmentby uncovering a small number of apparently wealthy family groups paying little or no

72 Thenewprovisionsamendthegeneralantiavoidancerulesandapplytosignificantglobalentitiesinregardtoschemesenteredintoonorafter1January2016.TheExplanatoryMemorandumtoTaxLawsAmendment (CombatingMultinationalTaxAvoidance)Bill2015explains (at54) that theamountofpenaltyisdoubledwhenimposedonqualifyingentitiesthatenterintoprofitshiftingschemes,unlesstheentityhasadoptedataxpositionthatisreasonablyarguable.

73 RefertoATO,LawCompanionGuidelineLCG2015/2:Section177DAoftheIncomeTaxAssessmentAct1936:SchemesthatlimitataxablepresenceinAustralia.

74 On3December2015,theTaxLawsAmendment(CombatingMultinationalTaxAvoidance)Bill2015passedtheAustralianSenaterequiringannualfinancialstatementsdisclosinglevelsoftaxbyentities.

75 Therecentlypublished1stannualCorporateTransparencyReportinvolvesatransparencypopulationof 1,539 entities (1,042 corporateswith annual turnover >$250m) for the 2013–14 income year,issuedbytheATOon17December2015,isonewaytoinformpublicdebateabouttaxpolicyintothecorporate tax system. A further release of taxation data for Australian‐owned, private residentcompaniesoccurredinMarch2016tofurtherassisttheglobalpushfortransparencyinthecorporatetaxsystem.


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personaltaxthroughawebofassociatedtrustandcompanystructures,therebyallowingoneormoreindividualmemberstoaccesswelfare.BecauseprivatelyownedandwealthygroupsoperatedsomeofAustralia’slargestandmostsuccessfulbusinesses,weconductedanextensivecompliancereviewtoworkouttheireffectivetaxrates.Wewerefacedwithoftencomplexfinancialandlegalarrangementswhichmanyhadstructuredtoobscure,forrevenueauthorities,detectionofanytaxavoidanceortaxsheltering.Somecountrieshavemorerecentlyleviedagreaterburdenoftax(orcalledforataxsurcharge)ontheirhigh‐net‐worthindividualsortop‐endearners,notingthedisproportionatedistributionofincomeasthegulfwidensbetweenthetop1percentandtherest.AberrationslikewealthyUShedgefundmanagerspaying lower rates of capital taxes thanordinarypeople on their carriedinterestreturns(ienotbeingtreatedasordinaryincome)isonetaxbreakfortheelite.

Taxevasion,avoidanceandcrime(abuseofoffshoresecrecyarrangements)wasaddressedthrough the establishment of the Project Wickenby Taskforce in 2006. This involved apartnershipofeightagenciestoaddresstheuseofsecrecy jurisdictionsby individualstoavoidtax.Workispresentlydonethroughtheeightmulti‐agencyAustralianSeriousCrimeTaskforceforseriousandcomplexfinancialcrimes.76

Successfulwork by theWickenby taskforce included approaches akin to tax amnesty toencouragepeopletocomeforwardandvoluntarilydiscloseunreportedtaxableincomeandobtainreducedpenalties.Forexample, the2014voluntarydisclosure initiativeknownasProject DO IT, which provides Australians with opportunities to declare undisclosed orincorrectlyreportedoffshorefinancialactivities,hasseen5,800disclosures(asat30June2015)lodgedwiththeATO.Thisisanexampleofnewerapproachesbeingadopted,andoftheATOworkingwiththewidercommunitytoencourageinternationaltransparencyinitsdealingswiththetaxsystem.

Inaddition,ProjectDO ITassistswith intelligence informationontherangeandscopeofinappropriateoffshorearrangements,includingthosewhochosenottovoluntarilydiscloseincome,anditcanbeusedtoinformtheATOaboutriskandcomplianceapproaches.

XI EXTERNALSCRUTINYOFTHEATOANDTHEROLEOFTHOSECONDUCTINGATOOVERSIGHT

WhiletheATOhashaditsown(internal)auditcommitteesince1998–99,externalscrutinyhastakenplacethroughvariousavenues.

A TheAustralianNationalAuditOffice(ANAO)

TheANAO,asaseparategovernmentagency,hasregularlyconductedefficiencyauditsoftheATOformanyyears,aboutparticularfunctionsoradvice,auditanddebtprogramsoftheATOaswellasaspectsoftaxadministration.

76 SeeATOComplianceProgram2011–12at24–5.The7otherATOpartnersforthecurrentSFCTare:

Australian Criminal Intelligence Committee, Australian Federal Police, Australian Securities &InvestmentsCommissionand(Cth)DirectorofPublicProsecutions,AustralianTransactionReportandAnalysisCentre,AustralianBorderForceandtheAttorneyGeneral’sDepartment.


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B TheInspector‐GeneralofTaxation(IGT)

The IGT, as an independent reviewer, now incorporates tax complaint handling.77 TheappointmentofanIGTtookplacealongwithproposalsforaBoardofTaxationfollowingthe2001Federalelection,wheretheoptionwasraisedasawaytobalancebusinessadvicefromthe ATO and Treasury and to complement the Commonwealth Ombudsman’s role withindividual taxpayers.78 The ATO provides assistance to support the work of the eleven‐memberadvisoryBoardofTaxation,whichinitiatestaxsystemimprovementmeasuresorassistancewithstudiesontaxmattersattherequestoftheTreasurer.ThefunctionsgivenbyParliamenttotheIGTbroadlyconsistofconductingreviews,athisowninitiative,oftherangeofATOsystemsusedtoadministertaxlaws.79

In the 2014–15 year Commissioner Jordan reported, in his Annual Report in respect ofexternalscrutinyreviews,thatfourAustralianNationalAuditOffice(ANAO)audits,fiveIGTreviewsandoneCommonwealthOmbudsmanown‐motioninvestigationwerecompleted.Inthecurrentyear(2015–16),threeANAOauditsandtwoIGTreviewswerecompleted,alongwith the (former) House of Representatives Standing Committee on Tax and RevenueInquiryinearly2016.

C ParliamentaryCommittees

The Senate Economics Reference Committee (SERC) and House of RepresentativescommitteescanconductinquiriesintotheoperationsoftheATO,andoftentheissuesstemfrommediaorcommunityconcerns.AnexamplewastheSenatereferralofanenquiryintocorporatetaxavoidanceofmultinationalstotheSERC,wheresomecompanieswerecalledtoprovideevidencebeforethecommittee,aswastheCommissionerandhisofficers.Thechangingdynamicsoflatereflectthegreaterdegreeofopennesswithwhichcompanieswereasked to, and did, provide information about tax performance and tax compliance –informationthatisusuallynotinthepublicdomain.Itgaveagreaterinsightintotherealchallenges of the ATO in reviewing and examining the complex financial affairs of largeglobal corporations and certain stresses on the tax framework that requires closeadministering.

Inpresenttimes,theHouseofRepresentativesStandingCommitteeonTaxandRevenuehasamandatetoexamineannualreportsofagenciesallocatedtoitbytheSpeakeroftheHouseor a Minister.80 After conducting hearings at which tax officials and key witnesses gave

77 TheATOwebsitenotesthatfrom1May2015,thetaxcomplainthandlingrolewastransferredfromtheCommonwealthOmbudsmantotheIGTasawaytoenhancethesystemicreviewroleoftheIGTandprovidetaxpayerswithspecialisedandfocusedcomplainthandlingfortaxmatters.ThepurposeofthismoveistoenhancethesystematicanduniquereviewroleoftheIGT.

78 JoshGordon,inhisarticleinTheAgeof22March2003titled‘SenatorslamsLaborforimpedingtaxreforms’, statedthat ‘Facingaserious taxadministrationbacklashduring the2001 federalelectioncampaign,theGovernmentpromisedtoinstallaninspector‐generaloftaxwithinquisitorialpowerstoaccess confidential Tax Office information…Senator Coonan said the Government had an electionmandatetointroducethereforms,andwouldnotbackdown.’

79 Sections7and8oftheInspector‐GeneralofTaxationAct2003.TheIGTmayberequestedtocarryoutareviewbytheCommissionerofTaxation,aMinister,aresolutionofacommitteeoftheHouse,butisnotrequiredtocomplywiththerequest.

80 StandingOrder215.TheCommitteecommencedtoactasascrutineeroftheATOinFebruary2014,aresponsibilitypreviouslyheldbytheJointCommitteeofPublicAccountsandAudit(JCPAA),tolookintoitspreviousyearAnnualReporttoParliamentandassessATOprogress.


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evidence,81 a report of the committee published its views, noting the moves towardssimplificationoftaxreturns,contemporaryserviceandacommitmenttocomprehensivelyassessthetaxgap.82InthefollowingreviewoftheCommissioner’s2015AnnualReportitwasreportedthat:

[3.33]TheATOisinthemidstoftwogreat,andrelated,changes.Theexpansionofthe digital economy has meant that it is involved in an extensive program oftechnologicalchangewhichinsomecasesisprofoundlyalteringitsapproachestodoingbusiness.Atthesametimeithasembarkedonaprogramofculturalchangewhichiswiderangingenoughtodeservethetitle‘ReinventingtheATO’.83

Parliamentary committeeswill continue to reviewsuccessiveATOannual reports, and itmightbeexpectedthatinterestingtopicsandoversightreportswillengagetheheartsandmindsofthecommunitywherepublicinterestmattersarise.

The extent of external scrutiny and inquiries into themanagement and effectiveness ofgovernmentagenciesincludingtheATO,whateverthesubjectmatter,islikelytocontinue.

XII TAXAPPEALSANDDISPUTERESOLUTION

The(then)SpecialTaxAdviserintheofficeoftheOmbudsman(Cth)wasoneofourfirstexternal casemediators for disputes,84 but since that time the ATO hasmoved tomoreavailableandtrainedin‐housefacilitationservicestoresolvedisputeswithtaxpayers,andotherformalandinformalservicesasavenuesforAlternateDisputeResolution.

Fromourearly timesat theTaxationBoardsofReview(nowtheAdministrativeAppealsTribunal)85I,asoneoftheyoungAppealsandReviewofficersdealingwithaconsiderableback log of (mainly individual taxpayers) smaller tax cases,86 regularly appeared for theCommissionerbeforethemembersoftheBoards.Theattractivenessofalow$2appealfeemeantmanypeoplegottheirdayattheBoardandwereself‐representedoraccompaniedbytheirtaxagents,andwewerepresentedwithsometrulynovelarguments,forexampleastotheneed for lavishentertainmentexpenses,or forabarrister tobeallowedhispersonalhomewaterratesbecausehereadhislegalbriefsinthetoiletandwhilerelaxinginthepool.Thentherewasthemanwhoarguedheshouldbeallowedtodepreciatehisbrain(fortax

81 Witnesses at the second hearing included the Commissioner of Taxation and senior staff of the

AustralianTaxationOffice;Inspector‐GeneralandDeputyInspector‐GeneralofTaxation;SeniorTaxCounseloftheTaxInstitute;SeniorTaxAdviseroftheInstituteofPublicAccountants;HeadofTaxPolicy of the Institute of Chartered Accountants of Australia and the CEO of the Council of SmallBusinessOrganisationsofAustralia.

82 Review of 2013 Annual Report of the Australian Taxation Office, Second Report, House ofRepresentativesStandingCommitteeonTaxandRevenue,October2014,atpara1.4.

83 Reviewof the2015AnnualReportoftheAustralianTaxationOffice–FirstReport, tabledon5May2016, Chapter 3. For the44thParliament theCommittee comprised tenMembersof theHouse ofRepresentatives, with six members nominated by the Government and four nominated by non‐Governmentparties.

84 ArecommendationoftheJCPAAinthe1990s.85 On1 July1986 theAdministrativeAppealsTribunal tookover the tax jurisdictionof theTaxation

BoardsofReview.86 Around80,000casesnationallyofwhich47,000wereclearedinthe1991–92taxyear.SeeAnnual

Reportat35.


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deductionpurposes);theCommissionerarguedinresponsethatheshouldnotbeaffordedadeductionfordepreciationashisbrainwouldhavebeenfullydepreciatedalready.

Thisleadsmetolitigationandmemorablecaselaw,whichistoonumeroustogivejusticetointhisarticle.Itwillinvokesomedissent,butI’llsaythatsomeimpactedusorganisationallymorethanothers.TheonesIthinkhadthewidestimpactrelatedtoindividuals’claimsforwork‐relatedexpenseswhichwehad consideredprivate innature, suchas stockings forflightattendantsandsunglassesforoutdoorworkers,orastudentreceivingyouthallowanceyet being allowed to deduct education expenses against that income.87 The Test CaseLitigation Program gave rise to a useful avenue to fund clarification of these types ofcontentiousareasofthetaxlaw.88

Overall,theATOhasasolidhistoryoflitigation,anditreflectsgooddecisionmakingbyourtaxadministration.Inthetaxavoidancerealmwewererelievedtohavethe‘nononsense’Spotlessdecisionhandeddown,whichhasstoodthetestoftimeasreferencedintherecentFederalCourtOricadecision.89Othercases,wherewedidnotsucceedinapplyingtheanti‐avoidance rules – such asMills vFCT90 –mark legal clarification points in our strategiclitigationprogram.Itislikely,asstrategiclitigationevolvesin‘hotspot’areasofglobalprofitshifting,thatthegeneralanti‐avoidanceprovisionswillcontinuetobearelevantsourceofjurisprudenceforAustraliantaxationpurposes.

Actually,itwasthemoremundanetopicofdebtanddeductibilityofinterestthatgaveriseto some of the more interesting tax cases, from the early days of questioning whethersomething was in the nature of interest and properly deductible or of a capital nature.CurrentlythemostrecentdecisioninChevron,atransferpricingcaseonthearms’lengthpriceofinterestonaloanbetweenrelatedparties,91isthefirstjurisprudenceonthattopic,anditsoutcomewillnotonlysteerthe(previous)Division13oftheITAA1936butmaywellinfluencethetestingofthereplacementprovisionsofSubdivision815‐Band/or815‐CofITAA1997.TheOECD’sBEPS studywasquite explicit in targeting consultationon threeothertaxriskareaswhereexcessiveinterestdeductionsneedtobecountered:debtdumpingordebtloadinginhigh‐taxcountries;creationofintra‐groupdebtatratesinexcessofthirdpartydebt;andthemismatchoftaxexemptincomebeingabletobefundedbydeductibleintra‐groupdebt.Onlylegislativechangecanaddresstheseissueseffectivelyinparticipatingcountries.92LawclarificationlitigationnecessarilymeanscasesarelostandwonbytheATO

87 HighCourtdecisioninFCTvAnstis[2010]HCA40reyouthallowance.88 The ATO Test Case Program receivedMinisterial approval for the 1995–96 tax year, and $2m of

fundingwassecuredfromtheDepartmentofFinance.In2006–07theIGTreviewedtheadministrationof test case litigation and although found it to be soundly conducted recommended a number ofchangestoimproveitsoperation:ReviewofTaxOfficeManagementofPartIVACLitigation,Chapter6,28April2006.

89 See Commissioner of Taxation,AnnualReport1999–2000, 80. Refer toFCT vSpotlessServicesLtd(1996)186CLR404andOricaLimitedvFCT[2015]FCA1399.

90 MillsvFCT[2012]HCA51.91 ChevronAustraliaHoldingsPtyLtdvFCT(No4)[2015]FCA1092.AppealtotheFullFederalCourtwas

undecidedatthetimeofwriting.92 BEPS Action Item 4 OECD publication 2015. The UK’s HM Treasury, as part of its Budget 2015

announced‘newbusinesstaxroadmap’,releasedanopenconsultationpaperon22October2015toseekviewsonhowbesttorespondtotheOECDproposalsforcountriestocountertheserisksandtomoderniseinterestdeductibilityrules.Australia’sThinCapitalisationrulesintroducedin2001werestrengthenedin2014topreventerosionoftheAustraliantaxbasefromdebtloadingbyintroducingasafe harbour for general entities (with debt deductions >$2m) of 1.5:1 and a worldwide gearingamountandasafeharbourlimitforbanksalongwithacapitallimit.


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over time, and the outcome is often dependent on theweight of evidence regarding theallegedmischiefinAustraliantaxlawterms,astheRevenueseekstointerpretsomenovelandinterestingaspectsofthetaxsystemthatgiveunintendedreliefanddonotfollowthemoreequitablepolicyprinciplesproposed.

It isdifficult topredictwhat future courtsmayhave toponderalthough…ourpivot towards a greater readiness to engage in Alternate Dispute Resolutionmeansthatwecandealmoreflexiblywithinevitabledisputationandensurethatthepathtoresolutionoftaxdisputeswillcontinuetoberefinedtopracticallygivefairandequitableoutcomes.93

Theremainingareatoembarkuponforourcountryisthenovelnotionofarbitrationforunresolved double tax cases, where a taxpayer has requested Competent Authorityinterventiontoassistinreducingoreliminatingtheeconomicoractual(two+country)taxonthesameprofits.AMutualAgreementProcedure(MAP)thatisnotresolvedwithinatwo‐yearperiod(iecountrylimitationswillapply)canfollowtheOECDBEPS14proposal.94ThisproposalinvolvesamandatorybindingMAParbitrationprovision,whichistobenegotiatedaspartofa‘multilateralinstrument’thatcountrieswouldratify(asenvisagedunderBEPSActionItem15).So,whilesomeyearsawayitpresentsapathforwardforaspectsoftreatydisputeswhereitisotherwisehardtomakeprogressorgetanyrealtraction.

XIII FUTUREEVOLUTIONOFTAX

Atonelevel,thetaxadministrationofthefutureisaboutanumberofinitiativesworkinginharmony.

Onevaluablekeyinitiativethatwillchangemanyissuesabouttrackingindividuals’PAYGpayments inthefuture isthe ‘SingleTouchPayroll’.Oncefullydeveloped, it iscapableofassuringemployees that taxandsuperannuationarebeingdeductedandremitted to theATOontheirbehalf.Inthisnewenvironment,payrolldatacanbesenttotheATOinrealtime.ThenprogressivepayslipinformationisremittedtotheATO,ratherthanleavingtheannualpaymentsummaryattheendofthetaxyearasthepointofreconciliation(fortaxandsuper).

Thetechnology initiativesof the futurewillalso incorporateelementsofwhathavebeenpilotedtoday,suchas‘voicebiometrics’.Thisstyleofspeechanalyticsleveragesthefactthateveryvoicehasuniquephysicalandbehaviouralattributes,whichincludeboth(stable)tonalaswellas(transient)environmentalcharacteristics.Acallercanvoluntarilyagreetoallowtheir voice characteristics tobe recorded to allow identification and retrieval of accountdetails to assist with service queries.95 Apart from voiceprints to allow for speedier93 House of Representatives Standing Committee on Tax and Revenue Report of March 2015

acknowledgesthatgivendifferentattitudestotaxanditscomplexity,disputesare‘inevitable’,at1andrecommendationsmade.

94 MakingDisputeResolutionMechanismsMoreEffective,OECDBEPSActionItem14–2015FinalReport,October2015.On31October2016theOECDreleasedaScheduleforcountrypeerreviewstogetherwiththeTermsofReferencetotranslateActionItem14minimumstandardinto21elementsthatareused to assess the legal and administrative framework of MAP programs in all countries beingreviewed.AMAPreportingframeworkwithstatisticsandprofilesaretobepublishedtoassistwithMAPguidance.

95 As at January 2016, 1.4m people had voluntarily agreed to enrol to use this technology for theiridentificationinrelationtodiscussingtheirowntaxaffairs,andthisnumberisexpectedtoincrease.


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identification,thereistheuseofvirtualassistantstoresolveonlineenquiriesandthelaunchoftheATOapp.Suchinitiatives,alongwiththemyGovfast,simpleaccesstoonlineservices,willbettershapetheefficiencyandeffectivenessofourinteractionswithclientsfromthetaxpayerpopulation.

Ifweextendthatthinkingintothefuture,itislikelytomeanourtaxadministrationcouldpotentially:

1. Embed a stream of contemporary digital services into our operations, thatallows individuals to be alerted to, and helped with their obligations inadvance;

2. Employacompleterangeofglobaldatasetsthatfeedintoanalyticprogramsforholisticassessmentofanydirectorindirecttaxriskandshiftresourcestoemerginghotspots;

3. Achieveimprovementsinfairnessandequitythrough:a) leveraging behavioural psychology approaches beyond just debt

collectioninitiativesandintoinnovation,tobalancesystemschanges;b) pursuing reliable assurances from business (eg ‘justified trust’)96 to

manage and control levels of large business compliance andinternationaltransparency;and

4. Demonstrate to government and the community that the tax andsuperannuationsystemcontinuestobewellmanaged.

In the future, any new principles and programs should have enough flexibility to meetwhatevereconomic,political,socialorbusinessneedarises.Taxadministratorswhohaveworkedintheserviceformanyyearshaveusuallyexperiencedthejoysofseeinginitiativeswork and also experienced the disappointment of seeing courageous ideas flounder,97notwithstanding some truly valiant briefings to those that decide our policy andadministrativesettings.

Overalldirectionsettingsuggeststhatfuturegrowthisdependentonastrong,sustainableandbalancedeconomysupportedbyarobusttaxsystem.WhattheATOdesiresasacapableandtrustedtaxadministratorrequiressettingsomestrategicgoalsoraspirations,whichinmyviewwouldincludethefollowing:

1. Anefficientapproachtopersonalincometaxreportingwithminimalcompliancecosts.98

2. Taxbeingafunctionofbusinessprofits,notaseparateglobalcostcentre,sothattaxfollowstheprofitswheretheyaremade,ratherthanbeingan‘orchestratedproduct’.

96 SeeforexampleanOECDReportin2013CooperativeCompliance:AFramework,whichdescribeshowtax administrations and large corporates base their relationship on mutual transparency,understandingandjustifiedtrust.

97 LeighEdmondsintheWorkingforallAustralians1910–2010:ABriefHistoryoftheAustralianTaxationOffice,ATOCanberrapublicationNovember2010,167providesaEulogyforataxbillstory,whereanATOseniorofficialrecountsreceivingabereavementcardfromafirstParliamentaryCounsel,afterthedeathof5taxbillsthatdidnotmakeitintolaw.Thebillsweredesignedtoassiststatestocollect‘receiptstaxes’andtheywereneverlegislated.

98 Digital advances will allow improvements in prefilling of individual income tax returns withemploymentdetails, financialdata(eg interest)andsharedata(egdividends)andaccessCLARIFYaccountdetails.


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3. Taxadministratorsunderstandingtaxperformanceandperceivedweaknessesinthetaxandsuperannuationsystems,through:

Creation of astute mechanisms for certainty to resolve disputes andadvise on ATO interpretation of the various tax laws applicable tosituations in an environment where the full facts are known andunderstood.

Anadvancedanalyticsprogramwhichiscapableoforganisingourever‐increasingwarehouseofdata99insuchawaythattheATOcanfindandusethosekeybitsofinformationthatwillhelpustargetouractivitiesandprograms in a more effective way to support operations includinglodgment,debt,disputes,adviceandassurancework.

Thethirstforbehaviouralinsightsintopatternsofcompliance,riskandmeasurementsoftaxgapsshouldcontinuewellintothefuture.

4. Havinganinclusive,well‐functioningprogramforstreamlinedandcollaborativeinteractionswithclientsacrossAustraliangovernmentagenciesandinternationalrevenueagencies.

5. Enhanced‘realtime’exchangeofdataandglobalbusinesstrends.Inanagewhereserviceprovidercompaniescanbouncepersonalinformationaroundtheirglobaldatacentres (subject toprivacyorregulatoryconstraints), taxadministrationsshouldusefinancialtransparencyinitiativestoemployincreasinglysophisticatedautomatic exchanges of information. A framework with other countries isproposedtobeinplaceby2017–18,alongwiththe‘minimumstandards’tobeimplementedwhich:

Create an improvement on the existing network of bilateral treatiesthrough thewidespread implementation of theBEPS actionplan areassuch as prevention of treaty shopping, country‐by‐country reporting,anti‐hybridrules,fightingharmfultaxpractices,etc.100

Modernise all relevant partner country tax rules. The degree towhicheach country is able to adopt the suggested BEPS measures usuallydependsonwhat carve‐outsbusinesses in that economyarewilling toallowandtheextentofadministrativecapability.

Checkglobaltrendsandmonitoringfordoublenon‐taxation.6. Capacity to build for new challenges, prevent threats to the tax and

superannuationsystemsandworktowardsfixingstressesontheadministrationthrough:

99 TheATOholdsandreceivesenormousamountsofdataeachyearanditisgrowingatarateofover

20%pa.InadditiontheATOreceivesover600mtransactionsofdataeachyearfromthirdparties.Suchinformationflowswillbefurtherenhanced,throughforexample,Country‐by‐Countryreporting,theForeign Account Tax Compliance Act (FATCA) intergovernmental agreement, Common ReportingStandard,ForeignInvestmentReviewBoard(FIRB),mandatorydisclosureandautomatedexchangeofrulings.

100 The instrumentwasannouncedbytheOECDasopenforsignaturebyall interestedcountrieswhowanttoassistwithitsimplementationfrom2016(referBEPSFinalpackageofreports:ExplanatoryStatement2015).ThisisBEPSActionItem15andincorporatesActionItems2,6,7and14.Theexistingglobal pool of around 3,600 bilateral double tax treaties have restrictions on how modern taxadministrationscanwork together to improve theirunderstandingof thedynamicof taxplanningthroughtransparency.Thelessonwasthatwegainbettermomentumandownershipwhenmovinginaresponsiveandcoordinatedwaytonewchallengestotheintegrityofourtaxsystems.


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Maintainingacapablequalifiedworkforcethatunderstandsthelong‐termimpact that compliance strategies, policy implementation andconcessionaryrulingshaveoncommunityconfidenceand the futureoftaxeffectiveness.

Modernising international tax rules to supportmultilateral approachesaroundcross‐borderharmfultaxpracticesandtransparency.

Working collaborativelywith sectorsof the community to improve theefficiencyandexperienceofthetaxandsuperannuationsystems.

7. Advancedrisksystemscapabilityoftheindividualandthesmallbusinesssectorsandadeeperunderstandingoflargebusinesstoprovide:

Moreaccurateandcomprehensivetaxgapmeasure;101and Swifterdisputeresolutionmechanisms.

8. Continuing interest and scrutiny in public Senate/parliamentary domain as towhethermultinationalsandglobalcitizensarepayingtheirfairshareoftax.Attheinternationallevel,thefocusontransparencyandcombatingtaxevasionisaconsensuspath.CheckingimplementationofminimumstandardsbyconductingglobalreviewsofcountryprogramsarethecurrentmonitoringapproachofOECDpeer review groups. If this approach achieves a better standardization ofdocumentationproceduresandifitprovidesimprovedtaxcertaintytoguaranteefuturerevenueflows,thenitislikelytobeanongoingassessmentframework.

XIV CONCLUSION

A blueprint for amodern tax administration to be efficient and effective suggests somedesirable features including adequate operational autonomy and adequate resources,togetherwithastablelegalframeworkforassessment,collectionandenforcement,whileatthesametimetheadministrationremainsaccountableforitsactionsandissubjecttocontrolandassessment.102Assumingthesefeaturesarepresent,theresultingoutcomeshouldbeavery good standard of tax administration, service to the community and advice togovernment.TheATO,drawingonitslonghistory,expectstocontinuetomeetcommunityexpectations with whatever the future of administration of the tax and superannuationsystemholds.

101 Recommendation5oftheJCPAAReport398wasfortheATOtoprovideamechanismtocalculatethetaxgaptoincreaseoverallefficiencyandpreventGSTfraud.IntheAnnualReportfor2014–15theATOaddedanumberofnewtaxgapestimatestoourGSTandluxurycartaxtaxgaps,andplanstoadviseothertaxgapsthistaxyear.

102 SeeFootnote9.EuropeanCommission‘FiscalBlueprints–apathtoarobust,modernandefficienttaxadministration’EuropeanCommunities2007forbestpracticeinternationalapplication.


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Report(UNSW,27November1995)GibsonBandIanWallschutzky, ‘ACaseStudyExplorationofTaxationComplianceIssuesinSmall

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Publishing2015)OECD,TaxAdministration2015:ComparativeInformationonOECDandotherAdvancedandEmerging

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C CommonwealthLegislationChildSupportAct1988DevelopmentAllowanceAuthorityAct1992IncomeTaxAssessmentAct1936IncomeTaxAssessmentAct1976IncomeTaxAssessmentAct1997Inspector‐GeneralofTaxationAct2003OmbudsmanAct1976TaxLawsAmendment(2012MeasuresNo.2)Act2012TaxLawsAmendment(CombatingMultinationalTaxAvoidance)Bill2015TaxationLawsAmendment(InfrastructureBorrowings)Act1997TaxationLawsAmendments(2006MeasuresNo.1)Act2006

D OtherAustralianTaxationOffice,LawCompanionGuidelineLCG2015/2:Section177DAoftheIncomeTax

AssessmentAct1936(ATO2015)Commonwealth, ‘Taxreform’.Filenote,SecretarytoCabinet,CabinetDecisionNo.6513,dated12

August1985:NAA:A13979,6513‐NationalArchivesofAustraliaGordon,J,‘SenatorslamsLaborforimpedingtaxreforms’,TheAge(Melbourne),22March2003OECD Revenue Statistics 2015, Press release 03/12/2015, report available at www.oecd‐

ilibrary.org/taxation/

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57

ISTHECITIZEN‐CONSUMERTHEFUTURETAXPAYER?

JONATHANBARRETT*

ABSTRACT

TheconceptionofcitizenshippopularisedbyThomasMarshallincludesasocialelement,intermsofwhichcitizensaretaxpayer‐beneficiariesoftheWelfareState.InthecontextoftheneoliberaldismantlingoftheWelfareState,socialcitizenshiphasbeengreatlyreducedinstatus. Today, citizensmaybe conceived simply as consumers of the goods and servicessupplied directly or indirectly by the State.Merging and developing traditional ideas ofcitizenshipandconsumerism,theEuropeanUnionhaspromotedtheimageofthecitizen‐consumer.Citizen‐consumersareexpectedtoactivelyprotecttheirowninterestsbutalsotobealerttothesustainabilityofthecommunityandtheenvironment,andtobealtruistic.Thisexploratory article considers how this emerging model of citizenship might apply totaxpayers.

* School of Accounting and Commercial Law, Victoria University of Wellington. Contact:[email protected]. I wish to thank the anonymous reviewer whose comments greatlyimprovedthisarticle.Anyremainingerrorsaremine.


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I INTRODUCTION

ThesocialelementofThomasMarshall’strifurcatedconceptionofcitizenshipwasreflected in the different tax‐welfare systems established in Western countriesduringthetwentiethcentury.1FrancisCastlesdifferentiatesbetweenAustralasian,British,andNordicwelfaremodels;2neverthelesseachschemewasinformedbytheidea that workers would willingly pay income taxes (and social insurancecontributions) in exchange for the promise of some form of State protection.Although the Marshallian model remains the archetypal starting point fordiscussions of citizenship,3 in the context of the neoliberal dismantling of theWelfare State, this conception of social membership has become moot. Indeed,taxpayersmaybeconceivedasnomorethanconsumersofthegoodsandservicessupplied directly or indirectly by the State. Government holds no conception ofsharedsocialsolidarity;4itmerelyrespondstoconsumerdemandsignals.Ratherthanbeingthebeneficiariesofwelfare,citizensare‘self‐responsibilised’tofendforthemselves in the market.5 Full social citizenship may, from a contemporaryAnglophone perspective, seem as historically remote as the prospect of sovietsocialism’seliminatingcapitalism,6butcitizenshipdoesnotneedtobereducedtoindividualisticconsumption.Pastmanifestationsofcitizenshiparegoneandcannotberesurrectedintheiroldforms,butnewwaysofcivicbelongingandparticipation,includingtaxpaying,canbeimagined.

Merging and developing traditional ideas of citizenship and consumerism, theEuropeanUnionhaspromotedtheimageofthecitizen‐consumer.AccordingtoJimDavies,citizen‐consumersactivelyprotecttheirowninterestsbutarealsoalerttothesustainabilityofthecommunityandtheenvironment,andtheyarealtruistic.7Couldthisimage,whichdoesnotseektoresurrectaprobablypassémodelofsocial

1 See,generally,THMarshall,TheRighttoWelfareandOtherEssays(HeinemannEducationalBooks,1981).

2 See Francis G Castles, The Working Class and Welfare: Reflections on the PoliticalDevelopmentoftheWelfareStateinAustraliaandNewZealand1890–1990(AllenandUnwin,1985)77.Broadly,theAustralasian‘labourdefence’welfareschemeensurestheeconomicstrengthofworkers so that theycan fend for themselves in themarket,whereasNordic‘structural’welfareshelterscitizensfromthevicissitudesofthemarket.

3 See,forexample,EnginFIsinandBryanSTurner,‘InvestigatingCitizenship:AnAgendaforCitizenshipStudies’(2007)1(1)CitizenshipStudies5.

4 SeeDavidHarvey,ABriefHistoryofNeoliberalism(OxfordUniversityPress,2005)80.5 See,generally,RikPeeters,‘ResponsibilisationonGovernment’sTerms:NewWelfareand

theGovernanceofResponsibilityandSolidarity’(2013)12(4)SocialPolicyandSociety583.6 Recognising that soviet socialism lost the ColdWar does not imply support for Francis

Fukuyama’s‘endofhistory’thesis:seeFrancisFukuyama,TheEndofHistoryandtheLastMan (FreePress, 1992).Authoritarian capitalismappears tobeprospering, inter alia, inChinaandVietnam. Itwould, therefore,beabraveundertakingtopredictwhich illiberalideologiesmightcontinuetothriveortakerootasthetwenty‐firstcenturyprogresses.

7 See, generally, Jim Davies, The European Consumer Citizen in Law and Policy (PalgraveMacmillan,2011).Daviestendstoreferto‘consumer‐citizens’.Ireversethewordordertoprivilegecitizenshipoverconsumerism.


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citizenshipbutdoesaimtocounterthesterilityofcitizenshipasconsumerism,beappliedtotaxpayers?

This article,which is exploratory innature, considers the conceptof the citizen‐consumerinrelationtotaxpaying.ThejurisdictionalfocuslieswithNewZealand,butoverseasexperience,particularlythatoftheUnitedKingdom, isdrawnupon.The paper is structured as follows: First, comparisons are made betweenMarshalliansocialcitizenship;theneoliberalimageofthecitizenasconsumer;andthecitizen‐consumerenvisagedbyEuropeanUnionpolicymakers.Theaimhereisto present a concept of citizenship distinct from both social democratic andneoliberal models. Second, the article draws parallels between differentconceptionsoftheconsumerandanalogousrepresentationsofthetaxpayer.8Third,thepossibilityof the taxpayerasacitizen‐consumer isconsidered.To theextentthatthisapproachtakestheideaofcollectiveactionseriouslyandisopposedtoanti‐tax libertarianism, it may be described as communitarian. But it is a nuanced,arguablydiluted,versionofpre‐neoliberalconceptionsofcommunitymembership.Fourth, reservations are noted about the socially‐undesirable possibilities ofactivisminthefieldoftaxpaying,especiallytheroleofshaming.Finally,tentativepolicyrecommendationsaremadeandconclusionsaredrawn.

II TOWARDSCITIZEN‐CONSUMERS

ThispartofthearticledrawscomparisonsbetweenMarshall’sconceptionofsocialcitizenship; the neoliberal image of the citizen as consumer; and the consumer‐citizenenvisagedbyEuropeanUnionpolicymakers.Theaimhereistopresentaconcept of citizenship distinct from both the social citizenship and neoliberalmodels.

A SocialCitizenship

Marshall outlined a conception of citizenship which included a civil component(rightsnecessaryforindividualliberty),apoliticalcomponent(electoralrights)andasocialelement(rangingfromarighttobasicwelfaretoliving‘thelifeofacivilisedbeing according to the standards prevailing in society’).9 Engin Isin and BryanTaylorsumupthisconceptionofcitizenshipas‘belongingtoasocietythroughtheentitlementsassociatedwithservice’.10Inthisscheme,citizenswillinglypaytaxesintheknowledgethat,shouldcertaincontingenciesoccur,suchasworkplaceinjuryorsuperannuation,theyareguaranteedbenefitsfromtheState.11

8 While demurring from using such grand terms as Foucaultian ‘epistemes’ or Kuhnian‘paradigms’,itissubmittedthatgovernmentapproachestotaxpayersaredistinguishableindifferentperiods.

9 Marshall,aboven1,74.10 IsinandTurner,aboven3,5.11 See Bernard Cadogan, ‘Welfare Policy: Governance History and Political Philosophy’

Treasury (2013) 86; Karen Boll, Taxing Assemblages – Laborious and MeticulousAchievementsofTaxCompliance(PhDThesis,ITUniversityofCopenhagen,2011)107.


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Marshallwas a sociologist, rather thanapoliticalphilosopher.His conceptionofcitizenshiphasneverthelessassumedanormativequality.12TheMarshallianmodelofsocialcitizenshipis,then,commonlyusedtotelluswhatcitizenshipoughttolooklike.ButMarshall’sconceptionofcitizenshipisspecifictoaparticulartime,placeand,probably,socialclassandgender(1945–1985,developedcountries,workingclassmen);13itisneitheruniversalnorfixed.Thisqualityofcontingencyhasbeenstarkly demonstrated by the diminution of the status of the worker–taxpayer‐beneficiaryinthefaceofneoliberalglobalisation.

B NeoliberalCitizenship

Globalisation is, in the definition of Robert Patman and Chris Rudd, ‘theintensification of interconnections between societies, institutions, cultures, andindividuals on a worldwide basis’.14 Few would deny the overall benefits ofglobalisedtechnology,suchastheInternet,ortheworldwidepromotionofhumanrights. Globalisation debate principally lieswith the ‘costs and benefits of tradeliberalizationandforeigninvestment’15and‘capital’sfreedomtomovearoundtheworld’,16whicharetheprincipalfeaturesofneoliberalglobalisation.Thisfreedomandvelocityofcapitalmovementisplannedanddeliberate,ratherthananaturalphenomenon, and has required the introduction of a suite of complementarypolicies.Andso,asWilliamTabbobserves,neoliberalglobalisation‘callsfortradeand financial liberalization, privatization and deregulation, openness to foreigndirect investment, a competitive exchange rate, fiscaldiscipline, lower taxes andsmallgovernment’.17‘Individualresponsibilityisstressed,whilecommunitarianismor state‐run social or cultural initiatives are discouraged.’18 The principalbeneficiariesofneoliberalglobalisationaretheownersofmultinationalenterprises(MNEs).19

12 See,forexample,VirginiaMantouvalou,‘WorkerswithoutRightsasCitizensattheMargins’(2013)CriticalReviewofInternationalSocialandPoliticalPhilosophy366,368.

13 SocialcitizenshipinNewZealandhastraditionallybeeninformedbypatriarchalnotions:see,generally,JaneMargaretScott,‘DiscoursesofDependency:Women,Work,andWelfareinNewZealand’(PhDthesis,UniversityofAuckland,2001).

14 RobertGPatmanandChrisRudd, ‘Introduction–NewZealandSovereignty in theEraofGlobalization’ in Robert G Patman and Chris Rudd (eds) Sovereignty under Siege:GlobalizationandNewZealand(Ashgate,2005)1,2.

15 Brian Roper, ‘Globalization and the Shift in Policy‐Making from Keynesianism toNeoliberalism:TheDeclineofNationalandStateAutonomy’inRobertGPatmanandChrisRudd(eds)SovereigntyunderSiege:GlobalizationandNewZealand(Ashgate,2005)23,33–4.

16 AlainTouraine,BeyondNeoliberalism(DavidMaceytrans,PolityPress,2001)14[transof:Commentsortirduliberalisme?(firstpublished1999)].

17 WilliamKTabb,EconomicGovernanceintheAgeofGlobalization(ColumbiaUniversityPress,2012)3.

18 Alison Hearn, ‘Brand Me “Activist”’ in Roopali Mukerjee and Sarah Banet‐Weiser (eds)CommodityActivism:CulturalResistance inNeoliberalTimes (NewYorkUniversityPress,2012)23,26.

19 See, generally, Naomi Klein, The Shock Doctrine: The Rise of Disaster Capitalism(MetropolitanBooks,2007).


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Neoliberalismisfoundedonthepresumptionthathumanbehaviourisdominatedbyself‐interest,andsocialinteractionsarevalue‐maximisingexchanges.20Indeed,society is imagined as an agglomeration of markets. Through its privileging ofindividualchoice,neoliberalismmayseemtorespectandpromoteautonomy,butitisnot, asBarryHindessobserves, ‘anatural outgrowth’ of liberalism.21Whereasliberal thinkerssuchasAdamSmith,DavidHumeandAdamFergusonconceivedhomoeconomicusasanautonomoussubject,whoseactivitiesshouldbefreefromgovernment interference, ‘neo‐liberalhomoeconomicus’, ColinGordonargues, ‘ismanipulableman’.22Neoliberalpoliciesengendercivicdocility;23theyalsotendtoestrange citizens from government, for example, when welfare functions areoutsourcedtocharities.Itisplausiblethatthird‐sectororganisationsorfor‐profitcorporations may deliver certain services more effectively than centralgovernment,24butanysuchefficiencygainsmayhaveacostfordemocracy.Indeed,Gino Dal Pont observes that, since the neoliberal ascendency in themid‐1980s,governmentshaveincreasinglyreliedoncharitiesastheyretreatfromtheroleofthe‘welfarestateasthereliableproviderofbenefit’.25ColinCrouch,inturn,arguesthatthelesstheStatedirectlyprovidesfortheneedsofordinarypeople,themoreapatheticthosepeoplewillbecomeaboutdemocracy.26Likewise,RichardMurphyobserves,‘themoreapersonperceivesadirectrelationshipbetweenthetaxtheypay and the government, themore likely it then is that the personwill vote inelections’.27

Intheneoliberalview,consumerismandcitizenshipmaycoincide.28RelativetotherichversionofcitizenshipidentifiedbyMarshall,thisconceptionofcitizenshipmustbeconsideredasterilevisionofsocialmembership.Liberalswhodenythatsocietyisacommunitywouldalsorejectthismonadicimageofthecitizen.Thus,forJohn

20 SeeJonathanBoston,JohnMartin,JunePallotandPatWalsh,PublicManagement:TheNewZealandModel(OxfordUniversityPress,1996)17.

21 BarryHindess,‘ASocietyGovernedbyContract?’inGlynDavis,BarbaraSullivanandAnnaYeatman(eds)TheNewContractualism?(MacmillanEducationAustralia,1997)14,15.

22 ColinGordon,‘GovernmentalRationality:AnIntroduction’inGrahamBurchell,ColinGordonand Peter Miller (eds)The Foucault Effect: Studies inGovernmentality (Harvester Press,1991)1,43.

23 Forexample,itiswidelythoughtthatstudentstypicallynolongerthinkoftertiaryeducationasa‘transformativeadultlearningexperience’whichmayenablethem,inturn,totransformsociety;rathertheyseetheiruniversitystudies‘asthepursuitofaqualificationthatcanbeexchanged for higher salary and status’: see StephenDBrookfield,ThePowerofCriticalTheoryforAdultLearningandTeaching(OpenUniversityPress,2005)25.

24 See,generally,AnupMalaniandEricAPosner,‘TheCaseforFor‐ProfitCharities’(2007)93VirginiaLawReview2017.

25 GinoDalPont,CharityLawinAustraliaandNewZealand(OxfordUniversityPress,2000)3.26 SeeColinCrouch,Post‐Democracy(PolityPress,2004)19.27 RichardMurphy,TheJoyofTax:HowaFairTaxSystemCanCreateaBetterSociety(Bantam

Press,2015)65.28 SeeUlrichHaltern, ‘PathosandPatina:TheFailureofConstitutionalism in theEuropean

Imagination’ (2003) 9(1)European Law Journal 14, 43. The ACT political party in NewZealandexplicitlyconnectsconsumptionandtaxpaying–itsfullnamebeingtheAssociationofConsumersandTaxpayers.Aconsumerandtaxpayer,thenameimplies,isoneinthesameactor;consumptionandtaxpayingarenottheseparatefunctionsofprivatechoiceandcivicobligation.


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Rawls, society is not a ‘private society’, rather it is a system of justice andcooperation.29 For those who support the idea of a progressive, discursivedemocracy,30theneoliberalhegemonyisadispiritingdevelopment.Yet,asMichelFoucault observes, the ‘intransigence of freedom’ will always assert itself.31Likewise, Steven Lukes’s analysis of ‘three dimensions of power’ leads to theconclusionthatdominationofpeople’sdeep‐seateddesirescanneverbe‘morethanpartiallyeffective’.32Allsocietieshaveethical–religioustraditionsofaltruismandsocialsolidaritywhicharenotextinguishedbyparticular formsofgovernment,33and will continue to resist selfish individualism. Similarly, Crouch identifies an‘emerging political imperative to protect the human self from the institutionalinvasion of themarket and the giant corporation, and to insist that themarketcannotbetheonlyinstitutionthroughwhichwepursuehumanvalues.’34

Examplesmaybeadducedofspecificpolicieslyingdormant,35but,ingeneral,weshould expect traditional values to be expressed in new forms in opposition toneoliberalism. Thus, Howard Glennerster argues that while collective actionthroughtradeunionismhasdeclined,otherformsofsocialsolidaritywillevolve.36TheBrexit–Trumpreactionagainstneoliberalglobalisationisanexampleofanewformofpoliticsemerging–onewhichappears tobe leading toanunpredictablenationalism, not, say, a return to a progressive, inclusive, collectivism seen, forexample,in‘theGreatSociety’andthecivilrightsmovementintheUnitedStates.37Post‐Brexit, a feature of Danish communitarianism, the sentiment of hygge(cosiness),hasattractedmuchattentionintheUnitedKingdom.38TheDanishtax‐

29 See John Rawls, Justice as Fairness:ARestatement (ed Erin Kelly, The Belknap Press ofHarvardUniversityPress,2001)199.

30 On an ideal discursive democracy, see, generally, Jürgen Habermas, Between Facts andNorms:Contributions toaDiscourseTheoryofLawandDemocracy (WilliamRehg, trans,Polity Press, 1997) [trans of: Faktizität und Geltung. Beiträge zur Diskurstheorie unddemokratischenRechtsstaats(firstpublished1992)].

31 Michel Foucault, ‘The Subject and Power’ in James D Faubion (ed)Power (trans RobertHurleyetal)(TheNewPress,2000)326,342.

32 StevenLukes,Power:ARadicalView(PalgraveMacmillan,2nded,2005)150.33 SeeCharlesTaylor,‘FoucaultonFreedomandTruth’(1984)12(2)PoliticalTheory152,180–

1.34 ColinCrouch,‘PuttingNeoliberalisminitsPlace’(2014)85(2)PoliticalQuarterly114,121.35 Forexample,theLabourgovernmentintheUnitedKingdomreverseditspositionona10

percentstartingincometaxrate:seeFrankField,‘Abolishingthe10pTaxRateShatteredtheContract on Which New Labour was Based’ The Spectator (online), 7 May 2008<www.spectator.co.uk/2008/05/abolishing‐the‐10p‐tax‐rate‐shattered‐the‐contract‐on‐which‐new‐labour‐was‐based/>.

36 SeeHowardGlennerster,‘TheSustainabilityofWesternWelfareStates’inFrancisGCastles,StephanLeibfried,JaneLewis,HerbertObingerandChristopherPierson(eds)TheOxfordHandbookoftheWelfareState(OxfordUniversityPress,2010)689,698.

37 SeeCornellWest,‘Goodbye,Americanneoliberalism.Aneweraishere’TheGuardian(online),17November2016<https://www.theguardian.com/commentisfree/2016/nov/17/american‐neoliberalism‐cornel‐west‐2016‐election>.

38 See, for example, Charlotte Higgins, ‘The Hygge Conspiracy’ The Guardian (online), 22November 2016 <https://www.theguardian.com/lifeandstyle/2016/nov/22/hygge‐conspiracy‐denmark‐cosiness‐trend>.


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welfare model has moved towards Anglo‐style workfare or ‘activisation’,39 butDenmarkremainsahigh‐taxcountry.40Suchfiscalprogressivitynodoubtpromotesequality and its benefits,41 but whether such attractions will translate intocommunitarianpoliciesinneoliberalcountriesisamatterofspeculation.

C Citizen‐Consumers

TheEuropeanUnionhasactivelysoughttoforgeanewversionofcitizenship‘basedon a fusion of neoliberalmarket citizenshipwith a communitarian element thatattemptstocountervailthemostharmfuleffectofneoliberalderegulation’butdoesnotresurrect‘thesocialrightsoftheKeynesianwelfarestate’.42ThusNorbertReichobserves that ‘there is a legal framework for a European Charter for citizens asconsumersintheareasofeconomic,ecologicalandlegalprotection’.43Daviessumsup the changing position of the consumer in the European Union as thephenomenonofmoving‘fromcogtocognisanceoftheconsumercitizen’,44sothat‘amongst the capable consumer behaviours there are traits more normallyassociatedwiththecitizen’.45ForDavies:46

consumer‐citizenshipcanbeexplainedintermsoftheopportunityandpower, of the capacity to influence and change the law and policythrough,ontheonehand,representativeandexpertnetworkstructuresofnewgovernanceand, on theotherhand, themarket throughdirectaction in the form of complaints enforcement of consumer rights,redress,switchingandethicalbuying.

Ifconsumptionwasonceanapoliticalmeansofsatisfyingmaterialdesires,toagreatextent, itno longer is.Neoliberal globalisationmayhave shiftedpower from the

39 SeeJohannesKananen,‘Nordicpathsfromwelfaretoworkfare:Danish,SwedishandFinnishlabourmarket reforms in comparison’ (2012) 27(5–6) LocalEconomy 558; Philip Tees,‘Danishgovernmentannouncesreformofbenefits:Itshouldpaytowork’CPHPostOnline(2 October 2015) <http://cphpost.dk/news/danish‐government‐announces‐reform‐of‐benefits‐it‐should‐pay‐to‐work.html>.

40 Denmark’s tax to GDP ratio of 49.9 per cent is the highest in the European Union: seeEuropean Commission, Tax Policies in the European Union: 2016 Survey (2016) 11<https://ec.europa.eu/taxation_customs/sites/taxation/files/tax_policies_survey_2016.pdf>.

41 Onthesocialbenefitsofequality,seeRichardWilkinsonandKatePickett,TheSpiritLevel:WhyGreaterEqualityMakesSocietiesStronger(AllenLane,2nded,2011).However,itmaybenotedthatneoliberalAustraliarankshigherthancommunitarianDenmarkintheUnitedNationsDevelopmentProgramme(‘UNDP’)HumanDevelopmentIndex:seeUNDP,‘Table1:HumanDevelopmentIndexanditscomponents’(2016)<http://hdr.undp.org/en/composite/HDI>.

42 Peo Hansen and Sandy Brian Hager, The Politics of European Citizenship: DeepeningContradictions in Social Rights and Migration Policy (Berghahn Books, 2012) 113. SeeHaltern,aboven28,24–6onwhythelackoforganicsupportforEuropeancitizenshiphas,inpart,drivenempowermentofconsumers.

43 NorbertReich, ‘AEuropeanConceptofConsumerRights:SomeReflectionsonRethinkingCommunity Consumer Law’ in Jacob S Ziegel (ed) New Developments in InternationalCommercialandConsumerLaw(HartPublications,1998)431,466.

44 Davies,aboven7,22.45 Ibid,23.46 Ibid,90.


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StatetoMNEs,but,asFoucaulttellsus,theexerciseofpowerinvitesreactionandrecalcitranceonthepartofthosewhoarethesubjectsofpower.47AccordingtoSueMcGregor, ‘when transnational corporations flouted their ability to escape stateregulation, they... highlighted their own responsibility for... corporate socialresponsibility’,48 ‘a phenomenon that has triggered the politicisation ofconsumption.’49

Daviesidentifies‘adevelopingconsumercitizenshippracticebasedontheideaofindividualsacting,aloneorcollectively,intheroleofapoliticisedconsumer’.50Thebreadth of this citizenship‐consumer practice is not confined to immediateconsumer transactions; it ‘extends to post‐transactional and extra‐transactionalbehaviours that embrace thepursuit of consumer rights, redress, empowermentandrepresentation’.51

Doesthisnewformofconsumerismrepresentaresurrectionofcommunitarianism?William Davies rejects that possibility outright, saying ‘[communitarianism]remindsusoftheenduringvalueofcustomsandheritage;consumerismrevelsinephemera.Theyrepresenttwomutuallyexclusivevisionsofethicalsovereignty’.52ForDavidHarvey,itistheineffectivenessofsporadiccommunitarianinitiativesinthefaceoftheneoliberalhegemonythatisrelevant.Hesaystheyachievenothing‘excepttochallengeethicalindividualismthroughsmall‐scalecollectivesolidaritiesthatoftenturnouttobemoreprotectiveofindividualprivatepropertyrightsandvaluesthangenerativeofnewkindsofsocialrelations’.53Bothauthors’argumentsare plausible, but the critical consideration is that in the context of neoliberalhegemony, collective action is categorically different from traditionalcommunitarianism.

Orthodoxcommunitarianism‘regardssocietyasacommunity,andthis,astheverywordimplies,meansthatsocietyisinsomeaunity,asinglethinginwhichindividualmembersareboundtogether’.54‘[S]ocialbondsarevaluableinthemselves,overandabovetheirvalueasmeanstotheattainmentofother,merelyindividualgoods,aretherebydowngraded’.55Theclassicalsociologicaldistinctionbetweensocialgroupsis made between Gemeinschaft (community, such as church congregation) and

47 Michel Foucault, ‘The Subject and Power’ in James D Faubion (ed)Power (trans RobertHurleyetal)(TheNewPress,2000)326,342.

48 CitedbyDavies,aboven7,63.49 Ibid(italicsinoriginal).50 Ibid,141–2.Typesofconsumersdo,ofcourse,varyfromthevulnerabletotheempowered.

As Davies notes, citizen‐consumers are at the empowered end of the spectrum: see JimDavies,‘EntrenchmentofNewGovernanceinConsumerPolicyFormulation:APlatformforEuropean Consumer Citizenship Practice?’ (2009) 32(3) JournalofConsumerPolicy 245,245. Acriticalconcerniswhathappensto‘incompetent’consumers.

51 Davies,aboven7,108.52 WilliamDavies, ‘BeyondCommunitarianismandConsumerism’(March2006)Renewal:A

Journal of Social Democracy <https://www.academia.edu/1316395/Beyond_Communitarianism_and_Consumerism>. See also William Davies, ‘The EmergingNeocommunitarianism’(2012)83(4)PoliticalQuarterly767.

53 DavidHarvey,CosmopolitanismandtheGeographiesofFreedom(ColumbiaUniversityPress,2009)197.

54 GordonGraham,ContemporarySocialPhilosophy(BasilBlackwell,1988)12.55 StephenMulhallandAdamSwift,Liberals&Communitarians(Blackwell,1995)15.


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Gesellschaft(voluntaryassociation,suchasapubliccompany).56Fortoday’scitizen‐consumers,communitymaynotconstituteanendinitself;rathercooperationandsocial solidarity may represent instruments for achieving individual goals. Inparticular,people commonly choose tobe transitoryandoccasionalmembersofonlinecommunities,whereas,inthepast,theobligatorynatureofmembershipwasthoughttobeoneofthedefiningcharacteristicsofcommunity.Thisshouldnotbetakenasapejorativeviewoncontemporaryjointaction;itissimplydifferentfromthepast.

III CITIZENSANDTAXPAYERSCOMPARED

Political rights are an element of the three forms of Marshallian citizenship.Taxpaying and political rights are closely associated.57 ‘No taxation without representation’was, of course, a rallying cry for theAmericanRevolution;58 and remainsacompellingpropositionfortheconnectionbetweencontributiontothecommontreasuryanddemocraticrights.59But themainconcernof thisarticle is socialcitizenshipanditsdecline.Andso,whilenotingtheimportanceofpolitical(andcivil)elementsofcitizenshiptotaxation,thispartfocusesontherelationshipbetweenwelfareandtaxation.

A TaxpayingandCitizenModels

Broaddifferencescanbeidentifiedbetweencitizenshipandtaxpayingintheerasofsocialcitizenshipandneoliberalism.Morespeculatively,emergingcharacteristicsoftaxpayinginthenewmillenniummaybeidentified.

1 SocialCitizenship

The strongest sentiment of social solidarity is likely to be experienced duringwartime, and this may be reflected in fiscal measures. For example, during theSecondWorldWar,thehighestmarginalrateofincometaxintheUnitedStateswas94percent–ameasurewhich90percentof Americansconsidered just.60Evenbeyondtheemergencyof war,veryhighratesof incometaxbecamenormalised,alongwith substantialwelfare transfers. Between 1974 and 1979 in the UnitedKingdom,thehighestmarginalrateofincometaxwas83percent;inaddition,a15

56 SeeTalcottParsons,‘NotesonGemeinschaftandGesellschaft’inMaxWeberTheoryofSocialand Economic Organization (Trans. AR Henderson and Talcott Parsons, William Hodge,1947)686–94.

57 Itmightbemoreplausibletoarguethat,historically,votinghasbeenmostcloselyconnectedwithpropertyownershipormilitaryservice:seeNeillAtkinson,AdventureinDemocracy:AHistoryoftheVoteinNewZealand(UniversityofOtagoPress,2003)53and181.

58 In an equally pithy rejoinder, inTaxation noTyranny; ananswer to theResolutions andAddressoftheAmericanCongress,SamuelJohnsonasked:‘Howisitthatweheartheloudestyelps for liberty among the drivers of the negroes?’ Cited in James Boswell,The Life ofJohnson(firstpublished1791,PenguinBooks,1984)176.

59 SeeMurphy,aboven27,19–20.60 PierreRosanvallon,TheSocietyofEquals(ArthurGoldhammer trans,HarvardUniversity

Press,2013)187[transof:Lasociétédeségaux(firstpublished2011)].


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percentsurchargewaspayableoninvestmentincome.61Inthispeakeraofsocialcitizenship, it was not only the quantity of tax paid and distributed which wasnotable,itwasalsothequalityofthediscoursebetweengovernmentandtaxpayer.TheUnitedKingdom introducedpayasyouearn (PAYE) towards theendof theSecondWorldWar.62BasilSabineoutlines themassivecommunicationsexerciseundertakenby the revenueauthority in the lead‐up to the introductionofPAYE,includingbroadcasts,articlesfornewspapersandperiodicals,postersandbranchofficesestablishedinverylargefactories–alldoneinthemidstofatotalwar.63

2 TaxandNeoliberalSubjects

Reductionofdirecttaxesisabadgeofneoliberalism.64Notionsof‘trickledown’andthe notorious Laffer curve informed substantial cuts to income tax.Will HuttondeniesthattheLaffercurvehadany‘empiricalortheoreticalsupport’,65whileJohnGalbraithdoubtswhether‘anyoneofsobermentalitytookProfessorLaffer’scurveandconclusionsseriously’.66Thetaxshortfall,especiallyinNewZealand,wasmadeup through regressive indirect taxes.The term ‘taxpayer’ is often conflatedwith‘income taxpayer’, even though, in, for example, the United Kingdom, personalincometaxaccountsforjust27percentofgovernmentrevenue.Thepeoplewhobeartheburdenofvalueaddedtax(VAT)(18percent)donotseemtobeconsideredtaxpayers.67 In New Zealand, personal income tax may account for a greater proportionofgovernmenttaxrevenue(45.2percent)butgoodsandservicestaxes(GST),theVATequivalent,accountsfor26.5percentoftaxrevenue.68

3 TaxintheNewMillennium

Havingderegulated,reducedcorporatetaxes,permittedthefreeflowofcapital,andencouragedmultinationalenterpriseempowerment,itisnosurprisethatneoliberalcountries should have found themselves embroiled in a race to the bottom.Consequently, in thenewmillennium, theOrganisationofEconomicCooperationandDevelopment(OECD)countrieshavefocusedtheirpolicyconcernsonshoring

61 SeeTClark,TheLimitsofSocialDemocracy?TaxandSpendunderLabour,1974–79(WorkingPaper01/04,InstituteofFiscalStudies,London,2001)<www.ifs.org.uk/wps/wp0104.pdf>.PAYEwasintroducedtoNewZealandin1958:seeRobVosslamber,‘HowMuch?TaxationonNewZealanders’ Employment Income1893–1984’ (2009)15NewZealand JournalofTaxationLawandPolicy299onNewZealand’shistoricalincometaxrates.

62 SeeBasilSabine,‘TheNewTaxpayersCharterorTaxationwithoutTears’(1991)BritishTaxReview411.

63 ‘PAYEwasfullyintroducedin1944…15mpeople,anyoneearning£100ayearormore,hadreceivednoticestellingthemtheircodenumberfortheyearuponwhichtheircumulativetax deductionswould be based.’ SeeDavid Gauke, ‘PAYE Story’ Taxation (21 September2011) <www.taxation.co.uk/taxation/Articles/2011/09/21/29571/paye‐story>. £250wouldhaveconstitutedtheupperlimitoflowincomesinthemid‐1940s:seeJRHicksandUKHicks,‘TheIncidenceofLocalRatesinGreatBritain’NationalInstituteofEconomicandSocialResearchOccasionalPaperVIII(CambridgeUniversityPress,1945)1.

64 SeeTabb,above17,3.65 SeeWillHutton,TheWorldWe’reIn(LittleBrown,2002)103.66 SeeJKGalbraith,TheCultureofContentment(Sinclair‐Stevenson,1992)10.67 SeeMurphy,aboven27,28–9.68 See Bill English, ‘Budget at a Glance: Investing in a Growing Economy’ Treasury (2016)

<www.treasury.govt.nz/budget/2016/at‐a‐glance/b16‐at‐a‐glance.pdf>.


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uptheirtaxbasesandpreventingprofitshiftingbyMNEs.69Paralleltogovernmentinitiatives, the phenomenon of tax shaming by media and activist groups hasemerged.70

B ConsumersandTaxpayers

ParallelscanbedrawnbetweenthedifferentconceptionsoftheconsumeridentifiedbyDaviesandconceptionsofthetaxpayer.Oneexampleistheparallelbetweenthepoliticisation of consumption and activism against aggressive tax planning. Thedifferent phases of interaction may also be compared: pre‐transaction(understanding one’s tax obligations); transaction (taxpaying); post‐transaction(expressing views on how tax revenues should be disbursed). Ultimately, bothconsumerismandtaxpayingmightinvolveparticipationintheformulationofpolicyandlaw.

Wemightsaythatconsumingisasoldasthehumanexchangeofthings,but ‘theconsumer’ and ‘consumerism’ only came to policy prominence in the 1960s ‘inresponsetochallengesfacingtoday’smoreaffluentconsumers’.71Taxpayershave,ofcourse,beenaroundformillennia,andhavebeentakenseriouslyasasubjectofresearch at least since the time of Adam Smith’s Wealth of Nations (1776).Consequently, comparisons of ‘paradigmatic’ treatment of taxpayers andconsumerscanonlybepaintedwiththeboldestofbrushstrokes.Daviesidentifiesfour levels of consumerism in a normative hierarchy, starting with protection,moving to information, then capability, and, finally motivation. Informingconsumers (level2)hasaparallel in themassive communicationsexercises thatwererequiredtoinformworkerswhentheywerebroughtintotheincometaxnetwiththeintroductiontoPAYE.Havingcompetentconsumers(capabilityatlevel3)isarequirementfortheneoliberalidealofmarketsbeingimaginedeverywhere.Ifcitizens are conceived as consumers, then GST,72 as a tax on comprehensiveconsumption, is likelytoconstituteasignificantelementforthetaxbase.Finally,justaslevel4consumersareexpectedtobeactiveinguardingtheirownandothers’rights,sotaxpayeractivismhasemergedasasignificantphenomenoninthenewmillennium.

69 Forexample,theUnitedKingdom’sdivertedprofitstax,colloquiallytermed‘theGoogletax’:see HM Revenue & Customs, ‘Diverted Profits Tax’ (2014)<https://www.gov.uk/government/uploads/system/uploads/attachment_data/file/385741/Diverted_Profits_Tax.pdf>.

70 SeeVanessaBarfordandGerryHolt,‘Google,Amazon,Starbucks:TheRiseof‘TaxShaming’’BBC News Magazine (21 May 2013) <www.bbc.com/news/magazine‐20560359>. Seebelown112onmucholderformsoftaxshaming.

71 GeraintHowells,IainRamsayandThomasWilhelmson,‘ConsumerLawinItsInternationalDimension’ inGeraintHowells, IainRamsayandThomasWilhelmson (eds)HandbookofResearchonInternationalConsumerLaw(EdwardElgar,2010)1,4.

72 BecauseGSTisataxonconsumption,itmightbearguedthatyou‘choose’whetherornottopay it: seeRichardA Epstein, ‘Taxation in a LockeanWorld’ in Jules Coleman and EllenFrankel Paul (eds)PhilosophyandLaw (Basil Blackwell, 1987) 39 on ‘Lockean taxation’correspondingwithconsumerchoices.Frictionlesstaxpayingmustbewelcomedbut,inthecaseofGST(typicallyaround20percentofgovernmentrevenue),itsinvisibilitydisguisestaxpayingandthatinvisibilitydiscouragesdemocraticdebateabouttaxation.


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Davies’s inclusion of the descriptors ‘solidaristic and communitarian’73 and‘individualistic’74 in level 4motivation,which applies to citizen‐consumers,mayappearoxymoronic.Butmembershipofpostmodernsocietydoesnotconformtostrict binomials such as liberal/communitarian; rather people tend to oscillatebetween singular needs and community engagement. In a useful metaphoremployedto interpretGianniVattimo’svisionofcontemporarysociety,75HeesokChanglikensoursocialexistencetobeingpassengersonatrain,aloneandyet,fromtimetotime,throwntogether.76

According to Éric Maurin, ‘[t]here has been a tremendous reorganization ofcollective identities in recent years, as our sense of social proximity hasfragmented.’77 Nevertheless, as Pierre Rosanvallon says, in explaining hisconceptionofequalityofsingularities:78

Ifthemeaningofaperson’slifeliesinhisdifferencefromothers,thenhemustcoexistwiththem…singularitybindsapersontoothers.Itdoesnotset him apart. It arouses in others curiosity, interest, and a desire tounderstand.Equalityofsingularitiesdoesnotimply“sameness”.

Rosanvallonadds:79

This form of equality defines a type of society whose mode ofcomposition is neither abstract universalism nor identity‐basedcommunitarianismbutratherthedynamicconstructionandrecognitionofparticularity.Thisshifthassignificant implications.First itsuggeststhatindividualsnowseektoparticipateinsocietyonthebasisoftheirdistinctiveratherthancommoncharacteristics.Thevalueofsingularityisthusdirectlysocial.Singularityisnotasignofwithdrawalfromsociety(individualismasretreatorseparation).Rather,itsignalsanexpectationofreciprocity,ofmutualrecognition.

Wehave,then,movedbeyondtraditionalcommunitarianism(nevertoreturn)butwemayalsobemovingbeyondneoliberalism.

IV TAXPAYERSASCITIZEN‐CONSUMERS

Thispartof thearticlebeginsbypresentingexamplesofactionswhichmightbeconsideredmanifestationsofcitizen‐consumerismintaxation.Theexamplesrange

73 Expandingon‘solidaristicandcommunitarian’,Davies,aboven7,48–9includes:altruism;ethicalandsustainableconsumption;communalinterest;perceivedeffectivenessofaction;wealth;trustworthinessofinformationsource;and‘goodguilt’.

74 ‘Individualism’ includes: self‐responsibility; personal safety; demand for quality andreducedcost;self‐interest;andperceivedeffectivenessofaction:seeibid.

75 See,generally,GianniVattimo,TheTransparentSociety(DavidWebbtrans,JohnsHopkinsPress,1992)[transof:Lasocietàtransparente(firstpublished1989)].

76 SeeHeesok,‘PostmodernCommunities:ThePoliticsofOscillation’(1993)4(1)PostmodernCulture<pmc.iath.virginia.edu/text‐only/issue.993/review‐3.993>.

77 CitedbyRosanvallon,aboven60,279.78 Ibid,260–1.79 Ibid,261.


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from the dissemination of comprehensive analysis by tax academics andpractitionerstodemonstrationsstagedbyactivistsasperformanceevents.

A Examples

1 TaxJusticeNetwork

TheTaxJusticeNetworkdescribesitselfas:80

an independent international network launched in 2003.We conducthigh‐levelresearch,analysisandadvocacyon international tax;ontheinternationalaspectsoffinancialregulation;ontheroleoftaxinsociety;andontheimpactsoftaxevasion,taxavoidance,tax ‘competition’andtaxhavens.Weseektocreateunderstandinganddebate,andtopromotereform,especiallyinpoorercountries.Wearenotalignedtoanypoliticalparty.

TheTaxJusticeNetworkmaynotbealignedtoaparticularpoliticalparty,butitisnotideologicallyneutral,particularlyinrespecttoitsconceptionofthecorporationand corporate duties. The dominant Anglo‐American theory of the corporation,which is consonant with and implicated with neoliberalism, is based on anassumptionofshareholderprimacy.81Inthisview,thecorporationisamerewebofcontracts, principally the contracts between directors and shareholders.82 Thecompany isnotacorporatecitizenwhichmighthavemoralobligations,83 say, torefrainfromaggressivelyavoidingtax.84Theguidingfunctionofdirectors, inthisscheme, is to maximise shareholder returns, even if that requires bending or,possibly, breaking the law. In contrast, the corporate social responsibilitymovement, whose principles are consonant with the aims of the Tax JusticeNetwork,seesthecorporationasacorporatecitizen.85TheCompaniesAct2006(UK)maymoveawayfromdoctrinaireshareholderprimacybyestablishinganobligationondirectorstotakeintoaccountabroadrangeofstakeholderswhenconsideringthebestinterestsofthecompany.Nevertheless,theprincipaldirectorialdutyis‘topromotethesuccessofthecompanyforthebenefitofitsmembers[shareholders]asawhole’.86WhiletheTaxJusticeNetworkispersuasiveinitsviewthatdirectors

80 SeeTaxJusticeNetwork,‘OurGoalsandMethods’<www.taxjustice.net/>.81 See,generally,HenryHansmannandReinierKraakman,‘TheEndofHistoryforCorporate

Law’(2001)89GeorgetownLawJournal439.82 See Daniel R Fischel, ‘The Corporate Governance Movement’ (1982) 35 Vanderbilt Law

School1259,1273.83 SeeFrankHEasterbrookandDanielRFischel,‘AntitrustSuitsbyTargetsofTenderOffers’

CorporateGovernanceMovement’(1982)80MichiganLawReview1155,1177.84 Forcounterarguments,seeWilliamBBarker,‘TheIdeologyofTaxAvoidance’(2009)40(2)

LoyolaUniversityChicagoLawJournal229;ZoePrebbleandJohnPrebble,‘TheMoralityofTaxAvoidance’(2010)43CreightonLawReview693.

85 See, for example, Reuven Avi‐Yonah, ‘Corporate Social Responsibility and Strategic TaxBehavior’inWolfgangSchön(ed)TaxandCorporateGovernance(Springer,2008)183.

86 CompaniesAct2006(UK),s172.


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of United Kingdom companies do not have a fiduciary duty to avoid tax,87 thewordingofsection172issufficientlybroadsoastopermitaggressivetaxplanning.

When groups, such as the Tax Justice Network, promote progressively‐biasedarguments,theyinviterebuttalfromoppositely‐alignedorganisations,particularlythosefundedbyBusinessRoundtablesandlibertarianfoundations.88

2 UKUncut

Malcolm James describes UK Uncut as a ‘grass‐roots pressure group … whichcampaignsagainst thepublicspendingcuts imposedby theConservative‐LiberalDemocratcoalitiongovernment’.89UKUncutcametoprominencethroughitsdirectactioninseekingtoshamecertainUnitedKingdomhighstreetstores.90Eitherthesecompaniesortheirprincipalshareholdershadengagedinaggressivetaxplanning.Mostly young people used Web 2.0 media91 to arrange and publicise theirdemonstrations.Inamoretraditionalapproach,UKUncutsoughtjudicialreviewofa decision by the United Kingdom’s revenue service (HMRC) to waive nationalinsurancecontributionsowedbyGoldmanSachs.Althoughthemovewasultimatelyunsuccessful,Jamesconcludes:92

UK Uncut has been extremely successful in shaping public opinion,because,sinceitwasfoundedinlate2010,therehasbeenanupsurgeofpublic interest in,andconsciousnessof, the taxarrangementsof largecompanies and wealthy individuals, thus subjecting them to greaterscrutiny. Similarly, HMRC has been called to account and the powerrelations which underpin the relationship between them and largecompanies.

Thehighstreetprotestsweredisruptive,93butthelong‐termeffectivenessofsuchperformances,94whichmayalienatemanyordinarypeople,mustbequestioned.95

87 See Farrer & Co LLP, ‘Fiduciary Duties and Tax Duties’ (2013)<www.taxjustice.net/cms/upload/pdf/Farrer_and_Co_Opinion_on_Fiduciary_Duties_and_Tax_Avoidance.pdf>.

88 The New Zealand Business Roundtable, under the leadership of Roger Kerr, providedconsiderableintellectualimpetustolibertarianideology,withRichardEpstein,asafrequentguestlecturer,makingasignificantcontribution.

89 MalcolmDavidJames,‘CuttingaGoodDeal:UKUncut,GoldmanSachsandtheChallengetoAdministrativeDiscretion’(2013)14(3)JournalofAppliedAccountingResearch248,258.

90 See, for example, the demonstrations in well‐known shops on London’s Oxford StreetavailableonYouTubeat<https://www.youtube.com/watch?v=ffYlE0lLBbI>.

91 Web2.0technologiesunderpinplatforms,suchasFacebook,WikipediaandTwitter,whichenable their users to participate in online activities, rather than passively consumeinformationproducedbyothers:see,generally,TimO’Reilly,‘WhatisWeb2.0?’inMichaelMandiberg(ed)TheSocialMediaReader(NewYorkUniversityPress,2012)32,32–52.

92 James,aboven89,263.93 SeeEllieMaeO’Hagan, ‘AMoment thatChangedMe– theDay IDiscoveredProtest’,The

Guardian (online), 16 July 2015 <www.theguardian.com/commentisfree/2015/jul/16/moment‐that‐changed‐me‐direct‐action‐uk‐uncut>.

94 Onprotestasperformance,seePiaWiegmink,ProtestEnACTed:ActivistPerformanceintheUnitedStates(WinterVerlag,2011)75–111.

95 OnthenegativepublicreactiontothepolltaxdemonstrationsintheUnitedKingdom,seeChrisRootes, ‘ShapingCollectiveAction:Structure,ContingencyandKnowledge’ inRicca


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3 CrickhowellGoingOffshore

Businesses in the small Welsh town of Crickhowell have emulated certain well‐known British firms and MNEs to establish the town’s own BEPS scheme.96 Theirobject is to protest against and to demonstrate the ease of aggressiveoffshoretaxplanning.TheFairTaxTowncampaignseekstoforcegovernment’shandinclosingtax loopholes.97 An implicit threat is that, if Crickhowell could ‘move offshore’, everytownandbusinessacrosstheUnitedKingdomcouldfollow.

4 ThePanamaPapers

In2016,theInternationalConsortiumofInvestigativeJournalists(ICIJ)releasedtheso‐called Panama Papers, a massive leak of information about the Panamanian‐basedlawfirmMossackFonseca,itsclients,andtheirinvolvementintaxevasiononagrandscale.98ThefirstpoliticalcasualtyoftheserevelationswasIceland’sPrimeMinister, SigmundurDavíð Gunnlaugsson, who resigned in the face ofdemonstrations against hisconcealment of offshore wealth.99 Following the ICIJ leaks, in Australia, ‘1000entities, involving hundreds of taxpayers – many of which include high‐wealthindividuals and their lawyers and accountants – [were] under investigation by theAustralianTaxationOffice’.100

5 Anti‐taxGroups

In contrast to the previously mentioned groups, whose fundamental aim is aprogressive distribution of tax burdens, other groups wish to cap or reducetaxes. From a Marshallian perspective, it is submitted that these groups exercisetheirpoliticalcitizenshipbuthavenoconcernforthesocialaspectsofcitizenship.Thisconflict must be understood in the context of a simple fact about Westerndemocracy: the poor and the young do not vote in the same proportionsasdothewealthy and old.101 In the context of local government, this electoral vacuum

Edmonson (ed) The Political Context of Collective Action: Power, Argumentation andDemocracy(Routledge,1997)81,90–1.

96 SeeAdamSherwin,‘Crickhowell:WelshTownMoves‘Offshore’toAvoidTaxonLocalBusiness’,Independent(online),12November2015<www.independent.co.uk/news/uk/crickhowell‐welsh‐town‐moves‐offshore‐to‐avoid‐tax‐on‐local‐business‐a6728971.html>;KimikodeFreytas‐Tamura,‘WelshTownLeadsaBritishRevoltagainsttheTaxSystemandCorporations’TheNewYorkTimes(online),21February2016<www.nytimes.com/2016/02/21/world/europe/welsh‐town‐leads‐a‐british‐revolt‐against‐the‐tax‐system‐and‐corporations.html?_r=0>.

97 FairTaxTown,‘SigntheFairTaxTownPledge’(2015)<http://fairtaxtown.com/>.98 International Consortium of Investigative Journalists, ‘The Panama Papers’ (2016)

<https://panamapapers.icij.or>.99 JonHenley,‘IcelandPMStepsAsideafterProtestsoverPanamaPapersRevelations’,The

Guardian(online),5April2016,<www.theguardian.com/world/2016/apr/05/iceland‐prime‐minister‐resigns‐over‐panama‐papers‐revelations>.

100 NassimKhadem,‘AustralianswithlinkstoPanamaPaperscouldbechargedfollowingraidsthis week’ The Sydney Morning Herald (online), 6 September 2016)<www.smh.com.au/business/the‐economy/australians‐with‐links‐to‐panama‐papers‐could‐be‐charged‐following‐raids‐this‐week‐20160906‐gr9sl0.html>.

101 InNewZealand,ifcurrenttrendscontinue,by2050,atleast40percentofpeoplewhovoteinnationalelectionswillbeaged65andolder: see JonathanBostonand JudithADavey,


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permits property owners to proscribe the scope of local democracy. California’sProposition13,whichlimitedincreasesinlocaltaxes,isperhapsthepre‐eminentinstance of the propertied class asserting their taxation interests through ademocraticprocess.102Becausetheyoungandthepoordonottendtovoteinlocalor national elections, taxation policy is likely to reflect the interests of older,propertiedcitizenswhodovote.Itis,therefore,unsurprisingthatanti‐taxgroupsbelievetheymightbeabletoinfluencetaxpolicy,particularlyatalocallevel.103Oneof these groups is the New Zealand Taxpayers Union, whose ostensiblyuncontroversialgoalsincludegoodfiscalgovernance.Butanothergoalis‘tolowerthetaxburdenonNewZealanders’.104Theimperativeofloweringthetaxburdenimpliessmallgovernment,theconservativeHolyGrail.105Murphypertinentlyaskswhetherthesesoi‐disant‘alliances’or‘unions’haveanymandatefromorconnectionwithtaxpayers.106

Oneofthekeychallengesfacedbyprogressivecivilgroupsistopresentaunitedfrontinthewaythatconservativetaxactivistsoftendo,notablyinpromotingaso‐called flat tax.Thus,despite sharing thegoalof just taxes,Murphyhas criticisedCrickhowell’sFairTaxTown,likeningtheinitiativeto‘protestingaboutstreetcrimebygoingouttodosomestreetcrime:irresponsible’.107SigmundFreud’s‘narcissismofsmalldifferences’seemsparticularlyrelevanthere.

‘PoliticsofAgeing’inJonathanBostonandJudithADavey(eds)ImplicationsofPopulationAgeing:OpportunitiesandRisks(InstituteofPolicyStudies,2006)363,364.

102 See, for example, KevinDrum, ‘Happy 35thBirthday, TaxRevolt! Thanks forDestroyingCalifornia’, Mother Jones (online), 7 June 2013 <www.motherjones.com/kevin‐drum/2013/06/tax‐revolt‐35th‐anniversary‐prop‐13‐california>.

103 See,forexample,theAucklandRatepayers’Alliance,whichdescribesitselfasa‘coalitionofindividual Aucklanders and ratepayer groups dedicated to championing prudent fiscalmanagement of our Super City’: see Auckland Ratepayers’ Alliance, ‘About’<www.ratepayers.nz/about>.TheAucklandRatepayers’Allianceis,infact,acompanysolelyownedanddirectedbyJordanWilliams,thechiefexecutiveoftheNewZealandTaxpayersUnion.Williamsfeaturedsignificantlyinanexposéofrightwing‘dirtypolitics’:seeNickyHager,DirtyPolitics:HowAttackPolitics IsPoisoningNewZealand’sPoliticalEnvironment(CraigPottonPublishing,2014).

104 New Zealand Taxpayers Union, ‘What We Stand for’, <www.taxpayers.org.nz/what_we_stand_for>.The‘union’doesnotpublishtheidentityofitssponsors>.

105 The New Zealand Taxpayers Union is far less overt in its libertarian leanings than itsinspiration, theUnitedKingdom’s Taxpayers’ Alliance: see The Taxpayers’ Alliance, ‘OurMission’<www.taxpayersalliance.com/our_mission>.

106 Murphy,above27,68.107 QuotedbyVanessaHoulder,‘CrickhowellIstheTownthatWentOffshore’,FinancialTimes

(online), 13 November 2015 <www.ft.com/cms/s/0/911b609a‐89f6‐11e5‐9f8c‐a8d619fa707c.html#axzz3tbAXLPG0>.MurphyisthefounderoftheFairTaxMark,aprivateaccreditationbody:seeFairTax,‘What’stheFairTaxMark?’<www.fairtaxmark.net/what‐is‐it/>.


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B ReservationsaboutActivism

If,ascommunitarianshold,thecommunityprecedestheindividual,108theinterestsof the communitymay trump the interests of individuals.109 Indeed, communityprecedencemayleadtooppressionongrandandindividualscales.Shaming,whichcanbebothpettyandsevere,isparticularlyrelevantinthisregard.

1 Shaming

AmitaiEtzioniobservesthatnotonlyisshaminganarchetypalsanctioninstronglyknit communities, but public humiliation may also represent a necessary steptowards repentance and, ultimately, reintegration in the community.110 It isstressed that Etzioni contemplates traditional communities, such as churchcongregations;veryfewofuslivetodayinsuchcommunities.Inopencommunities,shamingisunlikelytoworkasrestorativejustice,especiallyinthedigitalage;thecapacity of social media to disgrace others is unbounded. These media makestigmatisationeasy, far reaching,andpotentiallydevastating in itseffectson the subjects of shaming.111 Public humiliation, which has historically constituted a potent weapon in the armoury of social control,112 is incompatible with thefundamentallegalprinciplesofproportionalityandtheruleoflaw.113

Martha Nussbaum presents plausible arguments against shaming.114 First, byhumiliatingaperson,shamingoffendstheirinalienabledignity.115Second,shamingisamanifestationof‘mobjustice’;itis‘nottheimpartial,deliberative,neutraljusticethataliberal‐democraticsocietytypicallyprizes’.116Third,shamingisanunreliable

108 Theessentialdifferencebetweenprogressiveliberalismandprogressivecommunitarianismisthattheformerconceivesoftherights‐bearingindividualasbeingpriortosociety:seeMulhallandSwift,aboven55,45.

109 Individual rightsareplausibly incorporated into communitarianism theory; indeed, theymaybemorerichlyunderstoodinthecontextofparticularcommunities:seePhilipSelznick,‘TheCommunitarianPersuasion’inEmiliosAChristodoulides(ed)CommunitarianismandCitizenship(Ashgate,1998)15,16.

110 See, generally, Amitai Etzioni, ‘Introduction’ in Amitai Etzioni andDavid E Carney (eds)Repentance:AComparativePerspective(Rowman&LittlefieldPublishers,1997).

111 See, for example, Jon Ronson, ‘“Overnight, Everything I LovedWas Gone”: The InternetShaming of Lindsey Stone’, The Guardian (online), 21 February 2015 <www.theguardian.com/technology/2015/feb/21/internet‐shaming‐lindsey‐stone‐jon‐ronson>.

112 AccordingtoJohannesVoet,intheDutchcitystates,thosefoundguiltyoftaxfraudfaced,alongwithfinancialorphysicalpenalties,shaming‐stylesanctionsrangingfromlossofranktopermanentexile:seeJohannesVoet,SelectiveVoet(edandtransPEGane,Butterworths,1955–8) Book XXXIX, Title 4, Section 21. Bankrupts could also face shaming, beingostracisedorexiled.IncontemporaryChina,shaming isapotentweaponofboththeStateandgroupswithinsociety: see, for example, Xiaoming Chen, ‘Social Control in China: Applications of theLabelingTheoryandtheReintegrativeShamingTheory’(2002)46(1)InternationalJournalofOffenderTherapyandComparativeCriminology45.

113 SeePhilipAJoseph,ConstitutionalandAdministrativeLawinNewZealand(Brookers,3rded,2007)945;TomBingham,TheRuleofLaw(PenguinBooks,2011)66–84.

114 Martha C Nussbaum, Hiding from Humanity: Disgust, Shame, and the Law (PrincetonUniversityPress,2004)230–7.

115 Ibid,230.116 Ibid,234.


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formofpunishment.117Justiceisnecessarilyinformedbyproportionality,whereashumiliatingsomeonemayresult in ‘calibrating inaccuratelythemagnitudeofthepenalty’.118Fourth,shaming isnotnecessarilyaneffectivedeterrent.Peoplewhosufferhumiliationatthehandsofthedominantgroupmaybecomemorealienatedthanbefore,leadingtothepossibilityofsub‐groupsbeingattractedbythestigmaimbuedbyhegemonicgroups.Nussbaum’sconcernsliewithdisadvantagedgroups,butthealreadysociallydistantelitecanalsobefurtheralienatedbystigmatisationandmay,forexample,becometaxexiles.

Opposition to shaming is, in essence, about maintaining human dignity andpromotingsocialinclusion.Sincecorporationsdonothavehumandignity,119JuliaAnnasandDeborahRhodearepersuasivewhen theyargue thatshaming juristicpersons is different from shaming people, andmay be an appropriate legal andsocialsanction.120Concernedwithitsimage,Starbucksmadeavoluntarycorporatetaxpaymentof£15million,andtransferreditsEuropeanheadquartersfromlow‐taxAmsterdamtoLondon–effectivelyassumingahighertaxburdenasapublicrelationsexercise.121

Corporationsshould,nevertheless,expectproportionatesanctions.Itmayalsobenotedthatthecorporateveilmaybeignoredandindividualsbehindthecorporationvilified.122Thenatureofacorporationistoocomplexanideatobeconsideredhere,but,ifthelawmakesacorporationajuristicperson,thatentityoughttobesubjecttotheruleoflaw.123

117 Attempts by the liberal media to disgrace Donald Trump for his tax planning wereunsuccessful and seem tohave contributed to his image as a shrewd leader. See SophiaTesfaye,‘AllofDonaldTrump’sapologists:RudyGiuliani,ChrisChristiearguethatavoidingtaxesmakeshima“genius”’Salon(4October2016)<www.salon.com/2016/10/03/all‐of‐donald‐trumps‐apologists‐possible‐tax‐avoidance‐makes‐trump‐a‐genius‐rudy‐giuliani‐chris‐christie‐argue/>.

118 Nussbaum,aboven114,235.119 DeliveringaunanimousdecisionoftheSouthAfricanConstitutionalCourt,LangaDP,saidin

InvestigatingDirectorate:SEOvHyundaiMotorDistributors(Pty)Ltd2001(1)SA545,[18]:‘Juristicpersonsarenotthebearersofhumandignity.’

120 CitedbyNussbaum,aboven114,244.121 VanessaHoulder,‘StarbucksEuropeanUnitPays$15mUKTax’FinancialTimes(onlineed,

29June2016)<https://www.ft.com/content/5222fd14‐3d3b‐11e6‐9f2c‐36b487ebd80a>.122 See,forexample,theconflationofPhilipGreenandBritishHomeStoresplc,asseeninMatt

HunterandSamTonkin,‘SirShiftycarriesoncruisingwhilelaststoresclose:FormerBHSbossPhilipGreensunshimselfonhis£100millionsuperyachtasthedepartmentstorehe'saccusedofsinkingdisappearsfromtheHighStreetafter88years’TheDailyMail(online),29August2016<www.dailymail.co.uk/news/article‐3762304/After‐88‐years‐BHS‐finally‐disappears‐today.html#ixzz4QtVTveJg>. The point is not to condone directorialmalfeasancebuttoensurethatitisproportionatelypunishedinaccordancewiththeruleoflaw.

123 MarkBovensarguesthat,sincedueprocesswasdevelopedtoprotectindividualsagainstarbitrarybehaviouronthepartoftheagentsoftheomnipotentstate,dueprocessshouldnotbeextendedtolargeorganisationsastheyarenotsimilarlyweakinrelationtotheState:see Mark Bovens, ‘The Corporate Republic: Complex Organizations and Citizenship’ inEmiliosAChristodoulides(ed)CommunitarianismandCitizenship(Ashgate,1998)158,162.Itwould,however,weakentheproceduralelementsof theruleof law if juristicpersons,whichmayholdpropertyintheirownnames,didnothavefullaccesstothecourts:seeFirstNationalBankofSouthAfricavCommissioner,SARS2002(4)SA768(ConstitutionalCourt).


75

2 ActivismtoSlacktivism

TheInternethastransformedactivism,notablythroughonlinepetitionsorganisedby groups, such as MoveOn.124 But such ‘clicktivism’ or, more pejoratively,‘slacktivism’,125 iscontroversial.MicahWhite,aco‐founderofOccupyWallStreet,has,forexample,criticisedclicktivismforitsuseofmarketingmethodologyanditsdilutionof the impact of direct action.126Well‐consideredactivism can influenceindividualandcorporatebehaviour,includingtaxpaying,127buttheplaceofcyber‐vigilantesincivilsocietyisproblematic.

3 CorporateCo‐option

Online activist organisations, such asMoveOn,may emulate businessmodels inways that offend some grassroots activists,128 but businesses, notably Uber and Airbnb,whichhaveaccesstomillionsofcustomersandsuppliers,mayconverselyemulate online activists.129 The possibility becomes real of political discourse,including proposals for local taxes on hotel beds, being co‐opted by businessinterests.Despitehavingtheveneerofcitizenparticipation,UberandAirbnbareabletofloodthemarketplaceofideasbyharnessingtheself‐interestoftheirdriversorhosts.Thus,ConorDoughertyandMikeIsaacreport:130

Now,ascitiesgrapplewiththegrowthof[UberandAirbnb]andtrytopassrulesforhowtheyshouldoperate,thecompaniesarefightingbackbyturningtheirusersintoavastpoliticaloperationthatcanbemobilizedatanysignofathreat.

V POLICYRECOMMENDATIONSANDCONCLUSION

This part of the article makes tentative policy recommendations and drawsconclusions.

124 SeeMoveOn,‘WhatIsMoveOn.org?’<http://front.moveon.org/about/#.Vmdz4Tahd54>.125 ‘ActionsperformedviatheInternetinsupportofapoliticalorsocialcausebutregardedas

requiring little timeor involvement (eg signinganonlinepetitionor joining a campaigngroup on a social media website’: see Oxford Dictionaries, ‘Slacktivism’ (2015)<www.oxforddictionaries.com/definition/english/slacktivism>).

126 SeeMicahWhite,‘ActivismafterClicktivism’Q(2014)<http://qideas.org/articles/activism‐after‐clicktivism/>.

127 See, for example: John Gellemore, Edward L Maydew and Jacob R Thornock, ‘TheReputational Costs of Tax Avoidance’ (2014) 31(4) Contemporary Accounting Research1003;ScottDDyreng,JeffreyLHoopesandJasonHWilde,‘PublicPressureandCorporateTaxBehavior’(WP14/16,OxfordUniversityCentreforBusinessTaxation,2014).

128 SeeWhite,aboven126.129 SeeIssieLapowski, ‘Uber’sNewFakeFeatureDeridesRegulators’,Wired(online),16July

2015<www.wired.com/2015/07/uber‐de‐blasio/>.130 ConorDoughertyandMikeIsaac,‘AirbnbandUberMobilizeVastUserBasetoSwayPolicy’,

The New York Times (online), 4 November 2015 <www.nytimes.com/2015/11/05/technology/airbnb‐and‐uber‐mobilize‐vast‐user‐base‐to‐sway‐policy.html?_r=0>.


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A PolicyRecommendations

The least controversial policy recommendations will be considered first(constituencies for fiscal information,andconsultation); thenthemoreproblematicissuesofengagingwithactivistsandtaxeducation.131

1 ConstituenciesforFiscalInformation

Government agencies collect considerable fiscal information which, subject toprivacyconcerns,shouldbemadeavailabletothepublictofosterdiscourse.Oneofthe difficulties faced in this regard lies withmaking information comprehensibleandusefultothewidestaudience.(Alargebodyofliteratureexistsontheissueofusefully communicating financial information; much has been published in thejournal Accounting, Auditing & Accountability.) Potential also exists for non‐engagementandapathy.In2014,theUnitedKingdom’srevenueauthoritypostedaleaflet to 30 million taxpayers explaining how their income tax and nationalinsurance contributions were used.132 Two‐thirds of taxpayers later surveyed couldnotrecallreceivingthesummary.Nevertheless,oftheremainder,75percentfoundthe explanation of tax useful, and 60 per cent considered the explanationofgovernmentexpenditurehelpful.133

TheWorldBankhas longurgedgovernments topromoteconstituencies for fiscalinformation.134 But this laudable proposal is not unproblematic. In particular, agovernment‐fundedbodychargedwithdisseminatingtaxinformationwouldfinditdifficulttopresentinformationinausefulbutpoliticallyneutralway.Indeed,oneofthe perceptions of the United Kingdom revenue authority’s information exercisewasthattheauthorityhadbeenpoliticised.135

2 Consultation

Consultationisanuncontroversialelementinthedevelopmentofcontemporarytaxpolicy.136 New Zealand has instituted a well‐regarded generic tax policy process(GTPP).137ButtheGTPPtendstobedominatedbysubmissionsmadebytheNew

131 Thisarticle isabout therelationshipbetweengovernmentandtaxpayers.Thecontentofsubstantivetaxlawsliesbeyondthescopeofthearticle.

132 ItisnotobviouswhydetailsofVATrevenue,whichaccountsforapproximatelyone‐fifthofUnitedKingdomexchequerreceipts,werenotincluded.Butseeaboven67onthecommonexclusionofVAT‐payersfromtheconceptionof‘thetaxpayer’.

133 SeeAdamPalin,‘TaxStatementsSentouttoanApatheticPublic’,FinancialTimes(London),7November2015,3.

134 SeeDeepaNarayan(ed),EmpowermentandPovertyReduction:ASourcebook(WorldBank,2002).

135 SeePalin,aboven133,3.136 MichaelCadesky,IanHayesandDavidRussell,TowardsGreaterFairnessinTaxation:AModel

TaxpayerCharterPreliminaryReport(AOTCA,CFEandSTEP,2013)184.137 ForanoverviewoftheGTPP,seeAdrianJSawyer, ‘BroadeningtheScopeofConsultation

andStrategicFocusinTaxPolicyFormulation–SomeRecentDevelopments’(1996)2NewZealandJournalofTaxationLawandPolicy17.Foraconcise,plainlanguageoverviewoftheGTPP, see Peter Dunne, ‘Keynote Address to EMA Annual Payroll Conference’ (2013)<http://beehive.govt.nz/speech/keynote‐address‐ema‐annual‐payroll‐conference>. For acriticalreviewof theGTPP inpractice,seePeterVial, ‘TheGenericTaxPolicyProcess:A


77

Zealand Law Society, Chartered Accountants Australia and New Zealand, large lawfirms and accounting practices, and, depending on the issue, special interestbusiness groups. As consultation, it has a narrow practical focus. Ideally, we allwould be involved in tax discourse, but, in practice, which individuals and civicgroups have the time and resources to contribute to developing taxpolicy?Conversely, when only a few members of civil society are engaged, debatemay become skewed.138 Tax is seen as a technocratic preserve. Whendemocratically‐elected representatives fail to heed the wisdom of professionaltechnocrats, theymay be dismissed as ‘tax prats’. Contemplating this technocraticdismissal of non‐experts from tax policy discourse,Wendy Bradley observes ‘[t]heoutsider, the taxprat,mightthinkthereisasimplesyllogism,thatis,taxisgovernedby law, laws are made, the people making them have set simplicity as a priorityobjective,thereforetaxlawwillbecomesimplerviatheiractions.’139

3 Activism

Following Davies, European Union policymakers have sought to empower thecitizen‐consumer. It is submitted that this advanced stage of consumerism is alsoseen in the behaviour of taxpayers. The research‐based activism of the Tax JusticeNetwork seems to reflect an ideal of citizen empowerment expressed in rationaldiscourse. Butwas the pro‐tax activists’ disruption of shoppers on London’s OxfordStreetor the smallbusinessesofCrickhowell taking theirprofitsoffshorepartoftheBrussels‐based policymakers planned and executed policies for consumer‐citizenship?So,policymakersmustask:towhatextentiscitizenship‐consumerisman organic phenomenon that may resist shaping by government? Indeed, to whatextentshouldgovernmentbewaryofactivism?

4 TaxEducation

Murphyarguesthattaxationshouldbeacompulsorysubjectforschools,implicitly,inthewaythatCivics is taught in theUnitedStates.Support fordemocracyisnearuniversal but, in essence, Murphy argues that progressive taxation is as equallyuncontroversialasdemocracy.But,forplausibleandhonestreasons,otherswoulddisputethatassumption.Taxationisnotacoldscience:itis,initsnature,politicalandpartisan, and one must be sceptical that it could be taught without ideologicalinflectionintheschoolclassroom.

“JewelinourPolicyFormationCrown”?’(2012)25(2)NewZealandUniversitiesLawReview318.

138 InNewZealand,forexample,thewell‐endowedMorganFoundationhasgainedpublicityforitsproposalforanarguablyQuixoticformofcapitaltaxation:seeAndrewLaxton,‘GarethMorgan’s Big Tax Idea’ The New Zealand Herald (online), 1 October 2011<www.nzherald.co.nz/business/news/article.cfm?c_id=3&objectid=10755689>.

139 Mike Truman, ‘Tax Prat of the Year’ Taxation (6 February 2013)<www.taxation.co.uk/Articles/2013/02/06/53361/tax‐prat‐year>; Wendy Bradley, ‘TaxPratsandCitizenStakeholders:ProfessionalismintheGapBetweenTaxPrioritySettingandTaxPolicymaking’(2015)24(2)SocialandLegalStudies203,220.


78

B CONCLUSION

This article is exploratory in nature, and has considered the applicability of theemerging model of the citizen‐consumer to taxpayers. Despite the promise ofcitizen‐consumeractivisminthefieldoftaxlawandpolicy,reservationshavebeennoted.Someofthemaintoolsoftaxactivism–performanceprotestandshaming–canbedisproportionatelyharmfulbothtothecauseofsocialjusticeandthesubjectsofshaming.Co‐optionofonlineactivismbycorporateinterestsisalsoaconcern.Inanidealdiscursivedemocracy,citizenswouldactivelyparticipateintheformulationofthepolicyandlawsunderwhichtheycontributetoandbenefitfromthepublictreasury.140Web‐basedtechnologyostensiblypromotesthisideal,buttherealityismore complex. Distinctions between protest and consumption, and betweenbusiness and consumer interests, become increasingly difficult to maintain.Consequently, any policy recommendations must be tentative, and conclusionsuncertain.

The research of Davies in relation to consumerism and citizenship, and that ofRosanvallononsingularityandequalityarenotwellknownamongAustralasiantaxacademics.141 Nevertheless, their ideas have relevance beyond their source andimmediatecontextoftheEuropeanUnion.BothexaminethestructuralchangesintherelationshipbetweencitizensandtheStateandcitizenship.Thesechangesindeveloped countries, from social citizenship to neoliberalism and beyond, areequallyrelevanttoNewZealandandAustralia.Itmustbeconcededthattheauthors’conceptualisationofcitizenshipare,tosomedegreespeculative;nevertheless,inthefieldoftaxation,theysuggestwaysforbothcitizensandtheStatetoengagewiththepowerofMNEs.

140 See,generally, JonathanBarrett, ‘CommunitiesofTaxationand Justice:ACommunitarianApproachtoInequalityandTaxation’(2012)JournalofAppliedLawandPolicy1.

141 IamgratefultoMirandaStewartforalertingmetotheworkofPierreRosanvallon.


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TaxJusticeNetwork,‘Ourgoalsandmethods’<www.taxjustice.net/>Tesfaye,Sophia,‘AllofDonaldTrump’sapologists:RudyGiuliani,ChrisChristiearguethat

avoiding taxes makes him a “genius”’ Salon (4 October 2016)<www.salon.com/2016/10/03/all‐of‐donald‐trumps‐apologists‐possible‐tax‐avoidance‐makes‐trump‐a‐genius‐rudy‐giuliani‐chris‐christie‐argue/>

‘TheColonialEra’inAHMcLintock(ed)AnEncyclopaediaofNewZealand(NewZealandGovernment, 1966) Te Ara – the Encyclopedia of New Zealand (2009)<www.TeAra.govt.nz/en/1966/finance‐public>

TheTaxpayers’Alliance,‘OurMission’<www.taxpayersalliance.com/our_mission>Touraine,Alain,BeyondNeoliberalism (DavidMacey trans, PolityPress, 2001) [transof:

Commentsortirduliberalisme?(firstpublished1999)]Truman, Mike, ‘Tax Prat of the Year’ Taxation (6 February 2013)

<https://www.taxation.co.uk/Articles/2013/02/06/53361/tax‐prat‐year>UKUncut(YouTube)<https://www.youtube.com/watch?v=ffYlE0lLBbI>Vattimo,Gianni,TheTransparentSociety(DavidWebbtrans,JohnsHopkinsPress,1992)

[transof:Lasocietàtransparente(firstpublished1989)]Vial, Peter, ‘The Generic Tax Policy Process: A “Jewel in our Policy Formation Crown”?’

(2012)25(2)NewZealandUniversitiesLawReview318Voet,Johannes,SelectiveVoet(edandtrans:PEGane,Butterworths,1955‐8)


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Vosslamber,Rob, ‘HowMuch?TaxationonNewZealanders’ Employment Income1893‐1984’(2009)15NewZealandJournalofTaxationLawandPolicy299

White,Micah, ‘ActivismafterClicktivism’Q (2014)<http://qideas.org/articles/activism‐after‐clicktivism/>

Wiegmink,Pia,ProtestEnACTed:ActivistPerformanceintheUnitedStates(WinterVerlag,2011)

B OtherAucklandRatepayersAllianceLimited,‘About’<www.ratepayers.nz/about>


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UNIVERSITYSTUDENTSANDTAXLITERACY:OPPORTUNITIESANDLESSONSFORTAXTEACHING*

TONICHARDON,†CHRISANNLEE,‡LAURADEZWAAN§ANDYULINLIU**

ABSTRACT

Financialliteracyisimportantduetothegrowingcomplexityoffinancialproducts,increases in life expectancy and reliance on self‐funded retirement support.1Previousresearchhasidentifiedthataspectsoftaxandsuperannuationformpartofoverallfinancialliteracy,andthattherearegapsintheunderstandingofsomeoftheseconceptswhichcouldleadtopoorfinancialdecisions.2Thispaperreportsona recent survey of Australian university students and their perceptions of theimportanceoffinancialliteracy,theextenttowhichtheyhadbeentaughtfinancialliteracy at school, and their level of understanding of some basic tax andsuperannuation concepts. The results of the survey highlight the importance oftaxationasacomponentof financial literacy,opportunities forcross‐disciplinarytaxteachingandinsightsfortaxteachingandadvisortrainingmorebroadly.

* The authors wish to acknowledge the funding from QUT Business School, School ofAccountancy,SchoolResearchInitiativeGrantandKenSwanfromTheWealthAcademyforcollaborationinthisresearchproject.

† ToniChardonisalecturerintaxationlawatUSQ.Herresearchinterestsareintheareasoffinancialandtaxliteracy,accountingandlegaleducationandtaxcompliance.

‡ ChrisannLeeisalecturerinaccounting,superannuationandwealthmanagementatQUT.Herresearchinterestsareinaccountingeducation,financialliteracy,superannuationandfinancialplanning.

§ Laura de Zwaan is a lecturer in superannuation and wealth management at QUT. Herresearchinterestsareinsuperannuation,financialplanning,andfinancialliteracy.

** YulinLiuisanassociatelecturerinmathematicsandstatisticsatQUT.Hisresearchinterestsinclude innovations in learning and teaching quantitative skills, university studentwellbeing,andquantitativesocialresearch.

1 OECD,ImprovingFinancialLiteracy:AnalysisofIssuesandPolicies(OECDReport,2005).2 ToniChardon, ‘TaxationandSuperannuationLiteracyinAustralia:Whatdopeopleknow

(orthinktheyknow)?’(2014)1JASSA:TheFinsiaJournalofAppliedFinance42,7.


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I INTRODUCTION

ImprovingthefinancialliteracyoftheAustralianpopulationiscurrentlyhighontheGovernment’s agenda. A revised National Strategy for Financial Literacy wasreleasedfortheperiod2014—2017,andaNationalStakeholderForumwasheldinNovember2015.1TheNationalStrategyisimportantinthecontextthat:

Intoday’sfast‐pacedconsumersociety,financialliteracyisanessentialeverydaylifeskill.Itmeansbeingabletounderstandandnegotiatethefinancial landscape,managemoney and financial risks effectively andavoidfinancialpitfalls.2

The Australian Government has suggested that improving financial skills andprovidingfinancialeducationiscentraltoeconomicprosperity,andthatlowlevelsoffinancialliteracyactasabarriertoparticipationinthefinancialsystem.3Inrecenttimes,manyinvestorsandretireeshavebeenfacedwitheconomiccircumstancesthathaveimpactedontheirlifesavingsandsuperannuationbalances.Thefinancialliteracyofconsumers,financialdecisionmaking,advisor‐‐clientrelationships,andtheimpactofalloftheseonincreasedwealthandeconomicprosperityisthereforeanimportantareaofresearch.

Previous studies of financial literacy in Australia have found that the financialknowledgeofyoungerpeopletendstobelower,andtheyarethereforeatriskforless‐than‐optimal financialdecisionmaking.4Chardonhaspreviouslyarguedthatbasic concepts of tax and superannuation literacy should form part of anymeasurements of overall financial literacy, and that tax literacy also tends to belower for those in younger age groups.5 This article reports on the tax literacyfindings froma2015 financial literacy surveyof university students, specificallythoseparticipantsaged20yearsoryounger.The firstpart givesanoverviewoffinancialandtaxliteracyresearchinAustralia;thesecondpartgivesanoverviewoffinancialliteracyresearchspecificallyinthecontextofuniversitystudents;thethirdpart sets out methodology and presents the results and analysis of the currentsurvey.Thefindingsfromthisanalysisarebeexploredtodeterminewhetherthere

1 Australian Securities and Investments Commission,National Financial Literacy Strategy(2014) 2, <www.financialliteracy.gov.au/media/546585/report‐403_national‐financial‐literacy‐strategy‐2014‐17.pdf>.

2 Ibid.3 CommonwealthDepartmentofTreasury,TheNationalStrategyforConsumerandFinancial

Literacy<http://cfltaskforce.treasury.gov.au/content/terms.asp?NavID=2>.4 ANZ,ANZSurveyofAdultFinancialLiteracyinAustralia(ACNielsenReport2005);ANZ,ANZ

SurveyofAdultFinancialLiteracy inAustralia (TheSocialResearchCentreReport2008);ANZ,AdultFinancialLiteracyinAustralia–FullReportoftheresultsfromthe2011ANZSurvey(TheSocialResearchCentreReport2011);DianaBealandSarathDelpachitra, ‘FinancialLiteracyamountAustralianuniversitystudents’(2003)22(1)EconomicPapers:aJournalofAppliedEconomicsandPolicy65.

5 ToniChardon, ‘TaxationandSuperannuationLiteracyinAustralia:Whatdopeopleknow(orthinktheyknow)?’(2014)1JASSA:TheFinsiaJournalofAppliedFinance42.


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areanyimpactsonthecurrenttaxteachingcurriculumorfurtheropportunitiesforfinancialandtaxliteracyeducationprogramsatuniversities.

II FINANCIALANDTAXLITERACYOVERVIEW

In this article, ‘financial literacy’ is defined as ‘the ability to make informedjudgementsandtomakeeffectivedecisionsregardingtheuseandmanagementofmoney’.6Theimportanceoffinancialliteracyliesinthepotentialdifficultyarisingfromsuboptimal financialdecisionmaking,asacknowledgedbytheOrganisationforEconomicCo‐operationandDevelopment(OECD) in thecontextof theglobalfinancialcrisis:

the lack of understanding of households on financial issues and, inparticular,oncreditandinvestment,hasalsoamajorrole.Asaresult,individuals have accepted (sometimes unknowingly) to supportmorefinancialriskthanwhattheycouldafford.7

Thenotionoffinancialliteracyhasexpandedoverthelastdecade,withgreaterfocuson a combination of knowledge, behaviour, confidence and attitudes.8Internationally,‘financialcapability’isamorecommontermusedintheliterature.9AlthoughfinancialliteracyisnowanembeddedterminAustralia,giventheNationalStrategy,thisbroadeningofconceptshasbeenseenintheANZNationalSurveysofAdult Financial Literacy in Australia, which have acknowledged that financialliteracy ‘is a complex combination of a person’s skills, knowledge, attitudes andultimatelytheirbehavioursinrelationtomoney’.10

Ithasbeenarguedthatanincreaseintheavailabilityoffinancialproductshasledtoanincreasinglycomplexmarketforconsumers.11Thereisalsoanincreasedfocusbygovernmentsonself‐fundedretirement,andevidencesuggestingcertainat‐risk

6 ANZ,AdultFinancialLiteracy inAustralia–FullReportof the results from the2014ANZSurvey’ (The Social Research Centre, 2015); Financial Literacy Foundation, FinancialLiteracy–AustraliansUnderstandingMoney(CommonwealthTreasury,2007).

7 InternationalNetworkforFinancialEducation,FinancialEducationandtheCrisis–PolicyPaperandGuidance(OECD,2009),4.

8 EKempsonandSCollardandNMoore,Measuringfinancialcapability:anexploratorystudy,ConsumerResearchReport37(PersonalFinanceResearchCentre,2005);JohannaLeskinenandAnuRaijas,ConsumerFinancialCapability–Alifecycleapproach(November2005)<http://static.twoday.net/fes/files/FES_FinEd_Finland_lifecycleapproach.pdf>;AndrewWorthington,‘PredictingFinancialLiteracyinAustralia’(2006)15(1)FinancialServicesReview59.

9 Jeanne M Hogarth, ‘Financial literacy and family and consumer sciences’ (2002) 94(1)JournalofFamilyandConsumerSciences14;Kempson,andCollardandMoore,aboven8.

10 ANZ, Adult Financial Literacy in Australia – Full Report of the results from the 2014 ANZ Survey’, above n 6, 1; ANZ,AdultFinancialLiteracyinAustralia–FullReportoftheresultsfromthe2011ANZSurvey,aboven4,2.

11 Worthington,aboven8.


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groups have low levels of financial literacy particularly in relation to financialproductsandsuperannuation.12

TheANZ‘SurveyofAdultFinancialLiteracyinAustralia’ isthemostwidelycitedmeasurement of financial literacy in Australia and has been conducted over anumber of years.13 The surveys have consistently reported that Australians arebroadlyfinanciallyliteratewhenitcomestobasicconceptssuchasbudgetingandsaving, but that certain demographic groups ‐‐ such as females, those with lesseducation,thosenotinemployment,andthosewithlowerincomes‐‐havelowerlevelsofliteracy,andmorecomplexfinancialconceptsarenotaswellunderstoodor utilised by these groups.14 Further, all population groups tend to findsuperannuation concepts more difficult than basic financial concepts such asbanking.15

PreviousresearchbyChardonhasarguedthatfinancialliteracyframeworksneedto include an understanding of basic taxation and superannuation concepts thatimpactonday‐to‐dayfinancialdecisionmaking,financialobligationsandeffectivecommunicationwith advisors.16 Taxation and superannuation are usually poorlycoveredinfinancial literacysurveysandeducationprograms.Chardon,reportingtheresultsofanadultsurveyoftaxliteracyinAustralia,foundthat19percentofAustralianshadtaxliteracyscoresclassifiedaseither‘poor’or‘low’.Further,certaindemographicgroupswith low financial literacy (females, youngerage categoriesandlessemployment)werealsolikelytohavelowerlevelsoftaxliteracy.17

Recently, Australia participated in a trial of the financial literacy assessmentframeworkaspartoftheOECDProgrammeforInternationalStudentAssessment(PISA) survey. Australian students performed relatively well (ranked 4th of 18participating countries).18The OECD Financial Literacy Assessment Frameworkspecificallyrecognisedthatthefinanciallandscapeincorporatesanunderstandingofthe‘consequencesofchangesineconomicconditionsandpublicpolicies,suchaschangesininterestrates,inflation,andtaxationorwelfarebenefits’.19Similarly,the2008ANZAdult financial literacysurveyrecognised thepotential for tax tobeacomponentofafinancialliteracyframeworkwhenitstated:

12 ANZ,aboven6;ANZ,ANZSurveyofAdultFinancialLiteracy inAustralia2008,aboven4;ANZ,ANZSurveyofAdultFinancialLiteracyinAustralia2005,aboven4.

13 ANZ,AdultFinancialLiteracy inAustralia –FullReportof the results from the2011ANZSurvey, above n 4; ANZ, ANZ Survey of Adult Financial Literacy in Australia (The SocialResearchCentre,2008),aboven4;ANZ,ANZSurveyofAdultFinancialLiteracyinAustralia2005,aboven4;ANZ,AdultFinancialLiteracyinAustralia–FullReportoftheresultsfromthe2014ANZSurvey’,aboven6.

14 ANZ,AdultFinancialLiteracy inAustralia –FullReportof the results from the2011ANZSurvey,aboven4;ANZ,ANZSurveyofAdultFinancialLiteracyinAustralia2008,aboven4.

15 ANZSurveyofAdultFinancialLiteracyinAustralia2005,aboven4,2.16 ToniChardon,‘WeatheringtheStorm:TaxasaComponentofFinancialCapability’(2011)

5(2)AustralasianAccountingBusinessandFinanceJournal53.17 Chardon,aboven5.18 OECD,PISA2012Results:StudentsandMoney:FinancialLiteracySkillsforthe21stCentury

VolumeVI(OECD2014).19 OECD, PISA 2012 Financial Literacy Assessment Framework (PISA Report) (OECD, April

2012)18<www.oecd.org/pisa/pisaproducts/46962580.pdf>.


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Please note that other potential aspects of adult financial literacy (egtaxation; understanding of how and why government is financed;awarenessandunderstandingofgovernmentbenefits;understandingofhowfeesarecalculatedandhowtominimisethem)wereagreeduponasbeingbeyondthescopeofthecurrentproject,andthereforenotincludedintheframework.20

Asstatedearlier,themostrecentNationalFinancialLiteracyStrategyhasanumberof priorities. The strategic priorities relevant to the research presented in thepresent article are the first priority (educate the next generation, particularlythrough the formal education system) and the fifth – (improve research,measurementandevaluation).21Accordingly,thisarticleproposesways inwhichthe next generation, particularly university students, may be better financiallyeducated, and alsoprovides empirical evidence that adds to the research in thisfield.

III FINANCIALLITERACY:YOUNGPEOPLEANDUNIVERSITYSTUDENTS

Overtheyears,adultfinancialliteracyresearchconductedinAustraliabyANZhasconsistentlyfoundthatyoungeragegroups(under25years)tendtohavethelowestfinancialliteracyscores.Thiswasconfirmedinthemostrecentsurvey,whichalsofoundlowerscoresinbehaviouralindicatorssuchasplanningaheadandchoosingfinancial products.22 Further, younger peoplewere also themost likely group tohaveobtainedfinancialinformationoradvicefromfamilyorfriends(65percent).23A2007Australiansurveyofyoungpeoplebetweentheagesof12and17foundthattheywerelessconfidentthanadultswhenitcametomanagingmoneyandthattheyweremostlikelytogaintheirinformationandadvicefromfamily.24

Morerecently,asurveyof207Australianyear11schoolstudentsfoundtherewaslowerfinancialliteracyintheareasoffinancialriskawarenessandconsumerrightswhencomparedwithfinancialdecisionmaking.25Themajorityofparticipantsalsoagreed(70percent)thatlearningmoreaboutfinancialmanagementwasimportant.Theauthorssuggestthat‘somegroupsofyoungpeoplehavelowerlevelsoffinancialliteracyandthereforearemorevulnerabletopoordecisionmaking’.26

Oneof themostwidelycitedsurveysofuniversitystudents’ financialknowledgewas that ofBeal andDelpachitra.27 This surveypreceded all of the internationalgovernmentstrategiesforfinancialliteracy,yetsimilarlyfoundtherewasevidence

20 ANZ,ANZ SurveyofAdultFinancialLiteracy inAustralia–FinalReport2003 (The SocialResearchCentre,2008),aboven4,182.

21 AustralianSecuritiesandInvestmentsCommission,aboven1.22 ANZ,aboven6.23 Ibid.24 FinancialLiteracyFoundation,aboven6,57.25 Paul Ali et al, ‘The Financial Literacy of Young Australians: An Empirical Study and

Implications for Consumer Protection and ASIC’s National Financial Literacy Strategy(2014)32(5)CompanyandSecuritiesLawJournal334.

26 Ibid352.27 BealandDelpachitra,aboven4.


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oflowfinancialskillandknowledgeamonguniversitystudentsandrecommendedthat comprehensive secondary and primary school education programs bedeveloped.28

A2009surveyofthefinancialliteracyof472Australianuniversitystudentsfoundthattherewerelowlevelsoffinancialliteracyoverall,andthatthiswasimpactedby a range of variables depending on the specific area of financial knowledgetested.29ThissurveyisoneofveryfewinAustraliathathasincludedormeasuredunderstandingsoftaxandsuperannuation.Here,thesurveyfoundthatonly29.5percentofparticipantscorrectlyunderstoodthedifferencebetweenataxoffsetanda deduction, and that thiswas onlymarginally higher among business students(34.5per cent correct).30 Theauthors concluded that it cannotbe ‘assumed thatuniversitystudents,evenbusinessstudentsareimmunefromfinancialilliteracy’.31

InexaminingfinancialliteracyofyoungpeopleintheUnitedStates,Lusardi,Mitchelland Curto argued that the increasing debt load of younger persons from eithersecondary school or university is of concern, particularly when coupled withfinancialilliteracy.32IntheUnitedStates,financialliteracyeducationprogramsintheformofgeneraleducationcourseswithinuniversitiesaremorecommonthaninAustralia.Due to the styleof learner, their interest andengagement, it hasbeenargued that programs at the college (university) level have better outcomes forparticularaspectsoffinancialliteracythanthoseinhighschool.33Crainundertooka review of 308 universities that offer financial literacy courses and found thatalthough only 37 of the schools allowed the particular course to be taken as ageneral elective by all students, therewas substantial support, among academicstaff,fortheiravailability.34Thereviewconcludedthatsuccessfulimplementationoffinancialliteracyinitiativesrequiredmotivateddisciplineleaders,neverthelessprograms were often difficult to introduce due to university politics andcompetitionamongdisciplines.35 Similarargumentscouldbemade in relation tocompetingdisciplinesinuniversityaccountingprograms.Itisthereforeimportanttobeabletodemonstrate,withempiricalevidence,thatconceptssuchasfinancialliteracyshouldbeincludedbecauseoftheirsocialandeconomicimportance.

ResearchbyPalmandBismanhasarguedthatintroductoryaccountingcoursesatuniversity could benefit from more constructive alignment of objectives anddevelopmentofgenericskillsiftheyaretoremainrelevantinamodernaccounting

28 Ibid.29 MichelleCullandDianaWhitton,‘UniversityStudents’FinancialLiteracyLevels:Obstacles

andAids’(2011)22(1)TheEconomicandLabourRelationsReview99.30 Ibid.31 Ibid112.32 AnnamariaLusardi,OliviaS.MitchellandVilsaCurto,‘FinancialLiteracyamongtheYoung’

(2010)44(2)JournalofConsumerAffairs358.33 Tzu‐ChinMartinaPengetal, ‘TheImpactofPersonalFinanceEducationDeliveredinHigh

SchoolandCollegeCourses’(2007)28(2)JournalofFamilyandEconomicIssues265.34 Susan J. Crain, ‘Are universities improving student financial literacy? A study of general

educationcurriculum’(2013)39(1/2)Journaloffinancialeducation1.35 Ibid.


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environment.36Similarly,FreudenbergandBoccabellahavearguedthataccountingcurriculaneedtoreflectcurrent industrypractices(specifically inrelationtothepopularity of trusts and SMSFs) if they are to remain relevant and useful forpractitioners.37 The present study therefore provides valuable evidence foracademicsdesigningtax,financialandaccountingeducationcoursesatuniversitylevel,asitprovidesbackgroundofthelearnerinthecontextoffinancialliteracyaswell as providing evidence useful for training students in communicating withclients.

A Methodology

Asnoted,previousfinancialliteracystudieshavefoundthatfinancialliteracytendstobelowerinyoungeragegroups.Thisstudyaimedtoexplorelevelsoffinancialliteracy among university students as well as their perception of the financialeducationtheyreceivedinhighschool.Previousresearchhasexploredthefinancialliteracyofuniversitystudentsataparticularuniversity.ThissurveywasdistributedacrossfourAustralianuniversitiesaswellasbeingsharedthroughsocialmedia.38Theuseofsocialmediatodistributesurveysisarguedtobevalidnotwithstandingitslimitations.39

The survey asked both subjective and objective questions in relation to thefollowing financial literacy concepts: general interest, inflation, investment,budgeting and saving, insurance, superannuation and taxation. In all, fourteenliteracyquestionswenttowardsanoverallfinancialliteracyscore.Asubsetoffourspecific tax knowledge questions are the focus of analysis in this paper. ThequestionsweredrawnfromarangeofexistingresearchonfinancialliteracywithsomemodificationsfortheageofparticipantsandtheAustraliancontext.40

Previousresearchhashighlightedtheimportanceofconfidenceasacriticalaspectofbuildingfinanciallycapablepopulations.41Indeed,previoustaxliteracyresearchhasfoundthatfemales,thoseinyoungeragegroupsandthoseonlowerincomestend to be less confident when it comes to taxation and superannuation issues

36 Chrisann Palm and Jayne Bisman, ‘Benchmarking Introductory Accounting Curricula:ExperiencefromAustralia’(2010)19(1–2)AccountingEducation179.

37 Brett Freudenberg and Dale Boccabella, ‘Changing Use of Business Structures: HaveUniversity Business Law Teachers Failed to Reflect this in their Teaching?’ (2014) 9(1)JournaloftheAustralasianTaxTeachersAssociation180.

38 BealandDelpachitra,aboven4;CullandWhitton,aboven29.39 ChristineBrickman‐Bhutta, ‘NotbytheBook:FacebookasSamplingFrame’(2012)41(1)

SociologicalMethodsandResearch57.40 ANZ,ANZSurveyofAdultFinancialLiteracyinAustralia2008,aboven4;HazelBatemanet

al, ‘FinancialCompetenceandExpectationsFormation:Evidence fromAustralia*’ (2012)88(280)EconomicRecord39;Chardon,aboven5;AnnamariaLusardiandOliviaSMitchell,Financial Literacy and Retirement Preparedness: Evidence and implications for financialeducationprograms(MichiganRetirementResearchCenterResearchPaperNo.WP2006–144, 2006); Chrisann Palm, Financial Literacy and Superannuation Investment Decision‐makinginachoiceenvironment:Anexploratorystudy(PhDThesis,QueenslandUniversityofTechnology,2014)<http://eprints.qut.edu.au/78464/>.

41 LevonBlueandMarkBrimble,‘ReframingExpectationsofFinancialLiteracy:BringingBacktheReality’(2014)1JASSA:TheFinsiaJournalofAppliedFinance37.


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specifically.42Acknowledgingthedifferencebetweenself‐ratingofunderstandingand confidence, the current survey asked participants to self‐rate theirunderstanding of particular financial concepts. The self‐rating of taxationunderstandingbyparticipantswillthereforebeanalysedinthispaperinthecontextofactuallevelsofunderstandingoftaxationconcepts.

B DescriptiveStatistics

ThesurveywasconductedbetweenMayandJuly2015.Thenextpartpresentsthespecifictaxliteracyresultsofthesurveyalongwithrelevantstatisticalanalysis.Thesamplesize forparticipantsaged20yearsorunderwas297with165(55.6percent) complete responses (over 70 per cent missed one or no questions). TheanalyseswereconductedusingSPSS22withpairwisedeletionofresponseswithmissingdata,unlessindicatedotherwise.

Table1:SummaryStatisticsofVariables(N=297)

Variable(n) Category Count(%ofn)Gender(209) Male 41(19.6)

Female 168(80.4)Employment(208) Fulltime 7(3.4)

Parttime 39(18.8)Casual 89(42.8)Othermodes 15(7.2)Notworking 56(26.9)Neverworked 2(1.0)

Self‐ratingofTaxknowledge(267)

Verylow 69(25.8)Low 102(38.2)Fair 62(23.2)High 23(8.6)Veryhigh 11(4.1)

Question1(236)TaxationofSuperannuation

Correct 87(36.9)Incorrect 149(63.1)

Question2(220)CalculatingAssessableIncome


Question3(220)CalculatingTaxPayable


Question4(297)NegativeGearingMeaning


OverallTaxScore(220) 0 51(23.2)1 75(34.1)2 60(27.3)3 29(13.2)

42 ToniChardon,Taxationasacomponentoffinancialliteracy–HowliterateareAustraliansinrelationtotaxation?(PhDThesis,GriffithUniversity,2014).


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4 5(2.3)ATAR(198) 79.7(32,99) 79.4(12.2)Quizscore(220) 1(0,4) 1.4(1.1)

Table1presentsthesummarystatistics.Thissampleisover‐representedbyfemale(80.4 per cent) and employed (72.1 per cent excluding ‘notworking’ and ‘neverworked’) students, which should be noted as a limitation of the research. EachparticipantwasassignedanAustralianTertiaryAdmissionRank(ATAR)toenablecomparisonofuniversityentryscoresacrossstates.TheATARsofthissamplerangefrom32to99,withanaverageof79.4andstandarddeviationof12.2.

C Results

Thissectionofthepaperreportstheresultsofthespecifictaxliteracyquestionsthatwereposedinrelationtothesampleaged20yearsofageorlessassummarisedinTable1above.Comparisonsof theresultsagainst thepreviousadult tax literacysurveybyChardonwillalsobemadewhererelevant.43Thesurveyalsoprovidedparticipantswithanopportunitytoaddanyrelevantcommentsabouttheirfinancialskillseducation.Athematicanalysisoftheresponsestothatquestionwillalsobepresentedattheendofthissection.

Inrelationtoparticipantsself‐ratingoftheirtaxknowledge,morethanhalfofthestudentsratedthemselveslow(38.2percent)orverylow(25.8percent)intermsoftaxknowledge.AlthoughtheprevioustaxliteracyresearchbyChardonexploredparticipants’self‐rated‘confidence’asopposedto‘understanding’,theresultsherearebroadlyconsistent,inthatparticipantsappeartoself‐rateboththeirconfidenceandunderstandingoftaxationconceptsasmuchlowerthantheywereforfinancialconcepts such asbudgetingand saving.44 Interestingly, the current survey foundthatfinancialconceptssuchassuperannuationandretirementplanningalsohavealow level of self‐rated understanding. A finding of low self‐rated understandingmightbeexpectedforthoseareaswhichwillbemorerelevantlaterinlife,butthesamecannotbesaidfortaxationconcepts,whichwouldberelevantearlierinlife‐‐particularlygiventhatthecurrentsampleisover‐representedbythosecurrentlyinpaidemployment.

Inrelationtospecifictaxknowledgequestions,thefirstquestionwaspresentedasfollows:

As farasyouareaware, issuperannuationgenerally taxedata lower,higherorthesamerateasotherinvestments?

As seen in Table 1, 36.9 per cent of participants answered correctly thatsuperannuation was taxed at a lower rate than other investments. The mostcommonalternativeresponsewas‘Donotknow’.IncomparingtheresultsofthisquestionagainsttheadulttaxliteracysurveybyChardon,where57.3percentofadultsscoredcorrectlyforthesamequestion,itappearsthatthoseunder20yearsofagehavelessunderstandingofthetaxationofsuperannuation.45

43 Chardon,aboven5.44 Ibid.45 Chardon,aboven5.


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Thesecondtaxknowledgequestionwasinrelationtothecalculationofassessableincome, and therefore an understanding of the difference between assessableincomeandtaxableincome.Thequestionwasposedasfollows:

Ifapersonhastotalemploymentincomeof$70,000,interestfromabankaccountof$100,grossincomefromarentalpropertyof$16,000,$4,000in deductible salary expenses, and deductions (including interest)relatingtotheirrentalpropertyof$14,000,whatistheirtotalassessableincome?(Pleaseuseacalculatorifpreferred)

The correct response was $86,100 (ie the gross assessable amount excludingdeductions).AsseeninTable1,only20percentofparticipantsscoredcorrectlyforthis question. The most common alternative response was ‘Do not know’. Thisdemonstratesthattheconceptofassessableincomeand/orthedifferencebetweenassessableincomeandtaxableincomeisnotwellunderstoodbyuniversitystudentsaged20yearsandunder.TheadulttaxliteracysurveybyChardon,found53.1percentofadultsscoredcorrectly.Again,thoseunder20yearsofageappeartohavemuchlowerunderstandinginrelationtoassessableincome.46

The third tax knowledge question explored participant’s ability to calculate taxpayable,givenataxableincomefigureandacurrentversionofthetaxtables.Thequestionwaspresentedasfollows:

If a person’s total taxable income for the 2014/2015 tax year was$40,000,whatistheirtotaltaxpayablefortheyear(excludingmedicarelevy)? Use the following personal tax rates (please use a calculator ifpreferred)

Thecorrectanswerwas therefore$4,547.Theresultswere that56.8percentofparticipantschosethecorrectanswer.Themostcommonalternateresponsewas‘Donotknow’.Previoustaxliteracyresearchfoundamuchhighercorrectresponseratetothesamequestionamongadults(71.5percent).47

The final tax knowledge question asked about participant’s understanding ofnegativegearing.Thequestionwaspresentedasfollows:

Anegativelygearedinvestmentmeans(selectallthatapply)

– Theinvestmentislikelytodecreaseinvalueovertime

46 Chardon,aboven42.47 Chardon,aboven5.


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– Theinterestontheloanislessthantheincomereceivedfromtheinvestment

– Therearenoborrowingsassociatedwiththeinvestment

– Theinterestontheloanisgreaterthantheincomereceivedfromtheinvestment

– Negativegearingmeanssomethingelse

– Donotknow

– Prefernottoanswer

Thecorrectoptiontochooseherewas‘Theinterestontheloanisgreaterthantheincomereceivedfromtheinvestment’.Only17.5percentofparticipantsselectedthecorrectresponse.Themostcommonalternativeresponseswere‘Donotknow’followedby‘Theinvestmentislikelytodecreaseinvalueovertime’.Theadulttaxliteracysurveyfound54.1percentofadultsselectedthecorrectresponse,againsignallingpotentiallymuchlowerunderstandinginyoungerpersons.

D Self‐ratedUnderstandingComparedWithActualUnderstanding

Atotaltaxquizscorewascomputedforeachparticipantasthenumberofcorrectanswerstothefourtaxquestions.Table1(above)showsthatnearly85percentofthestudentscouldnotcorrectlyanswermorethantwooutofthefourtaxquestions.

Asillustratedintheclusteredbarchart inFigure1:, thesamplegroupsofhigherself‐ratings tend to have higher quiz scores. Prior to answering the knowledgequestions in thesurvey,participantswereaskedtoratetheirunderstandingofarangeofconceptsfrom‘VeryLow’throughto‘VeryHigh’.Figure1showsaclusteredbarchartof theself‐ratingsgroupedby the total taxquiz score (0–4questionscorrect), which allows a visual comparison of their self‐rated and actualperformance in tax literacy. As can be seen in Figure 1, a large number ofparticipantswhoself‐ratedaseither‘VeryLow’or‘Low’,scoredeither1or0correctfor the taxknowledgequestions.The twoevaluationsdemonstrate amoderatelypositivecorrelation(Spearman’srankcorrelationcoefficient=0.325,p<0.001).


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Figure1:Clusteredbarchartoftaxquizscoredistributionbyself‐ratinglevel

Table2comparesthedistributionandtheaverageoftheindividualtaxquizscoresacross self‐rating levels. Chi‐square test for linearity (χ2(1) = 20.096, p <.001)confirmedthelinearassociationbetweenthetwoordinalscales.One‐wayANOVAresult(F(4,215)=6.48,p<.001)confirmedthedifferencesintheaverageoftaxquizscore between self‐rating levels. All these support the claim of directionalconsistencybetweenself‐ratingandquestionscore.ThisresultisconsistentwithpreviousresearchbyChardon,whichfoundlessover‐confidenceinrelationtotaxandsuperannuationissuesbroadly.48Thoughover‐confidencetendstobehighinfinancialliteracyresearchgenerally,49itappearsthisisnotnecessarilythecasefortaxationconcepts.

Table2:TaxQuizScoreDistributionbyself‐ratinglevels(N=220)

Self‐rating(n)

Averagequizscore(%) QuizscoreMean(SD)0 1 2 3 4

Verylow(56)

37.5 39.3 19.6 3.6 0.0 0.9(0.8)

Low(87) 21.8 40.2 25.3 9.2 3.4 1.3(1.0)Fair(51) 13.7 25.5 31.4 27.5 2.0 1.8(1.1)High(18) 22.2 11.1 44.4 16.7 5.6 1.7(1.2)Veryhigh(8)

0.0 37.5 37.5 25.0 0.0 1.9(0.8)

48 Ibid.49 Batemanetal,aboven40;NatalieGalleryetal,‘FinancialLiteracyandPensionInvestment

Decisions’(2011)27(3)FinancialAccountability&Management286.


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E PredictorsofSelf‐RatedUnderstanding,OverallTaxScoreandIndividualQuestions

To predict self‐rated understanding and actual understanding respectively, anordinallogisticregressionmodelwasestimatedforeachordinalresponsevariableusingsuchpredictorsasgender(withfemalesasreference),employment(withtheemployedas reference), andATAR(seeTable3below).Bothmodelsareoverallstatistically significant at the 5 per cent level and both meet the parallel lineassumptionforordinalregressions.Bothmodelsalsoshowacceptablegoodnessoffit, although the fitof self‐ratingmodel ismarginally significantdue to thesmallcategoryof‘veryhigh’.50

Genderandemploymentwerefoundtobestatisticallysignificantpredictorsofself‐ratedunderstandingoftaxknowledge,whileATARwasnot(seeTable3).

Table3:Resultsofordinallogisticregressionsofself‐ratingandquizscoreandbinarylogisticregressionsofquestions(N=165)

Predictor

Response

Self‐ratingOverallTaxScore

Q1TaxandSuper

Q2AssessableIncome

Q3TaxPayable

Q4NegativeGearing

Male 0.816** 0.831** 1.367*** 0.177 0.320 0.356Unemployed

‐0.817** ‐0.080 ‐1.093** ‐0.068 0.259 0.445

ATAR 0.012 0.020* 0.016 0.014 0.015 0.014ModelfitLikelihoodratiotestofomnibussignificanceΧ2(d.f.)

10.1(3)** 8.8(3)** 15.3(3)***

.819(3) 2.594(3) 3.055(3)

ParallellinestestΧ2(d.f.)

3.6(9) 9.3(9) NA NA NA NA

PearsongoodnessoffittestΧ2(d.f.)

509.2(469)*

470.0(469)

114.5(115)

127.2(115)

130.4(115)

121.5(115)

PseudoR2

(Nagelkerke)

.064 .055 .121 .008 .021 .028

*** Statistically significant at 1% level; ** at 5% level; * at 10% level

Thepositivecoefficientfor‘male’meansthatmalestudentstendtoratethemselveshigherthanfemalesforanyratinglevel.Theratiooftheoddsforlowertohigherself‐ratings betweenmales and females is0.44= exp(‐β)=exp(‐0.816), holding all

50 J. Scott Long, RegressionModels for Categorical and Limited Dependent Variables (SagePublications,1sted,1997).


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othervariablesconstant.Theunemployedstudentstendtoratethemselveslowerthantheemployed.Theratiooftheoddsforlowertohigherself‐ratingsbetweentheunemployedandtheemployedis2.26,allelsebeingequal.

For overall tax score, gender and ATAR were statistically significant predictors,whereasemploymentwasnot(seeTable3).Malestudentsscorehigherinthetaxquizzesthanfemales.Theoddsforlowertohigherquizscoresamongmalesis0.44times (or 56 per cent) smaller than the odds among females, holding allother variables constant. Students with higher ATAR also tend to score slightlyhigherinthe tax quizzes. For one unit increase in ATAR, the odds for lower tohigher quizscores decreases by a factor of 0.98 (or 2 per cent), holding allother variables constant. This finding is consistent with the earlier findings inrelation to adult tax literacy,which found that gender and education levelweresignificantlycorrelatedwith tax literacy score.51However, previously it has beenfoundthatemploymenthourswasstronglycorrelatedwithtaxliteracyscore.52

A binary logistic regression model was estimated to predict each tax questionscore using gender, employment, and ATAR. Considering the similar overallfindings inthefourtaxquestions,theerrorstermsofthelogitfunctionsmightbesubstantially positively correlated. A multivariate probit model was estimatedusing State13.53Only the model for Question 1 (taxation of superannuation) is overall staticallysignificant,whichmeansthatnoneofthethreepredictorsaffectsQuestion 2, 3, or 4. For Question 1 (taxation of superannuation), male andemployed students have a higher chance of giving the correct answer. Theodds of correctly answering Question 1 among males is nearly four timeslarger than the odds among females, all else being equal. Among employedstudents, the odds of correctly answering Question 1 is almost three timeslarger than theoddsamong theunemployed,all elsebeingequal.This finding inrelation to males and the employed is consistent with the adult tax literacy survey, which found a relationship between high tax literacyscoresandgenderaswellasemploymenthours.54

F QualitativeAnalysis

Participants were able to make further comments about their ‘financial skillseducation’ at the end of the survey. A thematic analysis of the responses inthis section was also undertaken.55 The most common theme was thatparticipants identified familyand/orparentsas theirprimarysourceof financialknowledgetodate.Thisishighlightedbythefollowingcomments:

51 Chardon,aboven42.52 Ibid.53 Theresultswere thatnopairoferrortermswassubstantiallycorrelated(allcorrelation

werelessthan0.40).Therefore,theauthorsdecidedtointerprettheresultsoffourseparatebinary logistic regressions (see Table 3). Lorenzo Cappellari and Stephen P. Jenkins,‘Multivariateprobitregressionusingsimulatedmaximumlikelihood’(2003)3(3)TheStataJournal278.

54 Chardon,aboven42.55 MichaelHubermanandMatthewB.Miles,TheQualitativeResearcher’sCompanion (SAGE

Publications,2002).


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‘AllI’velearnthasbeenfrommyparentsandeventhenIstilldon’tknowhowtofiletaxreturnsorcheckmysuperorinvestanything.’

‘Neverreallyhadanyatschool.Ididn’tevenknowhowtodomytaxes.Ihadtohavemymotherhelpmethefirstcoupleoftimes.’

‘Virtuallynone,otherthanmyparents.’

Thisthemehighlightsoneofthecommonproblemsofthefinancialliteracycontext.In the past, financial literacy education programs within schools were scarce.Therefore, this important financial decision making knowledge tended to comefrom families or close friends. Since previous surveys of adult financial and taxliteracy have found significant deficiencies in financial and tax knowledge andbehaviour in the adult population,56 it is argued that misunderstandings arethereforepassedontotheyoungergenerationunlessthereisintervention.

Another common theme was that participants recognised the importance offinancialeducation.Thefollowingcommentshighlightthatwithinthisbroadtheme,taxandsuperannuationknowledgewererecognisedasimportantaspects.

‘But I have no recollections of learning anything about tax,superannuationoranyofthatotherstuff.IliketothinkIamintelligent,butinthisareaIknownothing.’

‘Ibelieveall kids shouldbe thought (sic)how tobudgetpaybills andotherimportantlife/financialskillsesp(sic)super/taxandsavings.’

Further,thesurveyfoundthat61.6percentofparticipants‘wouldprefertolearnmorefinancialskillsinuniversity’.

Overall, theresultsdemonstrate that there isrelatively lowunderstandingof taxand superannuation concepts among the university students surveyed. This lowlevel of knowledge was also reflected in low levels of self‐rated understanding.Gender and employment were found to be indicators of increased tax andsuperannuationknowledge.Thequalitativeanalysisalsosuggestedtheimportanceoftaxandsuperannuationknowledge.

IV IMPLICATIONSANDOPPORTUNITIESFORUNIVERSITYTEACHING

Theresultspresentedinthisarticleaddtothegrowingevidencethatbasictaxandsuperannuationconceptsarean importantaspect tobe included inany financialliteracyorcapabilityframework.PreviousresearchbyChardon,CullandWhittonhasdemonstratedthattheremaybelowlevelsofunderstandingofsomeimportantbasic tax and superannuation concepts.57 The results presented in this papersupportthesepreviousfindingsandfurtherfindthatunderstandingsofbasictaxandsuperannuationconceptsaregenerallylowerinthoseundertheageof20years.

56 ANZ,AdultFinancialLiteracy inAustralia –FullReportof the results from the2011ANZSurvey,aboven4;Chardon,aboven5.

57 Chardon,aboven5;CullandWhitton,aboven29.


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The results also demonstrate a correlation between gender, ATAR and taxknowledgeoutcomes.

Giventheliteraturepresentedinrelationtotheimportanceofcontinuedfinancialeducationthroughoutschoolanduniversity,theprevalenceoffinancialeducationprogramsintheUnitedStatesandtheargumentsthathighlevelsofdebtandlowlevels of financial literacy in university students is indicative of a risk of poorfinancialoutcomes,itisarguedthattheteachingoffinancialliteracy(includingtaxaspects)atuniversityshouldbeconsideredasapriority.Thequalitativedatadrawnfromthesurveyfurthersupportsthisargument.

The results also provide some important insights for tax teaching and advisortrainingmorebroadly.Itissubmittedthatthespecificevidencepresentedinthispaperandpreviousfinancialliteracyevidenceshouldbeusedinthedesignofanyprogramthatpreparesaccounting,legalortaxadvisorsforpractice.Taxcomplianceresearch has suggested that complexity of tax concepts may causemisunderstandingsbetweena taxpayer and their tax agent.58 This finding in theempiricalresearch‐‐ that therearebroadmisunderstandings inrelationtobasicaspects of taxation policy ‐‐ is important, and should be taught in taxation lawcourses to enable potential advisors (whether accountants, lawyers or financialadvisors)tomitigatemisunderstandings.Advisorsneedtobeacutelyawareoftheleveloffinancial,taxandsuperannuationknowledgetheirclientswillhave,whichdemographicsaremostlikelytohavepoorlevelsoffinancialliteracy(femalesandthosewith lowereducation levels)andstrategies toexplaintheseconceptsmosteffectively. Understanding the levels of financial and tax literacy of clients anddemographic groups will aid in ensuring our students are equipped with theknowledgetheyneedtocommunicateeffectivelywiththeirclients.

Enthusiasticandcommitteddiscipline leadersarekey todriving the inclusionoffinancialeducationprogramsattheuniversity level,whetherthatbestand‐alonecross‐disciplinarycoursesorembeddedunits inothercourses.59AsCrainargues,‘the foundations of financial knowledge and skills should be introduced inelementaryschools,expandedinhighschoolsandreinforcedincolleges’.60 Inthecontextofcompetingdemandsfromuniversityprogramreviews,otherdisciplinesandprofessionalbodies, it is important foruniversityacademics(specifically taxteachers) to remain committed to and passionate about the importance of taxeducation in university programs. The evidence that there are low levels of taxliteracy in the younger generation and that it is seen by them as important andworthwhile, only serves to bolster the argument for the inclusion of tax literacyeducationprogramswithinschoolsanduniversities.

Thecontinuedpassionfortaxteachingfromdisciplineleadersandchampioningofcross‐disciplinaryteachingopportunitiesserveanumberofimportantpurposes.ItimpactsuponnationalpolicybyfurtheringtheNationalFinancialLiteracyStrategy

58 Margaret McKerchar, The Impact of Complexity upon Unintentional Non‐Compliance forAustralianPersonalIncomeTaxpayers(PhDThesis,UNSW,2002).

59 Crain,aboven34.60 Ibid14.


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aswellascreatingbettertaxadvisorsandmoretax‐literateconsumerswhoareabletomakemoreinformedcontributionstotaxpolicyintothefuture.

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Bateman,Hazeletal, ‘FinancialCompetenceandExpectationsFormation:EvidencefromAustralia’(2012)88(280)EconomicRecord39

Beal, Diana and Sarath Delpachitra, ‘Financial Literacy amount Australian universitystudents’(2003)22(1)EconomicPapers:aJournalofAppliedEconomicsandPolicy65

Blue,LevonandMarkBrimble,‘ReframingExpectationsofFinancialLiteracy:BringingBacktheReality’(2014)1JASSA:TheFinsiaJournalofAppliedFinance37

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EMERGENCE,GROWTHANDMOBILITYOFEUROPEANCOMPETENCEONDIRECTTAXREGIME:ANANALYTICALANDEVOLUTIONARYREVIEW

SHAFIUKHANNIAZI*

ABSTRACT

Since its founding days, the EuropeanUnion (EU) constitution has not explicitlyempoweredtheUniontoformulatepolicyinthefieldofdirecttaxes;thisareahasbeenbroadly left to theMemberStates.Todate, limitedEU‐level intervention indirect taxes can, in part, be attributed to this power‐allocation scheme in theEuropeanconstitution.Infact,morethanthreedecadessincetheinceptionoftheEU,nosubstantiveEuropeanlegislationhasexistedinthisarea.Nevertheless,theEUwas,andstillis,implicitlyempoweredtoenacttaxlawsiftaxpoliciesofMemberStates infringe the EU’s single‐market principles. This article analyses the EU’sdirect tax powers, reviews the EU (tax) competence ‘submerged’ in theconstitutionalfreedomsandsingle‐marketideaanditssub‐textualgrowth,andthewaythisprogressivelyemerged.Italsoarguesthatasthesinglemarketgrows,sodothepossiblemeaningsofEUcompetenceinpolicyareasaffectingthatmarket,including (implicit) tax powers. By analysing growth and mobility in the (tax)legislativeregime,thearticleconcludesthatthepolicyoflimitedEUinterventionintherealmofdirect taxesmaynotpersist in the longrun,butrathermayshift toexpansivelegislationintimesahead.

* The author is a doctoral candidate at Monash Business School, Monash University, andworks as Additional Commissioner (Inland Revenue) for the Federal Board of Revenue,Pakistan.AnearlierversionofthisarticlewasawardedastheBestTaxPhDPaperbyATTA.


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I INTRODUCTION

TheEuropeanUnion(EU)isasinglemarketof28MemberStates.1Toachieveitssingle‐market objective, the EU adopted several legislative measures includingsinglecustomstariffsfortheregion,andintervenedcloselytoharmonisenationalVATregimes.Todate,however,littleprogresshasbeenmadetointegrateMembers’incomeandcorporatetaxregimes.Thisarticlereviewsthissituationandoffersalegal analysis of the lack of wider EU‐level actions to integrate direct taxes ofMemberStates.Basedontheevolutionofthedivisionofpowersbetweenstatesandthe supranational polity, the EU, this article argues that the current situation oflimitedinterventioninthefieldofdirecttaxesmaynotpersistinthelongrun,butmightshifttowide‐rangingEU‐levelactionsinthetimesahead.

Essentially,theEUdirecttaxlaw2foreseestheinstitutionofaninternalEuropeanmarket.3Thegoverningtreaties–the‘constitutional’documentofthejurisdiction–4 proclaim direct taxes generally as Members’ terrain,5 if they do not violate

1 TheEUcomprises28MemberStates.TheUnitedKingdomdecidedtoleavetheUnioninareferendum held on 23 June 2016. However, until the UK formally departs, the Unionmembershipremains28.

2 Direct taxation in this article refers to income taxes (personal and corporate taxes),notwithstanding any other formsof direct taxes in the national jurisdictions ofMemberStates.

3 CreationofaninternalmarketwithintheEUjurisdictionisaconstitutionalobligationundertheEUlaw;see,eg,theTreatyonEuropeanUnion(TEU)belown4,art3,[2010]OJC83/1,17andTreatyontheFunctioningoftheEuropeanUnion(TFEU),belown4,art26,[2010]OJC83/1,59.Forthetextoftheinternalmarketclause,seebelown18.Referencestosingle,commonorUnionmarketinthisarticlewilleffectivelymeaninternalmarket.

4 EUconstitutionorgoverningtreatiesinthisarticlereferstorespectivetreatydocumentinforceinEU.ThearticlereferstoseveralEUtreaties:(1)theexistingconstitutionknownasLisbon Treaty became effective from 1 December 2009. It comprises: The ConsolidatedVersionsoftheTreatyonEuropeanUnionandtheTreatyontheFunctioningoftheEuropeanUnion,[2010]OJC83/1(respectivelyTEUandTFEU).ThepredecessorsoftheLisbonTreatywere: (2) The Consolidated Versions of the Treaty on European Union and the TreatyEstablishingtheEuropeanCommunity,[2006]OJC321E/1(respectivelyTEUpre‐LisbonandEC Treaty); (3) Treaty of Nice amending the Treaty on the European Union, the TreatyEstablishing the European Communities and Certain Related Acts, [2001] OJ C/80/1(respectively,TEU (Niceversion) andECTreaty (Niceversion)); (4)TreatyofAmsterdamamending the Treaty on the European Union, the Treaties Establishing the EuropeanCommunitiesandCertainRelatedActs,[1997]OJC340/1(AmsterdamTreaty);(5)TreatyonEuropean Union Together with the Complete Text of Treaty Establishing the EuropeanCommunity (untilMaastricht), [1992]OJC224/1 [hereinafterMaastrichtECTreaty]; (6)SingleEuropeanAct,[1987]OJL169/1(SEA);(7)TreatyEstablishingtheEuropeanEconomicCommunity,25March1957,298UNTS11(EECTreaty).

5 Broadly,theconstitutionassignspowersinthedirecttaxregimetoMembers.Forexample,in the existing constitution, areas of exclusive Union competences as well as areas ofcompetencessharedbybothEUandMembers(TFEU,aboven4,arts3,4(2),[2010]OJC83/1,51–52)donotconfertaxpowerstoEUinexpressform.Hence,pursuanttoprincipleofconferralofresidualpowers(TEU,aboven4,art4(1),[2010]OJC83/1,18)thatstatespowersnotconferredupontheUniontostay(subjecttoTFEU,aboven4,art4(1),[2010]OJC83/1,51)withMembers,directtaxationgenerallyremainsaMembers’domain.LegalscholarshiponEUtaxlawalsoholdssimilarviews;see,eg,CharlesEMcLure,Jr,‘Legislative,


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fundamental freedoms6 and prohibition principles7 (collectively called ‘freedomclauses’) enshrined in the constitution to institute a singlemarket. The nationalgovernments of Member States are thus empowered to formulate their owndomestictaxpolicies,aslongasthesepoliciesdonotinfringetheEUlaw.Ontheotherhand,itisobviouslyhardtoachieveharmonyin28sovereignandparalleltaxsystemsoperativeinasingleEuropeanmarket.Subjecttospecifiedprinciples,8theEUneverthelessalwayshad–andstillhas–thepowertoenacttaxlegislation9thatcould intervene in thosenational tax policieswhich impede the functioningof asingleeconomicmarket.TheseareunspokenpowersintheEUconstitutionand,asthis article canvasses, they remain buried in the legal subtext and are likely toexpandfurtherovertime.

Judicial,SoftLaw,andCooperativeApproachestoHarmonizingCorporateIncomeTaxesintheUSandtheEU’(2008)14ColumbiaJournalofEuropeanLaw377,382(observingthat‘[M]emberStatesoftheECretaincompetenceinthetaxfield,exceptinsofarasexerciseofthecompetenceisrestrictedbyregulationsordirectives’).McLurefurthersaysthatitiswellestablishedinthecaselawthat‘MemberStatesmustnonethelessexercisethatcompetenceconsistentlywithCommunitylaw’(citingMarks&SpencervHalsey(C‐446/03)[2005]ECRI‐10837,para29,andcitationstopreviouscasesprovidedthere).

6 Freedomsguaranteed(referredtoasfundamentalfreedoms)intheinternalmarkethavingnexus to direct taxation are: freedom of movement to work (TFEU, above n 4, art 45),freedomtorightofestablishment(TFEU,aboven4,art49), freedomtoprovideservices(TFEU,aboven4,art56),freedomofmovementofcapitalandpayments(TFEU,aboven4,art63).

7 Prohibitionsdeclaredintheinternalmarkethavingnexustodirecttaxationare:prohibitionondiscriminationonthebasisofnationality(TFEU,aboven4,art18)andprohibitiononstateaid(TFEU,aboven4,art107).

8 Forinterveningnationalpoliciesondirecttaxes,thesuprastatepowersareexercisedandgovernedbyschematiclegalorderssetoutintheEUlaw,inparticularprovisionsmeantfordivision of powers (below n 17) and principles of subsidiarity and proportionality (seebelowPartIII(C)).

9 Thereareseveralwaystointerveneinnationaltaxpolicies.Themostwellknownisthroughtheadoptionofdirectives,oneoftheformsofEUlegislativeacts.Thecurrentlegislationondirecttaxes(seebelowPartII(C))takestheformofdirectives,whicharebindingundertheEU law. However, directives have only vertical effect (enforcement of EU rights againststate);theylack(horizontal)enforcementofEUrightsagainstprivatepersons.ThedoctrineofdirecteffectoriginatesfromtheEuropeanCourtofJusticerulinginthelandmarkcaseVanGendenLoosvNetherlandseAdministratiederBelastingen(26/62)[1963]ECR1.Thisrulingstipulatesthatcertainprovisions(orinstruments)ofEUlawinheritlegalforcethatbyvirtueofdirecteffectareeffectiveinMemberStateswithoutbeingenactedintodomesticlaws.Formoredetailsonthisprinciple,see,eg,KarenDavies,UnderstandEuropeanUnionLaw(5thed,EbooksCorporation,2013)69–84.Onevolutionanddevelopmentofthisprinciple,seeBrunodeWitte,‘DirectEffect,Primacy,andtheNatureofLegalOrder’inPaulCraigandGdeBurca(eds)TheEvolutionofEULaw(OxfordUniversityPress,2nded,2011)323.Besidesdirective‐basedlegislation,theEUisalsoempoweredtointerveneinthosenationaltax policieswhich are selective in nature and can distort free competition in the singlemarket.Forthesepowers,seeTFEU,aboven4,arts107–109;onuseofthesepowersbytheEuropeanCommissioninrecenttimes,see,eg,<http://europa.eu/rapid/press‐release_IP‐16‐2923_en.htm> (last accessed 30 August 2016), on Irish tax rulings issued to AppleIreland.


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Unlike VAT, which is subject to relatively strict central control by means of a VAT Directive10 based on explicit constitutional provisions,11 the legislative measures adopted to date in the field of direct taxes are narrow in scope, dealing with discreetissues.12 In fact, the EU-level legislation on direct taxes is constrained by two key factors: First, a constitutional framework that, in stark contrast with, for example, customs tariffs, contains no express provision directing the EU to intervene into the field of direct taxes. The Members, therefore, generally retain autonomy in this policy area.13 The second is the fact that the EU tax legislation requires unanimous consensus of all Members,14 a task difficult to achieve in the wake of fiscal sovereignty claims of national treasuries. With no change foreseeable in the unanimity rule to adopt direct tax legislation, any dramatic shift in politics of taxation in the near future is not expected. Nevertheless, the EU may be entering a new evolutionary phase of an ‘ever closer union’15 that could change the dynamics of the balance of powers between Member States and the EU, and this merits closer examination. This article examines the first of the two key restrictions posed to the tax legislation under EU law – that is, lack of express constitutional powers to enact measures in the field of direct taxes.

Investigation of the legislative regimes and balance of powers in the EU law is a challenging task. First, it involves scrutiny of a unique constitutional framework that is ‘a blend of international law, national constitutional law, and federalism’.16 Second, the analysis involves a legislative regime that is not otherwise articulated in the EU constitution – for that is the case with direct taxes. Thus, the complexity associated with defining four corners of a Union action in this area within a ‘sub-textual’ constitutional framework of division of powers17 is substantial. This article explores the gradual

10 CouncilDirective2006/112/EContheCommonSystemofValueAddedTax,[2006]OJL347/1(herereferredtoastheExistingVATDirective).ItreplacedtheearlierVATlegislationbasedonCouncilDirective77/388/EEConHarmonizationoftheLawsoftheMemberStatesrelatingtoTurnoverTaxes–CommonSystemofValueAddedTax:UniformBasisofAssessment,[1977]OJL145/1(herereferredtoastheOldVATDirective).

11 SeebelowPartIII(B)(2).12 EachDirectiveadoptedondirect taxes is fairly limited in scopeanddealswithspecified

issue;see,eg,belowPartII(C).13 Seeaboven5.14 Fordirecttaxation,existinglegislativeinstruments(Directives)arebasedonTFEU,aboven

4,art115,whichrequirestheunanimousconsensusofallMembers(eachrepresentedbyrespectiveministerintheCounciloftheEU).Theunanimitycriterionontaxlegislationispopularly known as veto power of eachMember; see, eg, Michael J Graetz and Alvin CWarren, Jr, ‘Income Tax Discrimination and the Political and Economic Integration ofEurope’ (2006)115YaleLaw Journal 1190–1191 (stating that theCouncil cannotactonincometaxissueswithoutunanimousconsensusasanyMembercanvetoanyproposal).

15 AcommitmentofMemberStates ‘tocreateanevercloserunionamongthepeopleoftheEurope’wasinsertedinthepreambleundertheMaastrichtTreaty([1992]OJC224/1,3),andcontinuestoexistthereinthecurrentEUlaw.

16 GraetzandWarren,aboven14,1190(citingJamesACaporaso,‘TheEuropeanUnionandFormsofState:Westphalian,RegulatoryorPost‐Modern?’ (1996)34 JournalofCommonMarketStudies29.

17 FortheconstitutionalplanondivisionofpowersbetweenEUandMembers,seeprincipleofconferral of competences (TEU, above n 4, arts 4, 5(1) (2)), general scope of exercisingcompetences(TFEU,aboven4,art2),EUexclusivecompetences(TFEU,aboven4,art3),EU‐Memberssharedcompetences(TFEU,aboven4,art4),ensuringcoordination(TFEU,aboven4,art5),EUsupportingactions(TFEU,aboven4,art6),ProtocolNo.25(onexerciseofsharedcompetences,[2010]OJC83/1,307);DeclarationNo.18annexedtotheTreatyof


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emergence of European tax power, the way it developed over time, and its possible expansion in prospect.

The remainder of the article is structured as follows. Part II provides insights into the implied character of EU powers to legislate direct tax measures in accordance with the constitutional scheme. It also offers a concise appraisal of existing EU legislation in the field of direct taxes. Part III analyses factors embedded in the EU legal system that have potential to impact Union-level actions in this policy area. It explores the way the three factors – (a) the implied character, (b) the general legal basis, and (c) the subsidiarity rule – could possibly impact EU tax legislation. Part IV offers a historical discourse, tracksthe tax journey and overviews the way EU tax powers have evolved since the foundingdays to attain constitutional force. By reviewing developments since inception of the EU,it also examines the so-called inertia of direct tax legislation during the initial threedecades alongside the sub-textual legislative power in tax matters that existed submergedin the constitution under the single market principles. It then examines the gradualemergence and growth of European powers in the area of direct taxes. This part alsoargues that the persistent growth in interstate trade and transnational economic activityattained over time through freedoms induce corresponding changes in the integrationalstatus of the single market. Accordingly, EU tax competence, now gestating in theundergrowth of freedom clauses, attains new meanings with the passage of time andgradually keeps expanding. The article also briefly touches upon the most recent EUdevelopments on tax practices that are detrimental to the single market – those thatresulted in the widely publicised taxation of Apple in Ireland. Finally, Part V draws abrief conclusion.

II SOURCESOFEUPOWERSTOLEGISLATEMEASURESFORDIRECTTAXINTEGRATION

The EU law is silent on legislative powers relating to income tax policymaking, as that realm has generally been left to the Members. The EU-level legislative powers are derived indirectly from other sources embedded in the constitution. To trace an implicit seamless story of direct tax law, three constitutional commitments together serve as threads (prerequisites) to interweave as the broad contours of EU tax powers: (1) a constitutional obligation to constitute a single market18 in accordance with the freedom clauses;19 (2) a constitutional authority or legal basis to enact measures to remove disparities in national tax rules and integrate them to make them compatible with the

Lisbon(principlesofde‐conferralofsharedcompetence,[2010]OJC83/1,344–45),etc.Onconstitutional principles setting out the plan to govern the use of non‐exclusive EUcompetences,seeprinciplesofsubsidiarityandproportionality(TEU,aboven4,art5(3),(4),andbelowPartIII(C)).

18 OnspecificobligationsassignedtotheUnion,seeTEU,aboven4,art3(3):‘TheUnionshallestablishaninternalmarket’,andcorrespondingpowersvestedintheUnion,inparticular,under TFEU, above n 4, art 26: ‘1. The Union shall adopt measures with the aim ofestablishing or ensuring the functioning of the internal market, in accordance with therelevantprovisionsoftheTreaties.2.Theinternalmarketshallcompriseanareawithoutinternal frontiers inwhich the freemovement of goods, persons, services and capital isensuredinaccordancewiththeprovisionsoftheTreaties.’

19 Seeabovenn6–7.Freedomclausesserveasprimevehiclestoachievethecoreobjectiveofcreatingsinglemarket.


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single market notion;20 and (3) while adopting such measures, a requirement that Union action remain consistent with power allocation scheme and the regulatory clauses set out in the constitution.21 The result is that a potential EU action in taxation is bound to adhere to these constitutional contemplations. Of these three ingredients, the first two are the main sources of power allocation that respectively inherit legal authority for supranational EU actions. The third component does not itself confer competence, but is rather an overseeing and regulatory provision, as explained in Part III(C).

A ThePowersInherentinSingleMarketPrinciples

Since its inception in 1957 through the foundational treaty establishing the European Economic Community (EEC Treaty), the EU law has not expressly mentioned direct taxes. The only explicit reference – concerning Members’ obligation to eliminate double taxation –22 also no longer exists, since the Treaty of Lisbon came into force. Despite lack of any directions and absence of its explicit mention in the body of the primary law,23 EU tax competence remained – and still remains – integral to the multilayered EU constitution.24 The obligation to institute a single European market together with freedom clauses25 creates room for an EU role in the field of direct taxes.

As long as national jurisdictions of Member States do not infringe the EU law in terms of having tax rules reasonably compatible with the freedom clauses and the single market notion, hypothetically, there would arise hardly any need to legislate EU-wide income tax rules. In practice, however, it is conceivable that several situations triggered by parallel exercise of multiple sovereign tax policies might inevitably end up in derogation to the freedom clauses. Then, where national tax measures intersect with the freedom clauses and infringe upon them, Union-wide measures might be necessary. Owing largely to the dual constraints posed to supranational tax legislation pointed out in Part I, such efforts have not, to date, translated into substantive legislation. In past, several legislative

20 Theseprovisionsembodythosetoolswhicharedestinedtoprovideaprecise(legal)base,and serve as a launching pad for legislative acts. Consequently, to initiate legislation indifferentareas,thereareseveralconstitutionalplatforms(bases);see,eg,belown27.

21 AlegislativeactionoftheUnionintheareaofdirecttaxes,whilefulfillingitsobligationstoinstituteasinglemarket,isakintointerventioninapolicyareathatotherwiseisgenerallyaMembers’domain.ThismakesthedivisionofpowersequilibriumbetweenMembersandUnionconvoluted.Inanycase,theequilibriumhastobeincompliancewithsubsidiarityandproportionalityrules(seebelowPartIII(C))thatgovernthelegislativeactsonallareasofnon‐exclusiveEUcompetencesincludingdirecttaxes.

22 SeeECTreaty,aboven4,art293,secondindent,[2006]OJC321E/1,173;forlegaltext,seebelown121.

23 Primary law, in EU parlance, refers to governing treaties or the constitution, whereassecondary law refers to legislation enacted thereunder, such as Regulations, Directives,Decisions,etc.

24 TheexpressionmultilayeredhighlightsspecificdesignofEUlawthatcomprisesauniquemixofnationaland international laws;see,eg,MichaelLongoConstitutionalisingEurope:ProcessesandPractices(Ashgate,2006)11(observingthat‘TheEUhasbeendescribedasamulti‐level governance; a postmodern polity; a confederation; a quasi‐federal systemfeaturingpre‐federalinstitutions;asuigenerislegalorder’andsoon);seealsoaboven16andaccompanyingtext.

25 Forconstitutionalauthorityonfreedomclauses,seeabovenn6–7.


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proposals in this policy area either could not take the form of a binding law or remain awaiting approval due to lack of unanimous consensus of Member States.26

B AnImplicitLegalBasistoRemoveDisparities

The initiation of an EU-level action requires a legal basis. That legal platform serves as a constitutional vehicle to translate the intents (legislative agenda) into actions (enactments). The clause that serves as a potential legal platform from which to initiate an EU-level (tax) measure is a general constitutional provision akin to the constitutional powers vested in freedom clauses to intervene into national (tax) rules in case the latter violate the single market notion. Article 115 (TFEU) authorises the EU to integrate those national laws (including direct taxes) that are incidental to the establishment or functioning of the single market.

The authority crafted in this legal basis inherits multiple characteristics that would support the initiation of a measure to integrate Member policy areas (including taxes). First, it is a constitutional prerequisite to initiating a legislative act.27 Second, it determines voting criteria to enact legislation – that is, whether majority or unanimity of Members is required – that in turn has its own implications.28 Third, among multiple legislative forms (such as regulation, directive, or decision),thelegalbasisinquestionsetsouttoadoptadirectiveform to enact direct tax legislation.29 A directive is a form of binding legislation that allows Members liberty to choose their own modes of transposition into national rules to achieve its objectives. In this way, the legal platform has affinities with the state–suprastate power-sharing formula envisioned under the EU legal system. Furthermore, on a case-to-case basis, the chosen legal tools may also be

26 Someofthelegislativeinitiativespursuanttoeliminatingspecifieddisparitiesandbringingintegration in direct taxes ended successfully in adoption of Directives (see below PartII(C));whileothersareeitherpending, eg,EuropeanCommissionProposal foraCouncilDirective on a CommonConsolidatedCorporate TaxBase (CCCTB), COM(2011)121/4 –2011/0058(CNS)(March2011)(CommissionProposalonCCCTBDirective),orwithdrawn(egEuropeanCommissionProposals,belown97).

27 ‘Legalactsshallstatethereasonsonwhichtheyarebased’(TFEU,aboven4,art296,para2).Onvarious legalbases for legislativeactions indifferentpolicysectors,see,eg,TFEU,aboven4,arts14,16,18–21,22–25,33,43,46,48,50–53,56,59,64,65,75,77–79,81,82–89, 91, 95, 103, 109, 113–116, 118, 352 and so forth. A few legal bases are general incharacterandmayservetoinitiatelegislationinmultiplesectors;eg,TFEU,aboven4,art115(seebelowPartIII(B)(1))andart352.

28 TheunanimitycriterionorvetopowerheldbyeachMemberiswidelyconsideredasoneofthe leading factors impeding legislation on direct taxes; see, eg, Tracy A Kaye, ‘DirectTaxation in the European Union: From Maastricht to Lisbon’ (2012) 35 FordhamInternational Law Journal 1232 (observing that unlike various other sectors having arequirementofqualifiedmajoritylegislativeprocedure,directtaxharmonisationproceededslowlyduetotheneedforunanimouslegislativeprocess).

29 LegislativeactsintheformofRegulation,Directive,andDecisionarebinding,andthoseinthe form of Recommendation and Opinion are non‐binding. While both Regulation andDecisionarebindingintheirentirety,andthereforeofdirecteffect,theformerisgenerallyapplicable to all Members, unlike the latter, which applies to whom it specifies. Incomparison,directive isa typeof legislationapplicabletowhomaddressedbut lacksthehorizontaldirecteffect(rightsenforceableonlyagainststateandnotprivateparties).TheMembersarefreetochooseformandmodalitiestointegrateitintotheirnationallawswithanobligationtotheeffectthattheresultsdesiredbyitmustbeachieved(seeTFEU,aboven4,art288;onprincipleofdirecteffect,seeaboven9).


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indicative of the schema of other broader guidelines – relevant but scattered elsewhere in the EU constitution – on exercise of powers in the multilayered European law.30

C ExerciseofImplicitPowersUntilNow

The EU has exercised very limited legislative powers in the area of direct taxes. The legislation adopted to date is limited to a few narrow and discrete measures focusing predominantly on qualifying corporate taxpayers. The legislative instruments tend to limit double taxation by targeting the tax consequences of itemised cross-border transactions of specified taxpayers. In addition to assistance and recovery measures,31 a few such instruments (directives) have been issued to date by the legislator (the Council of EU, where each Member State is represented by its respective Minister) on the recommendations of the executive organ (the European Commission).32 The legislation in force generally aims to abolish specified forms of double tax burdens likely to arise pursuant to divergent national tax systems in the internal market. A brief description of each directive follows.

The Parent–Subsidiary Directive33 is meant to bring interstate and intrastate companies to parity by removing tax disadvantages to the former. The legislation mitigates economic double taxation between parent and subsidiary by stipulating that the Member State of a parent company should either exempt the dividend distribution or extend an indirect credit of tax payments by the subsidiary. The Directive prohibits the Member State of a subsidiary company compulsorily imposing withholding tax on the dividend to avoid juridical double taxation. The scope of this directive is dividend-specific and limited to related companies, and is further subject to a qualifying ‘minimum holding’ requirement.

The Mergers Directive,34 at the time of merger, division, partial division or transfer of assets, prohibits the state of the transferring company to tax any built-in capital gain. The taxation of capital gain is not removed altogether; rather, it is deferred. If taxation of the gain were not deferred, the transferring Member State would tax the difference between the book value and current value at the time of transfer, and the new state of residence

30 See,eg,CouncilDirective2010/24/EUconcerningMutualAssistanceonRecoveryofClaimsrelatingtoTaxes,DutiesandOtherClaims,[2010]OJL84/1(RecoveryDirective)andCouncilDirective2011/16/EUonAdministrativeCooperation in theFieldofTaxation, [2011]OJL64/1(hereinafterCooperationDirective).BothDirectivesintheirpreambles,placerelianceonmultiple legal bases as ‘having regard to the Treaty on the Functioning of EuropeanUnion,andinparticularArticles113and115thereof’.Insertionofanadditionallegalbase(TFEU,aboven4,art113) is factually indicativeofconferringcompetence inadditiontowhatisrequiredfordirecttaxes,andhencerenderboththesedirectivesequallyapplicabletoindirecttaxes.

31 Recovery Directive and Cooperation Directive, ibid. The Cooperation Directive hasundergonesomekeyamendmentsinviewoftheongoingEuropeancampaignagainstBaseErosionandProfitShifting(BEPS);see,eg,amendmentsnotedinbelown37.

32 TheCouncilofEU(representedbyrelevantministerofeachMember)togetherwiththeEUParliamentconstitutethelegislatureoftheUnion.

33 CouncilDirective90/435/EEConCommonSystemofTaxationApplicableintheCaseofParentCompaniesandSubsidiariesofDifferentMemberStates,[1990]OJL225/6–9(asamendedfromtimetotime)(herereferredtoasParent–SubsidiaryDirective).

34 Council Directive 90/434/EEC on Common System of Taxation Applicable to Mergers,Divisions, Transfers of Assets and Exchanges concerning Companies of DifferentMemberStates,[1990]OJL225/1–5(asamendedfromtimetotime)(herereferredtoasMergersDirective).


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would tax the difference between book value and sale value of assets. The deferral, to mitigate double taxation that might have happened pursuant to differences in timings of taxation, ensures that both Members tax at the same time when actual sale of assets takes place. The Directive also accommodates the possibility of transfers involving a third Member, providing that the state of transferring company either to forego its taxing right or while taxing the gain allow a credit for the taxes that the permanent establishment would have paid on these gains.

The Interest and Royalty Directive35 makes it obligatory for the state of the paying company to refrain from charging withholding tax. The directive also resolves theproblemofdoubletaxationbyprohibitingwithholdingtaxonsubsidiarycompaniesand permanent establishments located in the source states. This is to eliminateissues of limitation of credit method that ordinarily stem from excessive taxdeductions in source states relative to the actual tax bill of the given firms inresidencestates.The scope of the legislation is also limited in a manner similar to that of the Parent–Subsidiary Directive.

The Savings Directive:36 This directive has recently been repealed.37 As long as the legislation remained operative, it extended to taxation of interest income of individuals. Members, in their capacity of source country, would not, in general, impose withholding tax on interest income of individuals. Rather, the information would be passed on to the residence country for tax purposes. On transitional grounds, a few Member States were entitled to levy withholding tax on interest income; in those cases, the residence states were obliged to apply credit method to avoid double taxation. If the tax liability was less than the tax withheld at source, the residence states had to refund the excess to individual taxpayers. The legislation was limited to income from interest earnings.

The Anti-Tax Avoidance Directive38 is the most recent addition to the EU tax legislation. It builds on some of the insights from the Base Erosion Profit Shifting (BEPS) project of the OECD and also serves as an interim measure towards a Common Consolidated Corporate Tax Base (CCCTB) system, since the directive also covers certain international aspects of anti-tax avoidance in the CCCTB draft.39 The legislation limits the

35 CouncilDirective2003/49/EContheCommonSystemofTaxationApplicabletoInterestandRoyaltyPaymentsMadebetweenAssociatedCompaniesofDifferentMemberStates,[2003]OJL157/49–54(asamendedfromtimetotime)(herereferredtoasInterest‐RoyaltyDirective).

36 Council Directive 2003/48, 2003 on Taxation of Savings Income in the Form of InterestPayments,[2003]OJL157/38–48(SavingsDirective).TheDirectivehasbeenrepealed;seebelown37.

37 SavingsDirectivehasbeenrepealedon10November2015throughalegislationadoptedunderCouncilDirective(EU)2015/2060[2015]OJL301/1–4.TherepealwasconsequentialtoanotheramendmentbroughtintheCooperationDirective,aboven29;fornewadditiontothisdirective,seeamendmentbroughtthroughCouncilDirective2014/107/EUamendingDirective2011/16/EUasregardsmandatoryautomaticexchangeofinformationinthefieldoftaxation;forthisamendment,[2014]OJL359/1–29.

38 CouncilDirective(EU)2016/1164layingdownrulesagainstavoidancepracticesthatdirectlyaffectthefunctioningoftheinternalmarket,[2016]OJL193/1–14(herereferredtoasAnti‐TaxAvoidanceDirective).

39 TheCommissionhasplannedtore‐launchtheCCCTBproposalinphases.Thisphase‐wiseapproach,interalia,seekstobuildinseveralwaysonanti‐taxavoidancemeasuresforeseenunder the BEPS guidelines; see, eg, European Commission Communication: A Fair andEfficientCorporateTaxationintheEuropeanUnion:5KeyAreasforAction,COM(2015)301Final (17 June 2015), available at <https://ec.europa.eu/priorities/sites/beta‐political/


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deductibility of interest for multinationals, provides a framework to tackle hybrid mismatches, sets out rules for exit taxation and controlled foreign companies, and lays down general anti-abuse rule to deny taxpayers the benefit of abusive tax arrangements.

III FACTORSAFFECTINGLEGISLATIVEPOWERSONDIRECTTAXATION

Leaving aside the political dimension (the unanimity requirement), three constitutional factors could impact the EU powers to formulate income tax policy. The first is the primary source that provides legislative force to the Union actions in terms of a submerged mandate inherent in the single market principle and freedom clauses. The second is an authority vested in a non-tax-specific legal basis to intervene into those national (tax) provisions that impede the institution of single market. The third is a factor that otherwise does not confer the legislative competence in itself, but rather impacts legislation through its regulatory character. This last aspect oversees the justification and reasoning of an intended EU action, and restricts undue intervention in national (tax) systems through a constitutional framework under the principles of subsidiarity and proportionality, as explained in the final segment of this Part.

A PowersofImplicitNature

The fact that it is buried in other powers (underneath the freedom clauses) only may limit the legislative competence on direct taxes. The powers to legislate are derived indirectly from the constitutional obligations to institute internal market. The implicit character might have at least two major implications for the policy area in question. First, an EU-level action in this area has to enter into the territory of the doctrine of derived powers. The restrictive designs generally adhering to the doctrine in extending powers from the principal framework to the derivative one are explicable.40

Second, and more evident, is the fact that the idea of an internal market and its related principles, on which the income taxation powers mainly rely, are dynamic concepts – that is, ever-evolving since the founding days. For instance, the fundamental freedoms, the core elements constituting common market, had yet to unfold in the transitional period (12–15 years) envisioned by the EEC system when founded.41 Unless the transitional episode were over and, in theory, the objectives successfully attained, the derived powers conditional upon them (for example direct taxation) would have little meanings. Once the specified transitional period is over, theconceptofthesinglemarketwouldattainrealmeaning, to the extent of realisation of the initial tasks, and so would the corresponding powers originating from it. Likewise, whenever new spheres of influence or policy areas were gradually added for EU-level actions, or the existing ones increasingly expanded

files/com_2015_302_en.pdf> (last accessed 18 June 2015); see also the accompanyingdocumentEuropeanCommissionStaffWorkingDocument:CorporateIncomeTaxationintheEuropeanUnion,SWD(2015)121Final(17June2015).

40 See,eg,AntonioTizzano,‘ThePowersofCommunity’inAntonioTizzano(ed)ThirtyYearsofCommunity Law (Commission of the European Communities, 1981) 47 (referring to thecomplexitiesofapplicationofthedoctrinefromjudicialperspective).

41 SeeEECTreaty,aboven4,art8;theclauseenvisionedaperiodof12–15yearsforgraduallyestablishingthecommonmarketinaccordancewiththeschemeof(thethen)givenpolicyareaswhenfoundedin1957.


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through various treaty amendments,42 the status of the single market over time would reach an advanced stage. With the assigned objectives of integration gradually accomplished in the expanded policy sectors, the market unification would take a new turn, and so, too, the scope of the implicit derivative powers dependent on market integration.

Thus the changing dynamics of conferral of implicit power in the area of direct taxes – a key lawmaking area – is not compartmerntalised in the text of the EU constitution. Instead, it remains implicit and has evolved without textual changes in the EU constitution. This implied power becomes comprehensible when traced as a common evolutionary thread running from past to present to future, as discussed in Part IV.

B Non‐SpecialisedLegalBasis

As a vital tool of legislative apparatus, a general legal basis (as opposed to a specialised basis) may at first glance appear to be equipped with powers of a restrictive character that might limit a wide-ranging supranational action in this area. This section explains how a non-specialist general legal basis applied to an (implicit) income tax regime could substantially differ in outcomes, compared with a specialised one, such as an area-specific (explicit) legal basis meant for legislation in the VAT regime – a sister policy area.

(a) LegalBasistoLegislateintheAreaofDirectTaxes

In the absence of express mention of direct taxes, how could one locate a legal basis for legislation in direct taxes? This aspect of the discussion – the evolution of EU tax powers – is discussed in Part IV of this article. This segment considers the legacy that mightdevolve from such a legal basis, if established – what the regime could possibly inherit,in terms of a mandate of prescriptions and proscriptions for tax legislation. Theconstitutional provision (Article 115 TFEU)43 invoked to date as legal basis to legislatedirect tax rules, set out in EU law reads as (emphasis added):

The Council shall, acting unanimously in accordance with a speciallegislativeprocedureandafterconsultingtheEuropeanParliamentandEconomicandSocialCommittee,issuedirectivesfortheapproximationofsuchlaws,regulationsoradministrativeprovisionsoftheMemberStatesasdirectlyaffecttheestablishmentorfunctioningoftheinternalmarket.

A legal analysis of the text reveals that the expression ‘unanimously’ refers to the requirement to have a unanimous consensus of all Members. The expression indeed manifests the political sensitivity of tax legislation in indicating that no Member wants a tax legislation to be adopted without its will. Undoubtedly, this is a serious impediment to European-level tax legislation. This study, however, does not focus on the politics of

42 Onaddition/expansionofareasofEUinfluence,seebelownn85–8.43 Since actual legislativemeasures taken in the field of direct taxesweremostly adopted

before TFEU came into force under Lisbon Treaty, the legal bases of these legislativeinstrumentshaveequivalentsofTFEU,aboven4,art115;thatis,the(then)legalbaseswere:EECTreaty,aboven4,art100forParent–SubsidiaryandMergersDirectives,abovenn33–34andECTreaty,aboven4,art94forInterest‐RoyaltyandSavingsDirectives,abovenn35–36.


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European taxation; rather, its key concern remains the legal and constitutional dimension of EU tax powers, as pointed out in the introductory part.

Besides that expression, at least three other expressions in the text, instrumental to an EU-level tax mandate, merit greater attention: ‘directives’, ‘approximation’, and ‘directly affect’. Of all the legislative forms that are binding in character, the ‘directives’ format may take precedence over others, given the sensitivity of national treasuries to EU tax measures. That is because directives require transposition into national statutes. Thus, directives can not only intervene in the national laws but, at the same time, also provide Members with a welcome breathing space in an area of heightened politics and sovereignty concerns. Other forms of legislation, such as Regulation or similar instruments, having a stronger impact (deeper national intervention), could better correspond to an area of extensive and explicit EU competence, but that is clearly not the case with the policy area in question.

‘Approximation’ (relative to the term ‘harmonisation’ used for indirect taxes), likewise inherits softer connotations of intervention in national (tax) powers.44 The expression ‘directly affect’, in the same vein, underpins a restraint on intrusion into national (tax) rules and subjects an EU action to it if – and only if – Members’ (tax) rules ‘directly affect’ the internal market. This is unlike the case with legal bases to adopt legislation on indirect tax laws and other national laws of non-fiscal nature.45 In both the latter situations, legal bases empowered to initiate integrative measures are not necessarily pre-conditioned as to whether a given (national) law ‘directly affects’ the internal market or otherwise.

To sum up, in exercising European supranational legislative powers, the in-built legal plan of (general) legal base is not sufficiently self-contained to impart greater or deeper force to EU-level actions on its own. It has empathy to house multiple traits for different policy areas, but it could be manifested only when the areas are spoken of in the EU law, which is not the case with direct taxes. No doubt the nature of a general legal platform may also not extend beyond the traditional dynamism, yet an action based on (implicit) platform relying, in turn, on implicit powers, seemingly adds to the convolution of the EU mandate to take actions in the area of direct taxes.

How a general legal basis (of direct tax legislation) inherits a different scope for potential Union actions relative to an explicit and specialised one as is in the case of VAT is illustrated in the following part.

(b) ComparisonwithLegalBasisMeantforIntegrationofVATLaw

Unlike direct taxes, right from the inception of European Community, indirect taxes were allocated an explicit segment in the European law, titled ‘Tax provisions’.46 To harmonise indirect taxes, a specialised legal basis also existed from the beginning stating that ‘The Commission shall consider in what way the laws of the various Member States

44 Fromthefoundingdays(undertheEECTreaty)todate(undertheLisbonTreaty),thewords‘harmonisation’and ‘approximation’havebeenemployed for, respectively, integrationofindirect taxes and direct taxes; the former embedded a specialised legal basiswhile thelatterimportedagenerallegalbasis.Seefurtherbelown53.

45 Forindirecttaxes,seebelowPartIII(B)(2);forotherlawsofnon‐fiscalnature,seeTFEU,aboven4,art114(equivalent toECTreaty,aboven4,art95 andMaastrichtECTreaty,aboven4,art100a).

46 EECTreaty,aboven4,arts95–99.


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concerning turnover taxes, excise duties and other indirect taxes... can be harmonised in the interests of the common market. The Commission shall submit proposals to the Council, which should decide by unanimous vote’.47 A distinct chapter titled ‘Tax provisions’ was also devoted to indirect taxes under the subsequent versions of the European (then Community) law48 and so it remains under the current EU law.49

With this brief preface on the constitutional agenda of indirect taxes, the EU-level power to intrude deeper into national VAT codes and to take wider EU-level actions in the VAT regime is fairly comprehensible. The existing clause (Article 113 TFEU)50 meant to serve as a legal basis to adopt VAT legislation, reads as (emphasis added):

The Council shall acting unanimously in accordance with a speciallegislativeprocedureandafterconsultingtheEuropeanParliamentandEconomicandSocialCommittee,adoptprovisionsfortheharmonisationoflegislationconcerningturnovertaxes,excisedutiesandotherformsofindirect taxation to theextent that suchharmonisation isnecessary toensuretheestablishmentandfunctioningofinternalmarketandtoavoiddistortionofcompetition.

The requirement of unanimous consensus of Members, similar to one for direct taxes, is a prerequisite to adopting legislative acts in the field of indirect taxes. Why unanimity hinders the adoption of European VAT law much less than it does for direct taxes, is not the issue at hand. However, it can fairly be attributed, in varying degree, to the political willingness of the Members and the competence and explicit character of powers laid down in the EU constitutional scheme right from the foundational times.51

In order to compare and analyse the legal bases on which to legislate two forms of taxation, at least four expressions emphasised in the above legal text are worth attention. First, the format of VAT legislation, contrary to direct taxes, is not confined to directives. The word ‘provisions’52 gives the law-maker liberty to adopt legislation beyond a

47 EECTreaty,aboven4,art99.48 MaastrichtECTreaty,aboven4,arts95–99;ECTreaty,aboven4,arts90–93.49 TFEU,aboven4,arts110–113.50 TFEU, above n 4, art 113 replaced EC Treaty, above n 4, art 93; the latter in turnwas

precededbyEECTreaty,aboven4,art99.Allthesethreeprovisionsaresubstantiallyalmostsimilar.ThelegalbasisofmainlegislativemeasuretakenforVAT(OldVATDirective,aboven10)referstoduallegalbasisbyplacingrelianceondoublelegalprovisions,ie,EECTreaty,aboven4,arts99–100.TheinstrumentwassubsequentlyreplacedbytheexistingVATlaw(ExistingVATDirective,aboven9)havingasinglelegalbasis,ie,ECTreaty,aboven4,art93.

51 See,eg,abovenn45–48andtheaccompanyingtext.52 Byvirtueoftheexpression‘provisions’usedinthelegalfoundation,TFEU,aboven4,art

296,para1(seeaboven29)becomesapplicabletoit.Thusthescopeofchoicetouselegaltools,unlikedirecttaxes,cannolongerberestrictedexclusivelytoDirectives.Basedonthecontent and depth required at the Union level (proportionality), an action can also beenforced in the form of a Regulation or Decision to intervene national VAT regimes.NotwithstandingthatthecurrentinstrumentofVATlawinforceisaDirective(see,ExistingVATDirective,aboven10),thescopeofitsapplicationandthelevelofintegrationofnational(VAT)regimesachievedbyitisunrivalledtosimilartool(s)adoptedfordirecttaxation;forbriefdiscussionsofarasrelativelyenhancedscopeofEUactionsinVATisconcerned,seealso below nn 54–55; for direct tax Directives, see above Part II(C) At the same time,irrespectiveofthefactthatcurrentcorelegislationonUnionVATlawinforceisintheform


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directive, using other forms such as Regulation or Decision. Second, the legal basis at hand considers ‘harmonisation’ of indirect taxes instead of ‘approximation’. The former seems to signify a relatively deeper penetration into national laws (enhanced integration) when viewed in the context of European constitutional scheme.53 Third, it intensifies the integrative scope by assigning ‘harmonisation’ (over and above the single market objective to) an additional but explicit objective to ‘avoid distortion of competition’.54 Likewise, when contemplating harmonisation initiatives as such, there is no legal obligation to pre-establish whether the national (VAT) laws ‘affect’ the internal market ‘directly’ (as is the pre-condition under Article 115 TFEU) or otherwise.

All these features, in aggregate, craft powers in such a way that supranational actions could permeate deeper into national VAT codes to institute a wider and deeper level of harmonisation at EU-level. As a result, contrary to direct taxation, the specialised and explicit legal basis for indirect tax laws ends up in (considerably) enhanced scope for Union-level VAT policymaking. This argument is also evidenced by the scale of the VAT legislation adopted to date.55 The European Commission’s recent and prospective VAT

ofaDirective,theauthorityconferreduponthelegalbasisforVATtoselectandadoptotherformsoflegislativetools(Regulations,Decisions,etc)remainsequallyintact.

53 AccordingtoMcLure,aboven5,379–80,‘theterm“harmonization”meansdifferentintheEU and theUS (“Coordination” is themore commonwordused in theUS)’. CitingLindaSenden Soft Law in European Community Law (Hart Publishing, 2004) 45–6, McLureidentifies threerelatedconceptsused intheEUdiscussionsof taxpolicy:harmonisation,approximation, and unification, and says that ‘harmonization – and thus by implicationapproximation–referstointegrationprocessesthatdonotleadtothecreationofuniformlaw,butrathertothecreationofcommonframeworksorlegalrulesestablishingacommongoal,whichleaveroomfordivergentnationalspecifications’.Myanalysisdiffersslightlyfromthis interpretationbymakingafinedistinctionbetween‘approximation’and‘harmonization’ongroundssetoutinthepeculiarityoftwolegalbases(EECTreaty, aboven4, arts99–100).WhereasEECart99wasapplicableexclusively toturnovertaxes,excisedutiesandotherindirecttaxes,EECart100wasnotintendedtobedirecttax‐specific.Byscope,thelatter,asagenerallegalbasis,wasextendabletoalllaws(andhenceallpowers)ofMembersdirectlyaffectingthecommonmarket.Bothexpressionsessentially involve integration (intervention) of national laws (powers). The use of oneexpressioncoveredasingle,tooexplicitarea(indirecttaxes),whilethesecondexpressioncoveredseveralimplicit(aswellasexplicit)areas.Againstthisbackdrop,‘approximation’relative to ‘harmonisation’plausiblyhintsatadegreeofreluctance inaccessingnationallaws.McLure’sobservationaboutharmonisationmeaningdifferentthingsintheECandtheUSseemsjustifiedwhenviewedinthewiderUScontextwhere,unliketheEU,harmonisationandapproximationaretakenasoneandthesame.Forinstance,theUSversioninEnglishtranslatesthetitleofsection3oftheEECTreatyas‘HarmonisationofLaws’(see,eg,TreatyEstablishing the European Economic Community (October 1957) 51 American Journal ofInternationalLaw900),whereastheEuropeanEnglishversiontranslatesthesametitleoftheEECTreatyas‘ApproximationofLaws’.Nevertheless,theuseofwordharmonizationinageneralsensetorepresentalliedconceptsmayalsonotbemisleadingunlessanEUlegalcontextotherwisesorequires.

54 TheadditionalobjectivecodifiedinthelegalfoundationproportionallydelegatesenhancedscopetoharmonisenationalVATlaws.To‘avoiddistortionofcompetition’(inadditiontothe core single market objective), the clause also takes into account constitutionalprovisionslaiddowninchapter(titled)‘Rulesoncompetition’(TFEU,aboven4,arts101–109). This entrusts additional sanction to this base and assignswider capacity to enactexpansivelegislativeacts.

55 ExistingVATDirective,aboven10; legislationtoharmonizenationalVATregimesunderthisDirectiveisanincomparablysweepingenactmentcomparedtothoseondirecttaxation


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agenda is also indicative of this rationale. For instance, based on studies and consultations,56 a draft legislation to adopt a common VAT return across the single market was on cards in the recent past.57

C Subsidiarity and Proportionality

1 InGeneral

The subsidiarity rule, a constitutional provision superimposed on the balance of powers, governs the exercise of legislative actions in all areas of non-exclusive EU competences. Since its introduction in the EU law under the Maastricht Treaty,58 the provision has been the subject of considerable academic discourse, and a plethora of literature is available on it.59 The distinctive clause, when added to the EU (the then Community) law, read as:

(above Part II(C)). The former sets out an EU‐wide detailed VAT regime and alsoencompasses legal acts of second generation; eg, Council Implementing Regulation282/2011/EU laying down Implementation Measures for Directive 2006/112/EC on theCommon System of Value Added Tax, [2011] OJ L 77/1. Factually, the ImplementingRegulationis‘secondgeneration’tool(andanon‐legislativedelegatedactintermsofTFEU,aboven4,art291)ofthelegalbasismeantforVATlaw.ECTreaty,aboven4,art93(nowTFEU,aboven4,art113)createdthe(ExistingVAT)Directive,aboven10andthenthe(art397oftheexistingVAT)DirectivecreatedImplementingRegulation.ThesameisthecasewithanumberofVATImplementingDecisionsaddressedtovariousMembersinpursuancetomandatederivedfromart395ofExistingVATDirective(egCouncilImplementingDecision2013/54/EU to the Republic of Slovenia on Certain Measures concerning Existing VATDirective,[2013]OJL22/15.

56 See,eg,EuropeanCommissionSpecificContractNo.9:StudyontheFeasibilityandImpactofCommonEU StandardVATReturn,TAXAUD/2011/DE/329FinalReport (February 2013),<http://ec.europa.eu/taxation_customs/common/publications/studies/index_en.htm>(lastaccessed26August2015).

57 EuropeanCommissionProposalforaCouncilDirectivetoAmendDirective2004/112/EContheCommonSystemofVATasregardsStandardVATReturn,COM(2013)721Final(October2013).

58 MaastrichtECTreaty,aboven4,art3b.59 On diverse views and interpretations on application of principles of subsidiarity and

proportionality,see,eg,IbMartinJarvad,‘SubsidiarityandAutonomy’(1994)19HistoryofEuropeanIdeas797–803;DeborahZCass,‘TheWordthatSavesMaastricht?ThePrincipleof Subsidiarity and the Division of Power within the European Community’ (1992) 29CommonMarketLawReview 1107;KoenLenaerts, ‘ThePrincipleof Subsidiarityand theEnvironmentintheEuropeanUnion:KeepingthebalanceofFederalism’(1994)17FordhamInternational Law Journal 846; Grainne de BrucaReappearing Subsidiarity’s Significanceafter Amsterdam (Harvard Jean Monnet Working Paper No. 7 1999), available at<www.jeanmonnetprogram.org/archive/papers/99/990701.html> (last accessed 12December2016);ThomasHorsley,‘SubsidiarityandtheEuropeanCourtofJustice:MissingpiecesintheSubsidiarityJigsaw?’(2012)50JournalofCommonMarketStudies267;AndreaBiondi, ‘Subsidiarity in theCourtroom’ inAndreaBiondi et al (eds)EULawafterLisbon(Oxford University Press, 2012) 213; P J Devine (ed) Competitiveness, Subsidiarity andIndustrialPolicy (Routledge, 1996); GMMGelauff et al (eds) SubsidiarityandEconomicReform inEurope (Springer,2008);AurelienPortuese, ‘ThePrincipleofSubsidiarityasaPrincipleofEconomicEfficiency’ (2011)17Columbia JournalofEuropeanLaw231;PaulCraig, ‘Subsidiarity: A Political and Legal Analysis’ (2012) 50 JournalofCommonMarketStudies72;GarethDavies,‘Subsidiarity:Thewrongidea,inthewrongplace,atthewrongtime’(2006)43CommonMarketLawReview63.


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In areas which do not fall within its exclusive competence, theCommunity shall take action, in accordance with the principle ofsubsidiarity,onlyifandinsofarastheobjectivesoftheproposedactioncannotbesufficientlyachievedbytheMemberStatesandcantherefore,byreasonofthescaleoreffectsoftheproposedaction,bebetterachievedbytheCommunity.

AnyactionbytheCommunityshallnotgobeyondwhatisnecessarytoachievetheobjectivesofthisTreaty.

Later, a protocol, and a declaration were added to the EU law to explain the procedure on application of the subsidiarity principle.60 These provisions in substance, together with an amended protocol on their application, remain part of the current version of EU law adopted under the Treaty of Lisbon.61 As an exceptional constitutional tool, it governs the exercise of EU powers in areas of non-exclusive Union competences. The scope of the subsidiarity principle does not extend to the conferral of powers, but rather performs a regulatory function. The subsidiarity principle does not confer powers to the EU. It may, however, expand or confine supranational actions while the Union exercises its shared-powers – the powers that are inscribed elsewhere in the EU law.62 Every legislative act in related areas, including taxation, must therefore undergo the test set forth in this principle. A Union action must pass that test; the EU cannot take legislative action unless (1) the Members’ action cannot sufficiently realise the objectives; (2) the Union can perform better in doing the same (3) by reason of scale or effects of the action; and (4) any intervention by the EU should strictly not exceed the limit of attaining objectives(proportionality principle).

2 InTaxationThe subsidiarity yardstick in the tax policy area may largely be applicable at the interface of law and economics rather than law and politics. The addition under the Amsterdam Treaty on how to apply subsidiarity sees it to be ‘a dynamic concept’63 applicable to the legislative process to achieve objectives laid down in the EU constitution. The principle encapsulates diverse notions: the economic dimension, in terms of a cost–benefit analysis is apparent from the text of the clause, since it invites an EU action when a similar action at the level of national governments is inefficient. Besides the economic dimension, subsidiarity has been termed ‘first and foremost a political principle’.64 Further, the

60 ProtocolandDeclarationonsubsidiaritywasaddedthroughtheAmsterdamTreaty,aboven4,[1997]OJC340/1,105–107,140.

61 See,TEUpost‐Lisbon,aboven4,art5(3)(onprinciplesofsubsidiarityandproportionality),ProtocolNo.2(ontheapplicationoftheseprinciples)annexedtotheLisbonTreaty,[2010]OJC83/1,206.

62 AccordingtoPortuese,aboven59,233,‘thisprincipledoesnotconveywhetherornottheEUhasthepowertoactwithregardtoaspecificpolicy’;onimpactsofsubsidiarityprinciplein relation to legislation, see also, European Commission Report: The Adaptation ofCommunity Legislation to the Subsidiarity Principle, COM(93) 545 Final, 1 (September1993)(CommissionReport)(explainingthat‘Itsfunctionisnottodistributepowers...Theaimofthesubsidiarityis,rather,toregulatetheexerciseofpowersandjustifytheiruse’).

63 Protocol,aboven60,para3;theprovisionalsostates:‘ItallowsCommunityactionwithinthelimitsofitspowerstobeexpandedwherecircumstancessorequire,andconversely,toberestrictedordiscontinuedwhereitisnolongerjustified’.

64 CommissionReport,aboven62.


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principle is denoted ‘a state of mind’ 65 (political dimension) and ‘a sort of rule of reason’66 (legal, political, economic dimensions).

The existence of a relatively scarce case law on subsidiarity is another remarkable feature; the provision has yet not undergone the process of extensive judicial review.67 As a multidimensional concept, it is ‘one of the most debated, analysed, criticized, despised and, in few cases, loved concepts of EU law’ in the academic world.68 The several aspects of the subsidiarity including its comprehensive discourse in relation to taxation are beyond the scope of this article. I do, however, briefly explore its regulatory interplay with the EU legislative powers in relation to direct taxes.

The argument that the subsidiarity rule takes lego-economic dimension to oversee a Union action in taxation takes its backing from the birth place of this rule within the EU law. When the policy area of environment was being added to the actionable spheres of the EU (then the Community) under the Single European Act (SEA),69 subsidiarity (without being named) was embodied in the EU law for the first time, and was applicable exclusively to Union actions in the field of environment.70 As within the newly assigned EU power (on environment) it was possible that certain supranational actions could encroach upon some Member States without their consent, by virtue of majoritarian voting,71 a subsidiarity check could, therefore, mitigate their concerns to a certain extent. The subsequent introduction of a subsidiarity calculus extendable to all non-exclusive EU powers under the Maastricht Treaty could also be a manifestation of similar national concerns about losing sovereignty by virtue of introducing majoritarian voting to various policy regimes in those times.72 If the subsidiarity check is there to cater for sovereignty fears raised by the ease of voting, the political dimensions of the rule are obvious.

Nevertheless, in the realm of taxation, the requirement of unanimous voting remains intact. That being the case, the lego-political role of the provision cannot be argued forcefully, since in the presence of unanimity rule for an EU legislation on direct taxes, national governments still retain the power to veto any supranational action deemed to be unwarranted intrusion. Against that backdrop, subsidiarity might rather seem to be a superfluous notion for taxation, if explained strictly in political terms. This is where the lego-economic character of this dynamic principle comes into picture. A legal rationale of subsidiarity that takes into account economic parameters better explains the application of this principle in matters concerning EU-level tax legislation. Further, application of

65 Ibid,2.66 Ibid.67 Craig,aboven59,80(observingthatsincethesubsidiarityprincipleputinplaceunderthe

MaastrichtTreaty(seeaboven58),therehadbeenhardlytensubstantialcaseschallengingtheprovisionbeforetheECJinalmost20years).

68 SeeBiondi,aboven59,213.69 SeeamendmentstotheEECTreatythroughSEA,aboven4,arts130r,130s.70 SEA,aboven4,art130r(5).71 Some of the Community actions on environment could be contemplated by qualified

majorityvoting;seeSEA,aboven4,art130s,para2.Thiscouldleaveroomforanactthatsome(opposingminority)Membersmightbeconcernedof.Thesubsidiarityinsertion,toanextent,couldpotentiallyaddressit.

72 Amendments under the SEA introduced the principle of qualified majority voting (incontrasttotheunanimityprinciple)toseverallegalbasesforEUactionsinanarrayofpolicyareas;eg,SEA,aboven4,arts28,57(2),70(1),84(2),100a,100b,118a,130q(2)(inconj.witharts130k,130l,130m,130n,130p),130s,para2.


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subsidiarity rule in tax matters takes precedence at the intersection of law and economics over law and politics notion. The criteria set out under the subsidiarity clause would thus predominantly take into account arguments of economic efficiency and a cost–benefit analysis to assess measures such as those meant to reduce transnational spillover effects of tax policy or tax-induced distortions in the internal market.73 To sum up, the overseeing effect of subsidiarity as to ‘expansion or restriction’ of an EU action in the area of direct taxes would be largely determined by economic efficiency rather than politics.

IV EVOLUTIONOFIMPLIEDCOMPETENCETOLEGISLATEINTHEFIELDOFDIRECTTAXES

Nothing in the legislative regimes of the EU constitution makes sense as clearly as in the light of evolutionary developments of power equilibrium. Supranational governance has evolved in the European jurisdiction, making it difficult to answer the question, who – whether Members or the Union – governs a particular policy area, because this changes over time.74 In relation to direct taxation, it was argued in Part III(A) that the powers implicit in single-market principles are dynamic and mobile in nature. In fact, all the three factors that were considered as relevant to legislation are not in the least compartmentalised. Considering each factor in isolation as to its potential impact on legislative outcomes might convey some broader outlines, but not the fuller picture of their interaction in the legislative tale.

Tracing the evolutionary path of the growth and allocation of powers in general, and the interplay of factors affecting legislative framework for direct taxes in particular, appears the best way to frame the right perspective here. Further, the atypical role of the three EU organs – the executive (Commission), the judiciary (European Court of Justice), and the legislator (Council) – is also hardly comprehensible in the legislative processes except in the light of peculiar institutional interactions. Thus, to facilitate such an analysis, in what follows, I take an excursion of contextual developments behind the shifting balance of powers in the European legal system in the area of direct taxes.

A TheFoundationalPhase

The EEC Treaty, founded generally along the lines of an international organisation, ostensibly kept direct taxes away from the purview of supranational meddling, in particular, relative to tariffs and turnover tax regimes.75 With no conscious policy agenda on its integration in the founding periods, the Treaty, prima facie, paid little attention to direct taxation in express terms. The one and only explicit mention of direct taxes found

73 See,eg,StephenSmith,‘Subsidiarity’andtheCo‐ordinationofIndirectTaxesintheEuropeanCommunity’(1993)9OxfordReviewofEconomicPolicy70,92.

74 Alec Stone Sweet and Wayne Sandholtz, ‘European integration and supranationalgovernance’(1997)4JournalofEuropeanPublicPolicy297,299(observing,inthecontextofCommunity’sseatsofpolicymakingandcompetencestogovern,that ‘withinthesamepolicysector,theanswertothequestion,‘whogoverns?’,haschangedovertime’);seealsoShafiUKhanNiaziandRichardKrever,‘IsintegrationoftaxationpossibleintheEU?’(2015)30AustralianTaxForum457,note11.

75 Unlikedirecttaxes,abolitionofcustomsdutiesbetweenMembers(EECTreaty,aboven4,arts12–17),andestablishmentofcommoncustomstariff(EECTreaty,aboven4,arts18–29) were amongst the most explicit supranational competences. On similar powers toharmonizeVATandindirecttaxes,seeabovePartIII(B)(2).


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its place in the last chapter (General and Final Provisions) of the Treaty.76 Intuitively, this reference too, commensurate with the (then) status of the polity akin to an international organisation, was nothing more than a recommendation to the Members to explore channels under public international law to avoid double taxation.

During the 1960s when, based on the land mark ECJ rulings, the EEC Treaty was transforming into a constitution covering areas such as shaping its supremacy over national laws,77 the indirect taxes, based on the explicit Treaty powers, also witnessed some pioneering legislation on harmonisation of national turnover taxes.78 No analogous EU actions in the area of direct taxes were observed in those times, however. The difference between the two tax regimes could fairly be attributed (besides the political willingness of Members) to the absence of any specialised legal basis or any expressed supranational powers on direct taxes in the Treaty.

The only supranational legal clout that existed in the foundational periods could be traced to ‘buried objectives’ deep down in the EEC Treaty. The objectives, inter alia, stated that ‘the activities of the Community shall include … the approximation of … [Members’] laws to the extent necessary for the functioning of the Common Market’.79 No doubt the objective did not exclusively target direct taxes; rather it encompassed a cohesion of all (national) laws in general, to the extent of their potential damaging effects to the common market. Direct taxation could, therefore, be considered as one of those (sub-textual) laws which the common market objectives (inherently) might intend to approximate in due course. Yet, several factors could substantially impede deciphering of tax power that otherwise existed submerged under the single market notion.

B DirectTaxationinthe‘BackSeat’?

At the time of the first major revision under the SEA, some of the amendments to the EEC Treaty also signify key underlying intents of the drafters towards potential EU powers (or lack thereof) in fiscal matters, particularly on direct taxes. The legal basis meant to enact directives in the policy area of direct taxes, which otherwise had general features to accommodate several sectors, was constrained to narrow down so as to become applicable to fewer areas including direct taxes.80 This constraint was created

76 EECTreaty,aboven4,art220,at87thatwasretainedasECTreaty,aboven22,art293(beforebeingrepealedundertheTreatyofLisbon).

77 Forexample,CostavENEL(6/64)[1964]ECR585(assigningsupremacytotheEUlawovernational laws). On the principle of direct effect that also lies at the core of theconstitutionalisationprocess,seeVanGendenLoos,[1963]ECR1,aboven9.Onmoredetailsofprincipleofdirecteffectandsomemajordoctrinesoftheinitialphase,seeDeWitteaboven 9. On judicial developments regarding ‘constitutionlaization’ of EU law, see, eg, J H HWeiler,‘TheTransformationofEurope’(1991)100YaleLawJournal2413.

78 Onexplicitprovisionsconcerningindirecttaxes,seeaboven46;onpioneeringlegislativeacts on turnover taxes, see First CouncilDirective 67/227/EEC on theHarmonization ofLegislationofMemberStates concerningTurnoverTaxes, [1967]OJ 71/1301, andSecondCouncil Directive 67/228/EEC on the Harmonization of Legislation of Member StatesconcerningTurnoverTaxes,[1967]OJ71/1303.

79 EECTreaty,aboven4,art3(h).80 Textually,thepowersvestedinexistinggenerallegalbase(EECTreaty,aboven4,art100)

and itsapplication toall lawsaffectingcommonmarket remained intact.However, sinceinsertion of a new legal basis (SEA, above n 4, art 100a), a number of areas wouldautomatically prefer legislation through the new basis over the existing one. Thepreferentialvalueofthenewlegalbasiswouldrestinitsvotingeaseaswellasflexibilityto


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without bringing any textual change to the legal basis in question; but rather within the same part of the constitution (titled as approximation of laws), another legal basis was crafted and, in chronological order, placed immediately next to the (general legal) basis considered for direct taxes.81 The new legal base, also designed to be somewhat general in character to legislate the EU-level acts in multiple policy areas, operated differently from the pre-existing (general) legal base meant for approximation of (national) laws on direct taxes. Unlike the older clause that served as a potential legal basis for EU actions in an array of areas including direct taxes, the new legal basis was equipped with a ‘legislative ease’ (no unanimity requirement), and could also adopt multiple legislative forms (not confined to directives).82 Further, the new legal basis also did not lay down a pre-condition that an EU action could be taken only if a national policy ‘directly affect[s] the internal market’. Thus, in the post-SEA era, intended EU actions in various policy areas would positively prefer to invoke the new legal basis, with its ‘convenience plan’, over the existing one. This indeed would render the old legal basis applicable only to those limited areas not covered by the new basis. For instance, the fiscal matters including taxation were debarred from the purview of the new basis,83 and an EU-level action on direct taxes required (and still require) the use of already existing general legal bases. The new legal basis also excluded indirect taxes from its purview; however, (besides unanimity), it had little impact on indirect tax legislation, since this policy area already had a specialised legal basis of its own (Part III(B)(2)).

Another feature of the SEA-induced amendments in the EEC Treaty was that they prioritised certain policy areas including indirect taxes and set out a project for their time-bound integration so as to gradually establish a single market.84 Direct taxes, covered under the general objective of approximation of laws, was certainly missing from this preferential time-bound sectoral integration plan. The changes inserted through the SEA were indicative of the progressive extensions of EU powers, indicating a go-ahead scheme for integration of various areas excluding direct taxes.

Does this imply that EU powers in the area of direct taxes from the EEC Treaty (1957) to the SEA (1986) were subject to inertia? With the foregoing analysis of the Treaty revision, and given the fact that the first ever substantive legislation on direct taxes had yet to materialise even after three decades, the response to this question could possibly be resoundingly in the affirmative. Nevertheless, a closer examination of the overall growth and expansion in EU powers in different policy sectors during the first three decades may shape a rather different response to this question. The picture becomes clearer if one takes into account the derivative nature of powers on direct taxes being

adapt any legal form that might not necessarily be a directive. Hence, after the SEAamendment, thepracticaluseof theexistingbasewouldnarrowdownonly to the fiscalmatters which were excluded from the purview of the new base (SEA, above n 4, art100a(2)).

81 Thenewlegalbase(SEA,aboven4,art100a)wasplacednexttothepre‐existinggenerallegalbase(EECTreaty,art100).

82 SEA,aboven4,art100a(1).83 Ibidart100a(2).84 Ibidart8a(inconj.Withibidarts8b,8c,100b)authorizedtheCommunitytotakeintegrative

measurestograduallyestablishinternalmarketuntil31December1992invarioussectors(coveredunderEECTreaty,aboven4,arts28,57(2),59,70(1),84,99,andunderSEA,aboven4,art100a)includingindirecttaxes.Notably,directtaxation,coveredundertheexistinggenerallegalbase,wasmissingfromthelistandthereforeexcludedfromthetime‐boundintegrationplan.


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‘nurtured’ within its principal framework, that is, in the undergrowth of freedom clauses and the common market – the market that certainly had grown and widely integrated much beyond its foundational status. By correlating the activities on direct taxation taking place at the Commission-level, the European executive organ responsible for initiating of legislative proposals, during the so-called period of inertia in direct taxes may capture a fuller and bigger picture of developments taking place in the European tax landscape.

C Sub‐TextualGrowthandEmergenceofTaxPowers

An incontrovertible assumption about several EU powers is that, to varying degrees, they originate from or, are impacted by, the schema of the common market crafted as a core objective in the constitution. As the market agenda can hardly be precluded from a wide range of policy sectors, several market essentials (powers) could be added to the menu of the market agenda.85 It is also plausible that when EU was founded as an international polity in 1957, neither all such ‘menu items’ in the garb of market-based European powers were explicit, nor were they designed to be readily enforceable in one go. At one point in time (EEC Treaty 1957), a few items of the ‘menu’ were active,86 while others (were semi-active or dormant and) gradually ‘queuing’ in the undergrowth of imperatives to establish a common market. At another point (SEA 1986), some of those powers ‘due-in-queue’ were added to the ‘activation list’,87 leaving behind another ‘updated list-in-waiting’ to be activated later at a certain optimal stage (Maastricht Treaty 1992),88 and so forth. Against that backdrop, EU powers to legislate measures in almost all policy areas, in theory, had inevitably to remain ‘mobile’ in the quest of achieving a common market.

85 ThisiswhatpracticallytranspiredifonetakesanoverviewfromtheEECtothepre‐Lisbontimes;Davies,aboven59,1(notingthat‘thescopeoftheCommunityactivityisnowsobroadthatfewifanyareasofnationalpolicyareimmunefromitseffects’).

86 See,eg,freemovementofgoods(EECTreaty,aboven4,arts9–11),eliminationofcustomsdutiesbetweenMembers(EECTreaty,aboven4,arts12–17),settingupofcommoncustomstariffs(EECTreaty,aboven4,arts18–29),eliminationofquantitativerestrictionsbetweenMembers(EECTreaty,aboven4,arts30–37).

87 See, eg, extension in supranational influence to newpolicy areas in EECTreaty throughamendmentsundertheSEA,aboven4,arts102a(2)(inconj.with236),118a,130a–130e,130r,130s(respectively,oneconomicandmonetarypolicy,layingdowncriteriafornationallawsonhealthandsafetyofworkers,onrolesinregionaldevelopmentandeconomicandsocial cohesion, on research and technological development, and on environment).Likewise, harmonisation of turnover taxes, excise duties and other indirect taxes stillrequiredunanimity(nochange inEECTreaty,aboven4,art99).Anewlyaddedgenerallegalbasis(SEA,aboven4,art100a)coveringanumberofpolicysectorsinsertedthroughthese amendments did not require unanimity to integrate national laws; however, fiscalmatters (includingdirect taxation)were excluded from its purview (SEA, above n 4, art100a(2)).Someofthenewlyaddedlegalbaseshowever,requiredunanimity;eg,ESA,aboven4,arts130q(1)(inconj.with130i,130o),130s,para1.

88 See,eg,MaastrichtECTreaty,aboven4,arts2,3,3a.Someoftheexplicitlyadded/amendednew tasks included common commercial policy, common policies in the spheres ofagriculture,fisheries,transport,environment,energyandtourism;measuresonmovementofpersons,avoidanceofdistortivecompetition,andstrengtheningofeconomicandsocialcohesionintheinternalmarket(MaastrichtECTreaty,aboven4,art3);measuresleadingtotheintroductionofsinglecurrency(MaastrichtECTreaty,aboven4,art3a),etc.SeealsoCommissionReport, above n 62 (reporting that pursuant to the amendments under theMaastrichtTreaty, asmany as twenty or so activities becameopen to the supranationalactions).


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Indeed, this was precisely also the case with EU constitutional powers on direct taxes that factually never suffered from inertia. It was – and to an extent still is – a matter of academic and legal argument to pinpoint where direct taxation could most likely be located in the ‘active, semi-active or awaiting’ items (powers) on the agenda menu (common market).89 What follows below is a brief narrative of some of the developments (at the Commission-level)90 during the first three decades when, prima facie, there had been a widespread vacuum (of EU powers) in terms of non-adoption of legislation on direct taxes.91

1 TheInitialPeriodShortly after the EEC Treaty came into force, the Commission appointed a committee to study issues concerning tax harmonisation in the common market.92 The report of this committee identified several problems in the field of direct taxes, such as disparities in company tax base and tax rates, withholding tax on dividends, and double taxation.93 The next study conducted by the Commission appeared in 1970; it largely focused on the

89 Certainly,themarket‐ledpowermobilityalonemaynotnecessarilybetheultimatefactorindeterminingsequenceof thesocalleddue‐in‐queue or list‐in‐waiting considerations.Onecannotignorepoliticalfactors(andalsowhetheragivenlegislationneedsmajoritarianorunanimousvoting)thatessentially–tovaryingdegreesinvarioussectors–havetheirsayinsurrenderingorretentionofnationalpowers.Forinstance,onquestionasregardsUnionpowers to legislate in taxpolicy area,Members’ concerns overpotential loss of (taxing)powersand(fiscal)autonomycanfairlybeconsideredasoneofthemajorfactorsimpactingit.TheevolutionofcompetencedynamicsintheCommunitylawandthepoliticaldimensionof Members, however, may not be mutually exclusive; in their interplay, both factorsinevitablymightalso,tovaryingdegreesindifferentsectors,pushandimpacteachother.Sincethisarticle,asmentionedinthestart,seekstoinvestigateonlycompetenceconstraintonEU‐leveltaxpolicymaking,thepoliticaldimension(veto)hasthuslargelybeenignoredwhileanalyzingthesocalledlist‐in‐waitingnotionandalike.Theforegoingargumentandtheanalysistofollowinnextsegment(PartIV(D))drawsupononandbuildsontheneo‐functionalisttheoryofEuropeanintegrationdevelopedbyErnstBHass, TheUniting of Europe: Political, Economic and Social Forces, 1950–1957 (StanfordUniversityPress,1958),andthenupdated,inparticular,byWayneSandholtzandAlecStoneSweet Neofunctionalism and Supranational Governance (unabridged version)SelectedWorks of Alec Stone Sweet (Yale University, 2012), available at<http://works.bepress.com/alec_stone_sweet/38/> (last accessed 26 August 2015). Themajordifference isthat insteadofcoveringgeneralprocessesofEuropeanintegrationastheorised by neo‐functionalmodel, this article briefly touches upon the policy spilloverconfined largely to direct tax domain within the framework of European constitutionalconstruct.

90 TheEuropeanCommission,theexecutiveorganoftheEU,isresponsibleformovingdraftlegislative proposals To the Council for adoption. The role of the Commission is thusextremelyimportantinthelegislativehistoryoftheEU.

91 CouncilDirective77/799/EECconcerningMutualAssistancebytheCompetentAuthoritiesoftheMemberStates intheFieldofDirectTaxation, [1977]OJL336/15–20,whichfeaturesproceduralaspectsofadministrativeandassistancemattersisnotbeingconsideredhereasasubstantivelegislativetooloftaxintegration.

92 Reportof theFiscalandFinancialCommittee (NeumarkReport)TheEECReportsonTaxHarmonization (an unofficial translation into English language, by Hugh Thurston,InternationalBureauofFiscalDocumentation,1963).

93 Ibid134–38,141–45.


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possibility to mitigate economic double taxation in the single market.94 The studies undertaken by the Commission contributed to the initial legislative proposals in the field of direct taxes. In fact, the 1970s witnessed the highest-ever legislative proposals on direct taxes submitted by the European Commission to seek consent of the legislator (the Council of EU).95

Most of these legislative proposals were aborted in due course.96 The failure to adopt tax legislation at that stage could be fairly attributed to the dual constraints noted in Part I, that is, a lack of political will together with controversies surrounding EU powers on tax legislation. In 1975, for example, the Commission submitted a proposal to adopt a directive on harmonisation of corporate tax systems and withholding taxes.97 The draft proposed an EU-wide single corporate tax rate (45–55 per cent), a partial imputation credit system with a single rate of tax credit on distributed dividends, and 25 per cent withholding tax rate on dividends (except for parent–subsidiary) in the common market. The proposal met strong opposition from Members in the Council (a political dimension).98 For the Council, a complete tax harmonisation could not be attained in absence of an integrated tax base99 (a connotation that the proposal was disproportionate to tax powers). The proposed legislation thus could not seek approval of the legislator and was finally withdrawn by the Commission in 1990.100

Another piece of draft legislation, proposed by the Commission in 1976101 to adopt a directive on arbitration convention for elimination of double taxation between associated enterprises, met a similar fate and failed. This proposal remained pending with the

94 A JVandenTempelStudies:CorporationTaxand Individual IncomeTax in theEuropeanCommunities,Competition:ApproximationofLegislationSeriesNo.15(CommissionoftheEuropeanCommunities,1970).

95 Duringthe1970s,atleastsixlegislativeproposalsfromtheCommissionseekingadoptionasDirectivesondirect taxationremainedpendingwith theCouncil;on fourof them,seebelown97.

96 See, eg, European Commission Proposals for Council Directives: (1) concerning theHarmonization of Systems of Company Taxation and Withholding Taxes on Dividends,COM(75)392Final(July1975); (2)ontheEliminationofDoubleTaxation inConnectionwiththeAdjustmentofTransfersofProfitsbetweenAssociatedEnterprises,COM(76)611Final(November1976);(3)ontheApplicationtoCollectiveInvestmentInstitutionsoftheCouncilDirective concerning theHarmonizationof SystemsofCompanyTaxationandofWithholding Taxes of Dividends, COM(78) 340 Final (July 1978); (4) concerning theHarmonizationofIncomeTaxationProvisionswithRespecttoFreedomofMovementforWorkers within the Community, COM(79) 737 Final (December 1979); (5) on theHarmonizationoftheLawsoftheMemberStatesrelatingtoTaxArrangementsfortheCarry‐Over of Losses ofUndertakings, COM(84) 404 Final (as amended throughCOM(85) 319Final) (September 1984); (6) concerning Arrangements for the Taking into Account byEnterprisesoftheLossesoftheirPermanentEstablishmentsandSubsidiariesSituatedinOtherMemberStates,COM(90)595Final(January1991)(respectivelyCommissionProposal(1),(2),(3),(4),(5),(6)).

97 CommissionProposal(1).98 J E Brinkman and A O Riecker, ‘European Community Taxation: The Ruding Committee

ReportGivesHarmonizationEffortsaNewImpetus’(1993)TheInternationalLawyer1061,1065.

99 George Kopits, ‘Overview’ in George Kopits (ed) IMF Occasional Paper No. 94: TaxHarmonizationintheEuropeanCommunity:PolicyIssuesandAnalysis(IMF,1992)11.

100 EuropeanCommissionCommunication:GuidelinesonCompanyTaxation,at10,SEC(90)601Final(April1990).

101 CommissionProposal(2),aboven97([1976]OJC301/4).


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legislator for several years. The Members, sensitive to potential loss of taxing powers and fiscal sovereignty, were reluctant to adopt that legislation. Alongside fiscal concerns, absence of spoken EU tax powers would further add to the controversies in the minds of legislators. To replace this proposed legislation, the Members agreed to institute an arbitration convention to resolve double tax disputes under public international law, outside the EU constitution. While concluding the arbitration convention, the Members took shelter under an advisory provision (now repealed) of the EU constitution.102 The Commission in the end had to withdraw its proposed legislation in 1996 – twenty years after its pendency before the Council.103

The synopsis of legislative endeavours presented above indicates the evolutionary developments of a direct tax regime with the hindsight of three decades of prolonged stagnation. It also suggests that the EU tax power was indeed seeking its locus in the progressively growing European agenda (common market). Instead of passing through legislative inertia, this tale is indicative of the propensity of direct tax measures to ‘search a legal space’ within the ever-evolving and mobile EU powers. It was finally in 1990, when, without any textual amendment in the constitution, European power on direct taxes secured a limited but substantive legal space. That is, a couple of long-awaited legislative proposals sought the approval of the law-maker, resulting in adoption of a narrow but substantive legislation in the field of direct taxes.104

2 TheSecondPeriodIn 1992, alongside a shift in constitutional paradigms under the Maastricht Treaty, in the form of new EU powers and the subsidiarity notion,105 the Commission, a few months from adoption of the pioneering legislation on direct taxes, appointed a high-profile committee to look into the tax-induced distortions in the internal market.106 Therecommendations of the committee (the Ruding Report) appeared in 1992. They included: elimination of double taxation in several forms; a uniform withholding tax rate of 30 percent on dividends, subject to waiver on appropriate tax identification; concerted action by the Commission and Members defining common policy on double tax agreements; a uniform tax base; and a minimum corporate tax rate of 30 percent to plug the harmful effects of the ‘race to the bottom’ approach.107

102 TheMembers,pursuanttoEECTreaty,aboven4,art220(predecessortoECTreaty,aboven22,art293beforebeingrepealedundertheLisbonTreaty)enteredintoanArbitrationConvention(90/436/EEC),[1990]OJL225/10–24)undertheinternationaldiplomaticlaw.TheactwasalsoindicativeofMemberstoproceedautonomously(potentially)indisregardtothependingsupranationallegislationforwantofthelatter’sauthorityinthegivenpolicyarea.

103 See[1997]OJC2/6.104 Parent–SubsidiaryandMergersDirectives,abovenn33–34.TheCommissionproposalson

thesedirectivesweretransmittedtotheCouncilon16January1969([1969]OJC39/1–2).105 DeliberationsbytheHeadsofMemberStates(EdinburghSummit,11–12December1992)

onthenewconstitutionalplan,andinaugurationofsubsidiarityruleintheearly1990s;seeabove n 58 and accompanying text. On additional information regarding extension ofcompetences,seeaboven89.

106 TheCommitteewithOnnoRuding,theDutchFinanceMinister,inchairwasappointedbytheEuropeanCommissionasof25October1990 toexamine company taxation;Ruding,belown107,7.

107 OnnoRudingConclusionsandRecommendationsoftheCommitteeofIndependentExpertsonCompanyTaxation(EuropeanCommission’sWorkingDocument,1992)27–40.Forviewson


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While most of these recommendations were widely seen as over-ambitious in political terms,108 a new impetus to the activities of the Commission in tax policy was nevertheless noticeable in the 1990s. For instance, in an attempt to cleanse the legislative agenda, some of the archaic pending proposals that in due course had lost relevance were withdrawn by the Commission.109 There was also a visible intensity in the European Commission as it issued recommendations and communications.110 These measures – generally known as a ‘soft law’ approach in EU parlance – are meant to ‘sensitise and orientate’ the Member States towards adopting a harmonious approach before adopting a ‘hard law’ approach that is binding in character. These European approaches resulted into adoption of soft law against harmful tax competition at an informal meeting of the ministers of the EconomicandFinancialAffairsCouncil (ECOFIN).111 This pioneering soft law in the field of direct taxes, known as Code of Conduct for Business Taxation, exists to this day and is widely considered an influential tool against several harmful tax practices in the common market.112 The momentum generated by the ECOFIN interactions also led the European Commission to revisit the two pending legislative proposals which were later adopted in 2003 as binding law in the form of directives.113 These were times when fresh plans found

thisreport,see,eg,FranzVanistendael, ‘TheRudingCommitteeReport:APersonalView’(1992)13FiscalStudies85.

108 See, eg, KPMG The KPMG Guide to CCCTB (KPMG, 2011) 8, available at<www.kpmg.com/Global/en/IssuesAndInsights/ArticlesPublications/Documents/ccctb‐part1.pdf>(lastaccessed24February2015).

109 TheproposedArbitrationConventionwaswithdrawnasithadlostmuchoftherelevance(see above n 103 and accompanying text); the pending legislation such as CommissionProposal (5),aboven97waswithdrawn([1997]OJC2/6).Otherwithdrawalsof1990s(respectivelyon13April1993and9September1992)includedCommissionProposals(3),(4),aboven97.

110 See,eg,EuropeanCommissionRecommendations:(1)94/79/EContheTaxationofCertainItemsof IncomeReceivedbyNon‐Resident inaMemberStateOtherThanThat inwhichTheyAreResident, [1994]OJL39/22–28; and (2)94/390/EConTaxationofSmall andMediumSizedEnterprises,[1994]OJL177/1–19;EuropeanCommissionCommunication:The Improvement of the Fiscal Environment of Small and Medium Sized Enterprises,COM(94)206Final(May1994).

111 SeeEuropeanCommissionReport:TaxationintheEuropeanUnion–TheDevelopmentofTax Systems, COM(96) 546 Final (October 1996). This report presented to the ECOFINrevealsthattheCommissioninitiatedaninformaldiscussionwiththeECOFINMinistersinmeetingatVeronaon13April1996regardingchallengessuchasstabilityoffiscalsystemandrealisationofthesinglemarket.TheECOFINappointedaGrouptoconsidertheissues.TheGroupmet four timestoexaminesomeof thecore issuesof taxpolicyandobtainedviewsofthestakeholdersandexperts.TheCommitteeonEconomicandMonetaryAffairs&IndustrialPolicyoftheEUParliamentwasalsotakenintoconfidenceonthedevelopments.See also European Commission Communication: A Package to Tackle Harmful TaxCompetitionintheEuropeanUnion,COM(97)564Final(November1997).ThisdocumentwassubmittedpursuanttomeetingwiththeECOFINinMandorf‐les‐Bainson13September1997.

112 ConsequenttodevelopmentsatthemeetingandtheEuropeanCommissionCommunication,ibid,theECOFINmetagainon1December1997andadoptedaCodeofConductforBusinessTaxationtotackletheharmfultaxcompetitionamongMemberStates,[1998]OJC2/2.

113 The ECOFIN meeting, ibid (of 1 December 1997) also approved text of draft SavingsDirective and led the Commission to resubmit its draft proposal on Interest‐RoyaltyDirective,aboven35.Accordingly,aproposalforthelatterwassubmittedtotheCouncil(EuropeanCommissionProposalforaCouncilDirectiveonaCommonSystemofTaxationApplicable to Interest and Royalty Payments Made between Associated Companies ofdifferentMemberStates,COM(98)67Final(March1998)).TheotherproposalonSavings


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a place in the European tax agenda. These included an introduction of the CCCTB and a vigorous pursuit of removal of double taxation in the single market.114

3 TheRecentPeriod

As noted above, the EU, owing to the ‘slow but consistent emergence’ of constitutional powers in the area of direct taxes, entered the twenty-first century with an updated tax agenda – an agenda that hinted towards some of the ‘proto-federal’ character of tax powers. For instance, the Commission’s policy initiative to have a CCCTB for internal market was launched in 2001.115 A decade down the road in 2011, the Commission submitted a formal draft legislation to the Council for adoption of CCCTB rules.116 The proposal includes an EU-wide single set of tax rules for computing, consolidating and sharing the tax bases under the CCCTB for the group of companies opting for it. No doubt the CCCTB proposal has since moved at a glacial pace for want of unanimous consensus. However, the draft CCCTB legislation remains at the top tax agenda and the Commission has recently announced to relaunch a more pragmatic version of the draft towards the end of 2016.117 The anti-tax avoidance drive that has taken an unprecedented momentum in 2016 indeed serves as phase one of the EU plan towards CCCTB legislation.118

In 2011, the European Commission also focused on the bilateral tax treaties network existing between the Member States, highlighting the inadequacy of classical tax treaty regime in abolishing challenges posed by double tax burdens to the free flow of labour and capital in the single market. The Commission held an extensive EU-wide consultation with individuals, professional bodies and businesses on factual cases of double

Directive,afterdeliberationbytheParliamentandthenagainbytheECOFINinitsmeetingof26–27November2000,wasresubmittedtotheCouncil(EuropeanCommissionProposalforaCouncilDirectivetoEnsureEffectiveTaxationofSavingsIncomeintheFormofInterestPayments within the Community, COM(2001) 400 Final–2001/0164 (CNS) (July 2001).Finally, both legislation were adopted through Interest‐Royalty and Savings Directives,abovenn35–36.

114 See, eg, European Commission Communication: Tax Policy for the European Union –Priorities for theYearsAhead,COM(2001)260Final (May2001);EuropeanCommissionCommunication: Towards an Internal Market without Tax Obstacles – A Strategy forProvidingCompanieswithaConsolidatedCorporateTaxBaseforTheirEU‐WideActivities,COM(2001)582Final(October2001);onrelatedwork,seealsoEuropeanCommissionStaffWorkingPaper:CompanyTaxationintheInternalMarket,SEC(2001)1681Final(October2001). Having regard to the Commission’s initiatives, the EU Parliament also adopted aresolution (Mar. 14, 2002) affirming the priority agenda ahead on tax policy (EuropeanParliamentResolutionontheEuropeanCommissionCommunicationonTaxPolicyintheEuropeanUnionCOM(2001)260,[2003]OJC47/E/591–594).

115 European Commission Communication: An Internal Market without Company TaxObstacles:Achievements,/OngoingInitiativesandRemainingChallenges,COM(2003)726Final(November2003).OntheCCCTBinitiative,meetingsanddocumentsofitsWorkingGroup, see <http://ec.europa.eu/taxation_customs/taxation/company_tax/common_tax_base/index_en.htm>(lastaccessed26August2015).

116 CommissionProposalonCCCTBDirective,aboven26.117 EuropeanCommissionpressreleaseIP/15/5188:CommissionpresentsActionPlanforFair

and Efficient Corporate Taxation in the EU (17 June 2015), available<http://europa.eu/rapid/press‐release_IP‐15‐5188_en.htm>(lastaccessed18June2015);seealsoCommissiondocumentscitedinaboven39.

118 Onanti‐taxavoidancemeasures,see,eg,aboven38,andaccompanyingtext;seealsobelown124.


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taxation.119 The EU model tax convention or some other multilateral tax treaty apparatus in the single market has long been an area of interest for several European tax law experts.120 This is because the supranational governance in the EU has attained a structure akin to a ‘federal-like’ polity. On the contrary, however, the classical bilateral treaty network between the Members, based largely on the OECD Model Tax Convention, does not go beyond traditional bilateral-market-solutions, and that too, in limited spheres between two sovereign nations concluded under the public international law. Thus the Commission’s focus on ridding the single market of double tax burdens through some kind of European apparatus beyond the traditional bilateral treaty regime seems consistent with the mobility of EU powers. Furthermore, pursuant to the demise of article 293 of EC Treaty, which urged Members to search for fixes to double taxation problems outside the EU law, one cannot rule out prospects of ‘new European tax powers’ against excessive taxation in the single market.121 Since the Lisbon Treaty came into effect in 2009, there has been an ongoing debate on a shift in EU tax powers because article 293 of EC Treaty – meant for bilateral negotiation to abolish double taxation – has been repealed.122 The Commission’s consultation on how to abolish double taxation in recent years is a fair indication as to a starting point towards prospective EU policy initiatives against double tax burdens in accordance with the expanding legal room in the European constitution.

A more recent focus of the EU on measures concerning anti-Base Erosion and Profit Shifting in the single market has witnessed unprecedented activity surrounding tax legislation. A series of legislative measures, including the adoption of an anti-tax avoidance directive123 together with several other measures amending pre-existing tax directives,124 indeed underpin that growth in unspoken European legislative powers, which have gained remarkable momentum in their journey along the evolutionary path.

119 EuropeanCommissionCommunication:DoubleTaxationintheSingleMarket,COM(2011)712Final(November2011);seealsoDirectorate‐GeneralforTaxationandCustomsUnion,‘Commission’s Consultation on Double Taxation Conventions and the Internal Market:Factual Examples of Double Taxation Cases’ (January 2011), available at<http://ec.europa.eu/taxation_customs/common/consultations/tax/2010_04_doubletax_en.htm>(lastaccessed26August2015).

120 See, eg, Pasquale Pistone, The Impact of Community Law on Tax Treaties – Issues andSolutions (Kluwer Publishers, 2002); Eric Kemmeren, Principle of Origin in TaxConventions:ARethinkingofModels(TilburgUniversityPhDDissertation,2001).

121 Aboven22(ECTreatyaboven4,art293,secondindent:‘MemberStatesshall,sofarasisnecessary,enterintonegotiationswitheachotherwithaviewtosecuringforthebenefitoftheirnationals:…theabolitionofdoubletaxationwithintheCommunity’).

122 See,eg,ShafiUKhanNiaziandRichardKrever,‘RomanceandDivorcebetweenInternationalLawandEUlaw:ImplicationsforEuropeanCompetenceonDirectTaxes’(forthcoming)53StanfordJournalofInternationalLaw(arguingthattheinternationallawparadigmgraduallyalienatesfromtheEUlawandthat,inturn,boostsconstitutionalpowerstoenactEU‐leveltaxpolicy);EricKemmeren,‘AfterrepealofArticle293ECTreatyundertheLisbonTreaty:theEUobjectiveofeliminatingdoubletaxationcanbeappliedmorewidely’(2008)17ECTaxReview156;KhanNiaziandKrever,aboven74,462–70.

123 ForAnti‐TaxAvoidanceDirective,seeaboven38andaccompanyingtext.124 Onsomeoftheamendments/draftamendmentsinthepre‐existingtaxdirectivesthathave

nexus with anti‐BEPS measures, see, eg, (1): Council Directive 2014/86/EU, amendingDirective2011/96/EUon the common systemof taxationapplicable in the caseofparentcompaniesandsubsidiariesofdifferentMemberStates,[2014]OJL219/40–41;(2)CouncilDirective(EU)2015/2376amendingDirective2011/16/EUasregardsmandatoryautomatic


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To that end, besides tax legislation at the Council-level, some of the measures initiated by the Commission against abusive tax practices and national tax subsidies are also unparalleled in EU tax history. There is, for example, no earlier precedent in the EU of recent actions against national tax rulings that in view of the Commission amount to illegal tax subsidies extended by Members to certain multinationals. The application of the EU state aid regime to national tax measures, which has resulted in rulings on recovery of huge tax amounts from Apple, Starbucks, and Fiat Finance and Trade,125 is already making headlines in the international tax arena. Also, the Commission’s scrutiny in other cases of similar character including McDonalds, Amazon and others is ongoing.126 While the executive rulings in this ‘new-found-land’ have yet to undergo judicial review,127 this activity nevertheless points to an opening of new doors to ever-evolving EU tax powers.

D EnhancedReferralstotheECJ

The landscape of EU tax powers remains incomplete without looking into the judicial version on the competence allocation in this policy area. One significant aspect of the judicial context is a remarkable rise in the frequency of ECJ rulings caused by increased tax litigation in recent decades. The Court rulings in direct tax regime have been increasing since the late 1980s and became intensive in the subsequent periods.128

exchange of information in the field of taxation, [2015] OJ L 332/1–10; (3) EuropeanCommissionProposalforaDirectiveoftheParliamentandtheCouncilamendingDirective2013/34/EUasregardsdisclosureofincometaxinformationbycertainundertakingsandbranches, COM(2016) 198/2, 2016/0107 (COD) (2016), <http://ec.europa.eu/finance/company‐reporting/docs/country‐by‐country‐reporting/160412‐proposal_en.pdf>(lastaccessed12April2016).

125 EuropeanCommissionpressreleaseIP/16/2923:Stateaid:IrelandgaveillegalbenefitstoAppleworth€13billion (30August 2016), available at <http://europa.eu/rapid/press‐release_IP‐16‐2923_en.htm>(lastaccessed30August2016);EuropeanCommissionpressreleaseIP/15/5880:CommissiondecidesselectiveadvantagesforFiatinLuxembourgandStarbucks in the Netherlands are illegal under EU State aid rules (21 October 2015),availableat<http://europa.eu/rapid/press‐release_IP‐15‐5880_en.htm>(lastaccessed30August2016).

126 See, eg, European Commission press release IP/15/6221: State aid: Commission opensformal investigation intoLuxembourg’s tax treatmentofMcDonalds (3December2015),availableat<http://europa.eu/rapid/press‐release_IP‐15‐6221_en.htm>(lastaccessed30August 2016); European Commission press release IP/14/1105: State aid: CommissioninvestigatestransferpricingarrangementsoncorporatetaxationofAmazoninLuxembourg(7October2014),availableat<http://europa.eu/rapid/press‐release_IP‐14‐1105_en.htm>(lastaccessed30August2016);EuropeanCommissionpressreleaseIP/16/3085:Stateaid:Commissionopens in‐depth investigations intoLuxembourg’s tax treatmentofGDFSuez(nowEngie)(19September2016),availableat<http://europa.eu/rapid/press‐release_IP‐16‐3085_en.htm>(lastaccessed19September2016).

127 TheCommission’staxrulingsinthecasesofStarbucks,andFiatTradeandFinanceareunderappeal;seeFiatChryslerFinanceEuropevCommission,T‐759/15,appealedon29December2015; Netherlands v Commission, T‐760/15, appealed on 23 December 2015. Likewise,Ireland has also decided to contest the Apple decision before the court; see<www.finance.gov.ie/news‐centre/press‐releases/minister‐noonan‐disagrees‐profoundly‐commission‐apple>(lastaccessed1September2016).

128 About290casesofallkindsofdirecttaxescamebeforetheECJuntil2014.Justafewofthesecasesrelatetothepre‐1990period,followedbyaround40casesin1991–2000,whiletheremainingcasescameupbeforetheCourtin2001–2014;seeMarcelSchaper,‘30yearsofDirecttaxLitigationbeforetheCourtofJusticeoftheEuropeanUnion:AnEmpiricalSurvey’


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Notwithstanding the disputation of ECJ tax case law by a segment of legal scholarship,129 the increased litigation in itself explains an ever-expanding space of European tax powers. The rise in number of tax disputes before the ECJ is also suggestive of a progressive shift in the locus of tax competence in the so-called flexible list of items on the menu (Part IV(C)). The following illustrates how a growing array of tax litigation also correlates with a changing notion for EU tax powers.

In its response to the evolutionary phase the single European market passes through and the level of integration it attains, the mobility of accompanying economic and fiscal essentials (ie powers in these areas) become inevitable. In these circumstances, either the Member States have to pre-empt or respond on their own to the integrational imperatives of the increasingly integrated market or, if their inaction (or insufficient action) does not meet the gaps created by inter-Member trade and economic activity, market forces call for an optimal EU intervention. If both national and EU actions are non-existent, or are deficient, the injured parties would tend to enforce their constitutional rights such as free movement of labour and capital by seeking remedies through national courts. The wider the gap, the larger would be the number of cases contested before the courts. With increased lawsuits in the national courts, the probability of referrals to the ECJ would equally increase. The result is obvious – that is, enhanced referrals from national courts seeking preliminary rulings of the ECJ – and this has been precisely the case in recent years.130

In addition to moving national courts, demands generated through transnational taxpayers, firms and other non-state, pro-integration lobbyists may also push the European Commission to activate its efforts to settle cross-border tax disputes of firms and individuals.131 This may again end up in increased litigation in tax matters before the ECJ, since one of the Commission’s key activities involves initiation of infringement

(2014) 68Bulletin for International Taxation 236–237 (data of ECJ cases during 1983–2013);seealsoDirectorate‐GeneralofTaxation&Customs&Union,CJEUCasesintheAreaof, or of Particular Interest for, Direct Taxation (2015), <http://ec.europa.eu/taxation_customs/resources/documents/common/infringements/case_law/court_cases_direct_taxation_en.pdf>(lastaccessed4January2016).

129 A segment of legal scholarship is critical of decisions of the ECJ on direct taxation, inparticular theCourt’s robust approach towardsachievingnon‐discriminatory taxation inabsenceofharmonizedtaxbaseandrate,dismantlingoflongestablishedimputationsystemondividendtaxationinEurope;see,egGraetzandWarren,aboven14,1208–1212;MichaelJGraetzandAlvinCWarren,‘DividendtaxationinEurope:WhentheECJmakestaxpolicy’(2007) 44 Common Market Law Review 1577–1623; Wolfgang Schön, ‘Neutrality andTerritoriality – Competing or Converging Concepts in European Tax Law?’ (2015) 69Bulletin forInternationalTaxation271–293.However,withoutgoingintoadiscussiononmerits of ECJ rulings, the point in question is to emphasize a significant increase intransnationaltaxlitigationinrecentdecades;see,eg,datainaboven128.

130 Unliketheknownlitigationprocessworldwide,whereaggrievedparties(taxpayersortaxauthorities, as the case may be) bring their cases to federal constitutional courts, it isdifferentwiththeECJ.TheaggrievedpartiescannotbringtheircasesbeforetheECJ.Rather,therecouldbetwomainpossibilitiesbehindinstitutionofcasesbeforetheECJ:(1)NationalcourtsmayrefercertainquestionsarisingfrominterpretationofprimaryorsecondaryEUlawtoseekpreliminaryrulingoftheECJ(TFEU,aboven4,art267);(2)TheCommissionmayreferanymattertotheECJifaMemberisconsideredtohavefailedtofulfilitsobligationundertheEUlaw(TFEU,aboven4,art258).

131 In theorising growth in transnationalism causing increased activity at the ECJ andCommission‐level,seediscussionandliteraturecitedinaboven89.


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proceedings against those national tax policies that impede free movement of labour and capital in the single market.132 Eventually, the infringement-based activity of the Commission also in several cases ends up in litigation at the level of the ECJ.133

The tax-related litigation, whether initiated through referrals of national courts or triggered by Commission infringement proceedings, is indeed supportive of the reasoning noted above. That is, the internal market, in consequence of growth in transnational economic activity caused by the freedom clauses, increasingly attained a new integrational phase over time. At each phase, the locus of the derivative EU (tax) power that otherwise is submerged in the freedom clauses and the single market notion migrates to a new position.

To that effect, if this argument – even in part – qualifies to explain the increased frequency of litigation before the ECJ in the field of direct taxes, it may then reasonably uphold the thesis of growing implicit EU legislative powers in the tax realm over time. Thus the EU power to formulate Union-wide policy for integration of direct taxes could be argued to have inevitably gained width and breadth relative to the founding times – and, on the same rationale, is likely to grow and expand further in times ahead.

V CONCLUSION

The EU law does not explicitly empower the Union to formulate policy in the area of direct taxes – an area left generally to Member States. Nevertheless, if national (tax) laws infringe the single market principles, the EU could intervene. This study dissected the constitutional notion of the internal market to explore the emergence of implied European powers on direct taxes developing in the undergrowth of freedom clauses. A unique feature of multilevel governance is that the Union-Members power equilibrium is of dynamic character and changes over time in accordance with the level of integration attained by the single market at a given point in time. The freedom clauses cultivate the seeds of transnational economic activity through free movement of labour, capital, goods, and services in the single market. Alongside the growth of these freedoms, economic activity across the European market also grows and, consequently, so do the meanings of EU powers in those policy areas which are incidental to that market including the (implicit) tax powers. This article suggests that pursuant to freedom clauses, the transnational economic activity has grown – and may grow further – to attain level(s) where adequate EU-level actions become increasingly inevitable in the tax policy sector. The result is an ever-mobile (implicit) supranational EU competence to address double tax burdens, tax-induced distortions and tax avoidance issues that impede the functioning of single European market. The analysis offered here, therefore, concludes that the policy

132 TFEU,aboven4,art258.133 In fact, about 56 direct tax cases decided by the ECJ until 2001 originated from the

Commission;outofthese,morethan90percent(around52)caseshavebeeninitiatedbythe Commission againstMembers for breach of EU (direct tax) law just since 2002; seeShaper,aboven128.Besides,alargenumberofinfringementcasesdonotundergolitigationsinceMembersmostlycomplywiththeinfringementnoticesoftheCommissionandremoveinconsistencies in their national taxmeasures. For example, during theperiod2000–13,almost700casesofinfringementproceedingsinitiatedbytheCommissionagainstincometaxmeasuresofMembersweresettledoutofcourt.(Commission’sletterof29January2015(personalcommunication;letteronfilewithauthor.)


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of limited intervention to formulate EU-level rules in the field of direct taxes may not persist in the long run, but rather may shift to wider and deeper European tax measures in times ahead.


134

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AREVIEWOFRESEARCHONCORPORATETAXAGGRESSIVENESSANDTHELEVERAGEPUZZLE

H KHIEM(JONATHAN)NGUYEN*

ABSTRACT

Thisarticlereviewspreviousresearchontherelationshipbetweencorporatetaxaggressivenessand leverageandshows that thepuzzleremainsunsolved.Mixedfindings are reported in prior literature. Fourmain propositions from previousstudies to explain this relationship are discussed in this paper: debt interestdeductibility; non‐debt tax shields; debtholders’ concerns aboutmanagerial rentextraction;anduncertaintyaboutthefuturecashflowsoftaxavoiders.Thisreviewpaper suggests fourmain factors to account for the inconsistent results in pastempirical studies: the causal or bi‐directional relationship between taxaggressivenessanddebt;proxiesfortaxaggressiveness;measuresoffirmleverage;and the endogeneity of corporate tax status.Suggestionsareprovided for futureresearchonthetaxaggressivenessandleveragepuzzlewithaviewtoreconcilingthemixedfindingsintheexistingliterature.

* Keywordsforthisarticle:corporatetaxation,taxaggressiveness,taxplanning,leverage,costofdebt.Theauthormaybecontactedatjonathan.nguyen@student.unsw.edu.au.


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I INTRODUCTION:THEPUZZLEOFCORPORATETAXSTATUSANDLEVERAGE

Researchers have long raised questions surrounding the relationship betweencorporatetaxesanddebtlevelsincompanies’capitalstructure.Theliteratureintax,accounting and finance fields in the last four decades has proposed differenttheoriesandperformedvariousempiricaltestsonthisrelationship.SincetheearlyoptimalcapitalstructuretheoryputforwardbyMillerin1977andDeAngeloandMasulis in1980,academicsacross those fieldshaveconsistently reportedmixedresultsontheassociationbetweenfirms’taxaggressivenessandtheirleverage.1

Myersstatedin1984, ‘Iknowofnostudyclearlydemonstratingthatafirm’staxstatushaspredictable,materialeffectsonitsdebtpolicy’.2Nearlytwodecadeslater,GordonandLee,intheir2001studyoftheimpactoftaxesoncorporatedebtpolicy,remarkthat‘economistshavehadgreatdifficultyprovidingevidencethattaxesinfactaffectdebt/assetratios’.3Sincethen,academicsinthisareahaveprovidedsomesignificantresultsregardingtheassociationbetweencompanytaxstatusandfirm’sleverage(orcostofdebt);however,thereportedfindingsaremixedwhenitcomestothesign(iepositiveornegative)anddirection(iecausation)ofthisrelationship.

Indeed,whilemanystudiesfindapositiverelationbetweentaxavoidancestrategiesanddebtholdingsbyfirmssupportingtheargumentthatcompaniesemployhighdebtstructurefortaxplanningpurposesduetothetax‐deductiblenatureofinterestexpenses, a number of other papers report that corporate tax aggressiveness isnegativelyassociatedwithbothleverageandcostofdebt;theyattributethisresulttothenon‐debttaxshieldsutilisedbytaxshelteringfirmsratherthantaxstrategieswhichfavourhighinterestdeductionsonborrowings.

On one hand, Graham observes an ‘under‐leverage puzzle’ phenomenon wherefirms’leveragelevelisnoticeablylowerthanexpectedwhentheyareoflargesizeand operate with good financial performance and liquidity.4 Researchers, in anattempttoexplainthis‘under‐leverage’phenomenon,proposethattaxsheltersactasnon‐debttaxshieldswhichsubstitutefortheuseofdebtandinterestdeductionstocompanies.5

Ontheotherhand,an‘under‐shelteringpuzzle’isobservedbyWeisbach,whonotesthatsomefirmsdonotengageintaxshelteringasmuchastheymight,giventhelowexpected costs associated with tax avoidance for those firms.6 Desai andDharmapalasuggestthattheexplanationforthis‘under‐sheltering’phenomenonis

1 MertonHMiller,‘DebtandTaxes’(1977)32(2)JournalofFinance261;HarryDeAngeloandRonald W Masulis, ‘Optimal Capital Structure under Corporate and Personal Taxation’(1980)8JournalofFinancialEconomics3.

2 StewartCMyers,‘TheCapitalStructurePuzzle’(1984)39(3)JournalofFinance575.3 RogerHGordonandYoungLee,‘DoTaxesAffectCorporateDebtPolicy?EvidencefromU.S.

CorporateTaxReturnData’(2001)82(2)JournalofPublicEconomics195.4 JohnRGraham, ‘HowBigAre theTaxBenefitsofDebt?’ (2000)55(5) JournalofFinance

1901.5 JohnRGrahamandAlanTucker,‘TaxSheltersandCorporatePolicy’(2006)81(3)Journalof

FinancialEconomics563.6 DavidAWeisbach,‘TenTruthsaboutTaxShelters’(2002)55(2)TaxLawReview215.


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thatcompanyshareholderstendtohaveconcernsaboutmanagers’rentdiversion,whichmightbeconcealedunderopaquereportingforpurposesoftaxavoidance.7However, many questions remain unanswered – not only in relation to under‐leveragebutalsoconcerningunder‐sheltering.Theserequirefurtherexamination.

Recognisingthisuncertaintymakesitlesssurprisingthattheinteractionbetweencompanytax‐aggressiveschemesandfirm’sleverage(orcapitalstructure)remainsa large puzzle. The corporate tax aggressiveness–leverage relationship is rathercomplicated when taking into account different sources of impacts on thisrelationship.Among these sourcesare taxdeductibilityof interestpaidondebts(Miller);non‐debttaxshields(DeAngeloandMasulis);agencycosts(CrockerandSlemrod);bankruptcycosts(Bartholdy&Mateus);firmsize(StickneyandMcGee);and capital intensity and research and development activities (Gupta andNewberry).8 The empirical findings have thus been inconclusive about therelationshipbetweentax‐aggressiveactivitiesandcostofdebt.Thispaperreviewstheconflictingresultsreportedinpreviousresearchanddiscussestheargumentsandtheoriesestablishedinsupportofthoseresults.

This article proceeds as follows. Part II documents studies that report positive,negativeorinsignificantassociationbetweencorporatetaxaggressivenessanddebtholdings. Part III reviews the rationale underlying these empirical results,prominently the tax deductibility of debt interest, the non‐debt tax shieldsubstitution effects and tax exhaustion theory, the debtholders’ concerns aboutmanagerialrentextraction,andtheuncertaintyaboutcompany’sfuturecashflows.InPartIV,issuesintheempiricaltestswillbeexamined,includingtheperceptionofthe causal relationship between tax aggressiveness and company leverage, thedifferences in proxies used in previous studies, and the endogeneity concern inmeasuringcorporatetaxrates.PartVprovidessuggestionsforpotentialresearchinthisareainthefuture.

II REPORTEDRELATIONSHIPBETWEENCORPORATETAXAGGRESSIVENESSANDLEVERAGE

A StudiesReportingPositiveAssociationBetweenTaxAggressivenessandDebtHoldings

Thissectionpresentspreviousresearchthatdocumentsapositiverelationbetweentax‐aggressiveactivitiesanddebtlevelsincorporations.

7 Mihir Desai and Dhammika Dharmapala, ‘Corporate Tax Avoidance and High‐poweredIncentives’(2006)79(1)JournalofFinancialEconomics145.

8 Miller, above n 1; DeAngelo and Masulis, above n 1; Keith J Crocker and Joel Slemrod,‘CorporateTaxEvasionwithAgencyCosts’ (2005)89(9–10) JournalofPublicEconomics1593;JanBartholdyandCesarioMateus,‘DebtandTaxesforPrivateFirms’(2011)20(3)International Review of Financial Analysis 177; Clyde P Stickney and Victor E McGee,‘EffectiveCorporateTaxRates:TheEffectof Size, Capital, Intensity, Leverage, andOtherFactors’ (1982)1(2) JournalofAccountingandPublicPolicy125;SanjayGuptaandKayeNewberry,‘DeterminantsoftheVariabilityinCorporateEffectiveTaxRates:EvidencefromLongitudinalData’(1997)16(1)JournalofAccountingandPublicPolicy1.


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First,StickneyandMcGee,intheirresearchoncorporateeffectivetaxrates(ETRs)ofUSfirmsinthreeyearsfrom1978to1980,report–amongotherfindingsaboutcharacteristicsoftax‐aggressivefirms–corporationsthathavelowETRarelikelytohavehighdebt levels in their capital structure.9Oneof the limitationsof thatresearch,asrecognisedbytheauthors, isthattheanalysisdoesnottakeintotheaccountthetaxbenefitsfromunusedtaxshieldsthatarenotindebtformsuchastaxlosscarry‐forwardprovisions.Itispossiblethatothernon‐debttaxshieldscouldhaveanimpactonthereportedassociationbetweentaxavoidanceandleverage.

Inthesamevein,Mills,EricksonandMaydewfindevidencesupportingtheincreaseindebtuseintax‐aggressivefirmsreportedbyStickneyandMcGee.10MillsetalusetaxplanningcostdataobtainedfromconfidentialsurveyspreviouslycollectedbySlemrodandBlumenthaltoconductresearchoninvestmentsintaxplanningbyUScorporations.11MillsetalreportresultsshowingthatETRisnegativelyassociatednotonlywithtaxplanningcostsbutalsowithleverage.12AhighETRsuggeststhatacompanyhasgoodtaxcompliancestatus,andthecorollary isalsotrue: lowETRindicates that the firmhas successfullyadopteda taxplanning strategy to lowertheir tax liabilities. In otherwords, the findings byMills et al demonstrate thatleverageissignificantlyandpositivelyrelatedtotaxaggressiveness.

Dyreng,HanlonandMaydewconductedastudyof long‐runtaxavoidanceforUSfirmsoveraten‐yearperiod(1995–2004)andreportedthattheirsample’sgroupoflong‐runtaxavoiders(iepayinglowtaxes)onaverageemploysmoredebtsthanthegroupoftax‐compliantfirms(iepayinghightaxes).13Theusefulnessofthisresearchliesinitsabilitytocapturesuccessfultaxavoidingfirmsinthelongrun;26percentofthecompaniesinthesamplekepttheircashETRbelow20percentfortheten‐yearperiodand9percentofthesamplefirms’cashETRswerebelow10percent,comparedwiththemeantaxrateof30percentforthesample.Thissuggeststhatthefindingofapositiveassociationbetweendebtholdingsandtaxavoidanceherereflectsthedebtstructureofthosefirmsthatarecommittedtolong‐termshelteringstrategiesratherthanmerelyhavingETRsdecreasedinoneyearforsomespecial(andlikelylegitimate)reasons.

Similarly Seidman, studying the difference in book income and taxable income(book–taxdifference,orBTD)reportedbyUScorporationsbetween1993and2004,producesregressionresultsshowingthatBTDispositivelyrelatedtocostofdebt,consistent with the discussion on off‐balance sheet financing by Mills andNewberry.14Whenusedasaproxyforcompanytaxsheltering,higherBTDimplies

9 StickneyandMcGee,aboven8.10 Lillian FMills, MerleM Erickson and Edward LMaydew, ‘Investments in Tax Planning’

(1998)20(1)JournalofAmericanTaxationAssociation1;StickneyandMcGee,aboven8.11 JoelSlemrodandMarshaBlumenthal, ‘The IncomeTaxComplianceCostofBigBusiness’

(1996)24(4)PublicFinanceQuarterly411;Mills,EricksonandMaydew,aboven10.12 Mills,EricksonandMaydew,aboven10.13 Scott D Dyreng, Michelle Hanlon and Edward L Maydew, ‘Long‐run Corporate Tax

Avoidance’(2008)83(1)AccountingReview61.14 JeriK Seidman, ‘Interpreting theBook‐Tax IncomeGap asEarningsManagement orTax

Sheltering’ (2010),McCombs Research Paper Series No. ACC‐02‐10, McCombs School ofBusiness,TheUniversityofTexasatAustin,March;LillianFMills andKaye JNewberry,


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amorehighly tax‐aggressiveposition takenby the firm. In Seidman’spaper, theauthor notes that their BTDmeasuremay only be considered a good proxy forcorporate tax avoidance once the impacts of Generally Accepted AccountingPrinciples (GAAP)changeshavebeencontrolled for.15Thus, thepositiverelationbetweentax‐aggressivestatusandleverageinSeidman’sresearchisnotasstrongastheevidenceprovidedinDyrengetal.16

A US study conducted over a longer period (25 years, from 1982 to 2006) byDhaliwal, Lee and Pincus finds that BTD is positively associated with cost ofcapital.17AlsostudyingUScompaniesfora25‐yearperiod(1985–2009),Hasanetaltesttherelationshipbetweentaxavoidancebycorporationsandcostofdebtbyexaminingloansfrombankstobusinesses.18Inthatstudy,evidencewasproducedtosupportthepositiverelationbetweentaxshelteringandcostofbankloans.19TheresultsetoutinHasanetalremainsrobustwhenaccountingfortheimpactsafterthe public becomes aware of a firm’s involvement in tax avoidance schemes. 20Further, not only are higher spreads of bank loans reported for tax‐aggressivecompanies,buthigherspreadsinissuingpublicbondsaswellasstrictercollateraland covenant terms imposedonbank loans are also found in those firms.21 It isnotedthatthestudybyHasanetalhasfocusedononlybankloansandpublicbonds;however, these two sources do not fully represent the financial liabilities ofcompanies. Nonetheless, asWelch points out, empirical studies of leverage andcapitalstructureshouldconcernnotonlyfinancialliabilitiesbutalsonon‐financialliabilities, which could affect the overall implication about cost of debt forbusinesses.22

Inaddition,Shevlin,UrcanandVasvariexaminetheeffectsoftaxaggressivenessoncostofdebt fromtheperspectiveofdebtholders,whoseonlywaytoassesstheirpotential lending decisions is from the publicly available information.23 Using asampleofcompanybondsissuedintheUSbetween1990and2007,Shevlinetalfindthatfirms’taxavoidanceactivitiesaresignificantlypositivelyassociatedwithcorporatebondyields.24Furthertestsperformedbytheresearchersshowthatthe

‘Firms’ Off‐Balance Sheet and Hybrid Debt Financing: Evidence from Their Book‐TaxReportingDifferences’(2005)43(2)JournalofAccountingResearch251.

15 Seidman,aboven14.16 Seidman,aboven14;Dyreng,HanlonandMaydew,aboven13.17 DanSDhaliwal,HyeSeungGLeeandMortonPincus, ‘Book‐TaxDifferences,Uncertainty

aboutInformationQuality,andCostofCapital’(WorkingPaper,UniversityofArizona,July2009).

18 IftekharHasan,ChunHoi,QiangWuandHaoZhang,‘BeautyIsintheEyeoftheBeholder:TheEffectofCorporateTaxAvoidanceontheCostofBankLoans’(2014)113(1)JournalofFinancialEconomics109.

19 Ibid.20 Ibid.21 Ibid.22 IvoWelch,‘TwoCommonProblemsinCapitalStructureResearch:TheFinancial‐Debt‐To‐

AssetRatioandIssuingActivityVersusLeverageCharges’(2011)11(1)InternationalReviewofFinance1.

23 TerryShevlin,OktayUrcanandFlorinVasvari, ‘CorporateTaxAvoidanceandPublicDebtCosts’(WorkingPaper,UniversityofCalifornia,Irvine,August2013).

24 Ibid.


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uncertainty of future cash flows is the main mechanism through which taxaggressiveness increases the bond offering rates.25 Interestingly, although noprivateinformationismadeavailabletopublicbondholders,informationqualityisfoundtonotplayasignificantroleinthepositiveassociationbetweentaxshelteringandbondyields.26

Moving outside the US setting, some Australian empirical works also produceresults supporting the positive tax aggressiveness–leverage relationship.Richardson,TaylorandLanis,inastudyof203companieslistedontheAustralianStockExchange (ASX), document a significantpositive impact of leverageon taxaggressivenessintheirregressiontests.27Theirmainfindingisthattaxavoidanceby a business is positively associated with financial distress.28 A possibleexplanation,takingintoaccountthehigherleveragecharacteristicoftax‐aggressivefirms, is that the high debt levels employed by those firms have induced theirfinancialdistress.Theauthorsnotethatoneofthelimitationsoftheirresearchisthepossibilityofomittedvariables in the regressionmodel, andsuggest there ispotentialtoincorporatetheimpactsoftaxauthoritiesinthetaxavoidancemodelinfuturestudies.29

AfewotherAustralianstudieshavealsoshownthattaxaggressivenessispositivelyrelated to debt levels, although exploration of capital structure is not theoverarchingaimofthesestudies.AmongthoseistheresearchbyRichardsonandLanis,whichexaminesthedeterminantsofvariabilityinETRofAustralianfirmsinthecontextoftheRalphReviewoftaxreformin1999inAustralia.30Theresearchersfindthat leverage isnegativelyassociatedwithETRs–that is, leverage increaseswiththeleveloftax‐aggressiveplanningbyfirms.31Inaddition,theauthorscontendthat following theRalph tax reform, theETRsare increased forhighly leveragedAustralian firms, and argue that the reason for such increase in ETRs is thereductionintaxbenefitsfrominterestpaymentsondebts.32

Analogously,inalaterstudyofcorporatesocialresponsibilityandtaxavoidanceintheAustraliansetting,LanisandRichardsonalsoobtainaresultofanegativeandsignificantrelationbetweenleveragelevelandETRs–thatis,companiesthatpaylesstaxhavehigherlevelofdebtsontheirbalancesheet.33Thisfindingonceagaingivessupport to thesuggestedpositivetax–debtrelationship.Richardson,Taylor

25 Ibid.26 Ibid.27 GrantRichardson,GrantleyTaylorandRomanLanis, ‘TheImpactofFinancialDistresson

Corporate Tax Avoidance Spanning the Global Financial Crisis: Evidence fromAustralia’(2015)44EconomicModelling44.

28 Ibid.29 Ibid.30 GrantRichardsonandRomanLanis,‘DeterminantsoftheVariabilityinCorporateEffective

TaxRatesandTaxReform:EvidencefromAustralia’(2007)26(6)JournalofAccountingandPublicPolicy689.

31 Ibid.32 Ibid.33 Roman Lanis and Grant Richardson, ‘Corporate Social Responsibility and Tax

Aggressiveness:AnEmpiricalAnalysis’(2012)31(1)JournalofAccountingandPublicPolicy86.


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andLanis,intheir2013article,includeleverageasoneoftheindependentvariablesintheirtaxavoidancemodel,andreportthatleverageispositivelyrelatedtothetaxaggressivenessmeasureforAustralianbusinesses.34Inthatstudy,ofthe30firmsidentifiedashavingtaxdisputeswiththeAustralianTaxationOffice(ATO),utilising‘deductibilityofinterestexpenses’isthesecondmostcommontypeoftaxstrategy,behindonlyschemesinvolving‘corporaterestructuring’.35

AsimilarresultisreportedinanempiricalstudybyTaylorandRichardsonwhichexaminestheincentivesforAustraliancorporationstoengagetaxplanningschemesfromasampleof200Australianpubliclylistedfirmsfortheperiod2006–2010.36Thisresearchyieldsregressionresultsshowingthepositiveeffectsofleverageontax‐avoidanceactivities.37

Nonetheless, and similar to theUS literature, theAustralian studiesdocumentedherearenotwithoutconflictwithregardtotherelationshipbetweencorporatetaxaggressivenessanddebtholdings.Thestudiesthatproduceregressioncoefficientstoreject thepositive taxaggressiveness–leverageassociationarereported in(B)and(C)below.

B StudiesReportingNegativeAssociationBetweenTaxAggressivenessandDebtHoldings

Thissectionreviewspreviousstudiesthatfindtaxaggressivenesstobenegativelyassociated with debt levels or with cost of debt, as opposed to the positiverelationshipdiscussedin(A)above.

First, inastudyoftherelationshipbetweendebtandthecorporatemarginaltaxrate,Grahamperformsregressionanalysison10,000UScompaniesfora13‐yearperiod,from1980to1992,andsimulatesthosefirm’smarginaltaxrates(MTRs),taking into consideration net operating losses, investment tax credits andalternativeminimumtax.38Graham’sresearchfindsevidencethatfirmswithlowertaxratesuselessdebtintheircapitalstructurethanfirmswithhighertaxrates.39Sincecompaniesthathaveaneffectivemarginaltaxratelowerthanthestatutoryrate are often considered successful tax planners, Graham suggests that taxaggressivenessisnegativelyassociatedwithfirmleverage.Nonetheless,thelowR‐squaredoftheregressionmeansthathisanalysiscannotconvincinglyexplainthelargerportionofleveragedecisionsbycorporations.40

34 Grant Richardson, Grantley Taylor and Roman Lanis, ‘The Impact of Board of DirectorOversightCharacteristicsonCorporateTaxAggressiveness:AnEmpiricalAnalysis’(2013)32(3)JournalofAccountingandPublicPolicy68.

35 Ibid.36 Grantley Taylor and Grant Richardson, ‘Incentives for Corporate Tax Planning and

Reporting: Empirical Evidence from Australia’ (2014) 10(1) Journal of ContemporaryAccounting&Economics1.

37 Ibid.38 JohnRGraham,‘DebtandMarginalTaxRate’(1996)41(1)JournalofFinancialEconomics

41.39 Ibid.40 Ibid.


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Lookingatthesameperiod(1981–1992),Graham,LemmonandSchallheimstudydebtandleasesusedbyUSfirmsandreportthatlowtaxratefirmsarelikelytohavelower debtlevels, supporting the negative relation between tax avoidance and debt.41Atthesametime,GrahametalfindanincreaseinuseofoperatingleasesincompanieswithlowerMTR,butfindnoclearevidenceofanassociationbetweencapital leases andMTR.42 Apart from contributing evidence of the negative relationshipbetween tax aggressiveness and debt, that article also demonstrates the differentpropertiesofdebtandleasesintermsoftheirimpactsoncorporatetaxes.

In another US study, Gordon and Lee document similar result from their empiricaltests on US companies for 37 years between 1954 and 1995 (excluding 1962 and1966–1969) – a much longer period than the studies by Graham in 1996 andGraham et al in 1998.43 That research, using US tax return data, shows a negativerelation between debt financing and tax planning opportunities for companies.44GordonandLeealsodemonstratethatshort‐termborrowingsaremoreresponsivetotax incentives than are long‐term borrowings; more specifically, the impact ofcompanytaxontheelasticityofshort‐termdebtisfoundtobeapproximatelytriplethatfor long‐term debt.45 The authors here recognise that tax consequences are not theonly issue considered by companies when changing their capital structure inresponse to potential tax benefits. Indeed, they argue that non‐tax implications alsoplayanimportantroleinleveragedecisionsofcorporations.

In the same research line, in 2008 Graham and Mills studied the differences betweensimulatedMTRbasedonfinancialstatementinformationandsimulatedMTRfromthe US tax return information, using a sample of firms from 1998 to 2000.46 Thisyielded the result that simulated bookMTR performs better than thesimulatedMTRfrom tax returns in respect of the ability to explain company’s debt ratios. Inaddition, these authors document a positive association between simulated MTRsanddebtratios,supportingthenotionthatcompaniesachievinglowtaxratestendtouselessdebt.47

In an attempt to explain the under‐leverage puzzle in tax‐aggressive firms(discussed by Graham in 2000), Graham and Tucker examine large corporate taxshelter cases under actual litigation in the US.48 This use of actual tax shelter casesgives the research the advantage of using identified tax‐aggressivecompaniescompared withotherformsofproxyfortaxavoidancesuchasETRorBTDemployed in other studies. However, the authors also confirm that thelimitation of their study, in using such a sample, lies inmaking inferencesfroma

41 JohnRGraham,MichaelLLemmonandJamesSSchallheim, ‘Debt,Leases,Taxes,andtheEndogeneityofCorporateTaxStatus’(1998)53(1)JournalofFinance131.

42 Ibid.43 GordonandLee,aboven3;Grahamaboven38;Graham,LemmonandSchallheimaboven

41.44 GordonandLee,aboven3.45 Ibid.46 JohnRGrahamandLillianFMills,‘UsingTaxReturnDatatoSimulateCorporateMarginal

TaxRates’(2008)46(2–3)JournalofAccountingandEconomics366.47 Ibid.48 GrahamandTucker,aboven5;Graham,aboven4.


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relativelysmallsample.49Theresearchfindsareductionof8percentindebtratiosintheirsampleoftaxavoidancefirms,suggestingthatfirmsthatusetax‐aggressiveplanningas‘non‐debttaxshield’tendtohavelowerdebtlevels.50

Additionally,WilsonreportsanegativeassociationbetweendebtholdingsandtaxaggressivenessforasampleoffirmsdrawnfromthedatapreviouslycollectedbyGraham and Tucker (2006) and additional tax avoidance cases discovered frompress articles from 1975 to 2000.51 Similar to Graham and Tucker, thegeneralisability of Wilson’s results is not strong, because it does not includecorporationswhosetaxavoidanceschemesarenotdetectedbythetaxauthorities(ie Wilson performs the tests only on a set of tax shelter firms successfullyidentified).52

Lim,inhisstudyofKoreanlistedcompaniesfortheperiod1994–2003,investigatestherelationbetweentaxavoidanceandcostofdebt,andexpandstheexaminationtoincludetheeffectsofshareholderactivismonthisrelationship.53Computingthetaxavoidancemeasurefrombook‐taxdifference,Limfindsanegativerelationshipbetweenthetaxavoidancevariableandcompany’scostofdebt.54FurthertestsinLim’sstudy indicatethat taxaggressiveness ismoresignificantlyassociatedwithcostofdebtincorporationswithahigherlevelofinstitutionalownership,andthatthisnegativerelationshipbecomesevenmoreremarkableafter1998asaresultoftheKoreancorporategovernancereformsallowingmorepowerstobeexercisedbyinstitutionalinvestors.55Hasanetal,whofindtheoppositeresultforUScompanies(discussedin(A)above)arguethatthenegativerelationbetweentaxavoidanceandcostofdebtfoundinLim’sresearchisduetothefactthattax‐aggressiveentitiesrelymore heavily on loans than bonds.56 However, the evidence supporting thisargument is insufficient to be persuasive, because different tax jurisdictions arebeingconsidered:Lim(2011)studiesKoreancompanieswhileHasanetal(2014)examineUSfirms.57

AnotherpieceofevidenceinsupportofGrahamandTucker’sconclusionsisfoundbyLim(2012) inhis studyofKorean listed firms ina seven‐yearperiod (2000–2006).58 The author proposes that tax‐aggressive activities could offer a partialexplanation for the under‐leverage puzzle.59 The context here was a voluntaryreduction in leverage after changes in government laws and companies’ ETR in

49 GrahamandTucker,aboven5.50 Ibid.51 Ryan J Wilson, ‘An Examination of Corporate Tax Shelter Participants’ (2009) 84(3)

AccountingReview969;GrahamandTucker,aboven5.52 Wilson,aboven51.53 YoungdeokDLim,‘TaxAvoidance,CostofDebtandShareholderActivism:Evidencefrom

Korea’(2011)35(2)JournalofBanking&Finance456.54 Ibid.55 Ibid.56 Hasanetal,aboven18;Lim,aboven53.57 Ibid.58 GrahamandTucker,aboven5;YoungdeokDLim,‘TaxAvoidanceandUnderleveragePuzzle:

KoreanEvidence’(2012)39(3)ReviewofQuantitativeFinanceandAccounting333.59 Lim,aboven58.


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Koreadecreasedfrom20.3percentin2000to14.6percentin2005.60Lim’s2012paper has complemented and generalised the finding ofWilson, and the earlierfinding of Graham and Tucker, by employing a larger sample for the regressionanalysis;however,thecomplementaryfindingfromLimshouldalsobeconsideredwith caution because of the different jurisdictions, which may make a materialdifferencetotheanalysis.61

AfterLim(2012),astudybyLin,TongandTuckerofferedtoresolvetheconcernabout country differences (specifically betweenUS andKorea) by examiningUSfirmsfortheperiodfrom2006to2011.62Linetal’sresearchextendstheresultsfound in Graham and Tucker by reporting the inverse association between taxavoidance and debt levels.63 In documenting the substituting characteristic ofcorporate tax aggressiveness and debt use, Lin et al provide justification forleveragechoiceasaresultoftax‐aggressiveplanning,butnottheconverse(whereleveragestructureiscausallylinkedtotaxavoidance).Theauthorsalsoarguethatchangesindebtstructurearelikelytobemorecostlythanataxavoidancestrategy.64If this argument is correct, it is more probable that tax aggressiveness causesimpactsonleverageandcostofdebtratherthanthatfirmschangetheirleveragepolicy to serve tax planning purposes. However, this is not necessarily true;anecdotally,somefirmsdointentionallyorganisetheirdebtholdingsinamannerthatassiststheoveralltax‐aggressivestrategyofthecompanies,especiallywhentaxplanning involves international tax schemes. Besides, Lin et al highlight theinteresting‘stickydebtpuzzle’whererigidityisobservedincompaniesthatremaintheir capital structures over a long period, even when profit position and taxplanningopportunitieshavealreadychanged.65

Inanothernon‐USstudy,BartholdyandMateususePortugalasasettingfortheirstudyofthetaxaggressiveness–leverageassociationinprivatefirms.TheauthorsattributethechoiceofPortugal,among‘theleastdevelopedcountriesintheOECD’,to the fact that Portuguese companies use predominantly bank financing andPortugalhasarelativelysmallfinancialmarket.66Usingasampleof998Portugueseprivate firms in theperiod1990–2000, thisstudyshows thatcompany taxhasapositive impact on the debt structure for private firms (ie company taxaggressiveness increases as debt level becomes lower). Bartholdy and Mateusexplainthatitischeaperforsmallprivatefirmstofinancetheirdebtsthroughbanksthan to access funds in the financialmarket, due to the asymmetric informationdisadvantageofsmallentities.67Thisaspectoftheproblemhighlightstheneedtocontrolforfirmsizewhenexaminingtherelationbetweentaxplanningactivitiesandleveragestructure.Atthesametime,becausethefocusofthispaperisonsmallprivatefirms,thefindingsheremaynotbegeneralisabletolargerlistedcompanies.

60 Ibid.61 Lim,aboven58;Wilson,aboven51;GrahamandTucker,aboven5.62 Lim,aboven58;ShannonLin,NaqiongTongandAlanTucker,‘CorporateTaxAggression

andDebt’(2014)40(1)JournalofBankingandFinance227.63 Lin,TongandTucker,aboven63;GrahamandTucker,aboven5.64 Lin,TongandTucker,aboven63.65 Ibid.66 BartholdyandMateus,aboven8.67 Ibid.


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Inaddition,duetothespecialfeaturesofPortugalasmentioned,thenegativetaxaggressiveness–leverageassociationdocumentedbyBartholdyandMateusshouldbeassessedcarefullybeforerelatingthefindingstootherdevelopedeconomies.68Nonetheless,thoseresearcherssuggestthatthecrucialfactorindeterminingdebtlevels, apart from the tax consequences, is the availability of collateral, and thissuggestioncanbe incorporated in futurestudieswhenmodelling taxesanddebtstructure.69

Recognisingthedifficultiesencounteredwhenattemptingtomeasurepreciselythetaxbenefitofdebts to companies,Barclay,HeitzmanandSmith research the taxaggressiveness–leveragerelationshipintherealestateindustrywhere,theauthorsargue, the taxbenefitofdebtscouldbecomputedwith lesserror.70BarclayetalattributethisadvantageinmeasuringdebtbenefitstothefactthattheUSindustrycontainsboth taxable andnon‐taxable entities.71 Resultsof this research showacorrespondingincreaseof4.7percentindebtratiowhenmarginaltaxrateofanentitychangesfrom0percent(non‐taxable)to35percent(taxable).72Onthatbasis,theauthorsconcludethatnon‐taxablerealestatefirmsintheUSuselessdebtthanthetaxablerealestatefirms.73

Anaiveinterpretationofthisresultmightbethatthereexistsanegativeassociationbetween tax aggressiveness and debt levels if non‐tax organisation form isconsideredasastrategytoavoidpayingtaxes.However,therearetwolimitationsinthisstudy.First,theresultsaredrawnsolelyfromtherealestateindustry,whichmakesitdifficulttogeneralisefromthemtootherindustries.74Second,theresearchbyBarclayetalessentiallyexamines thedebtstructureof twodifferent typesoforganisations.75Forthatreason,thefindingsarehardtointerpretbecauseachangefromanon‐taxableentity(with0percenttaxrate)toanorganisationaltypethatistaxable(at35percentinthiscase)isdifferentfromachangeintaxaggressivenesslevel(egwhereETRchangesfrom30percentto35percent).76

In an Australian setting, Richardson, Lanis and Leung examine Australian‐listedfirmsfrom2001to2010anddrawtheconclusionthattaxavoidanceisinverselyrelatedtoleverage,consistentwiththedebtsubstitutioneffectdiscussedinGrahamand Tucker (2006).77 An extension from previous literature by Richardson et al(2014) is that their research suggests that outside directors magnify the debtsubstitution effect.78 That finding is in contrast with the positive association

68 Ibid.69 Ibid.70 MichaelJBarclay,ShaneMHeitzmanandCliffordWSmith,‘DebtandTaxes:Evidencefrom

TheRealEstateIndustry’(2013)20JournalofCorporateFinance74.71 Ibid.72 Ibid.73 Ibid.74 Ibid.75 Ibid.76 Ibid.77 GrantRichardson,RomanLanis, SidneyCLeung, ‘CorporateTaxAggressiveness,Outside

Directors,andDebtPolicy:AnEmpiricalAnalysis’(2014)25JournalofCorporateFinance107;GrahamandTucker,aboven5.

78 Richardson,LanisandLeung,aboven77.


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betweentaxavoidanceandleverageforAustraliancorporationsreportedinothertax aggressiveness studies (Lanis and Richardson 2012; Richardson, Taylor andLanis2013;TaylorandRichardson2014).79TheconflictingresultshereareworthhighlightingwhenthesestudiesarecarriedoutinthesameAustraliancontextandforsimilarperiods.Againweseemixedfindingsontherelationshipbetweentax‐aggressive activities and leverage levels of cost of debt, leaving the taxaggressiveness–leveragepuzzleunsolved.

When quantitative research yields conflicting results,meta‐analysismay help tolocate the common ground in the mixed findings reported in past literature.According toStanley,meta‐regressionanalysis is anapproachused ineconomic,socialandmedicalsciencestosynthesiseresultsfrompreviousliteratureand‘canhelp toexplain thewidestudy‐to‐studyvariation foundamongresearch findingsandofferspecificreasons,basedonthestudiesthemselves,whytheevidenceonacertainquestionmayappearcontradictoryoroverlyvaried’.80

Reviewing past empirical studies of debt structure and corporate taxation, Feld,HeckemeyerandOvereschconductameta‐analysisthatsynthesisesfindingsfrom48 prior studies over 25 years.81 Their meta‐regression shows a negativeassociationbetweencorporatetaxaggressivenessanddebtratio,andsuggeststhatareductioninacompany’sMTRlowersthedebtleveladoptedforafirm’scapitalstructure.82Theauthorsarguethattheoutcomesofpreviousresearchdependonthemeasureofcorporatetaxstatusused,andsuggestthatusingthesimulatedMTRmeasure from Graham (1996) may overcome the issue of downward biasencountered in estimating the effects of tax strategies on debt structure.83Additionally, drawing on their meta‐analysis, the authors caution that debtfinancingofmultinationalcompaniesisalsoaffectedbythetaxincentivesbroughtabout by profit shifting activities that occur in the international businessenvironment.However,thatanalysisappearstoassumethattaxescausechangesindebt structure of a company.84 Whether or not the tax aggressiveness–leverageassociationisacausalrelationshipremainstobeaddressed.

The literaturereviewinthissectiondemonstratesthatpreviousresearchononehandreportsapositiverelationbetweentaxavoidanceanddebtholdings,andontheotherhandfindsthattax‐aggressiveactivitiesareinverselyrelatedtoleveragelevelsaswellastocostofdebt.Moreover,someotherpapersinthissamelineofresearch have presented mixed or insignificant findings, adding to the puzzleobservedforthetaxaggressiveness–leveragerelationship.

79 Richardson,LanisandLeung,aboven77;LanisandRichardson,aboven33;Richardson,TaylorandLanis,aboven34;TaylorandRichardson,aboven36.

80 TDStanley, ‘Wheat fromChaff:Meta‐AnalysisasQuantitativeLiteratureReview’ (2001)15(3)JournalofEconomicPerspectives131.

81 Lars P Feld, Jost H Heckemeyer and Michael Overesch, ‘Capital Structure Choice andCompanyTaxation:AMeta‐Study’(2013)37(8)JournalofBanking&Finance2850.

82 Ibid.83 Feld,HeckemeyerandOveresch,aboven81;Graham,aboven38.84 Feld,HeckemeyerandOveresch,aboven81.


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C StudiesReportingMixedorInsignificantFindings

This section discusses previous studies that reach a conclusion of mixed orinsignificantfindingsinrespectoftheassociationbetweentaxavoidanceandfirms’leverage.

First, Gupta and Newberry documentmixed results for this association in theirstudyofcompanies’ETRsusinglongitudinaldataforthetwoperiods,1982–1985and1987–1990,omitting1986,whentheTaxReformAct1986(TRA86)intheUStookeffect.85ForthefirstETRmeasure,whichiscalculatedbydividingtheincometaxexpensebythebookincomebeforeinterestandtax,theseresearchersfindthatETR isnegativelyandsignificantlyrelated todebtratio forbothperiods,namelypre‐TRA86andpost‐TRA86.86Incontrast,theresultsforthesecondETRmeasure,whichistheratioofincometaxexpensetooperatingcashflowsbeforeinterestandtax,showtherelationbetweendebtratioandETRtobepositiveandsignificantforthepre‐TRA86period,butpositiveandinsignificantforthepost‐TRA86period.87Indiscussing this ambiguous finding, the authors suggest that the relationshipbetweencapitalstructureandfirm’sETRissensitivetothedenominatorusedincomputationofETRmeasure,andthattheirmodelofETRsmightbeincompleteandmay have potential biases from omitted variables.88 Thus, the sign of thisrelationshipremainsinconclusiveafterthisstudy.

Next, inastudyofUScompanies for theperiod1994–2004,Ayers,LaplanteandMcGuireexaminefirms’creditriskandhowitisassessedbycreditanalystsusingBTDinformation.89SinceBTDcanbeameasurenotonlyforearningsqualitybutalsoforthetaxaggressivenesslevelofacompany,aninverseassociationbetweenchangesinBTDandcreditratingchangesisinsufficienttodrawconclusionaboutthe relation between tax sheltering and leverage. The research by Ayers et alattemptstoshedlightonthisbydividingthefirmsintotwocategories, ‘hightax‐planning’ firmsand ‘non tax‐planning’ firms.90Theauthors find that for ‘non taxplanners’,largemovementsinBTD,irrespectiveoftheirsign,necessarilyresultinlessfavourableratingchanges(iehighercostofdebt).91Onthecontrary,for‘hightax‐planning’firms,theydonotfindanysignificantrelationbetweenBTDchangesand credit rating changes. On that basis, these researchers suggest that theassociationbetweenBTDandcreditriskisattenuatedbytaxplanningactivities.92Nonetheless, it should be noted that in this paper the finding of no significantrelationship between changes in BTD and credit rating changes depends on thedefinitionof ‘hightax‐planning’ firms.Ayersetaladopttwomeasurestoidentify

85 GuptaandNewberry,aboven8.86 Ibid.87 Ibid.88 Ibid.89 BenjaminCAyers,StacieKelleyLaplanteandSeanTMcGuire,‘CreditRatingsandTaxes:The

EffectsofBook‐TaxDifferencesonRatingsChanges’(2010)27(2)ContemporaryAccountingResearch359.

90 Ibid.91 Ibid.92 Ibid.


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hightaxplanners,thecumulativecurrentETRandthecumulativecashETR,bothofwhicharecomputedoverafive‐yearperiod.

BesidesAyersetal,NejadmalayeriandSinghanalysecorporatebondsissuedbyUScompaniesfrom1994to2006andreportthatcompanieswithhighertaxratesarelikelytohavesmallercreditspreads,whichessentiallyleadstolowercost‐of‐bondissues.93 Nejadmalayeri and Singh show evidence that credit spreads, whichrepresentforcostofcorporatebonds,decreasewhentheamountoftaxlosscarriedforward grows larger; in contrast, wider credit spreads (ie higher cost ofborrowings)areobservedwhendepreciation taxshields increase.94Additionally,the authors suggest that large unutilised tax shields may give shareholders anincentive to continue tomake loan payments and to prevent the company fromgoingbankrupttoenablethefirmtoaccesstheunutilisedtaxbenefitsinthefuture.95According toNejadmalayeriandSingh, ‘athigher taxrates,equityholderswouldhaveagreaterincentivetoavoiddefaultingonshort‐termdebttopreservelargertaxshields’.96Althoughthisargumentisunderstandable,managersneedtoconsidermanymore important issueswhenmakingdecisionsonwhether towindup thecompany.Itismostlikelythatequityholdersarelessconcernedabouttaxshieldsthan about other operating and management considerations when it comes todecidingonliquidationofthecompany.

Apart from theUS, a studyof international corporate taxavoidancepracticesbyTaylorandRichardsonin2012usingAustraliancompanydatayieldsinsignificantresultsformostofthetaxaggressivenessmeasuresemployedintheirresearch.97TaylorandRichardsonlookatAustralian‐listedfirmsoverfouryears,from2006to2009,andtheirregressionresultsshowthattheratiooflong‐termdebtovertotalassetsispositivelyrelatedtofourproxiesoftaxavoidance,buttheassociationsareinsignificant for three out of the four proxies used.98 The insignificant resultreportedbyTaylorandRichardsonisintriguingwhenthepapersuggeststhatthincapitalisationisoneofthetwomaindriversoftaxaggressiveness(withtheotheronebeing transferpricing).99 If firmsutilise taxhavens incombinationwith thincapitalisationtoobtainsignificanttaxliabilityreductions,itisexpectedthatthosefirmswouldhavehigherdebt levels.Following fromthisargument, theexpectedresult would be that leverage has a significantly positive association with taxavoidance.However,theinsignificantcoefficientsofleveragedocumentedforthreeoutofthefourtaxavoidancemeasuresinTaylorandRichardsonseeminconclusiveaboutthis.100

93 AliNejadmalayeriandManoharSingh,‘CorporateTaxes,StrategicDefault,andTheCostofDebt’(2012)36(11)JournalofBanking&Finance2900.

94 Ibid.95 Ibid.96 Ibid.97 GrantleyTaylorandGrantRichardson, ‘InternationalCorporateTaxAvoidancePractices:

EvidencefromAustralianFirms’(2012)47(4)InternationalJournalofAccounting469.98 Ibid.99 Ibid.100 Ibid.


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Thediscussioninthissection,togetherwith(A)and(B)above,clearlyhighlightsthetax aggressiveness–leverage puzzle in past literature, where mixed findings aredocumentedforthedirectionoftherelationshipbetweentaxaggressivenessandleverage(orcostofdebt).InPartIII,theunderlyingreasonsandexplanationsusedinreportingthepuzzleof taxaggressivenessand leveragearediscussed inmoredetail.

III RATIONALEOFUNDERLYINGRELATIONSHIPSBETWEENTAXAGGRESSIVENESSANDLEVERAGE

Previousresearchersincarryingouttheirempiricalresearchalsoproposedifferenttheoriestoestablishtherationaleoftheirresultsoftherelationshipbetweentax‐aggressiveactivitiesanddebtlevels,orcostofdebt.ThisPartreviewsthefourmostprominent arguments supporting an association, either negative or positive,between tax shelteringand leverage.The first twopropositions relate to the taxbenefits frominterestdeductionsandnon‐debt taxshields,whichareconflictingarguments frequently referred to in tax aggressiveness studies examining firms’leverage. The third and fourth propositions are, respectively, the debtholders’concernaboutrentextractionbymanagersandtheuncertaintyaboutfuturecashflows.ThesetwopropositionsarerecentlystatedandputforwardbyShevlin,Urcanand Vasvari (2013), although the underlying arguments have appeared in thecorporatetaxavoidanceliteraturepriortothat.101

A DebtTaxShieldandUtilisingofInterestDeductions

First, one long‐standing proposition, frequently referred to by academics ininterpretingtherelationshipbetweentaxaggressivenessandleverage,isthedebttaxshieldandthedeductibilityofinterestpaymentsondebt.StickneyandMcGee(1982), who document a positive relation between tax aggressiveness and debtholdings,discussafindingbyTambiniwhichshowsthattheaverageafter‐taxcostofdebtcapitalisaroundhalfoftheaveragecostofequitycapital.102StickneyandMcGeearguethatthedifferencebetweencostofdebtandcostofequityistheresultofthetaxtreatmentofreturnstodebtholdersandequityholders.103Inparticular,returntodebtholdersintheformofinterestondebtisdeductibletocompanyfortaxpurposesandhencereducesthenetprofituponwhichtaxiscalculatedusingthecorporatestatutorytaxrate.Ontheotherhand,returntoshareholdersintheformof dividend is generally not a tax deduction in calculating the firm’s taxable netprofit. Thus, use of debt brings tax benefits to the company because interestpaymentsaretaxdeductible.

Forthatreason,researcherswhofindtaxavoidanceactivitiespositivelyrelatedtoleverageorcostofdebtoftenattributethatresulttothedebttaxshield,andpropose

101 Shevlin,UrcanandVasvari,aboven23.102 StickneyandMcgee,aboven8;LuigiTambini,‘FinancialPolicyandTheCorporationIncome

Tax’, in A C Harberger and M J Bailey (eds), The Taxation of Income from Capital (TheBrookingsInstitution,Washington,1969)185.

103 StickneyandMcgee,aboven8.


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that corporations may engage in tax‐aggressive schemes surrounding firms’leveragechoiceinordertomakethemostuseofthedebtstructure.Forinstance,LanisandRichardsonarguethat‘highlyleveragedcorporationsareexpectedtousetax‐deductible interest payments to promote tax aggressiveness in thecorporation’.104InastudyofthinlycapitalisedtaxavoidanceinAustralia,TaylorandRichardson also argue that the debt tax shield together with those interestdeductionssupplies rationale for thepositiveassociationbetween taxavoidanceactivitiesandleverage.105

Theproblemimplicitinthisargumentisthatitcontradictsthetrade‐offtheoryofcapitalstructure,whichsuggeststhatfirmswithhighMTRsshouldusemoredebtthanfirmswithlowMTRs,becausethebenefitofinterestdeductionsisgreaterforhigh‐tax‐ratefirms.106Thetrade‐offtheoryhereimpliesthattaxsheltering,whichcaneffectivelyberepresentedbylowMTRs,isnegativelyrelatedtodebtfinancing,contrary to the positive association between tax aggressiveness and leveragepredicted by the debt tax shield proposition. Graham and Mills advanced thisargument as a reason for the negative relation between tax avoidance and debtholdingsfoundintheirresearch.107

Allthispointstotheneedtotakethefurtherstepoflookingatwhathappensafterfirmsdecidetoemploymoredebtsbecauseoftheinteresttaxshields,giventheirhighMTRs.Theresultwouldmostlikelybethataveragetaxrates(alsoETRs)willbereduced.Thelargertheinterestdeductionbecomes,themoretheETRdecreases,resulting in a reduction in MTR (ie the tax benefit of interest deduction alsoreduces).Theremaythereforebeanoptimalpointatwhichthetaxbenefit frominterestdeductionisnotsufficienttojustifyafirm’sincreaseofleverage,giventhepotentialinsolvencyrisks,whichmoveinthesamedirectionasdebtlevels.

AfurtherpointdiscussedinHasanetal(2014)isthattax‐aggressiveactivitiescanresult in higher cost of bank loans, whichmay in turn reduce the incentive forcompaniestoemploytax‐shelteringtechniques.108Nonetheless,previousresearch(Stickney andMcGee 1982; Lanis and Richardson 2012; Taylor and Richardson2014)wouldatthispointarguethatanincreaseincostofdebtmeansthereisanincentivetofurtherengageintaxaggressivenessbyutilisinganytaxstructurethatcantakeadvantageofthetaxdeductibilityofinterestpaid.109ItisobservedherethatalthoughHasanetalhaverigorouslydocumentedtheimpactsoftaxavoidanceoncorporations’costofbankloans,thequestionsabouttheoppositedirectionofthisassociation (ie whether debt structure impacts on the tax‐sheltering decision)remainunsolved.110

104 LanisandRichardson,aboven33.105 Grantley Taylor and Grant Richardson, ‘The Determinants of Thinly Capitalised Tax

Avoidance Structures: Evidence from Australian Firms’ (2013) 22(1) Journal ofInternationalAccounting,AuditingandTaxation12.

106 GrahamandMills,aboven46.107 Ibid.108 Hasanetal,aboven18.109 StickneyandMcGee,aboven8;LanisandRichardson,aboven33;TaylorandRichardson,

aboven36.110 Hasanetal,aboven18.


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B Non‐DebtTaxShields:DebtSubstitutionandTaxExhaustionEffects

Apart from research articles that report a positive relation between taxaggressiveness and debt holdings, a number of studies show the opposite: taxavoidance is found to be negatively associated with leverage – hence the taxaggressiveness–leveragepuzzle.Whilethedebttaxshieldandinterestdeductibilityargument supports the positive relationship of the two variables, anotherproposition–‘non‐debttaxshields’–isputforwardasrationaletobackthefindingsofanegativeassociation.

Revisiting the research studybyDeAngeloandMasulis in1980,wecan see thatthose authors, 35 years ago, proposed that investment‐related tax shields andprobabilityoflosingdeductibilityofdebttaxshieldsarepositivelyrelated,resultingin firmswith high investment‐related tax shields using less debt in their capitalstructure.111 According to DeAngelo andMasulis, a ‘non‐debt tax shield’ (NDTS)servesasasubstitutefortaxdeductionsfromdebtinterest,andeveryfirmhasanoptimalamountoftotaltaxdeductions.112Instudyingthe‘debtsubstitutioneffect’suggested by DeAngelo and Masulis, research by MacKie‐Mason a decade latershowedthatthissubstitutioneffectismoreapplicabletocompaniesthataremorelikely to lose the taxbenefits from interestdeductions.113Theeffectdiscussed inMacKie‐Mason(1990)isreferredtoasthe‘taxexhaustioneffect’.114

StrongsupportforbothofthedebtsubstitutioneffectandthetaxexhaustioneffectcanbefoundinDhaliwal,TrezevantandWang(1992).115Inafurthernote,Dhaliwaletalalsodemonstratethatthetaxshieldsubstitutioneffectcouldbedominatedbythe ‘debt securability effect’,which suggests that a firm’sdebt level is positivelyrelated to its fixedassets,whichcanbeusedascollaterals forborrowings(Scott1977).116Inaseparatestudy,Trezevantexaminesthedebtsubstitutioneffectinasettingwhereasignificanttaxlawchange, introducedbytheEconomicRecoveryTaxAct(ERTA)intheUSin1981,providessupportforthedebtsubstitutionandtaxexhaustioneffectsaftercontrollingforthedebtsecurabilityimpacts.117

As for the studies by Dhaliwal et al and Trezevant, the reason for the reportednegative relationship between tax avoidance and leverage (such as Graham andTucker2006;Lim2011;Linetal2014)couldbethatcompaniesengagingintax‐shelteringactivitiesutilisetheavailableNDTS,whichactassubstitutesforthedebt

111 DeAngeloandMasulis,aboven1.112 Ibid.113 DeAngelo and Masulis, above n 1; Jeffrey K MacKie‐Mason, ‘Do Taxes Affect Corporate

FinancingDecisions?’(1990)45(5)JournalofFinance1471.114 MacKie‐Mason,aboven113.115 DeAngelo and Masulis, above n 1; MacKie‐Mason, above n 113; Dan Dhaliwal, Robert

Trezevant and Shiing‐Wu Wang, ‘Taxes, Investment‐related Tax Shields and CapitalStructure’(1992)14(1)JournaloftheAmericanTaxationAssociation1.

116 Dhaliwal,TrezevantandWang,aboven115;JamesHScott,‘Bankruptcy,SecuredDebt,andOptimalCapitalStructure’(1977)32(1)JournalofFinance1.

117 RobertTrezevant,‘DebtFinancingandTaxStatus:TestsofSubstitutionEffectandTheTaxExhaustion Hypothesis Using Firms’ Responses to The Economic Recovery Act of 1981’(1992)47(4)JournalofFinance1557.


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interesttaxshields.118ThedebtsubstitutioneffectpredictsthosecorporationswillreducetheirleverageremarkablyoncethesufficiencyoftheNDTScansatisfytheirdemandfortaxsavingsfromaggressiveactivities.

Schallheim andWells, in a study focusing onNDTS, propose three reasonswhycompaniesmaypreferNDTStodebt.119First,interestpaymentsrequiredfordebtservicingmakeitmorecostlytoengageindebt‐relatedaggressivetaxplanningthantodeveloptaxstrategiesusingotherformsofNDTS.120Forthatreason,SchallheimandWellsarguethatthereturnperdollarofinvestmentintaxshieldssourcedfromdebtismuchsmallerthanthereturnfromNDTS.121Second,debtoftencomeswithcovenantsthatcanimposehightransactioncosts,makingcompaniesleantowardsusesofNDTSratherthandebttaxshields.122Third,NDTSofteninvolveexploitationof accounting rules which allow firms to lower taxes without changing theaccountingprofitfigures.123

ApartfromthosethreereasonsdetailedinSchallheimandWells’paper,thereareothercostsassociatedwithutilisingdebtstructureasatax‐aggressivestrategy,andthosecostsarerealandsignificant.Insolvencyriskismostlikelytoincreaseasdebtlevel goes up. Additionally, highly leveraged structure is often not viewedfavourablybydebtholders,whomayconsequentlydemandhigheryieldsontheirlendingtocompensatefortheadditionalrisks.Graham’sstudyin1996showsthatacompanywilluselessdebtfinancingifithassufficientamountofNDTS,comparedwith an identical firmwithout NDTS.124 Once again, the tax exhaustion effect issupportedbyGraham,whocontendsthatfirmsexperiencingtaxexhaustiontendtoavoid issuingdebtbecausethe interestdeductionsfromdebt is ‘crowdedout’byNDTS.125

However,itispossiblethatdifferentformsofNDTSmayhavedifferentimpactsonleverage. Nejadmalayeri and Singh report that firms with higher depreciationexpenses –which are a formofNDTS– are likely tohavehigher cost of issuingbonds, because such depreciation expenses limit tax benefits from loss carry‐forwardsandconsequentlyincreasecostofdebt.126ThisfindingbyNejadmalayeriandSinghsuggests losscarry‐forwardsanddepreciationexpenseshaveoppositeeffectsoncostofdebt:theformerisnegativelyassociatedwithcreditspreads(ieconsistentwith the debt substitution effect inDeAngelo andMasulis),while thelatterispositivelyassociatedwithcostofborrowings.127

118 Dhaliwal,TrezevantandWang,aboven116;Trezevant,aboven117;GrahamandTucker,aboven5;Lim,aboven53;Lin,TongandTucker,aboven63.

119 James Schallheim and Kyle SWells, ‘Debt and Taxes: A NewMeasure for Non‐Debt TaxShields’(WorkingPaper,UniversityofUtah,February2006).

120 Ibid.121 Ibid.122 Ibid.123 Ibid.124 Graham,aboven38.125 Ibid.126 NejadmalayeriandSingh,aboven93.127 NejadmalayeriandSingh,aboven93;DeAngeloandMasulis,aboven1.


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Thefindingofapositiverelationbetweendepreciationexpensesandcostofdebtisdifficult to interpretandappears tobe incontrastwith thesubstitutioneffectofNDTS,whichmayalsoexistintheformofdepreciationexpenses,inaccordancewithDeAngeloandMasulis(1980)andDhaliwaletal(1992).128Inexplainingtheresultsoftheirresearch,NejadmalayeriandSingharguethatthepropertiesofdepreciationexpensesandtax losscarry‐forwardsaredifferent,andthatany ‘taxshields thatreducetheefficacyoflosscarryprovisionsshouldincreasethecostofdebt’.129

Moreover,themagnitudeofthedebtsubstitutioneffectmayvarydependingonthetypesoftaxshelteringstrategiesbeingemployedbythefirms,accordingtoLinetal2014.130Inparticular,Linetalshowthatdebtuseismoreweaklyassociatedwithbenign tax‐aggressiveschemes; theyargue that taxavoidancestrategiesmustbesufficientlypowerfulandbeneficialto justifyafirm’scostsofadjustmentoftheircapital structure for tax planning purposes.131 These researchers argue that thesubstitutioneffect is evident in companies that aremoreheavily involved in taxsheltering,butthatthiseffectisreducedinmorebenignformsoftaxaggressivenessandduringfinancialcrisistime.132

Therefore, although previous research that documents a negative relationshipbetweentaxaggressivenessand leverageoftenattributesthisresult to theNDTSanddebtsubstitutioneffect(GrahamandTucker2006;Lim2011;Richardsonetal2014), therearestillquestionssurrounding thisproposition.133First,wearestillunsureaboutwhetherthesubstitutioneffectvariesfordifferentformsofNDTS.134Second,moreresearchisrequiredtoascertainwhetherdifferenttypesanddegreesoftaxavoidancestrategiesresultindifferentmagnitudesofdebtsubstitutioneffect,asproposedbyLinetal.135

C Debtholders’ConcernsAboutManagerialRentExtraction

Shevlin et al, in their study of corporate bonds issued by US firms, report thatcorporatetaxavoidanceispositivelyassociatedwithbondyields.136Theseauthorsoffer an explanation related to the possibility of wealth expropriation bymanagers.137 They theorise that debtholders have concerns about potential rentextractionactivitiesbymanagers,sincethoseactivitiescanbeperformedthroughobfuscated reporting for purposes of concealing tax sheltering from the taxauthorities,assuggestedbyDesaiandDharmapala.138Inrespectoftheseconcerns,theysuggestthatdebtholdersviewlargeblockholdersnegativelybecausetheynotonlyhaveincentivetoexpropriateresourcesandtax‐aggressiveactivitiesbutare

128 DeAngeloandMasulis,aboven1;Dhaliwal,TrezevantandWang,aboven116.129 NejadmalayeriandSingh,aboven93.130 Lin,TongandTucker,aboven63.131 Ibid.132 Ibid.133 GrahamandTucker,aboven5;Lim,aboven53;Richardson,LanisandLeung,aboven89.134 NejadmalayeriandSingh,aboven93.135 Lin,TongandTucker,aboven63.136 Shevlin,UrcanandVasvari,aboven23.137 Ibid.138 Shevlin,UrcanandVasvari,aboven23;DesaiandDharmapala,aboven7.


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also capable ofmaking it happen.139 Thedebtholders’ concerns aboutmanagers’rentextraction lead todemandbydebtholders forhigherreturn fromlending tocorporationsthatengageintaxavoidance.

The ‘debtholders’concerns’argumentisdevelopedfromDesaiandDharmapala’scontentionthatmanagersmayemployopaquefinancialreportingtofacilitatethetax‐aggressiveactivitiesofthefirm.140Inaddition,Desai,DyckandZingalessuggestthatthedesignofthecorporatetaxsystemhascertainimpactsontheprivaterentdiversion carried out by the company’s managers, and that reduction of suchdiversionactivityisthecommongoaloftaxauthoritiesandshareholders.141

However,managerial rentdiversion is alsoargued tobea significant concern todebtholders,especiallytoholdersofpublicdebtswhoonlyhaveaccesstopubliclyavailableinformation–asopposedtobanksorcreditratingagencieswhocanobtainprivilegedinformation.142Thisconcernappearstobewell‐founded,becauseithasbeen documented by Frank, Lynch and Rego that aggressive tax reporting isaccompanied by aggressiveness in financial (book) reporting.143 Debtholders’concern about managers’ rent extraction becomes more pronounced in firmsheavilyinvolvedintaxshelteringschemes.

Therefore,besides thepropositionof interestdeductibility fromdebt tax shieldsdiscussed in Part III(A), managerial rent‐diverting activities provide anotherrationaletosupportthepositiverelationshipbetweentaxaggressivenessandcostofdebt.However,thisargumenthasnottakenintoaccountthebenefitsfromtaxavoidanceactivitieswhichcanbeviewedfavourablybydebtholders.Itispossiblethatlendersevaluatetax‐aggressiveschemesasprojectsthateffectivelyreducetaxliabilities and consequently increase cash flows and net profit position. Thatfavourable view by debtholders may counter their concerns about potentialresourceexpropriationbymanagers.Forthatreason,itispossiblethattheresultofincreasedcostofdebtfortaxavoidersdocumentedinShevlinetalreflectsthatthedebtholders’ concerns about managerial rent extraction is stronger than theirfavourable view of cash savings from tax aggressiveness, rather than merelyreflecting the additional risk from managers’ rent diversion which induce anincreaseincostofborrowings.144

D UncertaintyAboutFutureCashFlows

Besides the ‘debtholders’ concerns’ argument, Shevlin et al also attribute theirfinding of a positive relation between tax sheltering and cost of public debt touncertainty about the firm’s future cash flows.145 The authors argue that taxavoidance leads to lower cash flow levels and higher cash flow volatility in the

139 Shevlin,UrcanandVasvari,aboven23.140 DesaiandDharmapala,aboven7.141 MihirDesai,AlexanderDyckandLuigiZingales,‘TheftandTaxes’(2007)84(3)Journalof

FinancialEconomics591.142 Shevlin,UrcanandVasvari,aboven23.143 MaryMFrank,Luann JLynchandSonjaeORego, ‘TaxReportingAggressivenessand Its

RelationtoAggressiveFinancialReporting’(2009)84(2)AccountingReview467.144 Shevlin,UrcanandVasvari,aboven23.145 Ibid.


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future, which make bond investors view corporate tax sheltering negatively.146Theirresearchfindsempiricalevidencetosupportthisargumentafterexaminingthreemechanismsthroughwhichtaxaggressivenessincreasesbondyields:futurecashflowlevels,futurecashflowvolatility,andinformationquality.147

ThefindingsbyShevlinetalhighlightthefactthatdecreasedcashflowlevelsinthefutureaccountforone‐thirdofthetotaleffectthattaxaggressivenesshasonpublicdebt cost, but at the same time report that informationquality has a very smallimpact on the tax aggressiveness–leverage relationship.148 That is particularlyinterestingbecauseBalakrishnan,BlouinandGuayfindtaxavoidancesignificantlyreducescorporatetransparency.149 IfBalakrishnanetalareright,thentheminorrole played by information quality, coupledwith the opaque financial reportingfound in tax‐aggressive corporations (Desai and Dharmapala),might reasonablyleadustoexpectinformationqualitytoplayacrucialroleindebtholders’negativeviewabouttaxavoidancestrategies.150However,informationqualityisnotfoundtohaveacompellingeffectintheresearchbyShevlinetal.151

Similartoconcernsaboutmanagers’rentextraction,uncertaintyaboutthefuturecash flows of tax‐aggressive companiesmay be argued to result in debtholders’demandsforhigherbondyieldsinordertocompensatefortheadditionalriskfromlower expected cash flows and for the greater volatility in the firm’s liquiditypositioninthefuture.However,thisargumentseemstobeinstarkcontrastwiththecommonnotionthatdebtholdersviewtaxaggressivenessfavourablyduetothecashsavings in taxpaymentsrequired,whichcanbeeconomicallysignificant forprofitablefirms.

Forcompaniesinneedofcashforresearchanddevelopmentandotherinvestmentactivities,theirtaxaggressivenessmayalsobeviewedpositivelybylenders,sincethese firmsareusing taxsavings to invest in futuregrowth.Hence,although theuncertainty of future cash flows proposed by Shevlin et al is one possibleexplanationofthepositiverelationbetweentaxavoidanceandcostofdebt,thewaylendersevaluatecorporatetaxaggressivenessremainsunclear.152Andtheanswersmightdifferfromonetypeoflenders(egbanks)toanother(egpublicbondholders).

In summary, this article discusses fourmain propositions advanced by previousresearcherstoexplaintherelationshipbetweentaxaggressivenessanddebtlevels(orcostofdebt).Ontheonehand,thepropositionconcerninginterestdeductibilityfrom debt tax shields supports the finding of tax avoidance being positivelyassociatedwith leverage.On theotherhand, theNDTS theory, togetherwith the

146 Ibid.147 Ibid.148 Ibid.149 Karthik Balakishnan, Jennifer L Blouin and Wayner R Guay, ‘Does Tax Aggressiveness

ReduceCorporateTransparency?’(WorkingPaper,UniversityofPennsylvania,September2014).

150 Balakishnan,BlouinandGuay,aboven149;DesaiandDharmapala,aboven7.151 Shevlin,UrcanandVasvari,aboven23.152 Ibid.


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debt substitution and tax exhaustion effects, provides support for the negativerelationshipbetweentaxaggressivenessanddebtholdings.

Inaddition,thelasttwopropositions–thedebtholders’concernsaboutmanagerialrent extraction and the uncertainty about firm’s future cash flows – explain thepositive association between corporate tax avoidance and cost of debt.Nevertheless, interpretation of the results of prior research using those fourpropositions(andanyothers)shouldtakeaccountofanumberoffactorsthatcouldimpactontheempiricaltestsconducted.ThesefactorsarediscussedinPartIV.

IV ISSUESINEMPIRICALTESTS

Conflictingfindingsandanalysessuchasthosealreadydiscussednaturallyinvitesquestionsaboutthewaytheempiricaltestswereconducted.Differencesinthewayempiricalanalysisisperformedcangiverisetovariationintheresults,asinthecaseofthetaxaggressiveness–leveragepuzzle.ThisPartdiscussesfourmainissuesinempirical studies of tax avoidance and leverage: the causal or bi‐directionalrelationshipbetweenthetwovariables,theproxiesusedfortaxaggressiveness,theleveragemeasuresemployed,andtheendogeneitynatureofthisrelationship.

A CausalorBi‐DirectionalRelationshipBetweenTaxAggressivenessandLeverage

In empirical tests of the relation between tax avoidance and debt,most studieswhichdirectlyexaminethisrelationshipmodelleverageasthedependentvariableandcorporatetaxstatusastheindependentvariable(Graham1996;GrahamandTucker 2006; Lim 2011; Bartholdy et al 2011; Lin et al 2014).153 However, it isobserved that a number of other studies may use tax aggressiveness as thedependentvariable,andincludeleverageasaregressorintheirmodels(GuptaandNewberry1997;RichardsonandLanis2007;Seidman2010;LanisandRichardson2012).154Itisworthnotingthatthewaytheregressionmodelisconstructeddoesnotnecessarilymeanthatresearchusingsuchmodelassumesacausalrelationshipinwhichthedependentvariableisaresultofvariationintheregressorofinterest.

Manyofthepriortaxaggressivenessstudiesseemtoviewtherelationshipbetweencorporatetaxavoidanceandleverageasacausalrelationshipinwhichcompanies’debt policy changes under the impacts of tax‐aggressive activities. For instance,Richardson,LanisandLeungarguethatcorporatetaxaggressivenessandcorporategovernancemechanismaffectdebtfinancing.155Inthesamevein,Feld,HeckemeyerandOveresch,intheirmega‐analysis,contendthatanincreaseinmarginaltaxrate,whichimpliesalowerleveloftaxaggressiveness,causesanincreaseindebtratio.156

However,someotherresearchersadvocatetheideathattherelationshipbetweentaxavoidanceanddebtholdingsshouldbebi‐directional.GrahamandTuckertake

153 Graham,aboven38;GrahamandTucker,aboven5;Lim,aboven53;BartholdyandMateus,aboven8;Lin,TongandTucker,aboven63.

154 GuptaandNewberry,aboven8;RichardsonandLanis,aboven35;Seidman,aboven16;LanisandRichardson,aboven30.

155 Richardson,LanisandLeung,aboven77.156 Feld,HeckemeyerandOveresch,aboven81.


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theperspectivethatitisdifficulttoprovethedirectionofthisrelationship,asinthecaseofmostcorporatefinanceresearch,andsuggestthatthecoefficientsreportedintheirstudyshouldbeinterpretedascorrelationratherthanascausality.157

Inaddition,Hasanetalsuggestthatfirmswithhighercostofdebthaveincentivestousealternativewaystofundoperationsandengagingintaxshelteringisoneofthe alternatives,making it challenging to conclude about the causal inference inresearchfindings.158Hasanetal’sviewisconsistentwiththecontentionbyGrahamandTucker,supportingtheargumentthattheassociationbetweentax‐aggressivestrategiesandleverageshouldbeatwo‐way,ratherthancausal,relationship.159

Quite often higher leverage is interpreted as higher cost of debt; however, thisreviewdoes not find a convincing argument to infer a relationship between taxaggressiveness and debt levels from a documented association between taxaggressivenessandcostofdebt,andviceversa.Forinstance,Shevlinetal(2013)contend that they find evidence consistent with the debt substitution effect inGrahamandTucker(2006)andWilson(2009),whoproduceresultsofanegativerelation between tax sheltering and leverage.160 The authors advance theexplanationthat‘taxavoidancemakesborrowingmoreexpensivethusincentivizingthefirmstohavelowerleverage’.161However,thisviewisnotclearlysupportedbythe findings in Shevlin et al’spaper, becausewhat the researchers find is only apositive impact that tax sheltering has on bond yields, not a direct negativerelationshipbetweentaxshelteringanddebtlevels.162

Although the incentive for tax‐aggressive firms to reduce borrowings (or bondrates,inthecaseofpublicbonds)isalegitimateandhighlylikelyexplanation,thisargumentmighthavenotcapturedthecompletepictureofafirm’scapitalstructure,andtherearemanyotherimportantfactorsthatcouldalterthefirm’sdecisiontoincreaseordecreasetheirdebtlevels:163cashflows,liquidityposition,bankruptcycostsandagencycostswillenterthisleveragepuzzle.Itispossiblethatthehighcostofdebtfoundintheresearchisaresultofaheavilyleveragedstructure,regardlessof whether that structure is related to tax avoidance strategies; therefore,companiesmaynotbeabletocutdownontheircommittedborrowingsinspiteoftheirawarenessofthehighinterestratesondebts,atleastintheshortormediumterm.

Anotherpossibilityisthatthefirm’sengagementintaxavoidanceinvolvesusesofdebt interest deductibility, and hence high debt ratio (or high amount of debtholdings in general) is part of such a tax‐aggressive scheme. This makes itchallenging toconcludewhether theassociationbetween taxaggressivenessand

157 GrahamandTucker,aboven5.158 Hasanetal,aboven18.159 Hasanetal,aboven18;GrahamandTucker,aboven5.160 Shevlin,UrcanandVasvari,aboven23;GrahamandTucker,aboven5;Wilson,aboven51.161 Shevlin,UrcanandVasvari,aboven23.162 Ibid.163 Ibid.


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leverage(orcostofdebt)isacausalrelationship.Mostlikelythisrelationshipisatwo‐sidedcorrelation,assuggestedbyGrahamandTucker.164

B ProxiesforCorporateTaxStatus

Sincetaxavoidanceisasensitiveissuetocorporationsandtax‐aggressiveactivitiesarenotdirectlyobservable,priorstudiesuseanumberofdifferentmeasuresasaproxyfortaxavoidance.Thereisapossibilitythatpreviousmixedfindingsontheassociation between tax aggressiveness and leverage are due to the proxiesemployed in tax‐aggressiveness research. Some proxies may capture taxaggressiveness in its broadmeaning of ‘reduction in tax liabilities’,whereas theothersmayrepresenttaxshelteringattheextremelevelofaggressiveness.

First, in tax aggressiveness research, a number of academics use book–taxdifference(BTD)astheirproxyforcorporatetaxavoidance(Lim2011;Richardson,LanisandLeung2014;TaylorandRichardson2014;Linetal2014andsoon).165Taylor and Richardson in their 2013 paper propose that companies that aresuccessful at avoiding taxes are likely to sustain large difference between bookincome and taxable income.166Meanwhile, Frank et al, in studying corporations’aggressivenessinbothfinancialreportingandtaxreporting,suggestthatBTDmayreflectnotonlytax‐aggressiveactivitiesbutalsoearningsmanagement.167

In order to isolate the component of BTD that is attributable to earningsmanagement, Lim uses discretionary accruals from BTD in his study of taxavoidancebyKoreanfirms.168Theauthorsuggeststhatfirmsavoidtaxliabilitybyusing both permanent and temporary difference components while managingearningsusingmostlytemporarydifferencecomponent.169Aninterestingpointinthe Korean setting of Lim’s study is that the taxable income data of Koreancompanies are disclosed in the notes to their financial statements, and suchdisclosure avoids errors arising from estimating taxable income from financialreports,whichisanimportantproblemencounteredinmostUSstudies.170

Wilsonreportedin2009thatBTDispositivelyassociatedwithtaxshelteringcases,suggestingthatBTDcouldbeanappropriateproxyfortaxaggressiveness.171Ifthatis the case, thebiasproduced fromstudiesusingBTD, if any,maynotbestrongenoughtoimpacttheoverallresultsinthosepapers.Furthermore,Seidman,whoexaminestheinterpretationofBTD,adjuststheBTDforthreefactors:changesintheGAAP,macroeconomicconditions,andearningsmanagement.172SeidmanfindsthatBTDadjustedfortheGAAPchangescanprovideabetterproxyfortaxshelteringinmostcontexts,althoughtheBTDmeasure,whichisnotadjustedforanyofthe

164 GrahamandTucker,aboven5.165 Lim,aboven53;Richardson,LanisandLeung,aboven77;TaylorandRichardson,aboven

36;Lin,TongandTucker,aboven63.166 TaylorandRichardson,aboven105.167 Frank,LynchandRego,aboven143.168 Lim,aboven53.169 Ibid.170 Ibid.171 Wilson,aboven51.172 Seidman,aboven14.


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threefactors,isgenerallyareasonableproxyforearningsmanagement.173Overall,it is concluded in Seidman’s paper that BTD can be a reasonable proxy for taxavoidance,althoughcareistobetakenwhenthevariableofinterestoftheresearchislikelytobeaffectedundermacroeconomicconditions.174

Second,somestudiesexploreMTRsasameasureofcorporatetaxstatus(Graham1996;GrahamandMills2008;BartholdyandMateus2011;Barclayetal2013).175AfirmwithlowerMTRmaybeinterpretedassuccessfultaxavoidancecomparedwitha higher MTR firm. In Graham’s paper, MTR is explicitly calculated, using anexpandedversionofthemethodbyShevlin(1990),whosimulatedMTRwhilealsoaccountingforcarry‐forwardandcarry‐backtaxopportunities.176GrahamproposesthatthetruetaxratetoreflectthetaxbenefitofinterestdeductibilityshouldbeanaverageofthefutureexpectedMTRsandshouldaccountfortheeffectsofthetotalamountofinterestdeductionavailable.177

InanotherstudybyGrahamandMills,theresearchshowsthatthesimulatedMTRbasedonfinancialstatementsishighlycorrelatedwiththeMTRsimulatedfromtaxreturn information, which supports the reasonableness of using book‐simulatedMTR as a proxy of companies’ dynamic tax status.178 Besides, Graham andMillsprovideasummaryofsuggestionsofMTRmeasurestobeusedfordomesticandinternationalstudies.179However,sinceMTRmainlyreflectsfuturetaxbenefits,asdiscussed by Nejadmalayeri and Singh, MTR may not be a good proxy for tax‐aggressive strategies, which are associated with past decisions but lead to theexistingleveragestructure.180

Third, ETR is probably the most commonly used proxy for corporate taxaggressiveness(RichardsonandLanis2007;Dyrengetal2008;MinnickandNoga2010;LanisandRichardson2012;Linetal2014andsoon).181AnETRvaluethatislower than the corporate statutory tax rate is a strong indicator that the firmengagesinatleastsometax‐aggressiveplanning.Inspiteofitsfrequentuseintaxavoidancestudies,thereisnoconsensusabouthowtocomputeETR.IncalculatingtheETRmeasure,thenumeratorisofteneithertheincometaxexpenserecordedinthe financial report or the cash taxes paid, whereas the denominator is often achoicebetweenthepre‐taxbookincomeortheoperatingcashflows.

173 Ibid.174 Ibid.175 Graham, above n 38; Graham andMills, above n 46; Bartholdy andMateus, above n 8;

Barclay,HeitzmanandSmith,aboven70.176 Graham, above n 38; Terry Shevlin, ‘Estimating Corporate Marginal Tax Rates With

Asymmetric Tax Treatment of Gains and Losses’ (1990) 11(1) Journal of the AmericanTaxationAssociation51.

177 Graham,aboven38.178 GrahamandMills,aboven46.179 Ibid.180 NejadmalayeriandSingh,aboven93.181 Richardson and Lanis, above n 30; Dyreng, Hanlon and Maydew, above n 13; Kristina

Minnick and Tracy Noga, ‘Do Corporate Governance Characteristics Influence TaxManagement’(2010)16(5)JournalofCorporateFinance703;LanisandRichardson,aboven33;Lin,TongandTucker,aboven63.


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IntheresearchbyRichardsonandLanis(2007),twoETRmeasuresareemployedfortheirresearch:thefirstproxyETR1istheincometaxexpensedividedbythepre‐taxbookincome;thesecondproxyETR2istheratioofincometaxexpenseovertheoperatingcash flows.182HasanetalcomputetheircashETRmeasureas thecashtaxespaiddividedbythepre‐taxbookincomelessspecialitems.183

DyrengetalprefercashETRtobookETR,arguingthatcashETRisnotaffectedbyaccountingrules,whereascashtaxespaidacrossalljurisdictionscanreflectglobaltax‐aggressive activities in multinational firms.184 In their study, Dyreng et alcalculate the long‐runcashETRovera ten‐yearperiod (1995–2004) inorder toexaminelong‐runcorporatetaxavoidance.185Someotherstudies,however,useashorterperiod(ieaverageETRoverfiveyearsratherthantenyears,asdoMinnickandNoga)whenanalysing long‐term taxmeasures.186Nevertheless,ETR isoftenviewedasaratherstaticproxy,andanimportantdrawbackofusingETRliesinthefactthatETRcannottakeintoaccounttheinteractionbetweentaxadvantageofdebtandthefirm’sfutureprofitability.187

Fourth, recent studies in the US take advantage of the Financial AccountingStandardsBoardInterpretationNo.48(referredtoasFIN48),whichrequiresUScompaniestodisclosetheirtaxreserveforuncertaintaxpositions.188TheamountoftaxreservereportedunderFIN48disclosurerequirementisusedasaproxyfortaxavoidance activities. A larger reserve generally indicates a highly uncertain taxpositionduetoinvolvementinaggressivetaxplanning.LinetalalsouseFIN48taxreserve as one of the proxies for tax aggressiveness in their research, and findsignificantassociationbetweenthismeasureandleverage.189Theproblemwiththisproxyisthatitdependslargelyontheleveloffirms’compliancewiththeFIN48requirement.Ifcorporateaggressivenessinfinancialreportingisindeedpositivelycorrelatedtotax‐aggressivereportingasdocumentedinFranketal(2009),FIN48reservemaynotbeareliablemeasuretocapturefirmsthatareaggressiveinbothtaxandfinancialreporting.190

Fifth,someresearchersuseactualtaxsheltercasesintheformofdummyvariableintheirtaxavoidancestudies(GrahamandTucker2006;Wilson2009;Hasanetal2014).191 For instance, Graham and Tucker examine the under‐leveragephenomenonintax‐aggressivefirmsbyanalysing44actualtaxshelters,whichareused lateronbyWilson,whoadds to thissampleadditional taxavoidancecasesidentifiedbyhimself.192Inanotherstudyoftherelationbetweentaxavoidanceandbankloancost,Hasanetalperformtwoquasi‐experimentalsettings,oneofwhich

182 RichardsonandLanis,aboven30.183 Hasanetal,aboven18.184 Dyreng,HanlonandMaydew,aboven13.185 Ibid.186 MinnickandNoga,aboven181.187 Feld,HeckemeyerandOveresch,aboven81.188 See,eg,Hasanetal,aboven18.189 Lin,TongandTucker,aboven63.190 Frank,LynchandRego,aboven143.191 GrahamandTucker,aboven5;Wilson,aboven51;Hasanetal,aboven18.192 GrahamandTucker,aboven5;Wilson,aboven51.


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uses tax avoidance news announced to the public, while the other uses FIN 48disclosure.193

Likeanyothermeasureoftaxaggressiveness,utilisingactualtaxavoidancecaseshasbothadvantagesanddisadvantages.Theadvantageofthismethodisthattheshelteringschemesarealreadyidentifiedwithahighdegreeofcertainty,andthusthereisnoneedtoindirectlyinferthepropensityforsheltering,suchasusingBTDor ETR. The disadvantages include the small samples used for observations (egGrahamandTucker2006;Wilson2009)andtheinabilitytogeneralisetheresultsduetotheextremedegreeoftaxavoidancecapturedintheshelteringcasesthataredetected, prosecuted and announced to the public.194 This comes back to thedefinitionoftaxaggressiveness,whichgenerallyreferstoactivitiesthatresultintaxliabilityreduction,whereasthetaxsheltercasescaughtunderlitigationreflectthehigherendofthetax‐aggressivenessscale.

Thissectionreviewsthefiveproxiesoftaxaggressivenessfrequentlyusedintheaccountingandtax literature:BTD‐sourcedproxy,MTR,ETR,FIN48taxreserve,andactualtaxavoidancecases.Further,onthetopicofmeasuringtaxavoidance,HanlonandHeitzmanprovideacomprehensivediscussionintheirreviewofpriortaxresearchinaccounting.195

C MeasuresofCompanyDebtLevelsandCostofDebt

Notonlymeasuresofcorporatetaxstatusbutalsomeasuresofleveragearelikelyto cause variation in the previously reportedmixed findings in the relationshipbetween tax aggressiveness and debt. As mentioned above, while some studiesexplicitlytestdebtholdinglevels(ordebtratios)andthewaytheyarerelatedtotaxavoidance,theothersexaminethetaxaggressivenessandleveragepuzzlethroughcostofdebtinthetax‐aggressivefirms.Itisobservedthatpriorliteratureemploysavarietyofmethodstomeasuredebt;therefore,thepreviousresultsthatmayseemprimafacieconflictingareindeednotdirectlycomparable.

First, in respect of using debt holdings as a variable representing a firm’s debtstructure, a number of issues concern researchers in carrying out the empiricaltests.Theseincludetheformsofdebtholdingmeasureused(ieabsolutevalueorratio),lengthtomaturity(short‐termvslong‐term),anddifferencesindebtholdertypes. For example, Bartholdy andMateus use three debtmeasures: short‐termbankloans,long‐termbankloans,andtotalbankloans,beingthesumoftheshort‐termandlong‐termloans.196Linetal,amongothers,employdebtvariablesintheformofratios, including:debttoassetsratio,long‐term‐debttoassetsratio,debtover debt‐and‐equity ratio, and industry‐adjusted leverage ratio.197 In bothexamples,lengthtomaturityisanexplicitconcernwhentheresearchersexaminetheimpactofliabilitiesofbothshortandlongtermsontaxes.

193 Hasanetal,aboven18.194 GrahamandTucker,aboven5;Wilson,aboven51.195 MichelleHanlonandShaneHeitzman,‘AReviewofTaxResearch’(2010)50(2–3)Journalof

AccountingandEconomics127,139–46.196 BartholdyandMateus,aboven8.197 Lin,TongandTucker,aboven63.


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Indiscussingthepotentialeffectsofthedifferentmaturitiesontheresults,Feldetalargued:

On the one hand, a smaller tax response of long-term debt can be expected because it can hardly adjust to yearly fluctuations in the tax rate. On the other hand, long-term debt is associated with higher interest deductions relative to short-term debt, containing also trade payables that do not carry any interest deductions.198

Also,accordingtoFeldetal,long‐termdebtmightbemoretax‐responsivesincetaxdeductions from interest payments are the main tax advantage of debt overequity.199

Besides, book andmarket values of the firm are also taken into account in thecomputation of debt ratio. In the studies by Graham and Tucker (2006) andRichardsonetal (2014), leverage ismeasured inboth forms: (a)debtoverbookvalueoftotalassets,and(b)debtovermarketvalueoftotalassets.200However,inNejadmalayeri and Singh’s paper, the two measures of debt ratio used by theauthorsaretheratiooftotal liabilitiestomarketvalueofequity,andtheratiooflong‐termdebttototalbookvalueofassets.201

Further, Graham, in his 1996 study, focuses his examination on incrementalfinancingbytestingchangesindebtsratherthanusingdebtlevelsastheleveragevariable.202 Inadditiontoexaminingdebtlevelsaswellaschangesindebtlevels,previous literature in thisareaalso tests therelationshipbetweentaxavoidanceandcostofdebt.Themeasureforcostofdebtvariesfromstudytostudy,dependingonthefocusoftheauthors’analysis.WhileAyersetallookatcreditratingchanges,Hasanetal focusoncostofbankloans.203Quitedifferentfromthesetwopapers,Dhaliwaletalmeasurecostofcapitalbyaveragingthefourcostofcapitalestimatesadopted fromprevious studies (Gebhart et al (2001),Claus andThomas (2001),GodeandMohanram(2003),andEaston(2004)).204

Inaddition,Shevlinetal,intheirstudyoftheassociationbetweentaxavoidanceandpublicdebtcost,highlightthedifferencesbetweenthetypesofdebtholders.205Morespecifically, theseauthorspayattention tocorporatebond issuesandargue thatpublic lendersonlyhaveaccess topubliclyavailable information,not theprivate

198 Feld,HeckemeyerandOveresch,aboven81.199 Ibid.200 GrahamandTucker,aboven5;Richardson,LanisandLeung,aboven77.201 NejadmalayeriandSingh,aboven93.202 Graham,aboven38.203 Ayers,LaplanteandMcGuire,aboven89;Hasanetal,aboven18.204 Dhaliwal,LeeandPincus,aboven17;WilliamRGebhardt,CharlesMCLeeandBhaskaran

Swaminathan, ‘Toward an Implied Cost of Capital’ (2001) 39(1) Journal of AccountingResearch135; James Claus and Jacob Thomas, ‘Equity Premia as Low as Three Percent?EvidencefromAnalysts’EarningsForecastsforDomesticandInternationalMarkets’(2001)56(5)JournalofFinance1629;DanGodeandParthaMohanram,‘InferringtheCostofCapitalUsing theOhlson‐JuettnerModel’ (2003)8(4)ReviewofAccountingStudies 399;PeterDEaston,‘PERatios,PEGRatios,andEstimatingtheImpliedExpectedRateofReturnonEquityCapital’(2004)79(1)TheAccountingReview73.

205 Shevlin,UrcanandVasvari,aboven23.


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informationaboutthefirmsthatonlycreditanalystsorbankscangainaccessto.206Thus,whencontrastingtheresearchfocusinShevlinetalagainstthatinAyersetal,whostudythecreditratingsimposedbycreditanalysts,orthefocusinHasanetal,whoanalyseloanratesdeterminedbybanks,itisworthnotingthattheresultsinthosestudiesarenotdirectlycomparable.207

This section demonstrates that the wide variety of debt measures used in theliteraturemaypartlyaccountforthepuzzleobservedintherelationshipbetweentaxaggressivenessanddebt.Section(D)discussestheendogeneityissueinstudyingthisrelationship.

D EndogeneityofCorporateTaxStatus

Another concern of empirical research on the tax aggressiveness and leveragepuzzle is the endogeneity of corporate tax status, because it can influence thereliability of the results reported in prior research. The company tax rate isconsideredendogenousbecausewhenafirmincreasesitsdebtfinancing,taxableincomeisreducedasaresultofinterestpayments,leadingtoareductioninMTR.The more highly leveraged a firm is, the more obvious this reduction in MTRbecomes.

Graham et al (1998) document evidence showing that company tax rate isendogenous to financing decisions of the firms and that this endogeneity canpotentially result in a spurious relation between corporate tax proxies andmeasuresofdebtpolicy.208Inadiscussiononthisissue,theseresearcherscontend:‘Ifnotproperlyaddressed,thisendogeneityofthetaxratecanbiasanexperiment[…] against finding a positive relation between debt and taxes.’209 The authorsconclude that theendogeneityproblemcanhavereal, substantial impactsontheinterpretationofassociationswithtaxvariablesreportedinpreviousresearch.210Additionally,theendogeneityissuemayaffectallformsoftaxproxies,includingtaxvariablebasedonnetoperatinglossesoraveragetaxrate(Graham2003).211

This endogeneity issue is addressed in Graham et al (1998) by constructing ameasureofacompany’sMTRbasedonbefore‐financingtaxableincomeinordertotake out the interaction between interest expenses and MTR.212 Following thisapproach, Bartholdy andMateus compute theMTR variable in their research asbefore financing (ie using net income before interest deductions instead of nettaxableprofitafterinterest).213

206 Ibid.207 Shevlin,UrcanandVasvari,aboven23;Ayers,LaplanteandMcGuire,aboven89;Hasanet

al,aboven18.208 Graham,LemmonandSchallheim,aboven41.209 Ibid.210 Ibid.211 JohnRGraham,‘TaxesandCorporateFinance:AReview’(2003)16(4)ReviewofFinancial

Studies1075.212 Graham,LemmonandSchallheim,aboven41.213 BartholdyandMateus,aboven8.


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Ina reviewof researchon taxesandcorporate finance,Graham(2003)suggestslagging the estimated MTR by one period as another method to account forendogeneityissue(followingMacKie‐Mason),inadditiontousingbefore‐financingtaxableincome.214Richardsonetal,intheir2013study,controlforendogeneitybylaggingindependentvariables,asopposedtolaggingtheMTRvariableassuggestedbyGraham.215

Inanotherstudyofcorporatetaxesanddebt,GordonandLee(2001)dealwiththeendogenous nature of corporate tax rate by employing an instrumental variablewhich uses average profit rate before interest deductions to correct for anypotential bias from endogeneity.216 In order to directly address the endogeneityconcernofcorporatetaxavoidance,Hasanetaluseinstrumentalvariabletwo‐stageregressions.217

In summary, researchers can use a number of methods to account for theendogeneity concern in examining tax‐related effects. It is emphasisedhere thataddressingtheendogeneityproblemisnecessarywhenstudyingtherelationshipbetweentaxaggressivenessandleverage.Studiesofthepuzzleoftaxavoidanceanddebt relationship which do not control for endogeneity must therefore beinterpreted with caution, as the potential bias arising from endogeneity can bematerial.

V CONCLUSIONANDSUGGESTIONSFORFUTURERESEARCH

The relationship between tax aggressiveness and leverage has been a topic ofresearch to academics in tax, accounting and finance in the last four decades,especiallyafterthediscussionofdebt,taxesandequilibriumincompany’scapitalstructurebyMiller(1977).218Areviewofpriorliteratureonthistopicshowsthattherelationshipbetweentaxaggressivenessandleverageremainsapuzzleinspiteofnearlyfortyyearsofresearch.

There appear to be two lines of conflicting conclusions. The first line reportscorporate tax avoidance to be positively associated with debt holdings. Theexplanations include the interest deductibility from debt tax shields, thedebtholders’ concerns about rent extraction by managers, and the uncertaintyaboutthefirm’sfuturecashflows.Thesecondlinereportsanegativeassociationbetweentax‐aggressiveactivitiesandleverage.Anumberofresearchersattributethis finding to NDTS and the documented effects of debt substitution and taxexhaustion. Besides, some other studies showmixed or insignificant findings inrespectofthetaxaggressiveness–leveragerelationship.

The inconsistent results of research on the association between corporate taxavoidanceanddebthavepuzzledresearchersinthisarea.Sinceseveralconflictingpropositions and arguments have been offered as explanations of the signs and

214 Graham,aboven211;MacKie‐Mason,aboven113.215 Richardson,TaylorandLanis,aboven34;Graham,aboven211.216 GordonandLee,aboven3.217 Hasanetal,aboven18.218 Miller,aboven1.


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directionsoftherelationbetweentaxaggressivenessandcorporatedebtpolicy,aframework is nowneeded to systematically tease out the factors that drive thisrelationship.

Thisreviewsuggeststhat fourmain issues,andsomeminorothers, in largepartaccountforthecontraryfindingsinempiricaltests:(1)thecausalorbi‐directionalrelationship between tax avoidance and debt; (2) the proxies used for firm’sengagementintax‐aggressiveactivities;(3)themeasuresofdebtlevelsandcostofdebt;and(4)theendogeneityofcorporatetaxstatus.

Anumberof issuescontributingtothepuzzleoftaxaggressivenessandleveragerequire further examination in future research. First, since many competingtheories and arguments support negative and positive relations between taxavoidanceanddebt,itiscrucialtodeterminewhichpropositionisthemostrelevant,orhasthemostdominatingeffect.

Second,althoughseveralpreviousstudieshaveanalysed indepththe taxshieldsarising from debt interest and the NDTS under the debt substitution and taxexhaustioneffects,wearestillunsureaboutwhetherthesubstitutioneffectvariesfordifferentformsofNDTS(NejadmalayeriandSingh2012).219Thereisapossibilitythat different types and degrees of tax avoidance strategies result in differentmagnitudeofdebtsubstitutioneffect,assuggestedinthestudybyLinetal.220Futureresearch can examine the way each type of tax‐aggressive scheme (eg debtrestructuring, transfer pricing, use of tax havens, etc.) may relate to the debtsubstitutioneffect,andsubsequentlytothefirm’sdecisiononitsdebtstructure.

Third,futureresearchmayalsoattempttodocumenttheassociationbetweentaxavoidanceanddebtforeachleveloftaxaggressiveness.Forinstance,afirmwhichhasanaveragetaxrate5percentbelowthecompanystatutorytaxratecanhavedifferent properties in respect of debt structure comparedwith its counterpart,whichhassuccessfullyachievedanaveragetaxrate15percentor20percentbelowthestatutoryrate.

Fourth, it is important to recognise that while debtholders’ concerns aboutmanagerialrentextractionanduncertainfuturecashflowsarerealinfirmsthatareaggressive in both tax reporting and financial reporting, debtholdersmay at thesametimeviewtaxshelteringfavourably,duetothetaxsavingsyieldedfromtaxsheltering.Thereispotentialtoemployotherresearchmethods,perhapsinterviewsor surveys, to obtain insights about how debtholders view tax avoidance bycorporations.Interviewsmightbeconductedwitheitherthebankmanagerswhomakedecisionsaboutcompanies’bankloans,orwithseniorcreditanalysts.Surveyscanpotentiallyhelpresearchersunderstandhowthegeneralpublicperceivesthetax‐aggressiveactivitiesbycompanies,andwhatlevelofrisks(returns)isaccepted(demanded). When traditional archival research consistently reports mixedfindings, research using qualitative methods or mixed methods can provideopportunitiestoexploretheinconsistencyinpreviousfindingsandtotriangulatethenewresults.

219 NejadmalayeriandSingh,aboven93.220 Lin,TongandTucker,aboven63.


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Fifth,agencycostintaxisanotheraspectthatmayimpacttheassociationbetweentaxavoidanceand leverage,andCEOs,whenmakingdecisionsabout levelof taxaggressivenessaswellasthedebtstructureof firms,willtakeintoconsiderationnot only the real andperceivedbenefits to shareholders but also their personalinterests. Thus, future research canmake further inquiries intohowCEOsmakedecisions about tax aggressiveness and leverage structure by using interviews,surveys or a combination of both. As an example, Lavermicocca andMcKerchar(2013)previouslyconductedinterviewswithtaxmanagersanddirectorsinlargeAustralian companies, followed by surveys, in their study of tax compliancebehaviour of large corporations.221 Mixedmethodology canmeaningfully informresearchersintheseareas.

Finally,heavyuseofdebtisoftenassociatedwithacompany’sriskofinsolvency,which becomes higher when the economy experiences a financial crisis.Nejadmalayeri and Singh, in their US study of company taxes and cost of debt,observethatduringtheglobalfinancialcrisis(GFC)largelosseshadgreaterimpactonreductionincreditspread(ielowercostofdebt)throughtaxsubsidies.222Futurestudiescanpotentiallyprovidefurther insights intotherelationshipbetweentaxavoidance and leverage by examining this relationship not only during stablemacroeconomicenvironmentsbutalsoduringaneconomicdownturn,withtheGFCbeingagoodsettingforthisexperiment.

221 CatrionaLavermicoccaandMargaretMcKerchar,‘TheImpactofManagingTaxRiskontheTax Compliance Behaviour of Large Australian Companies’ (2013) 28(4)AustralianTaxForum707.

222 NejadmalayeriandSingh,aboven93.


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