In its 1955 Report, the Royal Commission on the Taxation of Profits and Income wrote that “Avoidance of tax is a problem that faces every tax system…but until some certainty is reached upon the question of definition, the question as to what sort of steps should be taken to prevent or correct it remains an aimless one”. So a two-stage approach should be adopted when discussing tax avoidance: define the problem and then propose solutions.

A 2012 Oxford University Centre for Business Taxation paper on tax avoidance similarly advocates the two-stage approach. In doing so, the paper makes a very important distinction between effective and ineffective domestic avoidance – effective being where the law is used successfully (in the sense of succeeding in a court or tribunal) to reduce tax liability in a way unintended by the legislature. Ineffective being where the avoidance is successfully challenged by HMRC. And that is important because it raises the issue of avoidance which would be ineffective but goes unchallenged (something which David Quentin highlights also in his paper on risk-mining the exchequer).

Meanwhile I view domestic avoidance[1] – the use of legislation in a way unintended by the Legislature (using HMRC’s definition) – as being an inevitable result of the limitations of language. HLA Hart explained this through the “core and penumbra” idea. Laws, like language, have a core meaning which is readily understandable. But there will also be a penumbra where the result of the application of the particular law in different situations is unclear. Where a rule states “no vehicles in the park” – it is obvious that this prohibits cars, but it is less clear if it prohibits bicycles, skateboards, electronic wheelchairs and so on.

The problem in tax is that there is an incentive to exploit the penumbra. Moreover, the core/penumbra idea highlights the fact that at the moment the relevant action is undertaken it may be unclear whether avoidance will be effective or ineffective. To put this in the context of domestic tax avoidance take the example of a speedometer which is very accurate up to 60mph, but after that point becomes gradually less and less reliable. Now imagine that you are driving in a car with this speedometer in an area where the speed limit is 80mph (‘the rule’). You have an incentive to try to go as close to the speed limit as possible, as this will get you to your location quicker. But the closer you try to get to the speed limit, the greater the risk that you will breach the rule. It becomes less clear whether you have in fact complied with the rule. Sometimes you will go over the limit but nobody will catch you – you have avoided the intended effect of the rule in a manner which would be ineffective if you had been caught. Other times you will be stopped by the police who will have their own calculation of your speed. Sometimes the police will be correct in their assessment of your speed, as adjudicated by an impartial third party. Sometimes the police will not be correct in their assessment of your speed, in which case you will be found determinatively to have complied with the rule.

When the problem is defined in this way, what does that tell us about the potential solutions? First, it highlights the fact that counteractive legislation such as TAARs and GAARs, in addition to the use of purposive interpretation can only go so far. They too are confronted with the limits of language. Secondly, it demonstrates that retrospective legislation does not necessarily undermine the rule of law. It seeks to catch and charge to tax those people who have tried to exploit the penumbra of legislation (a situation in which they have knowingly placed themselves) which they cannot be certain will succeed. Finally, it illuminates the wisdom at least from HM Treasury and HMRC’s perspective of legislative and administrative initiatives (such as The Code of Practice on Taxation for Banks and the Diverted Profits Tax) which seek to nudge persons away from placing themselves in the penumbra. Though these too are beset by the limits as language, as Prof Judith Freedman pointed out to me on Twitter, it might be said that the limits work in HMRC’s favour.

[1] (as opposed to avoidance using loopholes in the international tax system (p. 6))