Studies in the History of Tax Law Volume 8 9781509908370, 9781509908400, 9781509908394

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STUDIES IN THE HISTORY OF TAX LAW These are the papers from the 8th Cambridge Tax Law History Conference held in July 2016. In the usual manner, these papers have been selected from an oversupply of proposals for their interest and relevance, and scrutinised and edited to the highest standard for inclusion in this prestigious series. The papers fall within five basic themes: Two papers focus on tax theory; one on John Locke and another on the impact of English tax literature in the Netherlands in the nineteenth century. Five deal with the history of UK specific interpretational issues in varying contexts—an ancient exemption, insurance companies, special contribution, the profits tax GAAR and capital gains tax. Two more papers consider aspects of HMRC operations. Another three focus on facets of international taxation, including treaties between the UK and European countries, treaties between the UK and developing countries and the UN model tax treaties of 1928. The book also incorporates a range of interesting topics from other countries, including the introduction of income tax in Ireland and in Chile, post-war income taxation in Australia, early interpretation of ‘income’ in New Zealand and a discussion of some early indirect taxes in India and China.

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Studies in the History of Tax Law Volume 8

Edited by

PETER HARRIS & DOMINIC DE COGAN

OXFORD AND PORTLAND, OREGON 2017

Hart Publishing An imprint of Bloomsbury Publishing Plc Hart Publishing Ltd Kemp House Chawley Park Cumnor Hill Oxford OX2 9PH UK

Bloomsbury Publishing Plc 50 Bedford Square London WC1B 3DP UK

www.hartpub.co.uk www.bloomsbury.com Published in North America (US and Canada) by Hart Publishing c/o International Specialized Book Services 920 NE 58th Avenue, Suite 300 Portland, OR 97213-3786 USA www.isbs.com HART PUBLISHING, the Hart/Stag logo, BLOOMSBURY and the Diana logo are trademarks of Bloomsbury Publishing Plc First published 2017 © The Editors and Contributors severally 2017 The Editors and Contributors have asserted their right under the Copyright, Designs and Patents Act 1988 to be identified as Authors of this work. All rights reserved. No part of this publication may be reproduced or transmitted in any form or by any means, electronic or mechanical, including photocopying, recording, or any information storage or retrieval system, without prior permission in writing from the publishers. While every care has been taken to ensure the accuracy of this work, no responsibility for loss or damage occasioned to any person acting or refraining from action as a result of any statement in it can be accepted by the authors, editors or publishers. All UK Government legislation and other public sector information used in the work is Crown Copyright ©. All House of Lords and House of Commons information used in the work is Parliamentary Copyright ©. This information is reused under the terms of the Open Government Licence v3.0 (http://www. nationalarchives.gov.uk/doc/open-government-licence/version/3) except where otherwise stated. All Eur-lex material used in the work is © European Union, http://eur-lex.europa.eu/, 1998–2017. British Library Cataloguing-in-Publication Data A catalogue record for this book is available from the British Library. ISBN: HB: 978-1-50990-837-0 ePDF: 978-1-50990-839-4 ePub: 978-1-50990-838-7 Library of Congress Cataloging-in-Publication Data A catalogue record for this book is available from the Library of Congress. Typeset by Compuscript Ltd, Shannon To find out more about our authors and books visit www.hartpublishing.co.uk. Here you will find extracts, author information, details of forthcoming events and the option to sign up for our newsletters.

Preface These papers were given on 11 and 12 July 2016 at the eighth Tax Law ­History Conference organised by the Centre for Tax Law, which is part of the Law Faculty of the University of Cambridge. We are happy that the tradition of making the papers available in this form continues, maintaining the high standards our publishers set themselves. We thank those who gave papers and also those who participated in other ways. This was another successful conference, fully subscribed and by all accounts enjoyable. The conference continues as an important part of academic tax law life in both the United Kingdom and the many other jurisdictions again represented. The ongoing success has been such that there are plans for a Tax Law History IX, scheduled for July 2018. Of course, there would be no success if it were not for the efforts of the founder of this conference, the late Professor John Tiley. This conference was a continuation of the late Professor John Tiley’s legacy and a tribute to him. Without his efforts there would be no conference. The contributions are again to a high academic standard and it was particularly pleasing to welcome some new contributors who can hold their heads up with those of the faithful. Again we owe sincere thanks to Sally Lanham at the Faculty of Law, who, through her efficiency and detailed knowledge of how to run these ­conferences is primarily responsible for the smooth running of the eighth rendition. Thanks also to Lucy Cavendish College who worked with Sally to make sure that things ran ‘as usual’ and to Jillinda Tiley, our continuing inside connection at Lucy for these conferences. Cambridge February 2017

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Contents Preface������������������������������������������������������������������������������������������������������ v List of Contributors��������������������������������������������������������������������������������� ix

1. John Locke: Property, Tax and the Private Sphere���������������������������� 1 John Snape and Jane Frecknall-Hughes 2. The Birth of Tax as a Legal Discipline�������������������������������������������� 37 Hans Gribnau and Henk Vording 3. The Curious Case of Mr Trull�������������������������������������������������������� 67 Sir John Baker 4. The Architecture of Tax Administration: Function or Form?���������� 85 Chantal Stebbings 5. Let Them Pay For Their Starvation: The Imposition of Income Tax on Ireland in 1853������������������������������������������������ 109 Peter Clarke 6. Not Like Grocers�������������������������������������������������������������������������� 131 Richard Thomas 7. The Life and Times of ESCs: A Defence?�������������������������������������� 169 Stephen Daly 8. The Special Contribution of 1948������������������������������������������������ 195 John HN Pearce 9. The Profits Tax GAAR: An Aid in the ‘Hopeless’ Defence Against the Dark Arts������������������������������������������������������������������� 221 Peter Harris 10. Statutory Interpretation in Early Capital Gains Tax Cases������������ 257 Philip Ridd 11. The UK’s Early Tax Treaties with European Countries����������������� 295 John F Avery Jones 12. The ‘Great Powers’ and the Development of the 1928 Model Tax Treaties���������������������������������������������������������������������������������� 341 Sunita Jogarajan

viii  Contents 13. The UK’s Tax Treaties with Developing Countries during the 1970s�������������������������������������������������������������������������������������� 363 Martin Hearson 14. From Wartime Expedient to Enduring Element of Fiscal Federalism: Centralised Income Taxation in Australia since World War II�������������������������������������������������������������������������������� 383 Richard Krever and Peter Mellor 15. The Historical Meaning of ‘Income’ in New Zealand Taxation Statutes, Cases and Administration, 1891–1925��������������������������� 419 Shelley Griffiths 16. When Minerals are not Enough: The Origins of Income Taxation in Chile and their Importance to the Current Situation����������������� 443 Maximiliano Boada 17. Cesses in the Indian Tax Regime: A Historical Analysis���������������� 483 Ashrita Kotha 18. The State Salt Monopoly in China: Ancient Origins and Modern Implications������������������������������������������������������������� 513 Yan Xu

List of Contributors John F Avery Jones CBE, Retired Judge of the Upper Tribunal Tax and Chancery Chamber, former Visiting Professor, London School of Economics Sir John Baker, Downing Professor Emeritus of the Laws of England, ­University of Cambridge Maximiliano Boada, Graduate Student, Zeppelin University Peter Clarke, Emeritus Professor, University College, Dublin Stephen Daly, Researcher, King’s College London Jane Frecknall-Hughes, Professor of Accounting and Taxation, Business School, Nottingham University (formerly Business School, Hull University) Hans Gribnau, Professor of Tax Law, Tilburg University and Leiden University Shelley Griffiths, Professor, Faculty of Law, University of Otago Peter Harris, Professor of Tax Law, University of Cambridge Martin Hearson, Fellow in International Political Economy, Department of International Relations, LSE Sunita Jogarajan, Associate Professor, Law School, University of Melbourne Ashrita Kotha, Assistant Professor, Jindal Global Law School, OP Jindal Global University Richard Krever, Professor, Law School, University of Western Australia Peter Mellor, Research Fellow, Department of Business Law and Taxation, Monash University John HN Pearce, ex HMRC, Associate of the Institute of Taxation, Researcher, University of Exeter Philip Ridd, Law Reporter, formerly Solicitor of Inland Revenue John Snape, Associate Professor, Law School, University of Warwick

x  List of Contributors Chantal Stebbings, Professor of Law and Legal History, Law School, ­University of Exeter Richard Thomas, Judge of the First Tier Tribunal (Tax Chamber), formerly Inspector of Taxes Henk Vording, Professor of Tax Law, Leiden University Yan Xu, Assistant Professor, Faculty of Law, Chinese University of Hong Kong

1 John Locke: Property, Tax and the Private Sphere JOHN SNAPE AND JANE FRECKNALL-HUGHES

ABSTRACT

The events in England, Scotland and Ireland in 1688/1689 have had a foundational and global significance in the theory and practice of ­government. Without taxes there is, of course, no government and no state to be g­ overned. Few thinkers have ever been so closely associated with particular political upheavals as was one John Locke (1632–1704) with the events of 1688/1689 and with the so-called ‘Glorious R ­ evolution’. Locke, sometime Oxford philosopher and the trusted confidant of the Earl of S­ haftesbury, articulated—in a single passage of text in his S­ econd ­Treatise of ­Government (1690)—four of the philosophical tropes most closely associated with these events and with the practice of liberal ­government ever since and in all places: the legitimacy of property rights, the ­contractarian nature of government, just and unjust taxation and the need for ­majoritarian consent both to taxation and to other levies. In this chapter, the authors subject each of the four philosophical tropes to fresh insights in order to show Locke’s importance in marking out the legal frontiers of a private sphere in the lives of taxpayers and the nature and scope of taxation in relation to it. Property rights are legitimate because they are pre-politically just. They originate, in other words, from before the institution of the state. The common law preserves and enhances that justice. Property rights can therefore only be alienated, as in the case of taxation, by the consent of those who hold them. Consistently with this, the giving of such consent is informed by the formulae and methods of the common law. Government’s contractarian nature limits the range of people from whom majoritarian consent to taxation is required. It does so because of the incidence of taxation upon land. The justice of taxes does not therefore require the redistribution of resources from rich to poor. It does, ­however, involve the maintenance of the common law, ­ property-based, private sphere of the individual taxpayer.

2  John Snape and Jane Frecknall-Hughes INTRODUCTION

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HAT HAPPENED IN the British Isles between the autumn of 1688 and the spring of 1689 has divided communities, historians and political theorists ever since. Mid-twentieth century English schoolchildren learnt those events something like this. James II takes ship for France in December 1688. Most people at the time concede that ‘having “violated the fundamental laws and withdrawn himself out the kingdom, [James] hath abdicated the government and the throne is thereby become vacant”’.1 Luckily, William of Orange, the husband of James’s daughter Mary, is on hand to accept the crown jointly with her as constitutional monarchs. In fact, as Lisa Jardine has vividly re-told the story,2 and, as this same school history book pointed out, William had landed at Brixham, in Devon, in November 1688 at the head of ‘the largest professional army that had invaded England since Roman times’.3 Though there was not much trouble in England, in Scotland James’s adherents were ruthlessly ‘crushed by force of arms’ and, ‘[i]n Ireland’, as Paul Langford writes, ‘there was positively a blood-bath, one which still holds a prominent place in Irish myths and memories’.4 More recently, the events and their background have been reassessed by Steve Pincus,5 in an account to which we shall return. Before the mid-twentieth century gave way to the welfare state, what the upheaval denoted to the English mind was a new security of property rights under Whig government. The association between Whiggism and property and, more specifically, between Whiggism and commerce, was mistrusted by eighteenth-century Tories6 (Whigs, said Samuel Johnson, were political scoundrels).7 A certain idea of property—private property— was nonetheless the central constitutional achievement of the events of 1688/1689. It is arresting, therefore, that after much talk in our time of Adam Smith and his contemporaries, attention has shifted perceptibly to this earlier period. Notably, in a far-from-throwaway line, the Rt Hon George Osborne has revealed his interest specifically in late seventeenthcentury thinkers and ideas.8 The moment seems ripe for, not just talk 1  Quoted in EH Carter and RAF Mears [1937], A History of Britain: Book IV (rev D Evans, London, Stacey, 2010) 143. 2  L Jardine, Going Dutch: How England Plundered Holland’s Glory (London, ­HarperCollins, 2008). 3  Carter and Mears, above n 1, 101. 4 P Langford, Eighteenth-Century Britain: A Very Short Introduction (Oxford, OUP, 2000) 1. 5  S Pincus, 1688: The First Modern Revolution (Yale, YUP, 2011). 6  P Langford, Public Life and the Propertied Englishman (Oxford, Clarendon, 1991) 48. 7  J Boswell, Life of Johnson [1791] (RW Chapman and JD Fleeman (eds)) (Oxford, OUP, 1980) 592, 693. 8  London, at the end of the seventeenth century was, said Mr Osborne, ‘the age of Locke, Newton, Halley, Boyle and Purcell, when … the Glorious Revolution laid the foundations of

John Locke: Property, Tax and the Private Sphere 3 of property, nor just of an ideal tax system, but discussion of these late seventeenth-century tax ideas in their historical context. The events of 1688/1689 are often presented as about kingly power, about religious intolerance, and so on, but taxation was a foundational element of both. This, and John Locke’s contribution to tax thinking, are becoming ever more clearly understood. When these events began, Locke was reading about them in the Netherlands. What he was reliably informed by his friend Charles Goodall was that, in December 1688, the House of Lords had asked William to ‘take upon’ himself ‘the administration of public affairs … and the disposal of the public revenue for the preservation of our religion, our rights, liberties, and properties and of the peace of the nation’.9 As ‘was long ago established’, Locke was one of those ready to play ‘an active and highly visible role in lobbying, policy-development’ and legislative drafting under the new regime.10 Nothing could be more central to that regime than taxation. Without taxes there is, of course, no government and no state to be governed. In this chapter, we seek to map out an account of Locke’s theory of taxation in its historical context. That context, partly intellectual, partly a matter of historical events, is explored in the second section. Unlike those of other great Enlightenment theorists of taxation, notably Adam Smith’s, Locke’s theory is articulated principally by reference to a distinctive theory of property rights. The relevant aspects of this theory are explained in the third section. At the centre of it, so we contend, is a delimitation of the boundaries of legitimate governmental initiatives relative to property rights and, concomitant with this, a conception of the private sphere relative to taxation. An examination of these ideas forms the fourth section. Whether, in particular cases, governmental initiatives have transgressed those boundaries, and how we should know when they have done so, are discussed in the fifth section. This is where the issues involved in maintaining that private sphere against certain forms of taxation initiative become one of Locke’s central concerns. Our aim, by the concluding section, is to have shown, not only that Locke merits much more consideration in the history of taxation thought than it is customary to accord him, but that—seen in historical context—his taxation ideas are much more nuanced than his place in the history of liberal thought might suggest. In each of these areas, we engage with aspects of Edward

our parliamentary democracy. Quite a time to be alive’, quoted in J Ganesh, George Osborne: The Austerity Chancellor (London, Biteback, 2012) 35. See also J Snape, ‘Stability and its Significance in UK Tax Policy and Legislation’ (2015) 4 British Tax Review 561. 9 

Quoted in R Woolhouse, Locke: A Biography (Cambridge, CUP, 2007) 262. Knights, ‘John Locke and Post-Revolutionary Politics: Electoral Reform and the Franchise’ (2011) 213(1) Past & Present 41, 42. 10 M

4  John Snape and Jane Frecknall-Hughes Andrew’s two recent articles,11 to develop a distinctively tax-jurisprudential and legal historian’s approach to Locke and taxation. Our primary concern is Locke’s creation of a private sphere as regards taxation and what the historical implications of this might be. LOCKE IN HIS TIME

Few thinkers have ever been so closely associated with particular political upheavals as was Locke himself with the events of 1688/1689 and with the so-called ‘Glorious Revolution’. Here, we explain briefly who Locke was and how he came to be swept up in those historical events. We follow this by saying something about the distinctiveness of his thought and what it owed to ideas that had gone before. This section culminates by setting out, and drawing out some principal implications from, the passage of his work that contains the essence of his taxation teaching. Locke and the ‘Glorious Revolution’ There is certainly something deeply arresting about Mark Goldie’s verdict that, ‘where Locke was once assumed to be the ineluctable fountain of political wisdom, he has now come to have an elusive and fugitive presence’.12 Locke’s life was spent in the shadows of, though scarred by, the activities of illustrious personages and the consequences of tumultuous events. The ‘Glorious Revolution’, for Locke, was but one in a series of many life-changing events. Born in Somerset in 1632 to a land-owning family with Puritan leanings, he went up to Westminster School in London in 1647, just following the First Civil War (1642–46), after his father obtained patronage for him to be educated there. His family had Parliamentary sympathies, the impact of which was evident throughout his life. After school, in 1652 Locke went on to Christ Church, Oxford on winning a studentship, and he stayed on there after his graduation, until 1684, when he was removed from his place at the insistence of Charles II. While at Oxford, Locke’s school friend, Richard Lower, introduced him to a group of individuals clustered around John Wilkins—the Warden of Wadham College and brother-inlaw to Oliver Cromwell. This group was the nucleus of what later became the Royal Society, and when Wilkins left Oxford on the Restoration of

11  E Andrew, ‘Possessive Individualism and Locke’s Doctrine on Taxation’ (2012) 21(1) The Good Society 151; E Andrew, ‘Locke on Consent, Taxation and Representation’ (2015) 62(2) Theoria 15 (the latter repeats significant elements of the former). 12  M Goldie, The Reception of Locke’s Politics, 6 vols (London, 1999) i, quoted in Knights, above n 10, 41.

John Locke: Property, Tax and the Private Sphere 5 Charles II to the throne, its leadership fell to the chemist, Robert Boyle. Locke became a close friend of Boyle, whom he regarded as his scientific mentor, and also became well acquainted with Robert Hooke and Isaac Newton, the leading scientific thinkers of the age. Locke developed an interest in medicine during this time, and did eventually become a doctor, although he did not receive a licence to practise until 1675. He qualified for his MA at Oxford in 1658, was elected to a Senior Studentship in 1659 and was Lecturer in Greek in 1661 and 1662, Lecturer in Rhetoric in 1663 and Censor of Moral Philosophy in 1664.13 In 1665, however, Locke left Oxford as a member of a diplomatic mission to Cleves, although it is not really known how this appointment came about.14 On his return to Oxford, in the summer of 1666, Locke pursued his interests in medicine, helping his friend, David Thomas, who was a medical practitioner. In 1666, Thomas introduced Locke to Lord Anthony Ashley who was recuperating from illness in Oxford. This was a significant meeting, which, arguably, changed the course of Locke’s life. Ashley as Chancellor of the Exchequer at that time was an active political figure. He later became, in 1672, the Earl of Shaftesbury and Lord Chancellor of England. Locke moved to London and worked closely with Shaftesbury, as his physician, political amanuensis and friend. Locke’s chief work was as secretary to the Board of Trade and Plantations and secretary to the Lords Proprietors of the Carolinas. He was instrumental in drafting the Fundamental Constitutions of the Carolinas (1670, subsequently revised), but also drafted economic papers for Shaftesbury. Notably, for the purposes of this chapter, Locke was a registrar to the Commissioners of the Excise (‘at an annual salary of £175’), from 1671–74.15 Locke spent the years 1675–79 in France, possibly for health reasons or because one of his pamphlets had annoyed the government.16 He spent his time chiefly in Paris and Montpellier, meeting the leading intellectuals of the day. He returned to find England again in the grip of political strife.

13 Many books about Locke’s work also provide various biographical details and those given here are taken from DA Lloyd Thomas, Locke on Government (London and New York, Routledge, 1995) 4–7; G Thomson, On Locke (Belmont, Wadsworth/Thomson Learning, 2001) 3–10; W Uzgalis, ‘John Locke’, in The Stanford Encyclopedia of Philosophy (Winter 2003) accessed 13 June 2016; and Woolhouse, above n 9, passim. 14 See Woolhouse, above n 9, 60. Thomson, above n 13, 5 suggests that Locke possibly wished to escape the pressure that was placed on the majority of teachers to become clergymen. 15 JR Milton, ‘Locke, John (1632–1704)’, in Oxford Dictionary of National Biography (online edition, May 2008) accessed 16 June 2016. Over many years, Locke had considerable involvement with the excise, sitting—for instance—as a Commissioner of Excise Appeals in 1696 (see Woolhouse, above n 9, 362). 16  A Letter from a Person of Quality to his Friend in the Country—see Lloyd Thomas, above n 13, 5.

6  John Snape and Jane Frecknall-Hughes Shaftesbury had recently been freed from a year’s imprisonment in the Tower of London, seemingly from pressure from the recently called Parliament. The imprisonment was a result of his leadership of the opposition to the restored Stuarts, who had, because of their Catholicism, alienated much of the country. (Shaftesbury had switched from being Royalist to Parliamentarian during the Civil Wars, then back to Royalist after Cromwell’s death.) Shaftesbury was appointed as Lord President of the Privy Council, but amid Parliament’s opposition to the bill aimed to prevent James (Charles’s brother) succeeding Charles to the throne (Charles had no legitimate heirs), Charles dissolved Parliament and Shaftesbury lost his post. These events are known compendiously as the ‘Exclusion Crisis’. Shaftesbury then seems to have become involved with the rebellious elements that ultimately found a leader in the Duke of Monmouth, a Protestant, illegitimate son of Charles II. Shaftesbury was arrested in July 1681 on a charge of high treason. He was acquitted after a few more months’ imprisonment in the Tower and when Monmouth was arrested, he went into hiding and later fled to Holland, dying in 1683. It is not really known how heavily Locke was involved in all this political intrigue, but although based in Oxford, ‘he was said by a college member to live “a very cunning and unintelligible life … no one knows where he goes or when he goes or when he returns”’.17 He too fled to Holland in 1683. Locke did not return to England until 1689. Owing to his connection to Shaftesbury, Charles ordered Locke’s ejection from his studentship at Christ Church, and his extradition was requested from the Dutch government when his name came up in association with Monmouth’s rebellion of 1685. When the king offered a pardon in due time, Locke refused on the grounds that he had done nothing wrong. Locke moved to Rotterdam in 1687, undoubtedly to advise William of Orange, prior to his campaign to take the English throne—and he served William as Commissioner of Appeals when the latter became king. In his later years, Locke was less politically involved and devoted most of his time to his philosophical writings, although he was appointed Commissioner of Trade and Plantations in 1686, a role in which he was very active, and was one of the founding shareholders of the Bank of England, also being, in effect the ‘intellectual leader of the Whig party’.18 Andrew, following CB Macpherson in this regard,19 goes further, in fact, describing Locke himself as a ‘Whig oligarch’, formulating a theory of ‘taxation and representation’, designed to serve the interest of the section of society of which he himself was a member. While, of course, accepting

17 

Quoted in Thomson, above n 13, 9, although the source is not stated. Thomson, above n 13, 9. 19 Andrew (2015), above n 11, 18; CB Macpherson, The Political Theory of Possessive Individualism: Hobbes to Locke (Oxford, Clarendon, 1962). 18 

John Locke: Property, Tax and the Private Sphere 7 Locke’s adherence to Whig principles, we subscribe to a more recent refinement of this view. Locke, we take it, rather than simply wanting to protect the interests of the landed gentry, thought nonetheless that the views of that group could be enhanced and extended for the public good.20 Locke in his lifetime saw much of what had been established for centuries swept away to be replaced by something new, revised or completely different— the monarchy in its various forms, the House of Lords, the Anglican Church and the Cromwellian Protectorate. The idea of ‘starting from first principles’ permeated much of his writing. For example, in An Essay Concerning Human Understanding, he saw himself as ‘clearing the ground a little, and removing some of the rubbish that lies in the way to knowledge’.21 Likewise in the Essay, throughout Book 1, he uses the image of a ‘tabula rasa’, or blank slate, to describe the state of a man’s mind, before experience writes upon it. In his Second Treatise of Government, in defining political power, which is ‘for the regulating and preserving of property’,22 he aims to ‘derive it from its original’.23 This underlying concept of ‘going back to the beginning’, allied to his own political experience, often goes unremarked in terms of its influence on Locke’s writing, especially his political thought. Often forgotten, also, is the fact that, as Mark Knights and others have shown, Locke was, with his friends (his so-called ‘college’, which included John Freke and Edward Clarke), very politically engaged, even after the Revolution, and well into the 1690s.24 Distinctiveness of Locke’s Thought The twentieth-century conservative political philosopher, Eric Voegelin, isolates four distinctive and innovative features of Locke’s political thought. Essentially, these are contained in Locke’s Two Treatises of Government,25 originally published anonymously in 1690. Voegelin’s reading of Locke is idiosyncratic, yet, read in the light of recent Locke scholarship, these four features, or stages, are highly suggestive. They all involve a particular conception of what it is to be a human being living in civil society. It is on this

20 

See, eg, Knights, above n 10. J Locke, An Essay Concerning Human Understanding, Epistle to the Reader [1689, dated 1690] (P Nidditch (ed)) (Oxford, OUP, 1975) 9–10. 22  J Locke, ‘Second Treatise of Government’ in P Laslett (ed), Two Treatises of Government [1690] (Cambridge, CUP, 1988) 1 (hence referred to as TTG1 for the First Treatise and TTG2 for the Second). 23  Locke, above n 21, 2. 24  Knights, above n 10, at 42, 47. 25 Locke, above n 22. Though not published until 1690, it is now widely accepted that the manuscripts of both Treatises date from the time of the Exclusion Crisis, rather than the Revolution of 1688/1689 (see Woolhouse, above n 9, 181). 21 

8  John Snape and Jane Frecknall-Hughes new conception, says Voegelin, that the whole of Locke’s political philosophy rests.26 It implies a certain human attitude to two key features of civil society: property and taxation. Locke, in effect, invented ‘the commercial man’.27 First, Locke’s man is tolerant, in the sense of believing in ‘religious liberty’, defined as a requirement for people to worship some deity, so long as that worship does not threaten the safety of the state.28 So atheism is not a viable personal option in Locke’s state, and neither is Catholicism nor Islam, though for different reasons.29 Toleration, in this sense, means that ‘spiritual manifestation’ is ‘excluded’ from the public sphere. Locke’s circle of ‘Court Whigs’ and ‘commonwealthsmen’ which included religious freethinkers, would certainly have shared this point of view.30 Next, says Voegelin, Locke characterises man ‘as the product of divine workmanship’.31 A contemporary reader might consider this a fairly devout sentiment, but this is not so: it is a device. It enables Locke to postulate, first, that humans should live as long as possible,32 and, secondly, that their obligations towards each other can be spelt out in terms familiar from the English common law.33 What one owes to God should thus be, first, to preserve the lives of others and, secondly, to avoid damaging the assets of others.34 ‘Man is a proprietor who watches over his own property and recognises his duty not to damage anybody else’s, and God is formed in his image’.35 This, as Edward Feser explains, is a significant break from the scholastic idea that human nature is defined by the soul of man.36 The main end of man, says St Thomas Aquinas, is ‘the good for man’, namely ‘communion with God in the beatific vision’.37 ‘Subsidiary ends’, arising from man’s subsistence, include ‘self-preservation, procreation, knowledge and many other things’.38 These are the ends that governed scholastic

26  E Voegelin, The New Order and Last Orientation (J Gebhardt and TA Hollweck (eds)) (Columbia, University of Missouri Press, 1999), 146. 27 ibid. 28  ibid 142. 29  ibid 145. 30  Knights, above n 10, 59. 31  Voegelin, above n 26, 146. 32  ibid, referring to TTG2, para 6. 33  Voegelin, above n 26, 146. For the significance of the common law to Locke’s thought, see, eg, M Seliger, The Liberal Politics of John Locke (London, Allen and Unwin, 1968) 233–37. Locke joined Gray’s Inn in December 1657 (see Woolhouse, above n 9, 21). The future Lord Chancellor, Peter King (1669–1734), became almost a surrogate son to Locke from about the mid-1690s (ibid 414). Lord King LC’s judgment in Keech v Sandford (1726) 25 ER 223 is still an urtext in relation to constructive trusts (an institution, of course, of equity). 34  Voegelin, above n 26, 146–47. 35  ibid 147. 36  E Feser, Locke (Oxford, Oneworld, 2007) 16. 37  ibid 18. 38 ibid.

John Locke: Property, Tax and the Private Sphere 9 morality. There, moral obligations arise from what promotes these ends and what is ‘forbidden’ is what frustrates them.39 The Lockeian standpoint, focused on the here and now, and on the public sphere, marked an important departure from the transcendent orientation of scholasticism. What was central, for Locke, was public virtue. ‘Locke’, writes Knights, ‘was always nudging his friends into acting for the public good and he and Clarke spoke the language of virtue’.40 Locke and his circle were ­committed to the promotion of their view of the public good and to ‘public-spirited reform’.41 Thirdly, says Voegelin, with Locke, ‘man is the proprietor of himself’.42 What Locke actually says is that ‘every man has a “property” in his own “person”’.43 Contrary to what some have said, this is not inconsistent with the idea that man is the property of God. God’s and man’s are different proprietary rights subsisting in the same individual at one and the same time consistent with the common-law orientation of Locke’s thought.44 It is quite as radical as the first distinctive feature of Locke’s political thought rehearsed above. It is absolutely contrary to Thomas Hobbes (1588–1679), who, ‘if he had lived to witness it … might have classified it [that is, the idea of man having a property in his own person] as a variety of madness similar to that of the man who believes himself God’.45 These rights are the inverse of ‘right’ in scholastic natural law. While later scholastic philosophers differed, Aquinas conceived of right (ius) in terms of ‘every one carrying out his or her obligations relative to everyone else’.46 Locke, so Feser argues, thinks of liberty as freedom to pursue, autonomously, one’s ‘own private ends’, not freedom to ­‘participate in public decision-making’.47 James Tully,48 Richard ­Ashcraft,49

39 ibid. 40 

Knights, above n 10, 59. ibid 61. 42  Voegelin, above n 26, 147. 43  TTG2, para 27, quoted at Voegelin, above n 26, 147. 44 Whilst making an important but different point, Kevin Gray’s observation that ‘[a] ­pervasive influence in all philosophical thinking on “property” is still the brooding omnipresence of John Locke’ is revealing both of Locke’s influence on the common law and the attitude of common lawyers to Locke (see K Gray, ‘Property in Thin Air’ (1991) 50(2) Cambridge Law Journal 252, 293). 45  Voegelin, above n 26, 147. 46  Feser, above n 36, 19. 47  ibid 28. 48  J Tully, ‘The Framework of Natural Rights in Locke’s Analysis of Property: A Contextual Reconstruction’, in A Parel and T Flanagan (eds), Theories of Property: Aristotle to the Present (Waterloo, Ontario, Wilfrid Laurier University Press, 1979); J Tully, A Discourse on Property: John Locke and his Adversaries (Cambridge, CUP, 1980). 49  R Ashcraft, Revolutionary Politics and Locke’s Two Treatises of Government (Princeton, PUP, 1986). 41 

10  John Snape and Jane Frecknall-Hughes and Martin Hughes50 have denied this, arguing that Locke was a liberal, certainly, but also a democrat.51 Fourthly, for Locke, man consents ‘to incorporate as a community’.52 This incorporation authorises a ‘disproportionate and unequal possession of the earth’,53 at least so long as there is no bottom-up revolt. In the ‘state of nature’, there is equality. In civil society, there is ‘property differentiation’.54 From this, the deeply conservative Voegelin concludes that the ‘avowed purpose’ of Lockeian government is ‘the preservation of the inequality of property’.55 This conclusion about Lockeian political order is comparable to those drawn by Macpherson, who depicts Locke as one of the principal architects of a new seventeenth-century ‘possessive individualism’,56 and of Ellen Meiksins Wood, who portrays Locke as no more than ‘an advocate of ‘constitutional’ or ‘limited’ government, a believer in the traditional ‘mixed constitution’, albeit in its most parliamentary form.57 Either way, despising egalitarian democracy, it is Locke’s scheme to provide an intellectual foundation for securing property rights, via a sovereign legislature, against ‘the Fancy or Covetousness of the Quarrelsom and Contentious’.58 This, as will be seen, is the broad view to which we adhere in what follows, and it is supported by Andrew in the two articles referred to above. We agree, however, with Knights, that it is not as simple as this. Other, more recent, though historically less plausible readings, noted briefly above and developed below, understate Locke’s belief that Whig virtues could be adopted widely as the basis of a new type of commercial society. The fact that readings of Locke vary so markedly sits well with his often ‘very cunning and unintelligible life’, as it appeared to his contemporaries, and his ‘fugitive presence’ for historians. Voegelin is useful in pinpointing the innovative aspects of Locke but his work remains controversial. With Locke, he writes, ‘the spiritual p ­ ersonality of man is banished from the public sphere and condemned to impotence; the public person of man is abased to an object of property rights along with land, furniture, and other chattels; government is reduced to an instrument for the preservation of a social state of doubtful justice’.59 It is not necessary

50  M Hughes, ‘Locke on Taxation and Suffrage’ (1990) 11(3) History of Political Thought 423; M Hughes, ‘Locke, Taxation and Reform: A Reply to Wood’ (1992) 13(4) History of Political Thought 691. 51  See Andrew (2015), above n 11, 15–16, for a detailed review of the literature. 52  Feser, above n 36, 149. 53  TTG 2, para 50. 54  Voegelin, above n 26, 150. 55  ibid 151. 56  Macpherson, above n 19. 57  EM Wood, ‘Locke Against Democracy: Consent, Representation and Suffrage in the Two Treatises’ (1992) 13(4) History of Political Thought 657, 689. 58  TTG2, para 34, quoted in Andrew (2015), above n 11, 15. 59 ibid.

John Locke: Property, Tax and the Private Sphere 11 to subscribe fully to Voegelin’s views, nor to acquiesce in his idea of justice, to accept that the ideas that Voegelin deplores were seriously argued as being for the public good in Locke’s own time. That is why, though historians might be wary of Voegelin’s views, his conservatism nonetheless seems to cast into stark relief the kinds of ideas to which Locke and his circle subscribed. Locke’s association with natural law binds him to conservatives, while his individualism makes him appeal to liberals.60 Essence of Taxation in Locke Locke’s views on taxation follow on from the world-view just described. The essence of his taxation thought appears in the Second Treatise of Government (TTG2), paragraphs 138–142 and 157–158.61 Locke says, in the key passage: ’Tis true that Governments cannot be supported without great charge, and ’tis fit every one who enjoys his share of the Protection should pay out of his estate his proportion for the maintenance of it. But still it must be with his own Consent—i.e. the Consent of the Majority, giving it either by themselves or their Representatives chosen by them. For if any one shall claim a Power to lay and levy Taxes on the People by his own authority, and without such consent of the People, he thereby invades the Fundamental Law of Property, and subverts the end of government. For what property have I in that which another may by right take when he pleases himself?62

Locke’s comments in the Second Treatise of Government contain the essence of his teaching on taxation. Needless to say, they have been the subject of much debate as to their exact meaning. What, for example, does he mean by ‘estate’? The word is capable of different interpretations, from conveying the idea of particular assets (land or chattels) to the legal rights and obligations subsisting in relation to those assets. Given that the holding of a 40-shilling freehold at this time conferred the right to vote in the shires,63 some have suggested that Locke envisaged landholders only as having to pay tax, rather than everyone, although both views have attracted support.64 In Locke’s development of one element of this passage, in Some Considerations of the Consequences of the Lowering of Interest, and Raising the Value of Money (1692),65 Locke does suggest that the ‘publick charge’ of government must 60 

Feser, above n 36, 28. Andrew (2015), above n 11, 16. 62  TTG2, para 140. 63  See J Cohen, ‘Structure, Choice and Legitimacy: John Locke’s Theory of the State’ (1986) 15(4) Philosophy and Public Affairs 301. 64  See, eg, Hughes, above n 50, 442; and Cohen, above n 63, 301. 65 J Locke, Some Consideration of the Consequences of the Lowering of Interest, and Raising the Value of Money [1691] in The Works of John Locke in Nine Volumes, 12th edn, 61 

12  John Snape and Jane Frecknall-Hughes be borne by landholders, since merchants and labourers do not have the resources to bear it. This is very important to Locke’s theory. Similarly, the words ‘proportion for the maintenance of it’ (‘it’ being ‘protection’, by reference to the earlier part of the sentence) have caused debate. ‘Proportion’ might innately suggest ‘equity’ or ‘fairness’, which may or may not mean progressive or proportionate taxes in the current sense of these terms,66 but the linking of the concept to the ‘maintenance’ of protection opens up a debate on whether tax should be paid in relation to income/assets or on some consumption basis. Does the idea of a ‘share of the Protection’ suggest that a wealthy individual should be entitled to more ‘protection’ because he possesses more land and chattels? There is no real indication as to how tax revenues might be spent, as the basic idea is of individuals contributing to state coffers for protection. The concept of the state helping out a specific sector of the community or providing welfare for the needy cannot be easily accommodated within Locke’s thinking. At this distance in time, it is hard to be precise about Locke’s intentions, but it may be the case that he used words that would allow for the development of a tax system along one of several possible lines, and was doing no more than establishing a broad philosophical underpinning. Andrew makes the important point that, when late seventeenth-/early eighteenth-century people talk about ‘taxation’, especially in relation to representatives, they should not necessarily be understood to mean all taxes.67 ‘Taxation’ referred to hearth taxes and (especially) land taxes, not to duties of excise or to customs duties.68 It is useful to remember, too, that the real ‘age of excises’, so to speak, was the late 1690s, after Locke’s Two Treatises had been published, a fact that no doubt reflected their frequent use in The ­Netherlands. William III, presumably, had some hand in their introduction, although the English were already familiar with them. These excises provide the context for Locke’s arguments about the incidence of taxation and for the arguments of Locke’s college as to the need for ‘pragmatic measures’ to ensure ‘supply to fund the war’ with the new regime’s Absolutist Catholic enemies.69 Excises were of a piece with other measures designed ‘to preserve liberty, property and Protestantism’, namely the recoinage, freedom of the press, poor relief reform, the suppression of vice and the institution of the Bank of England.70 Vol 4 (Rivington, London, 1824) accessed 12 February 2014. This is cited by T Dome, The Political Economy of Public Finance in Britain 1767–1873 (London and New York, Routledge, 2004), 12, n 6. 66 See DM Byrne, ‘Locke, Property and Progressive Taxes’ (1999) 78(3) Nebraska Law Review 700. 67  Andrew (2015), above n 11, 19. 68  ibid 18. 69  Knights, above n 10, 60. 70  ibid. (Reading this list, it is not difficult to see, mutatis mutandis, why Locke seems so present in Mr Osborne’s thoughts.)

John Locke: Property, Tax and the Private Sphere 13 PROPERTY RIGHTS AND THEIR SIGNIFICANCE

‘Property’, for Locke, has a special significance. His theory is explanatory and justificatory. It precludes a role for taxation as an instrument for redistributing wealth from rich to poor. Property is instead identified with privacy and it signifies an opposition to the public realm of the state. ‘Property’ in Locke Locke’s is one of the most famous of all theories of property, a theory devised with the express purpose of refuting the arguments of apologists for the divine right of kings. Because of its importance to the present argument, though Locke’s property theory is well known, there is no harm in emphasising certain of its aspects here. Locke’s property theory is developed in his Two Treatises of Government. It is designed to show that those who hold property rights in Locke’s own day may do so rightfully. The reason for this is that the key political controversy of Locke’s career was with the followers of a leading but now dead apologist for divine right (or ‘absolutism’), Sir Robert Filmer (1588–1653). Filmer commended but sought to further the work of Hobbes, the great theorist of sovereignty, whose Leviathan had appeared in English for the first time in 1651. Filmer had wanted to show that property in resources within a kingdom was the monarch’s alone, having descended from Adam (the first man) to each successive king via his heir—that is, via his eldest son.71 Given the premises, Filmer’s was itself quite a sophisticated theory, addressed to followers of Hugo Grotius (1583–1645), who was then read as having argued that the earth had originally been divided by common consent of mankind.72 Locke even agreed with Filmer that Grotius’s was not a coherent position. Locke’s First Treatise of Government (TTG1) comprised a detailed engagement with Filmer, while TTG2 included a theory of property designed to show that all people have a natural right to property, God, at the creation of the world, having given the earth ‘to Mankind in common’.73 In addition, TTG2 stressed the inalienability of the right to property, along with those to life and to liberty.74 Basing itself on these natural rights, TTG2 ‘argued that government is based on a social contract, which binds current citizens 71  R Filmer, ‘Observations Concerning the Originall of Government’ [1680] in JP Sommerville (ed), Patriarcha and Other Writings (Cambridge, CUP, 1981) 184. 72  ibid 234. 73  TTG2, para 25. 74 These ideas came to be embodied in the 1776 American Declaration of Independence (see JW Ely, The Guardian of Every Other Right: A Constitutional History of Property Rights (New York, OUP, 2008) 17, 28–9).

14  John Snape and Jane Frecknall-Hughes through their express or tacit consent’.75 Finally TTG2 supported a people’s right of revolution in the event that their legitimate sovereign had greatly misused the competences placed in his hands. From these three ideas grew a Lockeian conception of the rule of law and of the competences vested in government being placed there on trust for the people.76 So far as the right of property was concerned, Locke’s fundamental premise was that God granted the world to mankind in common.77 By labour, the first men appropriated parts of the land: Though the Earth, and all inferior Creatures be common to all Men, yet every Man has a Property in his own Person. This no Body has any Right to but himself. The Labour of his Body, and the Work of his Hands, we may say, are properly his.78

For Voegelin, this is an outrageous attack ‘on the dignity of man’, because ‘the human person’ is reduced to ‘a capital good’, capable, by natural right, of infinite economic exploitation.79 For Waldron, however, labour is theologically significant, the ‘creation of natural resources’ itself having a ‘teleology’.80 Man has a duty to labour, to appropriate resources, so as to do God’s work, which is what he is for.81 That sits well with the practical, and pragmatic, thought of the members of Locke’s college. The successors of the first men have bought, sold and inherited property in land,82 right up to the present day.83 The justice of the original acquisition (namely, by the first men to cultivate land) was to be determined, said Locke, by two factors or ‘provisos’.84 First, there is the sufficiency proviso, which prevents a person from encroaching on property rights already established,85 subject to one important condition, to be discussed later. For this Labour being the unquestionable Property of the Labourer, no Man but he can have a right to what that is once joyned to, at least where there is enough, and as good left in common for others.86

75 

BH Bix, A Dictionary of Legal Theory (Oxford, OUP, 2004) 130; Ely, above n 74, 28–29. J Dunn, Locke (Oxford, OUP, 1984) 52–57. 77  TTG2, para 25. 78  TTG2, para 27. 79  Voegelin, above n 26, 148. 80  ibid 159. 81  ibid 160. 82  TTG2, para 47. 83  Locke’s property theory is summarised, eg, in Dunn, above n 76, 32–44. 84  There are useful discussions of the two provisos in A Clarke and P Kohler, Property Law: Commentary and Materials (Cambridge, CUP, 2005), 81–106; J Waldron, God, Locke, and Equality: Christian Foundations of John Locke’s Political Thought (Cambridge, CUP, 2002) 151–87. 85  Voegelin, above n 26, 148. 86  TTG2, para 27. 76 

John Locke: Property, Tax and the Private Sphere 15 This sufficiency proviso Robert Nozick regards as being faulty, since all appropriators of resources, from the very first one onwards, are in this position.87 Secondly, there is the spoilation proviso. Locke summarises this as follows: As much as any one can make use of to any advantage of life before it spoils; so much he may by his labour fix a Property in. Whatever is beyond this, is more than his share, and belongs to others. Nothing was made by God for Man to spoil or destroy.88

Locke finally gives property primacy in his commonwealth. ‘The great and chief end’, he says, ‘of men uniting into commonwealths, and putting themselves under government, is the preservation of their property; to which in the state of Nature there are many things wanting’.89 The traditional view is that the ‘property’ to which Locke refers is property in land and property in the proceeds of the sale of land, whether or not the latter has been reinvested in more landed property. That is the traditional view to which we adhere. However, it is fair to say that those who see Locke as a democrat, notably Tully, Ashcraft and Hughes, also take Locke’s property as referring to a much wider category of rights than this: rights relating to civil liberty; the right to live; and the right not to be enslaved.90 Explanation and Justification Today, we are apt to assume that a theory of property will make an argument about what should, or ought to, be the case. Such arguments are known as ‘normative’ arguments. Locke’s theory is somewhat different. Although a norm is important, the theory also has an interpretative element. While it shows that property rights can be legitimate, it does so by offering an explanation of how those rights came into existence. Notwithstanding this, Locke’s property theory is not simply one of historical significance. Locke is assuring his readers that, despite all this talk of equality, some kinds of inequality are acceptable. Waldron argues for the explanatory, but not the justificatory, force of Locke’s argument. What Locke is arguing for, he writes, is ‘basic equality’, not equality of outcome, and he does so both out of his Protestant convictions and a wish to demolish the inequality involved in Filmer’s argument that the earth was originally granted to Adam.91 Locke also does it to emphasise the legitimacy of the range of property rights that would be desirable to the members of commercial society. 87 

R Nozick, Anarchy, State, and Utopia (New York, Basic Books, 1974) 174–82. TTG2, para 31. 89  TTG2, para 124. 90  Andrew (2015), above n 11, 15. 91  Waldron, above n 84, 153. 88 

16  John Snape and Jane Frecknall-Hughes The idea that property in land was plunder had been fostered by one of the radical movements spawned by the Civil Wars. One of these ­movements was the ‘Diggers’, early communists, whose leader, Gerrard Winstanley (1609–76), poured scorn on English kings as perpetuators of the ­Norman yoke. Lords of manors bent on enclosing common land, priests who c­ ollected tithes and the judges who administered the laws of property were all ­complicit in plunder.92 Locke’s theory of property would have been ­cognizant of this idea, just as it would have been of divine right. ­Winstanley’s New-Yeers Gift for the Parliament and Armie (1650) had been uncompromising in its denunciation of property rights: The party that is called a king was but the head of an army, and he and his army having conquered, shuts the conquered out of the earth, and will not suffer them to enjoy it, but as a servant and slave to him; and by this power the creation is divided, and part are cast into bondage. So that the best you can say of kingly power that rules by the sword is this: he is a murderer and a thief … Property came in, you see, by the sword, therefore the curse; for the murderer brought it in, and upholds him by his power, and it makes a division in the creation, casting many under bondage; therefore it is not the blessing, or the promised seed. And what other lands do, England is not to take [as a] pattern; for England (as well as other lands) has lain under the power of that beast, kingly property.93

Locke’s theory is designed to meet this type of polemic just as surely as the arguments of divine right apologists. The theory is not just of historical significance. It was relevant in Locke’s day because enclosures of common land had been gathering pace. There was a sense in which common land was unappropriated in the way that the whole world originally was. In our own day, Locke’s theory continues to be relevant in relation to explaining the creation of intellectual property rights,94 as well as the conclusion of international agreements over the global commons.95 It still has considerable weight, too, when it comes to arguing about the reach and extent of the tax system. Property and Redistribution Locke’s property theory, in our view, is such as to preclude a role for ­taxation as an instrument for redistributing resources from rich to poor. 92  JC Davis, JD Alsop, ‘Winstanley, Gerrard (bap. 1609, d. 1676)’, Oxford Dictionary of National Biography (online edition, May 2008) accessed 10 May 2016. 93  G Winstanley [1650], ‘A New-Yeers Gift for the Parliament and Armie’ in D ­ Wootton (ed), Divine Right and Democracy: An Anthology of Political Writing in Stuart England (London, Penguin, 1986) 326–28. 94 A Clarke and P Kohler, Property Law: Commentary and Materials (Cambridge, CUP, 2005) 90–91. 95  For example, the 1982 UN Convention on the Law of the Sea; the 2013 Global Ocean Commission; see further accessed 10 May 2016.

John Locke: Property, Tax and the Private Sphere 17 This ­proposition follows from the pre-political nature of property rights. Relinquishment of any of those rights in favour of government, or ­fellow-subjects, must be voluntary or, if forcible, then compensated. Locke’s writing is, at one and the same time, as chilling and possibly as invigorating as that. By the late seventeenth century, there were good political reasons for someone in Locke’s position to contrast the timeless justice of property with both the contingency that characterised possessions under Filmerian monarchy and the communal right advocated by such as Diggers and Levellers. ‘Distribution’, say Liam Murphy and Thomas Nagel, refers to an existing determination of the shares, as between private property and ‘publicly provided benefits’ actually obtaining in a society for ‘different individuals’.96 It follows that ‘redistribution’ denotes political action that could involve both ‘in kind’ and cash ‘redistributive transfers’ between those individuals.97 We are accustomed to think of redistribution in favour of poor individuals and away from rich ones. Nonetheless, redistribution can equally well be effected in favour of rich individuals and away from the poor. To understand what Locke is saying about taxation, it is necessary, for sure, to keep his theory of property firmly in mind. However, it is also necessary to remember that, at least in early seventeenth-century England, not only was the tax system very weak, ‘absorbing only a tiny proportion of national income’, but also that taxes existed to fund royal government, an institution that ‘still betrayed its origin as a system for the administration of the king’s own household affairs’.98 To suggest that such a system was even capable of effecting public/private wealth transfers seems entirely anachronistic. Seventeenth-century taxes, for the most part, were barely capable of being raised exceptionally and to pay for defence against national emergency. However, the ‘vast bulk’ of government ‘revenue came not from taxes but from customs dues, the income on royal estates, and feudal dues such as wardship and purveyance’.99 For Locke, interfering with property rights is wrong because, as seen above and considered below, property rights originated before political societies began. For this reason, property rights are characterised as natural, or absolute, rather than political, or conventional. Property rights are in their origin, in other words, pre-political. The ­Lockeian conception of property, so Waldron writes, is of private property, ‘in the sense that Lockean rights are not dependent on the discharge of any function which cannot be related to the private affairs of the proprietor’.100 Tully and others had earlier denied this, arguing (against Macpherson) that Lockeian property rights are conventional and that it might be necessary 96  L Murphy and T Nagel, The Myth of Ownership: Taxes and Justice (New York, OUP, 2002) 76. 97  ibid 89. 98  Wootton, above n 93, 23. 99 ibid. 100  J Waldron, The Right to Private Property (Oxford, Clarendon, 1988) 162.

18  John Snape and Jane Frecknall-Hughes (in Andrew’s summary of Tully’s argument) to ‘mandate redistribution of property to ensure that the natural rights of the majority are secure’.101 We agree with Waldron’s conclusion ‘that Tully has presented no convincing evidence to challenge the traditional interpretation of Locke’s view on property in civil society’.102 To the contrary, their argument destabilises property rights, the opposite of what Locke needed to argue to interest commercial people in the Revolution settlement. It was about tying them into the new regime. If, contrary to Tully, and with Waldron, we read Locke as insisting on the sacrosanct nature of property rights, and if we bear in mind Locke’s emphasis on consent, it follows that any transfer of those rights must be voluntary or, if not voluntary, then justly compensated as an injury to the property-holder. The essence of Lockeian taxation, as already mentioned, is that it is a voluntary transfer by the subject to the sovereign of all or part (depending how ‘proportion’ in TTG2, paragraph 140, is interpreted) of the former’s property in some resource.103 The need for the voluntary transfer of property rights has the further consequence that it is the duty of man to accept the fact that, on entering political society, his ancestors consented to a ‘disproportionate and unequal possession’.104 Some people are more industrious, or more talented, than others and had evidently done better than others at that foundational moment. The need for just compensation of injured property rights, whether through acts of government or of neighbours, is entirely consonant with this requirement of consent. Grotius, in relation to the concept of ‘eminent domain’ (a term that Grotius apparently coined) had written of the need for compensation to the citizen.105 Paragraph 140 of TTG2, as extracted above, has, as Michael Taggart has claimed, ‘been taken (fairly or not) to reflect Locke’s view of the eminent domain power’ as well as of taxation.106 Eminent domain, it has been well said, differs from taxation, because of the disproportionate burden that falls on one, or on a small group of, property holders. In what follows, it may be seen to have something more in common with Locke’s idea of taxation than this might suggest.

101 

Andrew (2015), above n 11, 15, 26. Waldron, above n 100, 240. 103 R Harrison, Hobbes, Locke, and Confusion’s Masterpiece: An Examination of Seventeenth-Century Political Philosophy (Cambridge, CUP, 2003) Ch 8. 104  MJ White, Political Philosophy: A Historical Introduction, 2nd edn (New York, OUP, 2012) 281–82; Waldron, above n 84, Ch 6. 105  H Grotius [1625] The Rights of War and Peace, 3 vols, trans J Barbeyrac and J Morrice (R Tuck (ed)) (Indianapolis, Liberty Fund, 2005) III, 1540, referenced in M Taggart, ‘Expropriation, Public Purpose and the Constitution’ in C Forsyth and I Hare (eds), The Golden Metwand and the Crooked Cord: Essays on Public Law in Honour of Sir William Wade QC (Oxford, Clarendon, 1998) 93. 106  ibid 93. 102 

John Locke: Property, Tax and the Private Sphere 19 The disproportionate and unequal possession of which Locke speaks is, of course, chilling to our contemporary sensibilities. Chilling as it is, it is also invigorating for those in a position to take advantage of it. The members of Locke’s college would have regarded this as a ‘least worst’ situation. Property and Privacy Rather than providing a ground for redistribution from rich to poor, with Locke, property forms the foundation of a modern privacy, of a modern freedom. This privacy amounts to the establishment of an opposition between the private realm, of the hearth and of the household, and the public realm of the state. It can, moreover, be extended outwards, to all who aspire to that way of living. Locke develops a ‘modern’ privacy distinct from the ancient one. Modern privacy is the chief characteristic of modern freedom. Modern freedom (writes Alan Ryan), unlike the Aristotelian freedom, is ‘essentially private; it … [is] the ability to pursue our private economic, literary, or religious concerns without having to answer to anyone else. It … [is] freedom from the political sphere rather than freedom in the political sphere’.107 Property, especially the fee simple estate (or ‘freehold’) is the guarantee of privacy because of the exclusionary control that the fee simple confers on its holder. This is what Locke’s theory can prove. Locke himself says, that Filmer’s cannot. Locke writes: … [S]upposing the World given as it was to the Children of Men in common, we see how labour could make Men distinct titles to several parts of it, for their private uses; wherein there could be no doubt of Right, no room for quarrel.108

The common-law nature of the property right means that, whilst the squire in his manor house—or hall—can enforce the exclusive character of his property against the outside world, such an exclusive right does not protect the squire’s copyhold tenant in his cottage. In fact, along with the squire, all free tenants are within the scope of this protection. Copyholders are not because, unlike the squire, they hold their property rights not of the crown but of the manor.109 Leaseholders are different from both because their right, though a property right, is subject to different rules as to duration.110 Common-law property rights are what matter. 107 A Ryan, On Politics: A History of Political Thought from Herodotus to the Present (London, Allen Lane, 2012) xvii, 109, 524. 108  TTG2, para 39. 109  Copyhold tenure was not abolished until 1926. 110  Prior to 1926, the lease had developed into a hybrid real/personal property right called a ‘chattel real’. The Law of Property Act 1925, s 1, made it ‘capable of subsisting’ as one of only two common law estates in land (the other, of course, being the ‘fee simple absolute in possession’).

20  John Snape and Jane Frecknall-Hughes The natural law origin of the property right means that, in turn, the squire in his manor house both shoulders the burden, and takes the benefit, of the law of nature within his household, a household that extends to the cottage of his copyhold tenant. Because property is a natural, not a conventional, right, and because it has survived the institution of the state with its natural proprietary qualities intact, property retains its natural character albeit often regulated.111 Indeed, Locke’s argument in effect is that the Filmerian doctrine, since it is not based on property, reduces the state to a household. The ‘manor of England’ is a state of nature. It is in the squire’s legal relations with his peers, and in the boroughs, that the rule of law is to be encountered. The private realm, founded as it is on property, is not a realm of no law but of natural law, strengthened as necessary by the common law. Indeed, the common law is the ‘positivisation’ of natural law. These Lockeian ideas continue to be heavily contested.112 Where positive laws do not reach, however, the law of nature prevails. GOVERNMENT AND THE SOCIAL CONTRACT

Locke’s theory of property (and of taxation) requires limitations on the scope of governmental action. The principal such limitation is the need for the consent of the governed. That consent is to be given either in person or through the consent of representatives. Representative consent can be given by a majority of representatives. Limits on Governmental Action It follows, given the association between property and privacy, that Locke promulgates a boundary between the public and the private. The public is the proper sphere of legislation in political society. The private is the sphere of positive law that embodies and reinforces the law of nature. The boundary between public and private is determined by the effect of property rights. Property rights are exclusive and empowering (whether to sell or retain, the decision is an individual’s). Property rights are also stable.113 The private sphere is impregnable as long as these understandings hold. Excisemen, for instance, operate outside it. They work in market places and

111 Langford, above n 6, 28­ 9; JW Gough, John Locke’s Political Philosophy (Oxford, Clarendon, 1973) 81; R Wacks, Privacy: A Very Short Introduction (Oxford, OUP, 2010) 33–34; Waldron, above n 100, 238. 112  Ryan, above n 107, 915; Wacks, above n 111, passim. 113  K Gray and SF Gray, Elements of Land Law, 5th edn (Oxford, OUP, 2009) 99, 102–03.

John Locke: Property, Tax and the Private Sphere 21 smugglers’ cottages. Inside it, there are no land tax men and a gentleman can agree his land tax assessment with his neighbours, with his local assessors and collectors.114 Manorial tenants are outside the private sphere being shadows of their landlords. Women are ‘shadows’ of their husbands115 and fathers. Manorial lords are inside it, being public men only in a public capacity. All of this is so because of the legacy of man entering into political society. Natural rights were preserved and, logically, must be preserved, because that is the reason for political society in the first place. Public right must only go so far as to support them. Hobbes had also considered that levying taxes was justified as the price of protection.116 However, the almost fundamental contradiction implicit in these concepts never goes away. Richard Epstein,117 when looking at the US tax system from a Lockeian viewpoint, also comments on this: taxation is ‘… the power to coerce other individuals to surrender their property without their consent. … [It] authorizes the sovereign to commit acts of aggression against the very citizens it is supposed to protect’ and is ‘institutionalized coercion’. The dilemma is ‘how to preserve the power of taxation while curbing its abuse’.118 Locke, when read in context, was aware of this dilemma, hence his stress on the need to adhere to a majority decision, although this could mean that a sizeable minority might disagree, having ‘a distinct interest, from the rest of the Community’.119 However, they must still abide by the decisions of their elected (majority) representatives and cannot take individual action as that would undermine the security of property. Governments too cannot take property away arbitrarily, as this would have the same effect: For a man’s Property is not at all secure, though there be good and equitable Laws to set the bounds of it, between him and his Fellow Subjects, if he who commands those Subjects, have Power to take from any private Man, what part he pleases of his Property, and use and dispose of it as he thinks good.120

The town-dweller knows this, if not the tenant of the manor. The towndweller has private business and a sphere of private affairs governed, at least in part, by the common law.

114  C Brooks, ‘Public Finance and Political Stability: The Administration of the Land Tax, 1688–1720’ (1974) 17(2) Historical Journal 281. 115  See, for a disturbingly recent judicial use of this idea, Caunce v Caunce [1969] 1 WLR 286, ChD. 116 See D Jackson, ‘Thomas Hobbes’ Theory of Taxation’ (1973) 21(2) Political Studies 175, 176–77. 117  RA Epstein, ‘Taxation in a Lockean World’ (1986) 4(1) Social Philosophy and Policy 49. 118  ibid 50. 119  TTG2, para 138. 120 ibid.

22  John Snape and Jane Frecknall-Hughes Consent of the Governed The principal limitation on governmental action is the need for electoral consent. Consent is conceived of in terms of Locke’s contractarian theory, in his version of the social contract. The subject’s consent may be given in person or via the subject’s elected representative. Consent is only required from the elector, that is to say, from the holder of the property qualification of 40 shillings of freehold. It is important to recall that the potential for government action is limited. The raising of taxes is the main one. It is true, nonetheless, that there is a widening range of other possibilities in the 1690s, the most important of which, such as press freedom, recoinage and poor relief reform, have already been mentioned. More important, more pressing, though, was war with England’s Absolutist Catholic enemies, which needed to be paid for. Pincus paints a dramatic picture of Tory protest at the progressive land tax introduced, first, in 1689, then in 1692.121 With Locke’s social contract, though consent is fundamental, it is nowhere defined, and it is difficult sometimes to distinguish it ‘from compliance’.122 However, it is fundamental. A man would ‘have no Property at all’, he says, if anyone had ‘a right to take [his] substance, or any part of it from … [him], without … [his] own consent’.123 For Locke, uniting into a community means that individuals must surrender power to the will of the ­majority, agreeing to abide by a majority decision, in return for which they will receive the benefits available to community members—protection of life, health, liberty and property. This is Locke’s form of social contract theory, though other writers had a different idea of what this might mean.124 Consent in political society is not, however, a universal requirement in relation to taxation. First, taxation, as Andrew emphasises, referred to hearth taxes and land taxes, not to excise duties and customs duties. Duties of customs and excise were paid, or so it would appear, by everyone, regardless of whether they had the vote and thus of whether they were in a position to give their representative consent. As already hinted, Locke had an explanation for this apparent discrepancy. However, it is clear that representative consent was not required of wives, children, poor people, subjects resident in the colonies, etc.125 Consent in relation to taxation, as Andrew says, is therefore a ‘slippery’ concept.126 121 

Pincus, above n 5, 384. Andrew (2015), above n 11, 20. 123  TTG2, para 138; Andrew (2015), above n 11, 16. 124 Grotius, Hobbes, Pufendorf, Rousseau and Kant all had different views from Locke, ­particularly in terms of the issue of political authority. See also P Riley, ‘The Social Contract and Its Critics’ in M Goldie and R Wokler (eds), The Cambridge History of Eighteenth-­Century Political Thought (Cambridge, CUP, 2006) 347. 125  Andrew (2015), above n 11, 19. 126  ibid 22. 122 

John Locke: Property, Tax and the Private Sphere 23 The idea that the consent must be personal, or representative, follows from the quotation extracted above: ‘But still it must be with his own Consent [Locke insists], ie the Consent of the Majority, giving it either by themselves, or their Representatives chosen by them’.127 A peer of the realm gives personal consent, on behalf both of himself and of those who are his shadows.128 A representative Member of Parliament gives consent, not as such on behalf of his constituents, but on behalf of those holding the right to vote, and following a personal judgement about the interest of the nation as a whole. Arbitrary expropriation is: not much to be fear’d in Governments where the Legislative consists, wholly or in part, in Assemblies which are variable, whose Members upon the Dissolution of the Assembly, are Subjects under the common Laws of their Country, equally with the rest.129

Our point that consent is required only of those holding the property qualification is at variance with that of many distinguished commentators. On the one hand, Locke does not mention the basis of suffrage in the Second Treatise of Government. Tully and others have taken this as a cue to argue that Locke supported ‘universal manhood suffrage’.130 On the other hand, in recent years, various scholars have uncovered evidence that, at the very least Locke wanted to retain the 40-shilling suffrage in the shires while relaxing it somewhat in the boroughs. In TTG2, as Andrew points out, Locke does not say anything about ‘a property qualification for the franchise’, so TTG2, paragraphs 157 and 158 become key. Knights makes made what Andrew calls ‘a significant scholarly advance in the interpretation of paragraphs 157 and 158’.131 Andrew cites Knights’s reports of how Locke had marked up a 1679 parliamentary bill unifying the urban voting qualification, so that, in boroughs, the vote would be had by those who paid the ‘scot and lot’, that is, the ‘church rates and poor rates’.132 He concludes that, since the markings-up made no reference to the bill’s aim to increase the franchise in the counties from 40 shillings to 40 pounds, the matter in which Locke was really interested was what Knights dubs ‘a radical pettybourgeois reform’.133 We can now say definitively [writes Knights] that Locke sought to correlate ­borough representation with local taxation, at the same time as removing the customary variations in the franchise (a measure not achieved until 1832) and

127 

TTG2, para 140; Andrew (2015), above n 11, 16. Andrew, above n 11, 16; a ‘representative peer’ was a later invention (1707 onwards). 129  TTG2, para 138; Andrew (2015), above n 11, 16. 130  ibid 15. 131  ibid 16, 17. 132  Knights, above n 10, 70. 133  ibid 79. 128 

24  John Snape and Jane Frecknall-Hughes leaving the county franchise alone. At a stroke this provision would have defined the urban electorate as the relatively better-off, economically independent but by no means rich inhabitants.134

We accept Knights’s conclusion because it adduces archival documentary evidence in support that goes beyond an idiosyncratic reading of the p ­ ublished Lockeian texts. ‘The right to vote for a parliamentary representative’ (representation) and taxation are tied to Locke’s foundational ideas of the right to property and ‘consent to government’.135 Against Knights, Andrew argues that, as we shall see, Locke understood the incidence to fall in its entirety on landholders.136 Locke would not have thought non-freeholders were entitled to the vote if he had thought ‘that representation should be proportioned relative to tax payments’.137 This, says Andrew, is borne out by the provisions of the much-revised Fundamental Constitutions of the Carolinas, where Locke stated that only those with 50 acres of freehold land should have the vote.138 However, this does not dispose of Knights’s argument, because Knights finds Locke to be addressing a specific juncture in the development of the English state, one not yet attained in the Carolinas. Majorities and Consent The context of Locke’s majoritarian consent, so far as historical events were concerned, has been surprisingly little noticed. Majority decisions in ­Parliament, so Mark Kishlansky has written, had only become frequent in the parliamentary session of 1646, immediately following the First Civil War.139 Locke accepts the need for majorities but admitting them to his theory seems inconsistent with the primacy of consent as analysed above. This does not matter, however, in the terms of Locke’s argument, because his theory of government is shaped by the overriding need to protect the landed interest. So, representative consent can be given by a majority of representatives: consent does not have to be unanimous. A division, or majority, is not necessarily to be welcomed, for sure. It had not, traditionally, been ­Parliament’s way of proceeding. ‘Parliamentary practice had relied upon the deliberative process, through debates and committees, to arrive at resolutions that

134 

ibid 70, 72. Andrew (2015), above n 11, 16. 136  ibid 17. 137 ibid. 138 ibid. 139  MA Kishlansky, The Rise of the New Model Army (New York, CUP, 1979) 119–38. John Snape would like to record that he was prompted to follow up this reference by attending the seminar held on 10 December 2015, at the Department of History, University of Warwick, by Dr Bill Bulman (Lehigh University). 135 

John Locke: Property, Tax and the Private Sphere 25 expressed the sense of the whole House.’140 The use of majorities—or divisions—means that the representative assembly is not of one mind. Maybe one or other side of the argument has failed to discern the will of God. However, Locke allows for the expediency of majority decisions. That had been recognised in 1646. ‘The deliberative process with its practiced speeches and persuasive debates was entirely too cumbersome when confronted by the need for rapid policy formulation and executive control’.141 Locke, too, recognises that parliamentary business will likely have to be conducted quickly. The question arises of ‘what price?’ the vaunted consent if a majority will serve its turn. Andrew points out that majoritarian consent is hardly a working-through of the argument that all expropriations must be consented to personally or through a representative.142 He quotes John Dunn’s conclusion that Locke here makes an ‘extraordinary elision between the consent of each property-owner and the consent of the majority’.143 There is, writes Dunn, ‘[a]n air of massive bad faith … over this whole area of the argument’.144 Ross Harrison elaborates the problem: These representatives, once elected, may not happen to agree on a particular matter of taxation with some or all of the majority that elected them. So even an individual member of the electing majority may lose effective consent … [t]hen, typically, these representatives themselves will decide by majority vote rather than by unanimous decision. So, since their representative may be in the minority, even an individual who agrees with their representative may lose effective consent …145

Moreover, it is not clear whether ‘the Consent of the Majority’ in TTG2, para 140, refers to a majority of the nation as a whole or only to a majority of those with ‘taxable estate’ or to the representatives of those individuals.146 For us to worry about the consent of the majority, however, is somehow to ignore the purpose of Locke’s theory of government in its widest implications. First, the subject’s gift, via the representative, is subject to the implied condition that, in the absence of unanimity among the representatives, the gift will be made on the basis of the wishes of the majority of them. Secondly, the landed interest, for Locke, is worthy of special treatment in the commonwealth. ‘The landholder[’s] … interest [he wrote] is chiefly to be taken care of, it being a settled unmoveable Concernement in

140 

ibid 120.

141 ibid. 142 

Andrew (2015), above n 11, 21. J Dunn, ‘Consent in the Political Theory of John Locke’ (1967) 10(2) Historical Journal 153–82, quoted in Andrew (2015), above n 11, 20. 144  Dunn, above n 143, quoted in Andrew (2015), above n 11, 21. 145  Harrison, above n 103, 222. 146  Andrew (2015), above n 11, 21. 143 

26  John Snape and Jane Frecknall-Hughes the Commonwealth’.147 Why is this? It is because Locke believes that the landholder occupies a unique place in England’s political order, having the most to lose if the Revolution fails. So the landholder should be treated with consideration. [T]he Landowner, who is the person, that bearing the greatest burthens of the kingdom, ought, I think, to have the greatest care taken of him, and enjoy as many Privileges, and as much Wealth, as the favour of the Law (with regard to the Public-Weal) confer on him.148

So, Locke is not so much an oligarch, or regime-man, but one who thinks that the values that the regime promotes can benefit all those who are, or who might hope to be, involved in the political life of the nation. Landed values are, for the time being at least, consistent with those of the merchant. It is just a matter of getting lord and squire to accept that. Voegelin reminds us of the kind of man or woman who would assent to this close identification of the ‘Public-Weal’ with the interest of the landholder: the one who zealously guards his property, refrains from damaging anyone else’s and who has created a particular idea of God as conforming to human ideals.149 Though Voegelin’s language is highly rhetorical, he seems to be absolutely on point. He has identified, at one and the same time, the radical views held by Locke and his circle, and the fact that their sympathies were not confined to the landed interest. JUST AND UNJUST TAXES

If, as suggested, Locke’s theory does not suggest a role for taxation in the redistribution of wealth, what is the sense of justice that it embodies? That justice is encapsulated in his formulation of what has come to be known as the ‘benefit principle’. It has a number of features that, absent later readings, are unexpected and suggestive. Justice in Taxation In the light of what has been said, the question arises of whether Locke’s theory embodies a sense of justice and, if so, what sort of justice it is: it is not distributive at the level of the state but the individual—and it focuses on incidence. The benefits of civil society must be paid for by individuals on whom the incidence of taxation falls. This is the limited sense of justice in taxation 147 

Locke, above n 65, quoted in Andrew, above n 11, 23.

149 

Voegelin, above n 26, 147.

148 ibid.

John Locke: Property, Tax and the Private Sphere 27 to be found in Locke. There is an inherent contradiction in the idea that a government’s primary function is the ‘preservation of Property’150 while at the same time having the right to take it away. The citizen’s agreement to this, by a voluntary alienation of rights, is at odds with his right to private property. Locke is aware of this contradiction. The ‘end’ or aim of government is to preserve property and the reason for men entering into a community, so loss of property as a result of doing so is ‘too gross an absurdity for any man to own’:151 the only way of reconciling this is by the assumption that individuals are prepared to pay out of their own assets because by doing so they will be contributing to their own protection. Locke’s theory, as mentioned, is not redistributive in favour of the poor at the level of the state. In other words, a redistribution from rich to poor is no part of justice in Locke’s view of taxation.152 In a famous and muchcontested passage, not from TTG2, but from TTG1, Locke writes: As Justice gives every Man a Title to the product of his honest Industry, and the fair Acquisitions of his Ancestors descended to him; so Charity gives every Man a Title to so much out of another’s Plenty, as will keep him from extream want, where he has no means to subsist otherwise …153

As Edwin Seligman explained,154 Locke’s theory focuses on the incidence of taxation. He professed to believe, as mentioned, that all taxation ultimately fell on the landed interest. Andrew suggests that, besides wanting to protect the landed interest, Locke may have had two other things in mind.155 First, such a theory would incentivise the country squires, who sat in the House of Commons, to scrutinise the more zealously crown receipts and expenses. This is a very worthwhile observation. Secondly, it might make the same gentry more enthusiastic about paying land and hearth taxes. This seems less worthwhile, however. More accurate might be that, believing he knew where the incidence of taxation lay, Locke wanted to mollify those ­people whose support was so fundamental. A huge amount of public revenue needed to be raised. There was only one place where it could be found. Distaste for taxation, as Pincus says, was widespread among the landed gentry. Locke was well aware of the association in the minds of his Whig friends between duties of customs and excise and Stuart absolutism: the proceeds of these duties had financed the military and judicial operations against the Duke of Monmouth in 1685.156

150 

TTG2, para 138.

151 ibid. 152 

Andrew (2015), above n 11, 26. TTG1, para 42. 154  ERA Seligman, The Shifting and Incidence of Taxation, 2nd edn (London, Macmillan, 1899) Ch 5. 155  Andrew (2015), above n 11, 23. 156 ibid. 153 

28  John Snape and Jane Frecknall-Hughes Locke’s Benefit Principle This has five aspects, involving considerations as to the nature and scope of taxation, who must pay it, what is a just amount to pay, why justice does not depend on ‘ability to pay’, and how it is Locke’s property theory that both makes the benefit principle crucial and the ability to pay principle otiose. Taxation, in mid-seventeenth-century England was limited in scope and designed to address exceptional contingencies always of a military nature. O’Brien and Hunt157 comment, for example, that the fiscal system established after the ‘Glorious Revolution’ provided funds to protect not only Britain, but also her ‘hegemony over the international economic order’. Locke did not dissent from this. He was not interested in redistribution from rich to poor but in raising funds for war against a possible Stuart restoration after 1689.158 Everyone bears a burden of taxation but its incidence for Locke is, as mentioned, limited to the landed interest. Whilst Locke accepted that those unrepresented in the system paid duties of customs and excise, he strongly believed that the burden of all taxes, in a landed society, finally fell upon land: This by the way, if well considered, might let us see, that taxes, however contrived, and out of whose hands soever immediately taken, do, in a country, where their great fund is in land, for the most part terminate upon land. Whatsoever the people is chiefly maintained by, that the government supports itself on: nay, ­perhaps it will be found, that those taxes which seem least to affect land, will most surely of all other fall the rents. This would deserve to be well considered, in the raising of taxes, lest the neglect of it bring upon the country gentleman an evil, which he will be sure quickly to feel, but not be able very quickly to remedy. For rents once fallen are not easily raised again. A tax laid upon land seems hard to the landholder, because it is so much money going visibly out of his pocket: and therefore, as an ease to himself, the landholder is always forward to lay it upon commodities. But, if he will thoroughly consider it, and examine the effects, he will find he buys this seeming ease at a very dear rate: and though he pays not this tax immediately out of his own purse, yet his purse will find it by a greater want of money there, at the end of the year, than that comes to, with the lessening of his rents to boot: which is a settled and lasting evil, that will stick upon him beyond the present payment.159

157  PK O’Brien and PA Hunt, ‘The Rise of a Fiscal State in England, 1485–1815’ (1993) 66(160) Historical Research 129, 170. 158  Andrew (2015), above n 11, 27. 159  Locke, above n 65. Andrew (2015), above n 11, 22. This became the target of David Hume’s arch scepticism in his essay ‘Of Taxes’ (1752) in EF Miller (ed), Essays Moral, Political, and Literary (Indianapolis, Liberty Fund, 1987) 342.

John Locke: Property, Tax and the Private Sphere 29 As Andrew points out, Locke must have known, as a former Registrar of the Excise, that excise duties raised, along with customs duties, much more than the land tax.160 However, he believed that, notwithstanding this, ‘labourers pass[ed] on excises in higher wages and merchants pass[ed] on customs duties as higher prices’.161 A just amount of taxation to pay depends on the level of protection received by the taxpayer from the state. To reiterate, ‘’tis fit every one who enjoys his share of the Protection, should pay out of his Estate his proportion for the maintenance of it’.162 This is one version at least of what is nowadays referred to as the benefit principle. Locke himself describes it as ‘the true proportion’, which is ‘in proportion to the assistance, which it affords to the publick’.163 Indeed, it is more than that. If the monarch convened Parliament on that basis, he could not: be judg’d, to have set up a new Legislative, but to have restored the old and true one, and to have rectified the disorders, which succession of time had insensibly, as well as inevitably introduced. For it being the interest, as well as intention of the People, to have a fair and equal Representative; whoever brings it nearest to that, is an undoubted Friend, to, and Establisher of the Government, and cannot miss the Consent and Approbation of the Community.164

It should now be clear why, when the benefit principle is mentioned in the debates of our own day, it provokes such vehement partisanship, for and against. If you believe Locke’s argument, since arguments based on ability to pay transgress a priori the right to property, it is simply unjust. Again, if you believe Locke’s argument, since that right to property is coincident with a right to privacy, implementation of the ability to pay principle marks an illegitimate incursion of the legislative competence of the state into the private sphere. So, paying tax is almost a kind of ‘subscription fee’ for the membership of a political society. Locke stresses that it is only a legitimate government which can impose taxes and can take part of a man’s ‘estate’ in payment. Any other sort of taking away of property, even by a government, is wrong.165 Taxing land is particularly conducive to this consensual approach.166 With land tax, the person assessed knows how much he is paying, whereas the purchaser of a commodity typically does not know how much of the price is taxation.167 Furthermore, land tax is self-assessed and the amount is

160 

Andrew (2015), above n 11, 27.

161 ibid. 162 

TTG2, para 140; Andrew, above n 11, 16. TTG2, para 158. 164 ibid. 165 ibid. 166  Andrew (2015), above n 11, 24. 167 ibid. 163 

30  John Snape and Jane Frecknall-Hughes agreed between gentlemen (Andrew notes that Locke himself tried to get his land tax assessment lowered by getting a friend to suborn an official, but we have not examined this).168 Unexpected and Suggestive On the reading of Locke promulgated here, note what his theory does, and does not, do. First, it relies on an abstract and common-law oriented conception of property. Secondly, it contains no mandate for redistribution from rich to poor. Rather, thirdly, in the guise of an argument about tax incidence, the less well-off are the incidental beneficiaries of a theory that, without reliance on ability to pay, seeks to places the chief burden of taxation— by consent—on the landed interest. Anyone reading the accounts of Locke’s political thought in Tully, Ashcraft or Hughes will find this unexpected. However, this is the older understanding of Locke and it is more closely in line with Macpherson’s and, even Waldron’s, readings than any of these other three. This is a subtle variation on the conclusion that Andrew reaches in relation to Locke and taxes. There remain the suggestive elements in the light of this last point. This reading might explain why, in a property and jurisprudence conditioned by Locke’s thought, a special treatment subsequently grew up for the trusts and tax treatment of charities. Charity is at a premium when justice is so narrowly defined. None of those objects with which charities’ law has traditionally concerned itself,169 on this view of the world, fall within the scope of the state’s responsibilities. At the same time, all are worthy of special treatment in the Lockeian view of political society and the role of property rights and of taxation within it. The traditional four charitable objects, ‘trusts for the relief of poverty; trusts for the advancement of education; trusts for the advancement of religion; and trusts for other purposes beneficial to the community, not falling under any of the preceding heads’,170 all fit within the Lockeian categories of political thought elaborated here. Of them, the advancement of religion is perhaps the most striking for its Lockeian definition. ‘I am of opinion that the Court of Chancery makes no distinction between one sort of religion and another’, said the Master of the Rolls, Sir John Romilly, one day in May 1862: ‘They are equally bequests which are included in the general term of charitable bequests’.171 Locke’s college would have nodded in assent.

168 ibid. 169 

These were expanded and somewhat modified in the Charities Acts 2006 and 2011. The Commissioners for Special Purposes of the Income Tax v John Frederick Pemsel [1891] AC 531, 583 (Lord Macnaghten). 171  Thornton v Howe (1862) 54 ER 1042, 1044. 170 

John Locke: Property, Tax and the Private Sphere 31 This reading may also show how the reason why taxation is not required to facilitate redistribution from rich to poor is that the theory elevates political necessity (the primacy of the landed interest) while excluding significant social obligations from the public sphere. So, providing for the poor is about personal charity, not political justice, and the only class of people who legitimately command our charity are those who cannot work: the individual can choose what to do. As Peter Laslett writes, ‘[i]n his published works he [Locke] showed himself the determined enemy of beggars and the idle poor, who existed, he thought, because of “the relaxation of discipline and the corruption of manners”’.172 Andrew notes that, ‘following a long correspondence pressing his reluctant agent, Cornelius Lyde, to evict a widow from one of Locke’s properties, Locke cited the Pauline dictum that those who do not work do not deserve to eat’.173 The reading of Locke’s theory of taxation elaborated here also suggests why Locke’s theory establishes or reaffirms a role for the private sphere and minimises the gravity of tax impropriety. Andrew suggests that ‘the view of taxation as a voluntary gift may justify tax avoidance strategies, as Locke himself practised, which impair the ability of liberal-democratic governments to raise revenues to meet its [sic] level of expenditures’.174 This may well be a matter for debate, but Lockeian thought is certainly consistent with an almost impermeable private sphere around which the tax system operates and with which it interferes only minimally. The reading finally might explain why many people are so unconcerned about inequalities perpetuated by the tax system. Again Voegelin’s comments are relevant: ‘Locke, while not representing the most desirable features of bourgeois ­society, certainly is a part of it, and there are millions like him who accept his principles as the standards of political order’.175 So, if not forbidden by positive law, by public law, the avoidance of taxes may nonetheless be subject to natural law. With Locke, as Voegelin writes, the public sphere does not acknowledge ‘the spiritual personality of man’, and ‘the public person of man’ is entirely defined by Lockeian property rights.176 Though it may appear a little too harsh, this in essence is an absolutely plausible version of the Lockeian position. Common law protection of the private sphere is, at one and the same time, both the guarantee of large tax revenues and the enemy to the overweening power of the taxing authority. The understanding and appreciation of this point, not just among the gentry, but also among those who hope to better their condition, is central to a new understanding of the nature and purpose of taxation in post-Revolution England.

172 

P Laslett, ‘Introduction’, in Locke, above n 17, 3–126, at 43. Andrew (2015), above n 11, 26. 174  ibid 28. 175  Voegelin, above n 26, 152. 176  ibid 151. 173 

32  John Snape and Jane Frecknall-Hughes CONCLUSIONS

Locke’s taxation theory comes out as uncompromising stuff. The distinction between taxation and expropriation, so Locke warns us, is perilously fragile. However, all is not lost. Property rights, for him, embody a morality capable of reinforcing that distinction. Such rights, he says, can be alienated by consent. Representative consent, an admittedly awkward political counterpart for personal consent, will nonetheless suffice. What makes taxes just is not, primarily, the distribution of burdens but the benefit received in return. Locke is, in a real sense, the benefit principle. The implications of all this are, as shown above, surprising and even shocking. It remains for us to sum up the key elements of our argument and, in the process, to show how it differs from and, in important senses, develops, the arguments about consent and possessive individualism in Andrew’s two recent articles. Our argument starts from the intuition that Locke is correctly associated with the philosophical isolation of private life from public life. His rather secretive ways of living, his idea of man being his own proprietor, and his emphasis on consent as the only valid basis on which property rights should be alienated, each support this intuition. All of this is Locke’s intellectual response to a turn in ideas, and twists in historical events, that had seen the denial of the rights of property holders, in different ways, both by radical movements during the Civil Wars and by apologists for absolutist—or patriarchal—kingship in the decades afterwards. The perilously fragile distinction between taxation and expropriation can be weakened still further in various ways by invasive notions of either a kingly state or a levelling society; by the denial of the moral possibility that an individual might pursue his, or her, own ends without responsibility for others similarly placed; and by the downgrading and corruption of ideas of consent. Locke is not a Whig oligarch as such, but someone who thinks that the spread of Whig values would benefit everyone. His ideas carried great sway in eighteenth-century England, just as a version of them does in twenty-first century America. The underlining of the distinction between taxation and expropriation—the force of Locke’s intellectual response to levelling and to kingly tendencies— is grounded in Locke’s common-law conception of property rights. The common law of property, correctly understood, he suggests, can do all that is required to reinforce the distinction. First, the common law of property is a form of positive law, and that positive law is older than the societal tensions that have thrown up the royal and communistic ideas of the seventeenth century. Secondly, because the common law of property is indeed law, it stands in contradistinction to prerogative, to kingly will. Thirdly, because it is wise, the common law has artificially imitated the principles of the law of nature in those limited areas of human endeavour into which it has extended its reach. Fourthly, because, as the law of a civil society, the

John Locke: Property, Tax and the Private Sphere 33 common law draws its morality from the pre-political law of nature, the common law of property is also moral. For Locke, the presumption is that those who today hold property rights do so justly, in direct descent from those who, before the institution of political society, first took the spade to the turf, and began to dig. The common law of property rights is therefore not, as the Levellers and Diggers would have people believe, evil and oppressive, nor, as the divine-right monarchists would have us think, superfluous or outmoded. Moreover, for Locke, the morality that the common law of property embodies precludes, almost by definition, any sense of contingent entitlement, any sense of a rival morality that would dictate progressive taxation and redistribution, even if that were possible with government and tax system as they were in late seventeenth-century England. Common-law property rights are, in the clearest sense, the absolute entitlement of their individual holders. Moreover, the common law of property has a distinctive quality that is the guarantee of a new privacy, of a new type of apolitical freedom. The jurisdiction of the common law of property extends only to those holding property rights recognised by common-law courts. The holders of those property rights are subject only to the law of nature within the physical spaces over which those property rights confer absolute control, most importantly, the household. Property rights, in short, embody a morality capable of reinforcing a distinction between the life of the statesman—of the state, of politics—and the life of ‘any private Man’—of the household, of economics. Philosophical distinctions, such as those just enumerated, inform and condition Locke’s treatment of taxation. Taxation, it will be recalled, at this late seventeenth-century juncture, referred pre-eminently to land tax, and also to hearth taxes, but not to duties of customs and excise. Those most concerned about taxation were those who held the common-law property rights and, in doing so, had holdings of a considerable value. The nature of those property rights contributes significantly to these people’s understanding of the nature of taxation. Taxation, for Locke, in no way defines property rights a priori: rather, it entails the alienation of some of those rights, according to a measure of justice. This understanding of taxation explains why, on the reading propounded here, Locke’s theory of taxation is ‘deontological’ rather than ‘consequentialist’. Murphy and Nagel put the point with characteristic terseness.177 They focus on the property rights that, on a consequentialist view, taxation modifies. With Locke, the deontological thinker, by contrast, ‘property rights are in part determined by our individual sovereignty over ourselves, … by a right of individual freedom that does not need’ any other ‘justification’.178 That, for Locke, is the essential

177 

Murphy and Nagel, above n 96, 43.

178 ibid.

34  John Snape and Jane Frecknall-Hughes moral strength of those rights. Alien to Locke would be the idea ‘that property rights are [instead] justified by the larger social utility of a set of fairly strict conventions and laws protecting the security of property’.179 Locke therefore stands in stark contrast to David Hume, for example. Moreover, were Locke’s theory a consequentialist one, its radicalism would not have been so apparent to those who read TTG1 and TTG 2 in the 1690s. The radicalism of Locke’s property theory is, and ever will be, its deontological character. Property rights can, as discussed, be alienated by personal consent or by representative consent. Taxation can only be by consent. Personal consent would be ideal. Representative consent will have to do. In the foregoing pages of this chapter, we have acknowledged the problems of representative consent, noted the doubts expressed by those unconvinced by it, and attributed Locke’s accommodation with those problems to the ­overwhelming need, within his system, to support the landed interest to the benefit of everyone. Moreover, having rehearsed the arguments from the earlier part of the chapter, it is now possible to underscore that political justification with a distinctively jurisprudential one. When Locke’s subject consents to taxation (or not), via his representative, he does so—implicitly or explicitly—by authorising his representative to consent (or not), irrespective of the three difficulties with majoritarian consent referred to above. ­Harrison would object that, nonetheless, the difficulty is a real one and, no doubt, had Locke himself been challenged, this what he would have said.180 However, what Harrison does not draw out, is that Locke’s response would not have been the glib retort of the casuist but one informed by the selfevident logic of a common law of property replete with fine distinctions and carefully-wrought conditions. Such a response would have been entirely consistent with a theory of property and of taxation that holds to the virtues of the common law. In the subsequent half-century, conditions of this kind, express or implied, would become commonplace in an increasingly sophisticated mercantile law of contract. What makes taxes just, given majoritarian representative consent, is neither redistribution, nor ability to pay, but the benefit received by the taxpayer. Those with the most to lose in an Absolutist Catholic invasion, and post-1690 Stuart restoration, were those who held the great estates. They should therefore pay. It seems to Locke, in any event, that this is where the incidence of all taxes falls. If a merchant is taxed, he passes the burden on to his customer. Where his customer is only scraping by, the customer cannot pay his creditors. Notably, these include the customer’s landlord.

179 ibid. 180 

Harrison, above n 103, 222.

John Locke: Property, Tax and the Private Sphere 35 The landlord has therefore to accept lower rents or turn his tenants out on the highway. Let us therefore stop pretending, Locke seems to say, that duties of customs and excise fall on the customer and recognise that they instead fall on the holders of estates. Duties of customs and excise are opaquely redistributive from rich to poor. The system should not operate in this way. It should transparently tax the landed gentry. They benefit and so they should pay. This is Locke’s benefit principle. Whether the analysis on which it is based be correct or incorrect, the principle is designed for the good of everyone. Merchants like it and, although it imposes an obvious burden on the gentry, it is better for them, too, because it recognises what Locke takes to be inevitable. The tax system has this limited redistributive role consistently with the fact that, in the seventeenth century, the overwhelming purpose of taxation is national defence. For an individual to pay taxes is for him to act justly. However, justice also requires that he will act charitably. In the context of charity, there is no point in the state differentiating between religious objects (unless Catholic or Islamic), or placing undue restrictions on charitable objects that aim at the relief of poverty. Religious sentiment is a sufficient prompter for individuals to relieve the poor. The latter will be provided for, though not by the state. So the implications of all this are surprising and even shocking. It is ­politically controversial when, today, people cling to the ideal of the benefit principle. In its historical context, however, the principle’s significance was very different. Nothing less uncompromising, or jurisprudentially robust, could have withstood the prerogative of a king, even a non-Stuart one, in the ­person of William III.

36 

2 The Birth of Tax as a Legal Discipline HANS GRIBNAU AND HENK VORDING

ABSTRACT

Adam Smith’s taxation maxims found fertile ground in the Netherlands in the early nineteenth century—a time of national tax reform. But as the ­century drew to an end, progressive liberal thinking parted from its ­British inspiration. John Stuart Mill’s ‘equality of sacrifice’ was rejected by ­Nicolaas Pierson, the leading political economist of his age, as being too i­ndividualistic. Instead, the German Historical School with its idea of an organic relation between state and citizens gave guidance, especially to ­Pieter Cort van der Linden’s work on taxation. Borrowing from the German concept of Rechtsstaat, he laid the foundations for tax as a legal discipline. INTRODUCTION

T

HE ACADEMIC DISCIPLINE of tax law as we know it today has its roots in the late nineteenth century. In the Netherlands, it emerged out of a confrontation between (predominantly British) classical political economy and ­German Staatslehre (theory of the state). This contribution analyses the impact of the relevant ideas on Dutch theorising about taxes. It is argued that tax law as a legal discipline is heavily indebted to the German tradition. This may help to explain why it has proven difficult to develop meaningful communication between tax lawyers and tax economists. The focus of this contribution will be on the development of tax doctrine in the Netherlands over the nineteenth century. The starting point is the ­revolutionary era of around 1800. The Dutch Republic was very much Ancien Regime, in the sense that local law and custom impeded the development of a tax state. It was probably more Ancien than France itself, because there was hardly any tendency towards centralisation of political ­authority. When the Republic imploded (1795) in the slipstream of the French

38  Hans Gribnau and Henk Vording ­ evolution, it left an enormous government debt and a wide array of local R taxes. The next decade witnessed the development of a national tax system (introduced in 1806), with revenues now accruing to central government. The ideals of the French Revolution called for sensible government institutions.1 A national tax legislator was seen as capable of developing a ‘system’ of taxation—a system that made sense in terms of fairness, effectiveness and economic impact. The debate on ‘good taxation’, relying on an economic analysis of taxes, was then fully developing in the UK and also in France. The intellectual climate of the Dutch Republic had traditionally been focused on France. The well-educated would therefore speak and read French; the university professors read and wrote Latin in addition—­English was definitely not the international language that it is today. English ­literature tended to trickle down through French writers and thinkers— Jean-Baptiste Say did much to make Adam Smith’s thinking accessible on the continent. Broadly speaking, English was still a language of commerce. We may assume that among the Dutch merchant class, a working knowledge of English was present. And indeed the early tax theorists—Alexander Gogel, Gijsbert Karel van Hogendorp—read Smith in English.2 Typically, neither of them visited a university. Later on, in the second half of the nineteenth century, English became more common, and John Stuart Mill was read in his own language. Nikolaas Pierson in particular, author of the first Dutch book on political economy and father of the first Dutch income tax, knew Mill’s Principles of Political Economy intimately—though we will see that he did not agree with some of Mill’s stronger conclusions on fairness in taxation and described him as an ‘old-English’ economist. Pierson was another man to never study at university—his doctor’s title was earned by doctorates honoris causa at Leiden and Cambridge. Tax theory in the Netherlands in the nineteenth century was therefore largely developed by practical men, outside of academia. And it owed much, we will argue, to the English tradition in political economy, and especially to Smith and Mill. But towards the end of the nineteenth century, there was a movement away from Smith’s classical liberalism and from Mill’s fairness/neutrality doctrine. Progressive liberalism (not to mention socialism) brought a broadening of state intervention in the economy. More than Pierson, Pieter Cort van der Linden marks the shifting orientation, away from political e­ conomy and towards the German debate on the proper role of state and law. As Webber and Wildavsky argue: ‘Acting in response to public pressure, 1  Article I of the French Declaration of the Rights of Man and of the Citizen (1789) reads: ‘Men are born and remain free and equal in rights.’ These rights of man were held to be universal—free individuals were thus protected equally by law. 2 Concerning Gogel: S Schama, Patriots and Liberators. Revolution in the Netherlands 1780–1813 (New York, Vintage Books, 1992); JA Sillem, De politieke en ­staathuishoudkundige werkzaamheid van Gogel (PhD thesis) (Amsterdam, Johannes Müller, 1864); J Postma, ­Alexander Gogel (1765–1821) (PhD thesis) (Hilversum, Verloren, 2017).

The Birth of Tax as a Legal Discipline 39 late nineteenth century legislatures derived authority to enlarge government power from the idea of legislative responsibility which had become the core of democratic theory.’3 The ensuing increase in state intervention was an important determinant of the birth of tax as legal doctrine. The chapter consists of three main sections. Section 1 discusses Adam Smith’s maxims for taxation and their impact in the Netherlands. Section 2 discusses Nicolaas Pierson’s position: critical of British political e­ conomy but still an economist unwilling to adopt the Staatslehre framework. ­Section 3 explores at some length how Pieter Cort van der Linden imbued the S­ taatslehre to lay the foundation for a legal analysis of taxation. THE IMPACT OF SMITH: DUTCH THINKING ON TAXATION IN THE EARLY NINETEENTH CENTURY

Smith’s Maxims for a Good Tax System The early tax theory in the Netherlands relied heavily on Smith. His four maxims for a good tax system show up in the (still limited amount of) tax literature, even when not explicitly referred to. Smith’s maxims are so well-known that a brief quotation will be sufficient:4

I. The subjects of every state ought to contribute towards the support of the ­government, as nearly as possible, in proportion to their respective abilities; that is, in proportion to the revenue which they respectively enjoy under the protection of the state. II. The tax which each individual is bound to pay ought to be certain, and not arbitrary. The time of payment, the manner of payment, the quantity to be paid, ought all to be clear and plain to the contributor, and to every other person. III. Every tax ought to be levied at the time, or in the manner, in which it is most likely to be convenient for the contributors to pay it. IV. Every tax ought to be so contrived as both to take out and to keep out of the pockets of the people as little as possible over and above what it brings into the public treasury of the state.5

3  cf C Webber and A Wildavsky, A History of Taxation and Expenditure in the Western World (New York, Simon and Schuster, 1986) 299–300. 4 A Smith, An Inquiry in the Nature and Causes of the Wealth of Nations [1776] ­(Indianapolis, Liberty Fund, 1981) V.ii.b, 1–6, 825–827. 5  Smith refers to Henry Home, Lord Kames, Sketches of the History of Man (London, W Strahan and T Cadell, 1774); cf WC Lehmann, Henry Home, Lord Kames, and the Scottish Enlightenment (The Hague, Martinus Nijhoff, 1971) 266–269. FK Mann, Steuerpolitische Ideale (Darmstadt, Wissenschaftliche Buchgesellschaft, 1978) 156 argues that Smith’s fourth principle comprises four of Home’s principles which makes it quite miscellaneous. Mann offers an extensive discussion of Smith’s principles—including the question of their originality.

40  Hans Gribnau and Henk Vording Though his first maxim, on equitable distribution of the tax burden, is the most famous, legal certainty carries serious weight. In his own words: ‘The certainty of what each individual ought to pay is, in taxation, a matter of so great importance, that a very considerable degree of inequality … is not near so great an evil as a very small degree of uncertainty’.6 Smith’s stress on the importance of legal certainty is easily explained. Without sufficient legal certainty every taxpayer ‘is put more or less in the power of the tax-gatherer’, who is at liberty to tax this person as he pleases.7 Smith evidently wants to reduce arbitrary taxation—a pervasive phenomenon in the eighteenth century.8 Legal certainty was not only endangered in the United Kingdom though. Alexander Gogel, who introduced a national tax system in the Netherlands, opined that ‘however onerous the obligations of the citizen to the republic were, the state should be in a position to let him know the worst and assess the limit of the contribution’.9 Moreover, it goes without saying that arbitrary taxation frustrates any attempt to distribute the tax burden in a fair way. Without legal certainty, distributive justice remains illusory. In this sense, legal certainty is instrumental to distributive justice. And indeed, Smith uses the criterion of an equitable distribution of the tax burden to judge the quality of contemporary taxes. For example, he criticises the inequity of exempting from excise duty the product of private brewing and distilling, and therefore the alcoholic consumption of the rich. Consequently ‘the burden of those duties falls frequently much lighter on the rich than upon the poor’.10 Thus, as Ross argues, ‘the exemption cannot meet the higher criterion of his first maxim of taxation’.11 Smith may best be understood, not as trying to define a remote ideal, but as making practical recommendations for improvements. His friend David Hume was very practical about tax equity, stressing convenience of collection and generality in application;12 and we should consider Smith’s views 6 

Smith, above n 4, V.ii.b,7, 827. above n 4, V.ii.b,4, 825. E Rothschild and A Sen, ‘Adam Smith’s economics’ in K Haakonssen (ed), The Cambridge Companion to Adam Smith (Cambridge, Cambridge ­University Press, 2006) 354 observe with regard to British taxes: ‘All were in varying degrees uneconomical. Some required a great number of officers’ to collect. … Others created temptations of tax evasion … Yet others were vexatious.’ 8  cf N Phillipson, Adam Smith: An Enlightened Life (London, Allen Lane, 2010) 257: ‘By Smith’s days there were eight hundred separate acts of parliaments affecting custom duties.’ 9  Schama, above n 2, 385. 10 Smith, above n 4, V.ii.k.45, 888–889. See for example E Anderson, ‘Adam Smith On Equality’ in RP Hanley (ed), Adam Smith: His Life, Thought, and Legacy (Princeton, Princeton University Press, 2016) 159, who argues that Smith is a moderate political egalitarian’, who ‘while not using the language of distributive justice, … often takes up distributive considerations in assessing institutions.’ 11  IS Ross, The Life of Adam Smith, 2nd edn (Oxford, Oxford University Press, 2010) 340. 12  D Hume, Essays Moral, Political and Literary, EF Miller (ed) (Indianapolis: Liberty Fund, 1987), Part II Ch 8. cf J Snape, ‘David Hume: Philosophical Historian of Tax Law’ in J Tiley (ed), Studies in the History of Tax Law, Volume 7 (Oxford, Hart Publishing, 2015) 421–464. 7  Smith,

The Birth of Tax as a Legal Discipline 41 on taxation as ‘largely an elaboration of Hume’s’.13 Smith’s synthesis of eighteenth century ideas about equity, fiscal efficiency and organisational rationality was a response to the flawed tax systems of his time. Gradually a new rule-bound paradigm for taxing, spending and financial administration replaced the opportunistic policies and practices of earlier ages.14 There is an interesting relation here to Smith’s general idea of the role of government: ‘liberty, reason and the happiness of mankind’ cannot flourish without ‘the authority and security of civil government.’15 Firm government allows for the division of labour that creates general welfare,16 which, by inference, arbitrariness of rules would destroy. To summarise the point: Smith’s main concern with taxation, much like Hume’s, was to reduce arbitrariness by generality of taxation, not to base all tax systems on some principle of distributive justice—‘a viable tax system was one that reflected the distribution of national wealth and was easy and cheap to collect; anything else would be seen as arbitrary and oppressive’.17 To our minds, his plea for legal certainty implied the demand for a uniform tax system enforced by a competent and disciplined tax administration bound by the law. The duty of the sovereign to protect every member of society and establish ‘an exact administration of justice’18 logically includes taxation—in that sense, Smith laid a foundation for the later juridification of taxation. More implicitly, his demand for equitable distribution of tax burdens had the same effect—under that banner, tax reforms of the nineteenth century replaced object-based taxes by more sophisticated taxes on individuals.

Dutch Thinking on Taxes: Gogel and Van Hogendorp The legacies of the old Dutch Republic were an amalgam of local taxes with limited revenue capacity, a huge government debt, and limited effectiveness of central authority. Under strong French influence, a considerable centralisation of power was achieved within ten years. Article 210 of the ­Constitution of 1798 stipulated that the Executive Body was to make a ­proposal for a ‘new system of general taxes to cover the expenses of the State

13 

Phillipson, above n 8, 234. cf Webber and Wildavsky, above n 3, 303. They point at the growing interest in individual rights during the seventeenth and eighteenth centuries, as a result of which taxes should be justified on equity grounds. 15  Smith, above n 4, V.i.g. 24, 802–803. 16  A Smith, Lectures on Jurisprudence (Indianapolis, Liberty Fund, 1982) 14 and 459. 17  Phillipson, above n 8, 234. 18  Smith, above n 4, V.i.b.1, 708–709. See also Smith, above n 16, 213: ‘Written and formall laws are a very great refinement of government.’ 14 

42  Hans Gribnau and Henk Vording and to service the debts of the entire Republic.’ The constitution went on to give more guidance: the design of this new system of general taxes should achieve that everyone pay tax according to his relative abilities, as derived from his properties, revenues and observable expenditures. More specifically, Article 210 of the constitution stipulated that no tax can be imposed on basic necessities, and that taxes on consumption, if unavoidable, should be aimed at non-necessary goods. These provisions neatly express the contemporary feeling that excises on everyday consumption goods were much too high compared to other potential tax bases. This program resulted in the national tax system introduced in 1805/6 by Alexander Gogel. Gogel was an outsider to the Republic’s oligarchy. Born in 1765 in the southern—catholic—part of the Republic, he spoke French fluently. That proved an advantage in Amsterdam’s revolutionary circles—the place where he started a modest trading company in the 1780s. When the French Revolution came to the Netherlands in 1795, Gogel’s career in politics took off. He specialised in financial issues—dealing with the government debt, but especially, tax reform. In the ups and downs of the revolutionary tides, his opportunity came in 1805. Nevertheless, the system that he introduced owed much to the past. Gogel used the French idea of quattre vieilles (taxes on land, on business, on windows, and on other signs of personal wealth) to relabel and reform existing taxes in the Netherlands; the main novelty was the ‘patent’, a business tax that followed the French example.19 Simon Schama, who devotes a full chapter of his Patriots and L ­ iberators to Gogel,20 suggests that he never felt much at ease in the higher social ­circles where his career brought him. And indeed, there is an admonition of a close colleague and friend, when Gogel had already obtained high office, that his cool treatment of people who deemed themselves to be too important to be ignored, earned him a reputation of pride and stubbornness.21 When, in 1810, Napoleon appointed him as a member of the Empire’s ­Conseil d’État (State Council), he wrote to the same friend: ‘You know how I think about these offices. I do not have to explain to you how uneasy and almost sick I feel of obtaining a position, that hundreds of people fruitlessly strive for.’22 Gogel was best left in quiet, making practical provisions for an effective national tax system.

19 The quattre vieilles were adopted in revolutionary France to reduce the state’s dependence on excises. Three of these had been enacted by the Assemblee Nationale in 1790: the land tax (contribution foncière), the tax on furniture (contribution mobilière), and the tax on professions (patente). In 1798 a window tax was added (impôt sur les portes et fenêtres). 20  Schama, above n 2, 494–524. 21  Quote from letter of Canneman to Gogel (1804) as published in Sillem, above n 2, 65. 22  Letter of Gogel to Elias Canneman, dated august 1810, published online in resources. huygens.knaw.nl/retroboeken/gogel_canneman/#page=595&accessor=toc&source=1

The Birth of Tax as a Legal Discipline 43 As the political tide turned in 1813/1815, Gogel withdrew from public life. He refused to take office under the first Orange king, William I. But he was secretly consulted on the 1821 tax reform, and at that occasion, he wrote a number of reports and letters that look back on his involvement with the tax system.23 It is interesting to see how, in evaluating Dutch tax policy since 1805, he closely follows all four of Smith’s maxims.24 He considered the ‘patent’ business tax the least successful part of his tax reform, putting much of the blame on changes after 1815—the tax had become too elaborate, its distinctions between professions too arbitrary, leaving the assessment of tax due a matter of tax officers’ personal discretion in all too many cases. More generally, he criticised the course of tax policy under King William. It had been shaped by the unification with Belgium (to be undone in 1830), and by the king’s fiscal needs. The Belgian economic interests were determined by early industrialism and, therefore, tariff protection against British produce. This caused evident tensions with Holland’s interest in free trade. And the fiscal needs of the king required that the number and burden of excises be increased. Current tax policy, Gogel summed up, has put all the burdens on small business, to relieve the poor but especially the rich. In his view, landowners and portfolio investors lived on the efforts of others, while men of business created prosperity. But that was ignored in the policies of the day. Why, he asked rhetorically, was there so much political debate about taxing domestic servants, and riding horses used by the wealthy classes? Why not debate the taxation on rental value, that burdened productive business?25 While he claimed to prefer practical evidence over untested theories, his comments show that he did not consider taxation a purely practical ­exercise. Tax laws have to fit in with a society that provides opportunities to all its members. The more equality of wealth exists in a society, the higher the levels of general ­prosperity, of honesty and decency, the less poverty, and therefore, the more ­willing taxpayers one will find … If a government finds itself in the dismal ­condition of having to tax its citizens heavily, it has to take care that everyone pay according to his ability in a predictable way, that small businesses are not taxed even heavier to the relief of the rich, that the poor are not further suppressed by taxation, so

23 In IJA Gogel, Memorien en Correspondentien betrekkelijk den staat van’s Rijks ­geldmiddelen in den jare 1820 (Amsterdam, Johannes Müller, 1844). 24  This was not an era of referencing; nothing in the text refers to Smith. Smith’s m ­ axims had been translated into Dutch (again, without any reference) as early as 1782 in G D ­ umbar, ­Vertoog over de algemeene grondregels (Campen, JA de Chalmot, 1782). It is only Van Voorthuijsen’s thesis on theories of taxation (E van Voorthuijsen, De directe belastingen ­inzonderheid die op de inkomsten. Eene staathuishoudkundige proeve ((PhD thesis) (Utrecht, Broese, 1848) that provides a full translation of the maxims, plus a discussion of comments in the English and French literature. 25  Gogel, above n 23, 43.

44  Hans Gribnau and Henk Vording that they keep access to improvement of their lives, that labour be encouraged, commerce not deterred, that business remains free and unhampered, that the tax falls, as much as possible, on all that exceeds need, that represents luxury, and depends on free choice.26

Smith might not have disagreed; but the point here is that the notion of equity as used by Gogel was as open and flexible as Smith’s. To Gogel, a tax system was good when it contributed to a good society. And, echoing Smith’s second maxim (on certainty) Gogel stressed that tax law should be ‘clear and understandable, and not require study to which most taxpayers are not capable.’ By ‘clear’ he meant that laws can be applied in a straightforward way, leaving tax administrators no discretion.27 To Gogel, tax administrators were much like Montesquieu’s judges ‘les bouches de la loi’: disinterested executors of the law code. The underlying idea of taxpayer protection seems to be that clear legislation and professional administration will do. A comparable pragmatism with regard to equal distribution of tax ­burdens is to be found with Gijsbert Karel van Hogendorp. He was a contemporary of Gogel, but from a different social class and political affinity. Being born in an aristocratic family (connected to the Orange stadtholders), his ambitions in public life led to nothing in the era of Revolution and Emperor. Van Hogendorp’s window of opportunity seemed to open up with the downfall of Napoleon. He operated as the kingmaker for William of Orange, and could rightly expect to become the new political leader under a constitutional king. King William, however, had a more pronounced role in mind for himself. The Constitution of 1815 gave extensive political power to the king and allowed him an astronomical yearly revenue. As a reward for his efforts, Van Hogendorp was created Count—but his leading position in government soon dwindled due to disagreements with the king. He became an ordinary member of parliament and a prolific writer of ­economic advices and comments. His favourite issue was the advantage of free trade, but he took up broader tax issues as well. He was familiar with the English political economy literature and shared its general worldview of free market liberalism. The relevant point here is his pragmatic view on ability-to-pay as a guideline for tax legislation. The Constitution of 1798 had, in fact, laid out the dilemmas that were to linger on for a century. Taxation should be aligned to citizens’ economic capacity as measured by their possessions, their revenues and their consumption; citizens were expected to fulfil their tax obligations in good faith; publication of their wealth and revenues was to be kept to the minimum. In other words: the proper tax base was fairly indeterminate, but intrusive tax administration was to be avoided. 26  27 

ibid 39. ibid 40–41.

The Birth of Tax as a Legal Discipline 45 Van Hogendorp developed an elaborate model28 that was later, by some, believed to be a proposal for an income tax. He probably had the ­Prussian Klassensteuer in mind when proposing to divide the taxpaying population in classes according to their prosperity. That Klassensteuer, ­ adopted in 1820, divided the citizens ‘into a small number of categories or classes, ­differentiated according to simple external criteria like social standing, occupation, general estimate of wealth, and ordinary mode of life’.29 Its explicit aim was to address differences in individuals’ socio-economic ­positions without requiring inspection of personal finances. In the same vein, Van Hogendorp proposed to divide the citizenry into classes according to their prosperity. To Van Hogendorp, the best measure of social standing and prosperity was consumption rather than income. He argued that a consumption tax leaves a citizen some choice. As long as he does not spend, he is not taxed; when he shows his wealth by spending it, he also shows his capacity to pay tax. We saw that Gogel advanced the same argument of personal choice—despite their widely different social and political backgrounds, they agreed in many of their tax policy analyses and preferences. Van H ­ ogendorp then makes a pragmatic twist. Overviewing the existing tax system of his days, he argues that it does reasonably well in taxing each social group according to its consumption. Implicitly rejecting the relevance of a choice between ­taxing consumption, revenues, possessions, or whatever standard of p ­ rosperity, he points out that the choice between tax bases is always an instrumental choice, not a choice of social goals. But he realistically adds: ‘This is not how the general public reasons; it looks at tax bases and thinks no further’.30 Summing up, in the first half of the nineteenth century Dutch thinking on taxation fully accepted Smith’s maxims and their background of economic liberalism. And as Smith left the normative issue of tax burden distribution relatively open, so did his readers in the Netherlands. Pragmatic improvement was preferred over principled design. JOHN STUART MILL AND THE TURN TOWARDS PROGRESSIVE LIBERALISM

Around the middle of the nineteenth century, Dutch academic circles were still strongly focused on the classical economic liberalism as worded by, inter

28  GK van Hogendorp, Brieven over de nationale welvaart (Diederichs, Amsterdam, 1831). cf D Slijkerman, Wonderjaren: Gijsbert Karel van Hogendorp, Wegbereider van Nederland (Amsterdam, Bert Bakker, 2013) 167. 29  ERA Seligman, The Income Tax (New York, The Macmillan Company, 1914) 228. 30  Van Hogendorp, above n 28, 153.

46  Hans Gribnau and Henk Vording alia, David Ricardo, Jean-Baptiste Say and Frédéric Bastiat. One ­illustration is the 1845 academic thesis of Van Voorthuijsen31 on tax ­theory. It is predominantly an exposition of the arguments of British (Smith, Ricardo, McCulloch) and French (Say, Bastiat) economists concerning taxation, with application to the Dutch tax system.32 Interestingly, the author reveals that his thesis is the first ever to be written in Dutch rather than Latin—he obtained special permission due to the subject matter. Usually, professors of political economy were appointed at law faculties, and they taught economics alongside law. A prominent example is Johan Rudolph Thorbecke, a professor at the Leiden law faculty who also gave courses in political economy, but gained renown as the leader of the 1848 liberal revolt and the architect of the liberal 1853 Constitution. The focus of these professors was on making international economic literature accessible to a Dutch audience—not on contributing to that literature.33 The early reception of Mill’s Principles of Political Economy (1848) in the ­Netherlands is not well-researched, though it seems that he was conventionally referred to as the ‘famous English philosopher and economist’. One journal article in 1854 expresses praise, while noting that the Dutch professors of political economy had lately kept too silent in public debates on ­government policy.34 The first translation in Dutch dates from 1875.35 At that time, Nikolaas Pierson was among a new generation of progressive liberal professors, and perhaps the first to gain some international reputation as an economist. His response to Mill was critical: he explicitly rejected Mill’s ideas on tax equity as individualistic old-fashioned liberalism. His younger colleague Pieter Cort van der Linden was even more radical in his departure from the old English school of political economy. That brings us into the last quarter of the nineteenth century—and straight into the first true debate on taxation principles. The two main players are Pierson and Cort van der Linden. Both wrote voluminous handbooks on public finance and taxation. But their intellectual sources were different.

31 

Van Voorthuijsen, above n 24. It should be added that quite a number of long-forgotten German authors on tax matters are mentioned as well. 33 One of the leading classical liberals, professor Vissering, argued even in 1860, in his Handbook of practical political economy, that Dutch economists were too eclectic, too l­ittle interested in theory, and too much reliant upon indirect knowledge of the foreign economic literature: S Vissering, Handboek van praktische staathuishoudkunde (Amsterdam, Van ­ Kampen, 1860) 400. 34 A review of HA Wijnne, Waarde, Geld en Crediet in den Wereldhandel volgens de ­beginselen van John Stuart Mill (Groningen, JB Wolters, 1854) in (1856) 20 De Gids 293–294, by M. The reviewed booklet aimed at introducing some of Mill’s economics in the Dutch ­literature: the reviewer advises to read the English original instead. 35  John Stuart Mill’s Staathuishoudkunde (eerste deel), trans. Jacques Oppenheim ­(Groningen, JB Wolters, 1875); a French translation appeared in 1854 as Principes d’Economie Politique (Paris, Guillaumin, 1854). 32 

The Birth of Tax as a Legal Discipline 47 In a slightly agitated exchange of views in 1888, Pierson said that Cort van der Linden’s work was influenced by ‘a philosophical wind (…) from the East’.36 He notes that the German literature on taxation shows limited understanding of the economic impact of taxes, focusing on practical and historical issues; moreover, that Cort van der Linden does not show a full understanding of the economics of taxation either.37 Cort van der Linden replied that Pierson’s mind was apparently ‘more open to the simple logic of English Political Economy than to the more profound German ideas.’38 He criticised pragmatic eclecticism and argued that the time had come to consider the basic principles of taxation. In fact, both men were progressive liberals, and critical of classical economics—but their debate reflects the start of a separation between (Pierson’s) economic analysis of taxes, and (Cort van der Linden’s) development of a legal perspective on taxation. Mill’s Revision of Smith’s First Maxim The idea that the primary task of tax theory is to define the fair distribution of the tax burden was theorised and made popular by John Stuart Mill. Mill made fairness into a positive program for tax reform. To be sure, the chapter of his Principles of Political Economy that deals with taxation commences with quoting Smith’s four maxims at length. Mill then comments that the maxims 2 (certainty), 3 (ease of collection) and 4 (neutrality) are self-evident, but that maxim 1 (on equity) is ‘often imperfectly understood’ due to ‘false notions’. In his opinion, equality in taxation has a fairly precise meaning in terms of burden distribution: For what reason ought equality to be the rule in matters of taxation? For the reason that it ought to be so in all affairs of government. As a government ought to make no distinction of persons or classes in the strength of their claims on it, whatever sacrifices it requires from them should be made to bear as nearly as possible with the same pressure upon all, which, it must be observed, is the mode by which least sacrifice is occasioned on the whole. If any one bears less than his fair share of the burthen, some other person must suffer more than his share, and the alleviation to the one is not, caeteris paribus, so great a good to him, as the increased pressure upon the other is an evil. Equality of taxation, therefore, as a maxim of politics, means equality of sacrifice. It means apportioning the contribution of each person towards the expenses of government so that he shall feel

36 

NG Pierson, ‘Nieuwe litteratuur over Belastingen’ (1888) 52 De Gids 288. ibid 289. 38  PWA Cort van der Linden, ‘Drie vragen van belastingbeleid’ (1888) 45 De Tijdspiegel II, 333; see also J den Hertog, Cort van der Linden (1846–1935) (Amsterdam, Boom, 2007) 110–111. 37 

48  Hans Gribnau and Henk Vording ­ either more nor less inconvenience from his share of the payment than every n other person experiences from his.39

By translating fairness into equal sacrifice, Mill suggested measurability: the question how the tax burden should be distributed over the citizens seemed to be opened up to academic analysis. And by quoting Smith extensively, he suggested a continuous line of thought: distributive justice was the core of normative tax theory. He, Mill, had only made that core more explicit and precise. On this basis, he could also distinguish between normal and i­nstrumental use of taxation. In fact, he argued, if a government levy is aimed at something else than establishing fair contributions, it is by ­definition not a tax. To Mill, the ‘fair contributions’ tax is a neutral tax, it leaves the distribution of social welfare unaffected. By taxing neutrally, the state accepts as a principle that voluntary market transactions create just individual ­entitlements. Any levy to correct non-justifiable market outcomes should not be called a ‘tax’, as the payment should not reduce the payer’s fair contribution. An example is the structural increase in the value of land—the increase is due to demographic pressure, not to the landowners’ efforts; the levy used to reduce that increase is not, by definition, a tax.40 Summing up, what Mill added to tax theory was the idea that fair distribution of the burden is not an important though slippery ideal, but the primary aim of any tax system, and object of calculation and measurement. Pierson’s Response to Mill Nicolaas Pierson can be considered the first economist in the Netherlands who participated in the international academic debate. He started his career at a time when John Stuart Mill was already an ageing man. ­Nicolaas Pierson was born in 1839 to a well-to-do Lutheran merchant family in Amsterdam. Instead of going to university, he went to Louisiana to study the cotton ­production; back in Holland he quickly became director of the Dutch Central Bank. After a doctorate honoris causa at Leiden, he became a professor in Political Economy in Amsterdam, and wrote a two-volume book on ­Political Economy that educated the first generation of economists in the ­Netherlands. He corresponded frequently with the Austrian economists of his time,

39  JS Mill, Principles of Political Economy [1848] (Fairfield, August M Kelley Publishers, 1987), V.2.7, 804. 40  ibid V.2.30, 820. ‘… the existing land-tax (…) ought not to be regarded as a tax, but as a rent-charge in favour of the public; a portion of the rent, reserved from the beginning by the State, which has never belonged to or formed part of the income of the landlords, and should not therefore be counted to them as part of their taxation, so as to exempt them from their fair share of every other tax.’

The Birth of Tax as a Legal Discipline 49 e­ specially with Von Böhm-Bawerk. He was also acquainted with the leading English economist Alfred Marshall. One of the letters that he received at his deathbed was precisely from Marshall: ‘all the ladies who had met you here, spoke frequently of “that dear dr. Pierson”; and all the men vied with one another in praises of your bright mind, your perfect quiet oratory and your fascinating bonhommie’.41 Pierson indeed had a very sharp mind, had read widely both in economics and law, not to mention history, and had always remained a gentle and unpresumptuous man. His achievement in the field of economics was, in his own words, introducing and explaining new thoughts as he found them in the international ­literature. He was not, as Marshall did write to him, another Smith or Turgot. But while much nineteenth century reading can nowadays be dull, his work, and especially his many essays and articles, are as vivid as ever. He was among the few who introduced the deductive method of economic reasoning in the Netherlands: you start with well-defined assumptions on human behaviour and you see where these bring you.42 His Handbook on Political Economy showed how he supplemented classical economic reasoning with practical insight. In his lengthy chapters on taxation, his starting point was modest: economics can help to develop an efficient tax system— ie, a system that poses the smallest possible burden to national welfare. But for the tax legislator, the more important duty is to prevent discontent with taxes. And in that respect, economic reasoning cannot be of much help. Economic analysis was confined to developing tax rules that would adequately fund the government budget with the least possible distortion of economic life. Equity in the distribution of the tax burden was, on the other hand, not an economic category. Or not fully at least, as he does discuss the different views on the matter, all of them unsatisfactory. In the end, he believed that tax burden distribution was a matter of political deliberation driven by ‘humanity’—not by any well-defined and workable principle. By and large, and also in his many other contributions to tax theory and to the tax policy debate, he remained fairly agnostic on economic arguments relating to tax burden distribution. To Pierson, equitable distribution of the tax burden was not the main goal of a tax system. A tax system should generate adequate revenue. In comparison, an individual’s right to be taxed equitably carries much less weight: ‘if the general interest demands that you, though not wealthier than someone else, yet pay higher taxes, you will have to live with it, just like a soldier has to obey his general’.43 Mill’s requirement that a person shall feel neither

41  JGSJ van Maarseveen (ed), Briefwisseling van Nicolaas Gerard Pierson, 1839–1909. Deel III 1898–1909 (Amsterdam, De Nederlandsche Bank, 1993) 542. 42  NG Pierson, Leerboek der staathuishoudkunde. Eerste deel [third impression] (Haarlem, De erven F Bohn, 1912) 39 ff. 43  Pierson, above n 36, 295.

50  Hans Gribnau and Henk Vording more nor less inconvenience from his tax payments than his co-citizens is just a second-rank requirement, Pierson argues. It only means that taxes should not be more inconvenient to some person without proper (‘general interest’) reason.44 He was also a politician to acknowledge the ‘social question’ of labour conditions, which positioned him on the progressive wing of his liberal party. He believed classical liberal laissez faire to be outdated. For progressive liberalism, state intervention—to be paid for by higher levels of taxation, entailing more and more equitable taxes—was not anathema anymore. As a progressive liberal, Pierson headed the ‘Social Justice Cabinet’ (1897–1901) that introduced a wider voter franchise and the first disability and old age insurance. Previously, he was also the man to introduce an income tax in the Netherlands, as Minister of Finance in 1892/3. His perception of the income tax was highly influenced by Mill, but interestingly, in a negative way. He did not believe that Mill’s equal sacrifice approach could be of use in designing an actual income tax. This criticism concerned both the base and the rate. As to the choice of tax base, he did not share Mill’s notion that any specific tax base (be it all income or consumed income) could be relied upon to achieve equal sacrifices. He noted that some people work harder than others, that some have to make more expenses than others, that people have different positions in social life, etc. There is no tax base that can do full justice to all those differences, at least, Pierson added, the income tax was rated much too highly in this respect. As to the tax rates, and how progressive these should be, again, ‘equal sacrifice’ gave no practical guidance. Mill, Pierson later wrote, brings us in big problems. He describes us the land where we are to go but gives no map, no guidance on how ever to get there.45 In fact, Mill’s concept of tax equity was the reason why Pierson labelled him an old-style classical English economist. He considered Mill’s criterion too individualistic, as if independent individuals decide how to share the costs of some project of cooperation. Indeed, for Pierson all laissez faire economics was deficient in this respect: all individual improvement presupposes social cooperation. But while in his younger years, Pierson had sympathised with the German Historical School of economic thought,46 he later came to object to German Katheder-socialism for accepting erratic economic reasoning to reach political conclusions.47 Methodologically, the writers of that

44 

ibid 295–6. NG Pierson, ‘Belasting naar den Welstand’ (1879) 43 De Gids 1–24. 46 For a general background J Dorfman, ‘The Role of the German Historical School in American Economic Thought’ (1955) 45(2) The American Economic Review 17–28. 47  J d’Aulnis de Bourouil, ‘Levensbericht van Mr NG Pierson’ [1911] Jaarboek Koninklijke Nederlandse Academie van Wetenschappen 18; NG Pierson, ‘Het katheder-socialisme’ (1878) 42 De Gids 257–280. 45 

The Birth of Tax as a Legal Discipline 51 school advocated inductive reasoning, based on the collection of large quantities of historical and statistical information. They argued for social reform through state intervention, which earned them the name Katheder-socialists (‘socialists of the chair’). They did not mind this epithet at all, feeling that ‘their critics who would not accept, for example income taxation, were reactionaries.’48 Pierson instead tried to balance rigorous, deductive economic reasoning and openness to historical and social context—even when, to our minds, he tended to associate the former attitude with ‘science’ and the latter with ‘politics’.49 However, he saw no use for statistical information, deeming clear concepts and abstract rules more important—which to his mind the Germans did not deliver, on the contrary.50 His distance to Mill may have been smaller than he believed. Mill, in ­section 4 of the Preface to his Principles, had confessed: ‘For practical purposes, Political Economy is inseparably intertwined with many other branches of Social Philosophy. Except on matters of mere detail, there are perhaps no practical questions, even among those which approach nearest to the character of purely economical questions, which admit of being decided on economical premises alone.’51 Much like Mill, Pierson allowed non-economic arguments to be included in answering questions of economic policy and tax design, while at the same time defending the deductive purity of the economic method. THE GERMAN IDEA OF RECHTSSTAAT: CORT VAN DER LINDEN

Like Pierson, Cort van der Linden was an academic but also a politician. He was Minister of Justice in Pierson’s 1897–1901 Cabinet, and became prime minister between 1913–1918. He was one of the leaders in the shift from conservative to progressive liberalism in the third quarter of the ­nineteenth century. How did this change in liberal thought come about? The world as Smith had known had indeed dramatically changed. As Polanyi observes, ‘Adam Smith, in 1776, had been reflecting the mood of quiet progress.’52 But that had quickly changed, like a groundswell. Capitalism disrupted 48 H Landreth, A History of Economic Theory: Scope, Method, and Content (Boston, Houghton Mifflin Company, 1976) 274. 49  As a Cabinet Minister, he once explained in parliament that as a theorist, his aim was to contrast different perspectives, while as a practical man, he tried to reconcile them. Handelingen II (ie, the Hansard of the lower, Second Chamber of Parliament) 1891–1892, 23 juni 1892 1067. Likewise, according to Landreth, ibid 275, Schmollers in his earlier writings ‘was willing to admit that both methodologies had a place in economic investigation.’ 50  JGSJ van Maarseveen (ed), Briefwisseling van Nicolaas Gerard Pierson, 1839–1909. Deel II 1885–1897 (Amsterdam, De Nederlandsche Bank, 1992) 665–666. 51  Mill, above n 39, xxviii. 52  K Polanyi, The Great Transformation: The Political Origins of Our Time (Boston, ­Beacon Press, 2001) 97.

52  Hans Gribnau and Henk Vording ­ reviously existing practices and upset familiar ways of life. ­Industrialisation p created new jobs for workers in factories. Low paid factory work h ­ owever meant dangerous conditions and long hours. Growing population lead to urban growth with poor overcrowded working-class neighbourhoods.53 The ensuing demands for social reform, as for example voiced by socialists, put pressure on liberals to engage with the ‘social question’ and rethink the laissez faire doctrine. Liberals like Pierson and Cort van der Linden thought the classical l­iberal tenet led to individualism and materialism. Classical liberalism’s focus is on negative liberty, in the famous terminology of Isaiah Berlin.54 This ideal of non-interference corroded social justice, it was thought. The state should therefore interfere with the (negative) liberty of the individual to enhance social justice and positive liberty. For Berlin, positive liberty—or autonomy—derives from my wish that ‘my life and decisions to depend on myself, not on external forces of whatever kind.’55 It can be conceived broadly as the possibility to self-development and to participation in shaping society and the state.56 Progressive Dutch liberals, such as Pierson and Cort van der Linden maintained that liberty was not a matter of an atomistic individual but was embedded in society. Individualism and negative liberty were replaced by—a measure of—state interference and positive liberty. These liberals viewed individual citizens as parts of an organic unity connected by the division of labour and mutual interdependency. Individuals are thus metaphorically like cells that constitute society—seen as an organic unity. The state represents society and therewith in varying degrees the interests of the citizens.57 The state should therefore interfere to enhance individuals’ prospects of self-development.58 In this respect, Cort van der Linden went further than Pierson in advocating state interference in order to enhance social justice. Cort van der Linden authored a Handbook on Finance that deals extensively with taxation. His distinctive contribution to tax theory is the introduction of both an explicit legal perspective and an ideal of social justice as essential dimensions of taxation. Both are determinants of the birth of tax as a legal discipline. Thirdly, he advocated a more systematic approach

53 R Winks and J Neuberger, Europe and the Making of Modernity (Oxford, Oxford ­University Press, 2005) 103–107. 54  I Berlin, ‘Two Concepts of Liberty’ (1958) in I Berlin, Four Essays on Liberty (Oxford, Oxford University Press, 1969) 122: ‘I am normally said to be free to the degree to which no man or body of men interferes with my activity.’ 55  ibid 131. 56  C Taylor, ‘What’s Wrong with Negative Liberty’, in A Ryan (ed), The Idea of Freedom: Essays in Honour of Isaiah Berlin (Oxford, Oxford University Press, 1979). 57 PWA Cort van der Linden, Leerboek der Financiën. De theorie der belastingen (‘s-­Gravenhage, Gebr. Belinfante, 1887) 64. 58  MWF Treub, ‘De staat en het eigendomsrecht’ (1896) XXII(I) Vragen des tijds 76–77.

The Birth of Tax as a Legal Discipline 53 by arguing for a principled rather than pragmatic approach of taxation. The legal perspective was the upshot of his starting point that tax theory is the application of the science of the state.59 The (sovereign) state makes law and exercises supreme power over society, it permeates society with its laws. The monopoly of (legislative) power and a centralised apparatus of the state, such as Gogel’s national Dutch tax system and national tax authority, greatly enhanced the effective exercise of sovereignty. Tax law rather than economics therefore teaches the means by which the principles of taxation can be realised. The laws are principle-driven: ‘Tax law is the incarnation of tax principles.’60 Tax theory as part of public finance theory is therefore situated on the interface of constitutional law and public finance. Hence, he advocates to view the study of taxation as a legal discipline, not a financial discipline, as it had developed over the nineteenth century. According to Cort van der Linden, the relationship between the state and its citizens is not to be compared with the relationship between individuals who exchange goods and services, as if there were a ‘market for government services’.61 The state is not an association of individuals who cooperate on an exchange base (do ut des). Rather, it is an autonomous entity elevated above and at the same time supported by the individuals. ‘The citizen owes his taxes not to a representative of his interests but to the communal being which he himself is part of.’62 Like other progressive liberals, he thus extended the authority of the state and consequently the sphere of taxation.63 As will be shown below, Cort van der Linden was well read in German legal literature. This may explain his own style of writing, which made Pierson comment that Cort van der Linden ‘does not always express his ideas clearly, though after reading and reading again, I believe to have grasped his intention.’64

59  Cort van der Linden, above n 57, 1. At 4 ff he deals with the German social political conception of the state. Thus, the Dutch term staatsleer was derived from the German ­Staatslehre that emerged during the nineteenth century. The Staatslehre initially treated ‘the science of the state as a single discipline embracing political theory, sociology, and law’; M Loughlin, ­Foundations of Public Law (Oxford, Oxford University Press 2010) 190. Loughlin 190–204 gives an overview of the development of this peculiar field of knowledge. 60  Cort van der Linden, above n 57, 59. 61  Cort van der Linden, ‘Belastingbegrippen’ (1884) 48 De Gids 190–91. As shown above, he strongly disagrees with the pragmatic approach of contemporary economists who to his mind follow Smith—criticising existing practice merely on the basis of the principle of formal equality without developing any systematic view on state and (political) economy: Cort van der Linden, above n 57. 62  Cort van der Linden, above n 57, 149. 63  As Loughlin, above n 59, 87 observes: ‘Liberal political philosophies did not limit state power; in restructuring its forms, they actually extended its authority.’ 64  Pierson, above n 36, 287–318.

54  Hans Gribnau and Henk Vording German Inspiration: The Rechtsstaat Cort van der Linden’s is a juristic conception of the state, for he was inspired by the German idea of the Rechtsstaat rather than the English doctrine of the rule of law. The former sees the legal organisation of the state as the essence of the Rechtsstaat from which follows the essential principle of the legality of administration.65 Thus the concept of the Rechtsstaat, or the state under the rule of law, was developed in nineteenth-century German jurisprudence as part of the broader doctrine of the state. The state exercises authority through the medium of law. Individuals are citizens who are members of the state—being ‘both subjects of the state and objects of rule.’66 Note that the term ‘law’ has a connotation with a meta-legal sphere above the positive law of particular states—relying heavily on the distinction between Gesetz und Recht.67 Legislation (Gesetz) ordained by the state does not exhaust the law (Recht). Fundamental legal principles which do not originate with any particular state ‘transcend’ positive law.68 Consequently, government should exercise power according to pre-established legal principles. Legislation should be in conformity with these principles. The ‘law bound’ state limits its own power, being subjected to fixed mechanisms and pre-existing principles. The (sovereignty of the) state ‘is still the dominant source of what should count as law’,69 but the law also set limits to the exercise of sovereignty. The sovereignty of the state is its sovereignty over free individuals, ie persons holding legal rights. By recognising the ‘legal personality’ of these individuals, ‘the state limits itself, by drawing a line between itself and the personality of its subjects.’70 Thus the state recognises a legally protected sphere of individual freedom it has to respect. The requirement that ­government should exercise power through law and abide by law, as transplanted by Cort van der Linden to taxation, is an important factor in the juridification of taxation and the growth of a doctrinal approach to tax law in the Netherlands as will be shown below.

65 cf FL Neumann, The Rule of Law. Political Theory and the Legal System in Modern ­Society (Leamington Spa, Berg Publishers, 1986) 180: The legal organisation of the state alone is to guarantee freedom and security. According to Neumann the essence of Rechtsstaat consists in the separation of the political structure of the state from its legal organisation, which accounts for the difference from the English doctrine of the relation between the supremacy of Parliament and the rule of law. 66  Loughlin, above n 59, 192. 67 F D’Agostino, ‘The State under the Rule of Law’ in AM Rieu and G Duprat (eds), ­European Democratic Culture (London, Routledge, 1995) 105. 68  cf Cort van der Linden, above n 57, 110. 69 G Palombella, ‘The Rule of Law and its Core’ in G Palombella and N Walker (eds), ­Relocating the Rule of Law (Oxford, Hart Publishing, 2008) 20. 70 G de Ruggiero, The History of European Liberalism [1927] (Boston, Beacon Press, 1959) 259.

The Birth of Tax as a Legal Discipline 55 State Intervention on Behalf of Social Justice A second determinant is the ideal of social justice which Cort van der L ­ inden saw as an essential dimension of taxation. Again, he turned to G ­ ermany to find a theory which connected the ideal of social justice to a theory of state and law. As explained above, Cort van der Linden was inspired by the German idea of the Rechtsstaat—accounting for his juristic conception of the state. More specifically, he took his cue from Lorenz von Stein (1815–1890)—‘one of the most astute nineteenth-century German scholars of the state.’71 Cort van der Linden saw Stein as ‘the pioneer of financial science … not an economist in the first place, but his strength lies in administrative law.’72 Indeed, Stein maintained that the administration was the true core of the state, stressing the importance of the legal methodology of administrative law as balancing the state’s aims and the citizens’ liberty.73 Administrative law was the instrument for achieving the goals of the state as established by law on the one hand and of the legal protection of the liberty of the citizens on the other. Cort van der Linden applied these insights to tax law—a branch of administrative law in the civil law tradition—both factors account for its rise as a legal discipline. As for law in general, according to Stein ‘law is essentially an element in the organism of the state; it therefore takes form from the life of the state; and its value is dependent upon whether it accords with the state in its fundamental idea and specific manifestation.’74 Being the form rather than the restraint of the state, ‘law is the specific voice of the state’.75 The state is not a machine but an organic entity.76 Stein assigned an active role to the state which ‘has its own essence, law, morals and science’, in Cort van der Linden’s rendition.77 The administration of the state serves the interests of all households together. Here, Stein argues for a reciprocal dependency: the administration looks after the

71  Loughlin, above n 59, 209. To M Stolleis, Public Law in Germany, 1800–1914 (New York, Berghahn, 2001) 382, Stein is the last great representative of the complete political-scientific outlook (unsuccessfully) trying to unify the methodologies of philosophy, history, political science, sociology, law, and economics ‘to encompass and knit together the areas, which were at the time straining to separate.’ 72  Cort van der Linden, above n 57, 5. Interestingly, in his Lehrbuch der Volkswirtschaft (Wien, Wilhelm Braumüller 1858) Stein regards both philosophical deduction and empirical induction as indispensable methods: S Koslowski, ‘Lorenz Jacob Wasmer von Stein’ in R Voigt and U Weiß (eds), Handbuch Staatsdenker (Stuttgart, Franz Steiner Verlag, 2010) 407. 73  Stein saw an internal unity between constitutional and administrative law: Stolleis, above n 71, 382. 74  Cited in E-W Böckenförde, State, Society, and Liberty: Studies in Political Theory and Constitutional Law (New York, Berg, 1991) 5 (n 14). 75  Palombella, above n 69, 20. 76 L von Stein, Handbuch der Verwaltungslehre und des Verwaltungsrechts [1870], Utz Schliesky (ed) (Tübingen, Mohr Siebeck, 2010) 5. 77  Cort van der Linden, above n 57, 5.

56  Hans Gribnau and Henk Vording ­ aterial interests of the citizens and is enabled to do so by the citizens’ tax m payments. This interdependency is the driver of an organic societal development viewed as ‘a life process.’78 Stein was evidently inspired by Robert von Mohl who early in the nineteenth century programmatically expressed this kind of organic view on state and society. Mohl understood the society to be ‘the sum of life cycles formed through specific interests and habits, the individual and the family on the one hand, the state on the other.’79 ‘Interest’ is the common driver of society and individual. The goal of society is the empowerment of the individual as a free, self-determining ­person.80 Stein actually predicted the rise of the welfare state.81 For Stein, the French Declaration of Rights (1789) provided societal rather than political principles which reshaped the role of the state into enhancing (‘positive’) liberty.82 He thus distanced himself from the idea of an almighty state, for the human rights of the individual are the point of departure of both state and society. But Stein also extended the role of the state. He maintains that the state should not only accommodate the tension between the various interests in society but also actively create equality and therefore interfere with s­ ociety.83 He prepared the ground for the modern social welfare state, social reform enhancing equality. For Stein, a general obligation to pay tax is the foundation of a rational tax system and the prerequisite of individuals’ liberty.84 Stolleis renders Stein’s position as follows: the state overcomes ‘the lack of freedom that dominates the society and first creates the material prerequisites of personal freedom.’85 This implies a substantive conception of the

78 

ibid 6. Stolleis, above n 71, 129. EW Böckenförde, ‘Lorenz von Stein als Theoretiker der Bewegung von Staat und Gesellschaft zur Sozialstaat’, in EW Böckenförde, Recht, Staat, Freiheit. Studien zur Rechtsphilosophie, Staatstheorie und Verfassungsgeschichte (Frankfurt am Main, Suhrkamp, 2006) 185. 81  On the basis of his deep theoretical understanding of the historical development of state and society in modern Europe he saw this as a consequence of the French Revolution. Some contemporary critics labelled this prediction a product of speculative philosophy: EW Böckenförde, above n 80, 172–174. In the Nazi era, Stein’s ‘meta-positivist’ theory was abused by some German administrative law theorists idealising community and trying to ignore the tension between state and civil society, community and individual which was so vital to Stein: M Stolleis, Geschichte des öffentlichen Rechts in Deutschland, Dritter Band 1914–1945 (München, Verlag CH Beck, 1999) 367. 82  Böckenförde, above n 80, 182–183, 189. 83  Stein, above n 76, 39. Mohl already recognised the significance of social issues and its implications for law: Stolleis, above n 71, 129. He promoted the idea of positive freedom through the state in place of (the prevailing) Kantian ‘negative freedom’: Loughlin, above n 59, 318–319. Loughlin renders the characteristics of the Rechtsstaat in Mohl’s theory as follows: equality before the law, care for the maintenance of individuals in all suitable cases, equal access of all competent citizens to all public officers, and finally, personal liberty. 84  Koslowski, above n 72, 407. 85  Stolleis, above n 71, 383. 79  80 

The Birth of Tax as a Legal Discipline 57 rule of law, because it requires conformity ‘with justice of a moral ­principle’ such as substantive equality.86 However, Stein’s theory slowly passed into oblivion. After the débâcle of the revolution of 1848, the relation of the Rechtsstaat to the welfare aims of the state dwindled. In the succeeding period of German liberalism, the Rechtsstaat theory ‘only stressed the negative character of the state, that is to say the protection of liberty and the maintenance of the legal order.’87 Formal conceptions of the rule of law thus came to prevail in Germany, not seeking to pass judgement upon the actual content of the law itself. Nonetheless, state intervention increased to empower citizens and enhancing social justice in the way intended by progressive liberalists. Tax Principles Include Social Justice In the Netherlands the substantive conception of the rule of law as a­ dvocated by German scholars got a second life in tax theory, for indeed Cort van der Linden was inspired by Stein’s conception of the Rechtsstaat.88 This was underpinned by his organic view: the state represents society and therewith in varying degrees the interests of the citizens.89 As will be shown, this juristic conception of the state is inherently ­connected to the ideal of social justice, for Cort van der Linden conceptualises social justice as a legal principle. Moreover, he applies this ideal to taxation—entailing that social justice should determine the design of a tax system. In short, social justice demands a measure of substantive equality, though definitely not absolute equality, and taxes are an instrument to achieve this. Building on Stein’s conception of the Rechtsstaat, Cort van der Linden argues that the general principles of taxation derive from this conception of the state and thus the relationship between state and society.90 He stresses the legal foundation of taxation even more strongly than Stein, arguing that Stein still uses too much of an economic perspective.91 In the introduction of his textbook, he states that ‘economists too readily view the tax

86  BZ Tamanaha, On the Rule of Law: History, Politics, Theory (Cambridge, Cambridge University Press, 2004) 92. 87  Neumann, above n 65, 181. 88  This is not to say that he was uncritical towards Stein, see below n 91. 89  Cort van der Linden, above n 57, 64. 90  ibid 1. 91  Cort van der Linden, ibid 19, 59. He also criticises Stein who to his mind extends the scope of state activities too far, at 249 (n 2). See also 167–168 where he criticises a ‘tiring’ conceptually refined scheme by Stein (Pierson, n 42 502–505 agrees with Cort van der Linden’s critique), and 361–363.

58  Hans Gribnau and Henk Vording ­ rinciples as a factual given, and then start testing various taxes against p these ­principles’.92 Against this pragmatic approach, Cort van der Linden advocates a better understanding of tax principles by looking for their cohesion, foundation and historical justification. As will be shown, his conception of tax principles and their ranking reflects his juristic perspective. Tax principles are the subject of the first part of Cort van der Linden’s innovative ‘textbook’. They are threefold. The first principle is legal: the state creates and enforces law (Gesetz) to reflect Recht. Any tax theory should therefore deal with taxation from a legal perspective in the first place, because the distribution of the tax burden is, like all questions of equality, a legal question. Thus, a tax theory should start ‘formulating the legal principles concerning the determination of taxes’.93 He maintains that tax legislation has to conform to these legal principles as standing above legislation.94 Thus, they are an overarching framework for legislation. Next, economic principles for rational taxation should be developed because taxation is a burden which has an economic impact on citizens. Thirdly, principles of financial policy have to be formulated because taxation furnishes the state with the necessary means to achieve its goals.95 Cort van der Linden classifies Adam Smith’s second, third and fourth principle under the principles of financial policy which is quite remarkable at least with regard to the second principle.96 One would expect him to stress the legal perspective on certainty, ie, legal certainty (see below). He appears to give precedence to government’s certainty with regard to the amount of tax to be received over taxpayers’ certainty with regard to the amount of tax to be paid. He was not alone, however, in stressing this requirement of stable revenue—Pierson for example did the same. Though Cort van der Linden presents his principles as an hierarchy, a system of taxation should satisfy all three categories of principles—of justice, economy and financial policy—as much as possible. Of course, tax principles may and often do collide in practice. It is however impossible to establish any order of priority a priori. They have to be balanced in the light of the aim of the state.97

92 

Cort van der Linden, above n 57, 2. ibid 58. 94 ibid 110. For this critical function of legal principles, see more generally, H Gribnau, ‘Not argued from but prayed to. Who’s afraid of legal principles?’ (2014) 12(1) Journal of Tax Research 185–217, . 95  Cort van der Linden, above n 57, 58–59. 96  ibid 210. 97  ibid 60–64. cf 61: ‘Why should the state abstain from its legal task for the sake of more social welfare?’ On the other hand, lower social welfare implies a lower public budget, indirectly diminishing ‘the state’s capacity to realize law.’ 93 

The Birth of Tax as a Legal Discipline 59 Legal Tax Principles In order to fully appreciate Cort van der Linden’s legal approach and its implications it is useful to elaborate on the category of legal principles. The first legal principle is the principle of (formal) equality.98 For Cort van der Linden, the ideal of social justice constitutes the second legal principle. Thus, the ideal of social justice is part and parcel of the legal principles ruling taxation. The third legal principle is the principle of generality: taxes should be borne by all citizens, foreign residents, corporations, churches, foundations, but not charitable institutions.99 The last principle consists of the prohibition of privileges. ‘The law does not allow for favours.’100 This principle seems to be somewhat superfluous for as Cort van der Linden admits, it follows from the principle of equality. Nonetheless, contemporary writers mentioned it as a separate requirement, probably because privileges with regard to taxation had existed for such a long time and the prohibition was explicitly codified in the 1815 Dutch constitution (Article 198). The principle of equality, Cort van der Linden argues, is to be seen as an evolutionary concept. The (formal) requirement of equality, after all, does not say anything about which cases are to be considered alike and which as different. Views on relevant distinctions develop over time. Thus, the evolving so-called legal consciousness accounts for the fact that nowadays all citizens are equal before the tax law. However, in the past the generally recognised inequality of estates or different classes in society could not but imply ‘differentiated taxation in order to be equal’.101 Equality requires equal sacrifice, everybody has to pay according to his ability to pay.102 His reference here to Mill’s notion of equal sacrifice may suggest a specific norm based on measured utilities. This is not what Cort van der Linden has in mind, though he does explore economic arguments concerning tax rate progressivity.103 True to the German historical school, he argues that ‘only through the reconciliation with the higher ideal of social justice, taxation according to ability to pay becomes a fully determined principle.’104 Subsequently, Cort van der Linden deals with the requirement of social justice. By conceptualising the ideal of social justice as a legal principle, social justice becomes a matter of law and of the state (entailing state intervention). He argues that taxation should have social-political consequences

98  Here he refers to Mill, above n 39, as quoted above: ‘For what reason should equality be the rule in matters of taxation? For the reason that it ought to be so in all affairs of governments’. 99  Cort van der Linden, above n 57, 113 ff. 100  ibid 126. 101  ibid 66. 102  ibid 76. 103  ibid 59 ff. 104  ibid 111.

60  Hans Gribnau and Henk Vording which reach further than traditional ability-to-pay: that ability is itself unjustly distributed, for the distribution of property in society is unjust.105 To conclude this section, by arguing that legal principles are first among the general principles of taxation Cort van der Linden argues for an overarching framework for tax legislation in which the rule of law and social justice are closely connected—reflecting a substantive conception of the rule of law. He advocates tax theory to reflect on legal principles and to elaborate on the legal framework of tax laws. As shown above, (formal) equality constitutes the first of the legal principles. Moreover, he recognises as other formal characteristics of law generality and the prohibition of privileges— both closely linked to equality.106 This fits in well with rule of law-theories which, however, also stress the importance of legal certainty—as Adam Smith did by formulating his second maxim. So did Cort van der Linden miss this important requirement altogether? In order to answer this question, in the next section, we will briefly reflect on these two formal characteristics of the Rechtsstaat (state under the rule of law) doctrine and apply them to Cort van der Linden’s tax theory. This requires that the continuing growth and refinement of tax rules and doctrines be discussed as sources of increasing juridification of taxation in the Netherlands will be dealt with. Taxation by Laws The ideal of the ‘rule of law’ has a twofold implication because the concept of the (state under the) rule of law has two different—but closely ­connected—meanings. The first meaning is the already considered government sub lege, ie, government in accordance with the existing basic norms of the legal system. The rule of law can also refer to government per leges expressing the primacy of the legislature as the source of law. This means that government must function through laws, ie, through general and abstract norms rather than specific and concrete decrees. This is an important distinction. It is one thing for government to exercise power according to preestablished legal principles, it is another for it to exercise power via general legislation.107 Law conceived as a general and abstract norm, is attributed 105  In order to repair this injustice, taxation of wealth according to the ability to pay should be progressive. Taxation can thus affect the source of income, viz wealth/property. Again, progression should be moderate, not steep. Treub also argues that the demand for social reform should be have consequences for taxation, especially municipal taxes, or so it seems. A more equitable distribution of the tax burden will meet the justified grievances of the socialists: Treub, above n 58, 498–499. He agrees with Pierson however that abrupt changes are out of the question (in the same vein Cort van der Linden, ibid 353–354). 106 For a critical examination of the equality postulate and the generality postulate, see Mann, above n 5, 97 ff. 107  N Bobbio, ‘The Rule of Men or the Rule of Law’, in N Bobbio, The Future of D ­ emocracy (Minneapolis, University of Minnesota Press, 1987) 143.

The Birth of Tax as a Legal Discipline 61 the intrinsic virtue of promoting security (certainty), equality, and liberty. The capacity of law to provide certainty depends on a purely formal characteristic of law, namely its abstractness. In this way Smith’s second maxim for taxation, legal certainty, is enhanced by the state under the rule of law. A national system of tax laws enforced by a national tax administration is of course an important bulwark against arbitrary taxation by all kinds of local tax authorities applying diverging tax regulations and interpretations. The capacity of law to promote equality stems from another formal characteristic of law, viz the nature of the general norm as one which applies not just to an individual but to a class of individuals and which can even be formed by all the members of a social group.108 As stated above, the demand of generality was elaborated on by Cort van der Linden. He thus puts strong emphasis on taxation by laws.109 Moreover, legal certainty is one of the virtues of laws he deals with.110 A tax should be as determinate as possible. Moreover, legislation must be clear, accessible, precise, understandable and promulgated.111 Hence, the law should speak for itself: dependence on administrative rules and interpretation should be minimised.112 Moreover, he stresses the importance of uniformity of tax legislation, though he does not explicitly connect it to legal certainty.113 In passing, we note that he does not pose the principle of constancy as a requirement of tax law, because of the (financial) requirement that taxes be flexible.114 Unfortunately, he observes, legal certainty leaves a lot to be wished for in the Netherlands, and the tax system has to match the increasing complexity of society.115 ­Moreover, it takes time for society to adapt to taxes, so new taxes should not be too readily introduced. Here, the important point is that Cort van der Linden seems not to see legal certainty as inherent to taxation by laws. Again, as shown above, for him Smith’s second maxim about arbitrary

108 

ibid 143–144. van der Linden, above n 57, 215. Treub also argues that national taxes should be levied ‘by force of law’: Treub, above n 58, 557. To his mind, draft provincial and municipal taxation should need approval of central government with respect to legality and conformity with the general interest. 110 For a famous account of principles of legal certainty in the guise of the principle of legality, see LL Fuller, The Morality of Law [1964] (New Haven, Yale University Press, 1977) 46–91. For an application of these principle to tax legislation, see H Gribnau, ‘Legal Certainty: A Matter of Principle’ in H Gribnau and M Pauwels (eds), Retroactivity of Tax Legislation (Amsterdam, EATLP, 2013) 83–93. 111  For the requirement that legal rules ought to be published, see already Thomas ­Hobbes, On the Citizen [1641/1651], R Tuck and M Silverthorne (eds) (Cambridge: Cambridge ­University Press, 1998) XIV, 13, 160. 112  Cort van der Linden, above n 57, 218. 113  ibid 227. 114  This requirement conflicts with the need for reliable revenues; a balance is to be found by a variety of taxes, some of them being volatile, some of them delivering fixed revenues: Cort van der Linden, ibid 220. 115  ibid 350–351. He rejects the idea that the best tax would be one single tax. 109  Cort

62  Hans Gribnau and Henk Vording t­axation is a financial principle rather than a legal principle. This is rather surprising taking his legal perspective into account. Also, it goes without saying that in a state under the rule of law tax legislation should have primacy over the executive, the tax authorities. ­ However, taxation has for too long a time largely been the prerogative of the executive—and therefore arbitrary taxation prevailed. Taxation should be a legislative prerogative, for the rule of laws is the best safeguard against arbitrary interferences with individual rights and liberties.116 Here, his legal perspective shows in his concern for the separation of powers—a basic insight being that the tax (administration) should not interfere with legislation. Below it will be shown how Cort van der Linden is the first in the Netherlands who not only reflects extensively on the tax legislator but also on the tax administration—brought about by Stein’s administrative law inspiration. In sum, Cort van der Linden recognises that a complex tax system is inevitable, but the legislation making up such a system should not violate the principle of equality and consist of determinate, clear, accessible, precise and understandable tax rules in order to counter arbitrary taxation. From the early twentieth century onward, tax legislation would increasingly be tested against these and other aspects of legal equality and certainty by expert tax practitioners.117 They tried to grasp the exact meaning of the existing tax rules and judicial rulings using different methods of interpretation. They also critically evaluated the system of tax rules in respect of its conformity with the requirements of legal equality and certainty. Gradually legal reasoning applied to tax law matured which greatly contributed to the birth of tax as legal doctrine. Advancing Distributive Justice and Regulatory Goals As shown above, apart from the formal requirement that government must function through laws, thus promoting security, equality, and liberty, the state under the rule of law is meant to create the formal and material prerequisites of personal liberty, ie to enhance positive liberty and social justice. Thus, the state under the rule of law should not only protect liberty, (formal) equality and legal certainty but also actively intervene in society. Taxation thus becomes a legal affair, as shown above, on the one hand, and it rapidly expands, on the other. Here we see another determinant of the birth of tax law as an academic discipline in the Netherlands.

116 

ibid 312, 316, also referring to Stein. R Evans, The Pursuit of Power: Europe 1815–1914 (London, Penguin, 2016) 321 who argues that a process of professionalisation took place in the legal profession and ‘the civil service and higher state administration of most European states.’ 117  cf

The Birth of Tax as a Legal Discipline 63 Social reform increased government spending; more taxes and higher rates were introduced to increase revenues. In due course, the increasing state intervention, also advocated by Cort van der Linden, meant a multiplication of tax laws and rules. Indeed, legal rules almost inevitably generate more, and more detailed rules. This development reinforced the legal turn in Dutch tax theory; it is the basis of the blossoming of legal tax doctrine in the second half of the twentieth century. For taxation these demands regarded a more fair distribution of the tax burden—and doing away with privileges for certain groups in society.118 Here we see another important cause of the legal turn. Concepts like ability to pay, income, spending power, were introduced as criteria for the distribution of the tax burden. The (then recently introduced) income tax made use of these kinds of concepts, and therefore demanded more refined legal knowledge than excise duties, a poll-tax or window taxes.119 Consequently, technically complex rules were phrased in legal language with tax lawyers as its own specialised class of interpreters. More, more complex and higher taxes and an increasing number of taxpayers led to a growing body of case law, which in turn resulted in an expanding legal doctrine (see also the next section). An additional cause of juridification was the use of tax legislation as a regulatory instrument. Cort van der Linden defended the regulatory or instrumental function as an additional goal of taxation (for example to protect Dutch industry).120 It goes without saying that views on the state’s tasks and goals evolved in the course of time. Tax theory and practice followed suit adding to the increasing complexity of tax legislation, which constituted fertile soil for the blossoming of legal tax doctrine. Interestingly, Cort van der Linden warned that excessive regulatory use would diminish the respect for law and legislation.121 Tax Administration and Procedural Tax Law Having established the foundation of taxation by setting out the principles of taxation, in the second part of his book Cort van der Linden turns from taxation in general to tax law which itself belongs to the province of administrative law. As shown above, Van Hogendorp showed concern for the intrusiveness of tax administration. Interference with the taxpayer’s private sphere was deemed undesirable.122 As also shown, the liberals in

118 

Cort van der Linden, above n 57, 126. van der Linden, ibid 349 acknowledged that taxable income is a sophisticated concept. 120  ibid 222. 121  ibid 335. 122  cf Smith, above n 4, V.ii.f 848-9 and V.ii.j 867. 119 Cort

64  Hans Gribnau and Henk Vording the third quarter of the nineteenth century were less reluctant to accept government interference—in order to advance positive liberty123—but tax administration’s interference with taxpayers’ liberty should be bound by the law (principle of legality). Consequently, a legal perspective on taxation should elaborate on the relationship between taxpayer and tax administration. In the Netherlands, this kind of theorising indeed starts with Cort van der Linden, for his predecessors focused on the legislature rather than the tax administration. He shows awareness that the tax administration is not something like a machine mechanically applying the law but does a far more complicated and refined job. Moreover, he reflects on the relationship between administration and taxpayer from the perspective of administrative law, for the tax administration exerts power over the taxpayer which is bound by (administrative) law. Apparently, he again took his cue from Stein who advocated a legal methodology of administrative law as balancing the state’s aims and the citizens’ liberty. Tax law teaches the means necessary to realise tax principles. Again: ‘Tax law is the incarnation of the tax principles.’ Tax law is not a matter of practical dexterity but theory.124 From the perspective of administration tax law constitutes the technique of taxation. Law is the means to be used by the tax administration. Without technical application tax principles stay abstract truths. The administration itself is part of this technique—its behaviour is regulated by tax law. This technique, tax law, should be improved and refined because the tax system becomes more complex, hindering the assessment of individual tax liabilities. This is caused by taxpayer’s mobility and the multiplication of legal relationships between them which complicate the right discernment of the subject of the various taxes. The assessment of the tax objects becomes also more difficult; they should be more precisely distinguished while the increasing number of social relationships hinder individuation of (taxable) facts and acts. Therefore, tax revenues and the realisation of tax principles are becoming more and more dependent on educated, competent and honest tax officials.125 In case of complex taxes, equal taxation cannot do without a technically skilled central administration with knowledge of trade and business. As tax laws comprised more and more technical legal concepts and distinctions the need for a tax administration well versed in legal knowledge increased. Also legal certainty depends in large measure on uniformity in tax administration.126 Indeed, the hierarchical structured tax administration was centralised and the regional tax collection was controlled by the national tax authority at the national Ministry

123  cf WF Rochussen, De theorie der inkomstenbelasting (‘s-Gravenhage, Gebr. Belinfante, 1889) 123–124. 124  Cort van der Linden, above n 57, 224. 125  ibid 226, 241, 258. cf 354. 126  ibid 233 and 237. As shown below, he also values uniformity of tax legislation.

The Birth of Tax as a Legal Discipline 65 of Finance.127 Cort van der Linden thus reflects on the meaning of a centralised tax administration in a state under the rule of law and the impact of the ideal of social justice on the requirements the tax administration has to meet to advance the Rechtsstaat. His legal approach further shows in the treatment of the foundations of procedural tax law, which was not previously discussed in Dutch literature on taxation. He deals with, eg, the different methods/techniques to levy taxes, tax audits, and legal remedies, all of this in a book on public finance. Citizens’ liberty is protected by the law, because the concrete obligation to pay tax is a legal obligation, it is an obligation arising from the law.128 Thus tax administration is bound by the law (principle of legality). To Cort van der Linden the legal qualification of actions by the tax administration entails the requirement of a kind of objection procedure.129 Taxpayers therefore should have the possibility to dispute the lawfulness of the tax administration’s actions and appeal to an independent ­judiciary.130 He does not deal with statutory provisions or case law, but discusses the fundamentals of legal protection of the taxpayer. Because the state and the individual are in an evolving legal relationship, procedural tax law will inevitably evolve as well and indeed this lawyers’ domain will expand in all directions. Moreover, he deals with substantive tax law. This however, he does in a more traditional way, ie, does not give a detailed legal technical analysis of the provisions of the relevant legislation. Cort van der Linden should therefore be given credits for pushing taxation into the realm of administrative law entailing a legal perspective on the relationship between tax administration and taxpayer, rather than for his thoughts on substantive tax law. CONCLUSION

Summing up, this contribution argued that the Dutch debate on tax theory was strongly influenced (if not fully determined) by intellectual developments in other countries. Up to the last decades of the nineteenth century, Dutch authors on tax theory basically absorbed and translated (their understanding of) British and French political economy. Things did change towards the end of the century, as two leading progressive liberals exposed their versions of tax doctrine against the background of a shift in liberal thought. Progressive liberals advocated (more) state intervention, thus ­supplementing the

127 

T Pfeil, Op gelijke voet, de geschiedenis van de Belastingdienst (Deventer, Kluwer, 2009) 64. Cort van der Linden, above n 57, 312, also referring to Stein. 129  ibid 318–319. 130  ibid 316 and 322. 128 

66  Hans Gribnau and Henk Vording ideal of negative liberty with the ideal of positive liberty. Nicolaas Pierson was the more traditional of them. While critical of classical political economy, his position resembles Mill’s, perhaps more than he was prepared to admit, in that sound economic theory was to be used to help solve the pressing social questions of the day. His main disagreement with Mill was that he did not believe equitable tax burden distribution to be a matter of economic theorising. Pieter Cort van der Linden came to very different conclusions, borrowing heavily from the Staatslehre tradition. To him, the measure of ‘good’ taxes was not economic; it followed from the nature of the state as the agent of legal principles. This allowed him to make a shift towards a legal approach of taxation. His qualification of taxation as a matter of law was a precondition for the development of legal doctrine. From then on, two different perspectives on taxation developed. The economic tradition— of which Pierson was clearly a representative—kept focused on welfare criteria (like ‘maximising utility’) for judging tax rules, while the legal tradition started to refer to the concept of Rechtsstaat. The legal approach to tax in due course narrowed to legal doctrine.

3 The Curious Case of Mr Trull SIR JOHN BAKER

ABSTRACT

In 1992 Mr Trull was restrained by a High Court injunction from selling shares in a phantom Cornish tin-mining company which he said would entitle the investors to the privileges of tinners in the Stannaries of Cornwall. One of these privileges, as he asserted, was that they could claim exemption from paying the ‘Poll-Tax’ introduced by Mrs Thatcher’s Government in 1990. The claim was based on royal letters patent of 1508 granting to the tinners that they should not be burdened by statutes unless made with the consent of a convocation of 24 of their number (the ‘Stannary Parliament’). The defendant was not legally represented, and the case is unreported. The most obvious apparent flaw in the claim was that letters patent, being acts of the Crown alone, cannot prevail against Acts of Parliament. But Mr Trull was unaware that it is arguably still possible to claim exemptions from ­parliamentary taxation, at any rate where the revenue is payable to the Crown, on the strength of letters patent. The matter was fully discussed in several fifteenth-century cases, which settled that the Crown may dispense with future taxation just as it may waive accrued revenue. In consequence, many revenue statutes up to the present (eg, section 290(2) of the Taxation of Chargeable Gains Act 1992) have included an explicit provision that patents of exemption should not be available against the taxes which they impose. Although it is doubtful whether any such exemptions are still in force, the legal issues raised by the Mr Trull’s case are not without interest.

I

N 1989 THE writer was asked in a telephone call from a Government solicitor whether he might assist in translating a few lines of Latin occurring in a document of 1508. Thus began his intriguing association with the case of Mr Trull. A few weeks later, no less than seven solicitors, four from the Department of Trade and Industry (DTI) and three from the Treasury Solicitor’s D ­ epartment, came to Cambridge bearing large quantities of paper and large-size photographs of patent rolls. It became evident at that point that anyone wishing to stop a Government department in its tracks

68  Sir John Baker for a year or more, even on a question relating to the latest revenue legislation, could effectively achieve it by relying on an ancient document in Latin. Fred Trull was an avid Cornishman.1 He cherished the belief that Cornwall should be a separate sovereign state. Indeed, he was heard to argue in the High Court that Cornwall actually is a separate sovereign state, though the submission was met with bemused astonishment rather than consternation. The principal basis for his position was that the Stannaries, or communities of Cornish tin-miners, had once possessed an assembly known colloquially as the Stannary Parliament, and also their own courts of law. Putting two and two together with a dash of wishful imagination, he reached the conclusion that a body with a Parliament must be a sovereign state. Quite how it related to the rest of Cornwall which was not in the Stannaries was never made clear. He and his supporters nevertheless considered it vital to the liberties of the Cornish people that this ancient legislative assembly, which last met in 1753, should be awakened from two and a half centuries of slumber. The proper way of summoning it was by writ from the Lord Warden of the Stannaries, failing whom the Duke of Cornwall would do it. Unfortunately for Mr Trull’s campaign, neither the Lord Warden (then Earl Waldegrave) nor the Duke of Cornwall, when they were petitioned in the 1970s, felt that that there was any pressing need to call the ancient assembly out of abeyance. The men of Cornwall—half a dozen of them, at any rate—therefore decided to convoke their parliament anyway, appointing a Lord Protector. They are reputed to have met solemnly in a public house in Lostwithiel, passed a number of laws, declared their exemption from paying English taxes, and announced an intention to seize Crown lands. None of this, of course, had any effect. They also sought to obtain recognition of their sovereignty from the English Government and the United Nations, in order to avert what they called an impending constitutional crisis. This was equally unsuccessful. Banknotes were nevertheless issued in 1974, signed by F Trull as Chief Cashier or Minister of Finance. Printed in Cornish, in authentic Cornubian script, they are now collectors’ items but have no intrinsic value. The Cornish freedom fighters stopped well short of taking up arms, and were generally treated with wry amusement, but they were so earnest that they occasionally came into conflict with the law, as when Mr Trull attempted to arrest a magistrate’s clerk at St Austell, and the magistrate himself, for presuming to try him for a motoring offence.2 Perhaps they were fortunate to escape prosecution for treason, but in this day and age it made more sense not to take them too seriously.

1  He will be referred to here in the past tense, because nothing has been heard of him for a long time. He was already retired from work when the case arose a quarter of a century ago. 2 He was fined for using threatening words and behaviour: ‘Stannary Parliament Man Fined’, The Times (3 June 1975). There is a full account of all these goings on in the Wikipedia entry ‘Stannary Courts and Parliaments’, based on articles in The Times accessed 23 December 2016.

The Curious Case of Mr Trull 69 One of their activities, however, did require governmental intervention, and this brings us back to the telephone call. In 1989 Mr Trull started selling shares in a phantom tin-mining company—grandly named the Royal Cornish Consols United Tin Mines Cost Book Company—on the strength of a prospectus declaring that anyone who paid £1.50 to buy a share would become a Cornish stannator (or tinner). This would entitle the share-holder to the protection of a ‘charter’ of Henry VII, granted in 1508 to the tinners, which provided (inter alia) that they should be exempt from the operation of any law made without the consent of the Convocation of the Cornish Stannaries (the so-called Stannary Parliament). The shares were specifically marketed as providing protection against the unpopular and ill-fated poll-tax. No one is known to have tried them out for this purpose, but Mr Trull is said to have made as much as £1M–£2M from his scheme, without ever mining any tin. It was, in truth, more of a gold-mine than a tin-mine. The lawyer’s immediate reaction to the claim in the prospectus might well be: that is simply absurd; surely mere letters patent can never prevail against an Act of Parliament? That was the view of the DTI, which commenced proceedings in the Chancery Division to enjoin Mr Trull from continuing to offer shares upon these false representations. The case might have not have gone so far had not the eminent company lawyer, Professor Robert Pennington (1927–2008) of the University of Birmingham, a Cornishman by surname (though not by birth or residence), hinted in his book Stannary Law (1973), and asserted in subsequent correspondence in The Times, that the tinners had indeed such a privilege as they claimed. According to his obituary, this claim prompted a Member of Parliament to describe him in the House of Commons as one of the most dangerous men in England. Pennington did not adequately explain how the 1508 ‘charter’ took effect, or why it had not been impliedly repealed by revenue legislation. As a consequence Mr Trull, who had been unable to obtain legal aid, argued his case badly and lost; judgment was given against him by Millett J in a learned extempore judgment in 1992. His appeal also failed. But could a good argument have been made? Why were the Government lawyers so concerned? A version of an argument was privately printed in 1993 in an anonymous tract entitled The Constitution of Cornwall or Kernow the Country of the West Britons. It was clearly not the work of a lawyer, and indeed the author fulminated against ‘those [who were] the products of an education system based on the assumption of English cultural supremacy’. It said that the 1508 ‘charter’ was warranted ‘by authority of Parliament’ and quoted The Prince’s Case (1606),3 as deciding that those words ‘are sufficient to make it an Act of Parliament’. This was evidently based on a passage in Halsbury’s

3 

The Prince’s Case (1606) 8 Co Rep 13.

70  Sir John Baker Laws of England,4 without any grasp of the details. According to Coke’s report of the case,5 the charter then in question was granted ‘with the common consent and counsel of the prelates, earls, barons and others of our council in the present Parliament assembled’ and ended ‘by the king himself and the whole council in Parliament’. This was not, therefore, a grant solely by the king in Parliament, without mention of the Commons, which would not have been an Act of Parliament. Everything would therefore depend on the force of the words ‘by authority of Parliament’, which were not in issue in the 1606 case. But the 1508 charter was not ‘by authority of Parliament’. The only mention of Parliament was in a promise to annul certain grants in the next Parliament, a promise which was never fulfilled because of the king’s death. The learning was therefore irrelevant. The anonymous author added that the ‘charter’ of 1508 granted ‘the completely unprecedented and unique right to veto Westminster legislation … In those days an absolute monarch gave nothing without good reason. His knowledge of the Cornish language through his exile in Brittany must have impelled Henry VII to use his position to officially recognize the Celtic identity of Cornwall, by providing Cornish control over Cornish natural resources.’ The ‘charter’, so it was argued, was essentially a treaty.6 It is hardly necessary to deal with that in detail, since it ought to be self-evidently nonsensical even to someone hostile to English cultural supremacy. There is no doubt that the Stannaries of Cornwall and Devon were governed by a number of immemorial customs and possessed courts with jurisdiction over tin-miners. The common law still allows local customs, provided they are reasonable, consistent with Acts of Parliament, and immemorial. The patent of 1508 (not technically a charter) was granted to Robert, Lord Willoughby de Broke, and 40 Cornish gentry and ­merchants. It annulled various statutes made for the stannaries by Prince Arthur (d. 1502) as Duke of Cornwall, pardoned various offences committed against those statutes, and promised that all this would be confirmed by the next ­Parliament—which it never was, because the king died the next year, although Henry VIII confirmed the grant itself.7 The clause relied on by Mr Trull comes near the end: And furthermore, of our more abundant grace, we have granted, and do by these presents grant, for us and our heirs, unto the said Robert [and others] … or w ­ hatsoever other persons in whatever way concerning themselves with any 4 

Halsbury’s Laws of England, 8 (Constitutional Law), para 1560. The Prince’s Case (1606) 8 Co Rep 13 at 18. 6  The Constitution of Cornwall or Kernow, 14. cf ibid 9, where the author quotes the present writer’s translation of the charter dated 1991 and says ‘The right to veto legislation gives the Charter virtually the status of a Treaty’. 7  For the historical background see G Harrison, Substance of a Report on the Laws and Jurisdiction of the Stannaries (1835), especially at 33–4, 54; GR Lewis, The Stannaries (1908), especially at 41, 125–6, and the full bibliography. 5 

The Curious Case of Mr Trull 71 black or white tin in the aforesaid County of Cornwall, that no statutes, acts, ­ordinances, provisions, restraints or proclamations shall hereafter be made within the aforesaid County of Cornwall to the prejudice or burdening8 of the same ­tinners … or other persons in whatever way concerning themselves with any black or white tin in the aforesaid County, their heirs or successors … unless there shall first be summoned for this purpose twenty-four good and lawful men of the four Stannaries … whenever, as often and wherever any statutes, ordinances, provisions or proclamations are made by us or our Council … or by the Prince of Wales, Duke of Cornwall, or by his Council … so that no statutes, ordinances, provisions or proclamations hereafter to be made by us, our heirs and successors, or by the aforesaid Prince of Wales, Duke of Cornwall for the time being, or by our Council, or by the Council of our said heirs or our successors, or of the said Prince, shall be made unless by the assent and consent of the aforesaid twenty-four men ….

This body of 24 good and lawful men came to be known colloquially as the Stannary Parliament, though more formally as the Convocation. It seems to have owed its origins to the letters patent, since its first recorded meeting was in 1510. But in what sense was it a ‘parliament’? The counties palatine of Chester and Durham had possessed their own parliaments before their inhabitants were directly represented at Westminster,9 but these assemblies had never claimed to veto Westminster legislation when it was expressed to extend to the palatinates. In any case, the word was not used in the 1508 patent, and in itself it connotes no more than a deliberative meeting.10 Pennington put it thus:11 Herein lay the constitution of the Stannary Convocations of Cornwall of the sixteenth, seventeenth and eighteenth centuries. The only power given by the Charter to the twenty-four stannators … was to veto legislation enacted by the king or the Duke of Cornwall, not to enact legislation themselves. However, the dividing line between veto and initiative in legislating was one which Convocation was not too concerned to observe, and in the course of the seventeenth century the power to legislate was exercised by the Convocation in Cornwall … Had the Charter been formally incorporated in an Act of Parliament, a nice constitutional question would have arisen as to whether the Convocation of Cornwall had a power of veto over Acts of Parliament concerning the stannaries. The Charter of 1508 extended this power to statutes, which was sufficient to comprehend Acts of Parliament as well as enactments by the king alone. The fact that Parliament did not ratify the Charter left this question in abeyance, however …

8 

The Latin ‘exonerationem’ means the opposite, exoneration, but this must be the sense. The Chester parliament was abolished in 1542: 34 & 35 Hen VIII c 13. Cornwall, though sometimes called a county palatine, was not so in law: M Hale, The Prerogatives of the King, ed D E C Yale (92 Selden Soc, 1976) at 221. 10 The honourable societies of the Inner Temple and Middle Temple to this day hold ‘parliaments’, which are meetings of the governing Benchers. 11  RR Pennington, Stannary Law: A History of the Mining Law of Cornwall and Devon (Newton Abbot, 1973) at 20–1. 9 

72  Sir John Baker This passage was not as favourable to Mr Trull’s case as he thought it was, since Pennington here admitted that without parliamentary confirmation there could be no power of veto. But Pennington did not discuss the matter in any detail, and he was unaware of the medieval case law concerning exemptions from taxation. Although an Act of Parliament can only be repealed or overridden by Parliament,12 the Crown did assert a prerogative power to dispense with, exempt from, and pardon breaches of, Acts of Parliament. The distinction between these three applications of the prerogative is that a dispensation permits the grantee to do something notwithstanding a legislative prohibition, an exemption permits the grantee to omit doing something required by legislation, and a pardon retrospectively remits any penalty for breach of a legislative provision. Immunity from taxation is most appropriately classified as an exemption. Exemptions from taxation, or from collecting taxes (an onerous and irksome duty, though capable of being abused for private gain), were sometimes granted to corporations, especially religious houses, though rarely if ever to individuals. Thus, in 1262 Hailes Abbey was granted exemption from scot, geld, kings’ and sheriffs’ aids, hidage, carucage, danegeld, horngeld, and a long list of other taxes. A standard formula was settled early in Edward III’s reign: the patentees were to be quit of aids, contributions, tallage, tenths or other quotas granted by the clergy, and fifteenths or other quotas granted by the commons. This form of clause was used in a charter to St John’s Hospital, Oxford, in 1336, and was thereafter followed as a precedent. The new formula apparently ended earlier doubts as to whether the general language of the older ­charters could extend to quotas granted in Parliament by the clergy or the commons. Around 30 grants of exemption were made to religious houses in the fourteenth and fifteenth centuries, besides four to Oxford colleges.13 A number of towns, including Shrewsbury, Ludlow and the Cinque Ports had even more ancient grants of similar privileges.14 Lyme Regis was granted a reduction in its liability for 65 years in 1483 because it had ­suffered depopulation after flooding; this was renewed for another 50 years in 1543. The only Cambridge college known to have pleaded an exemption in the Exchequer was St John’s, relying on a charter of 1520. By that time, and ever since, colleges in the universities have relied instead on ad hoc exemptions written into revenue legislation,15 or more generally on their charitable status. For instance, the statute authorising a subsidy in 1515 contained an exemption not only for the colleges at both universities but 12  Or by authority of Parliament. Some modern statutes give ministers the power to amend parliamentary legislation by Order, though this is a controversial practice for obvious reasons. 13 They are listed, from the Exchequer rolls in which they were pleaded, in R Schofield, Taxation under the Early Tudors 1485–1547 (Oxford, Blackwell, 2004) 66–68. 14  Schofield (n 13 above) 65. 15  An early instance is 3 Hen VIII c 22, s 5.

The Curious Case of Mr Trull 73 also for all the scholars, students or learners resident there, which in the language of the time would have included all the dons.16 But a patent of exemption, assuming it worked, was far more valuable than an exception in a particular revenue statute, because it would extend to all future statutes. Occasionally an exemption might be granted retrospectively from an assessment already made. Most of the relevant case law on the king’s prerogative power to override statutes concerned dispensations rather than exemptions, and it established three principles: (i) the king could only dispense with criminal sanctions, or with his own rights, not with the rights of anyone else; (ii) he could not dispense with a statute directed to the public good, since that would prejudice other subjects;17 and (iii) a dispensation could not be granted to an unduly wide or indeterminate class of persons. Whether or to what extent these principles affected exemptions from taxation was a question actually aired in the courts in the fifteenth century. In the Bishop of Salisbury’s Case (1459),18 Danby J said (without being contradicted): ‘If the king grants to me that I and my heirs shall be quit of toll and tallage and the like, whenever they happen, and there is no tax or tallage at the time of the grant, nevertheless when a tax or tallage is granted I and my heirs shall be quit and discharged by virtue of the grant. And if the king grants to me that my heirs shall be quit, as above, this is a good grant even though I cannot have advantage of it, but only my heirs.’ It seems, therefore, to have been accepted that an exemption could be granted from something not yet in being—even to persons not yet in being.19 The first full reported discussion in court of a charter of exemption from taxation occurred in the Rector of Edington’s Case (1441).20 It concerned a royal charter of 1359 to the Rector and Brethren of Edington, a newly founded monastery (or house of bonhommes) in Wiltshire, which granted to them and their successors to be discharged of any tenth or fifteenth granted by the clergy or the commons of the realm; it was confirmed by Henry IV in 1400. In the time of Henry VI the clergy granted to pay the king a tenth, and the Rector came into the Exchequer and prayed to be discharged. The Attorney-General demurred —that is, challenged the legal validity of the claim—and the case was adjourned into the Exchequer Chamber to

16 7 Hen 8 c 9, s 19. The like exemption was granted to the colleges of Eton and Winchester. No one thought of exempting the universities themselves, probably because they had little income. 17  Unless it was very limited in scope. It would have been detrimental to the public good if large numbers of people were exempted from jury service, but it was thought that a few individuals could be exempted without infringing this principle. This exception is obviously connected with the third principle. 18  Bishop of Salisbury’s Case (1459) YB Mich 38 Hen 6, fo 9, pl 20 at fo 10. 19  A living person could not have heirs. 20  Rector of Edington’s Case (1441) YB Pas 19 Hen 6, fols 62–65, pl 1.

74  Sir John Baker be discussed by all the judges of the central courts, with arguments by the leading counsel of the day. Serjeant Fortescue began, contending that the grant was invalid on two grounds: (i) it was impossible to grant something not in being at the time of the grant, such as a future debt; and (ii) the rector was one of the clergy who had granted the tenth, and was therefore estopped from relying on the exemption to avoid paying it. On the other side, it was said that the king was equally estopped by his grant, since he had granted that he would not demand the tenth from the rector, and so the estoppels cancelled each other out. As to the first ground, the king could indeed grant something not in him at time, such as a market; even if he could not, the patent could still take effect as a release rather than as a grant. The Attorney-General challenged this last argument: since the king had no right to the tenth before his people granted it, there was nothing to release. Ayscough J agreed, and said it was absurd to grant to someone that he need not make a gift, and in this case he had given it anyway (as one of the Convocation of the Clergy) subsequently to the grant. Fray CB disagreed. Parliament was the highest court the king had; tenths were revenues of this court; and anyone who had a court could grant its revenues to someone else. Serjeant Fortescue then produced a third argument. Although the king could validly grant things which were not prejudicial to anyone but himself, provided he was apprised of the prejudice at the time of the grant, nevertheless if something was prejudicial to anyone else the grant would be invalid. Thus, a grant that someone might kill another person without being punished was invalid, even though the punishment for murder belonged to the king, because the grant would prejudice the person who was killed. An exemption from taxation granted to one inhabitant of a vill would likewise prejudice the other inhabitants, because they would have to bear his share. This attractive argument was, however, denied by the whole court, who said the other inhabitants would be discharged in respect of the uncollected part: in other words, the loss of revenue could not be recouped from the others. It was now time for the two chief justices to join in the discussion, and they disagreed with each other. Newton CJCP accepted the argument that the rector was estopped by the grant in which he had participated, and so he could not rely on the prior patent of exemption. But Hody CJKB said that, even when a tenth was granted by the whole clergy, there was no reason why particular individuals should not be discharged. It was absurd to say the taxpayer was estopped by virtue of his consent, because decisions were made by a majority and so refusing his consent would have had no effect. If an exemption had been granted to the whole population, however, that would have been void. He did not say why, but obviously the reason was that it would have made the tax completely nugatory. On another day, when the case was reargued, the chief justices fell out again. Hody CJ said the king could grant something which was not in him at the time, such

The Curious Case of Mr Trull 75 as the profits of a court; the tenth was a profit of his court of Parliament, which he could grant away before it vested in him. Newton CJ responded that it could not be called a perquisite or profit of his court of Parliament, for perquisites of courts were things accruing by law, whereas this was a spontaneous grant from the people; there was no inheritance in the king before it was granted. Moreover, according to him, the patent of exemption was void for another reason: a grant by Parliament binds everyone generally, even if no special mention is made of him. Hody CJ did not accept this. Parliament was the highest court the king had, and he was inheritable in this court to have tenths; for the same law which willed that the king should defend his people also willed that the people should grant him aid from their goods for that defence. As to the argument that the grant took effect as a grant from the people, that was not so; it was ineffective until the Lords had approved it and the king had accepted. It was, presumably, equivalent to an Act of Parliament. Fray CB then begged all the judges and serjeants to consider the matter carefully—no doubt hinting that it was time to make up their minds—so that he could give judgment according to law, because many other abbeys were in the same case. By the end of the report, we find that Fortescue had become lord chief justice in succession to Hody, who had died, and (being no longer of the king’s counsel) had shifted his opinion towards Hody’s. He agreed that a general provision in a statute did not exclude anything special unless express mention was made. After a brief discussion between him and the Attorney-General, the case was again adjourned, and no more was heard of it. This was hardly a decision, because there seems to have been no judgment; but it was common for the judges to fail to reach decisions in difficult cases. What the debate showed was that there was respectable judicial opinion in favour of the view that the king could grant exemption from future taxation granted by Parliament, just as an inferior lord could grant exemption from perquisites due to the lord’s court. The only difficulty was that taxation of this kind was in theory an ex gratia grant to the king by Parliament, not a matter of right, and it was a difficult conundrum whether the king could sensibly grant someone exemption from making him a gift. But Hody CJ’s argument was difficult to refute. Even if the Commons were seen as making a voluntary gift of the tax, the imposition and collection of it was authorised by an Act of Parliament and it then became law. Although it was law made by the sovereign legislative body, it was law which benefited only the king as the creditor to whom the tax was payable. There was therefore no logical or legal reason why the king could not waive this benefit, and the benefit of any future benevolences of the same kind, vis-à-vis a particular grantee. The failure to collect tax from such a grantee did not prejudice any of the king’s other subjects, because their burden of taxation was not correspondingly increased. This seems to have been the accepted position thereafter.

76  Sir John Baker Much the same arguments were repeated inconclusively in the Case of the Prior of Leeds (1441),21 later the same year, which concerned an exemption from being a collector of taxes, a privilege granted to the prior for life on account of his bodily infirmity. The Province of Canterbury had granted the king a tenth, and when the Archbishop of Canterbury wrote to the prior to collect part of it he pleaded his patent. The barons of the Exchequer were not sure what to do, and referred the question to the Exchequer Chamber. Portington, King’s Serjeant, argued that the prior’s privilege did not avail him, for two reasons. The first was that the patent was temporal and could not be pleaded against a spiritual obligation. The second was that the tenth had been granted with a proviso that no privileged person should be discharged from collecting it; the prior had been one of those who granted the tenth with this proviso, and he had thereby renounced his private privilege. Fray CB countered this. As to the first point, since the tenth was money granted to the king, it was a temporal matter even though it was payable by spiritual persons. Secondly, even had the prior voted against the tenth it would have made no difference, because only a majority was needed, and so it was wrong to presume that he had consented. Ayscough J said he should nevertheless have pleaded his patent in Convocation; he had now left it too late, and so he was estopped by his aquiescence. Hody and Newton CJJ disagreed. They both thought that, since the Convocation of the Clergy had no power to disallow royal letters patent, there was no point pleading them there; they therefore inclined to Fray’s view that the privilege was effective. On the other hand, the Lord Chancellor, Dr John Stafford, quoted the canon law maxim, Qui tacet consentire videtur, in support of the proposition that by keeping quiet and not mentioning his privilege at the proper time, the prior had waived it. Not surprisingly, therefore, he sided with the archbishop—whom he was to succeed at Canterbury two years later. ­Fortescue, still a King’s Serjeant, supported him with another argument. The grant to the prior was a prejudice to the archbishop, who was entitled to require the prior to collect part of the tax for which the archbishop was ultimately responsible, and a patent was void if it prejudiced anyone other than the king. This was the only argument which questioned the prerogative power to grant such exemptions, and ironically it was an argument put forward by the king’s own representative. But no decision is recorded, and in any case Fortescue’s point related only to the collection of revenue and had no bearing on an exemption from paying revenue, which could only prejudice the king. There was another long debate in the Abbot of Waltham v Tyrell (1481).22 This concerned another patent of exemption from a tenth, an 21  Case of the Prior of Leeds (1441) YB Mich 20 Hen 6, fo 12, pl 25. This was Leeds in Kent. 22  Abbot of Waltham v Tyrell (1481) YB Mich 21 Edw 4, fols 44–49, pl 6. (Dated 1482 in Fitz Abr Graunts pl 29.)

The Curious Case of Mr Trull 77 old patent granted by Richard II. The case arose from a grant of a tenth by the Convocation of the Clergy, again specifying that no privileged person should be exempt, and so the case reopened the point left undecided in the Prior of Leeds’s case. Serjeant Catesby, for the king, argued that all clergy were estopped by an Act of Convocation, just as everyone was estopped by an Act of Parliament. This was not a case where general words did not detract from special privileges, because the general words specifically said that special privileges would not be allowed. Serjeant Starkey responded that if the patent were not allowed, the judges would be affirming that the Convocation had higher authority than the king. The king had granted the exemption, and the Convocation was under the king’s power. On another day, Kebell argued that the patent was void, making the old point that the king had no interest in the tenth before it was granted, and it was not legally possible to release a future debt. After much further discussion it was eventually held that the plea was technically bad, but that the abbot should be allowed the benefit of the patent anyway. This was another helpful indecision. Finally, however, in a similar case concerning the Abbot of Shrewsbury (1484),23 a decision was obtained. The abbot’s exemption was properly pleaded, and the Exchequer pronounced judgment that the charter of exemption was valid. This seems to have settled the question.24 But a note in Spelman’s reports,25 written a decade or two later, added a new gloss. It was true that the king could not grant something of which he did not at the time have either the possession or inheritance, to operate by way of grant; but he could bind himself by way of contract (‘covenant’). Thus, it was true that if the king assigned to someone else part of the tenths before they were granted by the clergy, the grant would be void because he had nothing to grant. But if he granted to someone that he should not pay tenths, whenever they were granted, this would be good as a covenant. Although no one could bring action of covenant against the king, he could plead the agreement against the king. What all this came down to was that the effectiveness of a patent of exemption from tax was a question of construction, not of constitutional law. The fact that the year-book cases all concerned grants of taxation by Convocation rather than Parliament does not weaken their authority with respect to parliamentary taxation, since the arguments were equally

23  Abbot of Shrewsbury’s Case (1484) YB Mich 2 Ric 3, fo 4 pl 9; translation in 64 Selden Soc 102–104. 24  eg in Waller v Hanger (1615) 3 Buls 1, concerning an exemption from prisage, which was a form of royal revenue derived from prerogative and not statute, Williams J remarked obiter that ‘The king may grant away his inheritance, as taxes or tallages, 21 E. 4 fos 45, 48. The king may grant unto one to be discharged of the payment of taxes, subsidies and fifteenths.’ 25 93 Selden Soc 152.

78  Sir John Baker a­ pplicable to both.26 It is undoubtedly true that an Act of Parliament must prevail over letters patent if that is the intention of Parliament, and it was equally true in the fifteenth century. No one questioned that. But there is a principle of construction that general words in a statute do not detract from special arrangements. That was the view of Hody CJ (and his successor Fortescue CJ) in The Rector of Edington’s Case, and it is still the law. It was natural to apply the principle to patents of exemption from tax when many such patents were held by religious houses, and in practice respected by the Exchequer, so that a fifteenth-century Parliament or Convocation might be taken to have been aware of the current practice and expectation in passing revenue legislation. That can hardly be the case today. But there is some support for Hody CJ’s principle of construction in more recent cases on statutory exemptions. For example, it has been held that a statutory exemption from ‘all taxes whatsoever’ is not necessarily repealed by implication by a later statute introducing a new kind of taxation without exemptions.27 To return, then, to Mr Trull’s case: there was no insuperable difficulty about the contention that a patent exempting the grantees from paying taxes (assuming that was its meaning) could be pleaded against a tax imposed by Parliament. There was, however, another preliminary difficulty in that the dispensing power been abolished following its abuse by James II. The Bill of Rights 168928 contained two relevant provisions: (s 1) That the pretended power of dispensing with laws or the execution of laws by regal authority as it hath been assumed and exercised of late is illegal. (s 12) That from and after this present session of Parliament no dispensation by non obstante of or to any statute, or any part thereof, shall be allowed, but that the same shall be held void and of no effect except a dispensation be allowed of in such statute.

This certainly put paid to the dispensing power, but it did not obviously refer to exemptions from paying taxes, which did not use the non obstante clause. Although it seems improbable that exemptions were still being granted by that date, the possibility that an old patent of exemption might still be e­ffective was certainly present in the mind of the draftsman of a slightly earlier statute of 1689, which explicitly provided that they should

26  cf Schofield (n 13 above), 69–70, where, in commenting on these cases, it is argued that ‘in case of the parliamentary grant, the crown bound itself by its own words to accept the conditions of the grant. It would therefore have to show that its prerogative rights were somehow inalienable. It was this issue that was never taken before the judges.’ This overlooks the principle of interpretation. 27  Associated Newspapers v City of London [1916] 2 AC 428 (HL). See also Williams v Pritchard (1790) 4 TR 2, and the other cases cited in the House of Lords. 28  Bill of Rights 1689 1 Wm & Mar sess 2 c 2.

The Curious Case of Mr Trull 79 not avail against the taxation which it introduced.29 This statute was passed in the session prior to the Bill of Rights, but it shows that Parliament at that time considered patents of exemption to be still of legal effect. The 1689 Act was not the first attempt to curtail such privileges. Two centuries earlier, in 1489, an Act of Parliament recited that patents of exemption had been granted to religious houses on ‘feigned suggestions’, that their effect was to charge other taxpayers ‘more grievously’—an interesting point, since it contradicted what the judges were saying—and that they were in effect unfair, since the grantees of exemptions would benefit as much as others from the expenditure for which the taxes were being raised. It was therefore declared that all such patents should be void.30 This was modified a few years later so as to allow the grantees whatever had been allowed them in the previous reign, and it seems from the records that the legislation did not in practice affect any of their exemptions.31 A statute of 1540 forbade any exemptions to be pleaded against the taxes which it introduced,32 though again it seems to have had no effect in practice.33 It has been suggested that the Crown never took advantage of these statutory provisions lest it might throw doubt on the prerogative power to grant exemptions.34 The provision in the 1689 statute was, however, more specific and more permanent than these precursors. It was copied verbatim into the first income-tax measure, Addington’s Act of 1806,35 and in all subsequent ­ income-tax acts down to and including section 525(1) of the Income and Corporation Taxes Act 1970, which was no longer in force at the time of the 1992 case because it had been dropped from the 1988 Act.36 The wording of 1689 is still to be found unaltered in section 290(2) of the Taxation of Chargeable Gains Act 1992, which provides that no letters patent of exemption from subsidies, tolls, taxes, assessments or aids shall be construed to exempt any person from the tax chargeable in pursuance of the Act. These enactments clearly amount to a recognition by Parliament that such patents of exemption would be legally effective today in the absence of such a provision. The omission of the wording from the 1988 Act opens up the possibility that a patent of exemption could now be pleaded against income tax, and it is just possible that some of the non-monastic corporations which

29 

1 Wm & Mar sess 1 c 20, s 19. Rotuli Parliamentorum [London 1767–77] 6: 418. 31  7 Hen 7 c 5; Schofield (n 13 above), 69. Schofield regarded this statute as a clarification, though it is not worded at all clearly. 32  32 Hen 8 c 50, s 24. 33  Schofield (n 13 above), 69. 34  Schofield (n 13 above), 70. 35  46 Geo. 3 c 65, s 216. 36  However, pursuant to Schedule 29 to the 1988 Act, it was inserted retrospectively into the Capital Gains Tax Act 1979, s 157. Perhaps someone else can explain this. 30 

80  Sir John Baker were granted exemptions are in existence today. It is still, of course, accepted practice for the Crown (in the form of the revenue authorities) to grant retrospective dispensations or waivers of accrued income tax to individuals, at its discretion,37 and this might lend further weight to an argument that the same result could still be achieved prospectively. This conclusion goes some way towards supporting the position taken by Professor Pennington and Mr Trull with respect to the Stannaries. Whether or not the 1508 patent incorporated the tinners by necessary implication, it could be viewed as a grant to a class of people exempting them from laws made without the consent of the 24 stannators in their Convocation. Clearly such an exemption could not extend to criminal law, and it could not apply to legislation altering private rights affecting individuals. But it would not be inconsistent with the law, as explained above, for it to apply to revenue legislation, since it could in theory operate as an exemption—or at least as a binding covenant not to impose such legislation on the tinners without their collective assent. That is the best case that could have been made for Mr Trull and his tinless associates, but it is very far from resolving the matter. As it happens, Mr Trull was unaware of any of the authorities just cited, and relied on the bolder submission that Cornwall was a distinct sovereign state, or at least an independent province, with its own Parliament and courts, and that jurisdiction over the stannators (if not the whole Cornish people) belonged ­exclusively to either the Stannary Courts or the Duchy of Cornwall. This rather wild contention was not calculated to go down well in the High Court. The Duchy was not even a county palatine, like Chester, Durham and Lancaster; and in periods when there was no duke it returned to the possession of the Crown. Its ‘court’ was essentially a managerial council with a jurisdiction akin to that formerly possessed by many manorial courts, and in any case its jurisdiction was not coterminous with the stannaries. The County of Cornwall had always sent members to the Westminster ­Parliament and had been taxed as part of England, and this is now equally true of the palatinates. The English courts had always exercised jurisdiction there, and the assizes went there twice a year. As for the stannary courts, it is more or less impossible to argue that they could have survived the Stannaries Court (Abolition) Act 1896.38 Mr Trull had once tried to argue it, with a rashness peculiar to litigants in person, and in 1979 the Court of Appeal had expressed the clear view that no jurisdiction whatever remained in the Stannary Court after its abolition in 1896.39 That is the usual consequence

37  Vestey v IRC [1980] AC 1148 (HL); R v IRC ex parte National Federation of Self-Employed and Small Businesses [1982] AC 617 (HL). 38  59 & 60 Vict c 45. 39  R v East Powder Magistrates ex parte Lampshire [1979] QB 616 (CA).

The Curious Case of Mr Trull 81 of abolition. Mr Trull’s case did not appear to be that the legislation of 1896 had loopholes which the Court of Appeal had missed, but rather that it was altogether invalid because it affected the tinners and had not been approved by the Stannary Parliament. The same, he suggested, was true of revenue legislation. So it all depended on the effect of the patent of 1508. What, then, are the counter-arguments concerning the effect of the patent? First, there is the historical context. Edward III had settled the Duchy of Cornwall in 1337 on Edward the Black Prince and his heirs, eldest sons of the kings of England, for ever, with reverter to the Crown in the vacancies between heirs of that description. Vacancies in fact occurred in more than 80 of the years prior to 1508. There would be no duke from 1511–1537, and in the period 1486–1511 both dukes were under 21. At the time of the 1508 patent the Duke of Cornwall (Prince Henry, later King Henry VIII) was an infant aged 17 or 18, and therefore the duchy was presumably in the king’s wardship. Prince Arthur had also been a minor (born 1486) at the time of the regulations complained of, and so it is possible that they had actually been made by the king as his guardian. These circumstances would explain the naming of the king as well as the prince in the relevant clause of the patent. The immediate context of the 1508 patent was that it was designed to end discontent arising from the regulations issued in the name of the infant Prince Arthur as Duke of Cornwall. The wording of the patent shows that its central purpose was the annulment of that legislation and the grant of a very wide pardon to those who had offended against it. The clause about ‘acts’ followed on immediately from the annulment clause and was evidently intended to guarantee that similar legislation was not in future imposed on the Stannaries, either by the Duke of Cornwall or by the king in between dukes (or as guardian to infant dukes), without the consent of the stannators. The orders of the prince’s council were referred to in the patent itself as ‘acts’. This explains why the clause refers only to statutes and acts ‘made within the County of Cornwall’. That is not an appropriate expression to refer to Acts of Parliament made at Westminster. It applied only to local regulatory legislation. Another objection is that the words of the clause are not confined to ­legislation concerning tin or the revenue, and if they applied to parliamentary legislation at all they would extend to all legislation of any kind; the result would be absurd. Moreover, the clause says that ‘no statutes shall be made’ without the consent of the 24 men. That is not the same as saying that statutes shall not bind unless the 24 consent; it is expressed as a condition precedent to making any statute that the 24 shall consent. That is a very strong argument against taking parliamentary statutes to be within the meaning. If it applied to Acts of Parliament, it would mean that no valid statute of any kind had been passed at Westminster since 1508, because the consent of the Stannary Convocation had never been sought prior to

82  Sir John Baker the royal assent. It is hardly necessary to point out that that could not ­conceivably have been the meaning. But the words all make perfect sense as a provision governing local legislation made solely for the stannaries. Quite apart from all that, it must be a strong argument that no one before the later twentieth century—no one at the time when the Stannary Convocation was still functioning—ever suggested that the charter of 1508 might apply to Acts of Parliament. It must also be very persuasive that the patent was worded very differently from all the precedents of patents of exemption. If it was an exemption, it exempted only in a roundabout way, since it was conditional on the 24 not approving the legislation. There is no other example in history of taxation being imposed by Parliament subject (in certain specified areas) to the assent of the taxpayer. There are also some technical arguments against Mr Trull’s claim. First, medieval patents of exemption were all granted to corporations. No exemption is known to have been granted to a larger or more amorphous class. It was well established that dispensations—before they were outlawed in 1689—could not be granted to an unduly wide or indeterminate class, and the same principle would apply to exemptions from taxation. If, for instance, a whole county was exempted from paying tax, an indirect burden would certainly fall on other taxpayers even if they were not directly chargeable with the shortfall, because they would have to be taxed at a higher rate to produce the required revenue; such a grant would therefore prejudice other subjects. Secondly, even though the question whether a ­revenue statute impliedly repeals a particular exemption is one of construction, not of competence, there must nevertheless be a strong presumption that revenue legislation is intended to bind everyone falling within its terms. No less an authority than Sir Edward Coke took the view that an Act of Parliament which gave local authorities power to levy a community charge on ‘every inhabitant’ impliedly repealed all exemptions, even those granted by ­Parliament.40 Moreover, there seem to be no modern cases supporting the view that an Act of Parliament is to be understood as subject to implied exceptions in favour of patentees, and there is probably a convincing ­argument to be made that modern legislation cannot be taken as subject to such implied exceptions, given the great rarity of such claims. If the ­legislator had been asked at the time the statute was made, ‘Presumably this would not apply to persons or bodies holding ancient charters exempting them from taxes?’, the answer might have verged on the incredulous. Finally, and perhaps most convincingly of all, there is the inapplicability of a Crown grant of exemption to the kind of tax specified in Mr Trull’s prospectus. The claim was that involvement in Cornish tin-mining gave

40  2 Co Inst 704 (discussing the statute 22 Hen 8 c 5, which empowered justices of the peace to levy aids for repairing or rebuilding bridges).

The Curious Case of Mr Trull 83 ­ rotection against the community charge, or ‘poll-tax’, which was introp duced by Mrs Thatcher’s Government in 1990 as a replacement for local rates. Like the old rates, it was payable to the relevant local authority, not to the Inland Revenue. It follows that none of the arguments about taxes payable to the Crown were relevant. A local authority is not an emanation of the Crown. The Crown could not and cannot by letters patent exonerate any debtor from paying his creditor, unless the creditor is the Crown, since that would prejudice third parties. If the 1508 charter operated as Mr Trull contended, it would have exonerated the tinners from paying their dues to the people of the county of Cornwall whom he professed to represent. It was, of course, well worth a try. The Royal Cornish Consols C ­ ompany went into receivership as a result of the legal proceedings, though when a question about this was asked in the House of Commons in 1995, the reply was that the receiver had been discharged by the court without ­making any report to the DTI. For all we know, Mr Trull kept much of his £1M or £2M. It would have more than covered any poll-tax bill. He was sent to prison briefly for failing to comply with the order of the High Court, but the sentence was later suspended on condition of his undertaking to help the DTI recover the money. He was not listed as a stannator when a meeting of the self-styled Stannary Parliament was held in 1993.41 The last mention of him in the press is in a report of 2004 that one of his former associates—a parish councillor and known druid—had become a practising Satanist and had been found mysteriously bludgeoned to death near the Cornish coast and thrown into the sea.42 But that is a different puzzle and, though almost equally curious, beyond the scope of this chapter.

41  The Constitution of Cornwall or Kernow the Country of the West Britons (Truro, 1993) 15–16. 42  ‘Between the Devil and the Deep Blue Sea’, The Daily Telegraph (11 July 2004) accessed 23 December 2016.

84 

4 The Architecture of Tax Administration: Function or Form? CHANTAL STEBBINGS*

ABSTRACT

Britain first saw the development of public architecture as a distinct genre in the nineteenth century. When large buildings began to be constructed for official purposes of national or local government they formed highly visible elements in the landscape of major urban centres. This paper demonstrates that a discrete architecture of tax administration was developed in nineteenthcentury Britain. It argues that the style and design of those buildings dedicated to the administration of tax illuminate the imperatives of that system. Examining the major purpose-built tax structures in London as well as provincial tax buildings, it shows that while this architecture was mainly the product of functional imperatives, through the use of scale and ornament it revealed a subtle though clear aesthetic purpose of wider communication. The architecture of tax in the long nineteenth century when the modern ­fiscal state was being developed demonstrates a contemporary appreciation of the inevitable tensions surrounding the visual communication to the taxpaying public of the sovereign power of the state to tax and reconciling it with the principle of parliamentary consent to the imposition of taxes. INTRODUCTION

A

RCHITECTURE, NAMELY THE design of buildings, has always had a twofold purpose—primarily to provide practical and appropriate accommodation for a specific human activity, but also, to a greater or lesser degree, to serve an aesthetic purpose. One of the functions

* This research was funded by a British Academy Award, which support is gratefully acknowledged.

86  Chantal Stebbings of ­architecture is to communicate. It can make a statement, have a meaning, denote significance, embody an ethos.1 Architects (or those who commission them) intend a meaning in their work, and the extent to which the ­architecture communicates ideas and values depends on the nature of the building. A building could be entirely utilitarian and not express any particular wider message, but it could be both functional and deliberately designed to communicate a particular perception to the observer. The observers and users of a building would form a perception of it—simple or grand; large or small; elegant or vulgar; oppressive or inviting; powerful or weak; bold or conservative; appropriate to its purpose or not—and thus attribute a meaning to it ranging from the simple to the complex and the nuanced. Public architecture as a distinct genre developed in Britain only from the late eighteenth century. Until that period, architecture was almost exclusively vernacular in nature, namely a common style for houses in particular localities. Only churches and defensive castles broke that mould of domesticity. When in the Victorian period large buildings began to be constructed for official purposes of national or local government, from the majestic ­Foreign Office and Home Office in London to the imposing town halls of the north of England, they formed highly visible elements in the landscape of major urban centres. Architectural historians, in their discrete and complex discipline,2 have revealed and analysed the communication of meaning though public architecture in the case of churches, defensive structures, civic buildings, banks,3 courts of law4 and, above all, places of worship. Religious architecture is the most important and most written about in this respect, because of the importance, status and universality of such buildings. In the existing scholarship the absence of any discussion of, or even allusion to, the architecture of buildings accommodating the administration of tax is striking. Tax is, after all, one of the major expressions of the sovereign power of the state, and is an activity of central government that has, legally, socially, politically and economically, required the most sensitive and careful handling. Tax as an institution has certain clear practical needs, which increased as the fiscal activities of the state became significantly more extensive and complex in the nineteenth century. The levying of taxes necessitated accommodation to meet the entirely functional requirements of sufficient

1  See RG Hershberger, ‘Architecture and Meaning’ (1970) 4 Journal of Aesthetic Education 37 (no 4, special issue: The Environment and the Aesthetic Quality of Life). 2 For an introduction to architecture, see title ‘Architecture’ in Encyclopedia Britannica Online www.britannica.com/topic/architecture. 3 See generally J Booker, Temples of Mammon: the architecture of banking (Edinburgh, Edinburgh University Press, 1990). 4 See generally L Mulcahy, Legal Architecture: Justice, due process and the place of law (Abingdon, Routledge, 2011).

The Architecture of Tax Administration: Function or Form? 87 and suitable space and internal arrangement for administration, discussion and dispute resolution.5 The aim of this article is to assess whether a discrete architecture of tax administration existed at all, and whether the practical needs of tax administration determined the architecture of this sphere of human activity or embraced an aesthetic purpose of wider communication. If in its external appearance it purported to express any particular ideal, such as the centralised taxing power and control of the state, it explores whether it did so effectively, and how revealing it is of the nature of tax administration in nineteenth-century England. Integral to tax administration in this period was the adjudication of tax disputes, and this article also investigates the extent to which tax architecture reflected a positioning of tax adjudication as an instrument of government or of the law. The article assesses how far the appearance of the buildings in which tax was administered promoted, inhibited or affected the wider orthodox values of tax administration and the effect it had on the way taxpayers identified with the fiscal system to which they were subject in Victorian England. THE TAX BUILDINGS

By 1837, when Queen Victoria came to the throne, the fiscal system comprised four principal taxes—the taxes so called, namely the assessed taxes and land tax; the stamp duties on a wide range of documents and articles; the excise on home produced commodities; and the customs imposed at the port on imported goods. These taxes were administered, to a greater or lesser degree, from London, with the central boards of commissioners located there and exercising ultimate control. The Boards of Stamps and of Taxes were amalgamated in 1834, but the Board of Excise and the Board of Customs were in discrete existence. In 1849 the stamps, the taxes (which by then included the recently-reintroduced income tax) and the excise were merged into one Board of Inland Revenue, and that was the established form for the rest of the nineteenth century. At the beginning of the nineteenth century, the leading tax in terms of public revenue was the excise,6 an impost which was administered entirely centrally. The ordinance which introduced the excise to Britain in July 1643 provided that ‘for the better levying of the monies hereby to be raised, that an office from henceforth be erected and appointed in the City of London,

5  In relation to the resolution of tax disputes, minimal attention has been paid to the internal design of the accommodation, in striking contrast to law courts: J Hanson, ‘The architecture of justice: iconography and space configuration in the English law court building’ (1996) 1 Architectural Research Quarterly 50. 6  J Jeffrey-Cook, ‘William Pitt and his Taxes’ [2010] British Tax Review 376, 384.

88  Chantal Stebbings to be called or known by the name of the Office of Excise’.7 After having resided in Smithfield and Old Cockaine House in the seventeenth century, it moved to a number of buildings leased from the Frederick family in Old Jewry in the city of London. In 1769 it moved to a purpose-built office in Broad Street on the site of Gresham College.8 The new Excise Office was designed by William Robinson.9 It was necessarily spacious, consisting of four storeys and a large court,10 because after the amalgamation of the three excise boards of Scotland, Ireland and England in 1823, the central staff consisted of some 500 officials. The excise remained there until it was amalgamated with the rest of the inland revenue, moving out in 1852. The Broad Street building was sold in 185311 and demolished shortly after. In 1837 the now amalgamated Board of Stamps and Taxes was situated in Somerset House in London, the building which would be synonymous with tax administration throughout the next two centuries.12 Somerset House was originally built in the mid-sixteenth century as the residence of the lord protector, Edward Seymour, duke of Somerset. After his disgrace it passed into the hands of the Crown and was used as a royal palace for the Queen or Queen Mother until it was demolished in 1775 after years of decay, at which point the then Buckingham House was settled on Queen Charlotte in its stead.13 The last years of the eighteenth century marked the beginning of a demand for high quality public buildings, itself springing from a perception that London lacked far behind her continental neighbours in such provision. Government departments were housed in often inadequate accommodation dispersed all over the city. An Act was passed in 1775 to authorise the erection of purpose-built public offices on the Somerset House site.14 7  Quoted in C Knight, London, 1st edn 1843, vol 5 (Cambridge, Cambridge University Press, 2014) 99. 8  This was authorised by the Gresham College etc Act 1768 (8 Geo III c 32). 9  HM Colvin, A Biographical Dictionary of English Architects 1660–1840 (London, John Murray, 1954) 511. 10  The court was used by the merchant community when the Royal Exchange was destroyed by fire. 11  The National Archives (hereafter TNA) IR 115/3. 12  As the learned societies and Admiralty moved out in the course of the nineteenth century, to Burlington House and Spring Gardens respectively, the only public department located in Somerset House that was not directly or indirectly connected to the raising of the public revenue was the Registry of Births, Marriages and Deaths. In 1905 Somerset House was described as ‘little else than a vast labyrinth of offices for gathering in the State millions. The activities of which it is the centre extend invisibly to the remotest parts of the kingdom, and their sole objective is gold’: R Needham and A Webster, Somerset House: Past and Present (New York, EP Dutton & Co, 1905) 263. 13 For the history of Somerset House, see D Watkin, ‘The Architecture of a Palace’ in M Etherington-Smith (ed), Somerset House, The History (London Cultureshock Media, 2009) 57; HM Colvin, J Mordaunt Crook, K Downes and J Newman, The History of the King’s Works (general editor HM Colvin) vol v (London, HMSO, 1976) 363; Needham and Webster, above n 12, 31–189; (1852) 10 The Builder 193 (27 March); EW Brayley, An Account of the Edifices of London (London, 1823–25) 16–31. See also LM Bates, Somerset House (London, Frederick Muller, 1967). 14  An Act for settling Buckingham House 1775 (15 Geo III c 33).

The Architecture of Tax Administration: Function or Form? 89 From the very beginning, the intention was that tax a­ dministration would operate from there, and the Act expressly mentioned the Stamp Office and the Tax Office. The main learned societies, namely the Royal Academy of Arts, the Royal Society and the Society of Antiquaries, were to be housed there, as well as the Navy Board, the King’s Bargemaster, various other government boards, and their supporting staff. The new Somerset House was designed by Sir William Chambers, the Surveyor-General of Works and a leading architect,15 though he had not been the government’s first choice. Work began in 1776, with the construction continuing until well into the next century. By 1785 the Stamp Office, Tax Office and Legacy Duty office were all installed. When the Board of Inland Revenue was formed in 1849, the excise joined the taxes and stamps in Somerset House. Initially the chief office of the new board was at the Excise Office, but from 1852, by order of the Treasury,16 it was at Somerset House. This amalgamation, and the significant growth in the work relating to all its branches, required considerably more space. The architect to the Board of Works, James Pennethorne,17 prepared the plans for the building of extra accommodation. This was to be ‘an entirely new Edifice’.18 A prolific architect of public works, his new wing fronting Lancaster Place came to be regarded as one of his most successful designs. It consisted of three blocks—a central building and two wings—with each office to be accommodated being given a six-storey segment of the building from cellar to attic.19 The work began in 1851, was completed in 1856, when the Board of Inland Revenue moved in, and the cost was met from the sale of the old Excise Office in Broad Street.20 The Stamping Department occupied the vaults and basements. The Custom House21 of the city of London had as its principal function to collect the duty on those goods entering and leaving the country that were subject to the customs duties, but also administered the customs of Britain’s overseas territories and had duties extending beyond even the collection of customs revenue. It remained essentially on the same site on the north bank of the Thames for most of its very long history.22 Having been rebuilt by Sir Christopher Wren after the Great Fire of London of 1666, it was ­damaged

15  For a brief account of his life, see Needham and Webster, above n 12, 191–92. Chambers died in 1796 and did not see his building completed. 16  TNA IR 115/3. 17  For a brief account of his life, see Needham and Webster, above n 12, 245–47. 18  TNA WORK 12/99/6. 19  J Newman, Somerset House (London, Scala Books, 1990) 7. 20  For the subsequent arrangement of accommodation for the inland revenue in the new wing and the west wing, see N Price, Somerset House: a biography of a building (London, Inland Revenue, 1970) 49. 21  For an explanation as to why the word ‘Custom’ is in the singular, see G Smith, Something to Declare (London, Harrap, 1980) 6. 22  See J Mordaunt Crook and MH Port, The History of the King’s Works (general editor HM Colvin) vol vi (London, HMSO 1973) 422–30.

90  Chantal Stebbings by an explosion in the early eighteenth century and was replaced by a three-storey building designed by Thomas Ripley. It was again replaced by a new building a century later, designed by David Laing, who was architect and surveyor to the Board of Customs.23 When incompetent construction by the builders led to the collapse of the central section,24 it was redesigned and the façade rebuilt by Sir Robert Smirke in the mid-1820s.25 While all the principal taxes were subject to management and control by the central boards in London, the degree varied according to the tax in question. The orthodox model for the administration of direct taxes in Britain was a combination of central supervision and local administration. The assessed taxes, the land tax and the income tax were all administered locally by lay commissioners, under the supervision of the central boards which ensured the implementation of the law correctly and uniformly throughout the country. And while the excise and the stamp duties were administered entirely centrally, it was done by officers of the central board working in the localities. Whatever the nature of the regional administration of taxes, it was evident that it would require the provision of appropriate accommodation. Unlike the accommodation for the central boards in London, all of which was, by the nineteenth century, purpose-built, the premises used for the administration of tax outside the capital were generally not. In most cases, premises regarded as suitable would be rented or occasionally purchased for the purpose from an individual owner or a town corporation.26 In 1862, all tax buildings used by the inland revenue, other than Somerset House which was government property, were rented.27 In many cases they were rented by an individual in his private capacity. An example was revealed by rating litigation in 1860, where a distributor of stamps in Cambridge rented a house and occupied one room as an office for vending stamps and transacting public business. A family lived in some rooms to clean and look after the property, and with the agreement of the revenue authorities, he let five other rooms for the use of the surveyor of taxes and the collector of inland revenue.28 Most custom houses, on the other hand, were the property of the Crown.29 The city of Exeter in the south west of England, being a regional 23 

He had also designed the new custom house in Plymouth. Jarvis, ‘Laing’s Custom House, 1813–27’ (1961) 20 Transactions of the London and Middlesex Archaeological Society 198; J Mordaunt Crook, ‘The Custom House Scandal’ (1963) 6 Architectural History 91. 25  Smith, above n 21, 83–84. It survives today. 26  In the other taxes, whose physical needs were not as specific as custom houses, the p ­ ractice of building new tax administration offices came later. In the middle years of the twentieth century the practice of architectural competitions for the design was adopted even here. 27  Minutes of Evidence before the Select Committee on Inland Revenue and Customs Establishments (1862, HC 370) xii, 131 qq 648–49). 28  Smith v St Michael’s, Cambridge (1860) 3 El & El 383. I am grateful to Richard Thomas for drawing my attention to this litigation. 29  Report from the Select Committee on Inland Revenue and Customs Establishments (1863, HC 424), vi, 303, 508. 24 RC

The Architecture of Tax Administration: Function or Form? 91 capital, a port, and a legal, financial and commercial centre, illustrates the type of accommodation used for tax administration in the provinces. In the first quarter of the nineteenth century, the offices of the collectors of excise, stamp duties and taxes were in different premises across the city, though in relatively close proximity to each other. The surveyor of taxes, however, occupied an office on the opposite side of the city, and the customs officers were located in the Custom House situated on the Quay.30 The amalgamation of the three central boards of stamps, taxes and excise into the Board of Inland Revenue was reflected only very gradually in the provincial establishment. In Exeter, the collectors of inland revenue remained in the old quarter of the city, and the stamp duties staff were housed in premises in a new road, Queen Street, begun in 1835 to permit the erection of residences away from the centre of the city following the cholera epidemics and to permit easy access to rail travellers.31 The last quarter of the nineteenth century saw the entire inland revenue staff accommodated there in large houses converted to office use. In 1861 they occupied just one building, with other offices elsewhere in the city, but gradually acquired nearly half the handsome terrace.32 By 1913 four of the houses in the terrace were occupied by the inland revenue, the last department to join being the valuation department.33 Initially, the other occupants of buildings in that street were firms of solicitors, educational establishments, hotels, dentists, brokers, tea dealers, land agents, railway offices, chemists and a few private households. As the nineteenth century progressed, the character of the street became more professional, occupied by architects and surveyors, fewer private residences and traders. There was no sense, therefore, of the inland revenue offices being in any way apart from the general commercial life of the city. One tax establishment which was purpose-built and remained static throughout this time was the Custom House. It was the first brick public building to be constructed in Exeter. It was built in 168134 and was occupied continuously by customs officers until 1989. It was situated on the Quay.35 It was by no means always the case, however, that local custom houses were purpose-built. Indeed, in the eighteenth century it was more common to lease suitable buildings in the port. The uncertainty caused by such private arrangements in terms of negotiation over price where perhaps few buildings in the town were suitable for use as a custom house or over security

30  Exeter Itinerary and General Directory for 1828 (Exeter, T & H Besley, 1828), 77–78; Besley’s Exeter Director for 1835 (Exeter, Henry Besley, 1835) 9–10. 31  The Exeter Pocket Journal and Almanack for 1856 (Exeter, RJ Trewman, 1856) 158–59. 32 In 1881 the Inland Revenue Office occupied 48–49 Queen Street: The Post Office Directory of Exeter for 1881 (Exeter, H Besley, 1881) 61–62. 33  The Post Office Directory of Exeter for 1913 (Exeter, H Besley, 1913) 71. The inland revenue had moved out of the Queen Street accommodation by 1933. 34  By Luke Falvey to a design of Richard Allen. 35  The port of Exeter was responsible for all ports from Teignmouth to Lyme Regis.

92  Chantal Stebbings of tenure, led to an increase in the building of new custom houses for the purpose, or purchasing outright suitable buildings for conversion.36 Adjudication, in the sense of resolving disputes relating to tax assessments between the Crown and the taxpayer in the courts of law, was, for reasons of public policy, relatively limited in the nineteenth century. In line, however, with the particularly British pattern of central control and local administration of the direct taxes, there existed extensive lay adjudication of tax disputes.37 Local lay commissioners heard appeals against assessments to the land tax, the assessed taxes and the income tax. Hearing hundreds of tax appeals in their own localities, these local commissioners carried out their adjudicatory functions in a variety of premises. The Triple Assessment Act 1798 specified the appeals location as ‘the usual place of holding ­parochial meetings’.38 The local General Commissioners of Income Tax, hearing mainly straightforward appeals against income tax assessments, usually sat in a local hotel,39 inn or coffee house. Sometimes they used the formal courtrooms used by the justices of the peace. In Exeter, they used the Castle in the centre of the city, which was the location of the regular courts for the county of Devon.40 The Land Tax Redemption Appeal Commissioners, being justices of the peace, heard appeals at their local Petty Sessions.41 When hearing the more complicated appeals against income tax assessments in London, the Special Commissioners of Income Tax sat at their own offices in London, variously at Broad Street, Lancaster Place, the Old Jewry, Somerset House, and Kingsway. When they went out on circuit from London once or twice a year to hear more ­complex income tax appeals in the main towns and cities, they used local hotels,42 and sometimes the offices of the government surveyor.43 FUNCTIONAL IMPERATIVES

Architecture is the outcome of human needs and desires. Tax buildings were commissioned by the central government department responsible for 36 EE Hoon, The Organisation of the English Customs System 1696–1786 (New York, D Appleton-Century Company, c 1938) 170–71. 37  Criminal prosecutions, for example for breaches of the excise legislation or the stamp duty legislation, were heard in the regular criminal courts. 38  Triple Assessment Act 1798 (38 Geo III c 16) s 63. 39  For example, the General Commissioners in Leek sat in the George Inn in 1860: TNA IR 40/1052 (1860). 40  Law courts for the city of Exeter were located in the Guildhall: Assize, Quarter Sessions, Mayor’s Court, Steward and Provost’s Court: Exeter Itinerary and General Directory for 1828 (Exeter, T & H Besley, 1828) 30–31. 41  Land Tax Redemption Consolidation Act 1802 (42 Geo III c 116) s 197. 42  When hearing appeals in Chester in 1884 for example, the Special Commissioners sat in the Queen’s Hotel: Broughton and Plas Power Coal Co Ltd v Kirkpatrick (1884) 2 TC 69. 43 When hearing an appeal in Leeds in 1896: Leeds Permanent Benefit Building Society v Mallandaine (1897) 3 TC 577.

The Architecture of Tax Administration: Function or Form? 93 the construction of public works and the needs expressed by the users of the building, namely the various boards administering the range of taxes in eighteenth and nineteenth century England. Significant in the design of purpose-built accommodation for tax administration, and in the choice of rented or purchased accommodation for that purpose, were imperatives of function and convenience, the need to provide appropriate accommodation for the efficient administration of tax. The boards were very clear as to their practical needs, and consulted closely with the architects in question. Chambers’ plans for Somerset House, for example, were submitted to each office for their approval, and Pennethorne was in regular correspondence with the members of the Board of Inland Revenue. There were, first of all, obvious requirements of functionality, and all the tax buildings were designed or adapted to ensure they had these qualities. The work of the boards was essentially administrative in nature, requiring offices for clerks, committee rooms and board rooms, and storage for l­ edgers, correspondence, circulars, Acts of Parliament, regulations and reports. ­Sufficient light was an important requirement. These offices were also public facing, and accommodation had to be suitable for taxpayers coming to inquire in person as to tax matters, to buy stamps or bring their documents to be stamped, to petition the officials, and so had to be conveniently situated for public access and for communication with other elements of the tax administration, and provide waiting rooms and appropriate facilities. Premises were necessary for the hearing and resolution of tax disputes which, by law, had to be conducted in private. That meant that the rooms where the commissioners heard the appeal had to be out of earshot of other appellants waiting for their own cases to be heard. Furthermore, tax buildings needed to be secure, not because money changed hands (other than in the case of stamp duty), but because the information held there was highly sensitive. There were some rather more specialised needs. In some instances suitable space was needed for machinery, as for example the steam presses for manufacturing stamp duty stamps,44 print works to produce the forms, circulars and other documentation sent out from the central boards all over the country, or again specialist accommodation such as that for the inland revenue laboratory necessary to establish the adulteration of foodstuffs for excise purposes amongst other things. Custom Houses had special requirements, of location, and facilities for the receipt, secure storage and delivery of goods by sea, river or rail. Public convenience was a concern too. When discussing the shortcomings of the Old Jewry Excise accommodation in the mid-eighteenth century, it was said that members of the public were too inconvenienced by this outdated and adapted accommodation: the clerks were dispersed all over the

44 

See generally H Dagnall, Creating a Good Impression (London, HMSO, 1994) 76–82.

94  Chantal Stebbings jumble of buildings, and it was difficult for traders to locate the official they needed to address, or even to whom to pay their duties.45 The dominant and enduring requirement was for sufficient space. As the scope of taxation grew with the introduction of new taxes, the growth in the population and the increase in national wealth, so the demand intensified for space to accommodate a growing staff to undertake a highly labour-intensive activity and, significantly, a constantly increasing body of paper records.46 This was first seen in relation to the customs, for as trade and commerce grew, existing custom houses quickly became inadequate.47 Laing’s Custom House was built above all to address problems of space caused by the growth of overseas trade in the eighteenth century. When the Excise Office resided in Old Jewry in the early eighteenth century, space was a constant concern. The office acquired adjacent buildings as the increasing business of the office required, and as the volume of paper increased, so did concern as to the weight that the floors of the ageing buildings had to bear.48 The plans for the excise office in Tower Hill in 1828 included a whole floor to file survey books.49 Of all the government departments housed in S­ omerset House, the revenue boards were the ones whose business grew to such an extent that their physical needs drove other departments to seek accommodation elsewhere and ultimately resulted in the building of an entire new wing devoted to the administration of tax. As early as 1817 the Legacy Duty Office, already suffering from space problems and needing additional accommodation,50 attempted to purchase land on some vacant ground at Somerset House.51 With the storage of such extensive and important paper records, security from fire was an ever-present anxiety. When during the 1760s the leasehold accommodation for the Excise Office in Old Jewry was under scrutiny, fire was a major concern. The premises consisted of ancient houses built shortly after the Great Fire of London in 1666, were surrounded by other buildings and accessed by narrow roads. In those circumstances fire was a very real hazard, and the safety of the books and papers was prominent in the

45 

TNA T 1/441 267–282. Similar storage problems were a factor in calls for a new building for the Foreign Office: see Report from the Select Committee on Foreign Office Reconstruction (1857, HC 417), xi, 1, 3. For a more recent example, see the proposal to accommodate the Special C ­ ommissioners’ staff in prefabricated huts in the 1960s, caused by the increase in surtax work and the discussions as to how to reorganise the surtax administration to ensure sufficient office space: TNA WORK 12/509. 47  As with Ripley’s Custom House: Purchase of London Quays Act 1812 (52 Geo III c 49). 48  TNA T 1/441 267–82. 49  TNA WORK 30/43. 50  Price, above n 20, 36. 51 A dispute over title to adjoining land proved very costly for the Board of Stamps: TNA WORK 12/99/2. 46 

The Architecture of Tax Administration: Function or Form? 95 commissioners’ concerns.52 The Board of Works undertook a survey and found that the premises were ‘greatly out of Repair and very unsafe from Fire both as to the Buildings and situation’.53 The expense involved in securing the building against the danger of fire was one of the principal reasons for rejecting the proposal that Gresham College be converted into a general excise office.54 It was such considerations, the need for a ‘proper place’55 to house the principal tax boards, that led to the construction of new buildings to accommodate them, both in London and elsewhere. For example, between 1818 and 1821 the building of a new stamp office in Edinburgh was being considered. The choice lay between the purchase of one of two private residences for conversion and adaptation to the needs of the office, and the erection of an entirely new building. Considerations of economy jostled with those of security of title, public convenience, security, proximity to other tax offices, fire hazard, access, and, above all, space. Ultimately, a new building in Waterloo Place was constructed.56 All these new buildings were regarded as providing the desired accommodation. The Excise Office in Broad Street was the result of the inadequacy of the Old Jewry premises, while the new wing of Somerset House was required entirely for reasons of space. ­Pennethorne had to adapt his design to meet the requirements insisted on by the inland revenue to ensure ‘a much more satisfactory arrangement … for persons coming to the Court of Appeal from Charing Cross or the City; as well as for the business generally’.57 When completed in 1856, the new wing was large and described as ‘well-arranged and commodious.’58 THE QUESTION OF STYLE

In terms of design, the first matter to be addressed was that of the style of the building. The two dominant architectural styles in nineteenth-century Britain were the classical and the gothic. As with all styles, they had evolved from older architectural traditions, cultural and foreign influences, and individual creativity. The period saw a struggle for supremacy in architectural style, particularly in relation to public buildings, between the two principal styles,59 and whether there was, or should be, a ‘national style.’ This debate, 52 

TNA T 1/441 267–82 (1765). TNA T 1/459 18–19 (1767). 54 ibid. 55  TNA T 1/441 267–82. 56  Seven storeys in all, with four above pavement level in Waterloo Place and three below at the back. 57  TNA WORK 12/99/6 (8 October 1851). 58  Needham and Webster, above n 12, 249. 59 ‘Lord Palmerston and the Designs for the Foreign Office; or Classical versus Gothic’, The Gentleman’s Magazine, November 1859, 469–75; ‘The Question of Architectural Style 53 

96  Chantal Stebbings expressed in the leading architectural and general journals of the day,60 was strikingly illustrated by the competition for the design of government offices in 1857. New buildings were required for the Foreign Office and the War Office, and the Board of Works launched a competition, with no constraints and an extensive brief, and invited the architectural profession to respond.61 The Government Offices competition was one of the most important of that period.62 It was generally accepted that public buildings should be grander and more magnificent than domestic or industrial buildings.63 It was recognised as being a matter of taste, an aesthetic debate, and neither one style nor the other was regarded as inherently more suitable for government buildings in either style or function.64 Indeed, the new Houses of Parliament were designed in the gothic style by Sir Charles Barry. The gothic style, however, was redolent with religious and romantic symbolism and as such was perceived as affirming values contrary to the spirit of industrialisation and capitalism. The classical style, however, was appropriate to all government buildings in that it affirmed the continuing influence of Greek political institutions and constituted a physical expression of democratic values. With its careful proportions, aesthetic principles, symmetry, balance, and attention to scale, the style evoked perceptions of order, control and power. Furthermore, certain architectural forms were understood to have meaning, and, for example, domes, towers, columns and colonnades were accepted symbols of power. In purely practical terms, the classical style lent itself well to buildings on a large scale. For these reasons the classical style was entirely appropriate to house the taxing headquarters of government. The Excise Office in Broad Street, which is accepted as William Robinson’s most important work, adopted the classical style. It consisted of two ranges of stone and of brick of four storeys, and a large court.65 It was not regarded as splendid, but rather as for the New Public Offices’, The Saturday Review, 25 September 1858, 303–5; S Muthesius, The High Victorian Movement in Architecture 1850–1870 (London, Routledge & Kegan Paul, 1972) 161–65. 60  See for example ‘The National Style and its Critics’, The Gentleman’s Magazine, January 1860, 21–27. 61 See Report from the Select Committee on Foreign Office Reconstruction (1857–8, HC 417), xi, 1, 4; ‘The Prizes for the Public Offices’, The Saturday Review 1 August 1857, 105–6; ‘The New Foreign Office’, The Saturday Review, 30 July 1859, 129. 62  EK Morris, ‘Symbols of Empire: Architectural Style and the Government Offices Competition’ (1978) 32 Journal of Aesthetic Education 8 (no 2, Politics and Design Symbolism). 63  Minutes of Evidence before the Select Committee on Foreign Office Reconstruction (1857–8, HC 417), xi, 1 at qq 1292–95 per Samuel Angell. 64 See Report from the Select Committee on Foreign Office Reconstruction, above n 61, 1, 6; ibid 1, q 1212 per William Burn, architect; ibid qq 1316–20 per Henry Arthur Hunt; ibid qq 1414–15 per Sir Charles Barry. 65  The court was used by the merchant community when the Royal Exchange was destroyed by fire.

The Architecture of Tax Administration: Function or Form? 97 ‘very noble,’66 a ‘large pile of building’.67 When it was first built, James Ralph wrote that ‘[t]he stone front of the new Excise Office … charms us by the air of strength and propriety which it possesses’.68 Edward Mogg in his visitor’s guide to London in 1838 described it as ‘a building of magnificent simplicity and great extent’69 while Charles Knight, in his study of London in 1843, described it as being ‘of most commanding aspect’.70 He continued: The merits of this edifice are known far less extensively than many others of inferior character. There are architects of the present day who state that for grandeur of mass and greatness of manner, combined with simplicity, it is not surpassed by any building in the metropolis.71

Later critics described it as ‘not particularly impressive’72 and as ‘built in a competent but conservative Palladian style’.73 Simplicity was preferred for the design of all excise offices. In 1818 the ‘chasteness and purity of the architecture’ of the Excise Office in Edinburgh was praised.74 The government’s first choice as architect for the new Somerset House was William Robinson, the architect of the Excise Office. It seems that he had intended a building ‘in the plain manner, rather with a view to convenience than ornament’, but he was overruled in Parliament when Burke and other ‘men of taste’ ‘pressed for Splendour’. Ultimately the plan was to build for the convenience of the public offices to be housed there, but ‘likewise with an eye to the Ornament of the Metropolis, and as a monument of the taste and elegance of His Majesty’s Reign’.75 And when, on Robinson’s death, the commission was handed to Chambers, he proceeded to produce a grand, indeed a magnificent, building of consequence, in the classical style. It was no easy task to design a building to accommodate such a wide range of public, governmental and literary establishments. Chambers said it was ‘of a very uncommon kind, unusually extensive, intricately complicated’.76 His design was initially strongly criticised for its expense, inappropriate statues, faulty proportions and inadequacy of accommodation, and indeed

66  HB Wheatley and P Cunningham, London Past and Present: Its History, Associations, and Traditions vol 2 (1891) (Cambridge, Cambridge University Press, 2011) 23. 67  Knight, above n 7, 97. 68  J Ralph, A Critical Review of the Public Buildings, Statues, and Ornaments, in and about London and Westminster (London, John Wallis, 1783) 29. 69  E Mogg, Mogg’s New Picture of London, (London, E Mogg, 1838) 30. 70  Knight, above n 7, 111. 71  ibid 111–12. 72  Newman, above n 19, 4. 73 A Mackley, ‘Robinson, William (c.1720–1775)’, Oxford Dictionary of National Biography (Oxford, Oxford University Press, 2004). 74  ‘New Stamp Office, Edinburgh’ (1821 HC 488), xxi, 275, 289. 75  J Baretti, A Guide through the Royal Academy (London, T Cadell, 1781) 3–4. 76 Quoted from Chambers’ report to the House of Commons in 1780 in Needham and Webster, above n 12, 196.

98  Chantal Stebbings a degree of architectural criticism endured.77 However, with skill, taste, an eye for detail and an insistence on ensuring the highest quality of materials and workmanship, Chambers produced a building described as ranking ‘among the first examples of classic architecture in the eighteenth century,’78 ‘an almost perfect example of the master-builder’s craft’.79 The Builder, which was one of the leading construction and architectural periodicals of the time, described it as ‘one of the finest structures of which the metropolis can boast.’80 It continued: The admirable proportions and excellent details of the Strand front, the elegance of the open vestibule leading into the noble court-yard around which the offices are placed, the internal distribution, the river front, though not without objectionable points, and the decoration of the interior, have obtained for the architect the praise of those best qualified to judge. As a piece of masonry, it is unrivalled.81

In building the new inland revenue wing, Pennethorne was constrained by the aesthetic demands of harmonisation with the rest of the building. He was himself a committed classicist, and accordingly copied the essential classical design and details from the main building. Arches, columns, medallions and friezes made the construction a harmonious whole. Nevertheless, he adapted his design so as to satisfy the revenue boards’ functional requirements, notably in designing the frontage so as to alter the size of the windows to allow more light to officers working inside.82 Laing’s doomed Custom House on Lower Thames Street, also built in the classical style, was large enough to accommodate some 2000 staff in the late nineteenth century. Its size and position made it an impressive building appropriately reflecting London’s enormous volume of trade and position in the world of commerce. When Robert Smirke rebuilt the central section in 1825 he followed Laing’s design, which was very much to his taste as a leader of Greek revival architecture in London.83 A visitor’s guide to London in 1838 described it as ‘a vast and extensive pile’ and continued: ‘… the general character of this edifice is plainness and solidity, with the exception of the river front, the effect of which is grand and impressive’.84

77 The criticism of Anthony Pasquin was especially strident, and ultimately exposed as unfounded. It is repeated in Somerset House Weekly Miscellany of Fine Arts, Antiquities and Literary Chit Chat, no viii, 29 November 1823, 114–17. For a discussion of later criticism, see Needham and Webster, above n 12, 205–13. 78  Needham and Webster, above n 12, 190. 79  ibid 201. 80  (1852) 10 The Builder 193 (27 March). 81  ibid. For an architectural appreciation of the work, see Brayley, above n 13, 16–31. 82  TNA WORK 12/99/6 (8 October 1851). 83 His designs included the Covent Garden Theatre, the British Museum and the King’s College wing of Somerset House. 84  Mogg, above n 69, 30.

The Architecture of Tax Administration: Function or Form? 99 Whichever architectural style was preferred, a more refined message could be expressed within it. So the classical architects and gothic revival architects, whatever their fundamental differences, would seek to use the decoration which was inherent in both styles to convey certain more specific messages to the viewer. George Gilbert Scott, one of the leading ­architects of the gothic revival in the mid-nineteenth century, favoured symmetry and regularity for important public buildings but held the view that rich decoration was necessary in buildings of particular importance. The use of decoration was thus of great significance in conceiving and deciphering the message intended to be conveyed. It was the language, the words, of architecture. Sculpture in particular was integral to nineteenth century architecture.85 It was thought that it was key to communicating a message or meaning. It should not overwhelm a building, could be lavish, but should not be inappropriate. The Spectator complained of the entries for the government buildings competition in 1857 that most departed from the rule ‘that the simple purpose of the object to be constructed should be illustrated, not disguised, by the style of ornament’.86 The Excise Office in Broad Street boasted very little decoration, and since it was a building constructed exclusively for tax use, this was revealing. When the Board of Works submitted the design the intention was that it would ‘answer the purpose of that Office to be built in a plain substantial manner’.87 It was thus planned to be unadorned and well built, essentially functional and not ornate.88 It was described as ‘plain in design’,89 ‘a very noble though unornamented stone structure’.90 Laing’s Custom House was somewhat more decorated. The north front, built of brick, was plain, but its south front facing the river Thames, built of Portland stone, was a­ mbitious in its ornamentation. Carvings and statutes depicted commerce and industry, the arts and sciences, industry and wealth.91 When Smirke rebuilt the central range, he replaced Laing’s statuary with a simpler classical Greek portico.92 In contrast to the Excise Office, Chambers’ Somerset House, though also built in the classical style, boasted the richest decoration and statuary, all of

85  On the place of architectural sculpture in Victorian buildings of the classical style, see B Read, Victorian Sculpture (New Haven, USA, Yale University Press, 1982) 215–31. 86  ‘The Westminster Designs’ The Spectator Archive (9 May 1857) . 87  TNA T 1/459 18–19. It was estimated to cost £20,970 exclusive of desks, presses and other furniture: ibid. 88  Seen from the accounts of the building works: TNA WORK 6/117. 89  Knight, above n 7, 111. 90  Wheatley and Cunningham, above n 66, 23. 91  RC Jarvis, ‘Laing’s Custom House, 1813–27’ (1961) 20 Transactions of the London and Middlesex Archaeological Society 198, 207. 92  ibid 212.

100  Chantal Stebbings which was heavy with patriotic symbolism.93 Because Somerset House was not intended to house the tax departments exclusively, but a number of other government departments and the learned societies, the inferences that can be drawn from the design are limited. The building facing the Strand was particularly ornate, since it opened to one of the busiest streets in London, and was faced with Portland stone, adorned with columns, decorated windows, a range of allegorical statues and sculptures representing the ­ arts, classical history, myths of antiquity, different parts of the globe, many marine and naval allusions, the royal family, the principal rivers of England, emblems of justice and the attributes of good government.94 The decoration was, therefore, appropriate to the principal tenants, namely the learned societies and the navy, and to some of the more minor tenants but, strikingly, only the revenue offices had nothing specifically dedicated to them. Because Pennethorne’s design for the new inland revenue wing had to complement the original part of Somerset House, he was obliged to commission extensive statuary to ornament the façade. Because the new construction related solely to the inland revenue, discussions of these sculptures are particularly revealing as to the aesthetic imperatives underlying the design. Pennethorne, like Chambers before him, selected from the best sculptors of the day. The chief commissioner of works was of the opinion that as the front of the New Wing will be an important public Building, fully as conspicuous as any of the other parts of Somerset House, the Sculptures introduced thereon should be first rate works of Art like the Sculptures on the other fronts which were executed by … first men of that day.95

In 1855 Pennethorne drew up a specification of sculptures for the central block. He required six statues each seven feet high and a seated statue above the centre of the pediment, subject unspecified; then two sea horses ‘or other figure’, the royal arms, a festooned frieze and medallions of the Queen above the entrance door.96 All were to be sculpted from ‘the best and hardest quality of brown Portland’.97 The designs were to be approved by the chief commissioner of works. The fact that Pennethorne wrote that ‘[e]ach sculptor is to be at liberty to propose subjects’,98 suggests there was no sense of any intention to put over a specific tax message to the public through the architecture of the building. The accepted architectural view was that sculptures should clearly explain

93  For the later architectural depiction of empire, see GA Bremner, ‘“Some Imperial Institute”: Architecture, Symbolism, and the Ideal of Empire in Late Victorian Britain, 1887–93’ (2003) 62 Journal of the Society of Architectural Historians 50. 94  Needham and Webster, above n 12, 197–200, 202–205; Newman, above n 19, 23–29. 95  TNA WORK 12/99/6 (8 April 1852) 84. 96  ibid 113 (1 June 1855). 97 ibid. 98  ibid 114.

The Architecture of Tax Administration: Function or Form? 101 the object of the building through allegory. However, one sculptor who tendered for the work and said that his subjects of the statues had been ­chosen with the view of ‘directly illustrating the purpose of the ­Building’99 was in the minority in this respect. He proposed ‘Inland Revenue’ as the principal figure, with the departments of ‘industry and intellect from which Inland Revenue is derived, viz “Machinery,” “Raw produce,” ­“Manufactures” and “Fine Arts,” (the divisions of the Exhibition of ‘51) with the addition of “Science” and “Literature”’. He also proposed to represent ‘insular commerce’, ‘navigation’ and the division of the United Kingdom ‘into town and country’.100 The sculptor was John Bell,101 and his tender of £2,500 for the work was not accepted. The commission went to William Theed for £1,950,102 and his design, depicting Minerva, Lion, sea horses, the royal arms and foliage, paid less attention to the incorporation of tax-relevant symbols.103 He did not, however, ignore them altogether. The statues over the entrance represented the principal manufacturing cities of the United Kingdom. They were illustrated and discussed in The Illustrated London News. The first three of the six, representing Manchester, Glasgow and Belfast, were described as ‘noble figures’.104 The final three represented London, Edinburgh and Dublin.105 Reflecting the new industrial and commercial wealth of nineteenth century England, and thereby somewhat diminishing the older forms of wealth in land and agriculture, these constitute the closest allusion to the fiscal activity carried on in the building.106 Where regional tax buildings were purpose-built, they too regarded questions of style as important and addressed them explicitly. The new Stamp Office in Edinburgh, for example, was an imposing structure in the classical style. Of all purpose-built tax accommodation, however, custom houses were the most concerned with style, and tended to be the most imposing. The Custom House in Exeter, purpose-built in the late seventeenth century, was architecturally typical of the period,107 and in size, style and location made a clear mark on the landscape of the city. In the Memorials to the Treasury in the early 1850s praying for funds to erect a new custom house in Belfast, it was said that ‘it would be desirable to provide a new Custom

99 

ibid 139 (23 July 1855).

100 ibid.

101  Among John Bell’s most famous works are the Crimean War monument to the Brigade of Guards at the junction of Pall Mall and Waterloo Place in London, and the marble sculpture of ‘America’ on the Albert Memorial, Kensington Gardens, London. 102 William Theed (1804–1891), worked extensively for the royal family, and like John Bell exhibited in the Great Exhibition of 1851, and was responsible for ‘Africa’ in the Albert Memorial. 103  TNA WORK 12/99/6 (23 July 1855) 142. 104  The Illustrated London News, 1 November 1856, 459. 105  The Illustrated London News, 14 February 1857, 135–36. 106  Belfast, Edinburgh, London, Manchester, Dublin and Glasgow: Price, above n 20, 44. 107  H Meller, Exeter Architecture (Chichester, Phillimore, 1989) 30–31.

102  Chantal Stebbings House, more suitable as regarded accommodation and appearance … than the present building’ which, it was stated was in ‘a wretched state’ and ‘a blemish’.108 The Liverpool Custom House, built in the classical style in the m ­ id-nineteenth century, was magnificent in scale and the grandest outside London, reflecting Liverpool’s status as the second port in the country. A correspondent to The Civil Engineer and Architect’s Journal wrote in 1840 that it was ‘considerably larger, more imposing and magnificent’ than the London Custom House.109 Of the portico, the commentator said that it was ‘simple, grand, and expressive, and its large and chaste proportions beautifully adapted to its purpose’.110 He continued: The proportions of the rest of the building are upon the same scale of plainness, simplicity, and largeness … suitable to the extent and commercial nature of the building, where not elegance, but the substantiality and solidity commensurate to its subjects are required.111

He was critical of the use of decoration and the inclusion of a dome, but concluded that: upon the whole, in spite of many serious defects, this edifice, from its size, grandeur, chastened simplicity, isolation of position, and importance as to utility, is well worthy of admiration from the stranger, and respect from the citizens of the good town of Liverpool.112

In response, however, another correspondent, in a crushing technical ­critique, held that the building had been the subject of much ‘unmeaning and … ignorant admiration’.113 Though the building was indeed large, it was not magnificent, in that it was seriously defective in symmetry, proportions and decoration. This imposing character was typical of custom houses all over the world. The new Custom House in New Orleans, four storeys, 85 feet high, faced in marble or granite, was featured in The Builder in 1848,114 notable because it would be the largest building in the United States at that time, covering some 99,000 square feet and as such significantly larger than the Capitol in Washington. The new Custom House in Rouen, France, also merited description and illustration in 1849, and is seen to be equally imposing and functional, though with some ornamentation in the shape of two statues some eight feet high on the façade.115 108 

Belfast Custom House (1852, HC 503) xlvii, 43. ‘The Architecture of Liverpool’ (1840) 3 The Civil Engineer and Architect’s Journal 356. 110 ibid. 111 ibid. 112  ibid 357. 113 ‘H’, ‘Architecture of Liverpool’ (1840) 3 The Civil Engineer and Architect’s Journal 410, 411. 114  (1848) 6 The Builder 177 (8 April). 115  (1849) 7 The Builder 546–47 (17 November). 109 Eder,

The Architecture of Tax Administration: Function or Form? 103 British regional custom houses also displayed the principal exception to the paucity of external architectural symbolism on tax buildings in that typically they bore the royal coat of arms. This signified the authority and position of the monarch, and it featured prominently on many, but not all, provincial custom houses. It was an image legible to foreign traders unambiguously asserting the taxing authority of the Crown, and, thereby, the right of the customs’ officers to record goods entering or leaving the port and to collect the customs duties. Generally, however, since regional tax buildings were generally either rented or purchased for conversion, questions of style and architectural symbolism were generally not regarded as of particular importance. Before the early nineteenth century there was no office building in towns distinct from rest of urban architecture and most regional tax buildings were converted residences which necessarily were constructed in the vernacular style of the period of their design. So the Inland Revenue Office in Exeter was housed for many years in an elegant mid-nineteenth century stucco terrace with a classical façade116 with nothing to distinguish it as premises of the inland revenue. In this context, external symbolism had little place. Premises used for regional tax adjudication outside the regular courts of law, namely hearings by lay commissioners, raised different considerations in terms of style. Other than the ‘court of appeal’ in Somerset House, where the Special Commissioners settled tax disputes when sitting in London, they were never purpose-built. The imperatives were pragmatic. The holding of tax appeals in the local inn was a practical solution, simply because inns often constituted the largest rooms in the area other than the private houses of the gentry. Using the offices of the local tax officials was equally practical, because the appellants would in all likelihood have been advised in relation to their appeals on those premises. Using a variety of premises subject to multiple uses, from inns to formal law courts, they resolutely did not display any external feature to signify their use for tax adjudication. In such cases, the buildings themselves, whatever they were, created a specific perception, and one which often tainted the tax process. So if the premises which housed the regular courts of law were used for tax adjudication, as, for example, the Castle in Exeter, it could significantly affect the perception of the tax adjudication. From lay adjudication savouring of discussion and consent, it took on the nature of an intimidating police court with its criminal connotations. Similarly, holding tax hearings in the office of the government surveyor would significantly undermine the perception of impartiality and independent local administration of tax. The considerations of the suitability of the premises used for adjudication which were regarded as so important in the twentieth century, with its

116 

Meller, above n 108, 75.

104  Chantal Stebbings growing emphasis on fairness and access to justice, were hardly considered in the nineteenth. There is no formal evidence of an awareness of the importance of balancing a degree of formality and respect appropriate to these quasi-judicial proceedings with sufficient informality to prevent the intimidation of a self-represented taxpayer bringing an appeal, let alone any questions of the need for the appearance of impartiality. Such premises were regarded as unexceptionable. Only in the early years of the next century did concerns as to the suitability of premises begin to be voiced.117 FUNCTION OR FORM?

It was clearly understood that purpose-built constructions for the administration of the taxes, like all government buildings, should be fitting and dignified. The widespread acceptance was that government buildings in the metropolis housing the great departments of state should be large and majestic, built of the best materials, with quality decoration, conveying a message of wealth, power, majesty, authority and control. While this was clearly true of the new Foreign Office and Whitehall, it also extended to Somerset House and the Custom House. Purpose-built tax premises were owned by the government and formed part of the general body of government buildings, undistinguished beyond the orthodox conventions of appropriate style which determined the appearance of generic public buildings. Architecturally, therefore, the central tax buildings overtly affirmed the sovereign power of the state to tax and its place as part of central government. The evidence suggests that the importance of this message was accepted, and that there was certainly no desire to hide it. But it was also understood that it was important to avoid any stridency in proclaiming it. Indeed, architecturally, tax buildings were among the plainest of government buildings, with notable moderation in decoration and minimal, if any, overt symbolism. They all, even custom houses, were characterised by a degree of architectural restraint. Four principal reasons can be discerned. First, it was important to avoid any public perception arising from the construction of new accommodation that tax revenue was being squandered or wasted. The message should always be that tax revenue was being used responsibly, expended on the proper purposes of government, ensuring the country’s defence, economic, political and social ambitions, and not on selfinterested and self-indulgent comfort on the part of the board. For example, when in 1765 the commissioners of excise were criticised for not having maintained their Old Jewry buildings properly, and not having foreseen the 117 The appropriateness of the General Commissioners using the premises of the inland revenue was officially questioned by the Royal Commission on the Income Tax in 1920: Report of the Royal Commission on the Income Tax (1920, HC 615), xviii, 97, 185 para 365 (d).

The Architecture of Tax Administration: Function or Form? 105 growth in business that would necessitate more extensive accommodation and made appropriate inquiry, it was observed that an inquiry of this sort might be understood as a departing from their favourite plan of building at an enormous expense a pompous Office more magnificent, more commodious and in a better situation for themselves and the Officers under them, though not in a situation so convenient for His Majesty’s trading subjects.118

A modern commentator queried in relation to Somerset House [w]hy all this royal splendour and imperial magnificence in a building largely serving as government offices, particularly of revenue departments down even to the Salt, Stamp, Excise, Land-Tax, Hawkers and Pedlars, Hackney Coach and Lottery Offices? These may seem incongruously housed in a building of such magnificence.119

Such perceptions led buildings constructed exclusively for tax purposes, such as the Excise Office and the Custom House, to avoid the magnificence of the scale of Somerset House. Indeed, modern critics observed of the Excise Office that ‘the anonymous regularity of its fenestration was not, perhaps, altogether out of keeping with the functions of the fiscal department which it sheltered’.120 Architectural moderation thus reinforced a message of solidity in the management of the country’s finances. Secondly, grand tax buildings could fuel the popular resentment of taxes. This was well understood in relation to the excise, the most hated tax of the modern fiscal system, causing widespread riots and opposition in the eighteenth century. Excise offices were almost invariably the most plain and utilitarian of tax accommodation. This is striking in the case of the Excise Office in Broad Street. ‘The extension and increase of Excise laws’, it was said in 1766 when new accommodation was being considered, is now the great topic for clamour and discontent, great pains are taken by factions to spread this discontent throughout the kingdom by alarming the unthinking multitude with apprehensions that nothing less than a general excise is intended by the government, if this be the case will not the Commissioners even enquiring for a spot of ground at this time whereon to build an Excise Office add fuel to the present flame? But how much more will it inflame if they succeed in getting such a spot of ground, they set about building such an office as will be necessary to admit an increase of business which must only serve to corroborate and confirm every malignant reflection with which Administration is already too much oppressed.121

Thirdly, the premises of tax administration could give a physical, and v­ iolent, focus for the resentment of a particular tax. Tax buildings ­ symbolised 118 

TNA T 1/441 267–82. above n 13, 57. The reason lay, he says, in its past as the residence of the Lord Protector and then as royal palace, of which both George III and Sir William Chambers were acutely aware. 120  Colvin, Crook, Downes and Newman, above n 13, 350. 121  Memorial relating to the state of the Excise Office, 1766: TNA T 1/441 267–82. 119  Watkin,

106  Chantal Stebbings the taxes administered in them, and while violent popular objections to particular taxes tended to take the form of noisy meetings and at most the burning of tax officers in effigy, in some cases, so hated was the tax in question that tax premises were attacked or destroyed. A notable example was the burning of the Excise Office in Smithfield in the riots against the tax.122 The identification of a building with an unpopular tax could even professionally taint its architect. It was said that the work of James ­Gandon was never fully appreciated in his lifetime because he had designed the new ­Custom House in Dublin wherein the particularly unpopular duty was administered. And the unpopularity of the income tax was epitomised by Somerset House—the name formed part of the rhetoric against the tax itself and its administration (and indeed of all taxes administered there) throughout the nineteenth century. It was the fourth reason for favouring this austerity in the architecture of tax administration which was the most complex and revealing. Large and imposing buildings were undoubtedly perceived by some taxpayers as majestic and entirely appropriate, but were equally perceived as menacing to others. In terms of size and shape, the extensive frontage of the London Custom House, and that of Somerset House, to which was added the sheer size of its courtyard and magnificent entrance, and the massive aspect of the Excise Office, could be intimidating. It could create a perception of threat and coercion which undermined the core value of British taxation. That essential principle was that of consent, the consent of the taxpayer, through Parliament, to paying the taxes demanded by the state. As reaffirmed in the Bill of Rights 1689, tax was a gift from the people to the Crown and so was levied with their agreement and not arbitrarily by central government. Although this consent was formal legal consent through an established parliamentary process for the passing of taxing legislation, there existed a powerful notion of real consent embodying notions of voluntaryism and control. It was this kind of consent which ensured compliance, and both could be compromised if the message of powerful state authority was not tempered. This was particularly important in relation to the regional administration of direct taxes. The orthodox view was that this principle of localism was essential to ensure compliance, since taxpayers would be unwilling to be assessed by officials of central government. That necessarily limited the extent to which it was desirable to communicate a message of central Crown taxation potency in the localities. It was particularly important in relation to local tax adjudication. Holding tax appeals in the buildings of the regular courts of law could be daunting to individual taxpayers, and be too suggestive of adjudication by central government in its broadest sense

122 MJ Braddick, ‘Popular Politics and Public Policy: The Excise Riot at Smithfield in ­February 1647 and its Aftermath’ (1991) 34 The Historical Journal 597.

The Architecture of Tax Administration: Function or Form? 107 rather than local adjudication by their peers, a hostile exercise of centralised power rather than non-confrontational consensual discussion. Accordingly, most regional tax buildings were rented and were domestic buildings converted to tax use, with no external distinguishing features, and were thereby absorbed into the general townscape. The rooms used for tax adjudication tended to be neutral—offices, halls, libraries and inns—and accurately reflected the process as neither an instrument of government nor an aspect of the regular judicial process. It was, rather, a most powerful expression of the true lay localism which characterised the British direct taxes. CONCLUSION

In the late eighteenth and throughout the nineteenth centuries, the period in which the modern fiscal state emerged, a discrete architecture of tax administration was developed. It was certainly the product largely of ­functional imperatives, namely the need to house this labour-intensive and fast-­growing administrative work of government in suitable accommodation, but it did embrace a subtle though clear aesthetic purpose of wider communication. The architecture of tax demonstrated an appreciation of the inevitable ­tensions surrounding the visual communication to the taxpaying public of the sovereign power of the state to tax and reconciling it with the principle of consent. Buildings were accordingly designed to be imposing as befitted a government department, efficient and dignified to express the sovereign power of the state to tax. They avoided ostentation and flourish to show that tax revenue was used responsibly, to deny extravagance and reinforce solidity in the managing of the country’s finances. Regional tax buildings blended into the ordinary commercial and domestic life of the country, yet care was taken to ensure they were sufficiently authoritative. Through the physical infrastructure of tax, a message of taxation by consent rather than by the coercive power of the state was deliberately promoted. The architecture of tax revealed and affirmed the essential values of British tax, and was shaped by them. And like the process of administration itself, it was a uniquely British compromise.

108 

5 Let Them Pay For Their Starvation: The Imposition of Income Tax on Ireland in 1853 PETER CLARKE*

ABSTRACT

This chapter seeks to integrate two significant events in Irish history, namely The Great Famine (or An Gorta Mór in the native language) that occurred in the mid to late 1840s, and the imposition of income tax on Ireland in 1853. The former has been extensively researched from agricultural, economic, political, and social viewpoints by various authors over the years. In contrast, relatively little has been written about the origin of income tax in Ireland. The purpose of this chapter is to explain how these two events are inextricably linked. The motive behind the imposition of income tax in Ireland in 1853 by the British Government—Ireland was then part of the United Kingdom—was to reimburse the Treasury for a portion of the expenditure incurred on Irish famine relief starting in the late 1840s. This inappropriate and inopportune imposition resulted in a number of unintended consequences, including fuelling nationalistic attitudes in Ireland towards the end of the nineteenth century, and also stimulating the demand for individuals in Ireland who were well-versed in accounting and taxation matters. INTRODUCTION

R

ELATIVE TO OTHER developed countries, very little has been ­ublished on Irish taxation history, even though an early Irish p ­reference to this topic is contained in the records of the City of

* The generous financial support of Chartered Accountants Ireland Educational Trust is gratefully acknowledged. The author also acknowledges the invaluable assistance of Cormac Ó Gráda and Margaret Ó hÓgartaigh in preparing earlier drafts of this paper. Important comments were also received from the participants at the Irish Accounting and Finance Association’s annual conference at Queen’s University, Belfast in May, 2014 and the History of Tax Law Conference at the University of Cambridge in July 2016.

110  Peter Clarke ­ ublin in the year 1316, which state that ‘taxes be collected under the D supervision of four or six good men duly sworn, and that accounts be rendered of receipts and payments before their auditors’.1 The main reference work on Irish taxation history is Reamonn’s History of the Revenue Commissioners, but he notes that his comprehensive book ‘is not a history of taxation in Ireland. It is a history of the Revenue Commissioners’.2 More recently, O’Halloran provides a short commentary on the theoretical framework of Irish taxation policy from the twelfth century to the present time.3 A number of shorter works on Irish taxation history may also be noted. For example, Holden investigated aspects of property taxes in Dublin, including the hearth tax, during the seventeenth and eighteenth centuries.4 Ellis reported on the payment of scutage—a form of taxation that allowed a person to ‘buy out’ his military service due to his Lord or King—from its introduction in Ireland in 1222 until its abandonment in 1534.5 In technical journals, Ó Broin discusses the historical development of taxation with particular reference to the tax collecting agencies.6 Clarke details the introduction of Export Profits Tax Relief in Ireland in 1956, which was one of the most important factors in the economic transformation of Ireland during the 1960s.7 de Cogan comprehensively describes how the corporate tax system in Britain and Ireland followed, in most respects, an identical path between 1853 and 1922.8 Clarke outlines the development of the Irish taxation system across the centuries.9 Also, some unpublished theses should be mentioned. In a pioneering study, Kepple comprehensively reviewed the context and content of the early budgets of the Irish Free State from 1923 to 1935,10 while MacHale outlined, using professional accountancy examination questions, the technical aspects of income tax, supertax/surtax, and

1 

J Gilbert, Calendar of Ancient Records of Dublin (Dublin, Dollard, 1889) 133. Reamonn, History of the Revenue Commissioners (Dublin, Institute of Public Administration, 1981) xi. 3  M O’Halloran, From Boroimhe to Bit: The Art of Taxation (Dublin, Irish Taxation Institute, 2005). 4  F Holden, ‘Property Taxes in Old Dublin’ (1953) 13(3/4) Dublin Historical Record: An Tóstalissue 133. 5  S Ellis, ‘Taxation and Defence in Late Medieval Ireland: the Survival of Scutage’ (1977) 107 Journal of the Royal Society of Antiquaries of Ireland 5. 6  J Ó Broin, ‘The Taxpayer and the Revenue’ (1983) Accountancy Ireland, September, 20. 7  P Clarke, ‘The Introduction of Exports Sales Relief: A Fifty-Year Review’ (2006) Accountancy Ireland, February, 85. 8  D de Cogan, ‘The Wartime Origins of the Irish Corporation Tax’ (2013) 3(2) Irish Journal of Legal Studies 15. 9 P Clarke ‘The Historical Development of the Irish Taxation System’ (2015) 21(1–2) Accounting, Finance & Governance Review 1. 10 S Kepple, ‘A Survey of Taxation and Government Expenditure in the Irish Free State 1922–1936’ (MA thesis, University College Cork, 1937). 2  S

Let Them Pay For Their Starvation 111 corporation profits tax in Ireland.11 Clarke (1984) outlined some historical aspects of income tax evasion in Ireland over time.12 This chapter investigates one historical aspect of Irish taxation, namely the imposition of income tax in Ireland in 1853—it had already been reintroduced in Britain in 1842—in lieu of the write-off of some Treasury loans for Irish famine relief. This controversial trade-off seems to have been lost in history. Indeed, an important articulation of this ‘trade-off’ fact can be attributed to Professor George O’Brien, who said in the (Irish) Senate during the 1950s: From our point of view, the 1853 Budget was peculiarly significant because in that Budget income-tax was first imposed in Ireland. The reason was that large sums advanced for relief of distress after the Famine had been irrecoverable, owing to the impoverished condition of the country. Income-tax was imposed with the object of recouping the Exchequer for part of the loans and grants to Ireland which had become irrecoverable13

It is worthwhile to recall some statistics associated with the Irish Famine of the mid-1840s. Between 1841 and 1851—the years of the official Census— the Irish population of some 8.2 million shrank to 6.5 million persons, equivalent to a 20 per cent reduction using absolute numbers. However, it is possible that, given difficulties of access, particularly in the West of Ireland, the pre-famine population figures may have been understated.14 Also, while the 1851 Census reported a population of 6.5 million it calculated that, at the normal rate of increase, the total population should have been in excess of 9 million.15 In relation to these statistics Lee notes that both famine and emigration were highly class-sensitive, since they disproportionately affected the class of property-less labourers and very small tenant farmers.16 The purpose of this chapter is to investigate the imposition of income tax in Ireland in 1853, and to discuss it in the context of the Irish Famine. Although Frecknall-Hughes explains that different methods may be used to study taxation history, this chapter does not adopt a formal conceptual framework, given the underdeveloped nature of this specific topic.17 The chapter’s methodology is to review and synthesise the various parliamentary debates, government publications, and other works and articles associated

11  J MacHale, ‘The Present System of Direct Taxation in Éire’ (M Comm thesis, University College Dublin, 1947). 12 P Clarke, ‘A Critique of Income Tax Evasion with Special Reference to Ireland’ (PhD thesis, University College Dublin, 1984). 13  Seanad Éireann Debate 41(2) 3 December 1952. 14  TP Coogan, The Famine Plot: England’s Role in Ireland’s Greatest Tragedy (Basingstoke, Palgrave Macmillan, 2012). 15  Census of Ireland for the Year 1851. 16  J Lee, The Modernisation of Irish Society 1848–1918 (Dublin, Gill and Macmillan, 1973). 17  J Frecknall-Hughes, Research Methods in Taxation History (University of Vienna WU International Taxation Research Papers Series 2014–04).

112  Peter Clarke with the Irish Famine and the imposition of income tax in Ireland soon thereafter. The chapter is divided into three sections. The next section provides the Napoleonic context both in terms of the introduction of income tax in England and the subsequent Act of Union, which made Ireland part of the United Kingdom of Great Britain and Ireland. The second section discusses aspects of the Irish Famine including the relief expenditure by the Treasury. Much of this relief expenditure was provided by way of loan by the British Government rather than outright grant or subvention. The third section discusses aspects of the income tax system which was imposed on Ireland in 1853 and highlights some of its consequences. For example, the imposition of income tax provided a stimulus to an increasing nationalistic spirit in Ireland towards the end of the nineteenth century. The chapter concludes with a brief summary. THE NAPOLEONIC CONTEXT OF INCOME TAX

The introduction of income tax in Great Britain was a temporary measure intended to finance the Napoleonic War.18 Due to escalating war expenditure, which was mainly financed by national loans, Britain faced a financial crisis.19 The then Prime Minister and Chancellor of the Exchequer, William Pitt (the Younger), realised that the British policy of borrowing money to meet the war expenditure could not be sustained. In 1798, legislation was enacted entitled An Act for Granting to His Majesty an Aid and Contribution for the Prosecution of the War.20 The legislation, sometimes referred to as the ‘Triple Assessment’, provided that those who had paid tax on, for example, their carriages, horses, houses and servants were to pay again— three times over.21 The Triple Assessment, which was limited to ten per cent of a person’s income, was not a success because the actual yield was only half of what was expected.22 The following year (1799), the Triple Assessment was replaced by an income tax on rent received, profits and wages. It was intended as a temporary tax to last for the duration of the Napoleonic War and came into effect from 5 April 1799; and it provided for a levy of two shillings (ie, ten per cent) on all incomes in excess of £200 per annum,

18  E Seligman, The Income Tax. A Study of the History, Theory and Practice of Income Taxation at Home and Abroad (New York, Macmillan, 1911); B Sabine, A History of Income Tax (London, Allen and Unwin, 1966); W Phillips, ‘The Real Objection to the Income tax of 1799’ [1967] British Tax Review 177. 19  H Monroe, Intolerable Inquisition? Reflections on the Law of Tax (London, Stevens & Sons, 1981). 20  38 Geo III c 16. 21  Monroe, n 19 above. 22  Sabine, n 18 above.

Let Them Pay For Their Starvation 113 with abatements applying to incomes between £60 and £200, and incomes below £60 being exempt. Pitt’s income tax did not extend to Ireland because, since 1793, the Irish Parliament had obtained—in theory—full control over the public finances of the country, as regards both revenue and expenditure.23 However, due to the Napoleonic War, security and political issues were of vital importance to England and these resulted in an Act of Union of 1800, whereby the Irish Parliament voted itself out of existence, opting instead for a merged or ‘united’ parliament for all of the Great Britain and Ireland.24 As a result, of the 685 MPs who sat in the House of Commons, only 105 represented Irish constituencies, even though Ireland represented over 40 per cent of the population of the United Kingdom of Great Britain and Ireland.25 The defeat of Napoleon at Waterloo in 1815 resulted in income tax being abolished, but it was re-imposed in Britain in 1842 for a limited period of three years. The first report of the Commissioners of Inland Revenue26 notes that income tax was ‘reimposed by Sir Robert Peel’s Government in 1842, not as a war tax, but for the purposes of repairing the deficiency which then occurred in the revenue to meet the expenditure of the country, and to enable the Government to make some reforms, with the view of improving the commerce and manufactures of the Kingdom’. Income tax was not extended to Ireland because, due to the repeal of the hearth, window and ‘assessed’ taxes during the 1820s, there was no administrative machinery to facilitate its assessment and collection in Ireland.27 However, additional stamp and spirit duties were imposed ‘as a sort of an equivalent to the non-imposition of income taxes in Ireland’.28 THE IRISH FAMINE, GOVERNMENT RESPONSE AND EXPENDITURE

The main focus of this chapter concerns the imposition of income tax in Ireland in 1853, associated with Ireland’s inability to repay much of the loans associated with the Treasury’s expenditure on the Irish Famine. We shall present a brief chronology of the Irish Famine, which needs to be discussed in the context of the Act of Union. 23  Earl of Dunraven, The Finances of Ireland: Before the Union and After (London, John Murray, 1912). 24 P Gray, Famine, Land and Politics: British Government and Irish Politics 1843–1850 (Dublin, Irish Academic Press, 1999). 25  C Kinealy, This Great Calamity (Dublin, Gill and Macmillan, 2006). 26  Commissioners of Inland Revenue, First Report of the Commissioners of Inland Revenue on the Inland Revenue (C 2199, 1857, Session 1) 32. 27 S Dowell, A History of Taxation and Taxes in England, vol 11 (London, Longmans, 1884); Reamonn, n 2 above. 28  N Synnott, ‘Some Features of the Over-Taxation of Ireland’ [1897] September Journal of the Statistical and Social Society of Ireland 251, 256.

114  Peter Clarke From the time the Act of Union came into force in 1801, many ­Commissions and Special Committees reported on the condition of Ireland and, without exception, they prophesied disaster due to the dependency on the potato for food, and the low standard of living of its inhabitants.29 For example, the Devon Commission reported that the Irish peasantry were probably the worst off of all the peasants in Europe.30 A few years earlier, following similar English legislation, the Irish Poor Law Act (1838) was enacted and provided for ‘workhouses’ to aid distressed individuals.31 Immediately before the famine, it was estimated that one-third of the Irish population depended on potatoes for survival and this dependency on one food explains the enormity of the impending crisis.32 When the main crop was dug out in midOctober 1845, a new type of potato blight was discovered. THE RELIEF COMMISSION, INDIAN CORN (MAIZE) AND PUBLIC WORKS (1845)

The Prime Minister, Sir Robert Peel, established a Relief Commission in autumn 1845 to advise the Government, through the medium of the Treasury, as to the amount of distress within the country and to supervise and co-ordinate the activities of the local relief committees, of which some 600 were established. It was involved in two major initiatives. First, it acted as a medium for the purchase and re-selling of the Indian corn (maize) imported by the Government from the United States, the first supplies of which arrived in Ireland in the spring of 1846. Daly notes that this was six months after the potato blight was first reported.33 This supply of Indian corn was enough to feed one million people for one month.34 However, it was nutritionally inferior, and dependency on it created a vitamin deficiency. It was also much more difficult to prepare than potatoes and was unknown to the Irish peasant.35 The second initiative involved a public works programme, which commenced in March 1846.36 It was intended that such works would provide cash employment for the destitute. However, the projects were due to expire in August 1846, when it was hoped that a new potato crop would 29 C Woodham-Smith, The Great Hunger: Ireland 1845–1849 (London, Penguin Books, 1991). 30  Devon Commission, Report from Her Majesty’s Commissioners of Inquiry into the State of the Law and Practice in Respect to the Occupation of Land in Ireland (C 605, 1845). 31  1 & 2 Vict c 56. 32 M Crawford, ‘Food and Famine’ in C Póirtéir (ed), The Great Irish Famine (Cork, Mercier Press, 1995). 33  M Daly, ‘The Operations of Famine Relief, 1845–1847’ in Póirtéir, n 32 above. 34  C Ó Gráda, The Great Irish Famine (Basingstoke, Gill and Macmillan, 1989). 35  Coogan, n 14 above. 36  9 & 10 Vict c 1.

Let Them Pay For Their Starvation 115 be available. The legislation generally provided that one half of the funds provided for famine relief would be in the form of (repayable) loan, and the other half by way of (non-repayable) grant. Daly reports that by summer 1846, approximately 130,000 were employed by way of these public works schemes.37 Exhibit 1 provides an analysis of the total government expenditure presented in the House of Commons by Lord Russell for the first year of Ireland’s Famine (1845/46), which amounts to £852,481, of which £426,240 was repayable. Exhibit 1: Irish Famine Expenditure 1845/46 Analysis

Amount Advanced

Indian corn (maize) Grants for various projects

£185,432 £67,911

Public works

£452,727

Other advances

£146,411 £852,481

Of which repayable

£426,240

Source: House of Commons (1846). 17 August 1846. HC Debates Vol 88, cc 766–99.

One measure that could have had an important impact on famine relief would have been an export ban on agricultural produce from Ireland. However, such a ban was rejected by Government since it was contrary to the prevailing policy of free trade.38 In addition, Ó Gráda argues that, in terms of overall impact, the retention of the exported food may have made little difference in making up for the loss of the potato as the staple food.39 ­Nevertheless, the continued export of food from famine-stricken Ireland was ‘an inflammatory gesture’ by the British Government, as seen by the people of Ireland.40 Labour Rate Act and Public Works (August, 1846) Unfortunately, in the summer of 1846 there was widespread failure of the potato crop, with police estimates suggesting up to 90 per cent of the potato

37 

Daly, n 33 above. Ó Murchadha, The Great Famine: Ireland’s Agony 1845–1852 (London, Continuum International Publishing Group, 2011). 39  C Ó Gráda, Black’ 47 and Beyond: The Great Irish Famine in History, Economy and Memory (Woodstock, Princeton University Press, 2000). 40  Coogan, n 14 above. 38  C

116  Peter Clarke crop being ruined.41 In dealing with the Irish Famine, Lord Russell’s Government was influenced by both Christian Providentialism thinking, and the prevailing economic doctrine of laissez-faire, which favoured only minimal government intervention in the marketplace.42 Hilton describes this period as an age of obsession with the idea of catastrophes, which include famines.43 Thanks to the dominant evangelical ethos of that time, such sufferings seemed to be part of God’s plan, and governments took a harsh attitude towards social underdogs, in order not to interfere with divine providence. Thus, Charles Trevelyan, the influential Treasury official, justified the non-interventionist policies of the British Government when he wrote: the proper business of a Government is to enable private individuals of every rank and profession in life, to carry on their several occupations with freedom and safety, and not itself to undertake the business of the landowner, merchant, money-lender, or any other function of social life.44

Lord Russell’s Government rushed a new Labour Rate Act through Parliament in August 1846 and this provided for public works under the management of a more bureaucratic Board of Works.45 These public works began around mid-October 1846 and the legislation provided that able-bodied but destitute persons were to be employed on ‘works of public character, which were not likely to be undertaken except for the purpose of giving relief’. By spring 1847 they employed around 750,000, mainly on road-building—a task which did not require any great construction skills by labourers—and land drainage.46 Ó Murchadha notes that these public works represented the sole economic support of over three million people: nearly one-third of Ireland’s pre-famine population.47 In addition, about 12,000 officials, including pay-clerks and accounts personnel, were employed in organisational or supervisory capacities.48 Of more significance was the fact that, unlike Peel’s earlier legislation, the Labour Rate Act imposed the entire cost of public works as a local charge, to be assessed in the same fashion as the Poor Law rate. In simple terms, employment projects under this legislation, such as road building and land drainage, would be the financial responsibility of Irish landowners, large tenant farmers, and other well-to-do members

41 

Ó Murchadha, n 38 above.

42 ibid.

43 B Hilton, The Age of Atonement: The Influence of Evangelicalism on Social and Economic Thought, 1785–1865 (Oxford, Clarendon Press, 1988). 44  C Trevelyan, The Irish Crisis (Reprinted from The Edinburgh Review CLXXV January) (London, Longman, Brown, Green and Longmans, 1848) 190. 45  9 & 10 Vict c 107. 46  Daly, n 33 above. 47  Ó Murchadha, n 38 above. 48  P O’Regan, ‘A Dense Mass of Petty Accountability: accounting in the Service of Cultural Imperialism during the Irish Famine 1846–1847’ (2010) 35 Accounting, Organizations and Society 416.

Let Them Pay For Their Starvation 117 of Irish society.49 By making such expenditure a local charge, it was hoped that much of the supposedly wasteful, inefficient and corrupt practices of earlier works programmes would be eliminated.50 Soup Kitchens: The Temporary Relief Act (January, 1847) In January 1847, less than three months after they had been opened, the Government announced its intention to terminate the public works and replace them with soup kitchens, ie feeding programmes, under the Temporary Relief Act, which became law in February 1847. Lord Russell feared that the concurrent operation of the two relief systems, ie public works and outdoor feeding, would prevent the sowing of much of the agricultural land.51 The financial responsibility for these soup kitchens would be shared, though not equally, between charitable subscriptions and the Poor Law rates, supplemented pro rata by government aid.52 By the summer of 1847 some three million people were being fed daily, and in some parts of the West of Ireland the whole population was being fed.53 In terms of outlay, the soup kitchens approach was much more effective than the public works programmes, and this impact was achieved at a fraction of the cost: approximately £1.7 million, compared to £4.76 million for the public works (Exhibit 2). Poor Law Extension/Poor Law Amendment Act (1847) and Thereafter The late summer of 1847 brought a small but disease-free potato harvest, but yields were low because so little had been sown.54 In the Government’s opinion the famine was over; the soup kitchens were progressively closed down. The Poor Law Extension Act (also referred to as The Poor Law Amendment Act) was passed, which officially terminated the British Government’s relief operations, although some additional emergency relief was subsequently provided.55 Under this legislation, further support from the British Treasury would be minimal (especially compared with the expenditure of previous years), and the financial cost of future relief of destitution and distress would be relieved by the ‘normal’ mechanism, ie the workhouses.56 49 

Kinealy, n 25 above, 91. Ó Murchadha, n 38 above. 51  Gray, n 24 above, 264. 52  Ó Murchadha, n 38 above. 53  Daly, n 33 above. 54  R Killeen, A Brief History of Ireland (London, Constable & Robinson, 2012). 55  J Kelly, The Graves are Walking (London, Faber and Faber 2012). 56  Daly, n 33 above. 50 

118  Peter Clarke In simple terms, the British Government decided that the (Irish) workhouse system, with an original capacity for some 100,000 persons (subsequently increased), and which operated as part of the pre-famine Poor Law system, should be the primary device for relief of Irish famine suffering. Each electoral division, with its own workhouse, was made responsible for relief of the hungry poor. Not surprisingly, the workhouses were overwhelmed: by June 1848 a million people were being relieved.57 In Irish folklore the year 1847 is simply referred to as Black’ 47. There was appalling suffering and death from starvation and disease, since the workhouses were unable to cope with a burden that it was never designed to bear. The Times in London began to feature reports that gave a vivid picture of the crisis in Ireland and that horrified many of its readers.58 Indeed, many independent descriptions of conditions in those workhouses are extremely graphic and upsetting. Potato blight would return again in subsequent years until 1852, when the potato harvest was healthy and virtually free from potato blight. Before then, the Chief Commissioner of the Irish Poor Law, Edward ­Twisleton, resigned in March 1849. In an explanatory letter from the Lord Lieutenant of Ireland to Lord Russell, it was indicated that Twisleton resigned on the grounds that ‘the destitution here (in Ireland) is so horrible, and the indifference of the House of Commons to it so manifest, that he is an unfit agent of a policy which must be one of extermination … and he is placed in a position … which no man of honour and humanity can endure’.59 In June 1849, the Quakers (Central Relief Committee) abandoned their voluntary feeding programmes, commenting that ‘the Government alone could raise the funds and carry out the measures necessary in many districts to save the lives of the people (and) the condition of our country … was a matter for legislation, not philanthropy’.60 In relation to the Treasury expenditure, a single focus on spending for Irish famine relief is disrespectful to those who suffered during this period. Funnell criticises the moral inflexibility of the Treasury officials during the Irish Famine, who treated starving individuals as financial burdens on the public purse.61 These ‘financial burdens’ were to be minimised by restrictive qualifications for entitlement to relief, irrespective of the graphic reports of widespread need coming from its officers in the field. The Report on the Consolidated Annuities62 and the Report from the Select 57 

Kelly, n 55 above. Killeen, n 54 above. 59  Quoted by Woodham-Smith, n 29 above, 380. 60  ibid, 383. 61  W Funnell, ‘Accounting for Justice: Entitlement, Want and the Irish Famine of 1845–47’ (2001) 28 (2) Accounting Historians Journal 187. 62  Report on the Consolidated Annuities and the Modification of them for the Year Ended 30th September 1851, Authorised by the Treasury Minute of the 21st of the Following Month (C 1463, 1852). 58 

Let Them Pay For Their Starvation 119 Committee63 are lengthy but they provide an analysis of the initiatives of the British Government during the famine period. Based on these reports, Exhibit 2 provides an estimate of the Treasury outlay of £9.2 million for total Irish Famine relief and a figure of £4.4 million as the amount owing (in 1852) by way of repayable loan, and which would be transferred to the Consolidated Annuities. The total outlay on the construction of all workhouses has not been provided or ascertained so the amount owing as at 1852 is used. However, the Select Committee noted that many of the workhouses had been constructed as a result of the Poor Law Act 1838 and had been in operation before the outbreak of the famine. Indeed this point was acknowledged by Gladstone in his Budget speech when he said (using his rounded figures) that ‘£1,500,000 of this debt strictly belongs to the establishment of the Poor Law in Ireland. That was a great social and national good—a great and permanent good to Ireland’.64 Exhibit 2: Amount of Treasury Outlay on Irish Famine Relief (1845–1849 inclusive) Item Under 9th Vict, cap 1 (Relief works) Under 9th and 10th Vict, cap 107 (The Labour Rate Act for public works) (Tools and utensils provided free)

Treasury Outlay

Transfer to Consolidated Annuities

£476,000

£170,282

£4,462,000

£2,046,785

£304,789

Under 10th Vict, cap 7 (Temporary Relief/Soup Kitchens Act)

£1,724,631

£783,228

Under 13th Vict, cap 14 (Loans re Debts of Distressed Unions)

£300,000

£299,924

Grants by Parliament at various times (1845–1849)

£844,521

Nil

Loans for the construction of Workhouses

£1,122,707*

£1,122,707*

Grand total of Treasury expenditure

£9,234,648

£4,422,926

*Based on amount owing in 1852, rather than total gross outlay. Source: Report of Select Committee (1852): various appendices.

63  Report from the Select Committee of the House of Lords to whom shall be referred the Treasury Minute Providing for the Debts due from Counties and Unions in Ireland by the Imposition of a Consolidated Annuity for a Period not Exceeding Forty Years (C 585, 1852). 64  HC Deb 18 April 1853, vol 125, cols 1393–94.

120  Peter Clarke It should be noted that the Select Committee commented negatively about the amount owing in relation to the advances under the Labour Rate Act and the associated public works programmes. It opined that ‘the great portion of the works undertaken was of little or no usefulness; that an extravagant expenditure was incurred … that the relief works withdrew the labourers from their ordinary occupation, thus diminishing the agricultural production of the following year’.65 The report stated that the Committee felt it ‘to be their duty to submit to the House the consideration, in equity as well as in policy, of abandoning this claim’ (of some £2,046,785 as per Exhibit 2 above).66 This strong recommendation was not accepted. The Report of the Select Committee explained that the Consolidated Annuities Act was passed to consolidate and convert into equivalent annuities the sums due to the public by the several counties, baronies (numbering 330), unions (numbering 163), electoral divisions (numbering 3,439) and townlands (numbering 60,760) etc. in Ireland, for advances made for building workhouses, for the relief of the distress caused by successive failures of the potato crop (and) to provide for the payment of these annuities.67

The report also explained that the object of the Consolidated Annuities Act was not to remit any further sums but to facilitate the payment of the amount due. During the debate on the Consolidated Annuities in the House of Lords it was stated that the consolidated debt amounted to £4,422,851. This sum was required to be repaid by an annuity of £245,061, for terms extending to 40 years, interest being charged at three and a half per cent.68 These annual repayments, which included interest, would continue until the end of the nineteenth century and amount to £9,800,000 million in total. Thus, Gray opines that Ireland remained subject to a famine-related debt of £4,422,851, a burden that many regarded as unsustainable.69 In 1853, the UK Government decided to abandon the repayment of the Consolidated Annuities by the Poor Law unions: instead, Gladstone imposed income tax on Ireland in his now famous Budget speech. It is important to note that whichever figure is used for the Treasury’s monetary outlay for the Irish Famine, it is small in relation to the estimate of some £70 million spent on the British army and navy during the subsequent four-year Crimean War. This estimate was computed by identifying the increase in army and navy expenditure during the Crimean War with pre-Crimean War expenditure.70 65 

Report from the Select Committee, n 63 above.

66 ibid. 67 

ibid, 17. HL Deb 25 March 1852, vol 120, cols 64–76. 69  Gray, n 24 above. 70  (1869) 1(8) Advocate of Peace 117. 68 

Let Them Pay For Their Starvation 121 THE INTRODUCTION AND CONSEQUENCES OF INCOME TAX IN IRELAND

Ireland’s exemption from income tax was withdrawn in 1853, when Gladstone extended it to Ireland at the rate of 7d in the pound, ie about three per cent. The Financial Relations Commission explained: ‘In 1853, Mr. Gladstone, being Chancellor of the Exchequer … proposed in his budget to extend the income tax to Ireland for a limited number of years, and to increase the rate of spirit duty.’71 However, it should be noted that in the previous year’s Budget, Disraeli considered it his ‘duty’ to recommend the extension of income tax to salaries and funded property (but not landed proprietors) in Ireland.72 To support his argument, and referring to Ireland, he noted that there was a reduction on the amount of pauperism and that the state of Ireland is much improved. However, Sir Charles Wood said that he ‘did not think it wise to extend income tax to Ireland. I think you have put on Ireland burdens enough in her present state, and it is wise for us not to press her down with additional taxation’.73 With the Irish Famine and its relief expenditure as context, it is remarkable to note the cold words of William Gladstone, as Chancellor of the Exchequer, who on 18 April 1853, said: ‘Let me remind the committee what exemption means … The exemption of one man means the extra taxation of another, and the exemption of one country means the extra taxation of another’. Gladstone declared that the fact of a country being poor was no argument prima facie against the application of the tax when that tax did not attach to the class that were poor in that country, but only attached to a class which, being defined by a certain amount of income, were actually richer as regarding the enjoyment of the necessities and comforts of life than the corresponding class who paid tax in England.74

As a set-off for the imposition of income tax Gladstone relieved Ireland of the remainder of the Consolidated Annuities, which had been incurred for relief during the Irish Famine and which amounted to about £4.2 million, with repayments amounting to about £245,000 per annum.75 In addition, Gladstone increased the duty on spirits by 25 per cent on the grounds that an Irishman should not be allowed to intoxicate himself more cheaply than an Englishman.76 The increased duty on spirits was estimated to generate an additional £198,000 in revenue per annum. Simply, the most powerful

71  Financial Relations Commission, Royal Commission on the Financial Relations between Great Britain and Ireland, Final Report (C 8008, 1896) 9, 157–8. 72  HC Deb 3 December 1852, vol 123 cols 836–920. 73  HC Deb 10 December 1852, vol 123, cols 1309–10. 74  HC Deb, 18 April 1853, vol 125, cols 1393–94. 75  Dunraven, n 23 above. 76  HC Deb 23 May 1853, vol 127, cols 504–47.

122  Peter Clarke nation in the world at that time imposed an income tax on the remaining Irish population in order to repay some of the famine relief expenditure incurred. Ireland had just experienced a famine period whose duration, geographical extent and hardships created were previously unknown in the developed world. A subsequent Royal Commission concluded that ‘the increase of taxation laid upon Ireland between 1853 and 1860 was not justified by the then existing circumstances’ (emphasis added).77 Gladstone, like his predecessors, proposed to renew income tax at the rate of 7d in the pound for two years. Thereafter, it would be renewed for another two years at the rate of 6d in the pound, and for a further three years at the rate of 5d in the pound; and after April 1860, the ‘income tax will expire’.78 The actual income tax receipts collected in Ireland for the period from 1853–1860 are provided in Exhibit 3. Exhibit 3: Actual Income Tax Receipts in Ireland Year ending 31 March 1855

£823,839

Year ending 31 March 1856

£1,149,290

Year ending 31 March 1857

£1,180,452

Year ending 31 March 1858

£842,910

Year ending 31 March 1859

£509,245

Year ending 31 March 1860

£718,368

Total income tax receipts

£5,224,104

Source: Financial Relations Commission (1896). Table, p 373. app 1, vol 1, and Appendix to Report, p 214. (Note: figures for the year ended 1854 are not reported.).

Gladstone’s aspiration to abolish income tax in 1860 was destroyed by the outbreak of the Crimean War in the mid-1850s. Income tax rates would increase rather than decrease and income tax would be re-imposed after 1860 (and never withdrawn). Ireland would pay an average of £550,000 per annum in income tax between 1854 and 1894, giving a total in excess of £20 million over four decades until the end of the nineteenth century.79 Altogether, we have suggested that the Treasury spent some £9.2 million on Irish famine relief, but about £4.4 million remained post-famine in the form of repayable loans and were, subsequently, transferred to the Consolidated Annuities (see Exhibit 2). It was these Consolidated Annuities that were written off in lieu of the imposition of income tax in Ireland in 1853. The imposition of income tax on Ireland in 1853 resulted in a number of consequences which will now be discussed. Some of these consequences 77 

Financial Relations Commission, n 71 above, 2. HC Deb 18 April 1853, vol 125, cols 1350–427. 79  Dunraven, n 23 above. 78 

Let Them Pay For Their Starvation 123 were of a ‘technical’ taxation/accountancy nature, others had important social and political implications, and some may have resulted in unintended consequences. Technical Tax Provisions and the Accountancy Profession It is important to review some of the technical income tax provisions of the 1853 legislation. For example, income tax was assessed on income from professions and trade (Schedule D) and employment (Schedule E) using the average system, ie average profits over a three-year period, or a preceding year basis. This ‘average’ system was introduced in 1842. However, as noted by Seligman: it might happen that when profits were falling off, the actual profit in the year of assessment would be less than those which would be worked out on the average system. Accordingly, the legislation provided that when the actual profits fell short of the sum assessed, they might be substituted for any estimate whether based on the preceding year or on an average of years.80

The practical implication of this section was that a taxpayer whose income was increasing over a period of time would be advised to base his assessment using a three-year average rather than using a single year basis. (Conversely, where annual income was decreasing, the taxpayer would be advised to select a single year as the basis of assessment.) In addition, deductions were available for expenses that were ‘wholly and exclusively’ incurred for the purpose of the business, and ‘wholly, exclusively and necessarily’ for Schedule E taxpayers. There were no business deductions for ‘capital withdrawn’ or expenditure on ‘improvements’. Thus, in order to comply with the legislation, taxpayers had to make an important distinction between expenses incurred in earning income and outlay associated with private or personal activities, ie ‘drawings’. The correct application of this phrase may have encouraged businesses to avail of the services of persons with competency in income tax legislation in order to identify purely business expenses. (Such persons were unlikely to be qualified accountants since the Irish accountancy profession would not be formed for another three decades.) The application of the ‘wholly and exclusively’ rule may have encouraged businesses to switch from recording transactions using the cash basis of accounting to recording revenue and expenses using the ‘accrual’ basis of accounting. In addition, since capital expenditure, eg purchase of plant and equipment, was not deductible for income tax purposes, and therefore was not tax-efficient, more discussion was required in

80 

Seligman, n 18 above, 191.

124  Peter Clarke defining such expenditure as distinct from ‘revenue expenditure’. In addition, only ‘bad debts proved to be such to the satisfaction of the commissioners’ were allowable as deductions. Thus, in order to comply with income tax legislation, there was a need for Irish taxpayers and their advisors to debate and develop the concept of business income—probably influenced by British experience. An obvious consequence of the new income tax legislation was that it stimulated the demand for taxation and accounting professionals since income tax computations had to be prepared and submitted. For example, The Freeman’s Journal carried many advertisements for income tax services, one of which is reproduced as follows: Income Tax (Ireland) Important Notice The Advertiser, having devoted much time and consideration to the provisions of the several Income Tax Acts, has, in the course of his business as an Income Tax and general Accountant, ascertained that many persons assessed under those Acts can, upon a well-grounded statement of claim, obtain a repayment of a proportion of such tax, and, in many instances, of the entire amount, at which they have been assessed, and this being the period at which Returns of Income for the current year are required to be made, Advertiser begs to direct the attention of the Public to his offices, where every information respecting claims for exemption from, and repayment of, income tax can be obtained. All matters of account thoroughly investigated and made out A De B Bliss, Income Tax and General Accountant, 5, D’Olier Street (with office hours from 9am to 8pm)81

It is important to stress that the demand for bookkeeping and accounting services already existed in Ireland. Nearly a century previously, we see ‘numbers of little academies setting up throughout the nation, for the instruction of youth … in accounts (and) bookkeeping (and) these academies begin to be crowded with the children of persons of good distinction’.82 Indeed, it should be noted that the first bookkeeping text published in Ireland has been traced to Ammonet in 1696.83 We also know that many of the large estates in Ireland, or their land agents, employed bookkeepers and other accounting professionals for estate management purposes.84 It is reasonable to argue that the (new) income tax provisions in Ireland stimulated an extra

81 

The Freeman’s Journal, Dublin, 24 September 1856, 1. The Freeman’s Journal, Dublin, 18 October 1763, 4. 83 P Clarke, ‘The First Irish Accounting Publication: Ammonet, 1696’ in Disorder and Harmony: 20th Century Perspectives on Accounting History (CGA Research Foundation, Research Monograph no 23 1996). 84 T Dooley, ‘Estate Ownership and Management in Nineteenth and early Twentieth ­Century Ireland’, in T Dooley, Sources for the History of Landed Estates in Ireland (Dublin, Irish Academic Press, 2000). 82 

Let Them Pay For Their Starvation 125 demand for professional accountancy personnel. It also required a different set of knowledge and skills than those required for bookkeeping and accounts preparation. In addition, the knowledge of the income tax code needed to be updated as legislation changed, in contrast to the relatively static skills required for providing accounting services. Thus, in 1866, we see the formation of Craig Gardner & Co—now PricewaterhouseCoopers— which is the longest established accountancy firm in Ireland.85 In addition, Henry Brown, who survived to become the oldest of the signatories of the petition for a Royal Charter for the Institute of Chartered Accountants in Ireland in 1888, had advertised his accounting services in the Dublin Almanac and in Thom’s Directory.86 A Sound Financial Arrangement? An intriguing question is whether the set-off of the Consolidated Annuities of some £4.4 million in lieu of the imposition of income tax on Ireland, which was estimated to yield on an annual basis about £450,000, represented a sound financial arrangement for Ireland. Ignoring anticipated income tax rate reductions from 1853 to 1860, income tax in Ireland can be estimated to have yielded about £3.2 million over this seven-year period. To this potential yield should be added the additional duty on Irish spirits, which provided a total additional duty of £1.4 million. Thus, it is interesting to note that the additional revenue estimated to be generated in Ireland by Gladstone’s Budget presented here for the suggested seven-year period (ie, £3.2 million and £1.4 million) is very similar to the Consolidated Annuities remitted (ie, £4.4 million). However, expenditure on the Crimean War prevented the ­abolition of income tax in 1860 and caused income tax rates to increase rather than decrease. Synnott (1897) estimates that between 1853 and 1896 an average sum of £550,000 per annum was paid in Irish income tax, or a total of £23.5 million until the end of the nineteenth century.87 Bankrupt Landlords and Evictions88 During (and after) the Irish Famine, landlords were faced with crippling increases in Poor Law rates and a difficulty in collecting rent owing from their tenants. One solution was to sell their estates provided the properties were saleable. Many tenants were evicted. Between 1847 and 1851, the 85 

A Farmar, A History of Craig Gardner & Co. (Dublin, Gill & Macmillan, 1988). A Farmar, The Versatile Profession (Dublin, Chartered Accountants Ireland 2013). 87  Synnott, n 28 above. 88  Kelly, n 55 above. 86 

126  Peter Clarke eviction rate rose by nearly 1,000 per cent, overwhelming the Irish Poor Law system. There is a fascinating description of one such estate—the 200,000 acre Martin Estate in the West of Ireland. In 1849 the estate was surveyed and auctioned on behalf of its mortgagees, the London Law Life Insurance Society. The original manuscript of this survey has recently been uncovered and printed as a book.89 It should be noted that encumbrances were already a feature of Irish properties, especially after the end of the Napoleonic Wars.90 However, Lane concludes that ‘the phenomenon of the Irish Famine was all that was required to topple a shaky financial edifice’, especially with the introduction of the Poor Relief Act 1838.91 The Act appointed Encumbered Estates Commissioners to authorise sales for the purpose of discharging encumbrances on land, and to give the purchaser an indefeasible title. Within a decade or so of this Act being passed, one-quarter of the land of Ireland had been sold to middle-class Irish Catholics and Anglo-Irish landowning families.92 However, thousands of smallholders were evicted, without compensation, because they had no legal rights, the land being bought over their heads and converted into grazing. In terms of agriculture, the number of holdings under one acre had dropped from 134,000 to 36,000.93 Emigration Another enduring legacy of the Irish Famine was the phenomenon of mass emigration. Between 1845 and 1855, it is estimated that approximately onequarter of the Irish population had emigrated.94 This included, for example, over 4,000 adolescent female orphans and refugees from the famine who emigrated to Australia. Their emigration became known as the ‘Earl Grey Scheme’ after its principal architect, Earl Grey, Secretary of State for the Colonies in Lord Russell’s Government.95 Of interest is that one of the features that distinguishes the Irish Famine from modern famines in developing countries is that the Irish Famine (and resulting emigration) did not take

89  TC Scott, Connemara after the Famine: Journal of a Survey of the Martin Estate (Dublin, Lilliput Press 1995). 90  D Large, ‘The Wealth of the Greater Irish Landowners, 1759–1805’ (1966) 15(57) Irish Historical Studies 21. 91  P Lane, ‘The Encumbered Estates Court, Ireland, 1848/49’ (1972) 3(3) Economic and Social Review 413, 414. 92  Kinealy, n 25 above. 93  E Green, ‘Agriculture’ in R Dudley Edwards and T Desmond Williams (eds), The Great Famine: Studies in Irish History 1845–52 (New York, NYUPress, 1957). 94  Ó Murchadha, n 38 above. 95  K Caball, The Kerry Girls: Emigration and the Earl Grey Scheme (Dublin, History Press, 2014).

Let Them Pay For Their Starvation 127 place in the context of a civil war or, indeed, any war-like circumstances.96 Another feature is that emigration became a way of life from then on, causing the Irish population to decline to less than 4.4 million in 1911, so that in just over seven decades after the Famine, the population was almost cut in half.97 While emigration was always a feature of Irish society, the post-famine rate of emigration greatly exceeded the pre-famine decades, with the large stock of famine emigrants in North America serving as a magnet for further intending migrants. Thus, it was the Irish in America, replenished and enlarged by the refugees and migrants of the famine, who created, first, the Fenian Brotherhood, and later contributed powerfully to the revolutionary movement in Ireland towards the end of the twentieth century.98 Growing Nationalism Within and Outside Ireland The radical nationalist newspaper, The Nation, reported the number of Schedule D and Schedule E taxpayers for the newly imposed income tax in Ireland for the year ended 5 April 1854 (Exhibit 4), with comparative figures for the same financial year for England, which had re-introduced income tax some years previously.99 Exhibit 4: Total Income Tax Payers for Year Ended 5 April 1854 England

Ireland

Schedule D

Schedule E

Schedule D

Schedule E

265,796

69,588

16,686

4,127

Source: The Nation (25 August 1855, p 14).

The post-famine imposition of income tax in Ireland in 1853 had a direct financial impact, initially, on some 20,000 individual taxpayers, compared to about 335,000 in England (see Exhibit 4). But it would have, over time, a wider impact in terms of nationalist politics, and on people’s perceptions regarding the moral legitimacy of British rule in Ireland. The memory of the famine did not appear to have translated itself into an immediate and ­widespread disaffection with the union of Great Britain and Ireland.100 However, there was an underlying attitude that Ireland was misruled, and 96 

C Ó Gráda, ‘The Great Famine and Today’s Famines’ in Póirtéir, n 32 above. Killeen, n 54 above. 98  L Kennedy, P Ell, E Crawford, L Clarkson, Mapping the Great Irish Famine (Dublin, Four Courts Press, 1999). 99  The Nation, Dublin, 25 August 1855, 14. 100  Kennedy, Ell, Crawford, Clarkson, n 98 above. 97 

128  Peter Clarke that the imposition of income tax was another example of this, because of the apathy of members of the Westminster Parliament.101 For many, the lack of effective Government response to the Irish Famine brought into serious question the constitutional assertion that Ireland was a fully integrated part of the United Kingdom.102 Moreover, since Britain’s ‘occupation’ of Ireland was seen by many as entirely illegitimate, popular opinion facilitated the growth of Irish nationalism and republicanism. Neal argues that the specific tragedy of the Irish Famine further scarred the Irish national psyche, and that this has been disseminated down to the present day through literature, and oral and musical tradition.103 Thus, the narrative of the Irish Famine and the imposition of income tax inflated a sense of economic injustice and contributed to fuelling the nationalistic cause which gathered support during the latter part of the nineteenth century. For example, The Freeman’s Journal reported, that ‘the movement against income tax has become almost universal in Ireland’ and committees formed in Dublin, Cork, Belfast and Londonderry declared that the ‘income tax is inquisitorial and inequitable’.104 The growing Irish perception of the inequity of their contribution to the United Kingdom’s expenditure was given credibility by the Report of the Royal Commission, which was appointed to investigate the assertion that Ireland was an over-taxed country.105 The significant conclusion of the Royal Commission was that Ireland’s actual (in 1893/94) total revenue was £7,568,649 but that, based on her taxable capacity, ie aggregate money incomes of both countries, Ireland should have contributed £4,842,781, ie a lesser sum by about £2.5 million per annum. By the time the Report of the Financial Relations Commission was ­published, the Home Rule/Independence for Ireland movement was firmly established. The finding that Ireland was ‘over-taxed’ was frequently suggested as an example of British misrule and an argument for some ­ form of Irish independence. However, the British Government had already addressed some of these financial issues and had significantly increased its expenditure in Ireland by a considerable amount in excess of additional revenue raised up to the start of World War I. Thus, Hynes argues that it was not the economic arguments, but the misuses of economic arguments that were at the heart of the debate on separation from the United Kingdom.106

101  W Hynes, ‘To What Extent were Economic Factors Important in the Separation of the South of Ireland from the United Kingdom and what was the Economic Impact?’ (2013) 38(2) Cambridge Journal of Economics 369. 102  Killeen, n 54 above. 103  F Neal, Black’ 47: Britain and the Famine Irish (Basingstoke, Macmillan, 1998). 104  The Freeman’s Journal, Dublin, 9 January 1857, 2. 105  Financial Relations Commission, n 71 above. 106  Hynes, n 101 above.

Let Them Pay For Their Starvation 129 An Irish rebellion in Easter week 1916, followed by a (guerrilla) War of Independence, led to an Anglo-Irish Treaty in 1921 and the creation of the Irish Free State in 1922 (with the six northern counties remaining in the United Kingdom). The Anglo-Irish Treaty conferred sovereign powers of taxation on the Government and Parliament of the Irish Free State. In pragmatic fashion, the Irish Free State adopted, with minor amendments, the British Income Tax Act of 1918, together with the British Finance Acts of 1919 to 1922 inclusive. Thus, the Irish Free State of 1922 willingly began life under income tax (and other) legislation imported from Britain. Meenan notes that it was a matter of some importance that the standard rate of income tax should compare favourably with the British rate lest Ireland should lose both capital and the comparatively few payers of direct taxation, whose continued residence in the country could not be taken for granted.107 On 6 December 1922 came the transfer of staff to the Provisional Government and on 1 April 1923, the Revenue Commissioners were set up by an Order of 1923 to take over the care and management of Inland Revenue, Customs and Excise.108 Ireland had just become a fiscally independent nation in terms of income tax matters. CONCLUSION

The epoch of Irish famine of the 1840s is one of the defining events of modern Irish history. It caused many sweeping changes in Ireland’s social, agricultural, and economic characteristics; and this included a pattern of emigration to, for example, Australia, England, Scotland and North America.109 The Irish Famine fuelled distrust among Irish people towards Great Britain. Yet it is important to note that the British policy towards famine in Ireland was conditioned by the prevailing economic antipathy towards virtually all forms of government intrusion in the operation of the markets.110 This economic philosophy, combined with ‘providentialist’ overtones, represented the working assumptions by policy makers in London. It is the general tradition of Irish historical studies to blame the British administration for ‘An Gorta Mór’. The British Government, at that time, perceived things differently. In April 1848, Charles Wood, the Chancellor of the Exchequer, assured his Prime Minister, Lord Russell that ‘So much was

107 

J Meenan, The Irish Economy Since 1922 (Liverpool, Liverpool University Press, 1980). J Waldron, ‘The Irish Customs and Excise’ (1957/58) 5(4) Administration 35. 109 O MacDonagh, ‘Irish Emigration to the United States of America and the British ­Colonies during the Famine’ in Dudley Edwards and Williams, n 93 above. 110  Funnell, n 61 above. 108 

130  Peter Clarke never done for any country, by another, in the history of the world. The starvation has arisen from the misconduct of the Irish … not from any neglect on the part of the Government’.111 Charles Trevelyan, the Assistant Secretary to the Treasury during the Irish Famine, was rather dismissive when he wrote: ‘But what hope is there for a nation which lives on potatoes?’ and in relation to this dependency remarked ‘agriculture of every description was carried on in a negligent, imperfect manner’.112 However, it is important to note some relatively recent developments. On the 150th anniversary of The Great Irish Famine, the British Prime Minister, Tony Blair, expressed regret on behalf of the British Government in a statement published by the Independent newspaper, which read: The famine was a defining event in the history of Ireland and Britain. It has left deep scars. That one million should have died in what was part of the richest and most powerful nation in the world—as evidenced by the Great Exhibition of 1851 which was a triumphant declaration of Britain’s industrial, economic and political supremacy—is something that still causes pain as we reflect on it today. Those who governed in London at that time failed their people.113

Significantly, in a landmark speech during a state dinner at Dublin Castle, Queen Elizabeth II acknowledged the ‘mistakes’ of Britain’s troubled relationship with Ireland. She said: It is impossible to ignore the weight of history … the relationship has not always been straightforward; nor has the record over the centuries been entirely benign. It is a sad and regrettable reality that through history our islands have experienced more than their fair share of heartbreak, turbulence and loss.114

111  G Bernstein, ‘Liberals, the Irish Famine and the Role of the State’ (1995) 29(16) Irish Historical Studies 513, 530. 112  Trevelyan, n 44 above, 6, 8. 113  Independent, London, 2 June 1997. 114  The Telegraph, London, 18 May 2011.

6 Not Like Grocers RICHARD THOMAS

ABSTRACT

This chapter gives an account of the extensive early case law dealing with the computation of a trading profit of insurance companies, and shows that, although insurance accounts were very different from those of other concerns, those early cases enabled the Courts to establish judge-made principles for the computation of all trading profits in an era before generally accepted accounting principles rendered those principles redundant. It concludes that The Sun Insurance Office v Clark,1 a case about the ‘unearned premiums’ of an insurance company, was the most important case in the development of the relationship between tax and accounting. INTRODUCTION

I

N GRESHAM LIFE Assurance Society v Styles2 Lord Watson said that ‘[i]f there be one point free from obscurity in the Act of 1842 it is this, that the Legislature intended all traders, whether in groceries, annuities, or other articles of commerce, to be assessed upon the same footing.’ The chapter argues that this is at best an over-simplification. To show that it sets out firstly the way in which grocers’ profits are computed for tax purposes. It then indicates why insurance is different from grocers and it traces the development of the computation, under Case I of Schedule D, of the trading profits of insurance companies, especially those carrying on life assurance business.

1  2 

The Sun Insurance Office v Clark (1912) 6 TC 59 (‘Sun Insurance’). Gresham Life Assurance Society v Styles (1892) 3 TC 185 HL (‘Gresham Life’).

132  Richard Thomas THE TAXATION OF GROCERS3

In 1892, as in 2016, a grocer carried on a trade, the quintessential retail trade of buying goods wholesale and selling them to the public. In 1892 a person carrying on a trade was liable to income tax on the income from the trade. That income consisted of the profits of the trade for the year of assessment calculated in accordance with the rules of Case I of Schedule D, rules that in 1892 had been in place little unchanged since 1803.4 The only positive rule in that Case was that the charge to tax was on the full amount5 of the balance of the profits and gains. The word ‘balance’ has been interpreted to mean that in arriving at the profit one had to set outgoings against incomings, and not simply, as with most other types of income, look at the receipts. It had already been so interpreted in 1892. It had also been established by 1892, though perhaps not so well as the ‘balance’ question, that the starting point, the place where one looks for a balance, is a set of accounts produced by the trader. There is nothing explicit about this in the law, though since 1803 it has been the case that a trader’s period for assessment need not be the year of assessment6 if the trader has drawn up accounts to another date.7 It seems pointless to provide for this if the accounts are not to be used as the starting point for the computation of profits. The accounts to be used are, according to case law, those drawn up in accordance with normal commercial practice. This is not the place for a lengthy account of what such accounts would or should contain in 1892 or, for that matter, 1803, save to say that there was little common understanding of much beyond the proposition that there had to be a balance, and that on one side were incomings and on the other outgoings, both related in some way to the trade. Parliament must in 1803 have been conscious of the lack of common standards because it laid down some rules about what could not be included on the outgoings side, no doubt appreciating that traders faced with a new and, to their minds crippling, impost on their finances would seek to exaggerate their expenses. Thus in 1892 there were basic prohibitions against deducting expenses and losses that were not incurred for the purposes of the trade (eg, private

3  The author can claim to know a thing or two about this. In 1984 and 1985 he was the tax inspector responsible for the affairs of a large supermarket chain which described itself as grocers. In the guise of its predecessor unincorporated business these grocers were in business in 1892 when Lord Watson made his comment. 4  Except of course between 1816 and 1842. 5  ‘Full amount’ is essentially meaningless in this context—see R Thomas, ‘What is the “full” amount?’ in J Tiley (ed) Studies in the History of Tax Law, vol. 6 (Oxford, Hart Publishing, 2013) 221–60. 6  The year ending 5 April. 7  ITA 1803, s 84, 1st Rule of Schedule D Case I, ITA 1842, 1st Rule of Schedule D Case I.

Not Like Grocers 133 expenditure or expenditure incurred in another capacity such as landlord) and items which were capital, including depreciation.8 There were also implicit rules affecting incomings. The rule that only allowed a deduction for a debt if it was bad9 had as an implied necessary precondition that the debt had been brought into account already, ie incomings were not on a cash basis but an earnings basis. And the rule about no deduction for an amount for which insurance or indemnity10 was available suggested that it was not normal for such indemnity or insurance payments to be treated as incomings of the trade. There was also a rule preventing the deduction of dividends of any corporation etc.11 Applying these principles and rules to a grocer one would expect to see as incomings in accounts (and therefore tax computations) cash and, if applicable, credit sales to customers. The cost of sales, the purchases of the goods for resale would have to be included to create the balance. By 1892 the rules about stock would have been reasonably well established12 so that purchases deductible would be matched to sales by the device of including as a receipt the cost of the closing stock, and where that stock was valued at less than cost the lower value would be brought in thereby allowing a deduction for the depreciation of stock. The other deductions would be overheads that related to the trade, wages, costs relating to buildings including repairs, advertising and professional costs, all subject to disallowance for capital items. By 1892 it would be normal for the purchases of goods from suppliers to be deducted by reference to purchases made rather than paid for, and for recurrent expenses such as rates to be apportioned on an accrual basis. HOW IS INSURANCE DIFFERENT FROM GROCERY?

In 1892 there was one major difference. For grocers there were no accounting standards or any regulation of accounts or business in any official form. The same had been true in 1892 of all insurance until relatively recently. Although grocers can date themselves back to at least the fourteenth century,13 insurance is equally old established. Marine insurance was known in Elizabethan England14 and the first life assurance business conducted on 8 

ITA 1842, 1st Rule of Schedule D Cases I & II. ITA 1842, 3rd Rule of Schedule D Case I. 10 ibid. 11  ITA 1842, s 54. 12  There is an indirect reference to the method in Tennant v Smith (1892) 3 TC 158. 13  See the website of the Grocers’ Company, one of the 12 great livery companies of the City of London. 14  See An Act concerning Matters of Assurances used among Merchants 43 Eliz. I c. XII (1601). 9 

134  Richard Thomas a ‘scientific’, ie actuarial basis, the Equitable Life, was founded in 1762.15 Many insurance companies that are still in existence were founded in the late eighteenth and early nineteenth century (eg, Scottish Widows in 1814).16 Many were established by an Act of Parliament usually later amended many times: but a perusal of these Acts shows no indication of the adoption of any rules about the regulation of and accounting for the business. The middle decades of the Victorian era were a commercial and financial Wild West for many businesses. The railway financial scandals are probably the best known, but many other businesses rose quickly and often expired just as quickly, leaving fortunes for some and destitution for ­ others.17 ­Insurance companies followed that path with large numbers springing up and then down again.18 Because many companies which carried on life assurance also carried on other types such as fire, marine, property etc (normally called general insurance in the UK), it was frequently found that the more stable life business had supported other business with the result that there remained insufficient funds in the business to meet the claims of life ­policyholders. There was also great movement in transfers of business between companies, often in a vain attempt to rescue a weak company by having its business transferred to a slightly less weak one, usually with the value of the policyholders’ claims being reduced in the process. Thanks to the energy of a Conservative MP, Stephen Cave, a Bill with Cave as one of the sponsors, was introduced into Parliament in 1870 to bring regulation for the first time to insurance companies (though limited to those which carried on life assurance business with or without any other types of business), and only for the second time to any type of trade (the first was to railways in the Regulation of Railways Act 1868).19 A vivid account of the scandals and weaknesses of insurance companies can be read in Cave’s second reading speech.20 The Life Assurance Companies Act 187021 introduced three major innovations. It required life assurance companies to deposit capital with the Board of Trade (£20,000).22 It required such companies to create a separate 15  The demise of Equitable Life and its lack of application of actuarial principles can be read about at length in the Report of the Equitable Life Inquiry by Lord Penrose (2004, HC 290). 16  By 44 Geo. III c. 159 (1814). 17  For fictional accounts of these scandals see for example Little Dorrit and Dombey & Son (Dickens) and The Way We Live Now (Anthony Trollope). For a documentary account of the biggest railway scandals see RS Lambert, The Railway King 1800–1871, a study of George Hudson and the Business Morals of his Times (London, George Allen and Unwin, 1934). 18  See another Dickens novel, Martin Chuzzlewit, which tells of the Anglo-Bengalese Assurance Company. 19  Regulation of Railways Act 1868, 31 & 32 Vict. c. 119. 20  HC Deb 23 February 1870, vol 199 cc 719–754. 21  Life Assurance Companies Act 1870, 33 & 34 Vict. c 61. 22 ibid, s 2. In today’s terms about £2 million. But it pales into insignificance compared with the requirement on the London Assurance and Royal Exchange Insurance Corporations to deposit £300,000 (at least £30 million in today’s money) as the price for their duopoly of marine insurance.

Not Like Grocers 135 fund for their life assurance business into which all receipts of that business were to be taken,23 the fund to be held as security for the life policyholders as if the company carried on no other business, and it required every company subject to the Act to file financial accounts annually with the Board of Trade and to carry out an actuarial investigation every five years,24 the result also to be filed with the Board of Trade. Importantly, under section 11: A printed copy of the last deposited statement, abstract, or other document by this Act required to be printed shall be forwarded by the company, by post or otherwise, on application, to every shareholder and policy holder of the company.

Thus transparency in corporate affairs was born because it was not just shareholders who were entitled to a copy. Policyholders who were customers and creditors were so entitled, many decades before other public companies were required to file accounts available to other than shareholders. The annual return required revenue accounts and balance sheets to be in the format given in the Schedule to the Act. These formats are reproduced in Appendix 1. As is typical with Victorian Acts, commentaries sprung up immediately. Many were hack jobs often prepared by underemployed barristers and they consist of little more than précis. But one lasted: ‘A Treatise on Life Insurance Accounts’ by TB Sprague.25 Sprague shows how radical the ­ 1870 Act was. The first paragraph of the book contains: Before the passing of The Life Assurance Companies Act, 1870, the accounts published by most of the insurance companies were mere cash accounts of receipts and expenditure. … Sometimes there was appended a statement of investments of the company; but even when this was done, it was commonly the case that the total value of the investments was not stated.26

The format of the 1870 Act’s Schedule, a revenue account for different businesses using the concept of a ‘fund’; a profit and loss account covering mainly the distribution of profits; a balance sheet identifying assets and liabilities at historic cost and a periodic investigation into the valuation of liabilities to policyholders on actuarial lines, lasted, through a number of consolidating and replacing Acts,27 with little change until the present day.

23 

ibid, s 4. ibid, ss 5–10. 25  Sprague was a lawyer and an ex-President of the Institute of Actuaries and a member of the Faculty of Actuaries (in Scotland). His son AE Sprague revised the book for the 1909 Assurance Companies Act and changed the title to ‘a Treatise on Insurance Companies Accounts’. 26  AE Sprague, A Treatise on Insurance Companies Accounts (London, Charles & Edwin Layton, 1911) 1. 27  The Assurance Companies Act 1909, the Insurance Companies Act 1958, the Insurance Companies Act 1982 and the Financial Services and Markets Act 2000. Much of the detail of the returns to the Board of Trade was included in statutory instruments made under these Acts starting with SR&O 1910/566. 24 

136  Richard Thomas The main differences between 1870 and now being that in the 1980s market value replaced historic cost in the balance sheet for assets, the periodic investigation is annual and there is an explicit calculation of the annual surplus found by comparing the movements in a fund with the movements in the value of the liabilities to policyholders. Eventually insurance companies, like others, were required to produce accounts for the purposes of the Companies Acts. But there were a number of exceptions from disclosure for such companies and it is a reasonable generalisation to say that there was little difference, if any, between a company’s return to the insurance regulator and those to Companies House.28 This means that the accounts, whether those to the insurance regulator or to C ­ ompanies House differ from ‘normal’ company accounts submitted to the latter. In his book Insurance Companies’ Accounts; An Economic Interpretation and Analysis29 SJ Lengyel identifies 15 differences between insurance company accounts (looking at three different jurisdictions) and those of other companies. In brief the most relevant to this chapter are: 1. Other company accounts should be comprehensive and intelligible to an intelligent commercially experienced reader; insurance companies’ accounts are not. 2. Other accounts are deeply rooted in the past; insurance accounts are dependent on events in the future, often the far future. 3. In other accounts the main source of doubt is the value of assets; in insurance it is the value of liabilities. 4. Deferred items, items in advance and contingent liabilities are generally of little moment in other accounts; in insurance they are vital. 5. In insurance the higher the amount of new business the lower the profit and as business declines the greater the profit; this is not so in other business. 6. In manufacturing the plant of the business is on the balance sheet; in insurance the ‘plant’ is the sales force the costs of which are written off in the revenue accounts as incurred. 7. In insurance the value of the insurance contracts is not shown; in other companies the stock is shown. 8. In other companies offsetting amounts are shown so that gross figures appear; in insurance reinsurance is netted off unseen.

28  Scrutiny of Prudential Assurance Co Ltd’s Statement of Accounts for 1905 and of Legal & General’s 1965 Accounts shows that the format is essentially the same as that in the ­Assurance Companies Acts. Only the presence of Consolidated Accounts in the L&G accounts indicates any real difference. 29  SJ Lengyel, Insurance Companies’ Accounts; An Economic Interpretation and Analysis (Melbourne & London, FW Cheshire Pty Ltd and Wadley & Ginn, 1947). Lengyel was an economist at the University of Melbourne.

Not Like Grocers 137 9. Regulatory requirements of accounts lead to understatement of assets and overstatement of liabilities and thus hidden reserves. 10. In most companies the liabilities are a given; in insurance there is a definite correlation between the value of assets and the value of liabilities. Items 2, 3 and 4 of this list are the three main things which single out insurance as different, and are all consequences of the most important aspect of insurance: the customer pays for the service in advance of receiving it, but they may never receive it, and if they do receive it they do not know how much they will get. This is not like a grocer’s customers. This simple statement is complicated by the fact that in some types of life and similar insurance the policyholder is guaranteed to receive an amount at a fixed time, contingent only on survival. It is however always paid for in advance and often very much in advance. Finally, it has to be noted that where an insurance company only carries on business which is not life assurance, the 1870 Act did not apply. It was not until the Assurance Companies Act 1909 that accounting and filing requirements were extended to companies carrying on only those non-life types of insurance business that the 1870 Act covered only when carried on by a life assurance company. THE TAX LAW OF THE CALCULATION OF TRADING PROFITS OF INSURERS—LEGISLATION AND CASES

Lord Watson’s view is true to this extent: there was nothing in 1892 in the rules of Case I of Schedule D that applied only to insurance companies.30 The bodies of Commissioners who had to deal with the returns of insurance companies were therefore on their own. As is well known it was in 1874 when an appeal by Case Stated from the Appeal Commissioners to the superior courts became possible, and very shortly afterwards, cases reached the courts which involved insurance companies.31 And the court cases flowed

30  They had not been totally without mention in the past. See Pitt’s ITA 1799 (39 Geo. III c.13), Sch, 10th Case: ‘Profits of Manors, or of Timer or Woods, usually cut periodically, and in certain Proportions, Mines,Insurance Offices from Fire, and other Profits of uncertain Annual Amount. The Income arising therefrom shall be estimated on such Average as shall be settled by the respective Commissioners, before whom the Question shall be depending, except in the Cases of Mines, Insurance Offices from Fire, where the Average shall be taken on a Term not exceeding five Years.’ And one of the benefits given to the Royal Exchange Assurance and the London Assurance was the right to nominate General Commissioners for the City of London— see ITA 1803, s 6; ITA 1952 Sch 1, Part II; finally repealed by the Income Tax Management Act 1964, Sch 6. 31  A large number of cases in the first two volumes of HMSO Tax Cases involve the Inhabited House Duty and an exemption in it where the question was whether insurance companies could take advantage of that exemption.

138  Richard Thomas in some numbers up to World War I and shortly afterwards. This chapter now looks at those cases to see how the courts dealt with the insurance company issues. For this purpose the subject is divided into sections looking at premiums (the receipts from the customer paying for insurance) and the corresponding liabilities to policyholders for claims; investment returns (from the assets which the company purchases with the premiums) pending its having to (or not having to) pay out, looking separately at income and gains on realisation, and at losses; and expenses. Accounting and Tax Treatment of Premiums and their Associated Liabilities32 When the Imperial Fire Insurance Company appealed against an ­assessment of them for the year ended 5 April 1875 they produced for the Special ­Commissioners their accounts for the years ended 31 December 1871, 1872 and 1873. The accounts format (using the figures for 1871 and ignoring shillings and pence) was: Income Premiums received

£609,184

Balance (ie profit)

£656

Expenditure Losses

£472,342

The profit and loss account intended as part of the tax return supplied to the Commissioners under precept showed: Income Premiums received

£609,184

Do. Unearned in 1870

£151,808

Expenditure Losses

£472,342

Unearned premiums 33%

£201,030

Balance (ie loss)

£48,556

32  This part of the chapter owes a great deal to the illuminating and humorous (not easy when talking about insurance accounting and tax) article by William Phillips ‘Taxation of Insurance Offices and other Prepaid Contractors’ [1961] BTR 351.

Not Like Grocers 139 The only issue for the Commissioners was whether the net deduction for unearned premiums (the difference between £201,130 and £151,808) was deductible in arriving at the balance of the profits or gains for assessment under Case I. Some explanation of what the company was seeking to do in its tax returns is required. Fire insurance policies, indeed most insurance policies, cover a period of a year, that is the insurer is on risk from having to pay out if an event happens in the year to trigger a claim. Premiums are paid in advance and so if a premium is paid on 1 July the company is on risk for the six months ended in December of that year and the first six months of the next year. Under the basis of accounting used by the company (and in the forms in the 1870 Act) premiums received or due will be brought in in full in the year of receipt. But claims arising from the insurance will only be included in the same year’s accounts if they have been paid or agreed or at the outside notified in that year. Claims made etc after the year end will appear in next year’s accounts. In order to remedy the apparent overstatement of profits from the premiums written in the year, insurance companies used the notion of ‘unearned premiums’, that part of each premium received in the year which relates to the following year as far as possible payout is concerned. In the year of receipt the unearned premiums will be a deduction from profit and included in expenditure; in the next year that same amount will be treated as income and then next year’s unearned premiums will be deducted. This mechanism is much like that for stock-in-trade and is intended to fulfil much the same function—allocating profits to the ‘correct’ year. The Case stated to the Court of Exchequer in Imperial Fire Insurance Co v Wilson33 simply says: The Commissioners would not allow the introduction of the unearned premiums as they did not appear in the books …34

In the High Court, the judges found again for the Inland Revenue in the person of Mr Wilson, the surveyor of taxes, but on the part of Kelly CB with some reluctance: I say with reluctance, because it is impossible not to see that perfect justice cannot be done by giving our judgment in favour of the Crown, and, on the other hand, it is not to be forgotten that the scheme or mode of making out and settling the accounts suggested by the Insurance Company seems substantially, though it is

33 

Imperial Fire Insurance Co v Wilson (1876) 1 TC 71 (‘Wilson’). 72. Had this decision been upheld on the basis that it was (to the author at least) as obviously correct as the decision of the House of Lords in HMRC v William Grant & Sons (Distillers) & Small v Mars (UK) (2007) 74 TC 442 (‘Mars etc’) and if we assume that it was appearing in the profit and loss account that was relevant, then those learning tax law would have been spared a number of lengthy and difficult cases and would not have had to wonder why it took so long until Lord Justice Bingham slew the mythical dragon of judge-made principles of Case I or why FA 1998, s 42 was needed. 34  ibid

140  Richard Thomas not really unobjectionable, and perhaps it is the most reasonable mode that could be determined on in most cases, but it really would not be according to law. There is nothing in the Income Tax Acts which enables the parties in such a case, the Crown on the one side, and the Insurance Company on the other, to determine with certainty what is the amount or value of the risk which continues after the end of the year, while a number of policies upon which a year’s premiums have been paid are exhausted, and where they may or may not be upon one, or two, or more, or all, losses to a large amount or a smaller amount, or no losses at all. Therefore, in the mode suggested on the part of the company, they are obliged to resort to a speculative mode of ascertaining the probable amount of the risks which continue, and I see no warrant in the Income Tax Acts, nor indeed in the principle of the law, which will enable it thus to act.35

Thus the problem is not one of principle, it seems, but one of practicality, on which Chief Baron Kelly expanded: Therefore, looking at the very nature of the case, and to the absolute impossibility of doing perfect justice, because even if you were to take it upon an estimate on the report of an actuary, which might be fair enough, if you take into account the number of policies and the amount of premiums paid upon them, amounting to some hundreds of thousands of pounds, it would cost more money to get the calculations made by an actuary or by somebody else, than perhaps double the amount of the income tax which has to be paid. I say, under these circumstances, seeing that at the moment it is profit and that if any wrong be done by losses afterwards occurring, that will be taken into consideration in the next year’s account, it seeds to me that the only way in which something as near to exact justice as possible can be carried into effect in a case of this nature is by taking the accounts as they are made out are adjusted and the income tax assessed.36 [Author’s emphasis]

Baron Amphlett added: If they find it to their interest to adopt a new system I by no means intend to say that if they choose at a future time to alter the mode of taking the accounts, and set aside, for instance, some fund to answer the contingent losses in the next year, if they choose to do that, and make it intelligible, I by no means say that they may not oblige the Commissioners to accept the accounts in that amended form. … and I therefore think that as long as they keep their books in that way the ­Commissioners have a right to apply the same rule in estimating the amount upon which they ought to be assessed.37

And in similar vein Baron Huddleston said: I should have thought that the most convenient way for the Insurance Company to have kept the accounts would have been to have debited themselves first of all with the amount of premiums applicable to the risks of the year; that is to say, they might very readily have ascertained when the premium was paid, in whatever

35 

Wilson, above n 33, 73. ibid 74/75. 37  ibid 76. 36 

Not Like Grocers 141 month it was paid, how much was applicable to the current year, and how much would be applicable to the risks to be incurred in the succeeding year, assuming them to be annual payments, and they might very readily have carried out a figure which would really represent the amount applicable to the risks of that year; that is to say, they might either in the first instance have taken the gross sum of the premiums received, deducting from it such proportion as would be applicable to the succeeding year, and having debited themselves with the balance, or they might have done it in the way in which it is suggested by the company that they do it here; they might have debited themselves with the gross sum, and then have credited themselves with the actual sum which would be applicable to the next year, and, in that case, I think that they probably would have got at the right gross profits. I do not see that in fire insurance such a course would be as difficult as in the case of life insurance.38

But, as he adds, they did not do that: ‘they take an arbitrary sum which they say (we have no evidence of the fact whatever) would represent the unearned premiums, and they take that as something like 33 per cent.’39 The next case, five years later, to tackle premiums was the Scottish Union and National Insurance Co Ltd v Smiles.40 In the returns (but not the accounts) of that company there was a deduction for the increase in ­‘unexpired risks’, which were taken as equivalent on an average to one third of the premiums received during the preceding year. In one of the paragraphs of the ‘useful guide’ given after his magisterial put down of the General Commissioners for the Division of Midlothian41 the Lord President of the Court of Session42 said: (3) Seeing that fire insurance policies are contracts for one year only, premiums received for the year of assessment, or on an average of three years deducting losses by fire during the same period, and ordinary expenses may be fairly taken as profits and gains of the Company without taking into account or making any allowance for the balance of annual risks unexpired at the end of the financial year of the Company. (See the Imperial Fire Insurance Company v Wilson.)43

38 

ibid 76. ibid 77. 40  Scottish Union and National Insurance Co Ltd v Smiles (1889) 2 TC 551. The Scottish Union case was heard together by the Court of Session with The North British Assurance Co Ltd v Russell (Surveyor of Taxes). In what follows the judgment of the Lord President in the conjoined cases is described as the judgment in ‘Scottish Union et al’. 41  ibid 577 ‘In the case of the Scottish Union and North British Insurance Companies the Court are of opinion that the assessment originally imposed cannot be sustained, and that the mode of ascertaining the profits and gains of the companies in the department of life business adopted by the Commissioners is fundamentally wrong and quite inadmissible. We shall, therefore, reverse the determination of the Commissioners, and remit to them with the following instructions, which sufficiently embody our reasons for differing both from the assessor and from the Commissioners, and may at the same time form a useful guide to the Revenue ­Officers and the General Commissioners of Income Tax in dealing with cases of this description.’ 42  Lord Glencorse. 43  Scottish Union et al, above n 40, 577. 39 

142  Richard Thomas Nearly 20 years passed before the next case to consider the issue, G ­ eneral Accident, Fire, and Life Association Corporation v M’Gowan.44 The Case stated shows that the appeal was ‘on the ground that in arriving at the assessable profits no deduction had been allowed to meet losses on u ­ nexpired risks.’ This deduction was not shown in the accounts which were required to be produced by the company’s Articles of Association). The General Commissioners for the Division of Perth decided that they were bound by Scottish Union45 and dismissed the appeal. The Court of Session also dismissed the company’s appeal. Before the House of Lords the company argued that it should succeed: 1. Because, in order to ascertain the trading profit of companies dealing in yearly policies of insurance, it is necessary to take into account the unexpired risk on current policies. 2. Because, in ascertaining the profits of such companies for the purpose of assessing Income Tax, an allowance for unexpired risk is just and equitable and in accordance with the provisions of the Income Tax Acts. 3. Because the rate of allowance proposed by the Appellants is fair and equitable and in accordance with the general experience and practice of insurance companies. 4. Because, in the case of Companies with a progressively increasing premium income, like that of the Appellants, the method of ascertaining profits adopted by the Assessor involves continuous and cumulative over-assessment and fails to secure even approximate justice. 5. Because the Judgment appealed from, and the previous decisions which it follows are founded upon an erroneous conception of the limited effect of the method of ascertaining profit adopted by the assessor.46

In their detailed case they say: … The experience of insurance companies over an extended period, upon which the rates of one-third has been fixed as a fair normal allowance for unexpired risks upon current yearly fire and accident policies, does not differ in kind from the experience upon which is based the actuarial calculation of the prospective risks of life policies. So strongly have these considerations weighed with the Inland Revenue authorities that as a matter of practice, notwithstanding the decisions relied on by the Court of Session, they do allow the element of unexpired risk to be taken into account where the annual accounts of insurance companies are expressly framed on that footing …47

For the Inland Revenue it was argued that: Provision is made in the rules for the deduction of loss connected with, or arising out of, the trade carried on. To be deductible, however, the loss must have been

44  General Accident, Fire, and Life Association Corporation v M’Gowan (1908) 5 TC 308 (‘M’Gowan’). 45  Scottish Union et al, above n 40. 46  M’Gowan, above n 44, 321. 47  ibid 318.

Not Like Grocers 143 actually incurred. The deduction which the Appellants claim in respect of unexpired risks from the profits of each of the years coming into the average is estimated by the Appellants on yearly policies at 33⅓ per cent of the total premium income of the year … These are mere arbitrary sums, being estimates of contingent losses, The Income Tax Acts make no provision for estimated or probable losses. They allow as deductions only actual losses incurred. The profits of the Appellants were ascertained in the usual way by reference to their revenue accounts, that is, by subtracting the losses and expenses from the premiums and interest, &c., received by the Appellants during the year, and taking an average of three years. This is the method which has been invariably followed in the case of the Appellants. The losses on the unexpired risks of any year are paid out of the income of a following year, and in calculating the profits of such following year a deduction is allowed in respect of such payments. The Appellants do not specially appropriate any part of their revenue to a reserve for unexpired risks, nor do they charge any losses on unexpired risks to reserve fund.48

In the judgment of the House of Lords the Lord Chancellor said: Now, in my opinion, there is one sufficient reason for rejecting this contention. It is not found as a fact that 33⅓ per cent. does represent the real value of the risks that run on into 1904 in respect of premiums received in 1903. I am not prepared to assume that it is so, for all the statement of the Commissioners that it is the practice of insurance companies to estimate 33⅓ per cent as the proper figure to represent that value. We are not told either for what purpose such an estimate is made, or that it corresponds with the reality. If I am to conjecture, I should incline to the view that this percentage is very far from the proper figure. For, if this estimate be accepted, then in the three years 1902, 1903, and 1904, taken together, the total profit of this Company, making certain deductions, was £15,338, whereas we know that, for its own purposes, the total profit, after the same deductions, was treated by the Company as £62,850, and dividends were paid and moneys carried to the reserve on that footing. During 32 years, since the decision of Wilson’s case, the method of assessing fire and accident companies has been that adopted by the Commissioners in the present case. It is not scientifically unassailable, for it obviously proceeds upon the supposition that the unexpired risks at the beginning and at the end of each year are in substance the same, or that, if an average of three years is taken, they are upon an average the same. But no method is scientifically unassailable that does not enter into an analysis of the contracts made and contracts current in each year so minute that it is in a business sense impracticable. I think the particular correction sought by the Appellants in this case is quite indefensible upon the materials before us, and further that the method adopted by the Commissioners is a good

48 

ibid 323.

144  Richard Thomas working rule in the present instance and generally. If in any particular case an insurance company can show it works hardship, no doubt the rule ought to be modified, so that the real gains and profits may be ascertained as near as may be.49 [Author’s emphasis]

A few years later the General Commissioners and the Courts again addressed the issue of unearned premiums in Sun Insurance.50 The Case Stated reports: Apart from other Reserves, as to which no question arose, amounting at ­December, 1904, to £1,632,134 12s. 11d. this Office had since 1888 been in the habit of ­carrying forward annually, in its published accounts at 31st December, 40 per cent. of its yearly premium receipts as a reserve, or allowance, in order to bring about the correct incidence as between year and year of the premium income which has to answer the accidental incidence of fire losses, and on the balance of which, over or under the losses and charges for the year, the profit or loss attaching to their business depends.51

Before the City of London General Commissioners the appellant’s contentions were: (a) That, in view of the fact that all insurance premiums are prepaid and that at any given date when a balance sheet is drawn up payments have in fact already been received for risks which will remain to be run off after the date of the balance sheet, to treat all premiums receivable up to the data thereof as income, without deduction of the proportion prepaid and unexpired is unjustifiable and commercially. unsound and is not obligatory under the Income Tax Acts, and in any case ought not to be forced on an Office which, as between itself and its shareholders, takes steps by means of a proper reserve for unexpired and unearned premiums to throw the real premium income into each year to answer its actual losses. (b) That before the Directors can properly include in a profit and loss account as at 31st December, 1904, all premiums receivable up to that date as income, they ought, if not entitled to carry forward such a reserve as they in fact make in their accounts, to provide in some other way for the unexpired risks, and that in effect each successive year takes over from, and indemnified its predecessor against, its unexpired risks, and the per cent allowance made for the purpose is equally chargeable against the gross premium income as though it were a re-insurance premium paid out of pocket for the indemnity. (c) That the premiums are earned not by being got in but by the Office remaining on the risk for the agreed term of the policy, and that the Company is justified in throwing into each year the risk bearing premium which belongs to it.

49 

ibid 325. Sun Insurance, above n 1. 51  ibid 60. 50 

Not Like Grocers 145 (d) That 40 per cent is in fact, and is recognised by the best in formed opinion of the insurance world as being, the irreducible minimum rate for such an allowance and that the estimate of 40 per cent for the year of assessment had itself proved greatly insufficient by reason of the losses in respect of the San Francisco fire calamity and similarly in other years.52

The Surveyor, after maintaining that Wilson’s case53 was decisive added ‘if the Commissioners decided that the Company were legally entitled to such allowance as was claimed, he was not, for this specific appeal, in a position to contest that 40 per cent was an accurate estimated reserve.’54 The General Commissioners decided that the company’s claim was correct. On appeal the High Court agreed, with Bray J being clear in his view about the issue: … the proper way to arrive at the profits of the year is to deduct at the end of the year some sum which will fairly and properly represent the liability owing to the unexpired risks. You may put it in this way, that the whole of the premiums have not been earned and they are not profits; or you may prove that there is a contractual liability to pay in certain events certain persons the losses that they may have sustained by fires; just in the same way as there is a liability, when you have entered into any contract to do something, to do that thing. If you have agreed to pay five months hence a sum of £1,000, that is a liability which you must take into account when you are estimating the profits of the year. You have received your goods and you must set against them the price that you are going to pay; and the fact that that price has not been paid during the year does not prevent it being deducted. You must deduct the value of the liability to pay that price whenever it occurs. Therefore I doubt not, except for a few observations of Chief Baron Kelly in the case of the Imperial Fire Assurance Company v Wilson that the real and proper way to arrive at the balance is by making a deduction at the end of the year for the value of the liability in respect of the unexpired risks, and of course at the beginning of the year to bring a like sum into account on like other side of the account.55

This decision was overturned by the Court of Appeal with obvious reluctance, and only because they considered themselves bound by the House of Lords in M’Gowan.56 Fletcher Moulton LJ’s judgment was particularly clear: In the present case we are dealing with an Insurance Company. The characteristic of insurance business is that tile payments are in advance and that the risks come after the payments, and any commercial man who would treat the premiums that he receives as sums that he might put to income without making any allowance for the risks which he undertook in order to get those premiums, would be thought very little of in the commercial world. If it was a life insurance, to do such a thing 52 

ibid 60/61. Wilson, above n 33. 54  Sun Insurance, above n 1, 61. 55  ibid 62/3. 56  M’Gowan, above n 44. 53 

146  Richard Thomas would probably be gross fraud such as one sees in the insurance swindles that are immortalised in Martin Chuzzlewit. If it was a marine insurance it would be so grave a fault that we find in the case of the County Marine Insurance Company the Court of Appeal in Chancery compelled the directors who had treated the premiums so received as merely revenue and paid dividends out of them without making proper allowance for the risks to be covered, as having been guilty of such improper conduct that they had to refund to the Company the money so paid out. Fire insurance does not differ from that excepting that it is much more simple and easy in fire insurance to make allowance for future risks. Roughly speaking, they may be proportioned to the period covered by the premium which has not expired, and, therefore, I think that in fire insurance the companies ought in that way, or if practice had enabled them to guess what a calculation on that basis would lead to: by the adoption of some rough and ready method, to provide in their balance sheets for the unexpired risks. My opinion in this respect, which I do not think any commercial man would quarrel with, is absolutely confirmed by the action of the legislature in the Insurance Companies Act of 1909, which in the Schedule prescribes the balance sheet that is to be drawn up by every fire insurance company, and there there is a provision for these unexpired Risks, and it intimates by the form of the entry that it is intended that those should be calculated, as they are in the case before us, by a percentage on the total premiums received. Therefore, we have it that by our own reasoning, by the action of the legislature and I think by the action of all commercial men, the proper way to ascertain profits in fire insurance companies is to make a reserve for unexpired risks. In the circumstances I should not have the slightest hesitation in supporting Mr. Justice Bray’s decision if it were not that I feel compelled by authority to decide the other way.57

When it came as it inevitably did to the House of Lords surprise was expressed at the view taken by the Court of Appeal of their Lordships’ opinions in M’Gowan.58 All five members of the Appellate Committee gave a reasoned opinion. The reasoning of the Committee can be seen clearly in the opinion of Lord Loreburn who said: Thus it appears that you cannot base the assessment of income tax upon the actual facts of the business done and the actual pecuniary results of it in the case of Fire Insurance Companies who take single premiums to cover risks for a year or for more years. This is such a Company, and I believe nearly all Companies are in the same position. If that be so, it follows that in assessing such Fire insurance Companies, you must proceed wholly or in part by estimate. [Author’s emphasis] An estimate being necessary and the arriving at it by in some way using averages being a natural and probably inevitable expedient, the law as it seems to me, cannot lay down any one way of doing this. It is a question of fact and of figures whether what is proposed in each case is fair both to the Crown and to the subject.

57  58 

Sun Insurance, above n 1, 70/71. M’Gowan, above n 44.

Not Like Grocers 147 In McGowan’s case, to which reference is made, three methods estimating these gains or profits here before the House. I place first, merely for convenience sake and not for its importance or value a faint suggestion which was made in the case of McGowan, and which as I understood it, was as follows: It was suggested that each contract of insurance made during a particular year should be considered separately. If it had expired then the actual result should be taken, whether profit or loss. It if had not expired then an estimate should be made, having regard to the period unexpired and the degree of risk, which might be different (in summer and winter for example) during that period. I do not imagine that either the Crown or the Company would seriously desire such an enquiry. I do not know how many fire insurances are effected by a great Company within a twelvemonth, probably scores of thousands or even hundreds of thousands. Such a process, as to the unexpired contracts, would be minute and almost interminable. It was rejected because there was no evidence that it would be a reasonable way of ascertaining what was desired. The second method suggested in that case was that of merely taking for each year the sum total of the premiums received and the sum total of the losses paid and subtracting the one from the other, without regard to the fact that the premiums cover risks running on into subsequent years and the losses include losses arising out of contracts made in previous years. This method is of course not precise or scientific. It proceeds upon the view that when this is done for the three consecutive years indicated by the Statute and the figures thus reached are averaged, a fair and reasonable conclusion is attained. This method was adopted long ago and has more than once been the subject of consideration in courts of law. I can conceive it being unfair either in the case of a rapidly increasing or of a rapidly diminishing fire insurance business. It may prove unfair in other cases. But in McGowan’s case it was not proved to be unfair. On the contrary it closely corresponded with the dividends actually distributed and was upon the facts of that case clearly the most accurate and reasonable of the methods which alone were propounded for our consideration. Accordingly it was adopted. I think it is in general a good working rule, but no one in this House has said that it ought to supersede the truth if the truth is in conflict with it in any case. A third method, similar in principle to that advanced by the now appellants, was also considered by your Lordships in the case of McGowan. This method is to carry forward annually at the close of the year a percentage of the premium income in order to allow for unexpired risks. It has no pretensions to being precise. I can easily imagine cases in which an actuary could show it was misleading. But if it comes nearer to the truth than any other method in a particular case, I do not understand why it should not be adopted. This third method, however, in its application to that case, the McGowan case, would have meant that the Insurance Company was to pay income tax upon the footing of about £15,000—profits and gains in the three statutory years, whereas they had divided dividends of about £60,000 in those three years. And there was no evidence and no finding, nor could there honestly have been, that the third method worked fairly between the Crown and the subject.

148  Richard Thomas In those circumstances this House rejected the third method. The House adopted the second, but so far from laying it down as a rule of law, it was expressly pointed out that the second method was of itself imperfect and, thought a good working rule generally, would not be applicable if in any case it appeared upon the facts to involve hardship. … After this preface, tedious but necessary in the circumstances, I come to the merits of the present appeal. Here again there is competition between two methods of estimate. That which I have called the second is propounded by the Crown; that which I have called the third is propounded by the Company, who deduct 40 per cent of the premiums at the end of each year. The relevant facts are here the reverse of what they were in the Case of McGowan. The third method has been examined by the Commissioners and is stated in the Special Case to be right in this case. It was in terms admitted by the Surveyor of Taxes therefore the Commissioners that the fair and reasonable allowance for this Company to make if entitled to make any allowance was 40 per cent. The Surveyor’s point was that no allowance or deduction at all ought to be made, because he said the proper method according to law was the second method. He did not prove, or try to prove, that it was fair in this case. So that all the evidence and the finding in the present appeal was in support of the Appellants’ contention. In these circumstances it seems to me quite obvious that the third and not the second method must be applied here for the plain reason that upon the materials before us it is the fair and only way presented to us by which the truth can be approximately attained.59

It is Lord Atkinson who best expresses the link between this case and the general approach by the Courts to trading profits cases: A little consideration of one of the most illumination authorities in the books upon this question of the mode of ascertaining the taxable gains and profits of trading and commercial businesses, namely, Gresham Life Assurance Society v Styles60 (1893 Appeal Cases 309) will show conclusively that, consistently with that authority, no such rule could be laid down as a matter of law. The very nature of the thing forbids it. That case clearly decided that the receipts of a business are not in themselves profit and gains within the meaning of the Income Tax Acts, but that it is what remains of those receipts after there has been deducted from them the cost of earning them which constitute the taxable profits and gains. Now what is the service which a Fire Insurance Company renders to each insurer in consideration for the premium it receives? It is only be rendering this service in each case it earns these receipts. The services consists in indemnifying the insurer against loss by fire during the continuance of his policy. The Company are entitled to deduct what it will cost them to perform that service. In any given case where a fire occurs the loss,61 and therefore the cost of the service by which the premium is earned, may and almost certainly will vastly exceed the premium, but in the aggregate of all their policies

59 

Sun Insurance, above n 1, 75–77. Lord Watson’s ‘grocers’ case. 61  When the word ‘loss’ is used in relation to fire etc. insurance it means the amount which the insurer pays out to indemnify the policyholder for their real loss. It does not mean a negative profit. 60 

Not Like Grocers 149 and aggregate cost will, of course, be much less62 than the aggregate premiums. The difficulty of the position consists in this, that until the time for which a policy is to remain effective has expired, nobody can tell precisely how much the service will cost. Yet until that time has expired the service for which the Company has been paid has not been completely performed. If the accounts of the Company are to be rendered before the date of expiry, then some division of the premium must be made, and the proportion to be appropriated to the service which is to be performed thereafter. I think the description ‘unearned premium’ which has been used to describe this latter portion is a very appropriate and accurate description. It is obvious that the entire premium cannot in every case be divided in the same proportions as those into which the accounting period divides the entire duration of the policy, because the risk is not the same for each calendar month or each reason. On the contrary, the risk is admittedly greater in the winter months than in the summer months, because fires and artificial light are more used in the ­former than in the latter; for instance if the 31st of December be the accounting day and the policy be effected on the 1st of July, it might be quite right to divide the premium into two equal portions, one half being treated as earned in the year the policy was effected, and the other half as to be earned in the succeeding half year, but if the policy were affected on the 1st of October then it would, obviously, be unfair, in account of this greater risk, to treat only one quarter of the entire premium as having been earned in the three winter months if October, November and December. Having regard, therefore, to the fact that companies Carrying on this kind of business are, under the decision of your Lordships’ House, clearly entitled to object to their receipts being treated per se as their profits and gains without the proper deduction having been made of the cost of earning those receipts, it is obvious that the amount of the taxable profits and gains can only be ascertained by some system of averages or estimation, or by some other practical rule of thumb based upon experience and the facts of different cases. As I understand, Lord Justice Moulton is of opinion that some method might be adopted by which the problem could be solved with scientific accuracy. Unfortunately he does not describe in detail what that method is. It may, for all that appears, involve much complicated calculations in reference to each particular policy as to be practically unworkable, and certainly it does not appear to me that it is possible to adopt any method which does not involve recourse, at some stage of its processes, to estimates, averages, or such like things. If these matters be borne in mind, it does seem strange that it should have been supposed that it could ever have been laid down as a matter of law that one method, and one method alone, could legally be employed to solve the problem.63

Before considering the importance of Sun Insurance64 generally, the position of life assurance business needs to be considered. It can be seen from a 62 While this may have been true then, it ceased to be true of most types of policy (PPI excepted) by the last few decades of the twentieth century. In a memorable phrase, general insurance has been described as an investment business with a hobby loss trade attached. 63  Sun Insurance, above n 1, 82–83. 64 ibid.

150  Richard Thomas comparison of the Life Assurance Revenue Account and the Fire Revenue Account in the Schedule65 to the 1870 Act that premiums are brought into account in the same way: as shown in the fire insurance cases, that means on receipt or on falling due. The Revenue Account for life assurance is not a balanced profit and loss account because it takes no account of accruing liabilities to policyholders. These are only disclosed every five years following an actuarial investigation of those liabilities. The first case to consider is Last v London Assurance Corporation.66 In that case the profits of the life assurance business were taken by the company to the amount of ‘surplus’ appropriated to shareholders after setting the results of the actuarial investigation of the liabilities to policyholders against the value of the life fund. The Surveyor argued that: … to arrive at the net balance of profit chargeable for the life branch under the above rule, it was required on the one hand to take account of the life premiums received during the last three years, and on the other hand to allow as deductions nothing beyond the claims actually paid under policies becoming payable in the same period, together with the expenses of managing the business; that the balance remaining would be the profit chargeable to the income tax for the life branch; and that this profit, added to the untaxed profit of the marine and fire branches, would represent the total liability of the Corporation under Schedule D.67

The General Commissioners found for the company on this issue without elaboration, and the High Court confirmed their decision, again without elaboration.68 Shortly after the High Court decision, the Court of Session gave its general guidance in Scottish Union et al.69 In those cases the Midlothian General Commissioners had said of the calculation of profits of life assurance: But if it be incompetent to assess the Company on the annual balance of their premium income [ie the receipts and expenditure basis], there can, the Commissioners apprehend, be no doubt that they are liable to assessment in respect of the profits admittedly made, as ascertained or ascertainable by actuarial valuations. The Commissioners cannot, however, but feel that to assess on such a basis introduces many difficulties inconsistent with that simplicity and directness which characterises the incidence of the Income Tax on other trades and businesses. The tax is levied in ordinary cases on the profits of each year, or on the results annually ascertained; an average of a few years may be accepted as the measure or test of one year to save detail or equalise results. But the actuarial calculations of an insurance company run into a very distinct future, and embrace considerations all problematical and hypothetical, and some of them purely arbitrary; the

65 

See Appendix. Last v London Assurance Corporation (1884) 2 TC 100 (‘Last’). 67  ibid 103. 68  There is in fact a little elaboration, but the author is unable to understand it. 69  Scottish Union et al, above n 40. 66 

Not Like Grocers 151 Commissioners think it is hardly in accordance with the spirit of the assessment that its results should depend on guesses as to what may be the rate of interest, or the rate of mortality, or the rate of expense fifty years hence. If equal latitude were allowed to the imagination of other trades, the result would not be favourable to the Exchequer.70

And in relation to the statutory investigation of liabilities to policyholders they said: From this statement it would appear, First. That the effect of these valuations has been to add to reserve, and to d ­ iminish divisible profits. Second. That large sums, which, according to certain principles of calculation would have been available for division, have been reserved and that the Appellants who reported in 1884 a profit of £300,811 11s. 1d. (including £25,540 12s. 5d. brought forward from the previous valuation) divided only £183,874. Third. The two principle elements of life assurance are the rate of mortality and the rate of interest. In these valuations the Appellants have evidently adopted ­arbitrarily the scale they consider most expedient, with the result of increasing their reserves at the expense of revenue and profits. Thus the Appellants made an ­average of £4 7s. 6d. per cent on their investments, and yet based their calculations on 3 per cent for the future, a very prudent course no doubt but one purely arbitrary. Fourth. The premiums charged by the Appellants are estimated to provide not only the sums insured but to produce in some cases a profit, and in all cases to defray expenses. The Company lays aside as reserve all that portion of the future premiums which is in excess of the sum required to produce the bare amount insured. There is no obligation on them to pay profits to the insured unless they are earned, and no obligation on them to carry on business: if by any accident they incurred losses and could divide no profits, or if by adopting principles more and more stringent they reserved all they made, still the full amount of the premiums would be payable by the insured though no profits were shown available for division; and if they ceased business and thus dispensed with all expense but the trifling amount necessary to wind up their business gradually, still the same amount of premium would be payable. The sums thus reserved for these somewhat contingent purposes are often very large, in the case of the Appellants they amounted in 1884 to no less than £698,095, in this is included an estimate of future premiums based on their accumulation at a low rate of interest which is also estimated. Fifth. There may be no doubt that these large reserves out of profits are proper in the prudent management of the business, but it does not appear to the ­Commissioners that profits thus reserved ought to be exempt from assessment in

70 

ibid 559.

152  Richard Thomas the case of insurance companies any more than in the ease of other traders. Many a trader will lay aside part of his profits to meet ascertained or possible losses, or to equalise the profits of one year with those of another, but he does not thereby escape assessment. It is the profits made that are to be assessed, their application is beside the question of assessment.71

The Lord President’s general principle for life assurance was this: (4) That this rule [that for fire insurance one should use the receipts and expenditure basis] is not applicable to the ascertainment of profits and gains upon the life business; that life policies are contracts of most variable endurance, and the premiums are in many cases not annual payments. The contract may endure for the policy-holder’s life or for a certain number of years stated, or till the holder attains a certain age; and the Company may be bound on the expiry of a fixed number of years, or on the attainment of a certain age by the policy-holder, either to pay a lump sum or an annuity for the remainder of the policy-holder’s life. The premiums paid for such insurance may be paid all in one sum or by instalments within a fixed number of years, or annually during the holder’s life, or during the subsistence of his policy. The premiums, therefore, do in no sense represent the annual profits and gains of the Company. In like manner the amount of claims in one year arising on the death of persons insured, or as a deduction from the Company’s receipts for the year, cannot afford any criterion for the ascertainment of profits. A recently established company will receive a large amount of premiums and have few or no claims to meet. The profits and gains can be ascertained only by actuarial calculations and this actuarial calculation may he obtained by taking the result of the quinquennial investigation prescribed by Statute or the periodical investigation in use in companies established before the Statute, or by an investigation covering the three years prescribed by Schedule D. of the Income Tax Acts.72 [Author’s emphasis]

It was against the background of this case, decided in 1889, that Sun Insurance73 was decided. Scottish Union et al74 had established, though not at the highest level, that it was impossible to reach the balance of the profits and gains of life assurance business by the type of procedure suggested by the Midlothian Commissioners or that for general insurance in M’Gowan.75 The business of life assurance was a long-term business where the results of any contract were not capable of exact quantification until a future event happened. It followed that a ‘profit’ which excluded the accruing liabilities could not be a proper balance of profits. As was stated by the Court of ­Session in Scottish Union et al the only way the liabilities could be valued was by actuarial calculation, since it was taken as axiomatic that the liabilities could not be valued at the face amount of the policies. The Midlothian 71 

ibid 560/561. ibid 577/8. 73  Sun Insurance, above n 1. 74  Scottish Union et al, above n 40. 75  M’Gowan, above n 44. 72 

Not Like Grocers 153 Commissioners had criticised the valuation methods of the company’s actuaries as being too prudent: it understated the amount that the company could expect to earn on investment of the premiums and built in other cushions. In their decision the Court of Session did not accept in terms these criticisms, but they did not make it mandatory to use the quinquennial statutory investigation: the words ‘This actuarial calculation may be obtained’ suggest it was not the only method available, and indeed they referred to an ‘investigation covering the three years’ which could not be the statutory one. Suffice it to say at this stage that the issue whether the actuarial investigation was ‘sacrosanct’ (as it was often said) remained a live issue for more than a century after the decision in Scottish Union et al. Generally observed practice was however to accept that the amount of the surplus transferred from the life assurance fund following the actuarial investigation was the Case I profit of life assurance business. The effect of Sun Insurance was to apply the thinking of the Court of Session in Scottish Union et al to general (non-life) assurance. It made it clear for all time that there were cases where simply taking amounts paid or becoming due was not sufficient where there was a major element of contingency in the company’s liabilities for deductible amounts that had not yet crystallised, when the company had recognised as credits the amounts it had received intended to cover those liabilities. Calculations were simpler in most general insurance. It is clear that over simplistic calculations would not suffice, but it happens that as a result of Sun Insurance the Inland Revenue accepted for decades that 40 per cent of premiums was an appropriate amount for a provision for unexpired risks/ unearned premiums.76 Sun Insurance and Scottish Union et al are important for another reason. One reason why the appeal in Wilson’s case77 failed was that its unearned premium deduction was not reflected in any way in its accounts. Sun ­Insurance did create a reserve for unexpired risks in its accounts (though it is not at all clear whether any transfer to this reserve was reflected in the fire revenue account or the profit and loss account). In Scottish Union et al it seems the court’s preferred method was to use the statutory 1870 Act basis for the actuarial investigation, and it is likely that the same basis would be used in the accounts although only every five years. These cases can therefore be seen as important steps along the way to establishing that which is now an obvious and indeed clear statutory provision that when the Rules of Case I of Schedule D referred to a balance of profits and gains and to the date when accounts were drawn up, they were referring to what had to

76  See eg JS Macleod and A Levitt, Taxation of Insurance Business, 1st edn (Butterworths, London, 1985), 11.09. 77  Wilson, above n 33.

154  Richard Thomas be reflected in accounts drawn up in accordance with ‘normal commercial practice’. For insurance companies subject to the 1870 Act the accounts in the Schedule to that Act constituted such practice. And as the Court of Appeal in Sun Insurance recognised, the Assurance Companies Act 1909 introduced the concept of a reserve for unexpired risks into the accounts required under that Act. Treatment of Investment Return: (i) Income In 1930 the House of Lords put it beyond doubt in Salisbury House Estates v Fry78 that the schedular system established in Addison’s Income Tax Act of 1803 had the effect that each of the Schedules was mutually exclusive. It had also been established by then that within any Schedule that had more than one Case or other subdivision, the Inland Revenue could choose which of more than one appropriate case (except Case VI which as residual) should be applied. As most insurance company investments in the later nineteenth century consisted of fixed interest securities and many investments were held abroad there was a potential clash between Case I and Cases III and IV. The story in the courts starts yet again in the judgment of the Court of Session in Scottish Union et al.79 In the Lord President’s pithy judgment laying down general principles for the guidance of all parties he said: (2) That the interest of investments which has not suffered deduction of Income Tax at its source must be taken into account in ascertaining the assessable amount of profits and gains of the Company.80

Shortly afterwards the General Commissioners for the City of Edinburgh were called into action in a life assurance case. In Forbes v Scottish ­Widows Fund and Life Assurance Society81 they decided that despite its being a mutual company the Surveyor was correct when he argued that Case I applied and that the income from investments in Australia etc were chargeable as part of the profits under Case I and not under Case IV: the issue being that for the purposes of Case IV interest was only taxed if remitted to the UK. The issue was not however decided by the Court of Session. The Scottish Widows case was conjoined with that of Forbes v Scottish Provident ­Institution, where the Midlothian General Commissioners had held that Case I did not apply to that mutual company. Counsel for the Inland

78 

Salisbury House Estates v Fry (1930) 15 TC 266. Scottish Union et al, above n 40. 80  ibid 577. 81  Forbes v Scottish Widows Fund and Life Assurance Society (1895) 3 TC 443. 79 

Not Like Grocers 155 Revenue ­therefore did not proceed with that part of the appeal that related to whether Case I applied, and the case considered only whether there had been a constructive remittance for Case IV purposes.82 The next case in the HMSO Tax Cases is another insurance one, this time involving a general insurance company charged under Case I. In Norwich Union Fire Insurance v Magee83 Wright J went straight to the point that this chapter is concerned with: Supposing a firm of [grocers],84 trading abroad, instead of dividing their profits there, say profits made in an American trade, choose to invest those profits in American securities, the interest arising from that investment, I should say, would come within Case IV, and not within Case I. But that is not the point that we have to decide here. The real point in this case may be put in one sentence. If there is trade which cannot be carried on without making investments abroad, the interest arising on the investments necessarily made for the purposes of the trade is, as it seems to me, part of the gains of that trade.85

The issue came to the House of Lords in 1913 with the appeal of the ­Liverpool and London and Globe Insurance Co Ltd v Bennett.86 Lord Shaw sums the issue up nicely: It was argued, or it appeared to be argued, that this Company carried on separate businesses, and that the matter of investments of the Company’s funds was separate from its business of fire and life insurance. My Lords, such companies in the transactions for the year may make little profit, and sometimes considerable loss, on one or other of their fire or life departments; but nevertheless, their stability may be maintained, and often the regularity of their profit as whole is continued by the fact that in the general balance of profits and gains there falls on general accounting principles to be paid in as an item of credit to revenue the interest upon invested funds. The same kind of book-keeping occurs, and properly occurs, whether these funds are invested at home or abroad. Neither in the one case nor in the other are the funds kept, nor can they be kept on sound book-keeping out of the sum total of the profits or gains of the concern.87

Lord Shaw reiterated that not to treat the income from these investments, which included the assets needed to be kept in the USA and Canada as part of the regulatory requirements there to show the branch had sufficient capital, as part of business profits of insurance was contrary to correct accountancy principles.

82 

There hadn’t. Norwich Union Fire Insurance v Magee 3 TC 457 (1894) (‘Norwich Union’). 84  Author’s interpolation: the judgment actually says ‘traders’. 85  Norwich Union, above n 83, 460. 86  Liverpool and London and Globe Insurance Co Ltd v Bennett (1913) 6 TC 327 ­(‘Liverpool and London’). The case was conjoined with Brice v The Ocean Accident and ­Guarantee Corporation and Brice v Northern Assurance Co. 87  ibid 376. 83 

156  Richard Thomas According to Earl Loreburn it was a matter of fact and degree in each case whether the income from investments was a trading receipt: They are, to use Lord Justice Buckley’s apt expression, ‘fruit derived from a fund employed and risked’ in a business coming within the statutory description. … An argument was urged upon us on behalf of the Company that it should be treated in the same way as an individual, for example, a banker, whose private fortune would be available to pay his banking debts in the last resort, though the annual income from it would not be profits of his banking adventure. An infinite number of illustrations might be given of instances in which part of a trader’s income is or is not profit of his trade, and it will be time enough to decide each case when it actually arises. I know of no formula which can discriminate in all circumstances what are and what are not profits of a trade. Probably that is the reason why the Statute does not contain a closer definition.88

Lord Mersey scotched suggestions that because the investments were ‘required for the formation of the reserve fund, a fund created to attract customers and to serve as a standby in the event of sudden claims being made upon the insurers in respect of losses’ they were not trading receipts: It is, according to my view, impossible to say that such investments do not form part of this Company’s insurance business, or that the returns flowing from them do not form part of its profits.89

This decision became an authoritative exposition of the principles by which investment income that would otherwise be charged under Case III, IV or V can be included in a Case I profit calculation of insurers, both in life business and general business. It has been applied to other types of case including the operator of a nuclear power station,90 shipping companies91 as well as banks. In theory the question whether to charge under Cases III, IV and V or Case I remained an option. Inland Revenue would always opt for Case I: this is because the remittance basis applied to Cases IV and V. This is not the end of the story on investment income. The considerations above apply to income, particularly interest, which was not subject to deduction at source. Most interest received by insurance companies was of the tax deducted variety, and to an extent they received dividends on portfolio holdings of shares which had also suffered tax before payment. In these cases no attempt was made by Inland Revenue to include the ‘taxed’ income in the Case I profit.92

88 

ibid 378/9. ibid 380. 90  Nuclear Electric plc v Bradley (1996) 68 TC 670. 91  Bank Line v CIR (1974) 49 TC 307. 92  This continued to be the position in theory, and was reinforced by much later cases such as FS Securities Ltd v CIR (1965) 41 TC 667. In practice the Case I profit continued to be 89 

Not Like Grocers 157 In Revell v The Edinburgh Life Insurance Company93 the company claimed, for 1903–04, that as it had made a loss as shown in its profit and loss account it could claim relief and repayment of tax suffered on its taxed income. As in Scottish Union et al94 the Lord President was unimpressed by the decision of the General Commissioners, this time for the County of Edinburgh, and said: In 1890 an Act was passed95 by which certain relief was given to the person in a business who makes a loss, and under that Act if he satisfies the Crown there has been a loss actually in his business, then he is allowed to set that loss against, or rather to set the amount he would have to pay tax on that sum, against the sum he has already paid on his investments; but the whole condition precedent to that is that he has suffered a loss. Now, this Insurance Company, conceiving what I suppose may be called its trading side, had not been very successful of late, made a claim under the Act of 1890, and we have before us the profit and loss account which it submitted to the Crown in order to shew it had made a loss. I and bound to say there, again, I have considerable difficulty in seeing how upon what rational theory that profit and loss account is made up. But I see this very clearly, of course, that they entirely omitted the interest from all the investments at home on which they paid tax. The Crown not unnaturally replied: ‘These are as much part of your income as anything else, and if you are going to shew where you have made a profit or loss in the sense of the 1890 Act in order to claim exemption you must shew a loss as on an ordinary commercial balance sheet; that is, taking all the receipts on one side and all the payments out on the other—and you have not simply to consider whether apart from your investments your business is a prosperous one.’ And accordingly the Crown, by adding in on the receipt side of the account the sum they had received from investments proved conclusively their whole operations of the year did not represent a minus quantity, but a plus value. Since that was done, there was an end of the claim under the 1890 Act.96

Despite the trenchancy of this opinion (the stronger strictures were reserved for another part of the decision), for some reason confirming legislation was thought by the Inland Revenue to be necessary and it was enacted in Finance Act 1915. Section 11 required investment income from the life assurance fund to be treated as part of the profits of that business when considering whether a loss had arisen. Possibly it was because the section also deals with a claim for repayment under section 101 of the Income Tax Act 1842 as well as section 23 of the Customs and Inland Revenue Act 1890, the law that taken by starting with the transfer from the life assurance fund to the profit and loss account, until the changes made by FA 1989 and FA 1990 had the effect of including all investment return as a Case I receipt if it was included in the relevant line of the company’s long-term revenue account in its regulatory return: see e.g. Scottish Widows plc v Commissioners for Her Majesty’s Revenue and Customs (2011) 80 TC 796 per Lord Walker. 93 

Revell v The Edinburgh Life Insurance Company (1906) 5 TC 221 (‘Revell’). Scottish Union et al, above n 40. 95  Customs and Inland Revenue Act 1890. 96  Revell, above n 93, 227/8. 94 

158  Richard Thomas the Court of Session discussed, that a comprehensive statutory solution was thought necessary.97 Treatment of Investment Return: (ii) Gains on Investments Yet again the story starts with the Lord President’s pronouncements in Scottish Union et al.98 The fifth of his instructions was: (5) Where the gain is made by the Company (within the year of assessment or the three years prescribed by the Income Tax Act, Schedule D.), by realising an investment at a larger price than was paid for it, the difference is to be reckoned among the profits and gains of the Company.99

This issue arose only in relation to the Northern Assurance Co where the Aberdeen General Commissioners decided on a casting vote that the Inland Revenue’s arguments about realised gains on investments held for the purposes of the life assurance business was to be preferred. That argument was that in their accounts the company ‘treated profits on realised investments as income, that they brought the amount of such into their “Profit and Loss Account” out of which they paid their dividends, and that it was thus income assessable to Income Tax.’ The company had contended that profits on investments realised were capital and not income; that their business was not that of buying and selling shares of other companies, but of fire and life insurance; that when they sold an investment at an enhanced price from that at which it was bought, this was not a transaction in the nature of their own business, but a capital transaction, and therefore not coming within the scope of the Income Tax Acts.100

There is little discussion of principle or the giving of reasons here. But it must be assumed that the Lord President was persuaded by the Inland­ Revenue’s argument that inclusion in a profit and loss account was a significant matter. So at that time it was: in other types of company a gain on the sale of shares would almost certainly have been taken to capital reserves. In The Royal Insurance Company v Stephen101 the position in relation to general insurance was considered by Mr Justice Rowlatt. The precise issue was whether the company realised losses under Case I when it exchanged a

97  Somewhat ironically FA 1915, s 11 did become necessary later. FA 1937, s 13 introduced the now familiar rule that for the purposes of loss relief in a Case I trade the loss shall be c­ omputed ‘in like manner as the profits or gains arising or accruing from the trade are ­computed …’ ie excluding investment income. There was a saving for ITA 1918, Rule 15(2), Sch. D Cases I/II (the successor of FA 1915, s 11). 98  Scottish Union et al, above n 40. 99  ibid 578. 100  ibid 574. 101  The Royal Insurance Company v Stephen (1928) 14 TC 22.

Not Like Grocers 159 number of pre-grouping railway shares for those of the grouped companies as a result of the Railways Act 1921, it having been accepted that gains on sales of shares were part of the trading profits. The Case Stated by the Special Commissioners reported that: For the Crown it was contended (inter alia): (a) That the amounts claimed as deductions were not deductible in computing the Company’s profits; (b) That there was no sale or realisation of investments, but a mere substitution of securities; (c) That the amounts claimed as deductions were not an expense incurred in earning the Company’s profits; (d) That the Company’s claim was in effect a claim to write down the book value of investments which the Company still held, and that this writing down was not a permissible deduction for Income Tax purposes; (e) That the Company had not realised any loss and that therefore the assessments should be confirmed.102

Rowlatt J decided there had been a realisation. He made it passably clear that had he not so decided there could be no question of allowing a loss on the basis of depreciation. In other words the assets of an insurer that are held in order to meet the kind of risk referred to in Liverpool and London103 are not trading stock per se, and do not follow the ‘lower of cost and market value’ convention applied to stock. It would again be wrong to suggest that it is only in relation to insurance companies that these propositions were established: there are bank (and other credit providers)104 cases to similar effect. But the propositions do apply only to financial concerns and not to grocers. In 1932 by contrast the Court of Session decided that gains made by an insurance company were not taxed as part of the profits. This was in CIR v The Scottish Automobile and General Insurance Company.105 The General Commissioners for the Lower Ward of Lanark held that a gain of some £4,000 made on Government Bonds was a capital gain. They seemed to have accepted in full the appellant’s arguments, in particular that their case could be distinguished from Northern Assurance Co v Russell106 on the ground that the business was general insurance business with annual policies and that apart from the sums required by the Assurance Companies Act 1909 the company had no investments and had rarely changed those it

102 

ibid 26/27. Liverpool and London, above n 86. 104 See Agricultural Credit Corporation v Vale [1935] IR 681 (Ireland); Punjab Co-operative Bank v Lahore Income Tax Commissioner [1940] AC 1055 (‘Punjab’); Frasers (Glasgow) Bank 40 TC 698 (1963); to the contrary Davis v Hibernian Bank Ltd 2 ITC 111 (Ireland). 105  CIR v The Scottish Automobile and General Insurance Company (1931) 16 TC 381. 106  Heard in Scottish Union et al, above n 40. 103 

160  Richard Thomas had. The Court of Session felt unable to overturn what they characterised as a decision on which the Commissioners had ample material on which to base their decision. The case has been doubted since, with the usual remarks about being decided on its own peculiar facts. It is difficult to square the decision here with the acceptance by the Royal Insurance Company that its profits on such dealings were trading profits. Subsequent developments include the case of General Reinsurance Co v Tomlinson.107 This was a Dutch company108 with an agent in London which carried on the reinsurance and retrocession business placed with it in London. The company also held a portfolio of assets including a ‘New York trust fund’: the assets were derived from profits of the London business but were generally under the control of the head office in Amsterdam which made the decisions to buy and sell. The agent released the title to the investments where necessary. Part of the London portfolio was held in New York to meet the regulatory requirements of the New York authorities. In the High Court109 Foster J held that he could not interfere with the decision of the Special Commissioners that the gains were part of the Case I profits, and he added that ‘their conclusion was in fact the only true and reasonable conclusion’. His authorities on this point were Northern ­Assurance, Punjab110 and Colonial Mutual Life Assurance Society v Federal ­Commissioner of Taxation.111 It should be noted that the taxable profits included gains on the New York assets.112 There was also an issue of whether Article III of the double taxation agreement between the United Kingdom and the Netherlands, contained in the Schedule to the Double Taxation Relief (Taxes on Income) (Netherlands) Order 1950, SI 1950/1196113 altered anything. The company said that: United Kingdom tax can only be charged on the profits attributable to the London branch and that the only activities of the London branch were those of underwriting, 107 

General Reinsurance Co v Tomlinson (1970) 48 TC 81 (‘General Re’). The Stated Case reveals that the company’s correct name was Algemeene Herverzekering Maatschappij NV, but that its constitution provided for the use of the English name, General Reinsurance Co. Ltd., where it was convenient to do so. 109  There was an impressive line up of Counsel in the case consisting of three future Presiding Special Commissioners (Hubert Monroe, Patrick Medd and Stephen Oliver) and Frank Heyworth Talbot. 110  Punjab, above n 104. 111  Colonial Mutual Life Assurance Society v Federal Commissioner of Taxation (1946) 73 CLR 604, a decision of the High Court of Australia. 112  Foster J said of the company’s contention that the realised profit on the American investments should not be included in the profits, since those investments were specifically earmarked for possible American claims: ‘But the American business was done by the Company in ­London, and it is common ground that the American investments formed part of the London portfolio and were derived from profits of the Company’s London branch. In those circumstances I do not think that any distinction can or should be made between the American investments and the other investments in the London portfolio.’ 113 See JF Avery Jones, ‘The UK’s Early Tax Treaties with European Countries’, in this volume (Ch 11). 108 

Not Like Grocers 161 and that the dividends and interest from the dollar investments and the realised profit on the investments by the London portfolio were not derived from the activities of the London branch since the investments were controlled in Amsterdam114 and not by the London branch.115

Foster J held that Art III(3) required in accordance with the ‘independent enterprise’ principle that: If the London branch were an independent enterprise, as it must be considered to be, it would be necessary for it to have a portfolio of investments in order to carry on its business. It might be difficult in other cases to decide what the size of that portfolio must be, but in this case we find that the London portfolio was built up from the past profits of the business of the London branch, and there is nothing to suggest that the London portfolio is either too large or too small for the amount of business carried on by the London branch. I see no reason, therefore, to interfere with the decision which the Commissioners reached on this question, and I agree with it.116

This was not the first case in which the issue of the profits attributable to a permanent establishment in accordance with a double taxation agreement had arisen. But the previous case was also an insurance one, Ostime v Australian Mutual Provident Society117 though not one which was directly concerned with a Case I computation. Deductibility of Expenses It has been natural to assume in recent decades that distinctions between distributions of profits which are not deductible and expenses in earning profit, particularly interest, are of relevance only to relations between a company and its shareholders or at least members. But in Last’s case118 an issue reached the House of Lords having been the subject of much judicial dissent and which was also decided three-two there. Life insurers began in the nineteenth century to offer a new type of policy—‘with-profits’. Previously an endowment assurance policy, one which guaranteed a sum on maturity or earlier death did just that—it stated a sum which would be paid come what may and the premium was calculated with just that amount in contemplation. In with-profits policies a larger premium was charged so

114  The case mentions that reports on the investments were held on computer: this is the earliest reference to computers in HMSO Tax Cases. 115  General Re, above n 107, 102. 116  ibid 102. It is explicitly stated in the report of the Special Commissioners’ decision that the New York income and gains were included in the ‘industrial and commercial profits’ attributed to the London permanent establishment. 117  Ostime v Australian Mutual Provident Society (1959) 38 TC 492. 118  Last, above n 66.

162  Richard Thomas that it was likely that the insurance company would generate earnings from investments that would comfortably surpass the amounts needed to pay the guaranteed sum. In return for the larger premiums the insurer offered to give the policyholder a share of these extra profits. In the London Assurance Corporation at the time it was one-third of the profits, and in due course the general norm became 90 per cent. The balance of 10 per cent went to the shareholders. The extra for the policyholders (the ‘bonus’) could be given to them in three ways: in cash, by reducing future premiums or by adding the amount to the sum assured payable on death or survival. In Last’s case119 the first two methods were used, but in recent years only the last has been. Last decided that no deduction could be given for cash bonuses and reduction of premiums as they were just as much a distribution of profits as dividends to shareholders. It follows from Last that no provision or reserve for the value of liabilities to pay bonuses using the third method was deductible. What is not clear is whether a deduction was given for so much of any claim paid on maturity or death as constituted a bonus. One reason why this point is lost in the mists of time is that Last’s case was overruled by statute. This came about as a result of the recommendations of the Royal C ­ ommission on the Income Tax of 1919.120 This said that where Case I was used for life assurance business the profits should be limited to the amount transferred to the profit and loss account for potential distribution to shareholders,121 which meant that there was an automatic deduction for bonuses to policyholders (including provision for accruing bonuses as well as bonuses paid). The Inland Revenue’s first response to this came in Finance Act 1920 which introduced122 a rule for the short-lived Corporation Profits Tax. With some minor changes this was re-introduced for the purposes of income tax as section 16(1) of the Finance Act 1923 to the effect that ‘such part of [the] profits as belongs or is allocated to, or is reserved for, or expended on behalf of, policy-holders or annuitants shall be excluded in making the computation’. The part of this rule that allows for a deduction from profits of bonuses is ‘allocated to’.123 One aspect of the rule that is worth mentioning here is that ‘expended on behalf of’ includes income tax that is suffered by the insurer on investment income taxed at source so far as it is expended on behalf of policyholders. 119 

Last, above n 66. Report of the Royal Commission on the Income Tax (Cmd 615, 1920). 121  ibid Section X Part V [521(b)]. 122  FA 1920, s 53(2)(h). 123 Consideration of the meaning of the other terms is beyond the scope (and permitted length) of this chapter, and is of little relevance to any other types of business or trade than that of life assurance. It is unclear why the Government did not adopt the Royal Commission approach, as it left the status of unallocated surplus (ie, that carried forward in the life assurance fund) at large. In practice the Inland Revenue did adopt the Royal Commission basis, thus (erroneously and concessionally) treating the unallocated surplus as reserved for policyholders. 120 

Not Like Grocers 163 That at least was the agreed interpretation between the Inland Revenue and bodies representing insurers. It was presumably thought that there was a general prohibition against a deduction of income tax in computing profits and that section 16 of the Finance Act 1923 was necessary to override that rule.124 Whatever the thinking behind this agreement it does not seem that it can be said that the approach taken in section 16 of the Finance Act 1923 had any significant influence on other Case I computations. Finally we come to the very case in which Lord Watson made his remarks about grocers, Gresham Life.125 The issue is an arcane one relating to deduction of tax and its retention or its handing over to the Inland Revenue by the person deducting.126 If the company was entitled to retain then it would be substantially better off, but it was only so entitled if the annuities the company paid in the course of its life assurance business were paid ‘out of profits and gains’. Until Gresham Life it had been assumed that interest or other annual payments (of which annuities were a prime example) could only be not so payable if there were no profits. But Gresham Life established that if the payments were an integral part of computing a trading profit it could not be said that the payments were payable out of the profits of the company. The Appellate Committee of the House of Lords was in no doubt that the cost of the things supplied to a trader were incident to the carrying on of the trade. The cost of paying annuities was, for a life insurance company, just as much such a cost and just as incident to its trade of annuity business as that of, in Lord Halsbury’s words ‘a seller of any ordinary article of commerce, coals or corn, or the like’ or of course the celebrated grocer. But of course a life assurance company does not buy annuities so as to sell them on to someone else in the way that a coal merchant does. It receives a lump sum from a person and undertakes to pay amounts of income back to that same person. It is far more akin to the receipt of an amortising loan made by a bank etc with payments of mixed interest and capital in return. No one would say that the payments made by a borrower to a bank were akin to a payment for coal by a coal merchant, and indeed it is clear that where annual interest was paid by a person at the time it was not paid out of profits and gains.

124 It has always seemed to the author that the explicit agreement that ‘expended on’ included tax was unnecessary as the income tax which was not deductible was the income tax charged on the profit, and that was clearly not expended on behalf of policyholders. 125  Gresham Life, above n 2. 126  For a comprehensive account of the system so far as to applied to interest payable see R Thomas, ‘Retention of Tax at Source and Business Financing’ in PA Harris and DA de Cogan (eds) Studies in the History of Tax Law, vol 7 (Oxford, Hart Publishing, 2015). And for a more general account see J Tiley ‘Repeal of Section 52 of the Taxes Act 1970’ [1981] BTR 263.

164  Richard Thomas So in this case the author’s view is that it is definitely not like grocers: nevertheless the analogy with grocers and others was drawn and was used to justify the decision. CONCLUSION

I have been rather hard on Lord Watson. He is right to imply that insurance companies do not live in a world of their own when it comes to tax, at least not where the computation of profits under Case I of Schedule D is concerned. But the real differences between the way insurance works and the way nearly every other business works mean that awkward tax issues tended to arise more frequently and in a more acute form than in relation to other businesses. What I see the insurance cases as doing is to force the courts to think especially hard about issues such as matching incomings and outgoings, allowing relief for contributions to provisions against contingent liabilities, what is a trading receipt and the boundaries between Case I and the other Cases and where to draw the line between expenses of earning profits and distributions of them. The insurance company cases also had, I think, another effect. The fact that they had to produce accounts drawn up in accordance with government dictated formats contributed to a realisation in the courts that more than mere lip service should be paid to what ‘normal commercial practice’ was— leading eventually to the propositions accepted by Lord Justice Bingham in Gallagher v Jones; Threlfall v Jones127 and Lord Hoffmann in Mars etc128 that if one has a set of accounts drawn up in accordance with GAAP that is not just the starting point but the ending point unless there is a contrary statutory provision. And the case which to my mind really kick-started the trend was Sun Insurance.

127  128 

Gallagher v Jones; Threlfall v Jones 66 TC 77 (1993). Mars etc, above n 34.

Not Like Grocers 165 APPENDIX 1

‘FIRST SCHEDULE Revenue Account of the ______________ for the year ending _____________. Amount of funds at the beginning of the year

Claims under policies (after deduction of sums reassured)

Premiums

Surrenders

Consideration for annuities granted

Annuities Commission

Interest and dividends

Expenses of management

Other receipts (accounts to be specified) Dividends and bonuses to shareholders (if any) Other payments (accounts to be specified) Amount of funds at the end of the year, as per Second Schedule Note 1.—Companies having separate accounts for annuities to return the particulars of their annuity business in a separate statement. Note 2.—Items in this and in the accounts in the Third and Fifth Schedules should be the net amounts after deduction of the amounts paid and received in respect of re-assurances.

166  Richard Thomas SECOND SCHEDULE Balance Sheet of the _________________on the _______________ 18 ____. Liabilities

Assets

Shareholders’ capital paid up (if any)

Mortgages on property within the United Kingdom

Assurance fund

Do. do. out of the United Kingdom

Annuity fund (if any)

Loans on the company’s policies

Other funds, if any, to be specified

Investments: —— In British Government securities —— Indian and Colonial government securities —— Foreign government do. —— Railway and other debentures and debenture stocks —— Do. shares (preference and ordinary)

Total funds as per First Schedule Claims admitted but not paid*

House property Other investments (to be specified) Other sums owing by the company* (accounts to be specified)

Loans upon personal security Agents’ balances Outstanding premiums Do. interest Cash: —— On deposit —— In hand and on current account Other assets (to be specified)

*Note.—These items are included in the corresponding items in the First Schedule.

Not Like Grocers 167 THIRD SCHEDULE Revenue Accounts of the _____________for the year ending_____________. (No. 1) Life Assurance Account. Amount of life assurance fund at the beginning of the year Premiums, after deduction of re-assurance premiums Consideration for annuities granted Interest and dividends Other receipts (accounts to be specified)

Claims under life policies (after d ­ eduction of sums re-assured) Surrenders Annuities Commission Expenses of management Other payments (accounts to be specified) Amount of life assurance fund at the end of the year, as per Fourth Schedule

Note.—Companies having separate accounts for annuities to return the particulars of their annuity business in a separate statement.

(No. 2) Fire Account.

Amount of fire insurance fund at the beginning of the year Premiums received, after deduction of re-assurances Other receipts to be specified

Losses by fire, after deduction of re-assurances Expenses of management Commission Other payments to be specified Amount of fire insurance fund at the end of the year, as per Fourth Schedule

Note.—When marine or any other branch of business is carried on, the income and expenditure thereof to be in like manner stated in a separate account.

(No. 3) Profit and Loss Account. Balance of last year’s account Interest and dividends not carried to other accounts Profit realised (accounts to be specified) Other receipts

Dividends and bonuses to shareholders Expenses not charged to other accounts Loss realised (accounts to be specified) Other payments Balance as per Fourth Schedule.

Note.—This account is not required if the items have been incorporated in the other accounts of this schedule.

168  Richard Thomas FOURTH SCHEDULE Balance Sheet of the ____________on the ____________ 18____. Liabilities Shareholders’ capital General reserve fund (if any)

Assets Mortgages on property within the United Kingdom

Life assurance fund*

Do. do. out of the United Kingdom

Annuity fund (if any)*

Loans on the company’s policies

Fire fund

Claims under life policies admitted but not yet paid*

Investments: —— In British Government securities —— Indian and Colonial do. —— Foreign do. —— Railway and other debentures and debenture stocks —— Do. shares (preference and ordinary)

Outstanding fire losses

House property

Do. marine do.

Other investments (to be specified)

Other sums owing by the company (accounts to be specified)

Loans upon personal security

Marine fund Profit and loss (if any) Other funds, if any, to be specified

Agents balances Outstanding premiums Do. interest Cash: —— On deposit —— In hand and on current account —— Other assets (to be specified)

* If the life assurance fund is, in accordance with section 4 of this Act, a separate trust fund for the sole security of the life policy holders, a separate balance sheet for the life branch may be given in the form contained in Schedule 2. In other respects the company is to observe the above form. See also note to Second Schedule.

7 The Life and Times of ESCs: A Defence? STEPHEN DALY

ABSTRACT

In 1897, the UK Public Accounts Committee became simultaneously both aware and alarmed at the practice of the then Inland Revenue providing extra-statutory dispensations to taxpayers. Despite criticisms in the interim, it was not until the judgment of Lord Hoffmann in Wilkinson that HMRC began to put the brakes on this practice. Almost 120 years since the Public Accounts Committee’s awakening to the Revenue’s habit and over a decade since Lord Hoffmann’s judgment, it is timely to reflect upon the life and times of ESCs. INTRODUCTION

E

XTRA-STATUTORY CONCESSIONS (‘ESCs’) are one of the most controversial elements of the UK tax system. An ESC gives taxpayers a reduction in tax liability to which they would not be entitled under the strict letter of the law. Although dispensations of the law without Parliamentary approval have been unequivocally outlawed since the Glorious Revolution in the seventeenth century,1 there is evidence of the existence of concessions from as early as 1793.2 Given such an apparent incongruity, it is little wonder that the Treasury once remarked that ESCs are ‘one of the great mysteries of the British Constitution’.3

1 

Bill of Rights Act 1689, Article 1. this case, it was the benevolent treatment of the supply of wine and tobacco duty free for use on board ships of war. See Comptroller & Auditor General, Revenue departments appropriation accounts 1946–47, (HC 1946–47, 24) v. 3  This was drawn from a memo to Sir Wilfred Eady subsequent to a meeting of the Committee of Public Accounts. See TNA T233/1594, 1950 memo to Sir Wilfred Eady, cited in J Booth, ‘Inland revenue concessions: convenience or just illegal?’ (2000) 27 Amicus Curiae 23, 24. 2  In

170  Stephen Daly The judgment of Lord Hoffmann in the 2005 case of R (Wilkinson) v HMRC4 has however (seemingly) brought about the death of these curious instruments. Over a decade since this case, it is timely to reflect upon the life and times of ESCs. Have ESCs been a cause for good, or, as critics would suggest, were they practically disagreeable? The answer to this question, which this chapter will explore, is that ESCs may occupy both spaces: they are defensible in principle, but can be problematic in practice. The chapter accordingly is split into three substantive parts. The first provides a brief sketch of the history of ESCs. The second seeks to defend the use of ESCs, given their controversial standing in the tax machinery, by exploring their historical constitutional legitimacy and the benefits which they brought to the smooth running of the tax machinery.5 Thereafter the analysis shall shift to problems experienced in the promulgation of ESCs, such as favouritism, lack of publication and oversight. AN HISTORICAL OVERVIEW

The history of ESCs is bound up in the history of taxes. Stebbings has written for instance that taxes introduced in the eighteenth century were liable to being subject to concessions in the nineteenth century (provided that reforming legislation had not been introduced).6 A corpus of extra-statutory practices emerged in that century owing to the pragmatic consideration on the part of the revenue-collecting bodies that taxation is consensual and that compliance is crucial to the success of any tax.7 Perceived unfairness in the operation of taxing provisions had to be addressed without haste so as to ensure the tax in question was acceptable to taxpayers.8 It was the revenue authorities who felt mandated to mitigate the harshness of the legislation where it worked to create unreasonable hardship9 and thus by the end of the nineteenth century, the only way to ensure fairness at the periphery of the code was by executive equity.10 Indeed in 1889, Matthew J is reported to have endorsed the process of concession by the Revenue on certain issues.11

4 

R (Wilkinson) v IRC [2005] UKHL 30, [2006] STC 270. of the early terrain was explored in articles following the Vestey cases. See: D Williams, ‘Extra-Statutory Concessions’ (1979) BTR 137; M Gammie, ‘Extra-Statutory Concessions’ [1980] BTR 308; J Alder, ‘The Legality of Extra-Statutory Concessions’ (1980) 1 NLJ 180. A more recent contribution to this area is C Stebbings, ‘The equity of the executive: Fairness in tax law in nineteenth-century England’ 258–287 in P Turner (ed), Equity and Administration (Cambridge, CUP, 2016). 6  Stebbings, above n 5, 268. 7  ibid. 269. 8 ibid. 9  ibid. 270. 10  ibid. 282. 11  R v Special Commissioner (1889) 2 TC 510, 515. 5 Much

The Life and Times of ESCs: A Defence? 171 To this end, it is somewhat surprising that the Public Accounts Committee only took full notice of these practices in 1897, as recorded in a Treasury Minute from that year.12 The Bank of England held part of the estate of Alexander III of Russia and it came to light that a concession was granted which attempted to exempt this segment from death duty.13 The legal basis for ESCs was regularly critiqued thereafter in the ­twentieth century. At one time, the Chancellor of the Exchequer John Anderson sought to justify the existence of ESCs on the basis that they arise ‘in wartime not in peacetime’:14 Parliament was apparently little concerned about the ­practice, or of other practices which were adopted during the war.15 ­However in 1944, in response to the Institute of Chartered Accountants raising the issue of public awareness of concessions with the Board, the Board of Inland Revenue produced a list of all wartime concessions.16 This was the first publication of any such list of concessions. However, with concessions still existing five years later in peacetime and another list published therein containing the details of a completely new array of concessions, the Chancellor (Sir Stafford Cripps) diverted to another justification. He stated that they are issued ‘without any particular legal authority, but by the Inland Revenue under my authority’.17 Suffice it to say that first year constitutional law students would find issue with this kind of justification. Two camps emerged on the issue of the legal authority of concessions in the twentieth century. The first camp judged ESCs to be purely unconstitutional. The starting point is Wills J in Swayne v IRC who stated as follows: I certainly cannot assent to the suggestion made during the argument for the Crown, that the Commissioners as representing Her Majesty, are at liberty to avail themselves of anything like a dispossessing power—to say what portions of a taxing Act they think reasonable and what unreasonable, and therefore to collect some duties and reject others.18

In 1943, Scott LJ in Absalom v Talbot posited that no ‘judicial countenance can or ought to be given in matters of taxation to any system of

12 Public Accounts Committee, Second report from the committee of public accounts (HC 1897–98, 261–VIII) Appendix. 13  D Tallon, I Young, P Elliott, D Dave, Inland Revenue Practices and Concessions: 1984/85 Bound Volume (London, Oyez Longman Publishing, 1984) 11. See also Stebbings, above n 5, 272–73. 14  HC Deb 15 June 1944, vol 400, c 2177. 15  Williams, above n 5, 138. 16  Inland Revenue, Tax Bulletin Issue 32 (‘A Hundred Years of Inland Revenue Extra Statutory Concessions’), accessed 10 June 2016. 17  HC Deb 6 July 1949, vol 466, c 2267. 18  Swayne v IRC [1899] 1 QB 335, 344.

172  Stephen Daly ­extra-legal concessions’.19 20 years later, Ungoed Thomas J in IRC v Clifforia ­Investments Ltd remarked that ‘[t]his offends our fundamental conception of the rule of law’.20 The series of Vestey cases further highlight the ­apparent judicial aversion to ESCs. In somewhat caged language in Vestey (no 1), Walton J spoke of the legal basis of concessions: I am quite unable to understand upon what principle of law the Crown … feels itself entitled to mitigate [the monstrous legislative results] by such concessions as it chooses to make. One should be taxed by law, and not be untaxed by concession.21

Walton J was less equivocal in Vestey (no. 2) In the first place, I, in company with many other judges before me, am totally unable to understand upon what basis the Inland Revenue Commissioners are entitled to make extra-statutory concessions … This is not a simple matter of tax law. What is happening is that, in effect, despite the words of Maitland, The Constitutional History of England (1909), p 305, commenting on the Bill of Rights, ‘This is the last of the dispensing power,’ the Crown is now claiming just such a power.22

If what the Revenue in the case claimed were in fact legal, then ‘we are back to the days of the Star Chamber’.23 This is a reference to the 1686 case of Godden v Hales24 wherein it was held that King James II’s power to dispense with the Test Acts was effectively unlimited. Put another way, it would be a return to the time, prior to the Glorious Revolution and Bill of Rights Act 1688, in which the Crown exercised supremacy over Parliament. Writing in 1979 and having regard to the history of these judicial utterances on the subject, David Williams in probably the most critical and influential academic piece on the matter25 concluded that: Most of the extra-statutory concessions are illegal. That they exist at all in either overt or covert form is a matter of concern. That they not only exist, but grow

19 

Absalom v Talbot [1943] 1 All ER 589, 598. IRC v Clifforia Investments Ltd [1963] 1 WLR 396, 402. 21  Vestey v IRC [1979] Ch. 177 (‘Vestey (no. 1)’) 197. 22  Vestey v IRC [1979] Ch. 198 (‘Vestey (no. 2)’) 203. 23  ibid 204. 24  Godden v Hales (1686) 89 ER 1050. This point is noted by John Snape in his doctoral thesis: John Snape, ‘Public Law and Public Management: “Theory” and “Values” in Corporation Tax Reform’ (PhD thesis, University of Birmingham 2008) 87, n 73. 25 Subsequent articles dealing with this issue have consistently cited this article, see, for instance: Alder, above n 5, 180 fn 3; M Nolan, ‘The Unsatisfactory State of Current Tax Law’ (1981) Statute L Rev 148, 149; R Baldwin and J Houghton, ‘Circular arguments: the status and legitimacy of administrative rules’ [1986] PL 239, 284 fn 19; G Lock, ‘The Bill of Rights Act 1689’ (1989) 37(4) Political Studies 540, 547; W Hinds ‘Estopping the taxman’ [1991] BTR 191, 206 fn 3; Michael Zander, The Law-Making Process, 6th edn (Cambridge, CUP, 2004) 457. Likewise, it has been cited by members of the judiciary, see: Vestey v IRC [1980] AC 1148 (‘Vestey v IRC’), 1194 (Lord Edmund-Davies). Lord Edmund-Davies’ speech in turn 20 

The Life and Times of ESCs: A Defence? 173 regularly, in open contradiction to the rule of law, cannot but reflect on the quality of the executive that creates them and the polity that tolerates them.26

The House of Lords in Vestey (no. 2) subsequently echoed the sentiments of Walton J. Lord Wilberforce held that the Revenue’s ‘frightening’27 and ‘remarkable’28 claim to a discretionary power in the case did not involve a process ‘of construction, even one of strained construction, but is one of rewriting the enactment.’29 This would give rise to a course of interpretation ‘which Parliament might certainly have taken, but which it has manifestly avoided’.30 The courts, ‘acting on constitutional principles, not only should not, but cannot, validate’31 the Revenue’s proposition as it would give rise to ‘taxation by self-asserted administrative discretion and not by law’.32 Lord Edmund-Davies, who expressly cited David Williams,33 similarly stated that ‘it is surely high time to consider the basis of this claim by the executive to make such extra-statutory concessions.’34 A second camp emerged which endorsed the use of ESCs irrespective of their legal basis. Lord Upjohn in Korner v IRC noted that the practice was ‘very old’ and worked ‘great justice between the Crown and the subject, and I trust will never be disturbed’.35 Indeed, few would argue that the tax code is not difficult to administer and thus in FS Securities v IRC, Donovan LJ recognised that ‘practical considerations no doubt justify at times some departure from strict law, for the common convenience of the Revenue and the taxpayer’.36 Nevertheless, it was also acknowledged that there was no firm legal basis for their existence. The 1949 Royal Commission concluded that the concessions were reasonable but that it was disconcerting to find the statute law being amended by this special and selective process.37 Lord Upjohn (again) in Bates v IRC agreed that effectuating the true construction of taxing provisions was a monstrous undertaking in certain circumstances and as such the Revenue may resort to working out ‘what they consider to

has been cited by McNeill J in R v Inspector of Taxes, ex parte Fulford-Dobson [1987] 1 QB 978, 987-988; Adrian John Wilkinson v The Commissioners of Inland Revenue [2002] EWHC 182 (HC), [27] (Moses J); R (Wilkinson) v Inland Revenue Commissioners [2003] EWCA Civ 814; [2003] 1 WLR 2683 (‘Wilkinson CA’), 2696. 26 

Williams, above n 5, 144. Vestey v IRC, above n 25, 1172. 28  ibid 1171. 29  ibid 1170. 30  ibid 1170. 31  ibid 1172. 32  ibid 1173. 33  ibid 1194. 34  ibid 1194. 35  Korner v IRC [1969] 1 All ER 679, 686. 36  FS Securities v IRC [1963] 3 All ER 229, 234. 37  Final Report of the Royal Commission on the Taxation of Income and Profit (Cmd 9474, 1955), para 240. 27 

174  Stephen Daly be an equitable way of operating’ the provisions, ‘which seems to them to result in a fair system of taxation’. However, he was ‘quite unable to understand upon what principle they can properly do so’.38 Then came the twenty-first century and the 2005 case of Wilkinson. The House of Lords judgment in the case has been interpreted as bringing a fatal blow to the production of ESCs. Therein Lord Hoffmann stated that HMRC cannot ‘concede, by extra-statutory concession, an allowance which Parliament could have granted but did not grant’.39 The earlier High Court judgment of Moses J40 was even more striking. In particularly colourful language, he lambasted the practice of ESCs (thereby seeming to place him in the first camp), making a connection between the Glorious Revolution and a general levying or dispensing power in the hands of the Revenue: It is their haphazard nature, uncontrolled by any clear principle, promulgated as they are by the executive and not by the legislature, which justifies the criticism … Taxation by the executive, and not by the elected, has led to war; it seems anomalous that the courts should be invited to adopt a less militant attitude when tax has so often been relieved on the ukase of the executive.41

HMRC has since embarked on a process of reviewing all ESCs. It has consistently cited the House of Lords judgment of Lord Hoffmann as having ‘clarified the scope of HMRC’s administrative discretion’.42 THE DEFENCE OF ESCs

Since the twentieth century at least then, ESCs have been under attack. Strong dissenters have accused them of being unconstitutional43 and questioned their validity in light of the ever-available opportunity to simply amend the primary law.44 Both arguments are misconceived and the exploration of them in fact sheds light on the merit of ESCs. A prerequisite to mounting a defence however, is delineating the parameters of the domain. To this end, it is necessary as a preliminary step to define ESCs, the process of which should further buttress the argument of this section by h ­ ighlighting their largely benign nature. Thereafter, this section will address the issue of whether ESCs

38 

Bates v IRC [1968] AC 483, 516. Wilkinson, above, n 4, [21]. 40  As he then was. 41  Adrian John Wilkinson, above n 25, [27]. 42 See for instance HMRC, Withdrawal of extra statutory concessions: Technical note and call for evidence, January 2014, 4 accessed 10 June 2016. 43 Williams, above n 5; RE Megarry, ‘Administrative Quasi-Legislation’ (1944) 60 LQR 125; E Troup, ‘Unacceptable Discretion: Countering Tax Avoidance and Preserving the Rights of the Individual’ (1992) 13(4) Fiscal Studies 128, 132. 44  Absalom v Talbot, above n 19, 598 (Scott LJ); Inland Revenue Commissioners v Frere [1964] 3 WLR 1193, 1209. 39 

The Life and Times of ESCs: A Defence? 175 are unconstitutional, before finally addressing why ESCs, if not unconstitutional, should not all simply be placed on a statutory footing.45 The Definition of ESCs ESCs grant to a class of taxpayers46 relief or a reduction in tax liability to which they are not strictly entitled.47 This is the fundamental foundation of the definition of a tax concession, namely, that of relaxation of the strict law. Most concessions are made to deal with what are, on the whole, minor or transitory anomalies under the legislation and to meet cases of hardship at the margins of the code where a statutory remedy would be difficult to devise or would run to a length out of proportion to the intrinsic importance of the matter.48 This definition of ESCs, traditionally offered by HMRC,49 is incomplete however. Concessions may also arise where they are necessary for the practical collection and management of taxes. They may also relate to instances in which it would be an abuse of power for HMRC to insist upon the strict application of the law.50 As ESCs relate to benevolent treatment, they must by definition arise in the taxpayer’s favour.51 However, concessions can only operate within a narrow mandate. The constitutional background to the power to grant ESCs informs us that one must be taxed by law and not untaxed by concession.52 As such, it is important to distinguish between instances in which the law is rough at the penumbra and gives rise to strictly unintended consequences such as failing to give relief or encompassing cases at the fringe,53 as against instances 45  Margaret Thatcher once questioned why, if an extra-statutory concession is published, it should not simply be placed in statute. Finance Bill SC Deb (A) 6 February 1975, cc 1050–1051. 46  The definition of ESCs does not distinguish between concessions which are granted in individual cases and those that relate to classes of cases. Class concessions are those which are founded on fixed principles of general application affecting classes (A Johnston, Inland Revenue (London, George Allen & Unwin Ltd, 1965) 68). For the purposes of this chapter, ­references to ESCs should be taken as meaning concessions applying to classes of persons rather than individuals. Nor does the definition distinguish between concessions which are published and those which are not published. This distinction is at times overlooked, as evidenced by Walton J’s erroneous assertion in Vestey (no. 2) that ESCs represent a ‘published code’. See: Vestey (no. 2), above n 22, 204. 47  B Sabine, The Economist Publications: Pocket guide to Business Taxes (London, Edward Arnold, 1988) 3. 48 HMRC, Extra-Statutory Concessions: Concessions as at 6 April 2016, April 2016, 2 accessed 10 June 2016. 49  See, for instance, HMRC, Withdrawal of extra-statutory concessions, December 2010, 4 accessed 10 June 2016. 50  See below, ‘Abuse of power and administrative commonsense’, in text at n 66. 51  M Gammie, ‘“Revenue Practice”: A Suitable Case For Treatment’ [1979] BTR 304, 306; HC Deb 12 July 1976, vol 915, c 187. 52  Vestey (no. 2), above n 22, 203. 53  Johnston, above n 46, 68.

176  Stephen Daly where the law at its core is deemed to be unfair by HMRC.54 In the former, but not in the latter, concessions may apply. Similarly a concession may be used so as to make the effectuation of the law more workable, but may not be reformulated in such a way as to undermine its very intent.55 In brief then, ESCs grant to taxpayers relief or a reduction in tax liability to which they are not strictly entitled.56 As the definition is expanded upon by reference to categories, it is prudent at this juncture to give concrete examples of what might fall within these. Minor Anomalies Some ESCs are made to deal with minor anomalies arising under the legislation. Such an instance could previously be found in ESC F8 ­‘Accumulation and maintenance settlements’,57 which is now obsolete.58 In order for settled property to take the form of an ‘Accumulation and Maintenance S­ ettlement’, it was originally a requirement that the beneficiaries would become entitled to the settled property either on or before becoming 25.59 This concession merely irons out an anomaly such that even if the trust document does not actually specify this to be the case, the Revenue will not seek to disrupt the arrangement where it is clear that a beneficiary will in fact become entitled to the settled property by the age of 25. Transitory Anomalies Given not only the complexity of tax legislation but also the annual occurrence of Finance Acts, it should come as little surprise that transitory anomalies should arise. Concessions in this regard are issued so as to counteract such matters, for instance, as occurred in 1999, wherein an ESC provided transitional relief for taxpayers, whose fate under new legislation was otherwise ambiguous.60 Under the provisions of the Social Security Contributions

54 On the relationship between the core and the penumbra, see: HLA Hart, ‘Positivism and the Separation of Law and Morals’ (1958) 71 (4) Harvard Law Review 593; cf L Fuller, ­‘Positivism and Fidelity to Law—A Reply to Professor Hart’ (1958) 71(4) Harvard Law Review 630. 55  Finance Bill Deb HC, 17 June 2008, cc 754-755 (Philip Hammond). See also: J Whiting, ‘Power to give statutory effect to concessions—section 160’ [2008] 5 BTR 533, 534. 56  Basil Sabine, above n 47, 3. 57 HMRC, Extra-Statutory Concessions: Concessions as at 6 April 2013, April 2013, 85 accessed 10 June 2016. 58  HMRC, Concessions as at 6 April 2016, above n 48, 53. 59  See Inheritance Tax Act 1984, s 71(1)(a). Subsequent legislation deemed the age of entitlement to settled property to be 18. This means the concession is only relevant for the interpretation of Inheritance Tax Act 1984, s 71D for age 18-to-25 trusts. 60  ‘Inland Revenue’ (1999) 22 Simon’s Tax Intelligence.

The Life and Times of ESCs: A Defence? 177 Act 1999, interest would no longer be remitted where there was a dispute over national insurance liability. However, the Board of the Inland Revenue continued to allow interest to be remitted in situations which were caught by the transition, in other words, where disputes were outstanding at the time that the legislation was introduced. Cases of Hardship at the Margins Some ESCs are designed to meet cases of hardship at the margins of the code. A clear example of this is ESC A19 Arrears of tax arising through official error which was introduced in 1971 following a recommendation from the Parliamentary Ombudsman.61 ESC A19 precludes HMRC from seeking the arrears of income or capital gains tax liability if they result from the Revenue’s failure to make proper and timely use of information. Whilst technically the overdue tax could be collected, the concession operates to relieve the taxpayer of the injustice which would befall her if she were required to pay the back tax,62 for instance, after an amount of time had elapsed since the end of the tax year in which the return was, believed to have been, correctly submitted.63 Disproportionate to the Intrinsic Importance In some circumstances, legislating for a particular concession would take up an amount of time disproportionate to the intrinsic importance of the matter. As such, HMRC may purposively interpret the legislation in order so that it accords with the underlying legislative intent. This may arise where HMRC attempts to place the law in the context of specific sectors. For instance, the Greenwich University64 case gave rise to such a scenario in relation to the supply of zero-rated goods as regards student accommodation. Under strict legal interpretation, if Universities were to rent out accommodation during summer months to non-students, they would not be entitled to claim the supply of goods was zero-rated. By concession, the Revenue would allow a de minimis use of student accommodation for non-students, given that it could not be expected that the legislature would deprive relief in such circumstances. Put another way, it is simply not feasible that the University would not rent out its accommodation to non-students in any circumstances and to prevent them from doing so would effectively deprive the relief of 61  First report from the Select Committee on the parliamentary commissioner for administration together with the proceedings of the committee relating to the report and minutes of evidence (HC 1970–71, 240–XLII) vii–viii. 62 ibid. 63  These are now some of the circumstances in which the concession will apply: see HMRC, Concessions as at 6 April 2016, above n 48, 21–22. 64  R (Greenwich) v Commissioners of Customs and Excise [2001] EWHC Admin 230.

178  Stephen Daly any value. The purpose of the concession, accordingly, was to ‘interpret the law concerning VAT within the higher education context’.65 It is apparent that the concession is necessary, as its absence would make the relief redundant. What is also equally apparent is that putting this on a statutory footing would merely reflect what the Revenue already could do in order to give effect to the primary provision. To try to specify this more clearly on legislative paper would simply take up Parliamentary time to arrive at a result which would be arrived at in the absence of a reforming provision anyway. In other words, a statutory footing for such a provision would achieve the exact same result as already occurs, but with the extra resources spent of pushing it through Parliament. Abuse of Power and Administrative Commonsense Although the above categories are conventionally understood to encapsulate the majority of ESCs,66 not all fit nicely within such compartments. ­Public authorities are constrained by public law considerations. For instance, before an official can take a decision, she must be satisfied that it is rational, legal and devoid of irrelevant considerations.67 This has manifested itself in the case of ESCs by constraining HMRC’s strict application of the law where to do so would be an abuse of power. For instance, in Unilever, the Revenue was compelled to accept the submission of the taxpayer’s application for tax relief, notwithstanding the fact that such submission occurred outside the statutory time limit.68 To fail to do so would be an abuse of power.69 ESC B41 similarly provides a concession in relation to repayments of tax. Generally, a statutory claim for repayment of tax must be made within four years. However, the Revenue will not enforce this time limit where over-payment of tax has arisen because of an error on the part of the Revenue or another Government Department, and where there is no dispute or doubt as to the facts. In these examples, a procedural right precludes HMRC from collecting the full tax that may be due strictly under the law.

65 

ibid [9] (Collins J). assertion is based upon the fact that the following category is not traditionally offered by HMRC in defining ESCs. See, for instance, HMRC, Legislating Extra Statutory Concession D33, July 2014, 4 accessed 10 June 2016. 67 D Galligan, Discretionary Powers: A Legal Study of official Discretion (Oxford, ­Clarendon Press, 1986) 144. 68  R v Inland Revenue Commissioners, ex parte Unilever plc [1996] STC 681. Kieran ­Corrigan also endorses this view that the Revenue were forced to issue a concession as to fail to do so would be an abuse. See: K Corrigan, Revenue Law: Volume I (Dublin, Roundhouse, 2000), 226. 69  Unilever, above n 68, 689–91 (Sir Thomas Bingham). 66 This

The Life and Times of ESCs: A Defence? 179 Other concessions are introduced for the practical functioning of the tax system.70 HMRC are not expected to collect every last penny71 of tax which is due and may make concessions for the purposes of a­ dministrative ­convenience.72 An apt example arises in relation to Flat Rate Expense Allowances (FREA). These are ‘expenses’ arrangements which HMRC arrives at with particular industries or with particular undertakings within specific industries. Expenses incurred by employees which are incurred ‘wholly, exclusively and necessarily in the performance of’ his or her duties of employment, then the amount so incurred can be deducted from the income of that employee before it is assessed to income tax.73 Ordinarily, an employee would have to keep all receipts for expenses incurred as a means of proving what the outgoings have amounted to. An agreement on a flat rate to be granted in respect of expenses, as in the case of an FREA on the other hand obviates the need to retain all of the receipts in relation to expenses and for HMRC to analyse all the receipts.74 The Legal, Constitutional Basis for the Power to Produce ESCs It follows that although it is possible to understand the scope of concessions, it is still necessary to relate these to some power on HMRC’s part. To this end, as set out above, the legal authority for concessions has been a historic bone of contention. A closer examination of the facts of the judgments from the first camp however reveals that in each of these cases, with the exception of Wilkinson, what was at issue does not come within our definition of ESCs. For instance, Swayne v IRC concerned the assignment of leasehold property and the quantum of this assignment which should be subject to stamp duty. The Revenue argued that rent payable on the lease should form part of the consideration subject to stamp duty. The problem with the Revenue’s argument was that in the case of other leases where rent arose in a similar manner, it was their practice not to consider it part of the consideration. They sought to distinguish between such cases and that which arose in the case at hand, but the court held against such distinction given the substantive similarity of the cases. As this was so, it would have to be that the Revenue had a wide dispensing power at their disposal in order for the court to find in their favour. It was the idea of such a wide dispensing power being implied by the legislation which outraged Wills J. Likewise in 70  The House of Lords endorsed this jurisdiction in the Fleet Street Casuals case: see IRC v National Federation of Self-Employed and Small Businesses Ltd [1982] AC 617 (‘Fleet Street Casuals’). 71  ibid 660 (Lord Roskill). 72  ibid 663 (Lord Roskill). 73  See Income Tax (Earnings and Pension) Act 2003, s 336. 74  R (Bamber) v HMRC [2005] EWHC 3221 (Admin) [2]–[4].

180  Stephen Daly Clifforia Investments, the Revenue had argued that, although the legislation strictly applied would result in double taxation in certain cases, they would use their discretion so as not to enforce the provisions in such circumstances. Thus, they again sought to imply into the legislation a wide discretionary dispensing power. Absalom meanwhile was concerned with the valuation of ‘doubtful debts’ against which relief could be sought against profits. This valuation was subject to an extra-statutory concession by which taxable profits would be estimated by reference to actual receipts in a given year. Although clearly a prudent arrangement, this could not be purposively read into the legislation. The justices in the Vestey series of cases were dealing with the principle behind the argument that the Crown was putting forward to support its interpretation of the relevant legislation. This was to the effect that they were entitled to arrive at a working solution to incredibly complex and problematic legislation such that in any given case the Revenue would divvy up the tax payable on income arising in trusts as they thought prudent. As in the previous cases, this argument suggested a wide discretionary power in the application of legislation. More significantly, the justices also sought to distinguish between instances in which ESCs may properly apply and the contention of the Revenue that they had discretion in the case at hand. Walton J in the High Court and Lord Edmund-Davies in the House of Lords made clear the distinction between what may perhaps be a valid exercise of discretion in the form of ‘relatively harmless’75 ESCs and what was being sought in the immediate Vestey case. Walton J, with which Lord Edmund-Davies concurred,76 stated of the former that: they do represent a published code, which applies indifferently to all those who fall, or who can bring themselves, within its scope. What is claimed by the Crown now is something radically different. There is no published code, and no necessity for the treatment of all those who are in consimili casu alike.77

Lord Wilberforce likewise differentiated between the limited discretion available to the Commissioners to grant ESCs and the general dispensing power being sought in Vestey: They say that the income tax legislation gives them a general administrative discretion as to the execution of the Acts … The judge described the comparison of such limited discretions with that now contended for as ‘laughable’. Less genially, I agree.78

Clearly the justices were not commenting upon the legality or otherwise of the limited managerial discretion available to the Commissioners to issue ESCs, but were focusing their judgments on the wide discretionary power being sought to be interpreted into the relevant legislation in the case at 75 

Vestey v IRC, above n 25, 1194 (Lord Edmund-Davies). ibid 1194. 77  Vestey (no. 2), above n 22, 204 [emphasis added]. 78  Vestey v IRC, above n 25, 1172 [emphasis added]. 76 

The Life and Times of ESCs: A Defence? 181 hand.79 Further, the impugned discretion in each case was not being operated in favour of taxpayers, as our definition of concessions requires, but rather to their detriment. Finally, the Wilkinson case concerned the issue of whether statutory relief for widows ought to be extended to widowers. The Revenue advanced an argument to the effect that the court should not intervene in the area of the allocation of resources, which is the proper remit of Parliament. This argument angered Moses J, especially in light of the apparent fact that ESCs had historically been used to do just that, namely, intervene in Parliament’s ­allocation of resources. In spite of the criticism and expressive rhetoric, however, it is noteworthy that Moses J actually found that a concession could be extended to the case at hand. To this end, the reasoning of Moses J is oddly flawed in that he utilised previous criticisms of the unconstitutionality of general discretionary powers in the hands of the Revenue on the one hand and on the other hand found that such a power could be extended to the widower, notwithstanding the clear contradiction to Parliamentary will. What underpins this first camp accordingly is that the issues which arose in these cases could not properly be understood as falling within our definition of ESCs outlined above, but rather dealt with arguments attempting to interpolate wide discretionary dispensing powers. As a result, David ­Williams’ influential article is misconceived, as it conflates these judicial outbursts with ESCs produced on the published list. The strong and confusing dicta of Moses J on the other hand helps us little to understand the legal basis of ESCs. Underpinning the second camp on the legal basis for ESCs on the other hand was the acknowledgment of the practicality of ESCs. Indeed, the legal basis for the issuance of ESCs has ultimately been resolved on that basis, namely, their practicality. Thus, when a concession arose in the Fleet Street Casuals case,80 whereby casual print workers who had been less than truthful in their tax affairs were given a partial amnesty in exchange for future compliance, Lord Diplock explained that the authority to provide ­concessionary treatment came properly within the ambit of the Commissioners duty of ‘care and management’ of taxes (now found in section 5 of the Commissioners for Revenue and Customs Act 2005 (‘CRCA 2005’)): [T]he board have a wide managerial discretion as to the best means of obtaining for the national exchequer from the taxes committed to their charge, the highest net return that is practicable having regard to the staff available to them and the cost of collection.81

79  See also Corrigan, above n 68, 227 who similarly notes this distinction: ‘This, it must be admitted, is something less than a full-frontal assault on the granting of concessions. It would appear that Lord Wilberforce was swayed by the facts of the case, which were extreme and involved the most odious discrimination between persons in identical situations.’ 80  Fleet Street Casuals, above n 70. 81  ibid 636.

182  Stephen Daly On the question of whether the Commissioners had exercised their discretion to grant concessionary treatment appropriately, Lord Diplock held that: no court considering this evidence could avoid reaching the conclusion that the board and its inspector were acting solely for ‘good management’ reasons and in the lawful exercise of the discretion which the statutes confer on them.82

The Chief Secretary to the Treasury reiterated this legal basis in 1984, citing that: [b]oth the Inland Revenue and Customs and Excise are charged statutorily with care and administration, and from that statutory power their authority … is thought to derive.83

Such was similarly held in subsequent cases such as Fulford-Dobson84 and most prominently in the House of Lords hearing of Wilkinson: This discretion enables the commissioners to formulate policy in the interstices of the tax legislation, dealing pragmatically with minor or transitory anomalies, cases of hardship at the margins or cases in which a statutory rule is difficult to formulate or its enactment would take up a disproportionate amount of Parliamentary time.85

To this end, the legal basis of concessions has now been affirmatively put to rest on this basis as falling within the managerial discretion bestowed upon HMRC by virtue of section 5 of the Commissioners for Revenue and ­Customs Act 2005. This discretion allows HMRC, for reasons of administrative pragmatism, to depart from the strict law where such is done with a view overall to obtaining a higher net yield from the taxes committed to charge.86 However, this legal basis also serves to illuminate the inherent limitations of the power to issue ESCs. As was stressed by member of the first camp, managerial discretion cannot be extended to a wide discretionary dispensing power. ESCs are only authorised within a strict mandate, in giving effect to the law and the primary responsibilities of HMRC. Operation outside this mandate will be ultra vires. Numerous commentators have recalled this distinction over the years. Former Chairman of the Inland Revenue Alexander Johnston endorsed the use of ESCs but stressed that it was the Revenue’s business to administer the law and not to change it.87 ESCs are only appropriate in the limited terrain at the edges of the legislation. Outside this field, any problems must be corrected by legislation.88 Lord Wilberforce, in 82 

ibid 637. Deb 11 July 1984, vol 63 c 1171; see also, in relation to Customs and Excise, R v Customs and Excise Commissioners, ex p Kay & Co Ltd and another and other applications [1996] STC 1500 (Keene J). 84  Fulford-Dobson, above n 25, 988. 85  Wilkinson, above n 4, [21] (emphasis added). 86  Fleet Street Casuals, above n 70, 637 (Lord Diplock); Wilkinson, above n 4) [20] (Lord Hoffmann). 87  Johnston, above n 46, 68. 88 ibid. 83 HC

The Life and Times of ESCs: A Defence? 183 t­ ypically lucid, pragmatic fashion insisted that HMRC ‘may, indeed should, act with administrative commonsense’.89 The scope of the power to concede however cannot be extended beyond that, because ‘self-asserted administrative discretion’ is no substitute for law.90 Lord Hoffmann in Wilkinson stressed that the power to issue concessions should not be construed ‘so widely as to enable the commissioners to concede, by extra-statutory concession, an allowance which Parliament could have granted but did not grant’.91 An important distinction accordingly is that ESCs may deal with issues at the rough edges of legislation where it is unclear whether a particular effect was intended by the legislation,92 rather than instances where HMRC itself finds the law objectionable.93 Why Not Simply Regularise Concessions? It has been outlined that ESCs are not unconstitutional per se, but rather that promulgation of them falls squarely within HMRC’s managerial discretion. Constitutional concerns should already have been dampened by the examples above of concessions which fall within the various categories, thereby demonstrating that in large part ESCs are benign, issued pursuant to purposive interpretation and generally made in response to legislation which is rough at the edges. These remarks make way for an obvious challenge however. Why not ­simply amend the primary legislation? This was put plainly by Lord R ­ adcliffe in Inland Revenue Commissioners v Frere: I have never understood the procedure of extra-statutory concessions in the case of a body to whom at least the door of Parliament is opened every year for adjustment of the tax code.94

A variety of practical issues arise in relation to this suggestion however. The first is that there is simply insufficient Parliamentary time to place all ESCs on a statutory footing.95 This is no more evidenced than by the fact that despite a concerted effort over the last ten years, the placing of concessions in legislation has occurred at a sluggish pace. The Finance Acts of 200696 and 200797 89 

Vestey v IRC, above n 25, 1173.

90 ibid. 91 

Wilkinson, above n 4, [20] (Lord Hoffmann). Whiting, above n 55, 534–535. 93  Wilkinson, above n 4, [21] (Lord Hoffmann); Wilkinson CA, above n 25, [46] (Lord ­Phillips); see also Stock v Frank Jones (Tipton) Ltd [1978] 1 WLR 231, 234 (Viscount Dilhorne). 94  IRC v Frere, above n 44, 1209. See also: Absalom v Talbot, above n 19, 598 (Scott LJ). 95 Treasury and Civil Service Committee, Budgetary Reform in the UK (HC 1981–82; 137–vi) q500 (Sir Geoffrey Howe, then Chancellor of the Exchequer); G Ganz, Quasi-­ legislation: recent developments in secondary legislation (London, Sweet & Maxwell, 1987) 93. 96  Finance Act 2006, s 64. 97  Finance Act 2007, s 62. 92 

184  Stephen Daly gave a statutory footing to only one ESC relating to direct tax each respectively. The Income Tax Bill 2006–7 (which subsequently became the Income Tax Act 2007) sought to incorporate a modest four class concessions, only two of which were listed expressly in the HMRC publications as concessions.98 Neither ESC was incorporated into the final Act however. Even with the delegated power to legislate concessions by statutory instrument, namely section 160 of the Finance Act 2008, HMRC in 2008 sought only to regularise 19, of which a mere 14 in were classified in HMRC publications as ESCs, the others being either unpublished or to be found in HMRC manuals.99 In 2009, the ambition was to legislate 19 concessions, only 15 of which were previously in the concession lists;100 in 2010, seven were sought to be legislated, only four of which were classed as concessions;101 and in 2011,102 2012103 and 2014,104 the goal was to regularise a mere two in each year respectively.105

98 

Explanatory Notes to the Income Tax Bill (2006–07), at [14]. Extra-statutory Concessions—Technical Consultation on draft Legislation, November 2008, 5–6, accessed 10 June 2016. 100 See HMRC, Extra-statutory Concessions—Second Technical Consultation on Draft Legislation, July 2009, 5–6, accessed 10 June 2016; HMRC, Extra statutory concessions— third technical consultation on draft legislation, December 2009, 7, accessed 10 June 2016. 101 HMRC, Extra statutory concessions—fourth technical consultation on draft legislation, December 2010, 6 accessed 10 June 2016. 102 HMRC, Extra-statutory concessions—fifth technical consultation on draft legislation, December 2011, 6, accessed 10 June 2016. 103 HMRC, Extra-statutory concessions—sixth technical consultation on draft legislation, December 2012, 5, accessed 10 June 2016. 104 HMRC, Extra-statutory concessions—seventh technical consultation on draft legislation, October 2014, 5, accessed 10 June 2016. 105  There was no consultation on draft legislation to regularise concessions in 2013. 99 HMRC,

The Life and Times of ESCs: A Defence? 185 Secondly, the particular concessions may be unsuitable for legislation,106 for instance by reason of triviality, transience or complexity. Would it really be worth the Parliamentary time for instance to specify that accumulation and maintenance trust treatment would be granted where it is clear the beneficiary will not become entitled to the underlying assets until they reach 25? How exactly would Parliament legislate for FREAs given that they vary not only between industries, but also within industries themselves?107 To argue on the grounds of pragmatism however, is to entirely miss the point of ESCs. They should not be regularised into hard law because they are not hard law! ESCs serve a separate, pragmatic purpose. They serve to highlight to taxpayers their obligations and rights under the law. Endowed with management of the tax system, HMRC has recognised that communicating with taxpayers is a practical means of effectuating its primary duty. The point was forcefully made by Moses LJ in the Court of Appeal hearing of R (Davies) v HMRC; R (Gaines-Cooper) v HMRC:108 It is trite to recall that it is for the Revenue to determine the best way of facilitating collection of the tax it is under a statutory obligation to collect. But it should not be forgotten that the Revenue itself has long acknowledged that the best way is by encouraging co-operation between the Revenue and the public.109

Whipple J in R (Hely-Hutchinson) v HMRC110 endorsed this approach and more specifically placed it within the context of ESCs: [C]oncessions are just one type of ‘communication’ between the Commissioners and the taxpaying public, and so form part of the cooperative relationship discussed by Moses LJ.111

Accordingly, it merits a separate place in the infrastructure to hard law. The two co-exist in a symbiotic relationship and as such to regularise ESCs would be not only duplicative but also counterproductive. ESCs provide lubrication to the wheels of fiscal machinery.112 Interim Remarks The fact that it is not practically possible to put concessions on a statutory footing brings us back to the very heart of the matter: ESCs are ­justified as

106 

Ganz, above n 95, 93. Bamber, above n 74, [4]. 108  R (Davies) v HMRC; R (Gaines-Cooper) v HMRC [2008] EWCA Civ 1502. 109  ibid [12]. 110  R (Hely-Hutchinson) v HMRC [2015] EWHC 3261. On which, see S Daly, ‘Fairness in tax law and revenue guidance: R (Hely-Hutchinson) v HMRC [2016] 1 BTR 18. 111  ibid [60]. 112  Whiting, above n 55, 533. 107 See

186  Stephen Daly they provide a means of guiding the public as to the effects of the law, such communication on an extra-statutory basis being necessitated by the limits of law. In this sense, ESCs are an inevitability of, and desirable counteraction to, an imperfect system. For this reason, HMRC should cease its current apparent moratorium on the official issuance of ESCs,113 not only because such an approach is unattractive but also because the apparent cessation is fallacious. Concessions are continuing to be issued, the difference merely being that they are not being expressly recognised as such. For instance, on 4 August 2014, HMRC announced that it was removing a concession relating to the treatment of the use of unremitted foreign income or gains as collateral for a loan enjoyed in the UK.114 What was curious about the announcement was that when the ‘concession’ was introduced in 2010, it was neither cited nor listed as a concession. Rather, it was published in an HMRC manual.115 Ideally, ESCs should not seek to change the law but rather to make the law more readily implementable. ESCs should not be used as a proxy for amending the core fairness of a law, but rather may be used as a means of purposively interpreting the law so as to entitle parties to relief, or take entities out of the scope of taxing provisions. The foregoing has sought to argue that the use of ESCs in such a manner is in principle not only constitutionally acceptable, but also inevitable and even desirable. However, as will be chronicled in the proceeding section, ESCs are not without issue in practice. THE PRACTICAL PROBLEMS WITH ESCs

Concessions are much like today’s queen, they are in most cases harmless. History will have taught us however that concessions, much like monarchs of the past, can be dangerous. Discretionary powers are inevitably open to abuse. As such, an analysis of concessions reveals a myriad of problems which have arisen in practice.116 This part will elaborate upon a select few,

113  HMRC has not added a single concession to its list of direct tax ESCs in the ­aftermath of Wilkinson. Compare for instance HMRC, Extra-Statutory Concessions: Concessions as at 31 August 2005, August 2005, accessed 10 June 2016, against HMRC, C ­ oncessions as at 6 April 2016, above n 48. 114 HMRC News, ‘Remittance Basis’, 4 August 2014, accessed 10 June 2016. 115 HMRC, Remittance Basis: Identifying Remittances: Conditions A and B: Condition B—collateral in respect of relevant debt, 8 October 2010. 116 These, and other arguments, are explored in greater detail in S Daly, ‘Oversight of HMRC soft-law: lessons from the Ombudsman’ (2016) 38(3) Journal of Social Welfare and Family Law (forthcoming) and in the author’s not-yet-submitted Doctoral Thesis.

The Life and Times of ESCs: A Defence? 187 namely, certain classes of taxpayers being granted concessions outwith the authority of HMRC, the failure to publish ESCs and a lack of oversight. Favoured Groups in a Manner Inconsistent with the Law A particularly acute problem in relation to the power to produce extra-statutory relief is that there is an inherent tension with the ideal of Parliamentary Sovereignty. There is an obvious possibility that the use of extra-statutory concessions can undermine Parliament by providing relief from the law ‘which Parliament could have granted but did not grant’.117 A recurring problem accordingly is that of concessions issued to particular classes of persons which appear to be outwith the authority of HMRC.118 There are an array of examples from the history of HMRC and its predecessor bodies of pressure groups extracting benevolent treatment which may conflict with the underlying law. The classic example of such favouritism operated from at least World War II119 until 2003120 in relation to miners’ free coal. Miners were entitled to coal for personal use by virtue of their employment. This is a taxable benefit in kind, namely, something of direct monetary value to an employee, or something that is capable of being converted into money or something of direct monetary value to the employee.121 During World War II however, owing no doubt to the considerable shortage of coal (which caused some 48,000 persons to be conscripted to work down the mines between 1943 and 1948),122 miners were given cash payments in lieu. By virtue of a concession, the rationale for which the Office of Tax Simplification was unable to ascertain,123 this cash in lieu payment was not chargeable to tax.124 The practice continued to operate for either free coal or the

117 

Wilkinson, above n 4, [21]. example cited in Daly, ‘Oversight of HMRC soft-law’, above n 116, is that of a longstanding concession operates in relation to awards given to pupil barristers, whereby the payment that is received in the first six months of pupillage can be treated as tax-free. See The General Council of the Bar, Taxation and Retirement Benefits Guidance, 6th ed., 2012,

accessed 10 June 2016. 119  Inland Revenue, A List of Extra Statutory Wartime Concessions given in the Administration of Inland Revenue Duties (Cmd 1944, 6559). 120  It was enacted in Income Tax (Earnings and Pensions) Act 2003, s 306. 121 HMRC, EIM00530—Employment income: benefits in kind taxable as earnings: m ­ eaning of money’s worth, accessed 10 June 2016. 122 Department for Business Innovation and Skills, Bevin Boys, accessed 10 June 2016. 123  Office of Tax Simplification, Review of tax reliefs: Final report, March 2011, 57. 124  Inland Revenue, A List of Extra-Statutory Wartime Concessions, above n 119, 248. 118 An

188  Stephen Daly ­ ayment in lieu until the concession was legislated in section 306 of Income p Tax (Earnings and Pensions) Act 2003. Around the middle of the concession’s lifetime, at which point it was estimated to be costing circa £30 million per annum,125 Walton J in Vestey (no. 2) expressed his bewilderment at the practice: [U]pon what basis have the commissioners taken it upon themselves to provide that income tax is not to be charged upon a miner’s free coal and allowances in lieu thereof? That this should be the law is doubtless quite correct: I am not arguing the merits, or even suggesting that some other result, as a matter of equity, should be reached. But this, surely, ought to be a matter for Parliament, and not the commissioners. If this kind of concession can be made, where does it stop; and why are some groups favoured as against others?126

A similar charge can be issued against a concession to members of the police force in Northern Ireland who died from injuries caused by terrorist activity.127 Section 154 of the Inheritance Tax Act 1984 provides relief from Inheritance Tax for members of the ‘armed forces’ who die whilst on active service against an enemy or on other service of a warlike nature. It is the oldest exemption in the long history of death duties dating back to the reign of William and Mary and to the Probate Duty introduced in 1694.128 ­However, members of the police force do not come under the umbrella of ‘armed forces’. Although there is some ambiguity as to the precise parameters of the phrase,129 there is nevertheless a legislative distinction between armed forces and the police force in the UK.130 To remedy the effect of this distinction, given that during the 1970s in Northern Ireland, the armed forces and police forces were ‘scarcely to be distinguished’,131 a concession (‘ESC F5’) operated from at least 1974132 to 2015 as a means of extending the relief to officers of the Royal Ulster Constabulary and of its successor body, the Police Service of Northern Ireland. The concession was rendered obsolete by reason of section 75 of the Finance Act 2015 which extended the relief more generally to emergency service personnel. Much like Walton J’s understanding of the allowance in relation to free coal, this concession was clearly not without intrinsic merit, as was subsequently reflected in the

125 

HM Treasury, Appropriation Accounts 1980/81 (HC 1981-82, 76-IX), xxi. Vestey (no. 2), above n 22, 203. 127 ESC F5 ‘Deaths of members of the Police Service of Northern Ireland’: see HMRC, Extra-Statutory Concessions: Concessions as at 6 April 2015, April 2015, 53. 128 Stamp Act 1694, CXXXVII; STEP, New IHT rules for settlements and other recent developments, February 2015, 15; M Blake, ‘Emergency link’ (2015) 176 (4510) Taxation 10. 129  See for instance Ministry of Justice, War powers and treaties: Limiting Executive powers (Cm 7239, 2007) 26. 130  See Armed Forces Act 2006, s 375. 131  HC Deb 11 July 1978 vol 953, c 1408 (Enoch Powell). 132 See HC Deb 9 December 1974 vol 883, c 43W. See also Finance Bill SC Deb (A) 6F ­ ebruary 1975, cc 1049–1052. 126 

The Life and Times of ESCs: A Defence? 189 later extension in the Finance Act 2015. But it is for Parliament to decide who is to be accorded relief under the law, and not the Revenue. These are concessions issued, not because the law is rough at the edges, but rather because the Revenue finds it objectionable that the parties in question ought to be subjected to tax. As this is the case, they fall outside our understanding of the Revenue’s authority to issue concessions. The use of such a dispensing power contradicts the Bill of Rights. As Freedman J pointed out in R v Catagas: Today the dispensing power may be exercised in favour of Indians, tomorrow it may be exercised in favour of Protestants and the next day in favour of Jews. Our laws cannot be so treated. The Crown may not, by executive action, dispense with laws. The matter is as simple as that, and nearly three centuries of legal and constitutional history stand as the foundation for that principle.133

The Failure to Publish Class Concessions A strong argument can be made to the effect that if ESCs are to exist, they ought to be published.134 Speaking in relation to the then unpublished practice of relieving members of the Royal Ulster Constabulary, who had died as a result of terrorist activity, of Inheritance Tax, Margaret Thatcher remarked that: This is just one of the difficulties. It is not yet a published extra-statutory concession. It exists, but it is not yet published. A lot of people would like to know of its existence.135

In theory, the publication of ESCs should not be necessary, as HMRC is required to tax a person in accordance with a particular practice even if the taxpayer is unaware of the practice.136 However, this theoretical basis only holds in reality where a taxpayer approaches the Revenue and the Revenue then applies the concessionary treatment. Apart from such an exceptional circumstance, the taxpayer will fail to obtain the relief to which she or he is entitled. Efforts were made accordingly over the years to ensure that concessions were published. As already noted, the Inland Revenue agreed to publish 133 

R v Catagas [1978] 1 WWR 282, 287–288. See Daly, ‘Oversight of HMRC soft-law’, above n 116; A Rowland, ‘Is the Revenue being Fair? Revenue Statements and Judicial Review’ [1995] BTR 115, 121; Gammie, above n 5, 320 who recommend this course of action. 135  Finance Bill SC Deb (A) 6 February 1975, c 1050 (Margaret Thatcher). 136  J Rothschild Holdings v IRC [1988] STC 645, 665g. For an explanation as to why reliance is not a necessary component of Legitimate Expectations, see R (Bibi) v Newham LBC [2002] 1 WLR 237 [55] (Scheimann LJ); cf R v IRC, ex p Kaye [1992] STC 581; R v IRC, ex p Mead and Cook [1992] STC 482. See generally, SA De Smith, H Woolf and J Jowell, Judicial Review of Administrative Action, 5th edn (London, Sweet and Maxwell, 1995) 23–024. 134 

190  Stephen Daly its wartime concessions in 1944 following pressure from the Institute of Chartered Accountants. This was the first published list of ESCs. In 1950, the Board of Inland Revenue published as an appendix to its annual report a list of ESCs as at 31 December 1949.137 It likewise stated that additions to, and deletions from, the list would be noted annually in future Reports.138 Annual lists of changes were sent to the Comptroller & Auditor General regularly since then and were published in the Board’s Reports up to that for 1967.139 From that point, the practice was superseded by publication of pamphlet IR1.140 However, the history of the Inland Revenue nevertheless merits criticism in respect of publishing ESCs. It was once noted that the published ESCs in the Inland Revenue pamphlets merely represented the ‘tip of the iceberg’.141 Practitioners have written about many instances where HMRC has offered class concessions which are not published. Michael Nolan in 1981 wrote about the profit of a company being taxed as if it were the income of the shareholders unless it could be proved that the profit were needed for ‘­company purposes’.142 This practice which was well known by the bar prior to 1966, was revealed in a letter from the Revenue in 1966 to a professional accountancy body, but was not explicitly published in a Press Release until 1973.143 Similarly, the Inland Revenue went through a process of reviewing all ESCs in the mid-1980s and published dozens of previously unpublished extra-statutory class concessions.144 For this reason, the number of active Inland Revenue listed ESCs grew from 122 in 1980145 to 169 by 1987.146 Similarly, the review of ESCs in the aftermath of Wilkinson147 has served to bring to light a number of concessions which were previously

137 Inland Revenue, Ninety-third report of the commissioners of His Majesty’s Inland ­Revenue (Cmd 8103, 1950-51). 138  ibid 18. 139  Inland Revenue, Tax Bulletin Issue 32, above n 16. 140 ibid. 141  Gammie, ‘Revenue Practice’, above n 51, 314. 142  Nolan, above n 25. 143 See also Malcolm Gammie who in turn cites several examples of unpublished concessions: Gammie, above n 5; John Booth also cites an instance of a statement of practice being later recharacterised as a statutory concessions: J Booth, Stand and Deliver! The Inland ­Revenue and Non-Statutory Deduction (Winchester, Waterside Press, 1998) 180. 144  Inland Revenue, Tax Bulletin Issue 32, above n 16. 145  Board of Inland Revenue, Extra-statutory concessions in operation at 8 August 1980 (IR1 (1980)). 146 See Board of Inland Revenue, Inland Revenue extra-statutory concessions as at June 1985 (IR1 (1985)) and Board of Inland Revenue, Extra-Statutory Concessions Supplement (IR1 (Supp) (1987)). 147  Since the House of Lords judgment, HMRC has embarked on a process of reviewing all ESCs. It has consistently cited the House of Lords judgment of Lord Hoffmann as having ‘clarified the scope of HMRC’s administrative discretion’. See HMRC, Withdrawal of extra­

The Life and Times of ESCs: A Defence? 191 not ­published as concessions.148 As John Avery Jones has written, it is ‘sad to have to relate that unpublished concessions still exist’.149 A consultation paper on draft legislation was produced in November 2008,150 which sought to place a number of concessions on a statutory footing. Three of these concessions however were previously unpublished.151 For instance, the paper enlisted a concession allowing modest expenses for travel and subsistence by self-employed persons.152 Although this departed from the strict position otherwise outlined in HMRC’s manual,153 it can be traced back to a written answer in the House of Commons in 1976. Robert ­Sheldon, then Financial Secretary to the Treasury, wrote that a self-employed ­person ‘may be allowed a deduction for modest expenditure on meals consumed in the course of a travelling occupation or an occasional business journey outside the normal pattern’.154 As such, although the concession has existed since 1976, it had nevertheless not been formally published and indeed departed from HMRC’s published manual which still prescribes that expenses with an ‘intrinsic duality of purpose’, such as food for sustenance, are not ­deductible.155 The other two unpublished concessions listed in this document related to an extra statutory exemption from duty of spirits-based ­flavourings156 and a concession relieving goods supplied for consumption during EU rail journeys departing from VAT, dating to the opening of the Channel tunnel in 1994.157 In a document from April 2009, HMRC further sought comments on its proposal to remove two other unpublished ­concessions.158 One related to grants provided by the Highlands and

statutory concessions: Technical note and call for evidence, January 2014, 4 accessed 10 June 2016. 148  See, for instance, HMRC, Withdrawal of extra statutory concessions—Technical Note, December 2009, 13, for an unpublished concession which allowed VAT to be charged on school inspections supplied under contract to Ofsted. 149  J Avery Jones, ‘The equity of the executive: A commentary’, 294 in Turner, Equity and Administration, above n 5, referring to LH Bishop Electrical Co. Ltd v HMRC [2013] STI 3433, [510]; [2013] UKFTT 522 (TC). 150 HMRC, Extra-statutory Concessions—Technical Consultation on draft Legislation, above n 99. 151  ibid 5–6. Although there are five unlisted concessions in this document, two of these were previously to be found in HMRC manuals. 152  ibid 31. 153 HMRC, BIM37900—Wholly and exclusively: expenditure having an intrinsic ­ duality of purpose: contents, accessed 10 June 2016. 154  HC Deb 6 December 1976, vol 922, cols 66–67W. 155 HMRC, BIM37900, above n 153. 156 HMRC, Extra-statutory Concessions—Technical Consultation on draft Legislation, above n 99, 30. 157 HMRC, Extra-statutory Concessions—Technical Consultation on draft Legislation, above n 99, 42. 158 HMRC, Withdrawal of Extra-statutory Concessions—Technical Note, April 2009.

192  Stephen Daly Islands Enterprise (HIE).159 Some of these grants were strictly taxable as revenue receipts, but by concession from HMRC, were treated as capital receipts. The other related to the longstanding unpublished concession entitled ­‘Equitable Liability’.160 This concession concerned the acceptance of time-barred returns in instances where there was never a legal right to adjust the liability. This concession can be traced back to 1897 wherein the Revenue acknowledged that it remitted tax debts on grounds of equity.161 ­Nevertheless, the concession was not published until 1995.162 The Systemic Lack of Oversight To trace why practical issues such as ultra vires favouritism arise, it is appropriate to look to the system in place for overseeing ESCs. Elsewhere the author has argued that effective oversight is crucial as a means of tempering the practical problems which can arise in relation to ESCs.163 The current supervisory mechanisms can be traced back to a Treasury Minute from 1897. The Public Accounts Committee, perturbed by such gratuitous relaxations of the law by the Revenue, put in place a process for the oversight of individual and class concessions. Individual concessions above £50 would be furnished yearly to the Comptroller & Auditor general, together with the reasons for the dispensations.164 The Comptroller & Auditor general would thereafter use their ‘discretion with care and tact’ and report to the Public Accounts Committee any case in which s/he considered that the particular concession ought to be brought to their knowledge.165 Class concessions, meanwhile, should be put on a statutory footing at the earliest opportunity.166 Although the Treasury was clearly concerned with the use of concessions, it is notable that they did not suggest that the Revenue should cease to issue them.167 As a result of these instructions, the

159 

ibid 14. ibid 15. 161 Public Accounts Committee, Second report from the committee of public accounts, above n 12. 162  Inland Revenue, Tax Bulletin: Issue 18, August 1995, accessed 10 June 2016. 163  See: Daly, ‘Oversight of HMRC soft-law’, above n 116. 164 Public Accounts Committee, Second report from the committee of public accounts, above n 12. 165 ibid. 166 ibid. 167 It has also previously been claimed that since 1979, Ministerial authority has been sought for all new concessions. Gammie, ‘Revenue Practice’, above n 51, 310; Inland Revenue, Tax Bulletin Issue 32, above n 16. As recently as 1997, it was also authoritatively stated that Extra-statutory class concessions are subject to ministerial approval: Comptroller & Auditor 160 

The Life and Times of ESCs: A Defence? 193 Comptroller & Auditor general and Public Accounts Committee since 1897 have concerned themselves with simply questioning why class concessions have not been put on a statutory footing, rather than analysing whether the concessions were within the discretion of HMRC to grant.168 Even that nominal process seems to have lapsed since 1998.169 The result is that there has never been substantive oversight of ESCs. In fact, at a public lecture in February 2016, the author asked former chair of the Public Accounts Committee Margaret Hodge whether the term ‘extra-statutory concession’ had ever come up during her tenure at the Public Accounts Committee.170 She had never heard of the term. CONCLUSION

The relationship between ESCs and the primary law is much like the relationship between the Queen and the House of Commons when it comes to the State Opening of Parliament. Although apparently not permitted to enter, the monarch nevertheless fulfils an important constitutional role. Similarly, whilst ESCs may at first glance appear to be in conflict with the primary law, the two nevertheless can create a working relationship. In this respect, the foregoing has sought to explore and defend ESCs in greater detail than previous studies. The constitutionality of ESCs in principle has been thoroughly demonstrated and that arguments of constitutional impropriety, in part due to conflating the power to issue ESCs and a broader power to dispense with the law sometimes claimed by HMRC, have likewise been neutralised. Concessions can provide necessary, important and ‘useful lubrication to the wheels of fiscal machinery’.171 Nevertheless, serious issues emerge in relation to the power to issue ESCs and accordingly in relation to this proposal. Given the proximity to the line of constitutionality, it is little surprising that HMRC has been found on occasion to go beyond the boundaries of the power to issue ESCs. Failure

General, Financial auditing and reporting: 1996–97 General report of the comptroller and auditor general (1997/98 HC 251-XIX) 31. However, there are no recent records of such oversight. As this is the case, I will proceed on the assumption that in reality there is little, if any, oversight exercised at the ministerial level. 168 

See Daly, ‘Oversight of HMRC soft-law’, above n 116. were last mentioned in Comptroller & Auditor General, General report (HC 1997/98, 251–XIX), 31. 170  Margaret Hodge ‘Leader of the PAC’ (Pembroke College, Oxford, 25 February 2016). 171  Whiting, above n 55, 533. Indeed, as Stebbings has written: ‘The development of most revenue “practice” [including ESCs] was not motivated by considerations of fairness, but pragmatically driven by urgent administrative necessity to implement the tax laws and make the tax system workable on a daily basis so as to raise the anticipated public revenue and thereby to ensure the revenue authorities fulfilled their statutory duties’. See: Stebbings, above n 5, 259. 169 ESCs

194  Stephen Daly to publish concessions was demonstrated to have been an ongoing issue, in addition to the lack of substantive oversight. Whilst concessions are defensible in principle then, the substance of concessions can at times be worthy of criticism. The obvious question to follow must be how can it be ensured that concessions are used for their proper purpose? Can the benevolent principle of ESCs be harnessed without engaging the practical issues? Space does not permit discussion of solutions in this area, but other systems, such as the Australian regime for the promulgation of public rulings,172 offer some interesting potential reforms. Public rulings are pieces of determinative interpretations promulgated by the Australian Tax Office that go through a comprehensive development process before being released in final form. This includes significant public consultation, including publication of drafts, and consultation with an independent, expert body made up of lawyers, senior ATO officials and academics. Whatever the merit of this particular proposal, it stands to reason on the basis of the foregoing that there is still some life left in ESCs.

172  See Australian Tax Office, ATO Advice and Guidance, June 2016, accessed 10 June 2016.

8 The Special Contribution of 1948 JOHN HN PEARCE

ABSTRACT

The special contribution, the subject of Part V of the Finance Act 1948, had earlier writings on the subject of a capital levy as part of its ancestry; but the amount of contribution which an individual was required to pay depended upon ‘aggregate investment income’ with income from any source being ascertained as it was for surtax. This chapter is principally concerned to investigate why and how the government decided to introduce an impost with these characteristics: and administrative constraints are shown to be important. The chapter concludes by considering the determinants of this legislation in a more general manner. INTRODUCTION

‘T

HE GOVERNMENT ARE instituting a capital levy, and are basing the charge on a computation of income.’1 This was a proposition advanced by an opposition Conservative MP on 3 June 1948 while the House of Commons was considering Part V of that year’s Finance Bill, which made provision for ‘the Special Contribution’. The debating point was valid. The special contribution had earlier discussions of a capital levy as a major part of its ancestry; and the contribution was charged by reference to an individual’s ‘aggregate investment income’, with income from any source being ascertained for the purposes of Part V of the Finance Act 1948 as it was ascertained for the purposes of surtax.2 The question why the government proposed (and legislated to introduce) an impost with these characteristics obviously arises. The answer to this question provides information about the workings of government in the years following World War II: and so, in addition to 1  2 

HC Deb, 3 June 1948, vol 451, c 1260 (Henry Strauss). Finance Act 1948, ss 47(1) and 48.

196  John HN Pearce tracing the origins and development of the legislation enacted in Part V of the Finance Act 1948 (the matter with which this chapter is principally ­concerned), this chapter concludes by considering the determinants of that legislation more generally. ORIGINS AND DEVELOPMENT OF THE LEGISLATION RELATING TO THE SPECIAL CONTRIBUTION

Consideration of a Capital Levy up to 1927 An account of the origins of the special contribution must start with earlier material written about a capital levy; and, in particular, with material dating from the end of World War I and the years immediately following.3 This material discloses a policy that was advocated on two different bases.4 Before World War I, successive British governments had been exceedingly successful, over a very long period, in reducing the percentage of central government expenditure applied in debt charges. During the period from 1820–50, that percentage was mostly between 50–60 per cent; but, during the period from 1900–14, the percentage was between 9–20 per cent.5 World War I then saw a spectacular reversal of this long-term trend. The nominal amount of the unredeemed capital of the public debt of the United Kingdom stood at £706.2 million on 31 March 1914, but at £7,481.1 million on 31 March 1919. It has been stated that British Government expenditure between 1914–1919 exceeded British Government expenditure between 1689–1913.6 The source of most of the United Kingdom’s expenditure during World War I was borrowing; and this wartime borrowing had post-war consequences.7

3 For discussions of a possible capital levy during this period, see generally JR Hicks, UK Hicks and L Rostas, The Taxation of War Wealth, 2nd edn (Oxford, Clarendon Press, 1942) 252–66 and MJ Daunton, ‘How to pay for the war: state, society and taxation in Britain, 1917–24’ (1996) 111 English Historical Review 882–96. The discussion of a capital levy in this chapter draws heavily on Daunton’s article and on B Pimlott, Hugh Dalton (London, Jonathan Cape, 1985) 138–44. 4  ‘[F]rom the beginning the idea [of a capital levy] was supported both by socio-political and economic arguments. These two lines of thought were entirely separate, although naturally many individuals held a blend of both.’ Hicks et al, above n 3, 252. 5 See MJ Daunton, Trusting Leviathan: The Politics of Taxation in Britain, 1799–1914 (Cambridge, CUP, 2001) 49, Figure 2.2. 6  J Stamp, The Financial Aftermath of War (London, Ernest Benn, 1932) 41. ‘It has been pointed out by one well-known American authority that our expenditure in six years exceeded the aggregate of our expenditure in the previous 226 years, which included eight major wars.’ (Stamp did not name the ‘well-known American authority’.) 7  ‘The great war, which has shattered empires, desolated millions of homes, and sown the seeds of famine over enormous areas, has also, as a minor incident in its course, revolutionized fiscal conditions in nearly all the great states of the world. The scale of Government finance has been so changed that the problems it presents are different, not merely in degree, but in kind from what they were before the war.’ AC Pigou, A capital levy and a levy on war wealth (Oxford, OUP, 1920) 7.

The Special Contribution of 1948 197 A vastly increased government debt had the consequence that larger interest payments would need to be made to service that debt. In 1913–14, interest on the internal debt was £16.7 million or 9.6 per cent of budget receipts; by 1920–21, interest amounted to £308.7 million or 22.4 per cent of receipts. The size of the budget subsequently fell; but the ­proportion taken by interest on the internal debt rose to 36.4 per cent in 1925–26.8 It was this immense increase in government debt that formed the background for the first basis on which a capital levy was advocated. On this first ‘financial’ basis, a capital levy was advocated as a technical manoeuvre designed to improve the national finances. There seemed to be two alternatives. The first alternative was the payment of interest on an immense public debt over a long period with consequent high tax rates. The second alternative was the imposition of a capital levy, which would enable a great deal of that debt to be redeemed—and would also enable tax rates to be lowered in the future. In the years at the end of World War I and immediately after, this second alternative had adherents. One adherent was the MP Sydney Arnold, who thought that, ‘as a business proposition, there is an overwhelming case for a capital levy’; and that such a scheme was neither confiscation nor repudiation. ‘It is merely an alternative method of meeting a liability that has to be met anyhow, and met by the wealthier classes of the country.’9 Another adherent was the Cambridge economist AC Pigou, who thought that ‘the case for a special levy is that, by enabling the high rates of taxation which would otherwise be necessary to be reduced, it would encourage work and saving, and so indirectly stimulate national productivity.’10 He also wrote that ‘the plan of imposing a special levy on capital after the war is over is not red revolution. It is a policy seriously put forward to meet a financial situation so difficult that any method of dealing with it is bound to involve a number of grave disadvantages.’11 A proposal of this type initially attracted significant support. The economist John Maynard Keynes declared capital levy politics ‘an absolute prerequisite of sound finance in every one of the European belligerent countries’.12 Within government, the Treasury initially showed sympathy;13 and, in 1917, the Chancellor of the Exchequer, Bonar Law, was recorded as saying that it was for property owners to decide how best to deal with the debt which would fall on them: ‘I do not think it is a question which concerns the working classes against the financial classes.’14 A capital levy

8 

Daunton, above n 3, 883. HC Deb, 23 April 1918, vol 105, cc 895 and 897. Arnold was also the author of ‘A C ­ apital Levy: The Problems of Realisation and Valuation’ (1918) 28 Economic Journal 157–66. 10  Pigou, above n 7, 12 and 22. 11  AC Pigou, ‘A Special Levy to discharge War Debt’ (1918) 28 Economic Journal 156. 12  Quoted in Pimlott, above n 3, 142. 13  Daunton, above n 3, 892. 14 ibid. 9 

198  John HN Pearce could be represented as a policy which would favour the interests of the producers of future wealth (who would have the incentive of lower taxation) as opposed to the interests of rentiers (who lived off existing wealth already produced by others). However, advocacy for a capital levy, considered as a purely financial measure, nevertheless fell away decisively—because it was simply not possible to argue for a capital levy as a purely financial measure. Even if the case for a capital levy was argued in terms of economics only, there were also other matters to be taken into account. A first such matter was interest rates in general. As interest rates rose (or fell) so the servicing of interest on the government debt became a matter that was more (or less) pressing. A second matter was the structure of direct taxation. A capital levy would reduce the assets owned by the rich; and, consequently, the income derived from investments. However, with a graduated income tax (in the form of super-tax or surtax), it was this income that would be taxed most heavily—and, accordingly, make a disproportionate contribution to government receipts. To a significant extent, therefore, a capital levy was an anticipation of future tax revenues. It followed that the yield from a capital levy needed to be compared very carefully with estimated future tax receipts—and the more steeply income tax rates were graduated, the less decisive in favour of a capital levy the comparison was likely to be. A third matter to be taken into account was inflation. A capital levy would reduce the funds available to taxpayers and would be deflationary. If the economy was subject to inflationary pressures this might be excellent; but if the economy was already subject to deflationary pressures, a bad situation might be made worse. ­Economic conditions in the years following World War I were volatile: and it was, in fact, the argument that a capital levy would be unhealthily deflationary that turned Josiah Stamp against this possible policy initiative.15 It also seems that both Pigou and Keynes lost interest, fairly rapidly, in a capital levy.16 It became clear, too, that a capital levy had political implications: a matter relevant not only for the first but for the second basis on which a capital levy was advocated. On this second ‘social’ basis, a capital levy was advocated as a means of redistributing wealth within society, being supported for the social and political consequences that would follow. It could be urged that equality would be promoted. The rich would have assets taken from them. In theory (at any rate) the proceeds were capable of being applied in helping the poor: either directly (in the form, for example, of family allowances) or indirectly (in the form, for example, of greater government expenditure on such matters as education and housing). A variation on this redistributive theme, 15  J Stamp, Studies in Current Problems in Finance and Government, (London, PS King & Son Ltd, 1924) 227–8. 16  Pimlott, above n 3, 142.

The Special Contribution of 1948 199 discussed in the years immediately following World War I, could make use of a contrast between those who had fought in the trenches and those who had stayed at home and made fortunes. It was argued that ‘as young men have been compelled to sacrifice their lives in the war, stay-at-home people [should] … be compelled to sacrifice part of their property’ and that ‘the propertied classes “have made money out of the war” and consequently that they ought to bear the money cost of it.’17 This demand could take the form that increases in an individual’s wealth that could be traced to the war should be subject to a separate tax; but it could also feature as an argument for a capital levy. However, the ‘social’ basis for a capital levy, like the ‘financial’ basis, was found to have drawbacks. So far as the direct taxes were concerned, the political implications of a redistributive capital levy were found to be unattractive. Those with high incomes could expect to suffer more from a capital levy than they gained from lower tax rates—and could be expected to object to it. Those with middle incomes might well gain more from lower tax rates than they lost in paying the levy—and so might favour such a levy. However, those with low incomes paid no income tax—and so, in the absence of further considerations, would neither gain nor lose if a capital levy were to be imposed. Such people would certainly not be major direct gainers if the proceeds of a capital levy were applied in reducing government debt. Against this background, the Conservative and Labour parties both moved away from support for a capital levy. So far as the Conservative party was concerned, its chairman, Sir George Younger, was alarmed at Bonar Law’s initial willingness to consider a post-war levy; and wanted the point to be reconsidered. ‘The feeling [in the party]’, he wrote to Balfour, ‘is so strong against the slightest support of any such suicidal policy that it is impossible to say whether anything short of entire repudiation would satisfy our people.’18 Bonar Law, in his turn, came down decisively against a capital levy, believing that it might set a dangerous precedent for a confiscatory capital levy as a permanent feature of finance if a radical government should ever be in power.19 So far as the Labour party was concerned, a capital levy was only of advantage to those on low incomes if the proceeds of that levy were applied for their benefit. This possibility produced allegations of confiscation and Bolshevism—allegations that leaders such as MacDonald and Snowden considered did more electoral harm than good.20 The first Labour ­Government

17 

JE Allen, The War Debt and how to meet it (London, Methuen, 1919) 69 and 74. Quoted in Daunton, above n 3, 894. 19 R Blake, The Unknown Prime Minister: the Life and Times of Andrew Bonar Law 1858–1923, (London, Eyre & Spottiswoode, 1955) 401. 20 Pimlott, above n 3, 142; CA Cline, Recruits to Labour: The British Labour Party 1914–1931, (Syracuse University Press, 1963) 62–6. 18 

200  John HN Pearce took office early in 1924; and, at the time it did so, King George V was given assurances that a Commission would be established to consider means of dealing with government debt.21 A Committee was appointed in March 1924 under the chairmanship of Lord Colwyn ‘[t]o consider and report on the National Debt’.22 The Colwyn Committee then began its lengthy deliberations; and the fact that the Committee was considering the matter constituted yet another reason for the issue of a capital levy ceasing to feature in day-to-day politics. The Colwyn Committee finally reported in 1927;23 and dealt with the subject of a capital levy at considerable length. The majority of the Committee concluded that, even if there were a prospect of a capital levy being well received, the relief from debt which it offered would be insufficient to justify an experiment that was so large, so difficult and so hazardous. The majority also considered that, unless a levy was accepted with more goodwill than could then be anticipated, it would be highly injurious to the social and industrial life of the community. By the end of 1927, therefore, and so far as a capital levy was concerned, those with power wanted to do nothing—and were well equipped to argue that nothing was the thing to do. The Years from 1927–1947 However, although consideration of a capital levy largely disappeared from view for the remainder of the inter-war period, the subject was not entirely forgotten. One individual who had the subject very much in mind was Hugh Dalton, at various times reader in economics at the London School of Economics and Labour MP (and sometimes both). In his publications in the 1920s, Dalton had favoured a capital levy.24 ‘It is my personal opinion’, he wrote in a later book published in 1935, ‘that, once we have made good progress with socialisation, the policy of the capital levy should be brought to the front again’.25 A new and important departure in the consideration of a capital levy took place in the summer of 1944. In a conversation with James Meade, then

21  MJ Daunton, Just Taxes: The Politics of Taxation in Britain, 1914-1979, (Cambridge, CUP, 2002) 73. 22  Hicks et al., above n 3, 256. 23  Report of the Committee on National Debt and Taxation (Cmd 2800, 1927). 24  By the spring of 1923, Dalton had published three books on economics. There was a treatise, Some Aspects of the Inequality of Incomes in Modern Communities (London, Routledge, 1920); a textbook, Principles of Public Finance (London, Routledge, 1922); and a polemic, The Capital Levy Explained (London, Labour Publishing Co,1923). For these matters and a discussion of these works see Pimlott, above above n 3, 138–42. 25 H Dalton, Practical Socialism for Britain (London, George Routledge & Sons Ltd, 1935) 327.

The Special Contribution of 1948 201 working in the Economic Section of the War Cabinet Office, Clement Attlee, then Lord President of the Council and Deputy Prime Minister, referred to the post-war burden of national debt interest—and expressed the opinion that the Economic Section might usefully prepare a note for him on the capital levy. Meade believed that Attlee probably had in mind a personal note on the basis of the existing literature on the subject, merely setting out the general arguments which had been put forward in the past for and against a levy. Meade, however, believed that it might be more useful to prepare a document with a wider scope.26 It was eventually decided that there were matters that should be considered generally; and the National Debt Enquiry, a committee consisting of officials and economists from the Treasury, the Economic Section of the War Cabinet Office and the Inland Revenue, was set up at the beginning of 1945.27 The possibility of a capital levy was considered carefully during the first half of 1945; and Meade was heavily engaged in the preparation of the papers which the National Debt Enquiry had decided to produce. In a diary entry for 22 April 1945, he recorded of Sir Richard Hopkins, the recently retired Permanent Secretary to the Treasury, but still serving as a member of the National Debt Enquiry, that: Hoppy [ie Hopkins] would simply love to be in charge of a Capital Levy. He believes that the thing is practicable if (i) no attempt is made to collect in money but the state becomes a gigantic investment trust taking over a proportion of all forms of capital and (ii) all private valuers etc. are taken on as temporary civil servants for the duration. As an artist in financial administration he is as disappointed as I am that the arithmetic of the yield of a levy shows it not really to be worthwhile.28

The final version of the note on the capital levy was dated 15 June 1945.29 The document was a substantial one, with 36 numbered paragraphs, ­dealing with the case for the capital levy—and then with its general character; the

26 TNA T273/389. Note by Meade, 12 July 1944. In this note, Meade stated that his conversation with Attlee had taken place ‘recently’. 27 S Howson, British Monetary Policy 1945–51 (Oxford, Clarendon Press, 1993) 45. It is clear that the National Debt Enquiry began its work unencumbered by overmuch detailed knowledge of what Attlee had in mind: for it thought that it was ‘probable that the type of capital levy in which Mr Attlee is interested was the single operation levy, of the type advocated during the last war by Sidney Arnold. … At the same time consideration of an annual capital tax should not be ruled out.’ (TNA T233/158. ‘National Debt Enquiry: Note of First Meeting held at the Treasury on 19th February, 1945.’) For Arnold see n 9 above, and text around that note. 28  S Howson and D Moggridge (eds) The Collected Papers of James Meade: Volume IV: The Cabinet Office Diary 1944–46 (London, Unwin Hyman, 1990) 65. 29  Note, ‘The Capital Levy’, 15 June 1945. There are copies of this note in various locations in the National Archives. One copy is at TNA T171/395 (document 117); another is at TNA IR63/178, fos 24–31.

202  John HN Pearce equity of a capital levy; and its administrative practicability. There was then an attempt to assess the net budgetary saving that would accrue. On the subject of administration the note said that: The administration of a capital levy involving as it would a review of the greater part of the total wealth of the country and affecting possibly as many as three million individuals would be a task of great magnitude. But it would not be an insuperable one provided sufficient trained staff were available and the levy were accepted by the great majority of persons called upon to pay it as a fair if onerous burden; the successful administration of the income tax depends in great measure on the co-operation of the taxpayer—on his willingness to pay. It need hardly be said that if taxpayers as a whole resented the levy as an unfair or arbitrary imposition and were determined to raise not only all legitimate objections of substance but also points of technical legal detail, the successful administration of a levy would be gravely endangered.30

As it neared completion, the note on the capital levy was criticised by one of the members of the National Debt Enquiry (Sir Cornelius Gregg, the Chairman of the Board of Inland Revenue) on the basis that ‘the Paper is so long and examines the pros and cons with such nice judicial propriety that one cannot see the wood for the trees!’31 In order to guard against this criticism, there was some redrafting, particularly of the concluding passages,32 which, in the final version of the note, ended with a summary stating that: 31. The case for a capital levy is that, by the repayment of a substantial part of the debt, rates of taxation could be reduced, with consequential improvements in economic incentives. Moreover, it is precisely when the system of taxation employed is (like ours) highly progressive, and when (as now) rates of tax are high, that a reduction in taxation has the most marked effect in improving the economic incentive. 32. The capital levy would, of course, raise difficult problems of administration and would inevitably cause considerable disturbance and dislocation of the capital market. It would impose a burden of indebtedness on private businesses, including farmers. For many businesses would have to pay the levy in the form of a mortgage, and this would have a restrictive effect upon enterprise. Objections may also be raised against the levy on the grounds that its incidence would be inequitable. Thus, it would fall very hardly on persons with small incomes from property, while it would actually favour persons with high earned incomes. 33. But whatever may be the theoretical advantages of a capital levy, when one comes to consider its practical effects in present circumstances one is faced with a dilemma. Either the levy must be of the progressive type discussed by the C ­ olwyn Committee, in which case, despite the heavy rates, the savings on the Budget

30 

The subject of administration was dealt with in para 21 of the note. TNA T233/159. Note, [Robertson] to Tucker, ‘Capital Levy’, 20 June 1945. 32 ibid. 31 

The Special Contribution of 1948 203 would be negligible. Or if a levy is to produce a significant saving it has got to be both heavy and of an unproductive type and to hit quite small properties, e.g. properties of £1,000 and above, with extreme severity. In this event, the disturbance and administrative difficulties will be at their maximum and there will be numerous cases of hardship affecting persons with small means. 34. There is no escape from this dilemma. And it is difficult to avoid the conclusion that, so long as taxation remains at anything approaching the present high level and the rate of interest on the National Debt remains low, the game is not worth the candle.33

The crucial few words in this summary may be taken to be the final words quoted: ‘the game is not worth the candle’—the potential gain from undertaking the task was not worth the trouble involved.34 As Meade had recorded as the note on the capital levy neared completion, ‘we are all agreed that the yield of a levy would be so disappointingly low … as to make it for practical political purposes practically a non-starter.’35 During the years that followed, the note of 15 June 1945 was the essential starting point for the civil service’s approach to the possibility of the imposition of a capital levy; and the propositions for which the civil service wished to argue were those set out in the conclusion to that note. The immediate aftermath of the completion of the note of 15 June 1945 saw a minor curiosity followed by a major change. The minor curiosity was that the note on the capital levy had originally been requested by Attlee. However, by the time the note was at last ready for delivery to Ministers, in the second half of June 1945, the wartime coalition government had come to an end—and Churchill was presiding over a caretaker administration in which the Labour party was not represented. Attlee was no longer a Government Minister entitled to receive government documents; but it was clearly envisaged that a copy of the note might be forwarded to him.36 The major change was the arrival in power of a Labour Government following

33  Note, ‘The Capital Levy’, 15 June 1945. (See n 29 above.) The note contained one further para stating that ‘35. This chapter has not touched upon the psychological effect of a capital levy. It is clear, however, that the imposition of a capital levy might have serious adverse effects on confidence. This would arise partly from the fact that it would be regarded as a novel and revolutionary measure especially if it were to be applied to properties or savings of quite modest dimensions; but still more because the imposition of a capital levy would be regarded by those with capital as a device which, having once been adopted, would be likely to be repeated again in the future.’ 34  According to that great work of reference Brewer’s Dictionary of Phrase & Fable ‘The saying is of French origin, and translates Le jeu n’en vaut pas la chandelle. The reference is to a bad play or bad acting, which is not worth the lighting.’ (Millennium edition) (London, Cassell, 1999) 1283. 35  Meade, Cabinet Office Diary, above n 28, 84. 36 TNA file T233/159. Note, [Bridges] to Chancellor of the Exchequer (Anderson), 20 June 1945.

204  John HN Pearce the General Election of July 1945; and, at the end of that month, Hugh Dalton became Chancellor of the Exchequer. It might have been expected that, during the period from 1945–1947, when Dalton was Chancellor of the Exchequer, the subject of a capital levy would be given serious attention. The Labour party’s 1945 general election manifesto had claimed that ‘the Labour Party is a Socialist party, and proud of it’ and that its ultimate purpose was ‘the establishment of a Socialist Commonwealth of Great Britain—free, democratic, efficient, progressive, public-spirited, its material resources organised in the service of the ­British people.’37 Dalton himself had shown interest in the subject of a capital levy.38 During the years from 1945–1947, however, the subject of a capital levy was not pursued to any major extent. Dalton had expressed the personal opinion that the imposition of a capital levy was a task to be taken in hand only when ‘we have made good progress with socialisation’;39 and he certainly had many other claims upon his attention. To mention only legislative matters, the Treasury was involved not only with the Finance Acts of 1946 and 1947, but also with the legislation relating to the nationalisation of the Bank of England in 194640 and the imposition of exchange controls in 1947.41 During Dalton’s tenure of the Office of Chancellor of the Exchequer, the United Kingdom’s financial situation was always grave; and, during the summer of 1947, against the background of a financial deterioration, D ­ alton despatched a note stating that it was possible that there might have to be an autumn Budget. ‘If so, it should be exceedingly brief, leaving over for the main Budget any proposals of a more complicated nature’. The sole purpose of any such Budget would be to lessen the inflationary pressure by ‘mopping up’ some purchasing power—at the same time illustrating the Government’s intention that there should be ‘equality of sacrifice’ as between different sections of the community.42 The Inland Revenue commented, a few days later, on possible changes in direct taxation. So far as a capital levy was concerned: The capital levy was exhaustively considered in 1944–45 as a possible means of reducing the future burden of the national debt. It was rejected on the ground that it would substantially fail to achieve this purpose. At present high rates of taxation and low rates of interest on debt, the loss in revenue consequent on the

37  M Francis, ‘Economics and Ethics: The Nature of Labour’s Socialism, 1945–1951’ (1995) 6 Twentieth Century British History 223. 38  See text around n 24, above. 39  See text around n 25, above. 40  Bank of England Act 1946. 41  Exchange Control Act 1947. 42  TNA file T273/421. Note, [Dalton] to Bridges, 11 August 1947.

The Special Contribution of 1948 205 redemption of debt would largely offset the saving in interest and the resultant gain would be insignificant judged by the magnitude of the operation. Whether or not it would be possible in present circumstances to justify the necessity of a levy, its assessment and collection would be a major administrative operation completely beyond the existing capacity of the Inland Revenue Department. It would involve the recruitment and training of a large additional staff: in the present conditions, the diversion of man-power, even if it could be found, to such a task could not be justified.43

The Inland Revenue then went on to express the views that, if the aim was to lessen inflationary pressure, this could best be done by increasing the profits tax; and, if the aim was to create a bias against unearned income, this could be done by increasing both the standard rate of income tax and the existing earned income relief ‘thus maintaining the existing system of differentiation without imposing differential standard rates of tax.’44 Others offered Dalton advice that was significantly different. Douglas Jay MP, the Economic Secretary to the Treasury, sent Dalton some notes on 10 October 1947.45 Jay believed that purchasing power should be taken out of the economy; and considered a number of methods by which this might be done. One method was by a capital levy; and Jay believed that this was the ideal moment for a capital levy, both politically and economically. Politically, if the opposition Conservative party was crying out for deflationary taxes, they could not convincingly object to this one. Economically, the only serious objection to a capital levy was its deflationary effect. Jay also made the point, however, that ‘we ought to avoid any proposal which would involve much administrative labour and in particular a new capital valuation process’; and went on to mention two possible ways of going ahead in this sense. The first method was to use the existing income tax assessment for unearned income; and then to impose what could be called an annual capital tax. This tax could be paid partly in securities, but would involve no new capital valuations. The second method was to use the death duty valuations, and to take some of the untaxed portions of estates becoming liable into state ownership. A capital levy featured neither in Dalton’s Budget statement, made on 12 November 1947, nor in the supplementary Finance Act that followed it.46 However, that Budget statement achieved fame for another different reason: for Dalton, before delivering his speech in the House of Commons, gave brief details of his Budget proposals to a Lobby Correspondent—an

43 TNA file IR63/323 fos 49-52. ‘Note on suggestions made at the Budget Committee Meeting of 12th August, 1947’, 21 August 1947. 44  ibid. (Underlining in original.) 45  TNA file T171/392 fo 30. Notes by Jay, 10 October 1947. 46  Finance (No 2) Act 1947.

206  John HN Pearce event that led to his resignation.47 He was replaced as Chancellor of the ­Exchequer by Sir Stafford Cripps. Dalton stated in his memoirs that, shortly after departing from the Treasury, he had offered advice to his successor. In planning his supplementary 1947 Budget, Dalton told Cripps, he had deliberately avoided any large and complicated changes. ‘But my mind was moving towards making a capital levy the principal feature of the Spring Budget. Interest on the National Debt, in spite of the cheap-money policy, is much too heavy a charge to be carried forward through the next few years.’ ‘A capital levy is the only fair and satisfactory way of redeeming this burden. Nor, in my view, need it be unduly complicated, though some of your advisers will, no doubt, make heavy weather over any such proposal.’48 Sir Stafford Cripps and the Preparation of the 1948 Budget Sir Stafford Cripps became Chancellor of the Exchequer on 17 November 1947; and there is evidence that Cripps was a more effective and stronger departmental head than Dalton had been. Robert Hall, who, in 1947, succeeded Meade as the director of the Economic Section of the Cabinet Office, wrote in his diary for March 1948 that, during the past three months, there had been a revolution in Government policy. Cripps had been the undisputed master in the field. The more Hall saw of Cripps, the more highly he thought of him: ‘he is anxious to tell the truth, he is a man who is completely fair in his outlook, and completely bold if he is convinced that a particular course is right.’49 On another occasion Hall wrote that Cripps ‘commanded almost uncritical respect among senior civil servants, which is very unusual in my experience. He was a wonderful man to work for, especially if he respected you.’50 In devising his Budget for 1948, Cripps obviously had to pay very careful attention to the very serious economic situation. A short White Paper, issued in February 1948, made the point that it was everyone’s duty to play their part in averting the dangers of inflation: To sum up, if general increases in profits, salaries or wages take place without more goods being made available, no-one can obtain any real benefit except the black market operator; the rest of the community has to endure the dislocation and hardship which inevitably accompanies inflation. The alternatives now before

47 

For this episode, see generally Pimlott, above n 3, Ch 29, 524–48. Dalton, High Tide and After: Memoirs 1945–1960 (London, Frederick Muller Ltd, 1962) 287–8. 49  A Cairncross (ed), The Robert Hall Diaries 1937–53 (London, Unwin Hyman, 1989) 19. 50  Quoted in C Bryant, Stafford Cripps: The First Modern Chancellor (London, Hodder & Stoughton, 1997) 412 and 505. 48  H

The Special Contribution of 1948 207 us are therefore either a general agreement by the people to act together upon sound and public spirited lines or a serious and prolonged set-back in our economic reconstruction accompanied by a persistent low standard of living.51

For economic reasons, therefore, the government sought ‘a general agreement by the people to act together upon sound and public spirited lines’. Any such agreement, however, had political implications. All must make appropriate contributions: and representatives of one interest were understandably keen to ensure that other interests were playing their part. Trade Union representatives, at a meeting with government ministers on 11 ­February 1948, ‘expressed dissatisfaction with the Government’s policy as failing to provide for equality of sacrifice … Could not some more spectacular action be taken to capture the imagination of the workers during the coming critical days and weeks?’52 As far as a capital levy was concerned, the Budget Committee53 agreed, at a meeting held on 27 November 1947, to show the Chancellor the note dated 15 June 1945.54 Shortly after this, Cripps had a meeting with the Budget Committee; and it was recorded that the study of this question should be brought up to date and submitted to the Chancellor.55 Cripps took a personal interest in the subject of a capital levy. On 16 December 1947, Sir Edward Bridges, the Permanent Secretary to the Treasury, wrote to Sir Cornelius Gregg, the Chairman of the Board of Inland Revenue, stating that Cripps had spoken to him that morning about the possibilities of a capital levy. Cripps wondered whether it was possible to develop a proposal that it was to be assumed that every person in the country died on a particular date (say 5 April 1948) with Estate Duty at the appropriate rates being levied on that person’s estate.56

51 

Statement on personal incomes, costs and prices (Cmd 7321, 1948) 2 and 4 [2] and [11]. file T172/2033. ‘Note of a Meeting with representatives of the Trade Union Congress’, held on 11 February 1948. 53  Jay wrote of the Budget Committee that it was ‘so hallowed and secret in 1945–51, that, like the mysteries of the Vestal Virgins in classical Rome, it was not allowed by tradition to be even mentioned to the uninitiated. It consisted of all the chief officials within the Treasury, Inland Revenue and Customs, who prepared the Budget all the year round; and it was supposed to be unknown even to the rest of the Treasury, let alone lesser breeds. But as the alternatives and dilemmas became apparent in the winter every year, Treasury Ministers had to be brought in and decisions taken in meetings stretching right up to the Budget.’ D Jay, Change and Fortune: A historical Record (London, Hutchinson, 1980) 175. In TNA file T273/424, the Minutes of the meetings of the Budget Committee during the period leading up to the presentation of the 1948 Budget carry the endorsement ‘Only copy’. 54  TNA file T273/424. ‘Record of meeting of the Budget Committee held on Wednesday, 27th November, 1947.’ 55  TNA file T171/394. Note, ‘Summary of Decisions at a Meeting of the Chancellor and the Budget Committee on Wednesday, 3rd December, 1947.’ 56  TNA file IR63/324, fo 362. Letter, Bridges to Gregg, 16 December 1947. 52  TNA

208  John HN Pearce Given the existence of the carefully prepared note of 15 June 1945, it could be expected that the civil service would continue to argue in favour of the conclusions set out in that note—and that was indeed the case. The Inland Revenue would have to administer any levy imposed; and the department addressed itself to considering the administrative prospects. The views of the Board of Inland Revenue were set out in full in a note dated 12 ­January 1948.57 The Board were clear that the assessment of a capital levy was similar in principle to the assessment of the Estate Duty. Even though the scope of charge might not be identical, the technique (and especially the all-­ important task of valuing the assets) would be the same for both imposts. The Estate Duty Office would have to be expanded to tax the capital of the living—who would make returns and be assessed in the same way as executors. There would also be the further consequence that the Valuation Office, which valued land and buildings for the Estate Duty Office, would have to undertake the same duty for the levy. ‘The first question to be considered as regards practicability is whether the requisite staff, especially the trained staff, could be found to provide for the work.’ The Board of Inland Revenue then went on to argue that the requisite staff could not be found. So far as the Estate Duty Office was concerned: The measurement of staff strength necessary for a Levy depends upon the exemption limit and the nature and scope of the Levy. A levy of a graduated character, in which the rate of levy is dependent upon the determination of the total capital, would be much more difficult than a Levy at a flat rate and the higher the exemption limit for any Levy the smaller the number of cases to be dealt with. Some measure of the staff problem can, however, be obtained by taking a Levy at flat rate with an exemption limit of £5,000 and applicable to all capital of any individual which would have come under charge to Estate Duty if that individual had died on the day appointed as the date on which his capital should be determined. It is estimated that the number of individuals chargeable to such a Levy would be about three-quarters of a million. The Estate Duty Office at present has a skilled Examiner staff of 450 and a clerical staff of 300. It is estimated that the work of the Office in administering this flat rate Capital Levy would require staff units equal to 3,500 Examiner years and 2,500 clerical years; put otherwise, if the work were to be done within three years it would require a staff of about 1,200 additional Examiners and 850 additional clerks for the three years. The important staff would be the Examiners. The Inland Revenue Department has no available resources to provide any, and there is little hope of getting any staff from other Departments. The staff would have to be recruited from outside the Service and it is not likely that any trained personnel, e.g. legal, could be obtained. It would be necessary to take in raw material of not less than Higher Certificate standard through Civil Service examinations, and it is doubtful whether the numbers 57  TNA file IR63/178, fos 19–22. ‘Note by Board of Inland Revenue on the Assessment and Collection of a Levy’, 12 January 1948.

The Special Contribution of 1948 209 required could be quickly obtained. It would be necessary to dilute the Estate Duty Office by taking away probably half of their trained staff to mix with the untrained recruits, in order to get a team to tackle the Levy.58

The position in the Estate Duty Office was, however, the less unsatisfactory half of the situation. The Board of Inland Revenue then went on to consider the position in the Valuation Office: But the position is far worse when one looks at the Valuer staff that would be required by the Valuation Office for valuation of land and buildings (including leaseholds as well as freeholds). The Valuation Office, which has at the moment a staff of 1,020 Valuers, is undermanned for the tasks which it now has in hand. For the valuation work involved in the Town and Country Planning Act the Office is still 250 Valuers below the strength requisite for the work arising in 1948; it is 650 short of the number required in 1949. Great difficulty is being experienced in obtaining Valuers and it is already clear that it will be quite impossible for the Department to undertake the rating work arising under the Rating Bill by the date (1952) contemplated in the Bill. It is estimated that the work involved in valuing realty for a Levy with an exemption limit of £5,000 would require an addition of not less than 1,500 Valuers and 1,500 clerks for three years. There is no hope whatever of recruiting this Valuer staff.59

Having made these points, it was totally unsurprising that the Board of Inland Revenue reached the conclusion ‘that on manpower grounds alone the assessment of a Levy at a flat rate on capital values exceeding £5,000 (and a fortiori the assessment of a graduated Levy) does not pass the test of practicability.’60 The points made by the Inland Revenue were incorporated in a note from the Treasury (the note that had been promised to bring the earlier note of 15 June 1945 up to date). This note, dated 14 January 1948, like its predecessor, was a lengthy document, and ended with a concluding summary:61 32. We have sought to provide material on which judgment could be based on the question whether a capital levy at the present time would be in the public interest. In effect this means whether a levy would effect a substantial improvement in the economic health of the country which could not be achieved by any less drastic means, whether the advantages of the levy would outweigh the inevitable disturbance and possible loss of confidence, and whether it could be equitably administered. 33. In Section I of the note we show that the yield could hardly be defended today on fiscal grounds. In Section II we give reasons for doubting whether it would be

58 ibid. 59 ibid. 60 ibid.

61  TNA file T171/395, document 116. ‘Note on Capital Levy’ (B C (48) 13), 14 January 1948.

210  John HN Pearce a reliable and effective measure of countering inflation; and in Section III we have shown the difficulties of administration. 34. All this in our judgment points to the conclusion that the balance of advantage is clearly against the imposition of a capital levy at the present time, while the fact that the imposition cannot be demonstrated to be in the public interest would make its administration a matter of very great difficulty.

On 20 January 1948, Cripps had a preliminary discussion of the Budget with senior Treasury officials.62 So far as a capital levy was concerned: The Chancellor said that, after reading the Treasury note on this subject, he was not convinced that as much weight had been given to the ‘pros’ for such a levy as to the ‘cons’. But he admitted that the implications, in terms of staff, of any levy, however, organised, were extremely serious, especially in the light of the problems of valuation involved in connection with such assets as goodwill. On the other hand, it must not be forgotten that the political pressure for a capital levy would be extremely strong, and he was, therefore, in favour of imposing some sort of non-recurrent anti-inflationary impost. Such a charge might take the form of doubling the Surtax or Income Tax payment, for one year only. In the discussion of the suggestion it was urged that a levy of this kind would have a very disincentive effect, especially in the case of earned incomes, and most of all where such incomes included substantial earnings of the ‘piece-work’ variety—as in the case of e.g. doctors, lawyers and other professional earners. Thus a man earning £5,000 a year, and having three children would, if subjected to a charge of this kind, be left with an income of £70. The effect, so far as incentive was concerned, might, therefore, be very serious. It was agreed, however, that a scheme on these lines should be investigated, the exemption limit being fixed at, say, £2,000 and the effect being shown in relation to earned and unearned income.

During the weeks that followed, the Treasury and the Inland Revenue worked out two different schemes along the lines that Cripps had indicated. The first scheme took the form of a special levy on the investment income of all surtax payers. The second scheme took the form of a special levy on all investment income: but individuals who had a total income of less that £1,000, or investment income of £500 or less were to be exempt. It is possible to infer that civil servants had private reservations about the course of action being investigated. One memorandum that was prepared stated that: such a levy or contribution is administratively feasible. But we believe that its effect on confidence would be very marked indeed unless the taxpayer can be persuaded that the levy is not just the first turn of yet another screw on the owner of investments, and that what is this year represented as a special levy is not likely

62 

TNA file T171/394. ‘Budget’. Note [by Trend], 20 January 1948.

The Special Contribution of 1948 211 to be repeated later on. The only hope of persuading taxpayers that this is so is to treat such a levy as part of a balanced scheme designed to meet an emergency, and therefore to be broadly equitable as between different classes of the community.63

Another memorandum that was prepared concluded by stating that: in regard to both schemes the crucial point is whether the tax-payer will be willing to accept an assurance that the levy is a ‘once for all’ operation and will not be repeated. If this assurance is not accepted, then a strong inducement will be given to shed income-producing capital rather than to save. For these reasons we are convinced that a levy of this character should only be contemplated as one of a series of measures affecting the community as a whole and designed to meet an emergency situation. And even in this context we entertain fears that the resulting loss of confidence may have far-reaching effects.64

Jay also made a contribution during these same weeks. In seeking for further revenue from direct taxation, he took it for granted that it was desirable to make plain that some contribution was being made by the holders of property and recipients of unearned income. However, any proposed levy on capital or property which involved capital valuations was administratively impracticable—and would be an unwarrantable waste of time and energy. Jay then went on to suggest an impost not too unlike those which the Treasury and the Inland Revenue were already considering.65 Crucial decisions relating to the Budget were then taken, or ratified, over a working weekend at which the Chancellor of the Exchequer, Treasury Ministers and senior civil servants were all present. This was a system introduced by Cripps; and Jay later recalled that ‘the opportunity of all day discussion with all concerned, in total seclusion in the light of all the known facts, was a thoroughly business-like method of weighing up all Budget possibilities.’66 The working weekend took place on 14 and 15 February 1948 at Roffey Park, a home for rehabilitating nervous invalids near Horsham in Sussex; and Jay also recalled that ‘plenty of innocent mirth was excited among the participants at the thought of public reactions to the news that the annual Budget was being constructed in a rest-home for nervous wrecks’.67 When, during this weekend, the subject of a ‘Special Levy’ came to be discussed, the note of the discussion began by recording that it was agreed that a capital levy, in the ordinary sense, must be ruled out for the reasons 63  TNA file T171/394, (B C (48) 23 (Final)). Memorandum by Treasury, ‘Special measures to counter inflationary pressure’, 5 February 1948. 64  TNA file T171/395, document 124, (B C (48) 20 (Final)). Memorandum by Treasury, ‘Proposals for a special levy’, 5 February 1948. 65  TNA file T171/395, document 126. Notes [by Jay] submitted with a covering note from Jay to the Chancellor of the Exchequer [Cripps], 7 February 1948. Jay later stated that he had the private support of Dalton for the views that he was putting forward. (Jay, above n 53, 184.) 66  Jay, above n 53, 175. 67 ibid.

212  John HN Pearce set out in the note of 14 January.68 It was at this point, therefore, that plans for legislation in 1948 parted company, irrevocably, with earlier writings on the subject of a capital levy. Discussion then turned to the two schemes that had been worked out by the Treasury and the Inland Revenue. So far as the first scheme was concerned: The Chancellor of the Exchequer emphasised … that even if a levy of this character did not have a wholly deflationary effect, its psychological impact would certainly be deflationary. Moreover, it would from the political point of view, offset the increases in indirect taxation. Given that we must rule out an increase in the Income Tax (which would have to be very steep to bring in as much as £150 millions, and would, in any case, have disastrous effects on incentive) together with any increase in the Profits Tax (at least until we knew the result of his appeal to industry voluntarily to reduce prices and profits), something on the lines of the levy which had been discussed was unavoidable. Discussion then turned to the second of the alternative schemes whereby the levy would be charged on all investment income, but with exemption for (i) the income of all persons with a total income of less than £1,000, and (ii) all investment income of £500 or less. … The Chancellor agreed that this alternative scheme was preferable to the original version; but he was not sure that even the most severe of the three scales outlined … yielded sufficient revenue. It was pointed out that Scale C was the equivalent, at the maximum, of an additional 10/- in the £, which would, in some cases, be payable on top of a Surtax rate already standing at 19/6 in the £, and perhaps this was severe enough. Nevertheless, it was agreed that the details of the scale should be reconsidered with a view to a further increase in the yield. Consideration should also be given to special acceleration of collection; in the ordinary course of events, only about £30 millions out of the estimated total yield of £100 millions under Scale C would be collected in 1948–49, but the Chancellor asked that extraordinary steps should, if necessary, be taken—either by diversion of staff or by the provision of penalties for dilatory payment—to ensure a larger total of actual payment in the current year. The Chancellor said, in conclusion, that he was not prepared to emphasise the ‘once for all’ character of the special levy by giving any specific undertaking about the equally ‘once for all’ character of the increases in indirect taxation, and thereby committing himself to remove some, if not all, of these increases next year. It would be reasonable, he thought, to present the whole set of Budget proposals as a special operation, designed to meet the circumstances of an emergency year. Within that context the Special Levy could take its place as a ‘once for all’ operation. …69

68  TNA file T171/394. Note of the discussions held at Roffey Park on 14 and 15 February 1948. For the note of 14 January 1948, see text around n 61, above. 69  TNA file T171/394. Note of the discussions held at Roffey Park on 14 and 15 February 1948.

The Special Contribution of 1948 213 Revised proposals for the special contribution were then prepared in accordance with the decisions taken at Roffey Park; and those revised ­ ­proposals were approved at a meeting of Ministers and Senior Officials on 3 March 1948.70 Cripps then participated in another working weekend, this time at Chequers on 13 and 14 March 1948. His Budget proposals were discussed with the Prime Minister (Attlee), the Foreign Secretary (Bevin) and the Lord President of the Council (Morrison). On the subject of the special contribution, the briefing prepared provided an excellent account of how the impost had acquired its distinctive characteristics: It is proposed to raise a Special Contribution from the owners of capital. A Capital Levy of the traditional kind, designed to raise a large sum of money in order to redeem debt, is ineffective, judged as a purely revenue proposal, for the resulting loss in income tax, surtax and death duties will, in the initial years, be equal to, if not greater than, the saving in interest on the debt, so that for many years to come it can provide no relief to the Budget. But whatever may be the arguments in favour of the Levy on other grounds, it is completely out of the question for administrative reasons. The administration of a Levy would involve: (i)

A skilled technical staff of Examiners who would deal with questions of liability, the interpretation of trust deeds and other legal instruments and the general work of examination of accounts; and (ii) A professional Valuation Staff for the valuation of land and buildings including leasehold as well as freehold. With an exemption limit of £5,000 and spreading the work over three years, it would be necessary to have a staff, on the examination side, of 1,250 Examiners with 850 clerks, and on the valuation side 1,500 Valuers and 1,500 clerks. It will be difficult enough to get the Examiners but it would be completely impossible to get the Valuers. The existing staff of the Valuation Office is 1,020 Valuers and the Office is already undermanned for the tasks it has in hand and great difficulty is being encountered in recruitment. The Valuation Office needs 650 more Valuers by next year to cope with its existing work. To obtain another 1,250 for a Levy would be a physical impossibility. It is proposed, therefore, instead of charging the Levy directly on capital, to take the investment income … coming within the income tax (or surtax) as the measure of the capital and to charge the Special Contribution by reference to this investment income. The Contribution will only be chargeable where (a) the total income of the taxpayer exceeds £1,500 and (b) his investment income exceeds £250. … .71

The meeting at Chequers resulted in a decision that proposals for the special contribution should be modified. It was now proposed that the exemption 70 

TNA file T171/394, document 69. Note ‘Budget’ [4 March 1948]. TNA file T171/394. Briefing for discussions at Chequers during the weekend of 13 and 14 March 1948. (Underlining in original.) 71 

214  John HN Pearce limit for total income should be £2,000 and not £1,500, with any resulting loss of revenue being recouped from an increase in the rates at which the contribution was charged.72 This decision appeared to Sir Edwin Plowden, a leading Treasury Official, to disturb the balanced scheme at which the Budget should be aiming; and, one week before the Budget speech was due to be delivered, he sent a plea to Cripps: Over Easter I have been giving considerable thought to our economic policy and to the Budget in particular. You will remember that when we first discussed the Budget and the proposal of a Special Levy was made, you met the misgivings of some members of the Budget Committee by saying that you would present it to Parliament as a ‘once for all’ measure and as a part of a general sacrifice by all members of the community. Since then the form of the Budget has altered with the growth of the surplus. The additional taxation that is being raised on beer, tobacco and betting is more than offset by the remissions of direct taxation and of purchase tax. In my view your decision to promote incentive by remission of direct taxation is quite right. We are, however, left with the fact that we have the special levy, which is not balanced by any special levy on the rest of the community. I am sure that we must retain the special levy, but in the light of present circumstances I suggest that it should be lower than the top limit of 15/-. My reasons for suggesting this are really psychological. During the last six months you have done what no other man in the country could have done, and that is to secure the general support of industry and commerce for a Labour Government. This is a priceless asset and one without which there is no hope of our surmounting our economic problems. So long as you could present the special levy as a general ‘once for all’ sacrifice, in which all members of the community participated, I was not particularly impressed by the arguments of those that foretold a loss of confidence. Now, however, when it tends to stand out as a tax on one group of persons I fear that it may lead towards such a loss of confidence. …73

Once again it was decided to alter the rates at which the special contribution was charged;74 and, with this amendment, the proposals relating to the special contribution took their final form as part of Cripps’s Budget proposals. Those proposals were to be viewed as a special operation, designed to meet the circumstances of an emergency year; and the special contribution constituted part of a balanced scheme designed to meet that emergency.75

72 

TNA file T171/395. Letter, [Trend] to Gregg, 15 March 1948. TNA file T171/395. Letter, Plowden to Cripps, 31 March 1948. (Underlining in original.) 74 TNA file T171/395. Annotations on, and attachment to, letter, Plowden to Cripps, 31 March 1948. 75  See text before nn 69 and 63, above. 73 

The Special Contribution of 1948 215 The 1948 Budget—and After In his Budget statement, delivered on 6 April 1948, Cripps referred to inflationary pressures within the economy; to attempts to obtain voluntary agreements on the limitation of profits, the stabilisation or decrease in prices, and the avoidance of any general increase in wages and salaries; and to the need for increased taxation. On the Inland Revenue side: Various attractive suggestions have been put forward for a capital levy, but from the administrative point of view, a capital levy—in the ordinary sense of those words—is impracticable at the present time. It would be impossible to effect the valuation of all the capital assets in the country without a very large increase in the staff of valuers; and that staff is already very short for the jobs that it has got to do. Moreover, the assessment and collection would take years, and could be of no immediate value to the Revenue.

On the other hand, it was undoubtedly right that those who possessed large capital assets should make some contribution to help the country in this emergency—and Cripps then went on to outline the leading features of the scheme for a special contribution.76 The Budget debate was followed, in due course, by the Finance Bill; and the provisions of that Bill relating to the special contribution contained no indication that the contribution was an impost either of an income nature or of a capital nature. The very first draft of those provisions had proposed that the appropriate part of the Finance Bill should be entitled ‘special contribution from capital resources’ and the first subsection of this draft had provided for an individual to be charged to the contribution ‘in respect of the capital resources from which his investment income was derived’;77 but the references to capital resources were at once removed.78 Criticisms of the special contribution included a good number that could be related to the line of argument that the contribution was not part of a balanced scheme, but constituted class warfare. The Economist pointed out that the combined rate of income tax, surtax and special contribution on the top slice of the largest incomes would be 29s 6d (147.5 per cent); and calculated that a single man who had an investment income of £50,000 in 1947–48 would be liable to pay taxes of £69,243.79 In the House of Commons, a Conservative spokesman referred to the estimate that the special contribution would be charged on 140,000 individuals only; and considered the proposed legislation ‘naked class warfare’ of a type to which he

76 

HC Deb, 6 April 1948, vol 449, cc 47, 61 and 71–2. file IR63/386. Letter, See to Reid, 19 March 1948, and draft provisions sent with that letter. 78  TNA file IR63/386. Letter, [Evans] to See, 24 March 1948. 79  Economist, vol 154 (10 April 1948), 571. 77  TNA

216  John HN Pearce hardly thought that Cripps would descend.80 The Economist also considered it ‘childish’ to suppose that the special contribution would be ‘nonrecurring’. ‘Any tax which is administratively easy and brings in revenue without costing many votes will always be repeated.’ In a passage presented as being even-handed, the Economist then added that: Perhaps it would be wrong to be too harsh on Sir Stafford for this new proposal. The trade unions had made it clear that one of their conditions for reluctant agreement to the policy of wage stabilisation was that something should be done to capital, and this was probably the only thing that could be done that would be sufficiently spectacular without breaking the back of the Inland Revenue.81

By contrast, the government and Labour MPs were concerned to emphasise that the special contribution was part of a balanced scheme. One Government supporter referred to those on small incomes; and stated that the Budget was not at first sight popular amongst such people: Yet it was possible to point out that it was better to have a somewhat harsh Budget, which would cure inflation rather than a generous popular budget which would merely undermine the purchasing power of the pound. It was also essential at the same time to point out that the rich through this Special Contribution were playing a part in building up a Budget surplus. Otherwise, there would be a widespread feeling that inflation was being cured by cutting down the effective purchasing power of the worst off section of the community.82

Jay, speaking in the House of Commons, argued that the special contribution was a surcharge on large inherited wealth; and that it was perfectly fair that ‘some part of the burden should fall on those people who are best able to bear it.’ We defend this Contribution … first of all on the grounds that it raises revenue which we must have; secondly, because as everybody really knows, it is definitely anti-inflationary; and thirdly, because it makes a contribution, if only a small one, to social justice and to the better distribution of property.83

In due course, the proposals for the special contribution were passed; and the Finance Act 1948 received the Royal Assent on 30 July 1948. The primary legislation relating to the special contribution envisaged the making of subordinate legislation relating to assessment, collection, appeals and other matters;84 and the enactment of the Finance Act 1948 was followed, in due course, by the making of the Special Contribution Regulations 1948.85 So far as the yield from the special contribution was concerned, it was obviously useful, in the context of the country’s financial difficulties, to 80 

HC Deb, 12 April 1948, vol 449, c 644. The speaker was Oliver Lyttleton. Economist, vol 154 (10 April 1948), 571–2. 82  HC Deb, 3 June 1948, vol 451, c 1254. The speaker was the young Roy Jenkins. 83  HC Deb, 3 June 1948, vol 451, c 1282. 84  Finance Act 1948, ss 55(6) and 60(12). 85  SI 1948/2029. 81 

The Special Contribution of 1948 217 obtain funds quickly; and the Finance Act 1948 provided that the special contribution should be payable on or before 1 January 1949. It was also provided that payments of contribution made before that date should (in effect) have the benefit of a discount of two per cent per annum, while payments made after that date carried interest at the same rate.86 Cripps stated in his budget statement that the full yield of the special contribution would be £105 million, with £50 million of that amount being paid in the current financial year.87 On these figures, and as far as yield was concerned, the special contribution was a modest success. In the financial year 1948–49 the Exchequer Receipt from the special contribution was £79,500,000 (as opposed to the £50,000,000 mentioned in Cripps’s budget statement); and by the end of the financial year 1963–64 total Exchequer Receipts amounted to £110,859,000 (as opposed to £105,000,000).88 By the early 1960s, however, Exchequer Receipts from the special contribution had dwindled; and the enactment of section 32 of the Finance Act 1961,89 which provided that no further assessments to the special contribution might be made (except in the context of fraud or wilful default) may be taken as a signal that the special contribution’s career had come to an end. The special contribution had a successor. The young Roy Jenkins, elected as an MP for the first time in the early summer of 1948, made his maiden speech during the committee stage of the Finance Bill at a point when the provisions relating to the Special Contribution were under discussion.90 Twenty years later, during the period when Jenkins was Chancellor of the Exchequer, Part IV of the Finance Act 1968 provided for ‘the special charge’. The special charge (like the special contribution) was charged by reference to an individual’s ‘aggregate investment income’; and (following the 1948 precedent) income from any source was to be ascertained as it was ascertained for the purposes of surtax.91 In his autobiography, Jenkins wrote of the special contribution that it was ‘a fiscal device of which I was twenty years later to use a near copy, again on a non-recurring basis.’92 He wrote of the special charge that it was an impost ‘which I made clear I had no intention of repeating in future years; nor has any other Chancellor since done so.’93

86 

Finance Act 1948, ss 47(6), 54(2) and 54(3). HC Deb, 6 April 1948, vol 449, c 73 (6 April 1948). 88 Calculated from figures taken from the 100th Report of the Commissioners of Her Majesty’s Inland Revenue for the year ended 31st March 1957 (Cmnd 341, 1957) 188 and the 107th Report of the Commissioners of Her Majesty’s Inland Revenue for the year ended 31st March 1964 (Cmnd 2572, 1964) 180. 89  Section 32 also dealt with assessments to excess profits tax and the excess profits levy. 90  R Jenkins, A Life at the Centre (London, Macmillan, 1991) 72. HC Deb, 3 June 1948, vol 451, cc 1252–5. See also text around n 82, above. 91  Finance Act 1968, ss 41(1) and 42(3). 92  Jenkins, above n 90, 72. 93  ibid, 232. 87 

218  John HN Pearce THE SPECIAL CONTRIBUTION AND THE DETERMINANTS OF TAX LEGISLATION

A discussion of the determinants of the legislation relating to the special contribution may be framed by extracts from two communications: one from before the beginning of the period considered in this chapter and the other from after its end. On 12 March 1912, Sir Henry Primrose, who had been Chairman of the Board of Inland Revenue from 1899 to 1907, wrote to the then Chairman, Sir Matthew Nathan, about a conversation earlier that afternoon: ‘it seems to me’, Primrose wrote, ‘that, as is always the case with questions of taxation, there are the two sides to be considered, that of principle and that of practical convenience.’94 Nearly half a century later, on 29 October 1958, the Prime Minister (Macmillan) sent a note to the Chancellor of the Exchequer (Heathcote Amory) on what might be required if there was to be any repayment of Post-War Credits. Macmillan ended his note by saying that: I apologise for worrying you, but I have often found in the past that we spend a lot of time discussing whether a thing ought to be done and are then told that it is not practical to do it.95

This dichotomy was certainly apparent in the case of the legislation relating to the special contribution. A capital levy of the traditional kind was not practical because the Inland Revenue did not have, and could not obtain, the personnel required to administer it. As the briefing prepared for Cripps’s discussion of the Budget at Chequers had put it, ‘whatever may be the arguments in favour of the Levy on other grounds, it is completely out of the question for administrative reasons’;96 and Cripps made the same point in his Budget statement.97 When it came to justifying a decision not to introduce a capital levy of the traditional kind, it was administrative practicality that was placed in the foreground and centre stage. Earlier, in 1919, Pigou had noted that ‘[o]n the whole, capital seems to be a better basis for the assessment of a special levy than income, though an assessment based on income would be easier to administer.’98 The legislation enacted in 1948 saw a victory for what was administratively possible over what might have been theoretically superior. However, although administrative impracticability made it impossible to introduce a capital levy of the traditional type, the 1948 Budget did not

94 

TNA file IR63/47, fos. 408–9. Letter, Primrose to Nathan, 12 March 1912. TNA file T171/498. Note, Macmillan to Heathcote Amory, 29 October 1958. (Underlining in original.) 96  See text before n 71, above. 97  See text before n 76, above. 98  Pigou, above n 7, 48. 95 

The Special Contribution of 1948 219 have to contain the precise components that it did contain. In the summer of 1947, the Inland Revenue had expressed the views that if the aim was to lessen inflationary pressure, this could best be done by increasing the profits tax; and that, if the aim was to create a bias against unearned income, this could be done by increasing both the standard rate of income tax and the existing earned income relief.99 Plowden’s letter of 31 March 1948 made it clear that when the proposal for a special levy was made, some members of the Budget Committee had ‘misgivings’.100 The evidence leads straight to the conclusion that the Finance Act 1948 had legislation relating to the special contribution as one of its components because Sir Stafford Cripps, the Chancellor of the Exchequer, had decided that it should. The decision that there should be a special contribution was taken by a ‘strong’ Chancellor of the Exchequer who was ‘the undisputed master in the field’;101 and who took a definite personal interest in the subject of a capital levy.102 This, however, raises the further question why Cripps wished to take the decision that he did take: and, in answering this question, it is possible to observe both public and private reasons. The public reasons are easy to see. As Cripps himself is recorded as putting the matter at Roffey Park, it was reasonable to present the whole set of Budget proposals as a special operation, designed to meet the circumstances of an emergency year; and that, within that context, the special contribution could take its place as a ‘once for all’ operation.103 Everyone had to play their part in a set of measures designed to cure inflation; and within that overall context, the special contribution assigned a role to those with higher incomes. There is also a certain amount of evidence, however, to suggest that Cripps had his own private reasons. In winding up the Budget Debate, and in dealing with the special contribution, Cripps stated that: I have held certain theories for a long time, political theories which I believe to be right. I am not ashamed of believing them to be right, and I feel it is my duty to do the things which I think, according to those political theories, are right.104

At Roffey Park, and then, later, at Chequers, Cripps may be observed initiating or accepting decisions that the special contribution should be more steeply graduated.105 For those who believed in increasing equality, the special contribution presented an opportunity to take action. It is highly possible that Cripps was willing to exploit that opportunity.

99 

See text before n 44, above. See text before n 73, above. 101  See text before n 49, above. 102  See text before n 56, above. 103  See text before n 69, above. 104  HC Deb, 13 April 1948, vol 449, c 918. 105  See text before nn 69 and 72, above, respectively. 100 

220  John HN Pearce The conclusion that emerges is that the devising and enactment of legislation relating to a new tax (and, no doubt, on many other subjects) is a process that may be shown to involve a considerable number of different ingredients; and those ingredients may be of different types. Those ingredients, furthermore, will not be present in the same quantities for each particular major decision. Administrative considerations may be a major constraint—or they may not. Government Ministers may be the masters of their ministries—or they may not. Government Ministers may take a particular interest in the subject arising for decision—or they may not. The economic and political outlooks may point towards particular courses of action—or they may not. Circumstances will be different—and the legislation introduced may well reflect those differences. This conclusion, in its turn, prompts a further reflection: that the devising and the enactment of legislation is a subject with considerable complications of its own. It seems sensible to be wary of any suggestion that, once a particular course of action has been advocated or major decision has been taken, it may be embodied in legislation without any difficulty—and that there is nothing further to say.106 Funny things happen on the way to the statute book.

106  This proposition has a great deal of obvious common ground with remarks made by R Cocks, ‘Enforced Creativity: Noel Hutton and the New Law for Development Control, 1945–47’ (2001) 22 Journal of Legal History 48–9. Cocks quotes (with obvious disapproval) the statement of P Clarke, Hope and Glory: Britain 1900–1990 (London, Allen Lane, 1996) 221 that ‘Beveridge provided, broadly if not in every detail, the basis of the National Insurance Legislation of the post-war Labour Government.’

9 The Profits Tax GAAR: An Aid in the ‘Hopeless’ Defence Against the Dark Arts PETER HARRIS

ABSTRACT

This chapter has relatively modest purposes. A first purpose is to reflect on the similarities and differences between the profits tax GAAR and especially the 2013 GAAR. As a result, this chapter is only concerned with income tax and corporation tax. Having drawn that connection, a second purpose of this chapter is to gather together some disparate sources that were influential in the development of the profits tax GAAR and that aid in an understanding of it. The final purpose and primary focus of this chapter is to use the ‘Notes on Clauses’ prepared by the Board of Inland Revenue on introduction of the profits tax GAAR and its predecessors and contemporaneous revenue manuals to clarify the intention and scope of the words used. Some of this may be particularly useful in understanding aspects of the 2013 GAAR and difficulties with it. INTRODUCTION The existing law is powerless to defeat schemes of this kind … It would clearly be hopeless to attempt to legislate to render ineffective each particular device, for as soon as one gap was stopped the tax avoidance expert would find a way round the provision or a new device which might be equally effective. The proposed remedy is therefore a general avoidance Clause, akin to that adopted in the Excess Profits Tax legislation, which is designed to cover all types of avoidance and will serve as a general deterrent.1

The general anti-avoidance rule (GAAR) in the profits tax was brought to life by section 32 of the Finance Act 1951 and passed away with profits tax 1 

Board of Inland Revenue, Finance Bill, 1951: Notes on Clauses, 53.

222  Peter Harris in 1965, a short existence of only 14 years. Like any child, the p ­ rofits tax GAAR had a parentage and like many of us, it has descendants. The most immediate parent of the profits tax GAAR was the GAAR in the excess profits tax of World War II, and this GAAR has its own history. There are also the relatives and, in particular, other GAARs within the British ­Commonwealth that were contemporaneous with the excess profits tax GAAR. As for descendants, there are a number of targeted anti-avoidance rules (TAARs) that are clearly the direct spawn of the profits tax GAAR, the most [in]famous being the transactions in securities rules. This spawn has itself reproduced, sometimes in surprising places. Perhaps unsurprising is the United Kingdom (UK) GAAR introduced in 2013, although this child seems unaware of its profits tax parentage. There is also the Scottish GAAR and most recently the GAAR proposed for the Organisation for Economic Co-operation and Development’s (OECD’s) model tax treaty. Considering the vast amount that is written about GAARs and tax avoidance (for which there is an apparently instatiable appetite), this ­ ­chapter has relatively modest purposes. A first purpose is to reflect on the similarities and differences between the profits tax GAAR and especially the 2013 GAAR. As a result, this chapter is only concerned with income tax and corporation tax.2 Having drawn that connection, a second purpose of this chapter is to gather together some disparate sources that were influential in the development of the profits tax GAAR and that aid in an understanding of it. The final purpose and primary focus of this chapter is to use the ‘Notes on Clauses’ and other legislative materials prepared by the Board of Inland Revenue (Revenue) on introduction of the profits tax GAAR and its predecessors and contemporaneous Revenue instructions to better understand the profits tax GAAR.3 Some of this may be particularly useful in understanding aspects of the 2013 GAAR and difficulties with it. The chapter pursues these purposes under five headings. The first heading seeks to build an assessment framework by considering what are the essential elements of a GAAR. In keeping with the historical nature of this chapter, this consideration draws heavily on a seminal article by GSA ­Wheatcroft, the leading UK tax academic at the time of the profits tax GAAR, and the 1955 Royal Commission which reported during the currency of that GAAR.4 The second heading introduces the profits tax GAAR and compares it to the modern GAARs mentioned in the first paragraph, 2 The 2013 GAAR applies to income tax, corporation tax, capital gains tax, petroleum r­evenue tax, inheritance tax, stamp duty land tax, the annual tax on enveloped dwellings, national insurance contributions and diverted profits tax; see FA 2013, s 206(3). 3  This chapter relies on the copy of these materials rescued by Professor John Tiley and now in the possession of the Centre for Tax Law at the University of Cambridge. 4  G Wheatcroft, ‘The Attitude of the Legislature and the Courts to Tax Avoidance’ (1955) 10 Modern Law Review 209 and Royal Commission on the Taxation of Profits and Income: Final Report (Radcliffe Commission) (Cmd. 9474, 1955).

The Profits Tax GAAR 223 particularly the 2013 GAAR. The third heading looks backwards and considers the origins of the profits tax GAAR and particularly the fourth heading considers its predecessor in the excess profits tax. The fifth heading of this chapter considers the introduction, operation and expiry of the profits tax GAAR and developments during its currency. The chapter concludes by returning to Wheatcroft’s article and the relationship he drew between the complexity of tax law and tax avoidance. Unfortunately, his main suggestion was not heeded. The deficiencies he identified in the UK tax system in 1955 are multiplied more than tenfold a little over 60 years later. ESSENTIAL ELEMENTS OF A GAAR

Identifying the essential elements of a GAAR is a difficult and inevitably controversial topic. The author has previously expounded one view of the theory and essential elements of a GAAR, and this is not the place for a full engagement with those matters.5 The ‘general’ and ‘rule’ elements are straightforward—a statutory provision of general application in a tax law is what is expected.6 ‘Anti’ is also unproblematic and so we are considering a general statutory rule that is against or opposed to tax avoidance. Of course, the controversy is with tax ‘avoidance’.7 At its most basic: the word ‘avoid’ is used in its ordinary sense—in the sense in which a person is said to avoid something which is about to happen to him. He takes steps to get out of the way of it.8

This presumes that certain actions of a person would give rise to an income tax liability (the hypothetical or counter-factual). However, the person modifies the hypothetical behaviour to something else (by reducing, r­eplacing or adding to the actions) which does not attract a tax liability (the f­actual ­scenario).9 An additional issue is what the rule should do when tax ­avoidance

5  P Harris, ‘The CCCTB GAAR: A Toothless Tiger or Russian Roulette?’ in D Weber (ed), CCCTB: Selected Issues, EUCOTAX Series on European Taxation (The Netherlands: Kluwer Law International, 2012) 271, 276–80. 6 This chapter does not engage with the difference between rules and principles, but see J Freedman, ‘Improving (Not Perfecting) Tax Legislation: Rules and Principles Revisited’ [2010] British Tax Review 717 and the references cited therein. 7  ‘[T]here is no completely satisfactory answer to the question of defining tax … avoidance in an unambiguous manner.’ OECD, Tax Evasion and Avoidance: A Report by the OECD Committee on Fiscal Affairs (OECD, Paris, 1980) 13. 8  Newton v Commissioner of Taxation [1958] AC 450, 464 per Lord Denning. And see the wider view noted in J Avery Jones, ‘Nothing Either Good or Bad, But Thinking Makes It So— The Mental Element in Anti-Avoidance Legislation’ [1983] British Tax Review 9 and 113, 31. 9 In Alesco New Zealand Limited v CIR [2013] NZCA 40, [38]–[39] the New Zealand Court of Appeal rejected the relevance of a counterfactual in applying the New Zealand GAAR. C Elliffe and M Keating, ‘Alesco New Zealand limited v CIR: Concerns Over the Broad Discretion in the Application of the New Zealand GAAR’ [2013] British Tax Review

224  Peter Harris is identified, ie the consequence, and here inevitably the counter-factual is again relevant.10 There is a slippery distinction between an anti ‘abuse’ rule and an anti ‘avoidance’ rule.11 In principle, avoidance can be a simple matter, not involving any assessment of whether it is appropriate or not. However, GAARs are only triggered where something more is involved and this may be generically referred to as ‘abuse’.12 Defining ‘abuse’ is problematic but typically involves a comparison between the tax outcome of a regular application of the tax law to the factual scenario with the outcome the legislature might have intended for the factual scenario (presuming it had turned its mind to it).13 Determining legislative intent is also problematic and, in particular, whether it can be detemined only by reference to the words used in the law or whether and to what extent other extrinsic material may be referred to in overriding the express words used.14 In addition, some GAARs, like the

275, 279 suggest ‘this reasoning is questionable. Whether the taxpayers have actually avoided tax cannot be determined in isolation but presumably only by comparing the tax outcome of the present arrangement with what the taxpayer would or could otherwise have done.’ 10 J Freedman, ‘Designing a General Anti-Abuse Rule: Striking a Balance’ (2014) 20 ­Asia-Pacific Tax Bulletin 167, 171 accepts that a counterfactual ‘is needed in order to know what tax to impose’, but does not identify the relevance of a counterfactual in identifying tax avoidance in the first place. Contrast C Waerzeggers and C Hillier, ‘Introducing a general antiavoidance rule (GAAR)—Ensuring that a GAAR achieves its purpose’ Tax Law IMF Technical Note, IMF Legal Department, 1/2016, 3 who note that in determining whether there is a ‘tax benefit’ (tax avoidance) ‘it becomes necessary … to have regard to what the relevant taxpayer would have reasonably done in the absence of the scheme (ie determining a relevant counterfactual).’ 11  The UK GAAR, like the Canadian GAAR, is concerned with ‘abusive’ ‘tax arrangements’; FA 2013 s 207 and the heading of Part 5. However, ‘tax arrangement’ is defined in terms of obtaining a ‘tax advantage’ which is predominantly defined in terms of ‘avoidance’ of tax; FA 2013, s 208. The GAAR in the 2011 European Commission proposal for a common consolidated corporate tax base directive was entitled ‘General anti-abuse rule’, but only used ‘avoiding taxation’ in its text; see Harris, above n 5, 272. The title is the same in the 2016 Anti-avoidance Directive, but the formulation now refers to a main purpose of ‘obtaining a tax advantage’; see Council Directive 2016/1164 of 12 July 2016 laying down rules against tax avoidance practices that directly affect the functioning of the internal market [2016] OJ L193/1 Art 6. 12  See Avery Jones, above n 8, 31–32 and Lord Wilberforce’s distinction between ‘proper’ and ‘improper’ tax avoidance in Mangin v IRC [1971] AC 739, 755. See also Waerzeggers and Hillier, above n 10, 1 referring to ‘unacceptable tax avoidance’. 13  ‘A GAAR is typically designed to strike down those otherwise lawful practices that are found to be carried out in a manner which undermines the intention of the tax law such as where a taxpayer has misused or abused that law. This is typically achieved by giving the tax authority the power to cancel a particular tax benefit or assess a different (increased) tax liability against the taxpayer in circumstances where the course of action taken by a taxpayer is so blatant, artificial or contrived that it is only explicable by the desire to obtain a relevant tax benefit.’ Waerzeggers and Hillier, above n 10, 1. 14  J Freedman, ‘Interpreting Tax Statutes: Tax Avoidance and the Intention of Parliament’ (2007) 123 Law Quarterly Review 53, 54 draws the connection between determining ‘the intention of the legislature’, ‘tax avoidance’ and the use of ‘non-statutory’ evidentiary material under Pepper v Hart [1993] AC 593. And see the references cited at n 9.

The Profits Tax GAAR 225 2013 UK GAAR, identify the abuse in a motive or intention to avoid tax. This is u ­ sually accepted as being too broad, particularly where the l­ egislature intends the taxpayer to have such a motive in using a particular provision, eg a tax incentive. Finally, presuming a GAAR is triggered, there is the issue of what is the consequence of applying the GAAR. The predominant approach here is to impose tax according to the counterfactual. This combination of considerations has caused the author to previously conclude that ‘the three core elements of a typical GAAR are a reference to legislative intent, abuse by the taxpayer and a counterfactual comparison.’15 It is useful to compare this line of thinking with that of Wheatcroft in 1955. Wheatcroft discussed GAARs, but the focus of his article was on ‘tax avoidance’, which as noted is the critical element in a GAAR. Wheatcroft began his paper by identifying that the ‘[t]he shortest definition I know is “The art of dodging tax without actually breaking the law”… A more precise definition is not easy to frame.’ Nevertheless, he proceeded to define ‘tax avoidance’ as: a transaction which (a) avoids tax, (b) is entered into for the purpose of avoiding tax or adopts some artificial or unusual form for the same puprose, (c) is carried out lawfully, and (d) is not a transaction which the legislature has intended to encourage.16

This is a very different list from the suggested essential elements. W ­ heatcroft’s paragraph (a) tells us little and in particular does not identify the need for a counterfactual. Paragraph (c) seems to be an observation rather than an element of tax avoidance—there seems little point in talking about tax avoidance that is not effective in the first place (eg because it is evasion). Paragraph (d) is the inevitable reference to legislative intent. Paragraph (b) requires further consideration, but is clearly concerned with the abuse element. Wheatcroft thought that ‘[m]otive is … an essential element in tax avoidance’ and this was clear in both parts of his p ­ aragraph (b).17 It seems that for Wheatcroft the motive element was subjective to the tax avoider.18 Whether Wheatcroft took this view on theoretical grounds or whether he was merely observing the approach of the UK in anti-­avoidance rules (discussed below) is not clear. However, it is submitted that a tax 15 

Harris, above n 5, 279. Wheatcroft, above n 4, 209. 17  Wheatcroft, above n 4, 209. It appears that Wheatcroft uses ‘motive’ in the second sense identified by Avery Jones, above n 8, 10, ie to mean ‘purpose’. In Newton v Commissioner of Taxation [1958] AC 450, 465 Lord Denning noted that the ‘word “purpose” means, not motive but the effect which is sought to achieve—the end in view.’ Nevertheless, this chapter is full of quotes from the Revenue using ‘motive’ and ‘purpose’ interchangeably (as Wheatcroft did) and so nothing more is made of this distinction in this chapter. 18  As Avery Jones, above n 8, 27 notes, this ‘means that identical transactions carried out by different taxpayers will have different results.’ And note the cases he cites at 27–29. 16 

226  Peter Harris avoidance motive, at least a subjective motive, is not essential to finding abuse for purposes of designing a GAAR.19 The Australasian GAARs have always operated on the purpose of a transaction being to avoid tax and this is a matter of objective proof and not proof of the subjective intent of the persons involved in the transaction.20 The anti-abuse doctrine of the Court of Justice of the European Union is similar—‘it must also be apparent from a number of objective factors that the essential aim of the transactions concerned is to obtain a tax advantage.’21 Wheatcroft was writing before the publication of the final report of the 1955 Royal Commission. That report devoted chapter 32 to tax avoidance,22 and began with an effort to define it: By tax avoidance … is understood some act by which a person so arranges his affairs that he is liable to pay less tax than he would have paid but for the arrangement.23

This is the simple definition similar to the one noted above in that it does not incorporate any obvious elment of abuse. Further, this definition incorporates the necessary counterfactual, ie what ‘would have’ happened. The report proceeded to suggest that a person owed no duty and should not be under a duty not to alter the person’s affairs ‘for the purpose or for the main purpose or partly for the purpose of bringing’ about a reduction in tax.24

19  To use Wheatcroft’s phrase, it might be considered enough that ‘some artificial or unusual form’ was used to avoid tax. See also the narrower and wider views in Avery Jones, above n 8, 31–32. Avery Jones avoids the subjective/objective dicotomy—‘while some things. … are wholly objective, few things are wholly subjective, and therefore most things are both’, ibid 9. See also G Aaronson, GAAR Study: A study to consider whether a general anti-avoidance rule should be introduced into the UK tax system (London, HM Treasury, 11 November 2011) [5.12]–[5.15] rejecting a test based on purpose for a UK GAAR (although not identifying whether he is referring to subjective or objective purpose) and rather preferring a test based on ‘whether the arrangement is abnormal, in the sense of having abnormal features specifically designed to achieve a tax advantageous result’. It is not clear how one would determine whether an arrangement was designed in a particular manner without investigating its purpose. 20 See Newton v Commissioner of Taxation [1958] AC 450, 465 per Lord Denning and Avery Jones, above n 8, 21–23. With respect to recent authority on the New Zealand GAAR, Elliffe and Keating, above n 8, 280 note that it ‘is established law that the purpose or effect of an arrangement must be determined entirely objectively and not by reference to the subjective motives of the participants.’ C Elliffe and J Cameron, ‘The Test for Tax Avoidance in New Z ­ ealand: A Judicial Sea-Change’, (2010) 16 New Zealand Business Law Quarterly 440, 444–45 make clear that this approach derives from Newton. 21  Case C-255/02 Halifax [2006] ECR I-1609 [2]. 22  Above n 4, [1015]–[1047]. Chapter 31 of the final report of the 1955 Royal Commission dealt with tax administration and chapter 33 dealt with tax evasion. 23  Above n 4, [1016]. This definition was endorsed by the Canadian Carter Royal Commission; Report of the Royal Commission on Taxation, Volume 3 (Ottawa: Queen’s Printer, 1966) 538. The Commission proceeded to more clearly identify the need for a counterfactual—‘[tax avoidance] presupposes the existence of alternatives, one of which would result in less tax than the other.’ However, like Wheatcroft, but unlike the 1955 Royal Commission, the Carter Commission thought that ‘motive would seem to be an essential element of tax avoidance.’ 24  Above n 4, [1017].

The Profits Tax GAAR 227 The Royal Commission understood that the general legal system (which all tax laws must use as a starting point) was often ‘inadequate to serve as the final determinant’ for the allocation of income to particular persons.25 If anti-avoidance rules were to be justified: the tax avoidance that should be struck at is to be found in those situations in which a man, without being in law the owner of income, yet has in substance the power to enjoy it or to control the disposition of it in his own interest.26

The Commission felt this question of using anti-avoidance rules to ­allocate income to particular persons for tax purposes (such as in the settlements, close companies and transfer of assets abroad regimes) should not be confused with the question of ‘what is to be treated as income’. The Commission: found it impossible to formulate any general principle by which to test the propriety of a special legislative intervention … which has the effect of adding to the category of assessable income a limited class of payments to a limited class of person …27

It is submitted that any attempt to deal with tax avoidance though income allocation rules without a power to treat certain income as derived which was never derived is doomed to failure. Perhaps the general principle which the Commission could not find was the counterfactual that it had identified earlier—what would have happened ‘but for the arrangement’.28 COMPARING THE PROFITS TAX AND 2013 GAARS

The purpose of this heading is to compare the profits tax GAAR with some recent GAARs and, in particular, the 2013 UK GAAR. The profits tax GAAR was enacted as section 32 of the Finance Act 1951 in the following form: (1) Where the Commissioners are of opinion that the main purpose or one of the main purposes for which any transaction or transactions was or were effected … was the avoidance or reduction of liability to the profits tax, they may, if they think fit, direct that such adjustments shall be made as respects liability to the profits tax as they consider appropriate so as to counteract the avoidance or reduction … (3) If it appears in the case of [specified types of transactions] that … the main benefit which might have been expected to accrue from the transaction … was the avoidance or reduction of liability to the tax, the avoidance or reduction of

25 

Above n 4, [1019]. Above n 4, [1019]. 27  Above n 4, [1029(3)]. 28  Harris, above n 5, 277 makes a similar distinction in referring to legislative intent: ‘At its most basic in a tax context, a legislator may be presumed to have an intention as to the circumstances in which a tax is to be borne (liability intent) and, in the context of a direct tax, an intention as whom is to bear the burden of the tax (incidence intent).’ 26 

228  Peter Harris liability to the profits tax shall be deemed for the purposes of this section to have been the main purpose … of the transaction … (6) If … the Commissioners are satisfied that the transaction or transactions … have been … entered into for bona fide commercial reasons … their power to give a direction under this section … shall cease …

This rendition did not expressly incorporate any of the three essentials of a GAAR identified under the last heading. Like Wheatcroft’s formulation, it simply referred to avoidance of tax and the purpose of effecting a transaction rather than a counterfactual and abuse. There is no reference to legislative intent. The loose reference to ‘avoidance or reduction’ of tax was to be tested under section 32(1) by reference to a subjective test of the person involved but could also be proved objectively under section 32(3). These points are discussed below under headings 4 and 5. In 1983, Avery Jones (at least indirectly) assessed developments in antiavoidance tax legislation to that point. He observed the proliferation of TAARs (the profits tax GAAR having expired in 1965), an approach broadly in line with the recommendations of the 1955 Royal Commission.29 Avery Jones observed that the TAARs broadly (though not exclusively) fell into two categories. Objective tests of the type found in section 32(3) of Finance Act 1951 were used where taxpayers sought reductions in income (‘reliefs’ or ‘negative income’) whereas subjective tests of the type found in section 32(1) were applied to amounts that ‘would normally be taxable but which are relieved’.30 TAARs continued to proliferate after 1983, although there was a brief flirtation with the possibility of a GAAR in 1997–98.31 Rules on disclosure of tax avoidance schemes were introduced in 2004,32 and the information provided fed the growth of more TAARs. By 2010 there were ‘reportedly around 300 anti-avoidance clauses with unallowable purpose tests’ in UK tax legislation.33 With a change of government a study group was appointed to consider the introduction of a GAAR in the UK. The report in late 2011 recommended a GAAR,34 which was implemented in the Finance Act of 2013. The one section in the profits tax GAAR expanded to nine operative ­sections and a schedule of 13 provisions in the 2013 GAAR.35 The 2013 GAAR applies to ‘counteract’ tax arrangements that are abusive and produce 29 

Above n 4, [1029(1)]. Avery Jones, above n 8, 120–21. 31  See T Bowler, ‘Countering Tax Avoidance in the UK: Which Way Forward?’, Institute for Fiscal Studies Tax Law Review Committee Discussion Paper No. 7 (London: Institute for Fiscal Studies, February 2009) [2.7] and the references cited therein. 32  FA 2004, Pt 7. 33  J Freedman, ‘GAAR: challenging assumptions’, (2010) 1046 Tax Journal 12, 13. For an analysis of many of these TAARs, see Bowler, above n 31, Appendix C, 79–102. 34  Aaronson, above n 19. For a background to this report by one of the participants in the study group, see Freedman, above n 10, 168–69. 35  FA 2013, Pt V and Sch 43. 30 

The Profits Tax GAAR 229 a tax advantage.36 The power of the Commissioners in the profits tax GAAR is replaced with ‘adjustments’ that are ‘just and ­reasonable’.37 Like the profits tax GAAR, the 2013 GAAR makes no reference to a c­ ounterfactual.38 The definition of ‘tax arrangements’ also replaces the Commissioners’ opinion with ‘it would be reasonable to conclude’. The remainder of the definition draws heavily on the profits tax GAAR and, in particular ‘the obtaining of a tax advantage was the main purpose, or one of the main purposes, of the arrangements.’39 While it has been historically accepted that this is a subjective test, the change to ‘it would be reasonable to conclude’ is suggested turns this into an objective test.40 While ‘arrangements’ is broader than the profits tax GAAR ‘transactions’, it encompasses a transaction or series of transactions.41 ‘Tax advantage’ is also straightforward and encompasses both ‘avoidance’ and ‘reduction’ of tax amongst other things.42 In the profits tax GAAR, it is presumed that the abuse lay in having a main purpose of avoiding tax, unless the taxpayer could show they had bona fide commercial reasons for entering into the transaction. In the 2013 GAAR the main purpose of avoiding tax is built into the definition of ‘tax arrangement’. The tax arrangement must also be ‘abusive’ and this is defined in terms of failing to meet the much discussed ‘double reasonableness’ test.43 The incorporation of this test in the 2013 GAAR was new. In assessing whether a tax arrangement is abusive, regard must be had to various things including the principles and policy objectives of the provision that gives rise to the tax advantage. While not a direct reference to legislative intent, this is clearly related.44 On one view, the double reasonableness test is a defence 36 

FA 2013, s 209(1). FA 2013, s 209(2). 38  Freedman, above n 10, 171 accepts the need for a counterfactual but suggests that the ‘just and reasonable’ test was used so ‘that the rules governing counteraction of any transaction caught by the UK GAAR should be very open.’ Aaronson thought that a counterfactual would be relevant, Aaronson, above n 19, [5.37]. 39  FA 2013, s 207(1). 40  ‘The tests in the UK GAAR are all objective.’ Freedman, above n 10, 171. ‘The expression “reasonable to conclude” shows that this is an objective test … It is neither necessary nor appropriate to enquire whether any particular person actually had that intention’; HM Revenue and Customs, General Anti Abuse Rule (GAAR) guidance (approved by the Advisory Panel with effect from 30 January 2015), available at www.gov.uk/government/ uploads/system/uploads/attachment_data/file/399270/2__HMRC_GAAR_Guidance_Parts_ A-C_with_effect_from_30_January_2015_AD_V6.pdf, 16 [C3.3]. Aaronson thought that the GAAR should not apply if the taxpayer could show they had no intent of avoiding tax; Aaronson, above n 19, [5.31]–[5.33]. 41  FA 2013, s 214. 42  FA 2013, s 208. 43  Simply entering this phrase into an internet search engine produces many results discussing this test in the UK GAAR. 44  Aaronson, above n 19, [5.17] rejected the use of legislative intent in designing a GAAR, at least in terms of a result which the legislature ‘did not intend’. However, the discussion proceeded to accept, in a roundabout way, that a GAAR should not apply to ‘arrangements made to secure benefits which are legislatively intended to be available to the taxpayer’; see para 5.20 37 

230  Peter Harris for a taxpayer similar to the ‘bona fide commercial reasons’ defence built into the profits tax GAAR. A matter that may make the 2013 GAAR weaker than the profits tax GAAR is the absence of the main benefits test to deem a tax avoidance purpose. As will be discussed below, this was considered essentail for the success of securing practical application of the profits tax GAAR. ­However, the profits tax GAAR did incorporate a ruling system under which a corporation could apply to the Commissioners with respect to a concluded or prospective transaction and the Commissioners could give a direction that the GAAR would not be applied. It is this system that incorporated the ‘bona fide commercial reasons’ defence. A GAAR was introduced for Scotland in 2014.45 Here the test is the main purpose test, which is couched in similar terms as in the UK GAAR.46 Abuse is defined in terms of whether the arrangement is ‘artificial’, a term with a precedent going back to World War I (discussed below). However, in the Scottish GAAR there is a definition, which defines ‘artificial’ in terms of whether or not the arrangement is ‘a resonable course of action’ or ‘lacks economic or commercial substance’.47 Where the GAAR is applicable, Revenue Scotland can also make ‘adjustments as it considers just and reasonable’.48 There have also been developments in the tax treaty field. In 1983, Avery Jones noted various UK tax treaties that incorporated anti-abuse ­provisions.49 By 2003, an optional treaty GAAR had been embedded into the Commentary on the OECD Model tax treaty.50 This is a ‘purpose-based anti-abuse provision based on UK practice’.51 It applies where ‘the main purpose or one of the main purposes of any person concerned with’ the arrangement is to ‘take advantage’ of the article in question. It seems clear that this is a subjective test. In 2015, the OECD’s Base Erosion and Profits Shifting Final Report for Action 6 proposed insertion of a GAAR in the OECD Model as follows: [A] benefit under this Convention shall not be granted in respect of an item of income … if it is reasonable to conclude, having regard to all relevant facts and circumstances, that obtaining that benefit was one of the principal purposes of any arrangement or transaction that resulted directly or indirectly in that benefit, unless

(quoting the Hong Kong case of Ngai Lik Electronics Company Ltd v Commissioner of Inland Revenue, FACV No 29 of 2008, [101] per Ribeiro PJ). See also, Freedman, above n 10, 170. 45 

Revenue Scotland and Tax Powers Act 2014, Pt 5. Revenue Scotland and Tax Powers Act 2014, s 63(1). 47  Revenue Scotland and Tax Powers Act 2014, s 64. 48  Revenue Scotland and Tax Powers Act 2014, s 66(1). 49  Avery Jones, above n 8, eg 19, n 49. 50  Commentary on Article 1 of the OECD Model Tax Convention, [21.4]. 51 OECD, Preventing the Granting of Treaty Benefits in Inappropriate Circumstances, Action 6—2015 Final Report, OECD/G20 Base Erosion and Profit Shifting Project (OECD Publishing, Paris, 2015), 18. 46 

The Profits Tax GAAR 231 it is established that granting that benefit in these circumstances would be in accordance with the object and purpose of the relevant provisions of this Convention.52

There is clear UK influence in this formulation, although other influences are present as well, especially use of the ‘principal purpose’ test borrowed from the United States.53 The reference to ‘object and purpose’ of the provisions (presumably determined by reference to the intentions of the contracting states) is more direct than under the 2013 UK GAAR. There have also been developments at the European Union level. In 2015 a GAAR was inserted into the Parent-Subsidiary Directive and it has clear UK influence. The ‘benefits’ of the Directive are to be denied for arrangements: which, having been put into place for the main purpose or one of the main purposes of obtaining a tax advantage that defeats the object or purpose of this ­Directive, are not genuine having regard to all relevant facts and circumstances.54

This is a strange mixture of UK influence with the jurisprudence of the Court of Justice of the Euopean Union.55 The UK influence is dropped in the GAAR in the recent European Commission Directive against tax avoidance.56 Notwithstanding that one of the justifications for the 2013 UK GAAR was to dampened a perceived need for TAARs,57 TAARs continue to proliferate. To take but one example, a new TAAR was enacted in 2016 in reponse to the increased taxation of dividends. The government is concerned that small companies will retain profits, then distribute them in liquidation and then a similar company will be reincorporated (phoenix companies). The antiavoidance rule is broadly consistent with the 2013 GAAR, but importantly has no defence based on double reasonableness, a matter returned to at the end of this chapter.58 52  OECD, above n 51, 55. See also Art 7(1) of the draft Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting, available at www.oecd.org/tax/treaties/multilateral-convention-to-implement-tax-treaty-related-measuresto-prevent-beps.htm. 53  For example, US Model Income Tax Convention (2016) Art 22(6) (limitation on benefits, or LOB) and Avery Jones, above n 8, 19, n 49. The likely explanation for the change from the ‘one of the main purposes’ test currently used in the Commentary on Art 1 of the OECD Model to the ‘principal purpose’ test in the proposed treaty GAAR is in consistency with the proposed LOB article also proposed by the Action 6 Report. The LOB article is based on US practice and has a residual principal purpose test as in the current US model. See Art 7(12) of the draft Multilateral Convention, above n 52. 54  Parent-Subsidiary Directive, Council Directive 2011/96/EU of 30 November 2011 Art 1(2) as amended by Council Directive 2015/121/EU of 27 January 2015. 55  In particular, as in Case C-196/04 Cadbury Schweppes [2006] ECR I-7995 (ECJ) [54], [66], [68], [70] and [75]. 56  Anti-avoidance Directive, above n 11, Art 6. This GAAR is fundamentally different from the version in the previous proposed Directive for a Common Consolidated Corporate Tax Base considered in Harris, above n 5. 57  See Aaronson, above n 19, 5 benefits (iv) and (v) of the proposed GAAR. 58  Income Tax (Trading and Other Income) Act 2005, s 396B inserted by FA 2016, s 35. One of the conditions for the rule to apply is that ‘it is reasonable to assume, having regard to all the circumstances, that … the main purpose or one of the main purposes of the winding up is the avoidance or reduction of a charge to income tax …’

232  Peter Harris ORIGINS OF THE PROFITS TAX GAAR

The significance of the profits tax GAAR in the development of current GAARs and TAARs is clear, but where did the profits tax GAAR come from? That is the question to which this chapter now turns. To the 1930s In 2007 the author traced the origins of the Australian and New Zealand GAARs to UK provisions that had their ‘deepest roots in Tudor England’.59 By the reintroduction of income tax in the UK in 1803, these roots were present in three sections; the fraud provision, the contracts provision and, from 1806, the void provision. The fraud provision applied to persons acting fraudulently in order to not be charged ‘according to the true Intent and Meaning of this Act’.60 The contracts provision applied to render ineffective contracts between landlords and tenants touching the payment of tax that were ‘contrary to the Intent and Meaning of this Act’.61 The void provision rendered ‘utterly void’ provisions in contracts that sought to prevent deduction at source.62 These three provisions were reproduced in the income tax of 1842.63 In their historical context, the UK contracts, void and fraud provisions were bound up with three primary issues; the taxation of land, deduction at source and Parliamentary intent as to the incidence of tax rather than the circumstances in which a liability to tax arises (incidence intent rather than liability intent). When the Australasian colonies looked to the UK in developing their own income taxes in the second half of the nineteenth century,

59 P Harris, ‘Fair in Love but not Taxation: English Origins of the Australasian General Anti-Avoidance Rule’, (2007) 61 Bulletin for International Taxation 65 and 109, 124. 60  An Act for granting to his Majesty, until the sixth Day of May next after the Ratification of a Definitive Treaty of Peace, a Contribution on the Profits arising from Property, Professions, Trades, and Offices (43 Geo 3 c 122. 1803) s 156. 61  43 Geo. III, c. 122 (1803) s 212. 62  An Act for granting to His Majesty, during the present War, and until the Sixth Day of April next after the Ratification of a Definitive Treaty of Peace, further additional Rates and Duties in Great Britain [on the Rates and Duties on Profits] arising from Property Professions Trades and Offices; and for repealing an Act passed in the Forty-fifth Year of His present Majesty, for repealing certain Parts of an Act made in the Forty-third Year of His present Majesty, for granting a Contribution on the Profits arising from Property Professions Trades and Offices; and to consolidate and render more effectual the Provisions for collecting the said Duties (46 Geo 3 c 65. 1806), s 115. 63  An Act for granting to Her Majesty Duties on Profits arising from Property, Professions, Trades, and Offices, until the Sixth Day of April One thousand eight hundred and forty-five (5 & 6 Vic c 35. 1842), ss 73 (contracts provision), 103 (void provision) and 178 (fraud provision).

The Profits Tax GAAR 233 these provisions morphed into the New Zealand and Australian GAARs.64 The earliest version of these was in the 1877 Victorian land tax,65 which was further developed in the New Zealand land tax of 1878.66 The UK contracts provision was adapted to the 1879 New Zealand property tax.67 Similar early versions of GAARs were included in the Tasmanian real and personal estates duties law,68 and in the South Australian income tax of 1884 (the first Australasian income tax).69 When New Zealand replaced its property tax with a land and income tax in 1891, its GAAR prototype only applied to land tax.70 The infant Australasian GAARs did not clearly break their connection to land taxation until a new provision was inserted into the New South Wales Income Tax Bill of 1893 when it was in committee.71 While this Bill did not pass, its GAAR was incorporated in the New South Wales income tax of 1895.72 In the same year Victoria included a GAAR in its income tax, which was not quite the same.73 In 1900, New Zealand consolidated its land and income tax law and in doing so rewrote its GAAR taking into account the earlier New Zealand, New South Wales and Victorian GAARs.74 This settled as the New Zealand form of GAAR and formed the prototype for the Australian GAAR when federal income tax was introduced in 1915.75 Notably, when income tax was introduced in Cape Colony in 1904 it did not include a GAAR, despite having been based on the New South Wales law of 1895.76 By contrast, when Natal introduced an income tax in 1908 it included a GAAR based on the New Zealand version of 1900.77 When the

64 

Harris, above n 59. Land Tax Act 1877 (Victoria), s 55. 66  Land Tax Act 1878 (New Zealand), s 62. In Mangin v IRC [1971] AC 739, 753 Lord Wilberforce (dissenting) noted that this provision was comparable ‘to the policy in Great ­Britain concerning landlords’ property tax’. 67  Property Tax Act 1879 (New Zealand), s 29. 68  Real and Personal Estates Duties Act 1880 (Tasmania), s 51. 69  Taxation Act 1884 (South Australia), s 76. 70  Land and Income Assessment Act 1891 (New Zealand), s 40. 71  See Harris, above n 59, 115–16 and the references cited therein. In particular it is worth repeating the comments of Mr Neild in the House of Assembly that the GAAR ‘is a very vicious, iniquitous, and specious clause’, ‘[i]t is about the worst clause in the bill’, ‘I could not be pleased with rubbish of this kind’ and ‘such a clause could only have been designed by a politician absolutely desperate’. 72  Land and Income Tax Assessment Act of 1895 (New South Wales), s 63. 73  Income Tax Act 1895 (Victoria), s 44. 74  Land and Income Assessment Act 1900 (New Zealand), s 82. 75 Income Tax Assessment Act 1915 (Australia), s 53. And see Mangin v IRC [1971] AC 739, 753 per Lord Wilberforce (dissenting) referring to the 1900 New Zealand GAAR as the ‘parent’ of the subsequent Australian and New Zealand GAARs. 76  Additional Taxation Act 1904 (No. 36 of 1904) (Cape), Pt II. 77  Income and Land Assessment Act 1908 (No. 33 of 1908) (Natal), s 75. 65 

234  Peter Harris Union of South Africa introduced an income tax in 1914,78 it was based on the Cape law and so did not include a GAAR.79 The next development occured when the UK introduced excess profits duty in 1915 during World War I. At this time the Income Tax Act of 1842 was still in force and had not been reinforced from an avoidance perspective despite the introduction of differentiation in 190780 and progression in 1911.81 However, the narrow base and high rates of the excess profits duty made it particularly prone to avoidance. The law included a provision in the following terms: A person shall not, for the purpose of avoiding the payment of excess profits duty, enter into any fictitious or artifical transaction or carry out any fictitious or artificial operation …82

The Revenue described this provision as applicable to ‘devices to evade duty’, demonstrating that at this time ‘evade’ and ‘avoid’ were still being used in a mixed way.83 The only express consequence of breaching this provision was the imposition of a 100 pound fine. The Revenue described this as ‘small’ but thought that ‘the fear of publicity in a Court of summary jurisdiction is itself a deterrent’.84 A related provision was inserted in the rules for calculating the tax base. Under this provision, a deduction was denied for ‘any transaction or operation … to the extent to which it appears, that the transaction or operation has artificially reduced’ profits.85 This provision required no purpose of avoiding tax. There is no obvious connection between these 1915 provisions and the UK contracts, void or fraud provisions or the Australasian GAARs.

78 

Income Tax Act 1914 (No. 28 of 1914) (South Africa). regarding these developments, see P Harris, ‘Income Tax in South Africa and Australia Turn 100: A Letter from the Queen for the Dizygotic Twins?’ [2015] British Tax Review 93 and the references cited therein. 80 Differentiation (earned income relief) was first introduced by FA 1907, s 19, which applied a lower rate to earned income within a certain threshold. 81  In the form of Super-tax, see F (1909-10) A 1910, s 66. 82  F (No. 2) A 1915, s 44(3). 83  Board of Inland Revenue, Finance (No. 3) Bill: Report Stage (1915) 29. If ‘evasion’ were not dealt with the result would be ‘heavily penalising the straightforward taxpayer in comparison with his less scrupulous or more ingenious fellows’; Board of Inland Revenue, Finance (No. 3) Bill: Notes on Amendments (1915) 228. Regarding the historical mixed use of ‘avoid’ and ‘evade’; see Harris, above n 59, which provides many examples of the terms being used interchangeably. 84  Board of Inland Revenue, Finance (No. 3) Bill: Report Stage (1915) 29. 85  F (No 2) A 2015, Sch IV, Pt I, para 5. And see P Harris and JD Oliver, ‘Family Connections and the Corporate Entity: Income Splitting through the Family Company’, in J Avery Jones, P Harris and JD Oliver (eds), Comparative Perspectives on Revenue Law: Essays in Honour of John Tiley (Cambridge, Cambridge University Press, 2008) 257–58. 79  Generally

The Profits Tax GAAR 235 When the excess profits duty was in committee, there were attempts to define ‘artificial’.86 One proposal was to put the onus of proof on the taxpayer to show that the ‘sole explanation’ for the transaction was ‘some reasonable business object’.87 Another was to incorporate a test by reference to a counterfactual—‘escape payment of duty which but for such transaction or operation would have been payable’.88 The Revenue could accept something like the former but the response with respect to the latter was less welcoming. The Revenue thought it would change what the Revenue needed to prove to ‘intention’ of the transaction and ‘intention is extremely difficult—often impossible—to prove.’89 The void provision and, to a lesser extent, the contracts provision of the 1842 UK income tax morphed into Rule 23(2) of the General Rules in the Schedules to the Income Tax Act 1918, which provided: ‘Every agreement for payment of interest, rent, or other annual payment in full without allowing any such deduction shall be void.’90 The UK fraud provision became section 132 of the 1918 Act. Both the artificial transaction penalty and no deduction rules of the excess profits duty were included in the corporation profits tax in 1920.91 These rules expired with corporation profits tax in 1921. The no deduction rule in the excess profits duty came before UK courts in a number of cases.92 In Johnson Bros the taxpayer argued that an arrangement with his sons was ‘bona fide’ rather than ‘artificial’, which Rowlatt J accepted but held that in any case the sons had received a share of profits (no deduction) rather than wages.93 In Scottish Adhesives there was a partnership restructure, which the Special Commissioners found artificially reduced profits.94 The Court of Session said this was a finding of fact and

86  In assessing F (No 2) A 1915, s 44(3), the 1955 Royal Commission said that the ‘objection to a criterion based on phrases of this kind is that if a transaction really is fictitious it ought to be ignored, without the aid of special legislation; and a transaction is not well described as “artificial” if it has valid legal consequences, unless some standard can be set up to establish what is “natural” for the same purposes.’ Above n 4, [1024]. 87  Board of Inland Revenue, Finance (No. 3) Bill: Notes on Amendments (1915) 236A per Scott. 88  Board of Inland Revenue, Finance (No. 3) Bill: Notes on Amendments (1915) 237 per Scott. 89  Board of Inland Revenue, Finance (No. 3) Bill: Notes on Amendments (1915) 237. 90  See P Smyth, Dowell’s Income Tax Laws, 9th edn (London, Butterworth & Co, 1926) xviii, xix and 716 making the connection with Income Tax Act 1842, ss 73 and 103. 91  FA 1920, ss 53(2)(d) (no deduction) and 55(4) (penalty), respectively. There is only brief discussion of these provisions in the Board of Inland Revenue, Finance Bill, 1920: Notes on Clauses (1920) 81 and 89, respectively. 92  See J Simon, Simons Income Tax, Service Volume (London, Butterworth & Co, 1948–) [849]. Generally regarding excess profits duty cases, see P Ridd, ‘Excess Profits Tax Litigation’ in J Tiley (ed), Studies in the History of Tax Law, Vol 2 (Oxford, Hart, 2007) 137, 118. 93  Johnson Bros & Co v IRC [1926] 2 KB 717. 94  Scottish Adhesives Co v CIR (1922) 1 ATC 42.

236  Peter Harris refused to interfere with it. In Young there was a blatant attempt at accelerating a loss by altering the terms of forward yarn sales contracts. The Court of Session had no trouble in finding that the alteration was artificial. Clyde LP concluded that ‘the re-arrangement made with the sellers of the yarn made no substantial change in the relations of purchaser and seller’.95 The financial pressures of World War I and its fallout caused the introduction of income tax in other parts of the British Empire and some of the implementing laws included GAARs. The Straits Settlements (now S­ ingapore and parts of Malaysia) introduced an income tax in 1917. In 1919 it enacted a provision making ‘void and of no effect’ a contract between landlord and tenant shifting the incidence of the landlord’s tax to the ­tenant.96 This seems to have been influenced directly or indirectly by the 1842 UK contracts provision. Kenya introduced income tax in 1920.97 It is clear that the drafter had before them the Tasmanian income tax law of 1910,98 which the ­Kenyan law most closely resembled. However, the drafter also had before them the New Zealand consolidation of 1908 because the Kenyan law incorporated the New Zealand GAAR, virtually word for word.99 Fiji also introduced an income tax in 1920. In its 1921 incarnation it included a provision ignoring transfers of property between family members unless the ‘Commissioner is satisfied that such transfer or assignment was not made for the purpose of evading the taxes imposed under this ­Ordinance’.100 By contrast, Barbados introduced an income tax in 1921 and this law, like the Kenyan law, included a GAAR based on the New Zealand precedent.101 Despite these examples, there was no widespread adoption of GAARs outside Australasia at this time and the model income tax ordinance for colonies produced by the inter-departmental committee in late 1922 did not include one.102 With respect to the Australasian GAARs, initially the courts were true to the focus of the UK contracts provision and only applied the new GAARs to cases dealing with shifting of incidence of tax, and not whether a liability to tax arose in the first place. However, this began to change from 1922 when the Australasian courts began to apply the GAARs to matters of liablity intent.103

95 

J H Young & Co v CIR (1925) 12 TC 827, 839. War Tax Ordinance 1919 (No 3 of 1919) (Straits Settlements), s 47. 97  Income Tax Ordinance 1920 (No 23 of 1920) (Kenya). 98  Land and Income Taxation Act 1910 (No 47 of 1910) (Tasmania). 99  Compare Income Tax Ordinance 1920 (No 23 of 1920) (Kenya), s 55 with Land and Income Assessment Act 1908 (No 95 of 1908) (New Zealand), s 103. 100  Income Tax Ordinance 1921 (No 1 of 1921) (Fiji), s 11(5). 101  Income Tax Act 1921 (No 35 of 1921) (Barbados), s 52. 102 Report of the Inter-Departmental Committee on Income Tax in the Colonies Not ­Possessing Responsible Government (Cmd. 1788, 1922). 103  Generally, see Harris, above n 59, 124–25. Note Lord Wilberforce’s (dissenting) observation in Mangin v IRC [1971] AC 739, 754 that at least from 1900 the New Zealand GAAR arguably had ‘fiscal effect’. 96 

The Profits Tax GAAR 237 1930–40 In 1936 the UK enacted the first version of its transfer of assets abroad regime. As a defence to applicaton of this regime, the taxpayer could show: that the transfer and any associated operations were effected mainly for some purpose other than the purpose of avoiding liability to taxation.104

In referring to this defence, the Revenue suggested that the regime was ‘aimed at taxpayers who transfer assets to a person abroad with the deliberate intention of reducing their tax liability.’105 In justifying the generality of the approach, the Reveue suggested that: any attempt to define transactions so as to distinguish what is avoidance of taxation and what is genuine business only provides for the experts engaged in preparing avoidance schemes a fresh jumping off ground for new methods of avoidance.106

The Revenue preceeded to pre-empt the arguments against the generality: Objection may be raised to the proviso for its introduction of a ‘motive’ test. It may be urged that the canon that Parliament should impose taxation with ­certainty is infringed by the proviso, inasmuch as its effect is to enable the ­taxation authority to vary the burden on individuals at its discretion. It may even be contended that, instead of proceeding by means of these ‘Star Chamber’ methods, the Income Tax law should be so amended that it will state clearly what income of the individual is taxable, leaving it to him, if he can, so to dispose of his property that it attracts the minimum of taxation, in other words, that the canon of certainty in taxation implies certainty for the tax avoider as well as for the ordinary citizen.107

The ‘canon of certainty’ is surely a reference to one of Adam Smith’s principles of taxation.108 Further, the reference to the individual being permitted to avoid tax ‘if he can’ echos the approach in the Westminster case, which had been decided by the House of Lords in the middle of 1935.109 The Revenue would have none of it. It retorted that specifically legislating ‘against particular legal forms of tax avoidance … has been found to be quite impossible’. Further, a series of specific exceptions (as opposed to the general one): would give the tax expert ample opportunity so to arrange the affairs of the tax dodger that his transactions would come within the exceptions provided and so defeat the object of the legislation.110 104 

FA 1936, s 18(1). Board of Inland Revenue, Finance Act, 1936: Notes on Clauses 18 [12]. 106  Board of Inland Revenue, Finance Act, 1936: Notes on Clauses 18 [12]. 107  Board of Inland Revenue, Finance Act, 1936: Notes on Clauses 19 [16]. 108 A Smith, An Inquiry into the Nature and Causes of the Wealth of Nations (1776), Vol 36 of M Adler (ed), Great Books of the Western World, 2nd edn (Chicago, Encyclopedia ­Britannica Inc, 1990) Book V Chapter II Part II. 109  IRC v Duke of Westminster [1936] AC 1. 110  Board of Inland Revenue, Finance Act, 1936: Notes on Clauses 19 [17]. 105 

238  Peter Harris This early reference to legislative object or intent is interesting. As for certainty: if the forms of the law are being juggled with so as to make transactions appear to be what they really are not, the plea for certanty fails … Certainty predicates good faith and truth, and a person who clothes one transaction in the guise of another had neither quality to support his plea.111

When the provision was in Committee Stage, it was suggested that the onus should be on the Revenue to prove the tax avoidance purpose rather than the taxpayer. The Revenue defended the provision on the basis that the object of the defence was ‘not so much to provide a basis for charging the tax avoider as to provide a means for protecting the innocent from the incidence of the charge’. It was the taxpayer alone that had ‘the necessary information … to determine the object with which he entered into the transaction.’ It seems clear that the intention was that the taxpayer show a subjective purpose.112 The transfer of assets abroad regime was altered two years later in 1938 in two respects that are presently relevant.113 First, it was extended to cover ‘artifical transactions’ involving loans.114 Secondly, the main purpose test in the ‘motive proviso’ had proved difficult. An eye-watering 300–400 cases had been challenged under the provision since 1936.115 The defence was changed to a two-headed test. Either the taxpayer had to show that they had no tax avoidance purpose or ‘that the transfer and any associated operations were bona fide commercial transactions and were not designed for the purpose of avoiding liability to taxation’.116 It will be recalled that ‘genuine business’ transactions were never intended to be within the scope of the regime and the Revenue had suggested in 1936 that certainty should only be available to taxpayers acting in good faith. The Revenue ­understood that the regime would now more readily catch ‘transfers which are not c­ ommercial transactions’ and saw ‘nothing unreasonable’ in that.117 The transfer of assets abroad regime was applicable to income tax generally. In 1937 the national defence contribution was introduced based on excess

111 

Board of Inland Revenue, Finance Act, 1936: Notes on Clauses 19 [18]. of Inland Revenue, Finance Act, 1936: Committee Stage 11 [4]. Again at 12 [6] the taxpayer ‘can say at once what were the motives which prompted him to carry through the operations.’ 113  FA 1938, s 28. 114  Board of Inland Revenue, Finance Act, 1938: Notes on Clauses 59. 115  Board of Inland Revenue, Finance Act, 1938: Notes on Clauses 61 [11]. Page 62 [12] recounts a case where the taxpayer was ‘afraid of what a Labour Government … might do with his property’ and so he transferred it to the US. He succeeded before the Commissioners in arguing that his ‘main motive’ was to protect his capital and not to avoid tax. 116  FA 1936, s 18(1B) inserted by FA 1938, s 28. 117  Board of Inland Revenue, Finance Act, 1938: Notes on Clauses 63 [15]. 112  Board

The Profits Tax GAAR 239 profits duty.118 The law included from the excess profits duty the rule ­denying a deduction for artificial transactions,119 but did not include the rule providing a penalty for an artificial transaction with the purpose of avoiding tax. The Revenue’s Notes on Clauses repeated the brief discussion from the 1920 corporation profits tax equivalent, but using the words ‘check upon avoidance’ rather than ‘check upon evasion’.120 In 1937 the UK also introduced its first rules dealing with transactions in securities.121 While the heading of the section referred to ‘avoidance’ there was no reference to ‘purpose’, ‘avoidance’ or ‘legislative intent’ in the text of the section. An interesting parallel development occured in Canada in 1938. Before 1938, Canada had various provisions targetted at ‘surplus stripping’, but in that year it intoduced a targeted rule and a more general provision.122 It seems that the general provision was originally targetted at similar arrangements as the UK transfer of assets abroad regime. Like that regime the provision would not apply unless ‘the transaction was entered upon for the purpose of avoiding liablity to taxation’.123 In 1939, UK national defence contribution was supplemented with excess profits tax.124 The latter followed the former in including the provision denying a deduction with respect to artifical transactions and not including the rule providing a penalty for an artificial transaction with the purpose of avoiding tax.125 The relevant Revenue note on this provision continued to simply repeat from the discussion of the 1920 corporation profits tax provision.126 The Canadian general provision mentioned above was replaced in 1940: [The] Treasury Board may in its discretion determine that any transaction has artifically reduced or would reduce taxation and has no reasonable business purpose other than that of avoiding or minimizing taxation hereunder and that no deduction shall be allowed with respect to any expense or disbursement resulting therefrom …127

It seems clear that the reformulation of this provision was influenced by developments in the UK from 1937–39. 118 

FA 1937, ss 19–25. FA 1937, Sch IV para 10. 120  Board of Inland Revenue, Finance Act, 1937: Notes on Clauses 122. 121  FA 1937, s 12 and generally see Wheatcroft, above n 4, 225 and Harris and Oliver, above n 85, 278–79. 122  Stripping of Corporate Surplus, Studies of the Royal Commission on Taxation, No. 15 (Ottawa, Queen’s Printer, 1963) 14–17. 123  Income War Tax Act (RS 1927 c 97) (Canada), s 32A inserted by An Act to amend the Income War Tax Act (2 Geo 4 c 48. 1938) (Canada), s 7. 124  F (No 2) A 1939, Pt III. 125  F (No 2) A 1939, Sch VII, para 9. 126  Board of Inland Revenue, Finance (No. 2) Bill, 1939: Notes on Clauses 107–108. 127  Income War Tax Act (RS 1927 c 97) (Canada), s 32A replaced by An Act to amend the Income War Tax Act (4 Geo 4 c 34. 1940) (Canada), s 24. 119 

240  Peter Harris EXCESS PROFITS TAX GAAR

In 1940, in the depths of World War II, the Government increased excess profits tax to 100 per cent.128 At that time, the Chancellor warned the public that he would not hesitate to introduce retrospective legislation to deal with tax avoidance if ‘anyone is resorting to any device calculated to circumvent the provisions and the intention of Parliament’.129 This happened in 1941 with the introduction of a GAAR for the excess profits tax.130 The clause in the Bill (clause 26) originally read: Where the Commissioners are of opinion that the purpose, or one of the purposes, for which any transaction or transactions was or were effected (whether before or after the passing of this Act) was the avoidance or reduction of liability to excess profits tax, they may, if they think fit, direct such adjustments shall be made as respects liability to excess profits tax as they consider appropriate so as to counteract the avoidance …

The Revenue’s Notes on Clauses listed the type of transactions that had been causing difficulty. These included averaging (eg merger with a loss business, or acquisition of shares in a loss company followed by consolidation, referred to as ‘buying a standard’) and splitting (five farms to be run by five companies to get five minimum standards, transfer of shares so a company was no longer a director-controlled company and director remuneration could be deducted, and a controller of a company charging rent and royalties to reduce company profits).131 The urgency of the war was used to justify such ‘wide discretionary powers’: It would clearly be hopeless to attempt to legislate for each particular device … The only possible remedy is by means of a general avoidance provision, sweeping in character, designed to cover all methods of avoidance.132

In what can be only a reference to ‘purpose’, the Revenue considered that ‘enquiring into a person’s motives in carrying out a transaction is not new in tax avoidance law.’ In particular, the Revenue referenced the transfer of assets abroad regime (discussed above) as having ‘proved successful in counteracting avoidance’.133 It will be recalled that that regime had been amended in 1938 so that any purpose of avoiding tax might result in the

128 

F (No 2) A 1939, s 12 as amended by FA 1940, s 26(1). of the Exchequer (Wood) speaking in the House of Commons; HC Deb 5 June 1940, vol 361, col 947, quoted in Board of Inland Revenue, Finance Bill, 1941: Notes on Clauses 26b [5]. 130  FA 1941, s 35(1). 131  Board of Inland Revenue, Finance Bill, 1941: Notes on Clauses 26a [2]. 132  Board of Inland Revenue, Finance Bill, 1941: Notes on Clauses 26b [3] and [4]. 133  Board of Inland Revenue, Finance Bill, 1941: Notes on Clauses 26b [4]. 129 Chancellor

The Profits Tax GAAR 241 application of the provision unless the taxpayer could show it was a ‘bona fide commercial transaction’. Further, the transfer of assets abroad regime was effectively a defence for the taxpayer (the primary test being whether the taxpayer retained control over income). By contrast, having any avoidance purpose was the primary test in the 1941 clause. Further, there was no bona fide commercial transaction saving. So despite the reference to the transfer of assets abroad regime, the 1941 clause was much broader. As for the Revenue’s power of counteraction: In some cases the liability may be adjusted to what it would have been if the avoidance transactions had not taken place; in others, it may not be possible to make any precise calculation on these lines.

This is a limited recognition of the relevance of a counterfactual, but the Revenue continued to note that their ‘sweeping powers’ were not limited in this way.134 During the debate at the committee stage criticism was directed against the clause on the basis that the Revenue’s power was ‘too drastic’ and that ‘bona fide commercial transactions’ might be caught.135 The reference to ‘the purpose, or one of the purposes’ was changed to ‘the main purpose’.136 However, the Chancellor warned that if he found that the amendment ‘destroyed’ the provision he would ‘come back to the House and ask it to reverse its decision’.137 It seems likely that this new test was a variation of the ‘mainly for some purpose’ test used in 1936 in the transfer of assets abroad regime. Further, a proposed amendment at the committee stage would have reformed the test to refer to ‘improperly avoided’.138 The arguments used by the Revenue to resist this proposal are remarkably like some of the discussion in the Canadian Carter Royal Commission 25 years later.139 In the same year (1941), South Africa introduced a GAAR into its income tax: Whenever the Commissioner is satisfied that any transaction or operation had been entered into or carried out for the purpose of avoiding liability … or r­ educing

134 

Board of Inland Revenue, Finance Bill, 1941: Notes on Clauses 26c [7]. Board of Inland Revenue, Finance Bill, 1944: Notes on Clauses 44 [6]. 136  Board of Inland Revenue, Finance Bill, 1941: Report Stage 18. 137 Chancellor of the Exchequer (Wood) speaking in the House of Commons; HC Deb 1 July 1941, vol 372, col 1277, quoted in Board of Inland Revenue Finance Bill, 1944: Notes on Clauses 44 [6]. 138  See proposal of Mr Denman in Board of Inland Revenue, Finance Bill, 1941: Committee Stage 29. 139  ‘But the avoidance of taxation is not legally “improper” where the transaction itself is proper and properly carried out.’ In the Revenue’s view, ‘improper’ would ‘only’ refer to ‘fraud, misrepresentation, etc.’ Board of Inland Revenue, Finance Bill, 1941: Committee Stage 29. Compare, the Canadian Carter Royal Commission, above n 23, 569–70. 135 

242  Peter Harris the amount of any … tax, any liability … may be determined as if the transaction or operation had not been entered into or carried out.140

The South African provision continued to provide a rebuttable presumption of a purpose to avoid tax if avoidance of tax was in fact proved. The reference to ‘transaction or operation’ is the same as used in the denial of a deduction rule in the UK’s national defence contribution. The phrase ‘purpose of avoiding liability’ seems drawn from the UK’s transfer of assets abroad regime. The combined references to ‘avoiding’ and ‘reducing’ tax may have been drawn from the UK excess profits tax GAAR. By comparison, in 1943, Canada simply replaced its GAAR from 1940 with what was essentially a copy of the UK excess profits tax GAAR.141 The UK Revenue continued to have problems with avoidance of excess profits tax: The criterion of “main purpose” has proved to be the difficulty in administering [the excess profits tax GAAR]. There is considerable activity on the E.P.T. avoidance front, and the Revenue has lost many cases on appeal that were plainly governed by the idea of avoidance but were represented in such a fashion that the Revenue could not prove that avoidance was the main purpose. It is very difficult for the Revenue to adduce, as a matter of evidence, facts to rebut a taxpayer’s contention that, whatever ideas of avoidance may have been in his head, the main purpose of his transactions was the more efficient running of his business, the fulfilment of some family obligation and so on. At present the Head Office of the Inland Revenue has under consideration nearly 2,000 cases of avoidance of E.P.T., and fresh cases are arriving at the rate of 40 or 50 a week … There have been about 180 appeals to the Special Commissioners … and rather more than half of them have been lost by the Revenue; and of the cases which have been heard since the beginning of 1944 the losses have been appreciably higher.142

The Revenue thought that it was ‘crippled’ by the main purpose test.143 Rather than returning to the original draft of 1941, the approach in 1944 was rather ‘a half-way house between the “main purpose” test embodied in section 35 and the “one of the purposes” test as originally introduced.’ The result was the two tests reproduced under the second heading above in the context of the profits tax GAAR. It seems clear that the ‘main ­purpose or one of the main purposes’ test was intended to be subjective. It is equally clear that the main benefit test was intended to apply where ‘the taxpayer denies that avoidance ever entered his mind (or maintains that it is quite incidental).’ The result was that the subjective test of main purpose was

140  Income Tax Act (No 31 of 1941) (South Africa), s 90. And see E Mazansky, ‘A New GAAR for South Africa—The Duke of Westminster is Struck a Blow’ (2006) 60 Bulletin for International Taxation 124, 124. 141  Income War Tax Act (RS 1927 c 97) (Canada), s 32A replaced by An Act to amend the Income War Tax Act (7 Geo 4 c 14, 1943) (Canada), s 17. 142  Board of Inland Revenue, Finance Bill, 1944: Notes on Clauses 42–43 [3]. 143  Board of Inland Revenue, Finance Bill, 1944: Notes on Clauses 43 [4].

The Profits Tax GAAR 243 ‘presumed’ to have been met where the objective main benefit test was met.144 The new test enacted in 1944 had retrospective effect.145 The excess profits tax GAAR was interpreted on a number of occasions by UK courts.146 Crown Bedding was a consolidation case where the main benefit test was applied.147 The issue was what degree of likelihood that the benefit would materialise was required by the test. The main benefit test was also in issue in Marshall Castings. Here it was held that the tax benefit to the company must be weighed against other benefits to the company and not benefits to other persons such as directors.148 In Dixon & Gaunt, Atkinson J made it clear that in making a direction under the GAAR the initial burden of proof rested on the Revenue—‘a man charged with evasion should be told what the facts are on which the Commissioners of Inland Revenue rely, on which they base their opinion and their charge.’149 In 1948, Canada again reformulated its GAAR in apparent response to developments in the UK: Where the Treasury Board has decided that one of the main purposes for a transaction or transactions … was improper avoidance or reduction of taxes that might otherwise have become payable under the Act … the Treasury Board may give such directions as it considers appropriate to counteract the avoidance or reduction.150

It seems likely that the ‘one of the main purposes’ test was picked up from the 1944 amendments to the UK excess profits tax GAAR. Other features of this modified Canadian version are not so easily explained by reference to UK practice. The reference to ‘might otherwise have become payable’ clearly contemplated a counterfactual. The reference to ‘improper avoidance’ is also peculiar. In 1966 the final report of the Canadian Carter Royal Commission noted that the provision ‘contains no standards or guide-posts’ by which improper avoidance might be judged and proceeded to outline difficulties with the provision.151 It also noted that this ‘broad’ power had ‘never been interpreted by the courts’.152 144 

Board of Inland Revenue, Finance Bill, 1944: Notes on Clauses 44 [8]. FA 1944, ss 33(2) amending FA 1941, ss 35(1) (one of the main benefits test) and 33(3) (main benefit test). See Avery Jones, above n 8, 15 noting that ‘it is harder for the Revenue to succeed under a main purpose than under a main benefit test, since the person concerned may not correspond with the reasonable man.’ See also at 113–14 and Wheatcroft, above n 4, 224. 146  Ridd, above n 92, 169–71 notes 16 cases. And see Avery Jones, above n 8, particularly at 114–16. 147  Crown Bedding Co Ltd v IRC (1946) 34 TC 107. 148  Marshall Castings Ltd v IRC [1946] 2 All ER 21. 149  Dixon & Gaunt Ltd and Another v IRC [1947] 1 All ER 723, 726. 150  Income Tax Act (11–12 Geo 4 c 52, 1948) (Canada), s 126. 151  Above n 23, 568–70. See also the discussion above at n 138 regarding a proposed amendment during the passage of the UK excess profits tax GAAR suggesting a test of ‘improperly avoided’. 152 In his dissent in Mangin v IRC [1971] AC 739, 756 on the New Zealand GAAR, Lord Wilberforce asked whether ‘there is a distinction between “proper” tax avoidance and “improper” tax avoidance?’ It seems likely he derived this thought from the Canadian GAAR, which he reproduced in an appendix. 145 

244  Peter Harris PROFITS TAX GAAR

The excess profits tax GAAR expired with excess profits tax in 1946.153 National defence contribution morphed into profits tax, which only applied to corporations.154 As such, there was no GAAR initially applicable to profits tax, although the denial of a deduction for artificial transactions continued to apply through the Finance Act 1937. Introduction A few years later in 1951 there was a substantial increase in the profits tax rate due to the rearmament program and once again the Revenue was concerned that this would ‘give a fillip to devices’ to reduce profits tax. While tax reduction devices had not at that stage ‘reached serious proportions’, the Revenue wished to ‘nip the evil in the bud’.155 The Revenue identified six problem areas. The first two involved profit splitting between related companies (there was abatement for companies with small profits and an allowance for director’s remuneration per company). The third, fourth and fifth areas involved avoiding the provisions on director controlled companies so that directors’ remuneration was deductible in full and loans to directors were not treated as distributions. The fifth area involved the issue of bonus debentures out of accumulated profits and then claiming a deduction for the interest. This fifth problem involved the classic difficulty of distinguishing debt and equity and was particularly a problem because profits tax imposed a higher rate for distributed profits compared to no profits tax due on ­interest paid.156 In justifying the reintroduction of a GAAR, the Revenue adapted the ­phraseology it had used with the excess profits tax GAAR. The Revenue thought it was ‘powerless to defeat schemes of this kind’ and that it would be ‘clearly hopeless to attempt to legislate’ against each device.157 An obvious retort is that the excess profits tax GAAR was introduced at the height of World War II where the urgency of the situation dramatically added to the Revenue’s and legislature’s powerlessness and the hopelessness of a­ ddressing matters on a timely basis. The Revenue made no attempt to explain why the situation in 1951 was sufficiently comparable to simply cut and paste the same justification. 153 

FA 1946, s 36. 1946, s 44 (renaming ‘national defence contribution’ as ‘profits tax’) and FA 1947, s 31 (exempting individuals and partnerships from profits tax). 155  Board of Inland Revenue, Finance Bill, 1951: Notes on Clauses 53 [1]. The rate increase was introduced by FA 1951, s 28. 156  Board of Inland Revenue, Finance Bill, 1951: Notes on Clauses 53 [2]. 157  See the quote that the start of this chapter. 154  FA

The Profits Tax GAAR 245 In the initial Bill, the profits tax GAAR was essentially a re-enactment of the excess profits tax GAAR, incorporating both one of the main purposes test and the main benefit test.158 One main difference was that the profits tax GAAR was not to be retrospective. The Revenue again accepted that it had been granted ‘wide discretionary powers’.159 When the clause was debated in committee the proposed GAAR received stiff resistance from the Conservatives in opposition. Mr Lyttelton mounted a concerted effort to exclude ‘bona fide commercial transactions’.160 The Revenue considered it would be ‘very dangerous to accept the amendment’. It understood the connection to the defence in the transfer of assets abroad regime, but in that context the Revenue suggested that ‘the transactions hit … had normally no commercial flavour’. Under the profits tax GAAR ‘it is of the essence of the matter that the transactions to be challenged will partake, to some extent at least, of the nature of commercial operation’. The provision would be too restricted if the Revenue had to prove ‘that the transaction concerned was not a bona fide commercial transaction’.161 One proposed amendment to the draft GAAR is particularly topical in light of the treaty GAAR proposed by the OECD (see above under the ­second heading). Mr Eccles wished an express assurance that the GAAR would not operate if it was in ‘conflict with the terms of any … double ­taxation agreements’. The Revenue responded: Such an assurance can readily be given, for double taxation agreements under the Finance (No. 2) Act, 1945, must be applied ‘notwithstanding anything in any [other taxing] enactment’—Section 51(1)—and there could be no question of overriding such a double tax agreement unless a fresh agreement with the foreign country or dominion or colony is entered into for the purpose.162

Another proposed amendment sought the introduction of a clearance ­procedure into the GAAR.163 In the result, at the report stage the Chancellor of the Exchequer moved a number of amendments to the draft GAAR. In particular, one provision enabled a taxpayer to obtain a clearance from the Revenue if they could show that the transaction was or would be ‘entered into for bona fide commercial reasons’.164 There is clearly a relationship between this provision and the ‘bona fide commercial transactions’ test in the transfer of assets abroad regime. The mixing of this test with a clearance procedure was novel.

158  The circumstances in which the main benefit test applied had been expanded and the main benefit was tested only over a three-year period. 159  Board of Inland Revenue, Finance Bill, 1951: Notes on Clauses 54 [4]. 160  Board of Inland Revenue, Finance Bill, 1951: Committee Stage 89. 161  Board of Inland Revenue, Finance Bill, 1951: Committee Stage 89–90 [2]–[3]. 162  Board of Inland Revenue, Finance Bill, 1951: Committee Stage 101. 163  Board of Inland Revenue, Finance Bill, 1951: Committee Stage 105. 164  This amendment became FA 1951, s 32(6).

246  Peter Harris The provision was drafted by the Attorney General. It was the first occasion on which the Revenue was exposed to a clearance procedure, which it had strenuously resisted, and they were not happy: It would be well for Ministers, in moving the amendment, to emphasise [that it] is not the intention that the Revenue should be exposed to the obligation to express an opinion on hypothetical proposals or on a succession of schemes which merely represent a ‘try on’ to see whether some Profits Tax liability can be avoided. For this reason the granting of a ‘clearance’ is left wholly at the discretion of the ­Commissioners … The Opposition may say that there ought to be a time limit … within which the grant or refusal of a clearance must be given, but the answer is that many of these cases will require close examination which will take up time and even after such examination the position may not be clear.165

During its Operation The Conservative opposition became the government in late 1951. Despite having resisted inserting a GAAR into the profits tax, the Conservatives in government proceeded to use it for purposes of the excess profits levy imposed in 1952.166 They did this by simply applying the profits tax GAAR for excess profits levy purposes.167 The Revenue supplied the Chancellor with various defences to support the provision as it passed through Parliament. In particular, the Revenue noted: whatever view may be held about giving the administration wider powers to counter avoidance in relation to peace time taxes it has always been recognised that such powers are essential in relation to an extraordinary tax such as the Excess Profits Levy the powers now being sought are based on those adopted in the war for the Excess Profits Tax.168

Wheatcroft’s seminal article on tax avoidance was written only three years later. As will be discussed in the conclusion, he did not seem to have a problem with a GAAR, but rather with the state of the law that gave rise to the need for such a provision. Similarly, the 1955 Royal Commission didn’t think ‘any serious criticism’ could be made of the profits tax GAAR.169 As noted above, in 1937 the UK introduced its first rules dealing with transactions in securities (‘bond-washing’), but these rules did not refer to a purpose of tax avoidance. By 1955 dividend stripping had become a major

165 

Board of Inland Revenue, Finance Bill, 1951: Report Stage 92 [5]–[6]. Finance Act 1952, ss 36–66. 167  Finance Act 1952, s 69(1). 168  Board of Inland Revenue, Finance Bill, 1952: Notes on Clauses 175. 169  Above n 4, 313 [1034]. 166 

The Profits Tax GAAR 247 issue and the UK introduced rules targetting ‘financial concerns’ involved in such arrangements.170 They were supplemented in 1958171 and again in 1959.172 None of these provisions made reference to a tax avoidance purpose. Dividend stripping remained a problem and not just in the UK. In 1958 the Privy Council passed judgment on whether the Australian GAAR was sufficient to deal with dividend stripping.173 In Newton the Privy Council held that it was which gave ‘some fresh life’ to the Australian GAAR.174 In a critical passage, Lord Denning held that under the Australian GAAR: you must be able to predicate—by looking at the overt acts by which it was ­implemented—that it was implemented in that particular way so as to avoid tax. If you cannot so predicate, but have to acknowledge that the transactions are capable of explanation by reference to ordinary business or family dealing, ­without necessarily being labelled as a means to avoid tax, then the arrangement does not come within the section.175

While on the facts avoidance was not the ‘sole’ purpose of the stripping arrangement, it was ‘one of the purposes’ and that was enough to trigger application of the GAAR.176 The UK continued to have difficulties with dividend stripping and bond washing. The Revenue lamented that: experience has shown that the permutations and combinations for tax avoidance in this field are so numerous that it is not effective to legislate after the event against each device … Parliament is in danger of becoming ineffective and ­ridiculous … But some means clearly must be found to stop unscrupulous operators making a fortune by milking the Exchequer and increasing the tax burden on the great body of taxpayers who would not adopt these devices … What is needed is something which will stop new devices from being created …177

Newton had showed that even a badly worded GAAR could be effective against dividend stripping arrangements. Perhaps buoyed by this, in 1960

170  F (No 2) A 1955, s 4. Regarding these rules see Harris and Oliver, above n 85, 279 and the references cited therein. 171  FA 1958, ss 18–19. 172  FA 1959, ss 23–26. 173  Newton v Commissioner of Taxation [1958] AC 450, 463 per Lord Denning noting that this was the ‘first time’ the Australian GAAR had come to the Privy Council. 174  Mangin v IRC [1971] AC 739, 756 per Lord Wilberforce (dissenting). 175  Newton v Commissioner of Taxation [1958] AC 450, 466. This case is notable for Lord Denning’s rather curt dismissal of arguments by Sir Garfield Barwick (later Chief Justice of the High Court of Australia), eg at 468 ‘Sir Garfield Barwick submitted that Bell’s case was wrongly decided. In the opinion of their Lordships it was rightly decided’ and at 469 ‘Their Lordships were not disposed to allow Sir Garfield to raise this point … but in any case they think it is a bad point.’ 176  Newton v Commissioner of Taxation [1958] AC 450, 467. 177  Board of Inland Revenue, Finance Bill, 1960: Notes on Clauses 117 [7].

248  Peter Harris the UK government decided to introduce ‘a general anti-avoidance ­provision against the avoidance of tax by transactions in securities’.178 The Revenue’s Notes on Clauses on what became section 28 of the Finance Act 1960 is, for the time, a tour de force in considering tax avoidance. The Notes made reference to the GAARs in the excess profits tax, the profits tax and the excess profits levy. It made reference to the final report of the 1955 Royal Commission. It also made reference to the Australian, Canadian and New Zealand GAARs.179 With reference to the profits tax GAAR (still in force at this time), the Revenue noted that: A recent issue of the ‘Accountant’ contained various strictures about the operation of the Profits Tax anti-avoidance provision [which] seem to have little foundation in fact. It is stated that the Section ‘has been invoked many times, sometimes on very flimsy grounds’. In fact, formal directions have so far been made in only 23 cases (though some other cases have been settled by informal action locally without the need for a formal direction by the Commissioners of Inland Revenue). Of course, the real value of the Section cannot be judged by the number of directions made under it; its true value rather lies in the number of companies and other Profits Tax payers which have been deterred from adopting avoidance devices.180

The transactions in securities GAAR was based on the earlier UK GAARs. However, being a TAAR rather than a GAAR meant that the rules only applied in specified circumstances. These were set out in section 28(2) and are not further considered.181 The rules applied where the taxpayer secured a ‘tax advantage’ and this was defined, amongst other things, in terms of ‘avoidance or reduction’ of income tax.182 The rules would not apply where the taxpayer showed both: [i] that the transaction or transactions were carried out either for bona fide commercial reasons or in the ordinary course of making or managing investments, and [ii] that none of them had as their main object, or one of their main objects, to enable tax advantages to be obtained …183

These two tests are clearly derived from the profits tax GAAR. Where the section applied, the Commissioner was given the usual power to ‘counteract’

178 

Board of Inland Revenue, Finance Bill, 1960: Notes on Clauses 114 [2]. Commonwealth countries who are as much attached to the rule of law as we are have found it necessary to introduce wide anti-avoidance powers of a much more general character than is contemplated in this country.’ Board of Inland Revenue, Finance Bill, 1960: Notes on Clauses 117 [8]. 180  Board of Inland Revenue, Finance Bill, 1960: Notes on Clauses 119 [13]. 181  Board of Inland Revenue, Finance Bill, 1960: Notes on Clauses 121–23 is an appendix giving examples of transactions that were the target of the new rules. They all involved plays on the capital/revenue distinction (or lack thereof). 182  ‘Tax advantage’ was defined in FA 1960, s 43(4)(g). 183  FA 1960, s 28(1). 179  ‘Many

The Profits Tax GAAR 249 the tax advantage by making specified adjustments, none of which expressly referred to a counterfactual.184 There were complex rules on appeals and clearances, which are not presently relevant. Cases on the profits tax GAAR were few. Ackland & Pratten was a case involving a phoenix company that once again raised questions about the main benefits test. A tax benefit that was ‘more than a possibility’ was enough to trigger the test and so the GAAR.185 In the context of the profits tax GAAR, most of the cases referred to in the Instructions for Inspectors were on the excess profits tax GAAR. Inspectors were instructed to ‘settle informally without reference to Head Office, cases in which agreement can be reached’ in certain specified cases falling within the main benefit test.186 Under the main benefits test ‘as the PT benefit can only be measured in terms of cash, the other benefits should, as far as possible, be similarly measured.’ Inspectors were also instructed that they could ‘split up’ a series of transactions provided this was not done ‘artificially’.187 Inspectors were instructed that when using the profits tax GAAR ‘the liability should be computed as if the transaction challenged had never taken place.’ Potentially, this would seem to give rise to the same problems as under the annihilating approach of the Australian and New Zealand GAARs, but inspectors were told to submit a case to the chief inspector if they were ‘in doubt’.188 If, however, the inspector formed the view that the transaction: is caught by the ‘main benefit’ test, but is of the opinion that the transaction would have been effected at the same time and in the same form, if PT considerations had not been present, he should submit the case to the Chief Inspector (PT) before expressing any opinion as to the application of Section 32.189

Any case where the inspector thought application of the GAAR ‘may be appropriate’ that was not within the main benefit test was to be referred to the Chief Inspector and the inspector was not to express an opinion.190 The profits tax GAAR and the denial of a deduction for artificial reductions were repealed in 1965 when the application of both income tax and profits tax to companies was replaced with the unified corporation tax (also applicable to capital gains of companies).191 A brief review of the Revenue’s Finance Bill, 1965: Notes on Clauses gives no express reason as to why the 184 

FA 1960, s 28(3). Ackland & Pratten Ltd (in Liquidation) v IRC (1960) 39 TC 649, 662 and see Avery Jones, above n 8, 117. 186  Board of Inland Revenue, Instructions for the Use of H.M. Inspectors of Taxes: Profits Tax (London, Board of Inland Revenue, 1946–) para 1494. 187  Board of Inland Revenue, above n 186, [1495]. 188  Board of Inland Revenue, above n 186, [1496]. 189  Board of Inland Revenue, above n 186, [1498]. 190  Board of Inland Revenue, above n 186, [1499]. 191  FA 1965, s 97(5) and Sch 22, Pt V. 185 

250  Peter Harris GAAR was not carried into corporation tax. It is presumed that this was a question of maintaining consistency with the absence of a GAAR in the income tax. CONCLUSION

The profits tax GAAR was a sophisticated GAAR developed over an extended period. As a GAAR, it was blessed by both Wheatcroft and the 1955 Royal Commission. It did not suffer the major questions and issues that were suffered by the comparatively primitive Australian and New ­Zealand GAARs. Its predecessor in the excess profits tax clearly influenced the form of the early Canadian GAAR. However, unlike the Canadian GAAR, it is pretty clear that the UK GAAR was used, especially in its excess profits tax incarnation. It is easy to suggest that in the 1950s it was the best of the Commonwealth bunch. Nevertheless, the nature of the profits tax GAAR raised its own issues. It did not define ‘tax avoidance’ and dealt with the three essentials of a GAAR (identified under the first heading) in an indirect fashion. In particular, as the GAAR developed there were loose references in the legislative process to the necessary counterfactual, ie tax is avoided by comparison to what or there is a tax advantage by comparison to what? As Avery Jones points out,192 this is perhaps more straightforward in the case of actions to secure specific reliefs such as deductions and credits. Here it is a simple thing to say that but for the tax advantage there would have been no expenditure and so the comparator is often doing nothing. It is not so simple where the taxpayer has an intended course and it is the manner in which the taxpayer goes about it that avoids tax by comparison to what may be considered a more ‘normal’ manner.193 The profits tax GAAR was much more prescriptive on the abuse front. Having a ‘main purpose’ of avoiding tax was the residual test. This was not a test of the purpose of the transaction viewed objectively, as in the ­Australian and New Zealand GAARs. Rather, under the profits tax GAAR purpose was subjective to the persons involved in the transaction (although objective evidence could be used to support an argument of subjective intent). The Revenue noted on numerous occasions that this was particularly difficult to prove. So the subjective test was backed up with an objective test, applicable

192 

Avery Jones, above n 8, 120. the transaction would normally have been taxable but has merely been dressed-up to come within the relieving provision’; Avery Jones, above n 8, 120. Of course, the transaction may have been dressed-up to come within no particular provision, such as where it is a capital/revenue play. 193 ‘[W]hether

The Profits Tax GAAR 251 only in specified circumstances, which deemed a person to have the relevant purpose where the ‘main benefit’ of a transaction was the tax advantage. This was particularly useful for the Revenue and the majority of cases on the excess profits tax and profits tax GAARs involve it. As for legislative intent, there was no express reference to it in the profits tax GAAR, nor any related concepts such as the ‘spirit’ of the legislation, its ‘principles’ or ‘objectives’. However, as with the counterfactual, the mischief at which the various avoidance rules were targeted was always expressed during the legislative process, usually in terms of legislative intent and in 1960 going so far as the risk of making Parliament look ‘ridiculous’. In the early years, the Revenue particularly relied on the ‘hopelessness’ of legislating to close specific loopholes and tax planning devices. Later the Revenue’s argument developed to point out that the GAAR should be viewed as preemptive, and so was a useful tool for stopping the incentive of tax planners to dream up tax avoidance devices. As for what to do when the profits tax GAAR was triggered, the ­Revenue was given broad power to ‘counteract’ the avoidance. Again, the relevance of a counterfactual was often acknowledged in official documents, but the power was not circumscribed in that regard. The same was true of the ­Revenue’s power to trigger the rule, which was couched in terms of the ‘Commissioners’ opinion’. The standard defence to the broad discretionary nature of the Revenue power was the desperate times in which the power was introduced and the special appeals procedures upon exercise of the power. The former requires further comment. Unlike the Australian and New Zealand GAARs, the excess profits tax GAAR (and the Canadian and South African GAARs) were war ­measures. In the context of the First and Second World Wars one can a­ ppreciate ­references to the Revenue being ‘desperate’ and it being ‘hopeless’ to l­egislate, at least on a timely basis. It was not clear that such broad d ­ iscretionary powers should be granted to the Revenue in peace-time, and this explains the lack of a GAAR in regular taxation, such as income tax. It also explains the substantial resistance that the profits tax GAAR met on its passage through Parliament. There were unsuccessful attempts to limit its application to the period of the rearmament program. When the profits tax GAAR was extended to the excess profits levy in 1952 the question about whether this would be appropriate in ‘peace-time’ was left open. However, the power granted to the Revenue under the profits tax GAAR was not as broad as that granted under the excess profits tax GAAR. ­Further safeguards against arbitrary use of power by the Revenue were built in. Despite substantial resistance from the Revenue, a clearance procedure was introduced, something that would be replicated in numerous other areas (but no general clearance procedure would be introduced like those used in other countries). If a taxpayer could show that the transaction was entered

252  Peter Harris into for ‘bona fide commercial reasons’ then the Revenue’s power was taken away irrespective of the main purpose and main benefit tests. This good faith element was similar to that used in the transfer of assets abroad regime and was clearly targeted at whether the taxpayer’s behaviour was abusive. Through all this, it is clear that need and justification for a GAAR lie in defective legislation. Indeed, this was an underlying theme in ­Wheatcroft’s article in 1955 and was reflected in the discussion of tax avoidance in the reports of the 1955 UK Royal Commission and the 1966 Canadian Royal Commission. Wheatcroft understood that the difficulty inherent in ­anti-avoidance legislation is that it runs counter to the principle of certainty of law. He noted the complexity of the UK tax law at that time and suggested that ‘anti-avoidance legislation is responsible for much of the added obscurity.’194 He saw anti-avoidance legislation as working at the interface of a battle between individual liberties: One school of thought … asserts that as all tax laws are an encroachment on the liberty of the citizen he is perfectly entitled to get round them if he can legally do so … But if you regard our taxes as the contribution that each of us makes to the ­country’s expenditure on our joint behalf, these arguments ring a little hollow. If John Smith pays less tax than he should, all the others have to pay more. His ‘liberty’ to avoid tax is an infringement of you and my right to receive a fair contribution from him. What is his fair contribution may well be a matter for argument but certainly he is not the proper person to decide what it should be.195

Wheatcroft proceeded to consider the attitude of the courts, the tax administration and the legislature in this battle; this chapter has focused on the last two of these. In a discussion of extra statutory concessions administered by the Revenue, Wheatcroft noted: [w]hilst the Revenue acts in this way in a praiseworthy attempt to have reasonable public relations with the taxpayers who are its clients, one result is unfortunate. By protecting the legislature from criticism of unfair and sometimes badly drafted legislation, there is less anxiety to amend and correct the law.196

The same argument can be made with respect to granting anti-avoidance powers to the Revenue. Such powers are often a bandage applied to hide ‘badly drafted legislation’ and suppresses the ‘anxiety to amend and correct the law’. In turning to (or on) the legislature, Wheatcroft accepted the difficulties in drafting tax law, particularly income tax law. To the inherent difficulty of the nature of the topic, Wheatcroft added unhelpful procedures in the

194 

Wheatcroft, above n 4, 213. Wheatcroft, above n 4, 213. 196  Wheatcroft, above n 4, 221. 195 

The Profits Tax GAAR 253 legislative process, and particularly limits on time and appetite for change. He set this against the time and effort spent by the Macmillan Committee in 1936 in proposing a codification.197 That work was ‘wasted’ and the 1952 consolidation did ‘[n]othing … to remove obscurities and contradictions in the law.’198 The legislature here starts with a patchwork quilt of legislation of involved and doubtful meaning and it has to amend it piecemeal. Hence the problem of dealing with tax avoidance is much more difficult than it would be if there was a clear and coherent law to start with. The most obvious and clearly the best method of preventing any particular type of tax avoidance is to amend the general law affecting transactions of that type, so that it is stated in a manner which covers all contingencies and leaves no loopholes for the avoider.199

Wheatcroft understood that there would be some cases where this could not be done. There are some clearly identifiable areas where income tax law by its very nature falls into spectrum issues.200 Here Wheatcroft felt that anti-avoidance rules were justified and noted different approaches to formulating them. Like all academic works of the highest calibre, Wheatcroft offered helpful suggestions of how best to ‘deal with the problem of tax avoidance’. Not surprisingly, on top of his list was: [t]hat the codification of taxation law be undertaken as a matter of urgency so that the basic law is simplified and more clearly defined and tax avoidance thereby reduced.201

Wheatcroft also thought that ‘taxing Acts should be construed broadly and not literally’ and that there should be ‘increased use … of legislation which takes account of the “intention” of the taxpayer’. In particular, he foresaw extended use of the approach in the profits tax GAAR, but not as a substitute for rationalisation of the tax law.202

197 Income Tax Codification Committee: Report (Macmillan Committee) (Cmd. 5131, 1936). 198  Wheatcroft, above n 4, 222. 199  Wheatcroft, above n 4, 222–23. 200  For example, as long as private activities are not within the tax net, there is a question of what is ‘business’ (or ‘trade’ in the UK sense). Some people are more ‘busy’ than others. Business is a question of degree and there cannot be a clear line between what amounts to business and what does not. This is a spectrum issue and apportionment is not a practical possibility (‘I am conducting something that is 30% business’). The same is true of many areas such as the distinction between income and capital, between debt and equity and between related and unrelated parties. 201  Wheatcroft, above n 4, 229. 202  Wheatcroft, above n 4, 230.

254  Peter Harris In light of these suggestions more than 60 years ago, where are we in 2017? There seems little doubt about where we are. Wheatcroft’s second and third suggestions have proved prophetic—the courts have moved away from a literal approach to interpreting tax law and there has been a proliferation of avoidance rules of the nature that Wheatcroft suggested. As to the first suggestion, we are now in a dramatically worse position and the author has had cause to suggest that the position for the income tax is beyond recovery. The law is so unnecessarily long, so inconsistent, so obscure, so unclear that it would take 20 Macmillan Committees to unravel it and then reform proposals would likely be rejected out of hand in the same manner as the original committee. In the UK, talking about structural tax reform is acceptable, but doing something about it is at least politically unacceptable. What can the historical consideration in this chapter tell us about this complex relationship between legislative drafting and tax avoidance? First, the Revenue consistently used overly emotive language to justify additional powers. Rather than attempting a structural fix it was easier to cry foul and apply endless patches. When the law is such a mess and no effort is made to clean it up, it is hard to have much sympathy for the Revenue and the government when they face tax avoidance. However, as Wheatcroft suggested, this hard line does not mean that one must have sympathy for tax avoiders. In the face of a well-structured tax law, there will still be numerous areas where it is unrealistic to get certainty and this is particularly true of the spectrum issues. What all taxpayers deserve (tax avoiders or otherwise) is clear and structurally sound tax law, with anti-abuse rules to stop the benefit of the one to the detriment of the many. In this context, the 2013 GAAR may well be justified, but it is not a particularly strong GAAR and it is not surprising to see the Revenue back, as it has in the past, asking for new powers (as in the Finance Act 2016 provisions mentioned under the second heading). There is a place for a GAAR in tax law. What the author has serious concerns about is the large amount of resources that have been poured into tax law rewrites, disclosure regimes with overly targeted responses and development of a comparatively weak GAAR. How successful has any of this been? Would the resources have been better targeted first and foremost, as Wheatcroft suggested, at a proper review and rebuilding of the tax system to maximise clarity and consistency? This is not a novel view.203 Why isn’t there more clamour about the duty of the legislature to provide clear and structurally sound tax law? It is true that the overall picture is

203 ‘The GAAR reflects the failure of current policy and legislation and in particular the failure to think more carefully about the nature of the tax base—what you want to tax—and to articulate it correctly with greater principle, clarity and purpose.’ M Gammie, ‘Moral Taxation, Immoral Avoidance—What Role for the Law?’ [2013] British Tax Review 577, 577.

The Profits Tax GAAR 255 more complex than in 1955, particularly in the face of relations with the European Union and globalisation more generally, but that is not an answer, rather an excuse. As an academic, it is difficult to feel motivated to engage with an issue of the utmost pressing need when, even if you are Wheatcroft, it will inevitably fall on deaf ears. Judging by his 1955 article, clarity and conciseness were two of Wheatcroft’s greatest gifts. They are certainly ones which the UK legislature lacks in drafting tax law. Structural tax reform is not a matter of economics, although that of course has its place. As this author has said many times, it is the lawyers and accountants that use and abuse the system. The tax law is ‘law’ and must interface with the rest of the legal system. The tax law needs a structural legal fix, not an economic one. In 1895 Mr Neild in the New South Wales House of Assembly described the GAAR as ‘rubbish’ designed by ‘desperate politicians’ and it is not anti-social to have some sympathy with that view. If one were to apply that analogy to the UK tax system in 2017, then with its 300 odd TAARs plus a GAAR the UK tax system might be described as a ‘rubbish’ dump. Would someone please get on with the recycling?

256 

10 Statutory Interpretation in Early Capital Gains Tax Cases PHILIP RIDD

ABSTRACT

This paper takes its inspiration from observations made by Lord Steyn, in IRC v McGuckian,1 about a shift away from literalist to purposive methods of construction, and his reference to a breakthrough having been made in WT Ramsay v IRC.2 The paper examines the cases on Capital Gains Tax (‘CGT’) up to 1997 in an effort to demonstrate that both before and after the Ramsay case the courts were routinely construing and applying the statutory CGT provisions in a manner which produced sensible results, and that, tax avoidance schemes apart, Ramsay was not seen, in CGT cases, as involving any sea change so far as statutory construction was concerned. INTRODUCTION

In IRC v McGuckian Lord Steyn observed as follows: During the last 30 years there has been a shift away from literalist to purposive methods of construction. Where there is no obvious meaning of a statutory provision the modern emphasis is on a contextual approach designed to identify the purpose of a statute and to give effect to it. But under the influence of the narrow Duke of Westminster doctrine [1936] AC 1, 19 tax law remained remarkably resistant to the new non-formalist methods of interpretation. It was said that the taxpayer was entitled to stand on a literal construction of the words used regardless of the purpose of the statute: Pryce v Monmouthshire Canal and Railway Cos. (1879) 4 App Cas 197, 202–203; Cape Brandy Syndicate v Inland Revenue Commissioners [1921] 1 KB 64, 71; Inland Revenue Commissioners v Plummer [1980] AC 896. Tax law was by and large left behind as some island of literal interpretation.3 1 

IRC v McGuckian [1997] 1 WLR 991(‘McGuckian’). WT Ramsay v IRC [1982] AC 300 (‘Ramsay’). 3  McGuckian, above n 1, 999. 2 

258  Philip Ridd Lord Steyn went on to say that a breakthrough was made in Ramsay v IRC.4 Anyone familiar with nineteenth and twentieth century income tax case law will probably have sympathy with Lord Steyn’s observation and, given that Inland Revenue Commissioners v Plummer5 was decided close to the middle of the 30-year period to which Lord Steyn referred, it may well be that strict literalism continued to prevail in income tax cases. But that period includes cases on the then new tax, Capital Gains Tax. Did the courts apply the old strict literalist approach to CGT, or did they accept that the modern contextual approach should be taken to CGT? That is the question which this paper considers by reference to cases which concerned either CGT or Corporation Tax on chargeable gains. The paper takes in CGT cases up to 1997 in an effort to demonstrate that both before and after Ramsay the courts were routinely construing and applying the CGT provisions in a manner which produced sensible results: tax avoidance schemes apart, Ramsay was not seen, in CGT cases, as involving any sea change so far as statutory construction was concerned. There were many CGT cases over the period and consideration is given only to those which appear to be instructive in the context of this paper. References will be given to reports in the Law Reports, failing which to reports in Tax Cases. For convenience the paper will deliberately fall into the error of treating strict literal construction and purposive construction as if they were two entirely different approaches. When a statutory provision is a matter of dispute, the role of the courts is to ascertain and give effect to the intention of Parliament; statutory words, like any other words, appear in a context; it has never been suggested that the context might be ignored; but a word, or a collection of words, may be thought to have only one meaning; alternatively a word, or a collection of words, will often have a primary meaning; it may require some agility of mind to believe that a word, or a collection of words, should be understood in a sense which seems somewhat far removed from the meaning which first springs to mind, and the controlling factor for making the leap is likely to be the amount of weight accorded to the context. This tension, even dilemma, was the subject of instructive guidance in Oliver Ashworth (Holdings) v Ballard (Kent)6 a case which concerned the construction of the Distress for Rent Act 1737. Laws LJ said: By way of introduction to the issue of statutory construction I should say that in my judgment it is nowadays misleading—and perhaps it always was—to seek to draw a rigid distinction between literal and purposive approaches to the interpretation of Acts of Parliament. The difference between purposive and literal

4 

Ramsay, above n 2. Inland Revenue Commissioners v Plummer [1980] AC 896 (‘Plummer’). 6  Oliver Ashworth (Holdings) v Ballard (Kent) [2000] Ch 12. 5 

Statutory Interpretation in Early Capital Gains Tax Cases 259 construction is in truth one of degree only. On received doctrine we spend our professional lives construing legislation purposively, inasmuch as we are enjoined at every turn to ascertain the intention of Parliament. The real distinction lies in the balance to be struck, in the particular case, between the literal meaning of the words on the one hand and the context and purpose of the measure in which they appear on the other. Frequently there will be no opposition between the two, and then no difficulty arises. Where there is a potential clash, the conventional English approach has been to give at least very great and often decisive weight to the literal meaning of the enacting words. This is a tradition which I think is weakening, in face of the more purposive approach enjoined for the interpretation of legislative measures of the European Union and in light of the House of Lords’ decision in Pepper v Hart [1993] AC 593. I will not here go into the details or merits of this shift of emphasis; save broadly to recognise its virtue and its vice. Its virtue is that the legislator’s true purpose may be more accurately ascertained. Its vice is that the certainty and accessibility of the law may be reduced or compromised. The common law, which regulates the interpretation of legislation, has to balance these considerations.7

The reference to Pepper v Hart is important. The case is, of course, famous for the abrogation of the rule that Ministerial statements recorded in Hansard were not admissible as an aid to the construction of statutes. But, aside from that, it is, so far as the writer is aware, the first case in which it was acknowledged that the ‘more purposive approach’, to adopt Laws LJ’s ­phraseology, was applicable to tax statutes. In the leading speech Lord Browne-Wilkinson recorded that counsel for the taxpayers ‘points out that the courts have departed from the old literal approach of statutory construction and now adopt a purposive approach, seeking to discover the ­Parliamentary intention lying behind the words used and construing the legislation so as to give effect to, rather than thwart, the intentions of Parliament’.8 Lord Browne-Wilkinson did not comment on the tendentious suggestion that the courts had been in the business of thwarting the intentions of Parliament, but his acceptance of the burden of the point appears in the sentence which reads: Given the purposive approach to construction now adopted by the courts in order to give effect to the true intentions of the legislature, the fine distinctions between looking for the mischief and looking for the intention in using words to provide the remedy are technical and inappropriate.9

Lord Griffiths also mentioned that the purposive approach had superseded the strict literal approach, as follows: The days have long passed when the courts adopted a strict constructionist view of interpretation which required them to adopt the literal meaning of the

7 

ibid, 34. Pepper v Hart [1993] AC 593, 635. 9 ibid. 8 

260  Philip Ridd language. The courts now adopt a purposive approach which seeks to give effect to the true purpose of legislation …10

Pepper v Hart sponsored academic analysis on an industrial scale but little, if any, intention, was paid to the franking of the purposive approach to statutory construction. That is perhaps understandable, given that the point was adopted without controversy. Ramsay was not among the many authorities cited to the House of Lords but again that is explicable by the fact that there was no controversy about the purposive approach. It would be too much to say that the point came in by accident but nevertheless the answer to the question ‘When did the House of Lords first recognise that tax statutes should be construed purposively?’ is ‘26 November 1991 when judgment was given in Pepper v Hart’. It is, however, for question whether in subsequent tax cases counsel and judges cited Pepper v Hart as authority for a new approach, and it may be that, in its reference to the case aside from the Hansard point, the observation by Laws LJ is highly unusual. With those preliminary observations, attention will now be given to the instructive CGT cases. It will be suggested that Aberdeen Construction v IRC11 is of particular importance. Accordingly the cases will be divided as follows: cases which preceded Aberdeen; Aberdeen; cases between Aberdeen and Ramsay; Ramsay and later avoidance cases; and other cases after Ramsay and up to McGuckian. CASES WHICH PRECEDED ABERDEEN

Inland Revenue Commissioners v Richards’ Executors12 concerned the words ‘wholly and exclusively’ which are well known in the world of tax primarily for their relevance to the question whether expenses are deductible for income tax purposes. Two of the many income tax cases were cited in this case, namely Bowden v Russell & Russell13 and McKie v Warner.14 Each exemplify what is called the dual purpose test, ie expenditure fails to qualify for deduction if to any extent, however small, it is attributable to some purpose outside the ambit of purposes in relation to which an expense is deductible. The test may fairly be described as notoriously strict. This case concerned two items of expenditure incurred by executors in administering an estate, but only one item was still in issue when the case reached the House of Lords. This related to expenses in having the assets of

10 

Pepper v Hart, above n 8, 617. Aberdeen Construction v Inland Revenue Commissioners [1978] AC 885 (‘Aberdeen’). 12  Inland Revenue Commissioners v Richards’ Executors (1969) 46 TC 626 (‘Richards’ Executors’). 13  Bowden v Russell & Russell [1965] 1 WLR 711. 14  McKie v Warner [1961] 1 WLR 1230. 11 

Statutory Interpretation in Early Capital Gains Tax Cases 261 the estate valued for the purposes of estate duty, and was £242 16s 1d, the proportion of the solicitors’ fees relating to the shares which had been sold giving rise to liability to CGT. The executors’ contention that the expenses were deductible relied on paragraph 4(1) of Schedule 6 to the Finance Act 1965 by which deductions from the consideration accruing on a disposal were ‘restricted to … (b) the amount of any expenditure wholly and exclusively incurred [by the disponor] in establishing, preserving or defending his title to, or to a right over, the asset, (c) the incidental costs to him of making the disposal’. The Revenue argued that, as the expenses were incurred in connection with the payment of estate duty, they failed the ‘wholly and exclusively’ test by reason of dual purpose. In the House of Lords the taxpayers’ argument held sway with the majority. Lord Reid found indications in Schedule 7 that ‘“wholly and exclusively” must not be read too literally’ and might be read ‘so as to give a reasonable result’.15 Lord Guest, with whom Lord Donovan agreed, noted that success for the Revenue depended ‘upon a very strict reading of the words of para 4(1)(b)’,16 and he too found words in Schedule 7 which were not consistent with a strict construction.17 Both Lord Reid and Lord Guest could not regard payment of estate duty as an entirely independent purpose.18 The fact that the strict construction favoured in connection with income tax did not filter through to CGT is explicable by the finding that other words in Schedule 7 militated against a strict construction. Nevertheless, the decision is one which favours a contextual approach. Section 22(5) of the Finance Act 1965, was concerned, among other things, with the position in which two or more persons were jointly a­ bsolutely entitled to trust assets as against the trustee, or would be absolutely entitled but for infancy or other disability. In Tomlinson v Glyns Executor & Trustee Co19 the issue was whether section 22(5) applied. The trust concerned was for the benefit of those of the settlor’s children who attained 21 or married under that age. There were four infant children at the material time. In effect the argument for the trustee company was that section 22(5) required infancy to be disregarded with the consequence that the four children should be regarded as having attained 21, on which basis the class of beneficiaries would have closed. The argument failed. It was held that ­section 22(5) applied where infancy or disability was the only bar to absolute entitlement and did not apply where the beneficiaries’ interest was also contingent on attaining a specified age, notwithstanding that that age ­coincided with the age of majority.

15 

Richards’ Executors, above n 12, 635. ibid, 644. 17  ibid, 645. 18  ibid, 635 and 644. 19  Tomlinson v Glyns Executor & Trustee Co [1970] Ch 112. 16 

262  Philip Ridd This was one of the earliest CGT cases but the judgments, particularly that of Sachs LJ, show a concern to reach a result which reflected what he described as ‘the manifest intention of that section in relation to the Act as a whole’.20 The word ‘jointly’ gave rise to several cases. In Kidson v Macdonald21 the Revenue contended unsuccessfully that freehold land held by tenants in common was not held ‘jointly’. Foster J held that ‘jointly’ in section 22(5) was not to be construed as a term of art relating to joint tenancies in English law but was to be given its ordinary meaning of concurrently or in common. A consideration of some importance was that the Finance Act 1965 applied throughout the UK but both Scottish and Northern Irish land law differed from English land law. In Stephenson v Barclays Bank Trust Co22 Walton J agreed with Foster J’s understanding of ‘jointly’. The case concerned an assessment made on the basis that the beneficiaries of a trust became absolutely entitled to the trust assets when a family arrangement was made on 27 January 1969. Immediately prior to that the trust assets were held, in equal shares, for two grandchildren of the testator-settlor, but subject to annuities in favour of each of his three widowed daughters. By the arrangement a fund was appropriated to answer the annuities, a sum was advanced to the grandchildren for the purpose of buying additional income for the daughters, and the daughters released the trustees from any outstanding claims to the intent that the remainder of the trust property might be transferred forthwith to the grandchildren. Walton J’s agreement with Foster J would have been decisive had not the trustee company relied on two further arguments. One argument was that absolute entitlement had occurred long since—in 1955 when the younger grandchild’s interest had vested on his attaining 21. Reliance was placed on paragraph 9 of Schedule 19 to the Finance Act 1969: It is hereby declared that references in Part III of the Finance Act 1965 … to any asset held by a person as trustee for another person absolutely entitled against the trustee are references to a case where that other person has the exclusive right, subject only to satisfying any outstanding charge, lien or other right of the trustees to resort to the asset for payment of duty, taxes, costs or other outgoings, to direct how that asset shall be dealt with.

It was submitted that the widowed daughters’ annuities were ‘outgoings’. Walton J agreed that ‘outgoings’ was a word of the widest signification but continued that regard must be had to the context and held that the phrase in which ‘outgoings’ occurred was limited to trustees’ personal rights of indemnity by resort to the trust funds and could not extend to some other beneficial interest. The other argument was that absolute entitlement could 20 

ibid, 127. Kidson v Macdonald [1974] Ch 339. 22  Stephenson v Barclays Bank Trust Co [1975] 1 WLR 882. 21 

Statutory Interpretation in Early Capital Gains Tax Cases 263 not occur until actual distribution to the grandchildren, but that was inconsistent with the 1969 provision which plainly envisaged absolute entitlement at a point when the trust fund was still in the hands of the trustees. Strict literalism would have suited the taxpayer company better. Booth v Ellard23 involved several shareholders pooling their shares in a trust, so that each shareholder no longer owned specific shares but had an interest in a corresponding number of shares held by the trustees. The Revenue contended that the specific shares had been disposed of by becoming settled property in circumstances in which each former shareholder no longer had an interest in specific shares, but it was held that the former shareholders were absolutely entitled as against the trustees so that the shares had not become settled property. The view of ‘jointly’ taken by Foster J and Walton J in the earlier cases was adopted. Pexton v Bell24 concerned section 25(12) of the Finance Act 1965 which read: If there is a life interest in a part of the settled property and, where there is a life interest in income, there is no right of recourse to, or to the income of the remainder of the settled property, the part of the settled property shall while it subsists be treated for the purposes of subsections (4), (5), (6) and (7) of this section as being settled property under a separate settlement.

In this case (and in Crowe v Appleby which was heard alongside it) the Revenue’s contention was that ‘a part of the settled property’ meant a distinct item, or distinct items, comprised in the settled property and did not include a fractional interest such as the one-fourth interest which belonged to a beneficiary on whose death in 1968–69 there was a deemed disposal for CGT purposes. The contention failed. In the leading judgment in the Court of Appeal Sir John Pennycuick, noting that ‘part’ was not ‘a legal term of art’,25 favoured what he regarded as the ‘natural construction’26 but added ‘Moreover, it is a construction which produces a fair and logical result’.27 In the context he was not attracted by ‘the refinements of the law of property’. In the High Court Walton J, considering the context, had concluded that section 25(12) ‘was obviously … intended to include a fraction’.28 The case is, therefore, a good example of the courts avoiding a technical approach which would have produced an unduly harsh result. In Sansom v Peay29 trustees of a discretionary settlement exercised a power to permit beneficiaries to occupy a house. The issue was whether

23 

Booth v Ellard [1980] 1 WLR 1443. Pexton v Bell [1975] 1 WLR 885. 25  ibid, 895. 26 ibid. 27 ibid. 28  Pexton v Bell [1975] 1 WLR 707, 711. 29  Sansom v Peay [1976] 1 WLR 1073. 24 

264  Philip Ridd the beneficiaries were entitled to occupy it under the terms of the settlement within section 29(9) of the Finance Act 1965. Brightman J held that they were so entitled. He rejected the Revenue’s submission that ‘entitled’ denoted an absolute right. He was influenced by the broad conception of section 29, the need for a home owner, when selling, to retain money to buy a new home. He therefore favoured the alternative, broader construction advanced by the trustees. Again it may be said that strict literalism failed. Varty v Lynes30 deserves mention only as an example of a straightforward situation being overlooked in the legislation. The taxpayer, who had sold his house and part of his garden a year earlier, sold the remainder of the garden. It was held that the second disposal did not attract the private residence exemption in section 29 of the Finance Act 1965. The rival constructions revealed anomalies, so the judge had perforce to do his best with the statutory wording alone. Davis v Powell31 concerned a sum of compensation paid to a tenant farmer under section 9 of the Agricultural Holdings Act 1948 on his surrendering part of his land to his landlord. Templeman J held that this sum was not liable to CGT on the basis that the compensation was not derived from an asset within section 22(3) of the Finance Act 1965, but was simply a sum which Parliament said should be paid for expense and loss unavoidably incurred after the lease had gone. The very short judgment is remarkable in that, while the judge duly considered the statute, he prefaced this by examining the issue ‘in the light of nature’,32 and declared that the notion that CGT applied was ‘nonsense’. Two paragraphs further on he stated ‘whether viewed by the light of nature or by construction of the Finance Act 1965’, CGT did not apply. The same result was reached in Drummond v Brown33 in relation to compensation under the section 37 of the Landlord and Tenant Act 1954. The Court of Appeal agreed with Davis v Powell, but made no comment on the use of the light of nature as an aid to statutory construction. Harrison v Nairn Williamson34 concerned section 22(4) of the Finance Act 1965 which provided that ‘… a person’s acquisition of an asset and the disposal of it to him shall … be deemed to be for a consideration equal to the market value of the asset—(a) where he acquires the asset …, or (b) where he acquires the asset …, or (c) where he acquires the asset …’. The case involved circumstances in which a company acquired loan stock by subscription so that the acquisition was not by a means which involved

30 

Varty v Lynes [1976] 1 WLR 1091. Davis v Powell [1977] 1 WLR 258. 32  Perhaps ‘as a matter of common sense’ might be what was meant. 33  Drummond v Brown [1985] Ch 52. 34  Harrison v Nairn Williamson [1978] 1 WLR 145. 31 

Statutory Interpretation in Early Capital Gains Tax Cases 265 a ‘disposal of it to him’, and the company’s contention was that s 22(4) did not, therefore, apply. The courts did not agree. In the High Court Goulding J’s approach was ‘to give the words used by Parliament their ordinary meaning in the English language, and if, consistently with the ordinary meaning, there is a choice between two alternative interpretations then to prefer the construction that maintains a reasonable and consistent scheme of taxation without distorting the language.’35 Buckley LJ agreed with that approach and considered the language ‘quite suitable’36 to a result by which the provision applied, where there was an acquisition and a corresponding disposal, to both acquirer and disposer, but, where there was only an acquisition, to the acquirer, there being no disposer to be affected. Neither Buckley LJ nor Sir David Cairns mentioned the taxpayer company’s submission that the Revenue’s argument involved violence to the language by reading ‘the disposal’ as ‘any disposal’ or by reading the words ‘(if any)’ into the provision. Goff LJ rejected that submission but added that, if it were right, he was prepared to read words in.37 It is clear that the conclusion in favour of the Revenue was driven by a consideration of the policy of the Act. Buckley LJ noted that the Revenue’s contention ‘results in a more reasonable and coherent scheme of taxation than that for which the taxpayer company contended’.38 The case is a good example of a strict literal interpretation coming to grief. ABERDEEN

In Aberdeen39 shares in a company were bought under a contract by which the purchaser paid £250,000 and waived a loan of £500,000 owed to the company’s parent company. The main issue was not one of statutory construction. It was one of construction of the contract, namely whether the purchaser paid £250,000 for the shares or for the composite package of the transfer of the shares and the waiver of the loan. By a bare majority the House of Lords, overruling the Court of Session, opted for the latter construction. Lord Wilberforce, one of the majority, said: The capital gains tax is of comparatively recent origin. The legislation imposing it, mainly the Finance Act 1965, is necessarily complicated, and the detailed provisions, as they affect this or any other case, must of course be looked at with care. But a guiding principle must underlie any interpretation of the Act, namely,

35 

Harrison v Nairn Williamson [1976] 1 WLR 1161, 1165. Harrison v Nairn Williamson, above n 34, 151. 37  ibid, 153. 38  ibid, 151. 39  Aberdeen, above n 11. 36 

266  Philip Ridd that its purpose is to tax capital gains and to make allowance for capital losses, each of which ought to be arrived at upon normal business principles. No doubt anomalies may occur, but in straight-forward situations, such as this, the courts should hesitate before accepting results which are paradoxical and contrary to business sense. To paraphrase a famous cliché, the capital gains tax is a tax upon gains: it is not a tax upon arithmetical differences.40

That statement will be discussed below. CASES BETWEEN ABERDEEN AND RAMSAY

Floor v Davis41 is an unusual case in two respects. First, the House of Lords heard argument on some of the grounds advanced but found it unnecessary to consider the other grounds; that is not in itself unusual, but in this case the Law Lords divided three–two on the points considered; the minority were therefore not in a position to vote on whether the appeal should be allowed or dismissed. Secondly the case is remembered principally for the judgment of Eveleigh LJ in the Court of Appeal rather than for any of the speeches in the House of Lords. The background was the familiar one of a sell-out of shares in a family company (‘IDM’) with a reluctance to face the normal CGT consequences. The taxpayer and his two sons-in-law were shareholders in IDM such that they had control of the company. The scheme which was implemented involved a new company (‘FNW’) which arrived on and departed from the scene, and a Cayman Islands company (‘Donmarco’). FNW acquired the shares in IDM and then sold them to the purchaser for cash. FNW was put into liquidation immediately after Donmarco, through a shareholding in FNW which it acquired, had become entitled to virtually the whole of FNW’s assets (in effect, the purchase price of the IDM shares). The thinking behind the scheme was that the disposal of the IDM shares to FNW would attract the exemption from charge for reorganisation of share capital under paragraph 6 of Schedule 7 to the Finance Act 1965, and that the transaction by which the value of the FNW shares was transferred to Donmarco was not one which the legislation designated as a disposal by the taxpayer. The transactions would, almost certainly, be viewed nowadays through Ramsay spectacles as a composite transaction but only Eveleigh LJ was willing to take that approach. Parking other arguments, the House of Lords considered the Revenue’s argument that paragraph 15(2) of Schedule 7 to the Finance Act 1965 applied so that the transaction by which the value of the FNW shares was transferred to Donmarco was a disposal by the taxpayer. The opening words of para 15(2) were ‘If a person having control of 40  41 

ibid, 892–893. Floor v Davis [1980] AC 695.

Statutory Interpretation in Early Capital Gains Tax Cases 267 a company exercises his control so that value passes …’. As the taxpayer did not on his own have control of IDM, the crucial question was whether ‘a person’ in para 15(2) included the plural in accordance with what was then section 1(1)(b) of the Interpretation Act 1889, an aid which applied ‘unless the contrary intention appears’. In terms of the present paper the words ‘unless the contrary intention appears’ drive a close examination of the context, so Floor v Davis cannot be put forward as an example of strict literal interpretation being cast aside in preference for purposive interpretation. It is beyond the scope of this paper to set out the complex considerations which were discussed during disagreement between the Law Lords. The majority view in favour of the Revenue’s argument was given in the speech of Viscount Dilhorne which attracted the concurrence of Lord Diplock and of Lord Edmund-Davies. At the end of his speech Viscount Dilhorne referred to those responsible for the drafting of Finance Bills and remarked that it would be: odd if their prescience had not extended to appreciating that such a passing out of value might be brought about by the exercise of control by two or more persons as well as by the exercise of control by one person and if they had omitted to cover that possibility. That in my view they have neatly done by reliance on the Interpretation Act.42

This followed some closer reasoning. It might be unfair to describe Viscount Dilhorne as having wielded a broad brush, but it may fairly be said to have been a broader brush than those wielded by the dissentients, Lord Wilberforce and Lord Keith of Kinkel. Viscount Dilhorne was no friend of those seeking to avoid tax. He was plainly conscious that the overall purpose of tax statutes is to impose tax, with the concomitant of taking steps to prevent avoidance. The dissentients would probably not have disagreed in principle with that, but that general consideration did not deter them from a careful examination of the drafting of surrounding statutory provisions and analysis of the difficulties which would arise if the Revenue’s argument were favoured. By contrast Viscount Dilhorne’s approach was to wave such matters away. In other words the minority’s approach, though not involving strict literal interpretation, gave strict regard to the statutory wording while the majority approach preferred to give full rein to the overall purpose. There are three remarks in Lord Wilberforce’s speech which deserve note. First, he considered that, if a person who was not by himself a controlling shareholder was to be taxed, ‘clear words must be used’:43 that equates more to the old style of strict literal interpretation than to the more modern approach. Secondly, he disagreed with a line of argument by which the Court of Appeal had managed to construe paragraph 15(2) in the Revenue’s favour 42  43 

ibid, 713. ibid, 706.

268  Philip Ridd without need for the Interpretation Act, saying ‘it amounts, I respectfully think, to a rewriting of the paragraph. But nothing is clearer than that rewriting, or the introduction of words, into a taxing provision is inadmissible’.44 Despite ‘nothing is clearer’, that remark strikes the writer as debatable: a purposive approach often involves having regard to words which the draftsman has not included because they are necessarily implicit in the context, or words which have to be incorporated to enable Parliament’s evident intention to be achieved. Thirdly, Lord Wilberforce ended ‘I regard it as a dangerous and unsound principle to introduce an extensive and uncertain basis of taxation into a carefully drafted fiscal provision by the use of the Interpretation Act’.45 It would be difficult to disagree with that. In O’Brien v Benson’s Hosiery (Holdings)46 the taxpayer company received £50,000 for releasing an individual from his service agreement. The principal issue was whether the company’s rights under the service agreement were an asset within section 22(1) of the Finance Act 1965 which provided that ‘All forms of property shall be assets for the purposes of … this Act’. The Special Commissioners and the Court of Appeal took a restrictive view and decided in the negative. Restoring the order of Fox J, the House of Lords held that the rights were an asset in that they were something which the taxpayer company could turn to account: a purposive approach precluded a restrictive view. In Rank Xerox v Lane47 the taxpayer company disposed of a right to a royalty under contracts executed under seal. Paragraph 12(c) of Schedule 7 to the Finance Act 1965 provided that ‘No chargeable gain shall accrue to any person on the disposal of a right to, or to any part of—(c) annual payments which are due under a covenant made by any person and which are not secured on any property.’ The taxpayer company contended that that provision applied, and on a strict literal approach that contention looked sound. Indeed it succeeded in the Court of Appeal where it was appreciated that the result of the taxpayer company’s contention was absurd but it was considered that paragraph 12(c) was unambiguous, so that that result could not be avoided. The Revenue appealed successfully to the House of Lords. Lord Wilberforce described the result proposed by the taxpayer company as ‘paradoxical’;48 for liability to tax to depend on the affixing, or absence of, a seal was, he declared ‘arbitrary in the extreme’;49 he added that it was ‘impossible to detect any reason of fiscal policy why the affixing of a seal should have any

44 

ibid, 707.

45 ibid. 46 

O’Brien v Benson’s Hosiery (Holdings) [1980] AC 562. Rank Xerox v Lane [1981] AC 629. 48  ibid, 639. 49 ibid. 47 

Statutory Interpretation in Early Capital Gains Tax Cases 269 relevance to the imposition of the tax’;50 he then looked for a ‘reasonable meaning’51 for the statutory words which avoided arbitrariness and had ‘no great difficulty’52 in finding one, namely ‘a unilateral promise which is enforceable in spite of the absence of consideration’;53 the words were declared inapt to refer to a bilateral agreement in which the annual payments were consideration for some obligation undertaken by the payee. Three of the other four Law Lords made speeches but they were to the same effect as Lord Wilberforce’s speech. It is in the emphatic attention to arbitrariness of result that the case may be thought to differ from the approach of yesteryear. Several cases (apart from Varty v Lynes already mentioned) concerned the exemption from CGT which was provided in respect of a taxpayer’s only or main residence by section 29 of the Finance Act 1965. The section referred to ‘a dwelling-house or part of a dwelling-house’. The exemption extended to a garden or grounds of up to one acre or such larger area as, regard being had to the size and character of the dwelling-house, was required for the reasonable enjoyment of it or the relevant part of it. There was no definition of ‘dwelling-house’—no guidance to determine what was, or was not, a dwelling-house. That might have been because it was thought that the answer would be all too obvious. That, however, is not convincing. It is wholly improbable that various different states of affairs were overlooked, for example, the grand mansion with a lodge at its gates (consider the later television comedy series To the Manor Born), a flat over, or cottage attached to, a garage (consider Lucia’s chauffeur, Cadman, in EF Benson’s Mapp and Lucia),54 a cottage occupied by a gardener or other member of staff, or an annexe comprising what is popularly called ‘a granny flat’. A glance at any contemporary Country Life testifies that plenty of such properties existed. An astute reader, pondering section 29 soon after it was passed, would have predicted that it would give rise to litigation on three issues—first, whether some form of temporary makeshift structure might be categorised as a ‘dwelling-house’; secondly, whether a ‘dwelling-house’ might comprise not just a main house but also some associated residential building or buildings; and, thirdly, how many acres, if any, were required for the reasonable enjoyment of properties such as large country mansions. The third issue never came the way of the courts but from personal knowledge the writer can say that many cases came before the Commissioners. In an early case Commissioners in a division in Devon decided, despite the

50 ibid. 51 ibid. 52 ibid. 53 ibid. 54 

EF Benson, Mapp and Lucia (London, Black Swan, 1984), 165.

270  Philip Ridd best efforts of the Inspector of Taxes, that some 27acres were required for the enjoyment of a fairly modest mansion. Thereafter the Inland Revenue Solicitor’s Office fielded advocates, supported by evidence from members of the Valuation Office, in cases of this nature. The writer was the advocate in several cases, achieving a conspicuous lack of success. As the statutory test was such an amorphous one, Commissioners’ decisions were almost certainly going to be upheld as ones to which they were entitled to come, so it is not surprising that no cases went up to the courts. The first issue did, however, provide litigation in relation to caravans. A caravan may, as dictionaries testify, be fairly described as ‘a house on wheels’, so it was plain that there was scope for argument. Makins v Elson55 concerned a caravan occupied by the owner of a site on which a house was being built; the caravan was jacked up on supports and electricity, telephone and water were all connected. Foster J held that the caravan was a ‘dwelling-house’ within section 29. By contrast, in Moore v Thompson56 Millett J held that a caravan, possibly jacked up, but without benefit of connected electricity, telephone and water, was not a ‘dwelling-house’, while, additionally, the taxpayer’s sporadic and occasional stays in the caravan were insufficient for it ever to have been her ‘residence’. The second issue—multiple buildings—was first aired in Batey v Wakefield.57 The taxpayer, who had a flat in London where he worked, had a bungalow built in the grounds of his country house as a residence for a caretaker. Eight years later, when the taxpayer sold the London flat and took up full time residence in the country house, he sold the bungalow. The Revenue’s case for refusing the exemption took the simple line that the facts disclosed two dwelling-houses, the bungalow being a house in which the caretaker resided. That line failed throughout. It was held that a separate residential building might be a part of another dwelling-house if it was appurtenant to and occupied for the purposes of that dwelling-house. It is true that the judgments did not discuss different methods of statutory interpretation or examine the statutory purpose, so that the case is not particularly instructive for the purposes of this paper. Nevertheless, the strictly literal mind might boggle at the idea that two distinct dwellings, occupied by people linked only through the medium of employment, constituted the residence of only one of those persons. Green v CIR58 concerned a large mansion with two linked wings which had separate entrances and comprised self-contained flats. The Court of Session declined to disturb a Commissioners’ decision that the wings did not form part of a single dwelling-house. 55 

Makins v Elson [1977] 1 WLR 221. Moore v Thompson (1986) 61 TC 15. 57  Batey v Wakefield (1981) 55 TC 550. 58  Green v CIR (1982) 56 TC 10. 56 

Statutory Interpretation in Early Capital Gains Tax Cases 271 Batey v Wakefield was distinguished by Walton J in Markey v Sanders59 in which the taxpayer’s case failed in respect of a bungalow some 130 metres away from the main house, but in Williams v Merrylees60 Vinelott J, who disagreed with Walton J in his reading of the reasoning in Batey v Wakefield, declined to disturb a Commissioners’ decision in favour of the taxpayer on facts which were closely similar to those in Markey v Sanders. When Lewis v Rook61 came before the Court of Appeal Balcombe LJ, in the only reasoned judgment, declared the state of the law to be unsatisfactory. He did not specifically say that Markey v Sanders and Williams v Merrylees were irreconcilable, but it is a fair inference that that view underlay the comment. Lewis v Rook concerned a cottage some 175 yards away from the main house so the case was very much in Markey v Sanders and Williams v Merrylees territory. The Commissioners’ decision in favour of the ­taxpayer had been upheld by Mervyn Davies J. The Court of Appeal disagreed, upholding the Revenue’s contention that the second building must be ‘appurtenant to and within the curtilage of the main house’.62 There was one further case, Honour v Norris,63 which involved the unlikely proposition that three flats in different buildings in a London square, comprised a single dwelling-house: the taxpayer was unable to sustain his success before the Commissioners. But, leaving that case aside, it seems that Lewis v Rook put paid to the topic of multiple buildings. The decision in Williams v Merrylees might be said to have been overdeferential to the Commissioners, but otherwise the outcomes of the several cases may be said to have accorded with common sense and certainly did not involve the sort of strict literal interpretation which had given rise to bizarre results in some of the income tax cases of the years of yore. RAMSAY AND LATER AVOIDANCE CASES

Amidst the sequence of cases which started with Ramsay were several which dealt with capital gains, and Ramsay itself was one. In Ramsay the taxpayer company had made a capital gain in an ordinary commercial transaction and the purpose of the scheme involved in the case was to create a loss of an equivalent amount to eliminate the prospective charge to tax. The scheme comprised self-cancelling transactions which would leave the participants at the end of the process in an unaltered position, but the design was that, while one of the transactions would throw up a loss allowable for tax

59 

Markey v Sanders [1987] 1 WLR 864. Williams v Merrylees [1987] 1 WLR 1511. 61  Lewis v Rook [1992] 1 WLR 662. 62  ibid, 670–671. 63  Honour v Norris (1992) 64 TC 599. 60 

272  Philip Ridd purposes, the gain in the corresponding self-cancelling transaction would not be chargeable because it would attract the exemption in paragraph 11(1) of Schedule 7 to the Finance Act 1965, in respect of a debt which was not what that provision delphically described as ‘the debt on a security’. Short of the House of Lords the issue was whether that provision applied in the circumstances. That technical issue was then overshadowed in the House of Lords by what was then known, at least in Revenue circles, as ‘the global argument’, ie the argument that the correct approach was to view the transactions in the round rather than one by one. To the horror of the tax avoidance industry that argument succeeded. It is helpful to return at this point to Lord Steyn’s speech in McGuckian, an extract from which was set out in the Introduction to this paper. That extract was taken from a long passage in which Lord Steyn introduced and analysed Ramsay. Having explained the position as regards statutory interpretation, Lord Steyn continued: The second problem was that in regard to tax avoidance schemes the courts regarded themselves as compelled to adopt a step by step analysis of such schemes, treating each step as a distinct transaction producing its own tax consequences. It was thought that if the steps were genuine, ie not sham or simulated documents or arrangements, the court was not entitled to go behind the form of the individual transactions. In combination those two features—literal interpretation of tax statutes and the formalistic insistence on examining steps in a composite scheme separately—allowed tax avoidance schemes to flourish to the detriment of the general body of taxpayers. The result was that the court appeared to be relegated to the role of a spectator concentrating on the individual moves in a highly skilled game: the court was mesmerised by the moves in the game and paid no regard to the strategy of the participants or the end result. The courts became habituated to this narrow view of their role. On both fronts the intellectual breakthrough came in 1981 in the Ramsay case …64

Now, thus far Lord Steyn appeared to be identifying two distinct facets, ie statutory interpretation and factual analysis. But there must now be taken on board what he said in conclusion of his examination of Ramsay, viz: The new Ramsay principle … was not invented on a juristic basis independent of statute. That would have been indefensible since a court has no power to amend a tax statute. The principle was developed as a matter of statutory construction. … The new development was not based on a linguistic analysis of the meaning of particular words in a statute. It was founded on a broad purposive interpretation, giving effect to the intention of Parliament. The principle enunciated in the Ramsay case was therefore based on an orthodox form of statutory interpretation. And in asserting the power to examine the substance of a composite transaction the

64 

McGuckian, above n 1, 999.

Statutory Interpretation in Early Capital Gains Tax Cases 273 House of Lords was simply rejecting formalism in fiscal matters and choosing a more realistic legal analysis.65

Now, although the last sentence began with ‘and’, that passage appears to be a conflation in that it suggests that Ramsay produced a single solution to the two problems which Lord Steyn had identified. It is, of course, correct that in Ramsay the speeches of Lord Wilberforce and Lord Fraser of Tullybelton referred to the task of statutory construction, in particular to whether transactions gave rise to losses within the meaning of Finance Act 1965, but the actual conclusion in Ramsay was, in Lord Wilberforce’s words: ‘The true view, regarding the scheme as whole, is to find that there was neither gain nor loss, and I so conclude’.66 This was a finding on the facts that nothing whatsoever had happened; it was not a finding that there had been a loss which was not, on a true construction of the statute, an allowable loss; it is to be recognised that, as regards the global argument, neither speech involved examination of any of the provisions of Finance Act 1965; no statutory provision was construed because the occasion to construe did not arise. Normally, resolution of a tax problem entails a correct understanding of the facts, a correct understanding of relevant statutory provisions, and the marrying of those two correct understandings. Ramsay was unusual in that a correct understanding of the facts established that nothing had happened, so no statutory provisions came into play. The second case in the Ramsay sequence was IRC v Burmah Oil.67 Burmah differed from Ramsay in that it concerned a tailor-made scheme, rather than a mass-marketed one, and it involved a real asset, a considerable holding of BP stock owned within the Burmah group. A Burmah subsidiary bought the stock from the parent company for £380m, the price left outstanding on loan, but the stock was subsequently sold back for £220m: the subsidiary therefore owed £160m to the parent company, but the subsidiary had no assets and, as the debt was not ‘the debt on a security’, it was of no fiscal consequence because its disposal would produce no allowable loss. In these circumstances a scheme was arranged, the purpose of which was to convert the bad debt into an allowable loss. The scheme, which comprised a series of transactions within the confines of the Burmah group, involved the parent company in acquiring new capital in the subsidiary; the overall effect, as it was put to the Special Commissioners by Mr Edward Jackson for the Revenue, was that the true consideration given by the parent company for the new capital in the subsidiary was the waiver of a valueless loan; as put by Lord Diplock, the overall effect was that the parent company wrote off the subsidiary’s indebtedness by itself providing the subsidiary

65 

ibid, 1000. Ramsay, above n 4, 328. 67  IRC v Burmah Oil (1980) 56 TC 200. 66 

274  Philip Ridd with the money to pay it, ostensibly in the form of fresh capital, so that the real loss it sustained was of a debt not on a security. The House of Lords was unanimous that Ramsay applied, so that the transactions were to be viewed in the round. The result in Burmah turned on a true analysis of what had happened. It is true that Lord Fraser’s conclusion was: If the argument for Burmah is right, this would be one more case in which the taxpayer had achieved the apparently magic result of creating a tax loss that was not a real loss. In my opinion they have not achieved that result because, in the same way as in Ramsay’s case, when the scheme was carried through to completion there was here no real loss and no loss in the sense contemplated by the legislation68

It is difficult to square that conclusion with the fact that, whether by the parent company waiving it or writing it off, the subsidiary’s debt to the parent company was expunged. At any rate, as in Ramsay, Burmah involved no statutory provision, the meaning of which was in dispute. Even if, as has been argued Ramsay and Burmah were not, strictly speaking, cases on statutory construction, they were, of course, cases with a statutory backdrop. The cases were aptly characterised by Lord Steyn as a ‘breakthrough’. Plainly they were inspired by a notion that CGT should, if at all possible, be made to work rationally, and that meant getting away from the rigidities of the past which had often resulted in outcomes, whether in the Revenue’s favour or the taxpayer’s, which offended common sense. But it is submitted that Furniss v Dawson69 took the new approach a step too far. The facts were simple: the taxpayers, instead of selling their shares in family companies directly to Wood Bastow Ltd, exchanged the shares for shares in an offshore investment company, and that company then sold the shares to Wood Bastow. This method was designed to attract the application of paragraph 7 of Schedule 6 to the Finance Act 1965, by which gains were rolled over on a company reconstruction, so that the share exchange did not involve a chargeable disposal and the sale of the shares was made by a company not within the scope of the tax charge by virtue of it not being resident in the UK. The scheme, as carried out, did not involve sham or deceit, so that, as matter of general law, the share exchange took place and the offshore company was the vendor of the shares in the family companies. But the Revenue argued that, for CGT purposes, Ramsay applied, with the result that the taxpayers were the vendors. The House of Lords accepted that argument but, it is submitted, wrongly because it involved re-characterisation of what happened and the substitution of a fiction (taxpayers as vendors) for a fact (offshore company as vendor). Ramsay and Burmah involved analysis

68  69 

ibid, 221. Furniss v Dawson [1984] AC 474.

Statutory Interpretation in Early Capital Gains Tax Cases 275 by reference to the intentions of the parties and a conclusion that regard should be had to the overall transaction intended. By contrast in Furniss v Dawson the conclusion was that the parties had done exactly what they intended not to do. There was no statutory basis on which that conclusion might have been reached, and there is no common law power by which the courts may disregard the intentions of the parties and substitute fiction for fact. The Revenue did in fact advance an alternative argument which was that the share exchange was not a company reconstruction within the meaning of paragraph 7 of Schedule 6, because it was designed to be transitory and to have no commercial purpose. The argument was complicated by reason of a suggestion that Ramsay had some relevance to it whereas, it is submitted, it should have been a self-standing argument. Given a purposive approach to statutory construction, it is difficult to see how that argument might have been countered. As things transpired, Furniss v Dawson was a decision on the facts in much the same way as both Ramsay and Burmah were. Similarly Craven v White70 is not instructive for present purposes. In two of the three cases involved the scheme under consideration was the same as the one in Furniss v Dawson. The law report is very long but the outcome may be expressed simply—the transactions concerned did not take place in accordance with any pre-determined plan, so Ramsay did not apply. The alternative argument which the Revenue raised in Furniss v Dawson was not, perhaps understandably, given a re-run. Under this heading a brief reference may also be made to Chinn v Collins.71 As the speech of Lord Roskill made abundantly clear, the two crucial issues in Chinn v Collins did not involve statutory construction; one depended on interpretation of the documents and of the facts set out in the Special Commissioners’ Case Stated; the other depended on whether the relevant transactions involved bounty. Abiding interest lies in the passage in which Lord Wilberforce referred to his speech in Plummer72 in which he said that, where transactions take place in accordance with a pre-determined plan, the courts are entitled to look at the plan as a whole, but are not entitled to disregard the legal form and nature of the transactions carried out.73 That important qualification seems, sadly, to have got lost in the sequence of cases which started with Ramsay. Lord Wilberforce had retired before Furniss v Dawson was decided. It would be interesting to know whether Lord Wilberforce read, and made any comments about, Furniss v Dawson: we shall never know, but it is a matter of extreme doubt whether he would have subscribed to the reasoning. 70 

Craven v White [1989] AC 398. Chinn v Collins [1981] AC 533. 72  Plummer, above n 3. 73  ibid, 907. 71 

276  Philip Ridd If all or any of the Ramsay series of cases had involved statutory construction, then they would be of primary relevance to this paper. But if, as has been argued, they are cases on their facts, then they are, at best, only of peripheral relevance. As the paper’s foundation is the approach of Lord Steyn in the McGuckian case, the Ramsay series could not be omitted. OTHER CASES AFTER RAMSAY AND UP TO McGUCKIAN

In Berry v Warnett74 the House of Lords overturned a majority decision in the Court of Appeal. The facts, straightforward enough, comprised three transactions; first, on 15 March 1972 the taxpayer transferred shares to an offshore trustee company; secondly, on 4 April 1972 the taxpayer made a settlement of the trust fund under which he had a life interest but he sold the reversionary interest to another offshore trustee company for £14,500; thirdly, on 6 April 1972 the taxpayer sold his life interest to yet another offshore company for £130,753. The obvious purpose was to realise the available gain on the shares with only a modest bill for CGT: the thinking was that the first transaction was, indisputably, a non-event for CGT purposes (section 22(5) of the Finance Act 1965), the second transaction was a part disposal of the shares, the chargeable gains being £14,839; the third transaction was, indisputably, not a chargeable event (paragraph 13 of Schedule 7 to the Finance Act 1965). The Revenue maintained that the second transaction amounted to a full scale disposal of the shares, the chargeable gains being £150,483, relying on the ordinary meaning of disposal or on Finance Act 1965, section 25(2) by which a ‘gift in settlement’ was the occasion of a disposal. The taxpayer’s argument that the settlement effected a part disposal had at least a superficial attraction in the sense that the taxpayer could hardly be said to have made an outright disposal of the shares given that he had a life interest in the fund which comprised the shares. The Revenue’s counter to the argument was that the taxpayer had not retained an interest in the shares but had acquired an interest in the trust fund, a distinct and newly created asset. In the leading speech in the House of Lords Lord Wilberforce upheld that counter-argument, commenting that the taxpayer’s approach suffered from inconsistency in asserting that he claimed to have retained an interest in the shares but, for the purposes of having the third transaction accepted as a non-chargeable event, asserted that he had ‘an interest created by or arising under a settlement’ within paragraph 13 of Schedule 7.75 The decisive issue is of no concern to the subject-matter of this paper. It was the Revenue’s alternative argument which made statutory interpretation 74  75 

Berry v Warnett [1982] 1 WLR 698. ibid, 703.

Statutory Interpretation in Early Capital Gains Tax Cases 277 a live topic. As Buckley LJ noted, ‘The expression ‘gift in settlement’ sounds somewhat strangely in a lawyer’s ear, at any rate in the ear of a conveyancer’76 but, whether to lawyer or layman, ‘gift’ is a word which suggests bounty on the part of the transferor and, but for one thing, the Revenue’s submission would probably not have got off the ground. That one thing was that, if the Revenue were wrong, then there was nothing in the statutory provisions by which trustees would have been deemed to have acquired the shares at their market value when the settlement was made. The choice was therefore to conclude either that the meaning of language must be strained so that ‘gift in settlement’ meant ‘transfer into a settlement’ or that Parliament had fallen into error by making no provision to cater for the trustees’ deemed acquisition cost (‘casus omissus’). A conclusion in favour of the former reached by Buckley LJ was endorsed in the House of Lords by Lord Roskill, with whom Lord Fraser of Tullybelton agreed, but Lord Wilberforce, with whom Lord Scarman and Lord Bridge of Harwich agreed, had difficulty with it. Lord Wilberforce did not in clear terms declare the Revenue’s argument to be wrong and he moved on to the other issue in the case because he considered that issue to be the decisive one. But Lord Wilberforce did say: ‘I am reluctant, in a taxing act, to depart from the natural meaning of the words’.77 It is a matter for speculation whether, if the section 25(2) issue had been the only one, any of Lord Wilberforce, Lord Scarman, or Lord Bridge might have fallen in line with Lord Fraser and Lord Roskill. It is evident from the judgments in the courts below that Charles ­Potter QC, for the taxpayer put the familiar remarks of Rowlatt J in Cape Brandy Syndicate v IRC78 in the forefront of his argument on statutory interpretation. Citing Canadian Eagle Oil v The King79 and Ransom v Higgs80 Oliver LJ stated that to give a word (here ‘gift’) a meaning which it does not naturally bear was impermissible in the case of a taxing statute.81 Ackner LJ cited several authorities as justifying the proposition that ‘if the Crown claims duty under a statute it must show that the duty is imposed by clear and unambiguous words’.82 But neither judge applied the stated proposition with absolute rigour, instead facing the need to choose between the casus omissus approach and the strained language approach, coming out in favour of the former. Buckley LJ, observing that Rowlatt J specified the need to look at what is ‘clearly said’, pointed out that section 25(2) was anything but clear and commented that the context

76 

Berry v Warnett [1981] 1 WLR 1, 18. Berry v Warnett, above n 74, 702. 78  Cape Brandy Syndicate v IRC [1921] 1 KB 64, 71. 79  Canadian Eagle Oil v The King [1946] AC 119, 140. 80  Ransom v Higgs [1974] 1 WLR 1594, 1616. 81  Berry v Warnett, above n 76, 14. 82  Berry v Warnett, above n 76, 20. 77 

278  Philip Ridd was a legitimate aid to construction—indeed one to which the court was bound to have regard.83 Where then does this case stand so far as concerns the subject-matter of this paper? It is suggested that not many years earlier the Revenue’s argument on section 25(2) would have been given short shrift because the proposition which Oliver LJ derived from Canadian Eagle Oil v The King would have been applied with rigour and there would have been no shrinking from the notion that Parliament had simply failed to perform adequately. The judgments and speeches show, however, that strict literal construction was not adopted as the correct path to follow, and, even though a majority of the judges were not persuaded by the Revenue’s argument, it was given serious, even anxious, consideration and the case may be said to demonstrate a shift in approach. Williams v Bullivant84 concerned section 23(4) of the Finance Act 1965, which provided that: if, on a claim by the owner of an asset, the inspector is satisfied that the value of the asset has become negligible, he may allow the claim and thereupon this Part of this Act shall have effect as if the claimant had sold, and immediately re-acquired, the asset for an amount equal to the value specified in the claim.

In February 1978 the taxpayer made a claim that certain shares had become of negligible value in February 1974 and he contended that the sale and reacquisition under section 23(4) was to be considered to have taken place in 1973–74. The contention was hopeless on the statutory wording. Vinelott J did not need to decide whether the sale and re-acquisition was to be considered to have taken place on the date when the claim was made or the date when the claim was allowed, but he did so. He noted that on a literal construction ‘thereupon’ related to the ‘arbitrary date’ when the claim was allowed but, observing that ‘arbitrary consequences’ would follow, he preferred a ‘permissible construction’ that ‘thereupon’ referred to the date of the making of the claim.85 The case is no more than a very small straw in the wind but in its way it demonstrates that good sense was prevailing in the world of CGT. Williams v Bullivant was followed in Larner v Warrington86 though Nicholls J noted that it worked considerable hardship to taxpayers. A separate submission that there had been a ‘dissipation’ of assets, within section 23(3) failed because the assets concerned (shares and debts) still existed even after they had become valueless. Paragraph 23 of Schedule 6 to the Finance Act 1965 provided that where land acquired before 6 April 1965 was sold with development value, the 83 ibid. 84 

Williams v Bullivant (1982) 56 TC 159. ibid, 163. 86  Larner v Warrington (1985) 58 TC 557. 85 

Statutory Interpretation in Early Capital Gains Tax Cases 279 chargeable gain (or loss) was to be measured by reference to the value on 6 April 1965. In Mashiter v Pearmain87 the taxpayer contended that paragraph 23 did not apply because the first of the two conditions for its application was not met. That condition read ‘if, but for this paragraph, the expenditure allowable as a deduction in computing under this Schedule the gain accruing on the disposal would include any expenditure incurred before the 6th April 1965’. The taxpayer’s argument turned on the fact that there had been no actual expenditure. The Revenue’s argument relied on the deemed expenditure incurred when the land had been acquired by gift in 1950. The Court of Appeal decision in favour of the Revenue turned on a meticulous examination of several of the CGT provisions. Oliver LJ expressly disavowed resorting to purposive construction,88 but he plainly took a contextual approach. Purchas LJ, agreeing, said that ‘the code must be read as a whole’,89 and Neill LJ, also agreeing, said that ‘the relevant provisions of this Act have to be construed together’.90 If it were fair to describe the old judicial approach as involving strict literal interpretation with scant, if any regard to context, then the Court of Appeal’s decision in this case was a triumph for more modern methods. In Zim Properties v Procter91 the main issue was whether a right of action was an asset for CGT purposes such that its fruits fell into the scope of the CGT charge. Zim sued its solicitors for negligence in relation to an intended sale of land which had failed. The action was compromised, Zim receiving £69,000. For CGT purposes there were three possible results, viz: (1) the £69,000 was not taxable at all, (2) the £69,000 was wholly taxable, or (3) the £69,000 was a receipt but an acquisition cost was deductible. Warner J, upholding the decision of the Special Commissioners, held (3) to be the correct result. For present purposes there is a need to concentrate only on two points. Before Warner J reached them he concluded, in the light of O’Brien v Benson’s Hosiery (Holdings)92 that a right of action is an asset for CGT purposes because it is something which can be turned to account. Warner J then considered section 22(3) of the Finance Act 1965— disposal where a capital sum is derived from assets—and, while not disagreeing with the conclusion of Walton J in IRC v Montgomery,93 he held that it was not always the case that a capital sum was derived from its immediate source, the true view being that it was necessary ‘to look in each case

87 

Mashiter v Pearmain (1983) 58 TC 334. ibid, 346.ben. 89  ibid, 348. 90  ibid, 349. 91  Zim Properties v Procter (1984) 58 TC 371 (‘Zim’). 92  O’Brien v Benson’s Hosiery, above n 46. 93  IRC v Montgomery [1975] Ch 266. 88 

280  Philip Ridd for the real (rather than the immediate) source of the sum’.94 On the facts Warner J considered that it was not contrary to business sense to treat the £69,000 as a gain derived otherwise than from the properties as the properties were still owned by Zim, unimpaired and unaffected by the failure of the sale. In this connection Warner J referred to the Aberdeen extract above. The second notable point related to Zim’s argument that a right to compensation for loss was not an ‘asset’ for CGT. Warner J said: I have no difficulty in accepting that not every right to a payment is an ‘asset’ within the meaning of that term in the capital gains tax legislation. Perhaps the most obvious example of one that is not is the right of a seller of property to payment of its price. The relevant asset, then, is the property itself. What that shows, however, to my mind, is no more than that the interpretation of the capital gains tax legislation requires, as does the in­terpretation of any legislation, the exercise of common sense, rather than just the brute application of verbal formulae. In saying that I am, I think, expressing much the same thought as was expressed by Lord Wilberforce in [the Aberdeen extract above].95

When considering this broad approach taken by the judge, it is perhaps worth bearing in mind that, while Sir Jean-Pierre Warner had spent many years at the Chancery bar, and indeed was standing Counsel to the Inland Revenue, he had, prior to his appointment to the Chancery Division, been an Advocate-General in the European Court of Justice. Golding v Kaufman96 concerned a sum received for the abandonment of certain options and gave rise to an issue concerning the construction of paragraph 14(3) of Schedule 7 to the Finance Act 1965. It is unnecessary to give details of the complex facts and arguments. It is, however, to be noted that this was another case in which counsel for the taxpayer was obliged to concede that the legislature could not have intended the result for which he was contending, but asserted that that result was the inescapable consequence of the language used.97 Vinelott J found that the words of para 14(3) did not yield any compelling reason to adopt one or other of the rival constructions, so that the context would be determinative.98 His careful analysis of several of the CGT provisions resulted in a construction which ‘avoids the consequence that a capital sum received on the release of an option escapes capital gains tax and … gives a rational purpose and meaning to para 14’.99 The case exemplifies the proposition that the courts had moved far away from the notion that the subject was not to be taxed except by clear words and had come to accept that a charge to tax could be teased out of a 94 

Zim, above n 91, 391. Zim, above n 91, 392. 96  Golding v Kaufman (1985) 58 TC 296. 97  ibid, 307–308. 98  ibid, 308–309. 99  ibid, 310. 95 

Statutory Interpretation in Early Capital Gains Tax Cases 281 contextual examination of markedly obscure wording if that seemed the sensible conclusion to reach. Lyon v Pettigrew100 concerned section 27(2) of the Finance Act 1965, which provided that, if a contract for the disposal and acquisition of an asset was conditional, then, as an exception to the normal rule under section 27(1), the time at which the disposal and acquisition was made was not the time the contract was made but the time when the condition was satisfied. A taxi-cab proprietor sold seven taxis together with their licences. In six of the seven instances payment was to be by 150 weekly instalments. The Special Commissioners held that section 27(2) applied so that each of the six disposals did not take place until the payment of the price was ­completed. Walton J disagreed. His view was that: the words ‘contract is conditional’ have traditionally, I think, been used to cover really only two types of case. One is a ‘subject to contract’ contract, where there is clearly no contract at all anyway, and the other is where all liabilities under the contract are conditional upon a certain event.101

Having so stated he expressed surprise at having been told that there was authority on such a fundamental point, namely Eastham v Leigh London and Provincial Properties,102 a case on the equivalent provision in relation to the short-term gains tax introduced in 1962. The issue in Lyon v Pettigrew cannot be advanced as particularly striking but it is not a wholly odd notion that a contract which contains conditions would be a ‘contract (which) is conditional’ and, while Walton J regarded the point as obvious, two Special Commissioners, both qualified lawyers, failed to get it right. In Chaney v Watkis103 the taxpayer made an agreement (later varied) with his mother-in-law for her to vacate a house of which she was the protected tenant, and he then sold the house. Initially he had agreed to pay her £9,400 in compensation but the varied agreement was one by which he constructed for her use an extension to his own home, that extension costing £25,000. Nicholls J agreed with the General Commissioners that the £9,400 was not deductible but he held that the obligation to provide rent-free accommodation was capable of being valued in money terms and amounted to deductible expenditure. In Oram v Johnson104 Walton J had held that ‘expenditure’ in section 32 of the Finance Act 1965 meant expenditure in money or money’s worth and did not therefore include the value of the taxpayer’s time in effecting improvements to his property. Nicholls J held that the obligation to provide rent-free accommodation passed that test. Yet again a strict literal approach was not taken. 100 

Lyon v Pettigrew (1985) 58 TC 452. ibid, 465. 102  Eastham v Leigh London and Provincial Properties [1971] 1 Ch 871. 103  Chaney v Watkis (1985) 58 TC 707. 104  Oram v Johnson [1980] 1 WLR 558. 101 

282  Philip Ridd In Owen v Elliott105 the taxpayer claimed relief under section 80(1) of the Finance Act 1980, on the basis that rooms in a private hotel owned by him and his wife had been ‘let by him as residential accommodation’. The Revenue accepted that, as a matter of the ordinary use of the English language, the statutory words were applicable. The Revenue argued that a limited meaning was to be deduced from the context. Millett J agreed, holding that the words denoted letting to people who would be likely to use the accommodation as their home. The judges in the Court of Appeal, disagreeing with Millett J, accepted that the context should be considered but found that there was nothing in the context to drive a limited meaning. In Hirsch v Crowthers Cloth106 the decisive issue was the construction of section 31(1) of the Capital Gains Tax Act 1979, section 31(1) as amended by section 83(2) of the Finance Act 1980, which read: (1) There shall be excluded for the consideration for a disposal of assets taken into account in the computation under this Chapter of the gain on that disposal any money or money’s worth charged to income tax as income of, or taken into account as a receipt in computing income or profits or gains or losses of, the person making the disposal for the purposes of the Income Tax Acts.

The taxpayer company, which had acquired machinery for £545,930, sold it for £715,967, thereby making a gain of £170,037. The capital allowances position resulted in a balancing charge of £478,977, a figure reached by a calculation which included the £545,930 acquisition cost. The balancing charge had to be brought into the corporation tax computation of profits. For CGT purposes the taxpayer company argued that, in addition to the £545,930 being deducted as the cost of acquisition, it was also to be deducted by virtue of section 31(1) because it had been ‘taken into account’ within the meaning of that provision by reason of it having been a component in the calculation of the balancing charge and being, under the capital allowances provisions, treated as the disposal value of the machinery. The outcome of that double deduction was a loss of £375,893 in place of the real gain of £170,037, a result which Vinelott J described as ‘an affront to common sense’.107 He rejected the taxpayer company’s argument, holding that ‘taken into account’ in section 31(1) referred to sums brought directly into the computation and did not include sums brought into account to ascertain whether a writing down allowance or a balancing charge arose. Another route to the same end might have been to pay attention to the words ‘as a receipt’ and construe them as referring to real receipts as opposed to deemed receipts: alternatively the £545,930 could have been denied the status of

105 

Owen v Elliott [1989] 1 WLR 162. Hirsch v Crowthers Cloth (1989) 62 TC 759. 107  ibid, 769. 106 

Statutory Interpretation in Early Capital Gains Tax Cases 283 ‘money or money’s worth’ because it was merely the product of a calculation albeit expressed in monetary terms. For present purposes, however, the interesting feature of the case was that Vinelott J rehearsed what he described as ‘certain well-established principles’ of statutory construction.108 He started with some words from the speech of Lord Wilberforce in Ramsay, viz ‘There may, indeed should, be considered the context and scheme of the relevant Act as a whole, and its purpose may, indeed should, be regarded’.109 But purpose was not really the issue as the judge recognised in the passage beginning ‘The court will strive to find an interpretation which avoids injustice and absurdity …’.110 In the result he did not have to strive hard because he considered that the relevant statutory words were not merely ‘capable of being read’, but were ‘most naturally read’ in a sense which avoided an absurd result.111 O’Rourke v Binks112 concerned a company takeover as a result of which the taxpayer received a distribution and a liability to CGT arose. The main issue in the case was whether the taxpayer was entitled to make an election under section 72(4)(b) of the Capital Gains Tax Act 1979;113 if yes, the chargeable gain was £26,303; if no, it was £212,361. The Special Commissioners (Mr B O’Brien) and the High Court (Vinelott J) favoured the taxpayer’s submission, but the Court of Appeal preferred the Revenue’s. The other issue is not relevant for present purposes; it was whether 15.58% was ‘small’; the answer on all hands was ‘no’. It is helpful to recast section 72, as relevant, in a shorter version, viz: (1) the tax applies when a capital distribution is received; (2) if the distribution 108 

ibid, 769. Ramsay, above n 4, 323. 110  Hirsch v Crowthers Cloth, above n 106, 769. 111  ibid, 771. 112  O’Rourke v Binks (1992) 65 TC 165. 113  Capital Gains Tax Act 1979, s 72: (1) Where a person receives or becomes entitled to receive in respect of shares in a company any capital distribution from the company (other than a new holding as defined in section 77 below) he shall be treated as if he had in consid­eration of that capital distribution disposed of an interest in the shares. (2) If the inspector is satisfied that the amount distributed is small, as compared with the value of the shares in respect of which it is distributed, and so directs: (a) the occasion of the capital distribution shall not be treated for the purposes of this Act as a disposal of the asset, and (b) the amount distributed shall be deducted from any expenditure allowable under this Act as a deduction in com­puting a gain or loss on the disposal of the shares by the person receiving or becoming entitled to receive the distribu­tion of capital. (3) A person who is dissatisfied with the refusal of the inspector to give a direction under this section may appeal to the Commissioners having jurisdiction on an appeal against an assessment to tax in respect of a gain accruing on the disposal. (4) Where the allowable expenditure is less than the amount distributed (or is nil)—(a) subsections (2) and (3) above shall not apply, and (b) if the recipient so elects (and there is any allowable expenditure)— (i) the amount distributed shall be reduced by the amount of the allowable expenditure, and (ii) none of that expenditure shall be allowable as a deduction in computing a gain accruing on the occasion of the capital distribution, or on any subsequent occasion. In this subsection ‘allowable expenditure’ means the expenditure which immediately before the occasion of the capital distribution was attributable to the shares under paragraphs (a) and (b) of section 32(1) above. 109 

284  Philip Ridd is small, the Inspector may give a direction that (1) shall not apply and, instead of a charge to tax, the distribution reduces the taxpayer’s acquisition cost; (3) if the Inspector refuses to make such a direction, the Commissioners hearing an appeal may do so; (4) if the distribution exceeds taxpayer’s acquisition cost, then (a) (2) and (3) shall not apply and (b) the taxpayer may make an election by which he can make use of all of his allowable expenditure to reduce the gain on the capital distribution. The Revenue’s case was that (2)–(4) was a package to deal with the situation in which the distribution was small, but a difficulty lay in the fact that ‘if … the distribution is small’ appeared in (2) but not in (4), so the taxpayer was able, plausibly, to assert that (4) was a self-standing provision applicable even where the distribution was not small. It is plain from the report that the Revenue’s case was skilfully advanced by Ms Doyin Lawunmi before the Special Commissioner and by Launcelot Henderson (now Henderson LJ) in the High Court, but in both instances it was unable to surmount the last hurdle; it was concluded that the limitation (‘if … the distribution is small’) could not be implied: the High Court judgment mentioned several earlier cases in which the restricted scope of statutory interpretation was set out. Now, it is important to see why the Revenue had, short of the last hurdle, a strong case. Without (4), (2) would have created the oddity that, if the amount of the distribution exceeded the allowable acquisition cost, the excess would escape taxation. In fact the original legislation in 1965 did create that anomaly by having an equivalent to (2) but no equivalent to (4),114 and an equivalent to (4) was enacted in 1966 to eliminate the anomaly.115 Moreover, while the Revenue could invoke purpose in that way, the taxpayer was unable to suggest any purpose which might have stimulated the creation of (4) to cover a case in which the distribution was not small; quite the reverse; Vinelott J demonstrated by an example that the taxpayer’s construction ‘has precisely the opposite effect to that which the informed reader would expect’.116 In the Court of Appeal Scott LJ (as he then was), with whom Stuart-Smith LJ agreed, was sufficiently impressed by these factors to conclude that giving effect to Parliament’s presumed intention required the reading in to (4) of a limitation that it was applicable only to situations in which the distribution was small. Other provisions of the Act were also considered to support the Revenue’s construction. The presiding judge, Lloyd LJ (as he then was) agreed with Scott LJ but, in a short additional judgment, made a further point which was that the direc-

114 

See Finance Act 1965, Sch 7, para 3. See Finance Act 1966, Sch 10, para 9. 116 See O’Rourke v Binks, above n 112, 175–176. 115 

Statutory Interpretation in Early Capital Gains Tax Cases 285 tion in (4), that (2) and (3) should not apply, suggested that, but for that disapplication, (2) and (3) would be capable of applying.117 That, without more, would appear to have supported the Revenue’s case fully but, even if that were not so, it certainly established ambiguity. The taxpayer’s case was in fact that not simply that (4) was a self–standing provision but that it was self-standing either if shorn of (a) or if there were implied into (a) words such as ‘if otherwise applicable’. Vinelott J had reached his conclusion against the Revenue on the footing that effect ‘cannot be given to the apparent [of Parliament] by any process of interpretation’118 He referred to the passage in the speech of Lord Diplock in Carver v Duncan in which it was said that to give effect to the presumed intention would ‘involve “so great a distortion of the words the draftsman chose to use and Parliament to approve as to fall beyond the bounds of what is permissible by any process of judicial construction”’.119 But, as the Court of Appeal pointed out, implying words of limitation does not involve distortion of the express words of a statute.120 It does not seem unfair to suggest that the Court of Appeal was bringing to bear the modern contextual approach to statutory construction to correct an old-fashioned strictly literal approach. At the same time implying words of limitation was not exactly a novelty. Indeed it was sometimes done without question. An example of that was Arsenal Football Club v Ende.121 Section 69 of the General Rate Act 1967 provided for a proposal to be made by ‘any person who is aggrieved … (b) by any value ascribed in the ­[valuation] list to a hereditament’, but, though it did not spell out any limitations to restrict who might claim to be ‘aggrieved’ the Law Lords accepted ­without demur that some limitation should be implied. In Marshall v Kerr122 the facts were that Mrs Kerr’s father, a resident and domiciliary of Jersey, died in February 1977, leaving half of his residuary personal estate to Mrs Kerr; in January 1978 Mrs Kerr executed a deed of variation by which she settled her interest on family trusts; the trustee was the same Jersey trust company which was the executor of her father’s will; the administration of the estate was completed in June 1979; CGT assessments were made (on Mrs Kerr’s husband) for 1983–84 and 1984–85 on the footing that capital payments had been made to Mrs Kerr out of the trust funds. It was common ground between the parties that the assessments were to be upheld if Mrs Kerr was the settlor of the trust but that the assessments would fail if, as was contended on behalf of Mr Kerr, her father was

117 

ibid, 188. ibid, 179. 119  Carver v Duncan [1985] AC 1082, 1115. 120 See O’Rourke v Binks, above n 112, 187. 121  Arsenal Football Club v Ende [1979] AC 1. 122  Marshall v Kerr [1995] 1 AC 148. 118 

286  Philip Ridd to be regarded as the settlor. Unfortunately the case proceeded on a false footing until it reached the House of Lords; an assumption was made that the arrangement was a settlement of the assets comprised in the deceased’s estate; that overlooked the well-established proposition of general law that, while an estate is under administration, a testamentary beneficiary does not have an interest in the assets of the estate, but has only a right to have the estate duly administered. For the proposition that the deceased was to be regarded as the settlor the argument relied on section 24(7) and (11) of the Finance Act 1965. Section 24(7) provided that ‘On a person acquiring any asset as legatee, (a) no chargeable gain shall accrue to the personal representatives, and (b) the legatee shall be treated as if the personal representatives’ acquisition of the asset had been his acquisition’. Section 24(11) provided that: if not more than two years after a death any dispositions of the property of which the deceased was competent to dispose … are varied by a deed of family arrangement or similar instrument, this section shall apply as if the variations made by the deed or other instrument were effected by the deceased, and no disposition made by the deed or other instrument shall constitute a disposal for the purposes of this Part of this Act.

The Revenue argued that the provisions had no wider effect than negating the transfer of an asset to a legatee as an occasion of charge (with the direction as to the legatee’s acquisition cost) and negating the occasion of a deed of arrangement as an occasion of charge. The taxpayer relied on the proposition that ‘if you are bidden to treat an imaginary state of affairs as real you must surely, unless prohibited from doing so, also imagine as real the consequences and incidents which, if the putative state of affairs had in fact existed, must inevitably have flowed from or accompanied it’: per Lord Asquith of Bishopstone in East End Dwellings v Finsbury Borough Council.123 The argument was that the consequence of section 24(7) was that Mrs Kerr never acquired assets of the estate so she could not have made a disposition of them, and section 24(11) confirmed that the deceased was to be treated as having by his will made the disposition made by the deed of arrangement. That argument had plausibility and succeeded before the Special Commissioner and in the Court of Appeal. But it came to grief once it was recognised that the asset which Mrs Kerr had at the time of the family arrangement and which she was able to settle was only her right to have the estate duly administered; it is impossible to follow the fiction through and ‘imagine as real’ that the deceased settled that right because by definition it was something which he could not have owned and could have disposed of.

123 

East End Dwellings v Finsbury Borough Council [1952] AC 109, 132–133.

Statutory Interpretation in Early Capital Gains Tax Cases 287 In terms of this paper it is to be recognised that strict literal interpretation was not an option in Marshall v Kerr. As James LJ said in Ex parte Walton: ‘When a statute enacts that something shall be deemed to have been done, which in fact and truth was not done, the Court is entitled and bound to ascertain for what purposes and between what persons the statutory fiction is to be resorted to.’124 Marshall v Kerr is, however, an interesting demonstration of the purposive approach in action. In his speech in the House of Lords Lord Browne-Wilkinson took pains to demonstrate how acceptance of the taxpayer’s argument would ‘produce a chaotic situation which I cannot accept that Parliament intended’.125 It is also a salutary warning to make sure, before considering the impact of tax provisions, that the facts are properly understood in terms of the application to them of general law. Figg v Clarke126 concerned section 54(1) of the Capital Gains Tax Act 1979, the provision by which there was a disposal of trust property when ‘a person becomes absolutely entitled … as against the trustee’. Under a 1963 trust instrument property was held for such of the settlor’s children then living or born later during the life or within due time after the death of the settlor, as attained the age of 21 and, if more than one, in equal shares. The settlor died on 11 July 1990. An assessment to CGT was made for 1990–91 on the footing that section 54(1) applied. The ground of appeal against it was that the class of beneficiaries closed on 17 November 1964 when the settlor suffered a hunting accident and became paralysed from the chest down with the result that he could no longer father children. The case was very much one for ‘the lawyer’s lawyer’ in that it involved a body of Chancery case law stretching back to 1787 in which the courts declined to accept that entitlements under trusts might be ascertained by reference to an individual becoming incapable of having a child. That point was decisive of the appeal and the case would not have merited inclusion in this paper but for the fact that Blackburne J went on to say that section 54(1) would be ‘virtually unworkable’ if the trustee’s submission were correct, because investigation into the precise date on which a person ceased to be capable of having a child would be a ‘virtually impossible task’. A concern that a statutory provision should be workable might well not have troubled the judges in the days of strict literal interpretation. Incidentally no mention was made of the possibility of adoption of a child. Nor was any attention paid to the words ‘within due time after the death’ which, on the basis of a gestation period of 280 days, might have had the result that the class closed on 17 April 1991 so that 1991–92 was the correct year of assessment. 124 

Ex parte Walton (1881) 17 Ch D 746, 756. Marshall v Kerr, above n 122, 169. 126  Figg v Clarke (1996) 68 TC 645. 125 

288  Philip Ridd Jenks v Dickinson127 was concerned with complex statutory provisions concerning bonds known as ‘qualifying corporate bonds’. Space considerations preclude a full analysis—perhaps mercifully. The case concerned section 139(1) of the Finance Act 1989. The taxpayer’s argument was that, even though anomaly would result, the statutory words were so clear as to permit of only one meaning. In his discussion of the principles of statutory construction Neuberger J (as he then was) mentioned several of the standard cases, though not Ramsay, and quoted extensively from the judgment of Scott LJ in O’Rourke v Binks. In the result the judge, after an examination of considerable intricacy, favoured the second of two alternative constructions put forward by the Revenue. The case defies pithy encapsulation and is unlikely to be re-visited in a spirit of enthusiasm, but in the longer term there is one point which is well worth remembering. In considering the minor of two anomalies put forward, Neuberger J said: It seems to me quite conceivable that the legislature may have overlooked, and therefore not catered for, an anomaly which arose not only by virtue of a rather unusual set of facts, but also because of the somewhat different treatments contemporaneously or retrospectively applied to similar or identical transactions (namely, by s 78, para 9 and para 10) as further complicated by the unusual combination of prospective and retrospective effects in one statutory provision, namely s 139(1). Once again, it seems to me that the fact that the application of statutory provisions such as these can result in an anomaly is less surprising than in cases involving somewhat less complicated interrelated provisions (as in Luke and O’Rourke).128

It may be a fair generalisation to say that, the deeper it is necessary to delve in the statutory thicket, the more difficult it will be to discern any statutory purpose even if the assumption is made that the legislature has not overlooked something altogether. The notion of legislative intention, not an uncontroversial one, takes on an increasing air of unreality when tortuous legislation and esoteric underlying subject-matter come into collision. CONCLUSIONS

The primary function of these conclusions is briefly to reinforce what may already be apparent, namely that both before and after Ramsay the courts were routinely construing and applying the CGT provisions in a manner

127  128 

Jenks v Dickinson (1997) 69 TC 458. ibid, 482.

Statutory Interpretation in Early Capital Gains Tax Cases 289 which produced sensible results: and that, tax avoidance schemes apart, Ramsay was not seen, in CGT cases, as involving any sea change so far as statutory construction was concerned. But first there will be mention of several incidental points which emerge from the cases examined. A little more should be said about McGuckian, the spark for this paper, but without going into the tedious intricacies of the tax avoidance scheme involved in the case. Extracts from Lord Steyn’s speech have already been given. Lord Cooke of Thorndon, whom Lord Steyn referred to extra-judicially as ‘a free spirit’, spoke on much the same lines as Lord Steyn. Lord Cooke considered that Ramsay ‘may be recognised as an application to taxing Acts of the general approach to statutory interpretation whereby, in determining the natural meaning of particular expressions in their context, weight is given to the purpose and spirit of the legislation’.129 Lord Browne-Wilkinson spoke of purposiveness in examining the facts as opposed to purposiveness in statutory construction. He said: The approach pioneered in the Ramsay case and subsequently developed in later decisions is an approach to construction, viz. that in construing tax legislation, the statutory provisions are to be applied to the substance of the transaction, disregarding artificial steps in the composite transaction or series of transactions inserted only for the purpose of seeking to obtain a tax advantage. The question is not what was the effect of the insertion of the artificial steps but what was its purpose. Having identified the artificial steps inserted with that purpose and disregarded them, then what is left is to apply the statutory language of the taxing Act to the transaction carried through stripped of its artificial steps.130

Lord Clyde reached his conclusion without resort to Ramsay.131 Although there were plainly differences in the four speeches mentioned, Lord Lloyd of Berwick found it possible to agree with all of them.132 As already indicated, the writer’s own view is that a sharp distinction needs to be drawn between analysis of the facts, to which statutory provisions are no more than a backdrop, and, as needed, construction of particular statutory provisions. This is perhaps no more than to express admiration of the statement of Ribeiro PJ in Collector of Stamp Revenue v Arrowtown Assets133 that ‘The driving principle in the Ramsay line of cases continues to involve a general rule of statutory construction and an unblinkered approach to the analysis of the facts. The ultimate question is whether the relevant statutory provisions, construed purposively, were intended to apply to the transaction, viewed realistically’.134 The word ‘unblinkered’ is important

129 

McGuckian, above n 1, 1005. ibid, 998. 131  ibid, 1005–1007. 132  ibid, 998. 133  Collector of Stamp Revenue v Arrowtown Assets [2003] HKCFA 46. 134  ibid, [35]. 130 

290  Philip Ridd because it gives the lie to the use of ‘disregard’ in the Ramsay line of cases; it is axiomatic that courts have no power to disregard anything; to deny independent status to a transaction which is in fact interdependent is to regard that transaction correctly, not to disregard it. But a better understanding of Ramsay is a sidewind so far as this paper goes, so it is best to leave it there. Kidson v Macdonald provides a useful reminder that taxing statutes generally apply throughout the UK so that differences between the general laws of the constituent countries should not be overlooked. Sometimes taxing provisions specifically cater for differences: for example, coparcenry was still a feature of Northern Irish law so that a reference to it had to be made in section 28 of the Development Land Tax Act 1976.135 But the danger of oversight is acute when taxing provisions do not specifically cater for differences. One of the standard incidents of litigation is that issues become more sharply defined as the cases proceed up the court ladder, but another two features show up in the cases discussed. The first is that a case may altogether change shape because it emerges that some important incident of the circumstances has been overlooked. As has already been made clear, Marshall v Kerr is an example of this because, short of the House of Lords, there was a failure to recall the principle of general law that, while an estate is under administration, a testamentary beneficiary does not have an interest in the assets of the estate, but has only a right to have the estate duly administered. Hindsight criticism is apt to be uncharitable but all the same it is to be observed that this principle136 is not one which was buried deep in the undergrowth of Chancery law and it had even featured in revenue cases in the House of Lords and in the Privy Council,137 so the oversight is somewhat remarkable. The second feature is that, as a case proceeds up the appeal ladder, a wholly new argument may emerge. Chaney v Watkis is an example of this. The decisive point was not advanced to the General Commissioners but was one which occurred to Nicholls J (as he then was) during argument. It is not wholly unusual for judges to discern a new argument but there is a risk of over-enthusiasm for a new argument.138 A new argument may, of course, occur to one of the parties, and a good example of this is

135 This may conveniently be found in Worthing RFC v Inland Revenue Commissioners (1987) 60 TC 482, 492, though coparcenry was not an issue in the case. 136  It was established in Lord Sudeley v Attorney-General [1897] AC 11. 137 See Dr Barnardo’s Homes v Special Income Tax Commissioners [1921] 2 AC 1 and Commissioner of Stamp Duties (Queensland) v Livingston [1965] AC 694. 138  An example would be the Development Land Tax case, Taddale Properties Lt v Inland Revenue Commissioners (1988) 61 TC 26, in which the Court of Appeal rejected a new argument which had been identified and adopted by the High Court judge.

Statutory Interpretation in Early Capital Gains Tax Cases 291 the CGT case of Gubay v Kington139 (not discussed above) in which the taxpayer was obliged to instruct new Counsel for his appeal to the House of Lords and the fresh mind produced a new and successful argument. In strictness a case should not be decided on the basis of a fresh argument which has occurred to a judge after the hearing, but this can happen:140 likewise a decision on the basis of authorities not cited to the court.141 To say that any litigant wants to win may well seem a statement of the blindingly obvious, but there can be situations in which litigation can backfire, or at any rate prove uncomfortable, to the winner. Zim Properties v Procter prompted some wailing and gnashing of teeth on the part of Revenue policy makers who found that coping with the consequences of the Revenue’s win was extremely awkward. The winning of the CGT case of Marren v Ingles142 (not discussed above) also provoked discomfort. Anguish could even be caused to one branch of the Revenue by the success of another branch or by an overseas equivalent.143 An example of a taxpayer being discomfited by a win in a CGT case is not known, but it seems theoretically possible.144 There is, without doubt, a need to beware the law of unintended consequences.145 The main themes of this paper are now resumed. Three learned expositions, are well worthy of consideration. The first, a pre-McGuckian piece, is Interpretation of Fiscal Statutes, the transcript of a lecture given by the Hon Mr Justice Vinelott.146 It is, as might be expected, a most careful examination. The burden of it might be described as a limited acceptance of

139 

Gubay v Kington [1984] 1 WLR 163. for example, the decision of the Special Commissioner in BP Oil Development v Inland Revenue Commissioners (1991) 64 TC 498. 141 eg, De Pol v Cunningham (1974) 49 TC 445. 142  Marren v Ingles [1980] 1 WLR 983. 143  Hemens (VO) v Whitsbury Farm and Stud [1988] AC 601 and Glynn v Commissioner of Inland Revenue (Hong Kong) (1990) 63 TC 162 each upset a longstanding income tax practice (in favour of the taxpayer). If victrix causa placuit deis, sed victa Catoni comes to mind, an amusing reference to it may be found in Pepper v Dafurn (1993) 66 TC 68, 76. One of the writer’s treasured memories is reading an Opinion of Michael Hart QC (later Mr Justice Hart) which ended ‘said Victor Catoney’. 144  Gurney v Richards (1989) 62 TC 287 is an example in the income tax context. A fire officer’s vehicle was held not to be within the special car tax regime because the relevant definition of ‘car’ did not include emergency vehicles, but the consequence will have been a higher tax charge under the general rules for charging benefits. 145  An example from a non-tax context arose when a doctor, about to retire at 60, complained of unfair discrimination in relation to a General Medical Council concession by which retired doctors over 65 were not required to pay registration fees; unable to justify the concession, the GMC did not, as the doctor had hoped, eliminate the age requirement but decided to put an end to the concession; the British Medical Association lost a claim that the ending of the concession had been unlawful; see Regina (British Medical Association) v General Medical Council, The Times, 19 January 2009. 146  J Vinelott, ‘Interpretation of Fiscal Statutes’ (1992) 3(2) Statute Law Review 78–86. 140 See,

292  Philip Ridd ­ urposive interpretation, the limit being to avoid the danger ‘that the court p should not content themselves (sic) with interpretation but should, where the court takes the view that the scheme of the legislation requires it, itself fill in gaps in the legislation and mould it to adapt it to changing ­circumstances’.147 Mr Justice Vinelott remarked that ‘… fiscal legislation is unusual … in its length and complexity, in the daunting detail with which the draftsman sets out to identify and deal with every set of circumstances which he can foresee’148 and, while he did not overtly quarrel with the proposition that ‘clear words are necessary in order to tax a subject’149 he suggested that ‘the subject is only to be taxed on clear words, not on the intendment or equity of an Act’150 was ‘only concerned to stress the distinction between the process of interpretation on the one hand and of judicial legislation on the other’.151 Mr Justice Vinelott also considered IRC v Duke of ­Westminster,152 arguing that the principle laid down in that case was sound but that the majority had erred in the application of that principle.153 Mr Justice Vinelott’s words ‘It would, I think, be very dangerous for the courts to assert a power to disregard a transaction genuinely entered into because it offends against the judicial sense of what is proper or in accordance with the duties of good citizenship’154 and ‘ … although the court looks at the substance of a transaction the court cannot substitute for the actual transaction entered into some other transaction which would achieve a similar economic or business result’155 are especially striking given the fact that he was to decide Furniss v Dawson against the Revenue some seven weeks later. Unsurprisingly Mr Justice Vinelott was heard to say extra-judicially that the House of Lords’ decision in Furniss v Dawson was ‘unconstitutional’. The second exposition is an article by Jacqueline Dyson entitled Interpreting Tax Statutes.156 The article acknowledges the trend to ­purposive

147 

ibid, 85. ibid, 80. 149  Per Rowlatt J in Cape Brandy Syndicate, above n 78, 71. 150  Ramsay, above n 4, 323, per Lord Wilberforce. 151  Vinelott, above n 146, 86. 152  IRC v Duke of Westminster [1936] AC 1. 153  Lord Atkin was the dissentient. 154  Vinelott, above n 146, 83. 155  ibid, 85. 156 J Dyson, ‘Interpreting Tax Statutes’ in M Freeman (ed), Legislation and the Courts (Aldershot, Dartmouth Publishing Company, 1997) 45–63. It is worth noting that both Lord Renton (‘The Evolution of Modern Statute Law and its Future’, same volume, 14) and Michael Freeman (‘The Modern English Approach to Statutory Construction’, same volume, 2) suggest that purposive construction had been adopted over a 50-year period rather than Lord Steyn’s 30. Michael Freeman referred to Lord Diplock having taken the view in Carter v Bradbeer [1975] 1 WLR 1204, 1206–1207 that the period started 30 years previously (ie, previously to 1975). 148 

Statutory Interpretation in Early Capital Gains Tax Cases 293 construction, suggesting that courts have become ‘more flexible in their approach’, so that ‘they still start with a literal approach, but where this fails to provide an answer or produces an unreasonable result, the courts invoke the presumed intention of Parliament’.157 The article goes on to confront the length and the complications of tax law and to conclude that despite recent initiatives ‘the pressure for more fundamental change remains’.158 The third exposition is an article by Natalie Lee entitled A Purposive Approach to the Interpretation of Tax Statutes?159 As the question mark in the title indicates, this article throws doubt on whether the purposive approach had become entrenched and exposes its considerable difficulties. It is a long article which, without doubt, merits close reading. To the extent that it complements Mr Justice Vinelott’s view that use of the purposive approach should not be allowed to degenerate into judicial legislation the article represents powerful support. The counterpart to the proposition that the purposive approach will sometimes encounter difficulties is that on other occasions the legislative purpose will be plain and it is those circumstances that the courts will be able to use the purposive approach to reach sensible solutions and avoid the danger, endemic in the old approach of strict literalism, of reaching nonsensical conclusions. The idiom ‘horses for courses’ comes to mind. There is a danger, both in the law and elsewhere, of making things more complicated than they are (or need to be). For example, Pepper v Hart should have been resolved (in favour of the taxpayers) by appreciating that the statutory provision concerned meant only what it said and did not delve into the level of detail involved in the rival contentions.160 All the same, and pace Furniss v Dawson, badly reasoned outcomes are rare. The cases examined above161 do, it is submitted, convincingly show that from the outset of CGT, and all the more under the influence of Lord Wilberforce’s remarks in Aberdeen, the courts shied away from the old regime of strict literalism and reached conclusions, whether in favour of the taxpayer or the Revenue which, to put it a minimum, defy any criticism of perversity. Moreover, with only one exception, the influence of Ramsay was confined to avoidance cases.

157 

Dyson, above n 153, 51. ibid 59. 159  Natalie Lee, ‘A Purposive Approach to the Interpretation of Tax Statutes?’ (1999) 20(2) Statute Law Review 124–143. 160  See P Ridd, ‘Pepper v Hart—Verdict by Misadventure’, Tax Journal, 19 December 2010, commenting on views expressed in F Bennion, ‘Executive estoppel: Pepper v Hart revisited’ [2007] Public Law 1. 161  It is not considered that any of the many other CGT cases contradict the themes of this chapter. 158 

294  Philip Ridd Legislative provisions, in tax as elsewhere, vary across a spectrum between clear and straightforward on the one hand and hideously complex on the other hand,162 with the task of discerning legislative intent being correspondingly easy and more difficult, even impossible. Vexatious cases aside, litigation involves cases in which there is room for argument. What is needed is precisely the ‘flexibility of approach’ to which Jacqueline Dyson referred. Strict literalism was too crude and inflexible. The cases discussed above, which might be described as ‘flexibility in action’, suggest that, at least as regards CGT, the situation was not as stark as Lord Steyn painted it in McGuckian, though that is not to quarrel with his general theme.

162  It should be noted that complexity is not a recent phenomenon. In Bismag v ­ Amblins (Chemists) [1940] Ch 667, 687 Mackinnon LJ (dissenting) used the phrase ‘fuliginous obscurity’ as a comment on the 253 words of the Trade Marks Act 1938, s 4(1).

11 The UK’s Early Tax Treaties with European Countries JOHN F AVERY JONES*

ABSTRACT

Following on from my chapter for the third volume of this series on the 1945 US–UK treaty, this chapter explores the tax treaties made by the UK in the following ten years, a period which is chosen because it was before the OEEC started work on a Model on which treaties could be based. It will concentrate on the treaties with European countries (comprising those with Sweden, Denmark, the Netherlands, France, Norway, Belgium, Switzerland, Germany and Austria) rather than the treaties with the Dominions (Australia–UK (1946) having been dealt with by John Taylor in the fourth volume of this series) or with the colonies, as these are special cases. The European treaties set up new challenges for our treaty policy and exhibited additional problems such as dealing with civil law concepts and negotiating with countries who had been making treaties amongst themselves for some time and therefore were far more experienced in treaty negotiation than we were. Aspects to be considered include: the development of the definitions of ‘person’, ‘company’ and ‘resident’ (the use of the term resident in treaties derives from its use in UK and US treaties, and HMRC recently announced a change of interpretation of the residence article in 16 surviving treaties); the development of the permanent establishment concept; how we obtained a reduction in withholding taxes on dividends from the treaty partner

*  I am grateful to Professor Henk Vording for searching for, and providing me with, material from the Dutch archives on the UK–Netherlands treaty (1948), to Philip Baker QC and Brian Cleave QC for discussions about several topics, and to the following for their assistance with material from other countries: Professor Johann Hattingh and Professor Craig West (South Africa and other African countries), Gabs Makhlouf (New Zealand), Angelo Nikolakakis (Canada), and Dr John Taylor (Australia), and also to the Tax Treaty Team, HMRC, and the Treaty Enquiry Service, Legal Advisers Directorate, Foreign and Commonwealth Office.

296  John F Avery Jones when we had virtually nothing to offer in return; the development of the employment and professional services article; the development of the nondiscrimination article including the introduction of a non-discrimination provision based on ownership to counter discrimination by Denmark on this ground; and the extension of these treaties with European countries to our, and their, colonies. INTRODUCTION

T

HIS CHAPTER CONTINUES the history of the UK’s double taxation agreements following the 1945 treaty with the US described in my paper for the 2006 Conference.1 After that treaty, negotiations with the Dominions (except Australia) were relatively straightforward as we had done the unthinkable in giving the US a better deal, which we obviously had to extend to them. The negotiations with Australia2 were more difficult as the UK wanted as little source taxation as possible, and Australia the opposite, each reflecting their economic interests.3 The next target was mainland European countries where we had for many years stood out for something to which they could never agree—no source taxation—with the result that nobody made any comprehensive treaties with us,4 even though we had started unsuccessful negotiations with Belgium, Germany, Italy, the Netherlands, Sweden and Switzerland before the War,5 and had the War not intervened we would have had a non-standard treaty with France which we needed to prevent UK companies being liable to extra-territorial French taxation.6

1 J Avery Jones, ‘The History of the United Kingdom’s First Comprehensive Double Taxation Agreement’, in J Tiley (ed), Studies in the History of Tax Law, vol 3 (Oxford, Hart Publishing, 2009). 2  The lengthy negotiations with Australia are described in J Taylor, ‘“I suppose I must have more discussion on this dreary subject”: the Negotiation and Drafting of the UK–Australia Double Taxation treaty of 1946’, in J Tiley (ed), Studies in the History of Tax Law, vol 4 (Oxford, Hart Publishing, 2010), which are particularly interesting in comparing the official records in both countries. 3 This was essentially self-interest. Because UK outward investment was far greater than inward investment if the other state imposed tax we had to give relief for more tax than we would collect from domestic income of residents of that state. 4  There were a number of pre-War limited treaties dealing with shipping and air transport profits (with Denmark, Norway, Sweden, Finland, Netherlands, Germany, Iceland, Greece, Japan, Canada and France), and with agency profits (with Sweden, Switzerland, Finland, ­Canada, Newfoundland, Netherlands, Greece, Norway, South Africa and New Zealand). 5 The National Archives (TNA) IR 40/3419 Pt 3 (League of Nations), and IR 40/4307 (Sweden). 6  TNA IR 40/16897. This treaty was eventually signed in 1945 and given effect to in 1947 with the Protocol providing that one item was retrospective to 1931: IR 40/16897, SR&O 1947 No 164. It was subsequently replaced by a more normal treaty (1950) to which r­ eference herein to the treaty with France applies.

The UK’s Early Tax Treaties with European Countries 297 Now, having conceded some source taxation to the US and extended it to the Dominions, we were in a position to talk to European countries on a different basis. We started from the disadvantage that they had been making treaties among themselves for many years7 and the format of treaties reflected their tax systems. Their taxes started out as impersonal taxes or impôts réels: a series of separate taxes imposed on different types of income on a source basis, such as a tax on land, a tax on business profits etc, which for the most part no longer existed but they left the legacy of the types of income dealt with separately in treaties.8 In addition, for the first time we had to deal with the effects of civil law. However, we had fully participated in the international negotiations for a model treaty under the auspices of the League of Nations and would have been aware of some of the differences. We were therefore in the position of joining a club where most of the rules had already been agreed. This article explores the problems that we encountered, and considers what influence these treaties had on the OEEC and OECD Model tax conventions. The focus will be on the UK side rather than treaty provisions required by the other state’s tax law or policy.9 This article covers the period from the US treaty (1945) until the OEEC (the predecessor of the OECD, whose members were European states only) started work on a model treaty in 1956,10 on the basis that such

7  The number of income tax treaties made by European countries existing before the US-UK treaty to which each country was party was: Austria 8, Belgium 6, Czechoslovakia 6, Danzig 1, Denmark 5, Finland, 3, France 10, Germany 17, Hungary 5, Iceland 3, Ireland 1 (with the UK), Italy 7, Liechtenstein 1, Luxembourg 2, Netherlands 5, Poland 4, Romania 2, Saar 2, Sweden 8, Switzerland 3, Tunis 1 and Yugoslavia 2. (Because this counts countries separately, the total number of treaties is half the total of these numbers, namely 51.) The author is indebted to Professor Richard Vann for this list, who points out that the list in the three volumes of the League of Nations tax treaties is incomplete. Mitchell B Carroll gave a figure of around 60 treaties in evidence to the US Senate Foreign Relations Committee on behalf of the National Foreign Trade Council in 1945 in relation to the US-UK treaty, which suggests the existence of some other treaties (even if one adds Canada 1, US 4): SI Roberts (ed), Legislative History of United States Tax Conventions, Roberts & Holland Collection (William S. Hein and Co. Inc., Buffalo, NY, 1993), vol 20 (US-UK Legislative History) 2609. 8  The League of Nations 1928 drafts included draft 1a with separate provisions for p ­ ersonal taxes [income tax] and impersonal taxes, and draft 1c which made no distinction but which followed the impersonal categories of draft 1a. It was draft 1c that became the basis for the future which therefore continued the impersonal tax categories for income tax. See chapter 12 of this publication by Sunita Jogarajan. 9 For example, while Greece wanted an exemption in the UK for profits from shipping sailing under the Greek flag, we were only prepared to exempt Greek (and not UK) residents sailing under their flag, which was a continuation of the 1929 agreement (The Relief from Double Income Tax on Shipping Profits (Greece) Declaration 1929 (SR&O 1929 No 1003) made pursuant to FA 1923, s 18). This was the subject of long negotiations during which the Chancellor had to be consulted, see TNA IR 40/10709 (Pt 1) f 685. In other cases we gave a wider exemption to treaty partner residents regardless of the flag. 10  There was a gap in our treaty-making after the 1956 Austrian treaty, probably because states were waiting for the outcome of the OEEC work; when considering other state’s treaties I have imposed an arbitrary cut-off date of 31 December 1956. For the start of the OEEC work, see the heading Conclusion: the influence of these treaties on the OEEC and see also

298  John F Avery Jones t­ reaties were negotiated in the absence of an internationally-agreed framework. The latest League of Nations Mexico (1943) and London (1946) drafts suffered from the wartime domination of the Mexico Model by the South Americans, with the Europeans merely doing what they could in the ­London Model to reverse some of the worst excesses,11 and earlier League of Nations drafts were out of date. The treaties being considered comprise, in addition to Agreements with the Dominions and Arrangements with the Colonies,12 those with Sweden, Denmark, the Netherlands, France, Norway, Finland, Greece (which, unusually, is still in force), B ­ ­ elgium, ­Switzerland, Germany and Austria.13 Because of the number of treaties a selection of topics will be considered. The period under consideration was an active one for treaties by the US and the Dominions, but relatively quiet for European countries.14 One of the problems of knowing in which treaty a particular provision originated is that there can be a considerable time between a treaty being initialled at the end of negotiations and its being signed and a further time before ratification and its being brought into force by Statutory Instrument. The order can be determined only from the National Archives.15 The treaty

C(56)49(Final) (19 March 1956). References in this form are to this website containing the historical records of the OEEC and OECD Models, which is organised by the Institute for Austrian and International Tax Law, Vienna, IBFD, Università Cattolica del Sacro Cuore, Piacenza, Italy, IFA Canadian Branch and the Canadian Tax Foundation. 11  The UN Fiscal Commission continued until it was dissolved in 1954. The limited value of the Mexico and London drafts was recognised in the OEEC Secretary-General’s note of 12 November 1954 to the Council at the start of its work: ‘… nor, in particular, does it seem likely that agreement could be reached in the Council that the “London Draft” should be the standard form of bilateral convention between Member and associated countries, since the draft itself is not, as it stands at present, fully acceptable to every Member.’ C(54)294 (12 November 1954) para 8. 12  See the heading Treaty parties and nomenclature for the significance of these terms. 13  Contemporary comment on these treaties is found in a series of booklets about t­reaties of the time published by the IBFD with authors from each of the states, including No 3 The Anglo-Dutch Double Taxation Conventions by FE Koch and HJ Blok, 1950 (plus a ­Supplement, No 9, 1956), No 6 Le Convention Fiscale Franco-Britannique by FE Koch and HH Rothstein, 1954, and No 8 Tax Relations between the UK and Sweden by FE Koch and O Ekenberg, 1956 (all IBFD, Amsterdam). 14 During this period the US entered into 18 treaties, Australia 3 (see J Taylor, ‘The ­Negotiation and Drafting of the First Australia–US Double Tax Treaty of 1953’, in P Harris and D de Cogan (eds), Studies in the History of Tax Law, vol 7 (Oxford, Hart Publishing, 2015)), Canada 10, New Zealand 4 and South Africa 3 (because the numbers are of treaties to which the state is a party there is double counting for the number of treaties). The treaties between only European countries were Austria–Germany (1954), Belgium–Sweden (1953), France– Norway (1953), Germany–Greece (1952), Indonesia–Netherlands (1954), Italy–Sweden (1956), Japan–Sweden (1956), Netherlands–Norway (1950), Netherlands–Sweden (1952), Norway–Sweden (1947), Norway–Switzerland (1956) and Sweden–Switzerland (1948). 15 The order of negotiations was: The Netherlands—first approach by the Netherlands November 1945, heads of proposals sent by the UK November 1946 after a delay caused by changes in Dutch tax law, negotiations February and March 1948, draft agreed 28 ­January 1948,

The UK’s Early Tax Treaties with European Countries 299 with the Netherlands (1948) was the first one to be negotiated. The Dutch treaty made a surprisingly easy start. Their representatives announced at the first meeting that they were in general content with a treaty in the form of the US–UK treaty,16 which meant that negotiations were relatively short and simple and were completed about ten days later.17 A driving force seems to have been that British contractors working on the reconstruction of ­Rotterdam harbour, which had been badly damaged in the War, were pressing for a treaty.18 The standard of record keeping about negotiations of these treaties is variable and improved over time. UK Taxation at the Time To set the scene we need to remind ourselves of the UK tax system of the time. A company paid income tax (plus profits tax, until 1947 called national defence contribution)19 on its profits. Dividends were paid out of taxed profits and so it looked as if tax at the standard rate20 of income tax had been deducted from the dividends.21 Interest and patent and some signed 15 October 1948, SI 21 July 1950 (the unusually long timetable is caused by Dutch officials’ negotiations of their treaties with the US and Belgium and the Minister of Finance’s involvement with the devaluation of the Dutch guilder in 1949); Sweden— negotiations September 1948, signed 30 March 1949, ratification 20 September 1949, SI 29 September 1949 (an unusually short timetable); Denmark—negotiations October 1948, signed 27 March 1950, SI 21 July 1950; Norway—negotiations September 1949, signed 2 May 1951, SI 4 October 1951; Finland—main negotiations November 1950, signed 12 December 1951, SI 11 February 1953; Germany—negotiations November 1950, signed 18 August 1954, SI 29 July 1955; Belgium—negotiations July 1951, signed 27 March 1953, SI 13 April 1954; Greece—negotiations August 1951, signed 25 June 1953, ratified 15 January 1954, SI 10 February 1954; Switzerland—negotiations July 1952, signed 30 September 1954, SI 17 March 1955; Austria—negotiations March 1953, signed 20 July 1956, SI April 1957. Where dates are given for treaties it is the date of signing, not the date of the Statutory Instrument giving effect to it; dates will not be repeated and a reference to a treaty with a particular country is to one of these treaties. 16  TNA IR 40/17127 f 20. They had made this point in less definite terms in their letter of 12 November 1945 proposing negotiations by referring to ‘using it as a basis for discussions’. 17 Between 21 February and 3 March 1947. This was followed by lengthy discussions with the Foreign Office and the Colonial Office about the extension article (see the heading Extension of our treaties to dependent territories) lasting until 28 January 1948 when the Dutch agreed the draft. 18  Nationaal Archief, Den Haag, Ministerie van Financiën: Directie Internationale Fiscale Zaken, nummer toegang 2.08.5229, inventarisnummer 459, letter of 12 November 1945 proposing negotiations. I am grateful to Professor Henk Vording for this material. 19  This is the position after 1947, which therefore ignores the war-time excess profits tax. 20 The standard rate was 10s (50%) in 1945–46, 9s (45%) from 1946–47 to 1950–51, and 9s 6d (47.5%) in 1951–52 and 1952–53, 9s (45%) in 1953–54 and 1954–55, and 8s 6d (42.5%) from 1955–56 to 1958–59. The standard rate was a rate applicable to investment income; there was a relief for earned income up to £9,945 (ITA 1952, s 211). It became the basic rate (which was a rate applying to earned income) in 1973–74. 21  J Avery Jones, ‘Defining and Taxing Companies 1799 to 1965’ in J Tiley (ed), Studies in the History of Tax Law, vol 5 (Oxford, Hart Publishing, 2012) 1.

300  John F Avery Jones ­copyright22 royalties were paid under deduction of tax but were not deductible in computing profits: the payer obtained relief by deducting and retaining the tax. Profits tax was, until 1951–52, deductible in computing profits for income tax, after which it became an additional tax.23 From 1947 until 1958 profits tax was at a higher rate on distributed profits than undistributed profits to encourage reinvestment but, as the 1955 Royal Commission pointed out, it merely encouraged retention.24 TREATY PARTIES AND NOMENCLATURE

Traditionally treaties were made between heads of state through plenipotentiaries appointed to represent them. This was frequently the form of World War II tax treaties25 but a variety of other methods were also adopted, often with the same state adopting more than one method presumably to suit the other party. These included: treaties between states but with the heads of state still appointing plenipotentiaries,26 treaties between states through plenipotentiaries not appointed by the heads of state,27 a treaty between states through Ministers of Finance,28 and treaties between Governments.29 International practice was changing after World War II towards treaties

22  Film royalties were excluded from deduction of tax at source, on the basis that they were more like trading receipts, which is how they were dealt with in many of these treaties, see under Dividends, interest and royalties below. 23  FA 1952, s 33(1). 24 Royal Commission on the Taxation of Profits and Income: Final Report (Cmd. 9474, 1955) [536]. The relief was also complicated. The calculation of the charge was based on total profits from January 1947 but such profits included sums paid as profits tax; Royal ­Commission at [527]. Since the relief for undistributed profits was withdrawn on subsequent distribution companies built up a deferred tax charge which could bite on liquidation. This differential rate was abolished in 1958 following criticisms of it by the Royal Commission. 25  For example, Belgium–Luxembourg (1931), Belgium–France (1931), Belgium–Germany (1938), Belgium–Italy (1931), Belgium–Netherlands (1933), Czechoslovakia–Italy (1924), ­Czechoslovakia–Poland (1925), France–Italy (1930, 1931), France–Sweden (1936), Germany– Italy (1925), Hungary–Italy (1927), Hungary–Netherlands (1938), Hungary–Poland (1928), Hungary–Romania (1932, 1937), Hungary–Sweden (1936), Hungary–Yugoslavia (1928), Iceland– Sweden (1937), Netherlands–Sweden (1935), Italy–Romania (1938), Romania–Yugoslavia (1933) and Sweden–US (1939). 26  For example, Denmark–Sweden (1932), Finland–Sweden (1931) and France–US (1932, 1939). 27  For example, Austria–Czechoslovakia (1922), Austria–Germany (1922), Austria–­Hungary (1924), Austria–Poland (1932), Austria–Switzerland (1927), Czechoslovakia–Germany (1921), Czechoslovakia–Hungary (1923), Denmark–Germany (1928), Hungary–Germany (1923), Germany–Poland (1923), Germany–Romania (1927), Germany–Sweden (1928) and Germany– Switzerland (1923). 28  Denmark–Germany (1938). 29  For example, Canada–US (1942), Denmark–Germany (1928), Denmark–Iceland (1927), France–Romania (1942) and Germany–Poland (1922).

The UK’s Early Tax Treaties with European Countries 301 being made by governments. This culminated in the Vienna Convention on the Law of Treaties30 stating that the persons who did not need to produce evidence of their full powers to conclude treaties included Heads of State, Heads of Government and Ministers for Foreign Affairs. The same pattern continued in our early post-World War II treaties with European states.31 But since the enabling legislation, written with the US treaty in mind, applied where ‘arrangements … have been made with the Government of any territory outside the United Kingdom’,32 which is recited in the Statutory Instrument giving effect to a treaty, it was presumably realised at some point that anything other than a treaty between governments was incorrect for a tax treaty. This was generally adopted from about 1953, the last between heads of state being that with Austria (1956), which was done at their request.33 Making treaties between monarchs as heads of state gave rise to a problem with the self-governing Dominions34 sharing the same monarch because one cannot make a treaty with oneself and so the term used was ‘Agreement’, which was necessarily between governments; and ‘Arrangement’ for those with the Colonies, which is even less of a treaty because we were negotiating for ourselves on one side and on behalf of the colony, for whose foreign affairs we were responsible, on the other—indeed they are not even signed or dated. Parliament was informed about the early Agreements with the Dominions in British State Papers35 rather than as Command Papers, presumably on the basis that they were not regarded as proper treaties; this was in addition, of course, to the laying of the treaty before Parliament for scrutiny as a Statutory Instrument in accordance with the statutory provisions for giving effect to the treaty for tax purposes in domestic law. The practice changed in the early 1960s, following which Agreements

30 United Nations, Vienna Convention on the Law of Treaties, 23 May 1969, United Nations, Treaty Series, vol 1155, 331, available at www.refworld.org/docid/3ae6b3a10.html, Art 7(2). 31  Treaties with heads of state were those with: The Netherlands (1948), Sweden (1949), Belgium (1953), France (1950: the earlier (1945) treaty was with the Head of the Provisional Government of the French Republic) and Austria (1956). Those between governments were with: Denmark (1950), Finland (1951), Norway (1951), Greece (1953), Switzerland (1954), Germany (1954) and the US (1945). 32  Originally F (No 2) A 1945 s 51. The wording was changed by FA 2002, s 88 to read ‘arrangements have been made in relation to any territory outside the UK …’ (TIOPA 2010, s 2(1)(a)) in order to make a treaty with Taiwan when we did not recognise its government. 33  TNA IR 40/17255, and IR 40/17256. 34  I am using the normal term to include Canada, Australia, New Zealand and South Africa, although in their titles Australia was a ‘Commonwealth,’ and South Africa a ‘Union.’ Their full status in international law derives from the Statute of Westminster 1931. 35 The British State Papers (also known as the British and Foreign State Papers) which were produced by the Foreign and Commonwealth Office and published by HMSO from 1810 until 1968. This publication includes a number of agreements not published in the UK Treaty Series as well as some Orders in Council and diplomatic correspondence.

302  John F Avery Jones with the Dominions followed the same procedure as other countries with the A ­ greement being laid before Parliament for information as a Command Paper in the Treaty Series, in addition to the procedure for giving effect to it in tax law by Statutory Instrument,36 but the change does not seem to have been brought about by any specific reason.37 THE DEFINITION OF PERSON AND COMPANY

The central treaty definitions of ‘person’ and ‘company’, which are i­ mportant to the scope of residence, and therefore to most of the treaty provisions, and the latter to dividend taxation, were developing during this period. The US treaty was atypical because it contained no definition of person, presumably because this was not thought to be necessary, and the definition of company catered for the US taxation of corporations on the basis of incorporation. Later treaties generally contained the following definitions with some ­variations required by the other country:38 The term ‘person’ includes any body of persons, corporate or not corporate. The term ‘company’ means any body corporate.

This definition of ‘person’ followed that in the Interpretation Act 188939 but modernising ‘unincorporate’ to ‘not corporate’. In a few treaties the definition that company means was changed to includes,40 presumably because there were other entities charged to tax as companies, as indeed there were in the UK from 1965 when unincorporated associations were charged to

36  For example, the Agreements with Australia (1967), Canada (1966) and New Zealand (1966) were all presented to Parliament as Command Papers (in addition to the Statutory Instruments). The Convention with the South Africa (1962) is not an example because it was by then a Republic. 37 I am grateful to the Treaty Enquiry Service, Legal Advisers Directorate, Foreign and Commonwealth Office for confirming that they had no record of any specific change or reason leading to the change in practice. 38 For example, in the Netherlands treaty ‘“company” means any body corporate and any partnership the capital of which is wholly or partly represented by shares’ in order to ­differentiate it from a Dutch partnership. The French treaty defined person to mean (i) any physical person, (ii) any unincorporated body of physical persons, and (iii) any body corporate. The Swiss treaty defined person to include ‘any individual, company, unincorporated body of persons, and any other entity with or without juridical personality’, and company to mean ‘in relation to the UK any body corporate, and in relation to Switzerland any entity with juridical personality’. 39  Section 19. The definition in the Interpretation Act 1978, Sch 1 is the same. 40  Canada and South Africa. There was no definition of ‘company’ in the Australian treaty; see Taylor, above n 2, 261–62. The same variation is found in a few other states’ treaties, eg Canada–Ireland (1954) and Canada–Sweden (1951).

The UK’s Early Tax Treaties with European Countries 303 corporation tax.41 An important development was made in the German treaty which defined company to mean ‘any body corporate and any entity which is treated as a body corporate for tax purposes’, thus covering the same ground as the change to includes but with more clarity.42 It therefore covers any non-corporate entities that are taxed in the same way as companies, which later became more of an issue; however, it fails to deal with the converse: a body corporate not being taxed as a company, a defect that continues today. This definition was included in the 1963 OECD Draft. That draft contained a different definition that ‘the term “person” comprises an individual, a company and any other body of persons’, which is a small development on the approach in UK treaties.43 ‘Comprises’ was changed to ‘includes’ in the 1977 Model. THE DEFINITION OF RESIDENT

It may seem surprising today that ‘resident’ was not a term generally used by other countries in tax treaties of this time, as can be seen from a later OEEC Working Party minute of 5 November 1957 which says: … the Working Party thought it should find a brief term as stated and endeavour to makes its meaning clear by means of a definition. Consequently the Working Party has fixed upon the term ‘resident,’ which is used in Conventions concluded by the United Kingdom and by the United States of America. In the Convention between the United Kingdom and France the term ‘un resident’ is used in the French text.44

41 

FA 1965, s 46(5)(a), currently CTA 2010, s 1121(1). This wording was also used in Canada–Germany (1956). 43  This had some similarities to the Swiss treaty (see above n 38). 44  FC/WP2(57)3 (5 November 1957) [9]. Since the original minutes are in English it does not appear that the Committee was referring only to the French term. The treaty with France (1950) defined resident of France as ‘… any person whose fiscal domicile for the purposes of French tax is in France and who is not resident in the United Kingdom for the purposes of United Kingdom tax’ demonstrating that resident was an unfamiliar term in France. The earlier (1945) treaty which was negotiated before the War (see above n 6) used the expression ‘fiscal domicil’ in relation to companies for both countries, defining it to mean ‘the place where a company manages and controls its business and a company is to be deemed to be resident at the place where its fiscal domicil is situated’. The term ‘resident’ was used instead in certain provisions. In the treaty with Belgium ‘residence’ in relation to Belgium was defined ‘as having his fiscal domicile or as having a house available for his use in Belgium’ (and not resident in the UK for the purposes of UK tax). The treaty with Switzerland used ‘resident (by reason of domicile or sojourn) in Switzerland’ (and not resident in the UK for the purposes of UK tax). In the Austrian treaty ‘resident’ was explained (in brackets in the English text) as ‘Wohnsitz oder gewöhnlicher Aufenthalt’ [civil law residence or 6 months’ presence] and ‘resident’ was used in brackets in the German text, suggesting that there was then doubt about the meaning of resident [ansässige Person] in German too (although it was used without explanation in the German treaty). 42 

304  John F Avery Jones The use of the term ‘resident’, which would have been natural to use within most of the Dominions45 and Colonies since their tax systems were derived from ours, was therefore pioneering when used in our European treaties.46 These European treaties (as well as the Agreements with the Dominions and the Arrangements with the Colonies) contained a similar definition of resident, subject to variations in some of the European treaties:47 The terms ‘resident of the United Kingdom’ and ‘resident of []’ mean respectively any person who is resident in the United Kingdom for the purposes of United Kingdom tax and not resident in [] for the purposes of [] tax and any person who is resident in [] for the purposes of [] tax and not resident in the United Kingdom for the purposes of United Kingdom tax; and a company shall be regarded as resident in the United Kingdom if its business is managed and controlled in the United Kingdom and as resident in [] if its business is managed and controlled in [].

Defining residence to mean resident in the UK for the purposes of UK tax and not resident in the other state for the purposes if its tax (and vice versa), meant that dual residents (residents of both states by virtue of different domestic laws) were specifically excluded from treaty benefits. They had to rely on domestic credit provisions, which in the UK gave relief only for tax in the state in which the income arose, although some relief was extended to third state income of dual residents in three European treaties.48 Resolution of dual residence was not covered in UK treaties until the next treaty with Sweden (1960), after it had been dealt with in the OEEC First Report (1958)49 which was not therefore influenced by UK treaties. The reason for the last part of this definition stating that residence of a company depended on its management and control was to eliminate

45 The South African Agreement used ‘ordinary residence’ because, although their tax s­ystem was territorial, it treated income as having a South African source if received by (or accruing to) an individual ordinarily resident, or carrying on business, there from a neighbouring country, or from another country where it was not chargeable to tax because the person was not domiciled nor ordinarily resident there (Income Tax (Consolidation) Act 1917, s 6). It seems that while expressed as a source rule one could just as well regard it as a residence rule. One possible advantage of it is that ordinary residence is less likely to be in more than one country. I am grateful to Professor Johann Hattingh for this information. 46  ‘Resident’ was beginning to be used in other states’ treaties, eg Indonesia–Netherlands (1954) and Japan–Sweden (1956) (the same wording as in UK treaties, without the last ­sentence, presumably derived from our treaty with Sweden), although its use is difficult to determine using translations. 47  See text above around n 61. 48  The treaties with Sweden, Denmark and Norway provided in addition for a proportionate credit for the other state’s tax on third state income of dual residents, as was also the case in the treaties with Australia (which was the source for Sweden’s request for this (TNA IR 40/8872 f 56C)) and Ceylon. Such a rule was originally included in the 1945 death duties treaty with the US (and is currently contained in unilateral relief for inheritance tax in IHTA 1984, s 159). It became unnecessary when dual residence provisions were adopted. 49  The Elimination of Double Taxation: 1st Report of the Fiscal Committee of the O.E.E.C. (Paris, OEEC, 1958).

The UK’s Early Tax Treaties with European Countries 305 the ­possibility of residence on another basis applying to the treaty, as was wrongly thought to have been decided in Swedish Central Railway.50 This was that the company was resident because of UK incorporation plus (depending on the judge) ‘performing some of the vital organic operations incidental to the existence of the company’,51 or ‘certain other comparatively trifling circumstances’, or possibly even without anything else.52 In relation to a UK incorporated company having sufficient activities in the UK to make it resident in the UK in accordance with the then misunderstanding of Swedish Railway which was managed and controlled in the treaty partner state, one had to read the treaty as meaning that, for determining whether the company was resident in the treaty partner state under domestic law and not resident in the UK under domestic law, one must assume that the only domestic law test of residence is management and control. This gives rise to problems when incorporation became the only test of residence of UK incorporated companies in 1988. Now domestic law specifically tells one to ignore management and control (‘even if a different place of residence is given by a rule of law [case law management and control], the company is not resident in that place for the purposes of the Corporation Tax Acts’).53 There is an irreconcilable conflict between the two; the treaty

50 [1925] 1 AC 495 (HL). The misconception was that for a UK incorporated company a place of business plus some activities (other than merely complying with the Companies Act, as in Egyptian Delta Land and Investment Co Ltd v Todd [1929] 1 AC 1) constituted ­residence. That this was thought to be the case is demonstrated by the draft Bill attached to the Codification Committee’s Report defining ‘residence’ to mean (in addition to management and control): ‘… if it maintains in that year an established place of business in the United Kingdom and any substantial part of the activities of the company, whether administrative or other, is conducted in the United Kingdom, but a company shall not be treated as so resident by reason only of the fact that it has a registered office in the United Kingdom at which is transacted such ­administrative business only as is necessary to comply with the requirements of the Companies Act 1929.’ Possibly in error, this was not limited to UK incorporated companies as their Report had ­suggested. See Income Tax Codification Committee: Report (Cmd. 5131, 1936) cl 7. 51  Per Rowlatt J at 353. These were that ‘three Members of the said Board were appointed to be a Committee under Article 45a of the amended Articles of Association to deal with transfers of shares in the United Kingdom, attach the seal of the Company to share and stock certificates, and to sign cheques on the London Banking Account of the Company.’ 52 In Egyptian Delta [1928] 1 KB 152, 169 Sargant LJ in the Court of Appeal said: ‘and though on appeal to the House of Lords the Lord Chancellor, in an opinion concurred in by the majority of the House, preferred to base his decision on the view that the fact of registration together with certain other comparatively trifling circumstances entitled the Commissioners to find that the Swedish Railway Company had a residence here, I do not think that he intended to cast any doubt on the views of Warrington LJ and Atkin LJ [in Swedish Railway that a company registered under the Companies Act must necessarily have a residence here for the purposes on Income Tax]. …’ In fact, Atkin LJ was dissenting and he should have referred to Pollock MR. 53 CTA 2009, s 14(1) ‘A company which is incorporated in the United Kingdom is UK ­resident for the purposes of the Corporation Tax Acts. (2) Accordingly, even if a different place of residence is given by a rule of law, the company is not resident in that place for the purposes of the Corporation Tax Acts.’

306  John F Avery Jones tells one to apply only management and control when determining whether the company is not resident in the UK under domestic law, while domestic law tells one to ignore management and control with the result that incorporation on its own causes residence under domestic law. Management and control in say Greece is fine for making the company resident in Greece for the purposes of Greek tax,54 but it does not help to make it not resident in the United Kingdom for the purposes of United Kingdom tax. It would need something on the lines of the variation applicable to Sweden55 for it to work. HMRC’s earlier view was that the treaty did nothing to prevent dual residence in these circumstances but it has recently announced a change in its interpretation in the 16 surviving treaties still containing this definition (including Greece (1953)), saying that, for the purpose of the treaty, it is now understood to override residence in the UK on the basis of incorporation in favour of residence in the treaty partner on the basis of management and control.56 They do not explain how one can use management and control to determine that a UK incorporated company managed and controlled in the other state is not resident in the UK under domestic law if in fact it is so resident and domestic law tells you to ignore management and control. While not denying that the result is sensible since it removes the dual residence that prevents the treaty from applying, the writer prefers their original interpretation.57 Surprisingly, most other states went along with this part of the definition even though ‘managed and controlled’ probably meant something different to them.58 It was even included in the treaty with the Netherlands, which taxed on the basis of both incorporation and management, which is added evidence that the Netherlands were under pressure from British contractors

54 

The treaty with Greece is still in force. See below n 61. 56  ‘Change of view on the interpretation of the residence articles in sixteen Double Taxation Agreements’, HMRC Policy Paper, 30 November 2015, available at www.gov.uk/government/ publications/double-taxation-agreements-developments-and-planned-negotiations/change-ofview-on-the-interpretation-of-the-residence-articles-in-sixteen-double-taxation-agreements. The agreements are those (all made before 1955) with: Antigua, Belize, Brunei, Burma, Greece, Grenada, Guernsey, Isle of Man, Jersey, Kiribati. Malawi, Monserrat, St Kitts & Nevis, Sierra Leone, Solomon Islands and Tuvalu. The writer examined the history of this provision in J Avery Jones, ‘The Definition of Company Residence in early UK Tax Treaties’, [2008] BTR 556, concluding in favour of HMRC’s original view that this part of the definition was intended to prevent the use of definitions of residence in addition to management and control, so that when management and control became irrelevant to UK incorporated companies it could no longer be applied. There is nothing new about differences in view within HMRC. As summarised in that article at 572, TNA IR 40/11356 sets out three different and firmly-held views. 57  See J Avery Jones, ‘Changed HMRC interpretation of the residence articles in 16 Double Taxation Agreements’, [2016] BTR 1. 58  See text below at n 64. 55 

The UK’s Early Tax Treaties with European Countries 307 engaged in reconstruction of Rotterdam harbour to have a treaty.59 ­However, Sweden and Finland, which taxed on the basis of incorporation and management, and Switzerland, which taxed on the basis of incorporation, did insist on a change to the definition in their treaties.60 Under this, a company incorporated in Sweden (or Finland) but managed and controlled in the UK is excluded from being a Swedish (or Finnish) resident for treaty purposes, and would be a UK resident for treaty purposes.61 The Swiss treaty lists the bodies organised under Swiss law which are resident for treaty purposes if they are not managed and controlled in the UK.62 There was a variation in the New Zealand agreement that ‘a company shall be regarded as resident in the UK and not in New Zealand if its business is managed and controlled in the UK’ (emphasis added) (and vice versa). HMRC’s revised interpretation would be supported by this formula, and the difficulty is knowing whether this is a change or a clarification: the latter seems more likely. There was a special provision in the US treaty as the US taxes on the basis of incorporation. This part of the definition is not contained in the Australian Agreement, which does not use the term ‘company’.63 Because of the use of management and control in the UK’s numerous treaties of the time, the OEEC almost adopted it, although the Working Party was unclear about whether it referred to the managers, the board of directors or the shareholders, which is strange as they could have asked the UK.64 They decided instead to use ‘place of effective management’ to

59  It may also have been influenced by the Dutch wanting an estate duty concession, see text below at n 105. The usual wording for this provision was in the first draft and is never mentioned in the negotiations in TNA IR 40/17127. Incorporation was adopted by the ­Netherlands for the first time in 1942. The author is grateful to Prof. Kees van Raad for this information. It is interesting that the Netherlands agreed this wording in the agency profits treaty of 1936, which was before this change. Might they have been following the existing precedent? 60  In relation to Sweden a note in the National Archive file says ‘Sweden wished to retain semblance of “place of incorporation” test for company residence. This form still gives us the substance of the management and control test.’ (TNA IR 40/8872 f 63B) 61  The treaty provided: ‘a company shall be regarded as resident in the United Kingdom if its business is managed and controlled in the United Kingdom and as resident in Sweden if it is incorporated under the laws of Sweden and its business is not managed and controlled in the United Kingdom, or if it is not so incorporated but its business is managed and controlled in Sweden.’ (emphasis added) The treaty with Finland is similar. 62  The treaty provided: ‘The term “resident of Switzerland” means—(i) any company or partnership (société simple, société en nom collectif or société en commandite) created or ­organised under Swiss law if its business is not managed and controlled in the United Kingdom; …’ (emphasis added). The profits tax treaty with Ireland (The Double Taxation Relief (Profits Tax) (Ireland) Order, 1949, SI 1949/1434), also treats a company incorporated in one state and managed in the other as not being a treaty resident of either state (Irish profits tax, being a continuation of the UK corporation profits tax (FA 1920, s 52, repealed in the UK in 1924), was charged on the basis of incorporation only). 63  See above n 40. 64  FC/WP2(57)1 (27 May 1957).

308  John F Avery Jones harmonise it with the wording of the shipping article,65 with the UK stating that it had the same meaning as management and control, a view which we later disowned.66 PERMANENT ESTABLISHMENT

The treaty threshold for taxing a non-resident carrying on business is the existence of a ‘permanent establishment’. Our European treaty partners used the term, deriving from German law, in their domestic law for earlier impôts réels, this being the definition of a source of business income.67 The UK was out of line in taxing trades, professions and vocations rather than business; and exercising a trade in the UK had a wider meaning than permanent establishment. We had to adopt the permanent establishment concept in treaties in line with international practice. Related to this was a definition of industrial or commercial profits which in the European treaties normally included film royalties,68 and in the Dominion Agreements (and also the Belgian treaty) excluded dividends, interest, royalties and remuneration for labour or personal services.69

65 

Fourth Report of Working Party 2, FC/WP2(57)3 (5 November 1957). Report of Working Party 2, FC/WP2(58)1 (10 January 1958). The Revenue’s statement was first made in connection with the shipping article, see FC/WP5(57)2 (6 May 1957). It was disowned in SP6/83 (now SP1/90) and deleted from the OECD Commentary in 1992. 67  See J Hattingh, ‘On the Origins of Model Tax Conventions: Nineteenth-Century German Tax Treaties and Law Concerned with the Avoidance of Double Tax’ in J Tiley (ed), Studies in the History of Tax Law, vol 6 (Oxford, Hart Publishing, 2013) 31. He gives an example at 68 of an early definition in the treaty between Austria–Hungary and Prussia (1899) which has considerable similarity to the later League of Nations drafts: ‘Branches, factories, depots, counting houses, places of buying and selling, and other business facilities maintained for the exercise of a fixed trade by a proprietor himself, business partners, attorneys or other permanent representatives are to be regarded as permanent establishments.’ He notes at 61 that the expression ‘permanent establishment’ was first used in the 1885 Prussian municipal tax law, and that its meaning was derived from cases decided under the 1870 Imperial Double Taxation Law. 68  See the Colonial Arrangements, and the treaties with: Sweden, Denmark, the ­Netherlands, Norway, Finland, Germany and Switzerland (but not France). Film royalties are dealt with under the heading ‘Royalties’ below. 69  This exclusion gave rise to a claim by a Canadian bank with a permanent establishment in the UK to which was attributable interest on UK government securities which was free of tax to non-residents (TNA IR 40/9102). For some securities the exemption applies to trading profits (Hughes v Bank of New Zealand [1938] AC 366), although for others, which were in issue, it does not apply; the file ends with the Board ordering the assessment to be defended. The Swiss treaty excluded dividends, interest and royalties (except film royalties) unless attributable to a permanent establishment. Other variations existed, including the inclusion of mining and life insurance (Australia, New Zealand and Switzerland (all insurance, and also farming)), the inclusion of banking and insurance (France, Switzerland) and the exclusion of insurance (Belgium). There was no definition in the treaties with the US and Austria. 66 Final

The UK’s Early Tax Treaties with European Countries 309 The List of Items Constituting a Permanent Establishment The definition was well developed by the time of the League of Nations Mexico (1943) and London (1946) Model Conventions, the initial part of which listed various items followed by general words (fixed place of business): The term ‘permanent establishment’ includes, head offices, branches, mines and oil wells, plantations, factories, workshops, warehouses, offices, agencies, installations, professional premises and other fixed places of business having a productive character.70

We followed this approach. The definition in the US treaty started: The term ‘permanent establishment’ when used with respect to an enterprise of one of the Contracting Parties means a branch, management, factory or other fixed place of business …71

The definition in the Dominion Agreements, the Colonial Arrangements and the early European treaties were all extremely similar to the US treaty but with further items being added in individual treaties presumably at the request of the treaty partner, which suggests that we were insisting on using the definition in the US treaty.72 The German treaty (1954) is the culmination of this process containing a confusion of various items listed both before and after ‘other fixed place of business,’ which did not improve the logical construction of the provision:73 (l) (aa) the term ‘permanent establishment’ means a branch, management, factory, office or other fixed place of business, such as a mine, quarry or other place of natural resources subject to exploitation, a permanent sales exhibition, or a construction project, assembly project or the like, the duration of which has exceeded or is likely to exceed 12 months. …74

70 

Protocol art 5. Art 2(1)(l). The quotation is continued in the text at n 80. 72  However, other countries were using similar definitions at this time, eg (excluding those to which the US or a Dominion were a party which have been derived from the US treaty) Netherlands–Norway (1950), Netherlands–Sweden (1952), Denmark–Netherlands (1957) and Italy–Sweden (1956). 73  The additions in the German treaty can be traced to the following treaties: mine ­(Southern Rhodesia, Australia, Belgium), ‘a mine, quarry or any other place of natural resources subject to exploitation’ (Sweden, Norway, Finland, Switzerland, Austria), office (Finland, S­ witzerland, Austria), workshop, permanent sales exhibition (Austria), construction project lasting 12 months (Sweden, Finland, Switzerland, Austria). Other items not included in the G ­ erman treaty are: agricultural or pastoral activities (Australia); farm (Southern Rhodesia, New ­Zealand, Finland, Greece, Switzerland), workshop, warehouse, installation (Belgium), oil well (Austria), and adding after fixed place of business ‘in which is exercised, in whole or in part, the activity of the enterprise’ (France). 74  Art II(1)(l). The Austrian treaty is similar with the addition of ‘oil well’ after ‘mine.’ 71 

310  John F Avery Jones The German treaty is of particular interest because the OEEC Working Party on permanent establishment comprised representatives from Germany and the UK75 who made their first report on 17 September 1956, two years after the German treaty. Fortunately the Working Party redrafted this part of the definition in a more logical way, explaining: The general view of members of Working Group No. 1 is that it is preferable to have a general definition of the concept of ‘permanent establishment’ in a separate paragraph and not one which is almost hidden in a list of a number of agreed examples, as is the case in Article V, paragraph 1, of the London and Mexico Drafts of the Model Tax Convention published by the League of Nations.76

The result was a great improvement in separating the general principle from the examples:77 1. The term ‘permanent establishment’ means a fixed place of business in one of the territories in which the business of the enterprise is wholly or partly carried on. 2. A permanent establishment shall include: (a) a place of management; (b) a branch; (c) an office; (d) a factory; (e) a workshop; (f) a warehouse; (g) a mine, quarry or other place of extraction natural resources; (h) a construction or assembly project which has existed or is likely to exist for more than twelve months.78

According to the Commentary by the Working Party the second paragraph ‘contains a list of examples each of which can be regarded a priori as ­constituting a “permanent establishment”’ and in making the list they ‘have

75  The representatives were Mr Mersmann who had led the German negotiating team for the UK–Germany treaty and Mr Norman Leach who had not been involved with that treaty. 76  FC/WP1(56)1 App 2 Commentary [1]. 77  One can find precedents for this approach such as Sweden–Switzerland (1948): ‘For the purposes of this Convention, a permanent establishment means permanent premises of the undertaking in which its business is carried on wholly or partly. The following are therefore to be regarded as permanent establishments: the head office of the undertaking, the place of ­management, branches, factories and workshops, purchasing and selling offices, mines and other mineral deposits in production, permanent agencies, and installations for the construction of buildings when the period of building operations exceeds twelve months.’ Canada also made some earlier treaties (with the UK (1946), New Zealand (1948) and Ireland (1954)), containing just the general principle (‘branch or other fixed place of business’) without examples. 78  This is anomalous as an example of attachment because it may not be fixed spatially (for example the construction of a road) and is subject to a specific (and presumably longer than normal) temporal limit, and so cannot be an example of the general principle. In the 1977 Model it was more logically put in a separate paragraph. The principle of including construction projects had appeared as listed items in some of our treaties, see above n 73.

The UK’s Early Tax Treaties with European Countries 311 attempted to produce a list of examples which, they hope, will represent common ground on which member will be able to agree.’79 This first draft, with some minor variations became the OEEC definition and that in the 1963 OECD Draft which mostly survives today. Agents The US treaty contained a fairly standard agency provision extending the permanent establishment concept beyond a fixed place of business: … but does not include an agency unless the agent has, and habitually exercises, a general authority to negotiate and conclude contracts on behalf of such enterprise or has a stock of merchandise from which he regularly fills orders on its behalf. An enterprise of one of the Contracting Parties shall not be deemed to have a permanent establishment in the territory of the other Contracting Party merely because it carries on business dealings in the territory of such other Contracting Party through a bona fide commission agent, broker or custodian acting in the ordinary course of his business as such.80

The UK can claim a far greater influence here which is surprising in relation to a part of the permanent establishment concept originating in Germany. The wording ‘the agent has and habitually exercises a general authority to negotiate and conclude contracts’ was used in ten UK treaties on agency profits made in the 1930s (as was the provision about an agent holding a stock of goods);81 and the exception for bona fide brokers and general commission agents derives from UK tax law,82 as does ‘ordinary course of business’.83

79 

FC/WP1(56)1 App 2 Commentary [6]. 2(1)(l). The quotation is continued from the text at above n 71 and is continued in the text at below n 89. 81  Pursuant to enabling legislation in FA 1930, s 17, the UK made treaties with: Sweden (1931), Switzerland (1932) (the only one of the countries which were the cause of this legislation, see below), Finland (1935), Canada (1936), Newfoundland (1936), Netherlands (1936), Greece (1937), Norway (1939), South Africa (1939) and New Zealand (1942). Their ­purpose was recorded in the 1930 League of Nations report (C.340.M.140.1930.II, ( under Legislative History of US Tax C ­ onventions vol 4 Part 1 (League of Nations) and Part 2 (OEEC) at 4206; the clause is set out at 4212)) as being to enable the UK to conclude double taxation agreements to avoid double taxation resulting from the divergent definitions of the term autonomous agent The Revenue’s note to Ministers on the clause, however, disclosed that Germany, Switzerland and Belgium had started to retaliate for the UK legislation that had been changed in 1915 to tax the principal even when the UK agent did not receive the proceeds from the transaction (even though little tax was collected because contracts were made abroad) and to tax UK residents doing business through agents in those countries, so the treaties were really made on account of self-interest (TNA IR 63/125 f 189). 82  F (No 2) A 1915, s 31(6). 83  FA 1925, s 17 (which is probably derived from the Factors Act 1889). 80  Art

312  John F Avery Jones As before, the German treaty is the most detailed of the treaties of that time in specifying the German names for the types of agent concerned.84 In spite of the detail, the author has argued elsewhere that neither side ever understood the difference between the common law and civil law of agency.85 The essence of the difference is that civil law distinguishes between direct agency, described as contracting in the name of the principal (such as a Handelsvertreter) which creates a legal relationship between the principal and the third party purchaser, and indirect agency (such as a Kommissionär/ commissionnaire) who creates legal relations only between the agent and the third party, and a Handelsmakler/courtier, who merely introduces the parties without contracting. The distinction between direct and indirect agency creates a natural dividing line for tax treaty purposes in civil law between agents who create a permanent establishment for their principal and those who do not, with those who do not contract being mentioned for clarity. Unfortunately, common law makes no such distinction and, what is worse, uses extremely similar expressions, commission agent and broker,86 who do create legal relations between the principal and the third party, but who are excluded on the ground of being independent agents. Therefore, in common law brokers and general commission agents need excluding, whereas in civil law they are not caught anyway as they do not conclude contracts binding on the principal. One of the other changes made by the OEEC was that the final version of the agency provision read ‘… has and habitually exercises a general authority to negotiate and enter into contracts in the name of the enterprise’, (emphasis added) thus adopting civil law terminology for direct agency which has no meaning in common law and is misleading in English as ­suggesting ­literally acting in the principal’s name.87 Another change made later by the OEEC Working Party was to delete the provision that an agent maintaining a stock of goods created a permanent establishment.88

84  In relation to concluding contracts a Handelsvertreter or other selbständiger Vertreter; for the exception corresponding to brokers and general commission agents a Handelsmakler, Handelsvertreter (unless he is a Handelsvertreter of the type concluding contracts) or a Kommissionär: Art II(1)(l). 85  See JF Avery Jones and J Lüdicke, ‘The Origins of Article 5(5) and 5(6) of the OECD Model’, (2014) 6 World Tax Journal 203. Part of this section is based on that article. 86 ‘Broker’ is used here in the sense of someone who creates legal relations, such as a ­commodity broker who is available to act for either party on a commodities exchange; the equivalent of Handelsmakler, or courtier, as a person who introduces the parties, also exists in common law, such as a mortgage broker. 87  C(58)118 (22 May 1958). 88  It is not in FC/WP1(57)2 (29 August 1957). The Fiscal Committee added an explanation to the Commentary merely saying that for a number of reasons the matter was not pursued and they wanted concluding contracts to be the sole criterion, see FC(58)1 (31 January 1958). The Swiss treaty omits the stock of goods provision. It still survives in Art 5(5)(b) of the United Nations Model Double Taxation Convention between Developed and Developing Countries (currently 2011).

The UK’s Early Tax Treaties with European Countries 313 Exclusions The US treaty, and all the other early treaties, contained two exclusions: The fact that an enterprise of one of the Contracting Parties maintains in the territory of the other Contracting Party a fixed place of business exclusively for the purchase of goods or merchandise shall not of itself constitute such fixed place of business a permanent establishment of such enterprise. The fact that a corporation of one Contracting Party has a subsidiary corporation which is a corporation of the other Contracting Party or which is engaged in trade or business in the territory of such other Contracting Party (whether through a permanent establishment or otherwise) shall not of itself constitute that subsidiary corporation a permanent establishment of its parent corporation.89

A purchasing office is probably excluded for economic reasons so as not to discourage exports, and reflects UK domestic law: ‘It would be most impolitic thus to tax those who come here as customers.’90 These treaties also provided that even if there were a permanent establishment no profits would be attributed to the mere purchase of goods.91 These had not been included in a previous League of Nations Model but were later included in the OEEC Draft. The last paragraph excluding a subsidiary from being a permanent establishment reflects German and Italian law (and French law, but only in relation to income from securities), and had previously been included in the League of Nations Models from 1933. In some of the early UK cases the subsidiary was factually an agent of the parent,92 but gradually the separate business of the subsidiary became accepted, first for holdings of less than 100 per cent,93 and ultimately in 1908 for a 100 per cent subsidiary so by the time we entered into tax treaties this was no longer an issue.94 89  Art 2(1)(l). The quotation is continued from above n 80. In our other treaties ‘­ corporation of the other Contracting Party’ was changed to ‘resident of the other Contracting Party’. 90  Sulley v A-G (1860), abstract in 2 TC 149 (misleadingly not in the index to that volume), per Cockburn CJ. 91 This is not included in the Austrian treaty. The Belgian treaty also specified that no expenses relating to purchasing were deductible. 92  Apthorpe v Peter Schoenhofen Brewing Co Ltd (1899) 4 TC 41 where a US subsidiary that had formerly carried on the trade continued merely to hold real property as required by local law, and there was a finding of fact that the business carried on in the United States was in fact carried on by, and was the business of, the UK parent company; and St Louis Breweries v Apthorpe (1898) 4 TC 111 where the same finding of fact was made, and also that the US company was the agent of the UK parent company. 93  Kodak Ltd v Clark (1903) 4 TC 549 concerning a UK company that owned 98% of the shares in the American Kodak Company, reversing the Commissioners’ finding that the business of the subsidiary was carried on by the parent (or the subsidiary was an agent for the parent); the outside-held 2% was significant to the decision. Even then Phillimore J wondered whether 98% of the profits of the subsidiary should not have been taxed in the hands of the parent (p 588), but the point had not been argued. UK holding companies seem to have been surprisingly common at the time (see also next note). 94  Stanley v The Gramophone and Typewriter Co [1906] 2 KB 856, [1908] 2 KB 89 CA, (1908) 5 TC 358, relating to its wholly owned (earlier it had been 54% owned) subsidiary

314  John F Avery Jones In most of the European treaties, though not in the Dominion Agreements (except for New Zealand) or the Colonial Arrangements, no profits were attributed to sales pursuant to contracts made in the residence state95 from a warehouse in the other state maintained for the convenience of delivery and not for display, even when the purchase offer was obtained by an agent in that state and transmitted to the enterprise.96 From the German treaty, as had been the case in a few other countries’ treaties,97 this became a further exclusion from the definition of permanent establishment of a warehouse maintained for the purpose of delivery: (dd) The fact that an enterprise of one of the territories maintains in the other territory a warehouse or storage room exclusively for the purpose of delivery, and not for the purpose of display, of goods or merchandise shall not of itself constitute that warehouse or storage room a permanent establishment of the enterprise …

This caused an apparent conflict with the provision that an agent who maintains a stock of goods but who does not conclude contracts does cause a permanent establishment for his principal. This was resolved in the Model by the removal of this rule for agents. DIVIDENDS, INTEREST AND ROYALTIES

One of the mysteries of treaties of that time and the OEEC and OECD Drafts that followed them, and indeed many of today’s treaties, is why they provided for a 15 per cent (or 5 per cent for corporate holdings of 25 per cent plus) withholding tax on dividends, which are not deductible in computing the company’s profits, and so the income suffers tax both at the company level and the shareholder level; and at the same time a lower rate Deutsche Grammophon AG, with all the courts reversing the Commissioners’ finding that the directing power of the German subsidiary was in the United Kingdom and the entire business of the subsidiary was carried on by the parent. It was pointed out that German law did not forbid all the shares being held by one person; [1908] 2 KB 89, 99. 95  The place of contracting was important to whether profits were made in the UK, see the Champagne cases: for contracts made in the UK: Werle & Co v Colquhoun (1888) 2 TC 402 (Veuve Clicquot), Pommery & Greno v Apthorpe (1886) 2 TC 182 (Pommery) and Tischler v Apthorop (1885) 2 TC 89 (claret); and contract made outside the UK: Grainger & Son v Gough (1896) 3 TC 462 (Louis Roederer) (acceptance by conduct in France by fulfilling the order). 96  Not contained in the Belgian treaty but there is no explanation about this in the TNA file. An agent having a stock of goods would have been a permanent establishment but this had the effect of not attributing any profit to it, thus avoiding any conflict. The reference to offers being obtained by an agent is not in the Swedish treaty, and was described as involving ‘no change of substance’; TNA IR 40 /8872 f 63D. 97 For example, Sweden–Switzerland (1948), Switzerland–US (1951), France–Norway (1953), Germany–US (1954), Austria–Germany (1954) and Austria–US (1956). Austria refused to include it in our treaty with them.

The UK’s Early Tax Treaties with European Countries 315 of withholding tax of 10 per cent for interest and 0 per cent for royalties, which are deductible and so represent the only tax that the paying state receives, was provided in the OEEC Fourth Report98 and the OECD 1963 Draft.99 Perhaps this reflects the remnant of impôts réels thinking which makes a clear distinction between tax on the company and tax on the ­shareholder,100 or perhaps it reflects the economic reality that a lender can find many alternative sources of interest of equal security so that taxing it is likely to deprive the residents of the state of funds, and that taxing royalties deters the import of technology, whereas the investment producing dividends is unique to which the shareholder is locked-in and has no option but to bear any tax charges. Whatever the reason, this was not the way we thought in the UK where companies had since 1803 effectively been transparent except that dividends are not taxed until distribution but when they are distributed they are treated as franked by the tax that the company has paid on the same profits.101 That way of thinking regards profits and dividends as the same and so there is no reason to tax both of them. The ­surprising thing is that we had greater difficulty in persuading states to reduce withholding tax on dividends than on interest and royalties, which lends credence to the economic reality argument. Table 1 shows the withholding tax rates in our early treaties. Table 1:  Rates of Withholding tax on Dividends, Interest and Royalties (per cent) Country

US (1945)

Dividends % (Normal/Direct Investment)

Interest %

Royalties % (Excluding Film and Mining Royalties)

15/5

0

0 (includes film)

Canada (1946)

0§

15 (from Canada)

0 (copyright only)

South Africa (1946)

0^

–

–

Australia (1946)

0§

–

0

New Zealand (1947)

0

–

0

Colonial Arrangements

0

–

0

0

0

0

5/0

0

0

The Netherlands (1948) Sweden (1949)

(continued)

98  The Elimination of Double Taxation, Fourth Report of the Fiscal Committee (Paris, OEEC, 1961). 99  Draft Double Taxation Convention on Income and Capital (Paris, OECD, 1963). 100  Hattingh, above n 67, 57 refers to German decisions on this point from 1883. 101  See above n 21.

316  John F Avery Jones Table 1:  (Continued) Country

Dividends % (Normal/Direct Investment)

Interest %

Royalties % (Excluding Film and Mining Royalties)

Denmark (1950)

5/0

0#

0

France (1950)

–/10

–

0 (includes film)

Norway (1951)

5/0

0

0

Finland (1951)

5/0

0#

0

Belgium (1953)

–° (0 complementary personal tax only)

0

0 (includes film)

Greece (1953) Switzerland (1954) Germany (1954) Austria (1956)

–∼

0

0

(Formulaǂ)

0

0

15

0

0

10 (individuals only)/10

0#

0 (films half rate Austria, 0 UK)

Notes to Table – No treaty provision. ^ Only from a private company whose income is apportioned to a UK resident public company. § Only dividends paid to UK company by wholly-owned subsidiary in those countries. # Not for interest paid to a controlling company. ∼ Greece did not tax distributed profits (see OECD 1963 Comm Art 10 para 6), which was the same as the UK system under income tax and so no dividend article was included. ° Belgium did not charge tax on the company on its distributed profits so that the only tax was on the dividend, which was not reduced under the treaty. The treaty provided for a nil rate of complementary personal tax which was not in fact then charged. ǂ The rate on dividends for Switzerland for individual shareholders was between nil and the effective rate of UK tax, and for companies depended on the size of the shareholding and varied between a reduction in the Swiss rate of 10 to 20 per cent of the dividend.

The principal reason for our difficulty over dividends was that almost everyone else had a classical system under which the company paid tax on its profits and in addition deducted a withholding tax from dividends so that there was a clear separation between tax on the company and tax on the dividend, whereas for us it was the same tax. Our problem was that while it looked as if income tax had been deducted from UK dividends we could not reduce this as it represented tax on the company’s profits. The most we could offer is to exempt the dividend from surtax but it was generally known that since we could not obtain a return of total income from a nonresident we could not in practice collect this. However, giving non-resident individuals a proportion of personal allowances could be presented as a reduction in the corporate tax to the extent that the individual’s income consisted of dividends, and this argument was used to obtain a reduction

The UK’s Early Tax Treaties with European Countries 317 from the other state.102 We were particularly keen to reduce the other state’s withholding tax on dividends because we obtained no additional tax on dividends paid to non-residents while having to give relief (unilateral relief from 1950) for their withholding tax in taxing our residents. Dividend withholding tax was thus a complete loss to us, and withholding tax on interest and royalties was a loss to the extent—which was then considerable—that outward investment exceeded inward investment. The 15 per cent (or 5 per cent for subsidiaries) dividend rate in the US treaty was typical of US treaties.103 But we did better in reducing this in most of our European treaties. The results in the Table do not do justice to the problems we had in achieving a reduction in dividend withholding tax rates. The reduction to 5 per cent (nil on dividends paid to controlling companies, which was ahead of its time, being only just becoming to be accepted now) in the treaties with Denmark, Sweden, Finland and Norway required lengthy negotiation. The Netherlands started by saying that they could not reduce their 15 per cent withholding tax at all, but they would consider a reduction for dividends paid to controlling companies. In the end they agreed to a nil rate on all dividends, thus giving up the whole of their 15 per cent in return only for our giving up surtax which we could not collect anyway. This was something which we were never able to repeat. Unfortunately the Netherlands file does not contain a detailed account of the negotiations leading to this104 but the Dutch archives refer to their being keen to have an estate duty relief from the UK in the contemporary negotiations for a death duties treaty for property of Dutch people that had been transferred to Great Britain during the war.105 They achieved a concession that British situs movable property of a person domiciled in the Netherlands that was transferred to Great Britain on or after 3 September 1939 was treated as not situated in Britain.106 Presumably there was a considerable amount of

102 The UK’s (and Ireland’s) position on dividends was explained in the OEEC Fourth Report (Art XX Comm para 49) and later in the OECD 1963 Draft (Art 10 Comm para 47). 103 US treaties with: Australia (1953), Denmark (1948), Finland (1951), Ireland (1949), Netherlands (1948), Switzerland (1951), Italy (1955) and New Zealand (1948). Other rates were: Australia (1953) no further reduction for subsidiaries, Austria (1956) half normal rate, 5% for companies holding 95%, Belgium (1948) 5% from subsidiaries, no other reduction, Germany (1954) 10% for companies holding 10%, no other reduction, and Pakistan (1957) 15% from subsidiaries, no other reduction. 104  Uniquely the treaty reduction applied even to unremitted remittance-basis income. 105  Nationaal Archief, Den Haag, Ministerie van Financiën: Directie Internationale Fiscale Zaken, nummer toegang 2.08.5229, inventarisnummer 459. I am grateful to Professor Henk Vording for this material. The reference to Great Britain is because Northern Ireland then had its own death duty. 106  TNA IR40/9988. The concession was applicable to deaths between 10 May 1940 and 1 July 1948. The concession was contained in a letter from the Foreign Office of 15 October 1948 and acknowledged by the Dutch Embassy on the same date. It is not contained in the

318  John F Avery Jones such property so that this concession was important to the Dutch which may have accounted for their willingness to give up dividend withholding tax. Sweden also said initially that they could not go below 10 per cent which they had agreed in other treaties but at the last minute agreed to 5 per cent.107 In spite of our having agreed the same with Denmark and Norway, Finland held out on the basis that the flow of income was entirely in the direction of the UK but agreed the same as the other Nordic countries in the end.108 France and Germany made no reductions but these may be special cases after the War. Austria was particularly reluctant to agree any reduction but in the end agreed to reduce the withholding tax from 15 per cent to 10 per cent for individuals, but no further reduction for dividends from subsidiaries, and no reduction at all for minority corporate holdings. The fact that we managed to persuade the treaty partner state to reduce its dividend withholding tax may in part reflect more the desire of the other state to have a treaty with us than our negotiating skills. Something which seems strange reading these treaties today is that no European state protected itself against our changing our system for taxing companies,109 as indeed we did on the introduction of corporation tax in 1965. Although these treaties were renegotiated before the 1955 Royal Commission debated the merits of a corporation tax110 it should have been clear that just because we had a system of taxing companies for 150 years there was no certainty that this would continue for ever. The US had protected itself by a provision enabling the dividend article alone to be terminated, which they activated when we introduced corporation tax.111 But in order to avoid seeming to take unfair advantage of our treaty p ­ artners

death duties treaty or brought before Parliament although the Chancellor approved it. We also gave a written assurance in a letter of 12 March 1947 that we gave a liberal interpretation to death from ‘injuries caused by the operation of war’ in the exemption from estate duty in FA 1940, s 46 so that it would cover, for example, death in a concentration camp. 107 TNA IR 40/8872. There were negotiations on dividends on 8, 10, 13, 17 and 20 September 1948. 108 Negotiations on dividends took place on 20, 21, 23, and 24 November 1950 before Finland agreed on 27 November 1950: TNA IR 40/14102. Part of the problem was the ­unfamiliarity of our system; the Finns suggested that profits tax corresponded to their corporation tax and income tax to their dividend withholding tax, until it was pointed out that the income tax was the same even if there were no dividends. 109  Other than the Netherlands where their protection was automatic as both parties agreed to no taxation on dividends in addition to the tax on profits. 110  Royal Commission, above n 24. The majority concluded at [56] against introducing a corporation tax, but the minority, who had the political influence in 1965, were in favour, see [106] of the minority report. 111  By Exchange of Notes, Treaty Series No 34 (Cmnd.3010, 30 June 1965). The US then realised that they did not mean to terminate the article in respect of the territories to which the treaty had been extended and had to make an addition to their notice of termination: see the heading Extension of our treaties to dependent territories below.

The UK’s Early Tax Treaties with European Countries 319 we unilaterally reduced the withholding tax rate on dividends from the standard rate,112 which was likely to be considerably higher than the domestic law rate of withholding tax in the other country, to the rate applicable in the converse case of dividends paid from the other state to UK residents in a list of treaties with 11 countries (plus two territorial extensions)113 for a period of two years (subsequently extended for another two) in order to give time for renegotiation of those treaties.114 We did manage to renegotiate all of these, mainly in the form of new treaties, before the extended deadline,115 except that the extension to South West Africa116 of the treaty with South Africa was never renegotiated.117 All these reductions in withholding tax were subject to the dividends being subject to tax in the other state and the recipient not being engaged in trade or business in the source state through a permanent establishment (an advance on the US provision, that they had first used with Canada, that applied to any trade or business), which was further refined in the treaty with Switzerland which required the dividend not to be attributed to the permanent establishment. The subject-to-tax provision was necessary to prevent a UK resident nominee (or trustee) for a resident of a third

112 

Then 8s 3d (41.25%) from 1965–66 to 1970–71. See the heading Extension to Dependent Territories below for extensions generally. 114  FA 1966, s 31 applying to 1966–67 and 1967–68; and extended by The Non-Residents’ Transitional Relief from Income Tax on Dividends (Extension of Period) Order 1968, SI 1968 No 454 and ditto 1969, SI 1969 No 319. The applicable treaties listed in Sch 9 are with: Australia, Austria, Denmark (including the extension to the Faroe Islands), Germany, Finland, France, Japan, Norway, Pakistan, South Africa (including the extension to South West Africa) and Sweden. Some of these were subject to qualifications, such as with Germany ignoring the difference in rates between distributed and undistributed profits which determined the rate of withholding tax on dividends on direct investments. The US was not included in the list for the reasons given in the text. A new treaty with Canada of 12 December 1966 contained dividend provisions specifically applicable from 6 April 1966 (substituting one signed on 6 December 1965 which was silent on dividends), and similarly a new treaty with New Zealand of 13 June 1966 contained dividend provisions applicable from 6 April 1966. Presumably in both cases negotiations were sufficiently far advanced when the Bill that became FA 1966 was going through Parliament that it was not thought necessary, particularly with the Dominions, to provide for the transition by legislation. A new treaty with Australia was signed on 7 December 1967 (taking effect from 1967–68), and one with South Africa on 21 November 1968 (taking effect from 1968–69); their inclusion in this legislation suggests that negotiations with them were taking longer than those with Canada and New Zealand and they wanted to have their transitional position secured by legislation. Transitional provisions relating to interest and royalties becoming a distribution on the introduction of corporation tax, which was far less foreseeable than a change in the treatment of dividends, were also dealt with by a two-year transition, also extended for a further two years. 115  The extension (see previous note) covered the new treaty with Austria, applying from 1969–70, and the second the new treaty with Japan applying from 1970–71. The others were all renegotiated within the original time limit. 116  See below n 178. 117 See D Stopforth and A Goodacre, ‘The Birth of UK Corporation Tax—The Official View’, [2015] BTR 189, 212 in relation to the history of the corporation tax transitional ­provisions relating to foreign investment generally. 113 

320  John F Avery Jones state, who was taxable on domestic income as a person receiving income, although not taxable on foreign income, from benefiting from the treaty.118 It was also necessary to deal with income taxed on the remittance basis but not remitted because the standard treaty provision dealt only with exemption and not reduction in withholding tax, and if the treaty did not contain a remittance provision.119 Profits Tax The dual rate of profits tax on distributed and undistributed profits gave the treaty partner something to negotiate about even though the effect was to preserve domestic law from changing to the detriment of the other state. The differential rates were substantial, rising over time to 22.5 per cent on distributed profits and 2.5 per cent on undistributed profits so obtaining the lower rate became important.120 The treaties with Sweden, Denmark, Finland, Switzerland, and Austria secured that the lower rate would apply to profits of a treaty-partner resident company trading in the UK (which was a guarantee that the present law would continue so long as undistributed profits were taxed at a lower rate).121 Secondly, that the lower rate would apply where a treaty-partner resident company owned at least half of the voting power of a UK resident company,122 which the Swiss treaty extended to cases where more than one Swiss company owned this percentage so long as each company owned at least 10 per cent of the entire share capital.123 It is unclear how important this was in practice. In the Swiss treaty the ­continuation of the 20 percentage points differential in tax rates was also ­covered by a provision that if it changed the parties would consult, followed by the right of either party to terminate the profits tax provisions together with the reduction in Swiss anticipatory tax on dividends from Swiss companies.

118 This was before the introduction of the second sentence of art 4(1) of the OECD Model which was not introduced until 1977. A fuller explanation of this point is contained in J F Avery Jones, ‘The Beneficial Ownership Concept was never Necessary in the Model’, in M Lang, P Pistone, J Schuch, C Staringer and A Storck (eds), Beneficial Ownership: Recent Trends (Amsterdam, IBFD, 2013) 333. The OEEC Fourth Report (Art XX Comm para 32) and the OECD 1963 Draft (Art 10 Comm para 32) say that it had not been determined whether the relief should be given only when the income was subject to tax in the other state. 119  There was no remittance provision in the treaties with the US, the Dominions, Southern Rhodesia, the Netherlands or Belgium. Reduction in withholding tax and remittances was first dealt with in the Swiss treaty. 120  FA 1952, s 33(2). Previous differential rates were 7.5/12.5% (FA 1947, s 30); 10/25%; 10/30% (Profits Tax Act 1949, s 1(1)); 10/50% (FA 1951, s 28). 121  FA 1947, s 39(1); Art VI(2). 122  FA 1947, s 39(2). 123  Art VI(3). In addition Art VII(5) provided for deduction for profits tax of related-party interest or royalties that was exempt from withholding tax, see text below at n 131.

The UK’s Early Tax Treaties with European Countries 321 The differential in profits tax rates was abolished in 1958 following ­criticisms by the Royal Commission.124 Interest Most sources of UK income, including interest, annuities and other annual payments, were subject to deduction of tax at source at the high125 ­standard rate for both residents and non-residents, which meant that we had a better negotiation position than we had for dividends. We pressed for, and achieved, a nil rate of withholding tax on interest that was subject to tax in the UK so long as the recipient was not engaged in a trade or business in the other state. The relief was reciprocal. A factor that influenced the US treaty was that interest on government securities, which presumably also accounted for much of the interest paid to treaty-partner residents, was free of tax to non-ordinary residents.126 We preserved this result in all our European ­treaties127 although with much less of a case in principle since the source state was taxing only once since the interest was deductible in determining profits in the other state128 but we pointed out that an investor looks for a net return and so the effect of imposing a withholding tax was to increase the cost of borrowing by residents of that state. As with dividends, these treaties refined the trade or business exception to the case where this was carried on through a permanent establishment, and the treaty with Switzerland further refined this to the case where the ­interest

124 

Royal Commission, above n 24, [531]. See above n 20. 126  This exemption was initially introduced in 1915, that during World War I and for one year after, the Treasury had the power to issue securities, free of both income and capital taxes when in the beneficial ownership of persons not ordinarily resident in the UK and not domiciled; F (No.2) A 1915, s 47 (the non-domiciled condition was repealed by FA 1916, s 44); ITA 1918, s 46; ITA 1952, s 195; ICTA 1970, s 99; ICTA 1988, s 47, repealed FA 1996. 127  The treaties with the Dominions did not contain an interest article. Not all the European countries imposed a withholding tax on interest. 128 So far as the UK was concerned, obtaining relief through the mechanism of deducting and retaining tax on payment was unaffected by the nil rate under the treaty: Double Taxation Relief (Taxes on Income) (General) Regulations 1946, SI 1946/ 466, para 3(1), amended by Double Taxation Relief (Taxes on Income) (General) No 3 Regulations 1954, SI 1954/1366. There was a limited relief for interest paid by UK companies on loans raised abroad where tax deduction was not possible: FA 1949, s 23 reversing Alexandria Water Co Ltd v Musgrave (1883) 1 TC 521. This required that the interest was secured on trading assets abroad, the interest was required to be, and was, paid abroad, it was paid to a non-resident without deduction of tax, but not where the recipient controls the payer (being a body of persons), or the payer controls the recipient (being a body of persons) or both are bodies of persons controlled by the same person. The first and third of the last-mentioned restrictions would later be included in the definition of distribution (having the effect of disallowing the interest as a deduction) for corporation tax (FA 1965, Sch 11, para 1(1)(d)(iv), later TA 1970, s 233(2)(d)(iv); TA 1988, s 209(2)(e)(iv), repealed by FA 1995, s 87(2)). 125 

322  John F Avery Jones was ­attributable to the permanent establishment. The European treaties (except for France) also restricted the relief for cases where because of the special relationship between the parties the interest was paid at a greater rate than the arm’s length one. The treaties with Denmark, Finland and Austria included a provision, first contained in the US treaty, that the nil rate of withholding tax did not apply if the interest was paid to a company controlling 50 per cent of the voting power of the paying company, presumably on the basis of treating a subsidiary like a branch.129 It also has the effect of removing the advantage of the parent company financing the subsidiary in the treaty partner state by debt rather than equity, particularly when there were no provisions against thin capitalisation.130 The Swiss treaty also provided that interest within the article was deductible for profits tax purposes whatever the relationship between the parties.131 The OEEC did not follow this approach and had a suggested 10 per cent withholding tax on interest. Royalties In general, we had no difficulty in agreeing a nil rate of withholding tax on royalties, and the OEEC continued this. In some cases, particularly Greece, Austria and Finland, the treatment of film royalties required considerable negotiations and the results show some variations. First, in a majority of cases film royalties are included in the definition of industrial or commercial profits so that they are taxable on a net basis if there is a permanent establishment but otherwise are not taxable.132 This was our preferred basis and we claimed to consider that film royalties were in the nature of trading income; it may also have been because we did not have a withholding tax on film royalties paid abroad and so we did not want them to fall in the royalty article which might mean that the other state could apply a withholding tax in case we could not negotiate a nil rate. However, it should

129  Subsidiaries and branches were then effectively treated in the same way in domestic law in the UK. 130  A similar but wider provision is found in domestic law for interest paid abroad for which no deduction of tax is possible: FA 1949, s 23(4), see above n 128. 131 Of minor historical note is that the removal of this relief retrospectively to the start of corporation tax by the subsequent (1966) treaty required legislation in FA 1966, s 33. Although this is drafted in general terms the only treaty to which it could apply was the 1954 Swiss treaty. Treaty provisions relating to profits tax (rather than income tax) were unilaterally given effect for corporation tax; FA 1965, s 64(1). A consequence was that corporation tax adopted the profits tax double taxation relief provisions, see Legal and General Assurance Society Ltd v Thomas [2005] UKSPC SPC00461, [10]. 132  Sweden, Denmark, Norway, Finland, Netherlands, Greece, Switzerland and Germany, plus the Colonial Arrangements.

The UK’s Early Tax Treaties with European Countries 323 be mentioned that in most of these treaties133 no profits are attributed to a permanent establishment in the other state if sales contracts are made in the UK and delivery is made from a warehouse in the other state even when made through an agent, which could apply to films. Secondly, in a few cases, film royalties are included in the royalty article, as they were subsequently by the OEEC, and the definition of industrial or commercial profits excludes royalties generally (Belgium) or is silent about royalties (France) or there is no definition (US, Austria). In this category in the absence of a permanent establishment the rate under the royalties article applies, which is nil, except that Austria can charge at half their domestic rate.134 But if there is a permanent establishment, for example because there is an agent with a stock of films, but the royalties are not industrial or commercial profits under the treaty (certainly for Belgium, and if they are not such in domestic law for France, Austria and the US),135 domestic law applies whether it provides for taxation on a gross basis as a royalty or on a net basis as business profits. The existence of a permanent establishment has the purely negative effect of excluding the operation of the nil (or other) rate of tax under the royalties article and nothing more. Treaty provisions (such as that only profits attributable to the permanent establishment can be taxed, or the arm’s length basis of attribution of profits to the permanent establishment) that are normally associated with the existence of a permanent establishment are inapplicable because the profits are not industrial or commercial profits for treaty purposes, so that the permanent establishment state can do anything permitted by domestic law when taxing on a net basis. On the other hand, if domestic law in France, Austria or the US says that they are industrial or commercial profits (or the equivalent in domestic law) the treaty provisions following from the existence of a permanent ­establishment apply, as in the first category. Thirdly, the Dominions had their own surprising arrangement that all royalties are excluded from the definition of industrial or commercial profits, and film royalties are excluded from the royalty article, thus permitting domestic law taxation even if this is on a gross basis as a royalty. Reluctantly we had to accept this because Canada was fearful that if they agreed any other treatment the US would want the same from them.136 The OEEC draft did have a nil rate of withholding tax on royalties, but it included film

133 

Not Germany, and the treaty with Finland does not mention agents. was particularly reluctant to reduce their withholding tax on film royalties but by persisting, with the aid of the Board of Trade, in the end they agreed to reduce the rate for film royalties in the absence of a permanent establishment to half the normal rate, while the nil rate applied to the UK: IR 40/17255, and /17256. 135  Because of the operation of the treaty provision equivalent to what is now Art 3(2) of the OECD Model. 136  TNA IR 40/15639 f 46. 134  Austria

324  John F Avery Jones royalties in the royalty article, which has continued to the present day, and so in that respect these treaties did not influence the future.137 Mining royalties were also excluded from the royalty article in our treaties in almost all cases. EMPLOYMENT AND PROFESSIONAL SERVICES INCOME

Early treaties dealt with employment and professional services income in the same way. The US treaty had a fairly basic provision that a resident of one state was exempt from tax in the work state if he was present there for not more than 183 days in the taxable year,138 and the services were performed for (or on behalf of) a resident of the employee’s residence state.139 Later treaties added further conditions. Starting with South Africa140 and the Colonial arrangements the services had to be subject to tax in the residence state. This dealt with income taxed on the remittance basis, which applied to foreign employments141 until 1974. Although treaties contained a provision about remittances to the effect that an exemption in the other state applied only to the extent that the income was remitted, it was drafted narrowly and required that under the treaty the income be subject to tax in the residence state.142 The addition was also necessary if the treaty did not have a ­remittance provision.143 In the German and Austrian treaties a further condition was added that the employee must also be paid by the

137 

FC/WP8(58)1 (12 February 1958). This is a bad formulation that enables a continuous period of 183 days at the end of one tax year and another 183 days at the beginning of the next. The OECD changed this in 1992 to 183 days in any 12-month period. 139  Most contemporary treaties were in this form. Later US treaties mostly added a c ­ ondition of a monetary limit on the remuneration qualifying for exemption. 140 The same provision was found in the treaties with Australia, New Zealand, Sweden, Denmark, the Netherlands, Norway, Finland and Germany, as well as all the Colonial treaties. 141 The definition of foreign employment was a matter of some doubt. The 1955 Royal Commission said: ‘… the Courts have had to treat each question as one of fact and to decide it according to the balance of what seem to be the relevant considerations. There is the nationality, domicile or residence of the employer. As the employer is normally a corporation, that test is likely to be somewhat artificial anyway. Then there is the country in which the contract of employment is made, which may or may not correspond with the national system of law by which it is to be governed. Thirdly, there is the country in which the moneys earned by the employment are paid, though it by no means follows that the whole salary will be paid in any one country. Lastly, there is the country in which the work is to be done: again two or more countries may be involved.’ Royal Commission, above n 24, [298]. 142  Later versions of the remittance article applying from about 1970 (Japan (1969) is an early example) made a specific treaty reference to income being subject to tax unnecessary as it no longer referred to the treaty providing that the income was subject to tax but merely referred to income being subject to tax on the amount remitted under the laws in force in the UK. 143  See above n 119. 138 

The UK’s Early Tax Treaties with European Countries 325 employer resident in the non-work state;144 and the treaty with Austria added that the activity must not be carried out in a permanent establishment in the work state of a resident of the other state.145 The treaty with Belgium added that the income did not reduce the profits taxable in the work state.146 Essentially the OEEC adopted all of these conditions, except for subject to tax, which was mainly only of interest to countries adopting the remittance basis, but they enlarged the scope to enable the employer to be resident anywhere other than in the work state.147 The treaties with France, Belgium and Switzerland added that for exemption of professional services income the individual must not have an office or fixed place of business in the work state as a condition of taxation there, the German treaty using the expression ‘fixed base’ for the first time, and the Austrian treaty ‘fixed accommodation which is regularly at his disposal’. In the treaties with Germany and Austria this aspect of professional services income was dealt with in a separate paragraph of the article. Entertainers were normally excluded from the article, although this was limited to professional services income in the German treaty. NON-DISCRIMINATION

The US treaty had a nationality non-discrimination provision, which was unnecessary for the Dominions whose residents were British Subjects, although this would not give protection to companies, and it was unthinkable that we would discriminate against our Dominions and colonies (and vice versa). These European treaties, in addition to preventing nationality discrimination,148 also (and unusually at the time)149 prevented discrimination against permanent establishments compared to domestic companies.

144 France–Norway (1953) required that the remuneration be borne and paid by the employer. 145 This had first been included in Austria-Germany (1954) and so must be an Austrian innovation. Its omission from other treaties is, with hindsight, surprising. 146 Belgium–Germany (1953) and Italy–Sweden (1956) are to similar effect, that the ­remuneration must not be paid from the proceeds of gainful activity in the work state. 147  The Elimination of Double Taxation: 2nd Report of the Fiscal Committee of the O.E.E.C. (Paris, OEEC, 1959) Art VII. 148  From the UK point of view therefore giving their nationals the benefit of the remittance basis applicable to British subjects not ordinarily resident. See below in relation to personal allowances. 149 In the period 1945 to 1956 it was included only in Belgium–Sweden (1953) and ­Netherlands–Sweden (1952), but had earlier been included in Belgium–Germany (1938) (referring to ‘branches or agencies’). Two other treaties of the period (Denmark–Norway (1957) and Indonesia–Netherlands (1954)), and the much earlier Czechoslovakia–Germany (1921), prevented all discrimination against companies by the state other than the residence state which would include discrimination against permanent establishments, but are obviously too wide.

326  John F Avery Jones The UK was the first to use a paragraph preventing discrimination against enterprises with foreign ownership compared to local ownership in the treaty with Denmark. Denmark had such a discrimination in its law in the form of a capital tax on the increase in value of companies during World War II which charged 50 per cent higher tax rates for foreign-owned companies.150 Such a foreign ownership non-discrimination provision was then included in all our early treaties,151 presumably because it was a good idea rather than that there were any known discriminations of this type by our other treaty partners. These non-discrimination provisions related to taxation that was ‘other, higher or more burdensome’ than that of the object of comparison. ‘Higher’ would later be deleted as unnecessary in the OEEC Draft, and ‘other’ would not be applied to the permanent establishment provision on the basis that different provisions may be necessary to taxing them.152 The words ‘in similar circumstances’ were contained in the Swiss treaty in the nationality and ownership paragraphs because during the negotiations Switzerland had queried whether the nationality provision required them to treat a UK national resident in the UK in the same way as a Swiss national resident in Switzerland.153 The UK suggested the addition of ‘in similar circumstances’ in both the nationality and the ownership provisions to meet their concerns, although it would have been better to have said that it was clear that it did not require Switzerland to do this. And ‘same’ would have been better than ‘similar’ because the comparator is hypothetical and can be

150  Under law no 391 of 12 July 1946, of which s 5 para 5 contained the 50% increase in rates for foreign-owned companies (TNA IR 40/172). 151  Treaties with: France (one of the countries represented on OEEC Working Party (WP) 4), Norway, Finland, Greece, Belgium (ending ‘… other enterprises of the first-mentioned territory similarly carried on are or may be subjected’ and which stated that the provision was not to affect a specific treaty provision that profits distributed by a Belgian company to its UK 90% holding company were to be taxed at the lower rate normally applicable to undistributed profits), Switzerland, Germany and Austria (also ending ‘… other enterprises of the first-­ mentioned territory similarly carried on are or may be subjected’), but not the Netherlands or Sweden which were negotiated earlier. 152 For an example of an ‘other’ tax, which on the agreed figures was less burdensome, see Woodend (KV Ceylon) Rubber Co v Comr of Inland Revenue [1971] AC 321, 332F, PC relating to a branch profits tax (in a residence, rather than nationality, non-discrimination provision), although ultimately the discrimination was not prevented as the treaty had been overridden. The OEEC Working Party said later in an interpretative note, ‘The words “… shall not be subjected to any taxation or any requirement connected therewith which is other or more burdensome…” mean that tax may not be in another form (no different tax, no different mode of computing the taxable amount, no different rate, etc.) and that the formalities connected with the taxation (returns, payment, prescribed times, etc.) may not be more onerous.’ (FC/WP4(57)3). 153  TNA IR 40/11451 f 283J. The nationality provision was otherwise essentially the same as the current OECD Model’s. The addition of ‘in particular with respect to residence’ made in 1992 in the nationality provision only was viewed as unnecessary but intended to explain ‘in the same circumstances.’

The UK’s Early Tax Treaties with European Countries 327 identical except for the provision under review. The OEEC adopted ‘same’ but rather spoilt it by explaining that it meant ‘substantially similar’.154 Unusually, starting with the US treaty, in all these treaties (except for ­Belgium) the non-discrimination article applied to all taxes not merely the taxes covered by the treaty.155 The rationale for this was set out in our negotiations with Germany, who were resisting its inclusion: It is also essential to ensure—and this is primarily valuable from the taxpayer’s point of view—that the other country will not get round the provision by discriminating against him in other ways—e g by levying specially heavy stamp duties on his documents etc.156

Greece wanted to exclude taxes on goods but we persuaded them that the wording of the provisions would not cover goods anyway. However, the application to taxes not covered by the treaty had no effect in the UK because the enabling provision giving effect to the treaty in domestic law was ­limited to income tax, excess profits tax and profits tax (and later, ­corporation tax and capital gains tax), which is strange as the enabling provision was drafted to give effect to the 1945 US treaty the non-­discrimination ­article of which applied to all taxes.157 We were presumably unaware of this because, as with Germany and Greece, we were keen on their including the provision which we could not have done if we had made the other party aware of the defect in our domestic law implementation of the treaty. This defect must have been realised later because from the mid-1960s we started to limit the provision to taxes covered by the treaty, although ‘all taxes’ provisions were still being used in the 1980s presumably in some cases at the instance of the treaty partner.158

154  The Elimination of Double Taxation: 1st Report of the Fiscal Committee of the O.E.E.C. (Paris, OEEC, 1958), Commentary to Art IV,para 2 stated that in the same circumstances ‘refers to taxpayers placed, from the point of view of the application of the ordinary taxation laws and regulations, in substantially similar circumstances both in law and fact’ (now Art.24 Comm para 7 of the OECD Model). In French, Art 24(1) used the expression de méme nature in 1963, which was changed to similaires in 1977. 155  The US was the only other country using an ‘all taxes’ provision at the time, solely in nationality non-discrimination articles. It was included in 11 US treaties between 1945 and 1956 and not included in 2 (Ireland (1949) and South Africa (1946)). Apart from use by the US and UK it was included only in Norway-Switzerland (1956). 156  TNA IR 40/9629A f 110. 157  F (No.2) A 1945, s 51; ICTA 1988, s 788; and TIOPA 2010, s 6(3). 158 Early UK examples of the non-discrimination article applying to taxes covered by the treaty are Canada (12 December 1966), New Zealand (13 June 1966), South Africa (21 November 1968) (but not Australia (1968) which did not contain a non-­discrimination ­article), Singapore (1 December 1966), Swaziland (26 November 1968) and Portugal (27 March 1968). Late examples of it applying to all taxes are Norway (3 October 1985) and Nigeria (9 June 1987).

328  John F Avery Jones PERSONAL ALLOWANCES

Domestic law gave a proportion of personal allowances to non-resident British subjects (later, Commonwealth Citizens which would include ­ residents of the Dominions and Colonies and so no provision dealing ­ with this was necessary in their agreements or arrangements) corresponding to the proportion of UK income to world income. Although it had not been included in the US treaty, the same treatment was extended on a ­reciprocal basis to residents of our European treaty partners (irrespective of their nationality), which we used as a negotiating tool in relation to dividend withholding tax. At the same time, we excluded from the nondiscrimination article that nationals of the treaty partner state were entitled to the same allowances as we gave to our own non-resident nationals, so that non-residents of the treaty partner could not claim them on the basis of their nationality. EXTENSION OF OUR TREATIES TO DEPENDENT TERRITORIES

In the period between 1946 and 1952 we made a large number of ­‘Arrangements’ with our Colonies and similar territories such as protectorates (to which I shall refer as dependencies). As a corollary to this we offered to extend to the dependencies our treaties with the Dominions. Those who accepted are shown in Table 2 below.159 While these may have been driven by considerations of the Empire we also made the same offer to the dependencies in relation to our treaties with other states and the offer was taken up by many of them in the 1950s and 1960s, as can also be seen from Table 2; no extensions to dependencies were made after the ones in the Table.160 One has the impression that this was driven by the Colonial Office whose aim was that all our treaties would apply to the dependencies with which we had such Arrangements,161 rather than being driven by tax policy. The US treaty was the first to include a provision enabling it to be extended to dependent territories of either party, although the first extensions to be made were to the Agreements with Canada and New Zealand. It is interesting that right from the beginning a stated objection to the treaty

159  I have seen a reference to a list of 29 September 1949 but not seen it. I believe they comprised Aden, Antigua, Cyprus, Gambia, the Gold Coast, Jamaica, Mauritius, Montserrat, Nigeria, Nyasaland, St Christopher and Nevis, Seychelles, Sierra Leone, Trinidad, and the Virgin Islands. Grenada, the Falkland Islands and St Vincent agreed later. 160  Except that in 1972 the later (1960) treaty with Sweden was extended to some of the dependencies in place of the earlier treaty, see Notes to the Table. 161  Denmark wanted to extend the UK–Denmark treaty also to Hong Kong which we refused on the ground that our practice was limited to territories to which we had an A ­ rrangement: TNA IR 40/12346; FO 371/94678.

The UK’s Early Tax Treaties with European Countries 329 in the United States was the possibility that it could be extended to low tax territories and used to avoid US tax by non-resident aliens of the United States; such an objection was well in advance of its time.162 The answer given to the objection was that it was an encouragement to increase US trade with such territories, which may have had some force in relation to Caribbean territories.163 Such a provision was adopted in some subsequent US treaties164 and the United States later came to regret that they had not paid attention to the objection and terminated the extensions in 1983 saying: ‘The terminations occurred because, as extensions of old treaties with developed countries, they do not reflect the economic relationship between the United States and these respective jurisdictions. In addition, several of these treaties are susceptible to abuse.’165 The early Agreements with the Dominions followed the same pattern with extensions being made to the first treaties with Canada, South Africa and New Zealand, though not Australia who were recorded as saying that they would extend their treaty with the UK to dependencies only if it would give ‘tangible mutual advantages acceptable to Australia’,166 which presumably they concluded was not the case. The difference in procedure was that the extensions to our treaties with the Dominions were not laid before Parliament for information at all, whereas extensions to treaties with other countries were laid as Command Papers in the Treaty Series. Although, as mentioned above,167 the practice changed in the early 1960s for the ­making of Agreements with the Dominions after which they were reported to

162 The objections are anonymous and were either made up by the Joint Committee on Taxation to give a balanced view, or were based on comments received from outside, US–UK Legislative History, above n 7, 2607 and 2619. The State Department recommended to the President that the advice and consent of the Senate should be taken before the treaty was extended to any such dependency: US-UK Legislative History, 2652. 163  US–UK Legislative History, above n 7, 2594 and 2642. While the treaty provision was aimed at UK dependencies, the National Foreign Trade Council memorandum pointed out that it would enable the treaty to be extended to Puerto Rico (US–UK Legislative History, 2617), but this was denied in the Technical Explanation (US–UK Legislative History, 2595) on the ground that it was autonomous in revenue matters, which seems unconvincing. 164 US–Netherlands (1948) was extended to the Netherlands Antilles, and US–Belgium (1952) was extended to three dependencies; see D Rosenbloom and S Langbein, ‘United States Tax Treaty Policy: an Overview’ (1981) 19 Columbia Journal of Transnational Law 359, 379. The Belgian extensions were terminated at the same time as the UK ones, see next note. 165 The US Treasury announced in 1979 that it was investigating whether these extensions should be terminated to prevent use by taxpayers in third countries (Tax News Service 30 September 1979). The extensions were terminated on 1 July 1983 with effect from 1 January 1984, except for the extension to the British Virgin Islands which was terminated on 30 June 1982 with effect from 1 January 1983, and Antigua and Barbuda which gave notice to terminate on 26 February 1983 with effect from 26 August 1983 (US Treasury Department Press Release, 1 July 1982). 166  This was in a letter of 10 October 1951 from the Secretary of State for the Colonies to the South African High Commissioner on the file about the extensions to the South Africa Agreement: TNA IR 40/16978. 167  Text above at n 36.

330  John F Avery Jones Parliament as Command Papers (in addition to the Statutory Instrument procedure for giving effect to them in tax law), there are no examples of extensions being reported in this way, as no extensions were made after the change in procedure. All the early European treaties with the UK continued the practice and contained a similar article.168 Normally this applied to both states but the treaties with Sweden, Norway, Finland, Switzerland and Germany limited its scope to extension to UK dependencies only.169 As will be seen from the Table extensions were made to numerous UK dependencies. The benefits to the dependency were that they would obtain a better deal than they could have achieved on their own,170 and they did not need to arrange for us to conduct separate negotiations which were unlikely to have taken place in practice. The reason given by the US of the expansion of trade by the treaty partner with the extension territories, which may have been true for the US in relation to Caribbean territories, seems unlikely for most of the European countries concerned. During negotiations with the Netherlands it was realised that the original wording could have created a treaty directly between the dependencies of each state, to which the Foreign Office objected.171 The final wording avoided this problem. The extensions were made before the dangers of treaties with tax havens, which most of the UK dependencies were (or became), were understood. However, many of the extensions excluded the interest article, as had the extensions made by the US treaty.172 The normal treaty provision stated that if the parent treaty was terminated all the extensions were terminated too unless otherwise agreed. The US later fell into that trap when terminating the dividend article on the introduction of our corporation tax. They had not intended to terminate the dividend article in the extensions, which were not affected by the introduction of ­corporation tax in the UK, and they had to issue a revised termination retaining the extensions.173 Extensions to dependencies of the treaty partner were much less common: as will be seen from the Table below, the only extensions were that the treaty with the Netherlands was extended to the Netherlands Antilles in 1957 without it seems any thought of the possible effect,174 and the treaty 168 The same provision is found in a few treaties other than between the UK and the ­ ominions, eg Belgium–US (1948), France–Norway (1953), Canada–France (1951), Indonesia– D New Zealand (1954) and New Zealand (1948). 169  The records of the negotiations show that Sweden had no colonies, and Norway’s were uninhabited. 170  For an example of this see South Africa’s attempt to give reduced benefits to ­neighbouring countries to which the treaty was being extended in the text below around n 183. 171  TNA IR 40/17127 f 60. 172 Interest was also automatically excluded from the extensions of the Canada, New Zealand and South Africa treaties as those treaties did not cover interest. 173  See above n 111. 174 There is nothing in TNA IR 40/17155 to show that the possible tax effect was considered. Effect to the extension was given by the Double Taxation Relief (Taxes on Income)

The UK’s Early Tax Treaties with European Countries 331 with Denmark was extended to the Faroe Islands.175 The similar extension to the Netherlands Antilles made to the subsequent treaty with the Netherlands176 was ultimately terminated by the UK with effect from 1989.177 Our second treaty with South Africa (1962) was extended to South West Africa in 1962.178 An article providing for territorial extension of the treaty was later included in the OEEC Third Report (1960) and subsequently in the 1963 OECD Draft and OECD Models and survives to this day. Their archives do not contain any analysis of the merits of such extensions.179 The earliest draft of the Commentary merely referred to the constitutional necessity of such a provision in treaties: As these so-called ‘territories of extension’ have as such no international capacity of their own or only a limited one, both the extension of Conventions for the avoidance of double taxation and the termination of such extension are to be declared by the Contracting State concerned.180

(Netherlands Antilles) Order 1957, SI 1957 No 425. It also records that ‘We asked the Netherlands whether they would be extending the treaty to the Dutch East Indies but they could not say as their constitutional status was still in the balance’ (IR 40/17127 f 28). 175  There were also negotiations to extend the Belgian treaty to Ruanda–Urundi and the Belgian Congo, but these were never finalised. 176  The 1967 treaty with the Netherlands was similarly extended to the Netherlands Antilles in 1970 by the Double Taxation Relief (Taxes on Income) (Netherlands Antilles) Order 1970, SI 1970/1949. 177 Talks had been held about a new treaty from 1987 but it was announced in a Press Release of 19 October 1989 that Minsters had decided that having considered the position reached in these discussions a satisfactory basis for a new treaty did not exist. Domestic law was amended to provide a saving for the exemption for deduction of UK tax from interest paid by a UK resident company to its Netherlands Antilles subsidiary to fund interest on a quoted Eurobond issued by the subsidiary before 26 July 1984 (the start of the quoted Eurobond exemption); FA 1989, s 116. (When earlier terminating the extension to the Antilles of their treaty with the Netherlands, the US had caused disruption in the Eurobond market resulting in losses to investors and had undermined its credibility as a treaty partner; F Crandall, The Termination of the US-Netherlands Antilles Tax Treaty: What were the Costs of Ending Treaty Shopping, (1988–89) 9 Northwestern Journal of International Law & Business 355.) 178  This is not included in the Table which is restricted to the first treaty with South Africa. The extension is in South Africa No 2 (1962) (Cmnd.1894, 8 August 1962); and Treaty Series No 4 (Cmnd.2249, 1964). South West Africa (now Namibia) was a former German colony which after World War I became a League of Nations Mandated Territory under the administration of South Africa. Subsequently the UN asked South Africa to surrender South West Africa to United Nations trusteeship, which it refused to do culminating in a decision of the International Court of Justice in South Africa’s favour in 1950 declaring that the mandate was still in force now supervised by the UN General Assembly. Subsequently in 1966 the General Assembly terminated the mandate and in 1971 the International Court of Justice ruled that South Africa had no right to administer it. The extension was therefore made after the ICJ had ruled in favour of South Africa and before the mandate was terminated by the UN. 179 A draft was prepared by WP14: FC/WP14(59)1 (3 March 1959); TFD/FC/78 (23 September 1959); TFD/FC/82 (Countries’ comments on the previous item) (11 December 1959); TFD/FC/83 (12 December 1959); FC/WP14(60)1 (19 January 1960); FC(60)1 (14 March 1960); TFD/FC/89 (10 May 1960) plus corrigendum; FC(60)2 (25 May 1960); C(60)157 (13 July 1960). 180  FC/WP14(59)1 (3 March 1959).

332  John F Avery Jones By the time of the OEEC Third Report this had become an argument of convenience: A clause of this kind is of particular value to States which have territories oversea or are responsible for the international relations of other States or territories, especially as it recognises that the extension may be effected by an exchange of diplomatic notes.181

Table 2 shows the extensions made to these treaties. It demonstrates how the article was mainly used to benefit UK dependencies182 rather than the treaty partner’s dependencies. Another feature of the Table is that some treaties were extended to a smaller number of dependencies than others. In particular the treaty with South Africa was extended to only seven of them. This was because South Africa did not want to include the benefit of exemption from non-resident shareholders’ tax and undistributed profits tax to the dependencies. Initially our view was that such exclusions were not within the enabling power in our treaty with South Africa as being ‘such modification as may be necessary’ but in the end we accepted the interpretation that it meant modifications necessary to reach agreement.183 The dependencies to which the treaty was not extended were presumably those who did not agree to the two exclusions. However, even before the ­extension South Africa made separate treaties (with our consent) with a total of seven184 African dependencies listed in the Table, none of which contained the excluded articles, making an overall total of 14, compared to 21 for Canada and 18 for New Zealand. Originally South Africa had also objected to making extensions to Basutoland, Bechuanaland and Swaziland as they only wanted an exchange of information provision with those territories but we said that an extension had to be all or nothing. South Africa subsequently made a full treaty with them.185 There are also a few instances of dependencies objecting to the extension of treaties with particular countries to them recorded in the Notes to the Table. Although there was only one extension of the treaty with the Netherlands to Rhodesia and Nyasaland, proposals had been discussed to extend it to the usual dependencies. However, by the time that treaty had been extended to the Netherlands Antilles there were proposals for a new treaty, although no extensions to UK dependencies were made to the new (1967) treaty either. 181  The Elimination of Double Taxation: Third Report of the Fiscal Committee (Paris, OEEC, 1960) 47. 182  The term ‘dependencies’ is used in a loose sense without any political significance and as comprising the countries concerned at any subsequent time. 183  TNA IR 40/16978. 184  Plus one, Basutoland (now Lesotho), which is not relevant to the Table as there were no extensions to it. They objected to the extension of the treaty with Sweden to it: TNA IR 40/17218. 185  See C West, ‘From colonialism to apartheid: International influence on tax treaties in South Africa (1932–1990)’ in J Hattingh, J Roeleveld and C West (eds), Income Tax in South Africa, the first 100 years 1914–2014 (Cape Town, Juta & Co (Pty) Ltd, 2016) 226.

Table 2:  Territorial Extensions to Early Treaties

Treaty Date

Canada

South Africa

New Netherlands Sweden Zealand

1945

1946

1946

1947

1948

Note (3) 1960

Note (4) 1951

Note (5) 1962

1949

France 1950

Denmark Norway Switzerland 1950

1951

1954

Japan 1962

Extension to UK Territories186 Reference and year of main extension

Note (1) Note (2) 1958 1951

Aden Colony

Y#

Y

Y

Antigua

Y#

Y

Y

Barbados

Y#

Y

British Honduras Br Solomon Is

Y#

Y

Y#

Y#

Y#

Y ^#

Y#

Y#

Y ^#

Y#

Y#

Y#

Y#

Y#

Y#

Y ^#

Y#

Y#

Y#

Y# α

Bechuanaland

Note (6) Note (7) Note (8) Note (9) Note (10) Note (11) 1953 1963 1954 1955 1963 1970

Y# (1961)

(continued) 186  The territories included in the extensions concerned are listed by the names they had in the relevant documents extending the treaty to them. To the best of my knowledge the current names are: Aden Colony—Yemen (part), Bechuanaland—Botswana, British Honduras—Belize, British Solomon Islands—Solomon Islands, Gilbert and Ellice Islands—Kiribati and Tuvalu, Gold Coast—Ghana, Malaya and North Borneo—Malaysia (part), Northern Rhodesia—Zambia, Southern Rhodesia—Zimbabwe, Nyasaland—Malawi, Tanganyika and Zanzibar—(Tanzania).

The UK’s Early Tax Treaties with European Countries 333

United States

United States

Canada

South Africa

Cyprus

Y#

Y

Y

Dominica

Y#

Falkland Is

Y#

Fiji Gambia

Y

New Netherlands Sweden Zealand Y

Y

Y#

Y#

Y#

Y#

Y#

Y ^#

Y#

Y#

Y#

Y ^#

Y#

Y#

Y#

Y ^#

Y#

Y#

Y#

Y ^#

Y#

Y#

Y#

Y

Y#

Y#

Y#

Y

Y#

Y

Y#

Y#

Y#

Y# (1958)

Y# (1959)

Y# (1963)

Y#

Y#

Y#

Y

Y#

Y#

Y#

Y Y

Y

Gilbert and Ellice Is Gold Coast

Y

Grenada

Y#

Y

Jamaica

Y#

Y

Y §

Kenya Malaya Mauritius

Y

Y

Denmark Norway Switzerland

Y#

Y Y#

France

Y#

Montserrat

Y#

Y

Y

Y#

Y#

Y#

Nigeria

Y#

Y

Y

Y#

Y#

Y#

Y#

Y#

Y#

North Borneo

Japan

Y

Y ^# Y ^#

Y ^#

Y

334  John F Avery Jones

Table 2:  (Continued)

β replacing S. Rhodesia

Y

Y (N only)

St Christopher Nevis and Anguilla

Y#

Y

St Lucia

Y#

St Vincent

Y#

Y

Seychelles

Y#

Y

Y

Sierra Leone

Y#

Y

Y

Y (N only)

Y^

Y (1958)

Y (1959)

Y (1960)

Y (1961)

Y#

Y#

Y ^#

Y#

Y#

Y#

Y ^#

Y

Y#

Y#

Y#

Y ^#

Y

Y#

Y#

Y#

Y ^#

Y

Y#

Y#

Y#

Y#

Y#

Y#

Y

Singapore

Y

Swaziland

α

Y# (1961)

Tanganyika

§

Y# (1958)

Y# (1959)

Y#

Y#

Trinidad and Tobago

Y#

Y

Y

Y

Y

Y# (continued)

The UK’s Early Tax Treaties with European Countries 335

Federation of Rhodesia and Nyasaland (or one of them)

United States

Canada

New Netherlands Sweden Zealand

§

Uganda Virgin Is

South Africa

Y#

Y

Zanzibar Extension to treaty partner's territories

Y § Netherlands Antilles Note (12)

France

Denmark Norway Switzerland

Y# (1958)

Y# (1959)

Y#

Y#

Y#

Y ^#

Y# (1958)

Y# (1959)

Y# (1963)

Y ^#

Faroe Islands Note (13)

Japan

Y

336  John F Avery Jones

Table 2:  (Continued)

The UK’s Early Tax Treaties with European Countries 337 Notes to the Table Dates in the list of countries refer to the date of the extension to that territory (if that territory was not included in the original list of extensions). Only extensions to the first treaty with that country are included. Only the exclusion of dividends and interest are noted by the symbols below. Many extensions have other exclusions. Key to Symbols # Extension not applicable to interest. ^ Extension not applicable to dividends. § These territories were the subject of a separate agreement with South Africa on 27 September 1959 (Proclamation No 146, 1960, Government Gazette vol CC No 6433, 6 May 1960 at 5). α These territories (plus Basutoland) were the subject of a separate agreement with South Africa on 18 June 1959 (Proclamations Nos 260, 1959 (Basutoland), No 261, 1959 (Bechuanaland) and 262, 1959 (Swaziland), Government Gazette vol CXCVIII No 6314, 13 November 1959 at 1). β The subject of a separate agreement with South Africa of 22 May 1956 (Proclamation No 174, 1956, Government Gazette vol CLXXXV No 5734, 31 August 1956 at 1); amended 30 October 1959 (Proclamation No 60, 1960, Government Gazette vol CXCIX No 6383, 18 March 1960 at 5); replacing an agreement with Southern Rhodesia of 19 May 1952 (Proclamation No 162, 1952, Government Gazette, vol CLXXIX No 4906, 15 August 1952 at 4); after termination of the Federation in 1963 a new agreement was made with Southern Rhodesia of 10 June 1965 (Proclamation No 214 1965, Government Gazette vol 17, No 1214, 3 September 1965 at 5) and the extension continued in respect of the rest of Rhodesia and Nyasaland. Numbered Notes (1) No 62 (1959), Cmnd.824, 19 August 1957/3 December 1958. The termination by the US of art VI (dividends) of the treaty with the UK did not include the extensions: No 34 (1966), Cmnd.3010, 30 June 1965 (2) In Canada The Canada Gazette, 1 September 1951 at 2382. There is no official publication in the UK but the extension is recorded in UN Treaty Series vol 345 (1959) at 326. (3) In South Africa Proclamation by Governor-General No 32, 1961, Government Gazette vol CCIII 3 February 1961 No 6620 at 9. There is no official publication in the UK. The extensions to Grenada and Sierra Leone (Proclamations 299 of 1946, 271 of 1954 and 32 of 1961) are still in force so far as South Africa is concerned but this might be contested. (4) In New Zealand The New Zealand Gazette, 19 July 1951 No 55 at1018. See C Elliffe, International and Cross-Border Taxation in New Zealand (New Zealand, Thomson Reuters, 2015) 593 for how treaties become part of New Zealand law by a declaration of the Governor-General by Order in Council and ITA 2007 (New Zealand) s BH 1(1) and (3). There is no official publication in the UK. (5) No 47 (1963), Cmnd.2083, 20/27 December 1962. According to TNA IR 40/17155 Swaziland did not want to extend the treaties with the Netherlands to it, as it had with Sweden. (6) No 13 (1954), Cmd 9070, 18 December 1953. No 13 (1955), Cmd 9387, 25 November/3 December 1954, No 75 (1959), Cmd 891, 28 May 1958. No 75 (1962), Cmnd.1888, 27 November 1961 (also Sweden No 1 (1962), Cmnd.1647). The 1960 treaty was extended to a number of these territories in place of the 1949 treaty: No 37 (1972), Cmnd 4931, 19 January 1972. (7) No 15 (1964), Cmnd.2254, 5 November 1963. (8) No 34 (1955), Cmd 9468, 18 November/22 December 1954. No 81 (1959), Cmnd.903, 17 January 1959 (also Denmark No 1 (1959) Cmnd,705), amended No 20 (1962), Cmnd.1645, 31 October 1960 (also Denmark No 2 (1961), Cmnd.1275). No 72 (1961), Cmnd.1475, 30 May 1961. According to TNA IR 40/17218 Swaziland did not want to extend the treaties with Denmark or the Netherlands to it, as it had with Sweden.

338  John F Avery Jones (9) No 78 (1955), Cmd 9624, 18 May 1955. Norway No 1 (1960), Cmnd.1062, 23 March 1960. No 72 (1961), Cmnd.1475, 30 May 1961. No 54 (1962), Cmnd.1809, 12 October 1961 (also Norway No 1 (1962), Cmnd.1611). Norway No 1 (1964), Cmnd.2273, 21/26 November 1963. (10) No 72 (1961), Cmnd.1475, 30 May 1961. Switzerland No 1 (1964), Cmnd.2255, 20/26 August 1963. (11) No 52 (1971), Cmnd.4723, 25 September 1970. (12) Netherlands Antilles: No 20 (1958), Cmnd.452, 13/29 July 1955 (also Netherlands No 1 (1956), Cmd.9766); SI 1957 No 425. (13) Faroe Is: No 75 (1961), Cmnd.1477, 31 October 1960 (also Denmark No 1 (1961) Cmnd.1274); SI 1961 No 579. 1966 Protocol extended No 31 (1968), Cmnd.3588, 13 July/24 October 1967; SI 1968 No 307. 1968 Protocol extended No 40 (1971), Cmnd.4740 (also Denmark No 1 (1971) Cmnd.4587), 25/27 November 1970; SI 1971 No 717. 1973 Protocol extended No 63 (1976) Cmnd.6547 (also Denmark No 1 (1975) Cmnd.6088), 17 February/7 March 1975.

CONCLUSION: THE INFLUENCE OF THESE TREATIES ON THE OEEC AND OECD MODELS

At the end of the period covered by these treaties the Council of the OEEC set up a Fiscal Committee as a result of urging initially by the International Chamber of Commerce187 and then by the Dutch delegation. The terms of reference were worked out by an ad hoc committee of experts on taxation under the chairmanship of van den Temple, the Director General of Fiscal Affairs in the Netherlands.188 The Fiscal Committee was given the ambitious project of dealing not only with direct taxation but also indirect taxation, the standardisation of concepts and nationality discrimination189 in the period from March 1956 to July 1958 when it would be determined whether the Fiscal Committee should be continued.190 The Fiscal Committee made an interim report in 1957191 and a further report in 1958192 by which time it had prepared draft articles and commentary on the definition of taxes, permanent establishment, fiscal domicile, and non-­discrimination, 187 

C(54)294 (12 November 1954). C(56)1 (13 January 1956). The Dutch, Swiss and German delegations submitted memoranda, see Report C(56)49. 189  Note by the Secretary-General, FC(56)1 (16 May 1956). 190  C(56)49(Final) (19 March 1956). 191 C(57)145 (3 July 1957). By that time the following Working Parties, normally of two delegates from the countries in brackets, were in operation: 1 permanent establishment (Germany, the UK); 2 fiscal domicile (Denmark, Luxembourg); 3 listing of taxes (Italy, ­Switzerland); 4 discrimination (Netherlands, France); 5 shipping and air transport (Sweden, Belgium). More were then created: 6 inland waterways (France, Germany); 7 apportionment of profit (UK, Netherlands); 8 royalties (Germany, Luxembourg); 9 immovable property (Italy, Austria); and 10 dependent and independent services (Sweden). By the end, there were also Working Parties 11 interest (France, Belgium); 12 dividends (Germany, Italy, Switzerland); 13 capital (Switzerland); 14 territorial scope, definitions, mutual agreement, exchange of information, diplomatic privileges, entry into force (Austria, Sweden); and 15 avoidance of double taxation (Denmark, Ireland). (No.16 does not appear to exist, and No.17 dealt with inheritance taxes.) 192  C(58)118 (28 May 1958). 188 

The UK’s Early Tax Treaties with European Countries 339 which became a recommendation of the Council to be adopted in treaties, which was published.193 This was a very considerable achievement in such a short period. Further Reports followed in July 1959,194 August 1960195 and August 1961.196 With minor changes the ­articles included in these reports plus six further articles197 were joined together to become the OECD Draft of 1963. In many cases one can see the influence of these treaties on the OEEC and its successor the OECD. In particular, these treaties influenced the definitions of ‘person’ and ‘company’; the use of the expression ‘resident;’ the content of the permanent establishment article, particularly the exclusion for a warehouse (although the OEEC put the whole definition in more logical form); the nil rate of withholding tax on royalties (though not on dividends or interest); the development of the content of the employment and professional services article (which the OEEC split into two and redrafted, using the concept of fixed base which we had used with Germany for the latter); in the non-discrimination article the introduction of the ­permanent establishment, ownership and (together with the US) ‘all taxes’ provisions; and the territorial extension article. While the OEEC never adopted our subject-to-tax requirement for dividends, interest and royalties we can perhaps claim credit for its replacement by beneficial ownership in 1977 (about which it might be better if we kept quiet) which has the advantage over subject-to-tax by catering for bodies such as pension funds and charities.198 On the other hand, a number of cases have been mentioned where the OEEC diverged from these treaties, including their adopting a dual residence provision, and ‘place of effective management’ after rejecting ‘central management and control,’ dropping the rule that an agent holding a stock of goods constituted a permanent establishment, adopting suggested rates of withholding tax on dividends and interest, and including film royalties in the royalties article. The overall picture is that these treaties were a step on the road to the OEEC and OECD Models whose influence has continued to this day. None of the changes was earth-shattering but they formed an important ­contribution to today’s treaties.

193 

C(58)118(Final) (15 July 1958), published as the 1st Report, above n 49. 2nd Report, above n 147, covering shipping and air transport, dependent and independent personal services, immovable property, and capital. 195  Third Report, above n 181, covering allocation of profits to a permanent establishment, other income, personal scope, and territorial extension. 196  Fourth Report, above n 98, covering dividends, interest, royalties, avoidance of double taxation and mutual agreement procedure. 197  The articles on general definitions, capital gains, exchange of information, diplomatic and consular officials, entry into force, and termination. 198  But see above nn 118 and 119. 194 

340 

12 The ‘Great Powers’ and the Development of the 1928 Model Tax Treaties SUNITA JOGARAJAN*

ABSTRACT

In 1928, the League of Nations published three model tax treaties addressing double income taxation. These models form the foundation of the more than 3,000 bilateral tax treaties in existence today. It has been said that the United States of America, through her representative Thomas Sewell Adams, was a significant influence on the development of the League’s model treaties. Utilising original archival research, this chapter examines the veracity of this view. The chapter also explores the role of the other ‘great power’, Great Britain, on the development of the League’s model treaties. Great Britain was involved in the League’s efforts to address the problem of double taxation from the very beginning whereas the American representative only attended the penultimate session in 1927 and the final League session in 1928. Although both were strong countries economically, they were not natural allies and had contrasting positions with respect to addressing the problem of double taxation. Great Britain strongly favoured exclusive residence-based taxation while America supported some sourcecountry taxation. The chapter concludes that America did not in fact have a significant impact in the development of the League’s model treaties and it is Great Britain that had the greater (albeit short-lived) influence. This was largely because key decisions were made in earlier League sessions when there was no American involvement and the European representatives were keen to compromise with Great Britain as it was ‘a great economy’. America’s absence from the League’s work on double taxation was the result of domestic politics and one wonders as to the outcome for model tax treaties * 

I am grateful to John Avery Jones and Richard Vann for their comments.

342  Sunita Jogarajan if things had been different. The examination of the British and American involvement in the efforts against double taxation also presents an interesting case study of international cooperation regimes. INTRODUCTION

Dare we reject it and break the heart of the world?1 Unfortunately, the United States of America did reject membership of the League of Nations and the heart of the world did break over a greater war two decades later.2 In the field of international double taxation, America’s non-participation in the League meant that American experts were not involved in the League’s efforts to address the issue until quite late in the proceedings. By contrast, Great Britain was involved in every stage of the League’s work on double taxation in the 1920s. This chapter examines the influence of these two ‘great powers’ on the three model conventions on double taxation developed by the League in 1928 (‘the 1928 Models’) and in turn, the influence of the 1928 Models on their early tax treaty ­practice.3 The chapter demonstrates that assumptions regarding the impact of ­American influence on the 1928 Models may have been exaggerated. F ­ urther, America and Great Britain did not work together towards a c­ommon agenda, as commonly thought. The next section provides a brief introduction to the League’s involvement on double taxation in the 1920s. The third section discusses general ­British and American involvement in the League (or lack thereof). The fourth section demonstrates that America’s delayed participation in the work to address double taxation substantially diminished American influence in the development of the 1928 Models and the American expert, Thomas Sewell Adams, was not as dominant as some have suggested.4 On the other hand, Great Britain was an important influence on the development of the 1928 Models as the British representative, Sir Percy Thompson, was often the lone voice opposing the Continental European countries’ preference for source-based taxation. The discussions of the League’s Experts often referred to the need to find a compromise with Great Britain as it was ‘a great economy’. The fifth section then considers why America and Great 1 W Wilson, ‘An Address to the Senate’ (Speech delivered at the United States Senate, ­ ashington DC, 10 July 1919) in A Link (ed), The Papers of Woodrow Wilson, vol 61 W ­(Princeton, Princeton University Press, 1993) 434. 2  JM Cooper Jr , Breaking the Heart of the World: Woodrow Wilson and the Fight for the League of Nations (Cambridge, Cambridge University Press, 2001) 9. 3  Double Taxation and Tax Evasion: Report Presented by the General Meeting of Government Experts on Double Taxation and Tax Evasion (Geneva, League of Nations, 1928) (‘the 1928 Report’). 4  M Graetz and M O’Hear, ‘The Original Intent of US International Taxation’ (1997) 46 Duke Law Journal 1021, 1085–87.

‘Great Powers’ and the 1928 Model Tax Treaties 343 Britain, as the two largest capital-exporting countries at the time,5 did not form an alliance against the largely capital-importing Continental European countries. This was partly due to a difference of view on the principles, as has been assumed,6 but was also due to a quirk of fate. Finally, the sixth section examines the impact of the 1928 Models on the early tax treaty practice of America and Great Britain. It would appear that the 1928 Models were initially of little or no impact. LEAGUE OF NATIONS AND DOUBLE TAXATION A great change of heart among the peoples is necessary before a righteous international order can be set up. Brotherhood must drive away jealousy, and mutual service must take the place of mutual ill-will. The best available means for maintaining peaceful relations and diminishing the frequency and the horrors of war is the establishment of a League of Nations in which all or most civilised states shall bind themselves together for the purpose of settling disputes by justice instead of force.7

The League of Nations was established on 10 January 1920 as a result of the Paris Peace Conference which ended the Great War. The Covenant of the League of Nations was signed by 42 founding member countries and has been described as a significant turning point in the evolution of the world toward international organisation.8 It would also prove to be a significant turning point in the evolution of the international tax regime. As set out in the preamble to the Covenant, the League’s purpose was ‘to promote ­international co-operation and to achieve international peace and security’.9 The Covenant was primarily concerned with the prevention of war and ­dispute resolution but Article 23(e) provided for the ‘equitable treatment for the commerce of all Members of the League’. This provision stemmed 5 C Feinstein et al, The World Economy between the World Wars (New York, Oxford ­University Press, 2008) 78–79. 6  J Avery Jones, ‘The History of the United Kingdom’s First Comprehensive Double ­Taxation Agreement’ [2007] British Tax Review 211, 220. 7  TJ Lawrence, The Society of Nations: Its Past, Present and Possible Future (New York, Oxford University Press, 1919) xi. 8  CH Ellis, The Origin, Structure and Working of the League of Nations (London, G Allen & Unwin, 1928) 67. The 42 founding members were Argentina, Belgium, Bolivia, Brazil, the British Empire (with separate memberships for Australia, Canada, India, New Zealand, South Africa and the United Kingdom), Chile, China, Colombia, Cuba, Czechoslovakia, Denmark, El Salvador, France, Greece, Guatemala, Haiti, Honduras, Italy, Japan, Liberia, Netherlands, Nicaragua, Norway, Panama, Paraguay, Persia, Peru, Poland, Portugal, Romania, Siam (later Thailand), Spain, Sweden, Switzerland, Uruguay, Venezuela and the Kingdom of Serbs, Croats and Slovenes (later Yugoslavia). 9  ‘Appendix: Covenant for the League of Nations Showing the Preliminary Reported Draft and the Covenant as Finally Adopted at the Plenary Session’ (1919) 8(3) Proceedings of the Academy of Political Science 127, 127–54.

344  Sunita Jogarajan from the third of President Wilson’s Fourteen Points: ‘the removal, so far as possible, of all economic barriers and the establishment of an equality of trade conditions among all the nations consenting to the peace and associating themselves for its maintenance’.10 Economic matters were not discussed at the Paris Peace Conference and in February 1920 the Council passed a Resolution stipulating that the League would convene an international conference to study the financial crisis and look for the means of remedying and mitigating the dangerous consequences arising from it.11 The International Financial Conference met at Brussels between 24 ­September and 8 October 1920. Eighty-six private and public experts, attending in their personal capacity and not as official government representatives, from 39 countries attended the Conference.12 The financial problems were faced by all of the represented countries to differing degrees. The ‘belligerent’ countries of Europe (Belgium, Bulgaria, France, Germany, Great Britain, Greece, Italy and Portugal) were the hardest hit following the Great War and, with the exception of Great Britain, unable to meet the expenses of the War and the rebuilding effort from national revenue. Other economic factors such as inflation, severely depreciated currencies and impediments to international trade contributed to the financial crisis and impacted all represented countries. The Conference divided the work of examining these problems into four Commissions which were to examine general public finance; currency and exchange; international trade and commerce; and international action with special reference to credits. The Commission on International Credits recognised that general recovery would require a significant period of time and that some countries would require international financial assistance to restore their economic activity. The Commission’s main recommendation was the establishment of an international organisation to provide credit to countries for the purpose of paying for their essential imports. However, the Commission was also concerned with the lack of capital globally and made a number of other proposals including recommending that the League promote certain reforms and collect the relevant information required to facilitate credit operations. In this context, the Commission suggested that progress should be made on ‘an international understanding, which, while ensuring the due payment 10  M Hill, The Economic and Financial Organization of the League of Nations: A Survey of Twenty-Five Years’ Experience (Washington, Carnegie Endowment for International Peace, 1946) 18. ‘Fourteen Points’ was a speech by President Woodrow Wilson to the United States Congress on 8 January 1918 outlining the principles for enduring world peace. 11  International Financial Conference, Brussels 1920: Proceedings of the Conference, vol 1 (London, League of Nations, 1920) 3. 12  The 39 countries represented were Argentina, Armenia, Australia, Austria, Belgium, Brazil, Bulgaria, Canada, China, Czecho-Slovakia, Denmark, Esthonia, Finland, France, Germany, Greece, Guatemala, Holland, Hungary, India, Italy, Japan, Latvia, Lithuania, Luxemburg, New Zealand, Norway, Peru, Poland, Portugal, Roumania, Serb-Croat-Slovene State, South Africa, Spain, Sweden, Switzerland, United Kingdom, United States of America and Uruguay.

‘Great Powers’ and the 1928 Model Tax Treaties 345 by everyone of his full share of taxation, would avoid the imposition of ­double taxation which is at present an obstacle to the placing of investments abroad’.13 Following another recommendation of the Brussels Financial Conference, the League’s Provisional Economic and Financial Committee was created by the Council in October 1920.14 There were two sections to the Provisional Committee and each section had ten members, nominated by their governments but acting in their personal capacity and not as representatives of their governments.15 Each section had members from the four permanent Council members and neither section had more than one representative from a particular country. The members of the first section were mainly high officials from ministries of commerce and became the Economic Committee. The membership of the second section was more diverse, including bankers and public officials, and became the Financial Committee. The two sections operated quite separately and rarely met jointly.16 The issue of double taxation was allocated to the Financial Committee in the division of responsibilities at the first joint session of the Provisional Committee in November–December 1920.17 The Financial Committee was primarily concerned with the financial reconstruction of individual countries and most of its sessions were spent on this issue. However, its second most important work, albeit a distant second, was the work done to address double taxation.18 Almost a year after the matter was referred to it, the Financial Committee adopted the following resolution in September 1921:19 Representations have been made to the Financial Committee that there are grave objections, not only on grounds of equity, but also on economic grounds, to 13 

International Financial Conference, above n 11, 26. Y Decorzant, ‘Internationalism in the Economic and Financial Organisation of the League of Nations’ in Daniel Laqua (ed), Internationalism Reconfigured: Transnational Ideas and Movements Between the World Wars (London, IB Tauris, 2011) 115–29. Decorzant provides a broad examination of the establishment of the League’s Economic and Financial Organization (as the Provisional Committee came to be known) and its role during the period of interwar internationalism. 15  Hill, above n 10, 21–22. 16 A Menzies, ‘Technical Assistance and the League of Nations’ in United Nations (ed), The League of Nations in Retrospect: Proceedings of the Symposium, Geneva 6–9 November 1980 (Berlin, Walter de Gruyter, 1983) 295. 17  International trade was allocated to the Economic Section and the differences in the development of measures to address double taxation and international trade barriers is in part due to this division of responsibilities. 18  Hill, above n 10, 34. 19  Provisional Economic and Financial Committee, Report to the Council Upon the Session Held at Geneva, August–September 1921, Communicated to the Assembly in Accordance with the Council’s Resolution of September 19th 1921 (League of Nations Archives, United Nations Geneva: A. 95. 1921. II) 6. For the detail of the Financial Committee’s discussions leading up to the resolution, see S Jogarajan, ‘Stamp, Seligman and the Drafting of the 1923 Experts’ Report on Double Taxation’ (2013) 5 World Tax Journal 368, 370–72. 14 

346  Sunita Jogarajan e­ xisting systems of taxation, in so far as they compel citizens and corporations of one country to pay taxes in more than one country in respect of the same taxable subjects. The Financial Committee are of the opinion that it is desirable that this question should be studied from the widest possible standpoint, and that expressions of opinion upon it should be obtained from recognised experts on taxation together with concrete recommendations, if experts think fit, for eliminating any drawbacks attaching to double taxation. The possibility of an international convention regulating the matter should be considered.

The Committee also agreed that the question would be submitted to four economic experts for assistance: Professor Bruins of Commercial University, Rotterdam; Professor Senator Einaudi of Turin University; ­ ­Professor S­ eligman of Columbia University; and Sir Josiah Stamp of London ­University (‘the Four Economists’). The terms of reference for the work of the Four Economists were eventually agreed to by the Financial Committee in F ­ ebruary 1922 and communicated to them in March 1922.20 Also in February 1922, the Italian representative on the Financial Committee, Bianchini, proposed a conference of government officials to reach practical solutions on the more pressing double taxation issues.21 He provided the Rome Conference of 1921, which resulted in the conclusion of the first multilateral treaty on double taxation (the Rome Convention),22 as an example of what the League could aspire to. The Financial Committee agreed that such a conference would be useful but decided to wait until the Economists’ Report was available as government officials were not sufficiently knowledgeable of the conditions in other countries to make any real progress in preparing an international solution. At the Genoa Conference (April–May 1922) on global economic problems, the Financial Commission was concerned with capital flight and asked 20  Minutes of the Meetings of the 6th Session of the Financial Section of the Provisional Economic and Financial Committee held in London in February 1922 (League of Nations Archives, United Nations Geneva: Box R333, Doc No 19223); and Letter from Stamp to Seligman (Edwin Robert Anderson Seligman Papers, Rare Book and Manuscript Library, Columbia University: Box 44, Folder Box 118, League of Nations—Committee on Double Taxation, Correspondence & Notes, 1921–23, 29 March 1922). 21 Minutes of the First Meeting of the Sixth Session of the Financial Committee of the Provisional Economic and Financial Committee held at 11 am on 23 February 1922 in Geneva (League of Nations Archives, United Nations Geneva: Box R 333, E.F./Finance VI/P.V.I). 22 Convention for the Purpose of Avoiding Double Taxation between Austria, Hungary, Italy, Poland, Roumania and the Kingdom of the Serbs, Croats and Slovenes (signed 6 April 1922), reproduced in League of Nations, Double Taxation and Fiscal Evasion: Collection of International Agreements and International Legal Provisions for the Prevention of Double Taxation and Fiscal Evasion (Geneva, League of Nations, 1928) 73–75. The 1925 Report (refer below n 30) states that the Rome Convention was signed on 13 June 1921 but the date recorded in the official collection is 6 April 1922. The Convention was only ever in force between Austria and Italy. Hereafter referred to as the ‘Rome Convention’.

‘Great Powers’ and the 1928 Model Tax Treaties 347 the League to expedite its enquiries into double taxation and examine measures to address tax evasion to prevent capital flight.23 According to the British records, tax evasion was raised by the French at the Genoa Conference as a means of discovering hidden German wealth but the British did not want the question discussed and as such, the issue was referred to the League.24 The Financial Committee eventually decided to consult with governments that had already concluded treaties on tax evasion (Belgium, France and Britain) and three other countries which were likely interested in the issue (Italy, Netherlands and Switzerland).25 Three months later, the Financial Committee decided to invite those six countries to attend a conference to discuss double taxation and tax evasion.26 Thus, the impetus for the conference of government officials was in fact tax evasion and not double taxation. Further, the countries represented at the conference were chosen due to their interest in tax evasion and not for political reasons, as previously assumed.27 The only country represented at the conference due to double taxation was Czechoslovakia. The Czechoslovakian Minister for Foreign Affairs wrote to the Secretary-General and asked that their treaty negotiator, who had already concluded several tax treaties, be permitted to join the conference.28 The request was accepted by the Council. The Four Economists published their Report in April 1923.29 This was followed by the conference of government officials (‘the 1925 Experts’) who held five sessions between June 1923 and February 1925 resulting in

23  For more detail on the Genoa Conference and the referral of double taxation and tax evasion to the League, see: S Jogarajan, ‘The Drafting of the 1925 League of Nations Resolutions on Tax Evasion’ in P Harris and D de Cogan (eds), Studies in the History of Tax Law, vol 7 (Oxford, Hart, 2015) 254–62. 24  Letter from OEN to the Chancellor of the Exchequer (UK National Archives, London: File IR 40/3419 Part 3, 7 November 1922). 25 Minutes of the Fifth Meeting of the Seventh Session of the Financial Committee of the Provisional Economic and Financial Committee held at 3:30 pm on 8 June 1922 in Geneva (League of Nations Archives, United Nations Geneva: Box R 334, Doc No 21260, E&F/Finance/7th Session/PV5). For the detail of the Financial Committee’s discussions, see: ­Jogarajan, ‘The Drafting of the 1925 League of Nations Resolutions’, above n 23, 259–62. 26  Minutes of the Fifth Meeting of the Eighth Session of the Financial Committee of the Provisional Economic and Financial Committee held at 10:30 am on 6 September 1922 in Geneva (League of Nations Archives, United Nations Geneva: Box R 334, Doc No 23159, EFS/ Finance/8th Session/PV5). 27  ‘The underlying politics were obvious: while the 1923 Report was the product of creditor nations, a majority of the drafters of the 1925 Report came from debtor nations’; Graetz and O’Hear, above n 4, 1080. See also, B Wells and C Lowell, ‘Income Tax Treaty Policy in the 21st Century: Residence vs Source’ (2013) 5 Columbia Journal of Tax Law 1, 5. 28  Note by Léon-Dufour (Secretary), (League of Nations Archives, United Nations Geneva: Box R 362, C.278.1923.II, 17 April 1923); League of Nations, Official Journal (June 1923) 555. 29  GWJ Bruins et al, Report on Double Taxation: Submitted to the Financial Committee (Geneva, League of Nations, 1923).

348  Sunita Jogarajan the publication of a series of resolutions on double taxation.30 The League then convened an expanded conference of government officials (‘the 1927 Experts’) to develop the resolutions in the 1925 Report into model treaties. The government officials held three sessions between May 1926 and April 1927 and developed the first draft model convention on double taxation.31 Finally, the League convened an even larger conference of government representatives with all interested countries (27 governments sent representatives) (‘the 1928 Experts’) to finalise the draft conventions. The 1928 Experts held one session in October 1928. Two additional model conventions on double income taxation were developed at the 1928 Meeting.32 The 1928 Models are considered one of the few successes of the League’s work in commercial policy during the interwar period as more than 100 bilateral tax treaties based largely on the 1928 Models were concluded between 1929 and 1939.33 PARTICIPATION IN THE LEAGUE

The formation of the League was first proposed by President Woodrow Wilson in his ‘Fourteen Points’ speech before the US Congress in January 1918.34 The last of these points called for ‘a general association of nations … formed under specific covenants for the purpose of affording mutual guarantee of political independence and territorial integrity to great and small states alike’. President Wilson’s third point proposed ‘the removal … of all economic barriers and the establishment of an equality of trade conditions among all the nations consenting to the peace and associating themselves for its maintenance’. President Wilson presented the ‘Draft Covenant’ for the League of Nations to the Paris Peace Conference on 14 February 1919.

30  Double Taxation and Tax Evasion: Report and Resolutions submitted by the Technical Experts to the Financial Committee of the League of Nations (Geneva, League of Nations, 1925) (‘the 1925 Report’). 31  Double Taxation and Tax Evasion: Report Presented by the Committee of Technical Experts on Double Taxation and Tax Evasion (Geneva, League of Nations, 1927) (‘the 1927 Report’). 32  1928 Report, above n 3. 33  A Loveday, ‘The Economic and Financial Activities of the League’ (1938) 17 International Affairs 788, 790; A Sweetser, ‘The Non-Political Achievements of the League’ (1940) 19 Foreign Affairs 179, 183; Commercial Policy in the Interwar Period: International Proposals and National Policies (Geneva, League of Nations, 1942) 30; and ‘Part 2: The Progressive Development of International Law by the League of Nations’ (1947) 41(4–suppl) American Journal of International Law 49, 55. However, Spitaler argues that the 1928 Models were of limited use and the early German treaties were more influential: A Spitaler, Das Doppelbesteuerungsproblem: bei den direckten Steuern (Stiepel, Reichenberg, 1936) 32–46. 34  W Wilson, ‘Fourteen Points’ (Speech delivered at the United States Congress, Washington DC, 8 January 1918) avalon.law.yale.edu/20th_century/wilson14.asp.

‘Great Powers’ and the 1928 Model Tax Treaties 349 The Draft Covenant contained 26 articles covering the structure of the League, disarmament, colonial relations, labour conditions, international shipping, communication and commerce and the rights of minorities.35 Article 10 of the Covenant proved to be the most contentious in domestic American politics.36 Article 10 guaranteed League members political independence and territorial integrity from external aggression. Further, it required members to take action against any such external aggression. The commitments required by Article 10 raised questions as to American foreign policy and the future role of the United States in world politics. In the 1918 midterm elections, the Republicans won control of both the House of Representatives and the Senate (President Wilson was a ­Democrat). Senator Henry Cabot Lodge became the majority leader and Chairman of the Senate Foreign Relations Committee. Lodge proposed a number of reservations to the League’s Covenant, which were not accepted by President Wilson. Putting his health on the line, President Wilson embarked on a nationwide trip to promote American participation in the League.37 President Wilson suffered a crippling stroke on 2 October 1919 and was largely incapacitated for the remainder of his term. The fight over League membership continued but without Wilson’s tactics and personality, it was a losing battle. Republican, Warren Harding, was elected President in November 1920 on a platform of opposing the League. America never joined the League. Great Britain, on the other hand, was one of the founding members of the League and one of the initial four permanent members of the Council.38 Great Britain was heavily involved in every aspect of the creation of the League and British officials were instrumental in the development of the final League Covenant.39 The structure of the League, with a Council and an Assembly, has been described as analogous to the relationship between the Cabinet and the House of Commons in the British Parliament.40 The first Secretary-General of the League, and longest-serving, was a British politician, Sir Eric Drummond.

35 

‘Appendix: Covenant for the League of Nations’, above n 9, 127–54. an in-depth account of Wilson’s fight for the League domestically, see Cooper, above n 2. 37  ‘Diary Entries of Carl Travers Grayson’ (Wilson’s personal physician) in A Link (ed), The Papers of Woodrow Wilson, vol 63 (Princeton, Princeton University Press, 1993) xvi. 38  Germany became the fifth permanent member when it joined the League in 1926. 39  Ellis, above n 8, 69–99; and G Egerton, Great Britain and the Creation of the League of Nations: Strategy, Politics, and International Organization, 1914–1919 (Chapel Hill, ­University of North Carolina Press, 1978). 40  G Butler, A Handbook to the League of Nations (London, Longmans, Green and Co, 1925) 64. 36 For

350  Sunita Jogarajan PARTICIPATION ON DOUBLE TAXATION

American participation in the League’s efforts to address double taxation was complicated by the fact that America was not a member of the League while British representatives participated in all of the League’s efforts on double taxation. This section argues that America’s partial involvement in the process limited its influence while Britain’s continued involvement and strong representative, Thompson, enhanced British impact. The 1923 Economists’ Report Although America was not a member of the League, an American, Seligman, was involved in the League’s earliest effort to address double taxation. Seligman was one of the authors of the 1923 Economists’ Report and was chosen because the Financial Committee considered it important that Committee members were familiar with American domestic legislation on the issue.41 America was the first country to introduce relief for international double taxation (a credit system in 1918) in its domestic law.42 A British representative, Stamp, was also one of the authors of the 1923 Economists’ Report. The British had introduced the Dominion Tax Relief system which involved the division of taxes between source and residence countries.43 The 1923 Economists’ Report was a theoretical study on addressing international double taxation and neither Seligman nor Stamp pushed their domestic relief systems.44 The Report proposed four methods for relieving double taxation—credit (ie the American example where foreign taxes are credited against domestic taxes payable on foreign income),45 exemption (ie source country exemption for all non-residents); division of taxes (ie an allocation of a portion of taxes to origin and residence countries); and classification and assignment of sources (ie the classification of income into different categories and the allocation of taxing rights for each category). The Economists’ Report recommended both the second and fourth ­methods 41 Jogarajan, ‘Stamp, Seligman and the Drafting of the 1923 Experts’ Report’, above n 19, 372. 42  Graetz and O’Hear, above n 4, 1022. 43 See further P Harris, ‘An Historic View of the Principle and Options for Double Tax Relief’ [1999] British Tax Review 469, 476–79; and CJ Taylor, ‘Twilight of the Neanderthals, or are Bilateral Double Taxation Treaty Networks Sustainable?’ (2010) 34 Melbourne ­University Law Review 268, 287–97. 44 For the detail of the drafting of the 1923 Economists’ Report, see Jogarajan, ‘Stamp, Seligman and the Drafting of the 1923 Experts’ Report’, above n 19, 380–92. 45  The Economists’ Report and the 1925 Report refer to this as the ‘deduction’ method but in modern parlance it is in effect a credit system. The Royal Commission examining double taxation in Britain also used ‘deduction’ when referring to a ‘credit’; J Avery Jones, ‘Sir Josiah Stamp and Double Income Tax’, in J Tiley (ed), Studies in the History of Tax Law, vol 6 (Oxford, Hart Publishing, 2013) 16.

‘Great Powers’ and the 1928 Model Tax Treaties 351 depending on the circumstances of the countries involved. The mixed ­recommendation was due to disagreement between Stamp and Seligman. Stamp strongly supported the second method, exclusive residence-based taxation, and considered the division of taxes impractical and unsatisfactory. ­Seligman, however, favoured the fourth method proposed in the E ­ conomists’ Report, classification and assignment of sources of income. This was the system utilised in the Rome Convention and the German-Czechoslovakian treaty.46 The first method proposed in the Economists’ Report, a credit system, was considered an extreme remedy to be immediately discarded while the third method of division of taxes, utilised in the Dominion Tax Relief system, was dismissed as impractical. The 1925 Report As discussed in the second section, the 1925 Experts were in fact chosen for their interest in tax evasion and not double taxation. The inclusion of an American expert was not contemplated when the 1925 Experts were convened. However, midway through the course of the 1925 Experts’ discussion on double taxation of shipping companies, the possible inclusion of an American representative was raised.47 The 1925 Experts were especially keen to hear from an American expert as they were considering adopting the American reciprocal exemption system for foreign shipping companies which was being promoted by the League’s Transit Commission and the International Shipping Conference. Léon-Dufour (Secretary) explained that the League had approached the American Government to determine whether they would designate a representative to join the 1925 Experts if the 1925 Experts were agreeable. The issue was a tricky one as America was not a member of the League and appointment of a representative would amount to the same representation as member countries. The 1925 Experts nonetheless felt that the importance of America to the global economy meant that it would be useful to have an American representative join them. However, the attempt to add an American representative to the 1925 Experts proved unsuccessful. This significantly diminished American

46 Treaty between the German Reich and Czechoslovak Republic for the Adjustment of Taxation, at Home and Abroad, in particular for the Avoidance of Double Taxation in the Field of Direct Taxation (signed at Prague 31 December 1921), reproduced in League of Nations, Double Taxation and Fiscal Evasion: Collection of International Agreements and International Legal Provisions for the Prevention of Double Taxation and Fiscal Evasion (Geneva, League of Nations, 1928) 9–15. 47  Minutes of the Thirteenth Meeting of the Third Session of the Committee of Government Experts on Double Taxation and the Evasion of Taxation held at 10 am on 6 April 1924 (League of Nations Archives, United Nations Geneva: E.F.S./D.T./1-4 Session/P.V, E.F.S./ D.T./3ème Session/P.V.13 (1)).

352  Sunita Jogarajan influence in the development of the 1928 Models as the resolutions in the 1925 Report were the foundation for the draft model convention developed in 1927. The 1927 Experts were unwilling to diverge too far from the 1925 Resolutions as the resolutions had been agreed to after long deliberations and had unanimous approval.48 On the other hand, the British representative, Thompson, was a key influence in the development of the resolutions in the 1925 Report. He was a strong advocate for exclusive residence-based taxation and firmly held his position, even in the discussion on impersonal taxes.49 The Continental European countries were keen to include Great Britain in any agreement as Britain was ‘a great economy’.50 The final resolutions in the 1925 Report represent a compromise between the Continental European countries’ support for source country taxation and the British preference for residence country taxation.51 Even then Thompson only considered the last paragraph of the resolutions on income tax (as follows) useful to the British Government:52 Similar steps might be taken, or exemption might be granted, in the country of the origin of the income by means of bilateral conventions in cases where double taxation arises by reason of the existence of a general tax in the country of domicile, side by side with schedular taxes in the country of the origin.53

48  See, for example, Minutes of the First Meeting of the Sixth Session of the Committee on Double Taxation and Fiscal Evasion held at 11:30 am on 17 May 1926 (League of Nations Archives, United Nations Geneva: Double Imposition Et Evasion Fiscale Vol V 6 Sessions Du Comte Des Experts Gouvernmentaux (1518), D.T./6th Session/P.V.1(1)); and Minutes of the Third Meeting of the Seventh Session of the Committee on Double Taxation and Fiscal ­Evasion held at 10 am on 6 January 1927 (League of Nations Archives, United Nations Geneva: ­Double Imposition Et Evasion Fiscale Vol VI 7 Sessions Du Comte Des Experts Gouvernmentaux (1519), D.T./7th Session/P.V.3.(1)). 49  Personal taxes refer to the progressive income tax on total income which was one of the main sources of revenue for countries such as America, Britain, Netherlands and Germany (the ‘general income tax’). Impersonal taxes were separate taxes imposed at a proportional rate on different categories of income on the basis of source (schedular taxes or impôt reels) and were the main source of revenue for many European countries such as France, Belgium and Italy. Some European countries such as Italy and France also had a ‘residual’ general income tax which supplemented revenue from schedular taxes: J Avery Jones, ‘Avoiding Double Taxation: Credit versus Exemption—The Origins’ (2012) 66 Bulletin for International Taxation 67, 67–70. 50  Minutes of the Eleventh Meeting of the Third Session of the Committee of Government Experts on Double Taxation and the Evasion of Taxation held at 10 am on 5 April 1924 (League of Nations Archives, United Nations Geneva: E.F.S./D.T./1-4 Session/P.V, E.F.S./ D.T./3ème Session/P.V.11 (1)). 51 Very broadly, impersonal taxes were allocated to source countries and personal taxes were allocated to residence countries (but with exceptions) and the residence country was required to provide relief for source country taxes to address double taxation. 52  Minutes of the Second Meeting of the Eighth Session of the Committee on Double Taxation and Fiscal Evasion held at 3:30 pm on 5 April 1927 (League of Nations Archives, United Nations Geneva: Double Imposition Et Evasion Fiscale Vol VII 8 Sessions Du Comte Des Experts Gouvernmentaux (1520), D.T./8th Session/P.V.2. (1)). 53  1925 Report, above n 30, 33.

‘Great Powers’ and the 1928 Model Tax Treaties 353 The 1927 Report The Secretary-General of the League formally invited the American Government to participate in an expanded conference of experts to progress the resolutions in the 1925 Report to model treaties.54 Invitations were also sent to Argentina and Germany who were also non-members of the League at the time. The American Government responded that it was not interested in sending an expert.55 The first session of the 1927 Experts was held in Geneva from 17–22 May 1926 and the second from 5–12 January 1927. Just ten days prior to the start of the second session, Jan van Walré de Bordes, Secretary to the 1927 Experts, received a telegram stating that the American Government was willing to nominate an expert for the second session.56 The telegram was likely prompted by Carroll’s intervention.57 De Bordes noted that American participation would perhaps make the January meeting more interesting but probably also more difficult. The telegram was unofficial and stated that the American Government was willing to designate an expert if the League repeated its earlier invitation for the American Government to send an expert.58 The League dispatched an invitation that same night but the American Government subsequently responded that due to the shortness of the time remaining before the session, it was impossible for the American Government to arrange for an expert to attend. Nonetheless, the American Government asked to be kept as fully informed as possible as to the proceedings of the 1927 Experts. It was reported in the American press that the American Government wanted to send Adams as the designated expert but he was unable to leave the United States before 15 January 1927. Despite the confusion, de Bordes was pleased that the American Government had agreed in principle to send a representative to the 1927 Experts. The American representative, Adams attended the final session of the 1927 Experts which was moved from Geneva to London to facilitate American participation.59 America’s participation in the final session of the 54 Letter from the Secretary-General to the Secretary of State for Foreign Affairs (UK), (UK National Archives, London: File IR 40/3419 Part 3, 7 July 1925). 55 Note by the Secretariat dated 4 January 1927 referring to a letter from the American Government to the Secretariat dated 2 September 1925 (League of Nations Archives, United Nations Geneva: Double Imposition Et Evasion Fiscale Vol VI 7 Sessions Du Comte Des Experts Gouvernmentaux (1519)). Argentina and Germany did send representatives to the expanded conference. 56  Letter from de Bordes to Percy Thompson (League of Nations Archives, United Nations Geneva: Box R 368, Doc No 52952, 23 December 1926). 57  Carroll had visited Geneva and met with de Bordes. He reported to Washington of the League’s interest in cooperation with America which was favourably received by officials in the State, Treasury and Commerce Departments as well as the US Chamber of Commerce: M Carroll, Global Perspectives of an International Lawyer (Hicksville, NY, Exposition Press, 1978) 29. 58  Note by the Secretariat dated 4 January 1927, above n 55. 59 M Carroll, ‘International Tax Law: Benefits for American Investors and Enterprises Abroad (Part I)’ (1968) 2 International Lawyer 692, 698.

354  Sunita Jogarajan 1927 Experts was part of a broader shift in the American Government’s attitude towards the League’s Committees. The Economic and Financial Section’s (EFS) committees were of growing importance in 1927 and the American Government agreed to participate in a number of committees due to the sustained efforts of the US State Department and the EFS.60 Adams’ influence on the 1927 Draft Model Convention (‘1927 Model’) was somewhat limited as the bulk of the work in respect of the 1927 Model was done at the first two sessions. The majority of the final session of the 1927 Experts was in fact spent on the Draft Convention on Succession Duties which had been largely ignored in the earlier two sessions. However, Adams did influence the final form of the 1927 Model. At the final session of the 1927 Experts, Adams noted that the American Government was unable to adopt bilateral treaties for constitutional ­reasons.61 Consequently, he asked that the 1927 Model clearly set out definite solutions without exceptions or alternatives. The exceptions or alternatives could be moved to the Commentary. The 1927 Model as originally drafted contemplated exceptions or alternatives for the provisions on interest income, earned income and the general income tax. The Belgian representative, Clavier, and the German representative, Dorn, supported the proposed changes if it enabled the American Government to incorporate the proposed solutions in domestic law. However, the Polish representative, Zaleski, pointed out that the change of approach represented a substantive change. Zaleski’s point was not taken up by the other Experts who never decided on the role of the Commentary. Adams proposal was successful and the 1927 Model sets out definite positions with exceptions or alternatives contemplated in the Commentary. This change set a standard for the future and the OECD Model adopts a similar approach to the 1927 Model. The change also shifted the nature of the League’s work from one of unanimity to majority approval. Adams’ other main impact on the 1927 Model was in relation to A ­ rticle 3 on the imposition of impersonal taxes on interest income. The provision as originally drafted contemplated that Article 3 would only cover ‘nonprofessional’ interest income while interest income in a professional or business context would be covered by Article 5 on business profits. Adams pushed for the removal of the distinction on the basis of simplicity as he was ­familiar with the problems of making such a distinction from domestic

60  P Clavin and JW Wessels, ‘Transnationalism and the League of Nations: Understanding the Work of Its Economic and Financial Organisation’ (2005) 14 Contemporary European History 465, 472. 61 Minutes of the Second Meeting of the Eighth Session of the Committee on Double ­Taxation and Fiscal Evasion, above n 52. It is not clear what these reasons were as America did subsequently conclude bilateral tax treaties.

‘Great Powers’ and the 1928 Model Tax Treaties 355 law experience in America.62 The phrase ‘non-professional’ was removed from the text of Article 3 and moved to the Commentary as a result. Adams was also successful in ensuring that countries could agree to interest income being taxed in the creditor’s country of domicile if they wished.63 However, he was unsuccessful in his proposal for relief of source country taxes on interest income without substantiation. The 1927 Experts insisted that relief could only be available on production of ‘proper evidence’. Finally, Adams pressed for the removal of the distinction between personal and impersonal taxes adopted in the 1927 Model. Adams presented the 1927 Experts with a draft convention for situations where one country had a personal tax only and the other country had both personal and impersonal taxes.64 Herndon notes that the 1927 Experts studied Adams’ draft carefully but the minutes simply record that, after undocumented discussion, the 1927 Experts decided to refer Adams’ draft to the proposed permanent international organisation on taxation.65 Adams was not alone in recognising the need for a model convention which did not distinguish between personal and impersonal taxes. At the previous session (before Adams’ participation) the representatives from Germany (Dorn), ­Switzerland (Blau) and Poland (Zaleski) had pushed for the development of an alternative draft convention which did not distinguish between personal and impersonal taxes.66 However, due to a lack of consensus and timing pressures, an alternative draft convention was not developed. The possibility of modifying the 1927 Model for countries without both personal and impersonal taxes was addressed in the Commentary. Although Thompson did not consider the 1925 Report particularly useful for the British Government, it was not considered appropriate for Britain

62  Minutes of the Third Meeting of the Eighth Session of the Committee on Double ­Taxation and Fiscal Evasion held at 3:30 pm on 6 April 1927 (League of Nations Archives, United Nations Geneva: Double Imposition Et Evasion Fiscale Vol VII 8 Sessions Du Comte Des Experts Gouvernmentaux (1520), D.T./8th Session/P.V.3. (1)). 63  Above n 62. 64 Draft Convention proposed by Professor Adams (League of Nations Archives, United Nations Geneva: Double Imposition Et Evasion Fiscale Vol VII 8 Sessions Du Comte Des Experts Gouvernmentaux (1520), D.T.120, 12 April 1927). 65 J Herndon, Relief from International Income Taxation: The Development of International Reciprocity for the Prevention of Double Income Taxation (Chicago, Callaghan and Co, 1932) 174; and Minutes of the Tenth Meeting of the Eighth Session of the Committee on Double Taxation and Fiscal Evasion held at 5 pm on 12 April 1927 (League of Nations Archives, United Nations Geneva: Double Imposition Et Evasion Fiscale Vol VII 8 Sessions Du Comte Des Experts Gouvernmentaux (1520), D.T./8th Session/P.V.10. (1)). 66 Minutes of the Third Meeting of the Seventh Session of the Committee on Double ­Taxation and Fiscal Evasion (n 48); Minutes of the Seventh Meeting of the Seventh Session of the Committee on Double Taxation and Fiscal Evasion held at 9:30 am on 8 January 1927 (League of Nations Archives, United Nations Geneva: Double Imposition Et Evasion Fiscale Vol VI 7 Sessions Du Comte Des Experts Gouvernmentaux (1519), D.T./7th Session/P.V.7.(1)).

356  Sunita Jogarajan to take independent action on the problem of international double taxation (as promoted by the Federation of British Industries) while continuing to be involved in the League’s efforts.67 Thompson attended all of the 1927 Experts’ sessions and was a member of the sub-committee responsible for drafting the 1927 Model. As such, he was involved in every aspect of the drafting of the 1927 Model and it is not as easy, as in the case of Adams, to identify Thompson’s specific impacts on the 1927 Model as Thompson contributed to all of the discussions. He was especially influential in ensuring that a taxpayer’s country of residence was not entirely responsible for providing relief from double taxation. For most of the proceedings of the 1927 Experts, Thompson was the lone voice advocating for residence-based taxation but he also understood the need for compromise. While Adams pushed for a convention which did not distinguish between personal and impersonal taxes, Thompson accepted that such a distinction was a necessary compromise to reach an agreement with the Continental European countries.68 Thompson did not support the development of an alternative draft convention on the basis that the 1927 Experts had agreed to follow the resolutions in the 1925 Report which adopted such a distinction.69 Despite the lengthy discussions and compromises in the preparation of the 1927 Model and Thompson’s reluctance to develop an alternative draft convention, the British Government again only considered the observation to the 1927 Model (as follows) useful:70 The draft Convention applies more particularly to countries which levy impersonal taxes and also a personal or general tax; but the articles proposed could also be made to serve in the event of simultaneous existence of a general tax in the country of domicile and schedular taxes in the country of origin; moreover, these articles could be abridged if the fiscal systems of the two Contracting States were sufficiently similar to one another.71

Thompson explained that the 1927 Model was wholly inapplicable for ­Britain.72 He accepted that the Continental European countries were ­genuinely interested in finding a solution acceptable to the British but he

67  Note to the Chancellor of the Exchequer from Somerset House on Double Income Tax Relief (UK National Archives, London: File IR 40/3419 Part 3, 9 March 1926). 68  Letter from Canny to Dufour (UK National Archives, London: File IR 40/3419 Part 5, 20 May 1925). 69 Minutes of the Seventh Meeting of the Seventh Session of the Committee on Double ­Taxation and Fiscal Evasion, above n 66. 70 Minutes of the Second Meeting of the Eighth Session of the Committee on Double ­Taxation and Fiscal Evasion, above n 52. 71  1927 Report, above n 31, 18. 72 Memorandum by Sir Percy Thompson on the Application of the 1st Draft Bilateral ­Convention to the Fiscal Conditions Obtaining in Great Britain (League of Nations Archives, United Nations Geneva: Double Imposition Et Evasion Fiscale Vol VIII Reunion Generale des Experts Gouvernmentaux (1521), D.T. 134, 22 October 1928).

‘Great Powers’ and the 1928 Model Tax Treaties 357 did not think that the other countries appreciated the British point of view. The problem of double taxation was that capital would not flow and therefore it was for the borrowing country to remove barriers by providing relief. In fact, it was advantageous to the lending country to keep the capital at home as it would improve the terms for government borrowing. Thompson pointed out that the 1927 Model provided relief by requiring the ­British Government to provide a credit for source country taxes except in the case of income from public funds. However, even then the concession was illusory as foreign loans could not be issued on the London market unless they were exempt from taxation in the borrowing country. In Thompson’s opinion, the 1927 Model required the British Government to ‘mutilate’ its own general income tax to allow for ‘whatever taxation the foreign government may see fit to impose on income originating within its borders’. Meanwhile, the foreign government maintained its general income tax and only conceded that schedular taxes were limited to income earned within its borders, which was already the case anyway and inevitable. In sum, Thompson stated that the 1927 Model was one-sided and placed an undue share of the burden of relief on Great Britain. It would only be acceptable if it was in British interests to encourage overseas investment. Further, the 1927 Model imposed a greater burden than the Dominion Relief System. The 1928 Report American participation in the 1928 Meeting, which included two other nonmembers (the Free City of Danzig and the Union of Soviet Socialist Republics), was uncontroversial. The main achievement of the 1928 Experts was the development of two alternative draft conventions which did not distinguish between personal and impersonal taxes. Although this achievement has been attributed to Adams’ influence,73 the push for alternative draft conventions in fact came from a number of sources.74

73 

See above n 4. As noted above, the 1927 Experts had already recognised the need for alternative conventions before Adams’ participation in the final session. At the 1928 Meeting, it was the Swedish representative, de Luylenstierna, who initially proposed the development of alternative conventions; Minutes of the Sixteenth Meeting of the General Meeting of Government Experts on Double Taxation and Tax Evasion held at 11 am on 31 October 1928 (League of Nations Archives, United Nations Geneva: Double Imposition Et Evasion Fiscale Vol VIII Reunion Generale Des Experts Gouvernmentaux (1521), D.T./Reunion/P.V.16. (1)). The Austrian and Swedish Governments had also proposed the development of alternative conventions in their submissions to the 1928 Meeting: Summary of the Observations Received by 30 August 1928 from the Governments on the Report Submitted by the Committee of Technical Experts on Double Taxation and Tax Evasion (League of Nations Archives, United Nations Geneva: C.495.M.147.192.II, 19 September 1928). 74 

358  Sunita Jogarajan Adams and Thompson submitted separate draft conventions which did not distinguish between personal and impersonal taxes but these were not considered by the 1928 Experts.75 Instead, Adams and Thompson worked together to produce Draft Convention Ib. The development of Draft Convention Ib was considered a significant achievement as the Convention recognised residence as the primary basis for taxation but allowed for source-country taxation in the case of income from immovable property, business profits, directors’ fees and earned income.76 However, the achievement was not of lasting impact as it is in fact Draft Convention Ic (drafted by the German representative, Dorn, and the French representative, B ­ orduge) that has prevailed as the model for modern day bilateral tax treaties.77 Draft Convention Ic allowed for withholding taxes in the source country and for residence countries to provide a credit for source country taxes or for source countries to provide a refund. Thompson did not support Draft Conventions Ia and Ic as they required the British Exchequer to provide the relief.78 He approved of Draft Convention Ib and proposed that Britain proceed with negotiations with interested Continental European countries to conclude tax treaties based on that model. However, such negotiations were not fruitful, as discussed in the sixth section.

75  Draft of a Simplified Multilateral Convention Proposed by Thompson’s Sub-Committee (League of Nations Archives, United Nations Geneva: Double Imposition Et Evasion Fiscale Vol VIII Reunion Generale Des Experts Gouvernmentaux (1521), D.T.136). Thompson’s Draft was quite different to the 1927 Model and provided for exclusive domicile-country taxation of income from public funds, bonds, including mortgage bonds, loans and deposits or current accounts, income from shares, annuities and private pensions. Business profits were taxable in the country where the undertaking was carried on (but not shipping and air navigation which were taxable only in the country of real centre of management). Public pensions and salaries of public officials were taxable by the country which paid them and earned income generally was taxable where the employment activity was carried on. General Principles to serve as a Basis of Discussion in Drafting a Convention to Prevent Double Taxation in the Sphere of National Income Taxes (League of Nations Archives, United Nations Geneva: Double Imposition Et Evasion Fiscale Vol VIII Reunion Generale Des Experts Gouvernmentaux (1521), D.T. 141). Adams’ Draft Convention was in fact drafted by Carroll: Carroll, Global Perspectives, above n 57, 32. This Draft Convention recognised two classes of taxes—source taxes and residence taxes. Article 1 stipulated that all taxes were to be imposed in the taxpayer’s country of domicile unless specifically provided otherwise. Specific taxation rules applied to business profits, shipping and air transport, non-public service income, public service income and income from immovable property. 76 Although Draft Convention Ib was considered the model which prioritised residencebased taxation, it has been criticised as merely giving lip service to the principle of residence taxation as the two largest income amounts, income from immovable property and business profits, were allocated to source countries: WH Coates, ‘Double Taxation and Tax Evasion’ (1929) 92 Journal of the Royal Statistical Society 585, 589. 77 J Avery Jones, ‘Categorising Income for the OECD Model’ in L Hinnekens and P Hinnekens (eds), A Vision of Taxes Within and Outside European Borders (Alphen aan den Rijn, Kluwer Law International, 2008) 93, 99. 78  Letter from Hopkins to Fisher Enclosing Thompson’s Report on the Recommendations in the 1928 Report (UK National Archives, London: File IR 40/3419 Part 3, 18 February 1929).

‘Great Powers’ and the 1928 Model Tax Treaties 359 TRANSATLANTIC BRIDGE RULES AND THE FAILURE TO FORM AN ANGLO-AMERICAN ALLIANCE

Although Thompson and Adams combined forces to produce Draft Convention Ib, they were not natural allies on double taxation despite economic similarities.79 America and Great Britain were both creditor countries after the Great War while many of the Continental European countries were debtor countries with high capital needs for reconstruction.80 However, America and Great Britain had opposing positions with respect to taxation. As noted above, the British Government strongly supported exclusive residence-based taxation. Residence-based taxation was justified on the basis of the protections offered by the country of residence and as a better measure of ability to pay as the taxpayer’s total income was taken into consideration. As a means of resolving international double taxation, exclusive residence-based taxation was considered simple and more complex methods unjustified.81 Further, prioritising residence-based taxes benefited the British Exchequer.82 The American Government on the other hand supported taxation in the source country.83 This was largely because Adams thought that source-based taxation better embodied the benefit principle and was administratively advantageous (residence-based taxation was considered easily manipulated). Further, America could afford to be generous to capital importing countries which imposed source-based taxes as the international balance of payments overwhelmingly favoured America. Despite this difference in view, Adams was keen to form an entente with Thompson going into the 1928 Meeting.84 In Geneva, Adams and Thompson spent a day playing golf followed by dinner and a game of bridge. Everything was going well until Adams made a move in bridge that was done a particular way in America. Thompson insisted that the move would be done differently in London. Adams maintained that his way was correct while Thompson thought that only the London way could be correct. The rapport was broken and Adams and Thompson failed to form an alliance going into the 1928 Meeting.

79 America and Great Britain disagreed on many aspects of international relations in the 1920s; D Gorman, The Emergence of International Society in the 1920s (Cambridge, Cambridge University Press, 2012) 4. 80  Feinstein et al, above n 5, 78–86. 81 Jogarajan, ‘Stamp, Seligman and the Drafting of the 1923 Experts’ Report’, above n 19, 387. 82  Memorandum from Inland Revenue to the Chancellor of the Exchequer (UK National Archives, London: File IR 40/3419 Part 3, 4 October 1929). 83  Graetz and O’Hear, above n 4, 1072. 84 Carroll, Global Perspectives, above n 57, 31–32. This entire account is from Carroll’s book.

360  Sunita Jogarajan As mentioned earlier, Adams and Thompson continued to pursue separate agendas during the 1928 Meeting. They did not work together initially to develop a draft convention which did not distinguish between personal and impersonal taxes. Rather, they each developed a separate draft and at the urging of the Chairman of the 1928 Experts (Clavier, Belgium), eventually cooperated to produce a single draft model for consideration by the 1928 Experts. IMPACT OF THE 1928 MODELS ON TREATY PRACTICE

The first American tax treaty was concluded with France in 1932.85 The treaty was narrower than the 1928 Models and only covered business profits, royalties, income from government service, war pensions, private pensions and annuities.86 Broader tax treaties were agreed to with Sweden and France (to replace the 1932 treaty) in 1939.87 The only other American tax treaty concluded during this early treaty period was with Canada in 1942.88 These tax treaties had elements of the 1928 Models but were not obviously based on any of the Models. While America was able to conclude tax treaties with Sweden and France, albeit limited tax treaties, Great Britain was not so successful. Belgium, ­Germany, Italy, the Netherlands, Sweden and Switzerland approached the British Government to conclude tax treaties.89 The British Government agreed to discussions along the lines of Draft Convention Ib.90 However,

85  HD Rosenbloom and S Langbein, ‘United States Tax Treaty Policy: An Overview’ (1981) 19 Columbia Journal of Transnational Law 359, 374. Earlier American tax treaties were ­limited to shipping profits. 86  Convention and Protocol between the United States of America and France concerning Double Taxation (signed at Paris 27 April 1932) 49 Stat 3145 (1919–1936). 87  Convention and Protocol between the United States of America and Sweden respecting Double Taxation (signed at Washington 23 March 1939) 54 Stat 1759 (1936–1941); and Convention and Protocol between the United States of America and the French Republic respecting Double Taxation (signed at Paris 25 July 1939, entry into force 1 January 1945) 59 Stat 893 (1937–1946). 88  Convention and Protocol between the United States of America and Canada respecting Double Taxation (signed at Washington 4 March 1942) 56 Stat 1399 (1940–1942). 89  Letter from Gowers (Inland Revenue) to the Chancellor of the Exchequer (UK National Archives, London: File IR 40/3419 Part 3, 26 July 1928); Letter from Gowers (Inland Revenue) to the Chancellor of the Exchequer (UK National Archives, London: File IR 40/3419 Part 3, 7 December 1929); and J Avery Jones, ‘The UK’s Early Tax Treaties with European Countries’, chapter 11 of this volume, n 5. 90  Letter from Hopkins (Inland Revenue) to the Chancellor of the Exchequer (UK National Archives, London: File IR 40/3419 Part 3, 19 February 1929); and Negotiations between United Kingdom and Foreign Governments, Prior to the Passing of the Finance Act 1930, towards the Conclusion of Agreements for the Avoidance of Double Taxation (UK National Archives, London: File IR 40/3419 Part 3, Undated).

‘Great Powers’ and the 1928 Model Tax Treaties 361 none of the discussions were fruitful.91 The British Government was unwilling to allow for the European countries’ view that where the residence country and the source country had competing claims, the source country should prevail.92 However, the British Government was willing to compromise and allow for source country taxation of income from immovable property and business profits. This concession was not due to a desire to conclude tax treaties with European countries but because it was thought that British taxpayers would consider an exemption for income from property located in Britain or business profits sourced in Britain unacceptable.93 In the case of the negotiations with Italy, for example, the British representative (Thompson) attended with Draft Convention Ib as the model while the Italian representative (Bolaffi, also a League Expert) attended with Draft Convention Ia as the model.94 Not surprisingly in light of the discussions at the League, the two representatives were unable to reconcile their differences and ultimately decided to report to their respective governments that a tax treaty between the two countries was impossible. The British Government maintained its preference for exclusive residencebased taxation into the 1930s and only concluded a tax treaty with I­ reland,95 on this basis, prior to World War II. The British Government eventually changed its position on withholding taxes and was more willing to compromise to conclude tax treaties, resulting in several tax treaties being concluded after World War II.96 Britain’s first comprehensive tax treaty was with the United States in 1945.97 The Anglo-American ‘special relationship’ was burgeoning.98

91  United Kingdom concluded its first comprehensive double tax treaty in 1945, with the United States: Avery Jones, ‘The History of the United Kingdom’s First Comprehensive Double Taxation Agreement’, above n 6, 211–54. 92  Memorandum from Inland Revenue to the Chancellor of the Exchequer, above n 82. 93  Letter from Gowers (Inland Revenue) to the Chancellor of the Exchequer, above n 89; and Memorandum from Thompson to the Chancellor of the Exchequer (UK National Archives, London: File IR 40/3419 Part 3, 13 February 1930). 94  Letter from Gowers (Inland Revenue) to the Chancellor of the Exchequer (UK National Archives, London: File IR 40/3419 Part 3, 15 October 1929). 95 Agreement between the British Government and the Government of the Irish Free State in respect of Double Income Tax (14 April 1926), reproduced in League of Nations, Double Taxation and Fiscal Evasion: Collection of International Agreements and International Legal Provisions for the Prevention of Double Taxation and Fiscal Evasion (Geneva, League of Nations, 1928) 56–58). 96  Avery Jones, ‘The History of the United Kingdom’s First Comprehensive Double Taxation Agreement’, above n 6, 211–22 and 252–54. 97  For discussion of this tax treaty, see Avery Jones, ‘The History of the United Kingdom’s First Comprehensive Double Taxation Agreement’, above n 6. 98 For one account of the ‘special relationship’, see AP Dobson, The Politics of the Anglo-American Economic Special Relationship 1940–1987 (Brighton, Wheatsheaf, 1988).

362  Sunita Jogarajan CONCLUSION

The narrative demonstrates that the United States was not as influential in the development of the 1928 Models as previously thought. This was fundamentally due to domestic politics and unfortunate. There is no doubt that Adams was an expert in the field and respected by the League’s Experts.99 However, most of the key decisions had been made by the time of Adams’ involvement and his influence was therefore limited. It would have been interesting to see how the discussions would have unfolded if America was involved from the start of the League’s work. In particular, one wonders whether the Continental European countries would have been as willing or eager to compromise with Great Britain if America also supported source-based taxes. Great Britain, however, clearly had a significant influence on the development of the 1928 Models. The narrative suggests that the League’s Experts would have had a much simpler and more straightforward task if they were not trying to balance the Continental European countries’ preference for source-based taxes and Great Britain’s preference for residence-based taxes. However, the influence was not of lasting impact as Draft Convention Ic, drafted by the French and German representatives, emerged as the prevailing model.

99  For example, the Bulgarian representative, Bainoff, withdrew a proposed amendment in deference to Adams: Minutes of the Ninth Meeting of the General Meeting of Government Experts on Double Taxation and Tax Evasion held at 3:30 pm on 26 October 1928 (League of Nations Archives, United Nations Geneva: Double Imposition Et Evasion Fiscale Vol VIII Reunion Generale Des Experts Gouvernmentaux (1521), D.T./Reunion/P.V.9. (1)).

13 The UK’s Tax Treaties with Developing Countries during the 1970s MARTIN HEARSON

ABSTRACT

Tax treaties between developed and developing countries impose considerable costs on the latter, in the form of curbs on their right to tax investment from the former. Existing research assumes that such restrictions are accepted as a quid pro quo for resolving the problem of double taxation, which might act as an obstacle to inward investment. This chapter uses archival documents to examine treaty negotiations between the United Kingdom (UK) and developing countries during the 1970s, focusing on contentious provisions concerning ‘tax sparing’, the taxation of shipping, and withholding taxes. Consistent with critical literature on tax treaties, it finds that neither side was concerned about the double taxation problem, which was resolved unilaterally by the UK’s tax credit. Rather, developing countries were primarily focused on obtaining matching tax credits in the UK to maximise the benefits to investors from their tax incentives. UK priorities, meanwhile, were to bind developing countries into OECD-type tax treatment of British firms. Negotiated outcomes did not reflect the true balance of costs and benefits to each side, but their different negotiating capacities, the political salience of particular taxes, and the precedent certain concessions might set for future negotiations. INTRODUCTION

T

HE UNITED KINGDOM (UK) has the widest network of bilateral tax treaties in the world. A large proportion of these treaties are with developing countries, especially former British colonies, most of which inherited colonial era agreements on independence, which they soon

364  Martin Hearson sought to renegotiate. The paper uses civil service documentation released under the UK’s 30-year rule to analyse these treaty negotiations during the 1970s. Britain entered negotiations with about 40 developing countries during this time, successfully concluding agreements with just over half. Most of these agreements are still in force today. Conventionally, tax treaties between developed and developing countries have been understood as tools through which developing countries sought to enhance their attractiveness to foreign investors, by eliminating the problem of double taxation and providing a guarantee against concerns about the instability of their tax systems. Developing countries, it is thought, accepted to have their taxing rights curtailed, as a quid pro quo for the investment-enhancing effects of tax treaties. Debate about the wisdom of developing countries concluding tax treaties turned, therefore, on the balance of these costs and benefits. The evidence from the British negotiation files suggests that this view should be modified in a number of important ways. First, developing countries’ negotiating experience and capacity were limited. Certain clauses within tax treaties were highly politicised, while others were little understood and attracted limited attention. This meant that the negotiating priorities of developing countries did not always correspond to the biggest revenue gains or losses. Secondly, ‘tax sparing’ clauses, which do not relate to the shared costs of double taxation relief, but rather to the effectiveness of tax incentives in developing countries, were often the main motives behind developing countries’ pursuit of tax treaties. They also motivated the British, who actively sought tax treaties as tools to enhance the competitive position of their multinational investors in host markets, as well as to protect them from tax measures that contravened OECD standards. Finally, negotiating priorities on both sides, but especially for Britain, were not dictated solely by the costs and benefits of the particular treaty concerned, but also by the precedent that they set for future negotiations, especially any precedent for deviation from OECD standards. To illustrate these points, the chapter sets out various examples gleaned from the archived civil service documentations. It begins by setting this analysis in the context of existing literature on tax treaties and developing countries. It then moves on to some generalised discussion of British negotiators’ priorities, before discussing three types of treaty provision that illustrate the priorities of developed and developing countries. These are ‘tax sparing’ provisions, the taxation of shipping, and withholding taxes. DEBATING TAX TREATIES AND DEVELOPING COUNTRIES

Tax treaties are bilateral agreements that divide up the right to tax crossborder economic activity, ostensibly with the aim of mitigating the risk that multinational taxpayers will face conflicting claims to taxation. The formal

The UK’s Tax Treaties with Developing Countries during the 1970s 365 title of most tax treaties (‘agreement for the relief of double taxation and [in more recent treaties] the prevention of fiscal evasion’), as well as the commonly used term ‘double taxation treaties’, reflects this understanding of their role. Indeed, the introduction to the OECD Model Tax Convention on Income and Capital (‘the OECD model’) states that: The principal purpose of double taxation conventions is to promote, by eliminating international double taxation, exchanges of goods and services, and the movement of capital and persons.1

The OECD model, on which work began in what was then the Organisation for European Economic Co-operation in 1956, is intended as a template for negotiations between developed countries. In 1968, with a growing number of treaties being negotiated between developed and developing countries, the United Nations established an ad hoc group of experts to consider the particular circumstances faced by such negotiations, leading eventually to the publication of a United Nations model tax treaty.2 The principle difference between the OECD and UN model approaches is that the latter affords a greater share of the taxing rights within the treaty to the country of source, which is generally the developing country.3 Literature on tax treaties and developing countries has therefore tended to focus on the balance of costs and benefits to them, largely in the form of reduced tax revenue versus supposed increased inward investment. Several studies examining the withholding tax rates in groups of tax treaties have suggested that the UN approach, whereby more source-based provisions are included in treaties between countries with more unequal investment positions, is broadly consistent with negotiating practice.4 In Honey Lynn Goldberg’s words, ‘treaty partners having unequal income flows will allocate jurisdiction to tax so as to achieve a more even balance between the two extremes.’5 A critical literature sees matters differently. In her seminal paper The Tax Treaties Myth, Tsilly Dagan demonstrates through game theory that capital exporting countries will always have an incentive to relieve double taxation

1 OECD,

Model Tax Convention on Income and on Capital (OECD Publishing, 2014) 59. United Nations, Model Double Taxation Convention between Developed and Developing Countries (2011th edn, United Nations, 2011) vii. 3  M Lennard, ‘The UN Model Tax Convention as Compared with the OECD Model Tax Convention—Current Points of Difference and Recent Developments’ [2009] Asia-Pacific Tax Bulletin 4. 4  HL Goldberg, ‘Conventions for the Elimination of International Double Taxation: Toward a Developing Country Model’ (1983) 15 Law & Policy in International Business 833; R Chisik and RB Davies, ‘Asymmetric FDI and Tax-Treaty Bargaining: Theory and Evidence’ (2004) 88 Journal of Public Economics 1119; T Rixen and P Schwarz, ‘Bargaining over the Avoidance of Double Taxation: Evidence from German Tax Treaties’ (2009) 65 FinanzArchiv: Public Finance Analysis 442. 5  Goldberg, above n 4, 907. 2 

366  Martin Hearson unilaterally in the absence of a treaty.6 It is certainly the case that most capital exporting countries, including the UK during the 1970s, already give outward investors a unilateral credit or exempt their foreign income from tax altogether. Critics argue that, by concluding tax treaties, capital-importing developing countries have therefore been subsidising capital-exporting countries’ international tax systems. One particularly powerful example of this school of thought was written by Charles Irish, a legal adviser to the Zambian government, in 1974. He argued that: The practical effect of the present network of double taxation agreements between developed and developing countries is to shift substantial amounts of income tax revenues to which developing countries have a strong legitimate and equitable claim from their treasuries to those of developed countries. Concomitantly, these double taxation agreements result in a very considerable and unnecessary loss of badly needed foreign exchange reserves for developing countries. In other words, the present system of tax agreements creates the anomaly of aid in reverse—from poor to rich countries.7

In the 40 years since Irish’s publication, numerous other scholars have questioned the wisdom of the tax treaties concluded by developing countries.8 The focus of much of this criticism is not necessarily the existence of such treaties per se, but the terms of tax treaties that developing countries have signed. Surveys of the tax treaty networks of developing countries have tended to suggest that some developing countries have not been as successful as others at retaining their taxing rights, for reasons other than simply the amount of revenue at stake.9 Tax history scholarship can help to contextualise this discussion by opening a window onto the objectives and strategies of tax treaty negotiators. 6  T Dagan, ‘The Tax Treaties Myth’ (2000) 32 New York University Journal of International Law and Politics 939. See also E Baistrocchi, ‘The Use and Interpretation of Tax Treaties in the Emerging World: Theory and Implications’ (2008) 28 British Tax Review 352, arguing that, while Dagan’s result holds for an individual pair of countries, once several developing countries are competing for inward investment, they face a prisoner’s dilemma and the conclusion of a tax treaty is in effect a defection. 7 CR Irish, ‘International Double Taxation Agreements and Income Taxation At Source’ (1974) 23 International and Comparative Law Quarterly 292, 292. 8  V Thuronyi, ‘Tax Treaties and Developing Countries’ in M Lang and others (eds), Tax treaties: building bridges between law and economics (IBFD 2010); see also RS Avi-Yonah, ‘Double Tax Treaties: An Introduction’ in KP Sauvant and LE Sachs (eds), The Effect of Treaties on Foreign Direct Investment (Oxford University Press, 2009); K Brooks and R Krever, ‘The Troubling Role of Tax Treaties’ in GMM Michielse and V Thuronyi (eds), Tax Design Issues Worldwide, vol 51 (Kluwer Law International, 2015). 9  V Dauer and R Krever, ‘Choosing between the UN and OECD Tax Policy Models: An African Case Study’ (2012) (European University Institute, Robert Schuman Centre for Advanced Studies, EUI working paper RSCAS 2012/60); M Hearson, ‘Measuring Tax Treaty Negotiation Outcomes : The ActionAid Tax Treaties Dataset’ (University of Sussex, Institute of Development Studies, International Centre for Tax and Development Working Paper No 47, 2016); W Wijnen and J de Goede, The UN Model in Practice 1997–2013 (International Bureau of Fiscal Documentation, 2013).

The UK’s Tax Treaties with Developing Countries during the 1970s 367 Rather than assuming a priori that each side’s objective from a given tax treaty was to maximise its taxing rights, detailed studies of negotiations can reveal the more complex, dynamic nature of negotiating positions. Maikel Evers’ study of early Netherlands–Germany negotiations, for example, shows how one treaty emerged as a personal project of two tax diplomats with their own distinctive views of their countries’ national interests.10 Contributions to a volume examining country negotiating histories highlight that capacity constraints limit developing countries’ ability to prepare for and participate effectively in negotiations: Uganda ‘has a weak tax treaty negotiation team that concludes treaties more intensively reflecting the position of the other contracting state,’ while in Colombia in the 2000s a policy of ‘attracting investment at any price’ led to poorly-prepared negotiations and an outcome that was less favourable to Colombia than might otherwise have been the case.11 One suggestion often made in discussions of this topic is that some tax treaties may have been concluded by developing countries for political reasons, with little consideration for their content at all.12 Inspired by these examples, the next sections use civil service documentations obtained from the British National archives to help understand the determinants of some of Britain’s early tax treaties with developing countries, during the 1970s. This is the only complete decade after most British colonies had obtained independence, and before the 30 year cut-off date for release of the negotiation files. GENERAL CONSIDERATIONS

This section of the chapter briefly discusses the evidence from the archived files concerning the motivations and capabilities of tax treaty negotiators. While the nature of the evidence is more revealing about the motivations at the British end, it is also interesting to consider the British negotiators’ impressions of their developing country counterparts. British Negotiators’ Motivations Memos circulating within Whitehall during this time support the core contention of critical scholarship on tax treaties and developing countries, that 10 

M Evers, ‘Tracing the Origins of the Netherlands’ Tax Treaty’ (2013) 41 Intertax 375. Aukonobera, ‘Uganda’ in M Lang, P Pistone and J Schuch (eds), The impact of the OECD and UN model conventions on bilateral tax treaties (Cambridge University Press, 2012) 1024; NQ Cruz, ‘Colombia’ in Lang, Pistone and Schuch (eds), ibid, 204. 12  For example, A Pickering, Why Negotiate Tax Treaties? (United Nations/International Tax Compact, Papers on Selected Topics in Negotiation of Tax Treaties for Developing Countries, Paper No. 1-N, 2013). 11  F

368  Martin Hearson British investors were already protected from the bulk of double taxation risk through the UK’s unilateral tax credit regime. In one note from December 1973, an Inland Revenue civil servant recalls how he made the case to an adviser from the Tanzanian government: It occurred to me that where developed countries were prepared to make provision for tax sparing in their agreement there was advantage for the developing country in concluding an agreement … I pointed out that at least as far as UK businessmen were concerned there was evidence that they preferred to have a double taxation agreement in operation. It was true that there were generous unilateral reliefs available under the United Kingdom legislation but it was always possible to envisage cases where the individual taxpayer might lose out quite apart from the fact that on grounds of principle the United Kingdom would prefer to have a double taxation agreement with a developing country than to see it rely on UK investors gaining the benefit of unilateral relief.13

The topic of ‘tax sparing’ provisions will be returned to later in this chapter, but it is worth dwelling for a moment on the UK’s ‘grounds of principle’. In 1976, the Inland Revenue led a cross-Whitehall review of double taxation relief, intended to build a consensus position across departments. According to that review, ‘in the absence of an agreement there is no question of United Kingdom investors being doubly taxed’, but the benefits of an agreement, ‘include protection against fiscal discrimination, the establishment of a framework within which the two tax administrations can operate, and the expectation that an overseas authority which has negotiated a treaty will at least try to apply it reasonably.’14 A subsequent memo from another official adds that, ‘protection against fiscal discrimination is generally worth more [in developing countries] because they are more likely to include deliberately discriminatory fiscal practices in their general law than are developed countries.’15 With this in mind, the Inland Revenue opposed the conclusion of any treaty with a developing country whose negotiating position would require deviation from the standards embodied in the OECD model treaty. As the examples later in this chapter will show, relatively inexperienced negotiators from newly independent developing countries did seek to challenge some of these fundamental tenets, sometimes emboldened by discussions taking place at the newly established United Nations Ad Hoc Committee of Experts. A treaty with a developing country at variance with these standards might have benefited British businesses in the short term, but would undermine a long-term project, whose aim was to protect British firms from

13 

Memo from J Marshall to D Hopkins, undated. File ref IR40/17624. taxation relief.’ Report to the Paymaster General, 25 February 1976. File ref FCO 59/1459. 15  Memo from A Wilkinson, Inland Revenue, 8 April 1976. File ref IR 40/18941. 14 ‘Double

The UK’s Tax Treaties with Developing Countries during the 1970s 369 onerous taxation and, ‘“educate” developing countries … about acceptable international fiscal standards.’ Other Whitehall departments also took an interest in the Inland Revenue’s negotiating priorities, but with a slightly different perspective. A note within the Foreign Office, for example, describes two priorities for UK tax treaties: first, that ‘British overseas investors should enjoy the same advantages in developing countries as their rivals’ and secondly, that ‘taxation obstacles to private investment in developing countries should be removed.’16 Similarly, a Department of Trade memo states that, ‘it is important that we should not place our traders at a disadvantage when seeking out investment opportunities.’17 Capabilities of Developing Country Negotiators British negotiators’ comments on their developing country counterparts demonstrate that they often considered themselves to be negotiating with people whose capacity to understand the detail of tax treaties, and to drive forward discussions, was quite limited. For example, after a meeting in 1972 with ‘the only one who is able to talk about Double Taxation Agreements’ in Thailand’s revenue department, a British Foreign Office official concluded that, ‘in principle they would be interested but it was not likely that Thailand would take the initiative.’18 Similarly, an Inland Revenue note on talks with Egypt indicates that the Egyptians ‘were willing to be led by us most of the time in the drafting.’19 An initial draft treaty received from Nigeria was seen as ‘an opening bid from a country which has had little recent experience in negotiating double tax conventions’,20 while a British official ‘gained the impression that the Brazilians are constantly revising their policy in light of experience and a review of the effect of the concessions granted.’21 Tanzania had a six-strong team for negotiations with Britain in February 1977, of whom the British delegation concluded that only one was ‘familiar with the detail of the Tanzanian draft.’ The delegation was led by the Deputy Principal Secretary of the Treasury, who ‘did not know a great deal

16 

Memo from Golden to Kerr, 10 January 1971. File ref FCO 7/2206. Memo from Gill to Harris. 15 February 1973. File ref FCO 63/1126. 18 Letter from D Montgomery, British Embassy, Bangkok, 5 June 1972. File ref FCO 15/1645. 19  Note on UK/Egypt Double taxation talks, May 1976. File ref IR 40/19097. 20  ‘Taxation brief for Mr Barratt’s visit to Nigeria and meeting with the Director of Inland Revenue: December 1978.’ File ref IR 40/17629. 21  Memo from RG Tallboys to MF Daly, undated, circa October 1971. File ref IR 40/17189. 17 

370  Martin Hearson about taxation but seemed an able person’ and the Commissioner of Income Tax, who was described as: Again a very pleasant man. Knew very little about the implications of international tax agreements. Did not always display a full detailed knowledge of the Tanzanian tax system. Often slow to see points. Gave very little indication from day to day that he remembered (or cared) about what had happened earlier in discussions.22

These extracts support Charles Irish’s assertion that: In general, the income tax departments of developing countries are woefully undertrained and understaffed and are barely able to cope with the administration of domestic tax laws, much less give serious consideration to complex international tax matters. Consequently … new tax agreements are too often the product of unquestioned acceptance of the developed country's position after little or no substantive negotiation.23

Despite these observations, as the next section illustrates, there are examples of tough stances taken by developing countries, including some smaller countries such as Tanzania with little negotiating experience. CASE STUDIES

This section looks at some of the detail of individual negotiations, using correspondence between negotiators, meeting minutes, and civil service memos. It is structured along the lines of several particular sticking points for negotiators. In some instances, agreements were reached, but in others the differences in position led to a stalemate. Tax Sparing Although they do not form part of the OECD or UN model treaties, and indeed have been discouraged by the OECD since 1998,24 ‘tax sparing’ clauses, often referred to as ‘matching credit for pioneer reliefs’, were at the root of many tax treaty negotiations by the UK during the 1970s that are still in force today. As the UK operated a credit, rather than an exemption mechanism for its unilateral double taxation relief, the effect of a developing country offering a tax incentive to British investors was often simply to reduce the credit they received against their UK tax bill, hence increasing their UK tax liability by an amount corresponding to the concession.

22 

Minutes of UK–Tanzania negotiation meeting, 3–10 Feb 1977. File ref IR 40/17624. Irish, above n 7, 300. 24 OECD, Tax Sparing: A Reconsideration (OECD Publishing, 1998). 23 

The UK’s Tax Treaties with Developing Countries during the 1970s 371 Tax sparing clauses in treaties gave a matching credit against UK tax for the amount that would have been payable by a British firm in the treaty partner had it not been the subject of an investment-promoting tax incentive. This allowed investors to keep the benefit for themselves. Tax sparing clauses were, indeed, understood by the Inland Revenue to be ‘the main cash benefit for the investor’ from a tax treaty.25 When, in the December 1973 conversation referred to earlier, an economic advisor to the Tanzanian government asked an Inland Revenue negotiator, ‘whether in view of the fact that most developed countries had provision for unilateral relief there was any point in developing countries concluding double taxation agreements at all since the only effect of such agreements was normally in the case of developing countries to surrender rights of taxation to developing countries’, the latter responded that tax sparing provisions were likely to be the main benefit.26 From the perspective of developing countries that wished to ensure the effectiveness of their new investment promotion incentives, the sacrifice of taxing rights entailed by a tax treaty was a price worth paying for the ‘tax sparing’ clause. Zambia, for example, was keen to give full effect to the incentives outlined in its 1965 Pioneer Industries Act. All of the 11 treaties concluded between Zambia and OECD member countries during the 1970s and 1980s provided explicitly for tax sparing credits, or else contained provisions that had the same effect.27 The priority accorded to the tax sparing clause is illustrated by a formal letter sent by Zambia to the UK in 1969, requesting that negotiations be opened: In recently negotiated Agreements, Zambia has followed substantially the O.E.C.D. Draft Convention and it is suggested that any new Agreement should substantially follow this Draft Convention. Zambia would, in particular, wish to discuss matters arising from the operation of the Zambian Pioneer Industries (Relief from Income Tax) Act.28

The UK, for its part, was an enthusiastic supporter of tax sparing clauses, as illustrated in a speaking note drafted for a meeting of Commonwealth finance ministers in August 1973: We have taken the opportunity to offer matching credit for pioneer reliefs to all the developing countries with whom we have double taxation agreements. We also offer matching credit to any developing countries with which we enter into negotiations for the first time.29

The idea that tax sparing was a concession made by the UK to developing countries was reiterated during negotiations. The following remark by a 25 

‘Double tax relief’, above n 14. Memo from J Marshall to D Hopkins, undated. File ref IR40/17624. 27  Two exempted dividends paid to direct investors from tax in the home country entirely. 28  Communication from the Zambian Ministry of Foreign Affairs, 12 September 1969. File ref IR 40/16974. 29  Inland Revenue speaking note dated 24 August 1973. File ref OD 42/104. 26 

372  Martin Hearson British official, for example, is recorded in the notes of a negotiating meeting with Zambia: ‘Ministers had indicated that matching credit was a very real sacrifice by the UK and looked to see balancing concessions by the partner country in the rates of withholding taxes.’30 Whitehall correspondence from the Inland Revenue to the Foreign Office concurs that: In negotiating a Double Taxation Agreement we would naturally want to obtain a reduction in the other country’s tax rates, and we often find that the offer of matching credit for tax spared under the other country’s tax holidays is a useful bargaining counter in securing such reductions.31

Yet it was not only the governments of developing countries that were keen to obtain tax sparing agreements: British investors, and the Whitehall departments charged with championing their interests, were also interested. Correspondence within the Economic Department of the Foreign and Commonwealth Office illustrates the presence of such concerns. In a note attached to a newspaper clipping, for example, a civil servant compared the situation for British firms with those of a German competitor: You will see that Rollei’s success depends on its capacity to exploit not only the labour cost advantages of Third World production but also two major tax advantages offered by the host country. The first tax advantage—the five-year pioneer tax holiday—is available also to British companies under a tax sparing provision in the UK/Singapore treaty. But the second tax advantage of a negligible rate of tax on export profits will still be frustrated by countervailing UK tax. Here then is an example of how the range of UK matching relief might be expanded under an existing treaty.32

Perhaps the most significant example of British industry’s interest in a tax sparing agreement is the lobbying surrounding lengthy and ultimately unsuccessful negotiations with Brazil during the 1970s. A particularly difficult issue for the UK was Brazil’s insistence that the UK grant extensive tax sparing concessions. This would mean crediting the value of a Brazilian tax exemption against the UK company’s tax bill as if it had paid full Brazilian tax, in the manner of a normal tax incentive. It would also, however, mean doing the same for the reductions in withholding taxes that were built into the treaty. In the words of a Brazilian negotiator, ‘whilst Brazil does not want the United Kingdom to lose tax, she cannot allow the United Kingdom to collect more tax as a result of the convention.’33 Several European countries, including France and Germany, had reached agreement with Brazil, which both increased the pressure on the Inland

30  Minutes of negotiating meeting between UK and Zambia, 24–27 May 1971, London. File ref IR40/16974. 31  Letter from C Stewart, Inland Revenue. 7 December 1971. File ref IR 40/17189. 32  Letter from B Tarlton, FCO. 29 March 1973. File ref FCO 59/973. 33  F Dornelles, recorded in a note of talks in Brazilia, October 1974. File ref IR 40/19025.

The UK’s Tax Treaties with Developing Countries during the 1970s 373 Revenue and reduced its leverage in negotiations. ‘We have already forfeited opportunities for investment in Brazil, notably to the Germans and Japan’, one official from the Board of Trade argued.34 In October 1974, Department of Industry officials wrote again to the Inland Revenue citing ‘specific evidence of orders being lost by British companies [in Brazil] apparently because of their relatively lower post-tax returns forcing them to quote higher prices in compensation.’ The Inland Revenue, reluctant even to share information on negotiations with Brazil or any other country with other Whitehall departments, nonetheless felt under pressure, which provoked considerable internal discussion.35 One typical memo illustrates the Revenue’s dilemma: the possible repercussions of our acceptance of the Brazilian proposal on credit … could be far reaching. No-one would believe that we would not be prepared to concede similar terms to all other developing countries, and the Brazilian agreement would be looked on as a model for our future agreements with those countries.36

By 1974, even the Revenue was beginning to recognise that British companies ‘are undoubtedly at a competitive disadvantage as compared with companies from other countries’, but it was still unwilling to meet Brazil’s terms for tax sparing credits.37 In December, the debate between departments had reached ministerial level, beginning with a letter addressed from Secretary of State for Trade Peter Shore to Chancellor of the Exchequer Dennis Healey, to ‘place on record my strong commercial interest in concluding an agreement with Brazil.’38 This escalation to cabinet level appears to have eventually led to a partial thawing in the Inland Revenue’s resistance. The Brazilian form of tax sparing required new enabling legislation in the UK, which was eventually passed in 1976. Tax sparing was only one of several sticking points, however, and as British negotiators travelled to Brazil after gaining this new legislative mandate, instructions were cabled for them ‘to refrain from agreeing to the unacceptable features of Brazilian law which they wish to enshrine in the treaty, but to avoid a breakdown in the talks.’39 The Brazil files examined for this chapter stop at the turn of the 1980s, but the pressure to conclude an agreement did not. In 1992, in a separate file, an Inland Revenue official wrote that ‘Brazil continues to be the big prize: but it is not ripe for

34 

Letter from J Gill, Board of Trade, 15 February 1973. File ref FCO 63/1126. Letter from A Smallwood, Inland Revenue, 15 March 1973. File ref FCO 59/973. 36  Memo from D Hopkins, Inland Revenue, 9 November 1973. File ref IR 40/19025. 37 ‘Brazil Brief 16: Double Taxation Relief Agreement’, 25 August 1974. File ref IR 40/19025. 38  Letter from P Shore, 12 December 1974. File ref IR 40/19025. (In 1974 the Department of Trade and Industry was split into two separate departments.) 39  Telegram, 24 May 1976. File ref IR 40/19025. 35 

374  Martin Hearson an immediate approach and what indications there are suggest that it will be a difficult nut to crack.’40 Shipping The UK takes a particularly firm position on Article 8 of its tax treaties, which concerns the taxation of shipping. The OECD model tax treaty allocates all taxing rights over shipping activity to the country of residence of the shipping firm. The UN model, in contrast, includes the option of a shared taxing right, recognising that many developing countries impose a tax on the profits made by foreign shipping firms within their waters. The UK is unusual in that it has never signed a tax treaty that concedes any source taxation rights over shipping, although it has on occasions been willing to conclude agreements that omit the shipping article altogether, effectively leaving source taxation rights intact.41 As one British negotiator explained during a negotiation with Bangladesh: Shipping had an emotional appeal in the United Kingdom because of its importance to the economy … Shipping companies do not pay much corporation tax in the United Kingdom and might well incur losses if required to pay foreign tax.42

With Thailand, for example, the Inland Revenue had been under pressure from shipping firms to negotiate a treaty since the 1930s, because Thailand had implemented a gross basis tax on foreign shipping firms that was not eligible for credit in the UK.43 Knowing that the only terms on which an agreement could be reached would contravene this longstanding UK policy, the Inland Revenue resisted this pressure, and negotiations did not open in earnest until 1974. With the Chamber of British Mines now attaching ‘special importance’ to an agreement with Thailand, and the Confederation of British Industry (CBI) and British Insurance Association expressing a ‘strong interest’,44 the British made repeated requests to open negotiations, finally succeeding in 1976. Before finalising the treaty, the Inland Revenue consulted with the General Council of British Shipping (GCBS), who were concerned about the precedent the Thai treaty might set for future negotiations. A briefing note for the second round of negotiations states that, ‘we have decided, after consultation with the General Council of British Shipping, to have no Shipping Article in the Convention.’45 This would allow

40 

Memo from JB Shepherd, Inland Revenue, 14 July 1992. File ref IR 40/17808. Hearson, above n 9. 42  Minutes of negotiation between UK and Bangladesh, July 1977. File ref IR40/18445. 43  File ref IR 40/17358. 44  Letter from IP Gunn, Inland Revenue, 25 September 1974. File ref IR 40/18456. 45  ‘Double taxation convention talks with Thailand.’ c. October 1976. File ref IR 40/18456. 41 

The UK’s Tax Treaties with Developing Countries during the 1970s 375 Thailand to retain its taxing rights over British shipping, without setting a precedent through a clause specifically permitting this. Shipping was also a sticking point during unsuccessful negotiations from 1973 to 1977 with Tanzania, a coastal country in Africa whose port of Dar es Salaam is a major transport hub for central and East Africa. In negotiations in February 1977, both sides made clear that their positions on shipping taxation were a point of principle. The British notes of the meeting state that ‘the Tanzanians were not in a position to negotiate as firm guidelines had been laid down by their cabinet prior to the discussions’ and that ‘their political masters have forbidden any compromise on this matter.’46 Tanzania pointed out that it had already obtained shared taxing rights over shipping with Norway, Sweden, Germany and Italy. More importantly, ‘most favoured nation’ clauses in its German and Norwegian agreements meant that, were it to concede the UK’s position, the costs would cascade beyond just Tanzania’s taxing rights over UK shipping. With the stalemate over shipping risking contributing to the eventual breakdown of negotiations, the Inland Revenue consulted once again with the GCBS. As with their discussions about Thailand, the latter’s key concern was precedent, but by this point the concern was more specific: the UK had recently opened negotiations with India, a big prize for both the Inland Revenue and the GCBS. A letter from the GCBS to the Inland Revenue states: As to an agreement with Tanzania, it is the GCBS view that it should not contain a shipping article which accepts a reduced rate of tax on UK shipowners, even though it would rank for tax credit relief. To do so would prejudice the negotiations with India and would set a bad precedent for other negotiations.47

Withholding Taxes Articles 10 to 12 of tax treaties state maximum rates at which the country of source can levy withholding taxes on dividends, interest and royalty payments, and in some cases fees for management, technical and consultancy services. The OECD model provides for exclusive residence taxation of royalties and management fees, and while most tax treaties allow for some source taxation of royalties, this is much rarer in the case of management fees. For newly independent developing countries, especially those keen to attract investment as part of a policy of import substitution industrialisation (ISI), withholding taxes became increasingly important tools to raise revenue, prevent profit-shifting tax avoidance and also to incentivise investors to reinvest capital, rather than repatriating it. 46  47 

Minutes of UK–Tanzania negotiation meeting, 3–10 Feb 1977. File ref IR 40/17624. Letter from TS Donaghy to B Pollard, 11 March 1977. File ref IR 40/18456.

376  Martin Hearson In Zambia, for example, around one third of investible surpluses were removed from the country, creating considerable political debate.48 In 1973, as Zambia began to introduce withholding taxes on various forms of crossborder payment, President Kaunda delivered a speech criticising foreignowned mining companies, because, ‘in the last three and a half years … they have taken out of Zambia every ngwee [penny] that was due to them.’49 As well as dividend repatriation, Kaunda complained that government agreements with the mining companies permitted them to shift profits out of Zambia by providing ‘sales and marketing services for a large fee. Although most of this work is performed in Zambia the minority shareholders have entered into separate arrangements with non-resident companies for reasons best known to themselves.’50 The same was true of the East African Community countries, Kenya, Tanzania and Uganda, with which the UK negotiated during the late 1960s and early 1970s. After years of increasing health and education spending by politicians keen to demonstrate success to a fledgling electorate, these countries faced a budget crisis, to which they responded with a dramatic overhaul of their tax regimes, including the imposition of withholding taxes as high as 40 per cent.51 All three countries had inherited agreements put in place by the colonial administration, which prevented them levying withholding taxes on some forms of cross-border payment. While Kenya had agreed to extend this colonial-era treaty until a new one had been negotiated, Tanzania and Uganda had let theirs lapse. Tax administration had been a shared function of the three countries for a time after independence, and a treaty had been initialled in 1969 by the Commissioner of the East African Income Tax Office. It was rapidly abandoned by all three countries once these new taxes were put in place. The new negotiations were difficult, dragging on for many years, and in the end the only agreement secured was with Kenya, ratified in 1976. Much of the difficulty concerning these negotiations rested with the withholding tax rates, which are summarised in Table 1. In January 1972, a British tax treaty negotiator in Nairobi sent a telegram to his superiors informing them that, ‘talks with Kenya have broken down over treatment of management fees and royalties. The Keanyans [sic] have pressed me to obtain confirmation from the Board that the UK cannot agree to a 20% withholding tax.’52 48  A Seidman, ‘The Distorted Growth of Import-Substitution Industry: The Zambian Case’ (1974) 12 The Journal of Modern African Studies 601, 611. 49  Quoted in A Sardanis, Zambia: The First Fifty Years (IB Tauris, 2014) 97. 50  Quoted in ibid. 51  L Gardner, Taxing Colonial Africa the Political Economy of British Imperialism (Oxford, Oxford University Press, 2013) 238–241. 52  Telegram from D Hopkins, Inland Revenue, 27 January 1972. File ref IR 40/17623.

The UK’s Tax Treaties with Developing Countries during the 1970s 377 As with President Kaunda’s concerns in Zambia, the notes of the UK–Kenya negotiations indicate that Kenya’s concern about management fees related to tax avoidance by British multinational companies. Pressed for an example, Kenyan negotiators explained that a British firm had posted handwritten letters back to the UK, where they were typed up and posted back to Nairobi, with an inflated fee charged for this secretarial service.53 Participation in discussions at the United Nations Group of Experts had also emboldened Kenya, as the following record of comments from two of its negotiators illustrates: Mr Cropper said that there had been a big change in developing countries’ attitudes in the UN Group of Experts … Mr Ihiga said that modern thinking was that a withholding tax on management fees was justified.54 Table 1:  Kenyan Withholding Tax Rates, Actual and Proposed Portfolio Dividends

FDI Dividends

Interest

Royalties

Management Fees

Colonial treaty

0

0

No restriction

0

No restriction

UK-EAC initialled treaty

15

5

15

10

0

New Kenyan domestic law

12.5

12.5

12.5

20

20

Original UK proposal for treaty

15

5

10

0

0

Original Kenya proposal for treaty

30

20

25

40

40

Final agreed in treaty

15

15

15

15

15

Source: negotiating correspondence.

Kenya injected an additional sense of urgency by repudiating the c­ olonial agreement in May 1972, causing concern among British businesses. Meanwhile, the UK was also facing a strong demand for a management fees clause from Jamaica, where, in correspondence between the Chancellor

53  Minutes of UK–Kenya tax treaty negotiation meeting, London, 9–11 November 1971. File ref IR 40/17623. 54  Minutes of UK–Kenya tax treaty negotiation meeting, Nairobi, 25–29 January 1972. File ref IR 40/17623.

378  Martin Hearson of the Exchequer and the Jamaican Minister of Finance, the latter had ‘expressed his concern about the way in which profits were being drained from Jamaica in the form of management fees and similar payments.’55 The turning point in the UK’s approach seems to have been a meeting with representatives of British businesses in March 1972, in which a key area of discussion was the demand from Jamaica and Kenya.56 The business representatives reassured the Revenue that they were not overly concerned by this concession, and it was soon after that the UK wrote to Jamaica and Kenya informing them that it was willing to agree. The eventual treaty permitted Kenya to tax management and consultancy fees paid to the UK, but only at rates up to 12.5 per cent, and with an option to be assessed on a net basis.57 While the UK had relented on a point of principle, this was (and remains, at the time of writing) the lowest cap on management fees in any Kenyan treaty in force. The outstanding sticking point in the Kenya negotiations then became the rate of withholding tax on interest, where the parties differed by only 5 per cent, as well as pensions and Kenya’s desire to include the concept of ‘limited force of attraction’ discussed at the UN Group of Experts, which would have given Kenya greater rights to tax the net profits of British firms made within its borders. According to a British official working for the Kenyan government, civil servants in Kenya were happy to concede, ‘the difficulty was convincing the Permanent Secretary and the Minister to accept the rates.’58 The political salience of the withholding taxes is emphasised by the following exchange from the fourth round of negotiations, in April 1973: Mr Hopkins [for the UK] asked whether the 2.5% on Royalties was more important than the force of attraction principle. Mr Gheewala [for Kenya] replied that this was correct although it would not mean as much revenue. It was a political matter in Kenya.

The new agreement was initialled and signed in 1973, but not ratified until 1976, with further concessions from the UK, including a watering down of the UK’s net basis clause within the management fees article. According to a ministerial briefing, this was because British exchange controls reduced the benefit of the treaty to Kenya, and because other countries had cited certain provisions of the UK treaty as a precedent when negotiating with Kenya. Nigeria offers a further example of negotiations over withholding taxes on management fees. Negotiations began in earnest when Nigeria announced

55 

‘Background note for Minister of State’, undated. File ref IR 40/18990. of meeting between Inland Revenue and CBI, 15 March 1972. File ref IR 40/18109. 57  United Kingdom–Kenya double taxation agreement, 1973, Article 13. 58  Note of meeting with E Cropper in Somerset House, 21 July 1972. File ref IR 40/17623. 56 Minutes

The UK’s Tax Treaties with Developing Countries during the 1970s 379 the abrogation of all its colonial era tax treaties in 1978, and the concurrent imposition of new taxes on air and shipping companies.59 A telegram from the Inland Revenue to the British embassy in Lagos noted that the government ‘is very concerned at serious implications of termination of Double Taxation Agreement for British airline and shipping companies’, and asked the embassy to request immediate renegotiations ‘in view of the strength of representation already being made here at senior official level and the probability of escalation to Ministerial level in the near future.’60 In the Inland Revenue’s view, the draft subsequently received from Nigeria, ‘would require us to make concessions which are far in advance of the terms which other developing countries have accepted in treaties with us.’61 Progress was made in the first round of talks, but at the second round soon after February 1979 it became apparent to British negotiators that ‘an agreement on the terms offered would have been unattractive in itself and would have served as an unfortunate precedent for future agreements.’62 The main concern was the rate of tax that could be imposed on fees for technical consultancy and management services, on which Nigeria had declared what one of its negotiators explained was a ‘total war’.63 The British economic arguments against taxation of management fees carried little weight because Nigeria’s position was to use tax to discourage their payment at all. The Revenue discussed the situation in confidence with the CBI, who ‘share our reluctance to reach an agreement until the Nigerians make concessions.’64 The UK position did not change after this, but Nigeria did moderate its position after encountering a united front from OECD countries on this point, and a new treaty was eventually signed in 1987. While in many ways these accounts of negotiations concerning withholding taxes can be seen as simple cases of compromise between two sides, the matter of management fees constitutes an abandonment of a point of principle by the UK. From a position of absolute rejection, its volte face beginning with Jamaica and Kenya in 1972 seems to have been something of a damascene conversion, at least for some years to come. It subsequently signed more treaties including a clause permitting source taxation of management fees than any other OECD member.65 By 1984, an Inland Revenue official was writing to a colleague elsewhere in Whitehall that, rather than

59 

The note terminating the Nigeria–UK treaty is dated 29 June 1978. File ref IR 40/17629. Draft telegram, Inland Revenue, 27 July 1978. File ref IR 40/17629. 61  ‘Taxation brief for Mr Barratt’s visit to Nigeria and meeting with the Director of Inland Revenue: December 1978’. File ref IR 40/17629. 62  Letter from AP Beauchamp, Inland Revenue, 18 May 1979. File ref IR 40/17630. 63 Letter from DO Olorunlake, Nigerian Federal Inland Revenue Services Department, 17 April 1979. File ref IR 40/17630. 64  ‘Extract from briefing for Chancellor re meeting with Sir David Steel on Tuesday 10/7/79.’ File ref IR 40/17630. 65  Hearson, above n 9. 60 

380  Martin Hearson ­ ghting its inclusion, ‘[o]ur current practice with particularly source-minded fi countries, as in South America, is to include such an article in our initial draft.’66 CONCLUSION

Previous research on tax treaties between developed and developing countries has focused on the balance struck by the developing country between the sacrifice of taxing rights and the revenue promoting effect of relieving double taxation. This chapter has illustrated a number of ways in which this picture can be modified, considering both the position of the UK and that of the developing countries with which it negotiated. To begin with, developing countries frequently did not depart from a negotiating position determined through complete information, rationally analysed. In cases such as Egypt and Thailand, limited negotiating capacity in the developing country meant that the treaty largely followed UK priorities. In others, such as Tanzania and Kenya, the firmest negotiating positions were determined not by strict calculations of the revenue considerations, but by the political salience of certain clauses, often not the most significant in revenue terms. Variables such as these are idiosyncratic, but it may not be too much of a stretch to suggest that negotiated settlement in a typical treaty negotiated by a developing country during this era sacrificed more taxing rights than a fully competent, purely rational, experienced and autonomous negotiator might have achieved. Further complicating the picture is both sides’ interest in concluding treaties with ‘tax sparing’ clauses. In negotiations between the UK and many developing countries, such as Kenya, Brazil and Zambia, both sides appeared to understand tax sparing clauses as concessions made by the developed country in the interests of the developing country, which is logical since a tax sparing clause entails a revenue cost for the residence country. Reviewing the correspondence within the British civil service reveals, however, that British businesses were also very keen to secure tax sparing clauses, and more generally to obtain the protection and lower withholding tax rates resulting from a tax treaty. In countries such as Brazil and Spain, where their competitors were from countries that had already secured such agreements, British businesses lobbied hard for the UK to conclude one too. Developing countries might, thus, have underestimated their negotiating hands. A final way in which this chapter suggests an alternative perspective on negotiations is the extent to which precedent was important to both sides. For some developing countries, this was institutionalised through most 66 Letter from Allen, Inland Revenue, to Greaves, FCO, 17 August 1984. File ref IR 40 17808.

The UK’s Tax Treaties with Developing Countries during the 1970s 381 favoured nation clauses. For the UK, provisions with a relatively trivial revenue impact became much more important, to the extent that they jeopardised whole treaties, because of the precedent they would set for negotiations with much larger countries. Indeed, for the Inland Revenue, certain provisions were a non-negotiable point of principle, because they deviated from the standards developed within the OECD. On occasion, British officials expressed frustration when other OECD members broke ranks. Many of the treaties discussed in this chapter, including those between the UK and Egypt, Thailand, Kenya and Nigeria, are still in force today. In the 30 to 40 years since they were signed, the UK’s tax system has undergone radical changes, in particular a move towards a territorial approach that renders tax sparing credits unnecessary. This on its own suggests that a re-examination of tax treaty networks is in order. The insights from the archives provide further impetus for such a review: as well as considering the treaties themselves, present day policymakers and negotiators in developing countries should revisit their assumptions about their predecessors’ motivations and capabilities in creating their enduring tax treaty networks.

382 

14 From Wartime Expedient to Enduring Element of Fiscal Federalism: Centralised Income Taxation in Australia since World War II RICHARD KREVER AND PETER MELLOR

ABSTRACT

In the midst of World War II, the Australian federal Labor government effectively appropriated the states’ income tax systems, with the understanding these would be returned after the war. A state challenge on constitutional grounds in the courts was unsuccessful. The appropriation suited Labor’s agenda of centralising economic powers indirectly after it failed on constitutional grounds to achieve it directly and following the war Labor made it clear the income tax would remain as a federal impost only. The ascension to power of a conservative coalition in 1949 brought an offer to share the tax base with the states, allowing reinstatement of state taxes, but the states were divided in their response and the federal government never actually promised to reduce federal taxes if states reinstated their taxes, making actual implementation impossible. In the mid-1950s, two states challenged unsuccessfully the federal appropriation again in the courts, this time seeking to overturn the grant distribution scheme underpinned by the tax appropriation. Since that time, various conservative governments have notionally offered to return the income tax base to states and Labor governments have resolved to block it. The conservative offers have faltered in part because of state divisions and in part because the offers have not been matched by concrete proposals to make room for state tax, suggesting federal conservative politicians may actually share their Labor counterparts’ goal of a fully centralised income tax, albeit for different reasons.

384  Richard Krever and Peter Mellor INTRODUCTION

F

ROM NOT LONG after Federation and the creation of Australia in 1901, the federal Labor party adopted an agenda of centralisation of economic powers. Time and again they were stymied by the Constitution which had vested primary economic powers with the states. Attempts to rewrite the economic powers in the Constitution by way of Labor-­sponsored referenda failed in 1911, 1913, and 1915, as did referenda in 1919 and 1926 sponsored by a coalition government formed in part with a breakaway Labor faction. The gateway to federal control was provided first by the German invasion of Poland in 1939 with Australia’s subsequent declaration of war enabling the central government to invoke constitutional wartime powers that were interpreted to include most economic powers, and then by the Japanese attacks on Hong Kong, Singapore and Malaya in December 1941, bringing Australia into war on a new front, opening the door to federal monopolisation of income tax. In 1942, shortly after the Japanese air force bombed the port of Darwin, a Labor-led Australian federal government moved unilaterally to appropriate concurrent income tax powers from state governments for the duration of the war. Presented as a temporary wartime fiscal measure, but more likely attributable to the government’s agenda for broader economic control during the war, if not beyond,1 the federal government’s move was immediately challenged in the courts by the states, fearful of losing a major revenue source and distrustful of the federal government’s promises of offsetting grants. A ruling by the High Court in July 1942 confirmed the legal legitimacy of the tax usurpation and the central government moved quickly to implement the change. The Australian experience was not unique. War time finance needs and a desire to centralise economic powers during the conflict prompted the Canadian government to appropriate the provincial income tax field in that country. Importantly, however, income taxation at the subnational level was resumed in Canada in stages following the war and eventually restored to its role as a significant (and ultimately the main) source of revenue for provincial governments. In Australia, however, the temporary appropriation of state income taxes remains in effect, seemingly with bipartisan support at the federal level. The result has been an unequalled inter-government fiscal imbalance (states have retained key social spending responsibilities while only the federal government has access to the tax revenue needed to pay for those programmes) and possibly the only case worldwide where a central

1  R Krever and P Mellor, ‘The Development of Centralised Income Taxation in Australia, 1901–1942’, in P Harris and D de Cogan (eds), Studies in the History of Tax Law, Vol. 7 (Oxford, Hart Publishing, 2015), 363–392.

Centralised Income Taxation in Australia since WWII 385 government has fully commandeered taxing powers constitutionally allocated to another level of government. A range of factors might explain the Australian federal government’s desire to monopolise the income tax field in the post-war era. The government faced challenges managing the economy of a nation that stretched across a vast area encompassing widely divergent needs and resources. It also faced fiscal pressures arising from its role in the Cold War that followed on the heels of Germany’s surrender in 1945. The same factors were present to an equal degree in Canada, however, a country larger than Australia and with more geographic and socio-economic diversity and with Cold War military ties to the US paralleling those of Australia. The explanation for the very different path followed by the Australian central government, even during long periods of government by a conservative party traditionally committed to state economic rights, must lie in fiscal factors unique to Australia.2 This chapter explores those factors. THE POST-WORLD WAR II TRANSITION: THE RESUMPTION OF PROVINCIAL INCOME TAXES IN CANADA

As was the case in Australia, Canada’s tax system prior to World War II included personal and corporate income taxation levied by most of the subnational (provincial) governments, commencing from as early as 1876,3 and which from 1917 operated concurrently with the federal (Dominion) government’s income tax enacted in that year.4 Provincial retail sales taxes were slower to emerge, in the face of the constitutional allocation to the provinces of power only to impose ‘direct taxation’.5 However, a Privy Council decision in 1943 opened the door to provincial retail sales taxes (and eventually provincial goods and services taxes) when it characterised a sales tax as a type of direct tax imposed on purchasers, with the vendors liable for remitting tax described as agents for the Crown.6 On its face, the Canadian Constitution provided for far more power to the central government than Australia’s. Indeed, the desire of the Australian

2 Of course, chance cannot be ruled out as a central factor. Shortly after the War, an eminent Canadian scholar suggested diverging paths would be explained both by immediate fiscal needs and ‘political accidents’: JA Maxwell, ‘Recent Intergovernmental Fiscal Relations in Australia and Canada’ (1947) 32(5) Bulletin of the National Tax Association 138 (reproducing an address delivered in Cleveland, 27 December 1946). 3 JH Perry, Taxation in Canada, 2nd edn (Toronto, University of Toronto Press, 1953), 15–19; C Campbell, ‘J.L. Ilsley and the Transformation of the Canadian Tax System: 1939–1943’ (2013) 61(3) Canadian Tax Journal 633, 650. 4  See R Krever, ‘The Origin of Federal Income Taxation in Canada’ (1981) 3(2) Canadian Taxation 170. 5  See now Constitution Act 1867 (Can.), s 92(2). 6  Atlantic Smoke Shops, Ltd v Conlon [1943] AC 550, 30 July 1943.

386  Richard Krever and Peter Mellor colonies to avoid the level of apparent centralisation in Canada informed many of the decisions made in the drafting of the (later) Australian Constitution of 1901.7 Two features in particular gave the appearance of greater central powers in Canada: a constitutional provision which transferred the power of disallowance of provincial enactments from the Sovereign in the UK to the Governor General in Canada,8 a feature deliberately omitted from the Australian Constitution, and a far broader reading of the federal government’s power to make laws for ‘peace, order and good government’ than has been accorded to the corresponding constitutional provision in Australia.9 In practice, Canadian provinces have achieved a degree of sovereignty which vastly exceeds that enjoyed by Australian states, while retaining full responsibility for social sectors such as health and education that have been largely shifted to the federal government in Australia. In contrast with the judicial decisions on the Australian Constitution, however, at key points in the country’s fiscal history crucial court rulings on the Canadian Constitution affirmed the Canadian central government’s claim to hold powers of economic management that had been denied to the Australian government in similar circumstances. The differing outcomes of court challenges

7  See, for example, L Zines, ‘The Federal Balance and the Position of the States’, in G Craven (ed), The Convention Debates 1891–1898: Commentaries, Indices and Guide (Sydney, Legal Books, 1986), 75, 76, noting that the Canadian Constitution enacted in 1867 was rejected in Australia in the lead-up to Federation in 1901 as a comprehensive model for the Australian federal system, on the basis of being ‘too centralised’ particularly in comparison with the US model. 8  Constitution Act 1867 (Can.), s 90. Even before the official constitutional debates began in Australia, it had been established in Canada that this power could be used by the federal government to disallow provincial enactments on a much broader range of grounds than the UK government might have done to laws of former Canadian colonies: see GV La Forest, Disallowance and Reservation of Provincial Legislation ([Ottawa], Department of Justice, 1955), 28–33, 101, noting in particular the views in 1876 of then UK Colonial Secretary Lord Carnarvon that the disallowance provision did not extend to validly enacted intra vires provincial legislation, rejected however by Justice Minister Edward Blake. While as recently as 1976 Prime Minister Pierre Trudeau suggested use of the power against provincial laws cutting ‘directly across’ federal laws or creating ‘serious disorder’, the power was last actually used in 1943 and Canadian Supreme Court decisions have since held that the power has fallen into disuse: PW Hogg, Constitutional Law of Canada, 5th edn (Toronto, Carswell, 2015 looseleaf), sect. 5.3(e). In the case of the Australian States, by contrast, the power of disallowance remained with the Sovereign in the UK after Federation, until the power was ended entirely in its application to the States by the Australia Acts of 1986: Australia Act 1986 (Cth), s 8, enacted on 4 December 1985. A UK disallowance power over Commonwealth government legislation, however, continues: Constitution, s 59. See on this topic A Twomey, The Australia Acts 1986: Australia’s Statutes of Independence (Sydney, Federation Press, 2010), 279–283. 9 For a discussion of the history of usage of this provision in the UK’s North American and Australian colonies, and possible limitations on legislative power from the words in the Australian Constitution, see ID Killey, ‘“Peace, Order and Good Government”: A Limitation on Legislative Competence’ (1989) 17(1) Melbourne University Law Review 24 (noting, at 25 and 49, usage of this or similar wording in instructions to governors in North America ‘from at least 1673’, referring to LW Labaree (ed), Royal Instructions to British Colonial Governors 1670–1776 Vol. 2 (1935) 812).

Centralised Income Taxation in Australia since WWII 387 to federal economic powers play a key role in explaining the divergent paths of fiscal federalism in the two nations. Unlike their Australian counterparts, Canadian provincial leaders were forced to recognise the possibility of centralisation of the income tax early in the course of the war following the release in 1940 of the final report of a Royal Commission on Dominion-Provincial Relations which recommended centralisation of personal and corporate income taxes.10 While the Report was strongly criticised by provincial Premiers, the prospect of centralisation was real. When the central government set out its plan in the April 1941 Budget to appropriate the income tax field for the duration of the war, the provincial Premiers, unlike their Australian counterparts, ultimately accepted the proposal,11 agreeing to cede tax collection powers to the central government on a temporary basis on the condition that the provinces received compensatory grants known as ‘tax rental payments’ equal to the lost revenue.12 The agreement provided for suspension (rather than termination) of the relevant provincial taxes for the war period, so that they would resume automatically after the end of the war.13 By late 1944, it was clear that the Dominion government had reached the view that to achieve full employment and high income goals, it ‘required exclusive possession of the personal income tax, corporation tax, and succession duty fields’,14 and that it would be likely to have strong public 10 Canada, Report of the Royal Commission on Dominion-Provincial Relations (RowellSirois Commission) (Ottawa, King’s Printer, 1940). 11  Campbell, ‘Transformation of the Canadian Tax System’, n 3 above, 654–658, noting that all Dominion-provincial agreements had been signed by 27 May 1942. The agreement included specific provision for the Dominion government to lower its tax rates after the end of the agreement, in particular to lower the rate of corporation tax by 10%. 12  See the Australian press report of this development in, eg ‘Income Tax in Canada, Federal Monopoly’, Sydney Morning Herald, 20 January 1942, 3, noted in Krever and Mellor, n 1 above, 388. Similarly, the Canadian government seems to have maintained a watching brief on Australian income tax developments from 1942, including reciprocating the Australian interest in Canadian fiscal moves in 1946 referred to in n 31 below. See Canadian Government, ‘Miscellaneous Taxations, Australia Income Tax’ (1942–1948), Canadian Archive LAC File T-12053, and Canadian Government, ‘Australia—Taxation, Income Tax, Uniform Taxation System, Commonwealth-State Agreement’ (1946), Canadian Archive LAC File 402-108-1-2. 13  See Dominion-Provincial Taxation Agreement Act 1942, 6 Geo. VI, c. 13 (Can.), enacted on 28 May 1942, and also, eg Ontario’s Corporations and Income Taxes Suspension Act 1942, 6 Geo. VI, c. 1, enacted on 27 March 1942, which provided (in s 5(1)) for tax not to be levied under the province’s Corporations Tax Act 1939 until termination of the intergovernmental agreement (which was to occur automatically on cessation of the war unless terminated sooner by the province). In Australia, New South Wales enacted a similar suspending statute in 1942 to suspend its income tax, expressed to terminate on the same basis as the Commonwealth legislation after the conclusion of the war: Income Tax Suspension Act 1942 (NSW), enacted on 17 November 1942, s 7. The latter Act seems not to have been subsequently amended until eventually repealed in 1976 (Statute Law Revision Act 1976 (NSW), Sch 1), while the Income Tax (Management) Act 1941 (NSW) itself was finally repealed in 2002: Statute Law (Miscellaneous Provisions) Act 2002 (NSW). 14 C Campbell, ‘J.L. Ilsley and the Transition to the Post-War Tax System: 1943–1946’ (2015) 63(1) Canadian Tax Journal 1, 21, citing a draft Dominion government memorandum of 30 September 1944.

388  Richard Krever and Peter Mellor support not to implement the tax rate reduction provided for in the intergovernmental agreement to enable restoration of provincial taxation after the war.15 At a Dominion-Provincial conference in August 1945, three months after the surrender of Germany, and coincidentally starting on the day of the Hiroshima nuclear attack, the provincial Premiers pressed the case for provincial fiscal autonomy,16 but federal negotiators showed little inclination to retreat. Circumstances changed significantly in the following six months, however. With the surrender of Japan, Canada shifted from a wartime footing to a civilian environment and revenue needs fell with the winding back of war expenditures. At the same time, a decision of the Privy Council in January 1946 on federal government regulation over the national liquor market indicated the federal government had residual constitutional powers to regulate the national economy generally, providing an avenue for federal government intervention without the need to hold all taxing powers.17 Subsequent decisions confirmed the breadth of power conferred on the federal government, including its power to control prices.18 Ongoing negotiations between the provinces and federal government had yielded no agreement on taxing powers but even in the absence of any agreement to return taxing rights, it was clear that high wartime rates were not sustainable in peacetime. In its June 1946 Budget the federal government reduced personal and company tax rates, including a significant 10 per cent cut in the corporation tax rate, as envisaged in the 1942 intergovernmental agreement.19 The Budget also provided for resumption of provincial corporate

15  Campbell, ‘Transition to the Post-War System’, ibid 24, citing a revised memorandum dated 8 March 1945. 16  Campbell, ‘Transition to the Post-War System’, ibid 31. 17  Attorney-General for Ontario v Canada Temperance Federation [1946] AC 193. Similarly, in the US, the judicially recognised scope for governmental price regulation had expanded prior to World War II, and the cases on the wartime regulation of prices of utilities and firms in other industries, based on application of the principles of the constitutional requirement for ‘just compensation’ for a taking of private property, have been described as establishing the scope of the modern constitutional doctrine of price regulation, based on the factors of justification for the regulation, its duration and the scope for withdrawal of firms from the field: JN Drobak, ‘Constitutional Limits on Price and Rent Control: The Lessons of Utility Regulation’ (1986) 64(1) Washington University Law Review 107, 109–110. 18  Reference re Anti-Inflation Act [1976] 2 SCR 373 (Supreme Court of Canada). 19  JA Maxwell, Recent Developments in Dominion-Provincial Fiscal Relations in Canada (New York, National Bureau of Economic Research, March 1948), 16 (noting that the personal income tax exemption levels were raised for single and married taxpayers, and personal tax rates were lowered across the schedule so as to reduce average tax by 10 to 15% ‘for the majority of taxpayers’); Campbell, ‘Transition to the Post-War System’, n 14 above, 49. See Income War Tax Amendment Act 1946, 10 Geo. VI, c. 55; Income War Tax Amendment Act 1947, 11 Geo. VI, c. 63 and Income Tax Act 1948, 11–12 Geo. VI, c. 52 (Can.). Further personal income tax cuts were made in the April 1947 Budget of approximately 29% on average, ie 54% at the lowest rate, 7% at the highest: Maxwell, ibid; see also an Australian press report on this Budget and detailed comparisons with the Australian federal tax cut of 26%, in ‘29 Per Cent. Tax Cut in Canada on July 1 Next’, Courier-Mail, 1 May 1947, 1.

Centralised Income Taxation in Australia since WWII 389 taxation at a rate of up to 5 per cent,20 with a corresponding reduction in the tax rental payments, which would have yielded no fiscal benefit to provinces or incentive to restore provincial taxes. Provincial acquiescence to the federal takeover of taxation and wholesale usurpation of all amounts exceeding the level of pre-war revenues that were returned to the provinces effectively ended nine months later. Following a pointed criticism of the federal government for its failure to reach agreement on ending the wartime tax appropriation, Ontario resumed its own corporate taxation in its March 1947 Budget.21 Other provinces gradually followed with provincial company and personal income tax regimes, in most cases avoiding duplication of administrative resources by relying on the federal tax agency to collect the taxes. Seven decades later, income taxes are the primary revenue sources for provincial governments. POST-WAR AUSTRALIA UNDER LABOR

In Australia, the grants formula adopted by the federal government to accompany its appropriation of state income tax powers initially led to no financial detriment to the states—the formula guaranteed the states the average net revenue they had received from their income taxes in the years immediately prior to the federal takeover. As the economy grew, however, state grants fell further and further behind the revenue the states would have enjoyed had they retained their income tax powers. With the end of hostilities in Europe and Japan, state politicians in Australia turned their attention to the return to the states of income tax powers and return of the tax emerged as a central goal of state Premiers at the first post-war federal-state finance conference held in January 1946. The conference opened with strong protestations by state Premiers of the continuation of centralised income taxation, known at the time as the ‘uniform’ income tax, with the Premiers calling for swift return of income tax powers to the states. They emphasised the importance of income taxation as a state revenue source which would allow them to pursue policies for economic growth and development.22 While not endorsed by some sectors

20  Campbell, ‘Transition to the Post-War System’, n 14 above, 49: Dominion-Provincial Tax Rental Agreements Act 1947, 11 Geo. VI, c. 58 (Can.), s. 3(2)(b). 21 Treasurer L Frost, Budget Address, Legislative Assembly of Ontario, 11 March 1947 (Toronto, King’s Printer, 1947), 31. Ontario and Quebec also introduced special corporate levies in 1947 on capital and place of business amounting in effect to income taxes of about 1.5%: DB Perry, Financing the Canadian Federation, 1867 to 1995: Setting the Stage for Change (Toronto, Canadian Tax Foundation, 1997), 43. 22 See Commonwealth Government, Conference of Commonwealth and State Ministers, Canberra, 22–25 January 1946, Proceedings of the Conference (unpublished); National Archive Series A461, Control Symbol BM326/1/3 Part 1.

390  Richard Krever and Peter Mellor of the community,23 the proposal put forward by the states envisaged a system of joint taxation in which income tax would be imposed on a uniform base while states retained autonomy over the rates imposed for state income tax.24 From the outset, however, the states were stymied by the adamant refusal of federal Labor Prime Minister Ben Chifley to relinquish the taxing powers the federal government had unilaterally confiscated from the states three and a half years earlier. For the duration of the war, the government had exercised unprecedented command over the economy. But while the High Court had granted the central government control of income tax on the basis of general constitutional powers,25 authority for federal assumption of state economic powers in other key areas of the economy, in particular price controls, was recognised by the Court on the basis of the federal government’s defence powers.26 Pre-war litigation had shown the federal government had no legitimate claims to assume these powers in general27 and it had become clear the government could not alter those limitations by way of a referendum authorising a widening of federal constitutional powers.28 The only certain path to continuing federal government exercise of what constitutionally appeared to be state economic powers was by retaining primary taxing rights and controlling the purse strings.29

23  The editorial of the Sydney Morning Herald for 24 July 1942, for example, had criticised the conduct of the states in opposing the move by the federal government and noted that ‘[i]t may be seriously doubted whether the public, after experience of single and straightforward assessment, will desire after the war to see a revival of separate State income taxes, with all the complexities and anomalies they involve’. 24  See ‘States Want Tax Powers Back, Uniform System Criticised, Mr Chifley Rejects Plan’, Sydney Morning Herald, 23 January 1946, 4. 25  South Australia v Commonwealth (1942) 65 CLR 373 (First Uniform Tax Case); see C Saunders, ‘The Uniform Income Tax Cases’ in HP Lee and G Winterton (eds), Australian Constitutional Landmarks (Cambridge, Cambridge University Press, 2003), 62, 68–69. 26  Farey v Burvett (1916) 21 CLR 433. 27  Huddart Parker and Co Pty Ltd v Moorehead (1909) 8 CLR 330. 28 Referendum questions on the scope of federal economic powers were submitted on numerous occasions, all unsuccessfully: 26 April 1911 (nationalisation), 31 May 1913 (trusts and nationalisation), 1915 (trusts and nationalisation; withdrawn 4 November), 13 December 1919 (temporary extension of power in relation to trusts; nationalisation), 4 September 1926; 6 March 1937 (marketing; aviation). A referendum was, however, passed on 17 November 1928 to provide for the validation of the Financial Agreement of 12 December 1927 under which the Loan Council was established and government borrowing centralised. 29 A referendum for temporary conferral of several constitutional powers on the federal government had also failed on 19 August 1944. Commentary since this time has often debated whether the legal proceedings by the states in the midst of the war and consequent establishment of the constitutional validity of the federal government legislation undermined prospects for resumption of state income taxation after the war, in contrast to the position of the Canadian provinces which did not launch such a challenge (given also that the judgment in 1942 was relied upon as a precedent by the High Court in the second challenge in 1957): see, for example, R Fisher, ‘A Tale of Two Systems: The Divergent Tax Histories of Australia and Canada’ in J Tiley (ed), Studies in the History of Tax Law, Vol. 2 (Hart Publishing, Oxford, 2007), 335.

Centralised Income Taxation in Australia since WWII 391 The federal government made it clear to state Premiers that it had no intention of returning tax powers to the states or risking any moves that might threaten its control over income taxation.30 Instead, it put forward a plan to update the formula it had adopted in 1942 for distribution of appropriated tax revenues.31 The original formula provided states with grants equal to the average of their income tax revenues over the two fiscal years prior to the federal takeover. The 1946 variation established fixed entitlements for each state with provision for adjustments for population change, weighting for remote area residents (which favoured the less urbanised states), and increased annually by half of the percentage amount of any increase in national average wages.32 Following a number of subsequent meetings between federal and state officials, but not politicians, state representatives made clear the states’ continuing opposition to continued federal monopolisation of the field. However, less than two months after the end of the conference the government

30 See Sydney Morning Herald, editorial of 24 July 1942, n 23 above; see also ‘Uniform Tax, Continuance After the War, Govt. Confident of Powers’, Canberra Times, 7 September 1942, 2, noting that the government’s view that ‘it already has the necessary power to retain the uniform tax plan indefinitely after the war’ was its cited reason for not including the income tax question in a constitutional referendum proposed at that time. 31  Queensland Premier Cooper noted at the outset, for example, that the Commonwealth would no longer need to maintain the high level of military expenditure of the war. South ­Australian Premier Playford meanwhile referred initially to a matter in dispute of moneys collected by the Commonwealth relating to the period prior to commencement of the uniform scheme, and then moved to a comparison with a Canadian grant proposal at that time which, it was pointed out, ‘displays an anxiety on the part of the central government to ensure that the Provinces shall be treated generously’; Commonwealth Government, Conference of Commonwealth and State Ministers, Canberra, 22–25 January 1946, Proceedings of the Conference, above n 21, 15, 17, 77. A Commonwealth government (Department of Post-War Reconstruction, Melbourne) note on the plan for continuation of uniform taxation also claimed that there was an important reason for the policy ‘not mentioned, for obvious reasons, in the submission— namely the influence of financial relations between the Commonwealth and the States on the general question of Commonwealth/State relationships’: Commonwealth Government, ‘Continuation of Uniform Taxation, Notes on Commonwealth (Treasury) Submission to Premiers’ Conference—Agenda Item No 1’; National Archive Series CP80/1, Control Symbol Bundle 20/S821, Part 1. 32  For such a scheme to continue effectively on a long-term basis (at least in times of inflation), arguably it would need to express a tax share for the States as a proportion of overall revenue from time to time rather than involving a distribution of a nominal amount or an amount calculated by reference to collections in a fixed base period (see further discussion in ‘New Federalism’, 1976–1983, below, on the tax sharing model adopted in the 1970s with provision for top-up State own-income tax surcharges—but at a time, however, when the personal income tax included indexation for inflation). The German federation has constitutionally fixed arrangements for allocation, in the first instance, of specified proportions of total personal and corporate income tax revenue between federal and subnational governments: J Schnellenbach, ‘German federalism at the crossroads: renegotiating the allocation of competencies in a new financial environment’, in R Eccleston and R Krever (eds), The Future of Federalism: Intergovernmental Financial Relations in an Age of Austerity (Cheltenham, Edward Elgar, 2017), 147, sect. 6.4.1.

392  Richard Krever and Peter Mellor introduced legislation to enact its tax retention and revenue distribution proposals.33 The intended permanence of federal income tax appropriation was reinforced by the inclusion in the law of a schedule of intended variations to the base amount for the following decade. The annual uplift factor ensured ongoing declines in state grants relative to the increase in appropriated income revenue accruing to the federal government as the economy continued to grow. Complementing its plan to retain income tax revenues, the government introduced its Budget for 1946–47 (the Australian fiscal year runs from July to June) with reduction in the highest personal tax rate on personal exertion income from its war-time peak of 92.5 per cent to 72.5 per cent. The company tax rate remained unchanged, as did a company tax surtax. As was the case in many jurisdictions, Australia had also adopted a war-time excess profits tax in addition to the ordinary personal and company income taxes to sweep up windfall profits from war contracts and this tax was brought to an end on 30 June 1947.34 The change in personal income tax rates had little impact on finances. Apart from a small dip in overall income tax collections in 1946–47 from the 1945–46 level (more than offset by a jump in customs and excise revenue that year), personal income tax revenues (including the separately identified ‘social services contribution’ from 1 July 1945) otherwise continued to increase steadily after the end of the war years as did company tax revenues.35 The decision to keep tax rates and revenues largely intact, with the exception of windfall war personal income tax and company income tax rates, contrasted sharply with the Canadian experience where federal tax cuts left room for unilateral provincial tax action to re-establish income taxation. There remained no room for unilateral state action in Australia. At the same time the federal government moved to retain primary economic power indirectly through control over the revenue, it signalled its intention to seek direct control with a mid-1946 financial statement indicating its plan to retain war-time economic powers, particularly price controls. While some controls that could only be justified by the war were removed

33  States Grants (Tax Reimbursement) Act 1946 (Cth), enacted on 13 April 1946. The law received royal assent three weeks later and the 1942 Act that had governed distributions was repealed under the same legislation. 34  War-time (Company) Tax Assessment Act 1940 (Cth), enacted on 17 December 1940; discontinued after the 1 July 1946–30 June 1947 financial year by the War-time (Company) Tax Assessment Act 1947 (Cth), enacted on 27 November 1947. 35  Between 1946–47 and 1950–51, personal income tax and social security contribution revenue was as follows: £159.3m (45–46), £154.4m (46–47), £163m (47–48), £199.4m (48–49), £196m (49–50) and £228m (50–51 est.), while company tax and excess profits tax revenues were: £55.3m (45–46), £53.4m (46–47), £69.8m (47–48), £72.9m (48–49), £83.7m (49–50) and £84m (50–51 est.): Commonwealth, Budget, 1946–47 (Canberra, November 1946), 19, Table 5 and Budget, 1950–51 (Canberra, October 1950), 19, Table 5.

Centralised Income Taxation in Australia since WWII 393 in the post-war period (for example, restrictions on the supply of state and local government services ended in 1947, clothes rationing in 1948, controls over some building materials in 1949 and tea rationing in 1950, after a change in government),36 the government pursued what it viewed as key economic powers with vigour. As federal control of aspects of the economy such as price controls were based only on war-time constitutional powers, ongoing explicit retention of economic power in the key areas would require constitutional change, which the government sought in a series of post-war referenda. The referenda—to bestow power on the government to market agricultural products (1946), control employment contracts (1946) and to retain price controls and rent controls (1948) all failed to pass. With the election of a conservative government in late 1949 and the end of over eight years of Labor rule, the states seemed poised to regain much of their economic and possibly fiscal power. THE GIVE AND TAKE OF THE CONSERVATIVES

The return to federal government of a conservative coalition in 1949 under Robert Menzies, a long-time critic of centralised income taxation, albeit one who was aware of the practical issues to be resolved before it could be unwound,37 led many to believe a change in policy towards centralisation of power and revenue was imminent. The conservative coalition’s position on Labor’s three referenda proposals to increase federal powers had been at best messy and ambiguous38 and prominent coalition politicians had strongly criticised the Labor government for its ongoing retention of state income tax powers.39 36 This process of transition is described in detail in SJ Butlin and CB Schedvin, War Economy, 1942–1945 (Canberra, Australian War Memorial, 1977), ch 25, and S Macintyre, Australia’s Boldest Experiment: War and reconstruction in the 1940s (Sydney, NewSouth Publishing, 2015). For a closer examination of the interaction between government and expert advisers in relation to post-war reconstruction policies, see also C Holbrook, ‘The Collaboration of Intellectuals and Politicians in the Postwar Reconstruction: A Reassessment’ (2016) 47(2) Australian Historical Studies 278. 37 Menzies in debate on States Grants Tax Reimbursement Bill, CPDHR, vol 186, 667 (27 March 1946), where he indicated he was ‘still opposed to it in principle’ but conceded its immediate repeal was ‘not practical politics’. 38  G Sawer, Australian Federal Politics and Law, 1929–1949 (Melbourne, Melbourne University Press, [1963] 1967), 173. In the case of the 1946 referendum proposals, the Liberal party (member of the coalition) ultimately gave no party direction to voters on the questions: ‘Menzies Outlines Liberal Party’s Policy, Australia Must Expand, Issue Before Electors’, Sydney Morning Herald (21 August 1946), 5. 39 For example, in debate on the Bills for the 1948 referendum proposal, Harold Holt referred to the claimed breach by the government of its undertaking to bring uniform taxation to an end, ‘because that constitutes one of the tests which may be applied to the Government in order to judge of its good faith in regard to the exercise of constitutional powers’: CPDHR, vol 195, 2999 (2 December 1947).

394  Richard Krever and Peter Mellor The fiscal significance to the states of losing the ability to tax incomes was highlighted in the final days of 1949 when the High Court read the constitutional restriction on State imposition of ‘duties of excise’40 broadly, establishing a precedent that over time would lead to the removal of states’ power to levy any type of indirect tax.41 Alternative funding sources available to the states if income taxes were not returned were shrinking. It was, therefore, not surprising when, at his first meeting with the Premiers in September 1950, nine months after assuming office in December 1949, Menzies indicated to the states that he was prepared to consider the resumption of income taxation by the States and offered to convene a special conference on federal-state financial relations.42 The state Premiers’ responses to the offer were surprisingly mixed and overshadowed to a large extent by the more immediate issue of securing an increase in the amount of the grants for the year.43 The state Premiers’ opening gambit was a call for repayment of £7 million ‘arrears of tax’ owing to them since 1942, with the claim that the 1942 agreement had omitted a distribution to which all parties had agreed.44 On the key point of income tax, the Labor New South Wales Premier strongly pressed for the prompt return of state taxing powers, supported by the Liberal premier of South Australia, but was not supported by the Labor Premiers of Queensland and Tasmania or the conservative governments of Western Australia or Victoria.45 The positions of the non-supporting states varied; Queensland and Tasmania apparently were opposed outright, while in other cases the leaders indicated they were not opposed to centralised income tax provided the amount of distributions were increased and a new distribution formula adopted, or were content to wait until longer term federal-state fiscal relations were settled.46

40 

Parton v Milk Board (Vic.) (1949) 80 CLR 229, 21 December 1949. Perhaps not fully appreciating the implications of the Parton case, in an address in Sydney on 16 March 1951, former wartime Prices Commissioner DB Copland, who had also had a longstanding interest and involvement in fiscal federalism prior to the War, suggested the states should turn to sales or turnover taxation to replace lost income tax revenues: DB Copland, ‘A Comprehensive Plan for the Control of Inflation’, in DB Copland, Inflation and Expansion: Essays on the Australian Economy (Melbourne, FW Cheshire, 1951), 120, 128. 42  ‘Premiers Seek Funds; Clashes With Menzies’, Canberra Times, 6 September 1950, 1. 43  The Premiers’ claim for a further £25 million was rebuffed by the Prime Minister with the Commonwealth only agreeing to an increase of £5 million, in addition to the further £7 million accruing under the statutory formula: ‘States Get £12 Million More, Premiers’ Bitter Outbursts’, Canberra Times, 7 September 1950, 1. 44  ‘States get £12 Million More, Premiers’ Bitter Outbursts’, Canberra Times, 7 September 1950, 1. See n 31 above. 45 ‘Menzies and Premiers Clash On Uniform Tax Payments’, Sydney Morning Herald, 6 September 1950, 1, noting also that the New South Wales Premier sought appointment of a royal commission on the issue and a ‘special Commonwealth payment of £47 million pending restoration of the States’ taxing power’; the motion ‘lapsed for want of a seconder’. 46 ibid. 41 

Centralised Income Taxation in Australia since WWII 395 The 1950 meeting ended with a continuation of the status quo, subject to an increase in grants that year, and an agreement that a separate finance conference would be organised following initial meetings of state and federal Treasury officials.47 An initial meeting was held early in 1951 but no progress was made on the organisation of a fiscal conference.48 In August, at the federal-state Premiers meeting, Menzies renewed his offer of returning income tax powers to the states,49 but once again there was no state consensus on the issue. In the political turmoil of the post-war period, the disagreement between states over resumption of state income taxes may not have actually been about this issue. Rather, their positions may have been bargaining chips to obtain support for economic policies that were much more important to particular states at that moment, including a dispute between New South Wales and other states over the deregulation of butter prices,50 cost blowouts related to rising inflation, and the federal government’s decision to reduce borrowing on behalf of the states (states’ borrowing powers had been centralised in 1927).51 An important factor contributing to the states’ growing divisions over return of their income tax powers was the shifting nature of the federal government’s grants. From the time of the takeover of state taxation, the federal government had supplemented its general grants program (the program that initially substituted for lost income tax revenue based on net collections prior to the takeover) with ‘special assistance’ grants funded from the additional income tax generated by the growing economy that now accrued exclusively to the federal government. These grants, which had originally started in the midst of the Depression, amounted to a form of fiscal equalisation and were paid to the less prosperous states (South Australia, Tasmania and Western Australia). The federal government also provided the states with funding from ‘specific purpose’ grants such as roads programs or ­university education and these accrued unevenly to states. The view of states on the merit 47  ‘Federal-State Conference To Be Held On Finance’, Canberra Times, 8 September 1950, 1, noting that the decision had been reached at a private meeting on the evening of the third day of the conference and ‘came as a complete surprise’ after the earlier impasse on grants increases. 48 ‘Mr. Menzies To Ask Premiers To Cut Works Programmes’, Sydney Morning Herald, 27 February 1951, 1, reporting the officials’ meeting the prior day. A report by Treasury officials on the federal-state deliberations was finalised but never published; see RL Mathews and WRC Jay, Federal Finance: Intergovernmental Financial Relations in Australia Since ­Federation, (Melbourne, Thomas Nelson, 1972) 214; W Prest and RL Mathews (eds), The Development of Australian Fiscal Federalism: Selected Readings (Canberra, Australian National University Press, 1980), 271. 49  Mathews and Jay, Intergovernmental Financial Relations in Australia Since Federation, ibid. 50  ‘Premiers’ Deadlock On Price Of Butter’, Sydney Morning Herald, 17 August 1951, 1. 51  ‘Rail, Power Jobs May Be Cut, Effects Of Loan Council Vote’, Sydney Morning Herald, 18 August 1951, 1.

396  Richard Krever and Peter Mellor of recapturing income tax rights depended in part on whether they saw themselves as net winners or losers from the redistribution of income tax revenues through the special assistance and specific purpose grants. In any event, the conference in August 1951 was quickly overshadowed by the federal government’s ‘panic Budget’ in September, which introduced significant income tax increases to deal with an inflation crisis: individuals faced a surcharge of an additional 10 per cent of the tax payable under the existing rates, and companies an increase in the rate to 35 per cent and introduction of a special levy of 10 per cent, although the undistributed profits tax was removed.52 These 10 per cent additional levies were only imposed for that one financial year, however, and in 1953–54 the highest individual income tax rate on personal exertion income was also lowered to 70 per cent. The following Premiers Conference in July 1952 brought yet another offer by the federal government to return income tax space to the states.53 Once again, the states did not agree on the merits of regaining income tax powers. The New South Wales and Victorian Premiers (loser states under the combined grants regimes) once more supported resumption of state income taxation. The South Australian and Queensland Premiers were ‘lukewarm’ about the return of their income tax power and the Western Australian and Tasmanian Premiers saw more merit in revision of revenue distribution than a return of income tax powers.54 The meeting ended with agreement by the state and federal governments to commission a further conference and study

52  ‘Sweeping Tax Rises In Budget, Big Surplus Planned, Company, Sales, Income Tax Up’, Sydney Morning Herald, 27 September 1951, 1; also page one editorial, ‘Panic Budget Will Stun Nation’, ibid. The economy reacted quickly to this policy in terms of the fall in inflation but ironically it turned out to be one of the last times fiscal policy was successful as a tool to control inflation, and in subsequent years fiscal policy ‘proved to be much less flexible than was anticipated’: see M Keating, ‘The evolution of Australian macroeconomic strategy since World War 2’, in S Ville and G Withers (eds), The Cambridge Economic History of Australia (Melbourne, Cambridge University Press, 2015), 438, 443–444, in part because the entrenchment of inflationary expectations made the impact of any response slower. With ‘partial exceptions’ such as 1952–53 and 1960–61, monetary policy was the only policy ‘actually used’ for stabilisation purposes, even though itself limited by a policy approach de-emphasising interest rate and exchange rate moves: ibid. Inflation had been building the year before and the Menzies government made an attempt ahead of the federal election in April 1951 to restore controls on capital issues under ‘defence preparations’ legislation in the context of a perceived international emergency in the growing risk of a general war: see J Boyd and N Charwat, ‘Ideology and the Economy: Capital Issues Controls, Inflation and the Menzies Government’ (2014) 60(4) Australian Journal of Politics and History 503, 510–514. 53  ‘Tax Power For States: Menzies’s Offer’, Sydney Morning Herald, 8 July 1952, 1; see also ‘Ministers Say The Government Is Not Bluffing’, Sydney Morning Herald, 8 July 1952, 1, quoting ‘senior ministers in the Federal Government’ saying that ‘the States will not be allowed to “slide out from under” the proposal’. 54 ‘Views Of The Premiers’, Sydney Morning Herald, 8 July 1952, 1. While the Herald editorialised the developments under the title ‘Beginning of the End of Uniform Taxation’, further reports were also carried in that day’s edition suggesting political opposition was already developing: ‘Obstacles Seen In Restoring State Taxation’ (reporting comments by Professor

Centralised Income Taxation in Australia since WWII 397 by the Treasury officials of ‘technical problems’ involved in the return to state income taxation.55 State finances remained problematic. In the absence of sufficient tax revenues or transfer payments from the federal governments, the states had increasingly turned to debt finance to fund public works projects but this funding source declined further in 1953 as the federal government made major cuts to loans for state use. While newspaper articles had suggested the fiscal pressures would lead to the demise of centralised income tax by the time of the next federal-state Premiers’ Conference, scheduled for February 1953, the Treasury Secretaries’ study to devise a process for resumption of state income tax became mired in discussions on asserted difficulties and unresolved questions in the proposal (on-supplied with ‘great ingenuity’ by federal Treasury officials to the political leaders of reluctant States).56 It is difficult to judge the sincerity of Menzies’ repeated offers to return income tax capacity to the states. Inflation had spiked in the early 1950s and some states had, sometimes reluctantly, established state price controls to protect consumers.57 The political costs of doing so were high, however,58 and Menzies had made it clear that the federal government had no interest in recovering the power to regulate prices by way of legislative referral of power by the state governments;59 the federal government had no interest in inheriting the political difficulties the states faced with their limited price controls. In contrast, there was no apparent political cost to retention of income tax powers and this, combined with control of borrowing powers for loans to

FA Bland, chairman of the NSW Constitutional League), and ‘Risk Of Higher Taxes’ (quoting CA Sindel, president of the Taxpayers Association of NSW, that ‘any move to hand back taxing powers to the States would be “fraught with difficulties”’), although Opposition Leader Treatt and former conservative Premier BSB Stevens favoured the proposal: ibid 2, 3. 55  ‘Commonwealth Move To Quit Uniform Tax Field By 1953, Conference To Study Return Of Tax Powers To States’, Canberra Times, 8 July 1952, 1. See JA Maxwell, ‘Another Look at Resumption of Income Taxation by the States’ (1966) E1(22) Economic Papers 1, citing the Report by Commonwealth and State Treasury Officers, Resumption of Income Tax by the States (19 January 1953), Appendix A. 56  Maxwell, ibid. 57  New South Wales Premier McGirr claimed a majority of those attending were in favour of Commonwealth resumption of controls: ‘“Inflation Forum”: Premiers’ Views’, Sydney Morning Herald, 1 August 1951, 1; three of the Premiers, however, ‘expressed reservations … or opposed it’: ‘Premiers Differ On Price Control Transfer’, Sydney Morning Herald, 1 August 1951, 4. Menzies had explained the prior day that ‘price control could not be effective without the other controls which made it “broadly successful” during the war’: ‘Conference On Inflation Opened, Menzies On Price Control’, Sydney Morning Herald, 31 July 1951, 1. 58 See, eg reports of ‘[t]hreats of militant action by bakers’ in New South Wales if not granted a price increase by the state government in January 1950: ‘Bread [Subsidy] Sought, McGirr Asks Menzies’, Sydney Morning Herald, 31 January 1950, 3. 59  ‘Price Control Is Rejected By Commonwealth’, Canberra Times, 16 August 1951, 1, noting at this point that four Premiers supported Commonwealth price control including those of New South Wales and Victoria who were prepared to make a transfer for three to five years.

398  Richard Krever and Peter Mellor be used by states, left the federal government with an unparalleled means of controlling government expenditures across all levels of government. Centralisation of the income tax also made it possible for the conservative government to wind back the progressivity of the personal income tax. Apart from the reduction in the top rate, progressivity was undermined by the conversion in December 1950 of rebates for various concessions into income tax deductions, yielding the now well-known ‘upside-down’ benefit this approach provides to higher income claimants.60 The removal of the higher tax rate on ‘income from property’ as against ‘income from personal services’ followed in October 1953.61 When the property income differential was originally introduced with the federal income tax in 1915, the tax rates applicable to property income were about 70 per cent higher than that imposed on other income.62 The gap widened to more than 100 per cent prior to World War II,63 when it began to decline due to the general rise in rates necessitated by the War. The differential dropped to 25 per cent by the time the distinction was abolished in 1953.64 When the property income surcharge was briefly re-introduced by a federal Labor government in the 1970s following 23 years of conservative rule, a 10 per cent differential was adopted.65 Significantly, the federal income tax followed the historically limited interpretation of the income concept by the Australian courts in the context of state income tax systems and the few legislative extensions to limited capital gains such as the separate ‘casual profits’ provisions of the New South Wales income tax66 had disappeared upon centralisation in 1942. While this may not have been particularly significant in the context of the highly controlled

60  Income Tax and Social Services Contribution Assessment Act 1950 (Cth), 14 December 1950, s 12. This was a reversal of the conversion from deductions to rebates which had been a feature of the move to centralisation in 1942. 61 Income Tax and Social Services Contribution Act 1953 (Cth), enacted on 26 October 1953. 62  Income Tax Act 1915 (Cth), First and Second Schedules. 63 See, eg Income Tax Act 1938 (Cth), First and Second Schedules. The Commonwealth generally used separate formulas for calculation of the rate on income from personal exertion and income from property which produced a tapering differential as income of each kind (and the corresponding rate) increased. The Royal Commission on Taxation report of 12 April 1934 noted there was ‘good ground’ for such an approach as the sources of higher earned incomes could take on a character to some extent analogous to that of ‘the accumulated capital of the investor’: Royal Commission on Taxation (Sir D Ferguson, chair), Third Report of the Royal Commission on Taxation (Canberra, 1934), 93. The original state income taxes varied in their approach: the Victorian income tax applied a double rate to income from property while the New South Wales income tax made no distinction. See Income Tax Act 1895 (Vic.), s 5 and Income Tax Act 1895 (NSW), s 1. 64  Income Tax and Social Services Contribution Act 1952 (Cth), First and Fifth Schedules. 65  Income Tax Act 1974 (Cth), s 8. 66  Income Tax (Management) Act 1941 (NSW), ss 104–17. These provisions extended to shares and real property but excluded premises ‘owned and solely used’ as a taxpayer’s principal place of abode for a period of four or more years.

Centralised Income Taxation in Australia since WWII 399 wartime economy, it grew in importance with post-war de-control, exacerbating the limitations on progressivity of the income tax. The February 1953 federal-state Premiers’ Conference got off to a rocky start, starting only week after state elections in both New South Wales and Western Australia which saw the re-election of the Labor government in the former and a shift of government from conservative to Labor in the latter. The federal-state Premiers’ Conference—described as a ‘fiasco’ in one editorial67—proved to be another fruitless exercise in terms of resolving the income tax issue. Yet another reference was given to Treasury officials to investigate state taxation, this one more broadly considering all possible tax fields,68 and the federal government undertook to prepare a precise plan quickly.69 The absence of any tangible outcome from still another federal-state Premiers conference in August of that year led to reports that ‘authorities’ by this stage had concluded that return of income tax powers to the states was ‘a dead issue’,70 a conclusion reinforced by the scant attention the issue received at the following federal-state Premiers conference in mid-1954.71 The uniform tax issue stayed alive, however. In January 1955, Sir John Latham, the retired former Chief Justice of the High Court who had presided over the Court in its 1942 decision affirming the right of the federal government to effectively usurp state income taxes,72 delivered an address on national radio warning that without a return of income tax powers to the states or a radical overhaul of the federal grant system, the independence of the states was under threat.73 Shortly before the mid-1955 federal-state Premiers’ Conference, the Labor government in Victoria had been replaced by a conservative government under the leadership of Henry Bolte. The political alignment of Premier and Prime Minister did not reduce tensions at the meeting, however, and the federal government’s announcement of tax reimbursement grants was ‘condemned’ by all of the Premiers, with the Prime Minister and Victorian Premier Bolte in strong disagreement as to whether the proposal would leave

67  ‘Conference On Taxes And Works Was A Fiasco’, Sydney Morning Herald, 23 February 1953, 2: ‘[i]n the long series of such meetings, no more futile gathering of Commonwealth and State leaders has been held than that staged at Canberra last weekend. The conference got precisely nowhere’. 68  ‘Premiers Shelve Uniform Tax Until 1954 Poll’, Canberra Times, 23 February 1953, 1. 69  Statement by Prime Minister Menzies to the House of Representatives, CPDHR, vol 221, 396ff (26 February 1953). 70 ‘Restoration Of Uniform Taxation Now Regarded As Dead Issue’, Canberra Times, 12 August 1953, 1. 71  See, for example, ‘States Get £8 Mil. More From Uniform Taxation’, Sydney Morning Herald, 1 July 1954, 3. 72  South Australia v Commonwealth (1942) 65 CLR 373 (First Uniform Tax Case). 73 ‘Independence Of States Threatened—Sir John Latham’, Canberra Times, 24 January 1955, 2, reporting the ABC’s ‘Guest of Honour’ broadcast of the previous evening.

400  Richard Krever and Peter Mellor Victoria with, respectively, a budget surplus for the year of £2 million or deficit of £4 or £5 million. What was clear to Bolte and the other Premiers was that for 22 years the same three states (Tasmania, South Australia and Western Australia) had been the recipients of special assistance (equalisation) grants paid for from income tax revenues that disproportionately came from taxpayers in the other states.74 Bolte indicated that Victoria was now ‘fully prepared to accept the Prime Minister’s offer of three years ago that the states could have back their powers’.75 But at the same time, the New South Wales government, which had supported the return of state income taxation at federal-state Premiers’ Conferences, seemed to be wavering on the issue, with the Premier indicating the state would only resume income taxation if the federal government agreed to withdraw its proposed generous tax-free threshold.76 By the end of the year, Victoria was prepared to act alone and in December 1955 the state moved unilaterally to break the deadlock, bringing an action against the federal government before the High Court, Australia’s final court of appeal and the court of first (and last!) instance in the case of constitutional challenges by one level of government against the other. Reports indicated the case was expected to be heard early in 1956.77 The motive for unilateral action had become clear by the beginning of 1956, when it was revealed that the combination of inflation and inadequate transfers from the federal government had led to Victoria’s financial position becoming ‘increasingly acute’.78 In May 1956, when the case had yet to be argued before the court, the federal Liberal party executive called for tax powers to be given back to the states immediately, reaffirming a plank in its party platform.79 At that time it was expected that the case would be heard in the October sittings of the Court with a decision before the end of 1956.80 Although it faced serious financial problems and had previously also called for the return of state income tax powers, the Labor government of New

74 J Head, ‘Financial Equality in a Federation: A Study of the Commonwealth Grants Commission in Australia’ (1967) 26 Finanzarchiv 470, 480. 75  ‘Premiers Claim Tax Allowances Short Of Needs’, Canberra Times, 24 June 1955, 1. 76 ‘Mr. Cahill’s Sincerity On Tax Queried’ (quoting claims by then Opposition Leader Robert Askin of a ‘previous offer’ by Cahill to this effect), Canberra Times, 8 September 1955, 2; see also ‘Mr. Cahill Says NSW Not Seeking Restoration Of State Taxation Powers’, Canberra Times, 12 October 1955, 1. 77  ‘Uniform tax “costly”’, The Argus, 24 December 1955, 5. 78  ‘Loan Council Called For February 1st’, Canberra Times, 10 January 1956, 1. 79 ‘Liberal Executive Declares For State Taxation’, Canberra Times, 31 May 1956, 3, reporting also comments in federal Parliament the prior day by the Minister for External Affairs (RG Casey) critical of the perverse financial incentives on the States under the uniform taxation arrangements, and his view that ‘[y]ou can’t sustain illogical anomaly indefinitely in any country all the time’. 80  ‘Tax challenge ruling before Christmas’, The Argus, 26 July 1956, 8.

Centralised Income Taxation in Australia since WWII 401 South Wales sat on the sidelines initially, waiting to see how the Victorian action proceeded. By November 1956, however, with still no end in sight to the case brought by Victoria, New South Wales, facing immediate financial difficulties,81 commenced a parallel case, applying shortly afterwards for an immediate hearing of the action.82 The Premier of Queensland also reaffirmed that that State was also seeking a return of ‘full taxing powers’, although he indicated Queensland would not join the litigation.83 The High Court heard the Victorian and New South Wales cases together in April and May 1957.84 Outside the Court, the federal Treasurer called for the return of taxing powers to the states.85 Given the unambiguous decision of the High Court in the initial 1942 appeal by the states against the federal takeover of income taxation, there was little point in the states disputing the federal tax directly. Instead, the main argument put forward by Victoria and New South Wales was that the federal law governing distribution of the revenues86 was unconstitutional, meaning that if the state action succeeded, the collapse of the legislation governing distribution of tax revenues could lead to a return to the states of income tax powers;87 even if that were not achieved, it would at worst necessitate the enactment of a more permanent revenue-sharing arrangement and possibly prevent expansion of the use of ‘tied’ grants.88 The High Court’s decision, delivered in August 1957 was a resounding loss to the plaintiff states. All seven members of the Court confirmed the validity of the federal grants law which provided for payment of grants on the condition that the states had not in the relevant year ‘imposed a tax

81  ‘Living Costs Rise 9/- For Quarter’, Canberra Times, 20 October 1956, 1, noting that the increase, due largely to ‘phenomenal’ price increases in potatoes and onions, was largest in New South Wales at 11/- per week and would flow on to that state’s government through its automatic wage increase provisions and ‘wipe out the State’s carefully balanced Budget’. The State’s Opposition Leader considered that the increase had ‘blown the State Budget sky-high’ and he also pointed out the likelihood of industrial unrest due to the divergence between wages under federal and state awards (a reported ‘loophole’ in the Commonwealth Statistician’s report also raised the possibility that New South Wales workers may only receive a basic wage increase of a little over half the actual increase at this time). 82  Saunders, ‘The Uniform Income Tax Cases’, n 25 above, 70, citing High Court transcript of proceedings, 21 February 1957. 83  ‘Q’land Wants Full Taxing Powers’, Central Queensland Herald, 29 November 1956, 10. 84  Victoria and another v Commonwealth (1957) 99 CLR 575, 23 August 1957 (Second Uniform Tax Case). 85 ‘Treasurer Out To Abolish Uniform Tax’, Canberra Times, 15 April 1957, 2, reporting Treasurer Fadden’s address to the annual conference of the Australian Country Party in ­Rockhampton the prior day. 86  States Grants (Tax Reimbursement) Act 1946 (Cth). 87  By this time the war-time forcible transfer of State tax offices to the Commonwealth had expired; Income Tax (War-time Arrangements) Act 1942 (Cth) (this Act has not at any stage however formally been repealed). 88 P Hanks, P Keyzer and J Clarke, Australian Constitutional Law: Materials and Commentary, 7th edn (Sydney, LexisNexis Butterworths, 2004), [9.6.12].

402  Richard Krever and Peter Mellor upon incomes’.89 The Court by a majority did find in favour of the states on one point, holding that the federal provision requiring taxpayers to give priority to payment of federal income tax over any state income tax was not supported by the federal government’s taxation power.90 In the context of still significant federal government income tax levels, however, this provided little relief to the states in respect of the practical problem of how to create ‘room’ for their own income taxes to be reimposed in the field. While Australia’s geo-political situation in 1957 was far different from that in 1942 when the Japanese forces were attacking Australian territory and the first constitutional challenge to the federal takeover of income taxes was decided, the ‘peacetime’ environment was at best unsettling. In 1957, as the High Court was drafting its decision on the second constitutional challenge to the federal takeover of income taxes, the Cold War was reaching new peaks. In June 1957 the US test launch of its Atlas missile failed.91 A month later the US and Australia signed a further defence agreement92 to supplement the ANZUS defence agreement Australian had entered into in 1952 and two days before the judgment was handed down the Soviets successfully tested the world’s first intercontinental ballistic missile.93 Notwithstanding the tense international circumstances, the 1957 case brought to an end any debate about the legal ‘peacetime’ validity of the centralised income tax system. The suit had been brought by states seeking a return of income tax powers. On the other side of the case was a federal government controlled by a Prime Minister who had offered time and again to return taxing powers, echoing a central plank in his party’s platform. Why did the conservative government feel compelled to fight the action and preserve its power to control the distribution of income tax revenues to the states? The answer may turn on the impact of the schemes used by the federal government to distribute the income tax revenues it had monopolised. The 1946 ‘reimbursement’ Act provided limited annual increases based on population (weighted according to population density, which favoured the less economically developed states) and part of the national increase in average wages. The definition of the base pool in nominal terms left the states consistently

89 

States Grants (Tax Reimbursement) Act 1946, s 5. Tax and Social Services Contribution Assessment Act 1936, s 221(1)(a), introduced by Income Tax Assessment Act 1942. The former s 221 of the 1936 Act, relating to assessment of income of estates of deceased persons subject to the Estate Duty Assessment Act 1914–1928, had previously been repealed by the Income Tax Assessment Act 1941, enacted on 3 December 1941, s 28. 91  RA Divine, The Sputnik Challenge (New York, Oxford University Press, 1993), 26. 92 W Reynolds, ‘Loyal to the End: The Fourth British Empire, Australia and the Bomb, 1943–57’ (2002) 33(119) Australian Historical Studies 38, 53. 93  Divine, n 91 above, 32. 90  Income

Centralised Income Taxation in Australia since WWII 403 exposed to ever-increasing inflation costs as wages were fixed by conciliation and arbitration processes that regularly adjusted salaries for cost of living changes. The same inflation continually boosted federal income tax revenues that in turn could be used partly for special assistance (equalisation) grants, which could reach levels of almost half the general grants, and partly for special purpose grants. The latter grew increasingly important in terms of both amount and their role in allowing direct federal intervention in state responsibilities. Universities, for example, were state owned bodies created by state legislation but would eventually become entirely federally-funded and federally-run institutions. Similarly, social welfare payments and regulation including setting eligibility conditions, constitutionally the responsibility of states, would eventually become solely a federally funded and controlled process. While federal Labor governments were traditionally centralist and the federal conservative governments nominally backed state autonomy and professed support for return of taxing powers, at the end of the day, it seemed both were committed to horizontal equalisation and the redistribution of economic resources that entailed. Both also seemed to enjoy the use of appropriated resources to direct spending programs in states. The position of the conservative government was confirmed in the wake of the second judicial victory for appropriation. Despite his state’s defeat in the High Court, in January 1959 ahead of the 1959 federal-state Premiers’ Conference, Victorian Premier Bolte called once again for the return to the states of income tax powers.94 To put pressure on the government, Victoria and Queensland indicated they would seek to join South Australia, Western Australia and Tasmania as ‘claimant’ States needing special assistance under the fiscal equalisation processes administered by the Commonwealth Grants Commission, which would have left New South Wales as the sole provider to the other States at least in a relative sense.95 The attempt was unsuccessful in gaining revenue for the two states but it did have two lasting impacts. First, it signalled de facto recognition by almost all states that fiscal equalisation would be an important element of the distribution of appropriated income tax revenue. Secondly, it triggered a redesign of the general grants formula by the federal government and an increase in the base pool. This was done by modifying the formula so it looked at actual population rather than using a density-weighted value and provided annual increases based on increases in national average wages including an uplift of 10 per cent of that increase.96 The express condition of

94 

‘Bolte To Seek Return Of State Taxing Powers’, Canberra Times, 6 January 1959, 2. Head, ‘Financial Equality in a Federation’, n 74 above, 479–482. 96 D James, ‘Federal-State Financial Relations: The Deakin Prophecy’, Australian Parliament Research Paper 17, 4 April 2000, 15, (also in G Lindell and R Bennett (eds), Parliament: The Vision 95 

404  Richard Krever and Peter Mellor no State income tax was no longer stated, but nevertheless this requirement continued to be understood.97 As the formula for allocation of the base funding pool was based on the proportions of prior year general and special assistance grants, however, the new scheme still included an ongoing element of bias in the distribution in favour of the less industrialised states.98 In any event, by 1959, the larger effort to ‘reset’ the system for payments of grants was put into effect. The federal government’s hope was that the new rule would be sufficiently generous to have a prospect of being long-lasting.99 Victoria agreed that it would not seek to become a ‘claimant’ State under the equalisation arrangements for the six years leading up to the specified review date provided for in the 1959 legislation enacting the new formula.100 Queensland also voted to accept the plan (that it and South Australia would only make claims for special assistance in exceptional circumstances).101 As with its predecessors, however, the states’ grants formula proved wholly inadequate for the needs of the states. While post-war inflation, and consequent cost increases for states, had subsided by the late 1950s and would not become a serious problem again for more than a decade, the funds flowing to states through the formal grants formula were insufficient to cover state spending requirements. Special assistance (equalising) grants made to three states and the special purpose grants covering an ever widening range of fields such as science and technical training, housing, and other matters,102 covered some, but not all, of the shortfall and state Premiers regularly called for more federal funds. Finally, in 1964 the conservative government in Victoria announced it would introduce a ‘marginal income tax’ with a request to the federal in Hindsight (Sydney, Federation Press, 2001), 210). Average wages were now calculated by reference to the mean number of males represented in employer payroll tax returns to the Commonwealth, and 60% of the corresponding number of females (previously 50%): States Grants Act 1959, s 4(2)(a). 97 

Saunders, ‘The Uniform Income Tax Cases’, n 25 above, 76. and Jay, Intergovernmental Financial Relations in Australia Since Federation, n 48 above, 241–243. 99 See, eg the comments at the conference of Commonwealth Trade Minister John McEwen, in Commonwealth, Conference of Commonwealth and State Ministers, Canberra, 23 and 24 June, 1959: Proceedings of the Conference (Commonwealth Government Printer, Canberra), 27 (‘I am sure that what we have achieved under this new arrangement represents an even greater measure of equity as between the components of the Federation and there is certainly a more liberal element of provision for State finances. In effect, the States now enjoy, to a measure never previously enjoyed, a guarantee of their future financial arrangements over the years ahead’). 100  Head, ‘Financial Equality in a Federation’, n 74 above, 481. 101 Commonwealth, Conference of Commonwealth and State Ministers, Canberra, 23 and 24 June, 1959: Proceedings of the Conference, n 99 above, 27. 102 Special purpose funding for roads was also a long-standing area of Commonwealth assistance which had begun prior to the Second World War and resumed in 1948. States grants for universities began in 1951. 98  Mathews

Centralised Income Taxation in Australia since WWII 405 government to collect the impost103 under the residual joint administration provisions of the income tax legislation.104 The federal government refused to collect the impost, however,105 and state interest in the plan quickly died. State complacency with the federal dominated fiscal system changed in the early 1970s as the country encountered the first of what would prove to be a much greater series of difficulties both for Australian fiscal federalism and the economy as a whole. Inflation was beginning to build again and with it pressures on state finances. The states took the opportunity at a Premiers’ meeting in Adelaide in early 1970 to develop a detailed case for introduction of independent state income taxation along Canadian lines, with a final plan presented to the Prime Minister a month later.106 Ironically, the presentation occurred just days after the High Court invalidated yet another state indirect tax, once more shrinking the range of taxes potentially available to the states.107 Some relief was provided in the following year when the federal government abandoned the payroll tax field, allowing the states to impose the tax and, following the election of a federal Labor government in 1972, expanded direct federal government spending in areas outside its specific areas of legislative power.108 Escalating inflation fed in part by the extremely inflationary oil shocks of 1973 and 1974 brought matters to a head. In mid1974 the acting premier of New South Wales floated a proposal for ‘limited’

103 

See D James, ‘Federal-State Financial Relations: The Deakin Prophecy’, n 96 above, 14. Income Tax and Social Services Contribution Assessment Act 1936–1964, s 15 (the Governor-General and Governor in Council of a state ‘may make arrangements … for the collection by the Commonwealth on behalf of the State of income tax … on a taxable income ascertained in accordance with this Act or an Act of that State’). This provision was repealed with the introduction of New Federalism state income tax surcharge legislation in 1978 (see ‘New Federalism’, 1976–1983, below), but not reinstated when the 1978 Act was repealed in 1989. 105 CPDHR, vol 44, 2559, 30 October 1964. Ontario had previously also enacted a provincial personal income tax in 1950, but did not proceed to proclaim the law after the Dominion government refused to collect it: see F Vaillancourt and D Guimond, ‘Setting ­Personal Income Tax Rates: Evidence from Canada and Comparison with the United States of America, 2000–2010’, in V Ruiz Almendral and F Vaillancourt (eds), Autonomy in Subnational Income Taxes: Evolving Powers, Existing Practices in Seven Countries (Montréal & Kingston, McGill-Queen’s University Press, 2013), 100, 101. 106  See J Bennetts, ‘Premiers’ meeting inconclusive’, Canberra Times, 27 February 1970, 1. The memorandum left open whether such State taxation would be applied only to individual incomes or also extended to company incomes, but the conference focused only on the former as the data for personal collections to that point showed this to be the much stronger source of growth in revenue: see DA Dixon, ‘The Premiers’ Conference, February 1970: A View of Federal-State Financial Relationships in Australia’ (1970) 42(2) Australian Quarterly 47, 52–53. 107  Western Australia v Chamberlain Industries Pty Ltd (1970) 121 CLR 1, 19 February 1970. 108  This took place predominantly under the Australian Assistance Plan: see M Crommelin and G Evans, ‘Explorations and Adventures with Commonwealth Powers’, in G Evans (ed), Labor and the Constitution 1972–1975: Essays and Commentaries on the Constitutional Controversies of the Whitlam Years in Australian Government (Melbourne, Heinemann, 1977), 24, 25–45. 104 

406  Richard Krever and Peter Mellor resumption of state income taxation,109 and both the New South Wales and Victorian premiers in early 1975 issued proposals for states to receive a ‘fixed share’ of income tax.110 The Queensland Premier limited his state’s request at that time to a call for ‘much more substantial funds to allow state departments to carry on their operations’.111 A February leaders’ conference produced agreement with the federal government for additional temporary assistance payments, in a mood of apparent cooperation,112 although it subsequently emerged that the Queensland Premier’s party attending the conference had included an armed bodyguard.113 However, all six States then seemed to change tack in April, calling for indexation of grants.114 Soon afterwards, in the lead up to a further federalstate Premiers’ Conference in June 1975, some New South Wales country shires took up a call for a 5 per cent share of income tax revenues, to be paid to them ‘via the State governments’.115 The news at a pre-conference meeting of experts in June that the federal government’s offer would contain less than satisfactory increases in assistance and would include an expectation that the states would increase their own taxes and charges led to harsh reactions from the Premiers—the four non-Labor Premiers were reportedly ‘furious about the terms’, ­having anticipated non-confrontational ‘meaningful negotiations’.116 In August ­ 1975, the federal government released its proposed annual Budget (ultimately blocked in the Senate, the upper house of Parliament) containing announcements which spread the austerity more widely beyond the states, with significant cuts also to federal expenditures.117 In the aftermath of the Budget announcements, the opposition Coalition parties at the federal level made a major announcement at a ‘Constitutional Conference’ held in Melbourne in late September 1975 of proposed ‘New Federalism’ policies which included a commitment to provide the states with ‘permanent access to revenue raised through personal income tax’ and a proposed discretion to impose a surcharge or rebate, with an earmarked

109  See ‘“Threat” of new State taxes’, Canberra Times (22 June 1974) 3, quoting Acting Premier Sir Charles Cutler. 110  ‘States want fixed share of tax’, Canberra Times (8 January 1975) 1. 111  ‘Qld seeks more aid’, Canberra Times (10 January 1975) 3. 112  ‘United in Adversity’ (editorial), Canberra Times (15 February 1975) 2. 113 ‘PM’s Press Conference, Premiers “have no world standing”, “Bodyguard” at talks’, Canberra Times (19 February 1975) 14. 114  ‘States want guarantees’, Canberra Times (24 April 1975) 1. 115  ‘Shires call for percentage of income tax’, Canberra Times (4 June 1975) 3. 116  ‘States Not To Get Extra Tax Funds’, Canberra Times (13 June 1975) 3. New South Wales Premier Lewis in particular was reported to be ‘staggered’ at the Commonwealth’s offer given that money was ‘flowing like a torrent into the Commonwealth coffers from the rip-off from income tax immensely stimulated by inflation’. 117  G Davidson, ‘Beer, Tobacco, Petrol Up, New tax system announced’, Canberra Times (20 August 1975) 1.

Centralised Income Taxation in Australia since WWII 407 fixed percentage for distribution through the states to local government.118 Few details of the proposal were provided (eg the percentage share was not specified). Four state Premiers were in attendance, with the Victorian Premier suggesting to the media that it was ‘the most important occurrence which we have ever taken part in’.119 A few days later the Queensland Premier affirmed his support for the proposal, citing the success of the Canadian revenue-sharing system.120 ‘NEW FEDERALISM’, 1976–1983

Five months later, in December 1975 the conservative Coalition was elected into government and almost immediately began plans to implement its ‘New Federalism’ fiscal proposals. It planned to shift to the new arrangements in two phases. ‘Phase 1’ of the plan enacted in November 1976, comprised two ‘personal income tax sharing’ Acts that provided for a share of net personal income tax collections to be paid to the states for their use and a further share to be provided to states for distribution to local governments according to the findings of Local Government Grants Commissions to be established by the states. The legislation also included detailed provisions setting minimum entitlements based on prior year grant levels but allowed the federal government to declare any hypothecated taxes to be surcharges outside the sharing pool. The health levy (an income tax supplement) adopted to fund the national health system established by the predecessor Labor government was specifically designated as being outside the pool.121 From the states’ perspective the key practical feature of the income tax sharing system was access to a ‘growth tax’ commensurate with spending responsibilities under the Constitution. The impact of the change was

118  G Davidson, ‘States to be given access to income-tax funds’, Canberra Times (25 September 1975) 10. 119  B Juddery, ‘Opposition Policy on Federalism: Fraser Avoids Specifics’, Canberra Times (25 September 1975) 10. 120  ‘State Budget increases “could be last”’, Canberra Times (29 September 1975) 6. The article reported the Premier’s observation that the policy would end ‘the Federal Government’s “lurk” of collecting taxes for both itself and the States but keeping an increasing share’ and the Whitlam government’s practice of ‘doling out money to the States as Section 96 grants, where a refusal to accept socialist strings meant no money’, and also noted that the Premier would become ‘the first Queensland Premier to attend a meeting of the New South Wales cabinet, in Sydney on October 20’. 121  States (Personal Income Tax Sharing) Act 1976 (Cth), s 6, providing for a ‘base figure’ for distribution to be determined by the Commissioner of Taxation as ‘the amount that, in his opinion, would have been the amount of the net personal income tax collections for the year if health insurance levy and special surcharges (if any) had not been imposed and special rebates (if any) had not been provided for’.

408  Richard Krever and Peter Mellor blunted, however, by the federal government’s decision immediately prior to Phase 1 to implement the recommendation of a tax reform committee that thresholds for personal income tax rates be indexed.122 The designation of at least one of the offsetting personal income tax increases made during the period as a hypothecated surcharge sometimes outside the sharing pool also limited the benefits to the states of income tax sharing. These factors along with continuing high levels of inflation throughout in the latter half of the 1970s left the states with no apparent benefit from ‘New Federalism’. Exacerbating the problem was the impact on company tax and personal tax collections of a rapid increase in the late 1970s of extreme levels of tax avoidance and evasion following adoption of an extreme literalistic approach to tax law interpretation by the High Court.123 Reduced staffing levels at the time in the Australian Taxation Office and a focus on ‘cost-effective’ compliance activities appear to have also contributed to the excessive avoidance levels.124 A subsequent increase in mid-1978 of the proportion of prior year personal income tax collections put into the sharing funding pool,125 which accompanied the next stage of the New Federalism plan and the shift in 1981 from personal income tax sharing to total tax sharing (albeit at a lower rate)126 also appeared not to benefit the states.127 The limitations of the tax sharing arrangements set the scene for the introduction in June 1978 of ‘Phase 2’ of the New Federalism program, a legislated arrangement providing for states to impose their own income tax surcharges or rebates on the federal income tax base, and for the federal tax

122  Automatic indexation was converted to discretionary increases in 1978, and ended in 1981: C Terry, Personal income tax indexation (Sydney, Australian Tax Research Foundation, 1983), 47, 55–56. 123 The approach was described by one member of that Court (in dissent) as ‘an open invitation to artificial and contrived tax avoidance’; see Federal Commissioner of Taxation v Westraders Pty Ltd (1980) 144 CLR 55, 80, per Murphy J. 124  See A Freiberg, ‘Enforcement Discretion and Taxation Offences’ (1986) 3(1) Australian Tax Forum 55, 69–72. 125 From 33.6% to 39.87%; see C Saunders and K Wiltshire, ‘Fraser’s New Federalism 1975–1980: An Evaluation’ (1980) 26(3) Australian Journal of Politics and History 355, 356; States (Personal Income Tax Sharing) Amendment Act 1978 (Cth), enacted on 22 June 1978, backdated to 1 July 1977. 126  The proportion halved from almost 40% of personal income tax revenue to little more than 20 per cent of combined personal and company income tax; States (Tax Sharing and Health Grants) Act 1981 (Cth), enacted on 18 June 1981. 127  P Groenewegen, ‘Tax Assignment and Revenue Sharing in Australia’, in CE McLure Jr (ed), Tax assignment in federal countries (Canberra, Centre for Research on Federal Financial Relations in association with The International Seminar in Public Economics, 1983), 293, 305. The States seem to have been hoping for future gains from the inclusion of Commonwealth oil and gas levy, but revenue from these sources had peaked at that stage, thus continuing the suggested trend since World War II in which ‘the States have nearly always backed losers’ in national financial arrangements: RL Mathews, ‘Intergovernmental Relations’, in RL Mathews (ed), Australian Federalism 1981 (Canberra, Australian National University Centre for Research on Federal Financial Relations, 1985), 163–164.

Centralised Income Taxation in Australia since WWII 409 administration to act in accordance with state legislation for the purpose.128 Importantly, the law ensured there would be no reduction in grants to states that adopted income tax surcharges. The federal government was very keen over the ensuing 18 months to see this particular opportunity taken up by the states, although suggestions that cuts to other state funding were intended to force this result were denied.129 Western Australia did in fact make an initial move to list a bill for an income tax on its parliamentary notice paper, but this ‘quickly and mysteriously disappeared’,130 as a range of doubts about the scheme very quickly became apparent. Prime amongst these was the simple fact that the federal government’s own top marginal income tax rate on individuals remained at 65 per cent, a high level by historical standards, which applied to the middle income level of $28,250.131 The federal government made no move to adjust any of its personal income tax rates to provide ‘tax room’ for the states, and so afford any political benefit or cover to a state imposing a surcharge of such an amount or less. The cynical view at the time suggested New Federalism was not actually about shifting taxing powers and spending responsibilities to the states so much as deflecting blame for the depressed economy onto the states as the parties unwilling to take up the role of tax-andspend Keynesian pump-primers.132 The government’s further, but ultimately unsuccessful, move to absorb some specific purpose grants enthusiastically expanded in the Labor government period 1972–1975 into the income tax sharing payments without commensurate transfers of income reinforced this view.133

128  Income Tax (Arrangements with the States) Act 1978 (Cth). As a consequence, section 18 of that Act repealed the then existing provision of the income tax law allowing arrangements for Commonwealth collection of a State income tax: see n 104, above. For discussion of the debate in Parliament on the Bill, see C Sharman, ‘Changing Federal Finance: The Politics of the Reintroduction of State Income Taxes’, in DJ Collins (ed), Vertical Fiscal Imbalance and the Allocation of Taxing Powers (Sydney, Australian Tax Research Foundation, 1993), 221, 228–229. 129  ‘Tax Sharing is too generous: Howard’, Canberra Times (7 December 1979) 21, reporting proposed cutbacks in payments to the States ahead of a premiers conference discussion, but also that Treasurer Howard ‘rejected suggestions that the Commonwealth was forcing the States to adopt Stage 2 of the Government’s federalism policy’. Earlier that year, Queensland Premier Bjelke-Petersen had criticised excessive federal government taxation: Canberra Times (16 August 1979) 3, but separately suggested ‘the only good tax is a Commonwealth tax’: B Galligan, ‘Federalism and the Constitution’, in I McAllister, S Dowrick and R Hassan (eds), The Cambridge Handbook of Social Sciences in Australia (Cambridge, Cambridge University Press, 2003), 234, 239. 130  Saunders and Wiltshire, n 125 above, 357. 131  Income Tax (Rates) Act 1976 (Cth), Sch 1. 132  See G Sawer, ‘New Federalism? Isn’t it just a return to the Old Federalism?’, Canberra Times (28 June 1978). 133  Saunders and Wiltshire, n 125 above, 359–360.

410  Richard Krever and Peter Mellor THE END OF NEW FEDERALISM: CLOSING THE DOOR ON STATE INCOME TAXATION

The Coalition’s notional return to the states, however insincere it may have been in reality, of income tax powers remained in place initially following the Labor party’s return to government in early 1983 under the leadership of Bob Hawke. The report of a tax review committee in Victoria released in 1983, calling for broader and more equitable taxation by the states134 and the call by a state task force in New South Wales in 1988 for a state personal income tax surcharge135 had no apparent impact on the views of the federal government. The catalyst for change came in March 1989 with a renewed push by the federal opposition Coalition to allow increased state scope for taxation.136 The Labor government immediately responded by announcing the repeal of the previous government’s legislation facilitating the return of income tax powers to the states,137 characterising the opposition’s proposals as an attempt by the states to avoid implementing expenditure cuts sought by the federal government.138 The government’s move was strongly criticised by the then opposition leader John Howard but by the time of the debate on the repeal Bill in May 1989, a Coalition leadership change had also occurred, and the new leader Andrew Peacock stepped back from the issue, allowing passage of the repeal. The architect of the repeal of the conservative government’s facilitating law, Labor treasurer Paul Keating, suggested removal of the law would mean ‘the end of state involvement in personal income tax for the foreseeable future’,139 although in the course of debate on the repeal Bill, the opposition shadow treasurer pointed out that the states did not need the legislation about to be repealed to impose their own income taxes.140 In the event, Keating’s ‘foreseeable future’ came much sooner than he had anticipated. In 1991 the Hawke Labor government launched its own ‘New Federalism’ agenda with a series of proposed federal-state ‘Special Premiers’ Conferences’ leading to a federal-state tax reform conference to be held in

134 Committee of Inquiry Into Revenue Raising in Victoria (JP Nieuwenhuysen, chair), Report of the Committee of Inquiry Into Revenue Raising in Victoria (Melbourne, 1983), Vol 1, xliii–xlvii. 135  New South Wales Tax Task Force (Associate Professor DJ Collins, chair), Review of the State Tax System (August 1988), xxv. 136  A Fraser, ‘Libs to look at state taxes’, Canberra Times (13 March 1989) 1. 137  Income Tax (Arrangements with the States) Repeal Act 1989 (Cth), enacted on 21 June 1989, repealing the Income Tax (Arrangements with the States) Act 1978, referred to at n 128 above. 138  Hon P Keating (Treasurer), Second Reading speech on the Bill, CPDHR, vol 166, 2539 (11 May 1989). 139  See Sharman, n 128 above, 231. 140  Dr J Hewson (Wentworth), CPDHR, vol 167, 2824ff (24 May 1989).

Centralised Income Taxation in Australia since WWII 411 November 1991 in Perth. A ‘100-page options paper’ prepared by federal and state officials on the vertical fiscal imbalance issue had reportedly identified three revenue options for consideration (resumption of income tax powers at the state level; provision of a fixed percentage of federal revenue to the states, and providing the states with extra income from the tobacco, alcohol and petroleum excise).141 In the lead-up to the conference, the Premiers apparently abandoned any plan to seek independent state income tax powers under the reform proposals.142 Subsequently, the federal government also dropped the income tax sharing option,143 with the federal treasurer in the lead-up to the conference explicitly endorsing Australia’s level of vertical fiscal imbalance as a structural outcome as ‘something we should prize and fight to keep’ rather than a ‘design fault’ of the Constitution.144 The moves prompted the state Premiers to withdraw from the proposed federalstate November conference,145 and the convening of a ‘rebel’ state Premiers meeting for the same dates in Adelaide.146 At the same time, the opposition Coalition in its Fightback! election manifesto released in November 1991 apparently adopted a shift from the traditional view of the conservatives in favour of the resumption of state income taxation to an arrangement that would see a permanent share of income tax distributed to the states.147 In December 1991, the federal treasurer, Paul Keating, was elevated by his party to the position of Prime Minister. Soon after his appointment, the new Prime Minister described the federal government’s monopolisation of income tax as ‘the glue that holds the federation together’.148 The return of income taxation to the states or an alternative income tax sharing arrangement appeared to reach a dead end, reinforced by the re-election of the Labor government in 1993 and the initial silence on the issue by the conservative Coalition when it returned to power in 1996.

141  T Wright, ‘PM drops deal with the states, Keating supporters claim a win’, Canberra Times (5 November 1991) 1. 142  ‘Premiers to Hawke: jobs top priority’, Canberra Times (28 October 1991) 1. 143  As reported in Wright, ‘PM drops deal with the states, Keating supporters claim a win’, above n 141. 144  Hon P Keating, speech to the National Press Club, 22 October 1991 cited in B Galligan, ‘Federal Renewal, Tax Reform and the States’, Proceedings of the Tenth Conference of the Samuel Griffith Society, Brisbane, 7–9 August 1998, . 145 ‘Premiers revolt: PM humbled, Meeting cancelled over tax issue’, Canberra Times (12 November 1991) 1. 146 As reported in ‘Dawkins backs Hawke stand on tax sharing’, Canberra Times (14 November 1991) 15. 147 As reported in T Connors, ‘Tax-sharing: move and countermove’, Canberra Times (22 November 1991) 1; see also R Albon and J Petchey, ‘Federalism Aspects of Fightback!’ in J Head (ed), Fightback!: An Economic Assessment (Sydney, Australian Tax Research Foundation, 1993), 551, 563, n 3. 148  Hon P Keating (Prime Minister), address to the Australian National University Reshaping Australia’s Institutions Project, Canberra 1994, cited in Galligan, n 144 above.

412  Richard Krever and Peter Mellor THE RETURN OF THE CONSERVATIVES AND ADOPTION OF TAX MIX CHANGE

The following year, 1997, the High Court’s long established broad reading of ‘excise’ tax, reserved to the federal government under the Constitution,149 was further refined in a judgment150 on regulatory licence fee imposts, effectively invalidating over $5 billion in state revenue sources. The impact on state budgets was immediate and dramatic. Leaked draft working documents tabled by the Opposition in the Queensland Parliament showed state governments had considered a range of extreme spending and taxation measures to cover the expected shortfalls over time including a 50 per cent cut in overall state spending (‘equivalent to ceasing all of the states’ expenditure on health and education’), increasing then existing conveyance stamp duties ‘by a factor of 10’, and ‘[t]ransferring tax powers’ so as to allow a 14 per cent state personal income tax using the existing federal income tax base.151 The federal government’s immediate response was to enact federal excise duty increases on the relevant commodities to replicate the invalidated taxes, with further retrospective legislation imposing tax on any taxpayer obtaining a refund of the impost that had been found to be unconstitutional.152 A short term crisis was averted but a longer solution needed. The federal government’s response was to announce in August 1998 its own substantial further move into the indirect tax field with a proposal for introduction of a broad based goods and services tax (GST) to replace its existing wholesale sales tax, and assignment of all revenue from that tax to the states.153 While presented as a ‘growth tax’ for the states,154 the prospects for the tax keeping pace with economic growth and revenue needs were always in doubt given its initial exclusions of most health and education services155

149 

Constitution, s 90. Ha v New South Wales (1997) 189 CLR 465. 151 Western Australian Government, ‘Officials’ Steering Group: State/Territory Taxation Reform, 10 September Meeting, VFI Issues Paper (Western Australian Contribution)’ (Draft), emphasis in original, tabled in the Queensland Parliament by Opposition Leader P Beattie, 7 October 1997, Queensland Parliamentary Debates, Vol 344, 3578; cited in D Hamill, The Impact of the New Tax System on Australian Federalism (Sydney, Australian Tax Research Foundation, 2006), 123. 152  See Hamill, ibid 114–115; Franchise Fees Windfall Tax (Collection) Act 1997 (Cth), s 6. 153  Australian Treasury (circulated by Hon P Costello, Treasurer), Tax Reform: Not a New Tax, A New Tax System (Canberra, August 1998), 83. 154  Then Treasurer Costello’s press release stated that ‘the GST will provide the States and Territories with a secure source of revenue that grows as the economy grows to fund essential services, such as schools, hospitals and roads’: Hon P Costello (Treasurer), ‘A New Tax System for All Australians’, Media Release (13 August 1998) . See Hamill, n 151 above, 127. 155  Australian Treasury, n 153 above, 93–94. 150 

Centralised Income Taxation in Australia since WWII 413 and the later exclusion of food156 in the context of an aging society and the federal government’s plan to reduce other transfer payments when the proposed GST came into effect (planned for mid-2000). Argument broke out between net donor and donee states as to the method of distribution of the GST revenue,157 leading to a compromise agreement for a two-year post-GST transitional period in which the federal government guaranteed no net reduction in payments to any state and use of the horizontal fiscal equalisation formula for other grants after that period. The introduction of the GST was accompanied by some significant lowering of federal income taxation in some areas. A 50 per cent concession was introduced on the taxation of capital gains on assets held for 12 months and individual and company income tax rates were lowered, along with the adoption of a number of concessions, particularly for small business158 and dramatic concessions for private pension benefits, with no tax on earnings or distributions from the pension plans.159 POST-GST FISCAL FEDERALISM

Given their limited bargaining power, it would be unfair to say the states blindly accepted the conservative federal government’s tax mix change agenda as a tool to address fiscal federalism problems. At best it was a rearrangement of the deck chairs with broader indirect taxes substituting for a narrower predecessor sales tax. While some might assert the states ‘backed a loser’160 in accepting a share of the GST in lieu of broader reform, it is clear that some Premiers signed on to the agreement believing the federal assertions that the states had been handed a growth tax161 and it has also since been claimed that the agreement came with the understanding that it would be an end to states’ attempts to recover their income tax power.162 156  For a very detailed history of the introduction of the GST in Australia, see K James, The Rise of the Value-Added Tax (New York, Cambridge University Press, 2015). 157  ibid 131–133. 158  New Business Tax System (Integrity and Other Measures) Act 1999 (Cth), Sch 9; New Business Tax System (Income Tax Rates) Act (No 1) 1999 (Cth). 159  Tax Laws Amendment (Simplified Superannuation) Act 2007 (Cth), Sch 1, enacted on 15 March 2007. 160  Mathews, ‘Intergovernmental Relations’, n 127 above, 163–164. 161 Former Queensland Premier and 1999 Agreement signatory Peter Beattie, for example, claimed, ‘what the States were promised was a growth tax, it’s as simple as that.’ Former Queensland Premier P Beattie, interview on Sky News, PM Agenda, 24 December 2015 (author recollection). 162  See, for example, the view of Western Australian Premier Barnett that ‘if you go back to the start of the GST under John Howard, it was put in place where the states were to get the GST collection, all of it, and in return the states gave up their constitutional right on income tax and company tax’. See ‘WA Premier fires the first salvo ahead of COAG meeting’, ABC 7.30, transcript of interview (10 December 2015) .

414  Richard Krever and Peter Mellor The failure of GST revenue to grow while state spending responsibilities continued to climb prompted the states into action. In July 2007 Queensland commissioned a consultant report on funding options and received a recommendation that a state personal income tax be reinstated, a proposal quickly rejected by the state cabinet.163 Two months later, New South Wales commissioned a review of state taxes to be carried out by a state tribunal,164 which ultimately concluded there was little scope for resumption of income taxation by the states.165 Following a change in government in late 2007 and the election of the first Labor Prime Minister in over a decade, the federal government announced in its May 2008 Budget that it would proceed with a ‘root and branch’ taxation review. The ‘Henry Review’, as it became known after its chairperson, the Secretary of the Department of the Treasury, organised a major ­international academic conference in June 2009 which highlighted, among other things, the feasibility of state co-occupancy of the income tax field with the federal government in a manner similar to the system used in Canada, which was assessed as having ‘worked well’.166 At least one state was subsequently reported to be interested in pursuing the state income tax option,167 although other significant commentary at the time also ­emphasised the lack of any community pressure at that point for a change to centralised taxation arrangements.168 The review reported in December 2009, only noting

163  S Parnell, ‘Queensland open to levying income tax’, The Advertiser (20 August 2009) . 164  Hon M Iemma (Premier), ‘Review to examine ways to improve NSW taxes, State Plan Priority P5: Maintain NSW AAA credit rating’, News Release (16 August 2007) . 165  Independent Pricing and Regulatory Tribunal of New South Wales (Dr M Keating, AC, chair), Review of State Taxation, Report to the Treasurer (Sydney, October 2008), 38: ‘over time, Commonwealth government policy decisions and the High Court’s interpretation of the Constitution have effectively removed the States’ ability to impose income tax’. 166  R Bird and M Smart, ‘Assigning State Taxes in a Federal Country: the Case of Australia’, in Melbourne Institute of Applied Economic and Social Research, Melbourne Institute— Australia’s Future Tax and Transfer Policy Conference, Proceedings of a Conference (Melbourne, 2010), 72, 77, 87. A separate conference in June 2010, shortly after release of the report of the Henry Review, included commentary on the disincentives for state tax reform posed by the Commonwealth Grants Commission’s fiscal equalisation methodology, and the scope for reforms to state taxation such as expansion of the payroll tax or access to personal income taxation: see, respectively, N Warren, ‘Intergovernmental Fiscal Arrangements as a Constraint on State Tax Reform under Henry’, in C Evans, R Krever and P Mellor (eds), Australia’s Future Tax System: The Prospects After Henry (Sydney, Thomson, 2010), 305; JR Kesselman, ‘Payroll Tax, GST, and Cash Flow Tax: Reforming State Indirect Taxes’, in Evans, Krever and Mellor (eds), ibid 273. 167  S Parnell, ‘Queensland open to levying income tax’, n 163 above. 168  Hon Sir G Brennan, ‘The Parameters of Constitutional Change’ (2009) 35(1) Monash University Law Review 1 at 4, 11; Hon Sir A Mason, ‘Constitutional Advancement: Some Reflections’, in HP Lee and P Gerangelos (eds), Constitutional Advancement in a Frozen Continent: Essays in Honour of George Winterton (Sydney, Federation Press, 2009), 283, 294.

Centralised Income Taxation in Australia since WWII 415 that sharing of the personal income tax base between the federal government and states was constitutionally possible.169 In any event, most of the recommendations of the Henry Review were sidelined at the time by the federal government’s decision in May 2010 to proceed with a central and controversial recommendation of the review, adoption of a resource rent tax on mineral super profits.170 A later tax forum171 convened in October of 2011 saw a proposal from the Treasurer of Queensland for state access to income tax,172 and income tax sharing was also suggested by New South Wales, but there was no following discussion at subsequent federal and state Premiers’ meetings. The fiscal fortunes of the states changed completely following the return to power of the conservative Coalition in the second half of 2013 under the leadership of Prime Minister Tony Abbott. The new government’s first Budget in May 2014 signalled the most significant shake up of federal fiscal relations in decades based on a reduction in payments to the states in the areas of health and education of $80 billion over the following 10 years. This was followed in March 2015 by the release by the federal government of a taxation discussion paper indicating it was a priority for the states to reform their existing limited tax bases.173 The clear implication was that the only long term solution to the vertical fiscal imbalance would be a significant reduction in government health and education services with a shift to private providers paid directly by consumers. The lead party in the Coalition government subsequently replaced the Prime Minister in September 2015 and in the following weeks a variety of tax reform options were mooted by the federal government, including reform of income tax concessions,174 an increase in the rate of the GST,175

169  Australia’s Future Tax System Review Panel (Dr K Henry, AC, chair), Australia’s future tax system: Report to the Treasurer (Canberra, December 2009), Part 2, Vol 2, 682. 170  Hon K Rudd (Prime Minister) and Hon W Swan (Treasurer), ‘Stronger, Fairer, Simpler: A Tax Plan for Our Future’, Media Release (2 May 2010). 171  See P Darby, ‘The 2011 tax forum and the 1985 tax summit’, Australian Parliament, FlagPost (23 March 2011) . 172  C O’Brien, ‘Qld push for income tax access’, ABC Online (4 October 2011) ; Australian Treasury, Tax Forum, Day One, 4 October 2011, transcript of Session 2: State Taxes, (comments of then New South Wales Treasurer Mike Baird). 173  Australian Government, Re:think, Tax discussion paper (Canberra, March 2015), 154–155, . 174  P Coorey, ‘Turnbull’s summit greenlights super tax reform’, Australian Financial Review (1 October 2015) . 175  P Coorey, ‘Malcolm Turnbull confirms GST increase on the table’, Australian ­Financial Review (28 October 2015) .

416  Richard Krever and Peter Mellor and extension of the GST to fresh food, health and education,176 but there was no commitment to pass any consequent revenue on to the states and no reforms eventuated. For their part, some states called for an increase in federal income tax by way, for example, of a higher rate on the hypothecated income tax used to fund the national health system to provide additional state funding,177 or a partial switch from division of GST revenue to a guaranteed share of the federal personal income tax.178 More significantly, a concerted campaign by the states and the education and medical sectors for restoration of the $80 billion of cuts to payments to the states to fund health and education services led to a surprise announcement by the new Prime Minister, Malcolm Turnbull, in early April 2016 that a policy of allowing the states to return to the income tax field would be a central feature of discussions at the federal-state Premiers’ meeting scheduled for the middle of that month.179 The Prime Minister however immediately associated the proposal with a suggestion that the federal government would only continue to be involved in funding of private schools and withdraw from funding of state government (public) schools.180 This short-lived suggestion met with immediate resistance from a variety of sectors and the state income tax proposal was,

176 J Rolfe, ‘Experts argue the GST exemption on fresh food is outdated and means the government misses out on $6.4 billion in revenue’, News.com (6 December 2015) ; D Conifer, ‘GST: Fresh food, healthcare and education to cost billions more if tax broadened, PBO finds’, ABC News online (10 December 2015) . 177  J Massola, ‘GST to dominate agenda at COAG’, Sydney Morning Herald (2 December 2015) . 178 Hon J Weatherill (Premier), Address to the American Chamber of Commerce iiNet Business Luncheon, Adelaide, 26 November 2015, . Under this proposal, it was suggested (at 14) that ‘[a]ll non-GST Commonwealth grants to the States—excluding i­nfrastructure ­payments and on-passed grants—would be converted to a share of the income tax base’. 179  M Kenny, ‘Malcolm Turnbull’s tax revolution: Hand income taxing powers to the States’, Sydney Morning Herald (30 March 2016) ; C Chang, ‘Prime Minister Malcolm Turnbull asked whether income tax reform is a “double tax”?’, News.com (31 March 2016) . It was also noted at this time that ­Malcolm Turnbull had published commentary opposing the then state income tax surcharge proposals put forward by Malcolm Fraser in the mid-1970s: L Oakes, ‘The puff adder bites: Prime Minister Malcolm Turnbull borrowing from Malcolm Fraser’, The Herald-Sun online (2 April 2016) . 180  Kenny, ibid; Chang, ibid.

Centralised Income Taxation in Australia since WWII 417 not surprisingly, quickly dropped.181 A poll of voters reported a few days after the 2016 meeting found that 58 per cent ‘strongly oppose[d] giving states the power to levy their own income taxes’.182 WILL THE RESUMPTION OF STATE INCOME TAXATION EVER SEE THE LIGHT OF DAY?

More than 75 years have passed since the Australia federal government ‘temporarily’ appropriated state income tax powers in the midst of World War II. Subsequent litigation showed there are no legal or constitutional impediments to the enduring effective retention by the federal government of state income tax powers, the consequent vertical fiscal imbalance, the forced fiscal equalisation by way of redistribution of taxes, or the direct intervention in state economic and social responsibilities through the use of special purpose grants tied to implementation of federally mandated policies. The only constraints, it seems, are political. Labor governments since 1942 have been adamant that income tax powers will never be returned to the states. Economic control through control over revenue has been an aim of Labor since Federation. Until recently, Conservative coalition governments, in contrast, have regularly offered to return income tax powers to the states. The sincerity of the offers has never been tested, however, in the absence of state unanimity to negotiate the package of reduced grants and increased state taxing power needed to give effect to a return of state income taxes. There are a number of factors that make unanimity difficult to achieve. The net winners from fiscal equalisation fear a reduction in equalisation payments if a greater share of income tax revenues flow to the states that generate the revenue. There is also concern that inter-state competition could lead to a race to the bottom if states start to cut rates to attract investment or business activities. Other concerns include the difficulty of reaching agreement on the alignment of state and federal taxes to reduce compliance

181  This meeting was the subject of a Senate committee enquiry which included an examination of the development of the state income tax proposal in the lead-up to the meeting, the majority report finding that this development had occurred within the Department of Prime Minister and Cabinet without significant consultation with other departments such as the Treasury or the states: Australian Senate, Finance and Public Administration References Committee, Outcomes of the 42nd meeting of the Council of Australian Governments held on 1 April 2016 (Commonwealth, Canberra, May 2016), 23–27, discussed in N Aroney, ‘Reforming Australian Federalism: The White Paper Process in Comparative Perspective’, paper presented at the A People’s Federation for the 21st Century: A National Conference on Reform of Australia’s Federal Democracy conference, Brisbane, 16–17 June 2016, text at nn 27–29, . 182  D Crowe and P Hudson, ‘For voters, it’s a big no to Malcolm Turnbull’s income tax big idea’, The Australian (5 April 2016).

418  Richard Krever and Peter Mellor costs, the difficulty in negotiating an administration agreement with the federal government to ensure taxpayers only have to deal with a single income tax administrator, and finally, the difficulty in reaching an agreement among states on a single formula for distributing taxing rights in the case of enterprises across state borders. The pre-War experience, particularly from 1936 to 1942 when tax bases were largely harmonised (though with some areas of divergence in various states), tax administration agreements were in place, an income attribution scheme for cross-border transactions by a single entity was in place, and the federal government provided equalisation payments, shows that all these issues can be managed or overcome. The real question is whether vertical fiscal imbalance will grow to the point that states see no better alternative to reaching a consensus to recapture their taxing rights. The fact that the state income tax option continues to be advocated by state or federal representatives as a solution after 75 years illustrates clearly that its time has not passed. Restoration of state income taxation remains an option on the Australian fiscal federalism table.

15 The Historical Meaning of ‘Income’ in New Zealand Taxation Statutes, Cases and Administration, 1891–1925 SHELLEY GRIFFITHS*

ABSTRACT

New Zealand’s first income tax provisions were included as a relatively minor part of the Land and Income Assessment Act 1891. This Act was one of many reforming pieces of legislation introduced by the Liberal Government, led first by John Balance and later by Richard Seddon. The Act did not define ‘income’ or ‘profit’. The generally accepted orthodoxy is that faced with these undefined terms, judges turned to trust law for assistance and the result was the exclusion of ‘capital gains’ from the tax base. This chapter reconsiders this orthodox view. It looks at the role of land in late nineteenth century New Zealand society, the specific provisions about the taxation of land (both income tax and land tax) in the context of an overt policy to favour small over large holdings, the Parliamentary debates on introduction of the first income tax and its successors and the case law. The chapter suggests that judges, politicians and administrators in New Zealand were influenced by much more than the concepts developed in trust law. Indeed, there is some evidence that they were influenced as much by commercial, trade and agricultural ideas of structure and tangible and intangible assets with long (and sometimes perpetual) life and the periodic and measurable returns from those assets.

*  I am grateful to my colleague Stuart Anderson for his most helpful input to many aspects of this paper.

420  Shelley Griffiths INTRODUCTION

I

NCOME TAX FIRST came to New Zealand in a composite Land and Income Tax Act in 1891. To begin with, it was the smaller part of the statute and it was the minor revenue source until about the time of World War I. This paper sets out to explore what was meant by the term ‘income’. To put it another way, was ‘income’ ever a comprehensive term including what has later been described as capital gains? In 1986, Professor Ross ­Parsons wrote that: [t]he income tax is an institution whose policy, beyond the pursuit of revenue, was always obscure, an institution that borrowed a concept—income—from another institution, the trust, so as to spare its makers too much of a drain on their creative imaginations.1

Parsons referred in particular to the effect of the 1921 English case, Inland Revenue Commissioners v Blott.2 This use of a trust concept was a peculiarly inapt base for raising public revenue and income tax was therefore born with defects both ‘congenital’ and ‘incurable’.3 In New Zealand, this analysis gained rapid attention and a level of acceptance. The 1989 Consultative Committee Report on the Taxation of Income from Capital stated that the current exemption of certain types of capital income was not the result of overt legislative decision. Rather, it was the consequence of judicial interpretations that drew upon concepts that had evolved in the unrelated area of trust law.4 In 1986, the Royal Commission on Social Policy, chaired by Sir Ivor Richardson, also accepted that view.5 In A Taxpayer v Commissioner of Inland Review,6 it was given judicial endorsement. However, the full quote from Richardson J in that case describes other factors at play in the understanding of ‘income’. Commenting on the fact that the New Zealand courts had looked to English jurisprudence for guidance, he noted that it had been ‘natural’ for English courts to apply ‘property and

1 R Parsons, ‘Income Taxation– an Institution in Decay?’, (1986) 12 Monash University Law Review 77, 77–79. This analysis has been echoed by academic writers in New Zealand, see K Holmes, The Concept of Income: A Multi-Disciplinary Analysis (Amsterdam, IBFD, 2001) 185–193; J Prebble, ‘Why is Tax Law Incomprehensible’ [1994] British Tax Review 380, 388. 2  Inland Revenue Commissioners v Blott [1921] 2 AC 171 which relied on the principles in Bouch v Sproule (1887) 12 App Cas 385. On the principles in Bouch v Sproule see Law Commission (UK) Capital and Income in Trusts: Classification and Apportionment (Law Com No 315, 2009). 3  Parsons, above n 1, 82. 4  Consultative Committee on the Reform of the Taxation of Income from Capital, Consultative Document on the Taxation of Income from Capital (Wellington, New Zealand Government, 1989) 13, quoting directly from Parsons’ article. 5 Royal Commission on Social Policy, The April Report Vol III, part 2 (Wellington, The Commission, 1989) 450. 6  A Taxpayer v Commissioner of Inland Revenue (1997) 18 NZTC 13350 (CA).

Historical Meaning of ‘Income’ in New Zealand Taxation 421 trust’ concepts. Thus it had come to be seen that income was a gain derived ‘from’ property that left the property intact. Income was a ‘flow’ of money. Further underlying the notion of income was the idea of ‘gain from the ­carrying on of an organised activity’ directed at the making of a profit. Finally, there was the influence of the ‘ordinary concepts and usages in the community, particularly in commerce, in the ascertainment of income’.7 New Zealand tax academic, John Prebble, wrote in 1994: the 1891 Act charged all business profits and gains to income tax, making no distinction between capital and income. Of course, no one took this seriously, and New Zealand practice followed the law as interpreted by the English judges. But in case of excessive zeal on the part of tax authorities, Parliament knocked most of the capital gains provisions out of the Act by the time it was consolidated in 1900.8

This paper seeks to explore what was meant by ‘income’ tax by those who enacted the legislation, first in 1891 and in subsequent Land and Income Tax Acts, and by those who interpreted and administered it until about 1925. The aim of the paper is to consider what ideas were influential in that early period and, in particular, to identify whether trust concepts were evident in the understanding of income in the relevant sense. Later in the twentieth century, New Zealand chose, almost uniquely, not to adopt a comprehensive capital gains tax. What the concept of income meant in that early period might shed some light on that later policy choice. TAXATION IN NEW ZEALAND BEFORE 1891

There has not been a lot of research on the history of taxation in New Zealand either by general historians or by legal historians. There are some very valuable studies of brief periods,9 and broader reviews,10 by legal historians. There is a ‘political history’ of taxation.11 A check of the major general 7 

A Taxpayer v Commissioner of Inland Revenue at (1997) 18 NZTC 13350 (CA), 13355. Prebble, above n 1, 389. 9  M Littlewood, ‘In the Beginning: Taxation in Early Colonial New Zealand’, in P Harris and D de Cogan (eds), Studies in the History of Tax Law Volume 7 (Oxford, Hart Publishing, 2015). 10 P Harris, Metamorphosis of the Australasian Income Tax: 1866 to 1922 (Canberra, ­Australian Tax Research Foundation, 2002); L Facer, ‘The Introduction of Income Tax in New Zealand’, (2006) 12 Auckland University Law Review 44; J Barrett and J Veal, ‘Land Taxation: A New Zealand Perspective’, (2012) 10 eJournal of Tax Research 573; M Daunton, ‘Land Taxation, Economy and Society in Britain and its Colonies’, in J Avery Jones, P Harris and D Oliver (eds), Comparative Perspectives on Revenue Law: Essays in Honour of John Tiley (Cambridge, Cambridge University Press, 2008), 212–218; and A Cho, ‘The Five Phases of Company Taxation in New Zealand: 1840–2008’, (2008) 14 Auckland University Law Review 150. 11  P Goldsmith, We Won, You Lost, Eat That! A Political History of Tax in New Zealand since 1840 (Auckland, David Ling Publishing, 2008). 8 

422  Shelley Griffiths histories of New Zealand finds scant reference to tax or revenue raising.12 Indeed there is very little in the way of comprehensive economic histories of New Zealand. At some point we might be able to join the disparate pieces to get a rather more complete story. In the interim, we must be satisfied with vignettes. At a broad level we can say that until the late nineteenth century most government revenue was provided from the proceeds of land sales and from excise taxes and customs duties. In a colonial society whose original raison d’être was settlement for settlement’s sake, land was the most significant asset. On one hand was the working out of the relationship between settlers and the indigenous owners of the land, a matter still not entirely resolved in 2017. Even beyond that fundamental matter, the role of land in settler society was of paramount importance. Who owned it, how it was acquired, and how much should reasonably be owned by one person or family, were among the questions that came to vex settler New Z ­ ealanders by the late nineteenth century. In land we can see two important things combined. It was a significant and valuable asset to which taxation could be affixed. Secondly, tax could be used as a means of redistributing the ownership of land. The second aspect was something that assumed importance after the Liberal government was elected in 1890. Between the early nineteenth century and 1891 various methods of taxation were tried. Throughout that period, customs and excise duties remained a constant and, in the early part of the period, land sales were an important source of Government revenue. A Land Tax Act was passed in 1878. It was in force for barely a year when a change of Government led to it being replaced by a Property Tax Act in 1879. By 1878, the interest burden on foreign loans (that had been used to fund extensive infrastructure development in the previous decade) had become so heavy that more revenue was necessary. In 1878 George Grey, the Governor of the colony from 1845–1853 and 1861–1868, was the Premier. In between these two different phases of his career, Grey had returned to England and there he had developed radical views about land. He was convinced that the great English landlords had expropriated the land of the people and he was heavily influenced by JS Mill’s arguments that increases in land values were ‘unearned’.13 The Treasurer in the Grey Government, John Ballance, had also read Mill’s writing in the 1870s and he too was concerned about land ownership and the need to encourage small farms.14 It was Ballance who introduced the Land Tax Bill and spoke of the need to increase Government revenue but also

12  See eg: J Belich, Paradise Reforged: A History of the New Zealanders from the 1880s to the Year 2000 (Auckland, Allan Lane, 2001); and P Mein Smith, A Concise History of New Zealand, 2nd edn (Cambridge, Cambridge University Press, 2012). 13  Daunton, above n 10, 214–215. 14 T McIvor, The Rainmaker: A Biography of John Ballance Journalist and Politician 1839–1893 (Auckland, Heinemann Reed, 1989) 51–62.

Historical Meaning of ‘Income’ in New Zealand Taxation 423 identified that the population was increasing rapidly and land prices were increasing as a result. Further, the expansion of railways (the partial cause of the spiralling debt burden) had led to increasing land values and landowners ought to contribute some of that increase by way of tax. The tax was on the unimproved value, so as not to penalise industry and entrepreneurial behaviour and at the same time to discourage speculation. The following year in 1879, an income tax bill was proposed by a politically weakened Grey (who by then had publicly fallen out with Ballance) but failed to get past the first reading. The Grey Government fell shortly thereafter, lost the subsequent election and was replaced by a Government that quickly got rid of the land tax and replaced it with a property tax. Harry Atkinson, the new Premier, had long been opposed to land tax because it singled out one form of property for taxation. The new property tax was based on the New York model. The Act required every property owner to return statements on all ‘property’ owned and the ‘estimated’ value of that property if it were ‘offered at public auction for cash’.15 Assessments were made triennially. Tax was levied on the value of that property less a £500 exemption. The property tax remained in force through the 1880s although it was unpopular and much argued about. It provided about 10 per cent of revenue raised, with customs and excise duties still providing most of the revenue (around 70 per cent through the decade). NEW ZEALAND IN 1891 AND THE 1890 ELECTION

The Atkinson Government limped on until the election of 1890. Taxation was an issue in the election in two ways. First, the property tax and the ­levels of excise tax on the necessaries of life were widely unpopular. S­ econdly, the Liberal Party proposed a Land and Income Tax. Land, and what was termed the ‘land question’, was an essential part of the political philosophy of John Ballance, the Liberal Party leader and Premier from 1890 until his death in 1893. New Zealand’s first large nationwide industrial strike began in 1890 as seamen and wharf labourers lent support to their Australian counterparts. This strike was one of a number of issues that had brought the ‘labour question’ to New Zealanders’ attention. Two years earlier, the Reverend Rutherford Waddell had drawn attention to the appalling working conditions of seamstress pieceworkers.16 For Ballance, the labour problem would 15 

Property Assessment Act 1879, ss 12 and 32. response to the revelations and concerns was the establishment of a Royal Commission of Inquiry, see Sweating Commission, Report of the Royal Commission Appointed to Inquire into Certain Relations between the Employers of Certain Kinds of Labour and the Persons Employed Therein (Appendix to the Journals of the House of Representatives 1890, H—5). 16 The

424  Shelley Griffiths not be solved until the land problem was solved. Many unionists agreed, especially those who were followers of the single-taxer Henry George who visited New Zealand in March 1890.17 The 1890s were a key decade in New Zealand’s history and the reforms of the Liberal government formed the basis of one of the defining myths of twentieth century New Zealand. As a ‘better Britain’ freed from the moral turpitude of the Old World, populated by good yeoman stock, it was a nation poised to create a moral society. The revelations from the observations about sweating cast something of a shadow over this myth. Part of the underpinnings of this story is the special place land occupied in New Zealand society. There was in New Zealand an ‘idealised rural Britishness’.18 The open space and access to land made the New Zealand Briton healthier, stronger and fitter than his (or perhaps even her) Old World cousin. At the same time, ready access to land ownership was fundamental to the establishment of a democratic society of independent and self-reliant people. Ballance was convinced that the reduction of conflict in society would only occur through closer land settlement.19 Concentration of land ownership led to the dominance of the polity by a few. Breaking up the large estates became both a practical matter of policy and part of the developing special New Zealand story and attitudes to land and land ownership were an essential part of the Arcadian vision that took root in nineteenth century New Zealand. While historians agree that the Liberals had no coherent political philosophy, they created what later was seen as a ‘social laboratory’. One distinguishing political idea central to the Liberals’ world-view was land reform and specifically the need to encourage closer settlement.20 The 1890s were also a point of transition in New Zealand from an economy based on extractive industries and enthusiastic colonisation for its own sake, to one in which the production of protein, principally sheep meat and dairy products, was dominant. There was for New Zealand the happy co-incidence of a growing aspirational lower middle class in Britain keen for a diet of protein, and who liked the relatively mild flavour of sheep meat, and increasing production in the temperate climate of New Zealand. In New Zealand it was the growing class of small to medium farmers on blocks of their own land who were the suppliers of the meat and dairy products to the British market. Whereas pastoral farming depended on large tracts

17 RE Weir, Knights Down Under: The Knights of Labour in New Zealand (Newcastle, Cambridge Scholars Publishing, 2009) 52–58. 18 Belich, above n 12, 84; see also M Fairburn, ‘The Rural Myth and the New Urban ­Frontier. An Approach to New Zealand Social History, 1870–1940’, (1975) 9 New Zealand Journal of History 3. 19  McIvor, above n 14, 167–172. 20 D Hamer, The New Zealand Liberals: The Years of Power, 1891–1912 (Auckland, ­Auckland University Press, 1988) 64–66.

Historical Meaning of ‘Income’ in New Zealand Taxation 425 of land, the ‘protein factory’ needed smaller blocks.21 This transition was aided by easy access to credit but the government’s role in shifting land holdings to units compatible with protein production cannot be underestimated. These were the objectives behind the Lands for Settlement Act 1892 and the Government Advances to Settlers Act 1894 which aimed at breaking up the large estates and providing farmers with access to credit. In 1890, the Liberals campaigned on a policy that included greater access to Crown land and the compulsory acquisition of land out of the ‘big estates for small farm settlement’. They also promised the abolition of taxation on the ‘necessaries of life’. There would also be taxation on the value of land net of improvements and a ‘graduated [land] tax on the big estates’.22 Income tax was part of the policy, but it was not one to which much attention was paid.23 The Liberals won the 1890 election. The Land and Income Assessment Act 1891 was introduced by the following year. This took New Zealand on a new path to the raising of revenue. The Land and Income Assessment Act 1891 was a slim statute. Its purpose was revenue raising with no purpose of redistributing wealth and a blanket £300 exemption had the effect of excluding the majority of taxpayers.24 The statute was principally about land tax, as the Parliamentary debates on its passage ­demonstrate. In terms of the revenue raised, in the short run at least income tax was also something of a bit player as the following table shows.25 Percentage of Taxation Raised by Source, 1900–1930 Year

Customs Duty

Land Tax

1900–01

74

10

6

3

7

1905–06

73

10

7

3

7

1909–10

66

15

7

5

7

1919–20

33

9

39

6

13

1929–30

48

6

19

11

16

21 

Income Tax Death Duty

Other Direct Tax

Belich, above n 18, 54–56. ‘Mr Ballance’s Policy’, Evening Post (Wellington, 1 October 1890) 2. 23  It has not drawn much attention in later writing either, for example in the biography of Ballance income tax is only discussed in the context of the 1891 Bill. 24  By 1900, the land tax raised £295,000 and income tax £174,000 of the total £3 million raised. It was this way until the First World War, when income tax outstripped land tax, and by the beginning of World War II income tax raised more revenue than any other source. Until 1940, customs duties were a significant source of revenue: New Zealand Official Year Book, 1900, 1910, 1920, 1930, 1940, 1950 and 1960; . 25  On the introduction of land tax and its history until abolition in 1992, see Barrett and Veal, above n 10 and Daunton, above n 10, 212–218. 22 

426  Shelley Griffiths LAND AND INCOME TAX ACTS 1891–1920

The Land and Income Tax Bill was introduced into Parliament in July 1891. It adopted a schedular approach. The body of the Act was about administration, assessment and enforcement. The ‘core’ provision stated that taxation would be levied on ‘all land situate in New Zealand’ and on all ‘income derived from business, employment and emolument’.26 This core section was supported by the detail in five schedules—two on land tax and three on income tax. During the debates on the passage of the 1891 Act there was very little attention paid to the income tax part of the legislation. Given the policy imperatives noted above, it is not surprising that it was land tax that exercised the minds of members. The Premier, John Ballance, summed up the attitude to land tax. The measures were against ‘great landlordism’ and intended to divert the ‘course of capital’ from large estates to the small. It would fall with considerable severity on ‘large monopolists’. Land tax would force such holders to ‘cut up their estates’ and thereby assist the Government in the ‘great work of colonisation’ and in the ‘renewed prosperity’ that would result.27 Ballance did not advance the case for an income tax with anything like as much passion and there was no discussion about the rationale for it in the way there was about the land tax. Those opposed to income tax framed their strongest argument in terms of the ‘hurtful effect upon the body politic’. Every person knew what property ‘he has and other people have a means of ascertaining it’. Income was different. Honest men would have great difficulty in stating what their income was. If honest men had difficulties in ascertaining their income ‘what opportunities must be given to those who are not honestly inclined’. While it is very tempting to snigger at such a ‘moral’ rationale for opposing income tax, the Member was making an interesting point. In essence he was making a variant of the point made by Professor Parsons. ‘Income’ was essentially unknowable, indefinable and unverifiable. While the Member was concerned about the difficulties taxpayers might have in maintaining honesty when faced with ascertaining their ‘income’, it was the difficulties faced by the farmer, the professional man, the man of trade, in calculating annual income in a ‘commercial’ sense that bothered him.28

26 

Land and Income Assessment Act 1891, s 15. New Zealand Parliamentary Debates 4 August 1891, vol 73, 96–99. Zealand Parliamentary Debates 4 August 1891, vol 73, 104. John Bryce was a self-educated farmer turned politician. His political career included controversy over his ­ intransigent and belligerent responses to Maori land rights, especially relating to matters at Parihaka. He resigned in 1891 after refusing to withdraw words critical of the Premier. 27 

28 New

Historical Meaning of ‘Income’ in New Zealand Taxation 427 Land Tax Land tax was in Schedules A and B of the 1891 Act. ‘Ordinary’ land tax was levied on the ‘actual value of land’ less an allowance for up to £3,000 and less any outstanding mortgage. The ‘actual value’ was the amount for which the land and improvements ‘could be purchased for cash’. Mortgagees were liable for land tax on the actual value of such mortgages. The ordinary land tax was payable at the flat rate of 1d/£1, or 0.4 per cent. Graduated land tax was not payable on the value of mortgages, but was payable on land at a rate that was ⅛d/£1 on land worth between £5,000 and £10,000 up to a maximum rate of 1 6 8d/£1 on values greater than £210,000. Land tax remained in force in New Zealand until 1982 although it had long since lost any significant role in either breaking up large holdings or revenue raising, providing a mere 0.5 per cent of government revenue in 1967.29 Income Tax ‘Income’ was defined as ‘any gains or profits derived or received by any company or person in any year, or by any means, or from any source, which is made the subject of taxation under this Act’.30 The details were fleshed out in the schedules. ‘Income’ from sources such as ‘business’ and ‘employment’ and the income of companies were in three separate schedules.31 For our purposes, ‘income’ from business is the most interesting because that was, unsurprisingly, the one on which there was the most litigation. How that term was defined and interpreted shapes our understanding of what was meant by the term ‘income’. Business income had a quite brief definition in Schedule D in 1891. It meant ‘gains or profits derived or received in New Zealand from any trade, manufacture, adventure, or concern in the nature of trade’. The focus was therefore on the outcome of, or output from, an activity of some trade related sort. In 1892 Schedule D, among others, was amended to cure some of the ‘defects’ apparent in the first attempt the previous year.32 The 1892 version was rather longer. The original income from trade related activity remained. Added to it, however, were gains or profits from the ‘purchase, sale, or other disposition of real or personal property’, from ‘loans, investments or other deposits of money’ (other than mortgages, mortgages being included in land for the purpose of land tax)33 and from

29 

Barrett and Veal, above n 10, 577. Land and Income Assessment Act 1891, s 3. 31  Land and Income Assessment Act 1891, Schs C, D and E. 32  Harris, above n 10, 113–115. 33  Land and Income Assessment Act 1891, Sch A(ii). 30 

428  Shelley Griffiths ‘every source or kind whatsoever … outside the colony whereby income is derived or received in New Zealand’.34 In 1900, the schedular approach was abandoned.35 I have been unable to find any official documents explaining why and the Parliamentary debates were entirely silent on the change. While the schedules were done away with, a similar structure remained. Sections 51–57 had the heading ‘income of companies’. Sections 58–59 dealt with the income of taxpayers other than companies. Section 59 covered income tax on ‘income from business’ and section 60 ‘income from employment’. ‘Income from business’ was further defined to include the ‘profits’ from a number of activities, the word ‘gains’ had been slipped out and the categories increasing from five in 1892, to eleven in 1900.36 By 1900, quite specific types of business were overtly included, for example extractive industries in a broad sense, such as quarrying, mining and digging of gum. Dealing in livestock and other products which were the ‘natural products of land’ were specifically included. Whereas the 1892 schedule had included all profits or gains from the sale of real and personal property, the 1900 section split the treatment of real and personal property. Profits from the disposal of personal property were income. Profits from the disposal of real property were taxable only if the taxpayer’s ‘ordinary business’ comprised the ‘dealing’ in such property. The definition of business remained related to the same trade activities of the 1891 and 1892 schedules.37 In 1891 and 1892 the expression ‘gains or profits’ was used. In 1900, the word ‘gain’ was removed. It is this change that John Prebble was referring to when he suggested that the lack of distinction between capital and income in the 1891 Act was cured in 1900. However, in 1916 the expression ‘profits or gains’ reappeared in the core assessable income section. Until the re-write project that began in the 1990s and culminated in the Income Tax Act 2007, the expression ‘profit or gains’ was used in successive Acts.38 The 1916 Act was also structured differently. It is this Act that really marks the end of the schedule structure. First, business and employment were, for the first time, in the same section. Secondly, profits or gains from the sale of land were taxable if the business of the taxpayer was to deal in land and also if the ‘property had been acquired for the purpose of selling or otherwise disposing of it’. Personal property was not specifically mentioned

34 

Land and Income Assessment Act Amendment 1892, s 17(4). appears to be no readily available explanation of why this change was made, certainly no mention of the structural change was made in the parliamentary debate on the 1900 Act. 36  Land and Income Assessment Act 1900, ss 58 and 59. 37  Although the definition was now moved from the income section to the definition section, Land and Income Assessment Act 1900, s 3. 38  Land and Income Tax Act 1923, s 79; Land and Income Tax Act 1954, s 88; Income Tax Act 1976, s 65. 35  There

Historical Meaning of ‘Income’ in New Zealand Taxation 429 and the separate sub-section on income from agricultural activities was left out. Finally, a residual section to capture ‘income derived from any other source whatsoever’ was included.39 The income provision in the 1923 Act (which remained the principal Act until 1954) was identical to the 1916 version, except that the specific section on agricultural activity income made a re-appearance. Personal property was not specifically mentioned again until an amendment in 1951 that brought in what came to be known as the ‘three limbs’. By 1923, the taxation of land was more or less settled in a manner that would remain reasonably consistent until the 1970s. Land was taxed in several different ways. First, it was subject to annual land tax (and depending on its value that was either an ordinary flat rate or, if it were a significant amount of land, a progressive special rate until 1917 and thereafter a single graduated rate applied).40 Secondly, land was subject to income tax. This took two forms. Assessable income included all profits and gains from the business of farming in its many forms conducted on and with land. Assessable income also included profits or gains from the sale of land if the taxpayer’s business was to deal in land or the land was acquired for the purpose of selling it at a profit.41 Between 1891 and 1923, the structure of the legislation changed and by 1923 it had settled into a form that remained reasonably constant until the re-write project of the 1990s.42 Initially taxation attached to ‘profits or gains’ from certain activities, then for a short period to ‘profits’ and thereafter, from 1916, to ‘profits and gains’. By 1923 the ‘core’ income section ‘deemed’ a range of items to be assessable income.43 They were profits and gains derived from: —— business; —— salaries and wages; —— sale of land if the taxpayer’s business was to deal in land or the land was acquired for the purpose of disposition at a profit; —— extraction and sale of minerals and timber; —— business of dealing in livestock and agricultural products;

39 

Income Tax Act 1916, s 85. Zealand Taxation Review Committee, Taxation in New Zealand: Report (Wellington, Government Printer, 1967) [1010]–[1015]. 41  Commissioner of Taxes v Miramar Land Company (Limited) (1906) 26 NZLR 723 (SC); Commissioner of Taxes v Miramar Land Company (Limited) (1906) 26 NZLR 723 (CA); Wellington Steam Ferries Co v Commissioner of Taxes (1910) 29 NZLR 1025 (SC); The ­Whiterock Estate Co (Ltd) v The Commissioner of Taxes (1911) 30 NZLR 405 (SC); Commissioner of Taxes v Bolton, van Staveren & Ors; the Commissioner of Taxes v Bolton, Dwan & Ors (1911) 30 NZLR 1006 (CA). 42  Land and Income Tax Act 1954, s 88; Income Tax Act 1976, s 65: now see Income Tax Act 2007, Pt C. 43  Land and Income Tax Act 1923, s 79. 40  New

430  Shelley Griffiths —— rents from the lease of land; —— interests, dividends and pensions; and, finally —— ‘[a]ny other source whatsoever’. Two expressions recur—business and profit. Business was defined in each Act. By 1923 the definition was ‘any profession, trade, manufacture or undertaking carried on for pecuniary profit’.44 It was in 1916 that the phrase ‘for pecuniary profit’ was added to the definition that had, as we have seen, been directed generally to trade like activities since 1891.45 THE MEANING OF ‘INCOME’

In the 1891 Act, the language was couched as ‘gains or profits derived from any trade, manufacture, adventure, or concern in the nature of trade’.46 The 1900 language was slightly different and thus it remained until the more recent re-write project. Nevertheless, the statute always used expressions such as ‘profit’ or ‘profits and gains’, and the legislation was, and is, an ‘income’ tax Act. What then was meant by ‘income’? Putting the question another way, was it the interpretative work of judges that overlaid the distinction between capital and income on to a comprehensive concept? During the debates on the passage of the 1891 Act there was very little attention paid to the income tax part of the legislation. As noted earlier, there were only limited references to the income tax in the Parliamentary debates. Such discussions, as there were, were about the income tax in 1891, most especially about the liability of banks and the distinction between the professions and ‘trade and commerce’, and were unrelated to any notions of the trust. Certainly there was a clear distinction drawn between income and the source from which that income came. For example, in respect of railway companies, Ballance thought it appropriate to tax such companies not on the ‘land used for the permanent way’ but on the income ‘from’ it. Justifying the distinction in the rate of exemption from income tax for men of professions and for those in ‘trade and commerce’, Ballance thought the distinction lay in the fact that for the professional man, his ‘income dies with him’. The death of the ‘head of a firm’ did not entail the ‘stoppage

44 

Land and Income Tax Act 1923, s 2. In 1900 and 1908 the definition had included reference to the articles of association of a company but this proved difficult to apply in the land dealing cases, such as Commissioner of Taxes v Miramar Land Co (Ltd) (1906) 26 NZLR 723 (CA) and Wellington Steam Ferries Co v Commissioner of Taxes (1910) 29 NZLR 1025 (SC). 46  Land and Income Assessment Act 1891, Sch D, 1; the 1900 Act was intended as a consolidation and reorganisation of the 1891 Act: New Zealand Parliamentary Debates 1 October 1900, vol 114, 430. 45 

Historical Meaning of ‘Income’ in New Zealand Taxation 431 of the business’. Again, this indicates a distinction being drawn between income and the structure from which it came.47 Case Law As described in the table below, there were a number of cases on income tax in the early period. The range of issues covered was reasonably wide. There can be no doubt that judges and lawyers would have been familiar with the trust distinction between capital and income. It is less apparent that they used this reasoning in the few early cases that considered the meaning of ‘income’. A review of the various volumes of the New Zealand Digest of Cases from 1891 to 1943 indicates that Inland Revenue Commissioners v Blott48 was never cited in a New Zealand case. Bouch v Sproule49 was cited twice, but neither case had any connection with income tax: one concerned the capitalisation of trust income and the other, company ­distributions.50 This does not mean that the New Zealand courts did not use trust concepts to decide what was ‘income’ in the Land and Income Tax Acts. It is therefore useful to look at the cases decided in the early period to see if it is possible to identify the frame of reference used by judges in seeking to define what ‘income’ was. Between 1891 and 1925 there were about 40 cases categorised as ‘income tax’ that were reported in the New Zealand reports. The range was interestingly broad. The table is imprecise in the sense that categorising reported decisions is rather arbitrary. Income Tax Cases—reported Decisions 1891–192551 Land Deductions NonAnnuities Livestock Specific Default Dealing Residents and Industries Assessment International 7

47 

11

5

4

4

5

1

New Zealand Parliamentary Debates 4 August 1891, vol 73, 99–100. Inland Revenue Commissioners v Blott [1921] 2 AC 171. 49  Bouch v Sproule (1887) 12 App Cas 385. 50  McGruer v Gresham [1927] NZLR 704 (SC) and Perpetual Trustees Estate & Agency Co v Glendining [1921] NZLR 557 (SC). 51 The cases are those of the Supreme Court or the Court of Appeal reported in the New Zealand Law Reports or the Gazette Law Reports. (The Supreme Court as a court of general jurisdiction was re-named the High Court in 1980. It is not to be confused with the Supreme Court New Zealand’s current highest and final court, established in 2004, Supreme Court Act 2003.) They are compiled from the New Zealand Law Reports Consolidated Digest of Cases [1861–1902] and [1903–1923] and the Gazette Law Reports Consolidated Digest of Cases 1898–1928. 48 

432  Shelley Griffiths The expression ‘income’ in relation to business was not confined to taxation cases. For example, in 1914, in a case on a construction of a will depending on the interpretation of the expression ‘gross income’, Cooper J wrote: [t]he ‘income’ of a business is, in its ordinary and popular meaning, the gain resulting from the business. … [Gross income] means, in ordinary language in reference to a business, the gross result of the terminal trading as distinguished from the net result, the net result being what remains of the gross result after all salaries, … interest on capital, … have been deducted.52

Like so many New Zealand judges of that era, Cooper J had not gone directly to the law as a career. He began his career in the law as a bookkeeper for an Auckland solicitor in the 1870s. Subsequently he became that solicitor’s articled clerk and, after admission to the bar, practiced as a commercial solicitor before becoming a judge in 1901.53 His words in Yates indicate someone well versed in trade and business.54 Fragments are always dangerous as evidence, but there is room for a tentative hypothesis about the pragmatic, commercial focus of many of the New Zealand judiciary. Nonetheless, the more productive avenue for research on what was meant by ‘income’ in the income tax legislation is to look at the cases. The makers of the legislation appeared to have a pragmatic focus on trade and commerce. The taxation of the most important capital asset in colonial settler society was tackled in various ways both to raise revenue and to encourage some behaviour and to discourage other behaviour. The outcome in Whiterock Estate55 is particularly instructive on that. In Whiterock Estate, the taxpayer, Greenwood, owned two sheep stations that were held in two separate companies. The Court accepted, without any hint of disapproval, that Greenwood had done this to avoid the impact of land tax. However, in 1907 the land tax legislation was amended so that there was no longer an advantage in this structure. More than that, ­however, the rate of land tax was increased and a 25 per cent surcharge on larger holdings was due to come into force.56 Greenwood responded, as the government hoped in implementing these policy changes, and sold the ­Whiterock property. Although Whiterock Limited’s Memorandum p ­ ermitted the sale 52 

Yates v Yates (1913) 33 NZLR 281(SC), 285. Stone, ‘Theophilus Cooper’ in Department of Internal Affairs (ed), The Dictionary of New Zealand Biography, Volume 3 1901–1920 (Auckland, Auckland University Press, 1996), 113. 54 Elsewhere it has been noted that there were problems arising from ‘the intersection of the different conceptions of income deriving from judicial and accounting approaches’: AH Slater, ‘The Nature of Income: The Intersection of Tax, Legal and Accounting Concepts’ (2007) 36 Australian Tax Review 138, 142; in New Zealand the judiciary often had a broad prejudicial experience. 55  Whiterock Estate Co (Ltd) v Commissioner of Taxes (1911) 30 NZLR 405 (SC). Cooper J was also the judge in this case. 56 Goldsmith, above n 11, 108–109; see also D Hamer, The New Zealand Liberals: The Years of Power, 1891–1912 (Auckland, Auckland University Press, 1988) 64–66. 53  RCJ

Historical Meaning of ‘Income’ in New Zealand Taxation 433 of land, the Court held this was merely ancillary to the business of farming. Having the power to sell land in this way could not mean that the company was in the business of land ‘dealing’ as the statute required. The only class of person liable for income tax on the profits arising from the sale of land was ‘the land speculator, who, as part of his ordinary business, carries on the business of trafficking in land’.57 Greenwood was not such a person. He had done what one part of the taxation of land intended him to do, that is, divest himself of some of his holding. In doing that he could not be a speculator, the target of the income tax dealing provisions. Moving from the particular question at issue in that case and reviewing a range of cases will hopefully shed more insight on the particular question of how the term ‘income’ was interpreted. In one of the earliest income tax cases, Commissioner of Taxes v Ballinger & Co (Ltd),58 the court had to decide whether the costs incurred by the taxpayer, in defending a claim that its patent was an infringement of a prior existing patent, were deductible from income. The taxpayer claimed that the expenditure was deductible because ‘the possession of the patent would have resulted in a profit in the working of the business’.59 However, section 66 of the Land and Income Tax Assessment Act 1900 set out all those items that were not deductible in ‘ascertaining the income derived’. Among them was section 66(3), which stated that ‘… money used or intended to be used as capital therein’ was not deductible. Further, the effect of section 66(6) was that apportionment was not possible, an item was either wholly deductible or not deductible at all. The Court concluded that the ‘patent was a portion of the “capital” of the company’ and the expenditure to retain it was ‘of the same nature’.60 The expenditure could not ‘be properly classed as trade expenses’ and the argument, that the possession of the patent gave the company the means to earn future profits and expenditure to retain that means was thus deductible, failed.61 What is most interesting for our purposes is the frame of reference and the language of the reasoning used by Cooper J. It is most certainly commercial and business oriented. A similar issue arose in Ward & Co Ltd v Commissioner of Taxes.62 In 1919 there was a national licensing poll with the options of p ­ rohibition or 57  Whiterock Estate Co (Ltd) v Commissioner of Taxes (1911) 30 NZLR 405 (SC), 414. The amount of income tax at issue in this case was £5168—actually almost 2% of £278,000 the total amount of income tax collected in 1906/07. 58  Commissioner of Taxes v Ballinger & Co (Ltd) (1903) 23 NZLR 188 (SC). 59  Commissioner of Taxes v Ballinger & Co (Ltd) (1903) 23 NZLR 188 (SC), 191. 60  Commissioner of Taxes v Ballinger & Co (Ltd) (1903) 23 NZLR 188 (SC), 194. 61  Commissioner of Taxes v Ballinger & Co (Ltd) (1903) 23 NZLR 188 (SC), 192–193. 62  Ward & Co Ltd v Commissioner of Taxes [1921] NZLR 934 (CA), judgment delivered by Stringer J. Sir Walter Stringer was the Crown Prosecutor in Christchurch prior to his appointment to the Bench in 1913; on the make-up of the New Zealand judiciary in the 1920s see G Morris, ‘“Salmond’s Bench”: the New Zealand Supreme Court Judiciary 1920–1924’, (2007) 38 Victoria University of Wellington Law Review 813.

434  Shelley Griffiths continuance of the sale of alcohol. A bare majority was needed for national prohibition.63 It is hardly surprising that a company that was a brewer, importer of alcohol and hotel owner would be somewhat concerned about the poll. The company’s business depended on there being a vote for continuance and it spent £2,123 on advertising, canvassing and transporting voters to the poll. It sought to deduct the expenditure from assessable income. Section 86 of the Land and Income Tax Act 1916 was structured in the same way as the 1900 section at issue in Ballinger. However, in Ward the primary focus was not on the capital exclusion but on the subsection that stated the expenditure had to be ‘exclusively incurred in the production of assessable income’.64 The Judge made it clear that if he were able to resolve the question by ‘applying purely commercial principles’ he would have had no hesitation in finding that that the expenditure ‘could properly be’ a deduction against the yearly profits. But the legislation prohibited some deductions that ‘which on sound commercial principles’ might be made in calculating yearly profits. In this case the issue was whether the expenditure was ‘exclusively incurred in the production of assessable income’. The court found that it ‘was incurred not for the production of income, but for the purpose of preventing the extinction of the business from which the income was derived, which is quite a different thing’.65 The court noted that the English provision enabled the deduction of money wholly or exclusively ‘laid out or expended for the purposes of such trade’.66 The New Zealand section was less ‘liberal and comprehensive’ requiring a link with the ‘production of assessable income’. Among other things that are noteworthy about this case is the commercial focus of the judge. He could find no link with the production of assessable income, only one with the protection of the business’s ability to survive (and produce assessable income in the future). This is a commercial distinction between operations and structure. It is not framed in the language of income and capital and it certainly is not framed with any connections to trust concepts. It should come as no surprise that a number of early New Zealand income tax cases were about agriculture and, specifically, about the valuation of livestock. In Dalgety v Commissioner of Taxes,67 the taxpayer had adopted the practice of using uniform, standard values for the value of livestock on

63 

Belich, above n 12, 170–173. and Income Tax Act 1916, s 86(1)(a): it is not immediately apparent why this was argued in different terms from Ballinger, where the focus was on whether the expenditure was capital. The capital exclusion remained in the 1916 Act, s 86(1)(c). By 1916 the exclusivity provision was the first in the list. Potentially that change of order in the section may have ­influenced how the argument was framed. 65  Ward & Co Ltd v Commissioner of Taxes [1921] NZLR 934 (CA), 939. 66  Ward & Co Ltd v Commissioner of Taxes [1921] NZLR 934 (CA), 940. 67  Dalgety v Commissioner of Taxes (1912) 31 NZLR 260 (SC). 64  Land

Historical Meaning of ‘Income’ in New Zealand Taxation 435 hand. Actual prices were used for sheep bought and sold during the year but a standard value of 5s per head was used for ‘sheep on hand’. In 1910, the taxpayers held a clearing sale of their sheep at which 8s 11d per stock unit was realised. The issue was whether the surplus over 5s per head was assessable as profit, the counter argument being that this was the realisation of a capital amount and therefore not a ‘profit’ to which the Land and Income Tax Act 1908 applied. The court thus had to determine what ‘profit’ under the Act meant. Profit was determined as ‘the difference between the expenses necessary to earn the receipt of the year and the receipts of the year’.68 The court recognised that the opening value of 5s per head had been taken as the value of stock on hand for many years and in every year when stock was sold at a greater price than that, income had been earned. (By implication, although this was not stated, where stock had been sold at a lower price, a loss would have been sustained). It made no difference that in one year all the stock was sold in a clearance sale. At a more general level, the court cited with approval the English case City of London Contract Company v Styles where Lord Esher had stated that the ‘difference between the expenses necessary to earn the receipts of the year, and the receipts of the year are the profits of the business for the purpose of the income-tax’.69 A variation of the same issue of livestock valuation arose in Anson v Commissioner of Taxes.70 In this case, the taxpayer had a flock of some 6,000 sheep.71 The farmer was not a dealer in sheep and his only acquisitions were rams for breeding purposes. He had adopted a fixed standard value for stock on hand, a practice that was adopted as a matter of practical convenience and with the acquiescence of the Commissioner. In 1919, the taxpayer sold his sheep station and the sale of the stock yielded £9,650, significantly more than the holding value in his accounts. The argument was, of course, whether this was a profit on the realisation of a capital asset and therefore not one to which income tax would attach. The taxpayer argued that increase in the ‘capital value of his stock was no more taxable than is the gradual increase in the capital value of the land itself on which his business is carried out’.72 The Court saw this case as no different from Dalgety,

68 

Dalgety v Commissioner of Taxes (1912) 31 NZLR 260 (SC), 263. City of London Contract Company v Styles (1887) 2 Tax Cases 239 (CA), 244. The ­version of these reports I was able to consult in the University of Otago Library were donated to the Library by the trust established in the memory of Sir Joshua Williams by his daughters. He was the judge in the Dalgety case, and it is a matter of some historical interest that he had his own copy of an English tax reports series. 70  Anson v Commissioner of Taxes [1922] NZLR 330 (SC). 71  This was a huge flock—the average flock size in New Zealand in the early 1920s was about 950: New Zealand Official Year Book 1921–1922; . 72  Anson v Commissioner of Taxes [1922] NZLR 330 (SC), 333. 69 

436  Shelley Griffiths for ‘the flocks of a sheep-farmer are his stock-in-trade just as truly is the merchandise of a shopkeeper.’ The point was amplified further: Stock-in-trade consists of the property which is acquired for the purpose of being sold at a profit. Fixed capital consists of the property which is acquired to be retained and used for the purpose of deriving a profit from such use—such as lands, buildings, mines, machinery and plant.73

It made no difference whether the sale of stock-in-trade was from repeated sales or all at once. However, the court could not ignore what would be the retort to that proposition. This taxpayer derived income from the production from his stock of sheep, in the form of lambs and wool. In that respect the flock had a similar quality as plant or machinery. The Court recognised that was true, but it was ‘none the less’ stock-in-trade ‘acquired for the purpose for making a profit from its sale’. If sheep were an animal of such a nature that it was only useful for the growing of wool, the point might be established. But it was not—sheep yield a double profit, ‘first as an instrument for the production of wool, and second as merchandise for sale’. It is no different from a person who ‘makes it his business to buy and sell land’ and thereby makes the land his ‘stock-in-trade’ and farms the land for as long as he retains it.74 Thus certain assets are, or become, stock-in-trade. It is this trade characteristic that is the reason why profits are income in the required sense. In the past this taxpayer had treated his flock of sheep as stock-in-trade, by including them in his gross profit calculation, albeit in a way that yielded no income because of the adoption of fixed standard ­values.75 If his argument were valid, the ‘capital’ stock would have been kept separate from the income calculation. This analysis is made in commercial language, by reference to commercial concepts (‘merchandise’, ‘stock-in-trade’), and it sees the purpose of acquisition and what is practically done with assets, as being the determinative factor in whether they yield a profit to which income tax attaches. It is, in a sense, a dynamic account of income. That is to be compared with the more structural outcome of trust analysis. In Union Bank of Australia v Commissioner of Taxes76 the bank maintained, for the purpose of its business, a large reserve fund. This fund, created out of retained profits, was held in cash, Consols and marketable securities. From time to time these securities had to be realised for the bank’s cash requirements and on some of them losses were incurred on realisation. The bank sought to deduct these losses from its income in the years in which the losses were incurred. The bank was liable for ‘excess profits duty’.

73 

Anson v Commissioner of Taxes [1922] NZLR 330 (SC), 334. ibid, 335. 75  ibid, 337. 76  Union Bank of Australia v Commissioner of Taxes [1920] NZLR 649 (SC). 74 

Historical Meaning of ‘Income’ in New Zealand Taxation 437 This was levied by the Finance Act 1916 at a rate of 45 per cent on ‘excess profits’ which was the amount of the taxpayer’s income in excess of ‘standard income’. In essence, standard income was the average income of the three pre-war years. For banking companies the calculation of ‘income’ was based on a relationship with assets employed.77 The bank wished to deduct the amount of the losses described above to reach a calculation of income. Two questions arose. Was such a capital deduction prohibited by section 86(1)(c) of the Land and Income Tax Act 1916? That was a question of the relationship between the ‘normal’ income tax Act and the special regime applying because of the war. The second question was, if section 86(1)(c) did apply to the Finance Act 1916, was this particular loss a capital one and therefore disallowed? The Court concluded that because section 21 of the Finance Act 1916 applied to all income earned by the bank, whether in New Zealand or overseas, section 86 of the Land and Income Tax Act 1916 did not apply. The Court stated that the term ‘income’ in section 21 meant ‘net income’. What then was meant by the term ‘net income’ in section 21? That ought to be ascertained ‘according to ordinary commercial principles’.78 The court had no doubt, according to those principles, that the deduction was allowable. But even if section 86 did apply to the provisions of the Finance Act 1916, the answer would have been the same because the realisation of these investments was a part of the ‘business of banking’ and not the realisation of the capital assets of the bank. What is interesting for our purposes, however, is the notion that net profit is to be determined by ‘ordinary commercial principles’. ‘Net profit’ is a term of business, of trade, of commerce. There is in this case no influence of trust principles at all. In all the cases discussed, there are no references to trust principles’ distinction between capital and income. The tone adopted in the cases is distinctly commercial when applying the specific provisions of the income tax provisions. Analogies with commercial concepts such as stock-in-trade and merchandise were used to resolve issues about livestock valuation. The language of business, of structure and operations, was used to determine whether expenditure was deductible and the nature of losses from trading activities. A Shared Understanding of Meaning It is undoubtedly true that the income tax statutes did not define ‘income’ (nor indeed ‘capital’) and it was left to judges (and administrators) to interpret what the legislation meant in specific fact situations. The legislators 77  78 

Finance Act 1916, ss 9–11 and 21. Union Bank of Australia v Commissioner of Taxes [1920] NZLR 649 (SC), 655.

438  Shelley Griffiths were very quiet in articulating what was meant by ‘income’ in the relevant sense. That might be because they had a shared understanding of what was meant by the term, and that there was in fact a shared understanding in society about what the term ‘income’ implied. By the 1920s, New Zealand faced difficult economic times. World War I had a significant impact on New Zealand. About 19 per cent of all males served overseas and of the 100,000 who served overseas about 18,000 died in, or because of, the War. That and the influenza epidemic of 1918 ‘contributed to the slow burning sense of trauma in New Zealand of the 1920s’.79 During World War I income tax became the prime source of government revenue. Tax rates increased significantly. In 1914 the top income tax rate was 6.67 per cent, by 1921 it was 43.75 per cent and it then reduced to 22.5 per cent by the middle of the 1920s.80 By the early 1920s concern mounted about the incidence of taxation and especially the ‘steep’ progressive individual and corporate rates. Companies had, since 1916, been subject to a super tax of 33.3 per cent and an ‘additional income tax’ of five per cent. As we saw in the Union Bank case there was also an excess profits duty after 1916. A committee was appointed to inquire into taxation.81 Its recommendations included reducing the rates and shifting the taxation of companies to individual shareholders. It was followed in 1924 by a Royal Commission to inquire into New Zealand land and income tax and specifically to consider the graduated taxation of companies.82 These reports provide some of the few opportunities for us to hear what administrators and taxpayers said. One of the Commissioners put this question to DG Clark, the Commissioner for Inland Revenue: ‘Income tax is either on personal exertion or on capital, is it not?’ Clark answered ‘Or on income from capital’. Further questioning continued to use the language of income ‘from’ capital, and income as the reward for the ‘use’ of capital.83 The discussion with the Commissioner had a distinctly commercial flavour. It seems that judges and administrators used various notions of what income was but in New Zealand they do not seem to have been much influenced by inapt trust concepts. Recourse seems to have been more often made to commercial and business concepts.

79 

Belich, above n 12, 113. Goldsmith, above n 11, 140. 81  Committee on Taxation, Report of the Committee Appointed to Inquire into the ­Taxation of the Dominion of New Zealand (Appendix to the Journals of the House of Representatives 1922, B–5). 82  The rate of tax for companies was a flat rate until 1910, the rate being increased so the New Zealand government could meet its increased financial obligations to the British navy, see A Cho, ‘The Five Phases of Company Taxation in New Zealand: 1840–2008’ (2008) 14 Auckland University Law Review 150, 157. 83  Report of the Royal Commission Appointed to Inquire in to the subject of Land and Income Tax in New Zealand (Appendix to the Journals of the House of Representatives 1924, B–5) 46. 80 

Historical Meaning of ‘Income’ in New Zealand Taxation 439 As Martin Daunton has pointed out, the distinction between annual income and capital was founded in a variety of sources. Certainly the aristocratic estates and marriage settlements necessarily drew the distinction between income and capital. Also, in an agrarian society ‘the emphasis was on the actual physical piece of land or res rather than its value’. In such an economy, ‘income arose after a lapse of time from a continuing fixed source such as a farm’.84 Income could thus be used independently from the source from which it came. The concept of capital as res was extended from the tangible (land) to the intangible (such as securities). It is a concept that is inherent in the system of double entry bookkeeping and in the evolution of accounting. Double entry bookkeeping was developed in Europe, far from that hallmark of English law, the trust. The distinction was especially important in the development of the company. The company, an entity with perpetual life, encompassed the idea of a continuing enterprise (an intangible res) from which periodic returns flowed.85 The idea of a periodic (annual) return from a res with a long or perpetual life is endemic in commercial life. It is certainly patently obvious to those who farm both livestock and crops. Because revenue had to be raised annually by governments (a constitutional necessity in the Westminster system)86 this notion of income from the world of trade, commerce and farming provided a natural fit. Daunton quotes Lord Halsbury LC in Secretary of State in Council of India v Scoble that the Income Tax Acts ‘never intended to tax capital’.87 A bookkeeping text in use in New Zealand in 1900 described the essential features of the double entry system. Receipts are divided into two classes– capital and revenue. ‘All amounts expended in constructing, extending or acquiring the undertaking from which the revenue is earned are regarded as capital expenditure’.88 One of the leading company law textbooks of the period described the clear distinction between profits, out of which dividends were paid, and capital. Payment of dividends out of capital was a breach of the legislation (although some weakening of the principle was

84 M Daunton, Trusting Leviathan: The Politics of Taxation in Britain, 1799–1914 ­(Cambridge, Cambridge University Press, 2001) 206. 85 AC Littleton Accounting Evolution to 1900 (Alabama, University of Alabama Press, 1981) 206–207. 86  In New Zealand, see Constitution Act 1986, s 22 and Public Finance Act 1989, ss 4–5 and 7–10; and the annual legislation setting rates, for example Taxation (Annual Rates, Foreign Superannuation, and Remedial Matters) Act 2014, s 3 setting rates for 2013/2014; on the significance of the ‘year’ in taxation see Commissioner of Inland Revenue v Wattie [1999] 1 NZLR 529 (PC) where their Lordships noted, at 539, that ‘[i]f the payment or receipt ­cannot properly be brought into the income tax reckoning for a particular year then (apart from special statutory provision) it cannot be brought into that reckoning at all’. 87  Secretary of State in Council of India v Scoble [1903] AC 299 (HL), 302. 88  L Dicksee, Bookkeeping for Accountant Students, 3rd edn (London, Gee & Co, 1900, edition printed for the New Zealand Accountants and Auditors Association, Auckland) 250.

440  Shelley Griffiths apparent in the cases) and ­‘commercially unsound’.89 Thus, while judges would have been aware of the important distinction drawn in trust law between capital and income, it is just as likely that they would have been aware of the distinction applicable in the world of commerce (and farming) and the concepts of ‘income’ and ‘profit’ that were seen as relevant there. As was said in Gresham Life Assurance Society v Styles, ‘[t]he thing to be taxed is the amount of profits and gains. The word “profits” I think is to be understood in its natural and proper sense—in a sense which no commercial man would misunderstand’.90 CONCLUSION

For a whole variety of reasons, it appears that the concept of ‘income’ did not bear a comprehensive meaning when it was enacted as the basis for taxation in 1891. There seemed a shared understanding that ‘income’ did not have such a meaning. That does not mean there were not difficulties with categorisation then and in the future,91 and it does not mean that Parliament did not from time to time determine that certain gains that might be characterised as ‘capital’ ought to attract liability for ‘income’ tax. However, a review of some decided cases uncovers no reference to trust concepts. On the contrary, the judges appear to make reference to a more commercial, trade related framework. In colonial New Zealand, land occupied a special place. It was the most significant capital asset, economically and emotionally. That was the impetus for the land tax, both as a way to raise revenue and as an instrument of social policy. Parliament also specifically included gains on the disposition of land as taxable income from the start, to target the speculator and ­trafficker. This, it is suggested, is tied to the particular attitude to land in

89  F Palmer Company Law: A Practical Handbook for Lawyers and Business Men, 2nd edn (London, Stevens & Sons, 1898) 145; see also C Davidson Davidson’s Precedents and Forms in Conveyancing Vol 3 (London, Thomas Cooke Wright, 1864–1877) 45. 90  Gresham Life Assurance Society v Styles [1892] AC 309 (HL), 315. 91  The principles that are used by the New Zealand courts in the categorisation of income and capital are those set out by the Privy Council in BP Australia Ltd v Federal Commissioner of Taxation [1966] AC 224 and in Hallstroms Pty Ltd v Federal Commissioner of ­Taxation (1946) 72 CLR 634. These principles have been used most recently in 2013, Trustpower ­Limited v Commissioner of Inland Revenue [2013] NZHC 2970, [2014] 2 NZLR 502, [98]–[141] but have been employed on many occasions to characterise a transaction as revenue or capital. See eg, Commissioner of Inland Revenue v City Motor Service Limited; ­Commissioner of Inland Revenue v Napier Motors Limited [1969] NZLR 1010, 1022–1023; Commissioner of Inland Revenue v McKenzies (NZ) Ltd [1988] 2 NZLR 726 (CA), 740–741, (1988) 10 NZTC 5,233, 5,236; Birkdale Service Station Ltd v Commissioner of Inland R ­ evenue [2001] 1 NZLR 293, [53]; Milburn NZ Ltd v Commissioner of Inland Revenue (2001) 20 NZTC 17,017 (HC), [45]–[66].

Historical Meaning of ‘Income’ in New Zealand Taxation 441 New Zealand in the 1890s. Meanwhile, policy was directed to using the fruits of labour and of capital assets as the basis for ‘income’ tax. In that, in this early period, we can perhaps see some of the roots of the New Zealand reticence to enact a comprehensive capital gains tax. In the period considered in this paper, there is what might be styled a plentiful lack of trust reasoning in the interpretative process. Other paradigms appear far more influential in the construction of a shared meaning of ‘income’. That might be different after 1925. How far that is true, is a project for another day.

442 

16 When Minerals are not Enough: The Origins of Income Taxation in Chile and their Importance to the Current Situation MAXIMILIANO BOADA

ABSTRACT

Between the so-called Saltpetre War and the creation and expansion of the Haber-Bosch method to synthesise saltpetre, Chile was the main exporter of natural saltpetre, one of the most important fertilisers and warfare explosive elements of the time. This fact was reflected in the economic surplus created by the taxation on saltpetre’s exportation, which led to one of the more prosperous times in the history of Chile. In fact it created an increment of 800 per cent of the treasury funds a few years after its imposition and was followed by the abolishment of all direct taxation methods in 1891. This circumstance continued for 20 years, after which direct taxation needed to be reintroduced and was followed by the establishment of income taxation in order to cope with the public expenditure. Fast forward to the present-day economic situation of the country, Chile is currently the biggest producer of copper in the world, producing over one third of the world’s total production. Copper accounts for roughly 20 per cent of Chile’s gross domestic product and 60 of its exports, having a strategic relevance for the treasury of the country. However, the future of the mineral’s possibility to provide wealth is uncertain, mostly because of the decline of its demand by the global market, but also because of the increasing costs of extracting it. This is not the first time that Chile has encountered a situation like this, but it still has not created a system to defend its economy from the dependency on commodities. This paper analyses the relationship between the mineral cycles present in Chilean history and the taxation system present in the country, in order to apply it to the latest mineral cycle; lithium.

444  Maximiliano Boada INTRODUCTION

C

HILE HAS ALWAYS been a mineral-rich territory, and therefore analysing the mineral cycles and their impact in the country is an effective way to understand its history. The mineral history of Chile can be divided in three cycles: (i) the silver and copper cycle (1750–1880), (ii) the saltpetre cycle (1830–1930), and (iii) the copper cycle (1904–2016). Nowadays a fourth could be included; the lithium cycle.1 As these minerals have had a great economic importance for the country, a study of the legal framework given to their extraction, focused on taxation and property rights, is key to correctly understand the historical development of the economic institutions in the country based on the political decisions of its leaders. This research dwells on the conditions that led to the establishment of an income tax in Chile, the seeking of more reliable sources of revenue in times of uncertainty, and how this historic reaction can be applied to the subsequent mineral cycles in order to obtain the original goal: a more reliable source of revenue for the country. For the purposes of this research, it is necessary to analyse this issue in a systematic way, starting even before the saltpetre cycle, the cycle that led to the creation of the income tax in the country, in order to accurately understand the shifts of directions in the mineral taxation institutions. Saltpetre,2 commonly known as nitrate for its chemical composition,3 is a compound with a wide range of uses, from fertilising land to increase its yield, to explosive and gunpowder manufacturing. These uses were particularly appreciated during the first third of the twentieth century, a period of population and economic expansion in modern western societies. The saltpetre cycle is one of the most memorable economic periods in the history of Chile, not only because it placed Chile on the international economic map, but also because of the internal social conditions that went along with the extraction of the mineral, the War of the Pacific and the taxation and economic changes that came along with the newly found source of riches for the country. During the second half of the nineteenth century, Chile was a scarcely populated country with only a handful of cities, of which the majority were ports. It was confronted with the need to bring a high quantity of male workers to mine saltpetre in an almost uninhabited region of the country,

1  The first two cycles are discussed in JP Vallejos, ‘Historia y Mineria en Chile: Estudios y Fuentes’ (1994) 1 América Latina en la Historia Económica 65. The third cycle and the existence of the fourth cycle are discussed in this article. 2  Chemically, the compound extracted from Chile, Bolivia and Peru is not saltpetre but a mixture between saltpetre and an analogue of it, composed of sodium instead of potassium (NaNo3 and KNo3), among other salts. 3  Technically it is nitratine.

Origins of Income Taxation in Chile 445 and later to the regions acquired by the war. This need, summed to the poor conditions by which the aforementioned process was procured,4 created a level of societal separation that was not previously present in Chile. However, not everything was bad. A lot of great things came from this period, such as a higher level of public revenue that allowed the Chilean government to improve the conditions of the majority of its citizens. This led to greater development of the national market,5 which improved its role in the international economic community, and a better tax regulation. The aim of this paper is to give an in depth account of this period from the taxation policy point of view, to later contrast it with both, the copper cycle, which is just coming to an end or a redefinition of it, and to the future lithium cycle. In order to achieve this goal, this paper is divided into five parts: first a brief history of the origins of mineral taxation in Chile and an exposé of the taxation system before the War of the Pacific; secondly, the saltpetre cycle and its taxation methods and effect on the economic history of the country; thirdly, the copper cycle and its development and taxation methods; fourthly, the origins of what is considered in this paper as the lithium cycle, and the legal regulation of the mineral until the present day; and fifthly, the problems present, regarding tax and property regulation, in the cycles. The first part is divided into: (i) the origins of mineral taxation in Chile, and (ii) the taxation system before the War of the Pacific. The second part divides the saltpetre cycle into three parts: (i) the War of the Pacific, (ii) taxation after Chile gained control of the saltpetre-rich region, and (iii) taxation after the decay of the saltpetre cycle and the origin of the income tax institution in Chile. The third part continues by presenting the copper cycle from its origins, dividing it into four parts: (i) the development and the impact of the copper related industry in Chile, (ii) general taxation methods during the copper cycle, (iii) specific tax on mining, and (iv) a peek at the current economic uncertainty of the country. The fourth part follows with the analysis of the lithium cycle in four parts: (i) presence and history of the commodity in the country, (ii) the ­origins of the extraction, (iii) the growth of the supply, first attempt, and (iv) the growth of the supply, second attempt.

4  This is a part of what is known as ‘Cuestión Social’ (Social Thing). During this period workers were offered cheap or free tickets to go to the mining regions and once they were there, they would live in precarious conditions on mining camps next to the mines. The miners were paid in self-coined currencies that only had value in the shops owned by the producing company, which made leaving the mine extremely difficult. 5  See, eg O Muñoz, ‘Estado e Industrialización en el ciclo de expansión del salitre’ (1977) 6 Estudios Cieplan 1692 and C Cariola & O Sunkel, Un Siglo de Historia Economica de Chile 1830–1930 (Madrid, Ediciones Cultura Hispánica, 1982) 42.

446  Maximiliano Boada The fifth part consists of an applied analysis of the past failures to the current cycle and is divided into three elements: (i) resource curse and the lack of certainty in the taxable base, (ii) bad regulation, accounting and weak and untrustworthy tax and property rights institutions, and (iii) new technologies, abuse of dominant position in the market, and inaction. THE ORIGINS OF MINERAL TAXATION AND THE TAXATION SYSTEM IN CHILE BEFORE THE WAR OF THE PACIFIC

The Origins of Mineral Taxation in Chile Regarding the origins of the tax on mines and mineral extractions, the events that occurred in Chile are quite peculiar. This institution has its origins in 1832, as the result of the finding of the Chañaralcillo silver region, which lead from May of that year onwards to an influx of immigrants aiming for a piece of the riches into the region.6 This influx of people to the northern part of the country, in addition to the fact that there were no public entities in the area, such as administrative offices or legal enforcement agencies, created various problems for the newly arrived miners, such as confusion regarding mining rights and the rights of ownership which led to overall complications regarding the rights of the people living there. Under these circumstances, the miners asked the municipality to send a police squad and a judge to Chañaralcillo, in order to keep peace in the area. However, the governor was unwilling to spend the city’s funds for this request. As the situation was already precarious in the city, an agreement was reached between the miners and the governor, by which they resolved that the institutions required would be introduced in Chañaralcillo, but that the miners would have to cover the costs for bringing an administrative agent and legal enforcement to the mines, divided proportionally based on the richness and production status of each mine. This agreement, the first precursor of a tax on minerals, has a great importance for the institution, as it was the response of the civic society to the lack of sufficient common goods to conduct their economic endeavours that led to the imposition of a common fee. The sole purpose of this fee, originally, was to create the social conditions needed to have a peaceful interaction in the mining region. This fact can be interpreted either as a luxury or as

6  V Letelier, Letter to the regional newspaper, 12 March 1877 (1877) This letter is part of a collection of bound newspaper articles located in the Medina room of the National Library of Chile. The internal identification number of the document is: Fondo Archivos Documentales, Pieza 873830. Documents from the same author, belonging to the same collection, will be ­referenced by their internal identification number.

Origins of Income Taxation in Chile 447 an investment. Seen as a luxury the miners produced so much wealth that they could afford to be lazy and pay a police squad and a judge to be there for them and not to have the need to go back to the city. Interpreted as an investment the miners might have realised that in the long run it was better for the community, and their overall level of welfare, to give part of their earnings for the creation of a public organisation. Both interpretations lead to the conclusion that given those circumstances it was better for the individuals and for the community to take a part of their earnings to pay for providing (more) public goods, as this secured a better economic situation for the individuals, and a more organised and peaceful situation for the community. Meanwhile, a law introduced on 23 October 1834 allowed the exportation of copper and silver, imposing an export duty of one and a half Reales per quintal of unrefined copper and Silver,7 and three Reales per quintal of refined copper. After the agreed system was imposed, the mine owners realised that this accounting method was troublesome because the flat fee payment per mine richness method was based on the bonanza level of the mine present at the time the quota was established. This left the price to pay anchored to the level of riches of the past, that could be ridiculous compared to new found riches, or difficult to pay in mines that were over exploited. For this reason the mine owners developed an agreement which was approved on 20 April 1841 establishing a flat fee payment per marco extracted from the mines.8 This system was collected privately, and the fee was to be paid in the amalgamation centres. Although no mineral taxes were present at the time, this system created the proper environment for more formalised institutions to develop in the department,9 which lead to the founding of the ‘Junta de Minería’,10 on 3 July 1847, later ratified by the government on 15 September 1848.11 The Junta de Minería was a commission composed of seven mine proprietors and four deputies, whose responsibility was to manage, represent and promote the general interests of the miners. By this time the money collected by the mineral fee had not only been sufficient to cover the expenses of the police squad and the judge, but it also allowed the creation of public goods and infrastructure, such as better roads, which facilitated the mining labour and the conditions in the geographic area. 7 

A quintal is a unit of measure equal to 100 pounds. A marco is a unit of measurement consisting of roughly 230 grams. 9  At the time, Chile was divided in geopolitical units called departments. 10  The Miners Guild. 11  ‘Junta de Mineros en Copiapó’ Boletín XVI 1848 pagina 290. See also V Letelier, Letter to the Regional Newspaper, 13 of March 1877 (1877) Fondo Archivos Documentales, Pieza 873839. Here Valentín Letelier made a mistake regarding the year of the law, writing it was from 1847 when in fact it was from 1848. 8 

448  Maximiliano Boada This system continued to work without major issues for seven or eight years. After that, the situation changed due to the discovery of new mines and minerals in the Department, which attracted more people that were not bound to the previous agreement and did not want to comply with it. On the grounds that they did not agree to pay the fee and therefore they had no obligation to respect it, the newly arrived miners did not comply with the mineral fee, as it was their legal right to do so. In response to this situation the Junta de Minería asked the Government in 1848 to make the mineral fee a compulsory tax to be paid by all the miners in the department to a public office: the National Customs Office, basing it on an obligation to have the public goods required for them to be in the most favourable conditions to develop their industry. The executive power accepted this on a provisional basis,while the law in favour of the Junta de Minería was being discussed in the Congress. The result of this was the Government decree of 2 January 1851.12 This decree created a ‘voluntary tax’ converting what previously was a popular subscription into an obligation. Under this decree, the money was to be collected based on the needs of the geographical department in which the mines were located. This decree created the first mineral taxation regulation in the country,13 and it was originated by the will of the community existing before the newly arrived miners, as they were faced with the free rider problem that was created by the new miners. The miners who were not part of the agreement benefited from the public goods created with the fee, without the need to pay a fee themselves. They took advantage of their convenient position at the expense of those who willingly accepted the fee, which was built on the trust, expectation and logic that the burden of public goods would be divided proportionally among all the miners who benefited from them. It is important to say that this tax was against the constitutional regulation of Chile at the time, as the official process to impose a tax was only through the Congress and any other way was explicitly forbidden.14 The revenues of this tax were later used for different goals than those originally agreed upon. On 20 October 1852 the government passed a law that changed the exportation duty to five per cent of the value, stating in the law that part of the yield of that duty was going to be spent in the ­Miners Guild and the region.15 Following this, in 1853 the government decreed that a subsidy to the Department was going to be conceded, and the money

12 

‘Cobres fundidos’, 02.01.1851. Boletín, libro XIX 19, 1851. this article the different legal figures of Decreto, Decreto Ley, and Decreto con Fuerza de Ley will be interchangeably referred to as ‘decree’. The difference between them is the ­process and how the lawmaker acquired the power to regulate. 14  This prohibition was present in Art143 of the 1833 political constitution of Chile. 15  Plata i cobre—Derechos de esportacion sobre estos metales. Boletín, libro XX 296, 1852. 13  In

Origins of Income Taxation in Chile 449 to pay this subsidy was to be paid from the revenues of the mineral tax. From this moment on the Government used its control over the tax for its own purposes.16 Ten years later, on 8 October 1862, this tax was abolished for copper, based on the insignificant yields the industry was producing, remaining equal for all other minerals.17 This situation, among many others similar to it, together with the unconstitutionality and illegality of the procedure to create an enforceable tax, led a group of miners to decide not to pay the tax in 1875. In response to this action the Miners Guild asked the Government to prohibit the exportation of minerals out of the Department without an official certificate from the National Customs Office that proved the taxes had been paid. The government approved this measure on 22 March 1875, forcing them to pay a voluntary tax.18 Finally, in 1877 the system was reformed and became a Congress-­ sanctioned tax, thereby legally validating its existence as a tax.19 This tax was of particular importance for the geographical department where the mines were located, but it still did not represent a big part of the taxation system of the country. To understand the impact that the tax on saltpetre had after the War of the Pacific on the system of the country, an overview of the main components of the Chilean taxation system before the war is presented in the following section. The Taxation System Before the War of the Pacific The political constitution of 1833 stipulated that laws regarding taxation would be valid for 18 months only, so laws validating previous tax laws for 18 more months were common during the rule of this document. The Law of Contributions promulgated on 23 July 1878 was the law that grouped all the tax regulations then in force.20

16  V Letelier, Letter to the Regional Newspaper, 14 of March 1877 (1877). Fondo Archivos Documentales, Pieza 873840. 17  Cobre en barra—Liberacion de derechos de esportación. 8.10.1862. Boletín, Libro XXX, 346, 1862. Ten years later, on 24 December 1872, the tax on copper was reintroduced; consisting of a tax that depended on the level of purity of the copper. For refined copper it was 60 cents per quintal. This law stipulated that two thirds of the yields would go to the central government and the rest directly to the municipality. Ordenanza de Aduanas. 24.12.1872. Boletín, Libro XL 1,021, 1872. 18  V Letelier, Letter to the Regional Newspaper, 14 of March 1877 (1877). Fondo Archivos Documentales, Pieza 873840. 19  V Letelier, Letter to the Regional Newspaper, 14 of March 1877 (1877). Fondo Archivos Documentales, Pieza 873840. 20  Contribuciones. Se declaran subsistentes por dieciocho meses. Boletín, libro XLVI 327, 1878.

450  Maximiliano Boada The national taxation system, contained in the aforementioned law, was based on mixed techniques of taxation, combining direct and indirect taxation methods, and general and local government taxation, usually based either in direct relation to a concrete purpose or to a specific level of revenue desired for that year. Regarding municipal contributions, their composition before the war consisted mostly of: a tax for the cost of maintaining the security and the public lighting in the city,21 a tax for maintaining the public amusement centre,22 a tax on carriages23 and a tax on slaughterhouses.24 All these laws have something in common; they were direct taxation methods. Regarding national contributions, their composition before the war consisted mostly of: importation tariffs and exportation fees, an agricultural tax, a patent tax, a sealed paper tax and the alcabala tax, all contained in many laws.25 As it was common at the time, the most important taxation mechanisms for the Chilean treasury were importation tariffs and exportation fees. Regarding this subject, two main laws were applied during this period: the Customs Ordinance26 and the general law of imports tariffs.27 The Customs Ordinance established a general level of taxation of 25 per cent on the value of all goods imported, with the exception of goods included in restrictive lists that were either taxed at two per cent of their value or a flat rate amount, depending on the list in which the goods were included. The general law of imports tariffs included four levels of taxation: 35, 15 and four per cent of the value of the good, plus a flat rate specified for certain products. The general law of import tariffs of 1878 also levied an export duty only on minerals. This tariff was two pesos per kilogram of silver and 60 cents of peso per quintal of copper in the case of refined minerals, and a percentage of the tax depending on the purity of the mineral for the unrefined mineral. Regarding agricultural land, the Chilean system had a tax rate of nine per cent on the value of the property. The agricultural tax law was established on 18 June 1874 to collect a yearly revenue of $1,200,000 pesos,28

21 

Contribución de Serenos y Alumbrado, 23.10.1835. Boletín, libro VI 202, 1836. Contribución a los Establecimientos de Diversiones Públicas, 07.10.1852. Boletín, libro XX 210, 1852. 23  Contribución de Patentes de Carruajes, 23.09.1862. Boletín, libro XXX 310, 1862. 24  Impuesto de Matadero y Carnes Muertas, 26.11.1873. Boletín, libro XLI 340, 1873. 25  There were also less relevant taxes, revenue wise, included in the law, such as the toll tax, the exclusive privilege tax, the post office tax, the coinage tax and the cards and tobacco licence tax, although the last one was still relevant. 26  Ordenanza de Aduanas, 24.12.1872. Boletín, libro XL 1,130, 1872. 27  Derechos de internacion de las mercaderías estranjeras—Lei jeneral sobre la materia, 08.07.1878. Boletín, libro XLVI 327, 1878. 28  Ley de impuesto Agrícola, 18.06.1874. Boletín, libro XLII 428, 1874. 22 

Origins of Income Taxation in Chile 451 divided in a proportional way on all the landowners of the country. On 1 April 1875, and based on calculations made in order to divide the burden proportionally, a rate of nine per cent was levied on agricultural land, which resulted in a yield for the public revenue of the following year of almost $1,045,000 pesos.29 Regarding the patent tax, on 22 December 1866 a commercial licence or patent tax was established over professions, industries and arts in five categories with a flat fee varying depending on the municipality in which the patent was used.30 This law also included a two per cent rate on the income of industries obliged by law to carry complete accounting books. Regarding the sealed paper contribution tax contained in the law of 1 September 1874,31 it was levied on certain acts that required actions from the administration to have legal existence or validity. This ­contribution was included in the Chilean taxation system in 1817 and since then it has s­ teadily increased its rates and the extension of acts that needed sealed paper. The cost of the seals varied from instrument to instrument, and could be flat fees, in the case of papers presented to the court, or percentages of the operations, such as the purchase of a house. In 1878 a fine of five per cent of the value of the act, or 50 times the value of the seals was imposed in the case of non-compliance.32 Regarding the alcabala, it was a tax on the transference of lands, mines and, originally, vessels.33 It had a rate of three or four per cent of the value for lands, depending on their location in regards to a city, and two per cent for mines and vessels. Vessels were exempted from this tax the year before the war.34 After the 1878 Contributions Law and before the war, two important tax­ ation laws were promulgated: the inheritance tax of 1878 and the property/ income tax of 1879. Just a year before the war, on 28 November 1878, Chile created its first inheritance tax, to be imposed on inheritances and any irrevocable ­donations.35 The tax was based on a percentage of the value of the inheritance, and ranged from one to eight per cent depending on the amount and legal closeness of the relationship between the parties. This tax is important because the taxable event had no direct connection with the goals of the

29  Cuota que debe pagarse por el impuesto agrícola, 01.04.1875. Boletín, libro XLIII 137, 1875. 30  Impuesto de patentes, 22.12.1866. Boletín, libro XXXIV 500, 1866. 31  Contribución de papel sellado, 01.09.1874. Boletín, libro XLII 166, 1874. 32  Papel sellado.-Lei aclaratoria de Ia de 1º de setiembre de 1874, 18.01.1878. Boletín, libro XLVI 33, 1878. 33  Alcabala.-Disposiciones relativas a esta contribución o derecho, 17.03.1835. Boletín, libro VI 193, 1836. 34  Navegacion.-Lei jeneral sobre la materia, 03.07.1878. Boletín, libro XLVI 221, 1878. 35  Impuesto sobre las herencias I donaciones, 28.11.1878. Boletín, libro XLVI 576, 1878.

452  Maximiliano Boada revenue that it produced. During the discussion of this law, the Senate of the Republic held many discussions in which some senators were emphatic on the unconstitutionality of a progressive tax on inheritance, arguing that it went against an equal distribution of the burden of the State. Although this fact did not prevent the law from being passed, it is particularly important for a discussion regarding the figure and content of income taxation that was to follow years later. Regarding the taxation of wages in particular, Chile did have taxation and burden systems based on income in general or aimed at specific incomes, before a systematic regulation of the matter through an income tax was introduced in the country. This was embodied in the law of 21 May 1879 in the time previous to the War of the Pacific. However, three legislations existed before it, that in one way or the other did represent a burden on income and therefore are interesting to examine for the purposes of this research: (i) the laws of 21 November and 9 December 1817,36,37 (ii) the decree of 30 April 1866,38 and (iii) the law of 10 January 1867.39 The historical context is important to analyse the first appearance of a wage taxation law in the country, as it was a key factor for such a tax to be accepted by the population. From 18 December 1810,40 an uprising against the control of the Spanish Empire, and later the King himself, produced a series of conflicts that culminated in Chilean independence on 12 February 1818. The laws of 21 November and 9 December 1817 were both justified in providing economic support to the final process of the independence of Chile from the crown of Spain, and two different taxation methods to achieve this goal were introduced. The first law contained a progressive ‘tax’ imposed on civil as opposed to military, employees. This system was no proper taxation system because the obligation of the taxpayer came with the guarantee that once the government was not in such a desperate need for increasing the public revenue, it would repay all the ‘taxes’ collected under this method. The second law included a proper direct taxation method, by which the owners of rural or urban estates and businesses had to pay one per cent of the value of their merchandises.

36 

Contribución impuesta a los empleados civiles, 21.11.1817. Boletín, libro I 134, 1817. Contribución impuesta a los propietarios de fundos rústicos o urbanos i a los comerciantes, 9.12.1817. Boletín, libro I 150, 1817. 38  Contribucion sobre la renta, 30.4.1866. Boletín, libro XXXIV 145, 1866. 39  Imposición de una contribución de cinco millones de pesos sobre la renta, 10.1.1867. Boletín, libro XXXV 7, 1867. 40  On this date, the first government meeting of Chile was held in order to set a path of action while the King of Spain was held captive, as they did not consider themselves part of the kingdom of Spain, but rather a different territory of the crown of Spain. 37 

Origins of Income Taxation in Chile 453 On 30 April 1866 a decree was passed that imposed an income tax of five per cent on all listed incomes, which were practically all the possible incomes.41 Although this law did not approach income taxation in a systematic way, it is the first tax on income in Chilean legislation history. However, as it was not a tax purely on income, even though it taxed income, it was not the first ‘income tax’. The law of 10 January 1867, as well as the law of 9 December 1817, both contained the promise of returning the money to the taxed citizens once the state was able to, thereby making them a forced loan and not a tax. In the decade after the imposition of the tax of 1866 and based on the country’s needs to raise more taxes in order to support its rising expenditure level, a new tax was included in the Chilean taxation system. This was done through the law of 21 May 1879, which included a property tax of three parts per thousand.42 This tax, applicable to the value of capital invested in or subject to emphyteuses,43 real estate, debt titles, guaranteed loans, bank investments, capital gains of companies and life insurance capital, was different from what could be considered a regular income tax. As for the effects of this tax, any type of income (wages, rents, pensions and annuities included) from any private or public entity was considered to be the reflection of capital consisting of 10 times the yearly income, and therefore taxed at the same rate of three parts per thousand. The tax introduced in 1879, which could neither be considered a personal tax nor a property tax alone, was a solution that seemed fair at the time regarding how to equally divide the burden of the State. However, all these taxation methods were still not producing sufficient revenue to cover the level of expenditure held previous to the War of the Pacific. In fact, in 1876 the difference between the expected public revenue and the expected public expenditure levels for the next year was approximately $3,000,000 pesos. As the total expected expenditure level was around $18,000,000, this resulted in a yearly public deficit of one sixth of the total expenditure.44 Another relevant problem these taxes had was that they resulted in a revenue base with a low level of certainty and reserves for the case of an economic fluctuation or crisis, two undesirable things for a taxation system.

41  E Marshall, ‘El Impuesto a la Renta en Chile’ (1939) 5 Anales de la Facultad de Ciencias Jurídicas y Sociales 17, 10. 42  Contribución sobre los haberes, 21.5.1879. Boletín, libro XLVII 156, 1879. 43  ‘A Roman and civil law contract by which a grant is made of a right either perpetual or for a long period to the possession and enjoyment of originally agricultural land subject to the keeping of the land in cultivation or from depreciation, the payment of a fixed annual rent, and some other conditions’ ‘Emphyteusis’ Def 1, Merriam-Webster’s dictionary online, n.d. 44  A Carrasco Albano, La Cuestión Financiera para 1877 (Santiago, Imprenta de la Librería del Mercurio, 1876).

454  Maximiliano Boada SALTPETRE CYCLE

The War of the Pacific Saltpetre history, as opposed to the history of copper, is quite recent; the native people of the region did not extract it, and did not know how to use it in the ways it was being used elsewhere in the nineteenth century. The Compañia de Salitres de Antofagasta, the first extracting company of the mineral in the region, began extracting the mineral in 1869 in what used to be part of Bolivian territory. The saltpetre industry was mostly owned by British capitalists in Tarapacá (Peru), and by Chilean capitalists in ­Antofagasta (Bolivia). The impact of this commodity was so disruptive for the local economies that they began to depend on it once the e­ xtraction processes were more developed. In fact, halfway through the nineteenth ­century, Peru was already exporting yearly over one hundred thousand ­metric tonnes to Europe.45 The borders between Chile and Bolivia were not clearly established before the boom of saltpetre. This was mostly because the countries were founded just that century and until then there had not been any problems regarding the area because it was a desert and no country exercised sovereignty in the area. But as the saltpetre cycle began, so did the problems, such as the concession of the same mining rights by Bolivian and Chilean authorities to different persons.46 Confusing situations like this one were resolved by the signing of the Boundary Treaty of 10 August 1866, later substituted by the Boundary Treaty of 1874. The origin of the problem was the fourth article of the later convention, which stipulated: Los derechos de exportación que se impongan sobre los minerales exportados en la zona de terreno de que hablan los artículos precedentes, no excederán la cuota de la que actualmente se cobra, y las personas, industrias y capitales chilenos no quedarán sujetos amas contribuciones de cualquiera clase que sean que las que al presente existen. La estipulación contenida en este artículo durará por el termino de veinticinco años.47

This article prohibits any increase of taxation by Bolivian authorities applicable to any Chilean citizen or capital between parallels 23 and 24 of the Bolivian territory for the following 25 years. In the following years this article was disregarded by the Bolivian authorities, and caused one of the more expensive economic and tax problems seen in the newly founded countries of Latin America. 45  A Villegas Andazosa, ‘El Impuesto al Salitre y la Guerra del Pacífico’ (2015) 16 Revista Argentum, 379, 381. 46 See, eg, R Querejazu Calvo, Guano, salitre, sangre; historia de la guerra del Pacífico (La Paz, Los Amigos del Libro, 1979). 47  Bolivia & Chile, Tratado de límites de 1874 entre Bolivia y Chile (1874).

Origins of Income Taxation in Chile 455 In 1879, and only a few months after the same year’s property tax was included in the taxation system, the aforementioned problem culminated in the War of the Pacific. This conflict between Chile, Peru and Bolivia not only changed the future economic environment for these countries, but also the future tax environment once it was over. The conflict began with the imposition of a saltpetre tax by Bolivia on a Chilean company, the Compañia de Salitres y Ferrocarriles de Atacama (Atacama’s Nitrate and Railroad Company).48,49 This was done by ­making use of an agreement made in 1873 but approved and implemented by the Bolivian Government in 1878, by which Bolivia recognised the right of the company to extract minerals and to use the port in exchange for the ­payment of a tax of, at least, ten cents per exported saltpetre quintal. Chile argued that the 1874 Boundary Treaty, which stated that no tax increments could be passed in the next 25 years against any Chilean citizens in that region, forbade such a tax increase. Following the logic of the Chilean government position, the company decided not to pay the new burden. On 11 January 1879, in response to the lack of compliance by the Chilean company with the new Bolivian tax policy, Bolivia seized the property of the Chilean company. Bolivia intended to auction the property and pay with the results of the sale the tax debt that the company had with Bolivia under the new law. Following this, on 1 February of the same year, the Bolivian authorities decided that, as the lack of payment of the tax by the company showed that there was no intent to comply with the 1873 agreement, the agreement itself was voided. Furthermore, as the agreement was voided and the company had no right to extract the minerals, no tax could be applied and there was no breach of the Boundary Treaty of 1874.50 In retaliation, Chile declared war on Bolivia and invaded Antofagasta on 14 February 1879, the same day that the auction was to be held. What the Chilean government did not know when invading was that Bolivia and Peru had united in a secret pact against Chile, supposedly made to gain c­ ontrol over the saltpetre industry in the region in order to make ­monopolistic ­revenues possible.51 48  Technically, it was a law that contained only one article: the approval by the congress of a transaction process between the company and Bolivia, done in 1873. The article reads: ‘Artículo Único. Se aprueba la transacción celebrada por el ejecutivo en 27 de noviembre de 1873 con el apoderado de la Compañía Anónima de Salitres y Ferrocarril de Antofagasta a condición de hacer efectivo, como minimun, un impuesto de diez centavos en quintal de ­salitre exportado’. Asamblea Nacional Constituyente de Bolivia, Ley de 14 de febrero de 1878, Bolivia. 49 This episode is considered the direct reason for the war; however, it has been argued by some scholars such as Ronald Bruce St. John, below n 52, and Alvaro Villegas Andazosa, below n 51, that it was only a justification used by Chile to breach the treaty. 50  A Villegas Andazosa, ‘El Impuesto al Salitre y la Guerra del Pacífico’ (2015) 16 Revista Argentum 379, 396. 51 R John, ‘The Bolivia-Chile-Peru Dispute in the Atacama Desert’, in C Schofield (ed), Boundary and Territory Briefing (Durham, Ibru, 1994) 7.

456  Maximiliano Boada Before the war, the Chilean public economic situation was in a very precarious condition, because the taxation system could not provide enough to keep the expenditure levels of the state. Moreover, the yields of the saltpetre tax were decreasing for two reasons: the reduction in the production of the mineral, and the need for it to have a competitive price compared with the nitratine produced in Peru and Bolivia. However, once the war was over in 1893, and Chile took control of the Region del Litoral of Bolivia and the south of Peru, the situation changed, and Chile became the monopolist producer of saltpetre for the world by obtaining the saltpetre rich regions of Peru and Bolivia. The military aspects of the war are not relevant for this research; however it is important to mention that Chile won the war. This had two massive effects for Chilean tax policy. Firstly, the monopolised conditions created the possibility to have a non-competing exports tax that could be kept high, as there was no competitor for supply of the product. The second effect is that the influx of money increased prosperity of the Chilean people, which resulted in higher imports to the country, thus increasing the yields of the import tax. Taxation After Chile Gained Control of the Saltpetre Rich Region Taxation after the War of the Pacific is a problematic political issue. Many historians have argued that the way in which the taxation system was reengineered in Chile after the war, and particularly the high increments on the taxation of saltpetre, are proof that the Bolivian rise in taxation levels was merely an excuse by the Chilean government to take the region under its control. Whether the reason for the war was only the rise of taxation to a Chilean company that went against the treaty or the lack of respect the Bolivian government showed to the treaty with its Chilean counterpart is not a part of this research.52 During the occupation of the territories by Chile, and while still at war, a tax of 40 cents per quintal was levied beginning on 12 September 1879.53 On 2 October 1880 this tax was further raised to one peso and 60 cents per quintal.54 This increase was justified in front of the Congress by the Chilean ­Minister of Finance at the time, José Alfonso Cavada, based on the high costs of the

52  The author believes that the reason behind the conflict was the lack of respect for the ­ rinciple of international law pacta sunt servanta, in accordance with the posture that the p Chilean government has sustained since the beginning of the dispute until nowadays. 53  Salitre—Derechos de esportacion, 12.09.1879. Boletín, libro XLVII 315, 1879. 54  Derechos de esportacion del salitre I el yodo, 02.10.1880. Boletín, libro XLVIII 327, 1880.

Origins of Income Taxation in Chile 457 war that had to be covered, costs that went far beyond the regular expenditures of the country. In his speech given on 3 August 1880, the minister argued that the revenue could be used for ordinary expenditures as well as for credits the government took in order to fulfil its obligations during the war. Moreover, he promoted more stable taxation institutions, made necessary by the imminent losing of the revenue from the Estanco, the state’s monopoly on tobacco. An important aspect covered by the Minister during this speech is the fact that the mining endeavours in Tarapacá (previously Peru) would continue to be untaxed under the agreements signed with Peru.55 This point proves the pacta sunt servanta theory of the reasons for the war. This soon to be applied tax of one peso and 60 cents per quintal kept the simplicity of the previous tax, without considering either the ore grade or the earnings a company had. The justification of the taxation level levied on minerals is relevant for two reasons. It discloses the goal of the public administration at the time; to have a greater level of certainty. Further, from that moment onwards, the money being levied was openly going to the national treasury interests, as opposed to the miners’ interests in the first place, and later to the interest of the community on which the mining activities were done. Another interesting aspect is that the Minister of Finance stipulated that there was not a chance, as it had never happened before, for the National Customs Office to levy the taxation considering the cost of production. For that reason the government did not consider the grade of the ore of mineral present in the mines nor the different mechanisms to purify it to be ­relevant factors. The Minister also stated that the extra yield for the treasury expected from changes in taxation lay between four and five million pesos, a value that represented around a quarter of the total expenditures of the previous years. As a result of this increase in tax collection, Chile saw an increment of eight times the level of treasury reserves prior to the war in only 20 years,56 and the saltpetre export tax rose to account for 51.9 per cent of all tax ­revenues in the zenith of this period.57 This uncommon situation for a country, having a rapid increase in both the reserves and the public expenditures, could have been accompanied with a number of different taxation and expenditure policies for the country. The option that Chile chose, under economically liberal governments during the totality of this bonanza period, was to abolish all kinds of

55 See G Billinghurst, Legislación sobre salitre y borax (Santiago, Imprenta Cervantes, 1903) 279. 56  J Crow, The Epic of Latin America (Berkeley, University of California Press, 1992) 647. 57  P Meller, Un siglo de economia política chilena (1890–1990) (Santiago, Editorial Andrés Bello, 1996).

458  Maximiliano Boada direct taxation; in fact Chile didn’t have any direct taxation methods for 25 years, from 1891 until 1916. The Municipalities’ Organization and Attributions law of 22 December 1891 derogated all the remaining direct taxation methods in the system.58 The implementation of the aforementioned level of taxation of s­ altpetre has been considered as being close to one of the optimum tariff under ­Bickerdike’s theory for the period until the first decade of the twentieth century.59 After that period, it was considered to be over the optimum, and therefore being part of the causes of the later decay of the saltpetre cycle. Chile saw that it had a great position in the market, as a ­monopolistic producer of a good with many interested parties, and decided to take advantage of this situation by increasing the taxation levels imposed on it. The problem of this attitude is that it was taken in the zenith of the market position of the country, when it could actually afford to do such a thing. However, once the market position of the country was lowered by both national and international events, such as World War I and the rise of the price of production, the country did not take action to avoid lowering ­competitiveness of national saltpetre by reducing taxation levels. In fact, the impact of World War I was so disastrous to the saltpetre-based Chilean economy that one year after the war began, 35 saltpetre offices had to be closed down. There were more than one million quintales of surplus saltpetre available and waiting for demand, just considering the port of Iquique.60 The reason for this rapid decline in demand was the change of priorities in consumption in the markets involved in the war, and also that many markets were not safely reachable by vessels anymore. The saltpetre industry recovered itself momentarily because the market was still in need of the commodity, but the void it had left in the market during the war was filled by the synthetic saltpetre created by the Germans. With the Haber-Bosch method and the following research, the Germans were able to produce the substitute at a cheaper price and with no dependency on an international actor. These factors, added to the crisis of 1929, forced the end of the saltpetre cycle.61 Regarding the expenditure policies of Chile at the time, a part of the new influx of money that came as a result of the monopolist conditions of the

58  Lei de Organización y Atribuciones de las Municipalidades, 22.12.1891. Boletín, libro LX 261, 1891. 59  R Lüders & G Wagner, Export, Tariffs, Welfare and Public Finance: Nitrates from 1880 to 1930 (2003) 241 Working Papers Pontificia Universidad Católica de Chile, Instituto de Economía, 3. Regarding Bickerdike’s theory, see J Chipman ‘Bickerdike’s Theory of Incipient and Optimal Tariffs’ (1879) 25 History of Political Economy 461. 60  C Donoso Rojas, ‘El ocaso de la dependencia salitera (1914–1926)’ (2014) 45 Diálogo Andino 97, 99. 61  ibid 99.

Origins of Income Taxation in Chile 459 saltpetre cycle went to replace all the taxes that were abolished. However, a greater part was spent on the creation of infrastructure, such as the creation of sewerage and drinking water systems, a national museum, jails, ports, schools and a railroad system that covered most of the continental part of the country. These kinds of investments in institutions and infrastructure are usually considered a good thing, however the high level of growth of the Chilean government, required high expenditure just to cover the overhead of maintaining the new size of the government. Consequently, having rested on the bonanza of just one industry proved to be a critical and dangerous behaviour for the national economy.62 Based on imports and duties and greater expenditure levels, an overcharge of 40 to 50 per cent of the duties was approved by the Congress between 1887 and 1889.63 This led to discontent from the population, which protested particularly against the price of imported meat from Argentina, and culminated with the elimination of duties for most kinds of food.64 ­However, on 1 December 1897 the duties were reintroduced at a lower level, with a general treatment of 25 per cent, with four more levels, ranging from 60 per cent to four per cent, and flat fee duties.65 Taxation After the Decay of the Saltpetre Cycle and the Origin of the Income Tax Institution in Chile Direct taxation mechanisms, via asset taxation, were reintroduced in 1916 based on the frequent crises present in the saltpetre industry that were undermining the economic stability of the country. However, even before that, indirect taxation methods based on different taxable actions were already imposed by the government, either to incentivise a conduct, such as the 1902 tax on alcohol, or to increase the yields of taxation, such as the wooden matches import tax of 1907.66 During this period many of the current taxes, such as the stamp tax, suffered a raise in their tax rate. The re-introduction of direct taxation to the Chilean system came with the assets tax of 13 April 1916, which taxed real estate, movable assets, and

62  C Cariola & O Sunkel, Un Siglo de Historia Economica de Chile 1830–1930 (Madrid, Ediciones Cultura Hispánica, 1982) 41. 63 Contained in: Recargo sobre los derechos de internacion i almacenaje, 29.08.1885. Boletín, libro LIV 653, 1885, Derechos de esportacion del salitre y yodo, 03.10.1885. Boletín, libro LIV 922, 1885 and Reducción de la emission de billetes fiscales, recargo de los derechos de internación i almacenaje, garantía de los billetes fiscales de curso forzoso i disposiciones sobre la emission de los bancos, 14.03.1887. Boletín, libro LVI 376, 1887. 64 ‘Liberación de derechos de los comestibles, 25.04.1891. Boletín, libro LX 30, 1891. 65  Ley Nº 980, 31.12.1897. Fija el impuesto de internación. 66  Ley Nº1,911, 01.02.1907. Fija los derechos de internación de los fósforos de madera, and Ley Nº1,515, 20.01.1902 Lei sobre alcoholes.

460  Maximiliano Boada securities.67 Regarding real estate, the tax could account for up to 0.5 per cent of the value of the real estate, depending on the municipality, but could go up to 0.55 because the same law included a movable assets tax that had the same rate and the legal presumption that the movable assets present in any real estate were worth ten per cent of the value of it. Regarding transferable securities, they were taxed at 0.3 per cent. This period was the one that enabled the introduction of income tax in Chile. In his account on the subject, Marshall compares the discussions in the parliament in Chile with the ones present in France when income tax was enacted there. He argues that while in France the dispute between the political right wing and the political left wing was whether or not income tax should be included in the legislative system, in Chile in 1919 the discussion was about how it should be included in the system, being that both left and right wings already favoured its introduction.68 For a full perspective of the argument it has to be included that by 1919 the income tax, conceived as a permanent tax, already had a high international traction that included the application of the UK’s 1842 Income Tax Act, the 16th Amendment to the Constitution of the United States of America, and the 1914–1917 global income tax and professional tax of France.69 In 1919, Luis Claro Solar, Minister of Finance at the time, presented a draft bill to implement an income tax in Chile, initiating the debate over this tax. This draft bill, along with others presented by the Sociedad Nacional de Minería, by some congressmen and by the head of the Finance Commission of the Congress, Jorge Silva Somarriva, were discussed by the Finance Commission of the Congress, who had the responsibility to analyse the viability of the implementation of such a tax in Chile. In 1921 this commission gave a report regarding the income tax, presenting a draft bill based on Silva’s project but taking into account inputs of the rest of the proposals that made the income tax more practical and that generated a greater yield for the National Treasury.70 This draft bill included a schedular system of taxation, which contained five categories and different taxation levels depending on the category of the income, including progressiveness in the labour-related category, and a progressive global net income tax for natural persons (IGC),71 which went from zero to seven per cent. The draft bill was further discussed and later returned to the Finance Commission by the Chamber of Deputies in order to make amendments.

67 

Ley Nº3,091, 13.04.1916. E Marshall, ‘El Impuesto a la Renta en Chile’ (1939) 5 Anales de la Facultad de Ciencias Jurídicas y Sociales 17, 9. 69  ibid, 10. 70  ibid, 13. 71  IGC for its initials, in Spanish: Ingreso Global Complementario. 68 

Origins of Income Taxation in Chile 461 The draft bill was corrected based on the criticism made by the Chamber of Deputies and was re-introduced in 1922. The new version of the draft bill contained a simplified proportional schedular system divided into five categories of income, of which the mining and metallurgy industry category had the highest level of taxation at five per cent. Regarding the IGC, it contained a bracket progressive tax that started at ten thousand pesos, with one per cent, and went up to five per cent for all income above one hundred thousand pesos. This project, a project that left almost untouched the landed class in Chile, was passed by the Chamber of Deputies, a chamber in which the same class was significantly overrepresented. In 1923 the Senate of the Republic reviewed the draft bill and had a discussion on whether or not the Constitution allowed progressive taxation. The problem here was a matter of interpretation, as the national Constitution of 1833 stipulated: Artículo 12. La Constitución asegura a todo individuo: 3.º La igual repartición de los impuestos y contribuciones a proporción de los haberes, y la igual repartición de las demás cargas públicas.72

There were two interpretations of the legal precept. On the one hand were the Senators that followed the literal interpretation of the norm. On the other side were the Senators who took a broad sense interpretation method to analyse the national Constitution. This discussion was won in the Senate by the narrow-approach Senators and the income tax law was promulgated on 2 January 1924, excluding from it the figure of IGC, for its progressive nature.73 However, the discussion became a main public issue and Eliodoro Yañez, a public figure in Chile that at the time was a Senator and would become the President of the Senate of the Republic the following year, was particularly vocal on the subject. He argued that equality in equal situations was respected by the project because factual reality of the different brackets represented different economic situations that could not be compared. Besides this discussion, the project was dismissed for the reason that in the category system there was no taxation regarding assets in relation to their owners and also that saltpetre, iodine and iron were not included, leaving only the exportation duty levied on them. In 1924 the political environment grew particularly tense, even for Latin American standards. The president at the time, Arturo Alessandri, had minority support in both chambers in a parliamentary democracy, which

72 Article 12. The Constitution ensures to all individuals ‘3º the equal division of taxes and contributions in proportion to the assets, and the equal division of the rest of the public burdens’. 73  Ley Nº3,996, 02.01.1924. Que establece un impuesto sobre las rentas.

462  Maximiliano Boada meant that most of the law projects were either delayed or voted against. This situation, summed to an economic crisis which was partly due to the low saltpetre price, led to a great military movement known as ‘Ruido de Sables’.74 A group formed by low and mid-range officials of the national army, the epitome of the middle class in Chile at that time, went to the doors of the building in which the Congress was based during the discussion over the raise of the congressmen allowance. The officials stood outside the building while making their sables clash to intimidate the Congress. Following this demonstration, a commission went to the office of the President to ask for expedited promulgation of many laws, most of them regarding the labour conditions. In an attempt to control the situation, the laws were approved in only one day. After this happened the military commission asked the President to dissolve the Congress. In response to this, the President abdicated his appointment as president and proceeded to exile himself in the United States of America. The rule of this commission was finished by a coup d’état executed by another military official, Carlos Ibañez del Campo, who asked the former president Alessandri to return to finish his presidency period. The same year, on 18 September 1925, a new national Constitution was promulgated during the regained presidency of Alessandri. This Constitution added to the article regarding the burdens of the State the following paragraph, that is still present in the current constitution: Art. 10. La Constitución asegura a todos los habitantes de la República: 9.o La igual repartición de los impuestos y contribuciones, en proporción de los haberes o en la progresión o forma que fije la lei; y la igual repartición de las demás cargas públicas.75

As there was still no Congress to pass legislation, the legal device of lawdecree was used during the second part of his presidential period, enabling him to pass laws by using his executive power, without the need of a majority. This situation was particularly convenient for Alessandri, as he went from having only the support of a minority of the Congress, to holding the power over the whole institution. This legal device was used to include progressiveness in the Chilean income tax trough the IGC on 18 March 1925,76 and by the end of the year it was used again to include both the decreto ley Nº755 and the decreto ley Nº756. The first one includes the impuesto adicional (IA) in the system, an

74 

The literal translation is ‘Noise of Sables’. 10. The Constitution ensures to every inhabitant of the Republic: ‘9º the equal division of taxes and contributions in proportion to the assets, or in the progression or way that the law stipulates it, and the equal division of the rest of the public burdens.’ 76  Decreto Ley Nº330, 18.03.1925. 75  Article

Origins of Income Taxation in Chile 463 additional income tax to be paid by international legal entities and natural taxpayers registered in a different jurisdiction that hold earnings in the country. Along with this, the decreto ley created a different treasury fund to go directly to the defence budget, which was composed, among others, of the IA and the money not expended in the fiscal year.77 The second one created a new real estate tax of 0.33 per cent, which extended its reach to coal and saltpetre mines.78 In 1932, when the international economic crisis had already had a devastating effect on the saltpetre industry and on the national economy, and under the socialist government of President Carlos Dávila, a decree that systematised the income tax was passed.79 This decree clearly stipulated in its foreword that its goal was to create a fairer income tax, due to the fact that the previous one had failures like being particularly burdensome to the lower classes and not correlating with the reality of investments. Following this logic, the passive income tax was raised and the bracket system was improved to eliminate the cases in which earning a little bit over the bracket made the after tax result lower than for those earning a little bit under the same bracket. All this would later be merged and modified by Law Nº5.169 of 30 May 1933, Law Nº6.334 of 28 April 1939, Decree Nº824 of 31 December 1974, and Law Nº20.780 of 29 September 2014, just to name a few, but the system, its logic, and its principles were maintained in the Chilean legal framework. The income tax system currently in force in Chile is just an evolution of the one present in 1925, a system that was conceived as an application of a foreign taxation tool, which became necessary when the economic situation of the country could not rely on the mercy of the mineral cycles any more. THE COPPER CYCLE

In order to apply the experience of mineral taxation in the country to the lithium cycle, it is first necessary to analyse the current mineral cycle: copper. The Development of the Copper Related Industry in Chile Copper has been part of the Chilean aboriginal culture since before the Spanish colonisation. The first archaeological records of the usage of the

77 

Decreto Ley Nº755, 21.12.1925. Decreto Ley Nº756, 21.12.1925. 79  Decreto Ley Nº592, 10.10.1932. 78 

464  Maximiliano Boada mineral date from 500 bc.80 The Atacameños and the Diaguitas, located in what nowadays is the north of Chile, developed smelting technics to shape payen (copper). The mineral was massively exported for the first time from Chile in 1825, destined for the port of Swansea, where most of the English smelters were located. Copper was exported in the form of copper sulphide, an inefficient way of exportation, as the metallic yield of it in Swansea was lower than if it were to be processed in Chile. Carlos Santiago Lambert realised this issue and installed the first reverberator furnace of the country, which helped the sulphide copper reserves gain a valuable position in the market.81 From this moment onward, the economic importance of the mineral for the global industry gave Chile an important role in the international economy, passing from being the fourth biggest producer in the world in 1830, to being the greatest exporter of copper in the world in 1870. As is the problem with a commodity exporter country, the lower prices present in 1874, due to the world economic crisis originated on 8 May in the Vienna stock market, created a problem for Chile, which shut down many of the producing deposits. From 1860 to 1880 Chile provided 30–40 per cent of the world supply of copper, and during 1890 to 1910 this number decayed to four to five per cent of the world supply.82 As the high purity clusters of copper were mined, low level of purity copper deposits were left. This, combined with high prices in the international market of the newly acquired saltpeter, prevented the copper industry from recovering its importance. However, in 1904 and based on application of new extraction techniques that allowed working with porphyry copper deposits,83 a new era for copper began. Mining porphyry copper requires a great capital investment because of the great size of operations required to make a mine profitable. This fact summed with the know-how of the new techniques from the United States of America and a new boom in the market propelled by the new electric discoveries, brought the entrance of foreign capital from the United States of America to the national market. The first mining project of this type was done by Braden Copper Co. (USA) via the mining of the El Teniente mine in 1904. This investment was

80 A Sutulov, ‘Antecedentes Historicos de la Producción de Cobre en Chile’ in A Zauschquevich & A Sutulov (eds), El cobre Chileno (Santiago, Editorial Universitaria, 1975) 5. 81  ibid, 21. 82  G Wagner, ‘Un siglo de tributación minera: 1880–1980’ (2005) 288 Working Papers Pontificia Universidad Católica de Chile, Instituto de Economía 23. 83  Porphyry copper deposits consist of the deposits created by hydrothermal fluids. Their content of copper is low and therefore require greater extractions and a higher level of sophistication of the smelting process to be profitable.

Origins of Income Taxation in Chile 465 followed by the opening of the Chuquicamata mine in 1910 by the Chile Exploration Company (USA) and later by the opening of the Potrerillos mine by Andes Copper Mining Co. (USA).84 Of these three mines the first two are still open today and doing business, now under the ownership of the Chilean government. General Taxation Methods During the Copper Cycle From 1924 onwards, starting with the income tax law, and until 1964, the income from mining companies had general income tax treatment under the fourth category (mining and metallurgy) at a 12 per cent rate. After this, with the imposition of additional tax, mining companies were also subject to a remittance additional tax of six per cent. In 1939 Corfo was created.85 This institution’s goal was the advancement of national production and industrialisation and over the years it became crucial to the development of mining in the country. In order to finance this institution, additional tax burdens were imposed, particularly 12 per cent that was included in the tax system with regards to mining companies that employed more than 200 workers and an extra three per cent of additional income tax to be paid by international taxpayers. Under this law the companies that would later be referred to as Great Copper Mining Companies, or GMC for its initials in Spanish, were affected by a total tax burden of 33 per cent. In 1942 a system of expected returns was established in the tax regulation that imposed a 50 per cent extraordinary tax on all net income that surpassed the expected return on investment previously set.86 During this time the average tax burden for a mining company was around 65 per cent of earnings before taxes. A decade later, in 1952 the extraordinary tax rate was elevated to 60 per cent,87 raising the average taxation of the companies that would later be referred to as GMC, to 86 per cent of the earnings before taxes.88

84  Braden Copper Company, Mineral de ‘El Teniente’ (Santiago, Impresora Universo, 1942) 9 and Sociedad Nacional Minera, 100 Años de Mineria en Chile (Santiago, Lead, 1983). 85 Ley Nº6,334, 29.04.1939. Crea las corporaciones de reconstrucción y auxilio y de fomento a la producción. Corfo stands for Corporación de Fomento de la Producción. 86  Ley Nº7,160, 21.01.1942. Establece un impuesto extraordinario sobre la renta que pagaran los establecimientos que produzcan cobre en barra. 87  Ley Nº11,137, 27.12.1952. Suplementa, en las cantidades que indica, los ítem del presupuesto general de la nación, que menciona. 88  C Correa Iglesias ‘Historia Sobre la Legislación Cuprífera en Chile’ in A Zauschquevich & A Sutulov (eds), El cobre Chileno (Santiago, Editorial Universitaria, 1975) 74. In this figure Carlos Correa Iglesias includes the effect of the fixed rate price contained in Ley Nº10, 255, which, although not a tax, was an economic burden to be paid to the state, which from an economic perspective could be assimilated to a tax.

466  Maximiliano Boada This period of time was marked, as has been shown, by a great number of changes in legislation and great institutional uncertainty, which led to diminished production of copper, as suggested by institutional theory.89 The law of the new deal, promulgated on 5 May 1955, represented the solution to the uncertainty problems created by the previous laws.90 It introduced a more stable economic and legal treatment in order to increase the production and industrialisation of the copper industry in Chile. It introduced the concept of the ‘Gran Mineria del Cobre’ companies, or great copper mining companies, referring to those who had a yearly extraction record of more than 25,000 metric tonnes of the mineral, and gave them a special legal treatment. This law established a base applicable tax of 50 per cent of earnings before taxes and a 25 per cent variable rate based on a system of production incentives by which taxation would decrease proportionally until 50 per cent depending on the level of production. The problem with this system was that the base was static, grounded in the data from previous years, years that had resulted in such bad yields that they led to the imposition of this new law. As yields increased again, the rate became smaller in relation to the income. For this reason the amount of taxes paid by the GMC companies was lower than expected. The new deal was later strengthened by the decree Nº258, which gave the industry certainty of tax invariability under a 50 per cent tax rate.91 However, the continuity of this system would be once again compromised. The low levels of yield to the Treasury compared to the earnings of the companies, strictly due to a bad legislative technique, led to a change of the legislation in 1961.92 This established firstly an over-rate of ten per cent for the GMC companies (five per cent for the category and five per cent on them specifically) and later an overcharge of 24 per cent to be applied to a third of the tax rate applicable to the GMC. In 1964, the government continued its efforts to develop an industry related to the mineral and imposed, affecting the certainty of the tax system, a tax of two cents US per pound on non-refined mineral to the GMC’s burden, as long as they had not initiated projects to create the infrastructure necessary to refine the mineral in Chile.93 The same law also changed the treatment of the taxes paid in other jurisdictions and the legal definition of the GMC in order to limit it to companies producing more than 75,000 metric tonnes yearly, raising the level of

89 

ibid, 72. Ley Nº11,828, 05.05.1955. Fija disposiciones relacionadas con las empresas productoras de cobre de la gran minería y crea el departamento del cobre. 91 Decreto con Fuerza de Ley Nº258, 04.04.1960. ‘Fija las normas sobre inversiones de capitales extranjeros en Chile’. 92  Ley Nº14,603, 09.08.1961 and Ley Nº14,668, 23.10.1961. 93  Ley Nº15,575, 15.05.1964. Articles 134 and 136. 90 

Origins of Income Taxation in Chile 467 entrance to the category of GMC. The base would be raised again to 52.5 per cent in 1965.94 This second period of tax uncertainty was followed by a period of property uncertainty; the ‘Chilenización’, the ‘agreed nationalisation’, and the nationalisation of the GMCs. Although the changes relative to the rights of property are not part of this research, it is interesting and relevant to include these episodes in the analysis, as they show the importance of minerals for the national scenario. This process started in 1966, when the government of President Eduardo Frei Montalva passed a law that modified the law of the ‘New Deal’.95 This law included tax benefits for the GMC companies that invested in industries and technology, but most importantly, the creation of the figure of the ‘Mixed Mining Companies’:96 a legal entity in which the government owned, or had a contract to own, 25 per cent or more of the capital. Those companies, and the contracts related to their constitution, would not generate taxable obligations by capital contributions, and all the contracts and documents derived from the purchase agreement, including the interests, would have the same treatment. Under this law the taxation applicable to the GMC Mixed Mining Companies depended on the arrangement they made with the government.97 Five years later, on 15 July 1971, under the socialist government of Salvador Allende Gossens, the law of nationalisation of copper was promulgated.98 The first article of this law included two main amendments regarding mining rights in the national Constitution; the right of the government to nationalise the GMC companies and the theory of absolute domain. The first change gave the right to the State to take ownership of mines and minerals. Regarding compensation, this law specified that the compensation was going to be based on the original cost and investment on mines, taking away the depreciation and the excessive income that the companies had received during the period previous to the nationalisation. The second change introduced the theory of absolute domain of the mines, in contradiction to the theory of eminent domain of the minerals. This clause gave the State the absolute, exclusive, inalienable and imprescriptible domain of the mines.99

94 

Ley Nº 6,425, 25.01.1966. Ley Nº16,624, 15.05.1967. 96  Sociedades Mineras Mixtas. 97 The resulting tax benefits of each of the newly formed companies can be found in the ­following Decretos de Inversión: a) Nº1,699, 09.12.1966, b) Nº1,170, 23.12.1966, c) Nº1,771, 23.12.1966, d) Nº215, 13.02.1967, and e) Nº316, 01.03.1967. For an account of those d ­ ocuments see Correa Iglesias, above n 89. 98  Ley Nº17,450, 16.07.1971. Reforma la constitución política del estado. 99 On the topic of eminent domain see E Paul, Property rights and eminent domain (New Brunswick, Transaction Publishers, 2008). 95 

468  Maximiliano Boada The process of nationalisation consisted in making the whole nation; represented by the State, owner of the minerals, as from this law onwards it was considered a public good instead of a private one. The expropriation of the mines was made almost without any compensation to the previous private owners of the mines, as the above-mentioned formula was designed to have low, or negative, compensatory results. The justification for the expropriation was that the mineral concessions were administrative acts, carried out by administrative entities and were subdued to the laws. As the system was known to be based on the rule of law, and now the law kept ruling but in a different way, there was no change in the conditions which made compensation from the government to the previous owners necessary, as they were never really owners before. This legal justification was similar to the one that the Bolivian authorities used regarding the property rights of Chilean interests in their territory previous to the War of the Pacific. The government of President Allende, and the socialist ideals it represented, ended abruptly on 11 September 1973 with the coup d’état by his Commander-in-Chief of the National Army, Augusto Pinochet Ugarte. ­Pinochet’s regime, which lasted until the popular elections of 1990, defended a liberal market and a small interference by the government in the economy. This became visible in politic measures like in the defence of property rights, privatisation of nationally owned companies, and incentives to invest in the country. On 13 July 1974, the decreto ley Nº600 was introduced to the system, which contained the foreign investment statute. This statute was approved at the beginning of President Pinochet’s regime as a measure to attract foreign investment to Chile. Something particularly hard considering the grounded mistrust by the global market in the security of property rights and institutions during this period in Latin America in general, and Chile in particular after the nationalisation of the mining sector without real compensation.100 Global actors were still afraid this could happen again and, in the government’s opinion, trust had to be reinstalled. In order to do so, decree Nº600 contained a regulation to sign a law-contract between a commission representing the State of Chile and the investing party. Under this contract the relationship between the parties changed from a hierarchical relationship, ruler-ruled, to an equal relationship for the purposes of the investment. The important effect of this change was that the State could not change the rules unilaterally, and moreover, could be held responsible for a breach of contract in case it applied a legal rule that undermined the contract. 100  Allende’s government decided not to compensate the mineral deposits and to discount, in base of the Decreto Supremo Nº92 of 28 September 1971, so much of the compensation owned that at the end Chile paid less than US$20,000,000 for all the nationalised deposits and companies.

Origins of Income Taxation in Chile 469 This mechanism was not originally applicable to mining as this was considered an area reserved for national investment.101 However, subsequent reforms made it applicable to all kinds of investment and, moreover, gave the possibility to opt for tax invariability in the investment. On the one hand this meant a higher level of income taxation compared to the current regular system, but on the other hand it carried the certainty of not being affected by a different tax regulation at a later date.102 The invariability scheme was later extended to tax accounting rules, providing certainty for the depreciation and carry-forward loss rules, which combined created a great level of tax certainty for mining businesses. This is because the usual mining business model contemplates decades of losses based on depreciation, accelerated or not.103 On 30 December 1974 a new income tax law was promulgated in decree Nº824, which included a tax rate of 15 per cent in the first category, applicable to all income from capital, mining companies and industries in g­ eneral.104 This law also established a zero per cent tax rate for the disposal of mining concessions. The rate of the first category would sustain ­continuous rises until 24 per cent for the commercial year 2016.105 Regarding the property rights situation; it still remains unchanged from the system created during the dictatorship. Under the new national Constitution, promulgated on 21 October 1980, the state maintained absolute property rights over mines and minerals, but also gave protection to the property rights of the owners of mining concessions. Under the same regime, the Organic Law of Mining Concessions was promulgated on 7 January 1982, applying the property rights theory sustained in the national Constitution. It created a particular property right on the concession: the Concesión Plena. This legal figure gave the owner of the concession full and unlimited property rights, with the guarantee of compensation in case of an expropriation made by the State. This was based on the logic that the concession was granted by a court instead of it being an administrative act made by an administrative entity, and therefore was entitled to the property right protection present in the Constitution.106 This legal device gives the owner of the mine not only the right to receive compensation for economic loss, but also for the value of minerals present in the mine under a formula of present value of future cash flows. This system is still present in the legislation of the country today.

101 

Decreto Ley Nº600. Art 1, subpara 4. Decreto Ley Nº1,748, 18.03.1977. Estatuto de la inversión extranjera. 103  Ley Nº18,474, 30.11.1985. Introduce modificaciones al decreto ley Nº600, de 1974. 104  Decreto Ley Nº824, 31.12.1974. Art Nº20 nº3. 105  Ley Nº20,780, 29.09.2016. This law included an incremental rise from 21% to 24%; before this law there were continuous legal regulations increasing the first category tax. 106  Constitution of 1980, article Nº19 nº 24. 102 

470  Maximiliano Boada Specific Tax on Mining On 16 June 2005 a specific tax on mining was imposed by law No 20,026, which added a new title to the income tax regulation. This regulation was established after a commission was formed in March 2003 by the Congress in order to evaluate the contribution made to the National Treasury by private actors in the mining sector. This issue arose based on the public scandal produced by the sale, in 2002, of one mine; la Disputada. La Disputada mine, now named Los Bronces, was originally bought by Exxon in 1978 for US$90,000,000 during the privatisation period of the Pinochet Regime. Exxon sold the mine for US$1,300,000,000 to Anglo American without paying any taxes for the 24 years it had held the mine. More specifically, it did not pay income taxes because under the Chilean tax accountability system, when the yields were less than carried forward investments and usage of the minerals present in the mine, a company was not required to pay taxes. Regarding the sale tax, as the company bought was the controller of La Disputada outside of the country and not the company that owned the mine directly, the mine technically did not change its owners. This meant that the Chilean Revenue Services had no jurisdiction on the transaction and could not apply the sales tax to it.107 The commission established to investigate the scandal revealed its findings to the Congress on 7 July 2004. The findings made public that only two of the 45 Great Mining Companies had paid taxes from 1995 to 2002, and of these, one had only done so for two years.108 Despite La Disputada having the same reasons for not paying taxes, the Commission found that there was another reason for the companies not declaring any income: the loans to be paid to related companies in tax havens in the Caribbean Sea that they took to finance the investments. A clear case was La ­Disputada, which paid interest of close to US$800,000,000 to related companies in the Bahamas and Bermuda.109 Another issue was that the companies either sold their production to related companies for non-competitive prices, or bought welding and refinery services from related companies at an overprice. There was a law to prevent these issues from happening, but it was not being applied because the Chilean tax administration did not have enough specialised manpower for

107 J Ríos, E Maldonado & N Saavedra, La historia oculta de la Disputada’. Qué Pasa (Santiago, 07.11.2011.) 108 In Chile, since Ley Nº19,389, of 4 August 1995, the Servicio de Impuestos Internos (the Chilean equivalent to the Internal Revenue Service of the USA) cannot make public any information regarding the tax situation of the contributors, not even to the Congress. This information was obtained by asking for information on GMC companies as a group, without getting information on individual cases, and by later linking this information to that made public by the two companies that did in fact pay taxes in Chile. 109  R Nuñez Muñoz, Boletín Nºs/672-12. (2012) Congreso de Chile.

Origins of Income Taxation in Chile 471 the task.110 The commission said that a royalty was not a tax, but rather a tariff to be paid as compensation for the usage of a non-renewable resource and was charged under a different power of the government, something relevant as under this interpretation it could be applied to those enterprises with a contract including a right of tax invariability based in the decreto ley Nº600. Following these events, the previously mentioned law was promulgated and it imposed a royalty on operational income of up to five per cent, depending on metric tonnes of fine copper extracted. However, on 21 October 2010, through Law No 20,469, this method was modified to the operational mining margin method, a system that divides the mining companies in three groups. The first one is composed of companies that extract less than 12,000 metric tonnes of fine copper, which are exempted from the royalty. The second group consists of those companies that extract more than 12,000 and less than 50,000 metric tonnes, which pay a royalty between 0.5 and 4.5 per cent of their income. The third group consists of the companies that extract more than 50,000 metric tonnes, which pay a royalty based on the operating margin of the company, instead of the level of income as the previous group. For this third group there are different tax rates, ranging from five to 34.5 per cent, for each bracket of operating margin. A Peek at the Current Economic Uncertainty of the Country 2015 was a particularly bad year for commodities; copper included, due, among other factors, to the decrease in the growth rates of the Asian commodity market. This situation has continued through the first half of 2016, having as a repercussion the fact that the biggest national operation, Coldelco, had a loss of US$150,000,000 in the first quarter.111 The experts in the market already define the situation as a crisis and expect the situation to be worse than the one produced by the economic crisis of 2008.112 The executive president of Coldelco expects the situation to worsen for the foreseeable future, including 2017.113 This situation, in an industry that represents the biggest share of the yields of the Treasury creates a problematic economic situation for Chile.114

110 

Ley Nº19,506, 30.07.1997 Modifica […]. See Nuñez Muñoz, above n 110. Editorial, ‘Codelco no anota excedentes y registra déficit por US$151 millones en primer trimestre’ El Mercurio (Santiago, 27.05.2016). 112  C Pizzaro, F González & G Alvarez, ‘Diego Hernández y caída del cobre: “Ya se puede decir que es una crisis”’ La Tercera (Santiago, 25.11.2015). 113  F Villalobos Díaz, ‘Codelco prevé un peor 2017, pero descarta “congelar” proyectos en divisiones’ El Mercurio (Santiago, 27.05.2016). 114  M Donoso Muñoz, ‘El mercado del cobre chileno frente a la problemática financiera internacional’ (2014) 22 Ingeniare. Revista chilena de ingeniería 99, 102. 111 

472  Maximiliano Boada The economic situation of the country is not the main topic of this article; however, it is necessary to acknowledge the fact that the dependency that Chile has had on the copper cycle was enough to destabilise it based on a change of the price of the commodity. This fact shows the real importance that minerals have nowadays, and the size of the dependency issue. THE FOURTH CYCLE: LITHIUM

Presence and History of the Commodity Chile has, according to the US Geological Survey, 7.5 million tonnes of lithium, which accounts for 53.5 per cent of the world’s total reserves of the mineral.115 The importance of the mineral in today’s world is different from the importance that saltpetre or copper had in their respective cycles. As mentioned before, the economic importance of saltpetre and copper represented a great part of the national gross domestic product of Chile, sometimes around 50 per cent of it. Lithium, on the other hand, does not cover a great percentage of Chile’s total gross domestic product, and it does not seem to have a rapid participation increase at the moment, which makes it, from an economic perspective, not worthy of being considered a cycle by itself. In fact the production of lithium in Chile during 2015 was only 160 metric tonnes, compared to other states’ production levels like ­Australia’s with 13,400 metric tonnes during the same year. From a global perspective Chile’s production is not in the top five producers, unlike its position in the copper and saltpetre markets in their respective periods. However, lithium represents a possible solution to the scarcity and environmental problems that the petrol industry currently has, particularly through the use of rechargeable batteries. In fact, while ten years ago lithium was used mostly for ceramics, glass and primary aluminium products,116 this year, and due to the global development of using lithium for the production of batteries and the great global demand for it, the exportation of lithium for batteries represented 35 per cent of the entire demand, being the main use of the mineral nowadays. The vast reserves owned by Chile make it necessary to have a coherent and consistent legal framework regulating the mineral.117 The first time that lithium was treated differently in Chile’s legal regulation was in 1979. At that time the mineral had a completely different

115  US Geological Survey, 2006. ‘Mineral Commodity Summary Lithium 2006’; . 116 ibid. 117  US Geological Survey, 2016. ‘Mineral Commodity Summary Lithium 2016’; .

Origins of Income Taxation in Chile 473 importance: it was used in order to produce tritium, a radioactive hydrogen isotope used to produce nuclear energy. In 1965 the Chilean Commission for Nuclear Energy was created,118 and with the creation of it, the natural atomic materials uranium and thorium were reserved to the State. The law that created the Commission was modified by the Decreto Ley Nº 2,886 in 1979, which had in its previous considerations: ‘El interés nacional exige, en cambio, reservar para el Estado el litio, con las excepciones necesarias para resguardar debidamente los derechos de los particulares’.119,120 Following this logic, the fifth article of this law reserved natural lithium to the State, but kept previously granted concessions in order to protect the property rights of their owners. This last part was important as it showed that the property rights were something untouchable in that regime, as opposed to president Allende’s government. The lithium reserve would be later ratified in 1982 in the Organic Constitutional Law of Mining Concessions.121 The Origins of the Extraction These legal acts came just after Corfo applied for and obtained 59,820 ­mining claims in 1977. Three years later, in 1980, the Sociedad Chilena del Litio Limitada was founded, a public-private partnership between Corfo, who owned 45 per cent of the company in exchange for the right of extraction of 200,000 tonnes of metallic lithium of its mining claims, and Foote Minerals, who owned 55 per cent in exchange for its investment. Corfo would later, in 1988 and 1989, sell the totality of its ownership to Foote Minerals for $15,200,000 US. This background is particularly important for the application of royalty taxes to lithium in general. In particular, it was important to Foote Minerals and later to Chemetall, Rockwood Holding Inc. and Albemarle Corporation, as they had the rights to exploit the mineral that belonged to Corfo, and no royalty could be charged. Foote Minerals, and the companies that later acquired their rights, are one of the two holders of rights to extract lithium from Chile. The other one is SQM, a Chilean company that in the last couple of years has been accused of being involved in a lack of transparency regarding the buyers

118 

Ley Nº16,319, 22.10.1965. Crea la comisión chilena de energía nuclear. considerations, in the Chilean legislative technique, refers to the foreword or preamble of the law, which explains the reason behind the new law. 120  ‘The national interest requires, in contrast, reserving lithium for the state with the necessary exceptions to safeguard the rights of the individuals’. Decreto Ley Nº2,886, 14.11.1979. ‘[…] reserva el litio a favor del estado […]’. 121  Ley Nº18,097, 21.01.1982. Ley orgánica constitucional sobre concesiones mineras. 119  Previous

474  Maximiliano Boada of the ­mineral,122 fraudulent political campaign funding,123 tax fraud,124 ­collusion,125 and use of undue influence. Currently SQM is being sued by the government for breach of contract regarding its payments to the government, for which the government is requesting the cancellation of their exploiting rights.126 Originally, the company was founded in 1968 as a public-private partnership, the Sociedad Química Minera de Chile, SOQUIMICH, of which Corfo owned 37.5 per cent and Compañia ­Salitrera Anglo-Lautaro 62.5 per cent. This joint venture pursued the goal of revitalising the production of saltpetre and acquired the monopoly of the production of saltpetre in the country from its first year of existence. The company was nationalised under the Allende government policies in 1971 and in 1983 started its re-privatization, which was completed in 1988. On 12 November 1993, SQM started the acquisition of Minsal, Sociedad Minera Salar de Atacama SA, who owned the rights to extract lithium, by acquiring all the private part of the company through one of its subsidiaries (SQMK). The acquired company Minsal was another public-private joint venture between Corfo, Amax Inc. and Molymet, with 25, 63.75 and 11.25 per cent ownership respectively. Minsal was founded in 1986 after a public tender made in 1983 in order to extract minerals from the brine present in the Salar de Atacama. Corfo gave the extraction rights to 180,100 tonnes of metallic lithium in a lease contract to Minsal. On 21 December 1995, after a public auction in the stock exchange, Minsal became completely owned by SQM. The second extractor of the commodity in Chile, SQM, has had a constant taxation treatment of royalty since it started its lithium operations. The lease contract signed in 1993 between Corfo and Minsal that granted the right to extract the mineral required a rent of $15,000 US per year as compensation, plus a royalty of 6.8 per cent of the ‘free alongside ship’ value of lithium for all price and production levels.127

122  A Arellano & P Ramiréz, Las huellas de 4 mil toneladas de concentrado de cobre de Codelco que se esfumaron en el desierto Ciper (Santiago, 27.10.2016). 123  J Matus & S Labrín, ‘Fiscalía alude a pagos de SQM a campañas de Frei, Piñera y Bachelet en oficio a EEUU’ La Tercera (Santiago 31.03.2016). 124  S Jara, S Labrín & F Artaza, ‘Caso SQM: SII amplía denuncia y pediría a Fiscalía indagar boleta de subsecretario’ La Tercera (Santiago, 24.03.2015). 125  L Cárdenas, ‘FNE investiga denuncia por colusión contra SQM y Rockwood en derivado del litio’. El Pulso (Santiago, 13.03.2016). 126  E López, ‘Chile: solicitan investigar irregularidades en SQM para revocar pertenencias mineras en Salar de Atacama’ Biobiochile.cl (Santiago, 13.07.2015). Another particularly controversial fact of SQM is that the nowadays controller of the company, who orchestrated privatisation under the Pinochet regime, Julio Ponce Lerou, is also the son-in-law of Pinochet. On Julio Ponce Lerou see M Salazar, Todo Sobre Julio Ponce Lerou, de Yerno de Pinochet a Millonario (Santiago, Uqbar Editores, 2015). 127  5.5% during the first five years.

Origins of Income Taxation in Chile 475 Since 1993 the tax rate applicable to the extraction of lithium in Chile has been equivalent to the income tax for the rights currently owned by Albemarle Corporation, and income tax plus the royalty of the rights represented by SQM for the lease of the mining claims. Regarding the income tax, as we saw in the copper cycle, this is problematic as the national taxation system has possibilities to represent, with clever accounting and big corporate structures, less income than it is supposed to represent. Growth of the Supply: First Attempt In 2012 a different legal form was established in order to exploit lithium: Contrato Especial de Operación para la Exploración, Explotación, y Beneficio de Yacimientos de Litio.128 This special operation contract is a concession to be awarded via public tender granting the right to extract and sell 100,000 tonnes of metallic lithium in the following 20 years under the government’s right to the mineral. The seventh article of the Decree states that the winner of the concession will be paid by the State a monthly retribution of no less than 93 per cent of gross sales of lithium. Basically this creates a royalty for lithium for the purposes of this specific contract, consisting of seven per cent. The contract was awarded via public tender to SQM on 25 September, but it was cancelled less than two months later, on 19 November, because SQM did not comply with the rules of the tender, particularly because it had current litigation against the government. Instead of awarding the contract to the following bidder, the tender was cancelled. Growth of the Supply: Second Attempt On 1 February 2016, Corfo reached a memorandum of understanding with Rockwood Lithium, property of Albermarle Corporation, in order to increase their right of extraction of lithium. The agreement allows Rockwood to extract 262,132 tonnes of lithium metal equivalent for ­ 27 years, in exchange for taking measures to develop the industry of lithiumbased products in Chile. There is a variable progressive royalty starting at 6.8 marginal per cent and going up to 40 marginal per cent, an equivalent to 19.8 effective per cent, depending on the price of Li2CO3 (lithium carbonate) per tonne in the market.129

128  Decreto Nº16, 19.05.2012. Establece requisitos y condiciones del contrato especial de operación […]. 129 Corfo & Rockwood Lithium Limitada, Memorandum of Understanding (Santiago, Chile 01.02.2016).

476  Maximiliano Boada LEARNING FROM HISTORY: THE PAST PROBLEMS TO BE AVOIDED

The main goal of taxation has always been to obtain revenue; either to fund standing armies or to implement social projects. Regarding the rest of the goals that a taxation system should have there is a permanent debate going on that dwells on the philosophy behind taxation. However, nowadays most economically developed countries see the application in one way or another of Avi-Yonah’s three goals of taxation: revenue, redistribution, and regulation.130 There is a fourth goal that has been one of the main goals of economic regulation, hence taxation, of the twentieth century; the need of procuring stabilisation of economic movements. Until now, Chile as a country has had three different mineral cycles, an improbable situation for a country. During these cycles the country has not been able to create an economy nor a tax system that is capable of minimising its dependence on mineral commodities, which makes every international economic crisis or new research a possible threat to its economy. These cycle experiences, plus the evolution of taxation theories and ­methods, should be considered by the government and its legislators in order to plan a tax regulation for lithium, in order for it to achieve the goals of taxation. This section analyses the problems that have to be considered in taxing minerals in Chile. Resource Curse and the Lack of Certainty in the Taxable Base The resource curse paradox, a term coined by Gelb,131 refers to a situation commonly known as ‘Dutch disease’, although the latter concept contains only one of the explanations of the consequences currently understood as part of the resource curse. The term is used to designate the inverse correlation between economic growth and a high presence of natural resources in an economy. These phenomena caught the attention of the academic community in the period between the First and the Second World Wars as economists tried to understand why so many Latin American economies responded so negatively to the fall in the price of basic products and commodities.132 An analysis made in 2015 shows that Chile’s gross domestic product has a 77 per cent volatility based on the price of the primary sector prices, which

130 

R Avi-Yonah, ‘The Three Goals of Taxation’ (2006) 60 Tax Law Review 1, 3. A Gelb, Oil windfalls: Blessing or curse? (New York, Oxford University Press, 1988). 132 J Sachs & A Warner, ‘Recursos naturales y desarrollo económico’, in G Lagos (ed), Minería y Desarrollo (Santiago, Ediciones Universidad Católica de Chile, 2005). 131 

Origins of Income Taxation in Chile 477 is a really high percentage, especially for an OECD member country.133 The economic volatility of the prices of primary commodities is caused by the fact that industries based on these commodities tend not to produce solid economic foundations for the rest of the industries to develop in the market.134 This creates a ‘Catch-22’ situation, as societies with less industry development need to rely more on their primary sector, making it difficult for them to decouple their economies from the economic fluctuation of commodities. The state of the art regarding resource curse theory sees as a viable option, for understanding the problem and solving it, the explanation that the quality of fiscal institutions and policies can balance the effects attributed to the resource curse in different economies.135 Following this, taxation policy and the administration of those funds, should consider the problems of the past, acknowledging the fact that mineral cycles end. Not being prepared for that fact can dramatically decrease the economic and well-being stability of the country. Bad Regulation: Accounting and Weak and Untrustworthy Tax and Property Rights Institutions Regarding accounting rules, as it was shown in the copper cycle the taxation rate applied to a company means nothing if the rules applied to define the tax base are able to either represent a completely different picture of what is happening in reality, or can lead to unexpected results because of unforeseen, although foreseeable, uses of the tax and corporate regulation. Regarding tax and property rights of mining ventures, it is necessary to implement a system that: (a) provides sufficient guarantees and security to the private sector about its property rights and proper compensation in case of expropriation of any kind; (b) provides enough yields to the fiscal revenues for the industry not to be considered as an exploitative institution, thereby being better protected against the political climate changes not uncommon in Latin America; (c) considers enough economic variables in the tax scheme, in order for it to be as long-lasting as possible avoiding continuous change in the regulation seen in past cycles; and (d) is based on a general regime and not just in contracts awarded on different conditions 133  A Fernández, A González & D Rodríguez, ‘Sharing a Ride on the Commodities Roller Coaster: Common Factors in Business Cycles of Emerging Economies’ (2015) 280 IMF Working Papers, 24. 134 A Hirschman, The strategy of economic development (New Haven, Yale University Press, 1958). 135  N Torres, Ó Alfonso and I Soares, ‘A survey of literature on the resource curse: critical analysis of the main explanations, empirical tests and resource proxies’ (2013) 2 Working Papers Universidade do Porto, Faculdade de Economia do Porto 5.

478  Maximiliano Boada to different exploiters. As Chilean history has shown, without regulation the situation can quickly lead to irregularities and difficulties. New Technologies, Abuse of Dominant Position in the Market, and Inaction Even though the market of saltpetre went down for many reasons, the ­reason why it did not go up again was a breakthrough in technology with the Haber-Bosch method. The high price and the scarcity of the commodity in certain markets motivated research that led firstly to the creation of a substitute, and secondly to a way to manufacture this substitute in a less expensive way in comparison to the price of saltpetre. This historic incident should raise awareness of the great dependency that mineral cycles have to the state of the art research. Minerals are valued and necessary until society finds ways not to depend on them. Currently there are many researchers trying to find a way not to depend on lithium for the manufacture of batteries. A group of scientists in particular has already discovered a solution of gel electrolyte that, used together nanowires, could exceed the electric capacities of current uses of lithium.136 Research like this could mean the end of the usage of lithium in the one market that represents almost all the expected growth of the industry, ie batteries. In the lithium market Chile does not have a monopoly as it did in the saltpetre market during its cycle, but nevertheless it has enough reserves with good extraction quality to retake the position of being the greatest exporter of the commodity in the short future. If Chile expects that position to bring out-of-market revenues for the country by acting in cartels like it has been done with copper before, in a market where a similar number of exporters to the lithium market numbers were involved, such as the CIPEC agreement, it has to be careful. Actions like this would increase the reward for research aimed at making lithium an obsolete part of the battery production chain, and therefore reducing the value of the commodity altogether. Last but not least, it is necessary to care about the comfort of inaction produced by the limitation to exploitation of lithium currently present in the Chilean legislation, as it is easy to consider this important topic as non-urgent because the ownership of the property rights are secured for the country. If Chile wants to benefit from this resource, fast measures are needed; otherwise this cycle could be over for external reasons before it even starts to reach its supposed peak. 136 M Le Thai et al, ‘100k Cycles and Beyond: Extraordinary Cycle Stability for MnO 2 Nanowires Imparted by a Gel Electrolyte Supporting Information’ (2016) 1 ACS Energy ­Letters 57.

Origins of Income Taxation in Chile 479 CONCLUSION

Many scholars have dwelt in the mineral history of Chile before; the contribution of this research to the current state of art of the literature consists in both the prism and the objective present in it. Regarding the prism, the mineral history of Chile is analysed through the taxation perspective and how it is affected, and was affected by, the economic and political arena. With the first specific tax on minerals Chile saw a collective, local and voluntary institution become, in an unconstitutional manner, an obligatory one in aims of producing a better situation for the country. With the rise of taxes on minerals in a grotesque percentage compared to the one that caused the War of the Pacific, and with the economic crisis that came after its fall, Chile saw how the so called ‘white gold’ and the money that the government received from it were not enough to secure its economic position. Ghost towns such as Humberstone are still present today, now as open-air museums, to let us remember that all the greatness of that period was not sustainable. Chile tried to save itself by imposing an income tax to rely on. Sadly this measure was neither strong enough, nor was it imposed early enough to contain the impact of the resource curse that affected it; but at least it was a lesson that reliability is a key component for public revenue. Just when Chile was learning the lesson to depend on industry and not only on natural resources, the second coming of copper arrived, and with it another period of dependency on a natural resource. Copper, the longest mineral cycle that Chile has seen so far, is still so important to the country nowadays that in 2011 it represented more than half of total exports of the country, and now it represents almost one third of the gross domestic product of the country. A big part of this long profit was possible because the country kept the ownership of the most profitable copper mines, without a private interest in between. However taxation, the mechanism that is supposed to be the way to harvest the economic bonanza of a mineral cycle, was deficient for a great part of this cycle. Regulation has adapted during the last decade but as with saltpetre, neither strong enough nor early enough. Although with lithium it seems that the national policy is starting to correct the mistakes of the past, including better ways to tax the extraction of the mineral, it is not enough. Under the OECD founding declaration, the aim of economic and tax policy should be to procure the highest possible stable well-being level for a country.137 To achieve this goal it is necessary to lower the relative size of the mining cycles input regarding gross domestic product, while maintaining or increasing the current level. 137  OECD, ‘Convention on the Organisation for Economic Co-operation and Development’ (1960) Paris. Article 1 (a).

480  Maximiliano Boada Regarding the objective, a common criticism to this field of research is that it seems to be an actuary’s work and there is not a lot of room for interpretation and theory, even less for application.138 This research was conducted to serve as a recollection of past failures in order to prevent them from happening again. SS George Santayana said, ‘[t]hose who cannot remember the past are condemned to repeat it.’139 The reason behind the imposition of income tax in Chile, as well as the raise of the saltpetre tax once the country had control of the minerals monopoly, and most of the subsequent mineral taxation legislation, was to secure a stable source of revenue for the National Treasury. Therefore, it is not illogical to assume that this goal, which has been present for more than a century of mineral taxation in Chile, will change in the near future the mineral taxation system of Chile. Chile has endured the resource curse with devastating effects in the case of saltpetre, and with a grim-looking future in the case of copper. If the goal is to secure stability of revenues, it follows that government should seek to either receive a lower level of revenue or a different approach to expenditure if this leads to insure the stability of future revenue. Studies have found that there is an inverse correlation between the share of the resource creating the resource curse and the gross domestic product per capita growth rate. The cases of countries that have not suffered negative effects from natural resources have something in common: a policy regarding wealth created by the resource based on investment over consumption.140 A solution may be a taxation model in which the yields of lithium, or any non-renewable resources in the case of Chile, went to a different budget, with the only purpose of investing it in the secondary and tertiary sectors of the three-sector theory, preferably directed to internal demand. This could foment the revenue of the government in the long run by increasing the income tax recollected from the workers that would be needed to satisfy the increase of labour needed and from the owners of the companies fomented by this mechanism. Besides contributing to the country’s welfare and to the creation of healthy institutions, this specific treatment of the yields from lithium, or the yields of any other non-renewable resource, would be of great benefit for the taxed industry. The reason for this is that without incurring in a greater burden, as this system does not necessarily mean a higher or a lower tax for the companies, the industry would have the guarantee that the country is trying 138  See, eg, R Vosslamber, ‘Book review: John Tiley (ed) Studies in the History of Tax Law, Volume 5 (2013)’ 18 Accounting History 127, 128. 139  G Santayana, The Life of Reason; Or, The Phases of Human Progress: Introduction, and Reason in common sense (New York, C Scribner’s Sons, 1936) 284. 140  G Atkinson & K Hamilton, ‘Savings, growth and the resource curse hypothesis’ (2003) 31 World Development 1793, 1804.

Origins of Income Taxation in Chile 481 to develop more stability in revenue. This could lead to a higher stability of the country’s political and economic reality, and therefore increase the value of the industry altogether. It is necessary to add that the constitution of the country prohibits the possibility for revenues from specific taxes to be directed to one goal in particular instead of going to the general treasury. As we have seen, the constitution was not a problem at the beginning of mining taxation, and when it came to be one, it was overcome in a legal way. It is also necessary to include that this prohibition is a relatively new inclusion in the Chilean legal system, and historically, funds, especially those that were perceived from mining endeavours, were directed to particular goals. Another option that could have, in theory, the same effect is to have a public policy, which pursued this goal (the fomenting of the latter two sectors of the economy). Sadly, it does not seem to be a good solution in a country were the public and private mining sectors are under investigation for evading taxes to give money directly to the people that produce the public policy. The origins of the income tax in Chile lie in the fact that minerals were not enough to provide the expenditure and stability levels that the Chilean people needed. However, the income tax was not sufficient to represent the value that the Chilean people wanted to give to those minerals. Minerals were not enough, and the income tax was not enough to properly extract their value. If Chile wants to properly use the favourable, but finite, natural conditions it has in the long run and to base the country’s wealth on more than one pillar, it needs to include a systematic approach for economic sustainable growth and tax policies. The aim should be ending the dependency of the country’s welfare on one pillar, which is threatened by global changes and dynamics.

482 

17 Cesses in the Indian Tax Regime: A Historical Analysis ASHRITA KOTHA*

ABSTRACT

The Constitution of India is quasi federal, a feature which is also apparent from the provisions regulating distribution of revenues between the union government and the various state governments. India’s ‘co-operative federalist’ fiscal structure has historically empowered the union and state governments to raise revenue by levying taxes, fees, cesses, surcharges, etc. In the schedule to the Indian Constitution which delineates the legislative competence of the respective governments to impose taxes and fees, there is no mention of cess. That may be owing to the fact that a cess, as clarified by judicial precedents, is either a tax or a fee depending on the specific facts. The unique feature of a cess though is that it raises revenue for an earmarked purpose. By virtue of a constitutional amendment in the year 2000 union cesses are not required to be shared with state governments. Recent enquiries into the usage of funds collected under the head of cess reveal a lack of accountability. This has resulted in the Fourteenth Finance Commission cautioning against the frequent usage of cesses. Even so, the union government has recently announced three new cesses with a proposal to introduce another one post the introduction of the goods and services tax. This is an opportune time to undertake a study into the history of cesses in the Indian context. The following questions emerge for study: What does the Indian Constitution say about cesses? How is a cess different from a tax and fee? Why have successive governments imposed cesses? In the wake of * I am grateful to the team at National Institute of Public Finance and Policy, especially Dr Rathin Roy and Dr Sudipto Mundle for the comments during the seminar talk on 15 September 2016. I would also like to extend my gratitude to Radha Arun for her comments on the draft, Dr Vinod Vyasulu, Prashant Iyengar, Dr Rakesh Ankit and Sasidhar Chaluvadi for the many discussions and Pitamber Yadav, Raveena Sethia, Reeti Agarwal and Sree Ramya Hari for their research assistance.

484  Ashrita Kotha the criticism that cesses have been met with, what does history reveal? Are there any lessons to be learnt? INTRODUCTION

T

HE CONSTITUTION OF India (‘Constitution’) is quasi-federal, a feature which is also borne out from the manner in which the financial and taxation matters are dealt with therein. Both the Union government and State governments are empowered to raise revenue in the form of taxes, fees and duties within their respective spheres of legislative competence.1 Apart from taxes and fees, there also exists the category of cesses. Cesses imposed by the legislatures can be classified into one of the two broader categories of taxes (‘cess taxes’) and fees (‘cess fees’). Cesses though, have unique features; most prominent of which is the presence of an earmarked purpose. An earmarked purpose limits the spending of the revenue for general purposes. Hence, it seems counter-intuitive for governments to impose cesses. Nevertheless, Union and State governments have been imposing cesses for several decades. As per the estimates of the Union government for the financial year of 2016–2017, cess taxes form approximately 9.24 per cent of the total tax revenues.2 This percentage has been steadily increasing. Cess taxes were projected at 2.8 per cent and 7.02 per cent as per the budget estimates for the financial years of 1999–2000 and 2006–2007, respectively.3 Hence, a question is: Why do governments impose cesses rather than taxes and fees? This chapter reveals two possible answers to this question. State governments have been disgruntled with the policy of the Union government of levying cesses as they are not given a share of the proceeds.4 Cesses have also come under criticism for being inefficient and poorly administered.5 Despite the mounting criticism, successive governments have 1 

Constitution 7th Sch. tax revenues are projected at INR 16,308,878,100,000 while revenue from cess taxes are projected at INR 1,508,110,000,000 crores. 3  Total tax revenues were projected at INR 1,664,350,500,000 crores while revenue from cess taxes was projected at INR 46,710,000,000 for the financial year of 1999–2000. See Ministry of Finance, Government of India, ‘Tax Revenue’ in 1999–2000 Receipts Budget (New Delhi, 1999) accessed 9 January 2017. Total tax revenues were projected at INR 4,409,850,000,000 crores while revenue from cess taxes were projected at INR 309,600,000,000 for the financial year of 2006–2007. See Ministry of Finance, Government of India, ‘Tax Revenue’ in Receipts Budget 2006–2007 (New Delhi, 2006) accessed 9 January 2017. 4 ‘Union Duties of Excise’, Chapter VI in Eighth Finance Commission: Report (Finance Commission) (New Delhi, 1983) 47, [6.5]–[6.6]. The reports of the Finance Commissions are available online and can be accessed at . 5 Law Commission of India, ‘Obsolete Laws: Warranting Immediate Repeal’ (Law Com No 250, 2014) 33–34 and 42; Indian Audit and Accounts Department, ‘Comments on Accounts’, 2 Total

Cesses in the Indian Tax Regime: A Historical Analysis 485 continued to levy cesses and as demonstrated, in increasing proportions. Continuing with this trend, the Finance Act, 2015 imposed one new cess tax, swachh bharat cess (‘hygiene cess tax’)6 and the Finance Act, 2016 levied two other, krishi kalyan cess (‘agriculture cess tax’) and infrastructure cess tax.7 The indirect tax regime in India is set for a sweeping set of reforms with the introduction of the goods and services tax (‘GST’).8 It was hoped that GST would subsume a majority of indirect taxes and would result in cesses being replaced too. However, that does not seem to be the case as there is a proposal to impose a GST compensation cess.9 In light of the developments, it is becoming increasingly clear that cesses are here to stay. This is an opportune time to undertake a study into the history of cesses in India. The following questions emerge for study: What does the Indian Constitution say about cesses? How is a cess different from a tax and fee? Why have successive governments imposed cesses? In the wake of the criticism that cesses have been met with, what does the history reveal? Are there any lessons to be learnt? A perusal of cesses in the Indian context shows that cesses existed even before the enactment of the Constitution, as brought out by Article 277.10 However, this paper does not dwell on the pre-Constitution aspects. This chapter contributes to literature by documenting, for the first time, a study of various cess legislation in independent India. By reviewing cess legislation, there is an attempt to comment on the emerging convergences in the earmarked purpose, the workings of such legislation on the parameters of earmarking, administration, economic efficiencies and the extent of appropriation towards the earmarked purpose. This study does not comment on the legality and constitutionality of cess legislation under review. For the purposes of this chapter the study is confined to Union cess taxes levied from 1950 (the year marking the enactment of the Constitution) to 1 November 2016. There are approximately 39 Union cess taxes mentioned Chapter 2 in Report of the Comptroller and Auditor General of [sic] for the year 2013–14 (New Delhi, 25 May 2015) accessed 10 January 2017. 6 

Finance Act 2015, s 119. Finance Act 2016, ss 161 and 162. 8  Constitution (One Hundred and First Amendment) Act 2016. 9  Goods and Services Tax (Compensation to the States for Loss of Revenue) Bill 2016, s 8 available at . See AP Kotha, ‘Proposed sin cess against cess’ spirit’ Business Standard (New Delhi 31 October 2016) accessed 2 January 2017. 10  ‘Any taxes, duties, cesses or fees which, immediately before the commencement of this Constitution, were being lawfully levied by the Government of any State or by any municipality or other local authority or body for the purposes of the State, municipality, district or other local area may, notwithstanding that those taxes, duties, cesses or fees are mentioned in the Union List, continue to be levied and to be applied to the same purposes until provision to the contrary is made by Parliament by law.’ 7 

486  Ashrita Kotha in Appendix I forming a part of this review. It is difficult to arrive at the exact number of cess taxes as the projections for cess tax revenues have a head titled ‘cess under other accounts’.11 Given the limited literature and case law available on the concept, reference has been made to judgments on cess fees and cesses imposed by State legislatures to get a holistic picture of the concept. The second heading begins by discussing how cesses feature in the Constitution and goes on to discover the distinct treatment meted out to Union cesses in the distribution scheme. The third heading traces the history of distribution to establish that Union cess taxes were not a part of the divisible pool of revenues even before a specific amendment to the Constitution was made in this regard. The fourth heading goes on to explore the features of taxes and fees simpliciter on the one hand and cesses on the other hand. The fifth heading undertakes a historical study of the 39 Union cess taxes to analyse the track record on the criteria of earmarking, administration and appropriation for specific purpose. The concluding thoughts are presented under the sixth heading. CESSES AND THE CONSTITUTIONAL FRAMEWORK

This heading provides the background to the historical study undertaken in the paper. There is a discussion of the provisions of the Constitution which have dealt specifically with cesses over the period of study. Additionally, there is a more general introduction to the scheme of the financial provisions under the Constitution which enables an assessment of the status of cesses within the same. Under the Constitution, until an amendment in the year 2000 (‘Amendment’),12 there was only one specific reference to cesses. This was to save pre-Constitution legislation passed by State governments or local authorities that imposed levies including cesses henceforth covered within the competence of the Union Parliament.13 While doing so, the Constitution talks of cesses as a category, separate from that of taxes, fees and duties. This reference also brings to light, the pre-constitutional history of cesses which were local measures used for raising revenues and creating trade barriers and tariff walls.14 These early cesses are beyond the scope of the current paper.

11  Ministry of Finance, Government of India, ‘Tax Revenue’ in Receipt Budget 2016–2017 (New Delhi, 2016) 2–5 accessed 9 January 2017. 12  Constitution (Eightieth Amendment) Act, 2000 with effect from 1 April 1996. 13  Constitution, Art 277. 14  Atiabari Tea Co., Ltd. v The State of Assam and Ors. AIR 1961 SC 232, [12].

Cesses in the Indian Tax Regime: A Historical Analysis 487 When looking at the remaining provisions of the Constitution, cesses do not find mention as a distinct levy. The definition of taxation measures under the Constitution itself is broad and inclusive, covering any impost ‘whether general or local or special’.15 This definition has been held to include cesses.16 Further, the Seventh Schedule to the Constitution, which sets out the division of legislative heads between the Union and State governments,17 has specific entries relating to taxes,18 and a more general entry referring to fees,19 but there is no mention of cesses. The absence of an explicit mention of cess may be rationalised by looking at judicial precedents that have clarified that a cess may be in the nature of a tax (meaning a cess tax) or a fee (meaning a cess fee), depending on the concerned facts.20 Hence, it emerges that for purposes of legislative competence cesses are subsumed in the broader categories of taxes and fees. There is a more detailed discussion on the features of taxes, fees and cess taxes and cess fees under the fourth heading. Pursuant to the Amendment, cesses levied for a specific purpose under any law imposed by the Union Parliament need not be shared with the State governments.21 The reference to cesses here must be confined to a cess tax as Article 270 deals with which taxes are to form a part of the Consolidated Fund of India and how the proceeds are to be distributed further. In order to understand the context and significance of the Amendment, it is important to have an overview of the provisions governing financial relations and distribution of tax revenues under the Constitution. When the financial provisions were being debated in the constituent assembly, the provincial governments were content with allowing the Union government to levy, collect and distribute taxes rather than have the taxes brought within their own legislative competence. The negotiating stance of the provinces was a product of their own non-sovereign status, the immediate

15 

Constitution, Art 366(28). N. Balaraju v The Hyderabad Municipal Corporation AIR 1960 AP 234, [34]. 17  The Seventh Schedule is divided into three lists: (i) List I—Union List which enumerates matters in the exclusive competence of the Parliament, (ii) List II—State List which sets out the matters in exclusive competence of the State legislatures and (iii) List III—Concurrent List which identifies the matters over which both the Parliament and State legislatures have competence. In the event of a conflict between a law passed by the Parliament and State legislatures on an entry in List III—Concurrent List, the former prevails. 18  For example, entry 82, List I reads as ‘taxes on income other than agricultural income’ and entry 83 ‘duties of customs including export duties’ as opposed to entry 1, List I ‘defence of India and every part thereof including preparation for defence and all such acts as may be conducive in times of war to its prosecution and after its termination to effective demobilisation’. 19  For example, entry 96, List I reads as ‘fees in respect of any of the matters in this List, but not including fees taken in any Court’. 20  The Hingir-Rampur Coal Co Ltd. v The State of Orissa, AIR 1961 SC 459, [9]. 21  Constitution, Art 270. 16 

488  Ashrita Kotha colonial past marked by a centralised governance structure and the prevailing uncertainty of finances.22 History as well as convenience of administration has led to a number of lucrative tax heads and taxes with an inter-state base23 being conferred upon the Union government.24 The Union government is also empowered to impose any residuary taxes, not contained in List II or List III.25 While the Union government has been empowered to levy a number of taxes, it works in close coordination with the State governments to collect the said taxes. In turn, subject to the provisions of the Constitution, the State governments are given a share of the Union tax revenues.26 The share of the State governments and the inter se distribution among the different State governments is recommended by the Finance Commission, an independent body under the Constitution.27 The Union government also has the power to transfer revenues to State governments in the form of conditional and unconditional grants.28 Owing to these features the Indian system has been called a cooperative federalist structure.29 Given the otherwise cooperative federalist structure, it is apparent that the Amendment marks a distinct status for Union cesses in the distribution scheme. The Amendment was recommended by the Tenth Finance Commission as part of an alternate scheme of devolution of tax revenues suggested by it.30 Having understood that cesses enjoy a distinct status for distribution,

22 G Austin, The Indian Constitution Cornerstone of a Nation, 14th imp. (New Delhi, Oxford University Press 2009) 221. 23  For example, see Constitution, List I, Entries 82 to 92B which empower the Union government to inter alia tax income (other than agricultural income), customs and export duties, excise duties on petroleum crude, high speed diesel, motor spirit (commonly known as petrol), natural gas, aviation turbine fuel and tobacco and tobacco products, estate duty on properties other than agricultural land, succession duties in respect of property other than agricultural land, corporation tax, tax on sale or purchase of goods forming part of inter-state trade. 24  N Singh, ‘Fiscal Federalism’ in S Choudhary, M Khosla and PB Mehta (eds), The Oxford Handbook of The Indian Constitution (New Delhi, Oxford University Press 2016), 524. 25  Constitution, List I, Entry 97. For example, service tax was first imposed by virtue of the Union government’s residuary powers. Subsequently, List I was amended by Constitution (Eighty-eighth Amendment) Act, 2003 to include entry 92C dealing specifically with ‘taxes on services’. However, this entry was never notified and has now been deleted pursuant to the Constitution (One Hundred and First Amendment) Act, 2016. 26  Constitution, Arts 268–270. 27  Constitution, Art 280. 28  See Constitution, Arts 275 and 282. 29  The term was coined by AH Birch to describe a system where there is ‘administrative cooperation between general and regional governments, the partial dependence of the regional governments upon payments from the general governments, and the fact that the general governments, by the use of conditional grants, frequently promote developments in matters which are constitutionally assigned to the regions.’ AH Birch, Federalism, Finance, and Social Legislation in Canada, Australia, and the United States, (Oxford, Clarendon Press 1955) 305 quoted in Austin, above n 22, 187. 30  ‘Devolution: An Alternative Scheme’, Chapter XIII in Tenth Finance Commission: Report (Finance Commission) (New Delhi, 1994) 59–61.

Cesses in the Indian Tax Regime: A Historical Analysis 489 it is imperative to ask why this is so; answers to which are explored under the third and fourth headings. DISTRIBUTION OF TAX REVENUES AND CESSES: SINCE 1950

A review of the distribution of Union cess taxes reveals that the levies enjoyed a distinct status for several years prior to the Amendment. Hence, it is pertinent to study how Union tax revenues have historically been distributed since the commencement of the Constitution and why Union cesses came to enjoy this special status. Constitutional Scheme for Distribution of Tax Revenues: 1950 to 1996 Prior to the period when the alternate scheme of devolution came into being in 2000, Union taxes could be divided into five categories based on the scheme of their collection and retention. The categories are as follows: (i) taxes levied, collected and retained by the Union government,31 (ii) taxes levied and collected by the Union but compulsorily shared with the State governments,32 (iii) taxes levied and collected by the Union but which may be shared with the State governments,33 (iv) taxes levied and collected by the Union but the proceeds of which belong to the State governments,34 and (v) taxes levied by the Union but collected and retained by the State governments.35 A perusal of the cess taxes imposed by the Parliament prior to the year 2000, reveals that a majority were levied for development of specific industries and thus, on the respective commodities as an addition to the existing excise duties.36 When levying cess taxes on commodities, the Union government 31 Examples are corporation tax pursuant to Finance Act 1959, customs duties and surcharges. 32  An example is the tax on non-agricultural income excluding corporation tax. Prior to the Amendment, Art 270(1) of the Constitution provided that ‘Taxes on income other than agricultural income shall be levied and collected by the Government of India and distributed between the Union and the States in the manner provided in clause (2)’. Prior to the Amendment, Art 270(4)(a) clarified that income tax did not include corporation tax. 33  An example is excise duties other than on medicinal and toilet preparations. See Constitution, Art 272 which was repealed by the Amendment. 34 A few examples are taxes on inter-state sale of goods, estate duty in respect of nonagricultural property and succession duties on property other than non-agricultural land. For a complete list see Constitution, Art 269(1) prior to the Amendment. 35  Examples are stamp duties and excise duties on medicinal and toilet preparations. See Constitution, Art 268 which has now been amended to omit the reference to excise duties on medicinal and toilet preparations. 36  Ministry of Finance, Government of India, ‘Commodity-Wise Details of Revenue from Union Excise Duties’ in 1999–2000 Receipts Budget (New Delhi, 1999) 37 accessed 4 January 2017.

490  Ashrita Kotha could have chosen excise duties or even inter-state sales taxes as both are equally within exclusive legislative competence. Upon perusing the scheme outlined above, the preference for levying cess taxes as part of excise duties rather than inter-state sales tax is no longer puzzling. If the latter had been chosen as the tax base the proceeds could not have been retained by the Union government. However, the answer does not seem as straightforward. While under the scheme for devolution, excise duty proceeds need not have been shared with the State governments, Finance Commissions deemed it fit to progressively distribute the proceeds from Union excise duties to the State governments. The First Finance Commission recommended that 40 per cent of the net proceeds from Union excise duties on tobacco (including cigarettes, cigars, etc), matches and vegetable products be shared with the State governments with effect from 1952–1953. The rationale for choosing the specific commodities was that they yielded a sizeable sum of revenue.37 The Second Finance Commission expanded the list of commodities to include sugar, tea, coffee, paper and vegetable non-essential oils while reducing the share of devolution to 25 per cent.38 By the time of the Third Finance Commission, corporation taxes had been classified as a head separate from that of income taxes pursuant to the Finance Act 1959 leaving the proceeds outside the divisible pool. Owing to the narrower base of income taxes and also to alleviate concerns of over centralisation, 20 per cent of the proceeds from Union excise duties on all commodities were made shareable with the State governments.39 The recommendation that the Union cess proceeds should not form a part of the divisible pool was first made by the Fourth Finance Commission in its report dated 12 August 1965. The Commission noted that it would be undesirable to share the cess proceeds with the State governments as the legislation had already earmarked the purpose for which the proceeds were to be used.40 This marks the beginning of the trend of keeping Union cess taxes outside the divisible pool of tax revenues. Over the years, a number of cess taxes came to be levied (in addition to excise duties) on the very commodities, revenues from which were recommended to be shared with the State governments.41 Imposition of cess taxes

37 ‘Division of Union Excises’, Chapter V in First Finance Commission: Report (Finance Commission) (New Delhi, 1952) 82, [9]. 38  ‘Division of Union Excises’, Chapter X in Second Finance Commission: Report (Finance Commission) (New Delhi, 1957) 43, [115]. 39  ‘Devolution of Union Taxes/Duties’, Chapter IV in Third Finance Commission: Report (Finance Commission) (New Delhi, 1961) 20–22, [42]–[45]. 40  ‘Union Excise Duties’, Chapter VI in Fourth Finance Commission: Report (Finance Commission) (New Delhi, 1965) 24, [48]. 41  Cesses came to be levied on tobacco, vegetable oils, sugar, tea and coffee, as can be seen in Appendix I.

Cesses in the Indian Tax Regime: A Historical Analysis 491 ensured that the proceeds were not to be shared with the State governments, as opposed to the treatment meted out to the proceeds from excise duties. This distinct treatment is thus, perhaps one possible answer to why cess taxes have gained ground, distinct from taxes simpliciter and fees simpliciter. The Eighth Finance Commission disallowed sharing the cess proceeds with State governments on grounds that it would result in diverting funds to unintended purposes. The frequent usage of cesses was cautioned against on account of the grievances caused among the States owing to the shrinking divisible pool.42 Implicit in the recommendation against sharing of proceeds with State governments is the assumption that only the Union government is able and fit to apply the proceeds of cess taxes. Constitutional Scheme for Distribution of Tax Revenues: 1996 till Date India was in the midst of a number of economic reforms when the Tenth Finance Commission was constituted in 1992. Upon reviewing the scheme of devolution it found that income tax and excise duties which were being shared with the State governments, at 85 per cent and 45 per cent, respectively. However, these were less buoyant compared with the taxes retained exclusively with the Union, that is, corporation tax and customs duty. This led to two problems. Firstly, if the Union government wished to raise funds to be retained by itself, it would typically have to be through a tax base which was not part of the divisible pool. If however, it were to be done through a shared tax base, the imposition would have had to be significant so that the Union would get the desired amount.43 Secondly, the Union government had less incentive to develop the taxes which directly accrued to the State governments.44 The Tenth Finance Commission thus, recommended that 29 per cent of all Union taxes be shared with the State governments.45 Article 27046 was amended to carve out three exceptions: (i) cesses levied for specific purposes under a law passed by the Parliament, (ii) surcharges under Article 271,47

42 

Eighth Finance Commission: Report, above n 4. example, if the Union government wished to raise INR 100 crores for itself it would have had to raise INR 667 crores under income tax or INR 182 crores under Union excise duties. 44  Tenth Finance Commission: Report, above n 30. 45  Tenth Finance Commission: Report, above n 30. 46  ‘All taxes and duties referred to in the Union List, except the duties and taxes referred to in articles 268 and 269, respectively, surcharge on taxes and duties referred to in Article 271 and any cess levied for specific purposes under any law made by Parliament shall be levied and collected by the Government of India and shall be distributed between the Union and the States in the manner provided in clause (2).’ 47  A surcharge is an additional levy imposed by the Parliament for its exclusive purposes; proceeds of which form part of the Consolidated Fund of India. The nature of the surcharge is 43  For

492  Ashrita Kotha and (iii) some identified taxes.48 The rationale for granting a special status to cesses was that as the levies were to be utilised only for development of specific industries the proceeds thereof must not be shared with State governments.49 Pursuant to the recommendations, the Amendment was enacted which modified Article 270 to reflect the suggestions of the Tenth Finance Commission. This Amendment thus gave legislative sanction to the earlier treatment to cess taxes pursuant to the recommendations of the earlier Finance Commissions. The distinct treatment is directly linked to the fact that a cess is levied with a specific purpose in contemplation. Since the coming into force of the Amendment, there is another interesting trend. The tax base chosen for levy of Union cess taxes includes not only excise duty but also income tax for primary education cess and service tax for hygiene cess.50 It was technically possible to do the same even earlier as the Finance Commissions treated cess taxes as a distinct category. However, it is only after the Amendment that this actually happened. TAX, FEE AND THE CONUNDRUM OF CESSES

In order to understand the nature of a cess, we look to judicial precedents. A cess has been held to be a cess tax or a cess fee, depending on the concerned facts.51 The corollary to this conclusion is that while a cess shares some features with a tax or a fee simpliciter, it also has some unique features. Otherwise, there would be no meaningful distinction between a cess tax, a cess fee and a tax or a fee simpliciter. Consequently, to establish a cess tax there is a two-step analysis: first, show that the levy confirms to the features of a tax and not a fee, and secondly, prove that the levy has the unique features of a cess. This heading provides an overview of the features of a tax and fee simpliciter before moving on to a study of characteristics of a cess. Features of a Tax and Fee Simpliciter A tax is a mandatory collection of money by a public authority to fund public purposes, for which no reciprocal special benefit may be claimed. the same as the base tax on which it is levied. Sarojini Tea Co (P) Ltd. v Collector of Dibrugarh, Assam, AIR 1992 SC 1264, [17]. 48  Taxes falling under Arts 268 (stamp duties under List I), 269 (inter-state sales taxes) and 269A (GST on inter-state trade or commerce) of the Constitution. Art 269A was inserted pursuant to the Constitution (One Hundred and First Amendment) Act 2016. 49  Tenth Finance Commission: Report, above n 30, 22, [5.27]. 50  Finance Act 2004, ss 91–95 and Finance Act 2015, s 115. 51  The Hingir-Rampur Coal Co Ltd v The State of Orissa, AIR 1961 SC 459, [9].

Cesses in the Indian Tax Regime: A Historical Analysis 493 It is usually based on the ability to pay principle.52 The general principle is that all revenues from Union taxes form part of a general fund,53 termed the Consolidated Fund of India.54 As long as the legislature has the power to levy a tax, the purpose is irrelevant.55 The levy or collection of a tax can only be with the authority of a valid law.56 For any tax statute to be valid it should: (a) be within the legislative competence of the relevant legislature,57 (b) not be repugnant to the fundamental rights guaranteed under Part III of the Constitution,58 and (c) not be expressly prohibited under any other provision of the Constitution.59 For a tax statute to fulfil the test of legislative competence, the subject matter of the legislation must fall within any one of the specific tax entries allocated to the relevant legislature under the Seventh Schedule.60 An exception to this rule is the Union government’s power to make tax laws under the residuary entry.61 On the other hand, a fee is paid by an individual for a service rendered to him by the concerned government. The service must be over and above those otherwise provided by a local municipal authority.62 The fee collected must be correlated with the government expenditure in providing the specific service though not with mathematical precision.63 Fees are often applied at a flat rate, without reference to the payer’s ability to pay. Traditionally, the monies collected from fees are earmarked, not being merged into the Consolidated Fund of India, for effective utilization towards the promised service.64 The traditional distinction between a tax and a fee is based on the criterion of quid pro quo. However, the concept of fee has been diluted on various counts by subsequent judicial precedents. It has been held that quid

52  The Commissioner, Hindu Religious Endowments, Madras v Sri Lakshmindra Thirtha Swamiar of Sri Shirur Mutt, AIR 1954 SC 282, [45], [49]–[50] citing Latham CJ of the High Court of Australia in Matthews v Chicory Marketing Board (1938) 60 CLR 263, 276. 53  Some exceptions have been made such as in Constitution, Art 269. Proceeds of taxes on inter-state sale of goods are transferred to the States without being credited to the Consolidated Fund of India. 54  Constitution, Art 266. 55  Krishnan GK v State of Tamil Nadu, AIR 1975 SC 583, [9]. 56  Constitution, Art 265. 57  Constitution, Art 246 read with the 7th Sch. 58  Constitution, Art 13. 59  For example, Constitution, Arts 276(2), 285, 286 and 304(a). 60  AP Datar, Commentary on the Constitution of India, vol 2, 2nd edn reprint (Nagpur, LexisNexis Butterworths Wadhwa, 2010), 1444. 61  Constitution, 7th Sch, List I, Entry 97. 62  Nagar Mahapalika, Varanasi v Durga Das AIR 1968 SC 1119, [21]; State of Andhra Pradesh v Hindustan Machine Tools AIR 1975 SC 2037, [22]–[23]. 63  Indian Mica Micanite Industries v The State of Bihar and Ors. AIR 1971 SC 1182, [11]. 64  The Commissioner, Hindu Religious Endowments, Madras v Sri Lakshmindra Thirtha Swamiar of Sri Shirur Mutt AIR 1954 SC 282, [46].

494  Ashrita Kotha pro quo is not always a sine qua non for a fee.65 The individual bearing the fee need not be the recipient of a direct identifiable benefit in lieu thereof.66 The fact that money collected was credited into the Consolidated Fund of India (and not a separate fund) did not impact against the characterisation of the levy as a fee.67 Decoding the Nature of a Cess The earliest judicial exposition on the meaning of cess was laid down with reference to a tax entry in the legislative lists of the Government of India Act 1935 (a watershed legislation prior to the enactment of the Constitution) which used the term ‘cess’.68 Justice Din Mohammad quoted from Murray’s Oxford Dictionary to explain the meaning of a cess in the Indian context as being: ‘a tax levied for a specific object’. It is no doubt said that sometimes it meant a rate levied by local authority and for local purposes; but … it is now superseded in general English use by the word “rate”.69

Even after the enactment of the Constitution, a cess has been attributed the same meaning. Justice Hidayatullah explained the meaning of a cess in two Supreme Court judgments, each dated 26 September 1966, in the following manner: It means a tax and is generally used when the levy is for some special administrative expense which the name (health cess, education cess, road cess etc.) indicates.70

Both cases involved a challenge to the constitutional validity of a State legislation, the Mysore Health Cess Act 1962. It is to be noted that even though Justice Hidayatullah’s exposition was part of dissenting opinions he has

65 

Municipal Corporation of Delhi v Mohd. Yasin, AIR 1983 SC 617, [9]. Krishi Upaj Mandi Samiti v Orient Paper & Industries Ltd. 1995 (1) SCC 655, [31]. 67  The Commissioner, Hindu Religious Endowments, Madras v Sri Lakshmindra Thirtha Swamiar of Sri Shirur Mutt AIR 1954 SC 282, [51]; Sreenivasa General Traders v State of Andhra Pradesh AIR 1983 SC 1246, [32]. 68  7th Sch, List II, Entry 49, ‘Cesses on the entry of goods into a local area for consumption, use or sale’. The corresponding entry is Constitution 7th Sch, List II, Entry 52, but it used the word ‘tax’. The Supreme Court held that the Government of India Act 1935 used the word ‘cess’ to describe and connote an octroi tax. The term octroi was omitted as the category of terminal taxes was already included in List I, Entry 89 and the latter was also octroi in a sense (Burmah Shell Oil Storage v The Belgaum Borough Municipality, AIR 1963 SC 906, [21]; Jindal Stainless Ltd. & Anr. v State of Haryana & Ors. Civil Appeal No. 3453/2002, [107], [215]–[225]). It is of interest to note that pursuant to the Constitution (One Hundred and First Amendment) Act 2016, s 17(b) Entry 52 has now been omitted. 69  Daulat Ram v Municipal Committee AIR 1941 Lah 40, [9]. 70  Shinde Bros v Dy Commissioner Raichur & Ors. AIR 1967 SC 1512, [39]; Guruswamy & Co v State of Mysore [1967] 1 SCR 548, [57]. 66 

Cesses in the Indian Tax Regime: A Historical Analysis 495 been quoted as an authority on this point.71 The High Court of Andhra Pradesh makes an interesting reference to a cess as a tax limited to a local area for a specific purpose.72 However, the caveat of local area is not found in any Supreme Court precedents. The requirement of an earmarked purpose is also affirmed by the language in the amended Article 270(1) which creates an exception in favour of a Union cess levied ‘for specific purposes’.73 It was in fact this feature which led the Finance Commissions to recommend that proceeds from cess taxes ought not to be shared with the State governments, as elaborated under the third heading. The Amendment appears to give a misleading and contrary rationale for the change. It stated that cesses and surcharges were kept outside the divisible pool to allow the Union government sufficient flexibility to meet its ‘exclusive needs’.74 This may lead to an impression that the proceeds from cesses can be used to generate revenue for the Union government. However, the Constitution recognises cess and surcharge as separate categories and uses the language of ‘specific purpose’ for cess as opposed to ‘purposes of the Union’ for surcharge. Thus the difference between the two must not be blurred. Unfortunately, there appears to be a mix up between cess and surcharge even in various cess legislation, as demonstrated under the fifth heading. The feature of an earmarked purpose may lead one to think that a cess looks more like a fee simpliciter. However, the traditional conception of a fee requires not just identification of a particular purpose such as rendering of a particular service but also a quid pro quo to the payer. Hence, for a cess to be a cess fee it must have an earmarked purpose and a quid pro quo.75 If it lacks the latter it would be classified as a cess tax.

71 

India Cement Ltd. v State Of Tamil Nadu AIR 1990 SC 85, [19]–[20]. N. Balaraju v The Hyderabad Municipal Corporation AIR 1960 AP 234, [32]. 73  ‘[A]ny cess levied for specific purposes under any law made by Parliament.’ 74  Statement of Objects and Reasons, Constitution (Eightieth Amendment) Act, 2000 with effect from 1 April, 1996. Of interest to note here, is an observation by Biswanath Das, a member of the Constituent Assembly that debated the provisions of the draft constitutional provisions prior to its enactment. Arguing in favour of the Union government retaining some proceeds for equitable distribution in the interests of the country, Das quoted the precedent of a petrol cess fund or road cess fund. Das stated that 15% of the proceeds of the petrol cess fund or road cess fund were kept with the central government to undertake development. However, this observation was neither validated nor adopted by the Constituent Assembly. See ­Constituent Assembly Debates, Vol. IX, 5 th rep. (New Delhi, Jainco Art India, 2009) 215. 75  Following the dilution in the traditional concept of a fee, the evaluation of a cess has also been impacted. In Vijayalashmi Rice Mill v The Commercial Tax Officers, Palakol AIR 2006 SC 2897, [17]–[18], the Supreme Court upheld the validity of the rural development cess even though the proceeds were applied towards general infrastructure such as roads, bridges and storage facilities. 72 

496  Ashrita Kotha As established, the cess statute must spell out the earmarked purpose. The purpose must not be vague or uncertain as this may lead to an argument of excessive delegation of power.76 The measure of a cess varies across statutes and could be either fixed or ad valorem.77 It is typically imposed as an addition to an existing tax.78 For example, the hygiene cess is levied as an additional 0.5 per cent on the service tax rate. On the other hand, a cess may also be levied as a percentage on the taxes payable under a particular head. For example, the primary education cess is fixed at two per cent of the aggregate of all duties of excise payable by the assessee. Such cess has been described as a ‘piggy back duty’ as the liability to pay the cess is tied to the liability to pay the excise duty.79 Owing to the manner in which cesses are levied, the assessment is not independent and the cess legislation is not a complete code in itself. The cess legislation which imposes the cess incorporates by reference the provisions of a parent statute for provisions such as assessment procedure, appeal, etc.80 For example, a majority of statutes imposing cess provide that the cess would be levied and collected as an excise duty. Further, the statute incorporates the provisions of the Central Excises and Salt Act, 1944 by reference.81 A cess must be levied under the authority of law, meaning a constitutionally valid legislation and not merely an executive order.82 The legislation must prescribe the maximum rate of the cess otherwise it would be invalidated on grounds of excessive delegation of power to the executive.83 A cess may also be imposed under the residuary powers vested in the Union government under List I.84 Delay in the setting up the implementation machinery does not postpone liability to pay cess.85 As discussed earlier, cesses have been subsumed within the categories of taxes and fees for the purpose of legislative competence. The legislative

76 

V. Nagappa v Iron Ore Mines Cess Commissioner AIR 1973 SC 1374, [16]. cess under the Jute Manufactures Cess Act 1983 is an example of an ad valorem levy whereas the cine workers welfare cess under the Cine-Workers Welfare Cess Act 1981 is a fixed levy. 78  Ahmedabad Manufacturing & Calico Printing Co Ltd. v State of Gujarat AIR 1967 SC 1916, [12]. 79  Bharat Box Factory Ltd. v CCE 2007 (122) ECC 47, [6.2]; Cyrus Surfactants Pvt. Ltd. v CCE 2007 (120) ECC 443, [6.2]. 80  Ahmedabad Manufacturing & Calico Printing Co Ltd v State of Gujarat AIR 1967 SC 1916, [12]. 81  For example, The Tea Act 1953, s 25(3). 82  Gwalior Sugar Co. Ltd. v State of Madhya Bharat AIR 1954 MB 196, [10]. 83  Shanmugha Oil Mill, Erode v Coimbatore Market Committee AIR 1960 Mad 160, [57]. 84  For example, water cess imposed under The Water (Prevention and Control of Pollution) Cess Act 1977 being a cess in the nature of a tax on water consumption was held constitutionally valid in Municipal Corporation of Jullundur City v Union of India AIR 1981 P&H 287 when exercised invoking residuary powers in the Union List. 85  Dhanpat Oil and General Mills v Union of India MANU/SC/0185/1985, [11]; Seshasayee Paper and Boards Limited v The Appellate Committee MANU/TN/1053/1994, [2]. 77  Jute

Cesses in the Indian Tax Regime: A Historical Analysis 497 competence of a cess law is thus tied to the tax base and not to the earmarked purpose. For example, when the Mysore State government imposed a health cess as an increment to the excise duty, the competence was to be judged by whether the State government had the legislative competence to enact an excise duty law and not whether health was a matter within the competence of the State legislature.86 Hence, this provides a convenient window for the Union government to impose cess taxes for purposes not within its exclusive domain by merely picking a tax base it is competent to enact under. The Union government has in fact imposed cess taxes for purposes such as hygiene, agriculture and state and rural roads which are within List II.87 Also, purposes such as ­education (primary and secondary and higher) and labour welfare are within List III.88 Hence, this convenience may be the other prominent reason for Union governments imposing cess taxes over taxes and fees. Whether or not this poses any challenges under the Constitution is not within the scope of this paper. Dr BR Ambedkar explained the purpose of setting up the Consolidated Fund of India as being to prevent the squandering of money on account of laws earmarking purposes without due regard to the general necessity of the public at large.89 Cesses were perhaps intended to be the exception rather than the rule. A HISTORICAL ANALYSIS OF CESS TAXES: EARMARKING, ADMINISTRATION AND APPROPRIATION

Union cess taxes have been criticised on various counts and this heading begins by throwing light on the same. This heading then moves on to analyse the working of the various Union cess taxes on the basis of four criteria: earmarking of purpose, earmarking of proceeds, administration of cess taxes and appropriation of cess proceeds. Criticism Against Cess Taxes The criticism of the Finance Commission stems from the dissent of the State governments that have protested keeping the Union cess taxes outside the divisible pool of resources as this directly impacts their share in the revenue. The response of the Finance Commissions to this grievance has

86 

Shinde Bros v Dy Commissioner Raichur & Ors. AIR 1967 SC 1512, [22]–[32]. List II, Entries 6, 13 and 14. 88  List III, Entries 24 and 25. 89  Constituent Assembly Debates, vol VIII, 5 th rep. (New Delhi, Jainco Art India, 2009), 724. 87 

498  Ashrita Kotha been in cautioning the Union government to keep the levy of cesses to a minimum.90 The Sarkaria Commission, which was set up by the government to look at Union-State relations, recommended that the application of cesses must be confined to limited periods and for specific purposes. While doing so, the Commission also cited the government’s commitment in 1985 to reduce cesses owing to the multiplicity of taxes.91 The Law Commission has pointed to the economic inefficiencies in administering cesses and recommended the repeal of some cess statutes such as The Tobacco Cess Act 1975 and the various labour welfare cess laws.92 Reports by the Comptroller and Auditor General of India for the accounts of the Union government in the financial years 2011–2012 and 2013–2014 noted the discrepancies in collection and appropriation of cess tax proceeds of cess taxes such as the research and development cess tax, education and secondary and higher education cess tax, clean energy (environment) cess tax, labour welfare cess tax (on iron ore, limestone and dolomite and feature films).93 In response to such lack of accountability in the usage of cesses, it has been suggested that the Constitution may be amended to mandate the use of cess proceeds for the earmarked purpose.94 Since 1950, there have been approximately 39 Union cess taxes, as mentioned in Appendix I. A review of the working of these cesses begins by looking at the earmarked purposes to see if there is any emerging pattern. In the next step the administration of the cesses will be looked at: What is the mechanism of administration under the laws? Whether cess laws are economically efficient? To what extent were the cess proceeds appropriated towards the earmarked purpose?

90 Eighth Finance Commission: Report, above n 4; ‘Sharing of Union Tax Revenues’, Chapter 8 in Thirteenth Finance Commission 2010–2015 Volume I: Report (Finance Commission) (New Delhi, 2009) [8.6]–[8.7]. 91  R S Sarkaria, B Sivaraman and S R Sen, ‘Financial Relations’, Chapter X in Commission on Centre-State Relations: Report (Sarkaria Commission) (1980) [10.9.21] accessed 10 January 2017. 92  Law Commission, ‘Obsolete Laws: Warranting Immediate Repeal’ (Law Com No 250, 2014) [33–34] and 42. 93  Report of the Comptroller and Auditor General of [sic] for the year 2013–14, above n 5, [2.2.2], [2.2.4] and [2.2.6]; Indian Audit and Accounts Department, ‘Comments on Accounts’, Chapter 2 in Report of the Comptroller and Auditor General for the year 2011–12 (New Delhi, 13 August 2013) [2.2.2], [2.2.5] and [2.2.9] accessed 10 January 2017. 94  M Narasimham, YV Reddy, H Salve, I Ahluwalia, A Lahiri, BP Mathur, SS Tarapore and BPR Vithal, ‘Fiscal and Monetary Policies’, Vol.2, Book 3 in National Commission to Review the Working of the Constitution: Report (New Delhi, 2002) [2.6] accessed 10 January 2017.

Cesses in the Indian Tax Regime: A Historical Analysis 499 Earmarking of a Purpose Upon a perusal of the laws, it is apparent that all the laws earmark a purpose. These purposes can be categorised as follows: (a) development of a particular industry, (b) labour welfare and (c) general and broad-based causes. Development of a Specific Industry A majority of the cess taxes during the period of study have been for developing particular industries. Such enactments were passed from the 1950s through to the 1980s.95 The chosen tax base for these laws was primarily excise duties, which is a tax entry under List I.96 It is interesting to note the purposes identified under the different cess statutes. The Rubber Act, 1947, which was amended in 1961 to levy a rubber cess, states that the purpose is to develop the rubber industry under the control of the Union to further public interest.97 The Supreme Court upheld the constitutionality of the cess, determining it to be in the nature of a cess tax, on account of the purpose being for the benefit of the public.98 Other legislation has laid down a more elaborate set of purposes, either in the charging legislation99 or related ancillary laws.100 It can be seen that for this category of cess taxes, the burden is spread across the producers of the concerned commodity or end consumers if the 95  For example, handloom cess under The Khadi and Other Handloom Industries Development (Additional Excise Duty On Cloth) Act 1953, tea cess under The Tea Act 1953, salt cess under the Salt Cess Act 1953, oil cess under The Oil Industries (Development) Act 1974, textile cess under The Textiles Committee Act 1963, copra cess under the Copra Cess Act 1979, sugar cess under the Sugar Cess Act 1982, vegetable oils cess under the Vegetable Oils Cess Act 1983, jute cess under the Jute Manufactures Cess Act 1983, automobile cess under the Industries (Development and Regulation) Act 1951, tobacco cess under The Tobacco Cess Act 1975 and spice cess under the Spices Cess Act 1986. 96  Constitution List I, Entry 84. 97  The Rubber Act 1947 preamble and s 12. 98  Shri Krishna Rubber Works v Union of India (1971) 73 BOMLR 496, [22]–[23]. 99  The Tea Act, 1953 imposes a cess on teas produced in India proceeds of which are paid over to the Tea Board. The functions of the Tea Board are set out in The Tea Act, 1953, s 10. Similarly, the Salt Cess Act 1953 provides for a cess to fund the expenses incurred by the Salt Commissioner maintained by Government and for other government measures in connection with the manufacture, supply and distribution of salt. 100  For example, excise duty on the manufacture of Virginia tobacco in India is levied under The Tobacco Cess Act 1975 for the purposes of the Tobacco Board. The purposes of the Tobacco Board are laid down in The Tobacco Board Act 1975, s 8 which include inter alia promoting the grading of tobacco, sponsoring, assisting, co-ordinating or encouraging scientific, technological and economic research for the promotion of the tobacco industry, regulating the production and curing of Virginia tobacco. Similarly, the Vegetable Oils Cess Act 1983 levies the vegetable oils cess while the purposes are laid down in the National Oilseeds and Vegetable Oils Development Board Act 1983, s 9.

500  Ashrita Kotha burden is passed on.101 The benefit is intended to percolate to the chosen industry at large. In such sense, while there seems to be a certain connection between those paying the cess and those standing to benefit, individual quid pro quo, if any, is merely incidental. Labour Welfare in the Concerned Industry In the second category, the laws levied cess taxes for promoting the welfare of labour in the concerned industries such as mining, cinema, beedi, etc.102 These enactments were passed between the 1960s and the 1980s. These statutes typically have more elaborate and specific purposes,103 which are set out in the charging legislation104 or ancillary legislation.105 These laws are predominantly redistributive in nature as the cess tax is levied on owners of a mine or person selling minerals or producers of films, as may be the case, and the benefit of the cess tax is reserved for the persons employed in the particular industry.106 Owing to the beneficial nature of such laws, the Supreme Court has held that the provisions must be construed liberally.107 General and Broad-based Causes The benefits flowing from the first and second categories of cess taxes are meant for the chosen industry as a whole or more specifically, for the chosen beneficiaries within the industry. However, the third category of cess tax is more general and broad-based. These cess taxes have been imposed more recently in the last two decades, starting from the late 1990s; barring perhaps the water cess tax imposed under The Water Cess (Prevention and Control of Pollution) Act 1977.

101  For example, tea cess under The Tea Act 1953 is to be paid by the producers of tea, tobacco cess under The Tobacco Cess Act 1975 is to be paid by those who produce and sell Virginia tobacco. 102  Iron Ore Mines Labour Welfare Cess Act 1961, Limestone and Dolomite Mines Labour Welfare Fund Act 1972, Iron Ore Mines Manganese Ore Mines and Chrome Ore Mines Labour Welfare Cess Act 1976, Cine-Workers Welfare Cess Act 1981 and Beedi Workers Welfare Cess Act 1976. 103  For example, the Limestone and Dolomite Mines Labour Welfare Fund Act 1972, s 5 sets out the purpose of the cess as one to fund measures for inter alia improvement of standard of living including housing and nutrition, public health and sanitation, provision of water supplies, education, etc. 104  Iron Ore Mines Labour Welfare Cess Act 1961, s 3. 105  The cine workers welfare cess is levied under the Cine-Workers Welfare Cess Act 1981, purposes of which are laid down in the Cine-Workers Welfare Fund Act 1981, s 4. 106  See Cine-Workers Welfare Cess Act 1981, s 4. 107  Hindustan Steel Works Construction Ltd. v Limestone and Dolomite Mines Welfare and Cess Commissioner MANU/SC/1596/1996, [3].

Cesses in the Indian Tax Regime: A Historical Analysis 501 The earmarked purposes include development and maintenance of national highways, rural roads and inter-state roadways,108 financing of basic education,109 secondary and higher education,110 clean energy and ­environment,111 hygiene,112 agriculture,113 infrastructure projects,114 etc. It is apparent that the purposes encompass the responsibilities already entrusted to the government in its discharge of general administration. There are some other interesting things that have transpired during this phase. These cess taxes have most often been imposed by Finance Acts supplemented with ancillary laws in some but not all cases.115 There has been an apparent mix up between a cess and a surcharge, the earmarked purpose has been amended in some instances and in some others has been defined in a very open ended manner. The Finance Acts of 1998 and 1999 imposed road cess tax or additional duties of excise and customs on motor spirit and high speed diesel oil ‘for the purposes of the Union’.116 Such language makes the levy look like a surcharge rather than a cess; the distinction has already been highlighted in the fourth heading. However, the levy was retrospectively deemed to be a cess by the Central Road Fund Act 2000 which also then set out the earmarked purpose.117 A similar anomaly in the mix up of cess and surcharge language can be found in the Finance Acts of 2004 and 2007. These statutes made two levies: education cess and secondary and higher education cess, respectively. While the levies were termed a cess, it was described as a ‘surcharge for the purposes of the Union’. Further, the earmarked purpose was to finance universalised quality basic education and secondary and higher education, respectively.118 Additionally, section 83(6) of the Finance Act 2010 stipulates that the clean energy (environment) cess tax is for the purposes of the Union and that the proceeds shall not be shared with the State governments.119

108  Finance Act 1998, ss 103 and 111 and Finance Act 1999, ss 116 and 133 read with the Central Road Fund Act 2000, s 3. 109  Finance Act 2004, ss 91 and 95. 110  Finance Act 2007, s 2(12). 111  Finance Act 2010, s 83. 112  Finance Act 2015, s 119. 113  Finance Act 2016, s 161. The cess is termed as krishi kalyan cess which translates to agriculture welfare cess. 114  Finance Act 2016, s 162. 115  The Finance Acts have a number of provisions and thus, it is possible that the sections imposing cesses potentially do not get as much time and attention in the parliamentary debate. 116  Finance Act 1998, ss 103 and 111 and Finance Act 1999, ss 116 and 133. 117  Central Road Fund Act 2000, ss 3 and 7. 118  Finance Act 2004, ss 91–95 and Finance Act 2007, s 2(12). 119  Finance Act 2010, s 83(6) states ‘The cess leviable under sub-section (3) shall be for the purposes of the Union and the proceeds thereof shall not be distributed among the States and the manner of assessment, collection, utilisation and any other matter relating to cess shall be such as may be prescribed by rules.’

502  Ashrita Kotha There have also been instances where the earmarked purpose has been amended. The clean energy (environment) cess tax was levied by the Finance Act 2010 for financing and promoting clean energy initiatives, funding research in the area of clean energy or for any other purpose relating thereto. However, the purpose itself was amended to include clean environment initiatives and research in clean environment.120 The cess was renamed in 2016.121 A retrospective amendment to modify the earmarked purpose is also being sought with respect to the Central Road Fund Act 2000.122 The earmarked purposes of the three latest cess taxes are very brief: to finance and promote hygiene initiatives, to finance and promote initiatives to improve agriculture or related purpose and to finance infrastructure projects, respectively.123 No ancillary laws have been enacted for these cesses nor have any separate funds been set up. The use of ‘finance’ and ‘promote’ leads to a fear that the cess proceeds may be used for inter alia advertising rather than the actual cause.124 Administration of Cesses Earmarking the purpose is but the first step in the process. The Constitution provides that the cess tax proceeds must be credited to the Consolidated Fund of India. It further provides that once credited to the Consolidated Fund of India, proceeds can be withdrawn only when the Parliament passes suitable appropriation legislation.125 However, it is silent on the other nuances for administering cesses. For example, once the purpose is earmarked, do the proceeds also need to be earmarked while being credited into the Consolidated Fund of India? When the proceeds are being appropriated out of the Consolidated Fund of India do they have to go into a separate fund? Cesses lead to multiplicity of levies which need additional machinery for administration. A glance at the Union government’s accounts for the financial year 2014–2015 bears out the statement, especially looking at the numerous cess taxes under the head of excise duties.126

120 

Finance Act 2010, s 83 amended by Finance Act 2014, s 119. Finance Act 2016, s 235. 122 Arun Jaitley, ‘Budget 2016–2017’ (Speech at Lok Sabha, Parliament of India 2016) 74 accessed 2 January 2017. 123  Finance Act 2015, s 119 and Finance Act 2016, ss 161 and 162. 124  See R Arun and AP Kotha, ‘Swachh Bharat cess has many problems—for starters, its name’ Scroll.in (7 January 2016) accessed 2 January 2017. 125  Constitution, Arts 266 and 283. 126 MJ Joseph and RP Watal, Controller General of India, Ministry of Finance, Government of India, ‘Detailed Account of Revenue Receipts and Capital Receipts by Minor Heads’ in Union Government Finance Accounts 2014–2015 (New Delhi, 3 December 2015) 89–91 accessed 10 January 2017. 121 

Cesses in the Indian Tax Regime: A Historical Analysis 503 Some cess laws have set up or make reference to existing machinery such as boards,127 committees,128 councils129 and commissioners130 for administering the cesses. For example, the Tea Board set up under The Tea Act 1953 is to have 40 members representing different stakeholders such as owners of tea estates, employees in tea estates, manufacturers of tea, dealers, consumers, etc.131 Depending on the subject matter of the cess, the machinery is governed by different Union departments and/or ministries. For example, the water cess collected under The Water (Prevention and Control of Pollution) Cess Act 1977 is administered by the Union Ministry of Environment, Forest and Climate Change. Despite the presence of administrative machinery, non-compliance has been reported with respect to payment of the cess tax.132 The economic inefficiency of cess laws and the distortions caused have been highlighted by Indian economists.133 This fact was also admitted by the Finance Minister Arun Jaitley in his budget speech on 29 February 2016. He announced that 13 cesses raising less than INR 500,000,000 annually would be repealed in a bid to tackle multiplicity, cascading effects and added compliance costs.134 Using the threshold indicated by the Finance Minister, 16 of the 39 Union cess taxes referred to in Appendix I may be classified as inefficient.135

127  The Tea Act 1953, s 4 set up the Tea Board, The Oil Industry (Development) Act 1974, s 3 set up the Oil Industry Development Board, The Water (Prevention and Control of Pollution) Cess Act 1977 refers to Central and State Boards, the Copra Cess Act 1979 refers to the Coconut Development Board, the Vegetable Oils Cess Act 1983 refers to the National Oilseeds and Vegetable Oils Development Board, The Tobacco Cess Act 1975 refers to the Tobacco Board and the Spices Act 1986 refers to the Spice Board. 128  The Textiles Committee Act 1963 levies the impugned cess, sets up an earmarked fund and appoints the Textiles Committee to administer the cess proceeds. 129  Automobile Cess Rules 1984 refers to a Development Council for Automobile and Allied Industries, the Jute Manufactures Cess Act 1983 refers to the Jute Manufactures Development Council, Paper and Paper Board Cess Rules 1981 refer to the Development Council for Paper, Pulp and Allied Industries. 130  Salt Cess Rules 1964 refer to a Salt Organization and Salt Commissioner. 131  The Tea Act 1953, s 4. 132 Indian Audit and Accounts Department, ‘Performance Audits’, Chapter 2 in Report No.2 of 2014—Report of the Comptroller and Auditor General of India (General, Social & Economic Sectors) for the year ended 31st March 2013 Government of Bihar (15 July 2014) 12–13

accessed 12 January 2017. 133  ‘Cess, surcharge, transaction tax distortionary: Virmani’, Deccan Herald (New Delhi 5 July 2009) accessed 2 January 2017; NK Singh, The Politics of Change: A Ringside View (Penguin, New Delhi 2007) 170–173. 134  Budget 2016–2017 Speech, above n 122, 31, [174]. 135 The basis for the classification is data available in the public domain. See Detailed Account of Revenue Receipts and Capital Receipts by Minor Heads 2014–2015, above n 126, 85–98; Y Yadav, ‘Unable to Make Ends Meet, Government to Scrap Cess on Products’ The New Indian Express (New Delhi, 24 April 2016) accessed 2 January 2017; NK Singh, The Politics of Change: A Ringside View (Penguin, New Delhi 2007) 170–173. 136 For example, cess on vegetable oils was repealed by s 12 of the Cotton, Copra and Vegetable Oils Cess (Abolition) Act, 1987 but the accounts show a balance of INR 423,000. 137  Report of the Comptroller and Auditor General of [sic] for the year 2013–14, above n 5, [2.2.3]. 138  Negative balance is INR 2,852,094,000. See Detailed Account of Revenue Receipts and Capital Receipts by Minor Heads 2014–2015, above n 126, 90. 139  Gwalior Sugar Co. Ltd. v State of Madhya Bharat AIR 1954 MB 196, [44] and [49]—[50]. 140  Detailed Account of Revenue Receipts and Capital Receipts by Minor Heads 2014–2015, above n 126, 85–98. 141  The funds have been set up under The Rubber Act 1947, The Tea Act 1953, The Textiles Committee Act 1963, the Limestone and Dolomite Mines Labour Welfare Fund Act 1972, Iron Ore Mines Manganese Ore Mines And Chrome Ore Mines Labour Welfare Cess Act 1976, the Beedi Workers Welfare Cess Act 1976, the Cine-Workers Welfare Cess Act 1981 and the Cine-Workers Welfare Fund Act 1981, the Sugar Cess Act 1982 and Sugar Development Fund Act 1982, the Jute Manufactures Cess Act 1983, the Research and Development Cess Act 1986 and the Central Road Fund Act 2000 (which imposes four cesses: additional duty of customs

Cesses in the Indian Tax Regime: A Historical Analysis 505 fund and not the Consolidated Fund of India.142 The accounts of such cess fees are maintained in the public accounts of the Union government. There is no need for parliamentary approval for withdrawal of funds.143 Appropriation of Cess Proceeds As seen above, proceeds from Union cess taxes are first credited into the Consolidated Fund of India. It is significant to find out the percentage of the total proceeds that have been appropriated for the particular earmarked purpose. There is proof of short transfer/appropriation of cess proceeds in at least seven Union cess taxes under the current review and lack of transparency with respect to the secondary and higher education cess, details of which can be seen in Appendix I. In respect of the oil cess tax, only 0.64 per cent of the gross proceeds have been transferred to the Oil Development Board.144 In respect of the research and development cess145 and automobile cess146 there has been a transfer of only about 10 per cent of the gross cess tax proceeds. In respect of the clean energy (environment) cess only 43 per cent has been transferred to the National Clean Energy Fund.147 A report by the Comptroller and Auditor General has noted that transparent accounts

on motor spirit, additional duty of customs on high speed diesel oil, additional duty of excise on motor spirit and additional duty of excise on high speed diesel oil). The National Clean Energy Fund with respect to the clean energy (environment) cess has also been set up. 142  Commissioner of C. EX., Cus. & S.T., Belgaum v Shree Renuka Sugars Ltd. 2014 (302) ELT 33 (Kar.), [25]. 143  Constitution, Art 266. 144  Data available on the website of the Oil Industry Development Board reveals that since inception and up to 31 March 2015 the Central Government has collected INR 1,400,000.7 million (approx.) as cess. Out of this the Oil Development Board has received only an amount of INR 9,020 million. See Oil Industry Development Board, Ministry of Petroleum and Natural Gas, Government of India, Annual Report 2014–2015 (Noida) 51 accessed 12 January 2017. 145  Report of the Comptroller and Auditor General of [sic] for the year 2013–14, above n 5, [2.2.2]; Technology Development Board, Department of Science and Technology, Government of India, Nineteenth Annual Report 2014–2015 (New Delhi) 69 accessed 10 January 2017. 146  Data available on the website of the Department of Heavy Industry, Ministry of Heavy Industries & Public Enterprises, Government of India which is in charge of the cess shows that as of 2014–2015, INR 3,700,000,000 had been collected but only 250,000,000 was transferred to the dedicated fund. Further, only 192,400,000 crores have been spent. See accessed 12 January 2017. 147  Report of the Comptroller and Auditor General of [sic] for the year 2013–14, above n 5, [2.2.6]; See R Pandey, S Bali and N Mongia, ‘Promoting Effective Utilisation of National Clean Energy Fund’, (New Delhi, 2013) accessed 4 January 2017.

506  Ashrita Kotha were not maintained in relation to the secondary and higher education cess proceeds.148 With respect to sugar cess the short transfer is in the range of 16 per cent,149 for the primary education cess it is in the range of 8.7 per cent150 and for the road cess/additional excise duty on motor spirit and high speed diesel oil the short transfer is in the range of 4 per cent.151 While these smaller percentages make things look better, these are the levies which garner greater revenues and thus, even a small percentage results in non-appropriation of a relatively high amount. For example, as of 29 February 2016 INR 13,439,800,000 is lying unused in the Consolidated Fund of India under the head of sugar cess tax.152 The issue is not only one of under-appropriation but also of diversion of proceeds. In the instance of the research and development cess, the Comptroller and Auditor General has made a specific comment that the ‘the proceeds are being partly utilized to finance the revenue deficit of the Government over the years’.153 CONCLUSION

In simple words cess taxes are taxes for an earmarked purpose. In principle, an earmarked tax could prove to be a credible and efficacious policy tool when introduced and implemented in a targeted manner demonstrating the link between collection and utilisation.154 Earmarking of purpose and ­proceeds theoretically limits the power of the Union government to utilise

148  Report of the Comptroller and Auditor General of [sic] for the year 2013–14, above n 5, [2.2.4 (b)]. 149  Data available on the website of the Department of Food and Public Administration, Ministry of Consumer Affairs, Food & Public Administration, Government of India reveals that as of 29 February 2016, total cess collections stood at INR 90,400,000,000 while only an amount of INR 76,060,000,000 had been transferred to the Sugar Development Fund. See accessed 12 January 2017. 150  Report of the Comptroller and Auditor General of [sic] for the year 2013–14, above n 5, [2.2.4 (a)]. 151  Report of the Comptroller and Auditor General of [sic] for the year 2013–14, above n 5, [2.2.10]. 152  Data available on the website of the Department of Food and Public Administration, Ministry of Consumer Affairs, Food & Public Administration, Government of India reveals that as of 29 February 2016, total cess collections stood at INR 90,400,000,000 while only an amount of INR 76,060,000,000 had been transferred to the Sugar Development Fund. See accessed 12 January 2017. 153  Report of the Comptroller and Auditor General of [sic] for the year 2013–14, above n 5, [2.2.2]. 154  MM Sury, Fiscal Policy Developments in India 1947 to 2007, 1st edn (New Delhi, New Century Publications 2007) 439–440.

Cesses in the Indian Tax Regime: A Historical Analysis 507 the proceeds for any other purpose. Despite being counter-intuitive, successive governments have persistently imposed cess taxes. The study undertaken in this chapter reveals the reasons for this behaviour. First, the revenue from the Union cess taxes need not be shared with the State governments. Secondly, through the mechanism of cess taxes the Union government has been able to passively enter the domain entrusted to the State governments. Hence, Union cess taxes appear to provide some leverage for the Union government and have emerged as an important and popular fiscal instrument. The historical workings of the various Union cess taxes have shown how the earmarked purpose itself has transformed over the decades; from welfare of a specific industry to labour welfare within an industry to more general and broad-based causes. In some instances, despite the earmarking of a purpose, the laws appear to confuse a cess and a surcharge. Separate accounting codes are maintained but specific funds have not been set up in most cases. Administration of cesses is complex as it is divided across different ministries and designated bodies/authorities. Of the 39 cess taxes forming a part of the study, three cess taxes have been imposed for around or less than one year and so data on appropriation of proceeds is not yet available. Of the remaining 36, 16 cess taxes are inefficient, revenue from seven cess taxes have not been fully appropriated, one cess tax reveals reported non-compliance, one cess tax shows lack of accounts and two cess taxes show an adverse/negative balance. Despite reports by Comptroller and Auditor General pointing to the under appropriation and diversion of funds, amendments have not been made. The lack of accountability and transparency is concerning. The track record fraught with rampant economic inefficiency and under appropriation presents a worrying and shaky precedent. The government realises the inefficiencies and so has repealed some cess taxes. However, the policy making does not seem to be very informed. Even when data suggests that the proceeds of the clean energy (environment) cess have been under appropriated, amendments have been proposed to enhance the levy.155 The historical analysis in this chapter presents many lessons to be learnt. While it is the prerogative of government to choose the earmarked purposes it would be helpful to see data/explanation on the reasons for choosing a particular purpose, why taxes are not adequate for achieving it and the manner in which the object is proposed to be fulfilled. The purpose should be legislated in a well-defined manner so as to leave out any ambiguity and claims of excessive delegation of powers. Periodic review of the costs of collection and revenue garnered from the levy must be undertaken so that any inefficient levies can be dropped. Transparency in appropriation and utilisation

155 

Budget 2016–2017 Speech, above n 122, 29, [156].

508  Ashrita Kotha of cesses should be maintained. If funds are lying unused, appropriate programs for application of the same ought to be devised. Stipulation of a sunset clause in cess legislation could also help in building accountability. In the pre-Constitution era it appears that cesses were primarily levied as measures of taxation by local authorities such as local and district boards.156 It may be worthwhile to ponder if cesses are more suitable as local levies where the implementing authority is better equipped to understand the needs of the concerned communities.

156  L Alston, Elements of Indian Taxation Elements of the Theory of Taxation with Special Reference to Indian Conditions, 1st edn (London, Macmillan & Co Ltd, 1910) 89.

Cesses in the Indian Tax Regime: A Historical Analysis 509 APPENDIX I S.No.

Name of Cess

Levied Since

In Force?

Tax Base

Remarks on Working of Cess

–

Yes

Excise duty

Inefficient levy157

1.

Cesses on other commodities

2.

Bidi cess

N.A.

Yes

Excise duty

No data on appropriation

3.

Rubber cess

1961

Yes

Excise duty

No data on appropriation

4.

Handloom cess on cotton fabrics

1953

Yes

Excise duty

Inefficient levy

5.

Handloom cess on woolen fabrics

1953

Yes

Excise duty

Inefficient levy

6.

Handloom cess on rayon and artificial silk fabrics

1953

Yes

Excise duty

Inefficient levy

7.

Handloom cess on manmade fabrics

1953

Yes

Excise duty

Inefficient levy

8.

Tea cess

1953

Yes

Excise duty

No data on appropriation

9.

Salt cess

1954

Yes

Excise duty

Inefficient levy

10.

Iron ore cess

1961

Repealed

Excise duty

Inefficient levy

11.

Produce cess

1966

Repealed

Excise duty

Inefficient levy

12.

Limestone and dolomite cess

1972

Yes

Excise duty

Inefficient levy

13.

Crude oil cess

1974

Yes

Excise duty

Short transfer

14.

Coal Mines Conservation and Development cess

1974

Yes

Excise duty

No data on appropriation

15.

Textile and Textile Machinery cess

1973

Yes

Excise duty

Inefficient levy

16.

Iron ore, manganese ore and chrome ore cess

1976

Yes

Excise duty

Inefficient levy

17.

Water cess

1977

Yes

Excise duty

Noncompliance (continued)

157  Information pertaining to short transfers, inefficiency, non-compliance, adverse/negative balance, lack of transparency appears under the fifth heading.

510  Ashrita Kotha S.No.

Name of Cess

Levied Since

In Force?

Tax Base

Remarks on Working of Cess

18.

Copra cess

1979

Repealed

Excise duty

Inefficient levy

19.

Paper cess

1980

Yes

Excise duty

No data on appropriation

20.

Straw board cess

1980

Yes

Excise duty

Inefficient levy

21.

Cine workers’ welfare fund cess/cess on feature films

1981

Yes

Excise duty

Inefficient levy

22.

Beedi workers’ welfare fund cess

1982

Yes

Excise duty

Adverse balance

23.

Sugar cess

1982

Yes

Excise duty

Short transfer

24.

Vegetable oils cess

1983

Repealed

Excise duty

Inefficient levy

25.

Jute manufactures cess

1983

Yes

Excise duty

Negative balance due to refunds

26.

Automobiles cess

1984

Yes

Excise duty

Short transfer

27.

Tobacco cess

1984

Yes

Excise duty

Inefficient levy

28.

Cesses on export (for example, Spice Cess)

1986

Spice cess— Excise duty repealed

No data on appropriation

29.

Research and development cess

1987

Yes

Excise duty

Short transfer and diversion of proceeds

30.

Road cess/ Additional duty of customs on motor spirit

1998

Yes

Customs duty

No data on appropriation

31.

Road cess/ Additional duty of excise on motor spirit

1998

Yes

Excise duty

Short transfer

32.

Road cess/ Additional duty of customs on high speed diesel oil

1999

Yes

Customs duty

No data on appropriation

33.

Road cess/ Additional duty of excise on high speed diesel oil

1999

Yes

Excise duty

Short transfer

(continued)

Cesses in the Indian Tax Regime: A Historical Analysis 511 S.No.

Name of Cess

Levied Since

In Force?

Tax Base

Remarks on Working of Cess

34.

Primary education cess

2004

Yes

Corporation Short transfer Tax, Income Tax, Excise duty, Service Tax and Customs duty

35.

Secondary and higher education cess

2007

Yes

Excise duty, Service Tax and Customs duty

Lack of transparent accounts

36.

Clean energy (environment) cess

2010

Yes

Excise duty

Short transfer

37.

Swachh bharat cess/hygiene cess

2015

Yes

Service Tax

No data on appropriation

38.

Krishi kalyan cess/ agriculture cess

2016

Yes

Service Tax

No data on appropriation

39.

Infrastructure cess

2016

Yes

Excise Duty

No data on appropriation

512 

18 The State Salt Monopoly in China: Ancient Origins and Modern Implications YAN XU

ABSTRACT

It was not until 2014 that the state monopolisation of (table) salt began to be relaxed from strict government control in China. Salt was historically considered an important type of basic life necessity. The salt monopoly was in essence a quasi-tax in historical China and for certain periods of time salt was directly subject to a tax. The levies on salt had contributed a considerable portion of revenues to the government in historical times. Although the exact point of time for the origin of salt monopoly is debatable, the monopolisation did come into being at a very early time and the ways of administering the monopoly had significant impact on public finance and the relationship between the government, the business and the society. The adoption and retention of the salt monopoly reflects the development of ideas about the role of government and the means to achieve its aims. This research explores the origin of the state salt monopoly, examining the rationale, the legislation (in a broad sense) creating the monopoly and its administration at the time. It considers how the adoption of the salt monopoly interacts with state development and what lessons can be learnt from the more than two thousand years of salt monopolisation. INTRODUCTION

I

N THEORY AND practice, monopoly tends to be inefficient compared with a liberalised market. It often occurs with regard to natural resources such as salt and coal, and utilities such as electricity and petroleum. State monopoly of resources, typically salt, emerged in various parts of the world during historical times. Such monopoly is often found having negative impacts on not only the economy but also the society and institutional

514  Yan Xu development as evidenced in historical experiences. The salt monopoly and taxation has a long history in India, with its first introduction more than two thousand years ago.1 The severe imposition of salt tax under the British rule became the trigger of ensuing battles for the independence of India.2 The ‘Gabelle’ was a notorious tax levied upon salt in France from the 14th century and this much hated tax contributed to the French Revolution.3 In modern times, state monopoly in Vietnam has caused various problems to the economy and the society.4 In terms of legal impact, abuse of market dominance is always accompanied by adverse influence on the legislative process in the country.5 Presumably no country other than China has the world’s longest history of state monopoly over salt, and the Chinese state salt monopoly may be the first monopoly of this sort in the world. The monopoly was argued to be originated even before the establishment of the first imperial dynasty in 221BC. The monopoly continued for over two millennia and served as a significant revenue source for the government. In modern times, the operation of edible salt from production, transportation to sale was not liberated until 2014,6 and the control over price and distribution is only to be released from 2017.7 Before this very recent reform, the salt industry had been entirely monopolised by the government. Companies and entities engaged in production, transportation, wholesale and retail must obtain a licence from the in-charge government authority, or their activities would be regarded as illegal and individuals involved in the activities would be criminally sentenced to life imprisonment or monetary penalty according to the seriousness of the activity.8 Moreover, edible salt or table salt could not be

1 D Levinson and K Christensen (eds), Encyclopedia of Modern Asia, vol 5 (New York, Charles Scribner’s Sons, 2002) 120–121. See also AM Serajuddin, ‘The Salt Monopoly of the East India Company’s Government in Bengal’, (1978) 21 Journal of the Economic and Social History of the Orient 304; and R Moxham, The Great Hedge of India (New York, Carroll & Graf Publishers, 2001) 33–48. 2  Serajuddin, above n 1. 3  W Doyle, The Oxford History of the French Revolution (Oxford, Oxford University Press, 1989) 4 and 27. 4  TT Long and G Walker, ‘Abuse of Market Dominance by State Monopolies in Vietnam’, (2012) 34 Houston Journal of International Law 188, 195–197. 5  Long and Walker, above n 4, 189. 6  In 2014, the Measures for the Administration of Exclusive Licenses for Table Salt were abolished by the National Development and Reform Commission (NDRC) according to the State Council decisions on abolishing or delegating to lower level authorities licensing items; Guofa [2012] 52 and Guofa [2013] 44. 7  The Measures for the Administration of Salt Price were abolished on 1 January 2017 by NDRC Order [2016] 43 (issued on 8 October 2016) according to the State Council Reform Plan for the Salt Industry (issued on 5 May 2016). 8  The relevant crime is illegal operation under the PRC Criminal Law (National People’s Congress (NPC), passed on 14 March 1997, effective 1 October 1997, amended 29 August 2015 for the ninth time), Art 225. The first trialled case on illegal distribution and sale of

The State Salt Monopoly in China 515 sold across regions under the Measures on Monopoly of Table Salt and the Regulations on Salt Industry, the two administrative regulations forming the legal basis for the state monopoly of salt.9 A strict state monopoly over a basic commodity is rarely seen in other countries or regions in modern times. The government’s complete control over salt prices made the monopoly effectively a tax on people. Since salt is an necessity for human beings and there is no difference in the amount of consumption between wealthy and poor individuals, a salt tax or a complete state monopoly of salt is basically a poll tax. The current state monopoly has led the state-owned enterprise—China National Salt Industry Corp (CNSIC)—to be the only market player in the salt industry, which enjoyed exclusive privileges to the market. No other government-granted monopolists have such a dominant status as CNSIC in the country. Before the very recent liberation, the frequent occurrence of illegal operation of table salt implied that profits from dealing in table salt must be high. The only and the biggest beneficiary from the monopolisation is the company but not the consumers, nor the salt industry. China’s state salt monopoly in this modern time may be understood from two aspects. First, (table) salt has long been considered one of the ‘seven staples’ of Chinese people10 and as such it is an indispensable daily necessity of human life. The government may naturally find it necessary to control it in order to ensure a stable supply of the necessity and thus maintain social stability under the socialist regime.11 This may be more so when table salt was not sufficiently available in the early time of the People’s Republic period. Secondly, the monopoly could be justified by the government’s concern about public health. Almost all table salt sold in the retail market in China

table salt happened in Chongqing in 2009. See ‘Judgment Issued for the First Case on Illegal Operation of Salt in Chongqing’, available at . Another case happened in 2015, just before the repeal of control of salt price and distribution, which was reported to involve an illegal sale of around 140 tons of salt with estimated profits of around 2 million yuan (about GBP223,528). See ‘Shenyang Policy Cracking Down on an Illegal Sale of Table Salt with Involved Profits near 2 Million Yuan’, Xinhua News Net (28 December 2015) . 9  Regulations on Salt Industry (State Council, issued on 2 March 1990, effective 2 March 1990), Art 21; and Measures on Monopoly of Table Salt (State Council, issued on 27 May 1996, effective 27 May 1996), Art 14. A recent case is Taobao, China’s premier e-commerce provider, who was banned from selling table salt on its online website in 2013. The Regulations and the Measures required table salt retailers to obtain a retail sale certificate from the in-charge authority before they could sell table salt in their stores or shops in the locality. Since online sale of table salt did not have a region division and thus a retail sale certificate to sell across regions, Taobao’s online sale was prohibited. 10  The ‘seven staples’ are firewood, rice, oil, salt, soy sauce, vinegar, and tea. This is commonly known among all Chinese-speaking individuals. 11  Constitution of the PRC (NPC, passed on 4 December 1982, effective 4 December 1982, amended 14 March 2004 for the fourth time), Art 1.

516  Yan Xu is iodized salt. Iodine is an essential trace element for human beings and its deficiency has serious impacts on health including mental retardation and thyroncus.12 China used to have a large population with iodine ­deficiency: according to World Bank’s research on iodine deficiency, in 1995, about 400 million Chinese were estimated to be at risk of iodine deficiency disorders, accounting for 40 per cent of the global total; and children having goiter was about 20 per cent of its total population in 1995.13 As a way to address the serious problem, the government strengthened its control of production and sale of iodized salt through licensing regulations and legislation to ban non-iodized salt. Major laws (in a broad sense) on the monopoly of table salt including those prohibiting non-iodized salt were introduced in the 1990s. These measures effectively reduced iodine deficiency in the country.14 Another implicit reason for the salt monopoly related to revenue generation. The indispensable and irreplaceable nature of salt means salt is a comparatively stable revenue source if the government taxes or monopolises it. Indeed, historically, salt monopoly played a significant role in generating revenue to fund the government and its operation. However, the rationale from the government’s perspective is questionable with the socioeconomic development in the country over the last ­decade. Currently China has the highest table salt yields in the world,15 which leaves little space to argue that salt supply concerns social stability. Even if the yields are not high enough to satisfy demands, the shortage could be dealt with through market adjustment, given China is deeply involved in the global markets and it has been actively participating in cross-border investment and trade. Whether there is a shortage of salt supply does not necessarily give rise to the jeopardising of social stability. Moreover, although monopoly of producing and selling iodized salt is an inexpensive and efficient way to deal with iodine deficiency disorders, the fact that iodized salt is the sole type of salt available in the market has led to habitually excessive

12 Centre for Global Development, ‘CASE 15: Preventing Iodine Deficiency Disease in China’, ; see also C Goh, ‘An Analysis of Combating Iodine Deficiency: Case Studies of China, ­Indonesia, and Madagascar’, Operations Evaluation Department working paper series, no 18 (Washington DC, World Bank, 2001) . 13  Goh, above n 12. 14  Goh, above n 12. 15 See ‘China’s Salt Yields Top the World by 72 Million Ton’, China Economic Times (8 September 2009) ; and see also ‘Assets of China National Salt Industry Corporation Grew by 7 Times within 6 Years’, State-owned Assets Supervision and Administration Commission of the State Council (29 March 2010) .

The State Salt Monopoly in China 517 consumption of iodine.16 This caused thyroid diseases, such as hyperthyroidism, especially to those living in iodine-adequate regions.17 In addition to the public health risks, the state monopoly has not surprisingly engendered inefficient resource allocation and considerable inconvenience to consumers as there is limited coverage of retail stores that have the mandatory Table Salt Monopoly License and the administrative regulations have lagged behind in adapting to technological advancement in e-commerce.18 The monopolist was not able to efficiently react to market changes and to meet consumers’ need.19 The strict state control and the potential high profits from dealing in table salt encouraged rent seeking and its associated corruption problem.20 Furthermore, the importance of salt monopoly in government revenue in modern China has diminished significantly. The monopoly (or tax at some points of the PRC period) contributed around 5.49 per cent to total government revenue in 1950 but only 0.04 per cent in 2015.21 Despite the diminishing role and all the drawbacks, the state salt monopoly had been retained from very ancient times until the modern day. How was the monopoly first introduced, why was it introduced, and to what extent did the monopoly impact the state development? This chapter considers these questions with a focus on the origin of the salt monopoly. Following the introduction, the second part examines the rationale, the 16  The daily salt intake by rural residents was 11.1g, and by urban residents was 9.7g, which were both higher than the World Health Organization’s recommended amount of 6g.; GS Ma et al., ‘The Salt Consumption of Residents in China’ (2008) 16 Chinese Journal of Prevention and Control of Chronic Diseases 331, 332. 17  According to the Survey of Iodine Nutritional Status of Residents in Coastal Area conducted by the Departments of Health of Zhejiang, Liaoning, Fujian and Shanghai, iodized salt has caused excessive absorption of iodine and significant health hazards; SJ Liu, China’s Iodine Deficiency Report 2005 (Beijing, Renmin Weisheng Publishing House, 2005), cited in XD Hu, F Gao et al, ‘Health Risk Assessment of Iodine Status in Chinese Residents’ (2012) 7 Asian Journal of Ecotoxicology 285, 287–289. 18 The most relevant government regulation on licensing of table salt is the Table Salt Monopoly License Regulations (NDRC, issued on 28 April 2006, effective 28 April 2006, invalidated 12 April 2014), Art 14. 19  For instance, after the Fukushima Daiichi nuclear disaster in 2011, it was rumoured that iodized salt could provide radiation protection, which caused spiralling demand for salt. But the salt industry was not able to meet the demand nor assuage the market fluctuation. For more information, see ‘Salt Crisis More Terrifying than the Earthquake’ . 20  A good example is in 2009 when Guangdong Salt Group was revealed to be involved in conglomerate corruption. The Chairman of the Group, Shen Zhiqiang, who was also the Secretary of the Salt Affair Bureau of Guangdong province (departmental level of the Chinese bureaucratic system) involved in this corruption case. See ‘Exposing the Biggest Corruption Case in China’s Salt Industry’, Nanfang Daily (28 June 2010) . 21 The statistics are from news reports and there are no official data available for the exact amount of revenue from the salt monopoly and tax over the last several decades. China Review, ‘Useless Salt Monopoly’ (2 April 2013) .

518  Yan Xu l­egislation (in a broad sense) and administration of the salt monopoly at the time when it was originated. The third part discusses lessons that can be learnt from the more than two thousand years of salt monopolisation and considers its modern implications for tax law development. The chapter concludes in the fourth part. ORIGIN OF SALT MONOPOLY

Salt was cultivated in various parts of the world including China at a very early time. Emperors and kings throughout the continents of Africa, Asia and Europe had controlled the trade of salt for a long time. China is among the earliest regions in the world with cultivation and trade of salt. The ancient Chinese gradually mastered and advanced the techniques of producing salt. Notwithstanding the abundance and wide distribution of salt resources,22 salt mining was an arduous task for the ancient Chinese, subject to geographical and technological constraints. Natural salt (‘lu’),23 which was available for direct consumption, had been a scarce resource for making salt. Consequently, competition and battles for salt sources frequently occurred in ancient China.24 During the intervening years, salt played a ­pivotal role in government revenue and in state development. The exact origin of the salt monopoly in ancient times is not entirely clear. The issue has been hotly debated among contemporary researchers. Some argue that the monopoly can be traced back to as early as the Western Zhou period (1045–771 BC) of the Zhou Dynasty (1045–256 BC),25 while others believe that the monopoly was originated from the Spring and Autumn and Warring States periods (770–481 BC; 481–221 BC).26 The third group maintains that the monopoly was formally introduced and implemented in the Western Han period (206 BC–9 AD) of the Han Dynasty (206 BC–220 AD), 22  China has sea salt, well salt, rock salt and lack salt spreading over its territory. Sea salt was located in south-eastern coastal area, well salt in south-western area, rock salt in northwestern area and lake salt in areas of the Central Plain and Shanxi. 23  According to the classical Chinese dictionary, Explaining Graphs and Analyzing Characters (Shuowen Jiezi), written by Xu Shen in the Han Dynasty, the Chinese word ‘Yan’ referred to artificial salt while ‘Lu’ referred to natural salt. 24 A typical example is the hundred-year war between the states of Ba and Chu for salt springs in the Three Gorges Area of the Yangtze River Basin, and the wars between the states of Qin and Chu for salt sources. See M Chen, ‘Salt · war · culture’ (2010) 16 Encyclopedic Knowledge 9, 11. 25  FD Liu, Journal of Chinese Culture—Literature on Industry and Commerce (Gong Shang Zhi Du Zhi) (Shanghai, Renmin Publishing House, 1998) 61–62. 26  See eg, SS Hao, ‘Salt and Iron Monopoly in the Qin and Han Periods and the ­Strengthening of Central Power’, (1998) 3 Gansu Social Sciences 86; K Gao, ‘Pros and Cons on Salt and Iron Monopoly in the Han Dynasty’, (1992) 3 Journal of Zhengzhou University 51; YF Zeng, China Salt Administration History (Beijing, The Commercial Press, 1937) 5–8; ZF Fu, The Economic History of Feudal China, vol 2 (Beijing, People’s Publishing House, 1982) 569; WX Lin, CY Huang et al, The Monopoly System in Ancient China and Commodity Economy (Kunming, Yunnan University Press, 2003) 2–3; PL Liao, ‘The Origin of China Salt M ­ onopoly’,

The State Salt Monopoly in China 519 which was one of the most important historical periods for the ­development of the salt industry in ancient China.27 A few studies suggest an even earlier time than all the periods.28 Whenever the monopoly was firstly created, it is clear that it must have emerged at a very early time in China. The following discussion examines the three most commonly believed origins of the state salt monopoly. Western Zhou Origin The Zhou Dynasty is the third and also the last of the three pre-Imperial dynasties in ancient China. As shown in historical records, salt was produced and traded widely in this pre-Imperial period.29 Before Zhou, the scale and techniques of producing salt in the Shang Dynasty (1600–1046 BC), the second pre-Imperial dynasty, already transcended those in its preceding dynasty, the Xia Dynasty (2070–1600 BC). The Shang government inherited the Xia’s ‘tribute’ method of collecting salt, a tributary good, from its tributary regions at the time. An official position was created to oversee the production and provision of salt.30

(1988) 4 Salt Industry History Research 3; DM Jiang, ‘Origin of China Salt Industry and Salt Administration in Early Times’, (1996) 4 Salt Industry History Research 8; ML Xie, ‘Thoughts of Salt Administration in the Pre-Qin Period’, (1996) 1 Journal of Jiangxi Normal University 59; ZZ Xue, ‘Salt Monopoly as the Outcome of Legalists’ Anti-Commerce Idea’, (1989) 2 Salt Industry History Research 4; W Luo, ‘Comments on the Debate of the Origin of Salt Monopoly between Qi and Han’, (1991) 2 Journal of Yiyang Teachers College 84; and X Ma, ‘Evolution of Salt Policy before Emperor Wu of the Han Dynasty’, (1996) 2 Salt Industry History Research 4. 27  An extensive literature has discussed the salt monopoly in the Han Dynasty. See eg, JC Hu, History of Chinese Economic Thoughts (Shanghai, Renmin Publishing House, 1981) 92–94; QK Luo, ‘Development and Evolution of the Salt Monopoly Policy in the Han Dynasty’, (1990) 2 Jinan Journal (Philosophy & Social Science Edition) 35; QK Luo and W Luo, ‘Research on Salt System in the Han Time’, (1995) 1 Salt Industry History Research 54; QK Luo and W Luo, ‘Research on Salt System in the Han (II)’, (1996) 1 Salt Industry History Research 73; ZG Pang, ‘Evolution of the Salt and Iron Policy in the Han Dynasty’, (1987) 2 ­Jianghan ­Tribune 68; KG Wu, ‘Evaluation of Sang Hongyang’s Reform Measure and its Historic Impact’, (1983) 1 Economic Science 59; CJ Su, ‘“Guan and Lao Pen” and the Salt Monopoly Policy of Emperor Wu of the Han Dynasty’, (1988) 1 Salt Industry History Research 13; and CX Zhang, ‘Evolution of the Three Types of Salt Policy in the Qin and Han Periods’, in Studies on Issues of the Qin and Han Dynasties (Beijing, Peking University Press, 1995) 245. 28  For example, as argued by some studies, the Tribute of Yu, Book of Documents (Shang Shu) has the most original historical record of state intervention in salt. This record describes the use of salt as a tributary good to Emperor Yu of the Xia Dynasty. Book of Documents (Shang Shu), Tribute of Yu (Yu Gong), ch. 3, . See also TH Huang, ‘Discussion on the Origin of Salt Tax in China’, (2010) 3 Modern Finance and Economics 3, 6–8. 29  Book of Documents (Shang Shu), Tribute of Yu, above n 28. 30 The position was called ‘petty officers for salt’ (lu xiao chen). L Liu and XC Chen, The Archaeology of China: From the Late Paleolithic to the Early Bronze Age (Cambridge, Cambridge University Press, 2012) 364–65.

520  Yan Xu Salt products became diversified in the Zhou Dynasty thanks to the ­ evelopment of production techniques.31 Different types of salt with varid ous tastes, such as pond salt, sea salt and rock salt, were presented to the Zhou court from various regions. Salt was graded by certain standards and different grades of salt had different implications and served for different purposes. Some types of salt were given religious significance,32 and some were viewed as prestigious goods as indicated by their name as ‘noble, royal salt’ (‘jun wang yan’) or ‘jade brilliance salt’ (‘yu hua yan’).33 The grading of salt implies a technical refinement. As with the previous practice, salt was used as a tributary good from lesser lords and ordinary people to the Zhou king.34 This, as argued by some studies, represents the emergence of a ‘nascent administration’.35 A specific position, ‘person for salt’ (‘yan ren’) was set up to supervise salt ­administration.36 The administrator was responsible for the use of salt in ritual ceremonies, the preparation of food for the King and other things related to salt.37 The tributary system was consisted of a tribute from tributary states (‘bang guo zhi gong’) and a tribute from all people (‘wan min zhi gong’).38 All types of salt from the tributes were used to finance the court and its administration.39 The tributes of salt in the Zhou period may be regarded as a prototype of tax to the extent that it was in nature like a universal contribution from the governing regions and people to the Zhou king for creating institutions to protect them. This practice corresponds to the land tributes, another important source of revenue, at the time.40 There appeared to be no formal control over exploitation of salt in the early Western Zhou period. Commoners and nobles could access and make

31 

Huang, above n 28. Guo, Chinese Salt Production History—Regional Records (Beijing, Renmin ­Publishing House, 1997) 26, cited in RK Flad, Salt Production and Social Hierarchy in Ancient China (Cambridge, Cambridge University Press, 2011) 52. 33  ZZ Guo, above n 32, 16, cited in Flad, above n 32, 52. 34  Flad, above n 32, 52. 35  Flad, above n 32, 52. 36 The classical Chinese literature, Rites of Zhou (Zhou Li) records that ‘the person for salt’ was in charge of salt affairs, and the use of different types of salt under different occasions. For ritual, the normal salt is used. For honourable guests, the better shaped salt is used. For the emperor’s meal, the best salt is used. Rites of Zhou (Zhou Li), Offices of the Heaven (Tian Guan), Person for Salt (Yan Ren), . 37  Rites of Zhou (Zhou Li), Offices of the Heaven (Tian Guan), Person for Salt (Yan Ren), above n 36. 38  Rites of Zhou (Zhou Li), Offices of the Heaven (Tian Guan), Person for Salt (Yan Ren), above n 36. 39  Huang, above n 28, 5. 40 Y Xu, ‘Land Tax without Land and Land without Land Tax: A History of Land Tax in China’ in J Tiley (ed), Studies of History of Tax Law, vol 6 (Cambridge, Hart Publishing, 2013) 525. 32  ZZ

The State Salt Monopoly in China 521 profits from exploiting salt and other communal goods without restriction.41 However, in the late period, the Zhou King, Li (857–842 BC), decided to forbid private exploitation by commoners as he found the exploitation was profitable.42 The King monopolised the exploitation of salt (and iron as well as other communal goods) in 844 BC in the hope that the monopolisation could bring to him a good gain.43 The monopolisation was also adopted as a way to suppress the development of private economy at the time, which in the King’s view, was a threat to his reign.44 This monopoly benefited the King but harmed common people’s interests and impaired the economic development. It led to a widespread revolt, and, together with the King’s brutal control over expression, contributed to an ultimate overthrow of the King’s reign.45 The monopolisation in this period was rudimentary. The imposition of a ban on common individuals’ exploitation was more due to the King’s private greed and hierarchical thoughts than for any significant purposes of developing the political polity. Without control over private exploitation, salt already served as a type of payment good but only at a certain rate of private accumulations. The monopolisation effectively made the payment at a rather high level, if not 100 per cent. This satisfied the King’s intention of enriching himself. Origin in the Spring and Autumn and Warring States Periods The Spring and Autumn period (770–481 BC) was characterised by the transition from a Zhou feudal system to a multistate system.46 The multistate system developed into a new political system that was characterised by a small number of territorial states involved in constant diplomatic manoeuvring and frequent wars in the Warring States period (481–221 BC).47 During the periods, the power of the King of Zhou was weakened and became 41  Liu, above n 25, 61–62. Records of the Grand Historian (Shi Ji), Basic Annals of Zhou (Zhou Ben Ji) vol 4, . 42  L Feng, Landscape and Power in Early China: The Crisis and Fall of the Western Zhou 1045–771 BC (Cambridge, Cambridge University Press, 2006) 134. 43  Liu, above n 25, 62. 44  Liu, above n 25, 61–62. Remnants of Zhou Documents (Yi Zhou Shu), Rui Liang Fu, which says this is what the King worries about. The relevant text can be found from . 45 The King introduced a law that allowed him to send anyone speaking against him to death. Records of the Grand Historian (Shi Ji), Basic Annals of Zhou (Zhou Ben Ji), above n 41. 46  CY Hsu, ‘The Spring and Autumn Period’ in M Loewe and EL Shaughnessy (eds), The Cambridge History of Ancient China: From the Origin of Civilization to 221 BC (Cambridge, Cambridge University Press, 1990) 54. 47 ME Lewis, ‘Warring States: Political History’ in Loewe and Shaughnessy, above n 46, 616.

522  Yan Xu ineffective in controlling all feudal states.48 Local fiefdoms gained ­increasing independence with some states gradually rising to vie for hegemony.49 The numerous battles for asserting powers among the feudal states entailed a great deal of resources including capital and goods. Salt, as a valuable and indispensable life necessity, was targeted as a source of revenue. The state of Qi50 and the state of Qin,51 the two major powers at the time, were among the first states to introduce a salt monopoly as argued by contemporary studies. Salt Monopoly in the State of Qi The state of Qi was located on the Shandong peninsula and its Shandong coastal salt flats provided a valuable and critical resource for producing salt. This geographical feature was considered an important factor in helping the state emerge as a major power during the Spring and Autumn period. The state rose to prominence under the reign of Duke Huan of Qi (685–643 BC) and its industrial and economic development was the frontrunner among feudal states at the time. The Duke’s advisor, Guan Zhong (730–645 BC), was a preeminent advocate of state monopoly of salt. Guan Zhong believed that mandatory taxes and levies were nothing but a blatant seizure of private property,52 and thus could inflict grievance and resentment on people.53 As a result of this view, he adopted the policy of ‘governing the mountains and lakes’ (‘guan shan hai’) to monopolise salt (and iron) and to generate wealth.54 Guan Zhong’s monopoly policy was to control only sale but not production of salt.55 This policy allowed commoners to make salt from sea on the one hand and on the other hand it tightened the state’s grip over the sale of salt.56 Salt produced by the commoners was collected through state purchase and the collected salt was then distributed and sold to individual households according to the number of heads in the

48 

Lewis, above n 47, 551–52. Lewis, above n 47, 553–62. 50  See eg, Hao, above n 26, 86; and Gao, above n 26, 51. 51  See eg, Zeng, above n 26, 5–8; Fu, above n 26, 569; Lin, Huang et al., above n 26, 2–3; Liao, above n 26, 3; Jiang, above n 26, 8; Xie, above n 26, 59; Xue, above n 26, 4; Luo, above n 26, 84; and Ma, above n 26, 4. 52  Guanzi, State’s Store of Grain (Guo Xu) ch. 73, . Taxation was deemed as ‘importunity to grasp wealth from people’. 53  Guan Zhong believed that ‘grasping wealth from people arouses outrage, giving wealth to people arouses pleasure’. Guanzi, Economic Policies (Qing Zhong) ch. 80-ch. 86, . 54  Guanzi, Kingship Based on the Sea (Hai Wang) ch. 72, . For details of this policy, see Liao, above n 26, 3; and H Wu, Six Economics Reformers in Ancient China (Shanghai, Shanghai People’s Publishing House, 1984) 34–38. 55  Lin, Huang et al, above n 26, 3. 56  Guanzi, Economic Policies (Qing Zhong), above n 53. 49 

The State Salt Monopoly in China 523 households with a mark-up in the sale price. The official sale price of salt contained an element of tax as indicated by the difference between a lower mandatory purchase price and a higher mandatory sale price. All the profits from the sale belonged to the state. However, superficially the commodity was sold without any additional levy. This ostensibly ‘relieved’ tax burdens on people. Compared with the monopoly policy adopted by King Li of Zhou about one and a half centuries earlier, the monopoly in the Qi state was less strict since common people were not entirely prevented from salt operation, and they were given a certain portion of profits from producing the salt. The monopoly has been interpreted differently by contemporary studies. Some argue that the Qi government was also a major salt producer while private production was only supplementary to government production.57 Other studies believe that it was actually the other way around.58 Nonetheless, all studies seem to agree that the circulation of salt, including its collection, distribution and sale, was completely controlled by the state.59 The design of the salt monopoly by Guan Zhong reflects his preference over indirect taxation than direct taxation as a means to extract revenue from society. As recorded in classical literature named for and attributed to Guan Zhong, the reformer believes that a direct tax such as a poll tax on all individuals would make them remonstrate loudly and angrily against the leader, while taking firm control over salt (and other goods from natural resources) would make them difficult to dodge and at the same time would raise revenue that would far exceed the revenue extracted from the poll tax.60 The monopoly policy effectively changed the nature of communal resources to a state possession. Obviously, Guan Zhong’s ‘non-taxation’ policy was only nominal, and the economic effect of the monopoly on people was like a tax, albeit coming in a disguised form and being levied in an invisible way. The monopoly was successful in terms of its contribution to the increase in state wealth and the strengthening of the state’s bargaining power in inter-state relations since other states that were not adjacent to the sea had to rely on Qi for salt supply.61 To a substantial extent, the monopoly greatly assisted Duke Huan of Qi in becoming the first of the Five Hegemons during that period.62 57 

Liao, above n 26, 5–6; and Xie, above n 26, 61. Zeng, above n 26, 5–6. 59  See, eg, Liao, above n 26, 5–7; Xie, above n 26, 61; and Zeng, above n 26, 5–6. 60  Guanzi, Kingship Based on the Sea (Hai Wang), above n 54. 61  JH Zhai, The Economic Thought of Guanzi (Zhengzhou University Dissertation, 2005) 37–38. 62  There are different historical records about who the Five Hegemons are. It seems Duke Huan of Qi was included as a Hegemon of the Five Hegemons in all the records. One widely accepted Chinese classical literature, Records of the Grand Historians (Shi Ji), recognised Duke Huan of Qi, Duke Xiang of Song, Duke Wen of Jin, Duke Zhuang of Chu and Duke Mu of Qin as the Five Hegemons. 58 

524  Yan Xu The idea of using monopoly to substitute for direct taxation and applying state control over critical industries had a huge influence on later dynasties. Salt Monopoly in the State of Qin The State of Qin emerged as one of the dominant powers during the W ­ arring States period. An extensive reform of the state’s economic and political systems was launched during the reign of Duke Xiao of Qin (361–338 BC) with the aims of developing the economy, enhancing the population, and, ultimately, increasing state power. The reform was led by Shang Yang (390–338 BC), the chief adviser for Duke Xiao. A series of measures were taken to stimulate economic growth, in particular agricultural growth and immigration (as labour was short in Qin). The reformer favoured agriculture over commerce and as a result production and sale of salt (and iron) became completely monopolised by the state.63 This was to prevent peasants from getting away from working on the land, which was believed to be detrimental to agricultural development that was much needed for the state. Shang Yang maintained that the exploitation of natural goods from forests and lakes must be controlled from the very beginning stage of production, which could be done by imposing heavy taxes and thus leaving little profits, if not none, to the producers.64 The classical literature, Discourses on Salt and Iron (‘Yan Tie Lun’),65 records that Shang Yang managed to ‘obtain profits of a hundred fold’ and ‘collected taxes on mountains and marshes’,66 and it also records that Shang established ‘abroad prohibitions on the resources of the mountains and lakes and set up a hundredfold profit in the interior’.67 The latter seems to suggest that all natural goods including salt were forbidden from being exploited by private persons, and thus the state could gain all profits from the natural goods. An interesting question is if so, why were taxes needed as mentioned in the former? Some contemporary studies argue that the salt monopoly may be taken through two approaches. The first approach was a complete monopolisation, which was applied to the production, distribution and sale of salt (and iron) in regions where the commodities were abundant and concentrated,

63  Book of Han (Han Shu), Treaties on Food and Money (Shi Huo Zhi) vol 24, . It says that ‘the production and profits derived from the natural resources were monopolized by the State’. 64  Liu, above n 25, 64. 65  The literature recorded a debate on state policy including the monopolisation of salt and iron during the Han Dynasty. 66  Discourses on Salt and Iron (Yan Tie Lun), In Criticism of Shang Yang (Fei Yang) ch. 7, . 67  Discourses on Salt and Iron, In Criticism of Shang Yang (Fei Yang), above n 66.

The State Salt Monopoly in China 525 such as Sichuan.68 The second approach was just a partial monopolisation under which private exploitation would be allowed through registration and tax payment in regions where the yields of salt (and iron) were low and the resources were scattered.69 Another explanation is that not all natural goods from mountains and lakes were prohibited from exploitation.70 ­General goods such as bamboo and wood may be permitted to be exploited by private individuals, who then had to pay taxes on the profits derived therefrom.71 Meanwhile, the exploitation of critical and indispensable goods, primarily salt and iron, must be strictly controlled by the state and thus all profits went to the state.72 The second explanation appears to be the case of the Qin state, given its complete state monopoly of salt. As noted earlier, the reformer aimed at agricultural development and state wealth. Salt and iron were necessary goods for people’s daily life and agricultural activities, and as such there were high demands for these goods and potentially high profits from making and selling them. If the operation of salt, and similarly iron, were to be given to private merchants, they would dominate the market, gain control of the critical commodities, and extract considerable gains from the control, which was harmful from the government’s perspective. Their demand for labour for salt making and circulation would draw people away from agricultural activities, a situation that the Qin government did not want to occur. A complete state monopoly was thus considered necessary from the Qin government’s perspective so as to protect agricultural development, reduce speculation that may arise from private control, extract revenue and suppress commerce. The monopoly of salt production was first established in a local area, which had a salt (and iron) administration created in 316 BC to control the distribution of these resources.73 A central control over the salt production was established around six decades later.74 The state remained the dominant player in the administration of salt distribution, but the distribution and sale was not entirely taken by the state officials. This is because Shang Yang intended to reduce the number of persons involved in the operation of commerce in order to save costs and labour.75 He instead used merchants to distribute salt products but the merchants first had to obtain permission from the state and pay high taxes in exchange for the franchised right

68 ZP Ye, Study on Fiscal Reforms in Ancient China (Beijing, China Public Finance and Economics Press, 2013) 67. 69  Ye, above n 68, 67. 70  Ye, above n 68, 67; and see also Liu, above n 25, 64. 71  Ye, above n 68, 67. 72  Ye, above n 68, 67. 73  Flad, above n 32, 49–50. The local area was Sichuan, a region rich in well salt. 74  Flad, above n 32, 49–50. 75  Liu, above n 25, 64.

526  Yan Xu to sell.76 Sale price was determined by the state. With the high taxes and state-set sale price, the state gained a larger proportion of profits from the monopolisation. The amount of monopoly revenue was 20 times that in earlier periods.77 As claimed in the Discourses on Salt and Iron, the ­monopoly did not only increase the Qi state wealth but also improved ­people’s lives: The profits derived from the salt and iron monopolies serve to relieve the needs of the people in emergencies and to provide sufficient funds for the upkeep of military forces. These measures emphasize conservation and storing up in order to provide for times of scarcity and want. The beneficiaries are many; the State profits thereby and no harm is caused to the masses.78

Compared with Guan Zhong’s salt monopoly policy, the policy adopted by Shang Yan was more thorough and strict as it targeted the whole process from producing and distributing to selling of salt. The more complete salt monopoly in the Qin state brought almost all profits to the state. Guan Zhong’s policy was more liberal since it primarily controlled sale but left production and thus a certain portion of profits to private producers. The difference between the two policies can be explained by a number of factors surrounding the circumstances of the two states. One factor is that Qi was a coastal state in the east and its location at a major trade route junction allowed it to rely on commerce to enrich itself,79 while the Qin state was in the western edge of the Zhou territory and had to rely on agriculture to develop, which entailed a great deal of manpower. However, Qin lacked sufficient labour to work the land, and as a result it imposed a strict control over salt production to save the labour for agricultural activities. Although the policies and exact methods of implementing the monopoly were different in the two states, the monopoly greatly benefited both states’ coffers and contributed to their success in rising to predominance at the time. Western Han Origin The monopoly system was believed to develop into a new phase in Western Han (206 BC–9 AD), the first part of the Han Dynasty (206 BC–220 AD).80 Most studies suggest that the salt monopoly was formally established and implemented all over the territory of the imperial empire during the Western Han period. 76 

Liu, above n 25, 64. Book of Han (Han Shu), Treaties on Food and Money (Shi Huo Zhi), above n 63. 78  Discourses on Salt and Iron, In Criticism of Shang Yang (Fei Yang), above n 66. 79  Hsu, above n 46, 553. 80  The Han was one of the longest of China’s major dynasties and it rivalled its almost contemporary Roman Empire in the West. 77 

The State Salt Monopoly in China 527 The collapse of the Qin Dynasty (221–206 BC), the predecessor of the Han Dynasty, left the new dynasty many challenges to rule the empire, not least a badly disrupted economy. To recover the economy, the founding emperor, Gaozu of Han (202–195 BC), took a series of measures including ­measures for non-interference with civilian life and economic laissez-faire operation.81 One measure was to allow private ownership of natural resources including salt.82 In fact, there was no official control over operation of salt in the early Western Han period. Profits from the private exploitation of salt (and iron) were found to rival the former government revenue.83 The non-intervention and economic laissez-faire policy brought about a period of rest and recuperation to ordinary people and a general prosperity to the empire. By the time Emperor Wu ascended to the throne in 141 BC, the Han Dynasty had become a wealthy empire.84 The laissez-faire policy, however, led salt (and iron) to be monopolised by a few large merchants and producers, who controlled the market and dominated the production and sale of salt (and iron). Many merchants engaging in salt operation became rich and preeminent in society.85 As salt production required a lot of labour, many peasants were employed by the merchants and producers, which negatively affected agricultural development and thus harmed the government’s revenue interest.86 As it happened, the private monopolisation only benefited the merchants and producers, but not ordinary people. A widening wealth disparity began to emerge between rich and poor households. The rise of large merchants and landlords, whose identities were in many occasions mixed, threatened the empire’s political stability.87 Meanwhile, the previous foreign policy to maintain a de jure ‘peace’ with the powerful Xiongnu confederacy to the northern frontiers of Han failed to protect the Han borders against nomadic raids.88 Emperor Wu had to initiate many battles to address the increasing threat

81  The state policy during the reign of Gaozu was to loosen the control over market and civilian life in order to boost the economy (‘xiu yang sheng xi’). 82  Ye, above n 68, 105. 83 S Nishijima, ‘The Economic and Social History of Former Han’, in D Twitchett and M Loewe (eds), Cambridge History of China: Volume I: the Ch’in and Han Empires, 221 B.C.—A.D. 220 (Cambridge, Cambridge University Press, 1986) 583–584. 84  Book of Han (Han Shu), Treaties on Food and Money (Shi Huo Zhi), above n 63. It says that ‘money and grain accumulated in the capital were so much that the full tally could not be told, for the strings holding coins had fallen apart due to enormous weight, and the grain had overflowed from the stores to lie rotting.’ 85  Records of the Grand Historians (Shi Ji), Ranked Biographies about Goods and Money (Huo Zhi Lie Zhuan) vol. 129, ; cited in Ye, above n 68, 106. 86  Nishijima, above n 83, 584. 87  Ye, above n 68, 104–109. 88  Xiongnu was a warlike, nomadic people who penetrated deep into the frontier prefectures of Han, looting, slaughtering and kidnapping. CM Wilbur, Slavery in China during the Former Han Dynasty 206BC–AD25 (New York, Russell & Russell, 1967) 103–108.

528  Yan Xu from Xiongnu,89 and to keep powerful local lords under control.90 These wars were costly and quickly drained away the wealth accumulated by the Emperor’s ­predecessors.91 The Emperor fell into financial difficulty, and it was the difficulty that prompted him to take over control of salt (and iron) and to adopt a state monopoly as a way to raise revenue.92 The introduction of the salt monopoly started in 120 BC. Sang Hongyang (152–80 BC), the major official in charge of the monopoly, was appointed to assist the preparation of the adoption of the monopoly.93 A proposal for the state monopoly of salt (and iron) was presented to Emperor Wu by the then Minister of Agriculture in 117 BC,94 but it was not until 110 BC when Sang Hongyang became deputy Minister of Agriculture that the monopoly started to be formally applied.95 According to the Book of the Grand Historians (‘Shi Ji’), the salt monopoly was operated as follows: first, commoners were recruited to boil salt using government equipment and living at their own expense;96 and secondly, salt products were collected by the government, which paid salaries to the workers based on their cost.97 The government directly managed the transportation and sale of salt.98 Anyone who privately boiled salt could be severely punished and his equipment could be confiscated.99 The monopoly method has been interpreted differently by contemporary studies. One interpretation is that the monopolisation was only a monopoly on circulation of salt since the manufacturing was conducted by private individual workers and the government mainly purchased and resold salt produced by the workers.100 The other interpretation, which is a majority view, argues that the monopoly was a complete monopoly because the government controlled the salt industry through exclusive production, distribution and sale of salt, which enabled it to take all revenue generated 89 

Ye, above n 68, 95–97. Ye, above n 68, 91–95. 91  Ye, above n 68, 110. 92  Records of the Grand Historians (Shi Ji), Treaties on the Balanced Standards (Ping Zhun Shu) vol 30, . 93  Records of the Grand Historians, Treaties on the Balanced Standards (Ping Zhun Shu), above n 92. 94  Records of the Grand Historians, Treaties on the Balanced Standards (Ping Zhun Shu), above n 92; cited in DB Wagner, The State and the Iron Industry in Han China (Copenhagen, Nordic Institute of Asian Studies Publishing, 2001) 11–12. 95  Book of Han (Han Shu), Treaties on Food and Money (Shi Huo Zhi), above n 63; see also Ye, above n 68, 122; and Wagner, above n 94, 13. 96  Record of the Grand Historians (Shi Ji), Treaties on the Balanced Standards (Ping Zhun Shu), above n 92; Book of Han (Han Shu), Treaties on Food and Money (Shi Huo Zhi), above n 63. 97  Ye, above n 68, 125; and Liu, above n 25, 65. 98  Ye, above n 68, 126. 99  Record of the Grand Historians, Treaties on the Balanced Standards (Ping Zhun Shu), above n 92. 100  See eg, Hu, above n 27, 93–94. 90 

The State Salt Monopoly in China 529 from engaging in the salt industry.101 Although the government provided equipment and the workers bore their own living costs for producing salt, the relationship between them was in essence a contractual relationship.102 Workers did not have a stake in the distribution and sale of salt, while the salt (and iron) administration (‘yan tie guan’) did.103 All the collected monopoly revenue was turned over to state finance (‘da si nong’)104 and belonged to the state. This was essentially a state monopoly.105 The administration of salt monopoly was strengthened under Sang Hongyang’s management. Salt officers were appointed to counties with considerable salt yields.106 According to the Book of Han (‘Han Shu’), there were around 35 to 36 counties with salt officers, spreading all over the territory of the Han.107 The officers’ major duty was to manage the production, distribution and transportation of salt products. Retail sale of the products was made through government-owned shops or franchised small businesses.108 Sale prices were officially set,109 which meant there was an implicit tax element. The monopoly bore fruit to the Han government as evidenced from the fact that expenses for wars against various nomadic invasions at the time could be covered by the monopoly revenue.110 The strengthening of border defences protected exiled refugees from wars at the borders.111 As it purported, the monopoly contributed to the suppression of private

101  See eg, QK Luo, ‘Some Inquiries on the Han Salt System’, (1985) 3 Xiangtan University Journal 104; Luo, above n 27, 35; Luo and Luo (1995), above n 27, 54; LQ Liu, ‘Looking into the Monopoly System and Abuses of Western Han Dynasty from the Monopoly Policy of Salt and Iron’, (1994) 3 Southern College Journal; and Pang, above n 27, 68. 102  Liu, above n 25, 65. 103  Liu, above n 25, 65–66. 104 Book of Han (Han Shu), Treatise on Food and Money (Shi Huo Zhi), above n 63; cited in Z Chen, Review of Economic Historical Records of the Han Dynasty (Xi’an, Shaanxi Renmin Publishing House, 1980) 111–112. 105  Luo, above n 27, 35; Luo and Luo (1995), above n 27, 54; and Luo and Luo (1996), above n 27, 73. 106  Book of Later Han (Hou Han Shu), Records on Officials (Bai Guan Zhi) vol 118, ; cited in XJ Kong, ‘A Study on the System of Salt Officers in the Western Han Dynasty’, (2008) 9 Jiangsu Commercial Forum 171, 171–172. 107  Book of Han (Han Shu), Treaties on Geography (Di Li Zhi) vol 28, ; cited in Kong, above n 106, 171; and Luo and Luo (1995), above n 27, 59. 108  Liu, above n 25, 66. 109  Liu, above n 25, 66. 110  Discourses on Iron and Salt (Yan Tie Lun), In Criticism of Shang Yang (Fei Yang), above n 66. 111 ZK Xue, ‘The Policy for Improving Fiscal Revenue by Emperor Wu of Han’, (1997) 4 Beijing Normal University Journal 84, 85; BW Zhang, ‘Review of the New Economic ­Policy by Emperor Wu of Han’, (1987) 4 Shenyang Teachers College Journal 49; SH Zhu, The Ancient History of China (Fujian, Renmin Publishing House, 1982), 309–311; Pang, above n 27, 68; and XP Wang, ‘Reappraisal of the Salt Monopoly Policy of Emperor Wu of Han’, (1989) 2 Jiangxi Normal University Journal 60.

530  Yan Xu commerce.112 The development of private commerce was deliberately curbed with strict control of operation of salt and other important goods from natural resources, while public sector for producing and trading these goods was encouraged and supported by the Han government. The suppression of private commerce, however, seemed to primarily target large merchants but not small businesses, which were thought beneficial to the development of a normal salt market.113 As a result of strict control, the monopoly helped diminish the power of local wealthy households, thereby reducing their threat to political stability.114 The control over wealthy and powerful families was necessary from an equity perspective as it limited the ability of those families in exploiting ordinary people and thus indirectly deferred the bankruptcy of under-privileged families,115 and presumably reduced the wealth gap between wealthy and poor households. Importantly, as a historically progressive policy, the monopoly played an important role in consolidating state power and maintaining social stability at the time.116 However, the salt monopoly hindered the development of salt industry and capitalist market economy that had emerged in the early Western Han period.117 This was due to the barriers created for private capital and labour from entering the market. Ironically, this would actually accelerate the bankruptcy of poor peasants and led to social instability.118 In practice, the implementation of the salt monopoly harmed public interests as monopoly administrators failed to ensure good quality of salt sold to people who had to pay regardless of the quality.119 112  L Liu, ‘Business and Commerce Policy of the Early Western Han Dynasty and Economic Reforms by Emperor Wu of Han’, (1982) 5 Tianjin Normal University Journal 44, 45–46; ZF Fu, Discussion on Chinese Economic History (Beijing: Joint Publishing, 1980) 636–646; M Gao, ‘The Essence of the Suppression Policy of Mercantilism in the Han Dynasty’ in M Gao, History Essays of Qin and Han dynasties (Zhengzhou, Zhongzhou Painting and Calligraphy House, 1982) 157, 163–164. 113  XY Lu, ‘Fiscal Measures of Emperor Wu of Han and the Development of Business and Commerce in the Han Dynasty’, (1982) 1 Academic Journal of Suzhou University 89, 90–91. 114  ZK Zhang, ‘Two Problems of the Salt Monopoly Policy of Emperor Wu of Han’, (1983) 1 Yiyang Teachers College Journal 77. 115  Ye, above n 68, 129; Wu, above n 27, 59; Hao, above n 26, 86; and YJ Chen, ‘Military and Financial Policy in the Period of the Emperor Wu of Han’, (1987) 3 Yancheng Division College Journal 56 See also XD Jie, ‘Analysis of Sang Hongyang’s Theory of “Mercantilism”’, (1989) 6 Historical Journal 13; S Li, ‘Enlightenment of Sang Hongyang’s Thoughts on Financial Management’, (1999) 4 Henan Normal University Journal 17; DY Ma, Fiscal History of the Han Dynasty (Beijing, China Financial and Economic Publishing House, 1983) 125–126; and SJ Zhang, ‘Sang Hongyang’s Thought on Enrichment through Commerce’, (1994) 12 Business Research 32. 116  Wu, above n 27, 59; Jie, above n 115, 15–16; and Zhang above n 114, 33. 117  B Fu, ‘Re-evaluation of the Salt and Iron Monopoly Policy of the Han Dynasty’, (1991) 4 Zhejiang Academic Journal 104. 118  CN Hua, ‘Salt and Iron Monopoly and the Social Crisis in the Late Western Han Period’, (2000) 2 Journal of Shandong Normal University 74. 119  Wang, above n 111, 60.

The State Salt Monopoly in China 531 The monopoly policy attracted a great deal of attention and criticism from its operation. To address the criticism and various opinions, Emperor Zhao of Han (87–74 BC), with the assistance of his chief advisor, held a debate in the imperial court in 81 BC.120 This debate revealed a sharp ­difference on the ideas of the role of government and economic policies between a group of ‘worthies’ (xian liang) and ‘scholars’ (‘wen xue’) and a group of ‘officials’ (‘da fu’). The former were persons recommended by local authorities for possible official appointments and can be regarded as Confucian moralists. These persons opposed the monopoly policy and argued that a minimal government was best; the state making profits was to steal from the people and to undermine morality; and salt taxes afflicted the people and encouraged expansionary wars which would doom the empire.121 The latter group was often regarded as modernists who supported the policy. It responded that it was the state rather than private merchants that should organise production and trade of goods and realise profits; revenues from state monopoly helped the state fulfil its mission (for defending the empire and for other purposes).122 The debate led to the abolition of monopoly on certain goods such as liquor, but the monopoly on salt (and iron) promoted by Sang Hongyang remained largely intact. With a few interruptions and the application of the laissez-faire policy in the early Western Han period, the salt monopoly was implemented throughout almost the entire Han period. After the Han Dynasty, the salt monopoly was applied in many of the following dynasties including the Sui (581–618 AD), the Tang (618–907 AD), the Ming (1368–1644 AD) and the Qing (1644–1911 AD) dynasties, albeit in varying forms.123 The monopoly was retained in the Republic of China (1912–1949) through the ‘license verification fee’,124 and it continued until very recently. The millennia-old state monopoly had a profound impact on the economy and society and also the tax law development over a number of centuries.

120 The debate is recorded in the literature, Discourses on Salt and Iron (Yan Tie Lun), which was completed during the reign of Emperor Xuan (91–49 BC) of the Western Han dynasty. See ZB Zhu and N Wang, ‘Discourses on Iron and Salt and China’s Ancient Strategic Culture’, (2008) 2 Chinese Journal of International Politics 263, 264. 121 Wagner, above n 94, 25–26 and 53–54; M Loewe, ‘The Former Han Dynasty’, in ­Twitchett and Loewe (eds), above n 83, 189. 122  Wagner, above n 94, 28 and 55–56; and Loewe, above n 121, 160–161. 123 ‘Sub-Report 5: Administrative Monopoly in the Salt Industry’, in H Sheng, N Zhao and JF Yang, Administrative Policy in China: Causes, Behaviors and Termination (Singapore, World Scientific Publishing Co. Pte. Ltd., 2015) 317. 124  Sub-Report 5, above n 123, 317.

532  Yan Xu MODERN IMPLICATIONS

Historical Experience Salt is a necessary and valuable resource for human life. Historically, state monopolisation of salt was used as a way to generate government revenue. The types of salt product and the concentration of salt resources influenced the way in which the salt monopoly was administered. Usually, in circumstances in which salt resources were concentrated in a few localities, salt production was directly controlled by the state,125 while in other ­circumstances in which salt resources were more dispersed, the state controlled ­distribution and sale but left production to be engaged in by private individuals with close state supervision.126 State monopolisation of salt and other important goods in historical China was to achieve various purposes desired by the kings or emperors at the time. The exact design of salt monopoly was influenced by the chief official’s ideology and understanding of the role of government. In Western Zhou, King Li, encouraged by his chief advisor, took complete control over salt and monopolised all profits from salt exploitation after he found the exploitation was very profitable. The control was, in his view, also necessary, because he did not want commoners to become wealthy and thus rise to rival nobles. The King and his advisor probably did not realise the economic effect of monopolisation of natural resources on people and on the finance of the political polity. The purpose of monopolising salt seemed simple—enriching the King himself and keeping feudal social hierarchy unchallenged. Comparatively, the salt monopoly introduced to the state of Qi had a much clearer purpose—raising revenue for the state to vie for hegemony. The principal designer of the Qi monopoly policy, Guan Zhong, promoted the monopoly in preference to direct taxation because, in his view, direct taxation was equivalent to appropriation and could directly cause pain to and hatred of people. The monopoly was even a better tool than an indirect tax since superficially there was no tax on the sale of salt to consumers. The implementation of the state monopoly would thus be easy without inflicting people’s objection and arousing their awareness about the burden caused by the monopoly. It was because the monopoly was adopted mainly for revenue purposes that private salt production was not restricted in the Qi state. The implementation of the salt monopoly, a disguised salt tax, achieved its intended purpose.

125  126 

Flad, above n 32, 52. Flad, above n 32, 52.

The State Salt Monopoly in China 533 The monopoly policy in the state of Qin was, however, used not only for the purpose of generating revenue to help the state become a major power but for the purpose of suppressing commerce. The designer, Shang Yang, based on the demographic conditions of the state, believed agricultural growth was the way to develop the state. As commerce would draw scarce labour away from agriculturally productive activities, it was necessary to control the exploitation of salt, from production to sale. The monopoly policy in Western Han had more diversified purposes. First and foremost, it aimed to raise revenue to help the government go through financial difficulties at the time. Monopoly revenue was used to finance wars against border invasions and expand the territory as well as control domestic powerful households. Salt monopoly was implemented throughout the whole territory of the empire to meet high revenue demands for financing the wars. The monopoly also meant to address a number of issues including salt speculation, exploitation of large merchants and producers on underprivileged households, and the threat from large, powerful households to challenge the central power. The principal designer of the monopoly, Sang Hongyang, firmly believed in the role of government in regulating the economy and stabilising the society. The early Western Han experience suggested to the late governors that economic laissez-faire policy may be good for developing commerce and trade, but not for political stability. The historical experience from the origination of salt monopoly has a number of implications. First, state monopoly can be an effective way to generate revenue, and it is operated in a disguised form and an invisible way. Complete state control of salt or other critical consumer goods and the state setting of purchase and sale prices make a state monopoly effectively a tax. The state monopoly does not directly cause tax misery to people since the tax element is implicit, especially when prices are not too high.127 Secondly, compared with direct taxation, indirect taxation is much easier to apply and can be a more reliable revenue source: whatever the economic situation is, people have to consume, especially for their life and work necessities. Thirdly, state monopoly can be used for purposes other than revenue generation, such as strengthening central power or suppressing private commerce. Monopoly Today Monopoly has many drawbacks as demonstrated in historical experience and theoretical analysis. Studies of monopoly in law and economics both

127  Levinson and Christensen, above n 1, 121. This study found that generally, the state salt monopoly (and/ or salt tax) was a burden on poor people, but the burden was not high.

534  Yan Xu point to the two elements of monopoly: restriction of trade and control over the market.128 Restriction of trade is commonly used as a tool to secure control of the market, while control of the market serves to restrict trade and competition.129 As argued, restriction of competition is the legal content of monopoly, while control of the market is its economic ­substance.130 Inefficiency due to monopoly may cause an inefficient application of ­ resources, which leads to welfare loss.131 It may also cause productive inefficiency in which the absence of competition gives rise to managerial inefficiency and thus further welfare loss.132 Barriers on new entry due to monopoly reduce incentives for monopolists to invest in innovation and improvement,133 which is detrimental to the long-term development. Monopoly of natural resources cannot avoid the problem of market failure, and such problems ranges from deadweight welfare loss, productive inefficiency, increased possibility of private collusion, to increased likelihood of exploitation of consumers.134 When the monopoly is in a nature of state control, the monopoly would significantly contribute to the problem of corruption due to the absence of competition and little public comprehension and challenge.135 All the problems and shortcomings associated with state monopoly appeared in historical and modern China. The most important legal document setting up the contemporary state monopoly system, Measures on Monopoly of Table Salt, emphasises state controls from three aspects. First, the quantity of salt was controlled through a mandatory planning administration over the production, distribution and allocation of table salt.136 Secondly, the state imposed entry barriers to the salt industry through exclusive licences,137 including wholesale licensing, examination and approval of

128 

ES Mason, ‘Monopoly in Law and Economics’ (1937) 47 Yale Law Journal 34, 35. Mason, above n 128, 35. 130  Mason, above n 128, 36. 131 M Grego, ‘Liberalisation and Oligopoly’ (2015) 36 (5) European Competition Law Review 220, 221. 132  Grego, above n 131, 221. 133  Grego, above n 131, 221. 134  SR Kim and A Horn, Regulation Policies concerning Natural Monopolies in ­Developing and Transition Economies (United Nations Department of Economic and Social Affairs, March 1999) 706–707; and HJ Chang, ‘Critical Survey: The Economics and Politics of Regulation’ (1997) 21 Cambridge Journal of Economics 703, 706–707. 135  S Paul, ‘Corruption: Who Will Bell the Cat?’, (1997) 32 Economic and Political Weekly 1350, 1350. 136  The ‘Approval for annual plan of salt production quota’ and the ‘Approval for annual plan of salt distribution, allocation and transportation’ were repealed by the State Council Decision on Abolishing Non-Administrative Licensing Items (State Council, May 10, 2015). 137  The relevant legal document, Measures for the Administration of Exclusive Licenses for Table Salt, was repealed by an NDRC Decision issued on 4 December 2014. 129 

The State Salt Monopoly in China 535 designated production enterprises,138 and salt transportation licensing.139 Thirdly, salt prices for production, wholesale and retail were all set by the state.140 Although the Measures have not been abolished, many of the means for the operation of the state salt monopoly have gradually been repealed. Nonetheless, as noted in the beginning, until now there has been only one company, the state-owned CNSIC, dominating the market of edible salt. It has been delegated administrative power over production and circulation of edible salt.141 The monopolist and its subsidiaries have gained ­considerable benefits, including financial benefits, from monopolising the domestic salt market. Before the most recent liberation of licensing and pricing, salt ­operation was controlled at each stage of its entire business chain. A licensing requirement per se does not seem to create a state monopoly, although it may restrict competition. A government can also fix prices, which does not necessarily lead to a state monopoly. Nor does it restrict competition. Rather, it limits the freedom of a company in making business decisions based on supply and demand conditions of the market. Government controlling prices might give rise to higher costs or lower costs (which is effectively a subsidy). The major issue with the state salt monopoly in the present case of China is that CNSIC and its local subsidiaries were both a regulator and a market player. The mixed function means there was a serious lack of effective supervision. Without effective institutional constraints, the corporation could maximise its profits through driving down the price of manufacturers142 and escalating the market price, eventually consumers would bear the brunt.143 In a bid to further advance the market economy and stimulate a healthy and sustainable development of the salt industry, the central executive

138 The ‘License for Designated Salt Production Enterprises’ was repealed by the State Council Decision on Abolishing and Adjusting Administrative Licensing Items (State Council, 24 February 2015). 139  The relevant licensing was repealed by the State Council Decision on Abolishing and Adjusting Administrative Licensing Items of the Sixth Batch (State Council, 23 September 2012). 140  The Measures for the Administration of Salt Price were repealed on 1 January 2017 by NDRC Order [2016] 43 issued on 8 October 2016. 141  Shen, Zhao and Wang, above n 123, 327. 142  For instance, they could sidestep the national commanded price of table salt through requesting various types of subsidies and rebates, such as freight subsidies, warehousing subsidies and sales bonus. 143  For instance, the market price of table salt was usually around 2600 yuan/ton, while the wholesale price was about 2200 yuan/ton and the price from salt manufacturers to wholesalers was about 500 yuan/ton. This is exorbitant as compared to the industrial salt market without a monopoly policy, in which the wholesale price was only 500–600 yuan/ton. See YH Xie, ‘The Public Expects Reform on Salt Monopoly to Liberate Social Dividends’, China Youth Daily (16 May 2016) ; and JY Zhao, ‘The Pain from the Exclusive Salt Monopoly’, Beijing Newspaper (30 April 2014) .

536  Yan Xu announced a reform plan in May 2016. According to the reform plan, state controls of price and distribution will be removed while the licensing of salt producers remains unaltered.144 The licensed producers will be allowed to enter circulation and sales fields, set prices, and decide how to distribute the salt—selling it themselves or to other distributors, and inside or outside their locality.145 The implementation of the plan would be conducive to the development of the salt market as the plan provides more freedom to market participants. However, the reform measures do not mean the state salt monopoly is to be completely abolished, given the ambiguous and even self-contradictory language commonly used in official documents in China. The entry control of wholesale of salt seems to be maintained to a certain degree as only existing state enterprises, ie licensed producers, can engage in wholesale of salt, but social capital can be introduced through investment or corporate restructuring without affecting the state control of those existing enterprises. Importantly, necessary legislation is needed for the purpose of enforcing the reform plan. Despite that a set of documents were abolished for liberating the salt market in recent years, the Regulation on Salt Industry and the Measures on Monopoly of Table Salt—the legal basis of the table salt monopoly, remain effective. This has created inconsistency between legal rules. Such inconsistency and the lack of necessary laws enacted by the national legislature will cause confusion and compliance problems for market players. The purpose of applying state monopoly to salt in historical times has become outdated in today’s China. If the government intends to further increase the role of the market in reforming the state monopoly system, it needs to take into account any potential private monopolisation arising from the reform. To prevent private monopolisation, the government could rely on the Anti-Monopoly Law and in this regard, the existing administrative regulations on the table salt monopoly need to be repealed since many provisions are in conflict with the Anti-Monopoly Law. If the government attempts to protect public health, it can rely on the Food Safety Law but not the monopoly to do so. Finally, once the state monopoly is ended, companies and other business entities engaged in the production, distribution and sale of salt should be subject to taxation, including income taxes on profits derived from the business, VAT on the production and distribution of salt, resource tax on the exploitation of salt as a natural resource,146 and any

144  State Council Reform Plan for the Salt Industry (passed on 22 April 2016, issued 5 May 2016). 145  State Council Reform Plan, above n 144. Previously, salt producers were not allowed to enter the wholesale process. 146  A related question here is whether a royalty or resource rent tax for the exploitation of the natural resource needs to be charged. Minerals in the ground belong to the state and it is fair enough to charge the person who is digging them up and using non-renewable resources

The State Salt Monopoly in China 537 other related taxes. Compared with a state monopoly, a taxation measure is more transparent and less vulnerable to rent seeking, it would not cause inefficiency in resource allocation and production since a tax does not create scarcity, nor does it impose any barriers to new entry. In this respect, China’s tax law system needs to be further improved, to bring more equity, transparency, certainty and convenience to market participants. For example, China’s VAT law should be reformed to give effect to the neutrality principle that all goods and services should be subject to the same tax burden. The income taxation practice could be further improved to tax effectively profits of salt companies. It is also necessary to improve tax administration, ­especially in respect of cross-regional trade and investment. CONCLUSION

The state salt monopoly in China is presumably the oldest salt monopoly in the world. Historically it emerged as an effective way to raise revenue and was used for other purposes intended by the government at the time. The monopoly was a quasi-tax in terms of its economic effect. Compared with taxation, it is easier to implement as the burden is less visible and thus inspires less opposition from people. The revenue-raising role of the salt monopoly has significantly decreased over time. The state monopoly in contemporary China was characterised by strict government control until a very recent relaxation. There have been a number of problems associated with the state monopoly, not least inefficient resource allocation, productive inefficiency and rent-seeking and corruption. The lessons from the long history of the state salt monopoly show that the adoption of a state monopoly needs to take into account the socioeconomic circumstances of the state; although monopolisation can be effective in extracting revenue, it undermines the development of the market and the relevant industry and harms public interests. The recent announcement to relieve state control over table salt is likely to eventually bring the centuries-old monopoly to an end. A more market-based salt industry might act as a catalyst for replacement of the monopoly revenue with an explicit, transparent and more efficient tax. If the ultimate aim is to let the market play a decisive role in resource allocation and development of the salt industry, a well-designed tax law is much needed to reflect the changed nature of salt operation. This will help foster the modernisation and, importantly, the rule of law in tax law in China.

taken from the state. But salt can be mined or produced by evaporating sea water. In the latter case, royalties or resource rent tax cannot really be charged. In China’s case, salt mined by evaporating sea water is subject to the resource tax. See ‘Detailed Rules for the Implementation of Provisional Regulation of the People’s Republic of China on Resource Tax’ (the Ministry of Finance, State Council, issued on 28 October 2011, effective 1 November 2011), Art 2.

538