Studies in the History of Tax Law Volume Volume 9 9781509924936, 9781509924967, 9781509924943

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STUDIES IN THE HISTORY OF TAX LAW These are the papers from the ninth Cambridge Tax Law History Conference, held in July 2018. 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. Four papers focus on tax theory: Bentham; social contract and tax governance; Schumpeter’s ‘thunder of history’; and the resurgence of the benefits theory. Three involve the history of UK specific interpretational issues: management expenses; anti-avoidance jurisprudence; and identification of professionals. A further three concern specific forms of UK tax on road travel, land and capital gains. One paper considers the formation of HMRC and another explains aspects of nineteenth-century taxation by reference to Jane Austen characters. Four consider aspects of international taxation: development of EU corporate tax policy; history of Dutch tax planning; the important 1942 Canada–US tax treaty; and the 1928 UN model tax treaties on tax evasion. Also included are papers on the effects of WWI on New Zealand income tax and development of anti-tax avoidance rules in China.

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Studies in the History of Tax Law Volume 9

Edited by

Peter Harris and

Dominic de Cogan

HART PUBLISHING Bloomsbury Publishing Plc Kemp House, Chawley Park, Cumnor Hill, Oxford, OX2 9PH, UK HART PUBLISHING, the Hart/Stag logo, BLOOMSBURY and the Diana logo are trademarks of Bloomsbury Publishing Plc First published in Great Britain 2019 Copyright © The editors and contributors severally 2019 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/, 1998–2019. A catalogue record for this book is available from the British Library. A catalogue record for this book is available from the Library of Congress. ISBN: HB: 978-1-50992-493-6 ePDF: 978-1-50992-494-3 ePub: 978-1-50992-495-0 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

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hese papers were given on 10 and 11 July 2018 at the ninth 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 X, scheduled for July 2020. 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 ninth rendition. Thanks also to Lucy Cavendish College which 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 2019

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Table of Contents Preface�����������������������������������������������������������������������������������������������������������v List of Contributors������������������������������������������������������������������������������������� ix 1. Jeremy Bentham – Developing Ideas About Taxation and Law�����������������1 Jane Frecknall-Hughes 2. Contractualism and Tax Governance: Hobbes and Hume�����������������������17 Hans Gribnau and Carl Dijkstra 3. John Tiley and the Thunder of History��������������������������������������������������55 Michael Littlewood 4. Benefits Theories of Tax Fairness�����������������������������������������������������������93 Ira K Lindsay 5. Tax and Taxability: ‘Trade, Profession or Vocation’ Seen Through the Eyes of Jane Austen����������������������������������������������������������������������� 123 John Avery Jones 6. The Taxation of Road Travel: Revenue and Regulation in Georgian Britain������������������������������������������������������������������������������ 159 Chantal Stebbings 7. Deduction of Expenses of Management����������������������������������������������� 181 Richard Thomas 8. A Tale of the Merger Between the Inland Revenue and HM Customs and Excise��������������������������������������������������������������� 213 Penelope Tuck, Dominic de Cogan and John Snape 9. Through Ramsay Spectacles����������������������������������������������������������������� 243 Philip Ridd 10. Lloyd George’s Land Values Duties������������������������������������������������������� 279 John HN Pearce 11. Professional Status in Tax Law: The Case of Leopold Maxse���������������� 307 Emer Hunt 12. The UK Capital Gains Tax: The Conception of the 1965 Act���������������� 327 David Collison 13. The Early Proposals for a European Corporate Tax Policy�������������������� 365 Christiana HJI Panayi

viii  Table of Contents 14. How The Netherlands Became a Tax Haven for Multinationals������������ 391 Jan Vleggeert and Henk Vording 15. The Origins and Architecture of the 1942 Canada–United States Income Tax Treaty������������������������������������������������������������������������������� 413 Robert Raizenne and Colin Campbell 16. The Drafting of the First Model Treaties on Tax Evasion���������������������� 445 Sunita Jogarajan 17. Income Tax in New Zealand, 1914–18: The World War I Watershed������ 469 Shelley Griffiths 18. The Development of Anti-Avoidance Rules and the Modernisation of China’s International Taxation System�������������������������������������������� 493 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. Colin Campbell, Associate Professor, Faculty of Law, Western University. Dominic de Cogan, Lecturer, Faculty of Law, University of Cambridge. David Collison, Chartered Tax Adviser, former Chairman of CIOT Education Committee. Carl Dijkstra, Inspector, Netherlands Tax and Customs Administration and Associate Professor, Radboud University. Jane Frecknall-Hughes, Professor of Accounting and Taxation, Business School, Nottingham University. Hans Gribnau, Professor of Tax Law, Tilburg University and Leiden University. Shelley Griffiths, Professor, Faculty of Law, University of Otago. Christiana HJI Panayi, Professor in Tax Law, Centre for Commercial Law Studies, Queen Mary University of London. Emer Hunt, Assistant Professor, School of Law, University College Dublin. Sunita Jogarajan, Associate Professor, Law School, University of Melbourne. Ira K Lindsay, Senior Lecturer, School of Law, University of Surrey. Michael Littlewood, Professor, Faculty of Law, University of Auckland. John HN Pearce, ex HMRC, Associate of the Institute of Taxation, PhD, University of Exeter. Robert Raizenne, of Osler, Hoskin and Harcourt, LLP, Montreal; Adjunct Professor of Law, McGill University. Philip Ridd, Law Reporter, formerly Solicitor of Inland Revenue. John Snape, Associate Professor, Warwick Law School, University of Warwick. 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.

x  List of Contributors Penelope Tuck, Professor of Accounting, Public Finance and Policy, Birmingham Business School, University of Birmingham. Henk Vording, Professor of Tax Law, Leiden University. Jan Vleggeert, Associate Professor in Tax Law, Leiden University. Yan Xu, Associate Professor, Faculty of Law, Chinese University of Hong Kong.

1 Jeremy Bentham – Developing Ideas About Taxation and Law JANE FRECKNALL-HUGHES

ABSTRACT

Jeremy Bentham’s ideas on taxation are spread over several different works, such as A Protest Against Law-Taxes (1793), his Proposal for a Mode of Taxation (1794), Supply Without Burden or Escheat Vice Taxation (1795), and a further pamphlet of similar date entitled Tax With Monopoly. Ideas on taxation also appear in other works, such as his Manual of Political Economy (1798). While Bentham’s criteria for taxation reflect the utilitarian principles for which he is famed, his views are also coloured by the ideas developed by his predecessors, such as John Locke, David Hume and Adam Smith. This paper will examine Bentham’s substantial contribution to the development of tax theory in the light of these earlier thinkers. It will consider, for example, his opposition to Locke’s views on property and version of social contract theory, which posited that tax was something paid in return for protection from the state, by means of a voluntary alienation of the ‘natural’ right to property. Bentham did not accept the idea of natural rights: rights could not exist unless granted by law, which was the domain of government, and which thus had the power to interfere with property rights by taking property away by means of taxation. More than any other thinker, he enshrined the idea that a tax can only be imposed by law, an idea which remains relevant today, in the light of the proliferation of ‘quasi’/‘soft’ law and oft-iterated views that tax involves not only law but also a higher moral code. INTRODUCTION

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entham’s economic writings (including those on taxation) belong mostly to the middle phase of his life, and much in general of his work to this day remains unpublished. Werner Stark, in his Preface to Volume 1 of his edition of Jeremy Bentham’s Economic Writings, comments on the ‘immense difficulties’ of starting from scratch with Bentham’s manuscripts and papers,

2  Jane Frecknall-Hughes saying that ‘[t]he papers are in no kind of order: in fact it is hard to imagine how they ever became so utterly disordered. They resemble a pack of cards after it has been thoroughly shuffled.’1 In addition, Bentham’s handwriting is notoriously difficult to decipher (Stark was obliged to copy out the manuscripts by hand before he could make anything of them2). Holdsworth also comments on the ‘chaotic condition’ of the manuscripts.3 Bentham, moreover, while he wrote prodigiously, did not write for publication, but ‘primarily in order to clear his mind, and he left it willingly to others to make books out of his materials’,4 those others being during his lifetime chiefly Etienne Dumont, John Stuart Mill and George Grote. There have been numerous editions of Bentham’s work, in whole or part, notably the 11-volume edition produced by Sir John Bowring,5 the three-volume edition of the economic writings by Werner Stark,6 and an as yet unfinished edited collection being prepared by the Bentham Project at University College London. The production of editions of Bentham’s works is far from straightforward. Stark, for example, comments that there was sometimes ‘a vast difference between what Bentham wrote and what Bowring made of it’,7 although his own editions have also attracted criticism.8 This paper takes further earlier work on Jeremy Bentham’s ideas about taxation.9 He wrote four main works on taxation, namely A Protest Against Law-Taxes (1793), Proposal for a Mode of Taxation (1794), Supply Without Burden or Escheat Vice Taxation (1795), and a further pamphlet of similar but uncertain date entitled Tax With Monopoly. Additional comments on taxes are found throughout other works as well. This study uses the Bowring edition for the first of Bentham’s tax works and the Stark edition for the last three (the first not being included by Stark). The remainder of the paper looks briefly at the context of Bentham’s life and then the circumstances pertaining to taxation during that period. It moves on to consider Bentham’s view of the law and law reform, and then discusses individually the particular works on tax referred to earlier. The final section offers concluding remarks. 1 W Stark (ed), ‘Preface’ in Jeremy Bentham’s Economic Writings, Vol 1 (London, George Allen & Unwin Ltd, 1952) 7. There are three main collections of Bentham manuscripts and papers – at the British Museum, the Bibliothèque Publique et Universitaire in Geneva and the Library at University College London (where the Bentham Project is based, the aim of which is to produce an edition of his collected works). 2 ibid. 3 W Holdsworth, History of English Law, Vol 13, AL Goodhart and HG Hanbury (eds) (London, Methuen & Co Ltd, 1952) 66, citing in the text and in n 9 Thomas Whittaker’s Report on the Bentham MSS at University College London (no date is given). 4 Stark, above n 1, ‘Introduction’, 11. 5 J Bowring (ed), The Works of Jeremy Bentham, 11 volumes [1838–43] (New York, Russell & Russell Inc, 1962), https://oll.libertyfund.org/titles/bentham-works-of-jeremy-bentham-11-vols. 6 W Stark (ed), Jeremy Bentham’s Economic Writings, 3 vols (London, George Allen & Unwin Ltd, 1952–4). 7 Stark, above n 1, 8. 8 See P Schofield, ‘Werner Stark and Jeremy Bentham’s Economic Writings’ (2009) 35(4) History of European Ideas 475. 9 J Frecknall-Hughes, ‘The Concept of Taxation and the Age of Enlightenment’ in J Tiley (ed), Studies in the History of Tax Law, Vol 2 (Oxford, Hart Publishing, 2007) 253–86.

Jeremy Bentham – Developing Ideas About Taxation and Law  3 CONTEXT – BENTHAM’S LIFETIME

It is, however, necessary first to mention briefly the times in which Bentham lived (1748–1832). As a child of the ‘long eighteenth century’, he was born into the maelstrom of the Enlightenment’s unfettered and liberal ideas, and his life was nearly coeval with many other renowned thinkers of different n ­ ationalities – for example, Montesquieu, Voltaire, Benjamin Franklin, David Hume, Rousseau, Adam Smith, Kant, Burke, Paine, Godwin, Blake, Cobbett, Malthus, Ricardo, James Mill, Hazlitt, etc,10 many of whom had an impact on his thinking and some of whom he himself influenced. Cataclysmic political events occurred during his lifetime – the loss of the American colonies, the War of Independence, the revolution in France and the subsequent Napoleonic wars – which caused considerable upheaval, especially in terms of ideas. It is difficult to overestimate the climate of fear that French revolutionary ideas created in England, or the unease that percolated through society with the development and diffusion of liberal ideas. Hollond comments that Bentham’s life: may be conveniently divided into five stages: his boyhood and adolescence at Westminster and Oxford until 1767; from 1767 to 1781, his youth at Lincoln’s Inn; from 1781 to 1792, the first phase of his middle life during which he made frequent visits to Bowood,11 and stayed some two years in Russia; from 1792 to 1808, the second phase of his middle life, during which, his father having died, he established himself in the latter’s house in Queen’s Square Place in Westminster, and was heavily engaged upon his Panopticon scheme; from 1808 to 1882, his late middle and old age, during which he was converted to radicalism and fervently preached its doctrines.12

He was a child prodigy, who started to study Latin at the age of four, being able to read and write Latin and Greek by the age of 10. He was critical in later life of the education he received at Westminster, but he had progressed so far that he went up to Queen’s College, Oxford at the age of 12. He was also critical of his studies at Oxford, feeling he learnt nothing and that serious study was not encouraged. Although called to the Bar in 1769, he never practised law. His father was an attorney, whose successful speculation in house property enabled him to support his son in his studies during his own life, leaving him sufficient monies on death never to need to practise law. Bentham was known in his life for not completing his writing projects, often setting work aside when unfinished to start on something new, and for being reluctant to revisit earlier ideas or incomplete work. This undoubtedly contributed to the disarray of his manuscripts. If he had needed to publish to earn a living, then it is likely that his works would

10 ibid. 11 The country home of William Petty, second Earl of Shelburne, later Marquess of Lansdowne, and a pre-eminent statesman. 12 HA Hollond, ‘Jeremy Bentham: February 15, 1748–June 6, 1832’ (1948) 10(1) Cambridge Law Journal 3–4. Holdsworth, above n 3, 43–56 is the source of the subsequent details.

4  Jane Frecknall-Hughes have been bequeathed to posterity in better order, with a greater number of them being completed and published. Bentham, however, was content to study, and his own reading of Locke, Hume, Helvetius and Beccaria led him to feel that extensive reform of the law was required, as he came to despise its technicalities and inaccessibility. He was one of the few people whose views the French Revolution did not change, being more interested in establishing the (utilitarian) principles which should underlie a system of laws. Although Bentham’s ideas were seldom explicitly acted upon, their influence can be detected in some of the legislation subsequently enacted. The schedules and cases introduced into income tax by Addington in 1803 owe much to Bentham’s examination of different types of income (see later). CONTEXT – TAXES

In terms of the taxes prevalent in Bentham’s lifetime, while these varied to some degree, constant were direct taxes on land, houses and establishments, property insured against fire, property sold at auction, post horses, coaches and hackney coaches; and a variety of indirect taxes. The latter were chiefly on articles of consumption: eatables (salt, sugar), drinkables or drink-related items (beer, malt, hops, wine, spirits, tea) and tobacco; miscellaneous items which did not fall into the prior categories (coals exported and coastwise, raw and thrown silk, iron bars, hemp (rough), muslins and calicoes); and manufactured items (candles, leather, soap, printed goods, newspapers, glass, and bricks and tiles). In addition there were stamp duties on various deeds and instruments and law proceedings. These items are as per the list given by Stephen Dowell for 1792.13 The list for 1815 is very similar, though notable additions are income tax, succession tax and tonnage on shipping (direct); currents, raisins, pepper and vinegar and coffee (articles of consumption); timber (miscellaneous); and newspapers and advertisements (manufactured items).14 By this time window tax receipts are included in the receipts from ‘houses and establishments’ as inhabited house tax and window tax had been combined in 1798. Gradually in the late seventeenth and early eighteenth centuries, excises were bringing in more revenue than the land tax, which it was felt politically risky to tinker with, as it was based ‘upon consent and not force’,15 and while the ­government could have increased it, it preferred to have a non-contentious,

13 S Dowell, A History of Taxation and Taxes in England, Vol 2 (New York, August M Kelly, 1965) 206–7. A list of taxes for 1702 at 63 includes items similar to the 1792 list, although there is some variation in detail. 14 ibid 257–8. Dowell goes on at 261 to list the taxes ‘repealed, relinquished, or proposed and rejected since the Revolution’, including tax on shops, women servants, gloves and mittens and hats. 15 JV Beckett, ‘Land Tax or Excise: The Levying of Taxation in Seventeenth- and EighteenthCentury England’ (1985) 100(395) English Historical Review 285.

Jeremy Bentham – Developing Ideas About Taxation and Law  5 g­ uaranteed amount rather than ‘attempt to turn it into a real pound-rate’.16 While a general excise was thought likely to produce a public outcry, excises could be imposed on increasing numbers of individual items without arousing undue disquiet.17 However, they were noticed and resented. The author and critic, Sydney Smith, in 1820 in an essay in the Edinburgh Review, of which he was editor, expressed prevailing opinions: Taxes upon every article which enters into the mouth or covers the back or is placed under the foot. Taxes on everything which it is pleasant to see, hear, feel, smell, or taste. Taxes upon warmth, light, and locomotion. Taxes on everything on earth or under the earth, on everything that comes from abroad or is grown at home. Taxes on the raw material, taxes on every fresh value that is added to it by the industry of man. Taxes on the sauce which pampers man’s appetite, and the drug which restores him to health; on the ermine which decorates the judge, and the rope which hangs the criminal; on the poor man’s salt and the rich man’s spice; on the brass nails of the coffin, and the ribbons of the bride: at bed or board; couchant or levant, we must pay. The schoolboy whips his taxed top; the beardless youth manages his taxed horse, with a taxed bridle, on a taxed road; and the dying Englishman, pouring his medicine, which has paid 7 per cent., into a spoon which has paid 15 per cent., flings himself back upon his chintz bed, which has paid 22 per cent., and expires in the arms of the apothecary, who has paid a license of a hundred pounds for the privilege of putting him to death. His whole property is then immediately taxed from 2 to 10 per cent. Besides probate, large fees are demanded for burying him in the chancel. His virtues are handed down to posterity on taxed marble, and he will then be gathered to his fathers to be taxed no more.18

There was considerable debate about who actually bore the weight of excises, with Petty and Locke, for instance, arguing that that they ended up falling ultimately on land, though not everyone agreed.19 Beckett comments that ‘[t]he concern with methods of tax raising was endemic in the eighteenth century. Apart from published sources, a considerable amount of manuscript material can be found in family archives, especially those of prominent p ­ oliticians’,20 citing particularly the papers of the Marquess of Landsdowne (Shelburne). Pitt, in 1785, ‘reorganized the administration of assessed taxes and introduced new 16 ibid 301. See also J Brewer, The Sinews of Power (Cambridge MA, Harvard University Press, 1988) 95–100 and 147–8. 17 ibid 303. Beckett comments on Walpole’s failed attempt to introduce an extension of excise duties in 1733, which, while not itself general, was possibly considered by the Commons as an intention to introduce a general excise. 18 Dowell, above n 13, 259–61, giving the citation on 261 ‘Sydney Smith, Works, ii, 112’ for this quote, but he provides no further details. Strictly, some of the taxes referred to by Smith are assessed taxes, rather than excises. An excise is in essence a per unit tax, usually levied at the point of manufacture or where a process is deemed to add value, and is indirectly borne by an eventual purchaser. An assessed tax is one levied by reference to the value and/or number of taxable items an individual might have (e.g., windows, horses, servants, etc.) and so is direct. However, to an end user/consumer aware of how the taxes worked, there may have been little perceptible difference. 19 Beckett, above n 15, 304–5. 20 ibid 303, n 2.

6  Jane Frecknall-Hughes machinery which in the longer term proved capable of adaptation for the income tax’21 of 1799, but the effect on yield was not as had been hoped, which became critical in 1793, with the beginning of the wars against France,22 although England was at war with France intermittently for much of the period (1689–97, 1702–13, 1744–8, 1756–63, 1793–1802, 1803–15), and also with A ­ merica (1776–82, 1812–15).23 O’Brien and Hunt comment that, although the British state’s fiscal system and fiscal base had developed ‘haphazardly if at all’24 prior to the ­Glorious Revolution of 1688, it developed swiftly thereafter. ‘Revenue is the chief pre-occupation of the state. Nay more, it is the state’.25 BENTHAM AND (TAX) LAW

Hale comments that the contribution made by eighteenth-century liberalism to public finance was: a new understanding of the social order, one which turned the older, organic view of society on its head. Instead of placing obligation at the center of analysis, it advanced a concept of rights. Instead of seeing society as a network of classes, estates, and corporations, each with its appropriate duties, liberalism saw only a form of individuals, each in full possession, from birth, of a bundle of natural rights which it was the government’s duty to protect. Public finance could not be immune to such a radical restructuring of social theory.26

These liberal ideas were espoused by many leading thinkers, such as Thomas Paine in The Rights of Man27 – being manifest in the American Declaration of Independence28 and the French Declaration of the Rights of the Man and of the Citizen29 of 1789. In regard to taxation they were adopted especially by the social contract theorists, such as John Locke, whose views (in the Second ­Treatise of Government) on property and whose version of social contract theory posited that tax was something paid in return for protection from the state, by means of 21 ibid 303, citing WR Ward, ‘The Administration of the Window and Other Assessed Taxes, 1696–1798’ (1952) 52(265) English Historical Review 522; and JED Binney, British Public Finance and Administration, 1774–92 (Oxford, 1958), Ch 3. 22 JV Beckett and M Turner, ‘Taxation and Economic Growth in Eighteenth-Century England’ (1990) 43(3) Economic History Review, 2nd series 377. 23 ibid 398. 24 PK O’Brien and PA Hunt, ‘The Rise of the Fiscal State in England, 1485–1815’ (1993) Historical Research 66(160) 129. 25 ibid 130, attributing in n 10 this quotation from Edmund Burke to the report of it by FC Dietz, English Government Finance, 1485–1558 (Urbana, University of Illinois, 1920) 213. 26 D Hale, ‘The Evolutions of the Property Tax: A Study of the Relation Between Public Finance and Political Theory’ (1985) 47(2) Journal of Politics 382, 390–1. 27 T Paine (1791) ‘The Rights of Man, Part I (1791)’ and ‘The Rights of Man Part II (1792)’ in B Kuklick (ed), Thomas Paine Political Writings (Cambridge, CUP, 2000). 28 See WC Ford et al (eds) Journals of the Continental Congress, 1774–89 (Washington DC, 1904–37). 29 Declaration of the Right of Man and the Citizen, 26 August 1789, available at www.refworld. org/docid/3ae6b52410.html (accessed 18 June 2018).

Jeremy Bentham – Developing Ideas About Taxation and Law  7 a voluntary alienation of the ‘natural’ right to property. 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?30

Locke’s comments in the Second Treatise of Government constitute his only direct comments on taxation, and have been the subject of much debate as to their meaning.31 Bentham, however, famously regarded the idea of natural rights as ‘nonsense upon stilts’: ‘[n]atural rights is simple nonsense: natural and imprescriptible rights, rhetorical nonsense – nonsense upon stilts’.32 His attack on them and the ideas emerging from the French Revolution constitutes ‘one of the most influential attacks on the concept of natural rights ever written’,33 and was very ‘severe’.34 However, if natural rights are rejected, where does that leave the theorist? Some skirted the issue (David Hume) or outlined general principles which should govern an acceptable or ‘good’ tax (Adam Smith),35 but for Bentham, it boiled down to the fact that the law was the authority which granted rights – but it was law in a form which should take into account Bentham’s famed principle of utility: Legislation, which has hitherto been founded principally upon the quicksands of instinct and prejudice, ought at length to be placed upon the immovable base of feelings and experience; a moral thermometer is required, which should exhibit every degree of happiness and suffering … The feelings of men are sufficiently regular to become the object of a science or an art; and till this is done we can only grope our way by making irregular and ill-directed efforts.36

He goes on elsewhere to say that: Nature has placed mankind under the governance of two sovereign masters: pain and pleasure. … They govern us in all we do, in all we say, in all we think. … In words a 30 J Locke, ‘Second Treatise of Government’ in P Laslett (ed), Two Treatises of Government [1690] (Cambridge, CUP, 1988) [140]. 31 See J Snape and J Frecknall-Hughes, ‘John Locke: Property, Tax and the Private Sphere’, in PA Harris and D de Cogan (eds), Studies in the History of Tax Law, Vol 8 (Oxford, Hart ­Publishing, 2017) 1; also generally M. Bhandari (ed), Philosophical Foundations of Tax Law (Oxford, OUP, 2017). 32 J Bentham, ‘Anarchical Fallacies’ in J Bowring (ed), The Works of Jeremy Bentham, Vol 2, (Edinburgh, William Tait, 1843) 501. 33 See P Schofield, ‘Jeremy Bentham’s “Nonsense upon Stilts”’ (2003) 15(1) Utilitas 1. 34 Holdsworth, above n 3, 56. 35 Frecknall-Hughes, above n 9. 36 J Bentham, ‘Principles of the Civil Code’ in J Bowring (ed), The Works of Jeremy Bentham Volume 1 (New York, Russell & Russell Inc, 1962) 304.

8  Jane Frecknall-Hughes man may pretend to abjure their empire; but in reality he will remain subject to it all the while.37

More particularly, in A Fragment on Government, Bentham specified as a ‘fundamental axiom, it is the greatest happiness of the greatest number that is the measure of right and wrong’.38 While commonly associated with Bentham, Burns points out that the phrase does not recur in Bentham’s writings, although there are words used to convey similar meaning. As he comments: the origins and history of the phrase and of Bentham’s use of it have been the subject of protracted scholarly debate. The seeds of uncertainty were sown by Bentham himself in confused and inconclusive recollections recorded by John Bowring. The question of origins at least was definitively resolved over thirty years ago by Robert Shackelton, in an elegant piece of research. This demonstrated that by far the like­ liest source of the phrase as Bentham used it is the English translation of Beccaria’s Dei  delitti e dellepene, published in 1768. That was the year in which Bentham ­sometimes thought, mistakenly, that he had found the phrase in a work by Joseph Priestley, and it seems likely that he read the Beccaria translation in … 1769.39

This principle underlies Bentham’s view of the law and law reform.40 Takuo Dome has demonstrated its clear application to Bentham’s suggestions for tax reform, reconstructing them as ‘consistent with the principle of least sacrifice of enjoyment’.41 The discussion which follows adheres closely to Dome’s. Bentham states that ‘[t]he natural and only original object of taxation is revenue’,42 but as taxation reduces the means of achieving well-being or happiness from those who pay it, then it should be imposed in accordance with criteria which ­minimise its impact, namely: First object of finance – to find the money without constraint – without making any person experience the pain of loss and of privation. Second object – to take care that this pain of constraint and privation be reduced to the lowest term. Third object – to avoid giving rise to evils accessory to the obligation of paying the tax.43 37 J Bentham, ‘Introduction to the Principles of Morals and Legislation’ in J Bowring (ed), The Works of Jeremy Bentham Vol 1 (New York, Russell & Russell Inc, 1962) 1. 38 J Bentham, ‘A Fragment of Government’ in J Bowring (ed), The Works of Jeremy Bentham Vol 1 (New York, Russell & Russell Inc, 1962) 227. 39 JH Burns, ‘Happiness and Utility: Jeremy Bentham’s Equation’ (2005) 17(1) Utilitas 46, r­ eferring in n 2 to R Shackleton, ‘The Greatest Happiness of the Greatest Number: The History of Bentham’s Phrase’ (1972) 90 Studies on Voltaire and the Eighteenth Century 1461. 40 Holdsworth above n 3, 68, lists the ‘works which illustrate the principles upon which Bentham proposed to reform the law’. 41 T Dome, ‘Bentham and J.S. Mill on Tax Reform’ (1999) 11(3) Utilitas 320, 321. Much of this appears also in an extended chapter on Bentham in T Dome, The Political Economy of Public Finance in Britain 1767–1873 (London, Routledge, 2004) 66. 42 J Bentham, ‘Manual of Political Economy’ in W Stark (ed) Jeremy Bentham’s Economic W ­ ritings Vol 1 (London, George Allen & Unwin Ltd, 1952) 257. 43 J Bentham, ‘General View of a Complete Code of Laws’ in J Bowring (ed), The Works of Jeremy Bentham Vol 3 (New York, Russell & Russell Inc, 1838) 204.

Jeremy Bentham – Developing Ideas About Taxation and Law  9 There are clear influences of Adam Smith’s canons of taxation here, though the General View of a Complete Code of Laws in which these criteria appear is a much later work than Smith’s.44 Bentham was not in favour of enforced frugality to increase national wealth, nor of making individuals save for their own benefit nor of increasing another’s happiness. There should be no interference by government in these matters – and tax revenue should be spent only ‘to promote security, subsistence, and enjoyment of the public’.45 BENTHAM’S WORKS ON TAXATION

A Protest Against Law-Taxes In this pamphlet of 1793,46 Bentham attacked the tax (stamp duty) on legal proceedings, which he calls the ‘worst of all taxes, actual or possible’ because it is ‘a tax upon distress’,47 thus undermining at least two, if not all three, of the criteria outlined above. His reason for thinking so is that these taxes fall most often upon the poor, who are least able to bear them. They are the persons most likely to be charged with offences, rather than themselves bringing cases, which, even if justified, they cannot afford to do. Moreover, these taxes are not taxes which can be planned for, as the occurrence of a legal suit is unpredictable and does not admit of insurance, in the way that one might take out insurance against unexpected death. A tax on bread, though a tax on consumption, would hardly be reckoned a good tax; bread being reckoned in most countries where it is used, among the necessaries of life. A tax on bread, however, would not be near so bad a tax as one on law-proceedings: a man who pays to a tax on bread, may, indeed, by reason of such payment, be unable to get so much bread as he wants, but he will always get some bread, and in proportion as he pays more and more to the tax, he will get more and more bread. … Were a three-penny stamp to be put upon every three-penny loaf, a man who had but threepence to spend in bread, could no longer get a three-penny loaf, but an obliging baker could cut him out the half of one. A tax on justice admits of no such retrenchment. The most obliging stationer could not cut a man out half a latitat48 nor half a ­declaration. Half justice, where it is to be bad, is better than no justice: but without buying the whole weight of paper, there is no getting a grain of justice.49

44 ibid 156, the ‘Contents’ page indicating that the edition by Etienne Dumont appeared in 1802. 45 Dome, above n 41, citing at n 3 Bentham’s ‘Institute of Political Economy’ in W Stark (ed), Jeremy Bentham’s Economic Writings Vol 3, 321. 46 J Bentham, ‘A Protest Against Law-Taxes’ [1793] in J Bowring (ed) The Works of Jeremy Bentham, Vol 2 [1843] (New York, Russell & Russell Inc 1962) 573. 47 ibid 582. 48 A latitat was a type of writ, very roughly the equivalent of a subpoena today. The word means ‘s/he lurks’ in Latin and presumed that a person summoned was in hiding. 49 Bentham, above n 46, 573.

10  Jane Frecknall-Hughes The other tax that is ‘the worst possible species of tax, next to a tax on justice’ is a tax on medicines for the sick, though the tax on ‘quack medicines … falls … if at all, under this censure’.50 Bentham also takes time in A Protest Against Law-Taxes to comment on which taxes he considers to be the best. The best of all are taxes on consumption, because not only do they fall nowhere ­without finding some ability to pay them: but where necessaries are out of the question, they fall on nobody who has not the option of paying them if he does not choose it. Taxes on property, and those on transfer of property, such as those on contracts relative to property, are the next best: because though they are not optional like the former, they may be so selected as never to call for money but where there is ability, nay even ample ability, to pay them.51

Bentham goes on to say that of these two kinds of ‘most supportable … taxes, the second are all of them levied by means of stamps’.52 It is unclear what ‘second’ means in this context (eg, ‘in order of preference’, ‘in the order mentioned’), as he goes on to say that some taxes on consumption levied on ‘cards, dice, gloves, and perfumery’ by means of stamps are ‘very good taxes … and [author’s italics] taxes on justice are all stamp-duties’.53 One cannot but feel that the ‘and’ here should be followed by ‘yet’, as he seems to go on to say that there is no difference in tax generally as regards revenue generated, but there is in terms of who bears it and where it falls. It is too much to expect of a man of finance, that he should anticipate the feelings of unknown individuals: it is a great deal if he will listen to their cries. … The oppressed and ruined objects of the taxes on justice weep in holes and corners, [dying] as rats die: no one voice finds any other to join with it.54

Supply Without Burden or Escheat Vice Taxation In the above document, Bentham proposed reviving and extending the feudal law of escheat. At the time, the law of escheat applied only to landed estates which had no heir, which reverted to the Crown – a process meaning that no individual suffered, but that revenue into government coffers increased. Bentham’s ideas are summarised by Dome, namely: (1) that the state would confiscate all property in the case of intestate succession where there were no marriage-prohibited relations; 50 ibid 576. See also generally C Stebbings, Tax, Medicines and the Law: from Quackery to ­ harmacy (Cambridge, CUP, 2018). P 51 ibid 580. 52 ibid. 53 ibid. Further indications of Bentham’s preferred ‘order’ of taxes is given in the ‘Analytical View [or] Summary Sketch of Financial Resources, Employed and Employable’ in W Stark (ed), Jeremy Bentham’s Economic Writings, Vol 1 (London, George Allen & Unwin Ltd, 1952–4) 275, which is discussed later. 54 ibid 581.

Jeremy Bentham – Developing Ideas About Taxation and Law  11 (2) that the state would share a half of the intestate property in the case of collateral inheritance; (3) that wills of parents would be effective only with respect to half the amount of their property; (4) that the property which should be restored to the people would be converted into money through a public auction.55

The underlying concept is that individuals expect only to inherit from parents, and parents only to leave their estates/goods to their children. Relatives more distantly related by blood do not expect to inherit, therefore will not have any expectations disappointed, so the overall result would be to raise money with minimum unhappiness: you cannot miss what you did not expect to receive in the first place. As Bentham did not accept that there were natural rights, he did not accept that there was a natural right of inheritance which would be violated by his proposal: … who is this same Queen ‘Nature’, who makes such stuff under the name of laws? … in what year of her own or any body else’s reign, did she make it, and in what shop is a copy of it to be bought, that it might be burnt by the hands of the common hangman, and her Majesty well disciplined at the cart’s tail? It being well supposed, in point of fact that the children have or have not a right, of the sort in question, given them by the law, the only rational question remaining is, whether, in point of utility, such a right ought to be given them or not? – To talk of a Law of Nature, giving them, or not giving them, a natural right, is so much sheer nonsense, answering neither the one question nor the other.56

The money raised by the proposal would mean that taxes on law proceedings, medicines, windows and soap could be abolished,57 national debt and interest thereon reduced and current service reduced.58 Moreover, the measure would reduce litigation regarding inheritance, promote marriage and raise asset prices. However, relieving the poor of burdens and redistributing wealth were not primary aims. The text of Supply Without Burden or Escheat Vice Taxation is mapped out more as a plan for a larger work, but, as Stark comments, ‘[as] usual, this magnum opus was never completed’,59 most likely because when it was laid before the Secretary of the Treasury, Charles Long, he was not interested and Bentham abandoned it, although some major sections of the work were completed. Bentham does estimate the possible yield from his measure as £2m,60 but admits that this is ‘conjecture’,61 and he wrote 13 detailed sections ­addressing 55 Dome, above n 41, 322. The peerage would be exempted from these provisions. 56 J Bentham, ‘Supply Without Burden or Escheat Vice Taxation’ in W Stark (ed), Jeremy Bentham’s Economic Writings, Vol 1 (London, George Allen & Unwin Ltd, 1952–4) 310. 57 ibid 300. 58 ibid 359. 59 Stark, above n 4, 62. 60 Bentham, above n 56, 313. 61 ibid 311.

12  Jane Frecknall-Hughes possible objections, one of which (Objection 5) contains one of his most forceful ­denunciations of natural rights and statements that rights can only be granted by law. Of a natural right who has any idea? I, for my part, I have none: a natural right is a round square [or] an incorporeal body. What a legal right is I know. I know how it was made. I know what it means when made. To me a right and a legal right are the same thing, for I know no other. … Right is with me the child of law … By natural right is meant, a sort of a thing which is to have the effect of law, which is to have an effect paramount to that of law, but which subsists not only without law, but against law: and its characteristic property, as well as sole and constant use, is the being the everlasting and irreconcilable enemy of law. As scissors were invented to cut up cloth, so were natural rights invented to cut up law, and legal rights. A natural right is a species of cold heat, a sort of dry moisture, a kind of resplendent darkness.62

Supply Without Burden or Escheat Vice Taxation was, according to Bowring,63 first printed in 1793 (though not published until 1795), a year of particular turmoil in France and one which saw the execution of Louis XVI – and no doubt one of the reasons that Bentham describes natural rights as ‘the spawn of despotism’.64 Even if the principle of utility were supported by the likes of Bacon, Locke, Hume, Smith and Paley, he says, it ‘would be nothing against one Danton bawling out natural rights’.65 Proposal for a Mode of Taxation and Tax With Monopoly Bentham’s remaining works specifically on taxation turn to business taxation. In Tax With Monopoly, an undated work, but one which is likely to be close in date to Supply Without Burden or Escheat Vice Taxation,66 he proposed taxes on the profits on bankers’ and stockbrokers’ profits, in exchange for granting them business monopolies. One of the reasons bankers’ and stockbrokers’ profits could be taxed was because there existed sufficient written records of transactions to be able to calculate them, which there did not for the profits of other traders. In the case of the latter, ‘[t]he difficulty of ascertaining the profit and loss … would be an endless source of evasion’.67 Bentham returned to the subject in Proposal for a Mode of Taxation. While there were taxes on land and 62 ibid 334–5. 63 J Bentham, ‘Supply Without Burden or Escheat Vice Taxation’ in J Bowring (ed) The Works of Jeremy Bentham, Vol 2 [1843] (New York, Russell & Russell Inc, 1962) 585. 64 Bentham, above n 56, 335. 65 ibid 336. 66 Stark, above n 4, 73 cites a letter written by Bentham to Charles Long in 1794 (in J Bowring (ed) The Works of Jeremy Bentham, Vol 10 [1843] (New York, Russell & Russell Inc, 1962) 303) shortly after Supply Without Burden or Escheat Vice Taxation, which seems to refer to the subject matter of Tax With Monopoly. 67 J Bentham, ‘Tax With Monopoly’ in W Stark (ed), Jeremy Bentham’s Economic Writings, Vol 1 (London, George Allen & Unwin Ltd, 1952–4) 371.

Jeremy Bentham – Developing Ideas About Taxation and Law  13 on consumption, there was no tax on interest on money lent, annuities (government and personal), company dividends, profits from trade or income from professions, which did not fall within ‘the rule of equality’.68 Dome ­analyses Bentham’s divisions of income as follows:69 Property incomes (assured): rent from land; interest on money lent; government and personal annuities; and dividends paid by joint stock companies. Industrial incomes (casual): profits from trade; and professional incomes.

Dome goes on to comment that incomes had to be classified in terms of whether they lasted beyond the life of the recipient – perpetual income, which could be inherited by offspring, or temporary, which could not.70 Bentham proposed to deal with the inequality between incomes by taxing industrial incomes at half the rate of property income.71 Bentham’s proposal for how to tax incomes, on a graduated scale seems very modern, with those on ‘insufficient income’72 exempted; those above this amount, up to ‘full sufficiency’73 gradually paying more. Dome then suggests that the tax rate would be fixed with regard to income above the full sufficient level, but Bentham’s text is less clear on this.74 As the profits of bankers had not suffered tax (and could be ascertained), Bentham proposed to tax them in return for a licence which limited their number.75 He also thought stockbrokers’ profits similarly suitable,76 and although his proposal in a Proposal for a Mode of Taxation was limited to bankers, stockbrokers were included in Tax With Monopoly. As Dome goes on to comment, Bentham was well aware of the economic problems associated with monopolies, in that they ‘would decrease the supply; raise the price; impair the quality of the commodity; and increase the distance between demanders and suppliers’.77 However, these would not apply in the case of bankers and stockbrokers. The aggregate supply of money and rates of interest determined their dealings, so the quantity and quality of their dealings would be unaffected. Customers would not be disadvantaged because dealings 68 J Bentham, ‘Proposal for a Mode of Taxation’ in W Stark (ed), Jeremy Bentham’s Economic Writings, Vol 1 (London, George Allen & Unwin Ltd, 1952–4) 385. See also Dome, above n 41, 324. 69 Dome, above n 41, 325. 70 ibid. 71 Bentham, above n 67, 387. 72 ibid 388. 73 ibid. 74 Dome, above n 41, 325; Bentham, above n 67, 388. 75 Bentham, above n 67, 403. 76 ibid 400. 77 Dome, above n 41, 325.

14  Jane Frecknall-Hughes were almost exclusively in the City of London – and any initial losses would be made up by ‘high economic growth in England’,78 especially as numbers of banks/stockbrokers could not be increased. There was thus no impairment of anyone’s financial happiness. CONCLUSIONS

This paper has extended an earlier examination of Bentham’s ideas on taxation,79 but even so, much more remains to be considered in terms of Bentham’s own works, his voluminous correspondence, later commentaries, and further books and articles. In particular, tracing the ways in which his ideas informed and are reflected in subsequent tax statutes would be of great use and interest. Stark comments that ‘[a] work, or even works, on taxation must have been on [Bentham’s] programme very early on – indeed, for a man of his kidney, this field of endeavour must have had a more or less irresistible attraction’,80 and cites correspondence from 1783 as evidence of his search for material on public finances, when he was aiming: to get a comprehensive idea of the public burdens actually in force in the civilised world and to compile, for his own benefit and satisfaction, a tabular list of them that would allow him to survey the whole field at one glance. The Analytical View or Summary Sketch of Financial Resources employed and employable … is the fruit of these labours.81

Although Stark does not think this list and other comments about good and bad taxes that we have seen already are enough ‘to show a well-reasoned-out “order of preference”’,82 Dome does actually go so far as to ‘reconstruct the list of preference order’.83 First is the law of escheat, followed by a tax on profits with indemnity, such as on stockbrokers’ and bankers’ profits. Income taxes with indemnity would be next, then consumption taxes (‘more desirable than income taxes without indemnity’84). Given his comments on taxes on consumption, these are preferred to direct taxes, as a person has a choice about whether to buy the goods on which they are imposed, unless they are imposed on the necessaries of life, in which case, like taxes on law-proceedings and medicines, they become the worst of taxes. In regard to land tax, he did not think it a ‘just and eligible tax’85 – seeing it as a kind of income tax on land tenure, and to 78 ibid 326. 79 Frecknall-Hughes, above n 9. 80 Stark, above n 4, 59. 81 ibid. 82 ibid 60. 83 Dome, above n 41, 326. 84 ibid. 85 W Stark (ed), Jeremy Bentham’s Economic Writings, Vol 3 (London, George Allen & Unwin Ltd, 1954) 529.

Jeremy Bentham – Developing Ideas About Taxation and Law  15 correct it, he would impose tax on other kinds of income. His abatements as suggested in a Proposal for a Mode of Taxation influenced Pitt’s income tax, as he commented in Paper Mischief [Exposed].86 All in all, Bentham’s principle of utility and idea of the greatest happiness of the greatest number are consistently applied in his tax theories, in so far as we have them. It is, noticeable – and also significant – that he takes the opportunity to lambast within his tax works the topic of natural rights, which shows the long reach of the social contract theorists in regard to taxation, especially John Locke from nearly a century before, coupled with the liberal ideas still permeating, with ever greater vigour, if not violence, in the late eighteenth century.

86 J Bentham, ‘Paper Mischief [Exposed]’ in W Stark (ed), Jeremy Bentham’s Economic Writings, Vol 2 (London, George Allen & Unwin Ltd, 1954) 444.

16

2 Contractualism and Tax Governance: Hobbes and Hume HANS GRIBNAU AND CARL DIJKSTRA

ABSTRACT

In early modern history the concept of social contract was developed to ­establish sovereign authority and citizens’ duty to obey the law. The social contract marks the transition from the state of nature to the civil state. The contract or covenant is concluded by self-interested individuals driven by the fear of death. What Hobbes proposes is a covenant ‘of every man with every man’, whereby each gives up his right of governing himself to one man or assembly of men, on condition that the others do so too. The sovereign is given authority by covenant, but he is not a party to this, so he cannot forfeit the authority given to him. Natural unsociability of men accounts for almost absolute sovereignty, which translates in Hobbes’s thought on law and taxation. Hobbes famously saw law as command of the sovereign – reflecting a hierarchical, top-down view on governance. Coercion and fear of sanctions should deter self-interested subjects from non-compliance. Subjects have no property rights against the sovereign and can therefore legitimately be taxed. Taxation is an infringement on subjects’ liberties laid down in the law. In cases where the sovereign has not issued a command, no taxation is possible (silence of the law). The command theory is reflected in a strict attitude towards compliance: self-interested, distrustful individuals will go for the letter of the law, driven by a concern for their (negative) liberty. It is thus hard to conceive of any positive conception of taxation: taxation is not seen as a civic obligation to contribute towards society – enhancing one’s positive liberty. Hence, government has to rely on coercion. Tax laws are an expression of the sovereign will one has been necessitated to submit to. Nonetheless, the wise sovereign has certain duties that follow from the law of nature, such as equal taxation – that is, proportionate equality between burdens and benefits measured by consumption.

18  Hans Gribnau and Carl Dijkstra Hume has a more positive view on man. Though human beings are driven by self-interest to a certain degree, they possess for Hume a (limited) generosity and benevolence towards their fellow human beings. ‘(Natural) sympathy’ is one of the key concept in Hume’s ethics. Unlike Hobbes, for Hume citizens aren’t bound to a (historical) social contract, as none of them ever made a promise to obey the government. Cooperation comes naturally but has to be supported, and enhanced by government in large societies. Citizens obey the government in as much as they are born and educated to do so. Allegiance to the government originates from voluntary compliance with conventions of ownership and keeping of agreement in families and small societies. The willingness to comply with conventions and agreements is not only driven merely by self-interest, since it also has an intrinsic ethical component, namely to find favour in fellow human beings’ eyes for being (and acting) virtuous. An increase in population creates the need of government to enforce the rules or property and promise. This is the reason for the invention of government, born from (small) societies. For Hume, unlike Hobbes, taxes are partially voluntary. Hume also advocates taxes on consumption, presuming that these are (partially) voluntary and incentivise citizens to work harder in order to afford more levied goods and services. Therefore, one can argue that in Humean political philosophy taxation contributes to social welfare and thus community spirit. Hence, tax governance is not primarily seen as coercing unsociable taxpayers. Tax law is not conceptualised as a command. In this chapter we will examine these two radically different views on man, consent, contract, sovereignty and society entailing diverging conceptions of tax governance: that is, the legitimate exercise of the power to tax, and the ensuing relationship between government and taxpayers. INTRODUCTION

I

n early modern history the concept of social contract was developed to establish sovereign authority and citizens’ duty to obey the law. The classical contractarian thinkers rejected the then-influential view that there is natural authority among men, and that rulers are entitled to govern by birth. Powers and privileges of monarchs, social distinctions and hierarchies are not natural but conventional, and in need of justification, according to these contractarians. Their fundamental assumption was that men are, by nature, free and equal – the idea of a general human capacity for free agency.1 Indeed, contractarianism

1 CW Morris, ‘Introduction’ in CW Morris (ed), The Social Contract Theorists: Critical Essays on Hobbes, Locke and Rousseau (Lanham, Rowman & Littlefield, 1999) ix. Cf  M Forsyth, ‘Hobbes’ Contractarianism: A Comparative Analysis’ in D Boucher and P Kelly (eds), The Social Contract from Hobbes to Rawls (London, Routledge, 1994) 35, 37: ‘the notion of a social contract implied and embodied a huge advance in the idea of human equality’.

Contractualism and Tax Governance: Hobbes and Hume  19 can be seen as ‘a political outgrowth, a political expression, of a more general theory of human free action’.2 The social contract theorists’ concern is the political legitimacy of sovereigns and the political obligations of subjects, viewed as the voluntary creation of equal moral humans. Voluntarism, the idea that rulers require authorisation by individual men understood as ‘authors’, and ideas of a legitimate state – rather than a good state – all have their roots in the medieval period.3 It is primarily the relationship between ruler and the people that is said to rest upon consent, rather than civil society. The relationship between ruler and the ruled is said to be ‘contractual, explicitly or implicitly, and which specifies or implies the respective rights and duties of the contractees’.4 Hence, legitimate government (and obligations) should be based on agreement – willingly entered into and binding upon the ruler and the ruled. Natural political powers and privileges lacking, political authority can derive only from those over whom it is exercised, that is, the people themselves. The powers and privileges of rulers are thus conditional on the way they are ­exercised. ‘Rulers need to serve the interests of the governed if they are to elicit their consent’.5 The legitimacy of rulers is conditional on the performance of their responsibilities. In the period under analysis in this chapter, questions of human sociability and the analysis of the modern state were understood as being inextricably intertwined: one could not hope to understand the latter without taking a detailed position on the former.6 Thomas Hobbes built his theory on aspects of human unsociability that to his mind required an almost absolute sovereign. He did not deny that man may sometimes be motivated by concern for others, but to his mind this is too narrow a basis for a workable political theory. Hobbes believed that spontaneous social interaction takes the form of competition rather than cooperation. The ensuing struggle for survival makes security the paramount concern of each individual.7 Security, a (relative) state of peace, requires the institution of a commonwealth and a strong sovereign to guarantee security. By way of consent (expressed in a social contract), by which individuals renounce part of their natural liberty in the state of nature, obligation and

2 P Riley, Will and Political Legitimacy: A Critical Exposition of Social Contract Theory in Hobbes, Locke, Rousseau and Hegel (Cambridge MA, Harvard University Press, 1982) viii. He thus views social contract theory as a form of political voluntarism. 3 ibid, 1–8; cf H Gribnau and C Dijkstra, Social Contract and Beyond: Sociability, Reciprocity and Tax Ethics, working paper March 2019, 2–5; http://ssrn.com/abstract=3349793. 4 D Boucher and P Kelly, ‘The Social Contract and its Critics: An Overview’ in Boucher and Kelly (eds), above n 1, 1, 10. 5 Morris, above n 1, ix. 6 P Sagar, Sociability and the Theory of the State from Hobbes to Smith (Princeton NJ, Princeton University Press, 2018) 11. 7 A Rapaczynski, Nature and Politics: Liberalism in the Philosophies of Hobbes, Locke and ­Rousseau (Ithaca NY, Cornell University Press, 1989) 9.

20  Hans Gribnau and Carl Dijkstra political ­authority are legitimised.8 Fear of death and (civil) war and the ensuing ­overriding need for security lead to a justification of strong, hierarchical governance and strict obedience. Arguably, tax governance becomes a matter of command and control – relying on coercion and even deterrence. However, Hobbes’s emphasis on the legitimacy of this artificial sociability mechanism might have its shortcomings. Blackburn therefore wrote: ‘we need a more organic model, rather than designing our way out of the war of all against all, we are seen as growing out of it, or rather, growing so that it never occurs’.9 As Hume saw, we need not so much contract, as convention, and convention can just grow. The ‘organic model’ of Hume offers us a radically different view on human sociability and the modern state, with its focus on human benevolence and (parental) education. In Hume’s theory, prior to any sovereignty, human cooperation results in primitive societies with social conventions. State power is only developed after these primitive societies become more complex and need more supervision. Unlike Hobbes, Hume saw government as an almost natural consequence of society. The state and its institutions support individuals’ inborn but limited sympathy towards their fellow human beings to enhance cooperation in large societies. Sympathy motivates them to act according to the common interest. Hence, Hume does not emphasise the need for hierarchical government ruling by way of commands over uncooperative subjects. Hume’s focus on benevolence and reciprocity does not require governance by command and control. The focus is not primarily on coercion and deterrence to force citizens to comply. The difference between Hobbes and Hume shows also with regard to tax which Hobbes sees as the price to be paid for security. Hume prefers, like Hobbes, taxes on consumption, but he assumes that taxes are (partially) voluntary – evidencing a less hierarchical approach than Hobbes. In this chapter, we will examine the views of Hobbes and Hume. Other classical contractarian thinkers, such as Locke and Rousseau, may provide more nuanced views on the concepts of social contract, political authority, state, right, obligation, and governance.10 The same goes for (early) modern

8 T Hobbes, Leviathan or the Matter, Forme, & Power of a Common-Wealth Ecclesiastical and Civill [1651], R Tuck ed (Cambridge, Cambridge University Press, 1991) XLII, 395: ‘The right of all sovereigns is derived originally from the consent of every one of those that are to be governed’, and XL, 324: The authority of any prince ‘must be grounded on the Consent of the People and their Promise to obey him’. 9 S Blackburn, Practical Tortoise Raising and Other Philosophical Essays (Oxford, Oxford University Press, 2012) 107. 10 Cf J. Waldron, ‘John Locke: Social Contract versus Political Anthropology’ in Boucher and Kelly (eds), above n 1, 51; MP Thompson, ‘Locke’s Contract in Context’ in Boucher and Kelly (eds), above n 1, 73; J Snape and J Frecknall-Hughes, ‘John Locke: Property, Tax and the Private Sphere’ in P Harris and D de Cogan (eds), Studies in the History of Tax Law, vol 8 (Oxford/Portland, Hart Publishing, 2017) 1; J Jennings, ‘Rousseau, Social Contract and the Modern Leviathan’ in Boucher and Kelly (eds), above n 1, 115.

Contractualism and Tax Governance: Hobbes and Hume  21 ­ pponents such as Montesquieu, Burke, Hegel and Bentham.11 Contrasting o Hobbes and Hume, however, provides a clearer, black and white, picture which may serve as an analytical tool for reflection on the exercise of sovereign authority (governance) – the exercise of the power to tax being one of the hallmarks of sovereignty. HOBBES

Introduction: Hobbes’s social contract and its context Thomas Hobbes (1588–1679) sought to discover principles for the construction of a civil polity. He was witness to turbulent years of English history. The political upheaval of the mid-seventeenth century meant the disintegration of the early modern polity. The civil war fought between the king, Charles I, and Parliament in 1642–46 was disruptive. Parties were ‘contending on two fronts: for “the liberty of the subject”, which depended on free meetings and debates in parliaments and on the security of property, and, for “religion”’.12 Charles’s problems were not confined to England. Events in Scotland and in Ireland contributed to the collapse of his authority. Dramatic transformations thus occurred. A commonwealth and military rule replaced the abolished monarchy and the House of Lords. The Church of England was overthrown too. The English Civil War drove Hobbes into exile in France. Parts of Leviathan are certainly written with the civil wars in mind. Nonetheless, Hobbes started to develop his theories a bit earlier, namely, in the context of the troubles that led up to the English Civil War.13 According to Hobbes himself, ‘my country, some years before the civil war broke out, was already seething with questions

11 Cf S Goyard-Fabre, La Philosophie du Droit de Montesquieu (Paris, Librairie C Klincksieck, 1979) 141; J Snape, ‘Montesquieu – “The Lively President” and the English Way of Taxation’ in J  Tiley (ed), Studies in the History of Tax Law, vol 5 (Oxford/Portland, Hart Publishing 2012) 73, 85; R Bromwich, The Intellectual Life of Edmund Burke: From the Sublime and Beautiful to American Independence (Cambridge MA, Harvard University Press 2014) 4–5; P Riley, ‘Social Contract Theory and Its Critics’ in M Goldie and R Wokler (eds), The Cambridge History of Eighteenth-Century Political Thought (Cambridge, Cambridge University Press, 2005) 347–75; Riley, above n 2, 163–99; B Haddock, ‘Hegel’s Critique of the Theory of Social Contract’ in Boucher and Kelly, above n 1, 147–63. 12 B Worden, The English Civil Wars 1640–1660 (London, Phoenix, 2009) 7. With regard to terminology: the Civil War was ‘part’ of ‘the civil wars’ – meaning ‘the range of conflicts, military and political, of the 1640s and 1650s’. Worden argues that religious debates threatened the preservation of order and were an important cause of unrest and warfare, since religious tolerance was hardly conceivable in the seventeenth century; cf ibid, 78: ‘In a society without a police force or, ordinarily, a standing army, the preservation of order will seem dependent on the coherence, even the uniformity, of ideas and beliefs.’ 13 J Sommerville, ‘Life and Times’ in SA Lloyd (ed), The Bloomsbury Companion to Hobbes (London, Bloomsbury, 2012) 1, 3.

22  Hans Gribnau and Carl Dijkstra of the right of Government and of due obedience of citizens, forerunners of the approaching war’.14 Hobbes viewed human life as ‘perpetuall and restlesse desire of power after power, that ceaseth onely in Death’.15 As he wrote in the Preface to the readers of On the Citizen, his starting point was: a Principle well known to all men by experience, and which everyone admits, that men’s natural Disposition is such, that if they are not restrained by fear of a common power, they will distrust and fear each other, and each man rightly may, and necessarily will look out for himself from his own resources.16

This natural inclination fuelled conflict and civil war. This explains the pervasive need for security which animates Hobbes’s political thinking. In the natural condition all men are equal, having an unlimited but rather useless natural right to preserve themselves. Because of this equality, there is no natural authority among men. All authority has to be instituted ‘by the consent of those who authorize a sovereign to make law and to permit his will to stand for theirs’.17 Note that in this initial situation of equality, each person has rights, not duties. Thus in social contract theory, only consent legitimises obligations (and political authority).18 Hobbes sought to discover rational principles for the construction of a stable civil polity and ‘to furnish a means of judging the legitimacy of the actions government undertake’.19 To his mind, virtually any government would be better than a civil war. To assure stability and avoid dissolution into civil war, people ought to submit themselves to a government with almost unlimited power. Thus, the burdens of even absolute government are ‘scarce sensible, in respect of the miseries, and horrible calamities, that accompany a Civill Warre’.20 The origin of the sovereign authority to command (and the obligation to obey) is rooted in a social contract that institutes sovereignty. The people in the state of nature are presumed to confer their power to a common power. The duty to obey the law is created by the social contract – itself depending on trust.21 14 T Hobbes, On the Citizen [1642], R Tuck ed (Cambridge, Cambridge University Press, 1998) 13. The fact that Hobbes lived through the Thirty Years War, the last international religion-inspired conflict in Europe, certainly also contributed to the development of Hobbes’s insights; N Malcolm (ed), Reason of State, Propaganda, and the Thirty Years’ War: An Unknown Translation by Thomas Hobbes (Oxford, Clarendon Press, 2007); AP Martinich, Hobbes: A Biography (Cambridge, Cambridge University Press, 1999) 38, 84–85. 15 Leviathan, above n 8, XI, 70. 16 On the Citizen, above n 14, Preface to the readers, 10. 17 Riley, above n 2, 25. 18 Rapaczynski, above n 9, 82–83. 19 Q Skinner, ‘A Genealogy of the Modern State’ (2009) 162 Proceedings of the British Academy 325, 348. Cf Leviathan, above n 8, XX, 145: ‘The skill of making and maintaining Common-wealths, consisteth in certain Rules, as doth Arithmetic and Geometry; not (as Tennis play) on practice onely: which rules neither poor men have the leisure, nor men that have had the leisure, have hitherto had the curiosity, or the method, to find out.’ 20 Leviathan, above n 8, XVIII, 128. 21 Riley, above n 2, 26.

Contractualism and Tax Governance: Hobbes and Hume  23 By entering into this contract, people agree to give up their right to act solely on their private judgment, and ‘to act instead on the judgment of the sovereign, as expressed by the civil law’.22 The main thrust of Hobbes’s argument throughout his moral and political writings is the necessity of making private judgment take second place to public judgment, wherever the two come into conflict.23 The State of Nature To justify the establishment of sovereign authority and the obedience to its laws Hobbes paints the picture of life in a state of nature, that is, an imaginary condition without government (no person was ever actually in the state of nature24). Hobbes radically differs from Aristotle, because he thinks that man is by nature unpolitical or antisocial. His picture of human conduct and social interaction in the state of nature shows what he means by this.25 In such a state of nature, each decides for herself how to act, and is his own judge in case conflicts arise. Moreover, in this situation, ‘the condition of meer Nature, all men are equal’.26 Though there may be very strong or intelligent men, for Hobbes, equality of ability prevails. The weakest, indeed, ‘has strength enough to kill the strongest, either by secret machination or by confederacy with others that are in the same danger with himself.’ And, he goes on, with regard to ‘the faculties of the mind … I find yet a greater equality amongst men than that of strength’.27 For Hobbes, the natural condition is ‘one of liberty, equality, and the most extensive individual rights imaginable.’28 However, exactly because of this liberty and equality, the state of nature is a ‘dissolute condition of masterlesse men, without subjection to Lawes, and a coercive Power to tye their hands from

22 S Steedhar, ‘Obligation’ in Lloyd, above n 13, 192, 192. 23 RE Ewin, Virtues and Rights: The Moral Philosophy of Thomas Hobbes (Boulder CO, Westview, 1991) 71 referring to On the Citizen, above n 14, Preface to the readers, 8–9: ‘Finally, how many Rebellions have been caused by the doctrine that it is up to private men whether the commands of Kings are just or unjust, and that his commands may rightly be discussed before they are carried out?’ Cf M Lobban, ‘Thomas Hobbes and the Common Law’ in D Dyzenhaus and T Poole (eds), Hobbes and the Law (Cambridge, Cambridge University Press, 2012) 39, 53. 24 cf On the Citizen, above n 14, 102. See also B Gert, ‘Hobbes Psychology’ in T Sorell (ed), The Cambridge Companion to Hobbes (Cambridge, Cambridge University Press, 1996) 157, 167 and K Hoekstra, ‘Hobbes on the Natural Condition of Mankind’ in P Springborg (ed), The Cambridge Companion to Hobbes’s Leviathan (Cambridge, Cambridge University Press, 2007) 109, 114: ‘the natural condition is not simply to be identified with an original or primitive condition.’ 25 T Sorell, ‘Hobbes’s Moral Philosophy’ in Springborg, above n 24, 128, 146. 26 Leviathan, above n 8, XV, 107. Cf Leviathan, XV, 111: ‘the condition of meer Nature, (which is a condition of War).’ 27 ibid, XIII, 87. 28 Hoekstra, above n 24, 122.

24  Hans Gribnau and Carl Dijkstra rapine, and revenge.’29 Each person in the state of nature has a right to preserve himself, which Hobbes terms ‘the right of nature’ (jus naturale): ‘the Liberty each man hath, to use his own power, as he will himselfe, for the preservation of his own Nature; that is to say, of his own life’.30 Consequently, everyone has the right to do whatever one judges needful for one’s preservation.31 So this right of nature is theoretically limited to selfpreservation. However, because virtually anything might be judged to be helpful for one’s preservation against one’s enemies, this right becomes in practice, a right ‘to all things’.32 And thus there cannot be certainty, for the right of each to all things invites conflict and even war, men competing for resources. Hence, the problem is the disposition to fighting and the threat of violence, of bloodshed so bad that men would be virtually without security. Nobody will be secure in the state of nature. Self-preservation is permanently at risk. In this condition everyone is equally vulnerable to violence and uncertainty and no one can expect to be able to dominate the others. Absent a supreme authority that can lay down and enforce rules to govern human interaction, unrestricted competition for scarce goods between people makes enemies of them. Competition, diffidence and glory, all rooting in scarcity, are the three principal causes of quarrel – or the war of all against all.33 Such an ungoverned condition is devoid of sociability and civilisation.34 There would be no place for industry, because the fruit thereof is uncertain; and consequently no culture of the earth; no navigation, nor use of the commodities that may be imported by Sea; no commodious Building; no Instruments of moving and removing such things as require much force; no Knowledge of the face of the Earth; no account of Time; no Arts; no Letters; and which is worst of all, continuall feare, and danger of violent death; And the life of man, solitary, poore, nasty, brutish, and short.35

29 Leviathan, above n 8, XVIII, 128. The ‘idle’ poor were called ‘masterlesse men’ or ‘sturdy beggars’. They were composed of, on the one hand, ‘vagrants’ who populated the underworld of crime and vice (masterless in a literal sense), and abandoned wives and unmarried mothers, on the other hand, migrants seeking economic betterment. Riots or revolts by vagrants were threatening the political order, but according to Kishlansky ‘threats to the larger public order were inconsequential until the conflagration of the mid-century’ Kishlansky, above n 30, 29–30. 30 ibid, XIV, 91. 31 cf W Friedmann, Legal Theory [1944] (New York, Columbia University Press, 1967) 120: Hobbes prepares the way for the later revolution of individualism in the name of ‘inalienable rights by ­shifting the emphasis ‘from natural law as an objective order to natural right as a subjective claim based on the nature of man.’ 32 Leviathan, above n 8, XIV, 91. 33 ibid, XIII, p. 88, 90 (‘this warre of every man against every man’). See eg G Newey, The ­Routledge Guidebook to Hobbes’ Leviathan (London, Routledge, 2014) 85–88 and A Ryan, ‘Hobbes’s Political Philosophy’ in Sorell, above n 24, 208, 219–22. Sagar, above n 6, 31 argues that ‘glory’ is the real cause of quarrel, for ‘in Leviathan it is ultimately the seeking of “reputation,” the need to satiate pride through competition for status recognition, that generates humanity’s thoroughgoing natural unsociability.’ 34 Leviathan, above n 8, XVIII, 128. 35 ibid, XIII, 89.

Contractualism and Tax Governance: Hobbes and Hume  25 However, the desire to preserve their own lives is very strong in most people. Under pressure of necessity, the passions and reason make men choose for a sovereign-making covenant.36 The natural laws, being dictates of reason, prescribe men to seek peace and give up part of their natural liberty – as much as others will do (first and second law of nature).37 So, men seek peace and therefore they agree to leave the state of nature by establishing the civil state. This is done by the social contract. Note, however, that the state of nature persists. The transition from the state of nature to the civil state is therefore never absolute. As for example Newey argues, the state of nature ‘is never entirely superseded, nor are the motives that produce it’.38 Indeed, Hobbes’s statement that ‘in the nature of man, we find three principal causes of quarrel’39 (competition, diffidence glory) may suggest that it may be that Hobbes is not here referring to human features exclusive to situations without sovereign authority, ‘but to enduring aspects of human nature that will lead to conflict both in civil society and especially out of this’.40 Social Contract: Transition to Civil State and Justification of Obedience With this gloomy portrait of human nature and the state of nature in mind, people have strong reasons to find a way out of this natural condition. According to Hobbes, this can be done only by submitting to some mutually recognised public authority, for so long a man is in the condition of mere nature (‘which is a condition of war’), private appetite is the measure of good and evil.41 This is done by the use of a legal device, the social contract, which marks the transition from the state of nature to the civil state. The contract or covenant is concluded by self-interested individuals driven by the fear of death.42 36 ibid, XIII, 90: ‘The Passions that encline men to Peace are Feare of death; Desire for such things as are necessary to commodious living, and Hope by their Industry to obtain them’. For Hobbes’s concept of reason as calculation; see N Bobbio, Thomas Hobbes and the Natural Law Tradition (Chicago IL, Chicago University Press, 1993) 152. 37 Leviathan, above n 8, XIV, 91–92. Cf Ryan, above n 33, 222–24 and L Jaume, ‘Hobbes and the Philosophical Sources of Liberalism’ in Springborg (ed), above n 24, 199, 202–03. 38 Newey, above n 35, 92. To his mind, the persistence of the state of nature in under-remarked in writing on Leviathan. 39 Leviathan, above n 8, XIII, 88. 40 Hoekstra, above n 24, 117. Cf Ewin, above n 23, 100; and M Oakeshott, ‘Introduction to ­Leviathan’ [1946], in M Oakeshott, Hobbes on Civil Association (Indianapolis, Liberty Fund, 1975) 63 who argues that Hobbes denies the doctrine of the natural depravity of man (which implies that the state of nature arise out of a defect in the nature of man), and ‘he appears to take his place, on this question, beside Plato and Spinoza, basing his theory on “the known natural inclinations of mankind.” But not without difficulty.’ For an application of Oakeshott’s views to tax governance – partially reflecting Hobbes’s conception of sovereign authority, see D de Cogan, ‘Michael Oakeshott and the Conservative Disposition in Tax Law’ in M Bhandari (ed), Philosophical Foundations of Tax Law (Oxford, Oxford University Press, 2017) 101. 41 Leviathan, above n 8, XV, 111. 42 ibid, XIII, 90.

26  Hans Gribnau and Carl Dijkstra Men in the state of nature are supposed to contract with one another only for their own good.43 The contract consists of a mutual agreement among the many to submit to one or a few, who are expected to lay down the rules that will enable the many to peacefully coexist with one another. Thus, this pact is aimed at establishing rule and premised upon the idea of human equality. Nobody has a natural right to command others and civil society can only come about by an agreement by all individuals who compose it – that is, a simultaneous agreement by a multitude of equally free individuals.44 More specifically, the original contract is a combination of conferring of power, consenting to be governed, and mutual transferring of right. The latter component, the mutual transferring of right and simultaneously creating a party, the sovereign (as an artificial identity), to be the beneficiary of this transfer, is the driving force behind the move from state of nature into civil society.45 As will be shown, creating the sovereign in this way reflects a particular kind of governance: a hierarchical system of command and control by the imposition of law.46 The citizen’s obligation to obey the law, the command of the sovereign, is thus rooted in the social contract.47 The third law of nature backs this obligation: men have to perform ‘their covenants made; without which covenants are in vain, and but empty words’.48 Moreover, as shown above, for Hobbes, law is a command, more specifically, a command addressed to someone ‘formerly obliged to obey him’. This command is issued within the context of prior obligation. Thus, law is founded, not directly on power, but on obligation, and the ‘language of right and obligation replaces that of power’.49 However, the obligation to obey the commands of the sovereign is not established by a contract between governors and governed, but a covenant ‘of every man with every man’ whereby each gives up his right of governing himself to one man or assembly of men, on condition that the others do so too.50 This emphasis on reciprocity is reflected in Hobbes’s insistence that there is no obligation to observe the laws of nature in practice unless one has sufficient security that the others will observe the ‘same Lawes towards him’.51 43 cf Lobban, above n 23, 50: ‘The notion that there were some forms of contracting which were valid in the state of nature gave Hobbes the ingredients to devise a social contract whose validity did not depend on the existence of the sovereign it created.’ 44 Sorell, above n 25, 147. 45 L May, Limiting Leviathan: Hobbes on Law and International Affairs (Oxford, Oxford University Press, 2013) 52–54. 46 J Pierre and BG Peters, Governance, Politics and the State (Basingstoke & London, Macmillan, 2000) 15. 47 For Hobbes, ‘obligations are derived from promises, from contracts of will, and not from fear of punishment, which simply reinforces the intention that results from a promise’; Riley, above n 2, 9 referring to ‘his early’ De Cive. 48 Leviathan, above n 8, XV, 100. 49 D Gauthier, ‘Thomas Hobbes and the Contractarian Theory of Law’ (1990) 16 Canadian ­Journal of Philosophy, Supplement 7. 50 Leviathan, above n 8, XVII, 120. 51 ibid, XV, 110. Cf E Curley, ‘Introduction’ in T Hobbes, Leviathan, E Curley ed, (Indianapolis IN, Hackett, 1994) xxx.

Contractualism and Tax Governance: Hobbes and Hume  27 The sovereign is not a party to this contract, because, as Hobbes explains, his authority is actually given to him ‘by covenant only of one to another, and not of him to any of them’.52 Hobbes proposes therefore two obligations which are owed: a contractual one to the other citizens, and a non-contractual one to the person bearing the sovereignty not to ‘take from him that which is his own’.53 The sovereign is given authority by covenant, but he is not a party to this; consequently he cannot forfeit the authority given to him by covenant ‘by breach of covenant’.54 He may for example prescribe the doing of many things in pursuit of (his) passions contrary to the will and the conscience of every subject, ‘which is a breach of trust, and of the Law of Nature; but this is not enough to authorize any subject to make war upon their Sovereign’.55 The sovereign not being a party to the covenant accounts for Hobbes’s almost absolutist theory of the state.56 Sovereignty is absolute in the sense that, although limited by the aims of the contract, the sovereign ‘does not have rights that have correlative duties to individual subjects or citizens’.57 People submit to the almost unlimited sovereign, thereby transferring their rights to the sovereign (state). An artificial sociability mechanism is established comprising sovereignty wedded to a system relying on coercion and even deterrence. The sovereign’s power to enforce the social contract allows people to ‘safely enter into conditions of peace by terrorizing potential defectors into conformity’.58 The sovereign can do no wrong.59 Laws can be unfair, but Hobbes argues, they must be complied with. After all, the sovereign power of command came about through the social contract. That is an agreement, and one should observe such agreements, which one has voluntarily entered into. Submitting to the sovereign authority does nothing to subvert people’s liberty. For Hobbes, arbitrary power within a civil association does not undermine their freedom. Liberty is only undermined by overt actions of interference (so-called negative liberty60). Skinner therefore concludes that for Hobbes, it is sufficient for men to count as free-men that they enjoy their civic rights and 52 Leviathan, above n 8, XVIII, 122. 53 ibid. 54 ibid. 55 ibid, XXIV, 172. 56 R Harrison, ‘The Equal Extent of Natural and Civil Law’, in Dyzenhaus and Poole, above n 23, 22, 33: ‘The sovereign is absolute and the civil law is determined solely by the sovereign’s will.’ 57 May, above n 45, 65. 58 Sagar, above n 6, 33. Cf Q Skinner, Hobbes and Republican Liberty (Cambridge: Cambridge University Press, 2008) 159, who argues that no sovereign can ever hope to make the people endorse his legitimacy, and hence obey his laws, merely by ‘terrour of legall punishment’, quoting Leviathan, above n 8, XXX, 232. If the state is to survive, therefore, ‘the people must obey it not because they fear the consequences of disobedience, but because they recognise that there are good reasons for acquiescing in its rule’. 59 On the Citizen, above n 14, VII, 14, 97: Since it has been shown above (arts 7, 9, 12 [Leviathan, above n 8, XVIII, 122) that those who have obtained sovereign power in a commonwealth are not bound by any agreements to anyone, it follows that they can do no wrong [iniuria] to the citizens. 60 In Berlin’s famous wording: ‘the area within which a man can act unobstructed by others’. I  Berlin, ‘Two Concepts of Liberty’ [1958] in I Berlin, Four Essays on Liberty (Oxford, Oxford University Press, 1969) 118, 122.

28  Hans Gribnau and Carl Dijkstra liberties as a matter of fact.61 The establishment of a common sovereign power legitimises government’s interference with its subjects’ liberty. More specifically, the actions of government are ‘right’ and ‘agreeable to Equity’ if two related conditions are met.62 First, they must be undertaken by a sovereign duly authorised by the (future) subjects and, secondly, they must basically aim to preserve the life and health of the state and ‘hence the common good or public interest of its subjects’.63 Hobbes considers what one may refuse to do though commanded by the sovereign. This depends on ‘what rights we pass away when we make a Commonwealth’ for ‘in the act of our Submission [to a sovereign authority] consisteth both our Obligation and our Liberty.’64 The exception to the far-reaching duty to obey is based on the right to self-preservation, which indeed is the very ground of the social contract, and therefore the (civil) state. Self-preservation is an inalienable right. Citizens therefore have the natural right to oppose laws that affect their social security and security. As taxation is generally seen as an infringement of the right to property, the question is whether Hobbes sees the right to property as an inalienable right. The answer is simply no. The right to property is therefore not a right which has to be respected by the sovereign, for property itself is the result of the exercise of sovereign authority. For where there is no Commonwealth, there is, as hath been already shown, a perpetual war of every man against his neighbour; and therefore everything is his that getteth it, and keepeth it by force; which is neither Propriety, nor Community, but Uncertainty … Seeing therefore the introduction of Propriety is an effect of Commonwealth, which can do nothing but by the person that Represents it, it is the act only of the sovereign; and consisteth in the Lawes, which none can make that have not the Soveraign Power.65

There is no right to resistance in this respect. For Hobbes, it is necessary to root out opinions and doctrines which may seem to justify or encourage rebellion. Hobbes deals with several such opinions that incite to rebellion. The belief that one can invoke a right to property against an all-powerful sovereign authority, is one of the various seditious opinions, such as: that a man can do nothing lawfully against his private conscience; that they who have the sovereignty, are subject to civil laws; that there is any authority of subjects, whose negative may hinder the affirmative of sovereign power; that any subject hath a propriety distinct from the commonwealth; that there is a body of people without him or them that have the sovereign power.66 61 Skinner, above n 58, 212. 62 Leviathan, above n 8, XXIV, 171–72 and XXX, 239–40. 63 Skinner, above n 19, 348. 64 Leviathan, above n 8, XXI, 150. 65 ibid, XXIV, 171. 66 T Hobbes, Human Nature and De Corpore Politico JGA Gaskin ed (Oxford, Oxford University Press, 1994) xxviii, 176.

Contractualism and Tax Governance: Hobbes and Hume  29 Nonetheless, although the sovereign is not a party to the covenant, Hobbes argues that he cannot do just as he likes. The wise sovereign has certain duties, derived not from contract, but from the law of nature.67 These duties derive from the fundamental duty to procure the safety of the people: ‘the safety of the people is the supreme law’.68 Hobbes holds a very broad conception of safety, it is actually refers to good government. In Leviathan he writes: ‘by Safety here, is not meant a bare Preservation, but also other Contentments of life, which every man by lawful industry, without danger or hurt to the commonwealth, shall acquire to himself’.69 Moreover, safety requires that justice ‘be equally administred to all degrees of People … For in this consisteth equity’.70 However, the sovereign is accountable to God and to no one else.71 The duty is not a (binding) legal obligation. Hobbes’s Moral Psychology For a long time it was argued that Hobbes was committed to psychological egoism, the view that people are by nature self-interested and care only about their own good. There are indeed egoistic-sounding passages found in Hobbes’s texts, such as ‘every man by nature seeketh his own benefit, and promotion’72 and ‘no man giveth, but with intention of Good to himself’.73 Peters defends this (traditional) reading: ‘Self-interest, taught Hobbes, is the only operative mode’.74 According to Watkins, Hobbes’s alleged psychological egoism follows from his mechanistic materialism.75 Newey, however, argues that Hobbes’s picture of human motivations is not accusing ‘man’s nature’, but is more about people competing for scarce vital resources. They have a reasonable interest ‘in securing the necessities of life’. This does not make them egoistic. To his mind, ‘the bestial ethos of the state of nature shows that in some circumstances, there is no reasonable alternative to behaving like a beast’.76 Moreover, it is not unreasonable to take measures to protect one’s property, such as locking one’s doors. As Hobbes writes: Let him therefore consider with himself: when taking a journey, he arms himself and seeks to go well accompanied; when going to sleep, he locks his doors; when even 67 Lobban, above n 23, 53. He continues: ‘Moreover, he said that the ‘law of nature and the civil law contained each other and were of equal extent.’ 68 On the Citizen, above n 14, XIII, 2, 143 and Leviathan, above n 8, XXX, 231. 69 Leviathan, above n 8, XXX, 231. 70 ibid, XXX, 237. 71 ibid. 72 ibid, XIX, 133. 73 ibid, XIV, 105. 74 R Peters, Hobbes (Harmondsworth, Penguin Books, 1967) 61. 75 JWN Watkins, Hobbes’ System of Ideas (London, Hutchinson & Co, 1973) 72. 76 Newey, above n 33, 91.

30  Hans Gribnau and Carl Dijkstra in his house he locks his chests; and this when he knows there be laws and public officers, armed, to revenge all injuries shall be done him; what opinion he has of his fellow subjects, when he rides armed; of his fellow citizens, when he locks his doors; and of his children, and servants, when he locks his chests. Does he not there as much accuse mankind by his actions as I do by my words? But neither of us accuse man’s nature in it.77

According to Gert, Hobbes’s view about human nature is even rather ordinary.78 Gert argues that Hobbes was ‘aware of the wide variety of human behavior, especially human nature the state of nature.’ His remarks about human nature are meant as remarks which hold for a significant part of the human population, rather than about actual human beings in the real world. These remarks regard premises about human nature that he needs for building a workable political theory. It is therefore a mistake to think that Hobbes subscribed to psychological egoism. He definitely did not hold that ‘no one is ever motivated by concern for others’.79 Gert maintains that Hobbes thus uses limited altruism, rather than assuming that man is a political animal and man naturally loves ‘his fellow men’.80 Hobbes held that the behaviour of real humans is strongly determined by their education or training, which animates conflict.81 Unlike in the more optimistic Humean view (see below) it is inadequate moral upbringing rather than fundamental human nature that animates civil conflict. Moreover, various passions that Hobbes defines, such as indignation, benevolence, charity, love, express concern for others.82 In the end, Hobbes’s picture of human nature may not be so gloomy, but the point he drives home is that other-regarding human traits are an inadequate basis to build a workable political theory on. One should be realistic in order to design a political theory focused on security. Law as Command Hobbes’s conception of law reflects the notion of (near) absolute sovereign power: ‘Law, properly, is the word of him, that by right hath command over others’.83 Dealing with civil laws, he writes that law is not just a command, but a command issued to one ‘formerly obliged to obey him’.84 The duty to 77 Leviathan, above n 8, XIII, 89; cf On the Citizen, above n 14, Preface to the readers, 10–11. 78 Gert, above n 24, 166. 79 Gert, above n 24, 167. Cf SA Lloyd, ‘Egoism’ in Lloyd (ed), above n 13, 125–27. 80 On the Citizen, above n 14, I, 2, 22. 81 See, for example, Leviathan, above n 8, XI, 73: ‘like little children … have no other rule of good and evil manners, but the correction they receive from their Parents and Masters.’ Cf On the Citizen, above n 14, Preface to the readers, 11: ‘Still less does it follow that those who are evil are were made so by nature … an evil man is rather like a sturdy boy, or a man of a childish mind.’ 82 Leviathan, above n 8, VI, 41–42; cf Gribnau and Dijkstra, above n 3, 10–12. 83 Leviathan, above n 8, XV, 111. 84 ibid, XXVI, 183.

Contractualism and Tax Governance: Hobbes and Hume  31 obey u ­ ltimately roots in the agreement of people to obey the sovereign. This is Hobbes’s contractarian theory of political legitimacy, as shown above.85 Laws are commands given to those who have a prior obligation to obey. These commands have at least two important features. On the one hand they are meant to cut off deliberation, debate, or argument. They are peremptory in the sense that the subjects are intended to take the ruler’s (commander’s) expression of his will instead of their own will ‘as a guide to action and so to take it in place of any deliberation or reasoning of his own’.86 A second important characteristic of the notion of a command, is the ‘content-independent’ character of the reasons why a command is given: the ruler who issues a command ‘intends his expressions of intention to be taken as a reason for doing them … independent of the content or character the actions to be done’.87 This definition of law with its two key features make Hobbes not only a command theorist but also a legal positivist.88 His notion of almost unlimited sovereign power thus translates into a voluntarist conception of law and government: ‘the Law is a Command, and a Command consisteth in declaration, or manifestation of the will of him that commandeth, by voyce, writing, or some other sufficient argument of the same’.89 Hence the (civil) law, as the command of the sovereign, is nothing but an expression of will.90 The sovereign grants (civil) rights by law. The Hobbesian concept of political rule and the law represents a tradition in modern legal and political reasoning in which the law is closely associated with ‘the asocial, self-preserving actors who fight amongst themselves for their scarce resources, and must be protected from each other by the authoritative will of the sovereign’.91 Self-interested human beings require repressive, ‘command and control’ governance by way of law. For Hobbes, statute law is primary since the law emanates from the sovereign’s law-making authority. Moreover, this legislation is the embodiment of reason. In short, reason requires that there should be 85 C Finkelstein, ‘Introduction’ in C Finkelstein (ed), Hobbes on Law (Aldershot, Ashgate, 2005) i, xiii. 86 HLA Hart, ‘Commands and Authoritative Legal Reasons’ in HLA Hart, Essays on Bentham (Oxford, Oxford University Press, 1982) 253. 87 ibid, 254. 88 MM Goldsmith, ‘Hobbes on Law’ in T Sorell, above n 24, 274, 275. In principle no law can be unjust, since the lawmaking sovereign represents the subject who therefore are considered to be the author of the laws. Hence, a good law has little to do with justice, Hobbes maintains. ‘By a good law I mean not a just law, for no law can be unjust. The law is made by the sovereign power, and all that is done by such law is warranted and owned by everyone of the people.’ Leviathan, above n 8, XXX, 239. 89 Leviathan, above n 8, XXVI, 187. 90 AP d’Entrèves, The Notion of the State: An Introduction to Political Theory (Oxford, ­Clarendon Press 1967) 107 observes that Hobbes’s voluntarism seems to know no boundaries. 91 UK Preuss, ‘Communicative Power and the Concept of Law’ in M Rosenfeld and A Arato (eds), Habermas on Law and Democracy: Critical Exchanges (Berkeley CA, University of California Press, 1998) 325. Preuss contrasts the Hobbesian tradition of the law with the Lockean and Rousseauist traditions, seeing the law as ‘a reasonable mediator between competing utility-maximizers’ and ‘the law as expression of a collective identity’ respectively.

32  Hans Gribnau and Carl Dijkstra statute laws since they are ‘a necessary means of the safety and well being of Man … to be obeyed by all Subjects, as the Law of Reason ought to be obeyed’.92 This makes law-making a hierarchical legislative activity par excellence. Legislation provides the basic principles and values of the law. Nonetheless, the notion of reciprocity that lays the foundation of our normative order is central to Hobbes’s theory of political obligation – which regards the obligation to obey the law and the justification for doing so. The reciprocal relationship between the ruler and the ruled reflects the ‘mutuall Relation between Protection and Obedience’, as Hobbes puts it.93 The obligation of obedience to the command of the sovereign stems from the consent of the governed expressed in a social contract.94 However, once the political and legal order is established reciprocity steps back in the wings, as reciprocity is not a feature of the relationship between lawmaker and legal subject under Hobbes’s philosophy.95 For Hobbes, law (legislation) is a command. The law, however, has more characteristics, as evidenced by another definition: ‘a Law is the Command of him, or them that have the sovereign power, given to those that be his or their Subjects, declaring Publickly, and plainly what every of them may do, and what they must forbear to do’.96 The sovereign’s command must be addressed to the subjects and made public in order to qualify as law. This requirement of publication means that citizens know who the legislature is, so who is competent to legislate, the content of the law and that the command comes from the legislature. In this way the legal certainty of the citizens is served. As shown above, publication can be done in various ways, ‘by voyce, writing, or some other sufficient argument of the same’.97 Publication is a constitutive condition of law, without announcement no law;98 and a fortiori no sanctions are possible.99 The legislature must therefore be careful here. Anyone who, due to circumstances beyond his control, could not learn about a specific law is excused, which is why Hobbes emphasises that laws 92 T Hobbes, A Dialogue between a Philosopher and a Student of the Common Laws of England, J Cropsey ed, (Chicago IL, University of Chicago Press, 1971) 58. Cf Goldsmith, above n 88, 91. 93 Leviathan, above n 8, ‘A Review, and Conclusion’, 491. See D Dyzenhaus, ‘Hobbes and the Legitimacy of Law’ (2001) 20 Law and Philosophy 497. 94 D Dyzenhaus, ‘The Public Conscience of the Law’ (2014) 2 Netherlands Journal of Legal Philosophy 115; he points at three different reciprocal relationships in the Leviathan. 95 Though before Hobbes, Jean Bodin (1529/1530–96) points at the reciprocal relationship between tax legislature and taxpayers, arguing ‘that even kings are not allowed to levy taxes without the fullest consent of the citizens’. J Bodin, On Sovereignty: Four Chapters From the Six Books of the Commonwealth, first published 1576, JH Franklin ed and tr, (Cambridge, Cambridge University Press, 1992) xxvi. 96 Dialogue, above n 92, 71. 97 In addition to written publication and oral announcement there is, for example, the possibility of tacit consent. Customary law is a good example: it only becomes law because of the silence of the sovereign that Hobbes sees as implicit ratification; see Hobbes, On the Citizen, above n 14, XIV, 15, 161; cf Leviathan, above n 8, XXVI, 184. 98 On the Citizen, above n 14, XIV, 13, 160. 99 Leviathan, above n 8, XXVII, 203 & XXVIII, 216. Goldsmith, above n 88, 283.

Contractualism and Tax Governance: Hobbes and Hume  33 should be ‘sufficiently published’.100 Publication means a limitation to possible arbitrariness of sovereign power.101 Nonetheless, Hobbes clearly advocates a hierarchical, ‘command and control’ model of law and governance. In sum, Hobbes’s focus is on the powers of government and state, the duty of obedience to the commands of the sovereign and concentrated and centralised power. He envisaged ‘the state chiefly from the point of view of the rulers, the subjects being passive’, ‘matter rather than form’, and thus placed himself ‘ex parte principis’.102 Hobbes’s View on Taxation For Hobbes, taxation is a necessary part of any commonwealth. Actually, Hobbes starts to make the shift to taxation as the state’s primary source of revenue. He argues that, desirable as it may be that the state be funded out of public property, those in government are in fact not able to make prudent use of that property.103 In the distribution of land, the Commonwealth itself may be conceived to have a portion, and possess and improve the same by their representative; and that such portion may be made sufficient to sustain the whole expense to the common peace and defence necessarily required: which were very true, if there could be any representative conceived free from human passions and infirmities.104

For Hobbes, taxation is intimately linked to security. His main focus is on public security and the need for public revenue to provide for the payment of the armed forces.105 For the impositions that are laid on the people by the sovereign power are nothing else but the wages due to them that hold the public sword to defend private men in the exercise of several trades and callings.106

The imposition of taxes as such is not a problem for Hobbes, because as shown, there is no natural right to property. A fortiori, there is no natural right to property with which taxation could interfere. The sovereign has indeed the authority to dispose of his subjects’ properties as he sees fit. From the idea that there is no 100 Leviathan, above n 8, XXVI, 187 and 190. 101 Hobbes sees legislation as an increasingly important tool for organising society and influencing the behaviour of groups of citizens. Without publication, the effectiveness of this regulatory ­instrument would be minimal. 102 N Bobbio, Democracy and Dictatorship: The Nature and Limits of State Power (Minneapolis MN, University of Minnesota Press, 1989) 55–56. 103 H Vording, ‘The Normative Background for a Broad Concept of Tax’ in B Peeters (ed), The Concept of Tax (Amsterdam, EATLP, 2005) 30–31. 104 Leviathan, above n 8, XXIV, 172–73. 105 N McArthur, ‘Taxation and Trade’ in Lloyd, above n 13, 224–26. 106 Cf D Jackson, ‘Thomas Hobbes’ Theory of Taxation’ (1973) 21 Political Studies 75 and ­Leviathan, above n 8, XXX, 238.

34  Hans Gribnau and Carl Dijkstra such thing as a natural right to property in the natural condition it follows that the right to property is created by the civil law and is dependent on the sovereign will. It is the result of the legal system and the exercise of sovereign power. In the same vein, wealth and income are insecure and factually non-existent in the natural condition – everybody having a right to everything. Thus, security with regard to wealth and income are only conceivable in the civil state.107 Legal protection of wealth and income is entirely the product of the legal system, which in turn is established by the sovereign. There is therefore no pre-tax income of wealth or whatsoever to which one has a natural right. It simply has no reality in the natural condition without the power of the sovereign to enforce, which is established by the social contract. Furthermore, the concept of distributive justice is factually non-existent, and therefore meaningless, in the state of nature. If all are equal and everybody has a right to everything, there are no differences in terms of, for example, desert or merit, which may justify a differentiated (unequal) treatment. Consequently, no one is allowed to disobey the sovereign’s command invoking a natural principle of distributive justice. As Riley argues in On the Citizen, Hobbes redefines the Aristotelian concept of distributive justice not in terms of desert or merit, but in terms of what has been agreed to.108 Thus, distributive justice is not natural but conventional, and it is up to the sovereign to determine justice. Justice and morality indeed are an effect of law.109 As Gert writes, it is ‘by virtue of his contract that the subject can commit injustice’.110 Hobbes indeed asserts that justice simply is the law.111 So, for Hobbes, to argue that some tax or tax assessment violates the ‘higher’ value of distributive justice does not make sense at all. Actually, there are virtually no limitations to the tax system to be established by the sovereign. As long as taxation does not threaten the self-preservation of the subjects, it is justified. Citizens have a natural right to resistance if the ­ exercise of sovereign power affects their self-preservation and security.

107 Cf L Murphy and T Nagel, The Myth of Ownership. Taxes and Justice (Oxford, Oxford University Press, 2002) 17: ‘We cannot pretend that the differences in ability, personality, and inherited wealth that lead to great inequalities of welfare in an orderly market economy would have the same effect if there were no government to create and protect legal property rights and their values and to facilitate mutually beneficial exchanges.’ 108 Riley, above n 2, 28 referring to On the Citizen, above n 14, III, 6, 47: ‘If I give more of what is mine to him who deserves less, so long as I give the other [who deserves more] what I have agreed for, do I not wrong to either.’ 109 cf J Plamenatz, Man and Society. Vol 1: From the Middle Ages to Locke (London, Longman 1992) 65–66: Hobbes looks upon justice as an effect of law. However, ‘to hold that morality is an effect of law and social discipline is not to be committed to hold that man, by necessity of nature, is always selfish, or that there is no difference between merely obeying the law and having a sense of justice.’ 110 B Gert, ‘Introduction’ in T Hobbes, Man and Citizen (De Homine and De Cive), B Gert (ed) (Indianapolis IN, Hackett, 1991) 22. 111 Leviathan, above n 8, XIII, 90. Cf Dialogue, above n 92, 72–73: ‘A Just Action is that which is not Against the Law … Laws are in their Nature Antecedent to Justice and Injustice’.

Contractualism and Tax Governance: Hobbes and Hume  35 The subjects, therefore, retain a right to disobey commands when their lives are at stake. ‘When therefore our refusal to obey frustrates the end for which the sovereignty was ordained, then there is no liberty to refuse’, Hobbes writes.112 Disobedience can be justified when the sovereign is not protecting the people.113 The subjects have no property rights against the sovereign and can therefore legitimately be taxed. Taxation is an infringement on subjects’ liberties. ‘The Liberty of a Subject, lyeth therefore only in those things, which in regulating their actions, the Soveraign hath praetermitted’.114 The almost absolute sovereign is at liberty to interfere with the freedom of the subjects; his commands must be seen as their will. The obligation to pay tax – an interference with subjects’ liberty – has to be laid down in a command. It is up to the sovereign to determine this obligation. This obligation should be codified, prescribed by law, that is, a command. Sanctions should be put in law in order to enforce compliance. Coercion and fear of sanctions should deter self-interested subjects from non-compliance and enforce strict obedience. Absent any law that lays down such an obligation, there cannot be any duty to pay tax.115 ‘As for other Lyberties, they depend on the Silence of the Law’, argued Hobbes.116 In cases where the sovereign has not issued a command, prescribed no (detailed) rule, individuals possess a sphere of autonomy, not to be violated by taxation. The command theory is reflected in a strict attitude towards compliance: self-interested, distrustful individuals will go for the letter of the law, driven by a concern for their negative liberty (interference by others). It thus hard to conceive of any positive conception of taxation, citizenship and society: ­taxation is not seen as a civic obligation to contribute towards society – ­enhancing one’s positive liberty.117 With an almighty ruler above them, it is hard for taxpayers to view society as co-operative venture. In a state which relies on (almost) absolute sovereign authority and on coercive enforcement to overcome natural unsociability, voluntary ­taxation is hardly conceivable, as demonstrated by Rawls.118 He discusses in his Lectures on the History of Political Philosophy Hobbes’s doctrine of the social contract. 112 Leviathan, above n 8, XXI, 151. 113 May, above n 45, 126, referring to Leviathan, above n 8, ‘A Review, and Conclusion’, 491. At 136 he argues that though the conditions for justified obedience may seem quite harsh, they ‘leave the citizen with quite a bit more room than was generally allowed by those philosophers like Plato who wrote on this subject prior to Hobbes.’ 114 Leviathan, above n 8, XXI, 148. 115 The peremptory and ‘content-independent’ character of the sovereign’s commands (to pay tax) do not encourage taxpayers to reflect on the importance of tax as a contribution to society as ­cooperative venture. (See above.) 116 Leviathan, above n 8, XXI, 152. 117 Berlin, above n 60, 131: ‘The “positive” sense of the word “liberty” derives from the wish on the part of the individual to be his own master. I wish my life and decisions to depend on myself, not on external forces of whatever kind.’ 118 J Rawls, A Theory of Justice, rev ed (Oxford, Oxford University Press, 1999) 211. It is hard to imagine, he argues, ‘a successful income tax on a voluntary basis.’

36  Hans Gribnau and Carl Dijkstra In Hobbes’s view it is the role of the sovereign to stabilise the mutually beneficial social cooperation which ensures that ‘every person normally has a sufficient motive to comply with the rules and that these rules are ordinarily complied with’.119 In this context, Rawls gives the example of taxation.120 In order to focus on the issue of a coercive order, he proposes to assume that government spends taxes wisely for the common benefit and that the schedule of income taxation is fair. In case of a voluntary tax scheme, it might be that everyone is prepared to honestly pay their tax if other people do the same. But, as Rawls argues, in the large society one is not sure (even if there are actually no cheaters) and people do not want to be taken advantage of. In other words, can the taxpayer trust other taxpayers to pay for public action? Hence, there is need of a mechanism, that is, the state, that creates trust that taxpayers make their payments. Thus, there is a need for sanctions in case of non-compliance. ‘The idea is that it becomes rational for each of us to want some kind of sanction to be imposed, even though not anyone is actually unwilling [to pay their taxes]’.121 As shown above, there are hardly any limits to the power of the sovereign. Nonetheless, the wise sovereign has certain duties that follow from the law of nature. In his earlier work, De Corpore Politico, he says: ‘For the duty of a sovereign consisteth in the good government of the people’.122 He adds that governing to the profit of the subjects, is governing to the profit of the sovereign. Moreover, he continues, Salus populi suprema lex must understood not to refer to the mere preservation of the lives of the subjects, but ‘generally their benefit and goods’. This must have consequences for tax. Hobbes offers certain principles the sovereign should follow in determining the tax burden.123 Equality is a very important one. The burden of tax should be equally borne. Citizens often complain about taxes which they find too easily oppressive, he says. Yet, complaints about these kinds of burdens are justified when they are imposed on the citizens unequally.124 For a burden which would be light if all shared it, becomes heavy, and indeed intolerable, for the rest, when many wriggle out. And it is not so much the burden itself that men object to, as the inequality.125 119 J Rawls, Lectures on the History of Political Philosophy (Cambridge MA, Harvard University Press, 2007) 78. 120 cf J Rawls, ‘Legal Obligation and the Duty of Fair Play’ [1964] in J Rawls, Collected Papers (Cambridge MA, Harvard University Press, 1999) 126. 121 Rawls, above n 119, 79. To his mind, the example of voluntary taxation is just one of the many examples in ordinary life where such a mechanism makes sure that everyone does what is actually to their mutual advantage. 122 De Corpore Politico, above n 66, XXVIII, 172. 123 McArthur, above n 105, 224–25. 124 cf De Corpore Politico, above n 66, XXVIII, 174: ‘Secondly, to divide the burthens, and charge of the commonwealth proportionably. Now there is a proportionably to everyman’s ability and there is a proportionably to his benefit by commonwealth: and the latter is it, which is according to the law of nature. etc. when to men are equally enjoying it.’ 125 On the Citizen, above n 14, XIII, 10, 147. Cf Leviathan, above n 8, XXX, 238: ‘To Equall justice, appertaineth also the Equall imposition of taxes; the Equality whereof dependeth not on

Contractualism and Tax Governance: Hobbes and Hume  37 Tax exemptions are thus very sensitive matters, which lead to much envy. It is in the interest of the public quiet to address all just complaints, and therefore it is a duty of the sovereign authority to ensure that public burdens are borne equally. According to Hobbes, tax exemptions should be avoided because they fly in the face of equality. Equal taxation is not only in the interest of the public peace, for it is also a matter of natural law. For Hobbes, since what subjects contribute to the community is nothing else but the price they pay to purchase peace, it is logical that those who share equally in the peace should play an equal part – either by contributing money, or service to the commonwealth. It is a law of nature that in assessing others’ rights, every man should treat himself as equal to ever other man. Hence, sovereigns are obliged by natural law to impose the burdens of the commonwealth upon the citizens equally.126 Of course, the question is: equality of what? Hobbes elaborates on equal taxation. It is not about monetary equality, so he does not advocate a head tax. Rather, equal taxation refers to equality of burden, that is to say, ‘proportionate equality between burdens and benefits’. Tax is a contribution to the community paid to purchase peace and, of course, all citizens equally enjoy peace. Yet, the benefits springing from this peace are not equally distributed among the citizens, for some acquire more property and others less. So what’s the measuring stick? The question can be asked therefore whether subjects ought to contribute to the public purse, in proportion to their gains, or to their consumption, that is, whether persons should be taxed, so that they contribute in proportion to their wealth, or whether things should be taxed, so that each man contributes in proportion to consumption.127

Taxing wealth or consumption, that’s the question. Some benefit more by acquiring more property, others less. That would suggest taxing wealth. Nonetheless, taxing wealth is a bad idea, because people who possess equal wealth need not have acquired equal property – because consumption diminishes personal wealth. Some may be thrifty and keep what they have, others may waste their money on luxury goods. Paying taxes in proportion to wealth, thus implies that people do not bear the burdens of the commonwealth equally – while equally enjoying the benefit of peace. the ­Equality of riches, but on the Equality of the debt that every man oweth to the Common-wealth for his defence.’ It is rather unfortunate that Hobbes does not pay attention to low-income exemption, since according to M Kishlansky, A Monarchy Transformed: Britain 1603–1714 (London, Allan Lane/The Penguin Press, 1996) 27, ‘in the 1660s … one-third of all households were exempt from the Hearth Tax on grounds of poverty.’ He points at legislation aimed at alleviating the problem of poverty and the plight of the poor (establishing the principle of public welfare) which was sufficiently successful that by the end of the seventeenth century some of the better off were complaining about the increase of their taxes and rates (28–29). 126 ibid, XIII, 10, 147. He refers to ibid III, 15, 50: ‘that every man in distributing right to others, natural law forbids giving more or less to one person.’ 127 ibid, XIII, 10, 148.

38  Hans Gribnau and Carl Dijkstra On the other hand, where the things themselves are taxed, each man in spending his own money, without noticing it fully pays the portion due to the commonwealth, which is proportionate not to what he possesses, but to what, by virtue of the commonwealth, he did possess. There is therefore no longer room for doubt, that the first method of exacting money is against equity, and likewise against the duty of sovereigns, and that the latter method is consistent with reason, and with their duty.128

So, to Hobbes, government benefits were to be best measured by consumption. Indeed, it was ‘the heyday of the benefit theory of taxation, according to which a person should pay for what he gets’.129 Moreover, Hobbes’s suspicion of luxury shows. This aversion and the willingness to ‘see luxury consumption curtailed, was another commonplace of his time’.130 Hobbes: Conclusion Hobbes’s theory of political legitimacy and political obligation revolves around the legal instrument of the social contract, which marks the transition from the state of nature to the civil state. The contract is concluded by self-interested individuals driven by a fear of death. A lack of viable natural sociability, inadequate moral upbringing even animating conflict, requires strong, hierarchical mode of governance. The sovereign is not part to the contract – which accounts for his almost absolute sovereign power to which subjects submit themselves. This in turn translates into a voluntarist conception of law and governance. They therefore should be ruled top-down, ‘natural’ mutual obligations are partly replaced by obligations towards the rulers which have to be set out in laws. Absent any law that lays down such an obligation, there is no legal obligation (silence of the law). Coercion and fear of sanctions should enforce strict obedience, deterring self-interested subjects from non-compliance. This also goes for the obligation to pay taxes. In the Hobbesian model this obligation can hardly be seen as reciprocal obligation to contribute to society by paying to the state, since the almighty sovereign is free to rule as he pleases, having only a very limited obligation to the people. The sovereign’s power to tax is almost unlimited: there are no natural property rights which the sovereign has to respect and there is no such thing as (natural) distributive justice. Justice is conventional – to be decided upon by the sovereign. The obligation to pay tax has to be laid down in law – seen as a sovereign command backed by sanctions. Voluntary taxation is thus hardly conceivable. Nevertheless, ­natural

128 Ibid. Cf Leviathan, above n 8, XXX, 238 and 239: ‘nor is the Commonwealth defrauded by the luxurious waste of private men’. 129 H Groves, Tax Philosophers. Two Hundred Years of Thought in Great Britain and the United States, DJ Curran, ed, (Madison WI, The University of Wisconsin Press, 1974) 14. 130 McArthur, above n 105, 225. Cf Groves, above n 129, 15.

Contractualism and Tax Governance: Hobbes and Hume  39 law suggests some restraints to be observed by a wise sovereign. Equality is an important principle in this respect. Hobbes maintains that equal taxation refers to equality of burden. This implies proportionate equality between tax burdens and government benefits, whereas the latter are to be best measured by consumption. For him the benefit theory of taxation entails taxing consumption – curtailing luxury consumption being a secondary goal. In this hierarchical mode of governance, it is hard to rely on taxpayers’ willingness to comply with their legal obligations. Thus, the government (through the tax authorities) has to resort to enforced compliance based on the coercive powers of revenue authorities to make taxpayers comply with their legal ­obligations. DAVID HUME

Hume’s Social Contract and its Context David Hume (1711–76) and his contemporaries of the Scottish Enlightenment lived under better circumstances than Hobbes: political stability in a century of relative peace, far away from court or any other political institution. After the Union with England in 1707, great economic advantages were forthcoming in Scotland of Hume’s time. Despite several attempts of rebellion (1715, 1745), English power was established. This was highly dependent on the support of local aristocracy and clergy, under English supervision. After the Union the Scots were not to think of themselves as subjected people. On the contrary, shamed by their apparent backwardness, they patriotically tried to improve circumstances in every possible way: intellectuals, politicians, aristocrats, clergymen and above all entrepreneurs resolved to improve conditions in their country. The Republic of Letters was born.131 Edinburgh, coined by Voltaire as the ‘Athens of the North’,132 had been intellectually reformed in the late seventeenth century under the sponsorship of (the Scottish) King James VII. Academic life started to flourish, together with ­Aberdeen and Glasgow after 1700. The Aberdeen ‘Wise Club’ was founded, just as the Glasgow Literary Society and the Philosophical Society of Edinburgh. It was in Edinburgh that David Hume started his academic education, at the age of ten. Introduced into the Aristotelian-scholastic epistemology and (Dutch) Calvinistic theology, it is highly plausible that Hume also read Descartes, Locke, Hobbes, Bayle and Berkeley, the leading thinkers of modernity. Hume would share a lifelong scepticism with Descartes, Hobbes and Bayle. 131 R Emerson, ‘The Contexts of the Scottish Enlightenment’ in A Broadie (ed), The Cambridge Companion to the Scottish Enlightenment (Cambridge, Cambridge University Press, 2010) 9, 12–14. 132 M Stewart, ‘Hume’s Intellectual Development, 1711–1752’ in M Frasca-Spada (ed), Impressions of Hume (Oxford, Oxford University Press, 2005) 11, 15.

40  Hans Gribnau and Carl Dijkstra Hume’s ­ epistemology could be described as the most radicalised form of ­empiricism since Locke and Berkeley.133 With most of these philosophers Hume shared an almost natural distrust of religious authority. The philosophers who inspired Hume in his early years inspired him for the rest of his life, as the famous James Boswell noted. He witnessed Hume at his deathbed, claiming that he (Hume) ‘never had entertained any belief in religion since he began to read Locke and Clarke’.134 Despite Hobbes’s influence on Hume, the differences between Hobbes and Hume are striking. This cannot be separated from the aforementioned social and political circumstances. Whereas Hobbes lived under the constant threat of war, political instability and rival royal pretenders, the Scottish Enlightenment which Hume was part of can be characterised as an independent and unique movement. Being geographically isolated and thereby not of any political importance outside the Union, on the one hand, and shaped and challenged by a ‘global’ intellectual upheaval on the other hand, Scotland was destined to become a place of scientific, philosophical and cultural progress. After travelling throughout France and Britain, Hume returned to Edinburgh in 1751 (where he eventually died), to become one of the key figures of the Scottish Enlightenment.135 The completely different circumstances under which Hume worked, compared to Hobbes, result in a different moral psychology, and by consequence, a contrasting political philosophy and (tax) ethics. Whereas Hobbes (and to a minor degree Locke) emphasise the amorality of human nature, if not its immorality (a selfish ‘atomic’ individual), Hume’s moral psychology can be summarised as follows: human beings have an inborn but limited sympathy towards their fellow human beings. By nature, human beings are social and socially equipped. Cooperation arises naturally among kin and is further settled and expanded by education, custom, routine and the experience of its success. A general feeling of common interest, not a social contract, eventually construes (primitive) society. Unlike Hobbes, Hume believes that society is built on a convention or an agreement which, however, does not include a promise (contract) or strong authority. In short, public governance is based on cooperation naturally arising among kin which government has to safeguard and enhance in large societies, instead of on an asocial, self-preserving ethos which necessitates a contract to oblige subjects and establish an almighty government, ruling top-down by commands (Hobbes). Whereas Hobbes’s starting point is egoism and violence, for Hume it is a certain sympathy and care towards next of kin. Hobbes’s main concern is how

133 R Brandt, ‘The Beginning of Hume’s Philosophy’ in G Morice (ed), David Hume: Bicentenary Paper (Edinburgh, University of Edinburgh Press, 1977) 117–27. 134 J Boswell, ‘An Account of My Last Interview with David Hume, Esq.’ in Private Papers of ­Malahide Castle (New York, WE Rudge, 1928) 227. 135 D Norton, ‘An Introduction to Hume’s Thought’ in D Norton (ed), The Cambridge Companion to Hume (Cambridge, Cambridge University Press,1993) 1, 3–7.

Contractualism and Tax Governance: Hobbes and Hume  41 to exercise one’s rights without interfering with the rights of others, whereas Hume instead asks us how to lead a moral life of responsibilities in community with others.136 As a consequence, for Hume, unlike Hobbes, society is defined not by obedience and obligation, but by cooperation and convention. Mackie calls it ‘moral codes … reflecting ways of life’.137 Rowers in a boat agree to cooperate without making a promise, as Hume used this image to explain his view. When primitive societies are established, institutions, like the magistracy, are established, as our sympathy is limited. But above all, our benevolence towards our kin is always the starting point for every cooperation, there being no need for or proof of a (historical) contract which binds us all. That leaves us with the question: how is society precisely formed according to Hume, and what is the relation between public governance on the one hand, and taxpayers on the other hand? Hume and the State of Nature Whereas Hobbes framed the brutal but hypothetical state of nature (in contrast with the justified state under the rulership of the Leviathan), Locke believed the state of nature to be less violent but a historical matter of fact. Hume did neither believe in the hypothetical ‘war of all against all’, nor in any historical state of nature. Nevertheless, Hume’s account on justice places property within a historical, evolving framework.138 Or as Haakonssen explains Hume’s evolving state of nature: ‘Hume’s theory is of such a design that it fairly clearly points out the place of history, without itself being a historical theory.’139 How did he consider the presocial human condition in his A Treatise of Human Nature? When we consider a Humean state of nature, we should forget most of what Hobbes made of it. The latter held the opinion that human beings are basically ‘egoistic atoms’. Though human beings are born weak and in need, Hume believed in a natural benevolence or sympathy towards next of kin. However, the starting point is the physically deplorable state in which human beings are born: Of all the animals, with which this globe is peopled, there is none towards who nature seems, at first sight, to have exercised more cruelty than towards man, in the numberless wants and necessities, with which she has loaded him, and in the slender means, which she affords to the relieving these necessities.140

136 C Gilligan, In a Different Voice (Cambridge MA, Harvard University Press, 1982) 21. 137 J Mackie, Ethics: Inventing Rights and Wrong (London, Penguin Books, 1977) 30. 138 A Baier, The Cautious, Jealous Virtue: Hume on Justice (Cambridge MA, Harvard University Press, 2010) 80. 139 K Haakonssen, The Science of a Legislator: The Natural Jurisprudence of David Hume and Adam Smith (Cambridge, Cambridge University Press, 1981) 38. 140 D Hume, A Treatise of Human Nature, 2nd edn (eds LA Selby-Bigge and PH Nidditch) (Oxford, Clarendon Press, 1978) 484.

42  Hans Gribnau and Carl Dijkstra Nowadays this almost blunt claim could be validated by evolutionary biology and zoology, but in Hume’s days its credibility depended (probably) on Calvinistic theology, Aristotelian philosophy and the insights of (indeed!) Hobbes. With Hobbes, Hume pictures human beings as born in need for which society alone is the solution: It is by society alone he is able to supply his defects, and raise himself up to the equality with his fellow-creatures, and even acquire a superiority above them.141

But, unlike Hobbes, Hume doesn’t conclude that cooperation is born out of pure egoism. His reasoning is far more refined. Indeed, by the additional force, ability and security, a society becomes advantageous, but more is needed than just the advantages itself: in order to form society, it is requisite not only that it be advantageous, but also that men are sensible of these advantages.142

How do human beings become sensible of the advantages of society? For Hume, domestic life, custom and habit – summarised as upbringing – are the answer to that question: In a little time, custom and habit operating on the tender minds of the children, makes them sensible of the advantages, which they may reap from society, as well as fashions them by degree for it, by rubbing off these rough corners and untoward affections, which prevent their coalition.143

The ‘natural appetite betwixt the sexes’144 and its natural consequence, family life, forms the actual state of nature. Only custom and habit (concepts Hume also used in his empirical epistemology) in education socialise human beings by ‘evidence based’ proof of the advantages of social life. For that matter the upbringing of children by parents cannot be reduced to any primordial form of egoism. Here Hume speaks to Hobbes with human beings as ‘monsters, which we meet with in fables and romances’: So far from thinking, that men have no affection for any thing beyond themselves, I am of opinion, that though it be rare to meet with one, who loves any single person better than himself; yet it is as rare to meet with one, in who all the kind affections, taken together, do not overbalance all the selfish. Consult common experience: do you not see, that though the whole expence of the family be generally under the direction of the master of it, yet there are few that do not bestow the largest part of their fortunes of the pleasures of their wives, and the education of their children, reserving the smallest portion for their own proper use and entertainment.145



141 ibid, 142 ibid,

485. 486.

144 ibid,

487.

143 ibid. 145 ibid.

Contractualism and Tax Governance: Hobbes and Hume  43 Raised in family life, custom and habit shape human beings into socially developed beings, aware of the advantages of society. However Hume is well aware of sympathy being limited to close relations and acquaintances. Where benevolence is natural but bounded, a remedy is needed to save human beings from the their ‘uncultivated nature’,146 given this partiality and unequal affection. Hume catalogues it as follows: Now it appears, that in the original frame of our mind, our strongest attention is confined to ourselves; our next is extended to our relations and acquaintances; and it is only the weakest which reaches to strangers and indifferent people.147

It is emphasised: our sympathy weakens when our relation to the other is less strong, but it seems not to cease completely. The literal meaning of ‘neighbourhood’ of our fellow-creature captures the idea of how sympathy is distributed in the ‘presocial society’. But with limited sympathy the enjoyment of possessions is unstable, and scarcity of goods is a matter of fact: among strangers there exist no such things as possessions. Hume speaks of ‘chief impediments’ when he refers to the scarcity of goods and instability of property.148 The solution he offers seems at first sight similar to the ones Hobbes offered earlier: This can be done after no other manner, than by a convention entered into by all the members of the society to bestow stability on the possession of those external goods, and leave every one in the peacable enjoyment of what he may acquire by his fortune and industry.149

But notice that Hume writes ‘leave every one in the peacable enjoyment’ (emphasis added). For Hume, the pre-social human condition is thereby not ‘a war of all against all’, but a world of small societies built on kinship where people enjoy their possessions. The state of nature seems to be rather tranquil and peaceful, a view maybe even echoing that of Hume’s close friend Rousseau. It is primarily the instability of property and scarcity of goods which lead to a social contract to liberate human beings from the ‘uncultivated nature’. Secondly, there is partiality and unequal affection. The social contract itself, or as Hume calls it a convention, is quite different from the ones we have seen in the works of Hobbes. But with both of them Hume shares the simple but intriguing question: ‘how does a social contract or convention function?’ Hume and the Social Contract Partiality and unequal affection, but above all instability of property and scarcity of goods, are the main ingredients of the Humean social convention.

146 ibid, 147 ibid. 148 ibid. 149 ibid.

488.

44  Hans Gribnau and Carl Dijkstra But in essence it is a convention without being a contract. It is a general and mutual sense of common interest: I observe, that it will be in my interest to leave another in the possession of his goods, provided he will act in the same manner with regard to me. He is sensible of a like interest in the regulation of his conduct.150

Here, Hume makes the famous comparison of two men who pull the oars of a boat by agreement, though they have never given promises to each other. As far as Hume considers societies as the outcome of a convention, it is based on mutual positive experiences of cooperation on a personal level and the trust we build on these experiences, just like the two oarsmen. It is not a promise which guarantees their cooperation, it is the cooperation itself which guarantees the promise. For Hume, a convention is primordial to a promise: keeping a promise is only reasonable after trust between parties is consolidated. Drawn on experiences of mutual respect, custom and habit are the key concepts of the radical empiricist Hume; or reciprocity or mutual altruism, as it is called in evolutionary ethics.151 But social convention based on positive experiences of mutual altruism seems to function only within close relationships like kinship, or at least where there is a general sense of common interest. For Henley, Hume explains the way conventions of promise-keeping evolve because they serve the mutual advantage of individuals, securing to each what is in his interest.152 This makes Hume a different contractarian from Hobbes: mutual advantage is a necessary condition for any convention.153 Therefore, it is clear that the conventional character of justice should not be taken in the Hobbesian sense. Hume explicitly asserts that justice is a man-made device to cope with a world of relative scarcity and limited benevolence. Talk about ‘consent’ as the origin of government is for Hume ‘entirely erroneous’.154 In Hume’s philosophy it is precisely this notion of consent that is firmly placed within the limits of existing society: But when society has become numerous, and has increased to a tribe or nation, this interest is more remote; nor do men so readily perceive, that disorder and confusion follow upon every breach of these rules, as in a more narrow and contracted society.155

A further complication for social cooperation is presented here by Hume: the complexity of a growing society. In a numerous and complex society, 150 ibid, 490. 151 C Buskes, Evolutionair denken – de invloed van Darwin op ons wereldbeeld (Amsterdam, Uitgeverij Nieuwezijds, 2006) 307. 152 K Henley, ‘Hume’s “Wilt Chamberlain Argument” and Taxation’ (2012) 42(1) Canadian Journal of Philosophy, 148, 151. 153 D Gauthier, ‘David Hume, Contractarian’ (1979) 88(1)8 The Philosophical Review, 3, 12. 154 PC Westerman, ‘Hume and the Natural Lawyers: A Change of the Landscape’ in MA Stewart and JP Wright (eds), Hume and Hume’s Connexions (Edinburgh, Edinburgh University Press, 1994) 83, 91–92. 155 A Treatise of Human Nature, above n 140, 499.

Contractualism and Tax Governance: Hobbes and Hume  45 Hume argues, it becomes less self-evident to act according to the unwritten law of common interest. This is where justice is born. ‘Rules of justice’, as Hume call the civil laws which guarantee our property claims, bind every member of the young society by a regard to self-interest: To the imposition then, and observance of these rules, both in general, and in every particular instance, they are at first induced only by a regard to interest; and this motive, on the first formation of society, is sufficiently strong and forcible.156

For purposes of the consolidation of property in more numerous and complex societies regulation as an artefact is invented. On the other hand, there is still room for sympathy. Even more than that: Nay when the injustice is so distant from us, as no way to affection our interest, it still displeases us; because we consider it as prejudicial to human society, and pernicious to every one that approaches the person guilty of it. We partake or their uneasiness by sympathy; and as every thing, which given uneasiness in human actions, upon the general survey, is called Vice, and whatever produces satisfaction, in the same manner, is denominated Virtue: this is the reason why the sense of moral good and evil follows upon justice and injustice.157

Whereas sympathy is an intrinsic motive to act according to the common interest, regulation is its extrinsic counterpart. For the latter, politicians are needed to guard the ‘rules of justice’, as each act of natural virtue such as benevolence is like a stone added to a wall, contributing on its own to the building of happiness. Justice, in contrast, is like a vault – only the whole scheme, not individual parts, serves the purpose of promoting mutual advantage.158 The government by creating the vault, fills out the bare bones of justice and executes its requirements.159 Or, according to Snape, a prudent legislator mixes expedience with justice. He is an architect, a designer of the edifice of the state.160 Whoever these politicians may be, they are comparable with parents, in Hume’s view: educationists who teach human beings the practical rules of the social convention. This teaching demands coercion to remedy the short-sightedness of individuals and to coordinate their efforts in needed public endeavours.161 Next to educationists, they seem to be legal mediators: it is not only about the execution of justice, but also about the decision of justice, to speak in Humean language. According to Wiley, the role of the magistrates makes Hume an elitist, who sees social hierarchy as

156 ibid. 157 ibid. 158 J Sobel, Walls and Vaults: A Natural Science of Morals (Virtue Ethics According to David Hume) (Hoboken, John Wiley, 2009) 227–28 and Henley, above n 152, 153. 159 Henley, above n 152, 151. 160 J Snape, ‘David Hume: Philosophical Historian of Tax Law’ in: P Harris and D de Cogan (eds), Studies in the History of Tax Law. Studies in the History of Tax Law vol 7 (Oxford, Hart Publishing, 2015) 421, 461. 161 Henley, above n 152, 151.

46  Hans Gribnau and Carl Dijkstra necessary for all societies.162 But what is the role of these politicians? Hume gives plenty of examples to explain the role of the magistrates: while two neighbours may agree to drain a meadow which they possess in common, imagine, Hume argues, that a thousand persons are involved in making the decision to drain it: it being difficult for them to concert so complicated a design, and still more difficult for them to execute it; while each seeks a pretext to free himself of the trouble and expense and would lay the whole burden on others. Political society easily remedies both these inconveniences. Magistrates find an immediate interest in the interest of any considerable part of their subjects. They need consult nobody but themselves to form a scheme for the promoting of that interest.163

From this, Hume had drawn the ultimate conclusion: Men cannot live without society, and cannot be associated without government. Government makes a distinction of property, and establishes the different ranks of men. This produces industry, traffic, manufactures, law-suits, war, leagues, alliances, voyages, travels, cities, fleets, ports, and all those other actions and objects, which cause such diversities, and at the same time maintain such an uniformity of human life.164

For Hume, political power is the natural and direct consequence of self-interest in a complex and numerous society, whereas for Hobbes a social contract is required to subject people to the political authority. Hayek considers, like Hume, the social evolution of ‘spontaneous order’ the key to institutions of law and liberty in Western democracies.165 The government, according to Hume (unlike Hobbes), gradually unfolds itself, without a prior design.166 Hume’s focus is on benevolence, reciprocity, property, trade and economic stability, whereas the focus of Hobbes is on security, obedience and political legitimacy. For Hume, the role of the government is on the background. According to McArthur, who recapitulates Hume’s political philosophy, Hume believed that we should try to balance our demand for liberty with the need for strong authority, without sacrificing either. By that, Hume is characterised by McArthur as a ‘precautionary conservative’ whose actions would have been ‘determined by prudential concerns about the consequences of change, which often demand we ignore our own principles about what is ideal or even legitimate’.167 But whereas Hobbes argues for a vertical ‘command and control’ government, Hume seems to ­advocate a more

162 J Wiley, Theory and Practice in the Philosophy of David Hume (New York, Palgrave Macmillan, 2012) 252. 163 A Treatise of Human Nature, above n 140, 539. 164 ibid, 402. 165 F Hayek, Rules and Order (Chicago IL, University of Chicago Press, 1973) 122–23. 166 Henley, above n 152, 155. 167 N McArthur, David Hume’s Political Theory: Law, Commerce, and the Constitution of ­Government (Toronto, University of Toronto Press, 2007) 124.

Contractualism and Tax Governance: Hobbes and Hume  47 horizontal, organic and responsive governance and regulation.168 Whereas for Hobbes, a pre-requisite for society to exist is government, for Hume governance is the natural consequence of the needs of people. Where does this difference come from? Probably a different view on man and moral psychology. Hume’s View on Man: Moral Psychology What captures Hume’s moral psychology? Probably the denial that human beings regulate their actions by reason. Here again Hume shows his empirical, behaviourist stance, based on a ‘pain and pleasure’ principle: It is obvious, that when we have the prospect of pain or pleasure from any object, we feel consequent emotion of aversion or propensity, and are carried to avoid or embrace what will give us the uneasiness or satisfaction.169

As Hume’s moral psychology roots in experience, what is the precise interplay of ‘reason and experience’? The answer is that passions precede reason. Out of experience, custom and habit, we learn which objects cause aversion and which objects cause propensity. In short, our passions determine our goals (in life) as an impulse, after which reason directs us. This leads to the Humean credo: We speak not strictly and philosophically when we talk of the combat of passion and of reason. Reason is, and ought only to be the slave of passions, and can never pretend to any other office than to serve and obey them.170

Hume is not advocating any irrational sentimentalism, popular in late eighteenth century literature (see for example Laurence Sterne’s A Sentimental Journey), but maintains that reason is subordinate to the passions. Cohon speaks about the inertia of reason.171 According to Mason, Hume is not an anti-rationalists but rather a sceptic of practical reason.172 An interesting consequence of Hume’s inertia of reason is that, unlike for example Descartes, there is no tension between ‘sense and sensibility’, to speak with Jane Austen: The consequences are evident. Since passion can never, in any sense, be called unreasonable, but when founded on a false supposition or when it chooses means insufficient of the designed end, it is impossible, that reason and passion can ever opposite each other, or dispute for the government of the will and actions.173

168 H Gribnau, ‘Soft Law and Taxation: The Case of The Netherlands’ (2007) 1(3) Legisprudence 291, 293–96. 169 A Treatise of Human Nature, above n 140, 414. 170 ibid, 415. 171 R Cohon, Hume’s Morality: Feeling and Fabrication (Oxford, Oxford University Press, 2008) 14. 172 M Mason, ‘Hume and Humeans on Practical Reason’ (2005) 31(2) Hume Studies 347, 352. 173 A Treatise of Human Nature, above n 140, 416.

48  Hans Gribnau and Carl Dijkstra Whatever human beings wish is a matter of the passions, but in order to reach the thing wished for, reason should be involved, to inform us about the means. But Hume himself does not recognise a practical employment of reason as such. Hume’s theory leads to ‘his eschewal of the idea that there is such a thing as practical reason’.174 According to Singer, Hume’s denial of practical reason and his argument that morals cannot have a rational basis alone would have been enough to earn him a place in the history of ethics,175 although Cohon states: ‘Hume may be a great iconoclastic genius in metaphysics and epistemology, but he was a clumsy … ethical theorist.’176 Cohon might be right in as much as Hume’s moral psychology assumes the presence of impartial observer or spectator. For Hume, right and wrong is not a matter of reason, but of convention based on emotion and empathy: The hypothesis which we embrace is plain. It maintains, that morality is determined by sentiment. It defines virtue to be whatever mental actions or quality gives the spectator the pleasing sentiment of approbation; and vice the contrary.177

Hume holds a virtue theory here: a virtue is a quality of the mind. Traits are virtues in as much as they evoke moral approval by an impartial spectator. In absence of this effect, it would not be a virtue for Hume. Virtues, according to Hume, communicate pleasure because they tend to obtain ends to which the spectator is not by nature indifferent.178 This is a striking difference with the Aristotelian idea of virtue, which is independent from the response of the (impartial) observer.179 But how are these mental qualities necessarily recognised by others? For Hume, the notion of morals implies on the one hand some mysterious common ground of sentiments for all mankind (in modern terms ‘emotivist’180) and on the other hand a conventionalist premise, from which virtues, above all justice, arise: But if by convention be meant a sense of common interest; which sense each man can feel in his own breast, which he remarks in his fellows, and which carries him, in concurrence with others, into a general plan or system of actions, which tends to public utility; it must be owned, that, in this sense, justice arises from human conventions.181 174 J Hampton, ‘Does Hume Have an Instrumental Conception of Practical Reason?’ (1995) 21(1) Hume Studies 68. 175 See P Singer, The Most Good You Can Do: How Effective Altruism Is Changing Ideas About Living Ethically (New Haven CT, Yale University Press, 2015). 176 Cohon, above n 171, 12. 177 D Hume An Enquiry Concerning the Principles of Morals, TL Beauchamp ed, (Oxford, ­Clarendon Press, 1998) 85–86. 178 S Vodraska, ‘Hume’s Moral Enquiry: An Analysis of its Catalogue’ in S Tweyman (ed), David Hume – Critical Assessments. vol IV (London, Routledge, 2002) 13, 29. 179 Cohon, above n 171, 161. 180 The core idea of emotivism is that ‘ethical statements are not in the business of stating truths or falsehoods; they are instead expressions of emotion’; M Chrisman, ‘Ethical Expressivism’ in C  Miller (ed), The Bloomsbury Companion to Ethics (London, Bloomsbury, 2011) 38. Cf A MacIntyre, After Virtue (Notre Dame Press IL, University of Notre Dame Press, 1984) 5–35. 181 Enquiry, above n 177, 98.

Contractualism and Tax Governance: Hobbes and Hume  49 In his conventionalist point of view, Hume believes that virtues are praised within the society in which they are explored. Conventions express virtues which serve the common good. But nothing is at the end as volatile as conventions. So, may we conclude that Hume’s moral psychology makes him a modern relativist? According to himself he wasn’t: Though many ages have elapsed since the fall of Greece and Rome; though many changes have arrived in religion, languages, laws and customs; none of these revolutions has ever produced any considerable innovations in the primary sentiments of morals.182

Virtues are relative qualities of the mind but are generally approved within a certain society. Despite the differences, this perspective touches Aristotle’s ethics of virtues in a way, though Hume strongly focuses on the contingency of virtues within a certain historical society. On the other hand, the principle of humanity diminishes the diversity of ‘the primary sentiments of morals’. In the end, Hume can be classified as conventionalist, a slightly different position from today’s cultural relativism. Hume’s View on Taxation Unlike Hobbes, Hume wrote separately on taxation in his essay ‘Of Taxes’.183 However, the main disadvantage of this essay is its lack of consistency. This might explain his absence from the history of tax philosophers.184 His thoughts about taxation seem to be more an assemblage of separate thoughts, than a consistent exposition on taxation. Another disadvantage is that Hume neglected to embed his view on taxation in his political or moral theory. The consequence of this neglect is a ‘detached’ explanation of taxation, without a moral foundation. In addition, Hume does not unequivocally express his views on property and taxation, which leaves the reader considerable room for interpretation. Moreover, his essay on taxation shows a tension between the values of liberty and equality (in terms of wealth).185 According to Dees, this tension makes Hume both conservative and liberal, although these terms are anachronistic, when it comes to the politics of taxation.186 Wiley coins Hume as a conservative, but his conservatism is moderate.187 In his short essay, Hume assumes that taxes on consumption, especially luxury goods, are preferable, because that impacts the bulk of people the least.

182 ibid, 118. 183 D Hume, Essays, Moral, Political, and Literary (Indianapolis IN, Liberty Fund, 1985) 342–49. 184 Groves, above n 129, 15. 185 Henley, above n 152, 159. 186 R Dees, ‘“One of the Finest and Most Subtle Inventions”: Hume on Government’ in E Radcliffe (ed), A Companion to Hume (Oxford, Wiley-Blackwell, 2010), 388–405. 187 Wiley, above n 162, 252.

50  Hans Gribnau and Carl Dijkstra His preference for luxury taxes is not based on puritanical sentiments, but rather on a concern to burden the rich more than the poor – a kind of progressive taxation.188 So, although liberty (which is highly estimated by Hume, as we have seen) can be incompatible with equality of wealth, taxing the rich more than the poor is consistent with liberty in a commercial society as long as it fosters industriousness among all people. Henley summarises Hume’s theory of taxation as modest liberalism, which recognises a role for the state that is larger than a minimal state (Nozick), but limited by the need to maintain motivation for individuals to be productive and the working of commercial society with a free market.189 According to Stewart, Hume’s perfect equality would lead to impoverishment.190 Taxes do not primarily have the function of redistribution. Nevertheless, taxes can redistribute wealth, as Hume shows us, to our opinion. In as much as taxation corresponds with consumption, Hume presumes that taxes are (partially) voluntary. As human beings, we are able to influence by our consumption the level of taxes we have to pay. A positive side-effect, according to Hume, is that taxes on consumption might encourage sobriety and frugality. A disadvantage of these taxes is the fact that they are expensive to levy.191 The focus of taxation on consumption disguises Hume’s hesitation about any land taxes and poll taxes. At the end, Hume’s conventionalist agenda appears: poll taxes can be oppressive and intolerable, whereas taxes upon land are finally and exclusively laid on ‘the landed gentleman’. These few thoughts from his short essay show a lack of theoretical foundation: what would be wrong with levying ‘the landed gentleman’, and how voluntary is any taxation on consumption, in as much as it includes taxation of basic goods? In a nutshell, Hume’s short essay on taxation does not unfold a consistent (moral) theory of taxation, nor does it overcome its speculative character, as it is founded on tenuous assumptions or even prejudices. If Hume contributes anything to a debate on taxes, the sources of his contribution should not be found in his essay on taxes, but in the rest of his philosophy. A first remark is that taxation as such is not mentioned in Hume’s ­Treatise and Enquiry. But one could argue that the Treatise and the Enquiry equip us with an outline of a Humean theory of taxation, based on his general political and ethical theory. I will emphasise the interplay between the state and

188 Henley, above n 152, 158. 189 ibid, 159. 190 J Stewart, Opinion and Reform in Hume’s Political Philosophy (Princeton NJ, Princeton ­University Press, 2014) 163–64. 191 Adam Smith’s well-known fourth maxim of taxation springs to mind: ‘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’; A Smith, An Inquiry in the Nature and Causes of the Wealth of Nations [1776] (Indianapolis IN, Liberty Fund, 1981) V.ii.b, 1–6, 825–27.

Contractualism and Tax Governance: Hobbes and Hume  51 the ­community or taxpayers. Like Hobbes, the key concepts of a tax theory for Hume are the profit principle and the concept of social reciprocity. But the way in which Hume and Hobbes interpret these concepts is totally different. Evidently, this different approach has consequences for their ideas on, for example, the role of the government, governance and taxation. To recapitulate Hume’s political Treatise: Hume’s state of nature is, compared to Hobbes’s, rather peaceful, consisting of families and small communities. Unlike Hobbes, Hume didn’t believe in any historical ‘war of all against all’, nor in a social contract that would bind us all without any personal consent to it. The point of departure in Hume’s political theory is not war, but (limited) benevolence, which is further cultivated by upbringing, gaining and growing trust, custom and habit, which ‘shape’ human beings to socialise. But whereas our benevolence is natural but restricted, and goods are scarce, the instability of property in primitive societies can only be overcome by a social convention. This convention is not a contract: it grows ‘organically’ among people by cooperation, trust and a sense of common interest, but is protected by magistrates (or politicians). These politicians are educationists and legal mediators at the same time. Hume’s focus, we might conclude, is on civil law, not on public law. The magistrates regulate and guarantee the (civil) law: they manage society’s problems and affairs (governance), without being a vertical ‘command and control’ government. For Hobbes, fiscal obligations exist towards the sovereign, from whom we benefit in as much as he protects us under the social contract from other fellow human beings. Obedience is almost absolute. Taxes are, to put it bluntly, at the end, a lawful ransom in exchange for safety and the protection of property. Where there is the famous ‘silence of the law’, there exist no further obligations towards the sovereign. Hobbes’s legal philosophy is therefore positivistic: everything is allowed and nothing obligated as long as the sovereign and the law are silent. As a consequence, aggressive tax planning is not (morally) prohibited, unless the sovereign should decide differently or if it would harm the interests, mainly property, of fellow human beings. Hobbes’s political philosophy is almost amoral, but above all purely legalistic. Fiscal obligation reach as far as the law provides. The counterpart of Hobbes’s shallow tax ethics is his vertical style of government. The differences with Hume are striking: in Hume’s philosophy the role of the government is on the background; absolute sovereignty is not at stake. If there is any sovereignty it evolves organically, almost ‘horizontally’, from the growing complexity of larger societies in order to correct the limited benevolence. The relationship between the sovereign and the citizens can be qualified as collaborative, rather than based on absolute obedience. The magistrates are installed to oversee the common good in a complex society and to accompany small and local initiatives. Illustrative is Hume’s example of Indian tribes who only elect a chief in times of war. This proves for Hume that in primitive societies there is

52  Hans Gribnau and Carl Dijkstra no need of any central power. Political power is, at best, a remedy for the limited sympathy. Unlike Hobbes, in Hume’s theory the concept of the common interest is essential. Although taxes are levied by a central state authority, such as the magistrates, they are levied in order to serve the common interest. In as much as citizens have a sense of common interest, they might pay taxes voluntarily or at least consent with them as long as they catch the common interest which taxes serve. Unlike Hobbes, force might not be needed to create responsibility. In a naturalist reading of Hume’s view, attributions of (fiscal) responsibility are made via feelings of approval and disapproval, not by commands or judgments of the sovereign.192 Again, a strong hostile government (Hobbes) versus ­cooperative governance by the state (Hume). On the other hand, for Hume the fiscal obligation might reach further than the law if the common interest should ask for it. This idea is closely tied to the idea of voluntary taxes. Fiscal obligations can (at least in theory) be beyond the law. Whereas for Hobbes the letter of the law is predominant, for Hume the spirit of the law seems to be leading. This is nicely illustrated by Hume’s example of decision making with thousand people involved in the project of draining a meadow. A sovereign can steer the process; at the end it are the people who decide about the communal projects. But the common interest might ask more from citizens than what is written in the law: the drainage project might be in the public interest, yet there is no legal or judicial obligation to pay for the project through taxes. Well-informed citizens, aware of the need for the drainage project, might agree with voluntary taxes in order to finance the project. As for Hume, the common good seems to be so important that accurate information about it might increase the social support, by means of taxes, among the public. In more complex societies, proper information about the common good and its costs could contribute to the willingness to pay taxes. That also counts as governance. But the opposite might also be true for Hume: not everything which is allowed under the law is desirable for the common good. This idea might be applicable to aggressive tax planning, for example: though allowed under the law, it would be classified as undesirable for the common good, according to Hume. It would not only undermine the common good, but also the – already – limited benevolence between people. For Hume, trust, based on positive experiences from the past, is constructive for social interaction and therefore indispensable for societies. Benevolence and trust would diminish, and as a consequence social disintegration could occur, especially as Hume (unlike Hobbes) doesn’t seem to advocate a strong sovereign to protect society from instability.

192 P Russell, Freedom and Moral Sentiments: Hume’s Way of Naturalizing Responsibility (New York, Oxford University Press, 1995) 60–64.

Contractualism and Tax Governance: Hobbes and Hume  53 Whereas Hobbes’s Leviathan could (in theory) fight the social instability which could result from aggressive tax planning, Hume’s convention, based on trust and limited benevolence, would be weakened. CONCLUSION

Hobbes and Hume are key figures in the history of political thought, sharing an interest in political authority, consent and citizens’ duty to obey the law. As such, they represent two very different modes of governance; that is, the legitimate exercise of government power, and the ensuing relationship between government and citizens (taxpayers). These different modes reflect their diverging approaches to man, consent, contract, sovereignty and society. Hobbes’s theory of political legitimacy and political obligation revolves around the legal instrument of the social contract. Self-interested individuals driven by the fear of death leave the state of nature which is devoid of viable sociability and civilisation, and enter the civil state. The sovereign has almost absolute authority, to which subjects submit themselves. Hobbes advocates a very hierarchical mode of governance. The sovereign governs by way of law conceptualised as a command. His power to tax is almost unlimited – absent natural property rights and (natural) distributive justice. Justice is conventional – a matter of sovereign discretion. The obligation to pay tax has to be determined by the sovereign and be laid down in law – seen as a command backed by sanctions. Government (tax authorities) must rely on coercion and deterrence to force its subjects to comply with their legal obligations. In short, the overriding need for security leads to a justification of strong, hierarchical governance and strict obedience. Voluntary taxation is out of the question. A wise sovereign observes natural law, which suggests some restraints on taxation. Equality is an important principle in this respect. For Hobbes, equal taxation refers to equality of burden. This implies proportionate equality between tax burdens and government benefits, whereas the latter are best measured by consumption. For him, the benefit theory of taxation entails taxing consumption – curtailing luxury consumption being a secondary goal. In Hume’s philosophy the role of the government is in the background; absolute sovereignty is not an issue. Gifted with a natural (but limited) benevolence and developed with (parental) education, human beings cooperate without the intervention of a contract. A sense of the common good creates an unwritten convention – unlike any kind of explicit social contract. In as much as human beings share this sense of the common good, they might voluntarily pay taxes, and if they are not willing to pay taxes for the common good, the government is there to force them – not for the sake of the state power itself, but for the common good of the people. This is altogether different from Hobbes’s almost absolute

54  Hans Gribnau and Carl Dijkstra duty to obey – legal obligations being commands with sanctions to deter the subjects from non-compliance. Institutions do not need to force self-interested individuals to comply but rather support individuals’ inborn but limited sympathy towards their fellow human beings to enhance cooperation in large societies. Sympathy motivates them to act according to the common interest. For Hume, law is not a command issued by an almost unlimited sovereign authority ruling over uncooperative subjects. Hume’s focus on benevolence and reciprocity thus requires the government to incentivise and nudge citizens to comply and pay their taxes due, rather than governance by command and control.

3 John Tiley and the Thunder of History MICHAEL LITTLEWOOD

ABSTRACT

The aim of this paper is twofold – first, to present a selective overview of the work undertaken in connection with the series of tax history conferences initiated in 2002 by the late Professor John Tiley and hosted by the University of Cambridge; and, secondly, to examine Joseph Schumpeter’s claim that the ‘thunder of history’ can best be discerned by looking at taxation. In other words, the aim is to assess Schumpeter’s claim by reference to the work of what might be called the Tiley School of Tax History.1 INTRODUCTION

I

t is obviously impossible to understand a political system without understanding how its government has financed itself. In most societies, at most points in their history, the political process has been largely devoted to determining how that question is to be answered – and differences of opinion over taxation have often produced constitutional crises, rebellions, revolutions and wars. Tax history, therefore, is not just the history of taxation, but political and economic history, cut at a particular angle. Moreover, a society’s tax system typically reflects not only the dynamics of the political process, whether routine or revolutionary, but many other facets of life also. Perhaps most obviously, since the advent of modern income tax, almost all economic endeavour has given rise to tax consequences; and so, too, since the invention of value added tax, has almost every act of consumption.

1 This paper is dedicated to the memory of John Tiley, who inspired and helped numerous tax ­scholars around the world. Earlier versions were presented at the University of Sydney, 6  February  2018, the Law and Society Conference, Toronto, 9 June 2018 and the Tax History ­Conference, Cambridge, 9 July 2018. I am grateful to those who offered suggestions on those ­occasions and also to David V Williams, Katherine Sanders and Barry Littlewood.

56  Michael Littlewood But, since history began, tax consequences of one sort or another have been attached to birth, death, marriage, the buying and selling of land, and even eating and drinking – especially drinking. The great Austro-American economist Joseph Schumpeter made the point in these words: The spirit of a people, its cultural level, its social structure, the deeds its policy may prepare – all this and more is written in its fiscal history … He who knows how to listen to its message here discerns the thunder of world history more clearly than anywhere else.2

The aim of this paper is to use the work undertaken in connection with the tax history conferences launched by Professor John Tiley at Cambridge in 2002 and held every two years since as a means of examining Schumpeter’s claim that the thunder of history can best be discerned by looking at taxation.3 The paper therefore concentrates on developments in taxation that seem especially instructive as to broader political, social and economic dynamics. Even so, in order to keep it within conventional bounds (and within the word limit specified by the editors of this collection), it has been necessary to be highly selective. Although the paper concentrates on the work of what might be called the Tiley School (by which I mean everyone who has contributed to at least one of the conferences organised by Tiley and his successors at Cambridge, Professor Peter Harris and Dr Dominic de Cogan), reference is made to other material, too, where that seems helpful. The paper concentrates also on the UK and some of the other English-speaking countries. One reason for that is that Tiley was English, and most members of the Tiley School come from English-speaking countries. But the bias might be justified also on the basis that the peoples of the UK and the US have, for better or worse, made a disproportionate impact on the history of the world, and on the evolution of systems of taxation. THE ANGLO-SAXONS, THE VIKINGS AND DANEGELD

In about 410 the Romans abandoned Britain and there followed what used to be called the Dark Ages: the unitary Roman province of Britain split into a number of smaller fiefdoms beset by 500 years of economic and cultural decline or, at best, stagnation. By the tenth century, however, England was again a single political unit, ruled by Athelstan, generally regarded as the first king of England, and its economy had grown considerably. The population had increased; 2 JA Schumpeter, ‘The Crisis of the Tax State’ in R Swedberg (ed), The Economics and ­Sociology of Capitalism, (Princeton NJ, Princeton University Press, 1991) 101. See also J Snape and D de Cogan, ‘Introduction: On the Significance of Revenue Cases’ in J Snape and D de Cogan (eds), Landmark Cases in Revenue Law (Oxford, Hart, 2019). 3 See J Tiley (ed), Studies in the History of Tax Law, vols 1–6 (Oxford, Hart, 2004–14); P Harris and D de Cogan (eds), Studies in the History of Tax Law, vols 7–8 (Oxford, Hart, 2015 and 2017). These works are herein referred to as Tax History, vols 1–8.

John Tiley and the Thunder of History  57 agriculture had become more productive; the Anglo-Saxons were exporting grain and wool to Europe; and the legal system had evolved. Much trade was done by barter, but coins were also widely used again. For example, it seems to have been common for wages to be paid in coins.4 On the downside, England had become sufficiently wealthy for the Vikings to have discovered that raiding it was profitable. The first Viking raid came in 793 at Lindisfarne and many more followed. Alfred the Great (King of Wessex from 871 to 899) was the first to pay tribute to the Vikings – that is, to pay them to leave him and his people alone. The raids continued and in 991 Ethelred the Unready (King of England 978–1013) paid the Danes £10,000, raised by means of a new tax called danegeld. The story of danegeld has been told by numerous commentators, including John Selden,5 Philip Carteret Webb (an eighteenth-century legal historian)6 and Barbara Abraham (of the Tiley School).7 Ethelred used it repeatedly to raise funds to pay off the Vikings, in order, as one later commentator put it, ‘that they might abstain from rapine, burning, and slaughter’.8 That the money indeed found its way to Scandinavia was much later confirmed by the discovery there of large numbers of Anglo-Saxon coins minted in the tenth and eleventh centuries.9 But the Danes continued their ravages and in 1012 Ethelred was obliged to enter into a treaty whereby he agreed to collect the tax annually and to use the monies raised by it to pay the Danes to maintain a fleet of 45 ships in London, supposedly to defend England from other possible invaders10 – what we might call protection money. Ethelred died in 1016 but his successors continued to collect the tax. The last payment to the Danes was made by Harthacnut in 1040, but his successor (Edward the Confessor, who ruled from 1042 to 1066) continued to levy the danegeld, using the revenues for his own purposes. Danegeld was based on a system, already centuries old, under which the country was divided into ‘hides’. A hide was an area of about 120 acres of arable land.11 The tax was not charged on pasture or woodland. Cities and towns,

4 See generally BA Abraham, ‘“Danegeld” – From Danish Tribute to English Land Tax: The Evolution of Danegeld from 991 to 1086’ in Tax History, vol 6, above n 3, 261 and PC Webb, A Short Account of Danegeld (London, Society of Antiquaries, 1756). 5 J Selden, Of the Dominion or Ownership of the Sea (first published in Latin and entitled Mare Clausum in 1635; English translation by Marchmont Nedham, London, William Du-Gard by appointment of the Council of State, 1652). Chapter 11 of Book 2 of this work is called ‘The Sea Dominion of the English-Saxons and Danes … Also, concerning the Tribute or Paiment called Danegeld, which was wont to bee levied for the Guard of the Sea’. 6 Webb, above n 4. 7 Abraham, above n 4. 8 A Dr Brady, cited by Webb, above n 4, 28. 9 Abraham, above n 4, 264. 10 Webb, above n 4, 8. 11 FW Maitland, Domesday Book and Beyond: Three essay in the Early History of England (Cambridge, Cambridge University Press, 1897) 228, 237, 336. Of the three essays comprising Maitland’s book, the third is entitled ‘The Hide’ and is mostly about what that word means.

58  Michael Littlewood however, were assessed; Salisbury, for example, was assessed as 50 hides.12 The king’s own lands were exempt, because there would have been no point in the king taxing himself.13 The king usually did, however, operate his estates at a profit. The tax was imposed irregularly. It was usually charged at two shillings per hide and sometimes more. The weight of the tax is not easily determined, but all commentators seem to agree that it was extremely heavy; paying it was better than suffering ‘rapine, burning, and slaughter’, but that is about all that could be said for it. According to Selden, it was ‘a tax indeed so grievous, that scarce any man was able to pay it.’14 WILLIAM THE CONQUEROR AND THE DOMESDAY BOOK

In 1066 William the Norman conquered England and, with it, the danegeld.15 Over the years, however, his Anglo-Saxon predecessors had granted numerous exemptions from the tax – for example, to the Church, to lords rendering military service and to the king’s own sheriffs – with the result that the revenues it produced were much reduced. Moreover, over the period since danegeld had first been imposed, more land had been brought into cultivation – but the king had no reliable record of such land, so it was not within the scope of the tax. In 1083/1084, William increased the yield by tripling the rate from two shillings per hide to six. Then, however, he went much further, as is famously explained by Frederic William Maitland in his magisterial Domesday Book and Beyond, which begins: At midwinter in the year 1085 William the Conqueror wore his crown at Gloucester and there he had deep speech with his wise men. The outcome of that speech was the mission throughout all England of ‘barons,’ ‘legates’ or ‘justices’ charged with the duty of collecting from the verdicts of the shires, the hundreds and the vills a ­descriptio of his new realm. The outcome of that mission was the ­descriptio preserved for us in two manuscript volumes, which within a century after their making had already acquired the name of Domesday Book.16

Domesday Book was essentially a survey of all the land in England, conducted for the purpose of increasing the yield of the danegeld, for, as Maitland observed: When Duke William became king of the English, he found (so he might well think) among the most valuable of his newly acquired regalia, a right to levy a land-tax under the name of geld or danegeld.17



12 Webb,

above n 4, 19–20. above n 4, 21. 14 Selden, above n 5, 262. See also Webb, above n 4, 14. 15 Webb, above n 4, 16–24. 16 Maitland, above n 11, 1. 17 ibid, 3. 13 Webb,

John Tiley and the Thunder of History  59 Maitland refers to the amounts said to have been paid prior to the Conquest and concludes: If the huge sums mentioned by the chronicler had really been exacted, and that too within the memory of men who were yet living, William might well regard the right to levy a geld as the most precious jewel in his English crown. To secure a due and punctual payment of it was worth a gigantic effort, a survey such as had never been made and a record such as had never been penned since the grandest days of the old Roman Empire.18

Maitland proposed that ‘some future historian’, working from Domesday Book, might be able ‘to reconstruct the land-law which obtained in the conquered England of 1086, and … the unconquered England of 1065’.19 This was excessively modest, for Maitland himself contributed massively to that reconstruction. It is telling, though, that what interested him was land law, not tax law. This suggests a larger question: the feudal system is generally seen as a system of land tenure – which it was. But it was also a tax system. From the point of view of the inferior party to a feudal relationship (for example, a baron), the benefit was the land. But from the point of view of the superior party (for example, the king), the benefit was what was obtained by granting the land – for example, military service. In any event, Maitland tells us much of interest about the legal system and the tax system operating in England before the Conquest – which is why he called his book ‘Domesday Book and Beyond’. For instance, he tells us about ‘justices’, ‘verdicts’ and ‘jurors’ – all terms that meant something very different then to what they do now. The justices were not judges in the modern sense. Rather, they were those whom William despatched throughout England to conduct his survey. A verdict was not the answer to the question, ‘Is this man guilty?’, but to questions such as, ‘How much land does this man have?’ ‘How many cattle does he have?’ ‘How much tax can he afford to pay?’ The jurors were upstanding members of the local community charged with answering such questions.20 They were not chosen on the basis that they were ignorant of the relevant facts and would dispassionately consider the evidence; on the contrary, they were selected on the basis that they were familiar with local circumstances, and so well placed to advise on taxable capacity. One of the more interesting people mentioned in Domesday Book is Lady Godiva.21 She was interesting to William because she was perhaps the wealthiest woman in England, and therefore a valuable taxpayer. Most people nowadays, however, know of her because she rode naked through the streets of Coventry – or 18 ibid, 4. 19 ibid, 2. 20 ibid, 1–2, 11, 14, 26, 33, 39, 59, 63, 124, 130, 147, 168, 371, 395, 409, 413–14, 418–32, 437, 462, 469–70 and 478; Webb, above n 4, 25. 21 A Gordon, ‘Godiva’ in L Stephen and S Lee (eds) Dictionary of National Biography (London, Elder Smith & Co, 1890).

60  Michael Littlewood so, at least, we are told. The reason she did this, the legend goes, is that she objected to the heaviness of the taxes that her husband Leofric, the Earl of Mercia, had imposed on the people of Coventry. Whether the story is true is debatable; but true or not, Godiva is credited with having devised one of history’s more memorable methods of resolving a domestic disagreement. BAD KING JOHN AND MAGNA CARTA

Two of the worst kings that England has ever endured were John and Charles I – and what got both of them into trouble was their high-handed approach to taxation. In 1215 Magna Carta was sealed at Runnymede, representing a deal done between John and his disaffected barons. It is widely seen as a foundational constitutional instrument, representing a vital step along the way from absolute monarchy to democracy – and no doubt that is true, but the fact is that the main point of Magna Carta was to restrain John’s power to tax. As Jane Frecknall-Hughes points out, ‘well over half’ of its terms relate to tax, if ‘tax’ is interpreted as meaning any method by which the king might extract economic resources from the populace.22 The problem, from the barons’ point of view, was not merely that John’s taxes were extortionate (though that was bad enough), but that he had repeatedly used them not only to raise money but to deliberately ruin anyone he viewed as a threat.23 Most importantly, clause 12 provided that the king would not levy a scutage (a tax payable by a vassal to his lord in lieu of military service) or an aid (likewise a tax) without the ‘general consent’ of the Kingdom; and clause 14 provided that, if he wished to obtain such consent, the king would summon ‘the archbishops, bishops, abbots, earls, and greater barons’, giving them ‘at least forty days notice’. Clause 2 provided that an heir ‘shall have his inheritance on payment of the ancient scale of relief’ – meaning that the king could not charge more for confirming the inheritance. The scale was £100 for the heirs of an earl, 100 shillings ‘at most’ for the heirs of a knight, and less for lesser persons, ‘in accordance with the ancient usage of fees’.24 Other clauses provided, for example, that a free man convicted of an offence would be fined ‘only in proportion’ to its seriousness, ‘not so heavily as to deprive him of his livelihood’, and only ‘by the assessment on oath of reputable men of the neighbourhood’;25 that no one would be ‘forced to build bridges over rivers’ 22 J Frecknall-Hughes, ‘Fiscal Grievances Underpinning the Magna Carta: Some First Thoughts’ in Tax History, vol 4, above n 3, 89; J Frecknall-Hughes, ‘John Lackland: A Fiscal Re-evaluation’ in Tax History, vol 1, above n 3, 201. 23 Frecknall-Hughes, ‘Fiscal Grievances’, above n 22, 90. 24 The version of Magna Carta cited here is from the website of the British Museum (www.bl.uk/ magna-carta/articles/magna-carta-english-translation), originally from GRC Davis, Magna Carta (London, British Museum, 1963), 23–33. 25 Magna Carta, above n 24, cl 20.

John Tiley and the Thunder of History  61 unless he had ‘an ancient obligation to do so’;26 that no royal official would take corn or other movable goods without paying for it;27 that no royal official would take horses, carts or wood without the owner’s consent;28 and that any man ‘dispossessed of lands, castles, liberties, or rights, without the lawful judgment of his equals’ would have them restored to him ‘at once’.29 CHARLES I AND SHIP MONEY

Numerous important and revealing developments in tax took place under the Plantagenets and the Tudors (notably the invention of the trust as a taxavoidance device; and Henry VIII’s dissolution of the monasteries and seizure of their properties can perhaps be seen as a tax),30 but there is sadly no space here to examine them. Skipping ahead a few centuries, however, we come to Charles  I, who ruled from 1625 to 1649 and whose principal mistake was to insist that his authority was absolute and that he was therefore entitled to impose taxes under the prerogative without recourse to Parliament.31 Early in his reign, Parliament declined to vote funds in support of Charles’s military endeavours on the Continent. He responded by demanding large sums of money from various landowners, ostensibly as loans. These demands were without any parliamentary authority, and many of those upon whom they were made declined to pay. Charles thereupon imprisoned some of them.32 Parliament responded in 1628 by presenting the king with a document called the Petition of Right. The members of the House of Commons at this juncture included, notably, John Selden (mentioned above), Sir Edward Coke (another of England’s greatest jurists), John Pym (a famous critic of the king) and Oliver Cromwell (soon to become dictator of England – see below), and the Petition seems to have been mostly drafted by Coke. It comprised three main elements. First, it referred to the Englishman’s wellestablished rights and freedoms, as confirmed (according to Coke, the inventor of this myth)33 by Magna Carta and various other ancient instruments – in particular, 26 ibid, cl 23. 27 ibid, cl 28. 28 ibid, cls 30 and 31. 29 ibid, cl 52. 30 See eg N Jones, ‘Estate Planning in Early-Modern England “Having” in the Statute of Wills 1540’ in Tax History, vol 1, above n 3, 227; A Lewis, ‘When is a Tax not a Tax but a Tithe?’ in Tax History, vol 2, above n 3, 235; David Ibbetson, ‘Elizabethan Revenue Law: The Practice of the Court of Wards’ in Tax History, vol 4, above n 3, 107. 31 See generally MJ Braddick, The Nerves of State: Taxation and the Financing of the English State 1558–1714 (Manchester, Manchester University Press, 1996); JGA Pocock, The Ancient Constitution and the Feudal Law: a Study of English Historical Thought in the Seventeenth Century, 2nd edn (Cambridge, Cambridge University Press, 1987). 32 Five Knights Case (1627) 3 How St Tr 1. 33 J Baker, The Reinvention of Magna Carta (Cambridge, Cambridge University Press, 2017), ch 9; DV Williams, ‘Myths and History: The Treaty of Waitangi as “The Magna Charta of

62  Michael Littlewood that ‘no person should be compelled to make any loans to the king against his will’ and that the king’s subjects ‘should not be compelled to contribute to any tax, tallage, aid, or other like charge not set by common consent, in parliament’ (‘tallage’ being a label originally applied to certain taxes imposed by the Norman kings of England and later to taxes generally).34 Secondly, the Petition listed a series of complaints, notably that, contrary to their ancient rights, many of the king’s subjects had been ‘required to lend certain sums of money unto your Majesty’;35 and, on refusing to comply with this unlawful demand, some of them had been ‘imprisoned, confined, and [in] sundry other ways molested and disquieted’.36 The Petition complained also of the king’s unlawful billeting of his troops in his subjects’ houses:37 [G]reat companies of soldiers and mariners have been dispersed into divers counties of the realm, and the inhabitants against their wills have been compelled to receive them into their houses, and there to suffer them to sojourn against the laws and customs of this realm, and to the great grievance and vexation of the people.

Finally, the Petition called upon Charles to confirm, in accordance with Magna Carta and the other alleged ancient rights and freedoms of his subjects, that ‘no man hereafter [would] be compelled to make or yield any gift, loan, benevolence, tax, or such like charge, without common consent by act of parliament’ and that he would ‘remove the said soldiers and mariners’ from the houses of his subjects.38 Charles vacillated but eventually, reluctantly, on 7 June 1628, agreed. The Petition of Right is one of the most important documents in English constitutional history, spelling out the fundamental principle that the Crown cannot levy taxes except under an Act of Parliament. A century and a half later, it influenced the makers of the US Constitution, which gives Congress the exclusive power to tax39 (and provides also that ‘No Soldier shall, in time of peace be quartered in any house, without the consent of the Owner, nor in time of war, but in a manner to be prescribed by law’).40 Soon, however, Charles reneged, by levying and then extending a tax called ‘ship money’.41 It had long been accepted, Magna Carta notwithstanding, that in time of war the king could require coastal towns to supply him with ships

New Zealand”’ in S Winter and C Jones (eds) Magna Carta and New Zealand (Cham, Springer International, 2017) 45. 34 Petition of Right 1628, art 1. 35 ibid, art 2. 36 ibid, art 2. 37 ibid, art 6. 38 ibid, arts 9 and 10. 39 US Constitution, article 1, section 8. 40 US Constitution, 3rd amendment. 41 DL Keir, ‘The Case of Ship Money’ (1936) 52 LQR 546; S Dowell, A History of Taxation and Taxes in England, 3rd edn, (London, Frank Cass & Co, 1965), vol 1, 210–23; MJ Braddick, ‘Case of Ship-Money (R v Hampden) (1637): Prerogatival Discretion in Emergency Conditions’ in Snape and de Cogan, above n 2.

John Tiley and the Thunder of History  63 for military purposes, without the backing of Parliament; and it had sometimes happened that such contributions had been made in money rather than ships.42 In 1634, Charles provoked extraordinary resentment by levying ship money in peacetime; and in 1635 he aggravated the offence by extending the tax to the inland as well as the coastal parts of the country. He sought to justify this on the basis that ancient usage allowed him to impose such a tax in time of national danger – of which, he said, he was the sole judge. It seemed clear, however, that his real intention was to use ship money as a general and routine form of taxation, without parliamentary approval. John Hampden, a wealthy landowner and MP from the inland county of Buckinghamshire, declined to pay. He was arrested and he challenged his arrest on the basis that the tax was unlawful, because not authorised by Parliament. The case (R v Hampden) was heard by all 12 judges of the Court of ­Exchequer Chamber, and the Crown won by 7 to 5.43 It was, however, a short-term victory, for shortly afterwards the king and Parliament fell out altogether and civil war followed – with, to simplify somewhat, the king (with his Royalists or Cavaliers) on one side and the Parliamentarians (or Roundheads) on the other. In 1645 Parliament established the New Model Army, composed of full-time professional soldiers rather than part-time militia (which is why it has always been the British Army but the Royal Navy). Parliament won the war and on 30 ­January 1649 Charles was executed by public beheading, effected by means of an axe. The killing of a king was not unprecedented, but what was novel was that Charles’s execution was preceded by a trial. Charged with treason, he declined to plead and denied the validity of the proceeding; but the trial went ahead, and he was convicted and sentenced to death.44 WILLIAM AND MARY AND THE GLORIOUS REVOLUTION

England, Wales, Scotland and Ireland thereupon became a republic (referred to as ‘the Commonwealth’), ruled by Oliver Cromwell under the title ‘Lord ­Protector’. Charles I’s oldest son, also called Charles, famously hid in an oak tree and then escaped to France. There he was recognised as Charles II of England, though he was unable to return to that country. But the Commonwealth was not a success. In 1658 Cromwell died and was succeeded as Lord Protector by his son Richard, an ineffectual leader popularly known as ‘Tumbledown Dick’. He resigned in 1659 and Parliament invited Charles to return as king. He did so, and ruled until his death in 1685. His principal fiscal innovation was the introduction in 1662 of the hearth tax, charged at 2 shillings per hearth per year.45 The basic r­ ationale

42 Dowell,

above n 41, 213–19. v Hampden (1637) 3 St Tr 825. The judges’ reasoning is examined in Keir, above n 41. 44 See eg G Robertson, The Tyrannicide Brief (London, Chatto & Windus, 2005). 45 BEV Sabine, A Short History of Taxation (London, Butterworths, 1980) 96. 43 R

64  Michael Littlewood for this tax was that liability was somewhat proportional to wealth and the number of hearths or fireplaces in a house cannot easily be concealed. The tax raised significant revenue, though it was heavily regressive. Charles II had no legitimate (though at least a dozen illegitimate) children, so was succeeded by his brother James, who ruled England, Wales and Ireland as James II and Scotland as James VII. On 30 June 1688, however, a cabal of Protestant aristocrats invited William, the Prince of Orange, to come to England with his army (and his wife Mary, who was James’s daughter) and assume the throne. William’s life was complicated but he was effectively the ruler of what is now the Netherlands; and he was also James’s nephew (his mother being James’s sister). He accepted the invitation and there followed the joint rule of William III and Mary II. James accepted that his defeat was inevitable and ran away to France. The coregency arrangement enjoyed wide support because, first, William and Mary were both Protestants (whereas James was Catholic) and, secondly, they agreed to a more parliamentary and less autocratic form of government. For good measure, they also promised to abolish the unpopular hearth tax. William ruled more or less as sole monarch, though Mary was actively involved in government, especially when, as was often the case, her husband was away from London attending to military matters.46 The process by which James was deposed and William and Mary took over has been called the Glorious Revolution.47 The deal whereby they took the throne included their acceptance of an act of Parliament called the Bill of Rights, enacted in 1689. This statute limited the power of the monarch and is another of the key instruments in English constitutional history. In particular, it provides: That levying money for or to the use of the Crown by pretence of prerogative, without grant of Parliament, for longer time, or in other manner than the same is or shall be granted, is illegal[.]

In 1688, war broke out between, on one side, France and, on the other, an alliance of Austria, the Holy Roman Empire, the Dutch Republic, Spain, England and the Duchy of Savoy (a state at the conjunction of France, Italy and ­Switzerland, later absorbed by those countries). The war lasted from 1688 until 1697, so is known as the Nine Years’ War (or, sometimes, as King  William’s War). It is sometimes said to be the first war to be fought globally – in France, ­Flanders, Germany, North America, the West Indies, India, Ireland and the English C ­ hannel. In 1688 the English army comprised 15,000 men, but in the course of the war William expanded it to 60,000. As Jeremy Sims put it,

46 One recent account, W Troost, William III the Stadholder-King: A Political Biography, translated by JC Grayson (London, Routledge, 2016), ignores Mary almost entirely. 47 Elizabeth Wicks, The Evolution of a Constitution: Eight Key Moments in British Constitutional History (Oxford, Hart, 2006) 11–30.

John Tiley and the Thunder of History  65 the war entailed ‘expenditure of a formerly unimaginable magnitude’.48 James II had got by on about £1.8 million per year, but by 1700 William was raising £4.4 million per year.49 In order to achieve that, he maintained most of the existing sources of revenue (for example the land tax);50 he extended several of them, notably tonnage (a tax on shipping) and poll taxes; he introduced one important new tax – stamp duty (a tax on documents); and he established the Bank of England as an adjunct to the tax system.51 In 1688 he kept his promise to abolish hearth tax, but in 1694 he introduced something similar – a tax on windows. Poll Taxes William imposed poll taxes on several occasions but, to explain his use of them, it is expedient to first supply some background. The term ‘poll tax’ is sometimes used to mean a tax of a set amount per person (also called a head tax), but in England it generally meant a tax on persons according to their status – for example, more for a duke than for a baron. Such a tax seems to have been first used in England in 1222.52 Since then, poll taxes have been used repeatedly over the centuries and they have raised substantial revenues, but they have also incited considerable discontent. A poll tax imposed in 1381 sparked what is known (after its leader) as Wat Tyler’s Revolt, in which several thousand armed rebels marched on London (and on several other centres of power, including Cambridge University), sacked government buildings and killed a number of officials. The Revolt was suppressed, at least 1,500 rebels (including Tyler) were killed, and English governments continued to use poll taxes from time to time.53 Most recently, the British government introduced a poll tax in 1989, the failure of which obliged the Prime Minister, Margaret Thatcher, to resign, she and her advisers having evidently paid insufficient heed to what had happened in 1381.54 One of the more curious protests against Thatcher’s tax (examined by Sir John Baker at the 2016 Cambridge Tax History Conference) was the campaign of Frederick Trull, a Cornish separatist who maintained that he and a million or so other residents of the UK (each of whom had subscribed to his scheme for a

48 J Sims, ‘The Poll Taxes in Later Seventeenth Century England’ in Tax History, vol 4, above n 3, 121, 122. 49 Sims, above n 48, 122; J Brewer, The Sinews of Power: War, Money and the English State, 1688–1783 (Cambridge MA, Harvard University Press, 1990). 50 Land Tax Act 1688 (1 W & M c 20). 51 D Kynaston, Till Time’s Last Sand: A History of the Bank of England, 1694–2013 (London, Bloomsbury, 2017). 52 Sims, above n 48. 53 J Barker, 1381: The Year of the Peasants’ Revolt (Cambridge MA, Belknap Press, 2014). 54 D Butler, A Adonis and T Travers, Failure in British Government: The Politics of the Poll Tax (Oxford, Oxford University Press, 1994).

66  Michael Littlewood fee of £1.50) were exempt from the tax on the basis of the privileges granted to Cornish tin miners by Henry VII in 1508. Trull’s campaign raised some interesting arguments but ultimately failed.55 In the seventeenth century poll taxes were used repeatedly.56 They generated much obloquy and raised relatively little revenue, largely because of ‘systematic under-assessment and evasion’.57 For example in 1660 Samuel Pepys, the great diarist, expected his liability to be £10 but got away with paying only 12  ­shillings.58 But William persisted with them because he needed the money. The poll taxes were originally based on status, but, as time went on, elements of an income tax were introduced. For example, as early as 1667 a poll tax imposed by Charles II had included (among other levies) a charge on salaries paid by the government at a shilling in the pound – that is, five per cent.59 Under William this went further, with the support of discontented landowners who complained, justifiably, that the growing class of affluent merchants and businessmen were getting off lightly. His first poll tax was imposed in 1688, almost immediately after his accession.60 Its stated aim was ‘reducing’ the Catholic rebels in Ireland to ‘due obedience’ and thus alleviating the ‘deplorable condition’ of the king’s Protestant subjects there.61 It was a traditional, status-based poll tax: for instance, £50 for dukes and archbishops, £20 for barons and bishops, and so on down to £1 for everyone counting himself as a ­gentleman.62 But it also went further: among other imposts, it provided for a tax of 10 ­shillings for every £100 of ‘personal estate’, meaning either ‘ready moneys’ or debts receivable;63 a charge of 12 pence per pound on salaries paid by the government (as under Charles II’s tax, mentioned above); a tax on lawyers and physicians at 3 shillings per pound on their ‘salaries, offices, practices or ­professions’64 (though how this was assessed and collected is unclear); and a levy of £10 on merchants trading in London65 and on every foreign merchant and Jew ‘residing in the Kingdom’.66 The Act also imposed a tax on shareholders in four of England’s larger companies, referring by name to the East India Company, the Guinea Company, the Hudson’s Bay Company and the New River Company. That it dealt

55 J Baker, ‘The Curious Case of Mr Trull’ in Tax History, vol 8, above n 3, 67. 56 Sims, above n 48. 57 Sims, above n 48, 138. See also eg W Petty, A Treatise of Taxes and Contributions, 3rd edn (London, Obadiah Blagrave, 1685) ch 7. 58 R Latham and W Matthews (eds) The Diary of Samuel Pepys (London, G Bell and Sons, 1970), vol 1, 315 (10 December 1660). See also Sims, above n 48, 134–35. 59 Sims, above n 48, 126. 60 Poll Tax Act 1688 (1 W & M c 13); Sims, above n 48. 61 Poll Tax Act 1688 s 1. 62 ibid, s 5. 63 ibid, s 1. 64 ibid, s 4. 65 ibid, s 9. 66 ibid, s 10.

John Tiley and the Thunder of History  67 specifically with these enterprises reflected the increasing economic and political importance of the corporate form. The East India Company was established under Elizabeth I in 1600.67 Its original purpose was to trade in South East Asia, though it later operated also in China. Charles II conferred on it the right to acquire and govern territory, to form its own army, to make war, and to exercise both civil and criminal jurisdiction over the territories it acquired. Later, over the course of the eighteenth century, it was the East India Company, not the British government, that colonised India (though the government took control after the so-called ‘mutiny’ of 1857).68 The Company traded mainly in commodities such as spices, cotton, tea and opium, and at its peak accounted for a large part of world trade. The Guinea Company was established under James I in 1618 to trade along the west coast of Africa, dealing, most notably, in slaves.69 The Hudson’s Bay Company was incorporated under Charles II in 1670 for the purpose of gathering furs from North America. He granted it a monopoly over the region drained by all the rivers flowing into Hudson Bay – a territory comprising more than a third of modern-day Canada and a significant part of the northern United States.70 It still exists (unlike the East India Company and the Guinea Company) and is listed on the Toronto Stock Exchange.71 The New River Company was formed in 1619 under James I for the purpose of managing the New River, an artificial waterway augmenting London’s supply of fresh water.72 In the case of the East India Company, the Guinea Company and the Hudson’s Bay Company, the shareholders were taxed at £2 per £100 of capital invested and the tax was collected by requiring the company to withhold it from the next dividend.73 More innovative still was the tax on the New River Company’s shareholders: they were charged 2 shillings per pound not on their capital but on ‘the yearly value thereof’;74 this, Sims says, ‘may well have been the earliest tax on the income from shares in a company’.75 The Bank of England In 1690 Louis XIV’s navy decisively defeated William’s navy at the Battle of Beachy Head, off the south coast of England. William urgently needed to rebuild 67 J Keay, The Honourable Company: A History of the English East India Company (Toronto, Macmillan, 1994). 68 Government of India Act 1858. 69 H Thomas, The Slave Trade (London, Macmillan, 1998), 174–77. 70 The bay is nowadays usually referred to as Hudson Bay, but the company is still the Hudson’s Bay Company. 71 Hudson’s Bay Company, HBC Annual Report 2017, 1, 43. 72 B Rudden, The New River: A Legal History (Oxford, Clarendon Press, 1985). 73 Poll Tax Act 1688, s 9. 74 ibid, s 11. 75 Sims, above n 48, 127.

68  Michael Littlewood his navy, but he was desperately short of money. He wanted to borrow, but those with money were understandably reluctant to lend it to him. The solution to this quandary was to set up a bank – and so the Bank of England was born.76 The basic idea was that some of those who were in a position to advance the required funds to the king would do so, but they would be incorporated as the Bank of England and the loan would be secured over future tax revenues.77 More specifically, funds to repay the loan plus interest on it at 8 per cent78 would be raised by tonnage (see below), additional duties on liquor,79 and the sale of annuities.80 The Bank of England Act 1694 provided for the incorporation of those contributing to the loan as ‘one Body Corporate and Politick by the name of The Governor and Company of the Banke of England’.81 The Bank was thus owned by those who advanced funds (and it continued to be privately owned until it was nationalised in 1946).82 The Act provided also for the corporation to be perpetual; to be able to acquire, hold and dispose of property; to be able to sue and be sued; and so on.83 Thus, instead of the subscribers dealing with the Crown individually, the corporation would act on their behalf, collecting the funds due from the Crown and distributing them to the subscribers. Tonnage Tonnage was already an ancient tax,84 but William modernised it. The Bank of England Act 1694 provided for duties on ships importing goods into England or Wales, and also on coastal shipping.85 The duty was generally charged not on the actual weight or quantity or value of goods imported, but on the ship’s tonnage – that is, its capacity measured in tuns. (A tun was an ancient unit of volume used for measuring wine and other liquids, usually 252 gallons – just under one cubic metre.) The Act provided that a ship’s tonnage was to be calculated by determining its internal volume (its length multiplied by its breadth multiplied by the depth of its hold) and then dividing by 94.86 The basic rationale for the tax was that it could be assessed and collected without inspecting the

76 Kynaston, above n 51. 77 Bank of England Act 1694 (5 & 6 W & M c 20). 78 ibid, s 20. 79 ibid, ss 9 and 10. 80 ibid, s 33. 81 ibid, s 19. 82 Kynaston, above n 51. 83 Bank of England Act 1694 s 19. 84 Keir, above n 41; J Snape, ‘David Hume: Philosophical Historian of Tax Law’ in Tax History, vol 7, above n 3, 436. 85 Bank of England Act 1694 s 1. 86 Bank of England Act 1694 s 8. The Act did not specify the units in which ships were to be measured; presumably they were measured in feet.

John Tiley and the Thunder of History  69 ship’s cargo.87 (Ships are still today assessed for various purposes according to their tonnage, though it is nowadays measured differently.) The rate at which the duty was charged depended on the origin of the cargo – and the rates are worth reciting, because they are revealing of the state of the British economy at the time. The duty on ships importing goods from the East Indies (meaning not only the Indonesian and Philippine archipelagos but probably the other lands of South and South East Asia also) was 30 shillings per tun; from Italy or Turkey, 15 shillings per tun; from Portugal or Spain, 10 shillings per tun; from anywhere else in the Mediterranean, 15 shillings per tun; from the Netherlands, 3 shillings per tun; from Ireland or Scotland, 2 shillings per tun; from the West Indies, 10 shillings per tun; from anywhere on the Atlantic coast of Africa, 20 shillings per tun; from Hudson’s Bay, 20 shillings per tun; and other rates applied to imports from various other places.88 The rate for coastal shipping from any port in England or Wales to any other port in England or Wales was sixpence per tun.89 No rate was stipulated for imports from France because the two countries were at war and imports from France were accordingly banned.90 Conversely, the relatively cheap rate for imports from the Netherlands was presumably due to the fact that that country was England’s ally in the war against the French. The Act provided, however, that if peace were to be made with France, imports from that country would be taxed at the same rate as those from Portugal – 10 shillings per tun.91 That a rate was specified for imports from Hudson’s Bay reflected the importance of the Hudson’s Bay Company. No rates were specified for the other British colonies in North America; presumably imports from them were still too trivial to be worth legislating for. There was a special rule, too, for imports of whale oil, blubber and whale fins: the duty was only imposed on produce ‘really and bona fide brought home’, rather than on the ship’s capacity.92 The reason for this was presumably that a whaling venture might be unsuccessful. The penalty for evasion was harsh: if any goods were unloaded without the duty having been paid, the ship that brought them would be forfeit, with half the proceeds from its sale going to the Crown and the other half to whoever had discovered and acted upon the transgression.93 The Act initially provided that the duties it imposed were to remain in force for four years only,94 thus obliging William to convene Parliament again because he would otherwise be left without funds; and the reason for that was that the

87 Petty, 88 Bank 89 ibid. 90 1

above n 57, ch 6, [12]. of England Act 1694 s 1.

W & M sess 1 c 34, ‘An Act for prohibiting all Trade and Comerce [sic] with France’. of England Act 1694 s 6. 92 ibid s 4. 93 ibid, s 2. 94 ibid, s 1. 91 Bank

70  Michael Littlewood parliamentarians feared he might revert, despite his promises, to the autocratic mode of government favoured by his predecessors. If the taxes provided for by the Act proved insufficient to repay the loan plus interest, the Bank (that is to say, in effect, the lenders) would have first call on the Crown’s other revenues and, failing that, on ‘theire Majesties Treasure’.95 The duties provided for by the Act were in due course extended, but the idea that the executive should be restrained by the need to turn periodically to the legislature for funds remains a key component of modern constitutional thinking.96 Stamp Duty It was also in 1694 that William and Mary introduced stamp duty – a tax on documents, with payment of the tax being indicated by a stamp on the document.97 According to Stephen Dowell, stamp duty was invented in the Netherlands in 1624. The Dutch government, desperate for funds to finance the war with France, had offered a prize for the best new tax – and stamp duty had been the winning entry (though the identity of the inventor is unknown).98 The Stamp Act 1694 imposed duties on vellum, parchment and paper used in making documents of prescribed kinds. (Parchment is writing material made from animal skin; vellum is a superior kind of parchment made from the skins of young animals, such as lambs.) The prescribed documents included, among others, grants of land and leases (in respect of both of which the duty was 40 shillings); university degrees (40 shillings); admission as a physician, attorney or advocate (40 shillings); pleadings, affidavits and various other documents relating to litigation (from one penny to 40 shillings, depending on the nature of the document); marriage certificates (five shillings); probate of any will where the estate was worth more than £20 (five shillings); charter-parties (sixpence); and contracts (sixpence).99 The tax was in each case for a set amount; the value of the document’s subject-matter, if any, was irrelevant. Bills of exchange and debt instruments were exempt, and no duty was payable on the probate of the will of ‘any common seaman or soldier who shall be slain or die in their Majesties’ service’.100 Any person intending to create a document upon which duty would be payable had a choice. He could submit a blank piece of paper (or vellum or parchment) to the newly established Stamp Office, and pay the duty; the Office

95 ibid, s 39. 96 Halsbury’s Laws of England, 5th edn (2014), vol 20, Constitutional and Administrative Law, [480]–[481]. 97 Stamps Act 1694 (5 W & M c 21); see also 6 W & M c 12. 98 Dowell, above n 41, vol 3, 286. 99 Stamps Act 1694 s 3. 100 ibid, ss 5 and 6.

John Tiley and the Thunder of History  71 would accept the payment, affix or engross a stamp on the paper, indicating the amount paid, and return the stamped paper to the person, who could then proceed to craft the document on it. Alternatively, he could purchase prestamped paper from the Stamp Office. Either way, the duty was required to be paid before the document was created. The penalty for creating a document on unstamped paper when stamped should have been used was extraordinarily harsh: a fine of £500.101 Only a year later, however, this was reduced to £5.102 But the duties were to a considerable degree self-enforcing, because the Act provided that any document that ought to have been stamped and was not stamped was not admissible as evidence in court103 – and any document purporting to have any legal effect would be ultimately ineffectual, if not admissible. The Act also created a number of offences. The most serious was counterfeiting stamps, for which the penalty was death.104 Finally and crucially, the Act provided for ‘any person or persons, natives or foreigners, bodies politick or corporate’ to lend to the Crown any amount up to £330,000 in total at any rate of interest up to 8 per cent;105 and for the revenues derived from the stamp duties to be applied to paying off the lenders. Thus, as with the tonnage duties discussed above, the objective was to raise funds immediately by borrowing, and the stamp duties were merely the means by which the debt was to be discharged.106 Also, and again like the tonnage duties, the Act provided that the stamp duties would remain in force for only four years;107 but they proved enormously successful and stamp duties have continued to play a significant role in the British tax system ever since.108 They were also used in Britain’s colonies. Their role in the thirteen American colonies is notorious (and discussed below), but they were used also in, for example, the Australian colonies, New Zealand and Hong Kong – and in some of those places are still in force today.109 King William’s Window Tax Mary died in 1694 and William ruled alone for another eight years. The most important fiscal innovation during that time was perhaps the window tax, which was introduced in 1695 and remained in force until 1851.110 It was payable by



101 ibid,

s 11. Act 1695 (6 & 7 W & M c 12) s 7. 103 Stamps Act 1694 s 11. 104 ibid, s 11. 105 ibid, s 17. 106 ibid, ss 17–21. 107 ibid, s 2. 108 Halsbury’s Laws of England, 5th edn (2016), vol 23, Conveyancing, [280]–[284]. 109 See eg Stamp Duty Ordinance 1981 (Hong Kong). 110 House Tax Act 1695 (7 & 8 Will III c 18); see also House Tax Act 1808. 102 Stamps

72  Michael Littlewood the occupier of every inhabited dwelling house, according to the number of windows. 111 The thinking behind the tax was straightforward. Taxation, it was thought, should be roughly proportional to ability to pay; it should not be unduly burdensome on the poor; and it should entail as little invasion of the taxpayer’s privacy as possible. Thus, a tax on windows should impose liability roughly in accordance with wealth (the number of windows being roughly proportionate to the size of the house and the means of the occupier); cottages with fewer than seven windows were exempt, providing an exemption for the poor;112 and windows can generally be seen from outside, so the tax was only minimally inquisitorial. It turned out, however, that the tax was unexpectedly problematic. It incentivised the owners of houses to brick up existing windows; and that happened to such an extent that much elegant architecture was wrecked.113 It also encouraged developers to build houses with fewer windows than they otherwise would. For instance, one built an entire row of houses in Edinburgh without windows in any of the bedrooms.114 Moreover, the exemption for cottages with fewer than seven windows, although sparing the rural poor, failed to benefit the increasingly numerous urban poor, who lived in tenements, which were not exempt (because the seven-window threshold related to the building, not to each of the apartments within it). Further, liability was based simply on the number of windows, not their size. The affluent, therefore, could minimise their liability by building houses with relatively small numbers of relatively large windows – even though that might have been architecturally disadvantageous (for instance, it discouraged the use of ‘a series of narrow windows in the Italian style’).115 The poor, however, could not avail themselves of that option (even if it had been otherwise available), because a single window lighting two rooms was counted as two windows. Worse still, the window tax proved to be seriously injurious to the nation’s health. The living conditions of the urban poor in the eighteenth and nineteenth centuries were appalling – not only by modern standards, but also by the standards of the contemporary rural poor. Industrialisation drove very large numbers of people to the cities, where they lived in overcrowded slums. It was common for a large family to live – to eat, sleep, cook, wash and procreate – in a single room, with no drain, no sewer and no running water. Such conditions would have been dreadful in any event, but they were made much worse by the tax, which

111 See generally C Stebbings, ‘Public Health Imperatives and Taxation Policy: the Window Tax as an Early Paradigm in English Law’ in Tax History, vol 5, above 3, 43. See also C Stebbings ‘Tax and Quacks: The Policy of the Eighteenth-Century Medicine Stamp Duty’ in Tax History, vol 6, above 3, 283; and C Stebbings, ‘Tax and Pharmacy: A Synergy in Professional Evolution’, in Tax History, vol 7, above 3, 153. 112 Stebbings, ‘Window Tax’, above n 111, 54. 113 ibid, 50. 114 Dowell, above n 41, vol 3, 177, cited in Stebbings, ‘Window Tax’, above n 111, 50. 115 Stebbings, ‘Window Tax’, above n 111, 51.

John Tiley and the Thunder of History  73 effectively obliged the poor to block up as many windows as possible, causing the slums to be not only overcrowded and filthy, but dank, dark and unventilated. Disease and epidemics – typhus, typhoid, malaria, smallpox, whooping cough, scarlet fever, tuberculosis – were rife, and made worse by the tax. Eventually, in 1851, the tax was abolished; and its abolition was brought about mainly because of concern for the people’s health. It is striking, though, that the tax was not abolished until many years after its impact on health had become well known. The reason was that the government’s need of funds was seen as overriding other concerns, even though the tax produced relatively little money. The history of the window tax thus shows both how until the nineteenth century the health of the nation was of relatively little concern to the government; and also how, since then, that has changed. QUEEN ANNE’S NEWSPAPER TAX

William died in 1702 and there followed the reign of Queen Anne. The key event of her reign was the enactment of the Acts of Union of 1706 and 1707, by which England and Scotland were fused into the single nation of Great Britain; and the Scottish and English Parliaments were united to form the Parliament of Great Britain.116 The most notable fiscal development of Anne’s rule came in 1712, when her government introduced a tax on newspapers.117 The background to this begins in 1476, when William Caxton brought the printing press to England. Not long after, a system of press censorship was introduced. How it operated varied over time but in 1694 it lapsed altogether, largely because of arguments between the Stationers’ Company (a medieval guild that had until then controlled the publishing industry) and advocates of reform (notably John Locke). Consequently, there occurred an uncontrolled boom in the publishing of newspapers, accompanied by an increase in the rate of literacy (previously the preserve of the elite). At the same time, the rising class of merchants was becoming more politically active and the two great political parties – the Whigs and the Tories – were emerging. The tax on newspapers had three parts: first, there was a tax on newspapers as such; secondly, a tax on advertisements; and, thirdly, a tax on blank paper. The tax on newspapers was charged at rates of from one halfpenny per newspaper (for shorter newspapers) to an apparently prohibitive two shillings per sheet (for longer newspapers), generally payable prior to printing.118 Payment was evidenced by a large red stamp on the corner of each sheet. The publisher

116 Wicks, above n 47, 31–52. 117 Stamp Act 1712 (10 Anne c 19). See L Oats and P Sadler, ‘Stamp Duty, Propaganda and the French Revolutionary and Napoleonic Wars’ in Tax History, vol 1, above n 3, 243; L Oats and P Sadler, ‘The Abolition of the Taxes on Knowledge’ in Tax History, vol 2, above n 3, 287. 118 Stamp Act 1712 s 101.

74  Michael Littlewood was required to present his paper to the Stamp Office, together with the amount of the tax; the Stamp Office stamped it and returned it to him for printing.119 The advertisement tax was charged at a set rate of 12 pence per advertisement, irrespective of the number of copies of the newspaper containing it.120 And the paper tax was charged at different rates for different types of paper – from fourpence to two shillings per ream for paper manufactured in Britain,121 and from one to sixteen shillings per ream for imported paper (a ream being 480 sheets).122 The Act provided for a number of offences, with penalties ranging from a fine to death.123 The tax on newspapers was initially a revenue-raising measure. As time went by, however, the political function of newspapers became more important. Some of them advocated a broader suffrage and the abolition of the Corn Laws (which imposed a tariff on imported grain). Consequently, the government came to regard the tax less as a source of revenue than as a means of suppressing subversive opinions. The nadir came with the P ­ eterloo ­Massacre in Manchester on 16 August 1819, when the government used mounted troops against a large crowd calling for electoral reform. About a dozen people were killed and hundreds injured.124 Shortly thereafter, the scope of the newspaper tax was expanded (along with various other repressive measures), the amending legislation reciting that newspapers had ‘lately been published in great Numbers’; that they were ‘tending to excite Hatred and Contempt of the Government … and also vilifying our holy Religion’; and that it was ‘expedient that the same should be restrained’.125 Unsurprisingly, the tax on newspapers was widely opposed, its opponents denigrating it as a tax on knowledge. In 1832 the Great Reform Act was enacted, significantly increasing the representativeness of the British Parliament;126 in 1836 the newspaper tax was reduced to its original rate (usually one penny per sheet); in 1849 the Corn Laws were repealed; and in 1855 the newspaper tax was abolished.127 TAX THEORY: FROM THOMAS HOBBES TO KARL MARX

One of Europe’s greatest achievements has been the extraordinary flourishing of political theory that began in the mid-seventeenth century with



119 ibid,

s 104. s 101. 121 ibid, s 38. 122 ibid, ss 32 and 40. 123 ibid, s 115. 124 R Reid, The Peterloo Massacre (London, Heinemann, 1989), 171–95. 125 Newspaper and Stamp Duties Act 1819 (60 Geo. III & 1 Geo. IV c. 9) s 1. 126 Wicks, above n 47, 65–82. 127 Oats and Sadler, ‘Abolition’, above n 117. 120 ibid,

John Tiley and the Thunder of History  75 Thomas Hobbes and concluded in the mid-nineteenth with Karl Marx.128 ­Political theory tends to lead to fiscal theory; and the theories of taxation formulated in this period remain enormously influential today. They have also been examined by several members of the Tiley School.129 The key figures include the following. Thomas Hobbes In 1651 Thomas Hobbes published his book Leviathan, a tract devoted to ­demonstrating the importance of stability and order.130 In the wake of the English Civil War, that emphasis is readily understandable. A powerful state, said Hobbes, is better at providing order than a weak one; without a powerful state, he famously observed, most people’s lives would be ‘nasty, brutish, and short’.131 Moreover, he said, a tyrannical government is better than a weak one, so tyranny is a price worth paying for stability and order. As for taxation, he thought that every man should contribute to the state in proportion to the protection he derived from it; and that the appropriate measure of that protection is consumption. Thus, according to Hobbes, a man should contribute to the state in proportion to his consumption:132 To Equall Justice, appertaineth also the Equall imposition of Taxes; the equality whereof dependeth not on the Equality of riches, but on the Equality of the debt, that every man oweth to the Common-wealth for his defence. It is not enough, for a man to labour for the maintenance of his life; but also to fight, (if need be,) for the securing of his labour. They must either do as the Jewes did after their return from captivity, in re-edifying the Temple, build with one hand, and hold the Sword in the other; or else they must hire others to fight for them. For the Impositions that are layd on the People by the Soveraign Power, are nothing else but the Wages, due to them that hold the publique Sword, to defend private men in the exercise of severall Trades, and Callings. Seeing then the benefit that every one receiveth thereby, is the enjoyment of life, which is equally dear to poor, and rich; the debt which a poor man oweth them that defend his life, is the same which a rich man oweth for the defence of his; saving that the rich, who have the service of the poor, may be debtors not onely for their own persons, but for many more. Which considered, the Equality of Imposition, consisteth rather in the Equality of that which is consumed, than of the riches of the persons that consume the same. For what reason is there, that he which laboureth much, and sparing the fruits of his labour, consumeth little, should be more charged, then he that living idlely, getteth little, and spendeth all he gets; seeing 128 See generally J Frecknall-Hughes, ‘The Concept of Taxation and the Age of Enlightenment’ in Tax History, vol 2, above n 3, 253. 129 See generally M Stewart, ‘The State, Benefit and Legitimacy’ in Tax History, vol 7, above n 3, 483; H Gribnau and H Vording, ‘The Birth of Tax as a Legal Discipline’ in Tax History, vol 8, above n 3, 37. 130 T Hobbes, Leviathan (London, Andrew Crooke, 1651). 131 ibid, 62. 132 ibid, 181.

76  Michael Littlewood the one hath no more protection from the Common-wealth, then the other? But when the Impositions, are layd upon those things which men consume, every man payeth Equally for what he useth: Nor is the Common-wealth defrauded, by the luxurious waste of private men.

John Locke Hobbes was followed by John Locke, who published his Two Treatises of Government in 1690.133 This book is essentially a defence of two ideas – first, that the principal function of government is the protection of property and, second, that legitimate government can only be based on the consent of the governed. Locke’s theory of government included a theory of taxation, which has been the subject of a substantial literature, culminating, for present purposes, in a paper presented by John Snape and Jane Frecknall-Hughes in 2016.134 Since property is sacrosanct (according to Locke), it is generally wrong for the state to expropriate it. Taxation can be justified, therefore, only on the basis that those who are required to pay have consented – either directly themselves, or indirectly via their representatives in Parliament. He concluded that a tax on land was easily justified, in that the franchise comprised male landowners – so the tax was payable by the same people whose representatives had imposed it (leaving aside the small number of female landowners). But a substantial part of the government’s revenues came from customs and excise duties; and these taxes were paid by the entire populace, an overwhelming majority of whom were not entitled to vote. Locke resolved this difficulty by formulating a theory of incidence. The imposition of a tax on commodities, he said, will cause landowners to reduce the rents they charge their tenants, so the burden of the tax will really be borne by landowners. Thus, again, the tax will be borne by the very people whose representatives had imposed it – problem solved.135 Montesquieu In 1748 the French political philosopher Charles de Secondat, Baron de Montesquieu, published his great work, The Spirit of the Laws.136 In it he propounded his theory of the separation of powers – a notion adopted, most famously, by

133 J Locke, Two Treatises of Government (London, Awnsham Churchill, 1690). 134 J Snape and J Frecknall-Hughes, ‘John Locke: Property, Tax and the Private Sphere’ in Tax History, vol 8, above n 3, 1. 135 Snape and Frecknall-Hughes, above n 134, 28–30. 136 M de Secondat, Baron de Montesquieu, The Spirit of the Laws, 6th edn, translated by T Nugent (London, W Clarke and Son, 1793).

John Tiley and the Thunder of History  77 the framers of the United States Constitution.137 The Spirit of the Laws consists of 31 chapters (referred to by Montesquieu as books), one of which, Book 13, is about taxation. Montesquieu emphasised the importance of the subject: ‘Nothing requires more wisdom and prudence than the regulation of that portion of which the subject is deprived, and that which he is suffered to retain.’138 He was, however sceptical: ‘Often have ministers of a restless disposition imagined that the wants of their own mean and ignoble souls were those of the state.’139 Montesquieu posited a relationship between the nature of a state and the nature of its tax system. The more liberal the state, he said, the heavier the taxes it is able to impose. A despot, therefore, is only able to impose relatively light taxes; a moderate monarchy can impose somewhat heavier taxes; and a republic can impose heavier taxes still.140 He offered also various observations as to how taxes work. He says, for instance, that sales taxes are usually imposed on the seller rather than the buyer. The seller does not object to paying the tax, because he knows that it is the buyer who bears the burden; and the buyer does not object, because he tends to forget that the price includes the tax. But this only works so long as the tax is kept at a reasonable level; if the tax is excessive, the buyer will be acutely aware of it and object to bearing the burden.141 William Blackstone William Blackstone’s Commentaries on the Laws of England was a series of four volumes, the first published in 1765 and the last in 1769.142 The Commentaries served as the leading text on the common law for well over a century on both sides of the Atlantic. They are surprisingly readable and Abraham Lincoln, for example, regarded them as indispensable.143 Much of what Blackstone said remains directly pertinent today. That cannot be said, however, of chapter 8 of Book 1, which deals with taxation. Rather, Blackstone’s treatment of the English tax system is chiefly notable for demonstrating just how much has changed since the late eighteenth century (even though he acknowledged that much of chapter 8 was of more historical than contemporary relevance). For example, according to Blackstone, the king’s ‘ordinary revenues’ included, among others, corodies, royal fish, waifs, estrays and ‘the custody of idiots’.144 A corody was the right, enjoyed by the king, to have every bishop 137 See generally J Snape, ‘Montesquieu – “The Lively President” and the English Way of Taxation’ in Tax History, vol 5, above n 3, 73. 138 Montesquieu, n 136 above, 155. 139 ibid. 140 ibid, 159–162. 141 ibid, 158. 142 W Blackstone, Commentaries on the Laws of England (London, Clarendon Press, 1765–69). 143 AW Alschuler, ‘Rediscovering Blackstone’ (1996) 145 University of Pennsylvania Law Review 1. 144 Blackstone, n 142 above, book I, 292.

78  Michael Littlewood maintain one of the royal chaplains. The ‘royal fish’ were whales and sturgeon, which, ‘when either thrown ashore, or caught near the coasts, are the property of the king, on account of their superior excellence’.145 A waif was a chattel stolen and discarded by the thief during flight; at common law, waifs belonged to the king.146 An estray was a domestic animal found wandering at large; if its owner could not be identified, it belonged to the king.147 Finally, the law provided for the king to manage the estates of ‘idiots’, ‘to prevent such idiots from alienating their lands, and their heirs from being disinherited’.148 An ‘idiot’ was a person ‘that hath had no understanding from his nativity; and therefore is by law presumed never likely to attain any’.149 The king was obliged to maintain such persons, but could otherwise retain the income derived from their estates. Edmund Burke Edmund Burke – who was an MP as well as a writer – is best known for his antiutopian Reflections on the Revolution in France, which was published in 1790 and is perhaps the most influential paean to conservatism yet composed.150 But some years earlier, in 1774, he delivered a speech in the House of Commons in support of the idea that the British Government should refrain from taxing its colonies in North America.151 His advice was not followed, with consequences that are well known (and discussed below). It was, incidentally, in this speech that Burke delivered his famous aphorism that ‘to tax and to please, no more than to love and to be wise, is not given to men’.152 Adam Smith Adam Smith’s The Wealth of Nations is perhaps the most important book ever written, leaving aside religious texts and literature.153 It was published in 1776 and, as is well known, is a panegyric in praise of the ‘invisible hand’ of the market.154 145 ibid, 280. 146 ibid, 286. 147 ibid, 287. 148 ibid, 293. 149 ibid, 292. 150 E Burke, Reflections on the Revolution in France (London, J Dodsley, 1790). 151 E Burke, ‘On American Taxation’, 19 April 1774, in P Langford and WB Todd (eds), The Writings and Speeches of Edmund Burke, vol 2: Party, Parliament, and the American War: 1766–1774 (Oxford, Oxford University Press, 1981; online edn 2014), 406, www.oxfordscholarlyeditions.com/ view/10.1093/actrade/9780198224167.book.1/actrade-9780198224167-div1-50?r-1=1.000&wm-1=1 &t-1=contents-tab&p1-1=1&w1-1=1.000&p2-1=1&w2-1=0.400. 152 ibid, 454. 153 A Smith, An Inquiry into the Nature and Causes of the Wealth of Nations, RH Campbell and AS Skinner (eds) (Oxford, Clarendon Press, 1976). 154 ibid, vol 1, 456 (IV.ii.9).

John Tiley and the Thunder of History  79 According to Smith, the best way of organising economic resources is almost always to leave it to the market. Only in the case of what we would now call market failure, he said, should the government intervene; and, according to him, the market, if left to itself, seldom fails (though he was acutely alert to the abuses to which monopolies and oligopolies are prone). This theory has, obviously, proved hugely influential. In particular, it has implications for tax policy for, to the extent that one believes the market is the best way of allocating economic resources, one is likely to think that the government should be as small as possible and that taxes should be as low as possible. Smith is important also for formulating a theory of taxation.155 Most famously, he said that there are four criteria which a good tax system must satisfy – usually summarised by subsequent commentators as equity, certainty, convenience and efficiency. Thus, the merits of any existing tax system, or of any proposal for tax reform, can be evaluated by reference to these four ‘canons’ or ‘maxims’ of taxation – and they are still routinely invoked for that purpose today.156 Karl Marx Karl Marx produced a vast body of work, perhaps most importantly The Communist Manifesto (written jointly with Friedrich Engels and published in 1848)157 and Capital (published in three volumes, 1867–94).158 According to Marx, Smith was wrong to suppose that the market was a stable mechanism producing optimal outcomes. Rather, according to Marx, capitalism lurches from crisis to crisis and will eventually collapse. The proletariat, he says, will ‘win the battle of democracy’ and then ‘use its political supremacy to wrest, by degree, all capital from the bourgeoisie, to centralise all instruments of production in the hands of the State’.159 The goal, in other words, is the ‘[a]bolition of private property’160 – what one might call total taxation. It is common nowadays for people to think of the collapse of the Soviet Union as marking the end and failure of the Marxist project. But much of what Marx said is now generally accepted – in particular, that there is a connection between economic and political dynamics and that capitalist economies tend to

155 ibid, vol 2, 825–28 (V.ii.b.1–7). For an interesting earlier attempt at a theory of taxation, see Petty, above n 57. 156 See eg G Loutzenhiser, Tiley’s Revenue Law, 8th edn (Oxford, Hart, 2016) 10–11; Snape, above n 137; Stewart, above n 129. 157 K Marx and F Engels ‘Manifesto of the Communist Party’ in RC Tucker (ed) The Marx-Engels Reader, 2nd edn (Norton, New York, 1978) 473. 158 Karl Marx, Capital (London, Allen & Unwin, 1946). 159 Marx and Engels, above n 157, 490. 160 ibid, 484.

80  Michael Littlewood function in a somewhat cyclical manner. Moreover, important aspects of Marx’s programme have come to pass and are nowadays widely regarded as obviously desirable. Most importantly, it is generally accepted, in the West at least, that the only proper function of the government is to promote the interests of the populace, as democratically determined – whereas in the mid-nineteenth century, when Marx among others advanced that view, it was considered by most governments to be a radical left-wing heresy. More specifically, Marx advocated various policies that the governments of the time regarded as wholly unacceptable, but which have since become orthodox. For instance, he thought schooling for children should be free; that there should be a law against child labour; and that there should be a progressive income tax.161 In a nutshell, we are almost all Marxists now to some degree, though some of us prefer not to acknowledge it. THE BRITISH INCOME TAX

The modern British income tax was introduced by the government of William Pitt the Younger in 1799 to contribute to the financing of the war against Napoleon.162 But Pitt’s tax relied almost entirely on taxpayers’ honesty. Not surprisingly, that proved unsatisfactory, and so in 1803 Henry Addington, who succeeded Pitt as Prime Minister in 1801, radically restructured it. Most importantly, Addington introduced the system of schedules which still characterises the British income tax today (and which made the computation of taxpayers’ incomes more accurate); and he provided for the tax to be collected by means of withholding wherever possible (which made it less susceptible to evasion). Addington’s tax was generally charged at 5 per cent, but incomes of less than £60 per year were exempt – and since the overwhelming majority of incomes were less than that, the tax was confined to the affluent.163 The tax was abolished when the war ended in 1816, resurrected in 1842, and remained basically unchanged for the remainder of the nineteenth century. The twentieth century, however, saw the income tax transformed. As Basil Sabine (a British revenue official who wrote two landmark histories of the B ­ ritish tax system) observed, ‘If the eighteenth century was the age of enlightenment 161 ibid, 490. 162 See generally ERA Seligman, The Income Tax (New York, Macmillan, 1911), 57–115; BEV Sabine, A History of Income Tax (London, George Allen & Unwin, 1966); M Daunton, ­Trusting Leviathan: The Politics of Taxation in Britain, 1799–1914 (Cambridge, Cambridge University Press, 2001); M Daunton, Just Taxes: the Politics of Taxation in Britain, 1914–1979 (Cambridge, Cambridge University Press, 2002). See also A Mumford, ‘ERA Seligman: The Surprising Fiscal Sociologist’ in Tax History, vol 5, above n 3, 281. 163 JF Avery Jones, ‘The Sources of Addington’s Income Tax’, in Tax History, vol 7, above n 3, 1. Also on the Napoleonic era, see O Ydema and H Vording, ‘Dutch Tax Reforms in the ­Napoleonic Era’, in Tax History, vol 6, above n 3, 489; JF Avery Jones, ‘The Special Commissioners from ­Trafalgar to Waterloo’ in Tax History, vol 2, above n 3, 3.

John Tiley and the Thunder of History  81 and the nineteenth the age of industrialisation, the twentieth may well go down in history as the age of taxation.’164 That might seem an extravagant claim but it is actually readily defensible. Most obviously, over the course of the ­twentieth century the rates of income tax were cranked up dramatically, so as by the 1970s to reach 98 per cent.165 The rates of estate duty were raised steeply, too.166 Moreover, income tax allowances were dramatically reduced, so as to convert the tax, initially imposed only on the affluent, into a mass tax, payable by almost everyone in employment. The legislation and the mechanics of the tax’s administration achieved levels of complexity far greater than anyone had imagined.167 This was partly due to the need to curb avoidance and evasion (a more pressing problem with a heavy tax than a light one) and partly due to the need to redress inequities (likewise a more pressing problem with a heavy tax than a light one).168 As a result of these developments, the income tax produced far greater revenues than before, not only in absolute terms but also as a much larger proportion of a much larger economy. Many of the increases were due to war. In particular, the First and Second World Wars entailed colossal increases in government spending; but the increases effected during wartime were mostly maintained afterwards to fund spending on health, education and welfare – priorities produced by the broadening of the franchise and the advent, growth and electoral successes of the Labour Party. It is necessary also to mention John Maynard Keynes, on the basis of whose theory British governments, not only Labour but Conservative also, came to regard as orthodox the idea that the government should use the tax system and spending programmes to smooth out the ups and downs of the economic cycle (an approach shared by almost every other government in the developed world).169 Other key changes included the introduction of capital gains tax in 1965170 and value added tax in 1973.171

164 Sabine, above n 45, 132. See also Sabine, above n 162. 165 Loutzenhiser, above n 156, 145. 166 J Tiley, ‘Death and Taxes’ in Tax History, vol 3, above n 3, 359; J Tiley, ‘Estate Duty (1965–75): The Making of a Modern Tax’ in Tax History, vol 6, above n 3, 331. 167 See for example JHN Pearce, ‘The Road to 1944: Antecedents of the PAYE Scheme’ in Tax History, vol 5, above n 3, 193. 168 See generally J Snape, The Political Economy of Corporation Tax (Oxford, Hart, 2011). 169 E Johnson and D Moggridge (eds) The Collected Writings of John Maynard Keynes, vol 7: The General Theory (Cambridge, Royal Economic Society, 1978). 170 See D Stopforth, ‘Deliberations over Taxing Capital Gains – The Position up to 1955’ in Tax History, vol 1, above n 3, 133; D Stopforth, ‘Official Deliberations on Capital Gains Tax: 1955–1960’ in Tax History, vol 2, above n 3, 119; A Mumford, ‘Reviving Capital Transfer Tax Scholarship’ in Tax History, vol 7, above n 3, 465; and P Ridd, ‘Statutory Interpretation in Early Capital Gains Tax Cases’ in Tax History, vol 8, above n 3, 257. 171 K James, The Rise of the Value-Added Tax (Cambridge, Cambridge University Press, 2015). Ian Roxan presented a paper on VAT at the 2002 Tax History Conference, but he did not submit it for inclusion in the book.

82  Michael Littlewood As one might have expected, the Tiley School has devoted much of its attention to the twentieth-century development of the British income tax. Tiley himself addressed the perpetually troublesome concept of income,172 as have Martin Daunton,173 John Pearce174 and Richard Thomas.175 Others have examined the histories of diverse other aspects of the British income tax, such as tax ­litigation,176 the taxation of companies,177 the taxation of trusts,178 ­extrastatutory ­concessions,179 the computation of insurance profits,180 the deductibility of interest,181 the tax treatment of expenditure on e­ntertainment,182 charities,183 the tax profession,184 the tax treatment of employee share schemes,185 tax planning,186 tax avoidance,187 and constitutional aspects of the income tax.188 Several members of the Tiley School have written about various aspects

172 J Tiley, ‘Aspects of Schedule A’ in Tax History, vol 1, above n 3, 81. 173 M Daunton, ‘What is Income?’ in Tax History, vol 1, above n 3, 3. 174 JHN Pearce, ‘The Rise and Development of the Concept of “Total Income” in United K ­ ingdom Income Tax Law: 1842–1952’, in Tax History, vol 2, above n 3, 87; JHN Pearce, ‘The Role of Central Government in the Process of Determining Liability to Income Tax in England and Wales: 1842– 1970’, in Tax History, vol 3, above n 3, 323. 175 R Thomas, ‘What is the “Full” Amount?’ in Tax History, vol 6, above n 3, 221. 176 P Ridd, ‘Excess Profits Duty’ in Tax History, vol 1, above n 3, 101; P Ridd, ‘Excess Profits Tax Litigation’ in Tax History, vol 2, above n 3, 137; P Ridd, ‘Plaintive Glitterati: Famous People in Tax Cases’ in Tax History, vol 6, above n 3, 305; P Ridd, ‘Plaintive Aristocrati: The Upper Crust in Tax Cases’, in Tax History, vol 7, above n 3, 171. See also J Snape and D de Cogan (eds), above n 2. 177 JF Avery Jones, ‘Defining and Taxing Companies 1799 to 1965’, in Tax History, vol 5, above n 3, 1. 178 M Gammie, ‘The Origins of Fiscal Transparency in UK Income Tax’ in Tax History, vol 4, above n 3, 33. 179 S Daly, ‘The Life and Times of ESCs: A Defence?’ in Tax History, vol 8, above n 3, 169. 180 R Thomas, ‘The Crown Option’ in Tax History, vol 4, above n 3, 3; R Thomas, ‘Not Like Grocers’ in Tax History, vol 8, above n 3, 131. 181 R Thomas, ‘Retention of Tax at Source and Business Financing’, in Tax History, vol 7, above n 3, 33. 182 D Stopforth, ‘Restricting Tax Relief on Business Entertaining and Gifts: 1948–1965’ in Tax History, vol 5, above n 3, 219. 183 F Martin, ‘The History of the Taxation of Charities: How the Common Law Development of a Legal Definition of “Charity” has Effected the Taxation of Charities’ in Tax History, vol 4, above n 3, 297; M Gousmett, ‘A Short History of the Charitable Purposes Exemption from Income Tax of 1799’ in Tax History, vol 5, above n 3, 125. 184 J Frecknall-Hughes, ‘Contextualising the Development of the Tax Profession: Some First Thoughts’ in Tax History, vol 5, above n 3, 177; J Frecknall-Hughes and M McKerchar, ‘Tax and the Tax Profession: Assessing Social Standing and Prestige’ in Tax History, vol 7, above n 3, 133; J Frecknall-Hughes and M McKerchar, ‘The History and Development of the Taxation Profession in the UK and Australia’ in Tax History, vol 6, above n 3, 421. 185 P Casson, ‘The Evolution of UK Tax Legislation for Employee Share Ownership Plans’ in Tax History, vol 1, above n 3, 147. 186 P Baker, ‘A Book Review of The Saving of Income Tax, Surtax and Death Duties by Jasper More’ in Tax History, vol 2, above n 3, 223. 187 A Likhovsky, ‘Tax Law and Public Opinion: Explaining IRC v Duke of Westminster’ in Tax History, vol 2, above n 3, 183; P Harris, ‘The Profits Tax GAAR: An Aid in the “Hopeless” Defence Against the Dark Arts’ in Tax History, vol 8, above n 3, 221. 188 C Stebbings, ‘Consent and Constitutionality in Nineteenth-Century English Taxation’ in Tax History, vol 3, above n 3, 293.

John Tiley and the Thunder of History  83 of the administration of the British tax system, notably Dominic de Cogan, Lynne Oats and Mark Billings,189 Chantal Stebbings190 and John Pearce.191 THE UNITED STATES

In 1492 Columbus crossed the Atlantic and the European colonisation of the Americas began. The Portuguese concentrated on what is now Brazil, and the Spanish established numerous colonies in South America, Central America, the islands of the Caribbean, and the southern third or so of North America; the French claimed vast lands in the Mississippi Basin; and the British (to simplify a little) established the 13 colonies along the eastern seaboard. The lands that the Spanish conquered were rich in gold and silver, especially silver, so they took it from the people already there and they also used slaves (both indigenous and imported from Africa) to mine more. The Spanish state was largely financed by that silver for the next two centuries.192 English privateers (state-sanctioned pirates), for example Sir Francis Drake, occasionally relieved Spanish galleons of their bullion, but were generally no more than an irritant.193 Slavery played an important role in most of the British colonies, too; and taxes on slaves contributed substantially to their public finances. Indeed, according to Kevin Outterson, from colonial times to the civil war, American governments at all levels derived more revenue from slave taxes than from any other source.194 As the eighteenth century rolled by, however, the settler populations increasingly objected to paying taxes to London. The (British) Stamp Act 1765 imposed duty on various categories of document and various other paper goods (newspapers, playing cards and so on) in the colonies.195 The aim was to pay for the British troops stationed in the colonies. The Stamp Act proved troublesome in its administration and it was repealed only a year later in 1766. But in 1767 and 1768 the British government imposed new taxes on glass, lead, paints,

189 D de Cogan, ‘Law and Administration in Capital Allowances Doctrine: 1878–1950’ in Tax History, vol 6, above n 3, 175; D de Cogan, L Oats and M Billings, ‘The Board of Referees: “A Most Useful Addition to Fiscal Machinery”’ in Tax History, vol 7, above n 3, 107. 190 C Stebbings, ‘Income Tax Tribunals: Their Influence and Place in the Victorian Legal System’ in Tax History, vol 1, above n 3, 57; C Stebbings, ‘Access to Justice before the Special Commissioners of Income Tax in the Nineteenth Century’ in Tax History, vol 2, above n 3, 49; C Stebbings, ­‘Traders, the Excise and the Law: Tensions and Conflicts in Early Nineteenth Century England’ in Tax History, vol 4, above n 3, 139; C Stebbings, ‘The Architecture of Tax Administration: Function or Form?’ in Tax History, vol 8, above n 3, 85. 191 JHN Pearce, ‘The Income Tax Law Rewrite Projects: 1907–56’ in Tax History, vol 6, above n 3, 135; JHN Pearce, ‘The Rise of the Finance Act: 1853–1922’ in Tax History, vol 7, above n 3, 71; JHN Pearce, ‘The Special Contribution of 1948’ in Tax History, vol 8, above n 3, 195. 192 JH Elliott, Imperial Spain: 1469–1716 (London, Edward Arnold, 1963), 174–77, 183–86, 263–64. 193 ibid, 283. 194 K Outterson, ‘Slave Taxes’ in Tax History, vol 1, above n 3, 263 at 263–64. 195 5 George III c 12; L Oats and P Sadler, ‘Variations on a Theme: Stamp Duty in the Eighteenth Century’ in Tax History, vol 4, above n 3, 67.

84  Michael Littlewood paper and, most notoriously, tea;196 and in 1773 some of the colonists expressed their discontent by throwing a cargo of tea into Boston Harbour.197 Exactly what they hoped to achieve is still unclear, but the symbolism of the gesture was powerful. Three years later, in 1776 (the same year in which Adam Smith published his panegyric to the invisible hand), the 13 colonies declared themselves independent of Britain, adopting as their war-cry the rousing slogan, ‘No taxation without representation’. London endeavoured to hang onto its colonies, but lost the war that followed and so the United States was born. In 1781 the 13 ex-colonies formalised their system of government, entering into an instrument called the Articles of Confederation. It proved an unsatisfactory basis for the new nation’s governance, however, mainly because it did not confer on the federal government the power to tax.198 Eight years later, therefore, in 1789, the Articles of Confederation were scrapped and a new instrument, called the Constitution, was adopted instead. This has remained in force ever since, though it has been repeatedly amended (most extensively by the addition to it of the Bill of Rights in 1791). Unlike the Articles of Confederation, the Constitution conferred on the federal government the power to tax: Article 1, section 8 provides (among other matters) that ‘The Congress shall have Power To lay and collect Taxes’.199 That power was, however, circumscribed by Article 1, section 2, which provides that ‘direct’ taxes must be ‘apportioned among the several States’ according to their populations.200 What that meant remained unclear for just over a hundred years, but in 1894 legislation was enacted establishing a federal income tax – the constitutionality of which was challenged on the ground that it was not ‘apportioned’ among the states in the requisite manner. The challenge came before the Supreme Court in Pollock v Farmers’ Loan and Trust Co, and the Court held that the tax was indeed unconstitutional and therefore void.201 In 1909 Congress responded by enacting a tax on the profits of corporations; and in Flint v Stone Tracy Co202 the Supreme Court held that the

196 RJ Chaffin, ‘The Townsend Acts Crisis, 1767–1770’ in JP Greene and JR Pole (eds), The ­Blackwell Encyclopedia of the American Revolution (Cambridge MA, Basil Blackwell, 1991) 126. 197 DL Ammerman, ‘The Tea Crisis and its Consequences, through 1775’ in Greene and Pole, above n 196, 211. 198 P Maier, Ratification: The People Debate the Constitution, 1787–1788 (New York, Simon and Schuster, 2010) 11–17. 199 On the history of the US tax system, see eg S Ratner, Taxation and Democracy in America, revised edn (New York, John Wiley and Sons, 1967); S Steinmo, Taxation and Democracy: Swedish, British and American Approaches to Financing the Modern State (New Haven CT, Yale University Press, 1993); WE Brownlee, Federal Taxation in America: A History, 3rd edn (Cambridge, Cambridge University Press, 2016). 200 See also Article 1, section 9. 201 Pollock v Farmers’ Loan and Trust Co 157 US 429 (1895). See also Seligman, n 162 above, 531–89. 202 Flint v Stone Tracy Co 220 US 107 (1911).

John Tiley and the Thunder of History  85 corporate income tax was constitutional, the apportionment requirement notwithstanding.203 The decision in the Pollock case prompted a move to amend the Constitution so as to enable the federal government to tax personal incomes, and after much politicking the Sixteenth Amendment was ratified in 1913.204 It provides: The Congress shall have power to lay and collect taxes on incomes, from whatever source derived, without apportionment among the several States, and without regard to any census or enumeration.

Immediately after the ratification, another federal income tax was introduced. In the beginning, as in the UK, the rates of tax were low and the allowances operated so as to exempt all but the wealthy. The highest rate of tax was 7  per  cent, charged on incomes of more than $500,000 per year.205 But the rates of tax were soon increased, even more speedily than in the UK. In 1914, the First World War broke out; in 1917 the US entered the war; and by 1918 the maximum rate of tax had reached 77 per cent. Thus within the space of only five years the US had gone from no income tax at all to a tax charged at 77 per cent. The tax was, however, later characterised by one leading economist (Henry Simons) as ‘dipping deeply into great incomes with a sieve’.206 In other words, the rates of tax were high but the system was susceptible to avoidance on a massive scale, so the rich usually paid the high rates of tax on only a small part of their incomes. In the years after the war, the rates of income tax were reduced.207 Also, as in the UK, US government policy was heavily influenced by Keynesian ideas about the use of the tax system and public spending to manage the economy. The Second World War saw dramatic increases again: in 1944, the top rate was raised to 94 per cent to pay for military spending. Immediately after the war, the rates of tax were lowered a little, but the top rate remained at 91 per cent from 1951 until 1963 – except for 1952 and 1953, when it was 92 per cent.208 As in the UK, and in many other countries, the allowances were progressively reduced, so as to convert the income tax from an impost confined to the rich 203 RS Avi-Yonah, ‘Why was the US Corporate Tax Enacted in 1909?’ in Tax History, vol 2, above n 3, 377; SA Bank, ‘Entity Theory as Myth in the US Corporate Excise Tax of 1909’ in Tax History, vol 2, above n 3, 393. 204 See Seligman, n 162 above, 590–630. 205 RA Wilson, Personal Exemptions and Individual Income Tax Rates, 1913–2002 (US Internal Revenue Service, undated memorandum, www.irs.gov/pub/irs-soi/02inpetr.pdf, accessed 26 ­September 2018), 219. See also CC Jones, ‘Bonds, Voluntarism and Taxation’ in Tax History, vol 2, above n 3, 427. 206 HC Simons, Personal Income Taxation: The Definition of Income as a Problem of Fiscal Policy (Chicago IL, University of Chicago Press, 1938) 219. 207 Wilson, above n 205. For an account of various aspects of the US tax system in the 1930s, see ME Kornhauser, ‘Remembering the “Forgotten Man” (and Woman): Hidden Taxes and the 1936 ­Election’, in Tax History, vol 4, above n 3, 327. See also ME Kornhauser, ‘Taxing Bachelors in America: 1895–1939’ in Tax History, vol 6, above n 3, 467. 208 Wilson, above n 205, 219–20.

86  Michael Littlewood into one borne by almost everyone who had a job; and the tax on employment income (and on various other forms of income) was collected by means of withholding.209 The legislation was repeatedly amended, almost always by adding to it, rather than abbreviating it, mainly to combat avoidance (which became increasingly problematic as the rates of tax were increased) and to ameliorate inequities (likewise). The supporting paraphernalia (decisions of the courts, regulations and administrative instruments) proliferated also, and the US ended up, by the 1980s if not before, with the most byzantine body of tax law in the world.210 Since then, the principal trend seems to have been reductions in the rates of tax on large incomes. The maximum personal rate of tax is currently 37 per cent and it only applies to incomes over $500,000 per year; and the corporate rate was recently cut from 35 per cent to 21 per cent.211 The estate tax has also been drastically cut back.212 These changes seem to be largely due to the curious way in which the US political system operates, but they are associated also with the theorising of Milton Friedman, according to whom Adam Smith was mostly right and Keynes was mostly wrong.213 THE EMPIRE

As a result of the War of Independence, Britain lost most of its colonies in North America, but they were not the whole nor the end of the Empire. For a start there was the special case of Ireland, which in the twelfth century was invaded by an Anglo-Norman force whose number included one Miles de Cogan, perhaps an ancestor of the co-editor of this volume.214 In 1542 Henry VIII, King of England from 1509, declared himself King of Ireland also; and in 1800 the island was absorbed into the UK.215 There were also still the several colonies comprising what is now Canada, the various British colonies in the Caribbean, and India, the jewel in the crown, incorporating not just

209 ibid, 216–225; Steinmo, above n 199; Ratner, above n 199. 210 Steinmo, above n 199, 38–39. 211 C Marr, B Duke and CC Huang, New Tax Law Is Fundamentally Flawed and Will Require Basic Restructuring (Center on Budget and Policy Priorities, Washington, 2018), www.cbpp.org/research/ federal-tax/new-tax-law-is-fundamentally-flawed-and-will-require-basic-restructuring, accessed 27 September 2018, 3–7. 212 CC Huang and C Cho, Ten Facts You Should Know about the Federal Estate Tax (Center on Budget and Policy Priorities, Washington, 2017), www.cbpp.org/sites/default/files/atoms/ files/1-8-15tax.pdf, accessed 17 October 2018. 213 M Friedman, Capitalism and Freedom (Chicago IL, University of Chicago Press, 1962) ch 5. 214 FX Martin, ‘Allies and an Overlord, 1169–72’ in A Cosgrove (ed), A New History of Ireland, vol 2 (Oxford, Oxford University Press, 2008), 78–97. 215 P Clarke, ‘Let Them Pay for Their Starvation: The Imposition of Income Tax in Ireland in 1853’ in Tax History, vol 8, above n 3, 109; see also JDB Oliver, ‘What’s in a Name?’ in Tax History, vol 1, above n 3, 177.

John Tiley and the Thunder of History  87 modern India but also Pakistan and Bangladesh. Ceylon (now Sri Lanka) was colonised by Britain in the course of the Napoleonic Wars; and colonies were established further east, too, in Myanmar, Malaysia, Singapore, Hong Kong and several other parts of China. In 1788 the First Fleet, loaded with convicts, arrived in Botany Bay, just south of the site on which they, and their guards, established the settlement that grew into Sydney; and the colonisation of the whole of Australasia followed (though South Australia and New Zealand were free, not penal, colonies). In 1795, Britain seized the Cape Colony from the Dutch, and over the next few years colonised also the rest of what is now South Africa. The nineteenth century saw the so-called ‘scramble for Africa’, in the course of which the British established major colonies in Egypt, Sudan, Kenya, Uganda, Mauritius, Zimbabwe, Zambia and Nigeria, and smaller colonies in various other places. Finally, when the Ottoman Empire collapsed in 1918, Britain and France took the opportunity to grab large swathes of the Middle East. Having burnt its fingers in America, the British government generally resisted the temptation to tax its other colonies, but the colonial governments generally instituted taxes copied from those in the UK.216 Sooner or later the colonies all became independent, except for some of the smaller ones (which are still colonies, though nowadays euphemistically referred to as British Overseas Territories) and Hong Kong (which was returned to Chinese rule in 1997). Most of their tax systems, however, are still clearly derivative of Britain’s; and several members of the Tiley School have written about them – Martin Daunton (the Empire generally),217 Peter Harris (Australasia and the Caribbean colonies),218 Philip Ridd (the Privy Council’s tax cases),219 Diane Kraal (Malacca and Australia),220 Michael Littlewood (Hong Kong, New Zealand and the Privy Council cases),221

216 In 2008 the British Tax Review published a Special Issue on ‘The Legacy of UK Taxation’, with an introduction by John Avery-Jones and papers on Australia (Michael Walpole and Chris Evans), Canada (Benjamin Alarie and David Duff), Hong Kong (Michael Littlewood), Israel (Tsilly Dagan, Assaf Likhovski and Yoram Margalioth), New Zealand (Ivor Richardson) and South Africa (Eddie Broomberg). 217 M Daunton, ‘Tax Transfers: Britain and its Empire, 1848–1914’ in Tax History, vol 3, above n 3, 91. 218 P Harris, Metamorphosis of the Australasian Income Tax: 1866 to 1922 (Canberra, Australian Tax Research Foundation, 2002); P Harris, Income Tax in Common Law Jurisdictions: vol 1: From the Origins to 1820 (Cambridge, Cambridge University Press, 2009). 219 P Ridd, ‘Privy Council Tax Cases – A Ton of Fun’ in Tax History, vol 3, above n 3, 175. 220 D Kraal, ‘Of Taxes: An Enquiry into Dutch to British Malacca, 1824–39’ in Tax History, vol 6, above n 3, 393; D Kraal, ‘Customs Revenue in the British Colony of New South Wales 1827 – 1859: And Inquiries Concerning Frederick Garling, Artist and Customs Department Employee’ in Tax History, vol 7, above n 3, 329. 221 M Littlewood, ‘Tax Reform in Hong Kong in the 1970s: Sincere Failure or Successful Charade?’ in Tax History, vol 1, above n 3, 379; M Littlewood, ‘The History of Death Duties and Gift Duty in New Zealand’ in Tax History, vol 5, above n 3, 317; M Littlewood, ‘In the Beginning: Taxation in Early Colonial New Zealand’ in Tax History, vol 7, above n 3, 293; M Littlewood, ‘The Privy Council and the Australasian Anti-Avoidance Rules’ [2007] BTR 175; M Littlewood, ‘The Privy Council, the Source of Income and Stare Decisis’ [2004] BTR 121.

88  Michael Littlewood Shelley Griffiths (New Zealand),222 and David Duff (Canada).223 Australia has attracted the largest number of contributors: Rodney Fisher and Jacqueline McManus;224 Cynthia Coleman and Margaret McKerchar;225 Rick Krever and Peter Mellor;226 Kathryn James;227 Lynne Oats and Pauline Sadler;228 and Ann O’Connell and Joyce Chia.229 THE REST OF THE WORLD

Most of the work of the Tiley School has concerned English-language ­jurisdictions – but not all. Other countries that members of the School have written about include the Netherlands (Henk Vording and Onno Ydema),230 Germany (Andreas Their),231 France (Nicolas Delalande),232 Malta (Robert Attard),233

222 S Griffiths, ‘The Historical Meaning of “Income” in New Zealand Taxation Statutes, Cases and Administration, 1891–1930’ in Tax History, vol 8, above n 3, 419. 223 DG Duff, ‘The Abolition of Wealth Transfer Taxes in Canada’, in Tax History, vol 2, above n 3, 309. 224 R Fisher and J McManus, ‘The Long and Winding Road: A Century of Centralisation in Australian Tax’ in Tax History, vol 1, above n 3, 313; R Fisher, ‘A Tale of Two Systems: The Divergent Tax Histories of Australia and Canada’ in Tax History, vol 2, above n 3, 335. 225 C Coleman and M McKerchar, ‘The Chicken or the Egg? A Historical Review of the Influence of Tax Administration on the Development of Income Tax Law in Australia’ in Tax History, vol 1, above n 3, 285; M McKerchar and C Coleman, ‘The Ever-Elusive Definition of Income: A Historical Perspective from Australia’ in Tax History, vol 2, above n 3, 357; C Coleman, ‘The History of Progressive Tax in Australia’ in Tax History, vol 3, above n 3, 35; C Coleman and M McKerchar, ‘The History of Land Tax in Australia’ in Tax History, vol 4, above n 3, 281; M McKerchar and C  Coleman, ‘Avoiding Evasion: An Australian Historical Perspective’ in Tax History, vol 5, above n 3, 381. 226 R Krever and P Mellor, ‘The Development of Centralised Income Taxation in Australia, 1901–1942’ in Tax History, vol 7, above n 3, 363; R Krever and P Mellor, ‘From Wartime Expedient to Enduring Element of Fiscal Federalism: Centralised Income Taxation in Australia since World War II’ in Tax History, vol 8, above n 3, 383. 227 K James, ‘We of the “Never Ever”: The History of the Introduction of a Goods and Services Tax in Australia’ in Tax History, vol 3, above n 3, 139. 228 L Oats and P Sadler, ‘When Accounting and Law Collide: The Curious Case of Pre-1914 ­Dividends in Australia’ in Tax History, vol 6, above n 3, 449. 229 A O’Connell, ‘Charitable Treatment? – A Short History of the Taxation of Charities in Australia’ in Tax History, vol 5, above n 3, 91; A O’Connell and J Chia, ‘The Advancement (or Retreat?) of Religion as a Head of Charity: A Historical Perspective’ in Tax History, vol 6, above n 3, 367. 230 H Vording and O Ydema, ‘The Rise and Fall of Progressive Income Taxation in the Netherlands (1795–2001)’ in Tax History, vol 3, above n 3, 3; O Ydema and H Vording, ‘Charles Herckenrath’s 100 Per Cent Death Tax Rate’ in Tax History, vol 5, above n 3, 301; O Ydema and H Vording, ‘Dutch Tax Reforms in the Napoleonic Era’ in Tax History, vol 6, above n 3, 489. 231 A Thier, ‘Traditions of Wealth Taxation in Germany’ in Tax History, vol 3, above n 3, 73. 232 N Delalande, ‘Tax Reform in Early Twentieth-Century France: The Politics and Techniques of Redistribution’ in Tax History, vol 3, above n 3, 57. 233 R Attard, ‘The History of Income Tax in Malta, the Early Years (1641–49)’ in Tax History, vol 4, above n 3, 269.

John Tiley and the Thunder of History  89 Algeria (David Todd),234 Chile (Max Boada),235 India (Ashrita Kotha),236 China (Yan Xu)237 and Israel (Assaf Likhovski).238 INTERNATIONAL TAX

One of the distinguishing features of the twentieth century was globalisation – that is, in particular, the enormous increase in cross-border trade and investment. From a tax point of view, globalisation presented both opportunities and problems. The main opportunity, from the taxpayer’s point of view, was the possibility of arranging one’s affairs so as to shift one’s profits into countries where they would bear as little tax as possible – or, even better, into tax havens where they would not be taxed at all.239 The main problem was double taxation. By the middle of the century, most countries had introduced income taxes; and those taxes were commonly based on the twin jurisdictional pillars of residence and source. That is, a person (or company) resident in the taxing jurisdiction was obliged to pay tax on his worldwide income; and income derived from the taxing jurisdiction was taxable there, even if the person by whom it was derived was non-resident.240 Consequently, income produced by crossborder trade and investment was generally within the scope of the tax systems of two countries – in other words, potentially subject to double tax. That was a problem not only from the taxpayer’s point of view but from the points of view of both governments also. The reason was that almost all governments wanted to encourage both inbound investment (to promote the growth of their economies) and outbound (to promote the global interests of their country’s own large firms).

234 D Todd, ‘French Fiscal Frustrations: The Reform of the “Impots Arabes” in Colonial Algeria, 1830–1919’ in Tax History, vol 3, above n 3, 113. 235 M Boada, ‘When Minerals are not Enough: The Origins of Income Taxation in Chile and their Importance to the Current Situation’ in Tax History, vol 8, above n 3, 443. 236 A Kotha, ‘Cesses in the Indian Tax Regime: A Historical Analysis’ in Tax History, vol 8, above n 3, 483; C Jenkins, ‘1860: India’s First Income Tax’ [2012] BTR 87. 237 Y Xu, ‘Land Tax without Land and Land without Land Tax: A History of Land Tax in China’ in Tax History, vol 6, above n 3, 523; Y Xu, ‘A Historical Account of Taxes on Goods and Services in the Transition to Post-Socialist China’ in Tax History, vol 7, above n 3, 393; Y Xu, ‘The State Salt Monopoly in China: Ancient Origins and Modern Implications’ in Tax History, vol 8, above n 3, 513. 238 A Likhovski, ‘Formalism and Israeli Anti-Avoidance Doctrines in the 1950s and 1960s’ in Tax History, vol 1, above n 3, 339; A Likhovski, Tax Law and Social Norms in Mandatory Palestine and Israel (Cambridge, Cambridge University Press, 2017). 239 See eg United States Steel Corporation v Commissioner of Internal Revenue 617 2d 942 (2d Cir 1980). 240 See eg JF Avery Jones, ‘Taxing Foreign Income from Pitt to the Tax Law Rewrite – the Decline of the Remittance Basis’ in Tax History vol 1, above n 3, 15.

90  Michael Littlewood Although almost all governments agreed that double taxation was highly undesirable, they disagreed as to what should be done about it. The problem was that double taxation can be eliminated only by one or other of the governments concerned waiving its right to tax – which governments are usually reluctant to do. The basic issue was whether relief from double tax should be granted by the ‘source’ state (the country from which the income was derived) or the ‘home’ state (the taxpayer’s country of residence).241 Devising a solution to this problem occupied the governments of many countries for many years, with much of the work being carried out as a joint project through the League of Nations, the OECD and the United Nations. The solution that the national governments and the international bodies came up with was the bilateral double tax agreement (or DTA). Currently there are in the world about 4,000 DTAs, almost all of them based on a model produced by the OECD – so the tax systems of the world are now imbedded in a network of treaties covering the globe. The development of this network is the most striking feature of the modern international tax system, and the story of how it came about is one to which a number of the members of the Tiley School have contributed – in particular, Johann Hattingh (nineteenthcentury German DTAs),242 David Oliver (the UK/Ireland DTA and problems arising where a person resident in country A owns shares in a company resident in c­ ountry  B),243 Sunita Jogarajan (the work carried out by the League of Nations),244 John  Avery Jones (the UK’s early tax treaties with European countries and problems presented by companies,245 Martin Hearson (the UK’s DTAs with developing countries),246 John Taylor (Australia’s DTAs),247

241 See eg JF Avery Jones, ‘Sir Josiah Stamp and Double Income Tax’ in Tax History, vol 6, above n 3, 1. 242 J Hattingh, ‘On the Origins of Model Tax Conventions: Nineteenth-Century German Tax Treaties and Laws Concerned with the Avoidance of Double Tax’ in Tax History, vol 6, above n 3, 31. 243 Oliver, n 215 above; JDB Oliver, ‘The Rule in Gilbertson v Fergusson: 140 Years of Relief for Underlying Tax’ in Tax History, vol 3, above n 3, 281. 244 S Jogarajan, ‘The Drafting of the 1925 League of Nations Resolutions on Tax Evasion’ in Tax History, vol 7, above n 3, 253; S Jogarajan, ‘The “Great Powers” and the Development of the 1928 Model Tax Treaties’ in Tax History, vol 8, above n 3, 341; S Jogarajan, Double Taxation and the League of Nations (Cambridge, Cambridge University Press, 2018). 245 JF Avery Jones, ‘The History of the United Kingdom’s First Comprehensive Double Tax Agreement’ in Tax History, vol 3, above n 3, 229; JF Avery Jones, ‘Jurisdiction to Tax Companies: The Influences of the Jurisdiction of the Courts and of European Thinking’ in Tax History, vol 4, above n 3, 163; JF Avery Jones, ‘Defining and Taxing Companies 1799 to 1965’ in Tax History, vol 5, above n 3, 1; JF Avery Jones, ‘The UK’s Early Tax Treaties with European Countries’ in Tax History, vol 8, above n 3, 295. 246 M Hearson, ‘The UK’s Tax Treaties with Developing Countries during the 1970s’ in Tax History, vol 8, above n 3, 363. 247 CJ 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 Tax History, vol 4, above n 3, 213; CJ Taylor, ‘The Negotiation and Drafting of the 1967 United Kingdom–Australia Taxation Treaty’ in Tax History, vol 5, above n 3, 427; CJ Taylor, ‘The Negotiation and Drafting of the First Australia–United States Double Taxation Treaty of 1953’ in Tax History, vol 7, above n 3, 213.

John Tiley and the Thunder of History  91 Angharad Miller (the history of the international taxation of income from services),248 Richard Vann (technical problems in the taxation of the profits of multinational firms)249 and Malcolm Gammie (source rules and the UK tax treatment of defaulting Greek banks in the 1930s).250 CONCLUSION

When Professor Tiley organised the first Tax History Conference in 2002, he saw it as a part of his broader project to reduce tax law to a coherent body of rules; to transform the study of tax law from a purely doctrinal and practitioneroriented pursuit into a more reflective exercise; and to assess some of the world’s tax systems by reference to their social, political, economic and, not least, historical contexts. It is unclear whether he planned from the outset to repeat the exercise; but that first conference was such a success that, if he had not already decided to make it a regular event, he did so soon afterwards. It is sad that John is no longer with us, but the Tax History Conferences and the resulting books are a crucial part of his legacy. His successors, Peter Harris and Dominic de Cogan, are to be congratulated for carrying on the tradition and it is to be hoped that the Cambridge Tax History Conferences will continue until the writing of the history of taxation has been completed – that is to say, for ever.

248 A Miller, ‘History of the International Taxation of Income from Services’ in Tax History, vol 5, above n 3, 243. 249 R Vann, ‘Do We Need Article 7(3)? History and Purpose of the Business Profits Deduction Rule in Tax Treaties’ in Tax History, vol 5, above n 3, 393. 250 M Gammie, ‘An Older Tale of Default on Greek Bonds’ in Tax History, vol 5, above n 3, 359; M Gammie, ‘The Relationship of Situs and Source Rules for Tax Purposes’ in Tax History, vol 6, above n 3, 81. Several other members of the Tiley School, for example Reuven Avi-Yonah and Philip Baker, are very prominent in the field of international tax, but have not yet contributed papers on the history of international tax to the Tiley project.

92

4 Benefits Theories of Tax Fairness IRA K LINDSAY*

ABSTRACT

The benefits theory of tax fairness was the dominant approach to tax justice until the late nineteenth century. This paper examines the reasons for the rejection of the benefits principle in the nineteenth century and the evolution of benefits theory in the twentieth century in response to this criticism. It uses this historical inquiry as a launching point for re-evaluation of the prospects for benefits theory. Benefits taxation has a number of advantages. As an ethical claim, it appeals to intuitive principles of fair cooperation. As a rule of procedural justice, it tends to protect against oppressive tax schemes. Although benefits theory has the resources to respond to some of the most historically influential criticisms, it faces additional challenges. These include specifying the baseline against which benefits are to be measured and fair treatment of taxpayers who take a public-spirited view of government spending as opposed to those who are mainly concerned with their private advantages. INTRODUCTION

B

enefits theories of tax fairness evaluate tax burdens in light of the benefits received by the taxpayer from the state. The underlying idea is that of reciprocity: a fair taxation scheme is one in which taxes owed by a taxpayer bear the proper relationship to the benefits that the taxpayer receives from the state. This account of tax fairness was popular until at least the nineteenth century, but has fallen out of favour since John Stuart Mill’s critique in Principles of Political Economy,1 to the extent that it is barely mentioned

* The author wishes to acknowledge the research assistance of Benita R Mathew. 1 JS Mill, Principles of Political Economy (London, Longman, Green & Co, 1909, reprinted Fairfield, Augustus M Kelley, 1976) Book V, Ch II § 2, 804–05.

94  Ira K Lindsay in treatments of tax policy by leading contemporary economists.2 Its place in most discussions of taxation in contemporary legal theory is typically modest at best.3 This paper examines the history of this fall from favour and the response of benefits theorists. The benefits principle is amenable to two significantly different interpretations. One version of the benefits principle holds that taxpayers should pay taxes set in proportion to the benefits that they receive from the state. This classical version of the benefits principle was dominant until the nineteenth century. A second version of the benefits principle holds that each taxpayer should receive benefits that are sufficient to compensate them for the taxes that they pay. This modern approach to benefits taxation developed alongside modern economic analysis in the late nineteenth and early twentieth century and responded to some of the criticisms of the classical principle. This paper will reassess the prospects for benefits theories of tax fairness against the backdrop of this history. The verdict will be mixed. Benefits taxation has a number of advantages. As an ethical claim, it appeals to intuitive principles of fair cooperation. As a rule of procedural justice, it tends to protect against oppressive tax schemes as well as against more mundane wasteful spending. Moreover, the original reasons for its rejection in the late nineteenth century were not necessarily well justified. Nevertheless, benefits taxation faces difficult challenges in determining the baseline against which benefits are to be measured and in reconciling the perspectives of taxpayers who value public goods for different reasons. This paper will first situate benefits theories of tax fairness within the range of possible approaches to tax fairness. It next explores the history of debates over the benefits principle and examines why the reputation of the benefits principle went into decline in the late nineteenth century. Third, it describes the emergence of a modern approach to benefits taxation based on advances in economic analysis. Fourth, it considers various arguments for each version of the benefits principle and how defenders of benefits taxation might respond to historically influential objections. Finally, it introduces two new problems for benefits taxation and examines some of the potential responses.

2 Eg ‘Taxation according to ability to pay for the last hundred years or more has been a universally accepted postulate, not only amongst political and economic writers, but amongst the public at large.’ N Kaldor, An Expenditure Tax, 3rd edn (London, George Allen & Unwin, 1955) 26. See M Weinzierl, ‘Revisiting the Classical View of Benefit-Based Taxation’ (2018) 128, 612 The Economic Journal F37, F37–F40. 3 Eg ‘[B]ut it also assumes that taxes are to be levied in accordance with benefits received from the government – a standard long since replaced by ability to that means accretion, consumption, wealth or whatever.’ A Warren Jr, ‘Fairness and a Consumption-Type or Cash Flow Personal Income Tax’ (1975) 88 Harvard Law Review 931, 933–34; ‘There is broad, if not universal, agreement that fair taxation should be in accordance with “ability to pay”, or the capacity of the taxpayer to bear the tax burden.’ S Utz, ‘Ability to Pay’ (2002) 23 Whittier Law Review 867, 867–68.

Benefits Theories of Tax Fairness  95 TAX FAIRNESS

There are three basic approaches that are commonly taken to tax fairness. One might order them in terms of the information required to evaluate tax fairness from least to most demanding. The simplest approach, and probably the most common in contemporary tax theory, analyses fairness in terms of relative ability to pay. Following John Stuart Mill, this is sometimes glossed as equality of sacrifice, which Mill argued meant that every taxpayer should feel ‘no more and no less inconvenience from his payments than every other person experiences from his.’4 Proponents of this approach usually favour taxation by reference to the taxpayer’s income, wealth, or consumption, depending on which they believe to be the best proxy for ability to pay. Early proponents of the ‘ability to pay’ theory such as Mill tended to favour flat tax rates, but progressive taxation has become more popular in the past century. The subject of this paper is a second approach to tax fairness, which compares tax burdens to the benefits received from government spending. This ‘benefits’ theory holds that taxes ought to be set in relation to the benefits that the taxpayer receives from the state. Assessing tax fairness in these terms requires knowledge not only of the economic position of the taxpayer but also of the impact of public spending on taxpayers. Evaluation of taxation in light of benefits to the taxpayer therefore requires more information than ‘ability to pay’ theories do. Like ability to pay theories, benefits theories of tax fairness are compatible with a range of policies. For example, proponents might favour taxation in proportion to income, wealth or consumption, according to whether income, property or consumption taxes is the best proxy for benefits received from the state. Alternatively, defenders of the benefits principle might favour policies that aim to match benefits from government with the burdens of taxation in a manner tailored to the circumstances of individual taxpayers. A third approach to tax fairness is to analyse taxation in light of a broader theory of distributive justice. This approach is the most demanding in terms of the information required to evaluate tax fairness as it typically requires knowledge not only of taxpayers’ economic standing and the effects of public spending but also of further facts relevant to whether the distribution of wealth is just. Such a theory might be an egalitarian theory of distributive justice, such as that advanced by John Rawls.5 Or it might be a consequentialist theory such as utilitarianism.6 Of course, there is heated debate within both the egalitarian and the utilitarian camps over the implications of these theories for tax policy. 4 Mill, above n 1, 804. 5 Rawls, in fact, endorses a scheme of proportionate taxation, but this is against the background of a distribution of property rights and government spending policies that allow for relatively egalitarian outcomes without strongly progressive taxation. 6 One variant of applied utilitarianism is often discussed under the label of optimal tax theory. See JA Mirrlees, ‘An Exploration in the Theory of Optimum Income Taxation’ (1971) 38 The Review of Economic Studies 175.

96  Ira K Lindsay What both types of theories have in common is that tax fairness cannot be analysed in isolation from the entire scheme of property rights and government benefits and must be derived in light of these facts from more abstract principles of distributive justice. For egalitarians and utilitarians, there is nothing normatively distinctive about taxation and tax fairness is simply a matter of applying generally applicable normative principles to questions of tax policy.7 This third approach is not necessarily mutually exclusive of the first two. One might endorse some comprehensive egalitarian or utilitarian theory of distributive justice as the ultimate justification of tax policy, while arguing that either the ability to pay principle or the benefits principle is the best way to implement this theory. For example, a utilitarian might argue that taxation in proportion to ability to pay is the best policy in light of uncertainty in interpersonal comparisons of utility. Similarly, a utilitarian could argue that aligning tax obligations with benefits derived from public spending is preferable, on the basis of greater efficiency. Egalitarians might likewise adopt a system of taxation based on ability to pay in light of their larger theoretical commitments. For example, John Rawls favoured a system of proportionate taxation on all income above a personal allowance.8 But this policy would exist against a background of property entitlements and government spending policies that would allow for relatively egalitarian outcomes without progressive taxation.9 The key difference between this approach and the first two is that proponents of comprehensive theories of distributive justice adopt rules of tax fairness as outputs of their larger theories of distributive justice and not as freestanding principles. In this paper, I will mainly consider freestanding arguments for benefits taxation, some of which might be integrated into a larger consequentialist framework. CLASSICAL AND MODERN BENEFITS TAXATION

Following Richard Musgrave, I will distinguish between two strains of benefits theory.10 The classical theory, which predominated until the nineteenth century, treated contribution in proportion to benefits received from the state as the basic norm of tax fairness. Modern benefits theory, which developed in the late ­nineteenth and early twentieth centuries, evaluated taxes in terms of the willingness to pay for public goods of each taxpayer, but does not necessarily require taxation in proportion to personal benefit.

7 Eg L Murphy and T Nagel, The Myth of Ownership (Oxford, Oxford University Press, 2002). 8 J Rawls, A Theory of Justice (Cambridge MA, Harvard University Press, 1999), 246–47. 9 ibid, 242–46. 10 R Musgrave, The Theory of Public Finance: A Study in Public Economy (New York, McGraw-Hill, 1959) 66–69.

Benefits Theories of Tax Fairness  97 Classical Benefits Theory The classical benefit principle was the leading approach to tax fairness from the early modern period into the nineteenth century. It was defended by Grotius, Pufendorf, Sir William Petty, Hobbes, Turgot, Mirabeau, Montesquieu, Senior and Thiers, among others.11 American economist Henry Carter Adams described the benefits theory as ‘[t]he idea … that, insomuch as individuals receive benefits from the state, a payment should be made on account of and in proportion to these benefits.’12 Proponents of benefits taxation such as Thiers sometimes compared taxes to insurance premiums levied in proportion to the wealth that the taxpayer has under the state’s protection.13 Early classical benefits theorists were mainly concerned with apportioning tax burdens to finance basic public goods such as the military and the legal system. Edwin Seligman, an opponent of the classical view, explained, ‘Since protection was generally regarded as the chief function of the state, the conclusion was drawn that taxes must be adjusted to the protection afforded.’14 Although benefits theory is a rival of the ‘ability to pay’ theory, the two approaches might have similar implications if one makes plausible assumptions about the relationship between property ownership and benefits from the state. If the main function of the state is the protection of property, then it makes sense to allocate tax burdens in proportion to property holdings. Most theorists, therefore, favoured a form of proportionate taxation. For example, Adam Smith stated as his first maxim of taxation that ‘The subjects of every state ought to contribute to 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.’15 Smith drew an analogy between citizens of a nation and joint tenants in a common enterprise who contribute in proportion to their interests in the enterprise.16 It is worth noting that in Smith’s time, taxes roughly proportionate to income or wealth were the exception rather than the rule. Using them to replace the patchwork of tariffs, fees and duties would make public finance less arbitrary and quite possibly less regressive.17 Both the benefits theory and the ability to pay theory

11 E Seligman, ‘Progressive Taxation in Theory and Practice’ (1908) 9(1/2) American Economic Association Quarterly, 158–80. 12 H Adams, The Science of Finance (New York, Henry Holt, 1899) 299. 13 A Thiers, The Rights of Property; A Refutation of Communism and Socialism (London, R Groombridge, 1848) 229. 14 Seligman, above n 11, 150. 15 A Smith, An Inquiry into the Nature and Causes of the Wealth of Nations, vol 2, E Cannan (ed) (London, Methuen, 1776, Reprint 1904) Book V Ch 2 Pt II, 310. 16 ibid. 17 The public finance of the pre-modern state in turn likely represented an improvement over the early middle ages when states mobilised resources by granting land to nobles, who extracted rents from the peasantry. See, eg T Seto, ‘A Forced Labor Theory of Property and Taxation’ in M Bhandari (ed), Philosophical Foundations of Tax Law (Oxford, Oxford University Press, 2017).

98  Ira K Lindsay would therefore count as progressive when compared with the status quo and promise to produce a fairer distribution of burdens among taxpayers of similar economic station. Since the benefits received by taxpayers are not directly measurable, one must use some proxy for benefits in order to determine tax obligations. Potential proxies include consumption, property holdings and income. Thomas Hobbes, for example, favoured a consumption tax on the grounds that subjects should contribute taxes in proportion to the benefits they receive from the state and that these benefits are roughly proportional to their expenses.18 Persons who save rather than consume their income leave resources to be enjoyed by other citizens and thus should be taxed only on that increment of income which they consume. Thiers, by contrast, appealed to the benefits principle to argue that income from both labour and property should be taxed, since both property owners and workers benefited from the protection of the state.19 Late Nineteenth-Century Critiques of Benefits Theory Classical benefits theory went into decline by the late nineteenth century. It was rejected by leading figures in Britain such as John Stuart Mill and in Germany such as Adolph Wagner.20 Nineteenth-century critics identified three major challenges. First, the difficulty of measuring the benefits of public goods might undermine the benefits principle. Mill charged the benefits theory with ‘setting definitive values on things essentially indefinite’ by trying to attach precise figures to the benefits taxpayers receive from government.21 Generally speaking, there are two ways in which one might try to estimate the value of public services for taxpayers. Henry Carter Adams helpfully labelled these the ‘purchase theory’ of taxation and the ‘benefit theory’.22 The chief difference, as Adams puts it, is that the first ‘regards a tax from the point of view of cost to the state, the other from the point of view of advantage to the citizen’.23 In other words, the purchase theory compares tax burdens to the cost of services a taxpayer receives from the state whereas the benefits theory compares tax burdens to the value that a taxpayer places on services received from the state. The former approach has the advantage of beginning with concrete data such as figures on public spending from the state budget. However, it is difficult to apportion tax obligations between citizens on this basis. The principle that each taxpayer should bear their share of the actual cost of providing services does not seem to determine whether 18 T Hobbes, Leviathan (Cambridge, Hackett Publishing, 1994, Ch 30 [17] 227–28. 19 Thiers, above n 13, 229–30. 20 Mill, above n 1, 804–05; A Wagner, ‘Three Extracts on Public Finance’ in R Musgrave and A Peacock (eds), Classics in the Theory of Public Finance (London, Macmillan, 1958) 1–15, 14. 21 Mill, above n 1, 805. 22 Adams, above n 12, 298–99. 23 ibid, 299.

Benefits Theories of Tax Fairness  99 the cost of services should be divided equally among taxpayers, in proportion to income, in proportion to property holdings, in proportion to consumption, or on the basis of some other metric. The basic problem is that most public goods are subject to diminishing marginal costs as one provides services to additional taxpayers.24 Allocating tax burdens according to the marginal cost of each taxpayer will therefore not yield enough revenue to support the provision of these public goods. Once we set aside marginal cost, there does not seem to be any way to divide tax obligations between citizens in a way that is internal to the logic of the theory. One might try to allocate fixed costs in proportion to the marginal cost of providing services to each taxpayer. In most cases, the results will be that citizens will share in the costs in rough proportion to their economic standing. This version of the benefit principle therefore tends to collapse into a regressive version of ‘ability to pay’ theory. In addition to the difficulties of using cost to the state to determine tax burdens, there is a principled reason for instead measuring benefits in terms of willingness to pay. Measurement in terms of cost to the state allows the possibility that some taxpayers’ tax burdens will exceed their valuation of public services. This is especially plausible for taxpayers with little money and therefore a high marginal utility of income. For example, it may be perfectly rational to prefer having enough to eat and shelter for the night to paying one’s share of the cost of police services. Benefits as measured by cost to the state could tend, therefore, toward a conflictual relationship between state and taxpayer. Measurement in terms of willingness to pay has the opposite effect. If a tax is set in proportion to willingness to pay for government services, any given taxpayer is very likely to benefit, net, from government, unless taxes are extremely high or public services are of very poor quality. Willingness to pay as a measurement of benefits, therefore, tends to consensual fiscal policy and a cooperative mode of politics in which taxpayers divide the surplus made possible by effective government. Despite these advantages, in the heyday of the classical benefits principle, the willingness to pay approach was not very promising. There is no market for public goods such as national defence or the legal system and thus no market prices for them. Asking taxpayers how much they value services would be a futile exercise since, even if taxpayers could give accurate answers, there would be strong incentives to underestimate. Although one might assume for the purpose of simplification that all taxpayers of a particular class have similar tastes, and tax them accordingly, this assumption is unrealistic and, in any case, causes the benefits principle to collapse into an ability to pay theory. 24 Marginal costs should decline until the state reaches the optimal size for the provision of public goods. The optimal size changes in response to changes in the costs of raising revenue and the cost structure of providing public goods. Historically, changes in military technology have had a great influence on state development because technological change alters the nature, extent and costs of the military force needed to maintain control over territory and compete effectively with other states. See R Bean, ‘War and the Birth of the Nation State’ (1973) 33 Journal of Economic History 212, 212–17.

100  Ira K Lindsay A second difficulty is that the classical benefits principle might be thought to have undesirable distributive consequences. To the extent that the state protects persons as well as property, this might suggest that taxes should combine a per capita charge with a tax proportionate to property holdings, which would yield a quite regressive overall rate structure.25 Mill argued that, when taken to its logical conclusion, the benefits principle suggests regressive taxation because those who, without the protection of the state, would be oppressed by the wealthy and powerful would seem to enjoy disproportionate benefits.26 In practice, proponents of the classical benefits principle are more likely to favour proportionate taxation than regressive taxation. Either interpretation of the benefits principle was unpalatable for most progressives. Late nineteenth-century advocates of progressive taxation in the United States such as Edwin Seligman, Richard Ely and Henry Carter Adams attacked the benefits principle as obsolete and inadequate to the needs of the modern fiscal state.27 In part, their criticism was motivated by the perceived incompatibility of the benefits principle with progressive taxation. They urged acceptance of ability to pay theories of tax fairness as being more adequate to the circumstances of the modern progressive state. This tendency grew even stronger as income taxation became the primary mode of public finance in most developed countries and public spending became focused to a much greater extent on the social welfare state. A third criticism of the benefits principle was that it rested on too limited a conception of the nature of government. John Stuart Mill argued, ‘Government must be regarded as so pre-eminently a concern of all, that to determine who are most interested in it is of no real importance.’28 The range of projects undertaken by modern states makes the classical model seem inadequate. As Mill observed, ‘it is not admissible that the protection of persons and that of property are the sole purposes of government. The ends of government are as comprehensive as those of the social union.’29 One cannot, therefore assume that taxpayers benefit from the state in proportion to the protection afforded to their persons and property. Some defenders of progressive taxation took a more extreme position. For example, Seligman argued that ‘we pay taxes not because the state protects us, or because we get any benefits from the state, but simply because the state is a part of us. The duty of supporting and protecting it is born with us. In a civilised society, it is as necessary to the individual as the air he breathes.’30

25 Mill, above n 1, 804. 26 ibid, 805. 27 AJ Mehrotra, Making the Modern American Fiscal State: Law, Politics, and the Rise of Progressive Taxation, 1877–1929 (New York, Cambridge University Press, 2013) 112–16. 28 Mill, above n 1, 805. 29 ibid, 805. 30 E Seligman, Essays in Taxation (New York, Macmillan, 1895) 72.

Benefits Theories of Tax Fairness  101 This third line of criticism is difficult to assess. The observation that the activities of the state extend beyond personal protection does not entail that personal benefit is inapt as a criterion for apportioning tax obligations. Instead, one might look at the full range of advantages that a citizen obtains from the state. Mill’s larger point, that government is a public rather than a private concern, is weightier. One might think that citizens should relate to their collective obligations as citizens in a way that differs fundamentally from their role as private consumers. Although fair terms of exchange might be a central value in the second sort of relation, this may not be the right way to think about the first sort of relation. Seligman’s comments, on the other hand, seem to press the point too far. From the other side of the unhappy history of twentieth-century totalitarianism, his argument seems muddled at best. Modern Benefits Theory Ironically, just as the benefits principle was being eclipsed in the mainstream of tax theory, innovations in economic analysis provided a new approach to benefits taxation that addressed some of the traditional objections. The modern benefits principle holds that a tax is fair if benefits received from the state adequately compensate the taxpayer for the burdens of taxation. This new approach to benefits taxation is grounded in economic analysis and models public finance as an exchange between the state and taxpayers. Modern benefits theory can be traced to the work of Knut Wicksell and was further developed by Erik Lindahl.31 Wicksell’s basic insight was that requiring unanimous consent rule for each spending project and the taxes needed to fund it could both solve the problem of measuring private valuations of public goods and guarantee that each taxpayer receives public services that she values at least as much as the taxes that she pays. The unanimous consent rule allows each taxpayer to veto projects that do not provide adequate compensation. Conversely, taxpayers who value a particular public good highly should be willing to pay higher taxes to support it, even if some of their fellow citizens decline to support it financially. Negotiation in the shadow of a unanimous consent rule thus creates something like a market for public goods. Of course, securing unanimous agreement outside of very small collectives is virtually impossible in practice. Some people are irrational. Others might hold out for strategic reasons, making negotiations unduly cumbersome. For this reason, the unanimous consent rule would need to be relaxed to some degree in practice. I will not explore the practicalities of implementing Wicksell taxation in any detail, but instead evaluate Wicksell taxation as a normative standard for tax fairness.

31 K Wicksell, ‘A New Principle of Just Taxation’ in Musgrave and Peacock, above n 20, 72–118; E Lindahl, ‘Just Taxation – A Positive Solution’ in Musgrave and Peacock, above n 20.

102  Ira K Lindsay The modern approach to benefits taxation differs significantly from the classical approach. The classical benefits principle states that tax obligations should be assigned in proportion to the benefits the taxpayer receives from government. The classical principle thus looks to the total benefit received by a taxpayer and compares this to the total benefit received by another taxpayer. The modern benefits principle requires that every taxpayer should receive benefits from the state that they value more than the income that they sacrifice in tax. Modern benefits taxation accomplishes this by looking to the marginal value of taxes paid by each taxpayer since, if every taxpayer finds each increment of taxation worthwhile in terms of the services that they receive, every taxpayer will be made better off, net, by the fiscal system. In short, the classical principle looks to total benefit, while the modern principle looks to marginal benefit. Whereas the classical principle requires a particular relation between the taxes paid by each taxpayer, the modern principle is consistent with taxpayers who receive similar benefits owing substantially different amounts of tax so long as each taxpayer is adequately compensated by a package of public services that she values more than the foregone revenue. The classical principle, on the other hand, gives no assurance that a given taxpayer will prefer the combined package of government services and taxes offered by the state. At high enough levels of taxation, some taxpayers may be made worse off by government. The modern principle, by contrast, ensures that fiscal exchange represents a net gain for every taxpayer. Wicksell taxation represents an ingenious scheme for achieving efficiencies in the provision of public goods. For goods with increasing marginal costs and decreasing marginal benefits, an efficient level of production is reached where marginal cost equals marginal benefit. At this point, the next unit produced will cost more than it is worth, while the previous unit is worth more than it costs to produce. It is thus not rational to either increase or to decrease production. A competitive market in the production and sale of private goods will reach this equilibrium. Standard microeconomic theory suggests that this analysis does not apply to public goods because public goods are non-excludable and non-rival. In other words, one cannot sell individual citizens national defence, because it is not possible to defend a nation’s territory without thereby protecting those who live in it. And unlike private goods, one citizen’s enjoyment of military protection does not diminish that of any other citizen. An omniscient policymaker could simply set public goods provision and taxes to support them at an efficient level, but actual policymakers have no way to do so without a market in public goods. Wicksell’s scheme uses the unanimous consent rule as a way to reveal information about taxpayers’ valuations of public goods and exclude policies that make some taxpayers worse off. Wicksell taxation produces an efficient outcome in the provision of public goods by allowing any party or group of parties that values the public good at above marginal cost to assume the cost of producing it by offering to pay the additional taxes necessary to produce the good. Other taxpayers should not object even if they do not care at all about the public good, so long as they are not asked to make any additional

Benefits Theories of Tax Fairness  103 contributions. Wicksell taxation thus allows taxpayers to reach an efficient equilibrium in which all taxpayers fund exactly as much public good production as they find cost-justified. The classical benefits principle can claim no such advantage. Requiring taxpayers pay taxes in proportion to the benefits that they receive in return does not entail that these benefits exceed the net value of taxes paid to support them. Conversely, the classical principle permits but does not require schemes in which taxpayers who prefer additional supply of a particular public good pay additional taxes to support it. Although the classical principle does not require economically efficient taxation, supporters of the classical principle might argue that aligning tax obligations with benefits received reduces the likelihood that one faction will fund public goods that it prefers, while shifting the tax burden onto others. If those who benefit the most from a service bear the greatest burden, it is more likely that taxpayers will set the provision of public services at roughly the efficient level. And unlike the modern benefits principle, the classical principle is consistent with a range of decision procedures and so allows for more flexibility in institutional design. In addition to Wicksell taxation, two other strategies for aligning tax burdens with benefits from public spending are worth noting. One alternative to Wicksell’s unanimity rule is jurisdictional competition. The American economist Charles Tiebout argued that efficient provision of local public goods can be achieved by delegating tax policy and public goods provision to local governments, thus allowing taxpayers to choose jurisdictions on the basis of which package of taxes and services they prefer.32 Funding local public goods such as police, parks and libraries out of local property taxes links the benefits and burdens of taxation, since the value of high-quality public services tends to be capitalised into real estate prices. Citizens who prefer low taxes and sparse services can select a low-tax jurisdiction, while citizens who prefer high taxes and lavish public services can select a high-tax jurisdiction. Jurisdictional competition goes part-way to achieving the results of Wicksell taxation without the need for negotiation between citizens. In addition, one might think that local residents are best positioned to monitor the quality of local public goods and adjust their support for taxation in light of the quality of local public administration. Of course, Tieboutian competition works only in certain institutional settings and only for certain public goods. Significant power over taxing and spending decisions must be delegated to political entities that cover sufficiently small territories that a given worker might reasonably choose between living in a number of different jurisdictions. Such schemes are most practicable in nations such as the United States and Switzerland with a strong tradition of local government and a large number of well-paid workers. Where these conditions are not met,

32 C Tiebout, ‘A Pure Theory of Local Expenditures’ (1956) 64 Journal of Political Economy 416, 416–24.

104  Ira K Lindsay jurisdictional competition may allow mobile taxpayers to displace tax burdens on those who cannot move between jurisdictions. A third means of aligning benefits and burdens is funding programmes out of dedicated taxes that fall mainly on those who benefit from the programme. This might be done by restricting public services to those who have paid the relevant tax, or by funding a service out of a tax that is targeted at those likely to make use of the service. Contributory social insurance schemes that condition benefits on prior tax payments are examples of the first strategy. Taxation of vehicles and petrol to support road maintenance is an example of the second. The first approach is preferable from the perspective of linking burdens and benefits, but is only effective for excludable goods. The second requires that the tax imposed is a good proxy for use of the service. This is somewhat rare for public goods. Response to the Nineteenth-Century Critique The traditional argument against the benefits principle, that benefits to the taxpayer are impossible to measure, is a serious problem for the classical benefits principle. It is less threatening to the modern approach to benefits taxation, which identifies a number of ways to analyse willingness to pay. The technical challenges for proponents of the modern benefits taxation, although considerable, are less than those faced by utilitarian analysis, which has had renewed popularity in the twentieth century. For cases in which these technical difficulties prevent a more fine-grained approach to taxation, it is always open to the benefits theorist to use consumption, income or wealth as a proxy for the benefits received from public spending. This might yield policies that are similar to some versions of taxation based on ability to pay, but would rest on a very different normative foundation. The modern benefits principle does not provide an explicit response to objections to the distributive consequences of benefits taxation. Proponents of the benefits principle have at least two plausible responses to the claim that benefits taxation leads to regressive policies. First, if one calculates benefits in terms of willingness to pay, the wealthy will tend to pay higher taxes for the same services. As a person gains more resources, she is willing to bid more for a given good or service because she has more resources left over to pursue other projects, and thus compares the good or service to relatively fewer valuable projects.33 Whereas a poor person might need to decide between larger public parks and a second bedroom, a rich person who owns a five bedroom house might be deciding between larger public parks and a sixth bedroom. If the two taxpayers have similar needs for living space, the wealthier person should be willing to sacrifice more to receive the same service than a poor person. Benefits taxation therefore 33 A de Viti de Marco, First Principles of Public Finance, E Pavlo Marget (trans) (New York, Harcourt, Brace & Co, 1936) 172–73.

Benefits Theories of Tax Fairness  105 implies that the wealthy should pay more in taxes even when both rich and poor receive roughly the same services. When, as is often the case, local public goods increase the value of property holdings, this provides further reason to tax those with more property more than those with less. Because rich and poor are likely to value public goods in different ways, there is a danger that the wealthy and influential will succeed in enacting public spending on goods that they value and shifting part of the resulting tax burden onto the poor and powerless who would, on balance, prefer greater private consumption. Knut Wicksell was, in fact, concerned to prevent such outcomes.34 When Wicksell was writing, in the last years of the nineteenth century, Sweden derived four-fifths of its tax revenue from indirect taxes.35 As Wicksell pointed out, the ‘whole legislative and tax approval machinery’ rested ‘exclusively in the hands of the propertied classes.’36 The unanimous consent rule prevents the wealthy from imposing their preferences for lavish public spending on the poor, and encourages wealthier taxpayers to offer tax concessions or transfer payments to poorer citizens in order to buy their consent for spending projects that the wealthy prefer. Conservative Wicksellians, such as James Buchanan, concede that this is a foreseeable consequence of Wicksell taxation.37 Second, and perhaps more importantly, Wicksell taxation is conceived as a means to finance public goods and does not foreclose taxes that are levied for purely distributive reasons. This means that the benefits principle might be used to evaluate public finance and public spending after one has instituted any policies calculated to achieve a fair distribution of initial resources. Adopting the benefits principle as the primary guide to fairness in taxation is consistent with a two-tier tax system in which one set of taxes is imposed to regulate wealth inequality, and a second layer of taxation, based on the benefits principle, is used to finance public goods.38 John Rawls, in fact, endorses Wicksell taxation for the provision of public goods once other tax and transfer policies have ensured a fair distribution of resources between citizens.39 In this way, purely distributive questions might be distinguished from questions about financing public goods. Different taxes in the same fiscal system might serve different ends. Inheritance taxes and a progressive income tax might be largely designed to achieve distributive aims, while any additional tax revenue needed for public goods and

34 C Blankart and E Fasten, ‘Knut Wicksell’s Principle of Just Taxation Revisited’ in V Caspari (ed), The Evolution of Economic Theory: Essays in Honour of Bertram Schefold (London, Routledge, 2011) 134. 35 Wicksell, above n 31, 72–118, 84. 36 Wicksell, above n 31, 72–118, 86. 37 JM Buchanan, The Limits of Liberty (Chicago IL, The University of Chicago Press, 1975) 72–95. 38 The distinction between these two sorts of taxes is parallel to Richard Musgrave’s distinction between the allocation branch and the distribution branch of government. Musgrave, above n 10, 5–6. 39 Rawls, above n 8, 249–51.

106  Ira K Lindsay social insurance might be derived from taxes that follow the logic of the benefits principle. Supporters of the modern benefits principle might disagree about what sort of initial distribution is appropriate. Libertarians might argue that no such distribution is justified, whereas Rawlsians and market socialists might argue that a highly redistributive tax and transfer scheme is required. This might involve taxing the wealthy to fund wage subsidies and welfare payments that provide poorer citizens with more ability to ‘purchase’ public goods through the political process if they so choose.40 On a theoretical level, this seems a perfectly adequate reply to the claim that benefits taxation is regressive. As a matter of practice, one might worry that it is not possible to maintain political support for redistributive measures without disguising them behind the veil of public goods provision. It is difficult to assess the significance of this concern in the abstract, since its practical significance depends on the features of particular political cultures. Along with an over-emphasis on the regressive nature of benefits taxation, the redistributive character of ability-to-pay theories is sometimes oversold. Progressive taxation in proportion to income or wealth may mitigate inequity relative to proportionate taxation, but unless taxation reaches levels that amount to functional expropriation, there are considerable limits on the extent to which taxation alone can redress inequality of wealth. In order to do so, progressive taxation must be used to finance transfer payments. But in this case, public spending is doing much of the redistributive work. It is misleading, therefore, to identify ability to pay theories with egalitarianism when considering taxation to fund public goods as opposed to transfer payments. Modern benefits taxation requires linking taxation and public spending in a way that prevents sleight of hand in which taxes are justified as support for collective projects and used for transfer payments. Clarity is, however, a theoretical virtue. Redistributive social programmes should be justified directly as requirements of justice or of political prudence, and not concealed by severing the link between taxation and public spending on the one hand and effacing the distinction between public goods and transfer payments on the other. In response to the point that benefits taxation misunderstands the proper relationship between state and citizen, proponents may argue that their theory promotes relations of freedom and equality. Wicksell suggested that, ‘Each member of society would be happy in the knowledge that the goods which taxation withdraws from his private use are destined solely for purposes which he recognizes to be useful and in which he has a genuine interest, be it for purely selfish or for altruistic motives. Surely this would do more than anything else to 40 Although this might be quite expensive for wealthier taxpayers, it would create a context for purchasing public goods that is more favourable for the wealthy, in that poorer citizens would have greater means to support public goods and no incentive to support higher spending on public goods on the grounds that others will pay for it.

Benefits Theories of Tax Fairness  107 awaken and maintain the spirit of good citizenship.’41 More generally, Wicksell’s scheme aims to secure the freedom of each citizen to choose which public projects to support. Citizens must work together to find policies that command general assent and attend to the interests of all. In this way, the proposal seems especially democratic in spirit. Proponents of benefits taxation might in turn suggest that ‘ability to pay’ theories encourage a myopic focus on tax policy in isolation from the larger fiscal system, and that optimal tax theory glosses over the effects on individuals by aggregating effects across taxpayers. The benefits theory of taxation, by contrast, is individualist in its approach to taxpayers, but synthetic in its treatment of the fiscal system. It is individualist in that it is focused on the treatment of individual taxpayers, as opposed to metrics such as social utility that aggregate across individuals.42 This might be especially attractive to those looking for alternatives to utilitarian analysis, although it may also be acceptable to rule consequentialists such as Buchanan. Although attentive to the interests of individual taxpayers, benefits taxation facilitates evaluation of the fiscal system as a whole by linking taxation and public services. This may provide grounds to justify or to criticise a tax as it focuses attention on both the benefits and the costs of particular policies.43 Integration of tax burdens and public spending into a common analytical framework is a significant advantage for the benefits theory in relation to ‘ability to pay’ theories. ADVANTAGES OF BENEFITS TAXATION

The benefits principle might be defended as a requirement of fair terms of cooperation between citizens or as a means of ensuring fair relations between the state and its citizens. The classical benefits principle is most obviously aimed at the first notion of fairness, and the modern benefits principle at the second. However, both principles may be defended in either way. I will first consider the benefits principle as a norm of fair distribution of tax burdens and then consider how the principle might be defended in terms of broader considerations of political economy. Tax Fairness as Proportionality The classical benefits principle is founded on an intuitive notion of fairness in exchange that is aimed at balancing the benefits and burdens of cooperation.

41 Wicksell, above n 31, 97. 42 JM Buchanan, ‘The Pure Theory of Government Finance: A Suggested Approach’ (1949) 57 Journal of Political Economy 496, 497–99. 43 Although generally sympathetic to the progressive movement, legal historian Ajay Mehrotra argues that the attack on benefits taxation by American proponents of progressive taxation caused progressives to ignore the power of public spending to achieve distributive aims: ‘By privileging

108  Ira K Lindsay Contributions to the state reflect the benefits that one receives in return. From those to whom much is given, much is expected, and those who receive little might be expected to contribute little in return. Fiscal exchange under the classical principle is not based on market pricing, but instead requires that tax obligations reflect a taxpayer’s ordinal position in terms of benefits from the state, so that those who receive greater benefits bear greater burdens. According to this line of thought, the mark of an unfair tax system is one in which tax burdens are shifted onto those who benefit less from the state. As an archetype of unfair exchange, one might think of oppressed peasants who are forced to pay taxes to support a state that protects the rights and interests of landlords.44 From the point of view of the peasants, it might be a matter of near indifference whether their present landlords are replaced by new landlords. That the peasants pay less in tax than their landlords would be little consolation, since the peasants receive almost nothing in return for their tax payments. By contrast, in a city in which citizens share broadly in the city’s prosperity, citizens might willingly pay for protection and infrastructure. A fair tax system would be one in which the wealthier citizens paid more in tax since they benefit more from the success of the city. But less affluent citizens might also be expected to contribute something to common projects that produce common benefits. The citizens might face substantially higher taxes than the peasants, but because these taxes bring tangible benefits to each citizen and tax obligations are roughly calibrated to these benefits, the city’s tax system is seen as fair and legitimate. In modern democratic societies, it may be more apt to think of the benefits principle in terms of reciprocity between taxpayers (or at least prospective taxpayers) than in terms of exchange between taxpayers and the state. Taxpayers in a democratic society cooperate by contributing to the support of a government that provides public goods. They share in the benefits of public services and must decide how to apportion the burden of supporting these services. The benefits principle requires that fiscal exchange between taxpayers observes a norm of proportionality. Apportioning the burdens of cooperation in accordance with the benefits ensures that no one gains a disproportionate benefit from the collective endeavour by gaining a large share of the benefits while bearing little of the burden. And it prevents the burdens from being borne disproportionately by those who do not benefit. If the endeavour is successful (ie the government

the ability-to-pay principle over the benefits rational, these thinkers were severing the link between government spending and revenue collection … Although these intellectuals could not have foreseen how they were creating this blind spot in progressive thinking, the early stages of American fiscal myopia were becoming manifest.’ Mehrotra, above n 27, 117. 44 Even opponents of the benefit principle such as Seligman concede that it may have had progressive implications in pre-modern conditions: ‘A century ago, when the absolute rulers of central Europe loaded down their subjects with grievous burdens and devoted the profit to their own petty pleasures … it was natural that a school should arise to protest and to proclaim the principle of benefit. Their argument was that as the state protects everybody, everybody is under a duty to pay taxes; in other words, their plea was for universality of taxation.’ Seligman, above n 30, 71.

Benefits Theories of Tax Fairness  109 produces net benefits for taxpayers), this success is broadly shared with benefits spread across the population. And if the endeavour is less successful (ie the government costs more than the benefits it provides), these losses are also spread across the population. The provision of public goods under the classical benefits principle is thus aimed at providing proportionate advantages for all taxpayers, rather than at redistribution of advantages between taxpayers.45 Under the classical benefits principle, cooperation in the creation of public goods is subject to similar norms of those which typically govern private partnerships. All partners have a right to a share in the benefits of the relationship, but the right to profits is proportional to contributions to the partnership. This rule has at least two main appeals. First, it appeals to the participants’ sense of fairness.46 Second, it gives each partner an incentive to continue the relationship, rather than leaving for other ventures. In a world in which people can choose their partners in cooperative ventures, cooperative arrangements that do not allocate benefits in proportion to contributions will tend to see poorly compensated partners leave to join ventures in which all are treated equally (i.e. in proportion to their contributions). For this reason, voluntary cooperative endeavours will tend to adopt rules that spread benefits so as to give cooperators incentive to continue the relationship. The state is obviously not a voluntary cooperative endeavour. However, modern tax systems rely on a fair degree of compliance by the population. And democratic government functions better when there are common understandings about fairness in taxation. For these reasons, it is not desirable for tax rules to diverge too much from citizens’ sense of fair terms of cooperation between strangers. An implication of this model of tax fairness is that non-tax contributions to common projects, such as military service, may substitute for tax obligations in the accounting of a citizen’s benefits and burdens. There is historical evidence that people sometimes do reason in this way. Political scientists Kenneth Scheve and David Stasavage have recently argued that high tax rates for the wealthy in the mid-twentieth century were in large part a response to mass conscription during the First and Second World Wars.47 Voters saw high taxes on the

45 Although this strategy for the provision of public goods is in that sense anti-redistributive, it is consistent with the existence of an entirely separate tax and transfer scheme aimed at purely distributive ends. 46 In terms of the distinction introduced by political philosopher Brian Barry, the classical benefits principle is a form of justice as mutual advantage rather than justice as impartiality. See B Barry, A Treatise on Social Justice, Vol I: Theories of Justice (Berkeley CA, University of California Press, 1989) 7–8. Justice as impartiality is concerned with rules of cooperation that treat all parties as equals and do not unfairly advantage any party. Justice as mutual advantage is concerned with rules of cooperation that benefit all cooperators and divide the benefits of cooperation in a way that encourages all cooperators to continue the relationship. When the initial bargaining position is one of relative equality, the two approaches lead to similar results. However, when there are initial inequalities, rules that are aimed at mutual advantage will tend to preserve these inequalities since both the more advantaged and the less advantaged will benefit from cooperation. 47 K Scheve and D Stasavage, Taxing the Rich: A History of Fiscal Fairness in the United States and Europe, (Princeton NJ, Princeton University Press, 2016) 135–69.

110  Ira K Lindsay wealthy as justified in light of the sacrifices made by common people during the wars. Those who became wealthy while others gave their lives to protect the nation gained a special obligation to make substantial sacrifices for the public benefit in order to offset the contributions made by ordinary citizens subject to mass conscription.48 As memory of mass conscription faded, popular demand for high tax rates for the wealthy declined and the highest marginal rates drifted downward.49 The logic of the classic benefits principle makes sense of this historical pattern in a way that ability to pay theories and egalitarian theories do not. Mass conscription during wartime disrupts the balance between benefits and burdens that were obtained during peacetime. This balance can only be restored by increasing progressive taxes on the wealthy to account for the increased contributions of other members of the public. If Scheve and Stasavage’s historical claims are correct, this is reason to think that the logic of the classic principle is deeply ingrained in popular sentiment. If this analysis is correct, the classical benefits theory reflects a notion of fairness in exchange that is continuous with pre-modern political organisation. It is probably not an accident that the classical benefits principle was the leading theory in the early modern era when the modern state was in an early phase of its development. In a world with little conception of a distinctive public sector, it is natural to apply rules about fair terms of cooperation between private individuals to relations between the state and the taxpayer. It is hardly surprising, then, that accounts of tax fairness in the early modern era tended to preserve some of the normative character of pre-modern social relations. Two contradictory lessons might be drawn from this observation about the relationship of the classical benefits principle to non-state forms of exchange. On the one hand, one might conclude that the logic of the classical benefits principle preserves the normative character of private social relations, and is therefore inappropriate in the context of a modern state with a large professional administrative staff and an impersonal, law-governed relationship between state and citizen. As was discussed previously, this was an undercurrent of some of the criticisms of the classical principle in the nineteenth century. On the other hand, one might take the character of public finance in pre-modern states as having implications for the norms of human cooperation generally, and reason that cooperative endeavours that conform to these norms are more likely to be successful.50 The extent to which underlying norms of social cooperation differ across time and place is

48 ibid, 157–59, 166–68. 49 ibid, 185–205. 50 There is a tendency to discuss popular sentiments when doing hard-headed tax theory. No doubt, people hold all sorts of absurd views about taxation. And even setting aside idiosyncratic positions, there is a strong tendency for the median voter to favour new spending while opposing new taxes. But policy that aligns with common intuitions about tax fairness is important for several reasons. First, there is likely a significant relationship between tax morale – the disposition to comply with tax law – and perceptions of fairness. Second, in democratic states, tax policies that are widely viewed as unfair are likely to be politically unstable.

Benefits Theories of Tax Fairness  111 a highly complex question. The extent to which people model tax fairness on broader cooperative norms is also uncertain.51 A high level of certainty about either response is probably not warranted. The case for the modern benefits principle in terms of fairness between taxpayers is somewhat weaker. This is because the unanimity rule grossly underdetermines the distribution of tax burdens for public goods that all agree should be funded. For example, all property owners are presumably willing to pay a significant share of their income in order to support the minimum military and police services necessary to protect their property. These could be funded by a poll tax so that each taxpayer (except, perhaps, for the most destitute) pays the same sum. Or they might be funded exclusively from taxes on the wealthy. Neither arrangement would seem to violate the modern principle, since all citizens would rank both arrangements as superior to a world without police or military. It is consistent, therefore, with Wicksellian principles to require a relatively small number of taxpayers to pay for such services. The unanimity rule therefore does little to distinguish between very different distributions of tax burdens to support public goods that all would agree to support – the inframarginal public goods. Of course, it is unlikely that negotiations in the shadow of the unanimity rule would result in such extreme outcomes. But more plausible outcomes might differ greatly from one another along these lines. For this reason, it might be preferable to combine Wicksell taxation with rules that allocate taxes to support goods that everyone agrees upon – the inframarginal taxes – in ways similar to the classical benefits principle. This approach would ensure that the costs of essential services are not lumped onto any one subset of taxpayers. Constraining the State Although the classical principle might be better suited to provide an account of fair cooperation between citizens, the modern benefits principle appears more promising in giving an account of fair relations between citizens and the state. The modern benefits principle requires that each taxpayer receive benefits from the state that are at least as valuable as the taxes that they pay. This ensures that the state has a no worse than neutral net economic impact on every taxpayer. The modern benefits principle, therefore, might be seen as requiring that the exchange of taxes for public services be justifiable to each citizen.

51 Matthew Weinzierl has found that American survey respondents across all demographic categories found arguments for progressive tax based on the classical benefits principle more appealing than arguments based on diminishing marginal utility. M Weinzierl, ‘Popular acceptance of inequality due to innate brute luck and support for classical benefit-based taxation’ (2017) 155 Journal of Public Economics 54, 54–63.

112  Ira K Lindsay The modern benefits principle provides a plausible answer to the difficult problem of how to reconcile citizens’ full-blooded entitlements to property and income with the state’s full-blooded authority to levy taxes. The difficulty is in avoiding one of two extremes in formulating a principle of tax fairness. At one extreme is the rejection of any limits on taxes enacted through legitimate legal procedures. The problem with this view is that if there are no constraints on how tax obligations may be arranged, it seems that property entitlements and entitlements to earn income from labour have little normative substance since the state has the power to effectively expropriate property holders through the tax system. All workers and all property owners earn at the sufferance of the state. Some may not find this result particularly objectionable.52 If the post-tax distribution of property rights is fair to each citizen, then perhaps it does not much matter how this result was achieved. As a matter of abstract moral principle, there is something to be said for this view. As a matter of what one might call political morality – the background norms that structure political life in a polity – it is less attractive. The other extreme is the position that all taxation is a prima facie violation of property rights because it expropriates part of the value of a property from the rightful owner. This would provide a limiting principle for taxation, but one that casts doubt on the legitimacy of all taxation, even taxes that fairly directly serve the interests of property owners. What is needed is some principle that allows a significant range of tax policies but does not permit any tax whatsoever. One possible role for the benefits principles is to provide such a happy medium. The classical principle and the modern principle do this in slightly different ways. The modern principle constrains the state by requiring that fiscal exchange be at worst neutral for every taxpayer. In effect this means that when the state taxes property owners, it provides them with services that compensate each property owner enough to offset the losses from taxation. For example, a 5 per cent tax on the value of all land in a jurisdiction would reduce the financial value of landholding. But if the tax revenue is used to protect the property rights of landowners, it is likely that the net effect of the tax will be to increase the value of the landowners’ property rights. The same logic applies to local public goods such as roads, fire departments, libraries, schools, and museums. Public goods that make an area more attractive to live in will tend to raise property values and so may compensate the property owner for tax payments. Thus, even a taxpayer who does not personally value the public good in question may benefit, since public goods that appeal to a sufficient number of prospective buyers will increase the market price of the taxpayer’s property. The modern benefits principle thus restricts fiscal outcomes to those that are broadly win-win, and thereby ensures that the state, on net, enhances the entitlements of taxpayers.53 In such a system, taxation is fully consistent with robust property rights. 52 Murphy and Nagel, above n 7. 53 Because the unanimity criterion must be relaxed in practice, it is likely the case that taxpayers who have extremely idiosyncratic tastes will sometimes be subject to negative sum taxation.

Benefits Theories of Tax Fairness  113 The classical benefits principle negotiates the boundaries of legitimate taxation somewhat differently than the modern benefits principle does. In some ways it is more permissive, and in some ways more constraining. Whereas the modern benefits principle restricts fiscal policy to outcomes that are beneficial for all taxpayers, the classical principle requires that the gains from cooperation through the state be divided fairly between taxpayers. In other work, I have defended horizontal equity as a norm that prevents negative sum conflicts over distributive policy between similarly situated taxpayers.54 The crux of the idea is that a horizontally equitable tax code is preferable to a patchwork of wasteful credits and deductions designed to benefit some taxpayers at the expense of others. Horizontal equity thus constrains distributive conflicts between similarly situated taxpayers while remaining neutral on the question of how much to spend on public goods and the question of whether to redistribute from rich to poor (or, less happily, from poor to rich). Horizontal equity, however, does nothing to constrain the level of taxation or prevent one economic class from expropriating or oppressing another. The benefits principle might be thought both to constrain differences in the treatment of similarly situated taxpayers and to require fair treatment of taxpayers who are differently situated. Observing rough proportionality in the distribution of benefits and burdens prevents the state from collecting taxes primarily from one group of taxpayers and using them to support public goods favoured by another group of taxpayers. In this respect, the classical benefits principle has an advantage over horizontal equity, at least when considering taxation to support public goods as opposed to transfer payments. This observation also provides reason to prefer the classical principle to the modern principle. Although the modern principle prevents the state from imposing policies that are negative sum for any taxpayer, it is consistent with policies that concentrate the benefits of public goods disproportionately among only a few taxpayers. The classical principle, by contrast, is concerned with apportioning gains from cooperation fairly, so that those who receive similar benefits pay similar tax. The Jurisdictional Role of the Benefits Principle A final role played by the benefits principle is jurisdictional. Rather than using the benefits principle to determine tax obligations, one might appeal to the For example, someone who derives unusually great enjoyment from defending their own property might prefer to underfund police services because they prefer arming themselves and patrolling their property to hiring police. Such a taxpayer might genuinely prefer not to pay taxes to support the police department. But because this is such an odd preference, it is difficult to allow it to determine tax policy even for solitary taxpayers. In certain polities, geographical sorting might partially accommodate such preferences: citizens who prefer self-help to police services can move to the frontier. 54 I Lindsay, ‘Tax Fairness by Convention: A Defense of Horizontal Equity’ (2016) 19 Florida Tax Review 79, 79–119.

114  Ira K Lindsay benefits principle to determine who should be liable for taxation in a given jurisdiction. This idea is embedded in the modern system of international taxation, but pre-dates it. For example, the nineteenth-century American lawyer Thomas Cooley argued that ‘The protection of the government being the consideration for which taxes are demanded, all parties who receive or are entitled to that protection may be called upon to render the equivalent. The protection may be either to the rights of persons or to rights in property and taxes may consequently be imposed when either person or property is within the jurisdiction.’55 Delineating the right to tax is difficult when economic activity crosses jurisdictional boundaries. One also might use benefits logic to determine how to allocate the right to tax the corporate profits of a multinational that operates across international boundaries.56 It is fair that foreign investors who benefit from the public goods provided by states in which they invest pay to support the provision of these goods. One problem with international tax competition is that it threatens to deprive capital importing nations of tax revenue, since states with little bargaining power may be compelled to offer tax concessions if they wish to attract capital in an environment in which competitors offer tax incentives for foreign investors.57 Similarly, one might justify taxation of foreign nationals on the basis of residence by reference to their enjoyment of public goods provided by the host state.58 Whether to tax a nation’s citizens who live abroad depends in part on judgments about the extent to which expatriates benefit from public goods provided by the state, including the goods that will be enjoyed by an expatriate who returns home. Although ‘benefits theory’ logic is perhaps least controversial in the area of international taxation, tracing out its implications for international tax policy is immensely complicated, and cannot be accomplished within the scope of this paper. DIFFICULTIES WITH THE BENEFITS PRINCIPLE

The Baseline Problem As was argued above, proponents of benefits taxation have plausible responses to the claim that benefits taxation has objectionable distributive implications. However, the problem of redistribution points to a deeper concern with the benefits principle. This I will call the baseline problem. The baseline problem is 55 TM Cooley, A Treatise on the Law of Taxation: Including the Law of Local Assessments (Chicago IL, Callaghan and Co, 1881) 14. 56 Eg, R Avi-Yonah, ‘International Taxation of Electronic Commerce’ (1997) 52 Tax Law Review 507, 520–23. 57 P Dietsch, Catching Capital: The Ethics of Tax Competition (Oxford, Oxford University Press, 2015) 54–62. 58 Eg, ‘Residence taxation as such only seems to be a legitimate fiscal tool on the basis of the benefit principle’: W Schön, ‘Taxation and Democracy’ [Forthcoming 2019] 72 Tax Law Review 40.

Benefits Theories of Tax Fairness  115 that benefits of a particular public good must be measured against the state of affairs in which the good is not provided. This creates both normative and positive challenges. In some cases, the appropriate baseline is relatively clear. The value of a public park to a taxpayer is the difference between how the taxpayer values a neighbourhood with the park and the same neighbourhood without the park. Although it may not be possible to measure private valuations of the park directly because it is uneconomical to charge admission and because some benefits may accrue to those who do not enter the park, it is possible to determine implicit valuations by looking at the market for property located near the park. Goods that have a more pervasive effect on the taxpayer’s quality of life can be more difficult to value. What, for example, is the value of the legal system to a taxpayer? One could imagine a simple agricultural economy in which disputes are resolved by a combination of self-help, informal mediation, and community discussion. But it is difficult to imagine a complex economy that functions well without a specialised dispute resolution system backed by specialised enforcers. Lack of a formal legal system would both sharply diminish the economic value of property rights and significantly compromise personal security. If one adopts the theory that benefit is to be measured in terms of willingness to pay, then one must consider the alternative to lack of protection from the state and how much the taxpayer would be willing to pay to avoid this state of affairs. But this seems to depend on what the taxpayer’s situation would be outside of the state. Would the taxpayer own the same property? Or would there be a free-for-all such that the taxpayer could expect to end up with much less property. For taxpayers having valuable skills, one might consider the market for their labour abroad when considering their willingness-to-pay for protection by the state. But for other assets, one might wonder whether one is to suppose that patterns of ownership are to remain the same outside the protection of the state. If so, this seems a rather artificial assumption that will undervalue public spending given that the purported benefit of taxes is the protection of property. But if not, it seems quite plausible that a taxpayer would be willing to pay a very large proportion of income in order to protect her property. The modern benefits principle would therefore place only very mild constraints on the taxation of wealthy taxpayers (the poor being much quicker to conclude that taxes are not worthwhile since they are closer to their expected outcome in the state of nature). With respect to protection of persons, the problem is even worse. Taxpayers would presumably be willing to pay a very large sum for protection of their persons. But in this case, willingness to pay will give little guidance on how to allocate tax burdens. Benefits theorists have two options at this point. One is to rely on the classical benefits principle, which might suggest that if taxpayers benefit equally from protection to their persons, they should share the costs of providing this protection equally. This response is plausible, but might raise objections on distributive grounds. A second, perhaps more promising, approach is that taken by James Buchanan. This is to separate constitutional

116  Ira K Lindsay negotiations, which fix the political order, property entitlements and the legal system (the ‘protective state’), from the provision of other public goods (the ‘productive state’).59 The constitutional contract thus fixes the baseline against which negotiation over ordinary taxing and spending decisions take place. This has the advantage of determining a background against which fiscal policy can be evaluated. But it may incorporate a bias toward non-redistributive policies since separating the protective state from the productive state as Buchanan does, limits the extent to which the benefits that the wealthy receive from the protective state can be used to justify greater contributions to the public goods produced by the productive state. On the other hand, the justification of the protective state might require significant transfers from rich to poor, since transfer payments might be the price of political consent.60 The baseline problem is especially challenging for public goods such as national defence, police protection and the legal system that are fundamental to political order. For these goods, the modern benefits principle puts few constraints on tax policy, and the classical benefits principle is difficult to interpret. Here, the modern principle gives some reason to prefer progressive taxation, while the classical principle is more consistent with proportionate taxation. If one accepts the classical principle, taxes to support these public goods should probably be apportioned on the basis of the taxpayer’s economic standing through some mixture of income, consumption and property taxes. If one accepts the modern benefits principle, it seems plausible to support such goods on the basis of sharply progressive taxation. Aside from egalitarian distributional preferences, there is a plausible argument that the unanimity rule will tend in a progressive direction since poor taxpayers have less to lose from the breakdown of political order and may more plausibly threaten to veto such spending projects than wealthy taxpayers. The implications of benefits taxation to support goods that are not essential to the political system are slightly more straightforward and here Wicksellian taxation would have more predictable results. A second baseline problem concerns the point in time at which costs and benefits are to be measured. This is a particular problem for social insurance programmes that redistribute costs and benefits over a taxpayer’s life and provide insurance against poor outcomes or, in the case of state pensions, good outcomes. The difficulty is that the point of these programmes is in part to mitigate risks by redistributing ex post.61 Social insurance programmes work by pooling risks, by transferring resources from the lucky (the employed, the healthy, the able-bodied, etc) to the unlucky (the unemployed, the unhealthy, the disabled, etc). Part of the value of the social welfare state is that it provides benefits in the case of misfortune that most taxpayers will not need to use.



59 Buchanan,

above n 37, 88–90. 92. 61 J Heath, ‘The Benefits of Cooperation’ (2006) 34 Philosophy & Public Affairs 313, 346–47. 60 ibid,

Benefits Theories of Tax Fairness  117 Another function of the social welfare state is to help manage mismatches in income and needs over a person’s life. Programmes such as state-funded education, childcare subsidies and old age pensions respond to the problem of variable income over one’s life-cycle and uncertainty about future costs during lowincome periods by allowing citizens to pay into programmes when they have sufficient income, and to collect benefits when they have particular needs. The dilemma faced by proponents of the benefits principle is that the more they appeal to the benefits received by an actual taxpayer, the less scope there is for social insurance, while the more they appeal to benefits received by hypothetical taxpayers, the less the theory speaks to the benefits received by actual taxpayers. For programmes that mitigate risk over the life cycle, it is probably best to assess matters from the perspective of a young adult. This reflects exposure to various risks that a person faces over the course of their life but does not abstract away from many of the personal characteristics that determine their particular preferences. The insurance element of social programmes is more difficult to analyse. The value of insurance, especially for events that are difficult to insure on the private market, is considerable. This suggests that a taxpayer who pays slightly more in taxes than she expects to receive in social insurance benefits may still be advantaged by the social welfare state. It is difficult, however, to decide how to value the risks mitigated by social insurance. Some taxpayers are at greater risk of unemployment than others. Some taxpayers are more likely to be sick; others are more likely to outlive the numbers on actuarial tables. These risks are partially, but not entirely, understood ex ante. Children have actuarially different prospects from birth if we are told the identity of their parents. By the time that they are adults, even more information about their life prospects is available. In some cases – national health insurance that covers medical costs for those in poor health, and old age pensions that disproportionately benefit the healthy and long-lived – benefits from social programmes may be offsetting since the chronically ill are less likely to collect pensions. But in other cases, the same relatively small number of people tend to draw benefits from multiple programmes. To the extent that these benefit recipients are identifiable ex ante, this tends to undermine the insurance value of social welfare programmes for other taxpayers. The classical benefits principle might finesse this issue by making benefits proportional to contributions but compressing the payments schedule so that high contributors are somewhat underpaid relative to the value of their contributions, and low contributors are somewhat overpaid. This would preserve the proportionality that the principle requires, while allowing for some degree of redistribution to be built into the social insurance scheme. This strategy is less compatible with the modern principle. At any but a low level of redistribution, the most advantaged citizens will make contributions that are greater than their expected benefits. The very wealthy can self-insure against bad outcomes. When social insurance contributions become high enough, insurance on private markets becomes competitive with government benefits for high earners, even when taking into account market failures in private insurance.

118  Ira K Lindsay The baseline problem is not necessarily fatal to benefits taxation. But it does undermine one of its purported advantages. Although benefits taxation requires a thicker informational base than ability to pay taxation, it does not appear to require analysts to look beyond taxation and public spending to evaluate tax fairness. However, the baseline problem suggests that evaluation of the benefits of the minimal state is bound up in thorny questions about the correct way to model a taxpayer’s willingness to pay for essential services. The value of social insurance programmes to taxpayers crucially depends on how we model the risks that they mitigate. Both of these inquiries implicate deep questions about distributive justice. This is not necessarily a disadvantage for benefits taxation, as being embedded in a larger theory of distributive justice might make the approach to tax fairness more rather than less plausible. But it does mean that benefits taxation may have less appeal as a freestanding theory of tax fairness and must be considered as one part of a larger theory of fair terms of political cooperation. The Public-Spirited Citizen Problem A second problem with benefits taxation is that it may be unfair to public-spirited citizens. To simplify matters, suppose that there are two types of taxpayers: public-spirited taxpayers, and taxpayers who are not public-spirited.62 Publicspirited taxpayers care both about their private projects and about collective projects that do not directly influence their own well-being. This might be because they are nationalists who intrinsically care about the status of their nation, or because they are altruists who care about the welfare of their fellow citizens. Non-public-spirited taxpayers are concerned only with their private projects and care about the nation only insofar as its condition affects these private projects. Both types of taxpayers are willing to contribute to public goods. But their preferences for public goods and their willingness to pay for them will differ significantly. Public-spirited and non-public-spirited taxpayers are each willing to pay to support public goods that support their private projects. But public-spirited taxpayers are additionally willing to pay taxes beyond those necessary for their private projects in order to support projects that benefit the nation as a whole or benefit their fellow-citizens as individuals. Because of their greater willingness to pay for public goods, public-spirited taxpayers are likely to assume a somewhat greater proportion of the tax burden in a Wicksellian tax system. Under a Wicksell tax system, the public-spirited essentially purchase greater provision of public goods through their own taxes 62 Actual taxpayers fall on a continuum between entirely public spirited and entirely non-public spirited. It is easier to use ideal types for purposes of exposition. The basic problem will arise insofar as taxpayers differ from one another in their degree of public-spiritedness, even if few fall at either extreme.

Benefits Theories of Tax Fairness  119 that benefit public-spirited and non-public-spirited alike. Public-spirited citizens might object that this is unfair. They are no more benefited in their private projects than non-public-spirited citizens are. But because non-public-spirited do not intrinsically care about anything outside of their private projects, they bear a smaller share of the tax burden. Public-spirited citizens might also object that they are being disadvantaged precisely because of their good moral character. This may sometimes be so. It is important to keep in mind, however, that taxpayers could be public-spirited for a variety of reasons, some of which may be rather unsavoury. Zealous militarists who favour higher taxes to support foreign wars for the greater glory of the nation are no less public-spirited in the sense intended here than wealthy taxpayers who favour higher taxes to feed the poor. One response to this problem for Wicksellians is to dig in and insist that there is nothing improper with taxing citizens according to their marginal benefit. As already noted, this is the approach favoured by Wicksell himself.63 They might suggest that a compromise between the preferences of public-spirited and non-public-spirited taxpayers is a sign of a fair procedure. This, however, is not really responsive to the public-spirited taxpayer’s complaint. The objection here is that the compromise is not fair because the preferences of public-spirited and non-public-spirited taxpayers are different in kind, such that aggregating across them benefits the selfish. An alternative response is to differentiate between self-interested and other regarding preferences for the purposes of calculating willingness to pay for public goods. Taxes could then be apportioned using self-interested preferences. This response, however, tends to exacerbate the difficulties in measuring benefits as even procedures that identify willingness to pay will not be enough to distinguish between self-regarding and other regarding preferences. A third approach would be to fix the supply of public goods independently of tax obligations so that this compromise between taxpayers would not be infected by the differences in public-spiritedness among taxpayers. Taxes could then be apportioned on the basis of private valuations of these public goods, rather than all-thingsconsidered willingness to pay. This response is similar to that favoured by proponents of the classical benefits principle. But it would sacrifice many of the efficiency gains of the unanimity rule because the supply of public goods would no longer be determined by the willingness to pay of individual taxpayers. The public-spirited citizen problem is, in a sense, a reworking of the venerable criticism that benefits taxation misunderstands the difference between public and private consumption and is therefore inappropriate for analysis of the public sector. The critique is subtler than the nineteenth-century version. The point here is not that demand for public goods cannot be modelled by analogy to private consumption, but that treating altruistic and self-directed preferences as



63 Wicksell,

above n 31, 97.

120  Ira K Lindsay equivalent is unfair to those who are altruistic or collectivist. Ironically, it is the classical version of the benefits principle, which looks to private benefit, rather than the modern principle, which looks to willingness to pay, that is better able to respond to this criticism. CONCLUSION

After nearly a century of being confined to the margins of tax theory, benefits taxation is almost certainly underrated today. Its advantages are several. First, the benefits principle provides a way to analyse the relationship between property rights and tax burdens that avoids the Scylla of concluding that all taxes are a prima facie violation of property rights, and the Charybdis of conceding that commitment to private ownership of resources puts no constraints on tax policy. Benefits taxation places limits on the tax burdens that may be imposed on a taxpayer and the permissible scope of redistribution across taxpayers while leaving open a range of policies that provide sufficient benefits to each taxpayer. Second, the benefits theory situates tax fairness in the context of deeper norms of reciprocity. This has the theoretical advantage of providing a normative foundation for norms of tax fairness and the practical advantage of identifying policies more likely to elicit voluntary compliance from taxpayers and political support from voters. Third, the modern approach to benefits taxation promises to realise efficiencies in the provision of public goods that were previously thought possible only in private markets. The traditional objections to benefits taxation, that it involves appeal to unmeasurable quantities and that it is regressive, have some weight but are not dispositive. As a normative standard, willingness to pay is conceptually clear and may be estimated at least approximately using a variety of techniques. Even when benefits are difficult to measure, the benefits principle may suggest an alternative justification for taxes on income, consumption, or wealth. A second objection – that the benefits principle is regressive – is only effective against certain interpretations of the benefits principle. Both of these objections, however, are connected to a deeper problem, which is that the baseline against which willingness to pay is to be measured cannot be made precise without making a host of controversial normative judgments. A third objection, that the benefits principle is inconsistent with the proper relationship between citizen and government runs the risk of treating citizens as serving the state, rather than the state as serving citizens. But a related critique has more force. Modern benefits theory may tend to treat altruistic taxpayers unfairly and advantage those who care largely about their private projects. The classic benefits principle and the modern principle have different strengths and weaknesses. Both principles help to mediate the conflict between property rights and taxation authority, but do so in slightly different ways. The modern principle promises greater efficiency and an elegant solution to the

Benefits Theories of Tax Fairness  121 measurement problem, but is difficult to implement in practice. The classical principle better tracks plausible norms of fair cooperation but is more vulnerable to the measurement objection and less well calibrated to produce efficient provision of public goods. The classical benefits principle is better suited to evaluate taxes in support of public goods that are likely to be supported for altruistic reasons. Wicksell taxation, by contrast, is better suited to evaluate taxes to support public goods that are similar in character to private consumption goods. The case for the benefits principle is not straightforward. But neither is the case for any of its competitors. At the very least, benefits taxation is a plausible rival to ‘ability to pay’ theories. In light of the difficulties with each version of benefits taxation, it is probably not desirable to adopt a single principle to justify the fiscal system as a whole. What may be more promising instead is a modular approach in which different types of taxes are levied to support different sorts of spending programmes. Each part of such a fiscal system might be justified by the classical benefits principle or by the modern benefits principle or by purely distributive aims, but no single principle of tax fairness would explain the system as a whole.

122

5 Tax and Taxability ‘Trade, Profession or Vocation’ Seen Through the Eyes of Jane Austen JOHN AVERY JONES*

ABSTRACT

The United Kingdom is unique in taxing the profits of a ‘trade, profession or vocation’, while the rest of the common law world taxes ‘business’ (or ‘trade or business’ in the United States). It is suggested that the reason is historical relating to the social need to separate trades from professions rather than using a composite expression. This is illustrated by using characters from Jane Austen’s novels, which are contemporary with the original income tax, to understand the type of people who would fall within ‘trade, profession or vocation’, their social status and income, and to deduce how they would have been taxed. If income tax had been invented 150 years later we would almost certainly have used ­business like the rest of the common law world. INTRODUCTION

T

he question posed in this chapter is why, uniquely, we in the United Kingdom have since 17991 taxed the profits of a ‘trade, profession or vocation’, and the rest of the common law world, as demonstrated in Appendix 1, taxes ‘business’ (or ‘trade or business’ in the United States). It will * I am grateful to Richard Thomas for many discussions about points of tax history which are reflected herein. 1 Pitt’s 1799 Act (39 Geo 3 c. 13) (‘1799’) (Schedules substituted by 39 Geo 3 c 22), 15th Case taxed the income ‘from any Trade, Profession, Office, Pension, Allowance, Stipend, Employment, or ­Vocation.’ Addington’s 1803 Act (43 Geo 3 c 122) (‘1803’) s 84 (Sch D) taxed under Case I any trade or manufacture, and under Case II professions, employments or vocations. See now ITTOIA 2005 s 5, and ITA 2007 s 989.

124  John Avery Jones be argued that the question answers itself if one considers what the reaction of Addington or of Jane Austen would have been to the suggestion that trades and professions be classed – I use the word deliberately – together as businesses, even for tax purposes. Addington’s derogatory nickname in Parliament, as we shall see, was ‘the doctor’, on account of his father’s profession.2 Jane Austen has particular advantages as our authority,3 not only for her acute observation of fine class and income distinctions that make for the realism of the characters4 in her novels,5 but also because her mature work coincides almost exactly with the original era of Pitt’s and Addington’s income tax of 1799 to 1816,6

2 See text at n 134. 3 Among the large literature on her novels those dealing with the professions and trade include Professor G H Treitel, ‘Jane Austen and the Law’ (1984) 100 LQR 549 available at www.sscnet. ucla.edu/polisci/faculty/chwe/austen/treitel1984.pdf; A Drum, ‘Pride and Prestige: Jane Austen and the Professions’ (2009) 36(3) College Literature 92–115; T Fulford, ‘Sighing for a Soldier: Jane Austen and Military Pride and Prejudice’ (2002) 57(2) Nineteenth-Century Literature 153–78; B Southam, Jane Austen and the Navy, 2nd edn (London, National Maritime Museum, 2005); J Todd (ed), Jane Austen in Context (Cambridge, Cambridge University Press, 2005), particularly the chapters by R  Clark and G Dutton, ‘Agriculture’, E Copeland, ‘Money’, B Southam, ‘Professions’, J ­Wiltshire, ‘Medicine, illness and disease’, and M Ellis, ‘Trade’; E Copeland and J McMaster (eds), The Cambridge Companion to Jane Austen 2nd edn (Cambridge, Cambridge University Press, 2011), particularly the chapters by E Copeland, ‘Money’, J McMaster, ‘Class’, and D Selwyn, ‘Making a living’; A Digby, Making a Medical Living (Cambridge, Cambridge University Press, 1994); D Grey (ed) The Jane Austen Handbook (London, Athlone Press, 1986), particularly the chapters by DW Smithers ‘Medicine’, and M Butler ‘History, Politics and Religion.’ On the topic of money see also RD Hume, ‘Money in Jane Austen’ (2013) 64(264) The Review of English Studies 289–310; and Anonymous, ‘Percents and sensibility: Personal finance in Jane Austin’s time’, The Economist, 24 December 2005. (Why is it that authors (including myself) cannot resist making a play of words of her titles?) I have also cited other literature on more specific aspects throughout. 4 To avoid over-referencing, references to Jane’s (as I shall refer to her for short, although she would have disapproved) characters are not given, on the basis that either readers will know them or, if interested, will be able to find them on the Internet without difficulty, and in any case they serve merely as illustrations. An exception is made in relation to (the unfinished) The Watsons and Sanditon. Any quotations to the book (using initials for the titles except for those two books) are referenced to the chapter. 5 Sir Walter Scott, in his review of Emma, said ‘those which are sketched with most originality and precision, belong to a class rather below [well-bred country gentlemen and ladies].’ (Quoted by P Byrne, The Real Jane Austen: A Life in Small Things (London, Harper Perennial, 2013), 302), for whom the expression ‘pseudo-gentry’ was coined by D Spring, ‘Interpreters of Jane Austen’s Social World’ in Jane Austen: New Perspectives, J Todd (ed) (New York, Holmes & Meier, 1983) 53. We need also to bear in mind that she was writing about circumstances in the south of England which would not be typical of the country as a whole. 6 Northanger Abbey (formerly Susan) written 1798–99, revised in 1802 and published posthumously in 1817; Sense & Sensibility (formerly Elinor and Marianne) written in about 1795, rewritten in 1799 and published in 1811; Mansfield Park written between 1811 and 1813 and published in 1814; Emma written in 1814–15 and published in 1815; Persuasion written 1815–16 and published posthumously in 1816; Pride & Prejudice (formerly First Impressions) written in 1796–97, revised in 1811 and published in 1813; The Watsons was partly written in about 1803–05, then abandoned, and was published in 1871 (with number of writers, including the author’s niece, attempting to complete it); Sanditon was started in 1817 and was unfinished at the time of her death in the same year.

Tax and Taxability  125 which she must have paid,7 even though there is no reference to income tax in her novels.8 The bicentenary of her death was in 2017. We can use her novels to understand the type of people who would fall within the words ‘trade, profession or vocation’, their social status and income,9 and to deduce how they would have been taxed.10 No doubt because of her family connections, her best-developed professional characters are the clergy and the navy; less so for lawyers. Medical men have little more than walk-on parts. 7 Her literary earnings between 1812 and 1817 were between £631 and £668 in total (J Fergus ‘The professional woman writer’ in The Cambridge Companion to Jane Austen, above n 3, 8 et seq), when the annual exemption limit was £50, and most was received in 1812–13 and 1814–15. Because of the then strict interpretation of the wholly and exclusively rule (see below n 90), the deductions are likely to have been small. Her indirect connection is that brother Henry, who was ReceiverGeneral of Taxes for Oxfordshire, owed considerable sums of income tax to the Exchequer when he became bankrupt on the failure of the bank of which he was a partner. In Finance Accounts of Great Britain for the year ended 5 January 1817 (1817 HC 98) 95 the balance due from him on 14 March 1816 (when the bank failed) is shown as £44,445 10s 6d (made up, according to previous years’ accounts, of property tax (i.e. Addington’s income tax), subsequently reduced by four payments totalling £21,248 19s 1¾d received between 9 April 1816 and 18 March 1817, which are presumably payments by the sureties given by his brother Edward and his uncle James Leigh-Perrot, leaving £23,196 11s 4¼d outstanding. The accounts for the following year do not contain any relevant information, and so the debt must have been cleared by the sureties by 5 January 1818. 8 There are only two references to tax: one to land tax (that if Edward Ferrars did not marry the Hon Miss Morton, Mrs Ferrars would settle the Norfolk estate, which clear of land tax brings in £1,000 pa, on his brother Robert – honourably, Edward did not break off his engagement to Lucy Steele, only to be jilted by her after he had been disinherited, leaving him free to marry Elinor, with Mrs Ferrars’ eventual approval – and the estate was duly settled on Robert, who marries Lucy, who had kept her eye on the money); and the other to window tax (that Fanny visited more rooms in Mr Rushworth’s house, Sotherton Court, ‘than could be supposed to be of any other use than to contribute to the window-tax [which under (1803) 43 Geo 3 c 161 Sch A rose from 6s [30p] for six windows to £83 for 180 windows, increased to 6s 6d [32.5p] and £93 2s 6d [£93.125] by (1808) 48 Geo 3 c 55], and find employment for housemaids’) (MP ch 9). There are no references to income tax in her letters either, but one reference to assessed taxes, that she rode in a ‘tax-cart’ (D Le Faye, Jane Austen’s Letters 4th edn (Oxford, Oxford University Press, 2014) Letter 78). A taxed cart was a carriage of less than four wheels, drawn by one horse only used for the purposes of husbandry or carrying goods in the way of trade which shall or may be used occasionally for the conveyance of persons, constructed of wood or iron without any covering other than a tilted covering, or any lining, and without springs, having the words ‘A Taxed Cart’ at least one inch in length and the owner’s name and address, which was subject to a reduced rate of carriage duty under (1795) 35 ­Geo 3 c 109 ss 2, 5 of 10s [50p], and was exempt from Triple Assessment (1797) 38 Geo 3 c 16, s 32; duty increased by (1803) 43 Geo 3 c 161 to £1 4s [£1.20] Sch E and by (1808) 48 Geo 3 c 55 to £1 6s 6d [£1.325] (a separate rate of £2 10s [£2.50] was applied by 50 Geo 3 c 104 to taxed carts with non-metallic springs); and ultimately exempted by (1823) 4 Geo 4 c 11; the horse used only for drawing it was exempt from assessed tax under (1803) 43 Geo 3 c 161 for farmers, and clergymen with an income under £100, see below n 55. The assessed taxes (on windows, inhabited houses, carriages, men servants, horses, dogs, hair-powder and armorial bearings) brought in considerable revenue: in 1815, £6.5m compared to income tax £14.6m, death duties £1.3m, and land tax £1.2m, out of a total direct tax receipts of £25.4m (indirect taxes totalled £42.29m): S Dowell History of Taxation and Taxes in England 3rd edn, vol 2 (London, Frank Cass, 1965) 257–58. See C Stebbings in ch 6 of this book on the assessed taxes on carriages and horses. 9 See Appendix 2 for the standard of living enjoyed by incomes of various amounts illustrated by the income of her characters. 10 I trust that this will not be thought of as treating her characters as if they were real people, a familiar criticism of Janeites, but as helping the reader to understand better the type of person being taxed under each heading. I have also used members of her family for illustrations.

126  John Avery Jones TRADE, PROFESSION OR VOCATION

The need to separate professions from trade, dealt with below, is demonstrated by the Oxford English Dictionary definition of liberal profession ‘in early use worthy of or suitable for a person of noble birth or superior social status’.11 It also says of profession ‘in early use applied specially to the professions of law, the Church, and medicine, and sometimes also to the military profession’ with a first use in ?1541.12 A near-contemporary to income tax (1798) statutory reference required an alien to give ‘a full and true Account in Writing of his or her Name, Age, Rank, Occupation, or Profession’,13 carefully mentioning professions separately. The primary use of profession at the time income tax was introduced was liberal profession; tax legislation was careful to mention professions separately so as not to mix the liberal professions with occupations of lower social status. Interestingly there does not appear to have been any statutory use of v­ ocation earlier than Pitt’s 1799 Act, although the Oxford English Dictionary lists as a meaning ‘[o]ne’s ordinary occupation, business, or profession’, with a first use in 1553. Professions Not within Schedule D Before considering the meaning of ‘trade, profession or vocation’ in Schedule D, we need to be aware that two of the main liberal professions, the church and the military, were taxed under Schedules A (tithes, and farming the glebe land (church agricultural land)) and E (public employments) respectively, and so do not fall within Schedule D professions, which were therefore restricted mainly to the law and medicine. Interestingly, Schedule D covers the professions where success depended wholly on merit, while success in the church largely depended

11 For example, Adam Smith refers to ‘liberal professions’ in Wealth of Nations (I.x.22) ‘Inequalities arising from the Nature of the Employments themselves’. Its publication in 1776 coincided within three months with Jane’s birth. Jane’s brothers, two being clergymen (one formerly a militia officer) and two naval officers, are good examples. KL Moler has identified an apparent allusion to Adam Smith’s Theory of Moral Sentiments by Mary and Elizabeth Bennet when discussing Darcy’s pride and vanity, in ‘The Bennet Girls and Adam Smith on Vanity and Pride’ (1967) 46(4) P ­ hilological Quarterly 567, but would Jane have ever read this? P Knox-Shaw, ‘Philosophy’ in Jane Austen in Context, above n 3, draws parallels with Jane in Smith and Hume. 12 There is a statutory example of this last item: ‘divers lewd and licentious Persons … wandered up and down in all Parts of the Realm under the Name of Soldiers and Mariners, abusing the Title of that honourable Profession’ (1597 39 Eliz I c 17) (italics added). 13 (1798) 38 Geo 3 c 50 s 2. Similarly ‘full Description of the Residence, Profession, or Business, of the Person to whom or in whose Favour the said Letter of Attorney, or Will, is made’ (1786) 26 Geo 3 c 63 s 2; ‘That my Name is A. B. and that I am [specifying the Addition, Profession, or Trade of such Person]’ (Parliamentary Elections Act 1785). All these refer separately to professions, as does tax.

Tax and Taxability  127 on a living being presented to the clergyman, usually by a family member,14 and in the military depending partly on patronage15 and partly ability. Jane Austen’s contemporary (and then more successful16) rival, Maria Edgeworth, explored this contrast in Patronage,17 published about the same time as Mansfield Park, which promotes those professions based on merit. It is also interesting that the professions are dealt with more fully by Jane Austen’s later novels, Mansfield Park, Emma, and particularly Persuasion18 and, if she had completed Sanditon, she would have branched out into trade in the form of speculative (and, one suspects, unsuccessful) development, reflecting her understanding of the changing world caused by the industrial revolution.19 Her novels may have featured England’s green and pleasant land rather than dark satanic mills, to quote another contemporary author,20 and they may not have advocated change in the way that Maria Edgeworth’s did, but she was well aware of the changes taking place. The Church The patronage for appointing clergymen was exercised by the holder of the advowson, who had the right to present someone to a living. If the holder were the landowner it is likely that he would appoint a younger son or brother, who would not inherit the land.21 An advowson is governed by the law of real 14 No qualification other than a degree was necessary. Lucy Steele: ‘Edward have [sic] got some business at Oxford, he says; … and after that, as soon as he can light upon a Bishop, he will be ordained’ (S&S ch 38); and Edmund ‘was going to a friend near Peterborough, in the same situation as himself, and they were to receive ordination in the course of the Christmas week’ (MP ch 26). 15 See below n 73 for the example of William Price’s promotion to lieutenant through the patronage of Henry Crawford’s uncle who was an admiral, and for the point that promotion above the rank of captain was automatic and based on seniority (text at n 72). 16 As demonstrated by her receiving £2,100 for Patronage, compared to Jane’s £310 to £347 for MP, published at her own risk (Fergus, above n 8). 17 In which the sons of the Percy family successfully make their way in the law and medicine through their own merit, the parents suffer numerous hardships but ultimately succeed in spite of everything; while the sons of the Falconer family initially have greater success through the patronage of Lord Oldborough but ultimately fail to succeed in diplomacy, the army and the church. The daughters of the Percy family succeed in making good marriages (in one case marrying Count Altenberg in spite of the rivalry by one of the daughters of the Falconer family), while the Falconer daughters have no success in spite of patronage, the expense of promoting the daughters ruining the parents. Compared to Jane, Edgeworth is far less subtly didactic, but it is an enjoyable read with, as so often, the bad characters being far more interesting than the good, who are too perfect. 18 In which Mrs Clay describes the professions: ‘The lawyer plods, quite care-worn; the physician is up at all hours, and travelling in all weather … and even the clergyman, you know is obliged to go into infected rooms, and expose his health and looks to all the injury of a poisonous atmosphere’ (P ch 3). Why did she say ‘physician’ (who made up only 10% of the medical profession, see text at n 112)? Was it because she was familiar only with naval surgeons? 19 See Ellis, above n 3, 415. Sanditon was started less than a year after her brother Henry’s ­bankruptcy (see above n 7) and she might have been going to use her knowledge of the process. 20 Blake wrote 1804 on the title page of his Preface, now generally known as ‘Jerusalem’, to his epic poem Milton, which was published in about 1808. 21 An example is Sir Thomas Bertram appointing Edmund to the living at Thornton Lacey which brought in £700 pa (which was an insufficient addition to her income of £1,000 for Mary Crawford).

128  John Avery Jones ­ roperty in the same way as physical land, and descended in the same way p as land,22 being classified as an incorporeal hereditament.23 The right to the next presentation could be sold separately before the living became vacant, but not after, which would be simony; this would be a capital transaction for tax purposes.24 The right to the next presentation of the living of Mansfield, which originally brought Mr and Mrs Norris ‘very little less than £1,000 a year’25 was sold in order to pay Tom Bertram’s debts, depriving Edmund of his expected income.26 The going rate for a sale of the right was five times the income27 although Dashwood thought that Colonel Brandon could have sold the Delaford living for seven times the income, perhaps because agricultural prices were rising.28 The rector was entitled to the tithes29 but if he were not a clergyman, for example he was the holder of the advowson (‘a lay impropriator’, in the A contrary example is Lady Catherine’s presentation of an outsider, Mr Collins, perhaps because she liked to have a sycophant around. 22 Before 1926, to the heir (before the Inheritance Act 1833 traced from the last person seised) on an intestacy, as opposed to the next of kin in equal shares as personalty. 23 Other incorporeal hereditaments include rentcharges, profits à prendre, and easements (C Harpum, S Bridge, M Dixon, Megarry & Wade: The Law of Real Property 8th edn (London, Sweet & Maxwell, 2012) §31-007). An office also used to be an incorporeal hereditament because the holder would be remunerated by a grant of land. Addington’s 1803 Act, above n 1, was originally introduced as two Bills, one dealing with Schedules A, B and E, demonstrating the strong connection between public offices and land: see JF Avery Jones, ‘The Sources of Addington’s Income Tax’ in P Harris and D de Cogan (eds), Studies in the History of Tax Law vol 7 (Oxford, Hart Publishing, 2015) 1, 6. 24 (1713) 13 Ann c 12; see Treitel, above n 3, 568. Nor under that Act could Dr Grant have bought it and then presented himself; and in any case he did not have the funds to buy it. 25 MP ch 1. Since a wife’s income belonged to her husband, presumably this includes Mrs Norris’s £350 if she had the same wealth as her sister Lady Bertram. But deducting her income would make the Mansfield living worth less than the £700 produced by the secondary one at Thornton Lacy. The explanation is the considerable inflation of agricultural income and tithes during the intervening more than 20 years, by which time the Mansfield living would produce far more (and Tom’s debts would be five times the increased amount), see above n 28. I am grateful to Professor Jan Fergus for this point. 26 Edmund eventually gets the living just when he married Fanny following Dr Grant’s premature death from apoplexy caused by three great institutional dinners in one week. 27 Hume, above n 3, fn 17 quoting Copeland’s annotation to S&S. 28 Jane’s father’s two Hampshire parishes produced £200 in the 1770s; 30 years later the tithes were £600 and the farms produced £300 (Professions, above n 3, 369; Faye, above n 8, Letters 24 and 29). Since in many cases the annual value depended on the actual rent, it is likely to be fairly up-to-date, although in practice leases made within seven years earlier were accepted as reflecting the rack rent: Exposition of the Act (London, J Gold, 1803) 7; repeated in Guide to the Property Act (London, J Gold, 1807) 2 (both anonymous but obviously written within the Revenue). In 1806–07 (to take a sample year) 82% of assessments on tenants in England were based on the rent, implying that this proportion related to leases within the previous seven years: Accounts relating to the Property Tax (1813, HC 64), PP 1812–13 XII 235 F (Property tax accounts) 35. 29 The Church received one-tenth of agricultural produce (or its equivalent in money). The system was criticised by Adam Smith: ‘Upon the rent of rich lands, the tythe may sometimes be a tax of no more than one-fifth part …, whereas upon that of poorer lands, it may sometimes be a tax of one-half … The tythe, as it is frequently a very unequal tax upon the rent, so it is always a great discouragement both to the improvements of the landlords and to the cultivation of the farmer’ (Wealth of Nations V.ii.d.2). James Stanier Clarke, chaplain and librarian to the Prince Regent (to whom E was dedicated),

Tax and Taxability  129 tax legislation30) he would have to engage a vicar at a stipend. The insufferable Mr Collins is an example of a rector31 ‘with a good house and very sufficient income’ thanks to the ‘bounty and beneficence’32 of Lady Catherine, on which he could have supported Elizabeth whose meagre income was only £40, and that after the death of her mother. Mr Elton, on the other hand, was only vicar of Highbury. Although he was ‘known to have some independent property’,33 he must therefore have been particularly keen to marry the wealthy Emma (£1,500 pa34), but had to settle for Augusta Hawkins (£500 pa) with her lack of social graces.35 They could be assisted by a curate, like Charles Hayter who was Captain Wentworth’s rival for the affections of Henrietta and Louisa, and Captain Wentworth’s older brother. The age of 24 was the minimum age for a priest.36 The novels realistically distinguish between dedicated clergymen,37

suggested that Jane write a book about a clergyman which would ‘shew dear Madam what good would be done if Tythes were taken away entirely’ (Faye, above n 8, Letter 132(A)). She declined. 30 See below n 45. 31 Delaford was a rectory, meaning that the disinherited Edward Ferrars would receive the tithes, which were only £200 pa though capable of improvement: S&S ch 39 (see above n 28 for the rise in agricultural incomes). Mrs Jennings was ‘anxious that his [Colonel Brandon’s] tithes should be raised to the utmost’ (S&S ch 41). Another rector is Dr Shirley who appoints Charles Hayter as curate. Mr Morland’s two livings (one of which, worth about £400 pa, he proposed to make over to James on his proposed marriage to Isabella, who was not impressed by the amount), and Henry Tilney’s at Woodston must all be rectories. 32 P&P ch 15 and 13. He is referred to as the rector in ch 15 and tithes are mentioned in ch 18. 33 E vol 1 ch 4. 34 Assuming a 5% return for the Funds (Sch C, with tax deducted at source from 1806), which is the return used for Colonel Brandon and in numerous other places. This fixed return is unrealistic, as British government debt, the only form of ‘Funds’ quoted on the Stock Exchange from its foundation in 1801 until 1822 (when foreign government debt became quoted), was undated and the price (and therefore the yield) varied (The Economist, above n 3). Hume, above n 3, mentions that in 1803 the yield on 3% Consols varied between 5.99% and 4.12% with an average of 4.99%; the average for the first decade of the 19th century was 4.8%. 35 And he had to conduct Emma’s marriage service. Emma predicted on turning him down that ‘he would soon try for Miss Somebody else with twenty, or with ten’ [thousand] (E vol 1 ch 16); it turned out to be the latter. 36 The reference to Edward’s ‘first boyish attachment to Lucy [being] treated with all the philosophic dignity of twenty-four’ (S&S ch 49) demonstrates that Jane was aware that under (1804) 44 Geo 3 c 43 this was the minimum age he could be ordained as a priest (age 23 for a deacon), as Byrne, above n 5, points out at 204–05. Other probable allusions to this Act are (1) Wickham’s untrue story of how Darcy reneged on the promise to present him to a living which ‘became vacant two years ago, exactly as I was of an age to hold it’ (P&P ch 16) (this is the only clue to Wickham’s age, see www.goodreads.com/topic/show/1190676-how-old-were-they); (2) that James would have had to wait between two and three years for the living that his father proposed to make over to him on his marriage to Isabella ‘as soon as he should be old enough to take it’ (NA ch 16) (although NA, then called Susan, was sold to a publisher, who never published it, in 1803 before this Act, we can deduce that this is one of her amendments made after she bought the manuscript back in 1816); and (3) that Edmund would have £700 pa [from the living at Thornton Lacey] ‘by the time he is four or five and twenty’ (MP ch 23); the living must have been held for him for about three years either by appointing a vicar or by someone being presented who undertook to resign (Treitel, above n 3, 569). 37 Edmund, Edward, and probably in the future Henry Tilney (in spite of his being keen on dancing and enjoying himself in Bath). If The Watsons had been completed Mr Howard, who is destined to marry Emma [Watson], is obviously going to be a dedicated clergyman.

130  John Avery Jones for whom the church might be said to be a vocation (although she never uses the term38) and those with more interest in worldly matters.39 The rector obtained tax relief for the vicar’s stipend by deducting and retaining tax in the same way as relief was allowed for annual interest.40 The same applied to payment to curates. No deduction for other expenses, was allowed until a ‘wholly, exclusively and necessarily’ rule was introduced in 1853 for clergymen in assessing the duty under any Schedule, but that did not cover the expenses of keeping a horse because of the then strict interpretation of ‘wholly and exclusively’.41 Tithes were important, amounting to about 9 per cent of the income assessed under Schedule A,42 and their taxation was complicated. They might be taken in kind, or a composition made for a fixed payment in lieu.43 The rector or lay impropriator (or the tenant if the tithes were let) would be charged under Schedule A on a three-year average basis on the tithes if taken in kind; if there was a composition, from 180644 either the recipient or the occupier could be charged under Schedule A on the preceding year basis.45 The occupier would obtain a deduction by deducting and retaining the tax from the composition.46

38 Avocation, in the sense of a minor action (which is close to the original Latin avocare, meaning call away) was used once by Catherine in NA ‘her avocations above [looking for a book] having shut out all noise but what she created herself, she knew not that a visitor [Henry Tilney] had arrived within the last few minutes’ (NA ch 30). See nn 204, 205 for the (incorrect) use of avocation in tax legislation in Australia. 39 Collins, Grant, Elton. 40 1806 Act (46 Geo 3 c 65) (‘1806’) Sch A No IV, tenth. The rector was liable to the Triple ­Assessment, above n 8, s 18 on the house occupied by the vicar. 41 ITA 1853 (16 & 17 Vict c.34) s 52. See below n 135 for the expenses of keeping a horse failing the Sch D wholly and exclusively rule. See text at n 63 for the Sch E (then applying only to public offices) deduction for a horse introduced by ITA 1853 s 51. See below n 55 for a relief for clergymen from the assessed tax on horses. 42 In 1806–07 tithes [in kind] £2,012,064 plus tithes leased and compounded for £1,658,055, total £3,670,119 out of a total for Sch A of £39,897,440 (for England): Property tax accounts, above n 28, 27, 31–2. Tithes must have been controversial in Jane’s time. 43 The intermediate position of a sale of the standing crops at an estimated price was treated as the equivalent of taking the tithe in kind (see Guide, above n 28, 152 item A9). 44 Guide, above n 28, 152 explains that this was to overcome a difficulty if part of the tithe was payable in kind and part by composition, which previously had to be charged on the owner and occupier respectively. 45 1806, above n 40 s 74 deals with ‘Tythes belonging to a Lay Impropriator if taken in Kind’ (Sch A No II, first, three-year average basis), and ‘Tythes (arising from Lands) if compounded for, and of all Rents and other Money Payments in lieu of Tythes (arising from Lands, belonging to any Lay Impropriator as aforesaid) on the Amount of such Composition Rent or Payment’ (ditto, third, preceding year basis); and ‘Tythes belonging to any Ecclesiastical Person in Right of his Church or by Endowment if taken in Kind’ (No III, first, three-year average basis) and ‘Tythes (arising from Lands) if compounded for, and of all Rents and other Money Payments in lieu of Tythes (arising from Lands) belonging to any Ecclesiastical Person’ (ditto, third, preceding year basis); and the charge on the occupier under No IV, fourth. Land tax and parochial rates were allowed as a deduction (Sch A No V, fourth and fifth). The 1803 above n 1 and 1805 (45 Geo 3 c 49) (‘1805’) Acts are less specific about tithes. 46 1806, above n 40 Sch A No IV, ninth.

Tax and Taxability  131 The occupier was also charged under Schedule B in respect of the land subject to composition for tithes at one-quarter of the tax on the annual value, ie 6d (2.5 per cent) in the pound when the rate was 10 per cent.47 Apart from farming the glebe land many clergymen would have farmed in a larger way. George Austen, Jane’s clergyman father, farmed 195 acres as tenant and also 57 acres of glebe land in the neighbouring parish of Deane of which he was also the incumbent, making him a substantial farmer.48 A clergyman might also supplement his income by teaching, having boarders in the house, as did George Austen.49 Pitt’s 1799 Act had given a deduction from earnings of two-thirds of the rent paid on a house used for this purpose,50 but this was not repeated in Addington’s Act, although by the time of the 1806 Act a proportion of rent incurred for the purpose of a trade was deductible.51 Running a boarding school was a respectable occupation, although a trade. Mrs Goddard, proprietor of a ‘real, honest, old-fashioned Boarding-school, where a reasonable quantity of accomplishment were sold at a reasonable price’, which was ‘in high repute’,52 was on visiting terms with Emma.53

47 1806, above n 40 s 75 Sch B No VII. But if the land is not subject to tithes, which was the case for about 28 per cent of land in England in 1806–07 (Property tax accounts, above n 28, 35), a deduction of one-eighth of the rent was allowed. The explanation for this in the Guide, above n 28, 14 is that if tithe-free land is let at £200 the Sch B assessment (normally three-quarters of the full rate to allow for local rates and taxes = 7.5%) would be £13 2s 6d [£13.125] (200*7/8*0.075), and if land of the same value subject to tithes is let at £160 the assessment on the land would be £12 (160*.075) and on the tithe (valued at 30% of the rent, because the tithe is on the produce and the expenses of producing it are borne by the remaining nine-tenths, with the tenant or occupier charged on one-quarter of the owner’s rate) £1 4s [£1.20] (160*0.3*0.025), total £13 4s [£13.20]. Land might cease to be subject to tithes on enclosure and the rector given land in lieu (Guide, above n 28, 154 item B1). 48 Le Faye, above n 8, Letter 24 (1 November 1800, farm cleared £300 last year), and Letter 29 (5  January 1801, tithes very nearly £600). In 1806–07 81% of agricultural land in England was tenanted (Property tax accounts, above n 28, 35); in Jane’s territory, Southampton (as the county) was slightly lower at 78%. 49 See C Tomalin, Jane Austen, A Life (London, Penguin Books, 2000) 24–6 for a description. She says at 25, ‘The number of pupils was small enough for the Austens to run the school as a large family rather than an institution.’ In the early 1790s, when the pupils were roughly contemporaries of Jane’s, they paid fees of £65 pa (D Selwyn, ‘Making a Living’ in The Cambridge Companion to Jane Austen, above n 3, 153). The Guide, above n 28, 165 gives an example of the accounts of a clergyman keeping a school including disallowed expenses which strongly suggests Case I. 50 ‘… by Persons keeping any School, Academy, or Seminary for Learning, and usually having their Scholars to board and lodge (to a number not less than Ten) in their respective Dwelling Houses.’ 1799, 15th Case (Income from any Trade, Profession, Office, Pension, Allowance, Stipend, Employment, or Vocation, being of uncertain Annual Amount), Deductions. (There had also been a relief under the Triple Assessment, above n 8, ss 3, 11.) 51 See text at n 86. The existence of this specific deduction demonstrates the strict interpretation of the wholly and exclusively rule, see text at n 91. 52 E, vol 1 ch 3. 53 However, the teachers, including Miss Nash, the head teacher, had lower social status. Emma [Watson] in The Watsons says ‘I would rather be teacher at a school (and I can think of nothing worse) than marry a man I did not like’ (Pt I), to which her sister Elizabeth responds ‘I would rather do any thing than be a teacher at a school.’

132  John Avery Jones Clergymen with an income below £60 pa, which was the income tax exemption limit,54 keeping only one horse were exempt from the duty on horses (or originally £100 pa if the horse was used only for drawing a taxed cart).55 This represents a small income. Jane’s father was earning £900 pa from tithes and farming the glebe land around this time.56 The Military The military was another possible profession for the younger sons of the landed class: ‘Soldiers and sailors are always acceptable in society’57 said Edmund. But it was necessary to buy a commission in the army58 and it did not provide much of an income. Although one did not buy commissions in the navy, promotion to lieutenant, which was required to be on a specific ship, required patronage.59 54 Reduced to £50 from 1806. There are no rules for computing income for this purpose presumably because the limits are so low (see next note). 55 Duty £2 by (1803) 43 Geo 3 c 161 Sch E III (limit £100 for drawing only a taxed cart, see above n 8) and exemptions from Sch E and F Case VII (£60 if only for riding); duty £2 8s by (1805) 45 Geo 3 c 13 with a £60 income limit if the horse was either for the purpose of riding or drawing a taxed cart, but not if only occasionally performing his duties without being the regular officiating minister; duty £2 13s 6d by (1808) 48 Geo 3 c 55 reverting to the original £60 and £100 limits for only one or other purpose (which must have been unenforceable). The £60 limit was 40% of a reasonable income of a clergyman in 1810, see below n 125. 56 See above n 28 for his agricultural income, although relating to a few years later; in addition he had £105 investment income by the time of Pitt’s income tax (bank entries in D Le Faye, A ­Chronology of Jane Austen and her Family (Cambridge, Cambridge University Press, 2013). He bought a carriage, around the time of Henry Austen’s first marriage (31 December 1797) according to Anna Lefroy, and had the family coat of arms painted on it, but had to ‘lay it down’ the following year because of a tax increase (Byrne at 112). This would be first, the Triple Assessment, above n 8 (introduced in Pitt’s Budget on 24 November 1797), based on the preceding year 1797–98 but charged as if he had owned it for the whole year (s 1); and secondly, a new stamp duty of £2 2s [£2.10] on an annual certificate for the use of armorial bearings from 24 June 1798 ((1797) 38 Geo 3 c 53), continued by (1803) 43 Geo 3 c 161. The tax on a four-wheeled carriage in 1797–98 would have been £8, and on his three horses £4 9s [£4.45] so that he paid tax in 1798–99 of £37 7s [£37.35] (plus triple duty on male servants, depending on the number). The tax on the carriage for 1798–99 had also increased to £9 12s [£9.60] but would not operate until the following year if he had been assessed to the Triple Assessment before 6 April 1798 (s 6). The only possible transitional provision would be that, if the carriage had not been used before the Act was passed on 12 January 1798, the duty would be once (instead of three times) the duty for the whole year (s 31). R Vick, ‘Mr Austen’s Carriage’, Report of the Jane Austen Society 1999 (Winchester, Sarson Press, 2000) 226, argued that the date of purchase is wrong, particularly as it is unlikely that George would have decided that he could not afford it so soon after the purchase. He has found entries in his bank statement for 1793–95 which could be the cost of the carriage, and so, he argues, it was the duty on the armorial bearings that caused it to be laid down. My view is that, the Triple Assessment was the more probable cause, being unexpected and much larger than the armorial bearings duty, which was fairly insignificant in terms of his income, which would explain the decision to lay down the carriage so soon after its purchase. This was followed in 1799–1800 by Pitt’s income tax, which was worse: £100 in addition to the £9 12s for the carriage, £4 9s for the horses, and the other assessed taxes. 57 MP ch 11. 58 D Selwyn, ‘Making a living’ in The Cambridge Companion to Jane Austen, above n 3, 149 says Darcy would have paid £400 for an ensigncy in a regiment of foot for Wickham, but that it could cost as much as £1,600 for entry into an elite cavalry regiment such as the Life Guards. 59 See below n 73 for the example of William Price’s promotion to second lieutenant on HM sloop Thrush through the patronage of Henry Crawford’s uncle, Admiral Crawford.

Tax and Taxability  133 The military were taxed by deduction at source under Schedule E as holding a public office60 which contained its own rule for deduction of expenses: In estimating the Duty payable for any such Office or Employment of Profit, or any Pension Annuity or Stipend, all official Deductions and Payments made upon the Receipt of the Salaries Fees Wages Perquisites and Profits thereof, or in passing the Accounts belonging to such Office, or upon the Receipt of such Pension Annuity or Stipend, shall be allowed to be deducted, provided a due Account thereof be rendered to the said Commissioners, and proved to their Satisfaction.61

The 1807 Guide gives an example of an officer of excise who was not allowed any deduction for keeping a horse, and the same would apply to the military.62 It was not until 1853 that such a deduction was introduced for Schedule E: In assessing the Duty chargeable under Schedule (E.) of this Act in respect of any public Office or Employment where the Person exercising the same is necessarily obliged to incur and defray out of the Expenses of travelling in the Performance of the Duties thereof, or of keeping and maintaining a Horse to enable him to perform the same …63

From then, only necessarily governed the cost of keeping a horse, presumably because wholly and exclusively could not be satisfied;64 it is strange that no such relaxation was made for Schedule D, but perhaps this was because the necessarily was imposed by a third party for Schedule E. Jane’s brother Henry, who has something of Wickham about him, was in the Oxford militia;65 she also socialised with Tom Chute of The Vyne, near Basingstoke (in her brother James’ parish) who was also in the militia, and there were militia officers stationed nearby in Basingstoke.66 The militia were separate from the army and were the principal reserve forces in the 60 1806, above n 40 s 152 Sch E Third: any Commissioned Officer serving on the Staff or belonging to His Majesty’s Army in any Regiment of Artillery Cavalry Infantry Royal Marines Royal Garrison Battalions or Corps of Engineers or Royal Artificers; any Officer in the Navy or in the Militia or Volunteers’. 1803, above n 1 s 175 was similar but included any Court Martial, and excluded Royal Artificers and Volunteers. This seems to have been construed strictly. The Guide, n 28, 166 gives as an example an army agent (who paid the officers and men and provided uniforms) appointed by the commander of the regiment and under the orders of the secretary of war not being a public officer but holding a private employment. 61 1806, above n 40 Sch E r 9. 62 Guide, above n 28, 164. The yeomanry (the cavalry component of the British Volunteer Corps, yeomen being one rank below a gentleman), and non-commissioned officers and privates in cavalry or artillery regiments were exempted from the assessed tax on horses used in the Service by (1803) 43 Geo 3 c 161), and they and officers of the Volunteer Corps and those providing a horse for the yeomanry or volunteer cavalry were exempted from the additional duty by (1805) 45 Geo 3 c 13 and (1808) 48 Geo 3 c 55. There was an earlier exemption in 37 Geo 3 c 106. 63 ITA 1853 s 51. 64 See text at n 135. 65 Henry was first an officer in the Oxford militia, then banker (whose bank failed and he became bankrupt), and then clergyman. Tomalin, above n 49, 166 describes Henry as someone who ­‘hesitates between possible brides and possible careers, and shows himself to be more agreeable than reliable.’ 66 ibid, 166 says that Eliza Chute entertained officers from the Basingstoke militia to dinner.

134  John Avery Jones e­ ighteenth century. At the time with which we are dealing the militia would have to deal with the expected invasion by Napoleon. The attraction of officers was mentioned in one of Jane’s early letters.67 ‘The officers of the – shire were in general a very creditable, gentlemanlike set.’68 Their uniforms69 attracted the likes of Kitty and Lydia Bennet (‘Mr Bingley’s large fortune … was worthless in their eyes when opposed to the regimentals of an ensign.’)70 Mr Weston had been a Captain in the militia, which he left when he went into trade after his first wife’s death. Jane Austen’s knowledge of the navy derived from two of her brothers being naval officers who finished their careers as Admiral of the Red71 Sir Francis Austen GCB, and Rear-admiral Charles Austen CB Commander-in-Chief of the East Indies and China Station. However, it needs to be understood that promotion above the rank of captain was automatic and based on seniority, so their ultimate ranks reflect that Francis lived to the age of 91 and Charles to 73.72 The navy was a traditional career for the younger sons of clergymen which they could start at the age of 12 or 13.73 Although Edward Ferrars said ‘[a]s for the navy, it had fashion on its side’,74 the navy’s superiority, which had been severely dented by losses against the far weaker American navy in 1812,75 gave way to the army after Waterloo.76

67 Faye, above n 8, Letter 6 (15–16 September 1796). 68 P&P ch 16. Also ‘there is nothing like your officers for captivating the ladies’ The Watsons Pt 1. 69 Regimentals is the better term for the period because they were not uniform but varied with the regiment. 70 The lowest rank of commissioned officer in infantry regiments; replaced in 1871 by second lieutenant. 71 Admiral of the red is Admiral of the Fleet, the highest rank. Below that were admirals of the white, and blue; then vice-admirals of the red, white and blue; then rear-admirals of the red, white (which was Admiral Croft’s then rank), and blue. 72 Navy, above n 3, 56–58. 73 ibid, 19–20, although both Francis and Charles went to the Royal Naval Academy becoming ‘College Volunteers’, rather than the normal route of joining a ship by arrangement with the captain as a ‘Captain’s Servant’ until taking the exams for lieutenant at age 20. Having either joined as College Volunteers or passed the exams, one needed to wait for a vacancy as a lieutenant on a particular ship when at the time (1812) there are almost 2,000 of them waiting, hence the importance of ‘interest’ (patronage) that Henry Crawford arranged for William Price’s promotion to lieutenant through his uncle Admiral Crawford, thereby hoping to ingratiate himself with Fanny (Navy, above n 3, 188). Crawford’s words ‘He is made. Your brother is a Lieutenant’ (MP ch 31) echo Jane’s words in a letter ‘Frank [her brother Francis] is made – He was yesterday raised to the Rank of Commander’ (Faye, above n 8, Letter 16). Francis suffered from lack of patronage throughout his career. The eldest son of a clergyman normally went into the church, which involved going to ­university and then waiting until age 24 before he could be ordained (see n 36). 74 S&S ch 19. 75 Navy, above n 3, 265–68. Both of Jane Austen’s brothers were involved in the war with America, Francis achieving a successful capture of an American ship: ibid, 268. The war with America is touched on in MP ch 12 ‘A strange business this in America.’ 76 A few years later, Mr Parker in Sanditon (1817) regretted calling his house Trafalgar House, ‘for Waterloo is more the thing now.’ However, Waterloo was in reserve for a Waterloo Crescent if further building was warranted. Sanditon ch 4.

Tax and Taxability  135 One can detect some much-needed propaganda on behalf of the navy in ­Persuasion with the hero, Wentworth, not from the landed classes, promoted for his service at the great victory of St Domingo (in which Francis Austen fought) and having made £25,000 by prize money, far more than the few hundreds that Jane Austen’s brothers made,77 eventually marrying the heroine Anne Elliot, the daughter of a baronet, who had broken off her engagement with him because of the mistaken persuasion of Lady Russell. And Louisa marries another naval officer, the poetry-loving Captain Benwick, ‘his prize-money as lieutenant being great.’78 Sir Walter’s objections to naval officers in general79 and hence to A ­ dmiral Croft,80 who had served at Trafalgar, as the prospective tenant of Kellynch Hall, were overcome. There does not appear to be a specific income tax exemption for prize money,81 which would be ‘other emoluments … in the course of executing such offices or employments’,82 but no reference to taxation has been found, possibly as tax was deducted at source along with other deductions, such as in some cases the costs of the prize court in valuing claims.

77 Francis received £200 in 1799–1800 for the capture of La Ligurienne, plus an unspecified sum at St Domingo in 1806; Charles received £30 and an expectation of £10 more in 1801 for the capture of Le Scipio (Faye, above n 8, Letter 38), but missed out in 1808 when he captured a French schooner laden with sugar which was later lost at sea (Navy, above n 3, 136). Navy, above n 3, 127 gives two exceptional examples of captains making prize money of £30,000 and £40,000. Francis received much more from the East India Company for escorting their ships: 200 guineas in 1808, 500 guineas in 1809, and £1,500 in 1810 (Navy, above n 3, 103). This was paid, with the approval of the navy (except between 1801 and 1808), to the Captain who might share it, and was presumably taxed under Sch D (Navy, above n 3, 132, 137). 78 P ch 11. 79 ‘First, as being the means of bringing persons of obscure birth into undue distinction, and ­raising men to honours which their fathers and grandfathers never dreamt of; and secondly, as it cuts up a man’s youth and vigour most horribly; a sailor grows old sooner than any other man; I have observed it all my life.’ P ch 3. (He mentions ‘Lord St Ives’ [a possible allusion to the naval Lord Exmouth had recently been ennobled], the son of a country curate; Lord Nelson was the son of a clergyman (Navy, above n 3, 275)). 80 Note also the propaganda for naval wives as she ‘asked more questions about the house, and terms, and taxes, than the admiral himself, and seemed more conversant with business.’ Note the allusion to prize money in ‘If a rich admiral were to come in our way … A prize indeed would Kellynch Hall be to him’ (P ch 3). Other ladies who were good with money include Lady Russell and Mrs Harville. 81 Bills [of exchange] and receipts for prize money were exempt from stamp duty by (1814) 54 Geo 3 c 93 s 51; but there was no exemption from customs duty on ships, goods, wares or merchandises taken as prize by (1793) 33 Geo 3 c 66 s 13, later (1805) 45 Geo 3 c 72 s 27. An example of the division of prize money is set out in Navy, above n 3, 129 showing reduced shares for the captain after 1808. 82 1806, above n 40 s 152 Sch E, Fourth: ‘The Perquisites to be assessed under this Act shall be deemed to be such Profits of Offices and Employments as arise from Fees, or other Emoluments, and payable either by the Crown or the Subjects, in the course of executing such Offices or Employments’.

136  John Avery Jones THE SCHEDULE D PROFESSIONS (CASE II)

The Law The tax on professions, vocations and employments under Schedule D was, as in the case of trades, ‘computed at a sum not less than the full amount83 of the balance of the Profits Gains and Emoluments of such Professions E ­ mployments or Vocations (after making such Deductions, and no other, as by this Act are allowed)’ but was on the preceding year basis, unlike trades which were taxed on a three-year average basis. The deductions allowed were different from trades, not having any provisions about repairs, losses, capital withdrawn or sums employed as capital, or capital employed in improvement of premises;84 but the wholly and exclusively rule applied both to trades and professions and also to employments:85 In estimating the Balance of the Profits or Gains to be charged according to either of the First or Second Cases, no Sum or Sums shall be set against or deducted from, or allowed to be set against or deducted from, such Profits or Gains for any Disbursements or Expences whatever, not being Money wholly and exclusively laid out or expended for the Purposes of such Trade Manufacture Adventure or Concern, or of such Profession Employment or Vocation; nor for any Disbursements or Expences of Maintenance of the Parties, their Families or Establishments; nor for Rent or Value of any Dwelling-house or domestic Offices, or any Part of such Dwelling-house or domestic Offices, except such Part thereof as may be used for the Purposes of such Trade or Concern, not exceeding the Proportion of the said Rent or Value herein-after mentioned;86 nor for any Sum expended in any other domestic or private Purposes, distinct from the Purposes of such Trade Manufacture Adventure or Concern, or of such ­Profession Employment or Vocation.87

These were applicable to both trades and professions, except that the proportion of rent of a dwelling house that was used for the purposes of trade did not apply to professions.88 It would be odd if anyone thought that the expenses of 83 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. 84 1806, above n 40 Sch D Case I r 3, see text at n 150. 85 The addition of necessarily for Sch E, then applicable to public offices and employments, was not made until ITA 1853 s 51. 86 s 194 gives the general commissioners power to determine the proportion, whose decision was final (1806, above n 40 s 112, Sch D Cases I and II rules, r 1). Previously the 1803 Act above n 1 was silent on such deductions, and the 1805 Act, above n 45 prohibited any deduction from rent of any part of a dwelling house ‘although used for the Purposes of such Trade or Concern’ (Sch D, Cases I and II). 87 Sch D Cases I and II, r 1 [paragraphing added for ease of reading]. This was new in 1805 (except for the deduction of a proportion of rent of a dwelling-house which was introduced in 1806). 88 See above n 51.

Tax and Taxability  137 ­ aintaining the professional’s family, or expenditure on private purposes, could m be deductible but these restrictions are included to prevent any argument: ‘it would seem at first view scarcely necessary to have provided against such deductions. But there is no arguing against opinions of interested persons but by the express letter of the act.’89 It appears that the wholly and exclusively rule was originally construed strictly, hence the specific allowance of a proportion of rent of a dwelling-house only, including the means for determining this. The 1807 Guide gives as an example that ‘the wages or board of a servant [in a trade] sometimes employed in domestic purposes or a part thereof cannot be deducted; but the wages and board of a book-keeper, etc wholly employed in trade, may’;90 and a further example relating to an apothecary will be given under the next heading. It adds that ‘no equitable construction can be admitted.’91 Later (although it is not possible to say when) the Revenue took a more lenient approach to apportioning expenditure, which became enshrined in the legislation for the first time in 2005 enabling the deduction of an identifiable part or proportion of an expense.92 Becoming a lawyer was extremely expensive. A barrister paid a stamp duty of £25 to be admitted as a member of an Inn of Court and £50 to be admitted as a barrister; and an attorney or solicitor paid a duty of £120 on articles of clerkship to be admitted in the Courts at Westminster, or £60 in other courts of record, and £25 on admission, and also an annual certificate of £6 if residing in London or £8 elsewhere (both £4 for the first three years).93 Another comment made by Edward Ferrars was ‘The law was allowed to be genteel enough; many young men, who had chambers in the Temple, made a very good appearance in the first circles, and drove about town in very knowing gigs.’94 No doubt this is the sort of lawyer that Mary Crawford had in mind

89 Guide, n 28, 38. 90 ibid, 38. 91 ibid, 39. 92 ITTOIA 2005 s 34(2). There was slight judicial support for this, see the Explanatory Notes at www.legislation.gov.uk/ukpga/2005/5/notes [161] to [163] referring to Lochgelly Iron and Coal Company Ltd v Crawford (1913) 6 TC 267 (where the Court of Session allowed a further proportion of a subscription to a trade association above the proportion that the Revenue had agreed), and Copeman v Flood (1941) 24 TC 53 (where Lawrence J remitted the case to the Commissioners to find what part of the directors’ fees paid to the founder’s son and daughter was deductible). 93 Stamp Act 1815 (55 Geo 3 c 184) sch (the attorney’s annual fee was previously £5 and £3 under (1785) 25 Geo 3 c 80). A member of an Inn, not being a barrister, who practised paid an annual certificate of £12 (London) or £8 (elsewhere). These figures should be compared with incomes of some of the characters in the novels in Appendix 2. 94 S&S ch 19. A gig was a light two-wheeled carriage pulled by one horse (duty £5 5s [£5.25] on the gig plus £2 on the horse (if only one horse owned) by (1802) 42 Geo 3 c 37 increased to £2 13s 6d [£2.675] by (1808) 48 Geo 3 c 55), see E Ratcliffe, ‘Early Horse Drawn Transport’ at www. kevinstatham.co.uk/history/horsetransport/index.htm, which contains pictures of all carriages in Jane’s time. ‘Very knowing’ uses the obsolete sense of ‘fashionable, especially in matters of dress; stylish, smart, chic’ (meaning 4b in the OED, which quotes this sentence and also John Thorpe’s and James Morland’s arrival in Bath in a ‘gig, driven … by a most knowing-looking coachman’ NA ch 7). Other drivers of gigs are Collins, Admiral Croft, and Sir Edward Denham.

138  John Avery Jones for Edmund Bertram rather than his becoming a clergyman. The law provided another opportunity for younger sons of the landed class, like John Knightley, the younger brother of Mr Knightley married to Emma’s older sister Isabella, who must be a London barrister ‘rising in his profession’,95 as he often had to be in London on fixed dates, at least some of which correspond to the then legal terms,96 and at one point documents are delivered to his chambers.97 ‘Mr John Knightley’s being a lawyer is very inconvenient’,98 said Mr Woodhouse of the absence of his visits. He is not the sort of lawyer who moves in the first circles and drives around in a knowing gig, but one who gets on with the law and, if he appears to be bad-tempered when dining at Randalls, this may be because he prefers to stay at home in the evening. Another opening for barristers was to go into politics.99 Mr Shepherd ‘a civil, cautious lawyer’,100 presumably an attorney,101 who is one of two confidential friends of Sir Walter Elliot, steers Sir Walter into letting 95 E vol 1 ch 11. 96 Emma’s wedding was fixed for October as John had to be in London by the end of the first week in November, which corresponds to the then dates of Michaelmas Term. The dates in E are based on 1813–14; she started to write it in January 1814 (J Modert, ‘Chronology within the Novels’ in David Grey (ed) The Jane Austen Handbook (London, Athlone Press, 1986) 57). Michaelmas Term began on Tuesday 6 November 1814, see (1750) 24 Geo 2 c 48 and Sir N Harris, The Chronology of History (London, Longman, 1833) 339–45, available at https://books.google.co.uk/books?id = VFQuAAAAYAAJ. (The then dates of Michaelmas Term incidentally explain the opening of Bleak House – ‘Michaelmas Term lately over … Implacable November weather’ – by which time the term was fixed by 1 Will 4 c.70 as 2 to 25 November.) The other dates when John had to be in London do not correspond to legal terms: ‘it is so long since she [Isabella] was here [Hartfield] – not since last Easter, and then only for a few days – Mr John Knightley’s being a lawyer is very inconvenient’ [the Easter Term began 17 days after Easter]; and later ‘she is coming for only one week … Mr John Knightley must be in town again on the 28th [December 1813].’ Hilary Term did not start until 23 January 1814, so having to be in town on 28 December was unrelated. Christmas Day 1813 would have been a Saturday (Emma avoided Mr Elton both on Christmas Day and on a Sunday after the episode in the carriage and before John left: E vol 1 ch 16), so he must have left on Monday 27 December 1813 (with five children, a ‘competent number of nursery-maids’ (E vol 1 ch11) and two carriages, with a change of horses) in order to be in Chambers on 28 December. He also came down to Hartfield in August [1813], which would be in the long vacation. 97 E vol 3, ch 18. As his brother, a magistrate, consults him on points of law (col 1 ch 12) he presumably practised criminal law. Although ‘chambers’ might be used more widely than for barristers, see the quotation at the beginning of this paragraph about ‘chambers in the Temple’. Mr Elliot, the heir to Sir Walter Elliot, also ‘had chambers in the Temple, and it was as much as he could do to support the appearance of a gentleman. (P ch 21). 98 E vol 1 ch 9. 99 One in four MPs (including Addington) were then barristers (Southam, Professions, above n 3, 371). Mary Crawford suggests Parliament for Edmund after failing to convince him to go into the law. 100 P ch 2. 101 Before the Judicature Act 1873 attorneys practised in the common law courts, solicitors in the Court of Chancery (see the reference to a solicitor later in this paragraph; another literary example is Mr Tulkinghorn in Dickens’ Bleak House), and proctors in the ecclesiastical courts (‘he is a sort of monkish attorney’, replied Steerforth. ‘He is, to some faded courts held in the Doctors’ Commons – a lazy old nook near St. Paul’s Churchyard – what solicitors are to the courts of law and equity’ (David Copperfield)). This distinction is misunderstood by Drum, above n 3, who regards attorneys as quasi-legal assistants, and also by Southam in Professions, above n 3, 370 who equates solicitors with attorneys. Attorneys qualified by five-years articles for which a premium was paid, followed

Tax and Taxability  139 Kellynch Hall and smoothes over the difficulties that he is making about the tenant having use of the pleasure grounds: ‘In all these cases there are established legal usages which make everything plain and easy between landlord and tenant’,102 a proposition that seems unlikely. His worst failing is verbosity.103 Other lawyers fare less well, such as Mrs Bennet’s brother-in-law ‘stuffy uncle Phillips, breathing port wine’,104 who is one of the reasons Darcy initially looked down on the Bennet girls;105 and Mr Coxe, ‘a pert young lawyer’,106 whom Emma did not consider suitable as a husband for Harriet.107 The list of subscribers to the Sanditon library, described as being ‘without distinction’, included ‘Mr  Beard – Solicitor, Grays Inn’.108 Even far later, in 1890, Lady Warwick, probably with country practitioners in mind, said that ‘Doctors and solicitors might be invited to garden parties, though never, of course, to lunch or dinner.’109 by a cursory examination by a judge (Professions, above n 3, 371). Since Mr Shepherd met Admiral Croft when attending Quarter Sessions in Taunton (P ch 3), the jurisdiction of which was mainly criminal, this suggests that he was an attorney, but since he was involved with drawing up leases, presumably attorneys dealt with a wider range of non-contentious business. By Stamp Act 1804 (44 Geo 4 c 98) s 14 (currently Legal Services Act 2007 s 12; sch 2 para 5) lawyers were given a monopoly of preparing any conveyance or deed relating to real or personal property for reward. The lease of Kellynch Hall was under seal (‘This indenture sheweth’ (P ch 5)) although, being before Transfer of Property Act 1844 s 4 and Real Property Act 1845 s 3, it need not have been (Treitel, above n 3, 575). 102 P ch 3. 103 As in: ‘I presume to observe, Sir Walter, that, in the way of business, gentlemen of the navy are well to deal with. I have had a little knowledge of their methods of doing business; and I am free to confess that they have very liberal notions, and are as likely to make desirable tenants as any set of people one should meet with. Therefore, Sir Walter, what I would take leave to suggest is, that if in consequence of any rumours getting abroad of your intention; which must be contemplated as a possible thing, because we know how difficult it is to keep the actions and designs of one part of the world from the notice and curiosity of the other; consequence has its tax [not a reference to income tax but a figurative use in the sense of something burdensome]; I, John Shepherd, might conceal any family-matters that I chose, for nobody would think it worth their while to observe me; but Sir Walter Elliot has eyes upon him which it may be very difficult to elude; and therefore, thus much I venture upon, that it will not greatly surprise me if, with all our caution, some rumour of the truth should get abroad; in the supposition of which, as I was going to observe, since applications will unquestionably follow, I should think any from our wealthy naval commanders particularly worth attending to; and beg leave to add, that two hours will bring me over at any time, to save you the trouble of replying.’ (P ch 3). 104 P&P ch 14. 105 See below n 165. 106 E vol 1 ch 16. Emma’s reply to Harriet asking how the Coxes looked was ‘Just as they always do – very vulgar’ (E vol 2 ch 9). 107 Other lawyers are Mrs Elton’s uncle who was ‘in the law line’ in Bristol, whom Emma guessed to be the ‘drudge of some attorney, and too stupid to rise’; Mrs Bennet’s father was an attorney in Meryton; John and Isabella Thorp’s father was a lawyer living in Putney; Robert Watson in The Watsons was an attorney in Croydon in a good way of business having married the only ­daughter of the attorney to whom he had been clerk; and also Mrs Clay’s father, and Wickham’s father. Those who tried the law and gave up include Wickham and William Elliot. 108 Sanditon ch 6. 109 Quoted by Digby, n 3, 37 (by then, solicitors practised in all courts, see n 101). Cf Lady ­Bracknell’s approval of Miss Cardew’s family solicitors, Markby, Markby and Markby: ‘I am told that one of the Mr. Markby’s is occasionally to be seen at dinner parties’ in Oscar Wilde’s The Importance

140  John Avery Jones Medicine It is when describing medical men that Jane Austen seems to be weakest about professions, which may reflect that medical men were described as ‘members of a profession yet in the making’.110 Even the divisions within the profession were then unclear; an incomplete111 register of 1783 shows that 10 per cent of the profession were physicians (with a university education), and more than 80 per cent were surgeon-apothecaries, with the rest either solely surgeons or solely apothecaries (all of whom were trained only by apprenticeship),112 but whether surgeon or apothecary, they probably all had a similar practice. The distinction that physicians prescribed medicines, and apothecaries dispensed, had largely broken down by 1800, with apothecaries engaging in a profession rather than trade, and drugs being sold by chemists and druggists (a trade).113 The Apothecaries Act 1815114 required a five-year apprenticeship, attendance at courses, and an examination for apothecaries (but did not extend to affect the trade or business of a chemist and druggist), and made it an offence to practise without a certificate.115 At that time apothecaries were entitled to charge for medicines but not for advice or visits, which may have been the case in London where the Royal College of Physicians could enforce the law, but it seems unlikely to have been the case in the country.116 This did not change until

of Being Earnest (1894). Mr John Knightley’s put-down to Mr Elton ‘I know nothing of the large parties of London, sir – I never dine with any body’ (E vol 1, ch 13), which is usually taken as demonstrating his unsociability, could be because nobody invited lawyers to dinner. 110 Digby, above n 3, 108, citing I Inkster, ‘Marginal Men Aspects of the Social Role of the ­Medical Community in Sheffield, 1790–1850’ in J Woodward and D Richards (eds), Health Care and Popular Medicine in Nineteenth-Century England (London, Croom Helm, 1977). Jane was a near contemporary of Edward Jenner, the pioneer of smallpox vaccination, who is mentioned in one of her letters (Faye, above n 8, Letter 27). The first use of chloroform as an anaesthetic was not until 30 years after her death. 111 The first complete one is the census of 1841. 112 Digby, above n 3, 13. Relevantly to Jane, physicians congregated in fashionable place like Bath, where in 1800 there was a ratio of 1 physician to 1.7 surgeons and apothecaries (Digby 188), compared to the 1:10 ratio in the country as a whole. 113 See C Stebbings, ‘Tax and Pharmacy’ in P Harris and D de Cogan (eds), Studies in the History of Tax Law, vol 7 (Oxford, Hart Publishing, 2015) 153. The Medicines Stamp Duty Acts 1783 and 1785 required a licence for the sale of quack medicines but let off (initially) qualified practitioners (including chemists and druggists), and (subsequently) genuine medicines if sold by qualified practitioners. 114 55 Geo 3 c 194. 115 A literary connection is that an early holder of a licence (1816) was John Keats who had been apprenticed to a surgeon-apothecary from 1810 to 1815 and continued his training at Guy’s ­Hospital. He gave up medicine for writing shortly after. Naval surgeons with a certificate from the Royal College of Surgeons (see below n 122) also had to comply with the Act before they could prescribe and dispense drugs, until they were exempted by the Apothecaries (England) Act 1825 s 4. 116 Surely Mr Perry would not have visited Emma four times a day for a week when she had measles (E vol 2 ch 11) if he could not charge for visits. In all four cases during the time period of E Mr Perry is recorded as visiting his patients.

Tax and Taxability  141 those registered under the Medical Act 1858 were permitted to make ‘reasonable charges for professional aid, advice and visits’.117 Surgeons, who were formerly barber-surgeons,118 had lower status than physicians, which is why to this day they are addressed as ‘Mr’ rather than ‘Dr’.119 Only Tom Bertram, the eldest son, and General Tilney’s wife, merited a physician when they were seriously ill.120 After Louisa’s fall on the Cobb, causing concussion, the cry was for ‘a surgeon this instant’, but we are never told his name and he is not referred to again during her recovery; another reference to surgeons is to Mr Campbell, ‘a very well behaved young man’,121 the surgeon of the Thrush, William Price’s ship – the type of medical professional one would expect on a ship in the Napoleonic wars.122 But more normally the medical practitioner was an apothecary, of which the prime example is Mr123 Perry, Mr Woodhouse’s apothecary, ‘an intelligent, gentlemanlike man’. He must have been successful, as he considered buying a carriage, suggesting

117 S 31. 118 In London the surgeons separated from the Company of Barber-Surgeons in 1745, see n 122 (which is not to suggest that before then all surgeons did shaving – not haircutting, as gentlemen wore wigs, because practical separation between barbers and surgeons had started in the 16th century), becoming incorporated separately by Act of Parliament. In 1800 they were granted a Royal Charter to become the Royal College of Surgeons in London (and in 1843 became the present Royal College of Surgeons of England). Thus London surgeons had just received Royal recognition at the time with which are concerned. 119 It was said of Mary Edwards, who will inherit at least £10,000, ‘Her father and mother would never consent to it [marriage]. Sam is only a surgeon, you know.’ The Watsons Pt 1. See also the text at n 109. If The Watsons had been completed Sam seems likely to have lost out to the military (Captain Hunter). When commenting on a draft of a novel that her niece Anna (James’s daughter) was writing, Jane said ‘I have also scratched out the Introduction between Lord P. & his Brother & Mr Griffin. A country Surgeon … would not be introduced to Men of their rank.’ (Faye, above n 8, Letter 104). 120 A physician attended General Tilney’s wife before she died and ‘upon his opinion of her danger, two others were called in the next day’ (NA ch 24). Miss Lambe, the wealthy West Indian in delicate health in Sanditon, was ‘under the constant care of an experienced physician’ (Sanditon ch 11). A physician was called at the apothecary’s request when Jane’s father was dying (Faye, above n 8, Letter 40). 121 MP ch 38. 122 Under a Charter of Charles I the Company of Barber-Surgeons examined and approved surgeons for naval ships and inspected their chests and instruments, without which the ship could not leave an English port. On the separation of the surgeons from that Company by (1745) 18 Geo 2 c 15 the current examiners continued as examiners of surgeons for the Company of Surgeons (see n 118 for that body becoming the Royal College of Surgeons) who continued to issue Certificates until 1843. A humorous description of the (superficial) examination, during most of which the examiners disagreed with each other, is given in T Smollett, The Adventures of Roderick Random, ch 17 (1748) (Smollett himself took the examination in 1739 and his examiners have been identified (see J Dobson, ‘Smollett the Surgeon’, (1957) 11 Annals of the Royal College of Surgeons 260–64), so there may be a grain of truth in the description in the novel). A certificate, which did not entitle the holder to practise outside the forces, was a lower qualification than the diploma, holders of which became members of the College (MRCS). 123 See text at n 118. ‘Dr’ was used by physicians, but in her novels usually indicated a cleric like Dr Grant (MP) or Dr Shirley (P). She uses ‘The Rev’ when referring to clergy on only two occasions.

142  John Avery Jones that his income (no doubt much of which was derived from the valetudinarian124 Mr ­Woodhouse) was between £600 and £700 pa, which puts him almost in the top range of income of pseudo-gentry.125 A perspicacious reported remark of his is that Jane Fairfax’s nervous disorder was being made worse by being confined to one room in her aunt’s home.126 Another apothecary was Mr Harris who attended to Marianne, whose medicines had initially failed but ‘he had still something more to try’,127 this time successfully.128 For most of her other medical characters we know little more than their names. The unclear divisions of the profession are amply demonstrated by Mr Parker wanting a surgeon to reside in Sanditon, as part of his promotion of the seaside resort,129 although one of his sisters,130 who is helping to find one, was looking for an apothecary, and Lady Denham, the other main promoter of the resort, did not want a doctor: ‘I beseech you Mr Parker, no doctors here.’131 Socially, it is likely that the younger sons of the landed gentry took part in medicine only as physicians. Addington’s father was the Earl of Chatham’s (Pitt the Elder’s) physician – and therefore in the top echelons of the profession132 – which

124 The term used to describe Mr Woodhouse in E vol 1, ch 1. 125 Copeland, above n 3, does not deal with the income of surgeon-apothecaries, but it has been estimated that average earnings in mid-career would be £400 (Digby, above n 3, 136), demonstrating that Mr Perry was doing particularly well. A book in 1815 estimated that the average income of the medical profession was £200 pa, and the legal profession was £300 (Digby, above n 3, 164); JG Williamson, ‘The Structure of Pay in Britain’ 7(1) Research in Economic History 48 gives ­average earnings in 1815 for clergymen as £272.53, doctors £217.6 and lawyers £447.5. Hume, n 3, 290 quotes sources that a reasonable income for a clergyman in 1810 was £150. 126 E vol 3 ch 9, thus demonstrating his understanding of psychology, as Wiltshire, n 3, points out at 308. 127 S&S ch 43. We are told very little about what medicines were prescribed by apothecaries, although Mrs Norris’s folk remedies are mentioned. One should regard the treatment of the hypochondriac Susan Parker in Sanditon ch 5 (‘six leaches a day for ten days … had three teeth drawn, and is decidedly better’) with a large pinch of salt. Although written when Jane must have known she was dying, she retained her sense of humour on medical matters to the end. In her last illness she took a house in Winchester ‘where there is a Hospital & Capital Surgeons’ and was attended by Mr Lyford (Faye, above n 8, Letter 159). 128 Other apothecaries are Mr Robinson who attended to the Musgrove’s boy with a dislocated collar-bone, Mr Jones who attended to Jane Bennet’s ‘violent cold’, although Bingley’s sisters suggest that one of the most eminent physicians from town be sent for (P&P ch 7), and Mr  ­Wingfield, Isabella’s (who shared some of her father’s health obsessions) apothecary (the Mr indicates that he was not a physician) who provided ‘an excellent embrocation’, about whom and Mr Perry, she and Mr Woodhouse spend most of a chapter comparing notes (E vol 1, ch 12). 129 Sanditon ch 2. 130 Who had ‘consulted physician after physician in vain’ (Sanditon ch 5). 131 Sanditon ch 5 and 6. Lady Denham’s real reason was that ‘It would be only encouraging our servants and the poor to fancy themselves ill if there was a doctor at hand.’ 132 P Ziegler, Addington (London, Collins, 1965) 16 notes that Dr Addington FRCP was a Censor (senior examiner) of the College. (The Censors’ room, a 17th-century oak panelled room, can still be seen in its third home, the College’s modern premises in Regents Park.) He delivered the G ­ oulstonian Lecture (established 1639, and still being delivered) in 1757, an honour given to one of the younger fellows.

Tax and Taxability  143 is how Addington knew Pitt the Younger as a boy.133 Addington was accordingly nicknamed ‘the doctor’ in Parliament, a reminder that he was not an aristocrat like Pitt. It seems surprising to us that, in the words of his biographer, Philip Ziegler, ‘There was the freakish fact that for a Prime Minister to be a doctor’s son was considered not only socially distressing but irrepressibly c­omical as well’; and ‘[the nickname “the Doctor”] stuck to him for the rest of his life and the constant ridicule which the concept provoked did much to destroy his reputation as a serious statesman.’134 So far as tax is concerned, the position of Schedule D professions has been dealt with above in connection with the legal profession. The 1807 Guide contains a medical example prohibiting the deduction by an apothecary of the cost of keeping a horse, as the horse would not be wholly and exclusively expended for the purpose of his profession, even though he would not have kept a horse apart from his profession.135 This seems rather harsh, and is in contrast with the position under the Triple Assessment, where physicians, surgeons, apothecaries and midwives had been charged at only a single, rather than triple, assessment so long as they did not keep more than one carriage or two horses.136 Mr Perry would have been affected since his horse is mentioned: ‘Mr Perry passed by on horseback. The gentlemen spoke of his horse’ (one presumes with approval).137 A physician paid a stamp duty of £15 to be admitted as a licentiate, and £25 as a fellow, of the College of Physicians.138 I have not found any reference in primary legislation relating to duty on apothecaries.139 TRADE (CASE I)

We deal with trade after the professions, as Jane Austen would surely have done. ‘Trade’ is a long-standing term. The Oxford English Dictionary gives a

133 Ziegler, ibid, 31 says ‘By this time [1777] Dr Addington was as nearly a friend of the [Earl of Chatham’s] family as the conventions of the age and his own cautiously subservient nature would allow him … Dr Addington visited the household almost every day and would often bring his wife and children with him;’ and that ‘Though Pitt was later to describe himself and Addington as “friends from their childhood”, the two boys in fact do not seem to have made much of each other.’ 134 ibid, 111. 135 Guide, above n 28, 165. 136 Triple Assessment, above n 8, s 16; in spite of its name there was a progressive scale which rose to a quintuple assessment. 1799 was also silent on such deductions. There was no exemption for the medical profession from the duty on horses by (1803) 43 Geo 3 c 161 and the increases by (1805) 45 Geo 3 c 13 and (1808) 48 Geo 3 c 55, as there was for clergymen with an income under £60 (see n 55). 137 E vol 3 ch 5. 138 Stamp Act 1815, 55 Geo 3 c 184, sch. 139 Sydney Smith’s famous 1820 article in the Edinburgh Review, quoted by Jane Frecknall-Hughes in ch 1 of this book, sets out the taxes payable throughout life, starting with ‘The schoolboy whips

144  John Avery Jones first use in the current sense in 1525140 and there is a statutory example from 1543: Since the making of which Act141 the Trade and Adventure to Ireland hath much decayed …142

Addington’s Act charged under Schedule D ‘the annual Profits or Gains … from any Profession, Trade, or Vocation’, with Case I taxing the profits of any trade or manufacture,143 suggesting that manufacture was not within the term ‘trade’,144 on the basis of the average profits of the three accounting years ending in the preceding tax year,145 compared to Case II taxing ‘profits, gains, and emoluments of such professions, employments,146 or vocations’ on a preceding year basis.147 We have already dealt with the prohibition on deductions that applied to both trades and professions, including the wholly and exclusively rule and the permitted deduction for rent of part of a dwelling-house used for the purposes

his taxed top’ and ends ‘and expires in the arms of an apothecary who has paid a license of a hundred pounds for the privilege of putting him to death.’ 140 ‘In early use: any regular occupation, profession, or business, esp. when undertaken as a means of making one’s living or earning money. In later use usually: an occupation involving manual labour or the buying and selling of goods, e.g. that of a craftsman or shopkeeper, as distinct from a learned profession; spec. a skilled manual occupation, esp. one requiring an apprenticeship or other training, as that of a builder, plumber, electrician, etc.’ 141 (1533) 25 Hen 8 c 4 an Act against Forestalling and Regrating of Fish, which provided ‘That no manner of Person or Persons should from thenceforth be reputed and taken to be a Merchant Venturer, to take Advantage or Benefit of the same Act, except his Adventure in the said Ship or Ships to Ireland should amount to the Sum of xx. li. without Fraud or Covin, as by the same Act more plainly doth appear.’ Forestalling (buying-up goods before they reached the market, and re-selling in the market, thus driving up the price) and regrating (buying and re-selling in the same market at a higher price) were common law offences. 142 (1543) 35 Hen 8 c 7. 143 1805, above n 45 (s 93 Sch D Case I) added ‘adventure or concern in the nature of trade’ (and in ITA 1918 s 237 trade was defined to include ‘every trade, manufacture, adventure or concern in the nature of trade’). 144 But see below n 160. 145 1803, above n 1 s 84; 1805, above n 45 s 93; 1806, above n 40 s 112 (all Case I r 1). During the first three years the average for the lesser period were taken; and for the year in which the trade commenced an average for less than a year could be directed by the Commissioners (the Case VI rule applied by reference by Case I r 1). No doubt Case I came first because of the far greater yield than Case II, in spite of professions being mentioned before trades in the Act. Addington estimated the tax yield from trade as £625,000 and from salaries and professions as £200,000 in his budget speech introducing income tax: Parliamentary Register 1802–05, 13 June 1803, 572. 146 Employments other than public employments remained taxable under Sch D Case II until FA 1922 s 18, although a few differences from taxing professions existed eg taxing weekly wage earners on a current year basis from F(No2)A 1915 s 28. It is fair to say that in practice, more employments were taxed under Sch E than Great Western Railway v Bater [1922] 2 AC 1 (1922) 8 TC 231 decided should have been. Lord Sterndale MR said ([1921] 2 KB 128, 135; 236 (TC)) in the Court of Appeal ‘I think what is true is that the word ‘public’ has been interpreted in a very much more liberal sense than at first would perhaps seem to be its meaning …’ See John Pearce, ‘Great Western Railway Co v Bater (1922) A Question of Classification’ in J Snape and D de Cogan (eds), Landmark Cases in Revenue Law (Oxford, Hart Publishing, 2019) 119. 147 1803, above n 1 s 84; 1805, above n 45 s 93; 1806, above n 40 s 112. Pitt’s pension, allowance, stipend are not repeated.

Tax and Taxability  145 of the trade,148 but trades were subject to a list of further prohibited deductions. These differences require distinguishing between trades and professions etc.149 The prohibited deductions applying to trades were:150 3rd. In estimating the Balance of Profits and Gains chargeable under Schedule (D.) or for the Purpose of assessing the Duty thereon, no Sum or Sums shall be set against or deducted from, or allowed to be set against or deducted from, such Profits or Gains, on Account of any Sums expended for Repairs of Premises occupied for the Purpose of such Trade Manufacture Adventure or Concern nor for any Sum expended by them for the Supply or Repairs or Alterations of any Implements or Utensils or Articles employed for the Purpose of such Trade Manufacture Adventure or Concern, beyond the Sum usually expended for such Purposes according to an Average of Three Years preceding the Year in which such Assessment shall be made;

The deduction for repairs and alterations on a three-year average basis corresponds with the basis for computing profits; it seems that the word usually in ‘usually expended’ was given no meaning.151 nor on Account of Loss not connected with or arising out of such Trade Manufacture Adventure or Concern; nor on Account of any Capital withdrawn therefrom;

The 1807 Guide explains that the purpose of the reference to capital is to demonstrate that partnership accounts, which show a partner’s capital being repaid, cannot be used for tax purposes.152 Pollard explains that partnerships often used a balance sheet method showing that the profit was the difference between the balance sheets at the end and beginning of the year.153 This resulted in widely fluctuating ‘capital’, and capital repayments which were effectively distributions of profits. nor for any Sums employed or intended to be employed as Capital in such Trade Manufacture Adventure or Concern; nor for any Capital employed in Improvement of Premises occupied for the Purposes of such Trade Manufacture Adventure or Concern;

148 See above n 87. 149 See IRC v Maxse (1919) 12 TC 41 where the Court of Appeal differentiated between the profession of journalist and author from that of publisher of a magazine carried on by the same person, discussed by Emer Hunt in ch 11 of this book. 150 1806, above n 40 s 112 (Sch D Case I r 3) [paragraphing added in order to insert comments]. These were new in 1805, above n 45 s 93 (Sch D Case I r 4). 151 Guide, above n 28, 33 (n 37) says that it is not intended that the minimum in each of the three years, which would be the amount usually expended, should be used. Usually was changed to actually by FA 1926 Sch 4. The later wording does not require the expenditure to be paid rather than incurred: Jenners Princes Street Edinburgh v IRC [1998] STC (SCD) 196. 152 Guide, above n 28, 37: ‘This is evidently not the account which the act requires, for one side must necessarily contain the same capital repeatedly employed. The other side must as necessarily contain various expenses which cannot under the act be set off. The act therefore provides, that if any capital be withdrawn, the diminution of the capital shall not diminish the profit.’ 153 S Pollard, ‘Capital Accounting in the Industrial Revolution’ (1963) 15(2) Bulletin of Economic Research 75, 82–83.

146  John Avery Jones At the time, ‘any additions and improvements to the capital equipment were normally entered in the current accounts’.154 He mentions that even railway companies, which were then the largest companies, could not distinguish between capital and revenue until well into the second half of the nineteenth century.155 nor on Account or under Pretence of any Interest which might have been made on such Sums if laid out at Interest;

Pollard explains in relation to cost accounting that ‘there is much evidence to show that “profits” in common parlance were often understood to be the surplus after interest was paid’,156 including even interest on partners’ capital. The Guide describes such a deduction for tax purposes as deceitful.157 nor for any Debts, except such Debts, or such Parts thereof as shall be proved to the Satisfaction of the Commissioners respectively, to be irrecoverable and desperate; nor for any Average Loss beyond the actual Amount of Loss after Adjustment; nor for any Sum recoverable under an Insurance or Contract of Indemnity. 4th. In estimating the Amount of the Profits and Gains arising as aforesaid, no Deduction shall be made on Account of any annual Interest, or any Annuity or other annual Payment payable out of such Profits or Gains, except the Interest of Debts due to Foreigners not resident in Great Britain, or in any other of His Majesty’s Dominions.

The reason for the last item is, of course, that relief for annual interest was obtained by deducting and retaining the tax thereon, except for interest paid to non-residents where deduction of tax did not apply.158

154 ibid, 85. A deduction for depreciation was still being argued about in the first reported tax case, Addie & Sons (1875) 1 TC 1. 155 ibid, 79. 156 ibid, 80. 157 Guide, above n 28, 37 explains this item: ‘The third is scarcely intelligible but to those who have practised the deceit. In the construction of the word profit it has been warily, but I say fraudulently, considered that nothing is profit arising from the trade, but the excess above the legal interest [under the usury laws, then 5% by Usury Act 1713 (13 Ann c16)], and therefore the first deduction that such men have made is a deduction of 5 per cent. on the whole of the capital employed. So barefaced and base a practice has been pursued, and still is pursued when the commissioners are inactive; the act expressly restrains it, with a view to bringing the subject to the notice of the commissioners and of enabling then to rectify the abuse.’ This barefaced practice has, in the corporate field, since achieved academic respectability (see R Broadway and N Bruce, ‘A General Proposition on the Design of a Neutral Business Tax’ 24 Journal of Public Economics 231–39; IFS Capital Taxes Group, Equity for Companies: A Corporation Tax for the 1990s (London, IFS, 1991); Dimensions of Tax Design: the Mirrlees Review (Oxford, Oxford University Press, 2010) 877, 973–89) under the name of ACE [allowance for corporate equity], and is currently in use in the corporate tax systems of Belgium and Italy. 158 Deduction of tax did not apply where the interest was charged on any property or security outside GB: 1806, above n 40 s 114. See JF Avery Jones, ‘The Sources of Addington’s Income Tax’, and R Thomas, ‘Retention of Tax at Source and Business Financing’ in P Harris and D de Cogan (eds), Studies in the History of Tax Law vol 7 (Oxford, Hart Publishing, 2015) 1, 25 and 33.

Tax and Taxability  147 Although, as is the case of the rules applicable to both trades and professions, the Guide says that these were included to prevent arguments, it seems that the state of accounting practice at the time made them necessary. The use of trade was therefore a natural starting point for taxing profits and is a suitably wide concept. As Lord Wilberforce said in Ransom v Higgs:159 Trade has for centuries been, and still is, part of the national way of life; everyone is supposed to know what ‘trade’ means … ‘Trade’ cannot be precisely defined, but certain characteristics can be identified which trade normally has. Equally some indicia can be found which prevent a profit from being regarded as the profit of the trade  … Trade involves, normally, the exchange of goods, or of services, for reward … there must be something which the trade offers to provide by way of business. Trade, moreover, presupposes a customer (to this too there may be exceptions, but such is the norm), or, as it may be expressed, trade must be b ­ ilateral – you must trade with someone …

This quotation includes the provision of services, although there are earlier suggestions, admittedly made in a case concerning goods, that trade is restricted to goods.160 However the omission of services (other than professional services) was clearly never intended, and from the beginning both banking and insurance services were covered, although later these were described as businesses.161 Jane Austen covers trades in far less detail than professions. As most trade took place in cities, her experience was limited to the two extremes: the top (like Bingley) and bottom ends (like the local shopkeepers). She (through her characters) was far from prejudiced against trade as such; either those who had made money in trade were sympathetically treated (Bingley, the Coles, Gardiner, Mr  Weston)162 or, if initially prejudiced, they changed their minds (Darcy, Emma); others who remain prejudiced (Lady Catherine and Bingley’s sisters) provide the contrast.163 Darcy begins by pointing out that the Bennet sisters’ connection with an uncle (Gardiner) who lives near Cheapside164 and another

159 Ransom v Higgs [1974] STC 539, 554. 160 ‘Trade in its largest sense is the business of selling, with a view to profit, goods which the trader has either manufactured or himself purchased.’ Grainger v Gough (1896) 3 TC 462, 474 per Lord Davey. 161 See text at nn 182, 183. 162 Mr Weston made enough money in trade to purchase a little estate adjoining Highbury and to marry Miss Taylor (Emma’s governess). Mrs Bennet had a brother (Gardiner) settled in London ‘in a respectable line of trade.’ 163 I therefore have reservations about the statement in Ellis, above n 3, 416 that ‘characters in Austen express a profound distaste for trade’. 164 In fact in Gracechurch Street. P Honan, Jane Austen: Her Life (London, Fawcett Books, 1992) 314 suggests that Cheapside was full of warehouses, but a contemporary Ackermann print of 1812 shows a busy shopping street with this description: ‘The intermediate houses between Millard’s and the corner of St Paul’s Churchyard as exhibited in our view are occupied by Messrs Shapland, hosier; Brown, gold and silversmith; Giesler, furrier; Stark and Son, patent retiring stove and grate manufactures; Bunn, silk mercer; Hawkins, trunk maker; Seabrook of the same profession and two or three others. In the back ground at the one corner of Paternoster-row appears Butler’s newly erected patent medicine warehouse adorned with a neat balcony and stone balustrade at the top; and at the

148  John Avery Jones uncle who is a country attorney (Philips) ‘must materially lessen their chance of marrying men of any consideration in the world’,165 later confesses to himself ‘that were it not for the inferiority of her [Elizabeth’s] connections, he should be in some danger’,166 and finally ends up marrying her. And he associates with Bingley, whose very considerable inherited money (£100,000 which in the Funds would bring in an income of half as much as Darcy’s) was ‘acquired by trade’ in the north of England. After marrying Jane, Bingley acquires an estate in the neighbouring county to Derbyshire (where Darcy’s seat is) and their eldest son will be landed gentry. Even Emma, who has more faults, hopefully to be cured by Mr Knightley,167 than the other heroines, starts by regarding the Coles, in spite of their being ‘friendly, liberal, and unpretending’, as being ‘of low origin, in trade, and only moderately genteel’, but ends delightfully, after discovering that everyone else is going to their dinner party, without being seen to display too much enthusiasm, that ‘she owned that, considering every thing, she was not absolutely without inclination for the party’.168 Sir William Lucas was formerly in trade in Meryton ‘where he had made a tolerable fortune, and risen to the honour of knighthood by an address to the king during his mayoralty’. Somewhat lower in rank is Mrs Elton, the daughter of a Bristol ‘merchant, of course he must be called’ (to avoid using the word trade169), but Emma’s dislike of Mrs Elton, with which readers will sympathise, has nothing to do with her

other corner Dunnetts long-established Tunbridgeware and toy shop, the recollection of which we do not doubt calls forth agreeable associations in the minds of many of our metropolitan readers.’ It is suggested that Darcy’s objection was merely its association with trade. See https://austenonly. com/2010/05/06/jane-austen-and-london-if-they-had-uncles-enough-to-fill-all-cheapside-it-wouldnot-make-them-one-jot-less-agreeable/. 165 ‘To this speech Bingley made no answer; but his sisters gave it their hearty assent, and indulged their mirth for some time at the expense of their dear friend’s vulgar relations.’ (P&P ch 8). ‘The Netherfield ladies would have had difficulty in believing that a man [Mr Gardiner] who lived by trade, and within view of his own warehouse, could have been so well-bred and agreeable.’ (P&P ch 25). Darcy had no such difficulty when he meets the Gardiners. One sees the same prejudice in Maria Edgeworth’s Patronage, n 17, in which a daughter of the (good) Percy family declines to marry Mr Gresham because of his connections with trade. 166 P&P ch 10. 167 ‘… one of the few people who could see faults in Emma Woodhouse, and the only one who ever told her of them’ (E vol 1, ch 1). J Davidson, Reading Jane Austen (Cambridge, Cambridge University Press, 2017) 73 doubts whether Mr Knightley will succeed. One should not consider one of her faults to be snobbery as the concept did not then exist. Everyone had their place in society and one should not judge her age by considerations of our own age: see N Nicolson, ‘Was Jane Austen a snob?’ in Jane Austen Society Report for 1997 (Collected Reports 1996–2000, 117). 168 E vol 2, ch 7. And she ‘did not repent her condescension in going to the Coles. The visit afforded her many pleasant recollections the next day’ (E vol 2 ch 9). Nor is Emma put off by the revelation at the end of the book that Harriet was the daughter of a tradesman. 169 Byrne, above n 5, 221 suggests it is a euphemism for slave trade, which as Mrs Elton comes from Bristol and her maiden name is Hawkins (Sir John Hawkins was England’s first slave trader) is possible, but this does not seem to square with the rest of the sentence: ‘but, as the whole of the profits of his mercantile life appeared so very moderate, it was not unfair to guess the dignity of his line of trade had been very moderate also’, which does not sound like the slave trade. However, when Jane Fairfax refers to ‘Offices for the sale – not quite of human flesh – but of human intellect’ (meaning agencies for the employment of governesses) she is misinterpreted by Mrs Elton ‘if you mean a fling

Tax and Taxability  149 connections with trade; it was her personality: ‘Insufferable woman! Worse than I had supposed. Absolutely insufferable’, having ‘airs of pert pretension’, and being ‘self-important, presuming, familiar, ignorant, and ill-bred.’170 At the bottom end of the trading spectrum are the retailers, such as Ford’s, ‘the principal woollen-draper, linen-draper and haberdasher’s shop united’, in Highbury where Emma and Harriet buy ribbons, Frank Churchill buys gloves and where Mr Weston had ‘a great many errands for Mrs Weston.’171 There was snobbery within trades. To change authors for a moment, in Vanity Fair, Dobbin, whose father is a retail grocer, Dobbin & Rudge, is nicknamed Figs and given a hard time at school by his fellow pupils who ‘rightly considered that the selling of goods by retail is a shameful and infamous practice, meriting the contempt and scorn of all real gentlemen’, even though they are sons of merchants (avoiding the word trade again).172 But there is a change of mind against prejudice here too. When Dobbin had won a fight against Cuff, the Cock of the School: ‘the name of “Figs”, which had been a by word of reproach, became as respectable and popular a nickname as any other in use in the School. “After all, it’s not his fault that his father’s a grocer”’ said the pupil he had saved from bullying by Cuff.173 WHY NOT ‘BUSINESS’?

At the time of the introduction of income tax, business was already in statutory use when specific occupations were referred to, usually for the purpose of regulation by charging licence fees.174 Such use was in accordance with one of at the slave-trade …’ E vol 2 ch 17. The slave trade was then a delicate topic, hence the ‘dead silence’ that followed Fanny’s question to Sir Thomas Bertram in MP ch 21. The term ‘merchant’ was used more widely to avoid reference to trade, as in the text at n 172. 170 E vol 2 ch 14, 15. 171 E vol 2, ch 5. Other examples include the milliner’s in Meryton across the way from their aunt, visited three or four times a week by Catherine and Lydia; Molland’s, the pastry-cook’s, in Bath where Anne Elliot, while sheltering from the rain, has an embarrassing reunion with Captain ­Wentworth, having previously broken off her engagement with him and, now that he has £25,000 prize money, they are eventually reconciled and marry; in Highbury, Mrs Wallis the baker who bakes Mrs Bates’ apples; and Mr Gray’s jewellery shop in Sackville Street where Robert Ferrars (see above n 8) selfishly dithers over a toothpick case while Elinor is kept waiting to be served. Frequent shopping is a sign of bad character in the novels, as with Isabella [Thorp] and Lydia. 172 Ch 5. William Makepeace Thackeray was another noted commentator on class distinctions. Vanity Fair is set in the Napoleonic War era of the original income tax, even though published between 1847 and 1848. 173 Ch 5. 174 An Act for better regulating the Business of Pawnbrokers ((1800) 39 & 40 Geo 3 c 49), also (1796) 36 Geo 3 c 87; ‘every Person carrying on the Business of a Letter Founder, or Maker or Seller of Types for Printing, or of Printing Presses’ ((1799) 39 Geo 3 c 79 s 25); ‘… usually carry on the Business of printing or publishing such Paper, or where the same is usually sold’ ((1798) 38 Geo 3 c 78); ‘carrying on his or her Business of distilling or drawing off Spirits’ ((1798) 38 Geo 3 c 92 s 11); ‘the Business of Wharfingers’ ((1803) 43 Geo 3 c 161 Sch B). Sometimes business was used in combination with trade: ‘the Trade and Business of a Dealer or Dealers in, or a ­Manufacturer or Manufacturers of Linings

150  John Avery Jones the meanings in the Oxford English Dictionary of ‘a particular occupation or means of earning a living; a trade, profession, or pursuit’ first used in 1724. This is given as an instance of a more general meaning: ‘a person’s official or professional duties as a whole; one’s regular, habitual, or stated profession, trade, or occupation’, first used in 1477.175 This is wider than trade,176 but there does not seem to be any contemporary statutory use in this wider sense presumably because there had been no need for any statutory reference to occupations in general before income tax. An example of a different meaning of business is given by Rowlatt J, who was considering excess profits duty177 charged on a trade or business: ‘it is well known that if a private person goes to see his banker or his solicitor or anybody else, he goes very likely upon business, although he may not be carrying on any business; there is not a business in it, although he goes there upon business.’178 There are statutory examples of this use, such as ‘the Time required for giving Notice of the Meeting of Parliament for the Dispatch of Business.’179 for Hats’ ((1796) 36 Geo 3 c 125 s 5; (1803) 43 Geo 3 c 22 s 10); ‘Person exercising the Trade or Business of an Auctioneer’ ((1803) 43 Geo 3 c 69 Sch A); ‘the Trade or Business of an Horse Dealer, or Coachmaker’ ((1803) 43 Geo 3 c 161 s 27, 28); ‘every Corn Factor carrying on his Trade or Business in the City of London ((1791) 31 Geo 3 c 4 s 38); ‘such Trade, B ­ usiness, or Mystery of a Chimney Sweeper’ ((1788) 28 Geo 3 c 48 s 6: mystery meaning occupation); exemption from stamp duty on bills of exchange for drafts or orders upon any ‘Person or Persons acting as a Banker, and residing or transacting the Business of a Banker within ten Miles of the Place of Abode of the Person or Persons drawing such Draft or Order’ ((1799) 39 Geo 3 c 39 s 2 (also ss 9, 18, 22). License for insurance stating the place where such ‘business of insuring Houses, Furniture, Goods, Wares, and Merchandize, or other Property, from Loss by Fire … shall … be principally carried on’ ((1803) 43 Geo 3 c 21 s 72, 73). (Italics added throughout.) 175 T Percival, Medical Ethics (Manchester, S Russell, 1803), available on the internet at https:// books.google.com/books?id=tVsUAAAAQAAJ uses business in this sense applying it to professions when encouraging practitioners, whether physicians or surgeons, to ‘retire from the engagements of business’ when their memory starts to fail, or in the case of surgeons, they lose their ‘quickness of eye-sight, delicacy of touch, and steadiness of hand, which are essential to the skilful performance of operations.’ 176 ‘Now “business” itself is a word of large and indefinite import’ Smith v Anderson (1880) 15 Ch D 247, 258 per Jessel MR. In relation to inhabited house duty, Lord McLaren in Muat v Stewart (1890) 2 TC 601, 607 described business as wider than trade in relation to an exemption for ‘Every house or tenement which is occupied solely for the purposes of any trade or business’ in C&IR Act 1878 s 13(2). The width of business is demonstrated by the OED having 27 meanings (excluding use as a collective noun, and the obsolete meaning of being busy), six being obsolete, rare or archaic. 177 See text at n 185. 178 IRC v Marine Steam Turbine Co (1919) 12 TC 174, 179, and see text at n 190. See also Lord Young in Muat v Stewart (1890) 2 TC 601, 606 who misquotes Hamlet, the correct quotation being ‘For every man has business and desire’, and adds ‘The business of one man’s life is charity, another religion, a third (and I think Pope says the most numerous) pleasure.’ 179 (1799) 39 & 40 Geo 3 c 14, also (1797) 37 Geo 3 c 127; ‘the Officer whose Business it shall be to serve the Writ or Process issuing out of the Court’ ((1799) 39 Geo 3 c 80 s 36); ‘in respect of any ­Business depending in the said Courts of King’s Bench, Common Pleas, or Exchequer’ ((1799) 39 Geo 3 c 110 s 2); ‘the said Certificate and Receipt shall be afterwards brought to the Office of the Auditor of the Duchy of Cornwall, and be there forthwith enrolled in proper Books to be provided and kept for that Purpose, separate and apart from the other Business and Proceedings of the said Office’ ((1798) 38 Geo 3 c 60); ‘in the Presence of the proper Officer of Excise, whose Business it shall be to attend to unlock the same’ ((1798) 38 Geo 3 c 89 s 38 (also s 134)); ‘And whereas the Salaries

Tax and Taxability  151 Edward Ferrars says ‘I have had no necessary business to engage me, no profession to give me employment …’180 which is an example of this sense. Initially the only reference to business in income tax was in relation to partnerships where it had to be used because that was part of the (then common law) definition of partnership.181 Business was not used outside partnerships in income tax until much later; from 1915 it was used in relation to specific occupations: banking (‘a bank carrying on a bonâ fide banking business’182), insurance (‘where an assurance company carries on life assurance business’183), and other financial trades or the making of investments.184 The first general use of business in a charging section in tax legislation was in the WWI excess profits duty, charged on the profits arising from any trade or business185 which were to be determined on income tax principles.186 Income from investments was taken into account for life assurance companies and businesses whose principal business consisted in the making of investments, the last being an example where the charge was wider than trade (although the investment income of life assurance companies has consistently been held to be part

paid by the East India Company to the Clerks and Ministers of the Supreme Court amount to a large Sum, and yet nevertheless the said Clerks and Ministers have, and do receive, Fees for all Business done by them in the said Court’ ((1797) 37 Geo 3 c 142 s 5); ‘and such Justices and other Magistrates may appoint a Clerk to attend their Meetings, and transact such Business as shall belong to such Clerks, by virtue of this Act’ ((1795) 35 Geo 3 c 5 s 4); ‘any Advertisement published by the Trustees of Hospitals relative to the Business of such Hospitals’ ((1803) 43 Geo 3 c 21 s 107). (Italics added throughout.) 180 S&S ch 19. 181 1799 ss 82, 83. 1803 above n 1 s 46 (partnership; this was long before the Partnership Act 1890, which was an Act to ‘declare and amend the Law of Partnership’); s 162 (adjustments on the cessation of a trade, employment or vocation with a proviso that no adjustment was to be made where ‘any Person shall have succeeded to the Trade or Business of the Party charged … unless it shall be proved to the satisfaction of the said Commissioners that the profits or gains of such Trade or Business have fallen short from some specific cause … since such Succession took place’, which is merely a case of the draftsman not repeating ‘trade, employment or vocation’). There is also a reference in 1803 s 7 to the directors for conducting and managing the affairs and business of the West India Dock Company and London Dock Company appointing the City Commissioners, which is an example of the meaning in the previous note. The Apothecaries Act 1815 (see n 114) did not extend to affect the trade or business of a chemist and druggist. (Italics added throughout.) 182 FA 1915 s 22; F(No 2)A 1915 s 30. 183 FA 1915 s 11. This may be because composite insurance was a single trade (Last v London ­Assurance Corporation (1884) 2 TC 100) so that life assurance, being part of a trade, was a business. 184 ‘Bona fide carrying on business as a member of a stock exchange … bonâ fide carrying on the business of a discount house’ FA 1917 s 15. ‘Any company whose business consists mainly in the making of investments’ FA 1915 s 14. There is an earlier stamp duty example in F(1909–1910)A 1910 s 78 to ‘any person who by way of business deals, or holds himself out as dealing, as a principal in any stock or marketable security, and buys or sells any such stock or marketable security’. 185 F(No2)A 1915 s 38. This slightly pre-dates the use of the same expression in the 1918 US Code. The WWII excess profits tax also taxed the profits from any trade or business: F(No2)A 1939 s 12(1). There is an earlier more limited example in F(1909–1910)A 1910 s 16(2) in relation to undeveloped house duty that land is deemed to be undeveloped land if it has not been developed by the erection of buildings for the purposes of ‘any business, trade, or industry other than agriculture (but including glasshouses or greenhouses)’ (also s 24(4)(b) and full-out). 186 F(No2)A 1915 s 40.

152  John Avery Jones of their trading receipts).187 Professions where the profits were dependent mainly on the personal qualifications of the person carrying it on were excluded.188 A number of decisions were made on the meaning of trade or b ­ usiness, the best-known judicial definition, which was later applied to VAT,189 being ­ Rowlatt J’s ‘an active occupation or profession continuously carried on.’190 Perhaps the earliest income tax example of an all-embracing use of business, not restricted to particular occupations, is in the double taxation agreement with the Irish Free State in 1926: 4. For the purposes of this Agreement a company, whether incorporated by or under the laws of Great Britain or of Northern Ireland or of the Irish Free State or otherwise, shall be deemed to be resident in that country only in which its business is managed and controlled.191

The use of business here is correct because the company might be carrying on an investment business for which its residence was relevant. The number of such references to business in income tax grew rapidly from two sections in 1806192 to 11 in the 1918 consolidation, to 34 in the 1952 consolidation, and 857 today (including VAT). A recent addition made by the Tax Law Rewrite is the concept of ‘property business’.193 This did not change the substance of how property income was taxed, since deductions have always been allowable, but the use of business is interesting. Finally, in 1972 business was the all-embracing charging term used in VAT corresponding to the European Directive’s ‘economic activity’.194 Business is defined to include any trade, profession or vocation,195 thus bringing full circle the original income tax expression (although now non-exhaustive). 187 ibid, Sch 4 para 8. See Liverpool, London & Globe v Bennett (1913) 6 TC 327 in relation to the taxation of life assurance; and see R Thomas, ‘Not like Grocers’ in P Harris and D de Cogan (eds), Studies in the History of Tax Law vol 8 (Oxford, Hart Publishing, 2017) 131, 156. 188 F(No2)A 1915 s 39. See IRC v Maxse, above n 149. A limited company carrying on the ­business of auctioneers did not possess ‘personal qualifications’ and was not excluded in IRC v Peter McIntyre Ltd (1926) 12 TC 1006. In many borderline cases, such as insurance brokers in Durant v IRC, or the tax agent and unqualified accountant in Currie v IRC, both (1921) 12 TC 245, the courts treated it as a question of fact. Also excluded were husbandry, and offices or employments. 189 See below n 195. 190 IRC v Marine Steam Turbine Co (1919) 12 TC 174, 179. 191 FA 1926 sch 2 (italics added). For the reason for this definition see JF Avery Jones, ‘The ­Definition of Company Residence in early UK Tax Treaties’ [2008] BTR 556, 561. 192 SS 112, Sch D Cases I and II rules, r 4 (partnerships), and 140 (successions). 193 See ITTOIA 2005 s 264 onwards. ITTOIA ss 264 and 265 provide: ‘A person’s [UK/overseas] property business consists of – (a) every business which the person carries on for generating income from land [in/outside] the United Kingdom, and (b) every transaction which the person enters into for that purpose otherwise than in the course of such a business.’ And similarly for companies in CTA 2009 ss 205, 206 substituting company for person in the above definition. 194 Principal VAT Directive (2006/112/EC) art 9(1). 195 Originally FA 1972 s 45, now VAT Act 1994 s 94. In addition, the provision by a club of ­facilities for its members, and the admission for consideration of persons to any premises are deemed to be the carrying on of a business. Economic activity was recently considered in Longridge on the Thames v HMRC [2016] EWCA Civ 930.

Tax and Taxability  153 Accordingly, the reason why business was not used originally was that its then use, at least in statutes, was necessarily restricted to particular occupations, mainly those involving the provision of services rather than dealing in goods. If income tax had been invented 150 years later we would almost certainly have used business like the rest of the common law world. APPENDIX 1

Use of ‘Business’ in Other Common Law Jurisdictions196 Those familiar with the use of ‘trade or business’197 in the United States may be surprised to learn that an 1861 Act taxed the ‘annual income … from any profession, trade, employment, or vocation carried on in the United States or elsewhere’198 which is clearly derived from the UK – taxation with representation this time, although this tax never came into force.199 It was the regulations that introduced business. Form 24 dating from 1862 required a statement of ‘income … from profits of any trade, business, or vocation’; and a statement of ‘expenses necessarily incurred and paid in carrying on any trade, business, or vocation’.200 Business did not feature in the Code until the 1918 Act which referred to deductions for ‘all the ordinary and necessary expenses paid or incurred … in carrying on any trade or business.’ India had an early 1860 Act that closely followed the UK legislation and contained the definition that ‘“trade” includes any manufacture, and any business, adventure, or concern in the nature of trade’,201 which adds business to the

196 The author is grateful to the following for information in this Appendix: Peter Blessing (US), Shefali Goradia (India), Associate Professor Johann Hattingh (South Africa), Professor Craig Elliffe (New Zealand), Angelo Nikolakakis (Canada), and to Professor Peter Harris for copies of Bills and statutes of several jurisdictions. 197 According to RA Bolling and WB Carper, ‘The Evolving Definition of “Trade or Business”: Ditunno and Beyond’ (January 1985) Taxes 73 ‘trade or business’ was then used in over 60 sections and over 170 times in the Code, and no doubt the figure is higher today. 198 Revenue Acts 1861 and 1862. There were earlier state taxes, such as an 1819 Massachusetts tax on income from any ‘profession, handicraft, trade, or employment’. P Harris, Income Tax in Common Law Jurisdictions (Cambridge, Cambridge University Press, 2006) 451. 199 ERA Seligman, The Income Tax, A Study of the History, Theory and Practice of Income ­Taxation at Home and Abroad (New York, Macmillan, 1911) 435, available at https://archive.org/ details/cu31924021092733. 200 Form 24, ‘Detailed statement of sources of income and the amount derived from each, during the year 1862’, and ‘Detailed statement of deductions authorized to be made’ contained in ­Regulations (of 7 June 1862) for the Collection of Direct Tax (starting at 131) in GS Boutwell [former Commissioner of Internal Revenue], A Manual of the Direct and Excise Tax System of the United States (Boston, Little, Brown & Co, 1863) 156 (italics added), available at https://babel.hathitrust.org/ cgi/pt?id=hvd.hnnykc;view=1up;seq=9. The ‘necessarily’ might raise an eyebrow in the UK when applied to trading, rather than employment, income. 201 CL Jenkins, ‘India’s First Income Tax’ [2012] BTR 87, 99.

154  John Avery Jones UK definition. Shorter Acts followed in 1869 and 1886 which had less connection with the UK legislation and did not tax unincorporated traders.202 The current legislation dating from 1918 charges profits and gains of business and professions, with these definitions: ‘“business” includes any trade, commerce or manufacture or any adventure or concern in the nature of trade, commerce or manufacture’, and ‘“profession” includes vocation’.203 Therefore all the elements of the UK legislation are included within the definition of business. Australia followed the same pattern, initially with many failed attempts by the states to introduce an income tax from 1866 to 1884 based with varying degrees of similarity to the UK but with some additions to the UK list, such as business and calling.204 The earliest Acts dating from 1884 almost all made similar additions such as business, calling and occupation.205 Finally, the first Commonwealth of Australia Income Tax Assessment Act 1915 followed the 1891 New Zealand Act by using business as the defined term to include the items in the list, and added calling so as to read: ‘“Business” includes any profession, 202 P Harris, ‘Importing and Exporting income tax law: the international origins of the South ­African Income Tax Act’ in J Hattingh, J Roeleveld and C West (eds), Income Tax in South Africa (Cape Town, Juta, 2016) 8. 203 Income-tax Act 1961–2016 s 2(13), (36) and 14. The addition of commerce to the definition of business seems peculiar to India (but see below n 206 for its use in the Cape 1814 Proclamation). 204 For example, Tasmanian Bills (none of which was passed) of 1866 following the UK exactly (and unsuitably for a small jurisdiction was twice the length of the Act passed by the Commonwealth of Australia 50 years later: P Harris, ‘Metamorphosis of the Australasian Income Tax 1866–1922’, Australian Tax Research Foundation Research Study No 37, 2002, Summary and Conclusions): ‘profits or gains … arising or accruing from any profession, trade, employment, or vocation carried on in Tasmania’ [2.2], a 1873 Bill with variation of their own ‘trade, profession, or business’ [2.3], and a return to the UK in 1879 ‘any profession, trade, adventure, or concern in the nature of trade.’ [3.3.2] and 1893 ‘profession, business, trace or vocation’ [5.4.3]; a Bill of 1876 (not passed) in ­Victoria ‘profession, trade or vocation’ [3.1.1] (and described by Harris in his Summary and Conclusions as little more than a patchwork of provisions borrowed from the UK with no obvious structure or ordering); and South Australian Bills (none passed) of 1879 ‘annual gains and profits … arising or accruing to any person … and from the exercise or carrying on of any trade, profession, business, or calling’, thus introducing business and calling (presumably in preference to vocation which was not then in current use) [4.2], of 1883 ‘profession, trade, or avocation’, (a further alternative to vocation) and of 1884 contained the definition ‘“Trade” shall include all professions, trades, businesses, and avocations’ [4.5], and of 1893 [5.4.2]; New South Wales Bills (none passed) of 1860 (land tax only), 1886 ‘profession trade employment or vocation’ [5.1.1] and 1893 (same wording). (Italics added.) 205 South Australia Taxation Act 1884 s 1: ‘“Trade” shall include all professions, trades, businesses, and avocations’, thus adding businesses (Harris, above n 204 [4.5]); Tasmania Income Tax Act 1894 ‘“Trade” includes all professions, trades, businesses, employments, and occupations’, thus adding businesses and occupations; New South Wales Land and Income Tax Assessment Act 1895 s 15 ‘any profession, trade, employment, or vocation, carried on in New South Wales’; Victoria Income Tax Act 1895 s 2 ‘“Trade” includes every profession vocation trade business calling employment and occupation’, thus adding business, calling and occupation; Queensland Income Tax Act 1902 s 3 ‘“Business” – Every profession, vocation, trade, business, calling, employment, and occupation’, making business the defined term with the same additions; Western Australia Land and Income Tax Assessment Act 1907 s 16 ‘any profession, trade, employment, or vocation carried on in Western Australia’; Commonwealth of Australia Income Tax Assessment Act 1915 s 3 ‘“Business” includes any profession, trade, employment, vocation, or calling’, thus making the definition non-exhaustive and, surely unnecessarily, including both vocation and calling. (All these are contained in www. austlii.edu.au. Italics added.)

Tax and Taxability  155 trade, employment, vocation, or calling.’ Presumably the changes were made to enlarge the scope of the UK items. South Africa followed a different path in keeping trade as the defined term, although business was included within the items in the definition. In the Cape Colony Additional Taxation Act 1904 trade was defined to include ‘every profession, vocation, trade, business, calling, employment and occupation, and includes the business of mining and quarrying’;206 there was also a definition that ‘“carrying on business” shall mean conducting any operation by means of which any income is derived’, used in the definition of company207 which seems to be unique. The first Union of South Africa Income Tax Act 1914 had a shorter list in the source rule of ‘business, trade, profession or occupation’, and in relation to deductions that trade included ‘every profession, trade, employment or calling’.208 This was expanded in the current law that ‘“trade” includes every profession, trade, business, employment, calling, occupation or venture.’209 The tax is not schedular but the definition is relevant to deductions. New Zealand had initially followed the UK closely but made business the exhaustively defined term and dropped profession and vocation in the Land and Income Tax Assessment Act 1891, with Schedule C taxing income of ‘Every company carrying on any business, adventure, or concern in New Zealand’ and Schedule D providing that ‘“Income derived from business” means the gains or profits derived or received in New Zealand from any trade, manufacture, adventure, or concern in the nature of trade, whether the same shall be respectively carried on in New Zealand or elsewhere’. The 1892 amending Act changed the latter to a non-exhaustive definition to read ‘“Income derived from business” includes, but without limiting the meaning of those words, the gains or profits derived or received in the colony by any person in or out of the colony … from the following sources: (a.) From any trade, business, manufacture, adventure, undertaking, or concern of whatsoever nature’, thus also adding undertaking. Canada started by taxing income ‘from any profession or calling, or from any trade, manufacture or business’ in 1917,210 thus including business and ­calling from the start. It then moved to the current definition with business as the defined expression that ‘“business” includes a profession, calling, trade, manufacture or undertaking of any kind whatever … an adventure or concern in 206 S 42. This is the same wording as the Victoria Income Tax Act 1895, n 205, which is one of the known sources (together with New South Wales and New Zealand), see Harris, n 202, 13 and 19. The Natal income tax of 1908 is similar (at 14). Mention should be made of an earlier tax in Cape Town (only) under a Proclamation of 1814 (probably the earliest income tax in any of the Colonies) which taxed income from ‘Office, Profession, Trade, Commerce, Slave Hire and other sources of a Life Interest’, see EJ van Rensburg, ‘The History of income taxation in the Cape Colony’ in Hattingh, Roeleveld and West, above n 202, 25, 31. The tax was abolished in 1840 and a failed attempt was made in 1869 to introduce a tax on UK lines. The next income tax was the 1904 one. The author is grateful to Associate Professor Johann Hattingh for South African material. 207 The definition of company includes ‘carrying on business within this Colony or elsewhere’. 208 Income Tax Act, 28 of 1914 ss 4(5) and 16. 209 Income Tax Act, 58 of 1962 s 1(1). 210 Income Tax War Tax Act s 3(1).

156  John Avery Jones the nature of trade but does not include an office or employment.’211 It has been contended that the non-exhaustive definition of business widened the ambit of the terms.212 Finally, we provided the colonies with a Model Income Tax Ordinance in 1922 that imposed tax on various types of income, including the ‘gains or profits from any trade, business, profession or vocation’.213 Interestingly, business was included in this list before it was used in UK tax legislation apart from excess profits duty. Civil law states did not have the same problem of finding a comprehensive term because they borrowed an economic term ‘enterprise’, which is the term used in the OECD Model Double Taxation Convention, the meaning of which has given rise to problems in common law countries.214 This is comprehensive but excludes professions which were originally dealt with in a separate article of the Model, and following the deletion of that article there is now a definition that ‘the term “enterprise” applies to the carrying on of any business.’215 APPENDIX 2

Purchasing Power of Money and Standard of Living in Jane Austen’s Novels Copeland216 gives a useful breakdown of what standard of living various incomes will support, to which I have added the income of some of the ­characters and her relatives. 211 Income Tax Act s 248(1). The inclusion of adventure in the nature of trade follows the UK. Provincial taxes (including Quebec which, unlike the other provinces, does not rely on the federal government to collect tax on its behalf, and can vary its tax base) adopt the same definition (in French, entreprise comprend une profession, un métier, un commerce, une manufacture ou une activité de quelque genre que ce soit … un projet comportant un risque ou une affaire de caractère commercial, mais ne comprend pas une charge ni un emploi). 212 ‘Counsel for the respondent … referred to the definition of “business” … and contended that the word “business” in the Income Tax Act had a larger ambit than previously.’ MNR v Eastern Textile Products Ltd, 57 DTC 1070; [1957] CTC 48 (Ex Ct, Thorson P). However, the issue related to whether a loss had to be incurred in the same business, and otherwise the ambit of ‘business’ was not in question. 213 Report of the Inter-Departmental Committee on Income Tax in the Colonies Not Possessing Responsible Government, December 1922, Cmd.1788, to which the Model Ordinance is an Appendix, available at https://ia802205.us.archive.org/35/items/reportofinterdep00grea/reportofinterdep00grea.pdf. The Report contains no discussion about this wording. 214 In Australia, Thiel v Comr of Taxation 90 ATC 4717. See also Unisys Corporation v FCT [2002] NSWSC 1115, in which a company making a 0.5% margin on licensing intellectual property was held to be carrying on a business for purposes of an Australian internal law provision based on the definition of permanent establishment in the Model; and in Canada MNR v Tara Exploration and Development Co. Ltd (1972) 28 DLR 135. 215 The UK domestic law definition of permanent establishment in CTA 2010 s 1141 is drafted in terms of business, but the charge to tax depends on the non-resident company carrying on a trade in the UK (excluding dealing in, or developing, UK land), although if it does so, some non-trading income and gains are taxable (CTA 2009 s 19(1), (3)). 216 Copeland, above n 3, 127, 130–32.

Tax and Taxability  157 • £40 pa Elizabeth Bennet and each of her sisters prospectively after her mother’s death (from £1,000 in the 4 per cent funds) about which Mr Collins said ‘Your portion is unhappily so small that it will in all likelihood undo the effects of your liveliness and amiable qualifications’ (P&P ch 19); ‘portion’ is used in its technical sense of an annuity charged on the estate as it arose under a marriage settlement (P&P ch 50). We are not told the amount of Charlotte Lucas’s income, but Sir William Lucas says that they could give her little fortune, which is why she agreed to marry Mr Collins merely as a ‘preservative from want’ (P&P ch 22). • £100 pa clerks in government office and moderately prosperous tradesmen, poor curates:217 supports one maidservant (probably includes Mrs and Miss Bates). • £150 pa (Catherine Morland). • £200 pa (Mrs Bennet as widow). • £300 pa supports two servants (Edward Ferrars ‘but it cannot enable him to marry’ (S&S ch 39)). • £350 pa (Maria Ward, who became Lady Bertram, and presumably her sisters). • £400 pa supports two to three servants (Fanny Price’s mother). • £500 pa supports three servants (Miss King; Mrs Elton; Mrs Henry Dashwood and her three daughters, who retained two maids and a man when they moved out of Norland; and Mary [Edwards] (The Watsons, n 119)). • £700 pa was needed for a carriage (Mr Perry, Mr Woodhouse’s apothecary, at his wife’s persuasion considered buying a carriage, a secret that Frank Churchill inadvertently reveals, indicating that he must have heard it from Jane Fairfax). Hume quotes the cost of maintaining horses, the carriage and a coachman in 1796 to be £160 pa plus tax on the carriage of £8218 (plus £2 on the horses if the person owned two horses).219 Jane’s brother Edward paid

217 See above nn 54, 55 for a relief from the tax on horses for clergymen with an income below £60 (or £100). 218 n 3, at 298 gives the duty as £7 14s citing a secondary source; my figure is from (1785) 25 Geo 3 c 47 and (1789) 29 Geo 3 c 49. For the horses (1784) 24 Geo 3 c 31, (1789) 29 Geo 3 c 49 and (1795) 36 Geo 3 c 16. 219 By 1802 carriage duty increased to £10 by (1802) 42 Geo 3 c 37 (if four wheels) or £5 5s [£5.25] (if less); rising to £11 5s [£11.25] (or £5 18s [£5.9] if less than four wheels drawn by one horse or £8 5s [£8.25] if by two) and £8 19s [£8.95] by (1808) 48 Geo 3 c 55 Sch D and E); and horse duty increased to £6 12s [£6.6] for two horses by (1802) 42 Geo 3 c 37. The tax on both carriages and horses was highly progressive; in 1798 the tax per horse owned was 121% greater for 20 horses (£3 15s [£3.75]) than for one (£1 14s [£1.7]), and per four-wheeled carriage owned was 22% greater for nine carriages (£11 14s [£11.7]) than for one (£9 12s [£9.6]). It became more progressive: the equivalent figures for 1808 (1812 for carriages) were 145% and 51%. (These figures are derived from (1798) 38 Geo 3 c 41, (1808) 48 Geo 3 c 55 and (1812) 52 Geo 3 c 93.) See n 8 for the progressivity of window tax.

158  John Avery Jones 60 guineas for a pair of coach horses; and her brother James decided to keep three horses when his income increased from £1,000 to £1,100.220 • £700 to £1,000 pa marked the income of the most prosperous pseudo-gentry (Miss Bingley; Mr and Mrs Norris’s income was very little less than £1,000 pa; Mary Crawford £1,000; Elinor £850 to £900221). Jane’s father’s income was around £1,000 in 1800.222 • £1,500 pa (Georgiana Darcy; the Hon Miss Morton, whom Mrs Ferrars wanted Edward to marry; and Emma who was the heiress of £30,000; Captain and Anne Wentworth will together have £1,416). • £2,000 pa which Marianne thought would support ‘a proper establishment of servants, a carriage, perhaps two, and hunters’ (S&S ch 17) but this may include some wishful thinking on her part (Mr Bennet – whose establishment included at least a butler, footman (duty £2 10s each,223 housekeeper, two housemaids and a cook:224 income for life225 with remainder in default of heirs male to Mr Collins;226 Colonel Brandon – with, eventually, Marianne). • £2,500 pa (Mrs Willoughby née Grey). • £4,000 pa and above marked the top level of the land-owning classes who could afford a house in London (Henry Crawford £4,000; Bingley £5,000); above that you were really wealthy (Darcy had £10,000 pa, Rushworth £12,000 pa, and we are never told Mr Knightley’s income, who was not concerned with appearances ‘keeping no horses, having little spare money … [did] not use his carriage so often as became the owner of Donwell Abbey’ (E vol 2 ch 8)). A yield of 5 per cent has been used for converting capital into income, but see n 34. The income tax exemption limit (not a personal allowance or nil rate band) was £60 (1803, above n 1, rate 5 per cent; and 1805, above n 45, rate 6.25 per cent), or £50 (1806, above n 40, rate 10 per cent) with abatements for incomes up to £150 (1803 s 193, limited to earned income from 1806 (s 173)), so all the above (except Elizabeth prospectively) were taxable, although for land the amount depended on the annual value rather than the actual income. The relative figures are more meaningful than trying to convert them to current values but, Hume, n 3, 303 suggests multiplying them by 100 to 150 to obtain a rough equivalent (and presumably treating the current value as after-tax). 220 Faye, above n 8, Letter 22; Letters 49, 62 and 63. 221 Copeland, above n 3, 143 (n 15). 222 Tithes £600, farming profits £300 (see n 48), investment income £105 in 1799–1800. Although sufficient to have a carriage, he laid it up because of Triple Assessment, see n 56. 223 (1803) 43 Geo 3 c 161 Sch C, and £2 16s [£2.8] from (1808) 48 Geo 3 c 55. 224 The tax on female servants had been repealed by (1792) 32 Geo 3 c 3. 225 As Hume, above n 3, 306 onwards points out, Mr Bennet was extravagant, which not surprisingly left his family without the means to live after his death. 226 For the possible reasons why this was the case when he had a different surname, see Treitel, above n 3, 566.

6 The Taxation of Road Travel Revenue and Regulation in Georgian Britain CHANTAL STEBBINGS

ABSTRACT

Throughout the Georgian era, road travel was one of the most highly and comprehensively taxed activities in Britain. Not only were all vehicles kept for personal travel subjected to the assessed taxes – horses, carriages of all descriptions, carts and wagons – but all vehicles used for public hire were liable to both the assessed taxes and, almost invariably, to an Excise licence, a mileage duty and a tax on their personnel. These duties reveal a regime of taxation that went well beyond the raising of public revenue and incorporated a substantial element of trade regulation. The combined forces of technical advancements in road building and vehicle design, a growth in population and commerce creating a demand for road travel, and the motive forces of avoidance and evasion, resulted in a tax code of bewildering detail and theoretical ambiguity. As such, it marked the zenith of the traditional taxation methods that had dominated the fiscal system for a century. That, and the weight and breadth of the taxes on animal-powered road travel, made it entirely unable to compete against the new steam-powered railways, and constituted a material factor in its dramatic decline. INTRODUCTION

T

he orthodox model of taxation in the eighteenth century, when administrative systems were insufficiently sophisticated to contemplate the comprehensive taxation of incomes, was to tax expenditure on material commodities. Originally these were commodities which were believed,

160  Chantal Stebbings not unreasonably, to constitute an accurate reflection of individual wealth, such as, most famously, the number of windows in a house. Increasingly, however, and despite an intense popular resentment of taxes on any item which could be regarded as a necessity, the official understanding of the term luxury became more flexible, and commodities which were in daily use by individuals of even very modest means came within a charge to tax. The financial exigencies of the wars of the eighteenth century, exacerbated by the expense of the war with France at the close of the century, and the prevailing notions as to acceptable models of taxation, meant that any widespread use of a particular commodity would come to the attention of the government as a potential source of revenue. The remarkable increase in the use of horse-drawn carriages was one such activity, and accordingly private carriages were subjected to tax solely with the object of raising revenue. The orthodox view in the eighteenth century was that the purpose of direct taxation was to raise revenue for public purposes in accordance with certain tenets of acceptable taxation, and not to regulate any form of social behaviour or enterprise. However, in certain extreme cases where specific activities had a more direct impact on the public wellbeing and required a measure of regulation for the public good, the issue of regulation through either the substance of taxation or its administrative structures became an issue of some moment. In the case of carriages let out for hire, notably the rapidly proliferating hackney carriages in London, the need for regulation was so urgent that the machinery originally established for their taxation was pressed into service for their control. The context for the raising of revenue from, and for the regulation of, road transport was a transformation in the road transport infrastructure in the ­Georgian period, namely from 1714 to 1830. Before the beginning of Victoria’s reign in 1837, individuals travelled about their town, village and country on foot or using animal – usually horse – power. Most journeys beyond walking distance, to a maximum of some 20 miles, were undertaken by horse. The appalling state of British roads was such that internal travel of any kind was necessarily local in character.1 However, it was both a prerequisite and a consequence of the industrialisation of Britain, which began in the middle of the eighteenth century, that a system of viable internal communication should develop. So it was only when the growth in commerce and population created an irresistible demand for better roads that more extensive and frequent road travel could be contemplated. The turnpike trusts moved road maintenance away from local and often reluctant responsibility, dramatically improving the quality of thousands of miles of road by the 1770s.2 Technical advances in roadbuilding by engineers such as

1 See KG, ‘An Essay on the English Roads’ (1752) 22 The Gentleman’s Magazine 517–20, 552–54. 2 See generally WT Jackman, The Development of Transportation in Modern England, 3rd edn (London, Frank Cass & Co Ltd, 1966) 29–156, 211–354. For an insight to the administration of turnpike trusts in the 18th century, see J Sims (ed), Newbury and Chilton Pond Turnpike Records 1766–1791 (Reading, Berkshire Record Society, 2017).

The Taxation of Road Travel  161 John Loudon McAdam and Thomas Telford made road travel, and notably travel by wheeled vehicles, widespread both socially and commercially by the early 1830s.3 As a result of these developments, and as early as the last quarter of the eighteenth century, some 20,000 carriages were potentially chargeable to tax, a figure set to treble at the dawn of the new century.4 The development of communications, including road transport, is an acute and revealing reflector and, indeed, initiator, of social and economic change. This paper explores the interface between the classic eighteenth-century system of taxing commodities, and the dramatic and rapid changes in society and industry occurring within the course of some 50 years, as exemplified by the development and taxation of road transport. The aim is to assess how this orthodox form of taxation reflected these changes both in substance and administration, whether its suitability in social and fiscal terms was considered, or whether the status quo was valued to the extent that the taxes were maintained, however unsuitable or unprofitable they were. THE TAXATION OF PRIVATE ROAD TRANSPORT

Private horse-drawn carriages were an early and obvious target for taxation, and it was entirely in line with orthodox fiscal thinking in the eighteenth century that they should be charged to tax. For the most part carriages were then an unambiguous outward, and reasonably accurate, indicator of personal wealth. It was not the mere fact of owning a particular carriage, but the fact that such ownership would also require sufficiently large premises to accommodate the vehicle, stables for the horses to draw it, and staff to both care for the horses and, depending on the type of carriage, to act as coachman or postilion. In 1776 Lord North expressed the orthodox view that taxes should, as far as possible, ‘be laid on luxury, and the elegant conveniencies of life … because the first weight ought to fall on the rich and opulent’.5 While four-wheeled carriages were undoubtedly an object of convenience, they were equally a luxury, because only the very wealthy kept such a carriage. When the taxing legislation named the various types of carriage, a contemporary critic observed that these were ‘names which conveyed luxurious ideas of affluence’,6 ‘vehicles of grandeur’.7 Indeed in the eighteenth century the principle of the tax could provide no reason for criticism or objection. Unlike the taxes on windows or proprietary

3 See PS Bagwell, The Transport Revolution (London, Routledge, 1974) 24–43. 4 3 Parliamentary Register 1774–1780, 24 April 1776, 479. 5 ibid. 6 F Spilsbury, Discursory Thoughts Disputing the Constructions of His Majesty’s Hon. Commissioners and Crown Lawyers, relative to the Medicine and Horse Acts, 2nd edn (London, Soho Dispensary, 1785) 33. 7 ibid 34.

162  Chantal Stebbings medicines, for e­ xample, it could not be argued that the object of charge was a necessity, and, being a charge on an outward sign of wealth, it was not intrusive in its administration. The various types of carriage were revealing of the individual financial means, interests and social status of the user. The largest private carriage in general use was the coach, which was a plain but substantial vehicle which could carry some six passengers. A smaller, lighter and more elegant version was the chariot, drawn by four horses in some comfort. Chaises were popular four-wheeled closed carriages generally carrying two passengers, drawn by two horses and driven by a postilion sitting on the near horse. Curricles were small and lightweight carriages built for speed, generally with two wheels, and drawn by two horses. They were often open, were unstable, and were the favourite vehicle of young men keen to exhibit their courage and driving skills. Phaetons too were small and light, generally open, with perch phaetons being sporting vehicles, fast but precarious and therefore dangerous. Gigs were the simplest carriages, carrying two passengers and used where the ground was even, as their suspension was rudimentary. The whiskey was smaller, used in parks in fine weather, and so called because it could whisk around other traffic. Cabriolets were gigs with a folding hood, while the later Brougham, named after Lord Brougham who had one built to his specification when he came to London, was a light four-wheeled enclosed vehicle drawn by one horse and driven by one coachman which became a favourite with the wealthier and professional classes. The barouche, however, was the acknowledged superior form of carriage. It was a heavy open carriage, drawn by four horses. A landau, first made in the mid-eighteenth century in the German town of Landau, was a similar vehicle. Since the general term ‘carriage’ could cover all horse-drawn vehicles, from the most lavish private coach to the most humble farm cart, and carriages were built for the terrain on which they were intended to be used, and according to the taste, requirements and pocket of the purchaser, they ranged widely in design. There was accordingly an immediate problem of statutory definition. The taxation provisions had to be drafted sufficiently precisely to bring all these different vehicles into charge, and yet clearly enough to be understood by both taxpayer and tax administrator. It was inevitable that any carriage tax would be difficult to apply and in danger of eventually being overwhelmed by technicality and fine distinctions. When carriages were first taxed in 1746, initially as an excise duty then from 1785 as an assessed tax,8 the very expression of the charge indicated the problems of nomenclature and design that would come to plague the tax. The Act imposed an excise duty on ‘every Coach, Berlin, Landau, Chariot, Calash, Chaise Marine, Chaise, Chair and Caravan, or by what Name soever

8 National Debt Act 1746 (20 Geo II c 10) ss 1–3; Excise Act 1785 (25 Geo III c 47) s 3. See generally WR Ward, ‘The Administration of the Window and Assessed Taxes, 1696–1798’ (1952) 67 English Historical Review 522.

The Taxation of Road Travel  163 such Wheel Carriages now are, or hereafter may be called or known, that shall be kept by or for any Person, for his or her own Use, or to be let out to Hire’.9 The charge, to be paid annually by the owner, was £4 for every carriage with four wheels, and 40s for every carriage with two wheels.10 A person owning more than five carriages for his own personal use would only be charged for five, but if he kept them for the purpose of hiring them out, he would be charged on all of them.11 The charging provision would remain essentially unchanged, with all carriages of four wheels or less by whatever name known, for personal use or hire, being subject to the charge. Over the next hundred years the frequent amendments served principally to increase the rate of charge. In 1785 a new duty was imposed of £7 per annum on all four-wheeled carriages, and £3 10s for carriages with two or three wheels.12 Additional duties were introduced in 1789 and again in 1795.13 This pattern of increasing taxation based on the number of wheels and horses continued into the new century,14 and by 1812 additional rates meant that one carriage with four wheels paid an annual charge of £12, increasing to £18 3s for each carriage where nine or more were kept.15 From the inception of the tax on carriages, the legislation provided for a number of exemptions and reliefs. As with the charge itself, these remained largely unchanged throughout the legislative history of the tax, and related to carriages owned by the royal family, licensed hackney coaches, and the stock of coachmakers.16 An important and enduring exemption was directed to farmers using their vehicles only for agricultural purposes, since a major concern which permeated the debate on the original carriage tax was its possible adverse effect on agriculture. Accordingly any cart bona fide used wholly for farming or trade, duly marked with the name and address of the owner and the words ‘Common Stage Cart’, but allowing the owner occasional use to travel to church or parliamentary elections, was exempt from the tax.17 This exemption was very strictly construed by the revenue authorities and the courts of law. If, for example, the vehicle was used in any way other than for carrying a load to market, even riding

9 National Debt Act 1746 (20 Geo II c 10) s 1. 10 ibid. 11 ibid s 2. 12 Excise Act 1785 (25 Geo III c 47) s 2. 13 Duties on Horses and Carriage Act 1789 (29 Geo III c 49); Carriage Duties Act 1795 (35 Geo III c 109). See too Duties on Servants etc Act 1798 (38 Geo III c 41). 14 House Tax Act 1803 (43 Geo III c 161) Sch D nos 1, 2. See too Assessed Taxes Act 1806 (46 Geo III c 78); House Tax Act 1808 (48 Geo III c 55) Sch D nos 1, 2. 15 Assessed Taxes Act 1812 (52 Geo III c 93) Sch D. 16 House Tax Act 1803 (43 Geo III c 161) exemptions to Sch D cases 1, 2, 3. 17 ibid. Exemptions to Sch D, exemption case IV. See too Duties on Carriages Act 1832 (2 & 3 Will IV c 82) s 1, which allowed a reduced rate for taxed carts and common stage carts which did not qualify for complete exemption. The exemption for carts used in trade or husbandry was maintained after Gladstone’s rationalising reforms of 1853: Land Tax Redemption (Investment) Act 1853 (16 & 17 Vict c 90) Sch D.

164  Chantal Stebbings to market to purchase cattle, it did not come within the exemption and the full carriage tax was payable.18 Evasion of the carriage tax centred on the lower rate for vehicles with two wheels and driven by one horse. Of particular significance, having its own provision in the Act of 1803, and being material in the overall history of the carriage tax, was the ‘taxed cart’. This was a simple carriage with less than four wheels drawn by one horse only, unsprung, built only of wood and iron without covering or lining, with a fixed seat, plain and unornamented and £12 or less in value. To claim the lower rate it also had to bear conspicuously the words ‘A Taxed Cart’ and the owner’s full name and address in letters at least an inch high painted in white on a black background, or black on a white background, on the back of the cart.19 By 1812 taxed carts with non-metallic springs and of a value of £21 or less, with padded seat and covered footboard paid £2 15s,20 which was significantly less than half the charge for a two-wheeled carriage under the normal provisions.21 This reduced rate of charge for taxed carts, and their subsequent complete exemption from the charge in 1823 and 1825,22 ensured that they became the focus of evasion. Certainly in the years following the exemption appellants challenged assessments to the full two-wheeled carriage tax on their vehicles which would have been considered taxed carts before the repeal, but in most cases the judges refused and, interpreting the provisions in the legislation as to the specification of their construction strictly, demanded the full charge.23 Many two-wheeled carriages were expressly and legitimately built in order to save on the tax, but even then the strikingly strict interpretation of the legislation could disappoint an appellant.24 Cases of attempted evasion were clear, however, with numerous instances of owners of single-horse pleasure carriages simply writing the required information on the cart and seeking to pay the lower duty.25 This led the revenue authorities and the judges to the strictest

18 The National Archives [hereafter TNA] IR 12/1, Case No 715, Town of Cambridge (1832). See too TNA IR 12/1, Case No 7, Middlesex (1823); TNA IR 12/1, Case No 60, County of ­Southampton (1824). 19 House Tax Act 1803 (43 Geo III c 161) Sch D no 4; Assessed Taxes Act 1810 (50 Geo III c 104) s 5. Note that such was the condition of most roads that the suspension of carriages was an issue of great importance to coachbuilders. It was a complicated and evolving science. Suspension was generally a combination of steel springs and leather straps, and it was a matter which was reflected in the provisions for taxation. 20 Assessed Taxes Act 1812 (52 Geo III c 93) Sch D no 4. 21 ibid Sch D no 2. 22 Assessed Taxes Act 1823 (4 Geo IV c 11) s 1; House Tax Act 1825 (6 Geo IV c 7) s 8. See further relaxation of the regulations in Duties on Carriages Act 1832 (2 & 3 Will IV c 82) s 1; Assessed Taxes Act 1833 (3 & 4 Will IV c 39) s 5; Game Laws (England); Local Taxes etc (Scotland) Act 1836 (6 & 7 Will IV c 65) s 2. 23 See, eg: TNA IR 12/1, Cases No 717 and 718, Division of Pershore, County of Worcester (1832); TNA IR 12/1, Case No 713, District of Horncastle and Gartree, County of Lincoln (1832). 24 See, eg: TNA IR 12/3 Case No 2066. 25 Parliamentary Register 1796–1802, 23 March 1798, 410 per William Pitt, Chancellor of the Exchequer.

The Taxation of Road Travel  165 interpretation of the provision relating to the size, position and visibility of the lettering. In most cases which came before them, they denied the exemption on those grounds.26 Ultimately the exemption was ‘so perverted from its original purpose, and occasioned so much petty fraud’27 that it was abolished in 1853.28 The revenue authorities noted with interest in 1857 that nevertheless the practice of writing the name and address of the owner on the cart was continued, though unnecessary.29 It was not merely the vehicle itself which was subject to tax, but the motive power required for its use. In 1784 a stamp duty of 10s was imposed on each horse used for riding or for drawing a dutiable carriage,30 a duty later justified on the same grounds as the carriage tax, namely as a tax on luxury, in proportion to the wealth of the individual. William Pitt, who first introduced the tax, observed that anyone who habitually kept a horse for pleasure would find the duty neither oppressive nor a reason to reduce the number of their stable. Reiterating the orthodox tenets of eighteenth-century taxation, he affirmed that ‘a tax which attached on luxury – a tax which was in proportion to the wealth and fortune of the individual, was the fairest and least objectionable’.31 The tax on horses was included within the carriage tax legislation, and, as with the tax on carriages, additional duties were regularly imposed in the years following its introduction.32 As with carriages, the tax depended on the number of horses owned.33 By 1812 it had risen to £2 17s 6d for one horse, rising to £6 12s for each horse when 20 or more were owned.34 Exemptions from the horse tax began with military and post horses and the stock of horse dealers,35 and gradually others were added, notably horses belonging to the royal family; subject to the stamp duty on post horses; drawing public stagecoaches or licensed hackney coaches in London; the stock of horse dealers; belonging to an individual discharged from the house tax on the grounds of poverty; belonging to clergy on low income or to officers of a volunteer corps or to non-commissioned officers in the regular army.36 These exemptions remained

26 See eg: TNA IR 12/3, Case No 2068, Division of New Forest West, in the County of Southampton; TNA IR 12/3, Case No 2069, County of Worcester, District of Worcester; TNA IR 12/3, Case No 2112, County of Merioneth; TNA IR 12/3, Case No 2113, City and County of Norwich. 27 First Report of the Commissioners of Inland Revenue (1857 sess 1, HC 2199) iv, 65, 101. 28 Land Tax Redemption (Investment) Act 1853 (16 & 17 Vict c 90) Sch D. 29 First Report of the Commissioners of Inland Revenue, above n 27, 65, 101. 30 Duties on Horses Act 1784 (24 Geo III c 31) s 1. 31 43 Parliamentary Register 1780–1796, 8 December 1795, 635. 32 House Tax Act 1803 (43 Geo III c 161). The taxes on windows, inhabited houses, male servants, carriages, horses, mules, dogs, horse dealers, hair powder and armorial bearings were all brought under one Act. 33 Duties on Servants etc Act 1798 (38 Geo III c 41) Sch C; House Tax Act 1803 (43 Geo III c 161) Sch E. 34 Assessed Taxes Act 1812 (52 Geo III c 93) Sch E no 1. 35 Duties on Horses Act 1784 (24 Geo III c 31) s 15. 36 House Tax Act 1803 (43 Geo III c 161) exemptions from Schs E and F nos 1–9.

166  Chantal Stebbings unchanged in 1812.37 Despite a longstanding and widespread concern as to the effect of the tax on farming,38 horses used for agriculture were subject to the duty, starting at 2s in 1797 and rising to 17s 6d in 1812,39 though small farmers were afforded some relief. Sustained complaints eventually led to the tax specifically on husbandry horses being repealed in 1821,40 an exemption largely maintained even by Gladstone on the basis that ‘the case of agricultural horses is strictly analogous to that of steam power in our factories’.41 THE TAXATION OF HIRED ROAD TRANSPORT

From the inception of the carriage tax in the mid-eighteenth century, three express exemptions were directed to hired road transport. These were for post chaises used by the postmaster; public stagecoaches and other vehicles hired out for the carrying of passengers; and licensed hackney carriages in London.42 These reflected the different ways of hiring the means of road locomotion, and they depended principally on the means of the individual. Wealthy individuals owning their own carriage would use their own equipage for shorter journeys. If they wanted to undertake a long journey they would almost invariably use their own carriage and horses for the first portion of the journey and thereafter would hire fresh horses from various posting inns or stations along the route. The use of post horses, however, was expensive, not least because they were subject to tax.43 A stamp duty on post horses was first imposed, with little opposition, in 1779, driven by the exigencies of the American War of Independence. Every postmaster or innkeeper letting horses or carriages out for hire would have to obtain a licence, at the cost of 5s annually, and pay a duty of 1d for every mile each horse was hired to travel, or, if the distance could not be ascertained, 1s.44 The post horse duty was managed by the Stamp Commissioners and administered through a system of pre-paid tickets handed in by the hirer to the tollgate keepers along the route. And just as the inns hiring out post horses had to bear a clear notice that they were licensed to do so, so such carriages had to display the name of the licence holder, and

37 Assessed Taxes Act 1812 (52 Geo III c 93) Sch F exemptions. For an overview of the taxation of trade and farming horses, see FML Thompson, ‘Nineteenth-Century Horse Sense’ (1976) 29 Economic History Review 60, 67–75. 38 See 43 Parliamentary Register 1780–1796, 8 December 1795, 632–33. 39 Assessed Tax Act 1812 (52 Geo III c 93) Sch F no 2. 40 Horse Duties Act 1821 (1 & 2 Geo IV c 110). 41 HC Deb, 18 April 1853, vol 125, col 1410; Land Tax Redemption (Investment) Act 1853 (16 & 17 Vict c 90) exemptions from Schs E and F, nos 2,7,8. 42 National Debt Act 1746 (20 Geo II c 10) ss 7,8,11. 43 See generally, S Dowell, A History of Taxation and Taxes in England, vol 3 (London, ­Longman’s, Green and Co, 1884) 57–61. 44 Taxation Act 1779 (19 Geo III c 51) s 1; Taxation Act 1780 (20 Geo III c 51).

The Taxation of Road Travel  167 their places of departure and destination.45 At the close of the Georgian period, duties on horses let for hire were 7s 6d for the annual licence to let horses for hire, and 1½d per mile.46 It was under these provisions that the taxation of stagecoaches began. Most individuals other than the very poor would use these commercial vehicles for journeys between the major towns, and they were preferred especially when in the early years of the nineteenth century the danger from highwaymen had diminished through the increase of traffic encouraged by the new toll roads and the presence of toll-gate keepers. Stagecoaches improved in speed and comfort from the end of the eighteenth century in response to the introduction of mail coaches, whose purpose was to deliver the mail swiftly and securely, but were permitted to take up to seven passengers each.47 Adhering to strict regulations of time, and privileged in many ways such as not having to stop and pay road tolls, the speed, safety and reliability of road travel achieved by the mail coaches set new standards of road travel. Despite their efficiency, however, mail coaches, travelling mainly at night in all weathers and at top speed, were not a comfortable means of travel for the general public. Stagecoaches were first taxed effectively in 1779.48 Lord North argued that they were proper objects of taxation, and certainly the owners of private carriages perceived it as unfair that they should pay a heavy tax while stage and hackney coaches, often carrying more than a dozen passengers, were daily seen and yet contributed nothing to the public revenue.49 The 400 such chargeable carriages could raise some £2,000 a year.50 The tax met with some opposition on the basis that hired vehicles were not articles of luxury, but ‘very useful modes of conveyance … calculated for the conveniency of the middling and lower orders of people’ as well as being of importance as a means of communication in a manufacturing nation.51 The twofold character of licence duty and mileage duty first imposed on hired carriages carrying up to four persons in 1779 continued in 1783, and it was soon found so productive, having fostered a ‘spirit of competition between the proprietors’, that it was thought the trade could bear an additional rate of one halfpenny per mile.52 The tax was extended and the mileage tax doubled in 1797,53 and by 1798 public stagecoaches bore a duty

45 Taxation Act 1779 (19 Geo III c 51) s 31. 46 Stage Carriages Act 1832 (2 & 3 Will IV c 120) Sch A. 47 See B Austen, ‘The Impact of the Mail Coach on Public Coach Services in England and Wales, 1784–1840’ (1981) 2 Journal of Transport History 3rd series 25–37; D Mountfield, The Coaching Age (London, Robert Hale & Co, 1976) 11, 49–54, 57–65. 48 Taxation Act 1779 (19 Geo III c 51) ss 1, 25–31. See too Duties on Post Horses etc Act 1785 (25 Geo III c 51). See generally: Dowell, History of Taxation, above n 43, vol 3, 42, 46–56. 49 3 Parliamentary Register 1774–1780, 24 April 1776, 479. 50 ibid 480. 51 ibid 485 per Governor Johnstone. 52 10 Parliamentary Register 1780–1796, 26 May 1783, 71; Stage Coach etc Duty Act 1783 (23 Geo III c 63). 53 Stage Coach Duties Act 1796 (37 Geo III c 16) s 1.

168  Chantal Stebbings of £8 8s.54 The tax continued into the new century in its twofold nature. Plates would not be issued for a stage carriage unless the licence had been purchased. The licence was to be renewed every year, specifying the number of miles, and the mileage duty was charged accordingly at the rate then in force. At the close of the Georgian period the duty was levied under a comprehensive Act of 1832 at a rate of £5 for the licence, 1s for each supplementary licence, and a mileage duty which depended on the number of passengers the stagecoach was licensed to carry, ranging from 1d per mile for four passengers, to 4d per mile for between 10 and 21 passengers.55 London had its own infrastructure of vehicles for public hire, with hackney coaches operating from the early seventeenth century.56 These were general utility horse-drawn vehicles available to all passengers who could afford it to hire one with a coachman in the street. They increased so much in popularity that by the 1630s the practice was regulated by law through the issue of a limited number of licences, ensuring that the city did not become too crowded with coaches, until a tax was imposed by an Act of 1694, building on the system of licences.57 The duty, the oldest of the taxes on locomotion, comprised a £50 initial fee for a licence for the proprietor and a £4 annual charge thereafter.58 The Act allowed up to 700 licences to be issued, and each licensed hackney coach had to display a ‘Mark of Distinction by Figure or Otherwise’ on each side.59 In the early eighteenth century, when some 800 hackney carriages were allowed to be licensed, the duty was regarded as one of the principal direct taxes. In 1797 the revenue from hackney coaches was £26,000 gross per annum.60 The rates and limits were revised regularly by Act of Parliament and the legislation amended to include new types of hired carriages, notably the smaller cabriolets or ‘cabs’.61 The restriction on numbers made the licence a valuable privilege, but, the limit having risen to 1200 in 1831,62 it was finally abolished in 1833.63 The annual licence cost £5, with a weekly duty of 10s64 raising over £45,000 a year in 1833. The revenue authorities kept a register of hackney coaches, and the names and addresses of owners and numbers. They issued a numbered plate to

54 Duties on Servants etc Act 1798 (38 Geo III c 41) Sch B. See too House Tax Act 1803 (43 Geo III c 161) Sch D no 3. 55 Stage Carriages Act 1832 (2 & 3 Will IV c 120) Sch A. 56 For the early history of hackney coach regulation, see Jackman, Transportation in Modern England 115–32; Dowell, History of Taxation, above n 43, vol 3, 40–45. 57 Hackney Coaches etc Act 1694 (5 & 6 W & M c 22). 58 ibid s 3. 59 ibid s 5. See too Hackney Coaches etc Act 1710 (9 Anne c 16) ss 1–24. 60 Eleventh Report from the Select Committee on Finance, Hackney Coach Office (1797) 108 Eighteenth Century House of Commons Sessional Papers 351. 61 Hackney Carriages Act 1815 (55 Geo III c 159) s 2. 62 London Hackney Carriage Act 1831 (1 & 2 Will IV c 22) s 8. 63 ibid s 9. 64 ibid Sch A.

The Taxation of Road Travel  169 each carriage they licensed, and without that plate no carriage could ply for hire in public streets.65 The outstanding feature of the taxation of hackney carriages was that it had its origins in the regulation of the trade, and regulation rather than revenue characterised the entire regime and the fiscal apparatus created to collect the tax. It was not in the mould of usual excise regulation of a commercial activity, where the regulation existed to facilitate the taxation. In the case of the hackney carriage duty, the tax was imposed in order to facilitate the regulation. It was clear from the creation of the Hackney Coach Office in 1694 that it would have a dual function.66 The variety of duties was made clear in an Act of Anne in 1710, covering the issue of licences, the collection of revenue, the making of byelaws to regulate the proprietors and the trade, and adjudication as a court on complaints and offences against the regulations.67 It was observed in 1797 that the office partakes both of the Nature of a Revenue Office and an Office of Police; First, in granting Licences and receiving the Duties thereupon; and Secondly, in regulating the Conduct of the Hackney Coachmen and Chairmen, and in hearing and determining any Complaint that may be made.68

The Hackney Coach Commissioners’ power to make byelaws to regulate the trade constitute a potent affirmation of the extraordinary regulatory nature of this particular revenue board. These byelaws were controlled and yet given status and authority by being subject to the approval of the Lord Chancellor and the Chief Justices. They were to be printed and made public and displayed in the office of the Commissioners, and even though it appears that the byelaws themselves were used for a relatively short period of time before they fell into disuse in the last quarter of the eighteenth century, they accurately reflect the nature of the Commissioners’ duties. Their final iteration, in 1771, written by the five Commissioners then in office and duly authorised by the judges, comprised 15 byelaws addressing such topics as the specification of construction of coaches, the fines for failure to display the licence plates correctly, specifying certain areas in London where they were forbidden to stand or ply for hire and imposing fines for any kind of obstruction, summons to appear before the Commissioners, prohibiting anyone other than the driver and passengers from riding on the coach, allowing the charging only of the fares permitted by statute, allowing his licence plate number to be noted, fines for insulting the Commissioners, explaining the process for revocation of licences by the Commissioners, the lastmentioned power constituting a powerful element in their regulatory authority.69



65 ibid

s 7.

66 Hackney

Coaches etc Act 1694 (5 & 6 W & M c 22) s 2. Coaches etc Act 1710 (9 Anne c 16) ss 1–24. 68 Eleventh Report from the Select Committee on Finance, Hackney Coach Office, above n 60, 337. 69 ibid 352–56 (app C2). 67 Hackney

170  Chantal Stebbings Their duties were thus wide-ranging, going far beyond management of the revenue. The Commissioners were under a duty to ensure that all the permitted licences were issued, in order to maintain the revenue, but it was equally their duty to select, in their weekly meetings, the most suitable individuals to be the recipients of a licence to give the best service to the public, enquiring into the character, means, suitability and experience of the applicants. They also heard and determined complaints against the drivers and fined them for ill conduct and had the power of imprisonment for the non-payment of fines, a summary jurisdiction they shared with the magistrates.70 The great majority of cases went to them rather than the police magistrates, and they heard some 40 or 50 cases each week.71 The Commissioners had to ensure that carriages were weathertight and clean, and the horses fit and sound, and to this end they employed and managed a number of inspectors who went to the proprietors’ stables to check on the condition of the coaches to ensure they were strong, weatherproof and clean, and the horses to ensure they were fit and able, and out on the street to ensure the horses were not treated cruelly, and reported weekly to the Commissioners.72 Indeed, when Edward Jesse was appointed Commissioner in about 1814 he was ‘told at the Treasury, it was expected I should take an active part in improving the condition of the hackney coaches’, and to that end he was involved in the drafting of new legislation and the instructions to the inspectors.73 THE CHALLENGES TO REVENUE AND REGULATION

The taxes on road transport, both private and hired, which were in operation throughout the Georgian period were entirely suited to the social, cultural, economic and fiscal values of the time. The objectives of the taxes were clear: the assessed taxes on carriages and horses were unambiguously intended to raise revenue, while those on hired transport had a dual purpose of revenue and regulation of the trade, a twofold character particularly striking in the case of hackney carriages in London. These taxes, though epitomizing Georgian values, were soon showing signs that they would be too fragile to withstand the challenge of the rapidly changing technical, economic and social conditions, as well as the evolution of fiscal ideas, which were developing at the dawn of the Victorian age. The code of Georgian road transport taxation faced three principal challenges in this respect. The first challenge lay in a growing tension between social and cultural changes and the underlying principle of the taxes on road transport. By the end of the Georgian period the taxes on road transport were well on their way

70 Report from the Select Committee on the Hackney Coach Office (1830, HC 515) x, 301, 307–10. 71 ibid

333 per Edward Jesse, Hackney Coach Commissioner. 323–27, evidence of William Hill, Inspector. 73 ibid 327. 72 ibid

The Taxation of Road Travel  171 to having lost their original raison d’etre. The notion of carriages as luxuries to be taxed within the orthodoxy of commodity taxation was no longer selfevident by the 1830s, and by the 1860s, when the sustainability of the taxes was being seriously questioned, it was clear that it was the culmination of a long-standing problem. For example, the post horse duty was recognised as ‘indefensible, the duty too onerous in its amount, and … very unequal in its distribution’.74 Accordingly in 1853 the mileage duty was replaced by an excise licence duty on the postmasters, which varied according to number of horses and carriages kept, a reform which left the revenue unaffected but made its administration more efficient.75 Nevertheless, criticisms persisted. It was said in 1857 that the duty was ‘very difficult to charge, in consequence of the altered state of circumstances which new modes of travelling had introduced. The regulations, too, were troublesome to the Postmaster without effectually ­securing the duty’.76 In alluding to the obsolescence of the post horse duty in 1869, the Chancellor of the Exchequer, Robert Lowe, observed that it was justifiable when it fell almost exclusively on the wealthy, ‘when every gentleman travelled in his own carriage, and post horses were the means of locomotion’.77 Now, however, he continued: The change in human affairs has brought things round to the contrary; the tax is not paid by the rich at all, it is not paid by people who drive their own carriages – people now seldom drive their own carriages, except with their own horses – the tax is paid mainly by the middle classes – by those who travel for the purposes of trade, or who employ flys and carriages for short journeys into the country …78

Similarly the tax on stagecoaches was originally ‘a sumptuary tax paid by the richer classes, and as such was a legitimate source of revenue’.79 But again the incidence of the tax changed, and it was not the rich who used omnibuses, but rather the working classes travelling from their homes to their workplaces in the inner cities. So while it could be stated with confidence that ‘luxuries of all kinds ought to be taxed’,80 it was equally understood that ‘cheap locomotion [was] one of the greatest boons that could be conferred upon the public’.81 William Gladstone, when Chancellor of the Exchequer in 1866, was prepared to consider reducing the duties on public hire carriages because they were becoming ‘instruments of almost indispensable use’ to a large proportion of society.82 The cheap conveyance of workers – increasingly driven out of London by rising 74 HC Deb 18 April 1853, vol 125, col 1411 per William Gladstone, Chancellor of the Exchequer. See too Tenth Report of the Commissioners of Inland Revenue (1866, HC 3724) xxvi, 133, 144. 75 Duties on Horses Let for Hire Act 1853 (16 & 17 Vict c 88). 76 First Report of the Commissioners of Inland Revenue, above n 27, 65, 80. 77 HC Deb 8 April 1869, vol 195, col 396. 78 ibid. 79 HC Deb 11 May 1863, vol 170, col 1559 per Mr Ayrton. 80 ibid col 1566 per Mr Bentinck. 81 ibid per Mr Coningham. 82 HC Deb 3 May 1866, vol 183, col 384.

172  Chantal Stebbings property prices – was essential to the economy. ‘[T]he tax on locomotion’, he said, ‘considered as a tax on the labouring part of the community, is in the severest and crudest sense a tax of the raw material of industry’.83 The social obsolescence of the taxes on road transport was exacerbated by their archaic nature. Throughout the Georgian period there was an inexorable increase in the technicality, detail and volume of the statutory and administrative tax codes. This was a problem which arose with all the commodity taxes whose codes were constructed piecemeal from the mid-eighteenth century, and it was a problem which ultimately led to a decline in the yield through increased opportunities for evasion and legal challenge. The road transport taxes suffered from this inevitable consequence of an archaic tax code. By the early nineteenth century, despite being straightforward in terms of legal interpretation, raising few difficult or important questions, this body of law and regulation had become complex and detailed and the constant attempts at evasion made its administration time-consuming and expensive. It has been seen that it depended on a close observation of the physical characteristics of the vehicle, namely the number of wheels and horses, and the building specification, and all were integral to the charge, but then the mechanics and materials of the suspension, the size of the wheels, of the horses and of various mechanical components of the vehicle all became relevant.84 The cases on the carriage tax determined by the regular courts show that the construction of the vehicles was a matter of constant dispute, and that the carriages were viewed and closely examined by the Commissioners themselves to see whether they came within a provision or exemption in the legislation, and appeals from their decisions were common.85 By the close of the Georgian period the carriage tax provisions were detailed and overlapping, the legislation on taxed carts being the embodiment of obscurity, and it was difficult for individuals to know whether they were taxable or not, and at what rate. Inevitably this also provided great opportunities for evasion leading, observed Sir George Strickland in 1852, ‘to deception and immorality’.86 For example, the exemption for carriages with small wheels and drawn by mules or ponies had been introduced to benefit the poor, and yet it was common to see newspaper advertisements for ‘brilliant pony equipages under tax’87 and ‘under-tax equipages’.88 Similarly, the exemption for carts was abused because all that was necessary was to show

83 ibid col 385. 84 See eg, the Duties on Carriages Act 1832 (2 & 3 Will IV c 82) s 1 (1) which included the minutiae of the charge, as for example, the regulation as to the non-metallic composition of the springs permitted ‘iron tips, caps, or swivels, each not exceeding three inches in length, and painted of a different colour’ at the end of the springs. 85 See, eg: TNA IR 12/1, Case No 491, County of Surrey, Hundred of Wallington (1830). 86 HC Deb 17 February 1852, vol 119, col 693 per Sir George Strickland. 87 ibid col 688 per Sir de Lacy Evans. 88 HC Deb 12 April 1853, vol 125, col 1035 per Sir de Lacy Evans.

The Taxation of Road Travel  173 a receipt from the coachmaker for £21 and the owner’s name painted on the back for the exemption to be claimed. In practice a cart could not be built for so little, but this could be addressed by a variety of arrangements, such as selling a £40 cart for £21 and charging £19 for the whip.89 Similarly the exemption for vehicles bona fide used solely in the course of trade or husbandry, as long as they were marked with the name and address of the owner, was open to abuse, and surveyors were instructed to pay ‘particular attention’ to such carriages, ‘many persons keeping them may make the conveyance of goods in the way of their trade or business a pretext for riding therein at all times and on all occasions’.90 The horse tax took complexity to the extreme, having become ‘entirely founded on exemptions’ and as such ‘exceedingly difficult and ­inconvenient to levy’.91 The second challenge to the Georgian taxes lay in the changing nature of domestic transport. Road transport, particularly hire vehicles, did not keep pace with the development of steam-powered locomotion. The introduction of the railways in the 1830s would prove an almost overwhelming challenge to animalpowered road transport, and, quite apart from issues of speed, convenience and cost, the disproportionate rate of taxation on road transport was a matter of widespread complaint and debate. There was a significant and seemingly intractable inequality between the light taxation of steam-powered transport and a heavy tax burden on animal-powered transport. This was recognised as early as 1837 by a Select Committee on Internal Communication,92 but although the abolition of all taxes on public conveyances was recommended, the pressure for revenue was too great, and no meaningful action was taken. The assessed taxes on private carriages and horses, the post horse duty on hired horses, the duty on hired carriages, the postmaster’s licence duty, the stagecoach mileage and licence duties, and the assessed taxes on coachmen and guards all continued and amounted to a heavy tax burden. Stagecoaches in particular suffered from competition from the railways from the 1830s. Their tax burden had always been heavy, with duties on the licence and any supplementary licences to enable them to vary their routes, and with a mileage duty depending on the number of passengers stagecoaches were licensed to carry, whether the coach were full or empty. Railways, on the other hand, were charged duty on passengers conveyed which not only was lower, but was charged on the actual number conveyed. No alteration was made until 1842 when the licence duty on stagecoaches was reduced to 3 guineas, the supplementary licence set at 5s and the mileage duty to 1½d a mile irrespective of the number

89 HC Deb 17 February 1852, vol 119, col 689 per Sir de Lacy Evans. 90 Instructions to Surveyors on that Part of their Duty which relates to Taxes (London, HMSO, 1855) 107. 91 HC Deb 23 April 1874, vol 218, col 1017 per Sir Stafford Northcote, Chancellor of the Exchequer. 92 Report from the Select Committee on Internal Communication Taxation (1837, HC 456) xx, 291, 293.

174  Chantal Stebbings of ­passengers conveyed.93 Nevertheless it was clear that the impact of taxation was such that stagecoach enterprise was unsustainable in the face of competition with the railways94 which enjoyed ‘a great pecuniary advantage’,95 and stagecoaches were in sharp decline by 1840. The immense difficulties faced by the stagecoach proprietors were explained in a pamphlet published by the Committee for the Abolition of the Present System of Taxation on Stage Carriages in Great Britain in 1854, presenting a body of compelling evidence for the repeal of the tax.96 The omnibuses, which worked under the stagecoach legislation, paid the stagecoach duty of 4½d a mile on each horse, which was regarded as excessive by the proprietors of London omnibuses. As early as 1830 the proprietor of six omnibuses in London complained that he paid ‘very heavy duties to government’, some £2,000 a year.97 In their annual report for 1866, the Commissioners of Inland Revenue alluded to the accounts of the London General Omnibus Company, which showed that the duty absorbed some 44 per cent of their profit, while that imposed on the railway companies absorbed only 2.4 per cent.98 By the early 1860s railways on average paid some 5 per cent duty on their gross earnings while stagecoaches paid nearly double.99 The conflict between the stagecoaches and the railways on the point of taxation was brief, however, for the former were doomed and even putting stagecoaches on an equal footing in tax terms with the railways was not going to save them. So while the Chancellor of the Exchequer admitted in 1839 that the inequality in taxation was unjust, ‘an interference with the fair spirit of commercial competition’,100 and promised a bill, he was careful to caution that the inherent advantages offered by railways of speed, cheapness and comfort would inevitably cause coach transport to decline.101 And as Sir Robert Peel observed, if the inequality of taxation were to be addressed, then ‘the older description of vehicles must fairly take their chance of suffering by the introduction of other modes provided by the progress of science’.102 But what a reduction in the tax could have achieved was to enable stagecoaches to service those routes untouched by railways, and short routes to and from railway termini in the country. The difficulty of feeder transport from country railway stations was 93 Railway Passenger Duty Act 1842 (5 & 6 Vict c 79). By the Inland Revenue Act 1855 (18 & 19 Vict c 78) the duty was reduced to 1d a mile and the duty on supplementary licence to 1s. 94 See generally: EA Pratt, A History of Inland Transport and Communication in England (London, Kegan Paul, Trench, Trubner & Co Ltd, 1912) 329–34. 95 HC Deb 21 February 1839, vol 45, col 721 per Mr Gillon. 96 JE Bradfield, Observations on the Injustice, Inequalities and Anomalies of the Present System of Taxation on Stage Carriages in England, Scotland and Wales (London, Committee for the Abolition of the Present System of Taxation on Stage Carriages in Great Britain, 1854). 97 Report from the Select Committee on the Hackney Coach Office, above n 70, 301, 364 per George Shillibeer. 98 Tenth Report of the Commissioners of Inland Revenue, above n 74, 133, 143. 99 HC Deb 11 May 1863, vol 170, cols 1556–58. 100 HC Deb 21 February 1839, vol 45, col 729 (21 February 1839) per Thomas Spring Rice. 101 ibid col 730. 102 ibid col 735.

The Taxation of Road Travel  175 notorious, and to this extent the traditional taxes on road transport served to limit public access to new modes of transport. It was a common problem to travel from the railway stations to the town or residence. If no licensed hire vehicle were available, no one else would be willing to carry passengers for fear of the incidence of the post horse duty. Thus individuals without their own carriages, or beyond walking distance, were deprived of free access to the smaller railway stations in particular. The third major challenge to the Georgian taxation regime applicable to road transport concerned the admixture of revenue-raising and regulatory duties in the revenue boards governing hackney carriages in London. Their statutory powers and byelaws amounted to enforcing a monopoly in the individuals they licensed which in turn safeguarded their revenue. The ‘multiplicity of functions’103 in the revenue boards in this respect persisted throughout the Georgian period, but by its close its desirability was already beginning to be questioned. The revenue powers, namely to issue the licences and numbered plates to hackney carriage proprietors, were firmly retained in the revenue boards throughout the period and beyond. The Hackney Coach Commissioners were in charge of the hackney coach tax until the board was abolished in 1830, at which point the management of the duties was, in the interests of economy and efficiency, passed to the Board of Stamps.104 The seat of the regulatory powers, however, was less secure, not because the regulatory and taxation functions were viewed as theoretically incompatible, but on the practical ground that regulation appeared to be failing. Within the metropolis, it was clear that the rigid and detailed regulation of hackney carriages made them unable to respond to commercial pressures and thus vulnerable to competition from other vehicles which the public preferred. The system of licensing allowed for no flexibility whatever in the operation of the trade. A hackney coach, once licensed, had to be available to the public for hire for the period stated on the licence, whether the city was crowded in spring or empty in autumn, whether the weather was fine or wet. The cost of the licence was soon recouped when the coachman was working, but, as a fixed sum, could be an onerous burden where the coachman could not find sufficient trade. And this was often the case. The large number of licensed coaches, the competition from short-distance stagecoaches, the faster cabs, and from the taxed but largely unregulated one-horse carriages known as flys, the prohibition on transferring licence plates to other more suitable vehicles an owner might prefer, for example to suit differing weather or passenger conditions in a highly seasonal trade, the high cost of the licence, the large capital investment needed to set up in business and to ensure coaches were modern and kept clean with sound horses: all these

103 Report of the Departmental Committee of Inquiry into Cab Service of the Metropolis (1895, HC 7607) xxxv 1, q 9150. 104 London Hackney Carriage Act 1831 (1 & 2 Will IV c 22) s 7.

176  Chantal Stebbings factors resulted in hackney carriage businesses struggling to survive towards the end of the Georgian period. This was exacerbated by the economic depression of the 1820s, as Londoners were less able to afford the luxury of hackney coach travel. The principal challenge facing the tax on hackney carriages thus emerged as one of commercial viability, and an increasing realisation that the incidence of the tax worked against the needs of the public. Certainly when a Select Committee of 1830 recommended the transfer of the duties of the Hackney Coach Office insofar as they related to the collection and management of the revenue, to the Stamp Office, it was ostensibly in the interests of economy, but also to ensure that the regulatory function was exercised more efficiently and regularly.105 Accordingly, by an Act of 1831 the Stamp Commissioners took over the power and duty to licence the hackney proprietors and to issue the plates,106 but, significantly, they did not inherit the regulatory powers of their predecessors in the Hackney Coach Office. The Act laid down the code of regulation, including provisions as to correct display of licensed status, consequences of failure to obtain and display a licence, conduct of drivers in relation to passengers, correct fares and rates to be charged, the procedures to deal with lost property, the rules to avoid causing obstruction, the regulation of stands, and the misbehaviour of drivers. However, the jurisdiction to adjudicate as to offences against the provisions of the Act was given to a Metropolitan Justice of the Peace appointed for that purpose by the Home Secretary.107 This addressed a concern that the Hackney Coach Commissioners had insufficient powers to compel offenders against the regulations from appearing before them, or to punish them, and the public concern that they were only available once a week to hear and determine complaints.108 Despite a widely acknowledged growing social, cultural and fiscal obsolescence, reform, let alone abolition, was resisted by successive administrations and was, accordingly, slow. Reforms to reduce and simplify the taxes on private road vehicles began towards the end of the Georgian period, with a reduction in the carriage tax by half in 1823109 and again in 1832 for certain two-wheeled carriages,110 and the abolition of the progressive rate in 1853,111 but material simplification was introduced only in 1869 when a comprehensive review was undertaken, the taxes were abolished as assessed taxes and converted into excise licences to ensure the greater efficiency of administration which would result 105 Report from the Select Committee on the Hackney Coach Office, above n 70, 301, 303. 106 London Hackney Carriage Act 1831 (1 & 2 Will IV c 22) s 7. Note that from 1838 the drivers were to be separately licensed, and this was the function of the newly created Registrar of Metropolitan Public Carriages appointed by the Secretary of State: Hackney Carriages, Metropolis Act 1838 (1 & 2 Vict c 79) s 4. 107 London Hackney Carriage Act 1831 (1 & 2 Will IV c 22) s 62. 108 Report from the Select Committee on the Hackney Coach Office, above n 70, 301, 304, 328. 109 Assessed Taxes Act 1823 (4 Geo IV c 11) s 2; Duties on Carriages Act 1832 (2 & 3 Will IV c 82). 110 Duties on Carriages Act 1832 (2 & 3 Will IV c 82) s 1(1). See too Game Laws (England); Local Taxes etc (Scotland) Act 1836 (6 & 7 Will IV c 65). 111 Land Tax Redemption (Investment) Act 1853 (16 & 17 Vict c 90).

The Taxation of Road Travel  177 from official as opposed to lay administration.112 New duties on carriages were introduced.113 The definition of a carriage was simplified to include any vehicle drawn by a horse or mule, except vehicles used solely for trade or husbandry and duly marked with the name and address of the owner.114 As Stephen Dowell observed, the tax on carriages had now attained a ‘sweet simplicity’ in the use of the word ‘vehicle’ to include every description of carriage, but had lost something in ‘historical picturesqueness’.115 The old distinctions regarding the number of horses used in drawing a carriage and the diameter of the wheels were abolished and the number of wheels and overall weight became the sole determinants of the charge. The tax on horses was settled in 1869 at a uniform rate of 10s 6d116 on the basis, explained the Chancellor of the Exchequer, that horses are the very life and soul of locomotion, and will continue to be so until they are supplanted by velocipedes. I think we cannot do more to advance our object, which is to advance the free circulation of Her Majesty’s subjects, than we shall do by reducing the duty on horses …117

The tax was abolished only five years later, primarily in the interests of small traders such as brewers who still used horses extensively. The taxation of hire vehicles was not radically reformed initially, despite the magnitude of the challenges facing the trade. Reforms took the form of a reduction in the rate of duty on a number of occasions in the 1850s and 1860s, and only in 1869, over 30 years since the damaging effect of the tax had been revealed, were both elements of the duty repealed, the same year that saw the repeal of the post horse duty.118 Robert Lowe saw his comprehensive reforms of 1869 as not merely achieving a reduction in taxation, but as overcoming material obstacles to locomotion more generally. His reforms, a mixture of abolition, reduction, simplification, restructuring, were, he said, ‘an enormous blessing’, which ‘set men at liberty’.119 Successive administrations were best attuned to the problems arising from the hackney coach duty, possibly because the physical proximity of the hackney system to the political and fiscal institutions of the country made legislators and policymakers all too aware of the appalling state of London’s hire carriages. The Inland Revenue Commissioners’ statement in 1866 that the London hackney carriages were ‘a disgrace to the metropolis of a great empire’120 reflected a longstanding view. The condition of the carriages and horses, and the ignorance of the drivers, had long been notorious. Despite a reduction of the hackney 112 Revenue Act 1869 (32 & 33 Vict c 14) s 16. 113 ibid s 18. 114 Revenue Act 1869 (32 & 33 Vict c 14) s 19(6). 115 S Dowell, A History of Taxation and Taxes in England vol 3, 2nd edn (London, Longmans, Green & Co, 1888) 206. 116 Revenue Act 1869 (32 & 33 Vict c 14) s 18. 117 HC Deb 8 April 1869, vol 195, col 395. 118 Revenue Act (32 & 33 Vict c 14) s 17. 119 HC Deb 8 April 1869, vol 195, col 398. 120 Tenth Report of the Commissioners of Inland Revenue, above n 74, 133, 145.

178  Chantal Stebbings carriage duty from £5 on the annual licence to £1, and the weekly duty from 10s to 7s in 1853,121 the rate was still regarded as high and this, combined with fares fixed by statute meant that it was almost impossible for proprietors to recoup their outlay on taxes, let alone make a profit in their business. Inevitably the condition of the carriages and cabs suffered, with dirty and dilapidated vehicles and unsound horses. It was self-evident that the revenue boards had been unable to regulate the trade effectively, and the removal of regulatory powers from the revenue boards effected at the end of the Georgian period evolved into a definite policy to put such powers into the hands of the Metropolitan Police. This was a policy which was met with some concern in the House of Commons,122 but was promoted by the revenue boards, who understood that the problem lay not with the tax itself, but with inflexible regulation and the resulting lack of competition. The first step was in 1850 when the police were empowered to license the drivers of hackney carriages,123 and a material development occurred in 1853 when it was provided that the police should inspect the condition of all hackney carriages and horses and issue a certificate of fitness which would be a prerequisite to the revenue board’s issuing of the proprietors’ licence.124 The end of the revenue boards’ involvement with the hackney carriage trade, and the effective end of the hackney carriage tax itself, occurred in 1869 when the Chancellor of the Exchequer, having announced that the taxation of hackney carriages could not ‘be defended logically or reasonably’,125 repealed the tax entirely ‘as a matter of justice’, and from then on the hackney carriages were subject only to the significantly lower carriage tax.126 All licensing and regulatory functions were passed to the Home Secretary, acting through the Public Carriage Office and delegated to the metropolitan police.127 The tax became a significantly diminished licence fee, set by the Home Secretary at £2, with a 15s duty which was paid to the Metropolitan Police Fund. The duty was therefore no longer part of the imperial revenue,128 and hackney carriages were managed entirely by the Metropolitan Police. The reason for the reluctance to reform, and the implementation of change well after the taxes were demonstrably failing to reflect changing conditions, lay in purely fiscal imperatives. There was a widespread view that assessed

121 London Hackney Carriage (No 2) Act 1853 (16 &17 Vict c 127) s 2. 122 HC Deb 19 May 1853, vol 127, cols 422–29. 123 By the London Hackney Carriages Act 1850 (13 & 14 Vict c 7) all the powers of the Registrar of Public Carriages were transferred to the Commissioner of Metropolitan Police acting under the authority of the Secretary of State. 124 London Hackney Carriage Act 1853 (16 & 17 Vict c 33) s 1. 125 HC Deb 8 April 1869, vol 195, col 395. 126 Revenue Act 1869 (32 & 33 Vict c 14) s 17. 127 Metropolitan Public Carriage Act 1869 (32 & 33 Vict c 115). 128 Report of the Departmental Committee of Inquiry into Cab Service of the Metropolis, above n 103, 1, q 5757.

The Taxation of Road Travel  179 taxes were useful in that, with their inherent character of taxation according to means, they ensured comprehensive taxation. Articles of consumption were taxed and thereby the poor contributed to the expenses of the state, and land was taxed so as to ensure the rich contributed, while personal property remained untaxed other than through the assessed taxes.129 For example, such reasoning appealed to the Chancellor of the Exchequer in the early 1850s and led him to assert that he would neither abolish nor greatly simplify the carriage tax,130 despite clear problems with its administration, and a vigorous campaign against the tax by the coachmakers, who claimed their business was depressed by the effect of the tax. Above all, however, the yield was too significant for any government to relinquish without the most compelling reason. Such a buoyant activity as road travel, undoubtedly sustained and clearly increasing, constituted an obvious and attractive source of revenue to any government. At the end of the Georgian period, road transport was enjoying unprecedented prosperity. The ownership of private carriages was higher than ever and there was a growing demand for public hire travel about the country and within towns, not least the metropolis. The golden age of cross-country coaching was at its peak in the 1820s and 1830s, though admittedly about to decline dramatically, and the trade in horse-drawn hire vehicles in London would continue to grow throughout the nineteenth century until the advent of the omnibus and then the motorcar. As a result, the tax yield remained constant. In the 1850s the carriage tax was yielding a small but significant and, more importantly, consistent amount of revenue, in the region of £300,000 a year arising from over 90,000 carriages.131 The horse duty was yielding slightly more132 and by 1860 the duties on hackney carriages were yielding over £80,000 a year and, showing a slight increase, with stage carriages producing over £125,000 a year133 though set to decline further. CONCLUSION

Few British taxes demonstrate with greater clarity the changing nature of society and of taxation in the country’s transition to an industrial economy than the taxes on travelling by road. These taxes were imposed as the orthodox fiscal response to a new and popular social activity. For the whole of the ­Georgian

129 This explained Gladstone’s reluctance to abolish the assessed taxes at a time when the future of income tax was in doubt: see HC Deb 23 April 1874, vol 218, cols 1001–02. 130 HC Deb 17 February 1852, vol 119, col 690 per Charles Wood, later Viscount Halifax. 131 First Report of the Commissioners of Inland Revenue, above n 27, 65, 99. See too Third Report of the Commissioners of Inland Revenue (1859 sess 2, 2535) xiv, 451 476; Fourth Report of the Commissioners of Inland Revenue (1860, 2735) xxiii, 235, 252. 132 First Report of the Commissioners of Inland Revenue, above n 27, 65, 99. 133 Fourth Report of the Commissioners of Inland Revenue, above n 131, 235, 237.

180  Chantal Stebbings period, road transport was steadily increasing in volume, and its taxation epitomised conventional notions of taxing outward and generally accurate signs of wealth, often locally administered with minimal inquisitorial processes, and essentially voluntary in nature, in that road transport was regarded as a luxury which was not necessary to life, health or wellbeing. The regime, encompassing taxes on private carriages and horses, and hire vehicles such as post chaises, stagecoaches and hackney coaches, comprehensively addressed the entire activity and yielded a consistent and worthwhile revenue. Their administration was relatively though not entirely straightforward, raising few legal issues of any complexity, and evasion was extensive but limited to the abuse of a small number of very specific exemptions. The taxes on road transportation in the Georgian period embodied the guiding principles of taxation policy and practice which had dominated British taxation for over a hundred years. The orthodox model of taxation struggled to maintain its efficiency, effectiveness and popular acceptance because, unlike other commodity taxes, those on road transport faced an irresistible challenge arising from an exceptionally dynamic field of operation from the 1830s. It was revealed as inappropriate in social and fiscal terms. The inadequacy was primarily twofold – the first, which was common to all the Georgian commodity taxes and due to a combination of technical advances in coachbuilding and legislative apathy, was that the tax code was too complex, outdated and open to evasion. The second, which was peculiar to hire vehicles and of far more profound significance to the underlying principle of commodity taxation, was that cheap and accessible public transport was understood to be a social and economic necessity and not a luxury. As a result of new social and economic working and housing conditions, ease of access to locomotion had become of real social importance by the 1860s. It was this political realisation that the old system of road transport taxation was unable to withstand and which by the final quarter of the nineteenth century had overcome the fiscal imperatives and the traditional favouring of the status quo in tax matters that had kept such taxes, however unsuitable and commercially damaging they might be, within the national portfolio of taxes for a century.

7 Deduction of Expenses of Management RICHARD THOMAS

ABSTRACT

This chapter is about a particular type of relief for expenses given only to ­companies. The legislation giving the relief was enacted in 1915 as part of what would now be labelled a ‘package of measures’ dealing explicitly for the first time with the taxation of companies carrying on life assurance business. But unlike the other sections of the Finance Act 1915 in the package, the relief was not limited to such companies. The chapter explains the background to the relief and in particular the pressures that were brought to bear on ministers to enact it and how other companies got included. It goes on to consider how the legislation enacted in 1915 was interpreted by those having to operate the system, and the cases and legislative changes that resulted. THE ORIGINS OF EXPENSES FOR COMPANIES 1803–42

A

lthough this chapter is about a relief for certain expenses of ­companies that was first sought in 1910 and enacted in 1915, to put the issue in context it is necessary to go back to the nineteenth century. For convenience the Income Tax Act 18421 is taken as the starting point, as it was hardly changed from the Income Tax Act 1806,2 which in turn was, in relevant respects, very similar to Addington’s 1803 Act.3



1 5

& 6 Vict c 35 (the 1842 Act). Geo 3 c 65. 3 43 Geo 3 c 122. 2 46

182  Richard Thomas It is a feature of the 1842 Act that neither companies nor expenses feature at all prominently in the substantive parts of the Act. Companies were liable to pay income tax,4 as section 40 of the Act made clear: And be it enacted, That all Bodies Politic, Corporate, or Collegiate, Companies, Fraternities, Fellowships, or Societies of Persons, whether Corporate or not ­Corporate, shall be chargeable with such and the like Duties as any Person will under and by virtue of this Act be chargeable with, …

In the Rules of the first case of Schedule D to the Act it was explained further that: Second. – The said Duty shall extend to every Person, Body Politic, or Corporate, Fraternity, Fellowship, Company, or Society, and to every Art, Mystery, Adventure, or Concern carried on by them respectively, in Great Britain or elsewhere, as aforesaid; except always such Adventures or Concerns on or about Lands, Tenements, Hereditaments, or Heritages as are mentioned in Schedule (A.), and directed to be therein charged:

Section 54 of the 1842 Act explained how the returns of companies were to be made.5 In these provisions there is nothing that distinguishes companies from individuals except for the mention of dividends in section 54. Thus all the computational rules set out in the Schedules to the Act applied with equal force to companies as to individuals. As to expenses, it was a curious feature of the 1842 Act that it is almost entirely implicit that in computing the profits of a trade or profession under Cases I or II of Schedule D, expenses could be taken into account. What was charged on a person under the first Rule of Case I was the duty (ie income tax): on a Sum not less than the full Amount6 of the Balance of the Profits or Gains of such Trade, Manufacture, Adventure, or Concern...

The third Rule tells us: In estimating the Balance of Profits and Gains chargeable under Schedule (D.), or for the Purpose of assessing the Duty thereon, no Sum shall be set against or deducted from, or allowed to be set against or deducted from, such Profits or Gains, on account of …

There then followed a long list of the non-deductible matters. 4 See J Avery Jones, ‘Defining and Taxing Companies’ in J Tiley (ed), Studies in the History of Tax Law, vol 5 (Oxford, Hart, 2011). 5 ‘And be it enacted, That every such Officer before described of any … Company … shall … prepare and deliver … a true and correct Statement of the Profits and Gains to be charged on such … Company, … computed according to the Directions of this Act, together with such Declaration of the Manner of estimating the same as aforesaid; and such Estimate shall be made on the Amount of the annual Profits and Gains of such … Company … before any Dividend shall have been made thereof …’. 6 See R Thomas ‘What is the Full Amount?’ in J Tiley (ed), Studies in the History of Tax Law, vol 6 (Oxford, Hart, 2013).

Deduction of Expenses of Management  183 Although this list, which lasted in very recognisable form throughout c­onsolidations up to 1988 and is still recognisable in Part 2 of the Income Tax (Trade and Other Income) Act 2005 and Part 3 of the Corporation Tax Act  2009, has often been remarked on as a list of what cannot be deducted, leaving what can to be inferred, there are some qualifications in the list which suggest that deductions for certain expenses and costs were positively allowed. The prohibition of the cost of repairs is only for sums beyond the usual amount; the prohibition of bad debts does not apply to those proved to the Commissioners to be bad and the rather obscure prohibition for average losses does not prohibit a deduction for the actual amount of the loss after adjustment. To the list of prohibitions set out above must be added the fourth Rule: In estimating the Amount of the Profits and Gains arising as aforesaid no Deduction shall be made on account of any annual Interest, or any Annuity or other annual Payment, payable out of such Profits or Gains.

The third and fourth rules of Case I also applied to Case II (in its third rule). For reasons which are not clear to the author, there is another expenses rule applying to both Cases, the first Rule of Cases I and II: In estimating the Balance of the Profits or Gains to be charged according to either of the First or Second Cases, no Sum shall be set against or deducted from, or allowed to be set against or deducted from such Profits or Gains, …

There again follows a list of non-deductible items Again although primarily a list of still familiar prohibitions there is an implicit allowance of the rent or value of part of a dwelling house used for the trade etc up to the given proportion. If this were not enough, section 159 of the Act says: And be it enacted, That in the Computation of Duty to be made under this Act in any of the Cases before mentioned … it shall not be lawful to make any other Deductions therefrom than such as are expressly enumerated in this Act, …

What deductions are ‘expressly enumerated’? The Rules for Cases I and II contain none save by implication; none of the other Rules for other Cases of Schedule D contain any, and in the Rules for Cases IV and V there is an explicit prohibition of deductions and abatements in computing the full amount to be charged. Schedule A (taxation of the annual value of land) included in Head No III profits from a number of concerns such as mines, quarries and railways. The rule in that Head for the computation of profits was that the duty was charged on: the Amount of the Produce or Value thereof; and before paying, rendering, or distributing the Produce or the Value, either between the different Persons or Members of the Corporation, Company, or Society engaged in the Concern, or to the Owner of the Soil or Property, or to any Creditor or other Person whatever having a Claim on or out of the said Profits; …

184  Richard Thomas However a Rule of Head IV (Rules and Regulations respecting the said Duties [under Schedule A]) provided: Fourteenth. – No Deduction from the Estimate or Assessment on any Lands, Tenements, Hereditaments, or Heritages shall be allowed in any Case not authorized by this Act …

Head V (Particular Deductions and Allowances in Respect of Duties under Schedule A.) enumerated the deductions so authorised. After listing a number of provisions relevant only to ecclesiastical matters, the Head said: Sixth. – For the Amount charged on Lands, Tenements, Hereditaments, or H ­ eritages by a public Rate or Assessment in respect of draining, fencing, or embanking the same;

As for Schedule E (emoluments from offices etc.) there was a rule about deductions (the ninth Rule) but it would not apply to companies. It should also be made clear that where income was received having had tax deducted from it under the rules for annual interest, annuities and annual payments or where the income consisted of dividends from UK companies which paid the dividends net of income tax, no deductions of any sort were available. The position for those companies in being in 1842 was then that they obtained relief for the expenses of their trades in the same way as individual sole traders or persons in partnerships, certain limited reliefs from the amount of their Schedule A assessments (again like individual landowners) and nothing else. BETWEEN 1842 AND 1915

The next issue to examine is whether by 1915, when the relief with which this chapter is concerned was enacted, the position as it was in 1842 had changed at all. The most convenient way of doing this is to examine the Income Tax Act 1918,7 the first consolidation since 1842, and to ignore any changes between 1910 and 1918 that were consolidated in the 1918 Act. The position for Cases I and II of Schedule D, apart from a few immaterial changes to the Rules8 in the 1842 Act, was that the only significant addition was an allowance for wear and tear of machinery or plant in a trade was given (a predecessor of capital allowances). No change was made to Cases III, IV, V9 and VI. 7 8 & 9 Geo V c 40 (the 1918 Act). 8 They were: the prohibition on deductions unless expressly enumerated was put into a rule of Case 1 and II, r 1(1); the disallowance for rent etc of a dwelling house was lifted where part was used for a trade or profession but only up to two-thirds; a new prohibition of patent royalties was included to match, and for the same reasons as, that for annual interest; in relation to bad debts the expected return in an insolvency was treated as the value of the debt. 9 Deductions were introduced in FA 1914 s 5 from income charged under Cases IV and V for any sum paid in respect of income tax in the place where the income arose, and on account of any annual

Deduction of Expenses of Management  185 As to Schedule A, section 37 of the Income Tax Act 185310 added a deduction, spread over 21 years, for relief for making or repairing sea walls. But far more importantly, in section 35 of the Finance Act 189411 a form of relief was given for repairs. It was an odd and complicated allowance: for farms, the relief was one-eighth of the assessment; for other land the ‘authorised reduction’ was graduated from one-quarter where the assessment was under £40, one-fifth where it was between £40 and £100, and £20 plus one-sixth of the excess over £100 for all other assessments. Nothing however required the assessed person to have actually carried out any repairs or spent any money on them. In fact the only mention of ‘repairs’ is in the sidenote ‘repairs allowance’ and in a distinction between tenant’s and non-tenant’s repairing leases. The allowance was said to be given ‘for the purposes of collection’.12 In the Finance (1909–10) Act 1910,13 section 69 enacted ‘extension of relief from income tax under Schedule A’. This allowed an owner of any land to which the 1894 allowance applied to make a claim for repayment of tax on the excess of the actual cost to him of ‘maintenance, repairs, insurance and management’ averaged over five years, over the 1894 allowance. ‘Maintenance’ was defined, but only for farms. It included replacement of farmhouses, farm buildings, cottages, fences, and other works where the replacement is necessary to maintain the existing rent. The repayment was not to be given to the extent that the expenses were otherwise deductible (presumably in a Case I assessment).14 Another important rule was brought in in section 51 of the Income Tax Act  1853. This allowed the deduction of expenses of travelling in the performance of the duties and of keeping and maintaining a horse to perform them, or otherwise to expend money ‘wholly, exclusively and necessarily’ in the ­performance of the duties.15 SUMMARY OF POSITION IN 1910

In 1910, as was the position since 1803, individuals and associations (whether incorporated or not) were in generally the same position as far as expenses interest or any annuity or other annual payment payable out of the income to a person not resident in the United Kingdom. 10 16 & 17 Vict c 34. 11 57 & 58 Vict c 30. 12 I assume this was to ensure that the assessment remained at the full amount for the purposes of deduction of tax from rent by tenants. 13 10 Edw 7 c 8. 14 The legislation also introduced the concept of ‘land managed as one estate’. It is somewhat odd that a Liberal government should be giving tax relief to Tory landowners who did so much to thwart the Budget and the enactment of the Bill! 15 In 1913 a rule was enacted allowing the Treasury to fix a conventional amount of expenses ‘wholly, exclusively and necessarily’ for specific classes of persons, and this amount was it seems

186  Richard Thomas were concerned. Both could deduct expenses incurred wholly and exclusively for the purposes of a trade, profession or vocation in arriving at the taxable profits of the trade; both could as owners of land claim repairs relief under the 1894 Act and the extended relief for maintenance, repairs, insurance and management under the 1910 Act. True it was though that only individuals would be likely to be able to claim the Schedule E expenses of travelling or the upkeep of a horse, though the relief was not expressly limited to individuals. In relation to other major types of income such as interest, dividends and other annual payments, and irrespective of their territorial source, no relief was available for any expenses incurred in managing the assets producing such income. This was the identical position for individuals and companies. Certain persons, whether individuals or companies, were in a rather special position so far as income from investments16 was concerned. These were partnerships and companies carrying on financial businesses where it was likely that investment income would be received in ordinary course of the business. The two major types of such businesses were of course banks and insurance companies (the latter particularly in relation to their life assurance business). For them, so far as the income from investments was received in the course of the business it would, if it had not suffered tax at source, be included in the profits computed for the purposes of Case I of Schedule D. If it had been taxed at source (as most interest and dividends from UK sources were) it would be excluded from the Case I profit. Such exclusion however would often result in the Case I computation producing a loss which could be set against the taxed income, with the result that the tax on that income was repaid. Thus the lack of explicit relief for expenses of managing investments was not likely to cause a great deal of hardship, except for those financial concerns which were not taxed under Case I. There was one major group of companies that fell within this category, companies whose insurance business was life assurance. This was because in relation to such companies the Inland Revenue considered that they could opt to tax the profits of a trade carried on by any person either under Case I or under any of the other cases of Schedule D that were applicable (usually Case III, IV and V). The Courts had upheld the Inland Revenue’s right to do this in C ­ lerical, Medical & General Life Assurance Society v Carter (Surveyor of Taxes).17 The Inland Revenue exercised the option to tax otherwise than under Case I only

taken into account in making deductions from salaries etc under the withholding system for Sch E then in operation. But an additional amount could be claimed if the actual expense were greater. 16 ‘Investments’ here and subsequently, unless otherwise specified, does not include income from land in the UK. 17 Clerical, Medical & General Life Assurance Society v Carter (Surveyor of Taxes) (1899) 2 TC 623. And see other cases described in R Thomas, ‘The Crown Option’ in J Tiley (ed), Studies in the History of Tax Law, vol 4 (Oxford, Hart, 2009).

Deduction of Expenses of Management  187 where the only insurance business carried on by a company was life assurance. In the case of ‘composites’, those which carried on in the same company both life and non-life (general) business, the basis was always Case I.18 THE LOBBYING AND NEGOTIATIONS BETWEEN LOA/ASLO AND INLAND REVENUE

The difference of treatment between composites and the ‘pure’ life companies (as they were known) was a source of concern to the insurance offices. On 31 May 1910 a memorandum by the Life Offices Association (LOA) was sent to the Treasury to highlight the difference and to suggest remedies.19 The principal suggestion was that the pure life offices should also only be taxed under Case I of Schedule D, to bring them into line with the composites. They recognised that the Inland Revenue were unshakably committed to the system of deduction at source for interest and other annual payments, and that the Inland Revenue justified the taxation of all interest accruing to the life companies on the basis that it really belonged to the policyholders, a proposition which the companies rejected. On the 18th and 19th pages of the memorandum, though, it is stated: XI Even if it be admitted that the interest of Life Offices is properly regarded as ‘profits or gains’ – and that is strenuously denied by the Offices – it seems quite clear that the view of the Inland Revenue Authorities set forth in paragraph III is incorrect because in point of fact the whole interest does not find its way to the pockets of the Policyholders. A certain proportion of it is required to meet expenses of management without which the Funds of the Offices could not be accumulated nor invested to earn such interest. Various deductions are permitted to be made under the different Schedules of the Income tax Acts when arriving at the amount to be assessed and there on record a number of decisions to the effect that expenses incurred for the purpose of earning profits may be properly deducted when computing the ‘profits or gains’ of a business. It would therefore be equitable that the Life Offices should receive a refund of Income Tax already paid equivalent to tax on a sum equal to their expenses of management or to a proportion of such expenses. XII The Inland Revenue Authorities contend that, if any such allowance were made, Income Tax would be rightly chargeable on all profits from reversionary transactions and from investments realized. XIII The Life Offices reply that, if this contention were given effect to, they should be entitled to set off against such profits and losses which they might sustain from the same classes of investments.

18 The courts having held in Last (Surveyor of Taxes) v London Assurance (1885) 2 TC 100 that a composite company carried on one trade. 19 National Archives (TNA) IR63/49 (Finance Bill 1914 Life Assurance Companies and Income Tax), 10–18.

188  Richard Thomas The memorandum goes on to record the Inland Revenue’s preference for splitting off the life business of the composites and taxing it on the basis of interest, not Case I profits, to bring the life business of composites into line with that of the pure life companies. Thus were the battle lines drawn, though nothing happened in 1910 to deal with the apparent grievances that both sides had with the then current system. Nor was anything done in 1911 to 1913, but in January 1911 the then Chief Inspector of Taxes (Mr E H Bowers) wrote an internal memorandum saying ‘it has now been suggested that this grievance might be remedied by allowing such Companies repayment of tax on the amount of their working expenses. These expenses are of course already allowed in calculation of the “profit” at the valuation period’.20 He went on to say that ‘no ordinary commercial reasons can then be advanced for the special choice of working expenses as a measure for relief; but unless the items been selected at random, it presumably has some favourable feature to recommend its proposal for adoption’. He then considered some statistics which showed the large working expenses of the industrial business21 as compared with other life business. And he added that, after calculating the excess of taxed income over profits and the working expenses for each affected company, ‘it may be proposed by the Companies to cut down the allowance for expenses in the latter cases to the difference between the taxed income and “profits”’. He considered that this relief would not be a proper basis for remedying the main grievance of the companies. Battle was rejoined in 1914. The impetus for it was the government’s proposal to abolish the remittance basis for many types of foreign income, a  proposal which had been enacted as section 5 of the Finance Act 1914 in July that year. On 25 April 1914 the chairman of the Board of Inland Revenue, Sir Matthew Nathan KCMG, wrote to the private secretary to the Chancellor of the Exchequer with an outline of the effect on insurance companies of the proposal.22 The Chancellor, David Lloyd George MP, asked for an urgent report, as many MPs were pressing him to receive a deputation. In the event, it was the Inland Revenue which received the deputation from the LOA and the Association of Scottish Life Offices (together the Life Offices) on 12 May 1914 in the Board Room in Somerset House.23 As well as the chairman, Mr EE Nott-Bower CB (deputy chairman) was present with two other officials. Mr Geoffrey Marks, chairman of the LOA, made most of the running for the Life Offices and he repeated the 1910 grievances,24 and pressed the issues of adopting the Case I basis for all life business and against the taxation of the 20 ibid 256–64. 21 Industrial life assurance business is the business where premiums of very modest amounts were collected door to door by insurance agents on bicycles (the Man from the Pru with his bicycle clips, for those readers of more advanced years). 22 TNA IR63/49 1. 23 ibid 20–47. 24 See text at n 21.

Deduction of Expenses of Management  189 interest as a separate source of tax. At one point however Sir Matthew Nathan referred to the Inland Revenue view that the policyholders should be taxed, as it was they who get the interest in the end. Mr Gardiner of the Life Offices asked the chairman: ‘You would not contend that the whole of our interest ever gets –’ Sir Matthew, cutting across him, said: ‘Where else does it go?’ Mr Gardiner: ‘Hoarded up for the future.’ Sir Matthew: ‘That eventually goes to the policyholders.’ Mr Gardiner then said that even if they accepted the Inland Revenue view (which they did not) it could not be said that all the interest goes to policy­ holders. The Life Offices had expenses and although the Inland Revenue allowed them in a Case I calculation, when they were taxed on the interest and interest alone: you refuse us any kind – I do not say refuse us, because the machinery does not provide it at the moment – but we are deprived of any kind of relief at all, and there is no other Institution in the same position.

The chairman then asked: ‘Is this an alternative suggestion?’, to which the response was ‘The primary object of the Deputation is not to apply for limited relief of any kind whatever.’ The chairman then summed up this part of the discussion by saying that he wanted to know where the interest goes, and that he understood that some goes to meet expenses. On 18 May 1914 the Life Offices sent a memorandum to Sir Matthew Nathan replying to the questions he asked at the meeting.25 It pressed the Case I issue strongly but did not mention expenses of management. On 10 June 1914 Sir Thomas Whittaker MP, a man of many interests, including being chairman and managing director of the Life Assurance Institution, had a meeting with Sir Matthew Nathan and Mr Nott-Bower.26 He made three points on behalf of the companies: the unfair competition between the pure life companies and the composites; that there should be an allowance for expenses of management; and that many policyholders were people of small means for whom taxation at the source was over-taxation. He asked for legislation to ameliorate all three points. The papers contain a note by a Mr Jacob on a possible basis of settlement. He advocated a separation of life business from other business, and that as regards life business, ‘the Companies should pay tax on all interest + other profits – other losses, excluding premiums (such as realisation of investments) – expenses. The minimum payment must be on the Companies’ profits.’27 On Friday 12 June 1914 another Life Offices’ deputation met Sir Matthew Nathan and the other same Inland Revenue people.28 After much discussion

25 TNA,

above n 19, 76–80. 90–91. 27 ibid 95–96. 28 ibid 98–124. 26 ibid

190  Richard Thomas of the Life Offices’ grievances, Sir Matthew said: ‘You make out29 one point. You make out that the interest partly goes in the expenses of management.’ Mr Marks immediately tried to change the subject back to the main grievance, because he said it would not cost the government much. On 17 June 1914 Sir Matthew put a note to the Chancellor of the Exchequer with his conclusions from the discussion with the Life Offices.30 They were that the suggestion that the Exchequer should abandon the tax claim on interest in excess of Case I profits was unsound; but that it might be argued that a portion of the interest never enures as a profit to anyone, and that although the Deputation did not put forward a claim for an allowance for expenses of management, he thought they would do so when the major claim was rejected. Such a claim would be difficult to combat on equitable grounds. The Chancellor should therefore reject the claim for Case I only, but promise consideration of an allowance for expenses of management in the next Budget, with the proviso that any revision of the law should be accompanied by similar revision on points where the Inland Revenue is unfairly treated. On 18 June 1914 the Deputation, introduced by Sir Thomas Whittaker MP, met the Chancellor, who was accompanied by Sir Matthew Nathan, Sir John Bradbury (Permanent Secretary to the Treasury) and Mr Nott-Bower.31 Sir Thomas raised the question of expenses of management, saying no allowance was made for their working expenses. Later Mr Gardiner raised the absence of relief for expenses of management, while stressing that it was not an alternative proposal, but only to show the iniquities of the present system. The Chancellor, after a lengthy statement, referred to the points about expenses of management put by Sir Thomas and Mr Gardiner. He agreed that logically if you tax the interest as a way of taxing the policyholder, you ought to deduct expenses of management, because the policyholder only got his interest minus the expenses. He added that this was something which he proposed to consider and that it was ‘indefensible’. On 1 July 1914 Sir Matthew Nathan, writing to Sir John Bradbury primarily on the foreign income question,32 added that ‘We are getting into serious difficulties owing to the Chancellor of the Exchequer trying to meet the claim of the Life Assurance Companies for an allowance on account of working expenses’, but he did not elaborate.33 On the same day, Sir Matthew, writing to HP Hamilton at the Treasury on the costings of the various measures, mentioned that ‘there must be some 29 By ‘make out’, I take Sir Matthew as saying that only one of the Life Offices’ points is a good point. 30 TNA, above n 19, 136–47. 31 ibid 148–73. 32 Legislation in FA 1914 had abolished the remittance basis for most types of foreign income, something which was of major concern to the Life Offices many of whom had branches in especially the Dominions. 33 TNA, above n 19, 181 (the index is wrongly dated).

Deduction of Expenses of Management  191 further loss – not I am informed a serious one – by reason of the need to treat Investment Companies now taxed on the interest for their investments in the same way as Life Assurance Companies.’34 He added that they were in communication with Thring35 as to the draft clauses. On 2 July 1914 the Chancellor referred to the proposals in the Committee proceedings on the Finance Bill.36 He was responding to points made by Mr HW Forster37 who said: That is one case I want to make. The other I can develop in a moment. It refers to a question which was brought to the attention of the Chancellor of the Exchequer quite recently, and I understand that the right hon. Gentleman intends to do something to meet the case. I refer to the complaint of the life insurance companies that they are taxed upon their annual interest income instead of upon their profits. It may happen – I think it has happened in several cases – that the annual interest largely exceeds the annual profits. I think that the life assurance offices have a legitimate grievance which they have recently laid before the Chancellor. The true profits of life interest can only be ascertained by actuarial calculation, and I submit that this is really the basis upon which their Income Tax should be calculated, and not only upon the interests which they have received.

The Chancellor’s reply on this point was: With regard to the life insurance companies, I have looked into that matter. It is a very old grievance, but the grievance is rather against the mixed and composite companies than against the Inland Revenue. The Life and Fire Company is not treated in the same way as the purely life office, and the result is that in competition the purely life office suffers. I think that is rather a case for raising the amount to the composite companies than taking any off the others. I think that suggestion is well worth consideration … There are three points made which I think we are required to look into. First of all the expenses – which the hon. Gentleman has not mentioned. The question of the deduction of expenses is the second point. The point that has been made very clearly is a grievance against the composite companies. Then there is the case with regard to the foreign officers. I have thought those three matters did require to be looked into. They are old established grievances, but that is no reason why they should not be redressed. On the contrary, it is the very reason they should be. There are many anomalies in connection with the Income Tax which I should like to see redressed.

Back in Somerset House the Chief Inspector’s branch of Inland Revenue was working on the proposals for the 1915 Bill. An undated38 note from Thomas Collins, the Chief Inspector of Taxes, said: 1. By giving management expenses, the interest paid to policyholders (a) is not taxed at all, when the management expenses equal or exceed the excess of taxed



34 ibid 188–90. It seems likely that these companies would be primarily investment trust companies. 35 Sir

Arthur Thring, Parliamentary Counsel. in Committee 2 July 1914 col 652 (from pasted extract in TNA, above n 19, 191. 37 MP for Sevenoaks (Con). He became Governor-General of Australia in 1920. 38 TNA IR93/40 194–95. From its place in the papers it must be between 3 and 6 July. 36 HC

192  Richard Thomas income over profit, (b) is taxed in part only when the management expenses are less than such excess. 2. ‘Management expenses’. What is to be included under the title? Probably Commissions – but Commissions are often allowed by way of reduction on the premium direct to the policy holder. … 8. It is submitted that in cases of dispute, the deciding authority should be the same for the whole Kingdom. It is suggested therefore for consideration whether the assessment of the companies, and consequently all matters connected with the administration of the present proposals might not be transferred to the Special Commissioners.

On 6 July 1914 the Chief Inspector sent a memorandum on management expenses to the chairman.39 This contained the suggestion that relief for management expenses was not to exceed the tax on the difference between the amount of its taxed income and the amount of its profits (ie giving effect to item 1 of the undated note). He also pointed out that if an allowance for management expenses was given to assurance companies it would be inevitably be demanded by investment companies, and such a claim would be irresistible. The rest of the note dealt with other proposals. On 9 July the Life Offices wrote to the Chancellor, having obviously been informed that they would be given relief for management expenses, with a cap based on profits, but that there would be no redress for their main grievance.40 Matters then went into hibernation for a few months until in 1915 measures for the Finance Bill were discussed internally within government. On 26 ­February 1915, the Chief Inspector, Mr Collins, prepared a memorandum on ‘points to be considered’ about legislative measures on life assurance companies for the forthcoming Finance Bill.41 One point was ‘the allowance of expenses of management, so far as they are defrayed out of interest received’. Expanding on this point, he said that the claim for relief for expenses of management would arise, strictly speaking, only ‘on that part of the Life Fund pertaining to Life Assurance Policies’, and that two limitations should be made. One was to deduct from the actual expenditure all profits from reversions, surrenders and lapses (including amounts retained as contributions to future expenses) and all fines and fees, and all other casual profits. The other restriction was that the amount to be allowed should not exceed the excess of the investment income of the life policy fund over the profit of the fund as disclosed for actuarial valuation purposes (in the return to the Board of Trade) adjusted for income tax purposes. This restriction is called from now on the

39 ibid

206–10. 213–15. 41 TNA IR63/38, 1–7. 40 ibid

Deduction of Expenses of Management  193 ‘NC142 restriction’, the name by which it came to be known among practitioners in the field. The Chief Inspector struck a cautionary note about the possibility of the companies using valuation techniques to manipulate the relief, presumably by reducing the profit calculation. After dealing with his four points on life assurance companies, Mr Collins added a further section headed ‘Trust Companies – management expenses’. He remarked that claims were being made by these companies for expenses owing to the operation of section 5 of the Finance Act 1914 (curtailment of remittance basis) and that if any concession was authorised for Assurance Companies, claims by Trust Companies might exceed £1,000,000. He said the allowance for them should also be capped to the excess of taxed income and profits over total expenses as reduced by untaxed sources of income. On 26 March 1915 the ‘most obedient servants’ of the Lords of the Treasury (ie the Board of Inland Revenue) sent a report to the Treasury begging to submit draft clauses they had caused to be prepared on the measures for the Finance Bill concerning insurance matters.43 The fourth clause so prepared allowed for relief from tax on expenses of management so far as defrayed out of interest. The mechanism for the relief was to be a claim to be made for an allowance to be given effect to by a repayment at the end of the year of so much of the tax suffered by deduction as represented the duty on the expenses of management and commission during the year, subject to the NC1 restriction. It is apparent from the papers that before 8 May 1915, Sir Arthur Thring of the Office of the Parliamentary Counsel had drafted a clause for the Finance Bill. There were subsequently discussions with the Life Offices who suggested amendments, either for the government to pursue or for backbench MPs to promote on their behalf. Minor amendments were made44 about expenses of management in the Finance (No 2) Bill as it passed through its stages to become section 14 Finance Act 1915. TAKING STOCK OF THE 1915 MEASURES

It is appropriate at this stage, before considering what the section actually meant and how it was interpreted and evolved, to take stock of section 14 and to see its place in the larger picture of how the government came to introduce a number of other clauses in the Bill and how they related to the grievances first put forward by the Life Offices in 1910. The grievance over the stark difference in treatment between pure life offices and composites was the main, if not only, matter which the Life Offices wanted 42 NC1 stands for Notional Case I. It was also shown in writing as NCI. 43 ibid 35–48. 44 The reference to deducting ‘all casual profits’ as well as fines and fees from the expenses was removed.

194  Richard Thomas remedied, at least in relation to home business.45 They wanted pure life offices to be taxed like composites, which would give a substantial reduction in tax for most companies. They got the opposite, expressed in section 11 of the Finance Act 1915. In future the life business of the composites was treated as a separate business and could be taxed differently, which in practice meant taxed in the same way as the pure life offices, on the interest. Section 12 of the Finance Act 1915 prevented life companies from creating and using ‘artificial’ losses based on a strict reading of the effect of the schedular system. And in section 13 the ability of life companies to set off tax deducted from annuities against income was limited. These were the ‘anomalies’ referred to by David Lloyd George in the parliamentary debate on section 5 of the Finance Act 1914.46 But the companies’ complaints about section 5 of the Finance Act 1914 had been heeded. Section 16 effectively restored the remittance basis for income attributable to a company’s foreign life assurance fund (broadly a fund relating to its business done with foreigners at an overseas branch), but a corresponding limitation of its expenses of management was required. Looking back over the five-year campaign of the Life Offices, one can only say that it failed. It failed because the government, and particularly the Inland Revenue, had a clear vision of the dual nature of investment-heavy life assurance business carried on by proprietary (not mutual) companies, and that over and above the profits from the business attributable to shareholders which all accepted were taxable, the life companies were in effect collective investment vehicles for most of their policyholders and that the tax deducted from the interest and other investment income they received was suffered by the life companies on behalf of the policyholders. That was a sophisticated view of Addington’s notion of retention of tax as income passed between the originator and the eventual final consumer, because the interest received by the life companies would be carried to reserve to be paid out only when a policy paid out on maturity or death, and because there was no way of determining precisely how much interest was attributable to each policyholder. Having reached that view at the latest by 1911 the Inland Revenue was able to persuade ministers, particularly Lloyd George, that any rowing back from it would not only be costly as it would involve repayment of tax deducted but would be an unprincipled breach in the tax retention system. Absent something like a Royal Commission, the Life Offices would get nowhere. But in 1911 the Inland Revenue also realised that there was one flaw in their theory. Even if most of the taxed interest received did go to meet the policyholders’ claims and so was passed through to them eventually, it was clear that some of the interest must be used to meet the costs of managing the business.



45 They 46 See

had, as noted (see above n 34), a grievance over the abolition of the remittance basis. text at n 40.

Deduction of Expenses of Management  195 There were two ways that this issue might be dealt with. The Inland Revenue could say with justification that an individual with investment income, however large, and however much time and cost he spent on managing them, or having say a stockbroker manage them, would find no deduction was available for the expense. Or they could accept the case that it was iniquitous that the life companies were taxed on interest that the policyholders would not in fact get. The Inland Revenue realised that the life companies’ case on expenses was strong, and it seems to the author that this allowance was always planned to be the ­sacrificial lamb to buy off the much larger claim by the Life Offices. This can be seen from the clever questioning of the Life Offices by Sir Matthew Nathan, and from Mr Geoffrey Marks’ obvious annoyance when members of his committee and particularly Sir Thomas Whittaker MP, went ‘off message’ and started talking about the lack of expenses of management available to the companies taxed on their interest. THE ROYAL COMMISSION

The government had said to the Life Offices as part of their ‘sugaring the pill’ when turning down their major proposal that the post-war Royal Commission would look at any matters still outstanding. The Life Offices would have been encouraged to see that among the members of the Royal Commission were Sir Thomas Whittaker and Mr Geoffrey Marks, but they would also have found Sir Ernest Nott-Bower, now Chairman of the Board of Inland Revenue. The report of the Commission47 includes this statement: The provision authorizing the repayment of tax on management expenses is the first recognition by the Legislature that interest arising from investments can be anything other than net assessable income.48

The report also showed that as to the main grievance of the Life Offices in 1910 to 1915, the English life offices, represented by the LOA still maintained that the profits basis was the correct one, while the Scottish life offices (represented by ASLO) said they were content with I minus E.49 After full consideration, the Report came out against the LOA and agreed with the ASLO, that now there was an allowance for expenses the ‘new measure of profit’ (ie I minus E) was not inappropriate. The only other mention of management expenses in the Report stated that it had been represented (by the Life Offices) that it was unfair to deduct fines,

47 Royal Commission on the Income Tax (Cmd. 615, 1920). 48 ibid [510] (Part V Section X). 49 The author’s (and since 1915 everybody else’s) abbreviation for the basis of taxation described in the Report as ‘interest less expenses of management’. ‘I’ is now generally assumed to stand for ‘investment income’ (and since 1965 has included gains on disposal of assets).

196  Richard Thomas fees and profits on reversion from management expenses, because they were in the nature of trading profits, and that profits from the sale of annuities should be deducted from the expenses. The Report recommended that latter suggestion by the Inland Revenue50 and it was enacted in section 16 of the Finance Act 1923.51 THE RELIEF IN OPERATION

Anyone looking through twenty-first-century eyes at section 14 of the Finance Act 1915 or section 33 Income Tax Act 191852 (as it became on consolidation, unchanged part from the statutory references) as amended by section 16 of the Finance Act 1923 (the text of which appear in the first Appendix to this chapter) is likely to be struck by the lack of definition of what may reasonably be regarded as important concepts. That modern reader might well think that answers and explanations are needed in relation to at least the following matters: 1. What counts as ‘expenses of management’ as distinct from any other expenses that might be incurred by the companies concerned? 2. Why are commissions expressly included (but nothing else), what commissions are these, and why are they ‘expenses of management’? 3. Does ‘disbursed’ carry a connotation of cash payment, contrary to the general approach to expenses in Case I & II of Schedule D? 4. What count as ‘investments’ for the purposes of the section? Is a life assurance company limited to repayment of tax on income from its investments or is the relief more general? 5. What is the ‘otherwise’ way of charging tax? 6. Is an income tax year (the period in section 14 of the Finance Act 1915) the measure to be used for repayment and for calculating the NC1 restriction where a company draws up accounts to a different date? 7. How is the NC1 restriction to work in the case of an investment company? 8. What are fines and fees in the case of an insurance company? 9. Can a loss on reversions be carried forward and set-off more than once? 10. What is the position if the expenses exceed the income? Can that excess be relieved in any way? What follows is an examination of how those involved in the practical application of the provisions, the Inspectors of Taxes in the Inland Revenue and the relevant officers in the companies with their professional advisers would have

50 By Mr MC Furtado, Assistant Chief Inspector of Taxes. Royal Commission on the Income Tax Minutes of Evidence Part II (London, HMSO, 1920) (37th Session), 5 December 1919 paras 27,501 to 27,504. 51 13 & 14 Geo V c 14. 52 8 & 9 Geo V c 40.

Deduction of Expenses of Management  197 gone about finding the answers and how they were reflected in any guidance given to them.53 What Counts as ‘Expenses of Management’ as Distinct from any Other Expenses that might be Incurred by the Companies Concerned? In the lead up discussions and documents, it was the companies’ general practice to talk about management expenses (or expenses of management), while those in Inland Revenue talked of ‘working expenses’. The author’s supposition is that what the companies had in mind was those expenses that appeared in the entry ‘management expenses’ in the return54 made by them to the Board of Trade under the Assurance Companies Act (ACA) 1909.55 The Explanatory Notes for the 1915 Act did not add any more, although they did refer to section 14(3) of the Finance Act 1915 which operated on the assumption that repairs and management expenses that could be given under the 1894 or 1910 Acts could also count as expenses of management of the life assurance business. The Inspectors’ Manual dealt with some specific issues. Bank interest for which relief was otherwise allowed could be included in the claim for management expenses.56 This is ambivalent as to whether they would be management expenses but for a specific allowance. Charges on income (annual interest, annuities and other annual payments and rents on let properties) must be excluded from management expenses.57 This again is slightly ambivalent, but suggests that they might otherwise be so regarded. Dealing with the exclusion for Schedule A repairs etc, the manual said that cost of valuation for fire insurance purposes was allowable as a management expense58 but not valuations made in connection with changes of ownership etc.

53 The sources used for this examination are: Explanatory Notes to the Finance Bill 1915 in TNA IR63/38 195–222; Statements made in the lead up to the 1915 Bill by Inland Revenue officials in TNA IR63/38; The Inspectors’ Manual (IM) issued to Inspectors of Taxes (dating from 1934 but with amendments to 1953); ‘Assurance and Insurance Companies’, Quarterly Record of the ­Association of HM Inspectors of Taxes, January, April and July 1928; Guidance prepared by the Chief Inspector (Insurance) (Eastham); J Barnett, ‘Income Tax as affecting Life Assurance Offices’ (1922) 9(84) Transactions of the Faculty of Actuaries 65–98; AH Shrewsbury, ‘Income Tax as affecting Life Assurance Offices’ (1946) 72(1) Journal of the Institute of Actuaries 35–78; Reports of Tax Cases, HMSO. 54 The entry is in the Form referred to under Heading No 6 in Fourth Schedule (A.) to the­ Assurance Companies Act 1909. Statements made in Tax Cases reinforce the author’s view. 55 13 & 14 Geo V c 8. 56 IM, above n 54, 2707 (12/39). 57 ibid, 2708 (12/39). There were exceptions for rents paid in respect of properties in Eire. 58 And in a pasted slip the IM allowed the costs of valuation for the War Damage Acts 1941 and 1943.

198  Richard Thomas Another paragraph in the Inspectors’ Manual says that a property investment company must be governed by section 14(3) of the Finance Act 1915 in relation to Schedule A repairs and that no allowance is to be given to these companies for a portion of directors’ fees and office salaries. In 1943 an addition was made59 concerning ‘private holding’ companies. The admissibility of remuneration to directors and officials was to be governed by the Schedule D Case I Rules and the case of Copeman v William Flood & Sons Ltd.60 And in 1951 a further addition was made to prohibit a deduction as management expenses for the cost of professional advice in relation to a claim under the Town and Country Planning Acts for compensation for loss of development value. This disallowance was to be made because the expenditure was ‘regarded as capital outlay and hence inadmissible’.61 The matters mentioned above are included in a section of the Inspectors’ Manual on management expenses which applies to all concerns. As far as life assurance companies are concerned, there is a paragraph62 about ‘staff insurance schemes’. This refers to discounts or rebates allowed to such schemes. It ­disallowed any such rebates etc if the company accounted for the gross premiums and took the discounts to its management expenses. This is based on North British Mercantile Insurance Co v Easson,63 considered below. The second entry refers to commissions and says that ‘[n]o objection is to be raised to the inclusion as an expense of management of the “commission” paid to “own case agents”’.64 The Quarterly Record articles refer to the ‘paucity of litigation’ on the subject of management expenses which they say says ‘much for the manner in which this somewhat complex branch of Income Tax has been tackled both by the Revenue officials and those who have acted on behalf of the various Life Assurance Companies’.65 The articles do refer to two cases that had reached the courts, North British and Equitable Life Assurance Society v Hills.66 Neither case casts any great light on what counts as management expenses. But the Quarterly Record articles go on to say that the cost incurred in buying and selling stocks can be admitted, including all brokerages, contract stamps, transfer stamps and transfer fees, even though in the accounts these are not usually debited to the revenue account as expenses of management, and are charged as capital.

59 IM, above n 54, 2713 (9/43). 60 Copeman v William Flood & Sons Ltd (1940) 24 TC 53. 61 IM, above n 54, 2714 (5/51). 62 ibid, 2731 (8/47). 63 North British Mercantile Insurance Co v Easson (1919) 7 TC 463. 64 IM 2734 (8/47). There is a reference to another Manual to explain the reference to ‘own case agents’ which I do not have. 65 Quarterly Record, above n 54, July 1928, 570. 66 North British and Equitable Life Assurance Society v Hills (1924) 8 TC 657.

Deduction of Expenses of Management  199 Eastham (writing in the late 1960s) refers to the deduction for investment purchase and sale fees, saying that investment companies were denied a deduction in Capital and National Trust Ltd v Golder,67 but despite that case, life companies continued to be allowed to claim them on the grounds that their investments were trading assets.68 That approach was later reversed and was then challenged in Sun Life Assurance Society v Davidson,69 which held that all expenses of this type were not expenses of management. In Golder the Special Commissioners in their stated case said: 3.

It has for many years been the practice of the Commissioners of Inland Revenue in examining claims under Section 33 made by investment trust companies (including the Appellant Company), to offer no objection to the inclusion of sums disbursed by way of brokerage and stamp duties in connection with changes of investments as distinguished from investments representing capital expansions. A simple formula for the determination of the capital expansion element in such disbursements was year by year applied in the case of investment trust companies generally and the Appellant Company in particular.70

It was said in evidence by the company that the costs were charged to capital. In the High Court Croom-Johnson J said: The only question is whether the Company has proved that the expenses in question are expenses of management. The Commissioners have set out all the facts, which are not in dispute, and what I have to determine is: Is it right, as a matter of law, to say that the expression ‘expenses of management’ covers expenses of this nature? In a sense, the notion behind this Section may be thought to be that the expenditure is something which if you were looking at profits and gains under Schedule D would be deductible as a sum of money wholly and exclusively expended for the purpose of making profits and gains, within Rule 3 of Cases I and II of Schedule D, and accordingly that any expenditure partaking of a capital nature is not aimed at by the Section.71

In giving the only reasoned judgment in the Court of Appeal, Tucker LJ agreed entirely with the High Court. He then said: I would only add that Mr. Grant’s argument as it seems to me is really this. He says these expenses were ‘expenses of management’ because they were expenses incurred by the management in carrying out the business of the Company. That seems to me a totally different thing. What we are concerned with here is the expenses of management, not expenses incurred by the management in carrying out the proper business of the Company.72

67 Capital and National Trust Ltd v Golder (1949) 31 TC 265. 68 Eastham, above n 54, 49. 69 Sun Life Assurance Society v Davidson, heard with Phoenix Assurance Co Ltd v Logan (1955–57) 37 TC 330. 70 Golder, above n 68, 266. 71 ibid, 270. 72 ibid, 273.

200  Richard Thomas In Sun Life the case reached the House of Lords. The most relevant parts of the speeches in the Appellate Committee in that case are in the second Appendix. From Barnett73 it can be seen that irrespective of any arguments over the cost of acquiring or disposing of investments as to whether they were disallowable as being capital, it was accepted by the Life Offices that: … there might be items of a Capital nature included in repairs which would have to be deducted (ie deducted from the total claim)

and As regards the amount of Expenses and Commission entered in the Revenue Account of an office, it must be remembered that amounts in respect of certain ­business may not be admitted for relief of tax by the Revenue, and those that the Revenue consider to be of a Capital nature or of the nature of mere book entries.

In response, one of the members present at the meeting of the Institute of ­Actuaries at which Barnett’s paper was read, Mr Archibald M’Intosh, said: The matter of the allowance of income tax in respect of expenses of management is not very difficult nowadays, the principles involved have been mostly decided. For instance, one must not include capital outlays which are for the purpose of additional equipment but one can claim expenditure on something that has already been in use, such as replacements for books. The cost of new furniture must not be included except to the extent that it replaces old furniture.74

It can be seen then that both sides seemed to accept that the rules of Case I of Schedule D applied, when appropriate, to management expenses. This is reflected not only in the approach to capital expenditure but also to such Case I concepts as ‘wholly and exclusively’ expended, as suggested by the Inspectors’ Manual’s reference to Copeman v Flood,75 and the proposition that charges on income were disallowed. There was a reference to Bennet v Underground Electric Railways Co of London Ltd,76 in the extract above from Viscount Simonds’ speech in Sun Life. That case, as well as London County Freehold & Leasehold Properties Ltd v Sweet77 and Hoechst Finance Ltd v Gumbrell78 concerned matters which the courts have held to be capital, but which were decided simply not to be management expenses, without invoking the rule against allowing capital expenditure. In Atkinson v Camas plc,79 in 2004, Carnwath LJ held however that capital expenditure was not excluded by the legislation. 2004 was however the year in

73 Barnett,

above n 54, 77. above n 54, 92. 75 Copeman v Flood, above n 61. 76 Bennet v Underground Electric Railways Co of London Ltd (1923) 8 TC 475. 77 London County Freehold & Leasehold Properties Ltd v Sweet (1942) 24 TC 412. 78 Hoechst Finance Ltd v Gumbrell (1983) 56 TC 594. 79 Atkinson v Camas plc (2004) 76 TC 241. 74 Barnett,

Deduction of Expenses of Management  201 which legislation on management expenses was changed explicitly to disallow capital expenditure. Copeman v Flood was the basis of a decision on management expenses in LG Berry Investments Ltd v Attwooll80 where part of the directors’ fees was disallowed as simply being a distribution of profits and not any reward for services. Similarly in Fragmap Developments Ltd v Cooper81 the shares of an investment company (F) were purchased by the company carrying out a ‘dividend-stripping’ operation (S). F paid S two sums of £1,000, each described as administration expenses. It submitted a repayment claim on the basis that the payments were management expenses. The Special Commissioners dismissed F’s appeal, finding that there was no evidence that S had provided any relevant services to F. The decision was upheld by the High Court as one of fact. Summing this section up, it seems to the author that for decades there was an understanding between the two sides, the Inland Revenue and the life companies, that in general the Case I Rules applied, and that despite what the courts said they were not deciding, the rule against allowing capital expenditure was seen as a component of the relief for management expenses. It also seems accepted that, just as in Case I, the starting point was a set of accounts drawn up in accordance with normal commercial principles, and latterly GAAP, the starting point for a claim to management expenses by a life assurance company’s claim was the entry in the regulatory return for expenses of management. It should be remembered that until the 1990s the regulatory return and the Companies Act accounts of an insurance company were for all intents and purposes identical. When they diverged in 1995 the decision was taken by the Inland Revenue with the grateful acceptance by the life companies to continue using the return as the basis for taxation, including for management expenses. In relation to investment companies, however there was no such return, only the accounts, and they were what was used as the starting point. Why are Commissions Expressly Included (but Nothing Else), What Commissions are These, and Why are they ‘Expenses of Management’? It was the Inland Revenue who first mentioned the possibility of including commissions in the ‘working expenses’ of insurance companies. No one among the life companies and their backers objected, not surprisingly. Quite why the Inland Revenue thought the commissions paid to agents and employees whose job was to sell policies were part of the working expenses when it was an article



80 LG

Berry Investments Ltd v Attwooll (1964) 41 TC 547. Developments Ltd v Cooper (1967) 44 TC 366.

81 Fragmap

202  Richard Thomas of faith to Inland Revenue, expressed in the Explanatory Notes and all internal documents, that management expenses would only be allowable if they were defrayed out of interest, I cannot tell. Commissions were paid out of the premiums received, and generally the rule was ‘no sale, no commission’.82 The word ‘commissions’ does not appear in the Explanatory Notes. It may be that it is as simple as an official looking at the 1909 Act return and seeing ‘commissions’ just above ‘expenses of management’ and assuming they were also ‘working expenses’ defrayed out of interest. The Quarterly Record articles, Eastham, Barnett and Shrewsbury do not say anything more about commissions than the wording of the legislation. But they did feature in Golder (which was not about life assurance companies). In the High Court Croom-Johnson J said: The only other point left in the case is that the Section refers to ‘commissions’. I think that those words are not apt to cover a stockbroker’s remuneration which is calculated as a commission in making the bargains on behalf of the Company through its accountant. The Section is aimed at something quite different – managing a concern where somebody gets, as part of his remuneration perhaps, a commission on income or something of that sort. I should be disposed to think that these transactions partook of the character of capital transactions rather than income, but as I say, I do not decide that point.83

In the Court of Appeal, Tucker LJ said: With regard to the word ‘commissions,’ in my view that in no way extends the meaning of ‘expenses of management.’ Before these deductions can be made by the Appellants they must first of all be expenses of management, but it is made clear that those expenses can properly include expenses which have been paid by way of commission.84 82 The approach of a commission-based life assurance salesman was mentioned in the operetta, Maid of the Mountains (composed by Harold Fraser Simpson, with lyrics by Harry Graham) thus: TONIO I’m a model of discretion, And I’m quick to take a hint. It’s a very useful faculty, I find. From a fellow-man’s expression I can tell in half a squint, Just exactly what is passing in his mind. Once I travelled on commission For some life insurance firms, And I called upon a friend of mine one day And I gave a disquisition On the value of our terms, And I pressed him to insure without delay! I showed him how t’would benefit his heirs, if not himself. He merely took a heavy life-preserver off the shelf. He didn’t say he wouldn’t, and he didn’t say he would, He didn’t have to say a single word— I understood.

83 Golder, 84 ibid,

above n 68, 270. 273.

Deduction of Expenses of Management  203 In Sun Life, Viscount Simonds said: The question is, then, whether these particular charges are expenses of management. I have so far ignored the fact that these words have in the Section an appendage ‘(including commissions)’. It has been assumed on both sides that ‘commission’ here refers to the payment made to the agent who obtains business for his society and does not include the brokerage payable to a stockbroker, which is often called commission. I am content without deciding it to make the same assumption. Under these circumstances I do not get any help from these words. ‘Commission’ may be expressly included either because it would otherwise not be included or in order to make clear what might otherwise be in doubt. No light is thrown on what else is comprised in expenses of management.

However Lord Reed’s view of the breadth of the statutory term was not agreed by the other four Law Lords. All that remains in this section is to note that the ability of a life assurance company to deduct any commissions paid as management expenses led to a business of ‘commission buying’, of premiums being artificially inflated where a huge part of the premium was paid in commission (PPI policies in particular were subject to this) and the 100 per cent reinsurance of commission-heavy ­business. From 1990 until 2012 a considerable amount of legislation was aimed at curbing the worst excesses. Does ‘Disbursed’ Carry a Connotation of Cash Payment, Contrary to the General Approach to Expenses in Case I of Schedule D? This was not a subject on which any ink was spilled in any of the material I have mentioned. In North British it was held that payment from the insurer to the recipient was required: a discount on the premium received was not ‘disbursed’. The issue has arisen in the context of the accounting and regulatory return treatment of accruals and provisions. In the case of accruals it was accepted that the total amount charged in the accounts as expenses does not need to have been paid out (or disbursed) in the year, as long as it was eventually paid. And where a payment was made in and for the year but was spread forward for accounting purposes, it was deductible in full in the year the cost is incurred. This was held to be the case in Cadbury Schweppes plc v Williams (No 1).85 No expenditure on commission or other expenses on obtaining business which may be regarded as continuing for several years falls to be spread in the returns of life assurance companies, although it does in their accounts. To combat the front-loading effect, in 1990 such expenses including all commissions (except those for industrial business) were spread over seven years for tax purposes, irrespective of the accounting treatment. 85 Cadbury Schweppes plc v Williams (No 1) (2001) SpC 302 (Special Commissioner Dr John Avery Jones).

204  Richard Thomas The issue was probably put to rest as a result of the decision of the Special Commissioners (T Gordon Coutts QC and J Gordon Reid QC) in Jenners Princes Street Edinburgh Ltd v Commissioners of Inland Revenue.86 In that case it was held that a Schedule D Case I rule limiting the deductibility of repairs to the ‘amount actually expended’ did not imply a cash basis. What Count as ‘Investments’ for the Purposes of the Section? Is a Life Assurance Company Limited to Repayment of Tax on Income From its Investments or is the Relief More General? There seems no dispute that it included real property, or else the rule that was in section 14(3) of the Finance Act 1915 would be otiose. It obviously included shares and interest-paying debt of all types. It was also generally accepted that it included a trade where the trade was carried on incidentally to the trade of insurance, eg a farming business in a case where an insurance company which was a landlord found the tenant moving out and put the farming in the hands of agents.87 What is the ‘Otherwise’ Way of Charging Tax? The obvious answer is by assessment of income not subject to deduction of tax at source. A life insurance company taxed on the interest basis was subject to being assessed on short interest received gross. Is an Income Tax Year (the Period in Section 14 of the Finance Act 1915) the Measure to be used for Repayment and for Calculating the NC1 Restriction Where a Company Draws Up Accounts to a Different Date? The law says it is. This is an area where common sense prevailed. It would be far too complicated to try to compute a NC1 restriction for an income tax year where the company’s accounts were to 31 December or as in the case of Standard Life, 15 November. Such companies were permitted by the Inland Revenue to use the accounting year figure of tax suffered as well as using it for the NC1 restriction. This caused some problems on the change to corporation tax – see United Friendly Insurance Co Ltd v Eady (HM Inspector of Taxes).88

86 Jenners Princes Street Edinburgh Ltd v Commissioners of Inland Revenue [1998] STC (SCD) 196. 87 This happened to the author when he was a district inspector in a district dealing with life assurance companies. The farm produced blackcurrants for Ribena and borage for Pimm’s. 88 United Friendly Insurance Co Ltd v Eady (HM Inspector of Taxes) (1973) 48 TC 657.

Deduction of Expenses of Management  205 How is the NC1 Restriction to Work in the Case of an Investment Company? It didn’t. In Simpson (HM Inspector of Taxes) v Grange Trust Ltd89 the House of Lords said it did not apply to a company which did not in fact trade. What are Fines and Fees in the Case of an Insurance Company? The only discussion of this issue is in Eastham. That says that: Apart from the obvious fines levied on late payment of premiums there are also in some instances fines or ‘premiums’ as they sometimes called, levied on borrowers who redeem their loans prematurely, thus involving the company in re-investment expenses and possible loss of interest.

Can a Loss on Reversions be Carried Forward and Set-Off more than Once? In practice it never was, but the legislation can be read to allow it. The same applied to the carry-forward of losses in annuity business given by section 16 of the Finance Act 1923, and even when these profits and losses were brought into Case VI of Schedule D in 1956. What is the Position if the Expenses Exceed the Income? Can that Excess be Relieved in any Way? This question was asked by Mr Geoffrey Marks of Mr MC Furtado at the latter’s evidence session in the Royal Commission of 1919. The answer was that nothing happened. And nothing did happen until 1933. On 1 June 1933 in the committee stage of the Finance Bill, a backbench MP, Bob Boothby, moved a new clause to allow an investment company relief by way of carry-forward for any management expenses for which it had failed to obtain relief as a result of the operation of the NC1 restriction. Mr Boothby’s explanation to the House was that Inland Revenue were comparing the income tax suffered by way of deduction for a tax year with the notional Case 1 profit of the previous year, and where the company’s income was declining this worked against the company. The government made sympathetic noises and on 19 June 1933 at report stage Mr Boothby, supported by others, reintroduced his amendment, this time with some polishing by parliamentary counsel. Although he explained the provision



89 Simpson

(HM Inspector of Taxes) v Grange Trust Ltd (1933–1935) 19 TC 231.

206  Richard Thomas entirely in terms of investment trust companies, the revised amendment was apt to include life assurance companies, which strangely were not mentioned at all in the debate. They were however mentioned in the Explanatory Notes produced by the movers of the new clause; not, the author suspects, without help from the Inland Revenue, and the clause was duly accepted by the government and enacted, rather confusingly,90 as section 33 of the Finance Act 1933. It was explained that the movers saw the easy solution to the problems of the investment trust companies as the removal of the NC1 restriction, but had been told by the Inland Revenue and Treasury that it was not on account of the cost. So the provision said that if expenses had been disallowed solely by reason of the NC1 restriction, the excess could be carried forward. In a footnote to the Explanatory Note the movers pointed out that an investment company was appealing against the Inland Revenue practice and if it was ultimately successful, the clause would not be necessary. The case was Grange Trust,91 and it was ultimately successful in the House of Lords in 1935. The section was not however removed, and continued to apply to life assurance companies, although it became of no relevance to other companies as the ­provision could not apply after Grange Trust. In the Finance Act 1965 the treatment of management expenses was split between two sections, section 57 for investment companies and section 62(1) for life assurance companies with necessary modifications. In section 57 the Grange Trust decision was taken into account, and the reference to the NC1 restriction removed, but in its place was a general rule that any excess of expenses over income could be carried forward indefinitely. For life assurance companies the position was even better. In addition to being able to carry forward an excess of expenses over income indefinitely, they could add any amounts disallowed by the NC1 restriction. There is an interesting discussion of the 1933 clause in ‘Building Incoherence into the Law: A Review of Relief for Tax Losses in the Early Twentieth Century’ by Dominic de Cogan.92 The author agrees that the treatment of investment companies was incoherent, if what Mr Boothby MP said was correct. The Boothby clause however was as it turned out unnecessary for investment companies, but gave a coherent answer for life assurance. The author disagrees with de Cogan (on page 665) that section 33 of the Finance Act 1933 misses the point in relation to life companies.93

90 The provision which it sought to modify was ITA 1918 s 33. 91 Grange Trust, above n 92. 92 D de Cogan, ‘Building Incoherence into the Law: A Review of Relief for Tax Losses in the Early Twentieth Century’ (2012) BTR 655–71. 93 It was as it turned out a measure with a good deal of principle to support it, as is demonstrated by the author in the Inland Revenue’s (then HMRC’s) Life Assurance Manual.

Deduction of Expenses of Management  207 THE SCHEDULAR SYSTEM REVISITED

The paper began by setting out the availability of relief for expenses in the computation of income tax liability in the years before 1910. There was relief on a strictly schedular basis, with full relief for trading expenses and a less full relief for expenses in arriving at Schedule A94 liability, but no more. The relief introduced in 1915 for the expenses of management of life assurance companies not taxed under Case I and for investment companies (and savings banks) was not restricted to one Schedule: indeed it could apply to any Schedule other than Case I of Schedule D, including Schedule A, but it applied mostly to taxed interest.95 For that reason it was given by way of repayment, as there was no assessment to deduct it as there was for Case I of Schedule D. A major change to the way of giving the relief was introduced in the Finance Act 1965. Life assurance companies and investment companies became subject to corporation tax (CT). Taxed interest was charged to CT with credit being given for income tax deducted at source against CT generally, with only the excess being repaid. The structure of CT was an assessment structure, with the items of income computed under the Schedules of income tax being collected together and reliefs capable of being set against more than one type of income being deducted in a strict pecking order, in which management expenses formed one element. From being an anomalous cross-Schedule relief in income tax given effect to by repayment, it became an element in moving CT from a fairly strict schedular system to a fairly loose one with many global characteristics. Subsequent reforms in the Finance Act 2004 emphasised its kinship with Case I (and post-1970 Schedule A following reforms in the Finance Act 1996) by bringing the accountancy treatment into the foreground and tacking on Case I rules. The tax law rewrite of the CT tax basis rules in CTA 2009 now has three almost identical expense codes, a situation ripe for simplification to cut the CT legislation in half. APPENDIX 1

The Legislation on Expenses of Management as Enacted in 1915 and Amended in 1923 Section 14 of the Finance Act 1915 (as enacted) provided: (1) Where an assurance company carrying on life assurance business or any company whose business consists mainly in the making of investments, and the principal part of whose income is derived therefrom, claims and proves to the



94 The

pre-1963 Sch A, a tax on the annual value of property, whether let or not. taxed income belongs to any Schedule is an argument beyond the scope of this paper.

95 Whether

208  Richard Thomas satisfaction of the Special Commissioners that for any income tax year it has been charged to tax by deduction or otherwise, and has not been so charged in respect of its profits in accordance with the rules under the first case in section one hundred of the Income Tax Act, 1842, the company shall be entitled to repayment of so much of the tax paid by it as is equal to the amount of the tax on any sums disbursed as expenses of management (including commissions) for that year: Provided that— (a) relief shall not be given under this section so as to make the income tax paid by the company less than the tax which would have been paid if the profits of the company had been charged in accordance with the said rules; and (b) the amount of any fines, fees, or profits arising from reversions in the case of an assurance company, and, in the case of any other company, the amount of any income or profits derived from sources not charged to tax, shall be deducted from the amount treated as expenses of management for the year; and (c) in calculating profits arising from reversions, the company may set off against those profits any loss arising from reversions for any previous year during which any enactment granting this relief was in operation. (2) Notice of any claim to the Special Commissioners under this section together with the particulars thereof shall be given in writing to the surveyor of taxes for the district within twelve months after the expiration of the income tax year in respect of which the claim is made, and where the surveyor objects to such claim the Special Commissioners shall hear and determine the same in like manner as in the case of an appeal to them against an assessment under Schedule D., and section fifty-nine of the Taxes Management Act, 1880 (which relates to the statement of a case on a point of law), and any rules made for the purposes of that section shall apply in the case of any such appeal. (3) A company shall not be entitled to any relief under this section in respect of any expenses as to which relief may be claimed or allowed under section thirty-five of the Finance Act, 1894, or section sixty-nine of the Finance (1909–10) Act, 1910, as extended by section eight of the Finance Act 1914, by which enactments relief is conferred in respect of the cost of maintenance, repairs, insurance, or management of land or houses.

The amendments made by section 16 of the Finance Act 1923 were: (2) Where an assurance company carrying on the business of life assurance claims repayment under section thirty-three of the Income Tax Act, 1918,96 in respect of sums disbursed as expenses of management there shall, in addition to the amount directed by proviso (b) of subsection (1) of the said section to be deducted from the amount treated as expenses of management, be deducted therefrom the amount of any profits arising from the granting of annuities on human life.



96 ITA

1918 s 33 is what FA 1915 s 14 became when consolidated.

Deduction of Expenses of Management  209 For the purposes of this subsection, profits arising from the granting of annuities on human life shall be computed in accordance with the rules applicable to Case I of Schedule D: Provided that in making any such computation— … (b) No deduction shall be allowed in respect of any expenses of management in respect of which repayment of tax may be claimed under the said section thirty-three; and (c) There may be set off against the profits any loss, to be computed on the same basis as the profits, which has arisen in connection with the granting of annuities on human life in any previous year during which this section was in operation. (3) Where an assurance company carries on both ordinary life assurance business and industrial life assurance business, the business of each such class shall, for the purposes of the Income Tax Acts, be treated as though it were a separate business, and section thirty-three of the Income Tax Act, 1918, shall apply separately to each such class of business. (4) For the purpose of removing doubts, it is hereby declared that a mutual assurance company carrying on life assurance business is entitled to relief under section thirty-three of the Income Tax Act, 1918, in the same manner and to the same extent as if the business of the company were the business of a proprietary assurance company, and the provisions of this section shall be construed accordingly.

APPENDIX 2

Extracts from the Speeches in the House of Lords in Sun Life v Davidson (HM Inspector of Taxes) Viscount Simonds pointed out that: The Society’s right to relief cannot depend on the way in which it chooses to treat these payments in its books, but it is a matter to which reference has been made, and I therefore quote again from the Case to the effect that the sums were included in the amount debited for expenses of management in the Board of Trade return.

He added: It is in fact very clear that an expression like ‘expenses of management’ is insusceptible of precise definition and that there must be a borderline or twilight area in which a conclusion one way or the other could easily be reached. That does not mean that there is not on either side of it an area of sunshine and of darkness. The question is, then, whether these particular charges are expenses of management. I have so far ignored the fact that these words have in the Section an appendage ‘(including commissions)’. It has been assumed on both sides that ‘commission’ here refers to the payment made to the agent who obtains business for his society and does

210  Richard Thomas not include the brokerage payable to a stockbroker, which is often called commission. I am content without deciding it to make the same assumption. Under these circumstances I do not get any help from these words. ‘Commission’ may be expressly included either because it would otherwise not be included or in order to make clear what might otherwise be in doubt. No light is thrown on what else is comprised in expenses of management. Counsel for the Appellant Society further supported their submission by reference to the origin of the expression ‘expenses of management’. It is to be found in the statutory form prescribed in the First Schedule to the Assurance Companies Act, 1909, and had in fact been incorporated in that Act from earlier Acts. The form, which is that of a revenue account, contains inter alia two headings of deduction, namely, (1) commission, (2) expenses of management. But I cannot infer from this that all disbursements made by the Society must fall under one or other of these headings. That would be to ignore both the fact that there is a third heading, ‘Other payments (accounts to be specified)’, and the fact that as a matter of accounting such disbursements need not be and generally are not included in the item ‘Expenses of management’ … There is little other authority upon the meaning of the relevant words, but I get some assistance from a decision of Rowlatt, J., in Bennet v Underground Electric Railways Co. of London, Ltd … It could be said of this decision that, though the learned Judge very incisively said that the loss incurred in the purchase of foreign currency was not an expense of management, his reason for saying so, namely, that the cost of management remained the same, really involved a petitio principii. For the cost of management could only remain the same if the loss was not an expense of management. But the value of the case lies in the reaction of a very learned Judge to the argument that an expense necessarily incurred in order to carry on a business properly is therefore an expense of management. And if on analysis it would seem that in effect the learned Judge said: This is not an expense of management because it is not an expense of management, I should not give any less weight to his authority. He did not attempt to define management in this context; to him the plain English word could not properly extend to cover such a payment, and at the end of the day I doubt whether any more cogent reason can be given.

Lord Somervell said: Parliament decided to deal with this anomaly [inability to claim management expenses where interest taxed, not profits] in 1915. Assurance companies carrying on life assurance business, companies whose business consists mainly in the making of investments, and savings banks97 became entitled, on proof that they had been charged to tax by deduction or otherwise and not charged on their profits under Case I, to repayment of so much of the tax paid as equalled ‘the tax on any sums disbursed as expenses of management (including commissions)’ …

97 Relief for management expenses was given to penny savings banks and other banks for savings by FA 1915 s 21(2). In 2004 it was found that there was one savings bank still in existence using the relief.

Deduction of Expenses of Management  211 The Life Assurance Companies Act, 1870, provided, by Section 4, that a company carrying on life assurance and other business must keep a separate account in respect of its life assurance fund and prepare a revenue account in the form set out in the First Schedule. On the right hand side of the form appear the items, ‘commission’, ‘expenses of management’, ‘other payments (accounts to be specified)’. This Act was repealed and the above provisions re-enacted in the Assurance Companies Act, 1909. Parliament having decided to deal with the anomaly, one would expect it to be removed wholly or substantially. There would seem to be no sense in leaving life assurance companies still liable to suffer tax on some sum over and above their profits. The formula ‘expenses of management (including commissions)’ is clearly taken from the form of revenue account in the Schedule to the Life Assurance Companies Act. I would regard the words themselves as apt to cover the expenses which would normally be deductible in respect of its life assurance business if an assurance company carrying on life assurance business was assessed as a trader. There may be, as the Assurance Acts recognise, ‘other payments’, which might or might not be deductible under Case I. The fact that these words are qualified by the words ‘accounts to be specified’ is, I think, some indication that the words ‘expenses of management’ and ‘commission’ were regarded as covering all ordinary expenses. Proviso (a) contemplates that expenses of management (including commissions) may exceed in amount the expenses which would be deductible under Case I. This weighs heavily against the very restricted sense of management for which the Revenue contended. The Section has to operate by providing for a repayment of tax already suffered. The purchase price of the investment cannot enter into the computation as an expense. It would only come in if one was in search of the ‘profit’ made subsequently by its realisation. Having regard to the intention of the Section to be gathered from its terms and to the statutory background, the words should be given, in my opinion, a wide construction. I wholly reject the distinction sought to be drawn between the management, and the carrying on of the business, restricting the former to the head management … Unaided, I would, I think, have come to the conclusion that the items in issue here were expenses of management. The buying and selling of securities is clearly part of the business of the company, and a function of management. No one would dispute that it was proper to buy and sell on the Stock Exchange. Might not the expenses of doing so be said to be expenses of management? This is plainly a possible view, as it was that taken by the Inland Revenue from 1915 to about 1950. It was also, I think, the view taken by some of the learned Judges below, although they held themselves bound by Capital and National Trust, Ltd. v Golder, 31 TC 265. I am, however, impressed by the arguments on the other side as restricted to these two particular items. The brokerage and stamp duty, though not, as the Commissioners held in Golder’s case, an integral part of the purchase price, are a direct and necessary part of the cost of a normal method of purchase. I therefore, with some hesitation, agree that they should not be treated as expenses of management and that the appeals should be dismissed.’

212

8 A Tale of the Merger Between the Inland Revenue and HM Customs and Excise PENELOPE TUCK, DOMINIC DE COGAN AND JOHN SNAPE

ABSTRACT

The merger of HM Commissioners of Inland Revenue and HM Customs and Excise in 2005 stands out as one of the most instantly recognisable reforms of the UK Civil Service in recent times. A good deal has been written about the consequences of the merger, but we focus in this chapter on the period immediately before, culminating with the publication of the ‘O’Donnell Review’ and its recommendations that the old departments be merged and that key elements of the policymaking process be transferred to HM Treasury. We portray the merger as a collection of connected reform processes, embracing some although not all of the ideas for administrative change that were current in the early 2000s. The content of the reforms was not entirely revolutionary and shows strong continuity with previous and indeed subsequent initiatives. Yet the merger had a significance and scale that justifies its reputation as a landmark change in the UK tax system, as well as an ideological coherence as a belated application of market-inspired techniques to the tax authorities. INTRODUCTION

A

‘major review’ was announced in July 2003 by the Rt Hon Gordon Brown, the then Chancellor of the Exchequer, to examine the ­ organisations which dealt with tax policy and administration: HM Customs and Excise (HMCE), HM Commissioners of Inland Revenue (IR)

214  Penelope Tuck, Dominic de Cogan and John Snape and HM Treasury (HMT).1 The review was to be led by Gus O’Donnell, the then Permanent Secretary to HMT, and was intended to focus on the best organisational arrangements for achieving the government’s tax objectives. The UK, unlike most other tax administrations worldwide, had separate organisations dealing with direct taxes (IR) and indirect taxes and customs duties (HMCE). Both of these organisations had long histories, each with distinct cultures, modes of operation and workloads which had been built up over centuries. The findings of the O’Donnell Review were published in March 2004 and its recommendations that the IR and HMCE ought to be merged into a single tax department, HM Revenue and Customs (HMRC), with responsibility for policymaking partly transferred to HMT, were implemented promptly. A good deal of attention has been paid to the aftermath of these decisions,2 but there has been no systematic study of the period immediately preceding the publication of the report. In this chapter, for the first time, we present such a study. It is properly described as ‘history of tax law’ though it applies to relatively recent events similar types of examination as can be found in other parts of this volume, and in earlier volumes of Studies in the History of Tax Law. The difference is that the raw material for many of those other studies is documentary, whereas much of the information that we wished to write about was not documented but is rather in the memories of the people involved.3 Although our objectives are orthodox for this series of books, our methods are not. In order to gain understanding of the ideas, techniques and arguments in play during the period immediately before the merger, two of the authors carried out a series of seven interviews with key informants from the IR and HMCE who were significantly involved in the processes leading up to the merger. The third contributed insights gained from close study of contemporary political, and policymaking, ideas. Together, the three authors also held a ‘witness seminar’ at Birmingham Business School on 12 December 2016,4 funded by the Chartered Institute of 1 See HM Treasury Press Release 78/03, ‘Chancellor Announces Major Review of Inland Revenue and HM Customs and Excise’, 2 July 2003 (reprinted at [2003] Simon’s Weekly Tax Intelligence 1202–04). 2 See eg CJ Wales and CP Wales, Structures, Processes and Governance in Tax Policy-Making: An Initial Report (Oxford: Oxford University Centre for Business Taxation, 2012); C Wales, ‘The Making of Tax Policy in the Post-O’Donnell World: Can the HMT-HMRC “Policy Partnership” Meet the Challenge?’ [2009] BTR 245; C Wales, ‘The Implications of the O’Donnell Review for the Making of Tax Policy in the UK’ [2004] BTR 543. 3 This is the problem that has inspired ‘oral history’: see P Thompson and J Bornat, The Voice of the Past: Oral History, 4th edn (Oxford, OUP, 2017); R Perks and A Thomson (eds) The Oral History Reader, 2nd edn (Abingdon, Routledge, 2006). Note that oral history has several wellknown l­imitations, including the reliance on memory, which may not always be accurate. Certain events have greater significance in memory than when they occurred, and may be shaped by memory in idiosyncratic ways when recalled. 4 We record our gratitude to the Chartered Institute of T ­ axation for funding the travel and transcription costs of the interviews discussed within this chapter, as well as for funding a witness seminar on the merger held at Birmingham Business School. This was with the further participation of Rodrigo Ormeno Perez (University of Chile), Kevin Holland (Cardiff Business School) and Elaine

The Merger Between the Inland Revenue and HM Customs and Excise  215 Taxation, at which other key informants from the IR, HMT and professional firms discussed a series of questions relating to the period before the merger. All the quotations used in this paper are drawn from the interviews that were conducted by the two authors mentioned above. We particularly focused in our interviews on the period before the merger and did not cover the aftermath of the merger. Most of the interviews took place in late 2016 and early 2017, with a final one being held in March 2018. All interviews were recorded and transcribed. The interviews were coded for dominant themes which had arisen from the seminar, but in addition codes were generated from the data itself. Our codes were focused on the perceived rival cultures of IR and C&E; on the so-called ‘Mapeley affair’, discussed below; on ministerial and other accountability issues; and on policymaking (and ex ante scrutiny of policy and legislation more generally).5 In the final stage of the coding we sought relationships between the open codes and the themes until our categories emerged on the key aspects of the merger.6 This was carried out by all three authors ­separately and in discussion with each other. Our examination of this new evidence proceeds as follows. The next section of this chapter underscores the historical continuities of the merger processes by outlining some older developments in UK tax administration. This brief review demonstrates the sheer range of tasks performed by tax officials and the extreme difficulty of identifying any immutable set of functions for a revenue administration.7 We then focus more squarely on the period of the merger, looking broadly at the various reforms being discussed and implemented in the early 2000s and noting that the O’Donnell Review only concerned a subset of these. The subsequent section examines some of the big ideas articulated by the New Labour administration following the 1997 election, and which lend a sense of coherence to the merger as well as to the otherwise disparate reforms to tax administration that took place outside the scope of the O’Donnell Review. We then concentrate more squarely on the merger itself, looking in turn at the motivations for the merger; the intended consequences; funding; the role of special advisors (or ‘SpAds’); and the role of civil servants. The commonly held notion that there was a culture clash between IR and HMCE is then examined. We conclude by highlighting some important ways in which our oral evidence converges with, and diverges from, commonly held understandings of the merger.

Doyle (Kemmy Business School, ­University of ­Limerick). The format for the witness seminar drew on K Burk (ed) ‘Witness Seminar on the Origins and Early Development of the Eurobond Market’ (1992) 1(1) Contemporary European History 65–87. 5 On the last of these, see J Snape, The Political Economy of Corporation Tax (Oxford, Hart, 2011) esp ch 4. 6 See J Corbin and A Strauss, Basics of Qualitative Research: Techniques and Procedures for developing Grounded Theory, 4th edn (London, Sage, 2015). 7 See generally K Hickman, ‘Administering the tax system we have’ (2014) 63 Duke Law Journal 1717.

216  Penelope Tuck, Dominic de Cogan and John Snape HISTORICAL PRECEDENTS

It is an open secret that tax careers are more varied than many might imagine, but it takes a historical review of the tax departments to show just how varied.8 The annual reports of the revenue departments detail a breathtaking range of issues with which tax officials have had to deal. The following list is instructive, but does not even attempt to be comprehensive: drugs, pornography, trade sanctions, university finances, property valuation, company registration, pensions, merchant shipping, food safety, lotteries, coinage, copyright infringement, agricultural statistics, health regulation, Royal Navy Reserve enrolment, national insurance, passenger traffic, bilateral trade agreements, smuggling, civil aviation, war damage compensation, wartime rationing, the welfare of the blind, trade statistics, competition law, postal services, diplomatic privilege, probate, natural resource exploitation, environmental protection, the promotion of plain English, citizens’ band radio, the Channel Tunnel, the adulteration of alcoholic beverages, the procurement of munitions, the establishment of the Irish Free State, the encouragement of the Welsh language, high inflation, computerisation and the creation of international organisations such as GATT, the OEEC, the EEA and UNESCO. It is difficult to discern any natural way of classifying these tasks, which is a point that will become important in relation to the merger itself. There are, however two compelling reasons why tax officials have become involved in this huge range of activities. The first is that the activities of officials are bound to track the multifarious nature of the activities being taxed. If tax is imposed on shipping, for example, the tax authorities will need at least some degree of shipping expertise. The nature of this work depends in turn on the changing practices within the shipping industry as well as on other important contextual factors such as membership of the European Single Market. The second reason is that once tax officials are in post, they may become useful for other things that might not otherwise have been part of their role. Staying with the shipping example, if the shipping tax specialists are physically present at the ports, why not ask them to inspect the shipping documents, check for contraband, ensure that goods landed at the port meet safety standards and so forth? This point is made explicitly in the 1951 report of HMCE:9 In addition to its primary revenue work, the Department does much non-revenue work. Of particular interest … is the monthly summary of the trade of this country prepared by the Department and published as the monthly Trade and Navigation Accounts; this work was a natural development of the control exercised at the ports for some hundreds of years of goods entering and leaving the 8 See also J Brewer, The Sinews of Power (Cambridge MA, Harvard University Press, 1990) ch 4 for a vivid review of an even earlier period of administration. 9 HM Customs and Excise, Forty-Second Report of the Commissioners of His Majesty’s Customs and Excise for the Year Ended 31 March, 1951 (Cmd 8449, 1951–52) 7.

The Merger Between the Inland Revenue and HM Customs and Excise  217 country … The network of Customs and Excise control which covers the country is also a suitable and economical instrument for other forms of non-revenue work for which separate staffs in other Departments would not be justified.

There were also instances of tax collection being assisted by non-revenue ­departments such as the Post Office,10 the Office of Works and the ­Stationery Office.11 The munitions levy was for a while collected by the Ministry of Munitions12 and HMCE also collected on behalf of the IR.13 To say the least, therefore, the tasks of revenue administration were not ­allocated in a theoretically clean manner, even setting aside all the non-tax ­activities of tax officials. However, the disjuncture between the time before and after the O’Donnell report ought not to be exaggerated. It is clear from the Annual Reports of the departments that the generally pragmatic orientation towards tax administration was tempered by a continual reflection on what officials were doing, how and why. In some cases, this reflection was prompted by external stimuli such as the creation of the Irish Free State or the accession of the UK to the European Communities. In other cases, it was simply recognised that a period of reflection was overdue.14 Sometimes, the definite imprint of political ideology can be seen, most notably in the 1980s when not only the content but also the layout of the reports became notably more managerial.15 The division of responsibilities over time between the IR, Excise and Customs departments reflects this patchwork of inherited systems of administration, pragmatism, selfreflection and political ideology. On the one hand, there was no natural way of subdividing government, and it is clear from the O’Donnell Review that very different approaches were taken in other jurisdictions.16 On the other hand, it is natural that the self-understanding of the departments as reflected in their annual reports reflected the range of work that they did. To return once again to the shipping example, the presence of large numbers of customs officials at the major ports contributes to a self-understanding of HMCE as a frontier force, even though much of the department’s work happened inland. Thus, even after 10 Inland Revenue, Fifty-Second Report of the Commissioners of His Majesty’s Inland Revenue for the Year Ended 31 March, 1909 (Cd 4868, 1909) 97. 11 Inland Revenue, Seventy-Fourth Report of the Commissioners of His Majesty’s Inland Revenue for the Year Ended 31 March, 1931 (Cmd 4027, 1931–32) 5–6. 12 Inland Revenue, Sixtieth Report of the Commissioners of His Majesty’s Inland Revenue for the Year Ended 31 March, 1917 (Cd 8887, 1917–18) 4. 13 Inland Revenue, Fifty-Sixth Report of the Commissioners of His Majesty’s Inland Revenue for the Year Ended 31 March, 1913 (Cd 7000, 1913) 5. 14 See eg Inland Revenue, Twenty-Eighth Report of the Commissioners of Her Majesty’s Inland Revenue on the Duties under their Management, for the Year Ended 31 March 1885, with Some ­Retrospective History, and Complete Tables of Accounts of the Duties from 1869–70 to 1884–5 Inclusive (C 4474, 1884–85). For a convenient history of merger proposals dating back to the mid-nineteenth century, see House of Commons Treasury Committee, Second report: HM Customs and Excise (HC 53, 1999–00) xvii ff. 15 P Tuck, ‘A Study of the Changing Relationship Between Large Corporates and the Inland ­Revenue’, unpublished PhD thesis, University of Warwick, 2007. 16 G O’Donnell, Financing Britain’s Future: Review of the Revenue Departments (Cm 6163, 2003–04) Annex A.

218  Penelope Tuck, Dominic de Cogan and John Snape the Single European Act prompted a conscious switch of HMCE away from the borders and towards inland work,17 the department was in an obvious position to perform drug enforcement duties. The institutions of taxation were no more immutable than their workload. In 1834 the Board of Stamps was amalgamated with the Board of Taxes, and in 1848 Excise was added in order to form the Board of Inland Revenue.18 In 1909 responsibility for Excise was transferred to the Commissioners of Customs in order to form HMCE.19 More recent changes have been transfers of pension responsibilities from HMCE to the Assistance Board in 1943,20 the functions of the War Damage Commission to the IR in 1964,21 probate functions from HMCE to dedicated probate offices in the late 1960s,22 the introduction of VAT in 1973, the conversion of some customs duties into excise duties in the late 1970s23 and the subsequent rebalancing of customs and excise work towards other matters such as drugs enforcement and immigration control. The reforms that the New Labour government carried out to tax adminis­ tration are notable for their ambition, scale and sense of ideological consistency. However, it would be a mistake to see them as a radical departure from previous decades and centuries, which, as we have seen, involved a series of attempts to impose order upon wide-ranging, pragmatic and very old systems of ­administration. CONTEMPORARY REFORMS

The New Labour government of 1997 embarked upon an ambitious programme of reform relating to some of the most fundamental aspects of the UK ­constitution. Amongst other things, it started the processes of d ­ evolving executive and legislative powers to Scotland and Wales; engaged in the ­Northern Irish peace process to the extent that it was possible to devolve powers 17 HM Customs and Excise, Eighty-First Report of the Commissioners of Her Majesty’s Customs and Excise for the Year Ended 31st March 1990 (Cm 1223, 1989–90) 12–13. 18 Inland Revenue, First Report of the Commissioners of Inland Revenue on the Inland Revenue (C 2199, 1857 Session 1) 39–40. 19 For older history see HM Customs, First Report of the Commissioners of Her Majesty’s Customs on the Customs (C 2186, 1857 Session 1) 1 ff. 20 HM Customs and Excise, Thirty-eighth report of the Commissioners of His Majesty’s Customs and Excise for the Year Ended 31st March 1947 (Cmd 7252, 1947–48) 8. 21 Inland Revenue, Report of the Commissioners of Her Majesty’s Inland Revenue for the Year Ended 31st March 1965 (Cmnd 2876, 1965–66) 2. 22 HM Customs and Excise, Fifty-Ninth Report of the Commissioners of Her Majesty’s Customs and Excise for the Year Ended 31st March 1968 (Cmnd 3873, 1968–69) 24. 23 HM Customs and Excise, Sixty-Seventh Report of the Commissioners of Her Majesty’s Customs and Excise for the Year Ended 31st March 1976 (Cmnd 6694, 1976–77) 10. As the report explains, the old ‘customs revenue duties … comprised both a fiscal element and a small protective element (neither of which was separately identified in the law)’. These ‘were replaced by (a) new excise duties chargeable at the same rate on both home produced or imported goods and (b) separate protective duties chargeable on imports’.

The Merger Between the Inland Revenue and HM Customs and Excise  219 to  ­Stormont; enacted the Human Rights Act 1998; pursued reforms to the House of Lords, although more narrowly than was first envisaged; and for a while examined the possibility of voting reform. Whilst some of these initiatives represented a radical break, in other respects there were striking continuities from the previous Conservative administration. For example, the new government – continuing an approach based on the New Public Management (NPM)24 initiative begun under the Conservatives – strengthened the emphasis on managerialism, insisting on targets for efficiency savings and performance management indicators at the organisational level.25 Even if we confine ourselves narrowly to the reform of tax administration, a lot of reforming activity took place after the 1997 election. Self-assessment had already been introduced, but in 1998 the IR became involved with the collection of student loans repayments.26 In 1999 the IR merged with the Contributions Agency, in the process assuming responsibility for tax credits and effectively taking over functions previously associated with the welfare system.27 This was followed in 2003 with the transfer to the IR of the Child Benefit Office.28 Meanwhile, Sir Andrew Leggatt’s review into tribunals was concluded in 2001,29 leading ultimately to a radical restructuring of the system in the Tribunals, Courts and Enforcement Act 2007. This ultimately led to the creation of the tax tribunals on 1 April 2009, which replaced various older institutions including the General and Special Commissioners of Taxation. These reforms represented important changes to the structure and functions of the revenue authorities, yet not one of them was contained within the ambit of the O’Donnell Review. The merger was not only far from unique historically; it was only a subset of a much wider series of administrative reforms to the tax system within its own time-period. NEW LABOUR IDEOLOGY

All the same, dissolving both the IR and HMCE, and transferring their respective functions to the newly created HMRC,30 was a bold legislative move. 24 Snape, above n 5, 105. 25 See generally J Newman, Modernising Governance: New Labour, Policy and Society (London, Sage, 2001). 26 Student Loans Company Ltd, Annual Report 1999–2000, 13, available at https://www.slc.co.uk/ media/5530/slc_annualreport_2000.pdf (accessed 14 November 2018). 27 Inland Revenue, One Hundred and Forty-First Report of the Commissioners of Her Majesty’s Inland Revenue for the Year Ending 31st March 1999 (Cm 4477, 1998–99) 5, 27. The merger also encompassed the Northern Ireland Contribution Unit and the Department of Social Security’s National Insurance Contributions Policy Unit. 28 Inland Revenue, Annual Report and Accounts for the Year Ending 31st March 2004 (HC 1062, 2003–04) 37. 29 Andrew P Leggatt, Tribunals for Users: One System, One Service: Report of the Review of Tribunals (London, Stationery Office, 2001). 30 Commissioners for Revenue and Customs Act 2005, s 48.

220  Penelope Tuck, Dominic de Cogan and John Snape Such boldness now looks like a hubristic exploitation of the vast range of possibilities open to the New Labour government and illustrates a dangerous tendency, on the part of government ministers and their advisers, to view the practice of politics as a predominantly technical activity. To understand the boldness involved in merging two revenue departments in HMRC, it is important to appreciate the parliamentary conditions under which the 1997, 2001 and 2005 Labour governments operated. Those who had contemporaneous knowledge of the merger, whether as participants or observers, tended perhaps to take those conditions for granted. The late 1990s and early 2000s were, as Janan Ganesh has written, a time of parliamentary landslides.31 Though possibilities form and re-form almost daily, this has not been so since the 2005 General Election.32 In an atmosphere dominated by the feverish need to assemble Commons majorities from truculent and unpredictable party members, much legislation must be fought-over tooth and claw. ‘It is unclear’, concludes Ganesh, ‘what voters want these days, other than their rulers on the shortest of leashes’.33 Not so, in 2005, when a government bill would pass without effective opposition. In an atmosphere dominated, too, by populist mistrust of representative institutions, MPs seem, perhaps more than ever, to try to gauge the transient preoccupations of their constituents. Not so in 2005 when, as yet unchastened either by the scandal of parliamentary expenses,34 or by the mistrust of elites, parliamentarians seemed secure in their status. In hindsight, Europe also seemed non-salient; the divisions that had riven Conservative governments before 1997, and that do so to this day, had been replaced by constructive engagement under the Prime Minister, the Rt Hon Tony Blair, and Brown as Chancellor.35 The economy seemed to be thriving, too, the clouds of 2007–08 being yet in the future. Brown had stated in 1997 that: ‘I want ­British economic success to be built on the solid rock of prudent and consistent economic management, not the shifting sands of boom and bust’.36 The fall-out from Iraq had created some clouds but was yet to play out.37 In short, well ahead of its landslide 1997 general election victory, New Labour had a very clear idea of the tax policies it wanted to implement, and had assembled a package of measures that they wanted to take (interview #6).

31 J Ganesh, ‘Britain Opts For Weak Government By Popular Design’ Financial Times (8 May 2018) 11. 32 ibid. 33 ibid. 34 Daily Telegraph, The Complete Expenses Files (London, Daily Telegraph, 2009). 35 BBC Radio 4, ‘Blair, Brown and a Bike Ride’ Brexit: A Love Story? (Episode 9) (19 July 2018) available at https://www.bbc.co.uk/programmes/p06f4mdc (accessed 28 November 2018); J Powell, The New Machiavelli: How to Wield Power in the Modern World (London, Bodley Head, 2010) ch 10. 36 G Brown, Moving Britain Forward: Selected Speeches 1997–2006 (London, Bloomsbury, 2006) 87. 37 Powell, above n 35, ch 11.

The Merger Between the Inland Revenue and HM Customs and Excise  221 So, in reality, all that was needed, in 2005, to pass radical legislation, was to present a bill to Parliament, while the government whips would ensure its passage with minimal debate. This facility illustrates the hubris, since it was at one and the same time, both the great strength and the great weakness of the New Labour government: get the calculation right and no one notices, indeed if things go well, public opinion and vested interests might even concur; get it wrong, though, and there could be big trouble. The biggest tax policy embarrassment New Labour was living with in 2005 were the problems that had arisen from the introduction of tax credits in April 2003: their extreme complexity, IR staff shortages and a consequent lack of administrative capacity, the dislocation between the basis on which they were paid and the intervals between payments, chronic IT problems, and so on.38 In 2005, though, it seemed possible to see the tax credits debacle as a matter of faulty administration. The managerial approaches already alluded to were at home in this environment, though journalistic polemics already doubted, not only the place of ‘managerialism’ in politics, but in business too.39 In such calculations, enduring values get pushed aside, not least experience. Instead, as one of the co-authors has argued elsewhere, a certain Machiavellianism had free rein.40 Referencing Machiavelli’s account of Philip of Macedon, indeed, Jonathan Powell (Blair’s chief of staff, 1997–2007) writes that ‘Leaders should … have an overall plan, choose their target and aim high’.41 In relation to getting it right, there were few naysayers, so only Machiavellian political prudence guided success, in a kind of elite ­despotism. ‘As the Tax Credits Bill progressed through Parliament in 2001–2002’, write King and Crewe, ‘Conservative and Liberal Democrat MPs and peers were muted in their criticism, partly because many of them found the government’s overall welfare-to-work concept congenial’.42 Moreover, the scandals surrounding large-scale international ‘tax planning’, which first piqued the interest of a disaffected Public Accounts Committee were far in the future.43 Only the House of Commons Treasury Select Committee took a close interest in tax matters and that was stacked, its chair unelected, its members often supine, sometimes apparently even in awe of Brown’s forceful manner.44 Even more problematically, the early 2000s had seen a dramatic increase in the use of ‘the guillotine’, a procedure for curtailing debate (and hence the ex ante scrutiny of legislation), notoriously in relation to the 2003 Finance Bill.45 38 A King and I Crewe, The Blunders of our Governments (Oxford, Oneworld, 2013) 147–51. 39 See eg C Dillow, The End of Politics: New Labour and the Folly of Managerialism (Petersfield, Harriman House, 2007) 277 ff. 40 Snape, above n 5, 81. 41 Powell, above n 35, 171. 42 King and Crewe, above n 38, 146. 43 See M Hodge, Called to Account: How Corporate Bad Behaviour and Government Waste Combine to Cost Us Millions (London, Little Brown, 2016) ch 3. 44 Snape, above n 5, 72–74. 45 J Snape and J de Souza, Environmental Taxation Law: Policy, Contexts and Practice (Aldershot, Ashgate, 2006) 66, 66n.

222  Penelope Tuck, Dominic de Cogan and John Snape Such an approach tends, of course, to close off the possibility of debate about the end of public policy and instead to focus attention on the means by which ends can be attained and the stated rationales for the merger of the two revenue departments illustrate the narrowness of this conception of politics. The modernising end of public policy under New Labour was expressed in the 1999 White Paper, Modernising Government.46 ‘Modernisation, though, had to be for a purpose’, it read, ‘to create better government to make life better for people’.47 The means were to be threefold: the careful devising of ‘­policies and programmes’; appropriate delivery of ‘services to individual citizens and businesses’; and appropriate performance of ‘all the other functions of a modern government’.48 As Newman elegantly puts it, this focus on modernisation was drawn from selective ‘appropriation and trends and tendencies of the modern world’.49 The reference to ‘customer focus'50 represented a repackaging and extension of the ideas of the previous Conservative administration. Other elements of the White Paper were based variously on previous ideas of standardisation, Fordist production methods, measurement and evidence-based policymaking and practice. The rationales for the merger of the IR with HMCE were consistent with the White Paper. As we shall see below in the words of our interviewees, the merger took place in the context of two serious controversies that, at worst, posed a general threat to public consent to taxation. One, the Mapeley Affair, had seen the last chairman of the IR, Sir Nicholas Montagu, allegedly sanction the transfer of the title to the IR’s estate to offshore companies.51 The other, which involved HMCE losing some high-profile VAT prosecutions, had resulted in Customs and Excise’s prosecution functions ‘being brought under the direct supervision of the Attorney-General’.52 More generally, there was a mistrust of ideology and, in an ironic twist, a dogmatic assertion that the values of economic governance could be reduced to the single value of efficiency as being the best route to ‘fairness’. Brown, no less, had himself written in the 1990s a Fabian Society pamphlet to this effect.53 It meant, in practice, that tax measures had to be justified by the need to remedy ‘market failures’,54 not by reference to ideological dogma. New Labour’s meticulous planning of its path to power before 1997 took full note of these points. Conservative governments since that led by the Rt Hon Margaret Thatcher had fostered a mistrust of the state and promoted free market values, which, rather than seek to overturn, 46 Cabinet Office, Modernising Government (Cm 4310, 1998–99). 47 ibid, 13. 48 ibid. 49 Newman, above n 25, 173. 50 Cabinet Office, above n 46, 32. 51 Snape and de Souza, above n 45, 79. 52 ibid. 53 G Brown, Fabian Pamphlet 563: Fair Is Efficient – A Socialist Agenda for Fairness (London, Fabian Society, 1994). 54 Even for green taxes (see Snape and de Souza, above n 45, 115–20); also Snape, above n 5, 186.

The Merger Between the Inland Revenue and HM Customs and Excise  223 Brown and Blair (the latter influenced by the LSE academic, Professor Anthony Giddens)55 had tried to accommodate within a social democratic framework. Moreover, in a clever twist, rather than invoking those doyens of the twentiethcentury intellectual left, RH Tawney, Harold Laski, Keynes, etc, Brown had turned to that doyen of laissez-faire, the moral philosopher Adam Smith.56 Prior to the 1997 election, memories of the tax policies of the ­Callaghan era were still vivid in the memories of older voters. These tended to focus on income tax rates (hence New Labour’s carefully-guarded campaigning on tax policy in 1997)57 but, more relevantly here, they had resulted, too, in an exponential extension of the institutional competences of the revenue departments in the 1976 Finance Act.58 Even more generally, New Labour had big ambitions for the tax system centred on this central value of efficiency and its enhancement to enhance fairness, something that was thought to require expertise to be concentrated in a single institution. All of the taxes needed attention and new ones had to be introduced, admittedly a process begun under the Conservatives before 1997. High marginal rates of income tax for those on low incomes needed to be mitigated.59 All this involved a blurring of the boundaries between tax and social security, a blurring that was quite deliberate. The idea was that if a wider range of people could conceivably be both potential income taxpayers and benefits claimants, the social stigma associated with welfare might be reduced, along with popular opposition to greater generosity towards claimants.60 Our interviewees supported the idea that this was a designed consequence of Blair’s programme of modernisation. The allocation of responsibility for tax credits to the IR was, in part, so ­motivated. According to one of our interviewees, ‘Gordon [Brown] and Ed  Balls had got the idea on the Earned Income Tax Credit in the United States’ (interview #3).61 The reform of the obsolescent tax treatment of corporate financial instruments, again begun under the Conservatives, had to be further enhanced.62 To further enhance EU environment measures, environmental taxes had to be

55 A Giddens, The Third Way; the Renewal of Social Democracy (Oxford, Polity Press, 1998); A Giddens, The Third Way and its Critics (Cambridge, Polity Press, 2000). (See also, though for a later period, A Giddens, Over To You, Mr Brown: How Labour Can Win Again (Cambridge, Polity Press, 2007).) 56 See S Lee, Best for Britain? The Politics and Legacy of Gordon Brown (Oxford, Oneworld, 2007) ch 2; ‘Introduction’ in G Himmelfarb, The Roads to Modernity: The British, French and American Enlightenments (London, Vintage, 2008) ix, xiii. 57 S Richards, Whatever it Takes; The Real Story of Gordon Brown and New Labour (London, Fourth Estate, 2010) 89–95. 58 See eg J Snape, ‘WT Ramsay v Commissioners of Inland Revenue (1981): Ancient Values, Modern Problems’ in J Snape and D de Cogan (eds) Landmark Cases in Revenue Law (Oxford, Hart Publishing, 2019) 223. 59 W Keegan, The Prudence of Mr Gordon Brown (Chichester, Wiley, 2003) 249; King and Crewe, above n 38, Ch. 10. 60 King and Crewe, above n 38, 141–46. 61 This is well-documented (see eg Richards, above n 57, 115; King and Crewe, above n 38, 141). 62 Snape, above n 5, 142–46.

224  Penelope Tuck, Dominic de Cogan and John Snape introduced and expanded.63 Indeed, in retrospect, this says something about the role of HMRC in an EU-focused governance structure, and may go a long way to explain how, by and large, New Labour’s green taxes were of low salience and unloved.64 As Snape and de Souza explain,65 New Labour’s green taxes (national in origin)66 were nonetheless often grafted onto EU regulatory structures, ­notably for waste management and climate change. One of the most haunting images of Sir Edward Coke (1552–1634) is his definition of the surrender of a life estate, or of a term of years, in land, to the holder of the greater estate, as meaning that the former ‘may drowne by mutuall agreement betweene them’ in the latter.67 In this chapter, we make no judgment as to whether, in fact, either department was ‘drowned’ in the other when the two became HMRC. However, some hold this to be the case, and hints of that surfaced in the interviews. What remains strange is that, in an era of landslides, New Labour should have devoted such energy and political capital to the endeavour discussed in these pages. Stafford Cripps in the 1930s had looked forward to Labour landslides as resulting in the passing of socialist laws.68 The HMRC merger is perhaps a telling illustration of the preoccupations that a vast socialist legislative endeavour did not in fact happen when, at last, the opportunity arose. As it was, it provoked an unlikely nostalgia for revenue departments, a mistrust of perceived dominance by the tradition if not the personnel of HMCE in the new institution, and an implausible nostalgia for a gentlemanly Revenue.69 THE INTERVIEWS

We now move to our interviews on the O’Donnell Review and the process of the merger itself, which elaborate many of the themes just sketched although in a more conversational manner. The process of coding the interviews highlighted a number of discrete areas of interest which we now consider in turn: the motivations for the merger; the allocation of functions; the funding of the merger; the role of special advisors; the role of civil servants; and the distinctive cultures of the IR and HMCE.

63 Snape and de Souza, above n 45, ch 11. 64 J Snape, ‘The Green Taxes of the Brown Chancellorship, 1997–2007’ (2007) 19 Environmental Law and Management 143–58. 65 Snape and de Souza, above n 45, chs 8, 12. 66 ie on the basis that the EU Emissions Trading Scheme (see Snape and de Souza, above n 45, ch 28) while an ‘economic instrument’, is not properly a ‘tax’. 67 Coke’s Commentary upon Littleton (1832) vol II, s 636, p 337b. 68 M Loughlin, Public Law and Political Theory (Oxford, Clarendon Press, 1992) 236. 69 Belied, surely, by the Rossminster case (see N Tutt, The History of Tax Avoidance (London, Wisedene, 1989) originally published as The Tax Raiders: The Rossminster Affair (London, F ­ inancial Training, 1985)).

The Merger Between the Inland Revenue and HM Customs and Excise  225 Motivations for the Merger Our informants were unable to settle on a single, core, reason or driver for the merger. However, they were able to provide some detailed substance to the emphases on efficiency and the transformation of policymaking in the O’Donnell Review70 and indeed the Modernising Government White Paper.71 One suggestion was that Brown, as Chancellor of the Exchequer, spotted an opportunity to enhance his control over tax policy: Why did the merger happen? The official reason is that the Chancellor had given up effective ownership of the Bank of England; there weren’t many other levers for him and therefore he wanted to be able to control taxation or tax policy in a way that he hadn’t before. (Interview #4)

The following very revealing extract confirms that the question of control was closely connected to the overall approach that the government wished to take to policy, moving away from the more tax-specialist approach typically associated with the IR: But I think when the Labour government arrived they were shocked about a number of things and their special advisers, Ed Balls,72 Ed Miliband, Chris Wales, weren’t able to get what they really wanted and that was polymaths to talk to about the tax system. There were lots of, as the Scots would say, stooshies about who owned the tax system, and that was genuinely difficult … You’d have arguments about who was in charge and who owned the tax system broke out all over the place on a fairly regular basis.73 (Interview #4)

The suggestion that political motivations underlay the commencement of the O’Donnell Review, with the outcome a foregone conclusion, was contradicted by an interviewer, but not terribly forcefully: Foregone is strong. I think if we’re honest with ourselves, there was a pattern to the way Brown in particular operated, that he had a penchant for reviews, which as he would’ve seen them corroborated independently a conclusion. Now I’m not saying all the time that Brown said that ‘It has to be X, just get a whole lot of academics and make sure it says X and just weigh the stuff’; that’s a caricature I think. But on the other hand, the sense that there’s a very likely outcome in this case, was the case. (Interview #1) 70 Other motivations mentioned in the O’Donnell Review include the reduction in taxpayer compliance costs, the better use of information, better customer service and better accountability: see O’Donnell, above n 16, 3–4; House of Commons Treasury Committee, The Merger of Customs and Excise and the Inland Revenue (HC 556, 2003–04) 3–8. It is interesting that our evidence overlaps with, but does not replicate, this list of motivations: see text at n 104, below. 71 Cabinet Office, above n 46. 72 See eg W Keegan, The Prudence of Mr Gordon Brown (Chichester, Wiley, 2003) 128–41. 73 John Tiley quoted the memoirs of Denis Healey (Lord Healey) Labour Chancellor 1974–79, as writing that the Inland Revenue, like Customs and Excise, ‘considered itself to be at least as independent of the Treasury as the three armed services were of the Ministry of Defence!’ (J Tiley, Revenue Law, 4th edn (Oxford, Hart Publishing, 2000) 58n, quoting D Healey, The Time of My Life (London, Michael Joseph, 1989) 373.

226  Penelope Tuck, Dominic de Cogan and John Snape The same interviewee thought that the transfer of policy functions to HM ­Treasury ‘was always going to happen’ on account of inadequacies with the existing way of doing tax policy.74 The degree of secrecy around the decision to initiate the review strengthens the impression that the merger process involved decisions at a very high level of government: I think like all great decisions, the decision was made and they had to put something around it. So I was at the Treasury Select Committee with Dawn [Primarolo] and just as they started asking questions she said, ‘I’ve got an announcement I’d like to make, would you mind?’ And she announced the review and the whole room gasped. Well I knew – I got it in the neck from [the Chairman] because I’d known for an hour maybe and he said, ‘You didn’t tell me.’ I said, ‘I’d no idea where you were.’ So that will give you a feel for how close this was kept. (Interview #4)

A second perspective, which emphasises underlying policy considerations rather than Brown’s personal role, was that existing arrangements were dysfunctional and out of step with comparable jurisdictions.75 On this view, Brown did not so much initiate the process as accede to a widespread view that something had to change: I think Brown did have a think about it and then said ‘No, not now’ or ‘I can’t be bothered’ or ‘it’s too difficult’; I think it was, I’m pretty sure it was Brown because he was quite a cautious dot dot dot; and in the end I don’t know enough actually as to what was the particular trigger – was it that Gus [O’Donnell] finally decided that we had to nail the tax policy issue maybe, and was it the conjunction of things that said ‘this is more and more self-evidently eccentric at least, at worst dysfunctional, that you’re not maximising the joined-upness – not a very elegant word – that you could achieve. (Interview #1)

Exactly what these dysfunctions consisted of are spelled out in the following extract, dealing with what the interviewee described as (what must have been unusual at the time) ‘a very difficult Treasury Select Committee’: Dawn [Primarolo] had got in front of it and she was a bit panicky because things were difficult, but the Mapeley thing was simmering on, and with the Tax Credits and the EDS systems, and saying that there was going to be an inquiry helped to defuse things, so there was that element of it. (Interview #3)

At the risk of repetition, the Mapeley affair involved the indirect transfer of IR buildings to a Bermudan-registered company, which was widely interpreted as the tax authorities themselves being involved in tax avoidance.76 The introduction of tax credits in 2003 was mishandled with a large number of claimants

74 Interview #1 but also commented on by interviewee #6. 75 See similarly O’Donnell, above n 16, 34–35, 40–43, Annex A. 76 Phillip Inman, ‘Inland Revenue’s property sold to company in tax haven’, The Guardian (24 September 2002).

The Merger Between the Inland Revenue and HM Customs and Excise  227 receiving excessive awards that the Revenue later tried to claw back, with the predictable outcome of pushing low-income families into hardship.77 EDS was the IR’s IT supplier, and was replaced in 2003 after taking some of the blame for the tax credits failures.78 According to the following interview extract, the problems at HMCE were even worse, and reinforced existing concerns about the allocation of functions over taxation within government: Well looking back on it, all the alleged objective reasons given were valid in that only three other countries had VAT separate from the rest of tax administration and so it made sense to – to bring it under the roof of tax administration. Everyone always talks in terms of the review happening because in some ways the Revenue was getting itself into trouble but nothing like the trouble [Customs] were getting into. I mean they had really got themselves into some holes and all their policy was done in the Treasury and it was very substantially divorced from their operational teams. (Interview #4)

One interviewee believed that these public embarrassments served more as the occasion than the motivation for the O’Donnell Review and the merger processes: This was a political decision at the end of the day, don’t let’s be under any delusion. Customs had had a problem with the Hoverspeed case,79 which I think they’d lost because they were going hard on the booze cruises and things. The Revenue had their tax credit problems. And this is my own personal view, it’s typical, it’s an almost British thing which we’re seeing every day of the week: you get a problem so what do they do? ‘Oh, we’ll have an inquiry’ or ‘we’ll have a review.’ Don’t say, ‘Go away, it’s rubbish.’ We’ll have an inquiry, and you can see how these things just go mad. (Interview #7)

A third consideration cited by our interviewees was the reputation of HMCE for relatively heavy-handed administrative tactics, and the opportunity for the IR to adopt a similar approach and thereby reduce the incidence of tax avoidance.80 … the thing that struck us all on the merger was actually the tax risk in the Revenue. We did a review of anti-avoidance to try and see how much tax was at stake. Well, the VAT at stake was, I don’t know, probably a few billion, but on the direct side we got to about 16 billion and we got fed up counting, so you suddenly realised what a huge problem this was. And I suspect that was a key driver for the merger, that the government probably saw that Customs were pretty good. (Interview #7)

77 L Chong and M Atherton, ‘Revenue accused of failure on tax credit system’, The Times (13 October 2005); King and Crewe, above n 38, Ch. 10. 78 ‘Inland Revenue dumps IT provider’, BBC News (11 December 2003). 79 See House of Commons Treasury Select Committee, Tenth Report of Session 2002–03, Inland Revenue Matters (published 23 July 2003). 80 Though to anyone familiar with the Rossminster saga, this may seem strange.

228  Penelope Tuck, Dominic de Cogan and John Snape In particular, the same interviewee continued, Customs had been quicker in ­initiating the practice of calculating the ‘tax gap’, which is the difference between the respective calculations of tax owed and tax collected.81 The interviewee ­reinforced the same point in a different way: I’m trying to think back. I suppose we felt that being the smaller department we were likely to be swallowed up, but equally we felt that actually what the government was looking for, and I’ve said this already, that actually the way that Customs handled the tax, they wanted that translated into the Revenue … (Interview #7)

The curious point here is that our informants variously cited the heavy-handed tactics of Customs as arguments in favour of the merger both in a positive way (as a model for the IR to follow in order to improve collection) and in a negative way (as a public relations nightmare). It is not clear how these considerations were reconciled, but the adverse publicity certainly left an imprint on some of our interviewees. At one point, Customs practices generated such extreme hostile attention that the need to investigate its officials almost exhausted the resources of several police forces: We got into a terrible space in this sense because then you had those investigations running, you had people suspended pending various of these things, you had multiple police forces tripping over themselves. I’m not kidding: we ran out of police forces practically to do this because you ended up in situations where the Met were themselves conflicted, hence we had Thames Valley Police one time coming in … you know, it was like next police force down the list, very very difficult times … it was hugely destabilising … there was a point at which even the director general in charge of law enforcement was suspended, and our chief lawyer. (Interview #1)

These woes did not stop with enforcement activities but extended even to Customs’ conduct during litigation: Now this was on the law enforcement side of the business, where for a variety of reasons we got ourselves into deep deep water on cases where, if I remember, predominantly we were found to have failed on issues of due process; in simple terms failure to adequately have disclosed relevant documentation to the defence. We got crucified for those failings in some very very critical judgments, ie we were very very heavily criticised, and that sparked further judicial examination of some of these ghastly stories; it sparked a raft, frankly, of police investigations, many of which as I recall actually didn’t come to anything but we were deeply troubled by that scale of ­challenge. (Interview #1)

What is clear is that the IR and HMCE were experiencing serious problems in the years leading up to the merger, and that these problems were often widely publicised. In contrast, what is absent from our interviews is any sense of deep conviction that having a single revenue department is in some fundamental

81 See J Mirrlees, S Adam, T Besley et al, Tax by Design (Oxford, Oxford University Press, 2011) 42–43.

The Merger Between the Inland Revenue and HM Customs and Excise  229 sense better than having two. The nearest approximation to such an argument is the mention of the possibility of cost savings by a number of our informants, a point which was also brought out by the O’Donnell Review.82 The Allocation of Functions Even before the O’Donnell Review was commissioned, it is clear that substantial thought had been put into the allocation of responsibilities between ­departments. Several interviewees cited the allocation of VAT to HMCE in 197383 as a particular oddity, although one that might perhaps be explained by the accumulated experience of Customs officials with the older purchase tax that was replaced by VAT: I believe that in 1973, Inland Revenue … or 72, was offered VAT. And I believe the Chairman turned it down. He thought it was inappropriate for what they did. And I think a lot of people ever since have thought that that was a missed opportunity … I think VAT would have grown up with a different culture. (Interview #2)

The following excerpt once again brings in the unusual arrangement in the UK as an argument in favour of change, without quite explaining why it was wrong to be different: I remember arguing to Gordon [Brown], ages before there was any question of a merger, for Customs to go to the Home Office and Border Control, and Taxes to come to the Revenue. In my time, only three of the administrations in the world, three direct tax, didn’t do VAT, Malawi, Israel and us, and it was barmy. And Gordon was sympathetic, but he was against it because he didn’t think that the Home Office would give sufficient priority to the Revenue. I think he’s right there, because Customs revenues are pretty small. (Interview #3)

An interesting feature of our interviews was that despite the label ‘merger’, much of the discussion of high-level questions concerned not the consolidation of the tax departments but rather the other questions of control over tax policy and efficiency in administration. As discussed above, this was closely bound up with New Labour’s emphasis on managerial administration. As early as 1999, the Modernising Government White Paper included a commitment to make policymaking ‘forward looking’ rather than ‘reacting to short-term pressures’.84 It also discussed ‘ways of tackling cross-cutting policies’, including, significantly,

82 There is, however, a difference in emphasis in that our informants spoke principally of potential savings in the administrative costs of the tax authorities, whereas the O’Donnell Review also forecasted savings in the compliance costs of taxpayers: see O’Donnell, above n 16, 29. 83 See eg D Johnstone, A Tax Shall be Charged: Some Aspects of the Introduction of the British Value Added Tax (London, HMSO, 1975) 7 ff. 84 Cabinet Office, above n 71, 7.

230  Penelope Tuck, Dominic de Cogan and John Snape a commitment to closer collaboration on policy matters between the two revenue departments: Customs and Excise/Inland Revenue have agreed cross-representation on each other’s Boards and appointed a joint programme director to improve co-ordination of their tax policies, secure increased compliance and deliver better and more efficient services to businesses.85

Another example of an attempt to impose greater efficiency and professionalism on the revenue departments can be seen in a September 1999 report of the Strategic Policy Making Team at the Cabinet Office.86 The report discusses ­policymaking widely, but includes a pertinent example relating to the debt ­recovery policy of HMCE. In a foreshadowing of Tax Policy Making: a New Approach,87 the development of this policy involved relevant trade organisations and p ­ rofessional bodies together with those staff who had operational responsibility for implementing the policy. Some of these discussions may reflect the omission of previous Conservative administrations fully to extend the logic of ‘Thatcherite’ public service reforms to the tax authorities. A particular feature of those earlier reforms had been the separation of the delivery of the policymaking and delivery aspects of public services,88 yet by the time of the merger the IR retained responsibility both for direct tax policy and the administration of direct taxes: The inquiry wasn’t simply, ‘Shall we merge Revenue with Customs?’ it was also, ‘What about the Tax Policy branch line in Revenue?’ Because we were unique amongst advanced western tax administrations responsible for tax policy. The States, Australia and New Zealand, and I can’t remember about Canada, the Treasury was responsible for it, and the Treasury would always want to get its hands on Tax. (Interview #3)

Apart from, yet again, revisiting the unusual nature of the UK’s arrangements, this also returns us to the question of control over the tax system. The point is made even more explicitly in the following extract: The standout drivers … which Gus [O’Donnell] would doubtless articulate very lucidly, is the issue of where is the anchor of tax policy? Is the Treasury appropriately equipped? Are we able to service ministers appropriately? And clearly Gus’s diagnosis to that was ‘no’, and I suspect that will have been the judgment of our political masters at the time, Brown, and Dawn Primarolo in particular given that Dawn had experienced both of the departments for a very long time even by then and doubtless did, I’m sure, have very strong views. So Gus felt very powerfully that there was 85 ibid, 18. 86 Cabinet Office, Professional policy making for the twenty-first century: report by Strategic Policy Making Team, 30 September 1999, available at https://ntouk.files.wordpress.com/2015/06/ professional-policy-making-for-the-21st-century-1999.pdf (accessed 14 November 2018). 87 HM Treasury and HM Revenue and Customs, Tax policy making: a new approach, June 2010, available at http://webarchive.nationalarchives.gov.uk/20130102201052/http://www.hm-treasury.gov. uk/d/junebudget_tax_policy_making.pdf (accessed 14 November 2018). 88 N Flynn ‘Modernising British Government’ (1999) 52(4) Parliamentary Affairs, 582–97.

The Merger Between the Inland Revenue and HM Customs and Excise  231 a pressing need to get to a much more better place in terms of our ability to do tax policy. (Interview #1)

The bottom line is that the merger had the potential to equip HM Treasury with an extremely powerful set of instruments for influencing events. They saw it as an entry into power and the Treasury like power. And the great plan – and this is very, very important – there were two rigged appointments in the Treasury that Gordon [Brown] led … and one was the appointment of Nick Stern from being Chief Economist at the World Bank to being the Second Permanent Secretary … And Nick was also on Gus’s inquiry and was a critical factor in this. The idea was that the Revenue Tax Department would move to the Treasury under Nick, who, for the first time, would bring together a macroeconomic and fiscal policy. (Interview #3)

A different perspective is that HM Treasury already had plenty of work on its hands with respect to tax, but lacked the necessary human resources.89 On this view, the merger was not so much an opportunity to expand the power of Treasury as to consolidate a significant number of the people with policy aptitude in one place in order to make the workload more manageable and also to prevent inappropriate policy choices. But I think one of the problems was simply that the Treasury had too few people. So it was very stretched and they were covering an enormous front across the whole of the tax system. I don’t know what exactly the background was to the O’Donnell review in terms of the policy changes, but I think one of the things that might well have contributed to it was the zero rate of corporation tax,90 which was not a good move at all. And certainly in retrospect proved not to be. (Interview# 6)

A number of interviewees expressed the same point in reverse, highlighting the difficulties of in-house policymaking within the revenue departments. … my own experience of Customs was that we were okayish at doing some policy work, at times not, at times dysfunctional; at times we frustrated Dawn [Primarolo] intensely because we just didn’t get with her or on her wavelength, and the Treasury machinery was slight at this end … (Interview #1)

The notion that HMCE suffered from especial weakness in respect of policymaking recurred a few times: [X] had a fantastic ability, one has to say, to read the Chancellor especially. That was fine on politics but the substantive policy thinking development etcetera etcetera I think was relatively poor; we weren’t great at it in Customs for all sorts of reasons, despite efforts to try and bolster it – or I was partly supposed to be trying to bolster it but there you go, as we had a little central strategy component etcetera – but my broad reflection is that’s right we were weak at it; you can see why Gus [O’Donnell]’s conclusion was this is odd. (Interview #1) 89 On the expansion of HM Treasury in this period, see eg C Thain and R Christie, ‘Treasury Power: Past, Present and Future’, presented at JUC PAC Conference (Belfast, 3–5 September 2007). 90 See C Crawford and J Freedman, ‘Small Business Taxation’ in S Adam, T Besley et al (eds) Dimensions of Tax Design: The Mirrlees Review (Oxford, OUP, 2010) 1028, 1054–59.

232  Penelope Tuck, Dominic de Cogan and John Snape The IR had a more developed capacity but also experienced difficulties. Revenue had a different but equally troubled relationship with ministers and the Treasury machinery, a much bigger relationship; far more players in the Revenue were interacting with [HMT], whereas proportionally only a few were in our space [HMCE] – and that was before Dawn [Primarolo] said she’d only meet certain people but anyway that’s a different story – but joking apart clearly the scale of engagement was larger but I can say that there were lots of instances where it still was frustrating ministers, and I think quite reasonably frustrating Gus [O’Donnell] and others. (Interview #1)

A particular controversy that was mentioned a few times involved the zero per cent starting rate for corporation tax that was introduced in 2002,91 only to be repealed in 2006 after causing an entirely predictable but apparently unwanted rash of tax-motivated incorporations of previously unincorporated businesses.92 One interviewee attributed the original flawed policy to a decision of the C ­ hancellor of the Exchequer in close collaboration with his special advisors, which is worrying in view of the belief – mentioned below – that the merger itself originated from a similar decision.93 Yeah. So I think there had been a ten per cent rate and then it went down to zero. In the same way that Treasury didn’t have very many policy people, Inland Revenue didn’t have very many policy people either. And so I was also covering a massive waterfront. So the corporate tax change down to zero was not a very good move. And the way that that was decided was also a bit strange. And, again, I think it was probably the interaction with the special advisers and wasn’t really clear who was calling the shots. And so the Chancellor very much wanted to do it and it proved to be a very unfortunate move because you had hairdressers incorporating their businesses to take advantage of the zero rate of corporation tax, which was really not the idea at all. (Interview #6)

In the view of some interviewees, this translated into more general doubts as to the wisdom of the merger project, and in particular about the division of policy and operational decisions in the tax field: The Treasury had always wanted to control tax policy as far back as I can remember, completely. And lots of ministers had said, no, no, no, because I think they were – and I think they were wise because you can’t make good tax policy without operational input and experience. It’s a waste of time and I can remember saying that till I was blue in the face with Treasury officials but they wanted to control tax policy. And I think going back to [special advisors] and the like, he wanted to control tax policy and I think a lot of his criticism of the old Inland Revenue was borne of that. (Interview #4)

91 Finance Act 2002, s 32; G Maffini, ‘Corporate Tax Policy under the Labour Government, 1997–2010’ (2013) 29:1 Oxford Review of Economic Policy 142–164, 152–53, 159. 92 Finance Act 2006, s 26; Crawford and Freedman, above n 90. 93 Refer to text at n 95.

The Merger Between the Inland Revenue and HM Customs and Excise  233 The removal from the revenue departments of one of their most prestigious streams of work also did not go unnoticed, despite the decision to leave ‘policy maintenance’ in HMRC.94 And what they call policy maintenance was left in the tax department, so the Inland Revenue, Customs and then HMRC. And one thing that I think is quite important to recognise is that, for the people in HMRC or in the Inland Revenue as it then was, it was actually quite a difficult time. I felt personally at that time that the essence of my job was being taken away and given to Treasury. And it wasn’t clear how the roles would interact. But certainly the bit of my job that I’d always regarded as the most interesting seemed as though it was being taken away and given to Treasury. (Interview #6)

The same interviewee reinforced this point. So it was quite a difficult time personally for a lot of people on the policy side in HMRC. And so what happened to me personally at that time was I thought, ‘Well I enjoy the policy job I’m doing.’ So even people who stayed behind in Inland Revenue probably felt quite a loss that part of their role had been moved and actually probably the more interesting bit of their role had been moved to Treasury. (Interview #6)

Those who moved from the revenue departments into HM Treasury were also keenly aware of these sensitivities. And so one of the challenges we faced, so then moving into Treasury, was working with people in HMRC who had just had part of their jobs taken away. So it made for quite an interesting relationship in that you had to take quite a bit of care to make sure that the relationships worked well because it was not an easy time. (Interview #6)

The following extract suggests that the decision to allocate ‘policy maintenance’ to HMRC was informed by pragmatic considerations concerning the capacity of HMT, conceivably at the expense of more fundamental thought as to how responsibilities relating to tax might best be allocated within government. So a thing that Gus [O’Donnell] grappled with and then fought shy of, for I think logical reasons is: you could have either made the split more dramatic and hived off even more of policy maintenance and said ‘That’s right, you’re just an agency that executes, you just do all the doing, just collect debt, manage compliance and do other things that you’re tasked with doing; we’ll capture all tax policy and maintenance and have this thing.’ Well, one, that then is completely disproportionate in terms of the Treasury machinery; even the numbers that they brought in under this

94 This concept is not explained in detail in the O’Donnell Review, which states merely that ‘Policy maintenance, which aims to protect the taxation system against challenge, depends particularly upon a detailed practical understanding of how the law works’: see O’Donnell, above n 16, 10. In broad terms, HM Treasury developed ideas for tax policy, whereas HMRC was responsible for ensuring that they were and remained practicable.

234  Penelope Tuck, Dominic de Cogan and John Snape was a heck of a scaling up, wasn’t it … Surely what absolutely is the case and you probably know very well, the question of maintenance and managing challenges to the tax framework, litigation for pity’s sake, where are you going to put that? Are you going to get the Treasury doing all this litigation? You’ve got to be kidding! (Interview #1)

Nevertheless it might be said that the major problem with ‘policy maintenance’ was not the principle so much as the rather boring terminology. I think the term is a bit unfortunate and certainly at the time it wasn’t really very clear. So what was clear was that the strategic end was going to Treasury and what was left was just the bits that weren’t as strategic. But actually how it all panned out in practice was, certainly in the corporate tax area that I was in, there was still an awful lot to be done in HMRC on the policy side, particularly instructing parliamentary counsel on new legislation, working with colleagues in HMRC to make sure that measures were practicable and very much working on the detail, the very fine detail of the policy. So the Treasury would work on the high level principles, but HMRC would have to fill in an awful lot of the detail. So actually, as it turned out … in 2009, there was still an awful lot of the very interesting work on the policy maintenance side. Calling something policy maintenance is not necessarily very conducive to people thinking it’s a terribly interesting job. (Interview #6)

Funding A point that occupied a small amount of time in our interviews but seems very significant is that the merger was unfunded, unlike corporate mergers and acquisitions which are routinely expected to generate significant transition costs. We did not gain a clear sense of the reason for this decision, but it immediately placed constraints on what the newly merged entity could achieve: And I mean the real problem with the merger and I see it in some of the other countries I work in now, is you cannot hope to do something big like a merger without some funding and not a penny of funding was provided. The two departments had to find the funding. (Interview #4)

One interviewee recalled a discussion in which one-off transition costs, relating in particular to the integration of the two former departments, were raised. I think Gus [O’Donnell] said ‘Hey, thanks for telling us, that’s really interesting but let’s be clear the Chancellor is not going to stand up and say “I’ve created a new department and it cost more.”’ (Interview #1)

In view of the willingness of the government to learn from and draw upon business practices in other respects, it would be useful to understand this curious decision more clearly through further research.

The Merger Between the Inland Revenue and HM Customs and Excise  235 The Role of Special Advisors Perhaps in line with the suggestion that the transfer of policymaking functions to HMT allowed the Chancellor of the Exchequer to extend his personal control over tax policy, a conspicuous feature of the merger processes was the centrality of special advisors (SpAds). SpAds are appointed by Ministers to give input on the political aspects of their departmental work. The Public Administration Report in 2000 noted that the number of SpAds had doubled since the election in 1997 and that they had ‘consolidated senior positions in the machinery of government’.95 This deepening of roles is reflected in our interview evidence. The special advisors in question, Chris Wales, Ed Balls and Ed Miliband, seem to have played a key role in the relationship between HM Treasury and the departments. The other thing that was very much a feature of those kind of late nineties and early 2000s was that the special advisers were really quite influential. So there was probably less interaction directly with ministers and more interaction with special advisers. (Interview #6)

There was also, drawing on transatlantic experience, a Council of Economic Advisers, on which Chris Wales sat from 1997 to 2003.96 These appointments seem to have been part of a more general strategy to bring ‘new blood’ into government, which created difficulties despite having some positive aspects. The Treasury brought in an increasing number of really young people from the accountancy profession, some from the legal profession, mainly from the accountancy profession. They were very clever, I have to say that some were outstandingly good; others were just deeply knowledgeable in particular areas, and I think what came with that knowledge was a rigidity; and no real effort was being made other than by a few of us in the Revenue to build relationships … (Interview #4)

Other interviewees were more cautious still, whilst acknowledging the ability of special advisers and HM Treasury to work together in order to produce results: The people in the Treasury and those coming into the Treasury from outside cosied up a lot to the special advisers, and the three special advisers were brilliant at using them as their sort of storm troopers to get things done. (Interview #4)

The Role of Civil Servants In mirror image to the enhanced status of special advisors, the relationship between ministers and civil servants was distant. In line with the discussion 95 Public Administration Select Committee, Third Report: Special Advisors: Boon or Bane: The Government Response to the Committee’s Fourth Report of Session 2000–01 (HC 463, 2001–02) vi. 96 Snape, above n 5, 82, 83, 109, 126.

236  Penelope Tuck, Dominic de Cogan and John Snape above, the special advisers acted as a conduit between civil servants and the minister. Gordon Brown … rarely saw officials in the Revenue – you had to be doing something really interesting to get in to see him. (Interview #4)

The relationship between Sir Nicholas Montagu and the Paymaster General, Dawn Primarolo, was even more strained. A House of Commons Treasury Committee report examined IR matters including the use of offshore tax structures by bidders, tax credit implementation and the suspension of National Insurance Contributions Deficiency Notices.97 It highlighted the infrequency of contact between the Chairman of the Inland Revenue and the Paymaster General.98 It also observed the conflicting evidence between these two individuals in relation to the Mapeley affair.99 Nick [Montagu] was asked, now this is a matter of public record, at one Public Accounts Committee Hearing, how many times he’d seen the Chancellor and Dawn Primarolo the previous year and he said, ‘I haven’t seen the Chancellor in the last 12 months and I’ve seen the Paymaster General once.’ I mean what was actually going on wasn’t great. I mean I was busy seeing them because we could talk about the taxation issues and it was – and I took people with me all the time, but it was, it was jolly difficult. And the Chancellor naturally tended to turn to the Treasury for new policies; [Treasury] wanted to get in with him, so they would try and do it on their own. (Interview #4)

This is not an encouraging description of the traditional institutions of government, to say the least. Culture One of the most common reactions to the merger, amongst the authors, their interviewees, seminar attendees and others, is to wonder about the difference in organisational culture between the IR and HMCE. It has been suggested above that the reputation and self-image of an institution is closely connected to the range of functions that happen to be delegated to it at any given point in time.100 This point was mentioned specifically by some of our interviewees: In the early days, People worked boarding ships and then next day they would do a [VAT assessment]. There wasn’t the sort of separation of …? Of expertise? It was all one role. 97 House of Commons Treasury Committee, Inland Revenue Matters (HC 834, 2002–03) 14–19. 98 ibid, Ev 17 [Q 166]. 99 ibid, 5–6. 100 The organisational identity literature is helpful here. Organisational identity represents the interaction of the internal social identity of managers and employees, and the external image of an organisation held by others, such as customers and the public: see B Ashforth and F Mael, ‘Organizational identity and strategy as context for the individual’ in JAC Baum and JE Dutton

The Merger Between the Inland Revenue and HM Customs and Excise  237 And they functionalised it. And they had a culture of secrecy, because they’d got intelligence functions and people … information that was important. (Interview #2)

However, the degree of institutional separation that is reported by our informants as existing prior to the merger is still surprising: Just to come back to the reflections on how separate we were, which was by any stretch dysfunctional, so there were some connections but not many. The boards met once in a blue moon if ever, just extraordinary. Yes, the two perm secs would have known each other and seen each other on Wednesdays presumably like with the others; there was no structured engagement that I ever saw. (Interview #1)

Progress had been made, with a joint policy steering group set up in 1999/00 in order to ensure that the policies of the departments were coordinated.101 Yet it was widely appreciated that the difference between the departments involved not only the substantive tax treatments but also questions of approach. This can be seen clearly from divergent attitudes towards the conclusion of settlements with taxpayers. The following extract is from a former Customs official: Because I wouldn’t do the deals, because our view on the avoidance side was because if you did a deal even to an extent of saying, ‘Okay, well we’ll take 90% of the tax and we’ll walk away from 10%,’ it was still worth … doing another deal, whereas if you said, ‘We want the whole lot,’ then they wouldn’t do it. And VAT, the approach has always been on VAT, ‘Well if it’s due it’s due and you pay, if it isn’t due, well, fine it isn’t due,’ so that’s quite simple. But the Revenue had this approach of ‘Well, give us a bit of “go away money” even though alright, well, it might not be due.’ (Interview #7)

The significance of VAT to the substance and style of the work done by HMCE was emphasised several times. The following extract is typical, although it does not quite explain why VAT in particular is associated with a ‘can-do’ attitude: The other component is the VAT piece, which was the predominant tax of course in 1973, by far the most dominant and significant tax we managed … the Excises [were] good little earners but they didn’t have a lot of people even then doing them, so VAT was our big ticket thing, a strong sense of identity around that. So I think C&E saw (eds.) Advances in Strategic Management vol 13 (Greenwich CT, JAI Press, 1996) 19–64; MJ Hatch and M Schultz, ‘The Dynamics of Organizational Identity’ (2002) 55 Human Relations 989–1018). The concept of organisational identity was first developed by Albert and Whetten in S Albert and DA Whetten, ‘Organizational Identity’ in LL Cummings and BM Staw (eds.) Research in Organiza­ tional Behaviour vol 7 (Greenwich CT, JAI Press, 1985) 263–95. Subsequently the definition of the concept has become dynamic, in flux and often contested (DA Gioia, M Schultz and KG Corley, ‘Organizational Identity, Image, and Adaptive Instability’, (2000) 25 Academy of Management Review 63–81; SG Scott and VR Lane, ‘A Stakeholder Approach to Organizational Identity’ (2000) 25 Academy of Management Review, 43–62; and SG Scott and VR Lane, ‘Fluid, Fractured and Distinctive? In Search of a Definition of Organizational Identity’, (2000) 25 Academy of Management Review, 143–44. 101 Inland Revenue, One Hundred and Forty-Second Report of the Commissioners of Her M ­ ajesty’s Inland Revenue for the year ending 31st March 2000 (Cm 5029, 2000–01) 25.

238  Penelope Tuck, Dominic de Cogan and John Snape themselves as quite can-do, doers, get-on and whatever, plain-speaking and all the other stuff – and there’s almost a parody in this, it’s classic – and then clearly parts of the Revenue would have seen them as gentlemen tax inspectors, more professional. (Interview #1)

In any case, this self-understanding fed into a fundamentally different attitude towards the role of a revenue department in applying the law: [X from HMCE] was using the black letter law all the way down the line. Because that’s the only thing you can rely on. And of course I’ve been brought up in IR, which absolutely didn’t want to rely on the black letter law, because everybody tried to ­artificially get round it. (Interview #2)

The response of IR officials to the underlying assumptions of Customs people was one of mixed understanding and frustration: The footprint of Customs on the Inland Revenue was about, I think, 22%. Something like that. So you might say, ‘Why would you merge?’ But having come to merge, and you look at that 22%, they are the same people, culturally, that we encountered when the Contributions Agency merged. They are investigators. Which they … so they’re trained to be sceptical. And if you train people to be sceptical, to disbelieve, as they had to, and you train them to audit, and to challenge, you also create a culture which, I think, is resistant to change. And at its worst, you encounter people who don’t even want change when they were in the Inland Revenue. (Interview #2)

To some extent, the portrayal of HMCE officials ‘as a bunch of gangsters’ and IR officials ‘as a bunch of effete liberals’102 was a caricature, but many interviewees saw an element of truth to the exaggerations: I think if you over-characterise it, the Customs people saw the Inland Revenue people as rather soft. I mean, in our workshops we held with each other, we had to be honest to each other. In a polite way. For which we were trained. And I think the caricature was that … we the big Inland Revenue … valued intellect. And digging down. But were not as cost effective as we might be, and were soft. We made compromises. We did deals. And … I think there’s elements of truth in that. (Interview #2)

Despite these differences, some interviewees had an optimistic attitude towards the ability of officials from different backgrounds to work together: And these pleasantries were exchanged. But out of those caricatures, you began to see the good in each group. And you began to transform the group. And I think that’s what Gordon Brown was probably trying to do. (Interview #2)

A second difference between the departments involved recruitment practices and career progression. They had a different recruitment model. Whereas the Inspectorate in Inland Revenue were recruited as 2.1 undergraduates, 2.1s and firsts, with an expectation in the Civil Service Selection Board that they would get at least a Grade 6 and possibly to

102 Interview

#2.

The Merger Between the Inland Revenue and HM Customs and Excise  239 Grade 5 in those days, Customs recruited with the expectation that people would get to, I think, principal, grade 7.103 (Interview #2).

The outcome was that: There was a sense of the professional status of the tax inspector as being plainly higher than a Customs officer … (Interview #1)

However, this primarily concerned the more senior levels of the organisations. Both organisations employed a large number of clerical officials: When you look at the totality of the Revenue it had shed loads of administrative/ clerical functions, unbelievable scale, even at merger, and still battle with rather a large [staff]. So it is funny that parts of the characteristics of the … Revenue … were heavily governed, at least as I saw it I suppose, by the very top of the shop, who were indeed almost all gentlemen. (Interview#1)

Especially on the Customs side, there was a sense of fatalism, in the sense that whilst the merger fundamentally changed the work and approach of tax ­officials, things were changing quickly anyway: The culture of Customs was heavily conditioned up to point by the law enforcement component. Not that I ever worked in it – I worked all that time in Customs and Excise entirely in tax policy creation, and our law enforcement piece morphed and was different – but that was very powerful that sense of identity, the role we played, the enforcement role, the border-based role. Of course there was also SOCA’s ­[Serious and Organised Crime Agency] creation at the same bloody time so there were all sorts of things which were migrating away from us anyway. (Interview #1)

The interviewee explains further: The creation of SOCA was approximately coincidental with some of this debate, so that was already leading to the export from C and E of some of our functions. So I think the broad sweep of the thing was there was a disaggregation of our law enforcement functions anyway and then more stuff went to, [who] knows what it was called in those days, Border Force. (Interview #1)

CONCLUSION: ORAL AND DOCUMENTED HISTORY

The content of this chapter has been directed not by contemporary documentary evidence of the merger, by existing academic or professional literature, or by our own preconceptions. Instead, we have been very much led by the issues highlighted by our informants by our detailed open coding of the transcripts of interviews. We make no claim that this is a superior method of ­understanding 103 As Civil Service grades decrease with seniority, this meant that Customs officials tended to be less well-recognised than their counterparts in the Inland Revenue, which would of course have been highlighted by the merger.

240  Penelope Tuck, Dominic de Cogan and John Snape the merger to a review of published documents, or that the claims made by our informants are neutral and uncoloured by personal, professional, political or ideological considerations. Our claim is more modest, that the O’Donnell Review and the ensuing processes of merger had an irreducible human element. They were carried out by leading characters within the government and Civil Service of the time, and were centrally concerned with the management of people. This being the case, it is enlightening to understand what some of these leading characters thought they were doing – or, to be more precise, what they now think they were doing in these important years leading up to the merger. Matters get particularly interesting in those instances where the documented and recollections of events differ. These are relatively rare, and there were certainly aspects in which our informants mirrored the contents of the contemporaneous documentation, not least the O’Donnell Review itself. For example, there was a keen recollection amongst our interviewees of the perceived problems with the pre-existing allocation of functions, which for obvious reasons were brought to the fore in the O’Donnell Review but are also evident in the Treasury Committee report on the proposed merger that was published later in 2004.104 An area in which there was a difference in emphasis was in the claim made at the time that costs would decrease, not only for the government in terms of greater efficiency and modestly reduced staffing levels, but also for taxpayers seeking to comply with their tax obligations. This claim can be found in the contemporaneous documentation but the idea that taxpayers would experience cost savings from a disruptive process that reduced the total number of revenue officials seems rather remote and speculative, although not altogether impossible. It was not emphasised by our interviewees, although in balance they were not prompted on this point. An example of a theme brought out rather more strongly in our interviews than in the contemporary policy literature was the idea that the merger allowed HMT and the Chancellor to consolidate their control over tax policy. As we saw above, some interviewees linked this to the issue of how tax policy ought to be approached, with the post-O’Donnell arrangement being associated with a more big-picture and even economist-led approach, in contrast to the more detailoriented and experience-based approach of policymaking within the legacy departments. These points were made with force and clarity by our informants but are in some respects shrouded in euphemism in the documentary evidence. The O’Donnell Review, for example, highlights the need for tax policy to be permeable to economic expertise, but discusses the question of control in terms such as the need for ‘coherence’ and the need to be responsive to ­government objectives.105



104 O’Donnell, 105 O’Donnell,

above n 16, Ch 3; Treasury Committee, above n 70, 3 ff. above n 16, ch 5.

The Merger Between the Inland Revenue and HM Customs and Excise  241 Above all else, speaking to people about these events brings them to life, not only for our readers but for future researchers who may not have firsthand memory of the sense of importance, disruption and opportunity that surrounded the merger. Administrative reform can be a rather dry segment of history for those not directly involved, but to many of us who practised or studied tax at the time, the O’Donnell reforms involved something more meaningful than a simple shuffling of deckchairs. We have tried to capture something of this sense within the present chapter, which is also why we have preserved much of the conversational character of the interviews within the quoted extracts. We record our gratitude to our informants, without whose cooperation and enthusiasm this chapter would have been so much shorter and less colourful.

242

9 Through Ramsay Spectacles PHILIP RIDD

ABSTRACT

The principles laid down by the House of Lords in WT Ramsay Ltd v Commissioners of Inland Revenue [1982] AC 300 have been developed over many cases since the decision was pronounced on 12 March 1981, and the present state of play can most helpfully be found in UBS AG v Revenue and Customs Comrs [2016] 1 WLR 1005 and in RFC 2012 plc (in liquidation) (formerly The Rangers Football Club plc) v Advocate General for Scotland [2017] 1 WLR 2767. This paper argues that what we now have (‘Modern Ramsay’) is utterly different from what we originally had (‘Original Ramsay’). Full judicial approval has been given to the statement of Ribeiro PJ in Collector of Stamp Revenue v ­Arrowtown Assets Ltd [2003] HKCFA 46 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.’ The argument in the paper is that the early cases in the Ramsay sequence were confined to ‘an unblinkered approach to the analysis of the facts’ and that purposive construction of the relevant legislation has been added to the mix in subsequent cases such that what was one doctrine has become two. The paper then considers a selection of tax avoidance cases, starting with Duke of Westminster v ­Commissioners of Inland Revenue [1936] AC 1 and including Furniss v Dawson [1984] AC 474 and Craven v White [1989] AC 398, re-examining them through one or other or both of Original Ramsay and Modern Ramsay.

244  Philip Ridd INTRODUCTION

R

(WT) Ltd v Inland Revenue Commissioners1 was decided by the House of Lords on 12 March 1981. In UBS AG v Customs and Excise Commissioners2 Lord Reed, giving the only reasoned judgment, described the significance of Ramsay as follows: amsay

First, it extended to tax cases the purposive approach to statutory construction which was orthodox in other areas of the law. Secondly, and equally significantly, it established that the analysis of the facts depended on that purposive construction of the statute. Thus, in Ramsay itself, the terms ‘loss’ and ‘gain’, as used in capital gains tax legislation, were purposively construed as referring to losses and gains having a commercial reality. Since the facts concerned a composite transaction forming a commercial unity, with the consequence that the commercial significance of what had occurred could only be determined by considering the transaction as a whole, the statute was construed as referring to the effect of that composite transaction.3

For convenience this will be called ‘the UBS view’. The purposes of this chapter are twofold. The first entails examining Ramsay and the subsequent cases, in which Ramsay was, or was not, applied, to trace the evolution of the Ramsay doctrine into the form as described in the UBS view. It will be argued that the UBS view is a creative reinterpretation of Ramsay far removed from the way in which the case was understood for many years. The reinterpretation will be referred to as Modern Ramsay, while the previous understanding will be referred to as Original Ramsay. The second purpose of the chapter will be to re-examine a selection of cases to see whether they might have been decided differently under Original Ramsay or Modern Ramsay.4 All this would be relatively straightforward if the reasoning in Ramsay had been pellucid and uncontroversial but, as sometimes happens,5 that, unhappily, is not the position. There is a possible explanation. The main speech in Ramsay was that of Lord Wilberforce.6 There is a story that, after the hearing of the case, Lord Wilberforce called a meeting of all of the Law Lords, told them that the decision on the Revenue’s main argument must be unanimous, that they

1 Ramsay (WT) Ltd v Commissioners of Inland Revenue [1982] AC 300. 2 UBS AG v Commissioners of Customs and Excise [2016] 1 WLR 1005. 3 ibid [62]. 4 Some overlap with P Ridd, ‘Statutory Interpretation in Early Capital Gains Tax Cases’ in P  Harris and D de Cogan (eds), Studies in the History of Tax Law, vol 8 (Oxford, Hart, 2017) 257–94 is inevitable. 5 Eric Moses CB, who was the Solicitor of Inland Revenue from 1970 to 1979, found it impossible to formulate a ratio decidendi from the speeches in Owen v Pook [1970] AC 244. After the decision in Clark v Oceanic Contractors Inc [1983] 2 AC 130 the taxpayer company changed solicitors and, so it is said, the new solicitor arrived at a meeting with the Revenue, brandishing a copy of the House of Lords’ decision and exclaiming ‘But what does it mean?’, to which a Revenue official responded ‘It means you pay’. 6 Lord Fraser of Tullybelton also gave a reasoned speech but it did not differ in substance from that of Lord Wilberforce.

Through Ramsay Spectacles  245 would vote on it, and that the majority view would then be accepted by all: the story continues that Lord Wilberforce voted against accepting the argument and, upon finding himself in the minority, announced that he would nevertheless write the leading speech in favour of it. There is no authoritative confirmation of this story, but it has the ring of truth. Lord Wilberforce was a Chancery judge of a conservative, rather than revolutionary, disposition. During the hearing, when the time came for counsel for the Revenue, Peter Millett QC,7 to advance the Revenue’s radical argument, Lord Wilberforce said, without any show of pleasure, ‘Now for your American argument, Mr Millett’.8 It is easy to believe that Lord Wilberforce constructed his speech in Ramsay with a view to confining the new development as closely as possible. It is correspondingly difficult to believe that, if Lord Wilberforce had been alive in 2015, he would have recognised and subscribed to Lord Reed’s description of Ramsay. It is time to stop speculation and get down to some serious examination of the cases but, before doing so, a few words must be said about the highly complex topic of statutory interpretation. For the purposes of this chapter it is taken that there is a spectrum of approach ranging from strict literal interpretation through to full-blooded purposive interpretation. It is, of course, of the essence that statutory words, like any words, need to be considered in their context, but context can be given greater or lesser weight. A proper study of the development of the judicial approach to statutory interpretation in tax cases would result in a book of some size. So far as it is possible to generalise in a few words, it may be fair to say that the older cases involve strict literal interpretation with precious little, if any, regard being given to context, whereas the modern approach gives context all the weight which it can reasonably bear. For better or worse, that is the distinction between literal interpretation and purposive interpretation adopted in this chapter. RAMSAY

The aim of the scheme in Ramsay was to create an artificial capital loss; it was artificial in that the position of the parties, once the scheme transactions had been concluded, was the same as that at the outset because the transactions were self-cancelling. The scheme included two transactions which gave rise to a matching gain and loss; the gain-making transaction involved disposal of a debt (‘L2’) and, so it was asserted, the debt was a plain debt, not a debt on a security, so its disposal attracted the exemption from charge under ­paragraph 11 of Schedule 7 to the Finance Act 1965, leaving the matching loss to stand clear for fiscal purposes, available to be set against a gain



7 Later 8 I

Lord Millett. am indebted for this remark to Dr John Pearce who was at the hearing.

246  Philip Ridd which the company had made in an earlier ordinary commercial transaction and thus eliminate a prospective charge to tax. On the technical issue, whether the exemption applied, the Revenue was successful before the Special Commissioners, unsuccessful in the High Court, but successful again in the Court of Appeal. The Law Lords agreed with the Court of Appeal and could have resolved the case on that basis, but they chose to address the more radical, ­logically prior, argument put by the Revenue. The radical argument was that the scheme transactions were to be viewed as a whole, not one by one. The taxpayer company opposed that contention in reliance on the facts that the transactions were genuine, not sham, and the parties were not under a legal obligation to carry them through to completion. It could not, however, be said that there was, realistically, any possibility that the transactions, once set in motion, might have been arrested short of completion. The Law Lords held that the intentions of the parties, even though not set in a legally binding form, were a sufficient basis for considering the scheme transactions as a whole, so the correct analysis was that nothing had happened. Based on the speeches, the ratio decidendi might, though cumbrously, be cast as follows: finding the relevant facts should be done on the basis that, as the capital gains tax was created to operate in the real world, not that of make-believe, and as effect should be given to the intention of the parties, the correct approach to a series of transactions expected to be carried out as a whole, in circumstances in which there was no likelihood in practice that they would not be carried out as a whole, is to regard those transactions for tax purposes as a composite whole, not as a number of independent transactions. For present purposes that formulation will be described for short as Original Ramsay. The gulf between that analysis of Ramsay and the UBS view is, to say the least, considerable and it requires examination. The first component of the UBS view is that Ramsay ‘extended to tax cases the purposive approach to statutory construction which was orthodox in other areas of the law’. Any attempt to sustain this proposition has difficulty in getting off the starting blocks because purposive construction gets nary a mention in Ramsay. Lord Wilberforce did refer to ‘purpose’, but only in the passage in which he restated the familiar principle that ‘a subject is only to be taxed upon clear words’ and, in stating that the courts were not confined to literal interpretation, confirmed that ‘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’.9 That represents a limited inroad into strict literal interpretation by according a degree of prominence to context. It certainly does not follow that Lord Wilberforce would have countenanced the purposive construction of the unclear words of a statutory provision in such a way as to impose taxation. In Floor v Davis10



9 Ramsay,

10 Floor

above n 1, 323. v Davis [1980] AC 695.

Through Ramsay Spectacles  247 Lord ­Wilberforce had, in a dissenting speech, referred to the requirement that for taxation to be imposed ‘clear words must be used’11 and observed that ­‘nothing is clearer than that rewriting, or the introduction of words, into a taxing provision is inadmissible’.12 In any event it would be an argument of extraordinary desperation to assert that a major change to the canons of statutory interpretation was to be found in a passage which restated familiar principles. Two important passages in Lord Wilberforce’s speech read: For the commissioners considering a particular case it is wrong, and an unnecessary self limitation, to regard themselves as precluded by their own finding that documents or transactions are not ‘shams,’ from considering what, as evidenced by the documents themselves or by the manifested intentions of the parties, the ­relevant transaction is. They are not, under the Westminster doctrine [Inland Revenue Commissioners v Duke of Westminster [1936] AC 1] or any other authority, bound to consider individually each separate step in a composite transaction intended to be carried through as a whole. … The capital gains tax was created to operate in the real world, not that of make-belief. As I said in Aberdeen Construction Group Ltd v Inland Revenue Commissioners [1978] AC 885, it is a tax on gains (or I might have added gains less losses), it is not a tax on arithmetical differences. To say that a loss (or gain) which appears to arise at one stage in an indivisible process, and which is intended to be and is cancelled out by a later stage, so that at the end of what was bought as, and planned as, a single continuous operation, is not such a loss (or gain) as the legislation is dealing with, is in my opinion well and indeed essentially within the judicial function.13

The second passage cannot, it is submitted, be fairly described as an exercise in purposive interpretation: it merely uses the general nature of the statutory context to justify having regard to the transactions as a whole rather than individually. Further this passage cannot be understood as meaning that the facts, when properly analysed, disclosed a loss which was not a loss within the meaning of the statute; the passage refers to individual components within the ‘indivisible process’; but Lord Wilberforce’s conclusion on the facts was ‘The true view, regarding the scheme as a whole, is to find that there was neither gain nor loss’;14 so the individual components within the ‘indivisible process’ did not disclose such a loss or gain as the legislation is dealing with because they did not fall to be regarded one by one. The second component of the UBS view is that Ramsay ‘established that the analysis of the facts depended on that purposive construction of the statute. Thus, in Ramsay itself, the terms “loss” and “gain”, as used in capital gains tax legislation, were purposively construed as referring to losses and gains having

11 ibid,

706. 707. 13 Ramsay, above n 1, 323 and 326 respectively. 14 ibid, 328. 12 ibid,

248  Philip Ridd a commercial reality’. Again this cannot be sustained. On a simple level the speeches in Ramsay, in relation to the Revenue’s radical argument, did not even mention any specific statutory provision, let alone construe ‘the terms “loss” and “gain”, as used in capital gains tax legislation’. If the opaqueness of the Ramsay speech leaves any doubt on the point, it is quite impossible, for two reasons, to accept the second component of the UBS view. The first reason is to be derived from the context; the taxpayer company’s case was that the transaction involving L2, on the premise that it was properly to be considered on its own, amounted to the disposal of an asset which resulted in an exempt gain and the matching transaction gave rise to an allowable loss; the acceptance of the Revenue’s radical argument meant that the premise failed; further, that acceptance led to the conclusion that the correct factual analysis was that for fiscal purposes, as for commercial purposes, nothing had happened; the statutory provisions dealing with gain and loss did not fall to be considered because, nothing having happened, there was no gain and no loss to which attention might be given. The second reason is that the presence in the legislation of various deeming provisions precluded any possibility that references to losses and gains denoted only losses and gains having a commercial reality: deemed disposals would give rise to deemed (unreal) losses; had the point arisen, counsel for the taxpayer company would, no doubt, have been swift to point that out. It follows that Lord Wilberforce was, in saying that ‘the capital gains tax was created to operate in the real world, not that of make-belief’,15 doing no more than invoking a general proposition, and one which cannot be taken as an absolute though, as Ramsay did not involve deeming provisions, it is not surprising that the generalisation was not qualified. The third component of the UBS view of Ramsay is that ‘since the facts concerned a composite transaction forming a commercial unity, with the consequence that the commercial significance of what had occurred could only be determined by considering the transaction as a whole, the statute was construed as referring to the effect of that composite transaction’. This runs into a similar difficulty to that which, as mentioned, stands in the way of the second component. Once the transactions were viewed in the round, it was perceived that, as the transactions were self-cancelling, nothing whatsoever had happened. In other words there was no transaction and no statutory provision was in play at all, which in itself is an explanation for the fact that, except in relation to the technical argument, no statutory provision was even mentioned, let alone construed. The jigsaw has another missing piece. It is to be expected that, if the components of the UBS view had been spotted at the time, commentators would have had something of a field day in their reaction to Ramsay. But searching



15 Ramsay,

above n 1, 326.

Through Ramsay Spectacles  249 for excited references to tax law being caught up in the relatively new world of purposive interpretation of statutes draws a blank.16 For all these reasons it is considered that the UBS view is not sustainable as an accurate analysis of Ramsay itself, yet that is not to say that it involved any error so far as the development of the Ramsay doctrine over the intervening years was concerned. It is helpful here to mention the brilliant encapsulation of the Ramsay doctrine by the Hong Kong judge, Ribeiro PJ, as follows: ‘The ultimate question is whether the relevant statutory provisions, construed purposively, were intended to apply to the transaction, viewed realistically.’17 That formulation will be taken for present purposes to be Modern Ramsay. In simple terms the difference between Original Ramsay and Modern Ramsay is that purposive interpretation of statutes features in the latter but not in the former. THE EARLIER POST-RAMSAY CASES

Trawling sedulously through the subsequent Ramsay cases is a laborious exercise but a fascinating one, at least for those who enjoy intellectual rollercoasters. But brevity must be a watchword here and the focus will be on the topic of statutory interpretation. The principal task of this section of the chapter is to see to what extent, if any, the earlier post-Ramsay cases addressed the subject of statutory interpretation. At the time it was certainly not uppermost in the minds of those involved in tax litigation: it was not unknown, but during the hearing before the House of Lords in Coates v Arndale Properties Ltd,18 when counsel referred to Ramsay as an exercise in statutory interpretation, the Law Lords reacted with derisive laughter.19 Inland Revenue Commissioners v Burmah Oil Co Ltd20 concerned a tailormade scheme by which a simple debt owed to the parent company by a group company which had no assets was to be converted into the form of shares so that on liquidation of the debtor company the parent company’s loss would be allowable for the purposes of corporation tax on chargeable gains. Ramsay had not yet been decided when Burmah went through its early stages, but a

16 See, for example HH Monroe, ‘Fiscal Finesse: Tax Avoidance and the Duke of Westminster’ at [1982] BTR 200 in which Monroe, then a top QC at the tax bar (later the presiding Special Commissioner), welcomed Lord Wilberforce’s remarks in Ramsay about statutory interpretation and did not begin to suggest that they were revolutionary. 17 Collector of Stamp Revenue v Arrowtown Assets Ltd (2003) 6 ITLR 454, [35], referred to with approval in several subsequent cases including UBS, above n 2, [66]. Similar statements had been made in Shiu Wing v Commissioner of Estate Duty [2000] HKFAC 64, per Mr Justice Litton PJ at [25] and per Sir Anthony Mason NPJ at [85]. 18 Coates v Arndale Properties Ltd [1984] 1 WLR 1328. The speeches did not ultimately consider the Ramsay case. 19 So it was reported back to Somerset House by my colleague, Algy Bates. 20 Inland Revenue Commissioners v Burmah Oil Co Ltd (1982) 54 TC 200.

250  Philip Ridd Ramsay-type argument21 was put to the Special Commissioners to the effect that the scheme involved circular cash payments which effected nothing and the true consideration given by the parent company for the shares was the waiver of a valueless loan. In the House of Lords the Revenue was granted leave to argue in reliance on the then recent decision of the House in Ramsay,22 and the hearing was over within a day. It was evident almost from the outset that the Law Lords considered Ramsay to be applicable. Charles Potter QC, for the taxpayer company, recognised that the writing was on the wall and made what were really no more than token submissions. David Braham QC followed at greater length, but to no noticeable effect. The two main speeches were those of Lord Diplock and of Lord Fraser of Tullybelton, but the former also expressed agreement with the latter and the other three Law Lords agreed with both of them. Lord Diplock considered that the correct analysis was to look at the end result, which was that the parent company had sustained a real loss in the form of a debt, not on a security.23 Lord Fraser considered that the ratio of Ramsay lay in the second of the two passages from Lord Wilberforce’s speech quoted earlier,24 so that the relevant question was whether the scheme resulted ‘in a loss such as the legislation is dealing with, which I may call for short, a real loss’.25 On analysing the facts, he answered that question in the negative,26 and in his short speech Lord  ­Scarman said the same.27 The speeches do not advance matters so far as statutory interpretation is concerned. The case was purely one in which ­Original Ramsay was applied. Next came Furniss v Dawson.28 On 20 December 1971 the taxpayers, members of the Dawson family, exchanged their shares in family trading companies for shares in Greenjacket Investments Ltd, an Isle of Man company, and Greenjacket sold the shares to Wood Bastow Holdings Ltd. These events were pre-planned by the parties concerned, Greenjacket being specially incorporated for the purpose. The idea was this; a sale by the taxpayers to Wood Bastow would have given rise to a charge to capital gains tax for the year in which the sale took place; but disposal of the shares by share exchange would attract the exemption from charge in paragraph 7 of Schedule 6 to the Finance 21 The argument was advanced based on Black Nominees Ltd v Nicol (1975) 50 TC 229. On this and other occasions it was advanced by Mr Edward Jackson (of the office of the Solicitor of Inland Revenue) and was fondly known by the Special Commissioners as ‘Mr Jackson’s fettered transaction kit’. 22 Lord Mackay of Clashfern QC, then the Lord Advocate, had faith in the technical argument but was persuaded by the then Solicitor of Inland Revenue, RS Boyd CB, that Ramsay should be deployed. Due to Lord Mackay’s congested diary the meeting had to be held in a car which was conveying Lord Mackay to an airport. 23 Burmah, above n 20, 215. 24 See above n 13. 25 Burmah, above n 20, 220. 26 ibid 221. 27 ibid 222. 28 Furniss v Dawson [1984] AC 474.

Through Ramsay Spectacles  251 Act 1965, and disposal by the acquiring company would not attract a charge if that company was not resident in the United Kingdom. The Revenue accepted that the transactions were genuine and, as a matter of general law, as opposed to the law in relation to capital gains tax, the ownership of the family trading company shares had moved from the taxpayers to Greenjacket, and from Greenjacket to Wood Bastow. Moreover the Revenue was unable to rely on any statutory provision to support its contention that, for capital gains tax purposes, the taxpayers had made a disposal of the family trading company shares to Wood Bastow. That contention, which had failed to date, succeeded in the House of Lords. All five Law Lords gave speeches, but the leading speech was that of Lord  ­Brightman, with whom all the others agreed. On the basis of Ramsay Lord  Brightman concluded that the taxpayers were chargeable on the basis that there was ‘a tripartite contract between the Dawsons, Greenjacket and Wood Bastow under which the Dawsons contracted to transfer their shares in the operating companies to Greenjacket in return for an allotment of shares in Greenjacket, and under which Greenjacket simultaneously contracted to transfer the same shares to Wood Bastow for a sum in cash. Under such a tripartite contract the Dawsons would clearly have disposed of the shares in the operating companies in favour of Wood Bastow in consideration of a sum of money paid by Wood Bastow with the concurrence of the Dawsons to Greenjacket.’29 That reasoning was flawed for the simple reason that the courts do not have any general power to substitute fiction for facts. The proposition that the taxpayers made the disposal to Wood Bastow contradicts the fact that the taxpayers disposed of the shares to Greenjacket, and contradicts the fact that Greenjacket disposed of the shares to Wood Bastow. In Ramsay the several scheme transactions were fully respected as having taken place and having taken effect in accordance with their tenor. Moreover the speeches in Ramsay relied closely on the proposition that the favoured analysis accorded with the intention of the parties. The speeches in Dawson do not mention the fact that the intention of the parties was the precise opposite of that inherent in the Revenue’s contention: far from intending that the taxpayers would make the disposal to Wood Bastow, that was the very thing they intended should not happen. The ‘tripartite contract’, to which reference was made, was a figment of judicial imagination, as is clear from Lord Bridge of Harwich’s use of the word ‘if’ in ‘if there had been at the outset a tripartite contract’:30 the actual tripartite arrangement was that there should happen what in fact did happen, disposal to Greenjacket and disposal by Greenjacket to Wood Bastow. The case was regarded as a test as to whether Ramsay was to be confined to circular self-cancelling transactions or might also apply to what were called



29 ibid 30 ibid

527. 518.

252  Philip Ridd straight-line transactions.31 But that may be questioned. It seems possible to envisage a straight-line series which produces a composite transaction which does not involve contradicting the true facts. For example if, under a predetermined plan, A, owning a freehold in possession, grants a lease to B and sells the reversion to C, whereupon B assigns the lease to D and C sells the reversion to D, that would be a composite transaction by which A disposed of the freehold in possession to D. Lord Brightman’s speech provides helpful confirmation that whether there was a single composite transaction is a factual matter for the Commissioners to determine (infer) from their findings of primary fact.32 But, again, the speeches do not advance matters so far as statutory interpretation is concerned, the case being purely one in which Original Ramsay was applied. Craven v White33 concerned three conjoined cases which may conveniently be called White, Bowater, and Gregory. White and Gregory involved the same scheme as that considered in Furniss v Dawson. Bowater involved what was called for short ‘asset-splitting’ or ‘fragmentation’, that is, spreading the ownership of an asset among several persons so that, on sale, the resultant gain to each person falls below the threshold for the charge to tax. The major difference between the three cases and Furniss v Dawson was this: in Furniss v Dawson all of the arrangements were absolutely cut and dried before the transactions took place, in particular before the ‘intermediate’ transaction (the share exchange or, in Bowater, the reorganisation of ownership) took place; but in White, negotiations with the intending purchaser were still under way; the same was true in Bowater and in fact the prospective purchaser subsequently withdrew, though it resumed interest seven months later and the fresh negotiations were successful; and in Gregory the prospective purchaser withdrew before the share exchange took place and a fresh prospective purchaser surfaced 14 months later, whereupon fresh negotiations were successful. By a majority of three to two the House of Lords held that Ramsay applied only if the series of transactions in question was, at the time when the intermediate transaction was entered into, pre-ordained in order to produce a given result. Lord Templeman and Lord Goff of Chieveley considered that pre-planning as opposed to pre-ordainment, was sufficient and on that footing they dissented in White, but not in Bowater and Gregory. The speeches ran to over 33,000 words but they did not address the fact that the intention of the parties is a key feature of Ramsay so that, in a case involving a sale, the intention of the purchasers is a necessary component: a one-sided composite sale transaction is not a sensible notion. All was well in Furniss v Dawson because the purchasing company, Wood Bastow, specifically agreed to buying from Greenjacket, rather than from the taxpayers. There was no evidence

31 See

the first sentence of the Revenue’s argument – ibid 508. 528. 33 Craven v White [1989] AC 398. 32 ibid

Through Ramsay Spectacles  253 in White or Bowater that the prospective purchaser was agreeable to the intermediate step. In Gregory there could have been no such evidence as there was no prospective purchaser at the time of the intermediate step. It was, therefore, unnecessary to say any more than that a finding of a composite transaction was impossible because, in each case, there was no evidence that the purchaser had joined in the plan. It is arguable that the view of the minority was not without its strength. If an owner indicates during negotiations that the actual vendor would, for tax reasons, be an offshore company, and the buying side signified acceptance of that, then it would seem odd that a finding of a composite transaction would be dependent on analysis of the exact state of the negotiations. After all, a buyer is not obliged to buy until contracts are exchanged, so that by definition the sale is in the air until then, however confident the parties are that everything has been hammered out and a sale will result. Lord Templeman was concerned that the majority view would ‘revive a surprised tax avoidance industry’,34 but even if his (and Lord Goff’s) view had prevailed, that would have been so. Tax planning would plainly be effective provided that it was implemented well in advance. It was well understood within the Revenue that Craven v White was a disastrous loss.35 For present purposes it is important to note that Craven v White changed the Ramsay scene in that all of a sudden the Law Lords declared the Ramsay principle to be one of statutory construction.36 The justifications given for that proposition are debatable, but space considerations rule out a close analysis, and all that need be said is that the speeches give no hint that purposive interpretation now ruled the roost. It is also worth noting that Lord Oliver of Aylmerton, who had been a member of the Court of Appeal which decided Furniss v Dawson in favour of the taxpayers, made a valiantly loyal attempt to justify the House of Lords decision. In so doing he stated that the decision involved ‘reconstituting the transactions into something that they were not in fact, attributing to the parties an intended result which they did not in fact intend’.37 He did not, however, attempt the impossible by explaining what possible juridical basis enabled such an approach. In Ensign Tankers (Leasing) Ltd v Stokes38 the taxpayer company, a partner in Victory Partnership (‘VP’) which contributed to the funding for a film, claimed capital allowances under Finance Act 1971, section 41(1). VP paid $3.25m but 34 ibid 491. 35 During a later meeting about another case the possibility of raising a Ramsay argument was mentioned and a senior Inspector of Taxes crisply dismissed the idea, saying ‘Ramsay is a broken reed’. 36 Craven v White, above n 33, 510 (per Lord Oliver of Aylmerton, recording his understanding that all five Law Lords agreed with this) and 520 (per Lord Goff). 37 ibid 501. 38 Ensign Tankers (Leasing) Ltd v Stokes [1992] 1 AC 655.

254  Philip Ridd its claim, in reliance on complex financing arrangements effected by 17 ­documents signed in a single day, was measured at $14m. The Revenue rejected the claim on the basis that, as the complex financing arrangements constituted a tax avoidance scheme, VP had not been conducting a trade. That was the first issue in the House of Lords. The Revenue’s alternative submission, relying on Ramsay, was that, if capital allowances were to be given, they should be limited to $3.25m.39 Lord Templeman, giving the leading speech, concluded that VP was trading but had expended no more than $3.25m He referred to Ramsay and subsequent cases, but only after rejecting the taxpayer company’s submissions as inconsistent with Chinn v Collins.40 Lord Templeman’s speech included two quotations from Lord Wilberforce’s speech in Ramsay; first, the passage which stated that the Duke of W ­ estminster case41 does not require a court to look at a document or transaction in blinkers rather than as part of a combination which should be regarded as a combination; secondly, the passage which concludes: ‘The true view, regarding the scheme as a whole, is to find that there was neither gain nor loss’.42 Lord Templeman did not refer to Lord Wilberforce’s observations about capital gains tax. He did set out Finance Act 1971, section 41(1),43 and, in his supporting speech, Lord Goff made mention of statutory construction,44 but the speeches did not expressly suggest that section 41(1) was to be construed in any particular way. There are references in Lord Templeman’s speech to ‘real expenditure’,45 as opposed, in one instance, to what he called ‘magical expenditure’,46 which might be taken to indicate that he construed ‘expenditure’ in section 41(1) in that way. But the better view is that it was just taken as sufficient to conclude on the facts that VP’s expenditure was limited to $3.25m: after all, if the $10.75m was not VP’s expenditure, then it was not within the statutory provision and there was no need to construe ‘expenditure’ in any particular way. Moodie v Inland Revenue Commissioners and Sotnick v Inland Revenue Commissioners47 concerned a tax avoidance scheme by which, in consideration of a capital sum, a taxpayer would sell a five-year annuity to a charity; the charity would recover from the Revenue the tax deducted by the taxpayer when each annuity was paid; and the taxpayer would deduct the grossed up amount of the annuities for the purposes of income tax and surtax. In Plummer v Inland

39 It had been decided not to make the alternative submission, in reliance on Ramsay, but at the hearing Lord Templeman gave an early indication that he saw Ramsay as applicable. 40 Chinn v Collins (orse Chinn v Hochstrasser) [1981] AC 533. 41 Inland Revenue Commissioners v Westminster (Duke of) (‘Duke of Westminster’) [1936] AC 1. 42 Ramsay, above n 1, 323 and 328 respectively. 43 Ensign, above n 38, 661. 44 ibid 681–84. 45 ibid 673, 676, 677, 680. 46 ibid 677. 47 Moodie v Inland Revenue Commissioners and Sotnick v Inland Revenue Commissioners [1993] 1 WLR 266.

Through Ramsay Spectacles  255 Revenue Commissioners48 the Revenue failed to establish that such a scheme did not achieve its purpose, and Plummer loomed large in the arguments in Moodie and Sotnick. Lord Templeman, giving the leading speech in the House of Lords, declared that Plummer was to be ignored because a Ramsay-style argument had not been advanced. Lord Keith of Kinkel acknowledged that he had been a member of the Committee which heard Plummer and commented that he would have found for the Revenue if a Ramsay-style argument had been advanced.49 In the light of Ramsay Lord Templeman concluded that ‘upon construction of the taxing statute and in the events which happened, no annuity was paid’.50 Lord  Templeman had mentioned the relevant provisions in the Income and Corporation Taxes Act 1970,51 but their meaning was not the subject of dispute between the parties, so no question of statutory interpretation had arisen. It is interesting to note that Lord Templeman stated that the principle held by Ramsay to be applicable lay in Lord Wilberforce’s words: ‘It is the task of the court to ascertain the legal nature of any transaction to which it is sought to attach a tax or a tax consequence and if that emerges from a series or combination of transactions, intended to operate as such, it is that series or combination which may be regarded.’52 He did not take notice of Lord Fraser’s speech in Burmah,53 but did refer to Lord Fraser’s speech in Furniss v Dawson.54 Again this case does not advance matters so far as the topic of statutory interpretation is concerned. Again it was an application of Original Ramsay, save that the context was a different tax. The next case, Inland Revenue Commissioners v Fitzwilliam,55 concerns yet another tax, namely the death duty which was at the time capital transfer tax. When the 10th Earl Fitzwilliam died in 1979, his net estate was just under £11.6m, later corrected to some £12.4m. He was survived by, amongst others, his Countess (‘F’) and his step-daughter, Lady Hastings (‘H’). His testamentary provisions included a power of appointment exercisable during the period of 23 months following his death. If F were to inherit, there would be no charge to capital transfer tax but, as she was 81 and in poor health, there were concerns about the tax liability if she were not to survive long.56 Five steps were taken as follows: (1) on 20 December 1979, part of the residuary estate, to a value of £4m, was appointed out, to be held on trust for F absolutely; (2) on 9 January 1980,

48 Plummer v Inland Revenue Commissioners [1980] AC 896. 49 ibid 269. 50 ibid 273. 51 ibid 269. 52 Ramsay, above n 1, 324. 53 Burmah, above nn 24–25. Lord Fraser there identified the Ramsay principle by reference to the second of the two quotes at n 13 above. 54 Furniss v Dawson, above n 28, where Lord Fraser identified the Ramsay principle by reference to the first of the two quotes at n 13 above. 55 Inland Revenue Commissioners v Fitzwilliam [1993] 1 WLR 1189, (1992) 67 TC 619. 56 In the event she died in 1995, aged 97.

256  Philip Ridd F made a gift to H of £2m net of capital transfer tax; (3) on 14 January 1980, the trustees of the will appointed £3.8m net of the residue to be held on trust, by which the income was to be paid to F until the earlier of her death or 15 February 1980 and, subject to this, one moiety was to be held for H absolutely and as to the other moiety the capital was only to pass to H if she was living on the termination of F’s interest in possession; (4) on 31 January 1980, F assigned to H, for a consideration of £2m, her beneficial interest in the income of the contingent moiety; (5) on 5 February 1980, H settled the sum of £1,000 on trust to pay the income to F until the earlier of her death or 15 March 1980; subject to this, the trust fund was to be held for H absolutely; on 7 February 1980, H assigned to the trustees of this settlement her beneficial interest in the vested moiety expectant on the termination of F’s interest in the income, that interest to be held as an accretion to the £1,000 as one fund for all purposes. The Revenue took the view that Ramsay applied and capital transfer tax was exigible on H’s £3.8m. The Special Commissioners agreed, but the courts disagreed. The Revenue’s initial line was that all five steps constituted a scheme to which Ramsay applied. This ran into the difficulty that those concerned had not, at the stage at which the first step was taken, applied their minds to the question what, if any, further steps might follow. In the Court of Appeal three other possible bases were proffered for a finding of a single composite transaction: they comprised steps (2) to (5), steps (3) and (5), and steps (2) to (4). In the House of Lords the only basis put forward relied on steps (2) to (5). In the House of Lords Lords Ackner and Mustill agreed with Lord Keith. Lord Browne-Wilkinson came to the same conclusion for different reasons. Lord  Templeman dissented in trenchant terms. Lord Keith was prepared to accept that steps (2) to (5) were pre-ordained, in the sense that they all formed part of a pre-planned tax-avoidance scheme and that there was no reasonable possibility that they would not all be carried out but he concluded that the terms of the legislation were not such as to impose tax on the composite outcome. Lord Browne-Wilkinson preferred to take the view that steps (2) to (5) did not comprise a self-contained scheme because funding for those steps derived from step (1). This analysis has sidestepped a good deal of the complication of the case, but will suffice for present purposes. It may well be that few people took the trouble to study the case in fine detail but even a cursory appreciation will have left the impression that Ramsay had become a doctrine of extremely limited application. After all the effect of the majority view in the House of Lords was that a tax avoidance scheme had achieved its object even though there was a composite transaction within Ramsay. In that sense the case had ramifications beyond those in Craven v White. For those who like Latin tags, parturient montes, nascetur ridiculus mus57 (the mountains will go into labour, and give birth to a ridiculous mouse) must have come to mind.

57 Horace’s

Epistle to the Pisones.

Through Ramsay Spectacles  257 Before parting with this case notice must be taken of a remark of Nourse LJ in the Court of Appeal, as follows:58 In Craven v White each of their Lordships said that the Ramsay principle is one of statutory construction. That is without doubt true in the sense that once the single composite transaction has been identified the question is whether it is caught by the taxing statute on which the Crown relies. However, it does not always or usually involve a question of statutory construction in the sense that the meaning of the statute is in doubt. Usually the question is whether a statute whose meaning is clear applies to the single composite transaction. The principle might equally be described as one of statutory application.

The distinction there drawn is most important and requires to be borne in mind when words such as ‘question of statutory construction’ are encountered in a speech or judgment. For example, the assertion in Craven v White that the Ramsay principle was one of statutory construction59 fits with Lord Keith’s statement that ‘The Ramsay principle is simply that you look at the result which the parties actually intended to and did produce and apply to it the ordinary fiscal consequences which flow from that result’60 only if there is borne in mind the valuable distinction which Nourse LJ made. PAUSE FOR BREATH

The message thus far is that Ramsay, Burmah, Furniss v Dawson, Craven v White, and Ensign are of little, if any, interest to the student of statutory interpretation. This should occasion no surprise because, leaving aside technical points which were not decisive, the parties were not at odds about the meaning of any statutory provisions, the disputed territories being confined to analysis of the facts. The majority line in Fitzwilliam was an exception in that the decisive factor was that, on construction of the statutory provisions, there was no fit between the composite transaction and the statutory provisions. Ramsay had been confined by most of the Law Lords: Lord Templeman was a notable exception but he was due to retire in 1995, so there was no realistic prospect that he would be able to bring his colleagues round to his view. Ramsay had been branded as a principle of statutory construction, but without that proposition being explained and justified. Speculation is hazardous, but the likelihood is that the unease about Ramsay, which from the outset was strongly felt in academic circles, among practitioners, and in the lower echelons of the judiciary, was shared in the House of Lords, the principal concern being whether there was a sound juridical basis for Ramsay and, if so, what it was. The search for justification concentrated on statutory interpretation.

58 Fitzwilliam,

above n 55, (1992) 67 TC 619, 702B. above n 36. 60 Craven v White, above n 33, 501. 59 See

258  Philip Ridd It is helpful at this stage to recall the long-standing general position on s­ tatutory interpretation in tax matters. Two authorities were dominant. First, there is the much-celebrated dictum of Rowlatt J in Cape Brandy Syndicate v Inland Revenue Commissioners: ‘in a taxing Act one has to look merely at what is clearly said. There is no room for any intendment. There is no equity about a tax. There is no presumption as to a tax. Nothing is to be read in, nothing is to be implied. One can only look fairly at the language used’.61 That dictum was approved at the highest level, for example in Canadian Eagle Oil Co Ltd v The King.62 In subsequent cases that dictum was almost invariably relied on by counsel for the taxpayer, but it is worth remembering that the judge said this in the course of disposing of a submission by the taxpayers’ counsel, not Revenue counsel. Secondly, there is the summary set out by Lord Donovan in his judgment for the majority in the Privy Council in Mangin v Inland Revenue Commissioner: ‘First, the words are to be given their ordinary meaning. They are not to be given some other meaning simply because their object is to frustrate legitimate tax avoidance devices … Secondly, [the Rowlatt dictum]. Thirdly, the object of the construction of a statute being to ascertain the will of the legislature it may be presumed that neither injustice nor absurdity was intended. If therefore a literal interpretation would produce such a result, and the language admits of an interpretation which would avoid it, then such an interpretation may be adopted. Fourthly, the history of an enactment and the reasons which led to its being passed may be used as an aid to its construction’.63 A third matter worthy of note in this connection is the conservative approach of Lord Wilberforce, as already mentioned,64 the burden of which is that statutory interpretation in tax matters remained unchanged. THE ELEPHANT IN THE ROOM

Pepper v Hart65 is famous for the ruling that statements made in Parliament during the passage of a Bill, as recorded in Hansard, may be admissible in evidence on an issue of statutory construction of a provision in the subsequent Act, but a close study of the case66 reveals something else. In a speech with which five other Law Lords agreed, Lord Browne-Wilkinson referred, with evident approval, to ‘the purposive approach to construction now adopted by the courts in order to give effect to the true intentions of the legislature’67 and 61 Cape Brandy Syndicate v Commissioners of Inland Revenue [1921] 1 KB 64, 71. 62 Canadian Eagle Oil Co Ltd v The King [1946] AC 119, 140. 63 Mangin v Inland Revenue Commissioner [1971] AC 739, 74. 64 See above nn 9–12. 65 Pepper v Hart [1993] AC 593. 66 See P Ridd, ‘Pepper v Hart and Others (1992): the Case of the Misunderstood Minister’ in J Snape and D de Cogan (eds), Landmark Cases in Revenue Law (Oxford, Hart, 2019). 67 Pepper v Hart, above n 65, 635.

Through Ramsay Spectacles  259 Lord Griffiths, in his supporting speech, said much the same.68 For the second hearing in the House of Lords, the hearing in which the Hansard issue was considered, Anthony Lester QC69 was brought in to lead for the taxpayers. In his argument Mr Lester made submissions which led to the approval of purposive construction. It is possible that Mr Lester, who was not of the Revenue Bar, did not realise that the modern doctrine of purposive construction had not yet entered the world of taxation, and it is true that counsel for the Revenue did not take issue on the point, so in a sense the outcome was revolution by a back door. It is also the case that it was overlooked in the subsequent commentary on Pepper v Hart and that a search of the tax cases which followed in the next few years does not reveal instances in which judges, in reliance on Pepper v Hart, invoked purposive construction. It is in that sense that for a few years there was an elephant in the room of the tax world. BREAKTHROUGH

Inland Revenue Commissioners v McGuckian70 concerned a complicated scheme to avoid taxation of a dividend paid by a company by means of transmutation into the form of capital. The Revenue lost the Ramsay argument in the Court of Appeal for Northern Ireland, but Kelly LJ’s dissenting judgment provided an encouraging basis for an appeal to the House of Lords. Lord  Browne-Wilkinson was in the chair, but the other four Law Lords were newcomers to the Ramsay scene, although Lord Cooke of Thorndon could rely on his New Zealand experience. At the end of the first day it was reported back to Somerset House that Lords Steyn and Cooke were suggesting that the Revenue’s line of argument should have been even stronger than it was.71 The House of Lords decided unanimously in favour of the Revenue. The four reasoned speeches72 are not consistent with each other, but for present purposes it suffices to concentrate on the speech of Lord Steyn, with whose remarks on statutory interpretation Lord Cooke associated himself.73 Lord Steyn said: 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 68 ibid 617. 69 Now Lord Lester of Herne Hill QC. 70 Inland Revenue Commissioners v McGuckian [1997] 1 WLR 991. 71 The report was made by the late Roger Waterson, Assistant Solicitor of Inland Revenue. Apparently it was suggested that the Revenue was pusillanimous in failing to challenge the correctness of Paget v Inland Revenue Commissioners [1938] 2 KB 25. 72 With all of which Lord Lloyd of Berwick agreed: McGuckian, above n 70, 998. 73 ibid 1005.

260  Philip Ridd ­ uke of ­Westminster doctrine [1936] AC 1, 19 tax law remained remarkably resistant D 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 … 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, i.e. 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 ... 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 House of Lords was simply rejecting formalism in fiscal matters and choosing a more realistic legal analysis.74

It has been argued that in Ramsay Lord Wilberforce did no more than recognise that the general nature or purpose of the relevant statute was to be borne in mind when analysing facts, and that Pepper v Hart represented the first occasion on which the House of Lords sanctioned purposive interpretation of tax provisions. On that footing it was not Ramsay which made the double intellectual breakthrough, but it was Lord Steyn’s speech in McGuckian. MODERN RAMSAY BEDS IN

MacNiven v Westmoreland Investments Ltd75 concerned an investment company which was so unsuccessful that it ended up without assets and in debt to its



74 ibid

999–1000. v Westmoreland Investments Ltd [2003] 1 AC 311.

75 MacNiven

Through Ramsay Spectacles  261 owner, a tax-exempt pension scheme, to the tune of some £70m, which included £40m accrued interest. But the company would have value as a company with established tax losses which could be set off against future profits earned by assets transferred to it. For that purpose the tax losses needed to be crystallised by payment of the outstanding interest. The company borrowed from its owner the money with which to pay the interest and on the same day paid the owner the outstanding interest net of tax and accounted to the Inland Revenue for the tax due, thus replacing the liability to the owner for interest with a liability for an equivalent capital sum. The owner, being exempt from tax, was then able to reclaim the tax which had been paid by the company. The company was later sold for £2m. The Revenue contended that Ramsay applied, so that the payment to the owner did not qualify as a deductible payment of interest within the meaning of section 338 of the Income and Corporation Taxes Act 1970. The contention failed because ‘interest’ in section 338 was held to refer to the legal concept of interest, not the commercial concept. Interestingly, Lord Nicholls of Birkenhead thought that the phrase ‘the Ramsay principle’ was potentially misleading, in that no new legal principle had been propounded, and he preferred the phrase ‘the Ramsay approach’.76 Lord Hoffmann, with whom all the other Law Lords agreed, discussed the Ramsay line of authorities in detail, but his horse fell at the first fence; observing that Lord Wilberforce’s reasoning was ‘characteristically compressed’, Lord Hoffmann explained that Lord Wilberforce was ‘construing the words “disposal” and “loss” to refer to commercial concepts’;77 as already indicated, that was quite impossible in relation to ‘loss’, and, for much the same reasons, it was impossible in relation to ‘disposal’; it may well be that Lord Wilberforce often deployed compressed reasoning, but the notion that he took compression so far as fail to mention that statutory words were in point, and required to be construed, is nothing short of fantastic. Lord Steyn’s speech in McGuckian received approval,78 as also did Lord Cooke’s observation that ‘the ultimate question is always the true bearing of a particular taxing provision on a particular set of facts … Always one must go back to the discernible intent of the taxing Act’.79 The outcome in Westmoreland was similar to that favoured by the majority in Fitzwilliam in that there was no fit between the facts viewed in the round and the statutory terms. For present purposes the importance of Westmoreland is that the McGuckian approach held sway. Inland Revenue Commissioners v Scottish Provident Institution80 concerned a scheme born out of a proposal in a consultative document to bring capital



76 ibid

[1], [7]. [12]. 78 ibid [55]. 79 ibid [56], referring to McGuckian, above n 70, 1005. 80 Inland Revenue Commissioners v Scottish Provident Institution [2004] 1 WLR 3172. 77 ibid

262  Philip Ridd gains on gilt derivatives into charge as income and capital losses to be relieved as income losses. The scheme involved transactions in options which would give rise to a gain arising during the currency of the old tax regime and therefore non-chargeable, with a matching loss arising once the new tax regime was in force and therefore allowable. Allied to the main arrangements were collateral provisions designed to cope with the risk that the price of gilts might rise or fall to levels rendering it undesirable, to one party or the other, for the scheme to be carried through. The statutory issue was whether one of the options involved was a ‘qualifying contract’ within the meaning of section 147A(1) of the Finance Act 1994. The taxpayer company accepted that the scheme fell to be considered as a whole, and its main argument was that Ramsay did not apply because there was a genuine commercial possibility that the collateral provisions would be triggered and the options would not be exercised together. The House of Lords, by a single speech delivered by Lord Nicholls, robustly dismissed the argument as follows: We think that it would destroy the value of the Ramsay principle of construing provisions such as section 150A(1) of the 1994 Act as referring to the effect of composite transactions if their composite effect had to be disregarded simply because the parties had deliberately included a commercially irrelevant contingency, creating an acceptable risk that the scheme might not work as planned. We would be back in the world of artificial tax schemes, now equipped with anti-Ramsay devices. The composite effect of such a scheme should be considered as it was intended to operate and without regard to the possibility that, contrary to the intention and expectations of the parties, it might not work as planned.81

As indicated in that passage the case was an important one in that the scheme under consideration was wholly artificial and, though the scope of Ramsay was still the subject of probing in case law, it would have been startling if a wholly artificial scheme had been found, Ramsay notwithstanding, to be effective. The speech did not elaborate on the subject of statutory interpretation. Barclays Mercantile Business Finance Ltd v Mawson82 was another capital allowances case in which the taxpayer company succeeded. The company paid some £91m for a gas pipeline which it then leased back to the vendor. The company claimed writing down allowances under section 24(1) of the Capital Allowances Act 1990 in respect of depreciation of assets. The purchase had been attended by complex financing arrangements under which money loaned by the company’s parent company to fund the purchase ended up back with the parent company, and it was this which sponsored the Revenue’s resistance to the claim. The House of Lords held that those financing arrangements were irrelevant because the statutory provision was concerned only with the acts and purposes of the lessor and the fact that the purchase and leaseback of the pipeline was



81 ibid

[23]. Mercantile Business Finance Ltd v Mawson [2005] 1 AC 684.

82 Barclays

Through Ramsay Spectacles  263 part of the taxpayer company’s ordinary trade of finance leasing sufficed to activate section 24(1). The decision was given in a single speech to which all members of the committee had contributed and which was delivered by Lord Nicholls. Discussion of the Ramsay principle opened with extracts from Lord Steyn’s speech in McGuckian.83 It was observed that Ramsay ‘did not introduce a new doctrine operating within the special field of revenue statutes’.84 The speech went on to stress that there were two distinct processes; first, purposively construing the relevant statutory provision, and, secondly, deciding whether the transaction concerned answered the statutory description’; the encapsulation by Ribeiro PJ was invoked.85 It was observed that ‘The need to avoid sweeping generalisations about disregarding transactions undertaken for the purpose of tax avoidance was shown by [Westmoreland]’.86 All in all, the case was an affirmation and application of Modern Ramsay. Before leaving BMBF it is instructive to mention two points made in the Court of Appeal in the judgment of Carnwath LJ.87 First, noting what Lord Oliver said in Craven v White about the reconstitution of the transactions in Furniss v Dawson,88 Carnwath LJ commented that that involved applying a purposive approach not just to statute but also to the characteristics of the facts.89 Like Lord Oliver, Carnwath LJ did not confront the question as to what juridical basis there was for such an approach. Secondly, Carnwath  LJ observed that ‘[All taxing statutes] draw their life-blood from real world transactions with real world economic effects, to which the Revenue is not a party’.90 This reflects Lord Wilberforce’s comment in Ramsay about capital gains tax.91 That the same could be said about taxes other than capital gains tax had been assumed in some of the subsequent cases, but Carnwath LJ made specific recognition of this. It is, however, to be remembered that the statement is subject to the exception that deeming provisions may come into operation. So far as capital allowances cases were concerned, Tower McCashback LLP 1 v Revenue & Customs Commissioners92 represented, after Westmoreland and BMBF, third time lucky for the Revenue. The case concerned a software licence agreement and, like Ensign, involved funding by non-recourse loans. The claim was for first-year capital allowances and the crucial issue was the extent to which the taxpayer company had incurred expenditure within section 11(4) of the Capital Allowances Act 2001. That provision was construed to require

83 ibid

[28]–[29]. [33]. 85 ibid [36] – for Ribeiro PJ, see above n 17. 86 ibid [37]. 87 Now Lord Carnwath of Notting Hill. 88 See above, n 37. 89 Barclays Mercantile Business Finance Ltd v Mawson [2003] STC 66 (CA) [66]. 90 ibid. 91 See above n 13, second quote. 92 Tower McCashback LLP 1 v Revenue & Customs Commissioners [2011] 2 AC 457. 84 ibid

264  Philip Ridd real expenditure for the real purpose of acquiring plant for use in a trade, and, on a close analysis of the funding arrangements, it was held that the taxpayer company had expended only 25 per cent of the amount claimed. A procedural point was also decided in favour of the Revenue. Lord Walker of Gestingthorpe gave the leading judgment, Lord Hope of Craighead gave a supporting judgment, and the other five justices agreed with both. Lord Walker did not find it necessary to discuss at length the history of the Ramsay principle, but it is noteworthy that he referred to the ‘drawing back from the rigidity of Furniss v Dawson’ as ‘continued’ in McGuckian and Westmoreland and he mentioned that there were also ‘many helpful insights’ in Arrowtown.93 Both judgments were clear that the relevant statutory provision required to be construed purposively,94 and Lord Walker maintained that both BMBF and Ensign were still to be regarded as good law.95 The case represents further confirmation of Modern Ramsay. REVISITING FURNISS v DAWSON

Of the cases discussed so far, there is one only which must be revisited and that is Furniss v Dawson. As it has been submitted that the House of Lords’ reasoning was fundamentally flawed, the question arises whether there was any other line of reasoning to justify the outcome. A possible line lies in purposive construction of the exemption provision, paragraph 7 of Schedule 6 to the Finance Act 1965, on which success of the scheme hinged. The obvious purpose of provisions which relieve commercial restructuring from taxation is to prevent ossification of business structures by removing the disincentive that a reconstruction would give rise to a charge to tax. Unless some other purpose could be identified, there is a strong argument that it is implicit that any restructuring must have business purpose to qualify for the relief. In other words, Modern Ramsay could be deployed to justify the decision rather than the tortuous analyses set out in various of the subsequent cases, none of which confront the fundamental problem that facts cannot be replaced by a fiction. If Furniss v Dawson were to be justified in that way, it would not follow that the Revenue would have succeeded in Craven v White. Apart from the fact that some of the assessments in issue would, in relation to this argument, have been for the wrong years, White involved a possibility that the share exchange might have facilitated a merger rather than a sale of the shares, and in any event, in relation to all three cases, a restructuring by way of strategic planning involves the business concerned being run, pending developments, under the altered structure so that it may be said that there was business purpose even if the parties had fiscal matters primarily in mind.

93 ibid,

[43]. [80] and [88]. 95 ibid, [80]. 94 ibid,

Through Ramsay Spectacles  265 Chinn v Collins96 involved a scheme to enable shares to be transferred from trustees to two beneficiaries without occasioning charges to capital gains tax. UK-resident trustees were replaced by a non-resident trustee company. Several events then occurred on a single day: first, funds which comprised the shares were appointed to the beneficiaries contingent on them surviving for a period of three days; secondly, the beneficiaries assigned their contingent interests to a non-resident company in return for some £350,000 payable three days hence; thirdly, the beneficiaries contracted to buy, three days hence, the same number of shares from the non-resident company for a little over £350,000. In fact the legal title was at all times with a nominee, so the dealings were with beneficial interests. Viscount Dilhorne died between the hearing of the case and the day of decision.97 The decision was unanimously in favour of the Revenue, but both Lord Fraser and Lord Russell of Killowen said that they had found the case difficult.98 There were two grounds of decision, but for present purposes only the first one is important. Lord Wilberforce repeated the view which he had expressed in Plummer99 that, in relation to pre-arranged, pre-drafted tax avoidance schemes, regard should be had to the scheme as a whole, though without disregarding the legal form and nature of the transactions.100 He dismissed as ‘wholly unreal’ the argument (which had been successful in the Court of Appeal) that the share sale agreement did not specifically refer to the settlement shares.101 He held that under the share sale agreement the equitable title passed at once to the purchasers and, as the trustees were bound to transfer the shares on the vesting of the contingent interests, the beneficiaries were the beneficiaries within Finance Act 1965, section 42. Lord Fraser simply agreed, and Lord Russell and Lord Roskill spoke to the same effect. The analysis fell short of Original Ramsay in that consideration of the scheme as a whole was used only as an aid to appreciation of the individual steps, in particular the issue as to whether it was the beneficiaries or the nonresident company to which the equitable title passed on the making of the share sale agreement. Had Original Ramsay been available, it would have led more directly to the same result. Modern Ramsay would not have been needed as it was just a matter of viewing the facts realistically and there was no occasion for construing any statutory provision purposively.

96 Chinn v Collins, above n 40. 97 The writer learned of this from Edward Jackson (who was mentioned in n 21 above). He burst into a room, announced, machine-gun fashion, ‘Heard the news? Dilhorne’s dead. Chinn v Collins. Lost his vote. Bye’, and exited. 98 Chinn v Collins, above n 40, 549 and 550. This gives credence to a story that the Law Lords were evenly divided, but at a meeting Lord Wilberforce, with Lord Roskill alongside him, addressed Lord Fraser and Lord Russell, and said ‘You know how Reggie would have voted, so you will fall in with us’. 99 Plummer, above n 48, 907. 100 Chinn v Collins, above n 40, 547. 101 ibid, 548.

266  Philip Ridd Floor v Davis102 was another case of sale of shares in a family company effected through a tax avoidance scheme. The scheme was of the Furniss v Dawson-type, but with the complication of the intermediary company being wound up in circumstances in which it became an issue whether the taxpayer and his two sons-in-law103 were ‘a person having control’ of a company, of which they held all the shares via three minority shareholdings, within ­paragraph 15(2) of Schedule 7 to the Finance Act 1965. By a 3-2 majority the House of Lords held that that provision applied by virtue of the Interpretation Act rule that, unless the contrary appeared, words in the singular included the plural.104 By taking that issue first and concluding in favour of the Revenue, the House of Lords resolved the case without hearing argument on the other issue,105 the Furniss v Dawson-type issue, whether the taxpayer and his sons-in-law had disposed of the shares in the family company to the intermediary company or to the ultimate purchaser. The taxpayer had succeeded on that issue in the High Court and, by a majority, in the Court of Appeal, where Sir John Pennycuick and Buckley LJ concluded that the Revenue’s argument fell foul of the Duke of Westminster case.106 Eveleigh LJ disagreed on the basis that there was ‘no real possibility at any time that the shares would not reach [the purchaser]’ and the Court was ‘not required to consider each step taken in isolation’.107 Plainly this case was, on the unargued issue, indistinguishable from Furniss v Dawson. Thereapart the only point worth noting for present purposes is Lord  Wilberforce’s restrictive approach to statutory interpretation of tax ­provisions108 in remarks which cannot be squared with the notion that, 20 months later in Ramsay, Lord Wilberforce countenanced purposive interpretation of taxation provisions. If the Duke of Westminster case109 were re-litigated in the modern era, there can be little doubt that the Revenue would succeed. As is well known, the case concerned an arrangement by which the Duke made covenants in favour of employees, and the employees’ wages were reduced. In Ensign Lord ­Templeman remarked that ‘gardeners do not work for Dukes on half-wages’.110 Yet in Ramsay Lord Wilberforce observed that the Duke of Westminster case had established a cardinal principle, though he added that it must not be

102 Floor v Davis, above n 10. 103 There is an incidental connection with Fitzwilliam in that one of Major Floor’s sons-in-law was Michael Naylor-Leyland, whose brother, Sir Vivyan, was the first husband of Lady Hastings. 104 Interpretation Act 1889 s 1(b), later Interpretation Act 1978 s 6(c). 105 In consequence Lords Wilberforce and Keith, who were the minority on the issue argued, were precluded from voting when the decision was pronounced, a highly unusual, possibly unique, circumstance. 106 Floor v Davis, above n 10, 307 and 315. 107 ibid, 312 and 313. 108 See above nn 11 and 12. 109 Duke of Westminster, above n 41. 110 Ensign, above n 38, 669.

Through Ramsay Spectacles  267 ­ verstated or overextended.111 The point of concern is the observation by which o Lord Tomlin exploded a perceived ‘doctrine that the court may ignore the legal position and regard what is called “the substance of the matter”’.112 It is easy to see why that observation, taken as saying no more than it actually says, appealed to Lord Wilberforce, who had already said, repeatedly, that looking at a scheme as a whole should not involve disregarding the legal form and nature of the ­transactions concerned.113 Indeed Lord Tomlin’s observation (again, it is stressed, taken as saying no more than it actually says) is utterly beyond criticism, because any idea that a court might ever ‘ignore the legal position’ is, quite simply, anathema. The observation does not involve a blanket rule that substance must be disregarded, but merely states that substance must not be regarded at the expense of ignoring the legal position, and in that way it does not rule out a realistic analysis of facts. The neat statement that ‘gardeners do not work for Dukes on half-wages’ looks like a realistic, indeed starkly realistic, appreciation of the facts of the Duke of Westminster case, but the crucial issue in that case was the correct construction of the arrangements between the Duke and the employees, as is evident from a more extensive quote from Lord Templeman’s speech in Ensign, viz ‘The second explanation of the facts in the Westminster case is that the gardener worked full time for full wages and volunteered or agreed that he would not take his annuity until he had retired. Lord Atkin thought that this was the true effect in law on the facts. I agree with Lord Atkin; gardeners do not work for Dukes on half-wages.’114 The case is, obviously, far removed from the Ramsay scene (Original Ramsay or Modern Ramsay) because it did not involve a series of transactions. But the modern judge’s predilection for looking at facts realistically would be in line with Lord Atkin’s analysis rather than the majority view. As to ­principle, the Duke of Westminster case, duly confined, presents no difficulty. In the VAT case, Customs & Excise Commissioners v Faith C ­ onstruction Ltd,115 counsel for the taxpayer company, Roderick ­Cordara, described the Duke of ­Westminster case as ‘essentially unscathed, albeit perhaps a bit battered’,116 but Bingham LJ treated it as good law.117 Ransom v Higgs118 was one of the earlier cases in which Lord Wilberforce said that the courts were entitled to have regard to a tax avoidance scheme 111 Ramsay, above n 1, 323. 112 Duke of Westminster, above n 41, 19. 113 See above n 100. 114 Ensign, above n 38, 669. 115 Customs & Excise Commissioners v Faith Construction Ltd [1990] 1 QB 905. 116 ibid 912. 117 ibid 921. 118 Ransom v Higgs [1974] 1 WLR 1594. The case involved other appeals, but they may, for present purposes, be ignored. It may however be noted that the first speech in the House of Lords was given by Lord Reid and was one of the last speeches in his long and distinguished career as a Law Lord (1948–75); it was generally recognised at the time that Lord Reid, then 84, still had a mind as sharp as a needle; he retired in January 1975 and died in March 1975.

268  Philip Ridd as a whole.119 But, all the same, the Revenue did not succeed. The complex facts were described by Lord Reid as a ‘labyrinth’.120 Lord Wilberforce commented that ‘complete immersion in the details tends to confuse rather than to clarify’.121 The case involved what was called a ‘stock stripping’ scheme. The trading stock of companies, the shares in which were owned by Mr and Mrs  Higgs, included undeveloped land. The function of the scheme was to arrange development in such a way that the profits would be turned into capital. In the event the profits were £200,000, of which £30,000 accrued to the financial advisers involved and the remaining £170,000 accrued to the trustees of a discretionary settlement for the benefit of the Higgs family. The detailed facts are best taken from the judgment in the High Court of Megarry  J, as follows: This involved a Mr Higgs, his wife, certain companies under their control which carried on the trade of dealing in or developing land (which I shall call ‘the Higgs companies’) and certain other companies in which Mr and Mrs Higgs held no direct or indirect interest: I shall call these ‘the non-Higgs companies.’ The initial step was for various Higgs companies to agree to sell land to a newly formed partnership at less than its market value. The partnership consisted of Mrs Higgs, who owned a 90 per cent interest in it, and two non-Higgs companies, who owned 5 per cent each. Pausing there, the partnership thus acquired an asset far more valuable than the price of some £87,000 paid for it; and it was this excess value which was to produce the sum in dispute. The next step was for Mrs Higgs to settle her 90 per cent interest in the partnership on discretionary trusts for herself, Mr Higgs and his issue. The trustees promptly sold this 90 per cent interest to a non-Higgs company for £170,000, a figure which obviously gives some idea of the undervalue at which the land had been sold to the partnership. It is this £170,000 which is in dispute. This sale, I may say, was frugal in its yield of stamp duty, for it was effected by means of the grant and oral exercise of an option which had been made exercisable orally, and then by Mrs Higgs being replaced in the partnership by the purchasing company. In place of any ad valorem duty, there was no more than two adhesive 6d stamps and a 10s impressed stamp. The partnership then proceeded to contract to sell the land to the purchasing company for some £87,000. The purchasing company then had vested in it the right to both the land and the 90 per cent interest in the partnership, and it proceeded to contract to sell both to another non-Higgs company for £286,000. That company then sold the land to another non-Higgs company for a little over £286,000, and the 90 per cent share in the partnership, now greatly reduced in value as the partnership no longer owned the land, to yet another non-Higgs company for a mere £275. Finally, the purchaser of the land brought it once more under the control of a Higgs company to the extent that a Higgs company contracted under an agency agreement to carry out the development of the land for the purchaser in such a way as to yield to the purchaser

119 ibid

1612. 1600. 121 ibid 1609. 120 ibid

Through Ramsay Spectacles  269 a little over £287,000. The Higgs company was put in funds for this purpose by the trustees of the settlement lending the company the £170,000 that they had received for the 90 per cent share in the partnership. The partnership, I may say, had been constituted on March 1, 1961; but all the other steps that I have mentioned were taken during what must have been a busy period of eight days ending on April 5, 1961.122

The Revenue raised assessments to income tax on Mr Higgs and on the trustees, but the former were not pursued in the House of Lords as it had become clear that, even if Mr Higgs could be said to have been trading, he had not received any of the profits. The trustees had received them and the Revenue’s contention was that the profits were taxable in the trustees’ hands on the basis that they emanated from a trade conducted by Mr Higgs. Short of the House of Lords that contention was successful, but the Law Lords demolished it in terms which are beyond criticism; Mr Higgs had done nothing except agree to the carrying out of the scheme which, incidentally, he did not fully understand; the courts below had held that procuring things to happen by way of trade was itself a trade, but procuring was held to be insufficient and to have alarming consequences, including profits being taxable more than once.123 Moreover, Lord  Simon of Glaisdale mentioned that there were outstanding assessments against Higgs companies.124 A short comment on the case might be that, in pursuing assessments on Mr Higgs and on the trustees, the Revenue were barking up wrong trees. It is impossible to see that, if the case were re-litigated in the light of ­Original Ramsay, the Revenue would have fared any better so far as assessments on Mr Higgs (or, for that matter, on both Mr and Mrs Higgs) and on the trustees were concerned. If, as seems likely, a composite transaction were identified, it would surely be one under which the Higgs companies reaped the profits even though they ended up in the hands of the trustees. That appears to be the correct analysis in real world terms. After all, the initial prospect was that the land belonged to the companies and, if it were developed, the profits would be taxable in the hands of the companies; the scheme was designed to prevent that prospect being realised; the consequence of any conclusion that the scheme fell

122 Ransom v Higgs [1973] 1 WLR 1180, 1186. 123 Ransom v Higgs, above n 118, per Lord Wilberforce at 1613, per Lord Simon at 1619–20, and per Lord Cross of Chelsea at 1621. Lord Wilberforce, at 1613, remarked that if ‘organisation’ were a principle of taxation, that would imperil ‘many estimable ladies throughout the country’. 124 ibid 1619. Incidentally this was the case in which Lord Simon said: ‘It may seem hard that a cunningly advised taxpayer should be able to avoid what appears to be his equitable share of the general fiscal burden and cast it on the shoulders of his fellow citizens. But for the courts to try to stretch the law to meet hard cases (whether the hardship appears to bear on the individual taxpayer or on the general body of taxpayers as represented by the Inland Revenue) is not merely to make bad law but to run the risk of subverting the rule of law itself. Disagreeable as it may seem that some taxpayers should escape what might appear to be their fair share of the general burden of national expenditure, it would be far more disagreeable to substitute the rule of caprice for that of law’: ibid 1616–17.

270  Philip Ridd foul of Ramsay would surely be that the transmutation into capital did not work and the diversion of the profit to the trustees did not bear on the reality that the companies were realising the benefits of development of their land. Nor would Modern Ramsay have sensibly assisted the Revenue’s pursuit of Mr Higgs and of the trustees. Even with the benefit of Ramsay, the Revenue would still have been barking up wrong trees. A good many of the earlier pre-Ramsay cases, especially in the inter-war period, concerned tax avoidance by means of transfers of assets abroad. For present purposes one only of those cases will be discussed in detail, though a second one will be mentioned. The case for discussion is Admiral Earl Beatty’s Executors v Inland Revenue Commissioners.125 This case comprised three cases, the second and third of which were identical to each other. In the first the taxpayers were the executors of Admiral Earl Beatty, and the taxpayers in the other two cases were his two sons. The family was especially wealthy by reason of Admiral Earl Beatty having married the daughter of the founder of a Chicago department store. She died on 17 July 1932 and Admiral Earl Beatty died on 10 March 1936. Meanwhile events had taken place to avoid surtax liabilities. These involved four private companies incorporated in the Prince Edward Island province of Canada in 1933: they may, for short, be called Pilgrim, Dingley Dell, Dauntless and Bluejacket. The first case concerned Pilgrim and Dingley Dell, the structures of which were identical. Subject to the limited rights attached to ‘A’ shares, to which attention need not be paid, the holders of the ‘B’ shares were entitled to the profits and assets of the company. The ‘B’ shares in Pilgrim were issued in June 1933 to Montreal Trust Company as nominee for Admiral Earl Beatty who paid for them at their par value, $900. Correspondingly, in February 1934, the two sons acquired, equally, the ‘B’ shares in Dingley Dell. In June 1933 Admiral Earl Beatty sold assets to Pilgrim for $675,000, the price to be satisfied by the issue of debentures redeemable in blocks over 19 years and, by a separate disposition, the debentures were to be held by Montreal Trust Company in trust for Admiral Earl Beatty for life with remainder to his two sons. The circumstances in relation to Dingley Dell started with a sale in February 1934 for $465,000, but were otherwise much the same. All three cases concerned surtax assessments raised in reliance on Finance Act 1936, section 18, which was designed to counteract tax avoidance by the transfer of assets abroad. The issue in the first case was whether Admiral Earl Beatty, up to his death, had had power to enjoy the income of Pilgrim and of Dingley Dell. The executors argued that Admiral Earl Beatty was merely getting back capital, but the wording of section 18 was held to justify the assessment concerned.



125 Admiral

Earl Beatty’s Executors v Inland Revenue Commissioners (1940) 23 TC 574.

Through Ramsay Spectacles  271 The second and third cases arose from two deeds of gift made in 1937 after Admiral Lord Beatty had died and the remainders in favour of the sons had taken effect. The circumstances in relation to Dauntless and Bluejacket were similar to those relating to Pilgrim and Dingley Dell. Immediately prior to the deeds of gift the ‘B’ shares and outstanding debentures in Dauntless were beneficially owned by the younger son and, correspondingly, the ‘B’ shares and outstanding debentures in Bluejacket were beneficially owned by the elder son. The deeds of gift reversed that position. The idea was to disengage section 18, but the gifts were held by Lawrence J to be associated operations within the meaning of that term in section 18.126 It is impossible to relate Ramsay to the circumstances of the case because, understandably, consideration was not given to questions as to matters of pre-planning. Even if the earlier events had been pre-planned, it is extremely doubtful whether the 1937 gifts were pre-planned as things which would be done once Admiral Lord Beatty had died. The case does, however, demonstrate how arrangements of this broad nature might have fallen foul of Original Ramsay. Another point of interest lies in the legislative technique of preventing circumvention by means of associated operations.127 If it be assumed that the idea behind the gifts was generated only after Admiral Lord Beatty’s death, then it would follow that the scope of ‘associated operations’ is, plainly, much wider than the scope of Ramsay. Lawrence J reached his decision without any discussion of the concept of ‘associated operations’ and there does not seem to have been any such discussion in any of the Ramsay line of cases. Lawrence J’s decision was endorsed in Lord Howard de Walden v Inland Revenue Commissioners.128 This was another case involving section 18 and Canadian companies. It is memorable for the remarks in the judgment of the court delivered by Lord Greene MR about ‘burnt fingers’ in the passage which read: The section is a penal one, and its consequences, whatever they may be, are intended to be an effective deterrent which will put a stop to practices which the legislature considers to be against the public interest. For years a battle of manoeuvre has been waged between the legislature and those who are minded to throw the burden of taxation off their own shoulders on to those of their fellow subjects. In that battle the legislature has often been worsted by the skill, determination and resourcefulness of its opponents of whom the present appellant has not been the least successful. It would not shock us in the least to find that the legislature has determined to put an

126 Section 18(2) read: ‘For the purposes, of this section an associated operation means, in relation to any transfer, an operation of any kind effected by any person in relation to any of the assets transferred or any assets representing, whether directly or indirectly, any of the assets transferred, or to the income arising from any such assets, or to any assets representing, whether directly or indirectly, the accumulations of income arising from any such assets.’ 127 Compare, amongst others, Inheritance Tax Act 1984, s 268. 128 Lord Howard de Walden v Inland Revenue Commissioners [1942] 1 KB 389.

272  Philip Ridd end to the struggle by imposing the severest of penalties. It scarcely lies in the mouth of the taxpayer who plays with fire to complain of burnt fingers.129

In 1964 Lord Devlin retired at the age of 58. The reasons for that may have been many and varied, but one often mentioned was that he did not care for revenue cases, a staple of the House of Lords’ diet.130 In subsequent years Lord Devlin may, when contemplating the succession of dividend-stripping cases with which the House of Lords had to deal, have been fortified in his decision to retire. In fact one such case, Griffiths v JP Harrison (Watford) Ltd131 had already occurred and, while Lord Devlin was not on the panel, he would have been aware of it. The intervention of Parliament132 did not halt the flow of old cases. In Finsbury Securities Ltd v Inland Revenue Commissioners133 Lord Denning  MR, albeit in a dissenting judgment, gave a useful explanation of ­dividend ­stripping as follows: This is yet another case about dividend stripping, but of a new kind. It is forwardstripping as distinct from backward-stripping … The essence of backward-stripping is that a dealer in shares buys shares in a company which has accumulated large profits and has paid tax on those profits. It is in a position to declare a dividend, after deduction of tax. The price is high because of the dividend soon to be distributed. The dealer pays the price and receives the dividend. In consequence the value of the shares falls at once by a large amount. He re-sells (or holds till the end of the year). The dealer then makes out his accounts for income tax purposes. These accounts omit all reference to the dividend received. (This practice is sanctioned by law: see F.S. Securities Ltd v Inland Revenue Commissioners [1965] AC 631] The accounts show simply the shares bought at a high price, and re-sold (or re-valued) at a low price. So they show a large loss on the purchase and sale of the shares. The dealer claims tax-repayment on this loss; and succeeds. He gets back into his own hands all the tax which the company paid. It is all sheer gain to him. No tax on it. No surtax. The only loser is the revenue, or rather the other taxpayers. Now in forward-stripping the dealer buys shares in a company which hopes to make in the future large profits out of which it will be asked to declare a dividend, after deduction of tax. The dealer agrees to pay a lump sum price to cover the anticipated amount of dividends in the next few years. It may be five years, three years, or only one year. He keeps the shares and receives the dividends each year as they are declared. The value of the shares drops each year as and when the dividends are received. Then each year he makes out his accounts for income tax purposes. These omit all reference to the dividends received. So the accounts show a loss each year as the shares are revalued. The dealer claims tax-repayment on this loss. Can he succeed? I should add that if the dividends should not reach the anticipated figure, the original price is reduced to meet the deficiency. So the dealer in the long run only pays the amount of 129 ibid 397. 130 See, for example the obituary in The Independent, 10 August 1992, but contrast the obituary in The Times, 11 August 1992. 131 Griffiths v JP Harrison (Watford) Ltd [1963] AC 1. 132 By FA 1960 s 28. 133 Finsbury Securities Ltd v Inland Revenue Commissioners [1965] 1 WLR 1206.

Through Ramsay Spectacles  273 the dividends. The price equals the amount of the dividends received. But he gets the whole of the tax-repayment (if permitted) free of any tax at all. It is plain that in all these dividend-stripping cases the so-called ‘loss’ sustained by the dealer is an artificial loss. He sustains no loss in fact on his outlay because he gets it all back in dividends. But there is a strange rule of income tax law which enables him in his accounts to ignore the dividends he receives. He takes advantage of this rule so as to show a fictitious loss. All he does is to make artificial book entries: and this enables him to claim hard cash from the revenue. Thousands and thousands of pounds of it. He says it is all part of his trade. If so, it is a most discreditable part. I feel, for my part, that the courts should do nothing to encourage it. Encourage it they do if they allow this palpable device to succeed. Repayment should only be permitted if there is genuine loss in a genuine trading transaction. It should not be permitted when it is a device to outwit the revenue.134

As the last part of this passage makes clear, the major issue was whether or not the dealer was engaged, in relation to the relevant transactions, in trading. In Harrison the taxpayer company succeeded in a 3-2 decision in the House of Lords but, in retrospect, it may be seen that that decision flattered to deceive. In subsequent cases reliance on Harrison was unsuccessful. Some Law Lords chose to distinguish it, while others expressed the view that it was wrongly decided. For present purposes it is necessary to refer only to Lupton v FA and AB Ltd.135 Lord Morris of Borth-y-Gest and Lord Guest, members of the majority in Harrison, distinguished that case.136 Viscount Dilhorne and Lord ­Donovan thought it wrong,137 but Lord Simon, who considered it ‘a very narrow decision’138 did not go so far. Viscount Dilhorne said that the relevant transaction was to be viewed as a whole, explaining that this meant that ‘regard must be had not only to the inception of the transaction, to the arrangements made initially, but also to the manner of its implementation’.139 Lord Donovan said ‘this is not trading in stocks and shares. If I am asked what it is, I would reply that it is the planning and execution of a raid on the Treasury using the technicalities of revenue law and company law as the necessary weapons’.140 Lord Simon, concentrating on the paramount object of the transaction said ‘It is plainly a joint venture of the appellants and the vendors of the shares, by taking advantage of quirks of revenue and company law, to obtain money out of the public purse and share it between them.’141



134 ibid

1216–17. v FA and AB Ltd [1972] AC 634. 136 ibid, 644–47, and 650 respectively. 137 ibid, 656–57, and 658 respectively. 138 ibid, 659. 139 ibid, 657. 140 ibid. 141 ibid, 660–61. 135 Lupton

274  Philip Ridd Modern Ramsay, in relation to purposive interpretation of statutes, would have had no application because trading was not the subject of a statutory definition. Original Ramsay might perhaps have given the Revenue case in Harrison a fillip, but in the later cases reality was grasped in a manner not dissimilar to the approach in Ramsay. One thing which is clear is that there will be circumstances involving tax avoidance in which Ramsay, whether Original Ramsay or Modern Ramsay, will have no possible application. An example would be Newstead v Frost.142 The function of the scheme involved in that case was to park in the Bahamas a considerable portion of the earnings of David Frost who made his name as a television presenter. This was done by a partnership, formed in 1967, between David Frost and a Bahamian company, the share capital in which had been bought by a charitable trust out of a donation by a friend. The business of the firm was, to put it simply, to exploit David Frost’s talents. In effect the firm was a Bahamian moneybox for a good deal of David Frost’s earnings and UK tax would be avoided except in so far as any of the money was remitted to the UK, in which event Case V of Schedule D would be engaged. There were other factual complications, some of which were designed to avoid US tax. The Revenue advanced various technical arguments to defeat the scheme, but they failed at all levels. It may be said, without elaboration, that neither Original Ramsay nor Modern Ramsay would have availed the Revenue. Another example of successful tax avoidance is ceasing to be resident in the United Kingdom. An example is Reed (HMIT) v Clark143 in which Dave Clark, leader of the 1960s pop group, The Dave Clark Five, lived in the United States from 3 April 1978 to 2 May 1979 and did not set foot in the United Kingdom during that period and, by so doing, avoided tax on a receipt of $450,000.144 Moreover, as a general proposition it is to be remembered that a tax avoidance motive is not fatal in the context of commercial transactions. As Lord Templeman observed in Ensign,145 adverting to Reed v Nova Securities Ltd:146 ‘There was a tax avoidance motive in both transactions. This did not prevent the taxpayer from claiming and proving that the book debts had been acquired and disposed of as trading stock.’147 The cases which have been considered are, of course, only a few of the vast number of tax avoidance cases of the past. In general those cases did not involve flurries of activity designed to transmogrify what was really happening into something with happier tax consequences or even to plunge into the realm 142 Newstead v Frost [1980] 1 WLR 135. 143 Reed v Clark [1986] Ch 1. Dave Clark followed in the footsteps of other eminent folk from the arts world: Sir Terence Rattigan went to live in Bermuda; Sir Noel Coward also lived in Bermuda, but later in Jamaica. 144 It also escaped US tax as it was received before 1 January 1978 – in fact, on 19 December 1977. 145 Ensign, above n 38. 146 Reed v Nova Securities Ltd [1985] 1 WLR 193. 147 Ensign, above n 38, 679.

Through Ramsay Spectacles  275 of complete artificiality. It was the development of the ‘new and sophisticated legal devices’ to which Lord Wilberforce referred in Ramsay148 which sparked a revised approach. Leaving aside tax avoidance cases, purposive interpretation, if it had been introduced earlier, might well have had quite an impact in tax cases, but that is beyond the scope of this chapter. CONCLUSION

The Ramsay series of cases thus presents a strange history. No doubt there are many reasons for that, but one prominent reason is that from the outset there have been fundamental misunderstandings and confusions. One thing which has been inadequately recognised is that the crucial issue in Ramsay was whether regard could be had to the outcome of the scheme although the parties were not contractually bound to carry it out from its beginning to its end; in the companion case, Eilbeck v Rawling, there was such a contractual commitment and it was conceded that regard could therefore be had to the outcome of the scheme; as the circumstances in Ramsay presented no real possibility that the scheme would not be carried out from beginning to end, the taxpayer company’s position was weak in having to rely on the mere fact that the parties had not, as it were, signed on the dotted line. Another thing which has been inadequately recognised is that the outcome in Ramsay was a conclusion that, as the scheme transactions were self-cancelling, nothing had happened, so there was nothing to which the statutory provisions might have applied:149 Ramsay was, in this respect, a highly unusual case. It follows that there was no justification for concerns that the Law Lords had gone beyond their brief. A choice had had to be made between the fact that each of the transactions had taken place and the fact that their outcome was a nullity; as the former would have had the effect that transactions, intended to be interdependent, and in fact interdependent, would have been treated as independent, it scarcely seems surprising, let alone revolutionary, that the latter secured the vote. But obiter remarks in Burmah and the reasoning in Furniss v Dawson amounted to the lighting of the blue touch-paper. The process of rethinking ran into obstacles. It was not assisted by Ramsay being designated (in Craven v White) as a principle of statutory construction, given that it was about statutory non-application. It was also not assisted by a failure to recognise that the reasoning in Furniss v Dawson was untenable. Yet another problem was the confusion caused by Lord Hoffmann’s baffling distinction (in Westmoreland) between legal and commercial concepts. There have

148 Ramsay, above n 1, 326. 149 Lord Wilberforce used the word ‘nullity’: see ‘We are asked, in fact, to treat [the scheme] as fiscally, a nullity, not producing either a gain or a loss’ – ibid 323.

276  Philip Ridd been many imperfections in the analyses in the course of subsequent cases. But, as has, it is hoped, been demonstrated, a safe haven has been reached. The fluidity of law is represented by changing legislation and in court decisions by which legislation is interpreted and advances, or retreats, and by development of the common law. Ground-breaking court decisions may be made at any level: for a High Court example, consider the doctrine of promissory estoppel adopted by Denning J in Central London Property Trust Ltd v High Trees House Ltd.150 The vast majority of ground-breaking decisions are, however, made at the highest level, now the Supreme Court. But they are not immutable, as they may be overruled, whether sooner or later. An example of swift reconsideration may be taken from the criminal law in relation to attempt: the decision in Anderton v Ryan151 was overruled just over a year later in R v Shivpuri.152 More often it takes a little while for error to be recognised; in Revenue law Congreve v Inland Revenue Commissioners153 and Bambridge v  Inland Revenue Commissioners154 were overruled many years later in Vestey v Inland Revenue Commissioners;155 and in criminal law, relating to joint enterprise, R  v Powell and English156 was departed from some 18 years later in R v Jogee.157 Sometimes development of a major change may be regretted and a process of confinement follows: consider, for example, the law of negligence. Sometimes a development provokes great controversy, but a reverse is ruled out: consider the Hansard ruling in Pepper v Hart.158 Where, in all this, does Ramsay stand? Like the Hansard ruling just mentioned, it was controversial but has survived. Why? It is important to recognise, however trite the point may be, that legal principles are not debated in a vacuum and each case has to have an outcome. Tax avoidance practitioners had moved into the business of creating schemes which made a mockery of the tax system, and it was at least arguable that their efforts were assisted by a confined approach on the part of the judiciary. A decision in favour of the taxpayer company in Ramsay would have been grotesque. Lord Wilberforce was careful to say that acceptance of the Revenue’s radical argument would ‘not introduce a new p ­ rinciple: it would be to apply to new and sophisticated legal

150 Central London Property Trust Ltd v High Trees House Ltd [1947] KB 130. 151 Anderton v Ryan [1985] AC 560. 152 R v Shivpuri [1987] AC 1. The earlier decision had been heavily criticised by Professor G ­ lanville Williams in an article entitled ‘The Lords and Impossible Attempts, or Quis Custodiet Ipsos Custodes?’ at [1986] CLJ 33, which Lord Bridge noted to have been in language ‘not conspicuous for its moderation’ – R v Shivpuri [1987] AC 1, 23. 153 Congreve v Inland Revenue Commissioners [1948] 1 All ER 948. 154 Bambridge v Inland Revenue Commissioners [1954] 1 WLR 1460. 155 Vestey v Inland Revenue Commissioners [1980] AC 1148. 156 R v Powell and English [1999] 1 AC 1. 157 R v Jogee [2017] AC 387. 158 Pepper v Hart, above n 65, but the need for caution was stressed by Lord Nicholls in R v S­ ecretary of State for the Environment, Transport and the Regions, ex parte Spath Holme Ltd [2001] 2 AC 349, 399.

Through Ramsay Spectacles  277 devices the undoubted power and duty of the courts to determine their nature in law and to relate them to existing legislation’.159 In that way he was denying the assertion by counsel for the taxpayer company that the Revenue’s approach was ‘revolutionary’.160 It is, therefore, not surprising that, despite the disturbed rumblings which followed, there was no serious assertion that Ramsay should be overruled. In the final analysis Ramsay was a good, and well reasoned, decision and the introduction of purposive interpretation is also to be welcomed as it is better adapted to the task of ascertaining the intention of Parliament. Modern Ramsay also has a pleasing simplicity, although that does not discourage extensive re-examinations of the history, such as that in the judgment of Patten LJ in Chappell v Revenue and Customs Commissioners.161 But a more verbally economic analysis is sometimes achieved.162 One matter which is of great importance and may require stress in future cases is the proposition that Ramsay ‘did not introduce a new doctrine operating within the special field of revenue statutes’,163 so the scope for application of Modern Ramsay seems to be ­unlimited. It is a matter of regret that this study has had, for space reasons, to be so confined that little attention has been given to the extensive academic literature on Ramsay,164 and it is also to be regretted that the reaction to Ramsay in other countries has not been covered. Perhaps a further study beckons. By way of final comment, it is an irony that, although the reasoning in the post-Ramsay cases was anything but consistent and sustainable, it may well be that the correct result was reached in each case.

159 Ramsay, above n 1, 326. 160 ibid 323. 161 Chappell v Revenue and Customs Commissioners [2017] 1 WLR 2701, [27]–[37], comprising some 3,400 words. 162 For an example see RFC 2012 plc (formerly the Rangers Football Club plc) v Advocate General for Scotland [2017] 1 WLR 2767, [12]–[14]. 163 See above n 84. 164 Recent examples are J Snape, ‘WT Ramsay v Commissioners of Inland Revenue (1981): Ancient Values, Modern Problems’ and J Vella, ‘Barclays Mercantile Business Finance v Mawson (2004): Living With Uncertainty’ in Snape and de Cogan, above n 66. Dr John Vella’s study of BMBF included tributes to the late Professor John Tiley whose memory is fondly cherished by all who had the privilege to know him.

278

10 Lloyd George’s Land Values Duties JOHN HN PEARCE

ABSTRACT

This chapter investigates the history of the three land values duties – ­undeveloped land duty, increment value duty and reversion duty – which were imposed in 1910 when the proposals contained in Lloyd George’s 1909 Budget were finally enacted. That history is viewed in terms of the relative strengths of three different stakeholders: the advocates of taxes on land values; David Lloyd George, the Chancellor of the Exchequer in the years before the First World War; and the Inland Revenue. In the years before the First World War, the stakeholders who wished the duties to exist were in the ascendant; but, after the First World War, that ceased to be the case and the three land values duties were abolished. INTRODUCTION

T

he background to the imposition of Lloyd George’s land values duties was one of high political drama. In 1909, there was a constitutional crisis when the House of Lords rejected the proposals contained in Lloyd George’s Budget; and the vehement opposition to that Budget most certainly included opposition to its proposals to introduce duties on land values. Legislation to give effect to Lloyd George’s Budget proposals finally reached the statute book in the following year; and the Finance (1909–10) Act 19101 (‘the 1910 Act’), in Part I of that Act, made provision for taxes on land to be imposed.2 In 1920, however, the ‘land values duties’ (defined as undeveloped land duty, increment value duty and reversion duty – but not mineral rights duty) were abolished; and provision was made for the exceedingly small sums

1 10 Edw 7 c 8. 2 Those taxes were increment value duty, reversion duty, undeveloped land duty and mineral rights duty. Of those taxes, after 1920, only mineral rights duty remained.

280  John HN Pearce collected under them to be repaid.3 The mountains had brought forth a returnable mouse. In any investigation of the brief and inglorious careers of those three land value duties, it soon becomes apparent that important roles were played by three different stakeholders: the advocates of taxes on land values; David Lloyd George, the Chancellor of the Exchequer in the years before the First World War; and the Inland Revenue. Each of those stakeholders had objectives and preoccupations which made remarkably little contact with those of the others; and the introduction, continuation and abolition of the land values duties may be viewed in terms of their relative strengths. SUPPORT FOR THE TAXATION OF LAND VALUES

By the first years of the twentieth century, those who advocated the introduction of taxes on land values presented their arguments against the background of significant writings on this subject. During the nineteenth century, economists had advanced the propositions that the population of a state might be expected to increase; that the prosperity of a state might be expected to increase; but that the land within a state might be expected to remain constant. It followed, accordingly, that the value of land could be expected to increase, whether or not the owner expended capital, labour or skill upon it. In other words, and to deploy a term invented by John Stuart Mill, the owner of the land had the benefit of an ‘unearned increment’.4 Once this line of argument was accepted, it was not particularly difficult to take a further step, and to argue that the ‘unearned increment’ was an item that might legitimately be taxed. By the end of the nineteenth century, however, the taxation of land values was a subject dominated by the views of the American author Henry George, whose work, Progress and Poverty, first appeared in 1879.5 In that work, Henry George started from the proposition that the nineteenth century had seen remarkable economic progress – but that poverty nevertheless persisted. His solution to this paradox was this: The reason why, in spite of the increase of productive power, wages constantly tend to a minimum which will give but a bare living, is that, with increase in productive 3 By the Finance Act 1920 (10 & 11 Geo 5 c 18). See Pt VI, s 57 of that Act. The expression ‘land values duties’ was defined in s 57(6). For the net receipts from the three land values duties see the table in the text following n 108 below. 4 This paragraph relies, very heavily, on H Higgs (ed), Palgrave’s Dictionary of Political Economy, new edn, vol 2 (London, Macmillan, 1925) 381–82. The article on ‘Increment, The Unearned’ begins by stating that ‘Although the germ of the idea may be traced in the Wealth of Nations, and is distinctly seen in Ricardo’s Principles, the term “unearned increment” was first invented by J.S. Mill. By “unearned increment” is meant that increase in the value of anything subject to a natural monopoly which is due not to the expenditure of capital, labour, or skill by the proprietor, but to the general progress of society resulting in an increased demand for that thing.’ (ibid.) 5 This work was first published in the United States. In this chapter, citations are from an early English edition (London, Kegan Paul, 1883).

Lloyd George’s Land Values Duties  281 power, rent tends to even greater increase, thus producing a constant tendency to the forcing down of wages. … In all our long investigation we have been advancing to this simple truth: That as land is necessary to the exertion of labour in the production of wealth, to command the land which is necessary to labour, is to command all the fruits of labour save enough to enable labour to exist.6

What was to be done? Henry George’s answer was that there should be major changes in landownership; and he argued that no man had a better right than any other to a parcel of land. Land should be available to all. A person who sought exclusive possession of land should compensate the community for this monopoly by paying a yearly land value tax. This tax should discount the value of any improvements made by human agency and equal the total annual value of the land itself. This single tax should be on the site value of the land, replacing all other taxation and forcing proprietors to put it to its full use, or to sell it to those willing to improve it. This, he hoped, would lead to a lifting of the tax burden on the poor, the restoration of small peasant proprietorship, and result in the break-up of the great aristocratic estates in the British Isles. If landowners were forced to be more productive by a single tax on land values, and the poor could be resettled on the land, the glut on the labour market in cities might be reduced, and the value of wages increased. The single tax thus acted as a possible redress for the problems of both town and countryside.7 Henry George’s work Progress and Poverty, therefore, combined economic analysis with a programme for political action. However, even the most cursory examination of this work also prompts a further reflection: for the text has a quality for which adjectives such as biblical, evangelical, revivalist and apocalyptic are appropriate.8 The movement inaugurated by Henry George, it has been said, encompassed ‘an economic critique, [and] elements of sect, with characteristics of a mass political agitation’; and the same author has noted that this movement ‘is not easily compressed within traditional explanatory categories like parties or movements’.9 Henry George’s work was influential. ‘Without exaggeration, it may be described as one of the dozen most influential books written in the nineteenth century’.10 One of those on whom Henry George had an impact was Philip Snowden, the Chancellor of the Exchequer in the Labour governments between

6 H George, Progress and Poverty, above n 5, 199, 208–09. 7 This paragraph relies, very heavily, on R Douglas, ‘God gave the land to the people’ in AJA Morris (ed), Edwardian Radicalism (London, Routledge & Kegan Paul, 1974) 149 and A Taylor, Lords of Misrule (Basingstoke, Palgrave Macmillan, 2004) 47. 8 ‘There was a strong revivalist quality to Georgeite meetings noted by both his admirers and detractors alike. … This tied in strongly with George’s own concept of Progress and Poverty as a social gospel presented in religious terms and revealed to him through divine intervention’. (Taylor, above n 7, 55.) 9 Taylor, above n 7, 50. 10 Douglas, above n 7, 149.

282  John HN Pearce the wars, who wrote that ‘No book ever written on the social problem made so many converts. Economic facts and theories have never been presented in such an attractive way’.11 Another MP who was influenced by Henry George was the radical, Josiah Wedgwood, who stated in his autobiography, written towards the end of his life, that: Henry George gave me those sure convictions on free trade and the taxation of land values which have been at once my anchorage and my object in politics. Even before I reached Parliament I had become a pamphleteer, a propagandist and a m ­ issionary. Even to-day my audiences can never know whether I am expounding my own arguments or using sentence by sentence the words of Henry George. From those magnificent periods, unsurpassed in the whole of British literature, I acquired the gift of tongues. Ever since 1905 I have known ‘that there was a man from God, and his name was Henry George.’ I had no need thenceforth for any other faith.12

The views held by those who advocated the taxation of land values nevertheless differed considerably during the early years of the twentieth century;13 but one of the leading advocates of the taxation of land values, James Dundas White, described ‘the policy known as the Taxation of Land Values’ in a memorandum submitted to a House of Commons Select Committee in 1919 by saying that: This policy is founded on the principles that the land which Nature has provided ought to be treated as common property; that when it is in private hands those who hold it should pay to the people a rent or tax for it; that this rent or tax should be based on the true market value of the land apart from the improvements; that it should be payable whether the land is being used or not; that buildings and other improvements should be tax free; and that taxation along these lines should be substituted for the present taxation of landed property. The application of this policy would enforce the rights of the people to the land, would secure to them the value that attaches to the land owing to their presence and demand for it, would prevent withholding of

11 Philip Snowden, An Autobiography, vol 1 (London, Ivor Nicholson and Watson Ltd, 1934) 49. As late as the summer of 1931, Snowden told the House of Commons that ‘The land was given by the Creator, not for the use of dukes, but for the equal use of all His People … By this measure we assert the right of a community to the ownership of land. If private individuals continue to possess a nominal claim to the land, they must pay a rent to the community.’ C Cross, Philip Snowden, (London, Barrie and Rockliff, 1966) 272. 12 Josiah C Wedgwood, Memoirs of a Fighting Life (London, Hutchinson, 1940) 60. 13 One work states that ‘Contemporaries themselves distinguished between three categories of land-value taxation advocates. First, those who simply wanted to make all land accessible, and to divert some of its proceeds into public hands, but had no intention of ending private property. This was more or less the view of the Land Law Reform Association. Secondly, the single-taxers like Wedgwood who wanted to tax all private landlords out of existence. Thirdly, the land nationalisers, who wanted to abolish all private property in land, and who favoured site-value taxation because it was a means of arriving at a fair basis upon which the actual transfer of the land to public ownership might be safely (and profitably) effected. The nationalisers thought it impossible to tax private landlords out of existence, pointing out that such taxation, if intended to first break up the big estates, must also increase the number of landowners, and hence the opposition to further taxation would also increase.’ (HV Emy, Liberals, Radicals and Social Politics 1892–1914 (CUP 1973) 209.)

Lloyd George’s Land Values Duties  283 land from use, would make more land available on fair terms, and would give free course to its development.14

Those who advocated the taxation of land values also held differing views about the effectiveness and implications of such taxation. There was no consensus about the revenue that taxing site-values would produce; and much liberal thinking on this subject has been described as ‘more optimistic than informed’. One writer guessed at a figure of £200 million; but otherwise ‘figures were few’.15 There was no consensus, either, about the rate at which land taxation should be imposed or about the impact of such taxation on other existing taxes. At one end of the spectrum there were those who ‘calculated that an annual tax on land values, eventually to be raised to 100 per cent, would be enough to meet all demands of state expenditure. All other taxes, both direct and indirect, could then abate in favour of a “Single Tax” on land values’.16 At the other end of the spectrum there were those who considered that land value taxation, at a low rate, would be a useful addition to existing taxation. As a matter of first impression it might be thought that land value taxation would benefit labour and not capital; but the position was more complicated than this. The advocates of land value taxation were quite clear that those who suffered under a system of rents included not only poor wage-earners, obliged to pay rent on their inadequate housing, but also industrialists, obliged to pay rent on their factories. The contrast drawn was between the productive elements of society on the one hand and the unproductive elements on the other. The latter could then be denounced as rentiers and plutocrats. This contrast between the productive and unproductive elements of society had political implications. The Conservative Party respected property in general and landed property in particular: the Liberal Party, by contrast, was characterised by an antipathy to privilege. A policy of taxing land values, furthermore, appeared capable of being popular with two important sections of society whose support the Liberal Party was keen to obtain and retain: labour, and the business and professional classes. Against this background, it is not surprising to find that Asquith, early in 1904, was recorded as saying that he believed that ‘there was lying untaxed a large reservoir from which … a substantial contribution might be made to fertilize the country at large, and that was the taxation of land’.17 In the case of David Lloyd George, the taxation of land values was a long-cherished idea and genuine personal commitment expressed as far back

14 Report from the Select Committee on Land Values (Cmd 556, 1920) 94. James Dundas White (1861–1951) was a Liberal MP from 1906 to 1910 and from 1911 to 1918. He published the last of many works on land value reform in 1948. 15 Emy, above n 13, 206–07. 16 Douglas, above n 7, 150. 17 Quoted in HCG Matthew, The Liberal Imperialists (Oxford, OUP, 1973) 256.

284  John HN Pearce as 1891 in a speech in Bangor.18 In the General Election of 1906, 52 per cent of Liberal candidates in England mentioned the taxation of land values in their election manifestos.19 When, after that General Election, a Land Values Parliamentary Campaign Committee was formed, 280 MPs had joined before Easter 1906.20 The Liberal government that won the decisive victory in the general election of 1906, therefore, had a body of MPs that favoured the taxation of land values among its supporters and a government that was sympathetic (as opposed to unsympathetic) to the demand that land values should be taxed. The prospects for the enactment of legislation imposing taxes on land values appeared good. THE IMPOSITION OF THE LAND VALUES DUTIES: 1906 TO 1910

The years from 1906 to 1908 nevertheless saw no progress in imposing taxation on land values. There was widespread agreement that, if land values were to be taxed, the way to proceed was to enact legislation providing for land to be valued; to value that land; and then to impose taxation upon the land as so valued. The King’s speech on 12 February 1907 contained the statement that Bills would be introduced to deal with the holding and valuation of land in Scotland;21 and Campbell-Bannerman, the Prime Minister, described the proposed land valuation of Scotland as ‘an indispensable preliminary step’ for the government’s programme.22 The Land Values (Scotland) Bill was passed by the Commons in 1907; but was then refused a Second Reading in the Lords. The same Bill was reintroduced in 1908; but was subjected to a wrecking amendment in the Lords: and, once again, no statute was enacted. In 1908, furthermore, the King’s speech had included, for the first time, the promise of land valuation for England; and, on 12 May 1908, Asquith gave a definite promise that a Valuation Bill would be produced23 – but no such Bill appeared. The advocates of taxes on land values nevertheless continued their activities. By the end of 1906, about 400 MPs had petitioned Campbell-Bannerman for the introduction of land values taxation;24 and, in 1908, the continued nonappearance of a Bill providing for land valuation in England led to another memorandum being presented on 24 November. This memorandum had 250 signatures, reminding Asquith of his promise.25 18 B Short, Land and Society in Edwardian Britain (Cambridge, CUP, 1997) 23. 19 AK Russell, Liberal Landslide: The General Election of 1906 (Newton Abbot, David & Charles, 1973) 65. 20 Emy, above n 13, 209. 21 HC Deb 12 February 1907, vol 169, col 6. 22 R Douglas, Land, People & Politics: A History of the Land Question in the United Kingdom 1878–1952 (London, Allison & Busby, 1976) 141. 23 Emy, above n 13, 210. 24 Douglas, above n 22, 142. 25 Emy, above n 13, 210.

Lloyd George’s Land Values Duties  285 It had become clear, by the end of 1908, as a result of actions taken in the House of Lords, that, if taxes on land values were to be imposed, this could not be done by providing, in a first statute, for a valuation of land in the United Kingdom, and then, later, by imposing taxation, in a second statute, on that land as so valued. However, if it was not possible to enact a Valuation Bill, it might nevertheless be possible to make progress by placing provisions for the valuation of land in the annual Finance Bill – a Bill which (it was believed) the House of Lords would not touch. ‘Failing a new Valuation Act, it is possible to secure taxation from site values by means of annual Finance Bills.’26 By the end of 1908, it had also become clear, for a variety of reasons in which both financial and political considerations were mixed, that the 1909 Budget would be of very great significance when considering the Liberal government’s competence and ability. The Chancellor of the Exchequer, David Lloyd George, accordingly, became a figure of great significance. The mixture of financial and political considerations included (on the financial side) the fact that the government needed additional funds; and that taxation would have to be increased. Funds were needed for armaments (and, in particular, to take account of the expansion of the German navy); and because the government’s policies of social reform, which it hoped would satisfy the demands of labour, were proving more expensive than had been initially believed. As Lloyd George put the matter in the House of Commons on 29 June 1908, in remarks that did not please Treasury officials: I have no nest eggs at all. I have got to rob somebody’s hen roost next year. I am on the look-out which will be the easiest to get and where I shall be least punished, and where I shall get the most eggs, and, not only that, but where they can be most easily spared, which is another important qualification.27

The government was also subject to constraints as to the way additional revenue could be raised. The Liberal government was firmly opposed to the Conservative policy of raising revenue from tariffs (and accordingly by indirect taxation); and was accordingly committed to the proposition that its expensive policies could be financed while free trade continued – a proposition that pointed in practice towards the raising of additional finance through direct taxation rather than indirect taxation. The government, furthermore, wanted to raise additional finance in a manner that did not alienate those sections of society voting Liberal at general elections. Any redistribution of income ‘was not to be at the expense of the small business, professional and lower middle classes; on the contrary, these classes were to be protected and reassured’.28 On the other hand, the

26 TNA file IR 73/2. ‘The Budget and site values’. Copy of memorandum by Sir Robert Chalmers. Other entries in this piece give the date of this document as 27 October 1908. 27 HC Deb 29 June 1908, vol 191, cols 395–96. BK Murray, The People’s Budget 1909/10: Lloyd George and Liberal Politics (Oxford, OUP, 1980) 86. 28 Murray, above n 27, 36.

286  John HN Pearce government could aim to increase the taxation of unearned incomes – and to attack rents received by landlords. As far as political considerations were concerned, the government had lost popularity. Lloyd George’s ‘overall political goal in the Budget was to restore the Government’s credibility and, as he had put it to his brother when he took over as Chancellor, to “stop the electoral rot”.’29 The government needed initiatives that would appeal to its own supporters and to the electorate. The introduction of taxes on land values would constitute one such initiative. It would be welcomed by one important body of opinion within the Liberal Party; it would also provide an opportunity, in the Finance Bill to enact legislation that would circumvent vetoes by the House of Lords on Bills sent to that House. Both financial and political considerations, therefore, ‘encouraged Lloyd George to produce a Budget that would at one and the same time prove the resources of free trade finance, provide a fund for advanced social reform, and offer a way round the veto of the Lords on the issues of land valuation and licensing.’30 The Budget proposals ‘represented a bold initiative along a wide front, and one that was likely to rally the rank and file. No alternative initiatives were forthcoming.’31 It is clear, however, that, in introducing the land values duties, Lloyd George was responding to the demands of politics and not to those of finance. Estimates presented to the Cabinet on 7 April 1909 envisaged that more than £95,000,000 would be raised through taxation;32 but taxes on land values were only budgeted to produce £500,000.33 ‘I knew the land taxes would not produce much’, Lloyd George told Lord Riddell in May 1912. ‘I only put them in the Budget because I could not get a valuation without them.’34 As far as political considerations were concerned, however, Lloyd George could take the view that this initiative had been a success. By July 1909, there had been a revival in favour of the Liberal government; and Lloyd George had no doubt that the key to this revival was the land taxes. He told JA Spender that: The party had lost heart. On all hands I was told that enthusiasm had almost disappeared at meetings, and we wanted something to rouse the fighting spirit of our own forces. This the land proposals have undoubtedly succeeded in doing.35

The inclusion in the 1910 Act of the provisions imposing the land values duties was nevertheless an achievement that did not come cost-free. One cost was set

29 ibid 112. 30 ibid 110. 31 ibid 111. 32 ibid 144. 33 R Douglas, above n 22, 144. 34 Lord Riddell, More Pages from my Diary (London, Country Life, 1934) 65. 35 HV Emy, ‘The Land Campaign: Lloyd George as a social reformer, 1904–14’ in AJP Taylor (ed), Lloyd George: Twelve Essays (London, Hamish Hamilton, 1971) 35, 43.

Lloyd George’s Land Values Duties  287 out very clearly in a document sent by Lloyd George to his Cabinet colleagues on 13 March 1909: It is now clear that it would be impossible to secure the passage of a separate valuation bill during the existence of the present Parliament, owing to the opposition of the Lords, and therefore the only possible chance which the Government have of redeeming their pledges in this respect is by incorporating proposals involving land valuation in a Finance Bill. On the other hand it must be borne in mind that proposals for valuing land which cannot form part of a provision for raising revenue in the financial year for which the budget is introduced would probably be regarded as being outside the proper limits for a Finance Bill by the Speaker of the House of Commons. I have consulted Sir Courtney Ilbert36 on the subject and he is distinctly of the opinion that, unless it is contemplated to raise substantial revenue during the year, valuation clauses would be regarded by the authorities in this House as being a fit subject for a separate bill, and not for a Finance Bill.37

The relationship between the making of the valuation and the levying of the land values duties, therefore, was far from ideal. As a matter of analysis and administration, the making and existence of the valuation logically preceded the levying of the new duties; but the necessity to comply with the requirements of House of Commons procedure had produced the result that it was the levying of the new taxes that validated the making of the legislation providing for the valuation. The cart had been placed before the horse. The land values duties also encountered vehement opposition from the Conservative Party. Balfour attacked the undeveloped land duty by saying: This is not a tax to get money. It is a tax to get votes. It is a tax cynically put forward as a tax which is going to catch votes because it affects the few and leaves the many untouched. A more contemptible calculation, a more preposterous method of dealing with great interests under the guise of meeting the nation’s necessities never was presented by any Statesman of whom this country has any record whatever.38

Conservative politicians ultimately came to take the view that the Budget presented a challenge on such a scale that they had no option except to resist it by all means at their disposal. They argued, at a more specific level, that the Budget represented the first step in a socialist war against property; and stressed that it was ‘property’ itself and not simply particular forms of property, such as land, that was ultimately under attack.39 The vehement opposition of the

36 Sir Courtney Ilbert was the Clerk to the House of Commons. 37 Quoted from BB Gilbert, ‘David Lloyd George: Land, the Budget, and Social Reform’ (1976) 81 American Historical Review 1058, 1064. 38 HC Deb 10 August 1909, vol 9, col 313. Asquith’s reply was that those on whom the new tax would fall had been ‘selected for the purpose of this tax because of the exceptional position in which they have hitherto stood, which has enabled them and the property they own to escape their fair share of contribution to the resources of the state’. (ibid col 314.) 39 Murray, above n 27, 176 and 180.

288  John HN Pearce Conservative Party to the land values duties may accordingly be viewed as one particular component of a more general vehement opposition to the Budget proposals as a whole. The land values duties may have attracted particular attention because they were dealt with in the first part of the Finance Bill – with the consequence that they were discussed first (and at great length) and so obtained a great deal of publicity. Part I of the 1910 Act, when it reached the statute book, made provision for three duties on land values. The first was undeveloped land duty, which was charged for each financial year at the rate of one halfpenny in the pound in respect of the site value of undeveloped land.40 The second was increment value duty, which was charged at the rate of 20 per cent on the increment value of any land on any one of a number of occasions. Three important occasions were the transfer on sale of the fee simple; the grant of a lease; and the death of any person where an interest in that land passed on that death for the purposes of the estate duty legislation.41 The third of the three land values duties was reversion duty, which was charged at the rate of 10 per cent on the value accruing to a lessor by reason of the determination of a lease.42 The drafting of Part I of the 1910 Act was variously assessed. Viscount Haldane LC was complimentary: The sections of this Act [ie the 1910 Act] which relate to duties on land values have obviously been drafted with remarkable skill. But the subject was so novel and so complicated that it was inevitable that questions should arise on which the meaning of the Legislature has not been made wholly free from ambiguity.43

Scrutton LJ, by contrast, called the 1910 Act: an Act which, in my experience, establishes a very artificial system in very vague language difficult to construe. I personally find it difficult to believe that if the individual members of the Legislature had been taken aside and cross-examined as to what they intended by any particular clause or what they thought they were doing, you would have got any intelligible result from such a cross-examination.44

In similar vein, Sir Courtney Ilbert, a former First Parliamentary Counsel and now the Clerk to the House of Commons, wrote to Lord Bryce on 3 August 1909, that the provisions relating to the land taxes had ‘never been thought out, and were obscurely and awkwardly expressed’.45 By the end of 1910, the land values duties had been imposed; but it was possible to foresee that there might well be problems ahead.



40 See

s 16(1) of the 1910 Act. s 1 of the 1910 Act. 42 See s 13(1) of the 1910 Act. 43 per Viscount Haldane LC in Lumsden v IRC [1914] AC 877, 887 (HL). 44 per Scrutton LJ in Ecclesiastical Commissioners for England v IRC [1919] 2 KB 67, 82 (CA). 45 Quoted in Emy, above n 13, 213. 41 See

Lloyd George’s Land Values Duties  289 THE LAND VALUES DUTIES FROM 1910 TO 1914

During the period from the enactment of the 1910 Act46 until the outbreak of the First World War, the preoccupations of the three major stakeholders identified (the advocates of taxes on land values, the Inland Revenue and David Lloyd George) were very different. The advocates of taxes on land values now had their first objective of legislation for a national valuation successfully accomplished. Their next objective was the completion of that valuation. On 18 May 1911 a delegation of backbenchers met Asquith and Lloyd George and presented them with a memorial, signed by 183 MPs, demanding speedier implementation of the valuation provisions in the 1910 Act. Asquith and Lloyd George were friendly; but the leading land taxers were appalled when Lloyd George intimated that the Inland Revenue would not complete the process of valuation until 1915.47 In the years that followed, the style of the advocates of taxes on land values sometimes aroused opposition in the Liberal Party.48 It was also the case that the leading advocates of taxes on land values gave little support for the duties brought into existence in 1910. Josiah Wedgwood wrote of the increment value duty that: This duty is not properly a land value tax at all. It makes land no cheaper, no easier to get; it in no way frees the margin. It has all the disadvantages of a tax partial in its application and accidental in its incidence. Its chief advocates only recommend it as a weapon to secure a ‘full’ valuation, and, as soon as it has fulfilled that more or less useful purpose, it may well be buried without any regret on the part of even moderate land taxers. Looked at from the mere Treasury point of view, ‘there is no money in it.’ Something of the same sort may be said of the other land value duties as imposed in 1909. They were only a makeshift at first. They are only a nuisance now, and may well give place at an early date to the general annual tax asked for by the politicians.49

Another leading advocate of the taxation of land values, James Dundas White,50 in a work published in 1924, went so far as to state that the United Kingdom ‘has yet to make a start with anything deserving the name of land-value legislation’. The duties introduced by Part I of the 1910 Act ‘did not deserve the name of Duties on Land Values, and were unworthy substitutes for the real reform’.51

46 The 1910 Act received the Royal Assent on 29 April 1910. 47 Douglas, above n 22, 155; BK Murray, ‘Lloyd George, The Navy Estimates, and the Inclusion of Rating Relief in the 1914 Budget’ Welsh History Review 15 (1990–91) 58, 73–74. 48 Emy, above n 13, 219. ‘A feature of Liberal politics after the final passage of the “People’s Budget” in 1910 … [was] the breach that … opened up between Lloyd George and the Land Values group, still a formidable pressure group in the Commons.’ (Murray, above n 47, 73.) 49 Josiah C Wedgwood, ‘The Principle of Land Value Taxation’ (1912) 22 Economic Journal 388, 392. 50 For White see n 14 above. 51 James Dundas White, Land-Value Policy (London, 1924) 83–84.

290  John HN Pearce The advocates of taxes on land values were the obvious supporters of the land values duties now imposed – but remarkably little support was actually given. The Inland Revenue, meanwhile, had to administer the land values duties that had been brought into existence – and administration was not easy. There was no overall valuation of all landed property in the United Kingdom; the valuation on which the land values duties depended had to be brought into existence at the same time as the land values duties were themselves being administered. Progress was made, however, and in his Budget Speech on 4 May 1914, Lloyd George was able to say that: The vast majority of the hereditaments of this country have already been surveyed and inspected, all the necessary information with regard to them has been collected, and boundaries have been ascertained for the first time. The annual values and the total values have been assessed, and in urban sites the value of the improvements has been ascertained.52

Immediately before the outbreak of the First World War in 1914, it was possible to say that the valuation of land as at 30 April 1909 was largely – but not wholly – complete. Section 28 of the 1910 Act, however, provided that all undeveloped land should be valued as at 30 April 1914 and in every subsequent fifth year – and the further 1914 valuation had not been undertaken. The administration of the three land values duties was also encountering serious operational difficulties. In the case of undeveloped land duty, the tax received a formidable blow in the judgment delivered, on 28 February 1914, by Scrutton J in the case of IRC v Smyth (often referred to, in official documents, as ‘the Scrutton judgment’).53 In that case, Scrutton J held that the principles on which the valuation had been carried out where an agricultural element was present did not accord with the requirements of section 25 of the 1910 Act and were incorrect. The consequence was that all assessments to undeveloped land duty had been made on a basis that was legally defective. The Inland Revenue did not appeal this case; but took the view that the basis of valuation that the Court considered to be correct was one to which it was impracticable to give effect. The remedy was to pass amending legislation legitimating the basis on which the Inland Revenue had in fact proceeded; but, in the meantime, the assessment and collection of undeveloped land duty was wholly suspended. Amending legislation was duly prepared in the form of clause 2 of the Revenue Bill 1914; but, during the summer of 1914, the Revenue Bill was not enacted – and was ultimately abandoned. The assessment and collection of undeveloped land duty, therefore, continued to be wholly suspended. The administration of increment value duty had also given rise to litigation that was operationally inconvenient, although here, in the case of



52 HC

Deb 4 May 1914, vol 62, cols 69–70. 3 KB 406 (KB) (Scrutton J).

53 [1914]

Lloyd George’s Land Values Duties  291 Lumsden v IRC,54 where the House of Lords delivered judgment on 20 July 1914, the Inland Revenue was successful at every level in the courts. The difficulties arose because it was held that increment value duty was leviable in a case in which the value of the site had not increased; and because the tax was payable by a builder out of the profits of his trade (a fact that did not march well with a policy objective of taxing unearned increments). Legislation to deal with these difficulties was embodied in the Revenue Bill of 1914 – but that Bill did not reach the statute book. On 23 July 1914, Asquith stated, in the House of Commons, in reply to a question from Austen Chamberlain, that the government was prepared to introduce and pass a one-clause Bill in the current session to deal with these matters, provided that the Bill was not opposed,55 but no such legislation was enacted. The reversion duty also saw litigation decided against the Crown: for, in Marquess Camden v IRC,56 in which the House of Lords gave judgment against the Crown on 22 July 1914, it was held that the calculation of liability fell to be carried out in a manner that destroyed the real value of the duty in all cases where land was let on a building lease at a ground rent. The yields from the land values duties were very unexciting. According to figures produced by the Inland Revenue after the First World War, the net receipt from the three land values duties totalled only £585,787 during the financial years from 1910–11 to 1913–14.57 But David Lloyd George cared for none of these things. As one of the most important members of the Cabinet, many matters of great importance could – and did – demand his urgent attention during the period from 1910 to 1914: (for example) the constitutional crisis involving the role of the House of Lords, national insurance legislation, the Marconi scandal, the state of near civil war in Ulster, and relations with Germany. The technical details of revenue law were given no priority whatsoever. ‘We shall never get the ChofEx to go into the [Revenue] Bill’, the First Parliamentary Counsel lamented to the Chairman of the Board of Inland Revenue early in 1914.58 One initiative that Lloyd George did take during these years, however, had implications for the enactment of revenue legislation; and, in the case of the land values duties, may be viewed as producing harm as opposed to 54 [1913] 1 KB 346 (Horridge J); [1913] 3 KB 809 (CA); [1914] AC 877 (HL). Only four speeches were delivered in the House of Lords, with the House being equally divided (so that the decision of the Court of Appeal, not having been shown to be wrong, continued to stand). Speeches in favour of the Crown were delivered by Haldane LC (a member of the Liberal Cabinet since 1905) and Lord Shaw of Dunfermline (Lord Advocate in the Liberal government from 1905 to 1909). Speeches against the Crown were delivered by Lord Moulton (a former Liberal MP) and Lord Parmoor (a former Conservative MP). 55 HC Deb 23 July 1914, vol 65, col 631. 56 [1915] AC 241 (HL). 57 For the net receipts from the three land values duties see the table in the text following n 108 below. 58 TNA file IR 63/40, fo 491. Letter, Thring to Nathan, 28 January 1914.

292  John HN Pearce being  ­beneficial. In 1913, Lloyd George came forward with an initiative to enact both a Finance Act and a Revenue Act each year, with technical matters being placed in the Revenue Act.59 Both in 1913 and 1914, however, the Revenue Bill received too little attention, and too late: and neither in 1913 nor in 1914 did a Revenue Act reach the statute book. The amendments to the legislation governing the land values duties that the Inland Revenue wished to see were, accordingly, never made. Lloyd George also gave thought, during this period, to the political problem of how the Liberal Party should approach the next general election, due to take place by the end of 1915. As in 1908, it appeared likely that the Liberals would lose ground. Lloyd George’s response to this problem was to concentrate on issues relating to the land. This response, it was believed, would be electorally popular; and, during the period from 1912 to 1914, Lloyd George presided over a party initiative known as the land campaign.60 The Tory strategy for the next general election, Lloyd George told Percy Illingworth, the Chief Whip, in October 1913, was ‘to talk Ulster to the exclusion of land’; and he warned that ‘[i]f they succeed we are “beat” and beat by superior generalship’.61 The Liberal strategy, he believed, should be precisely the reverse: to talk about land to the exclusion of Ulster. Against this background, Lloyd George continued to believe that the taxation of land was an important matter. In a speech in ­Glasgow, in February 1914, he stated that the government had already accepted the principle of the rating of site values and intended to give effect to this principle by legislation.62 It may be conjectured, however, that, for Lloyd George, this belief was more important for the purposes of party politics than for those of public finance. Lloyd George’s whole approach, indeed, may be regarded as existing in the context of party politics. During the summer of 1914, however, it was not clear whether or not Lloyd George’s plan was achieving success. A report sent to Lloyd George at the end of May 1914 stated that ‘Public attention has been so occupied with gun-running [and] army revolts … that it has been difficult to arouse interest on Land and Housing.’63 At the end of July 1914, therefore, the state of the land values duties was such that both a pessimistic and an optimistic view could be taken. On the pessimistic side, the duties were producing little money; had run into major operational difficulties; and Bills containing remedial legislation had not been enacted. On the optimistic side, however, the existing difficulties could be dealt with in a further Revenue Bill to be enacted during the next few months. It was also 59 For the matters dealt with in this paragraph see JHN Pearce, ‘The Rise of the Finance Act: 1853–1922’ in P Harris and D de Cogan (eds), Studies in the History of Tax Law: Volume 7 (Oxford, Hart, 2015) 71, 93–99. 60 For the land campaign see, generally, Emy, n 35 above, and I Packer, Lloyd George, Liberalism and the Land (Woodbridge, Boydell Press, 2001) chs 6 and 7. 61 Murray, above n 47, 62. 62 Douglas, above n 22, 162. 63 Quoted in Emy, above n 13, 230.

Lloyd George’s Land Values Duties  293 the government’s intention to introduce a Valuation Bill in the autumn of 1914, ­forcing it through the Commons before the 1915 Budget. If the House of Lords then passed the Bill, the government could point to constructive achievements. If the House of Lords blocked the legislation, that would be a good battle cry in the general election campaign.64 The problems that the land values duties had encountered could still be regarded as being capable of being overcome. The view taken is that, immediately before the First World War, the land values duties were already down – but that they were not out. THE LAND VALUES DUTIES FROM 1914 TO 1918

But then, in early August 1914, the First World War began. The Inland Revenue’s operational difficulties in administering the land values duties were set out in a lengthy report submitted to the Treasury in February 1915. The covering note stated that the administration of the land values duties: has revealed many practical difficulties and is at the moment seriously impeded by adverse legal decisions and the postponement of remedial legislation. … [W]e were obliged in February 1914 to suspend the collection of Undeveloped Land Duty, and have found ourselves unable to make the revaluation of Undeveloped Land which under the [1910 Act] … should have been made last year, although in the Revenue Bill 1914 its postponement was proposed. The yield of Undeveloped Land Duty for the current financial year will in these circumstances be merely nominal, and we see no prospect of collecting duty until the necessary legislation (which was embodied in the last Revenue Bill …) is obtained. The collection of Reversion Duty has also been practically in abeyance during the whole of the current financial year on account of the adverse decision of the Courts in … [Marquess Camden v IRC], which as it stands defeats the purpose of the duty and would reduce its yield to an insignificant amount. As we are advised that in the absence of legislation the only possibility of re-instating the duty lies in contesting a new case from the beginning we fear that neither in the current nor in the ensuing year will the yield of this duty be more than nominal … We have also been led … to postpone proceeding with the periodical collection of Increment Value Duty from corporate and unincorporate bodies. Collection of Increment Value Duty on sales is to some extent delayed pending the enactment of the concession which was embodied in the last Revenue Bill regarding the Lumsden judgment, and to which the greater urgency attaches on account of the Prime Minister’s promise in regard to it. … We are not aware whether, regard being paid to the present understanding as to the nature and extent of Parliamentary business, Your Lordships will decide at present to introduce legislation on these matters, however desirable and even necessary such



64 Douglas,

above n 7, 158–59.

294  John HN Pearce legislation might appear in normal times, but we think it our duty to call Your Lordships’ attention to the position.65

It is known that the Treasury acknowledged receipt of this report;66 but no evidence is known of any substantive reply. There was no legislation relating to the land values duties during the First World War. The existing difficulties accordingly continued; and, with the passing of time, grew worse. The administration of undeveloped land duty remained wholly suspended. There was also an important new development: for, on 11 April 1916, in answer to a parliamentary question raising the position of those who had paid the duty before the First World War, the Chancellor of the Exchequer (McKenna) stated that there would be no eventual discrimination.67 If, therefore, the duty were to be repealed so that payments were not required, it followed that the refunding of earlier payments might also be required. The difficulties encountered in administering increment value duty continued as before; but, in the case of reversion duty, the position at the end of the First World War was that the new case chosen for contesting, Ecclesiastical Commissioners for England v IRC,68 had been decided in the Crown’s favour by Lush J. During the First World War, however, receipts from the duties fell to levels that were still more dismal. Net receipts in each of the financial years from 1914–15 to 1917–18 were lower than in the years 1912–13 and 1913–14.69 An internal Inland Revenue document headed ‘Land Values’, to which the date of 31 October 1918 may be assigned,70 dealt with ‘Points requiring legislation or decisions by Ministers at an early date after the termination of the war’. The document stated that: From their very inception, the three Land Values Duties proper (Undeveloped Land Duty, Increment Value Duty and Reversion Duty) have met with an organised opposition on the part of the taxpayers affected by them. No scheme of taxation, which does not gain at least to some extent the acquiescence of those taxpayers who are subject to its charge can be expected to be successfully administered; and when as in the case of these duties, every point of opposition which human ingenuity can discover – whether beneficial to the taxpayer or not – is taken against the Crown, the ultimate failure of the tax is merely a matter of time.

65 TNA file IR 40/2444. ‘Note on the position of the land values duties’, sent by the Inland Revenue to the Treasury, together with a covering note, 22 February 1915. 66 TNA file IR 40/2444. Letter, Bradbury to Inland Revenue, 16 April 1915. 67 HC Deb 11 May 1916, vol 81, cols 1606–07. 68 [1918] 2 KB 602 (Lush J). See also text around n 98 below. 69 For the net receipts from the three land values duties see the table in the text following n 108 below. 70 TNA file IR 40/12637. ‘Land Values. Points requiring legislation or decision by Ministers at an early date after the termination of the war.’ The date ‘31 October 1918’ appears in manuscript at the end of this document. It may be conjectured that the Inland Revenue produced this internal document as a contribution towards the substantial advice to Ministers that would be needed in due course.

Lloyd George’s Land Values Duties  295 Without entering into detail in this memorandum, it may be bluntly stated that for various reasons, many of which are inherent in the scheme of the duties as enacted, two of the three Land Values Duties proper (the Undeveloped Land Duty and Increment Value Duty) have broken down and are unworkable: while the third (Reversion Duty) is moribund. Further it may be added that no amount of legislative ­amendment – even if legislation of such a highly controversial nature could be passed through Parliament in the years immediately after the termination of the war – could render the administration of the Undeveloped Land Duty or Increment Value Duty a really practical proposition: and that the Reversion Duty would require amending ­legislation before it could be successfully administered. Undeveloped Land Duty has been in abeyance since February 1914 in consequence of a judicial decision. Increment Value Duty is in partial abeyance in consequence of Ministerial pledges pending promised legislation. Reversion Duty is in partial abeyance pending a ­decision in the Courts.

The document considered it ‘essential’ that undeveloped land duty and i­ncrement value duty ‘should be repealed as soon as possible’; and that it was ‘desirable’ that reversion duty should also be repealed.71 The cessation of hostilities on 11 November 1918 was followed by a general election on 14 December 1918; and the result of that election had major implications for the land values duties. As far as party politics were concerned, a coalition which envisaged that Lloyd George would continue as Prime Minister was victorious. Of the 707 seats in the House of Commons, the Lloyd George coalition won 478. However, in that figure, there were 335 Coalition Conservatives. There were only 133 Coalition Liberals. (Other members of the House of Commons included 10 Coalition Labour MPs, 28 opposition Liberals and 63  other Labour MPs – so that Labour now became the leading opposition party in Parliament.) When it is borne in mind that the 73 Sinn Fein MPs elected did not take their seats, the party which, before the war, had opposed the taxes on land values (the Conservative Party) was now in a majority in the House of Commons.72 That party was also in a majority – a much larger majority – within the governing coalition. Lloyd George, the government minister who in 1910 had been responsible for the introduction of the land values duties, was therefore no longer well-placed to safeguard his earlier handiwork – despite now being Prime Minister. It was also the case that, following the 1918 general election, leading advocates of the taxation of land values in the previous Parliament were now no longer in the House of Commons. EG Hemmerde did not stand in the election; RL Outhwaite, CP Trevelyan and James Dundas White were all defeated. Of those who were returned, PW Raffan was a coalition Liberal, but Josiah Wedgwood was an opposition Liberal.73 71 ibid. (Underlining in original.) 72 The figures in this paragraph have been taken from D Butler and J Freeman, British Political Facts 1900–1967, 2nd edn (London, Macmillan, 1968) 141. 73 During the period from 1918 to 1922, Hemmerde, Outhwaite, Trevelyan and Wedgwood all joined the Labour Party.

296  John HN Pearce At the end of 1918, therefore, the relative strengths of the three stakeholders identified differed greatly from their relative strengths immediately before the First World War. The advocates of taxes on land values had been a significant component of the governing coalition in 1914. They were now much fewer and divided, and were no part of the party (the Conservative Party) which now dominated the governing coalition. The significance of the advocates of taxes on land values was accordingly much reduced – and that of the principal party opposed to the existence of the land values duties was much increased. David Lloyd George was now Prime Minister; but, as far as the taxation of land values was concerned, no longer had a working majority in the House of Commons. The Inland Revenue administered the land values duties; but contained officials who favoured their repeal. Those who might be expected to favour the continuation of the land values duties, therefore, now no longer had sufficient power to compel that continuation; but those who favoured the repeal of those duties now had sufficient power to compel that repeal. THE LAND VALUES DUTIES FROM 1918 TO 1920

Following the ending of the First World War, the operation of the land values duties was obviously a matter that the government needed to consider. Ministers could expect to be advised by officials; and the Inland Revenue was keen to advise. The Inland Revenue’s major report on the working of the land values duties (‘the 1919 memorandum’) was submitted to the Chancellor of the Exchequer on 13 February 1919.74 This report was less explicit in its overall conclusions than the earlier ‘Land Values’ document;75 but there could be no doubt that inferences to the same effect should be drawn. The Chancellor of the Exchequer, Austen Chamberlain, later referred to the 1919 memorandum in the House of Commons and recalled that the memorandum had been presented to him as one of the first matters that he had to consider on assuming that office. Austen Chamberlain then went on to say that: It is a document drawn up, not by party politicians, not by people who were accustomed to take or do take any share in our party strife, but by officials whose business it is to make these taxes work, and … [the Board of Inland Revenue] said that they

74 ‘Land Values Duties and the Valuation under Part I of the Finance (1909–10) Act 1910. Note by the Board of Inland Revenue.’ The top copy of the 1919 memorandum is in TNA file T 171/161, but has been heavily marked to enable the memorandum to be printed as a paper for the War Cabinet. (See also below, text around n 100.) At the National Archives it was found convenient to study the carbon copy of the 1919 memorandum to be found in TNA file IR 63/86, fos 114–43. A version of the 1919 memorandum was later printed and made publicly available as part of the Report from the Select Committee on Land Values (above n 14) 16–42. (See also below, text around n 107.) 75 See text around n 70 above.

Lloyd George’s Land Values Duties  297 [ie the land values duties] are not workable in their present condition. It is a cold and damning document; an absolutely damning document.76

The 1919 memorandum may accordingly be considered in some detail. The object of the 1919 memorandum was stated to be to set out the present position of the valuation and the land values duties introduced by the 1910 Act ‘and to examine the reasons which have led to their unsatisfactory state and the various questions which have to be considered in this connection at the termination of the war.’77 As far as the valuation was concerned, the 1919 memorandum began by recalling that the Commissioners of Inland Revenue were under a statutory duty to cause a valuation to be made of all land in the United Kingdom as at 30 April 1909.78 It distinguished three stages in the making of that valuation: the making of the separate valuations; the issue of the valuations to owners and others interested in the land; and the settlement of objections and appeals entered against the valuations so that those valuations became final. According to the memorandum, the making of the valuation had been practically completed. There was, however, a problem: all valuations within the ambit of the Scrutton judgment79 were not in accordance with the law. The issue of the valuations to owners and others, according to the 1919 memorandum, had also been practically completed – except that valuations made after February 1914 in which an element of agricultural value was present had not been issued. And, finally, according to the memorandum, the valuations were final in about 60 per cent of the cases – although these included a certain number in which the valuations were final on the basis held to be bad in the Scrutton judgment. The remaining 40 per cent fell into a number of different categories. There were a few in which valuations had not been issued: and a large majority in which the valuations were still open – either because the objections and appeals had not yet been dealt with, or because the date by which notice of objection had to be given remained to be fixed. The 1919 memorandum then turned to consider the present position of the land values duties. Before dealing with each particular duty, however, the 1919 memorandum indicated ‘the more general causes contributing to their failure from the administrative point of view’. The fact that the valuation had not been undertaken before the duties had been imposed so that valuation, assessment and collection all had to proceed concurrently had made the administration of the duties ‘exceedingly difficult’. The duties were complicated – and expert assistance was likely to be necessary. ‘This consideration in itself is bound

76 HC Deb 14 July 1920, vol 131, col 2477. Austen Chamberlain had succeeded Bonar Law as Chancellor of the Exchequer in January 1919. 77 1919 memorandum, above n 74, para 1. 78 1910 Act, above n 1, ss 26(1), 96(2). 79 See text around n 53 above.

298  John HN Pearce to make a tax more than usually unpopular and to render its administration difficult’: The organised opposition to the valuation has been extended also to the assessment and collection of the duties. The smooth administration of taxation must to a great extent depend upon the consent of the public to bear the taxes imposed upon it. In the case of the Land Values Duties such consent has never been apparent on the part of the bulk of the taxpayers affected.80

The 1919 memorandum then considered undeveloped land duty. Assessment and collection of the duty had been wholly suspended following the Scrutton judgment. Moreover, in so far as the duty had been operative, it had failed to achieve its objective – that of taxing land which was ripe for building, but was held up for other purposes. In practice, most of the land that was ripe escaped, and the duty fell principally on ripening land around urban areas. The duty had proved both difficult and expensive to administer, giving rise, among other matters, to many assessments made in small amounts. ‘Experience has shown that a tax of this character does not lend itself to administration as a centralised tax.’81 As far as increment value duty was concerned, the assessment and collection of the duty were partially suspended: and two reasons were given for this state of affairs. The first was that the original valuation, which formed the basis for the computation of liability, was still uncompleted; and the second was a ministerial pledge, arising out of the decision in the Lumsden case, under which cases in which there was no genuine increase in site value were not being pursued until there had been legislation. The duty was complex, with complicated calculations and apportionments; complicated valuation problems could be raised; and other problems were also known. ‘Each of these in itself tends to delay the settlement of liability and clog the machinery of administration. Cumulatively their effect is overwhelming.’82 The final duty to be considered was reversion duty. For some time, this duty had been partially in abeyance in consequence of the decision of the courts in the Marquess Camden case.83 Its viability was therefore dependent upon success in later litigation – or, failing that, remedial legislation.84 The 1919 memorandum then concluded its review of the present position relating to the duties on land values by observing that: these three Land Values Duties, which have been in force for over eight years, have resulted in a negligible yield of revenue, have been received with widespread hostility by the public, and have been found extremely difficult to work even in a partial manner. They are at present either wholly or partially in suspense.



80 1919

memorandum, above n 74, para 11. para 15. 82 ibid para 21. 83 See text around n 56 above. 84 1919 memorandum, above n 74, para 23. 81 ibid

Lloyd George’s Land Values Duties  299 Moreover the hostility of the taxpayer in this connexion has re-acted unfavourably on his attitude in the sphere of the other taxes under the management of the Board of Inland Revenue; and it may safely be assumed that any attempt now made to resuscitate these duties would prove a considerable handicap to the Department at a time when it is responsible for raising an enormous revenue from taxpayers who now that the war is over are as a body becoming more critical and less disposed to pay.85

The 1919 memorandum then turned to the subject of future legislation. Whether or not the valuation and the duties were continued, legislation would be required. ‘If they are continued, the legislation required will be considerable in amount and of a complex and highly technical character; if they are discontinued, the amount of legislation required will be small and comparatively simple.’86 It would also be practicable to discontinue the duties but to complete the valuation: But once the Duties were repealed, the Valuation as contemplated by the [1910] Act would cease to have any fiscal significance or at this date to serve any other useful purpose. Even if a new scheme of land valuation taxation were introduced in the near future the completion of the valuation would not prove of any material assistance. Any new scheme, whether imperial or local, would have to proceed upon an up-to-date valuation and not one that dates back to 1909. Moreover the Valuation Office has already in its possession the records of tenure, ownership boundaries of land etc. up to date, and if the machinery, by which this information is obtained is continued, … the Department will in the future have at their disposal the bulk of the material upon which to commence the work of a new and up to date valuation.87

The 1919 memorandum then turned to the subject of arrears. The suspension (in whole or in part) of the three duties had resulted in the accumulation of large arrears; and the question of their treatment was one that had to be faced, whether the duties were continued or not.88 As far as undeveloped land duty was concerned, the 1919 memorandum stated that the assessed arrears outstanding amounted to £320,000 and that there  were also considerable unassessed arrears. Section 19 of the 1910 Act provided that no undeveloped land duty might be assessed more than three years after the expiration of the year for which it was charged. It followed, accordingly, under the law as it stood, that, during the tax year 1919–20, no undeveloped land duty could be assessed in respect of a liability arising before the tax year 1916–17. On the other hand, undeveloped land duty, once assessed, was recoverable from ‘the owner of the land for the time being’. It followed, accordingly, that the duty, once assessed, could always be collected, however old the liability. However, the 1919 memorandum considered it indefensible to 85 ibid paras 24 and 25. These two paragraphs were omitted in the version of the 1919 memorandum printed as part of the Report from the Select Committee on Land Values (see n 74 above). 86 ibid para 26. 87 ibid para 39. 88 ibid para 40.

300  John HN Pearce discriminate between taxpayers according to whether, some years earlier, they happened to have been assessed to the duty or not. ‘It follows that both assessed and unassessed arrears arising prior to 1916–17 must be given up.’89 What should be done about the arrears of undeveloped land duty (all unassessed) arising from 1916–17 onwards? If it were decided to repeal the duty, it was presumed that legislation authorising the collection of these arrears was out of the question. If the duty was to be given some operational viability, it had to be borne in mind not only that legislation would be needed to reverse the effect of the Scrutton judgment, but also that provision had been made for there to be a revaluation of all undeveloped land every five years90 – although there had been no revaluation in 1914. An attempt to give the duty operational viability in the future accordingly implied not only a new valuation but also (if recent arrears were to be recoverable) further legislation to authorise the clearing up of unassessed arrears arising since April 1916. ‘It is submitted that any such course is impracticable … The conclusion is that all arrears of the Undeveloped Land Duty must be abandoned’.91 If all arrears of undeveloped land duty were to be given up, the position of those persons who happened to have paid the tax in the period up to 1914 fell to be considered. In this connection reference was made to McKenna’s pledge in 1916 that there would be no eventual discrimination.92 It was foreseeable, accordingly, that, should there be an abandonment of arrears, ‘this pledge may very well give rise to a demand for the refund of all Undeveloped Land Duty paid amounting to some £400,000, which would be difficult, if not impossible to resist.’93 The 1919 memorandum, although it did not underline the point further, had arrived at the conclusion that all sums collected by way of undeveloped land duty would have to be refunded. As far as increment value duty was concerned, the 1919 memorandum stated that the assessed arrears outstanding amounted to £146,000 and that there was also a very large number of unassessed arrears. The memorandum distinguished six overlapping classes – and divided one of those classes into three sub-classes. One important class of arrears consisted of cases within the ambit of the Lumsden case;94 another class consisted of those within the ambit of a concession contained in the Revenue Bill 1914 exempting small owners. It was assumed that whether the land values duties were continued or not, no further action would be taken regarding the arrears coming within these two classes as it was the intention of the pre-war Liberal government to enact legislation declaring that no charge arose in those cases. If all arrears in Lumsden cases were given up, however, it was foreseeable that a demand might arise for the repayment of sums



89 ibid

paras 41–42. s 28 of the 1910 Act. memorandum, above n 74, para 43. 92 See text around n 67 above. 93 1919 memorandum, above n 74, para 44. 94 See text around n 54 above. 90 See

91 1919

Lloyd George’s Land Values Duties  301 of increment value duty paid in Lumsden cases before the First World War; and it would be difficult to resist that demand.95 Having set out the Inland Revenue’s analysis of this matter, the 1919 memorandum, once again, did not state any conclusion explicitly; but, once again, there was a ready inference that a consistent administrative result could be reached only by the complete abandonment of the duty and by refunding all sums already paid. As far as reversion duty was concerned, the 1919 memorandum stated that the assessed arrears outstanding amounted to £83,000 and that there were also large unassessed arrears amounting to some £500,000. In the case of this duty one important class of case consisted of Marquess Camden cases held up pending a final decision of the Courts in the later Ecclesiastical Commissioners case. If this litigation were to end in a manner adverse to the Crown and without subsequent legislation, these claims for duty would lapse. The 1919 memorandum made no explicit recommendation as to how the arrears of this duty should be dealt with – but permitted the working hypothesis that this duty would need to be dealt with in the same manner as the other two land values duties. The 1919 memorandum ended with a paragraph on mineral rights duty. This duty was easy to assess and collect, and presented practically no difficulties.96 The memorandum did not end with a general conclusion; but the points made in it pointed very clearly to the repeal of undeveloped land duty, increment value duty and reversion duty. Following the despatch of the 1919 memorandum on 13 February of that year, it appears that there was an interval of more than a month before the Chancellor of the Exchequer, Austen Chamberlain, took decisive action; but there is material from which it may be inferred that a conference on the subject of the land values duties was held on 25 March 1919.97 During that interval, the Court of Appeal reversed the decision of Lush J in the case of Ecclesiastical Commissioners for England v IRC:98 a state of affairs which, if left unreversed, meant that ‘the duty … may be regarded as killed’.99 It may also be inferred that, at that conference, it was decided that the whole subject of the land values duties should be referred to the War Cabinet, with the 1919 memorandum being printed as a paper for the War Cabinet’s use.100 A covering note, dated 31 March 1919 and initialled by Austen Chamberlain, stated that: I circulate to the Cabinet a Report by the Board of Inland Revenue on the Land Values Duties. 95 1919 memorandum, above n 74, paras 45–47. 96 ibid, para 50. 97 See TNA file IR 40/12637, letter, dated 24 March 1919, from Gower to Hamilton. Gower stated that the Chancellor hoped to arrange a conference on the subject of the land values duties in the course of the next few days; and (in a postscript) that the Chancellor now proposed to hold the conference on the following day. 98 [1919] 2 KB 67 (CA). The Court of Appeal delivered judgment on 19 March 1919. See also text around n 68 above. 99 Report from the Select Committee on Land Values, above n 74, 18, para 23. 100 See TNA file T 171/161, annotations on the top copy of the 1919 memorandum, and the course of events described in the text.

302  John HN Pearce The subject will certainly be raised during the Budget debates, and the Government must come to a decision as to the attitude that they will adopt. I do not think that we should have any chance of carrying legislation on the subject in the present state of opinion in the House of Commons. Any attempt to do so would inevitably revive the controversies of 1909–10, and would probably cause a sharp division in the Coalition. A careful enquiry by a Select Committee, bringing out all the facts, might afford material for agreed action next year, and I would propose that we either offer such an enquiry or agree to it if asked, as I think we probably should be, to grant it. It is not easy to see any solution of the problems raised, but not solved, by the Land Values Duties. As a means of raising revenue they are at present useless, and I do not see how they can be made effective without serious injustice. But the valuation itself should be maintained whatever the decision on the taxes, and one object of the enquiry should be to secure that it is made on right lines.101

On 29 April 1919, the War Cabinet approved the appointment of a Select Committee of the House of Commons as proposed;102 and, in his Budget speech, delivered on the following day, Austen Chamberlain referred to the land values duties and stated that: I do not need to remind the … [House of Commons] that at the time of their birth these duties were the subject of fierce and prolonged debate, and, as fate would have it, the Prime Minister [ie Lloyd George] and I took opposite sides. There is a certain delicacy in a Chancellor of the Exchequer touching the handiwork of his existing chief, and it is not made easier if the Chancellor of the Exchequer, before being a Minister serving under the Prime Minister, was one of his most active opponents. But fortunately on this occasion I have the benefit of the advice of the Prime Minister instead of having to face his opposition. I am glad to be able to say at once that the Prime Minister and myself, no less than the rest of our colleagues in the Government are entirely agreed as to the course that ought to be pursued … [T]he taxes by now have become unworkable … They must either be amended or repealed; they cannot be left indefinitely as they are. But if I were to attempt the task of amendment or repeal at this moment, in the present divided state of public opinion on the subject, and in the absence of full knowledge as to the facts of the case, I should be inviting, as we hope on the eve of the conclusion of peace, a recrudescence of all the old controversies, which we have forgotten during the war. Under the circumstances, the Prime Minister and I joined in recommending to the Cabinet that before action is taken the present position of the duties should be referred to a Select Committee of this House in order that they may explore it and may recommend a course of action in regard to it. We hope that such a careful inquiry, before which all parties can be heard, may secure something in the nature of common agreement as to the best course to pursue in future.103



101 TNA

file T 171/161. Note by Chamberlain dated 31 March 1919. file T 171/161. Decision of the War Cabinet, No 557, 29 April 1919. 103 HC Deb 30 April 1919, vol 115, cols 190–91. 102 TNA

Lloyd George’s Land Values Duties  303 On 25 July 1919, accordingly, a Select Committee was set up to inquire into the present position of the duties imposed by Part I of the Finance (1909–10) Act, 1910; to make recommendations in relation to their retention, alteration, or repeal, and in regard to such legislative or administrative measures as may be necessary in order to give effect thereto; to inquire into the basis and present position of the valuations of land prescribed by Part I of the Finance (1909–10) Act, 1910, and to make recommendations thereon, regard being had to the desirability of State valuations of land being available for public purposes.104

In his covering note to the War Cabinet, Austen Chamberlain had remarked that it was ‘not easy to see any solution of the problems raised, but not solved, by the Land Values Duties’.105 It may be agreed that it was appropriate to discuss a subject that had been put to one side during the First World War before enacting legislation; and it may also be agreed that a Select Committee of the House of Commons was a legitimate vehicle for any such discussion. Furthermore, since hope is alleged to spring eternal, it was also possible to hope that the Select Committee might be able to agree upon a course of action that could then be adopted. The view may also be taken, however, that any such hope was unrealistic. The taxation of land values had been a contentious subject. Liberal MPs who, before the First World War, had advocated the taxation of land values were exceedingly unlikely to have changed their minds – and could view the Select Committee as an opportunity to devise new, and better, land values duties. Conservative MPs who, before the First World War, had opposed the taxation of land values were also exceedingly unlikely to have changed their minds – and could view the Select Committee as an opportunity to repeal the existing duties. The setting up of the Select Committee, it could be urged, was likely to produce deadlock – and not an agreed course of action. In the events that happened, deadlock was indeed the result. The Select Committee had three ‘business’ meetings between August and November 1919; but then reported in December of that year that, ‘owing to difficulties arising from different interpretations of the order of reference and divergent views as to the scope of their inquiry, they had been unable to consider the matters to them referred’. The Select Committee, therefore, was unable to recommend any course of action regarding the taxes on land values.106 The Committee, however, published the proofs of evidence submitted to it. Those proofs included one from Percy Thompson, a Commissioner of Inland Revenue, and which constituted a version of the 1919 memorandum.107 In this manner, the contents of

104 Report from the Select Committee on Land Values (Cmd 556, 1920) 2. Apart from the word ‘alteration’ (added by Austen Chamberlain), the terms of reference were virtually identical with those proposed in a letter to Chamberlain from Warren Fisher (then the Chairman of the Board of Inland Revenue) and dated 23 May 1919. See TNA file T 171/161. 105 See text before n 101 above. 106 Report from the Select Committee on Land Values (Cmd 556, 1920) 3, 4. 107 ibid 16–42. See also n 74 above.

304  John HN Pearce the 1919 memorandum became publicly available well before the legislation to repeal the land value duties was enacted. In one of the Appendices to the 1919 memorandum, as printed by the Select Committee, the net receipts from the land values duties from 1910–11 to 1918–19 were given. These are reproduced in Table 10.1.108 Table 10.1  Net receipts of the land values duties: 1910–11 to 1918–19 Year

Undeveloped land duty (£)

1910–11

2,351

1911–12 1912–13

Increment value duty (£)

Reversion duty (£)

Total (£)

127

257

2,735

28,947

6,127

22,621

57,695

97,852

16,981

47,974

162,807

1913–14

247,916

34,199

80,435

362,550

1914–15

8,652

48,316

19,313

76,281

1915–16

–638

46,070

11,796

57,228

1916–17

–196

67,088

18,009

84,901

1917–18

74

103,005

23,164

126,243

1918–19

61

183,321

39,221

222,603

Total (£)

412,019

505,234

262,790

1,170,043

In the state of deadlock that had resulted, the government had to make its own decision as to how to proceed – and there could be no surprise about the decision taken. In his Budget speech, delivered on 19 April 1920, Austen Chamberlain stated that: [T]hese duties in their present form are unworkable. They have produced hardly any revenue, and, from a variety of causes into which I will not now enter, they are, with the exception of the Mineral Rights Duty, either wholly or partially in abeyance, and can only be revived, if at all, by proposing legislation of a highly technical character. In these circumstances, if Parliament ever wishes to levy duties of that character, it will have to begin over again. We have come to the conclusion that the proper course for us to pursue is to repeal the duties.109

The duties were accordingly repealed by the provisions enacted as Part VI (section 57) of the Finance Act 1920.110 There is evidence, however, that the government’s Coalition Liberal supporters (numbering around 130) were unenthusiastic about the repeal. When the provisions were considered in Committee on 14 July 1920, only 18 supported the government, while 13 supported



108 Report

from the Select Committee on Land Values (Cmd 556, 1920) 41. Deb 19 April 1920, vol 128, col 83. 110 10 & 11 Geo 5 c 18. 109 HC

Lloyd George’s Land Values Duties  305 the opposition. The vast majority, therefore, were absent or chose not to vote.111 The government nevertheless won all the divisions;112 and the Finance Act 1920 received the Royal Assent on 4 August 1920. The Liberal politician and author, CFG Masterman, wrote eloquently about the position reached by the end of the year 1920: Liberalism looked on, saddened and amazed, while the new Parliament destroyed all the results of the vigorous campaign. The Coalition dug the grave wide and deep. They flung into it the Land Taxes of Mr. Lloyd George, the Land Valuation of Mr. Lloyd George, and the Land Policy of Mr. Lloyd George. They dumped earth upon it. They stamped down the ground over the grave. They set up a stone to commemorate their victory for testimony to the passing stranger. ‘Here, buried for ever, lies the Land Crusade.’ And finally – so that there could be no doubt at all as to their triumph – they extorted from the taxpayer of the present every penny which had been paid by the landlords as Land Taxes in the past, and returned two millions of money, as an unexpected windfall, to the landlord owners of the increment of the urban lands of Britain. Never, it would seem, was a cause so sensationally and utterly destroyed.113

CONCLUSION

The American academic, ERA Seligman,114 in his work on the income tax, published in 1911, concluded the part devoted to the United Kingdom by observing that the United Kingdom’s income tax had become a ‘mighty fiscal and social engine’. The tax was a signal example of how ‘sound theory and admirable administration’ might combine to overcome long-continued prejudice and opposition. The United Kingdom’s income tax was ‘a phenomenal success, because it is recognised by the public as a loyal and well-considered effort to accomplish that which the people desire, and in a way which commands their sympathetic approval’.115 The United Kingdom’s income tax, therefore, gained Seligman’s approval on the grounds of ‘sound theory’, ‘admirable administration’ and public acquiescence. The land values duties deserved approval on none of these grounds. Even granting that owners of land obtain the benefit of an unearned increment, it does not follow that the unearned increment can be identified and taxed successfully. More particularly, the three land values duties introduced in the 1910 Act could most certainly not be described as displaying ‘sound theory’. They were of too miscellaneous a nature and had too many particular complications to merit such a description. 111 Douglas, above n 22, 180–81. 112 HC Deb 14 July 1920, vol 131, cols 2421–2527. 113 CFG Masterman, The New Liberalism (London, Leonard Parsons, 1920) 164. 114 For an article on Seligman see A Mumford, ‘ERA Seligman: The Surprising Fiscal Sociologist’ in J Tiley (ed), Studies in the History of Tax Law vol 5 (Oxford, Hart, 2012). 115 ERA Seligman, The Income Tax, A Study of the History, Theory, and Practice of Income ­Taxation at Home and Abroad (New York, Macmillan, 1911) 217–18.

306  John HN Pearce It was also the case that the land values duties were not characterised by ‘admirable administration’. The valuation on which those duties depended had no prior existence independent of the duties; it was being brought into existence at the same time as the duties themselves were being administered. It was then held that the valuation was being conducted on principles that were erroneous in law; and the crucial decisions were not reversed – either by later litigation or by later legislation. Well before their abolition in 1920, the operation of all three land values duties was either partly or wholly suspended. The land values duties were also expensive to administer. On 26 April 1920, in answer to a parliamentary question, Austen Chamberlain stated that the total receipt from the land values duties, up to 31 March 1920, was £1,329,000, but that the total cost incurred in connection with the Inland Revenue’s Valuation Department up to that same date was estimated at £5,000,000.116 On the basis of these two figures, the cost of each £1 received by way of the land values duties was between £3 and £4. There can also be no doubt that Seligman’s requirement of public acquiescence was not met. The Inland Revenue was completely clear that the land values duties had met with an exceptionally hostile reception. The memorandum on ‘Land Values’, which dated from the autumn of 1918,117 had expressed the opinion that ‘No scheme of taxation, which does not gain at least to some extent the acquiescence of those taxpayers who are subject to its charge can be expected to be successfully administered.’ None of the land values duties had gained that acquiescence; and, against the background of general taxpayer hostility, ‘the ultimate failure of the tax is merely a matter of time’. The proposition advanced by the Inland Revenue may or may not be right: but general taxpayer acquiescence for the land values duties was never obtained. The Inland Revenue may, perhaps, have looked on the land values duties as an exceptionally nasty nightmare. The proposition, again advanced in the 1919 memorandum, that good tax administration presupposed public acquiescence118 may also be found in later documents produced by the department; and, in 1926, when confronted with one of the more optimistic ideas of the then Chancellor of the Exchequer, Winston Churchill, Hopkins, the Chairman of the Board of Inland Revenue, lamented to Harrison, the Chief Inspector of Taxes, that ‘You and I have already participated in one practical fiasco – the pursuit of duties on land values calculated from an unsettled register and due from owners not yet ascertained.’119 The extant evidence permits the conjecture that, for the Inland Revenue, the land values duties constituted the exemplar of what was capable of going wrong when a tax was imposed.



116 HC

Deb 26 April 1920, vol 128, col 860. text around n 70 above. 118 See text around n 80 above. 119 TNA file T 171/255 fos 134–38. Letter, Hopkins to Harrison, 18 June 1926. 117 See

11 Professional Status in Tax Law: The Case of Leopold Maxse EMER HUNT

ABSTRACT

Leopold Maxse was one of many taxpayers who challenged an assessment to excess profits duty, a tax introduced in 1915 to raise money to pay for war, and to engender a sense of national unity by ensuring that war profiteering was publicly punished through a tax on ‘excess’ profits. Maxse successfully relied upon a specific relief for a profession the profits of which were dependent upon the personal qualifications of the individual. The stance of reluctant and litigious taxpayer sat uneasily with Maxse’s warmongering rhetoric prior to World War I, when he had sought containment of German militarism through British armament in the pages of the National Review, of which he was at once contributor, editor and proprietor. Delineating the relief from excess profits duty occasioned a pithy description by Lord Scrutton of the attributes of a professional, in which professional status was equated to intellectual skill. The distinction between a professional and a trader is a long-standing feature of tax law, but is not particularly a distinction dictated by the logic of the tax system. Instead such a distinction embodies the functional differentiation of modern society, where each profession is pre-eminent in its domain, and excludes nonprofessionals. Alongside this functional differentiation are to be found notions of social status, which can be seen in the Maxse case and also in literature. Studying the history of tax law can elicit glimpses of cultural norms, where the professional is distinguished from other occupations, and possession of ­nebulous intellectual skill brings with it fiscal advantages.

308  Emer Hunt INTRODUCTION Needless to say, the last thing we desired was to evade any taxation due from the Review, but we could not acquiesce in the denial of a salary to its industrious Editor merely because he is burdened with the responsibilities of Proprietorship.1

S

uch was the verdict of the redoubtable Leopold Maxse, editor and proprietor of the National Review, a man described as possessing ‘an unremitting and caustic pen’,2 on his successful appeal against a charge to excess profits duty. The tendentious Maxse combined an ‘unrelenting belief in the merit and correctness of his own views’3 with a belief in causes such as the rightness of British imperial power, tariff reform, a pro-Union stance on the Irish question, and a crusade against Prime Minister Balfour. Yet, in a tax context, he embodied the distinction between a professional and a businessman or trader, providing a context for Scrutton LJ to opine on a profession as involving ‘intellectual skill’.4 On the designation of an occupation as requiring intellectual skill rested an exemption from excess profits duty. The case gives a fascinating insight into the contradictions of a conservative polemist, Leopold Maxse who, in the pages of the National Review (of which, crucially in the context of the tax dispute, he was at once contributor, editor and proprietor), railed against Germany, and championed UK rearmament in trenchant terms. Yet the tax under dispute was described by the Chancellor of the Exchequer, Reginald McKenna, as taxing profits accruing to a man ‘in time of national emergency’.5 The Chancellor appealed to reason: ‘I think it is only reasonable that that man should make a contribution to the State out of those profits at such a time’.6 Waging war, as Maxse had urged for years through the pages of the National Review, also involves the tricky issue of who should pay for war. At the same time, Maxse’s successful appeal against an assessment to excess profits duty is redolent of a structural issue of the tax system – the distinction in status between professions, trades and other businesses, which is a persistent leitmotif of tax statute, an instance of the tax system evidencing deep notions of correct social distinction.7 Excess profits duty, introduced in 1915, subscribed to a distinction between professionals, trades and businesses; not a new distinction

1 The National Review, vol 73 (London, WH Allen, 1919) 836. 2 AJA Morris, The scaremongers: the advocacy of war and rearmament 1896–1914 (Boston, Routledge & Kegan Paul 1984) 38. 3 JA Hutcheson, Leopold Maxse and the National Review, 1893–1914: right-wing politics and journalism in the Edwardian era (New York, Garland Pub, 1989) 16. 4 CIR v Maxse [1919] 1 KB 647 at 656. 5 HC Deb 23 September 1915 vol 74 cc587–699. 6 ibid. 7 See, for example, ME Kornhauser, ‘The morality of money – American attitudes toward wealth and the income-tax’ (1994) 70 Indiana Law Journal 119, Assaf Likhovski’, ‘Chasing Ghosts: On Writing Cultural Histories of Tax Law’ (2011) 1 UC Irvine L Rev 843.

Professional Status in Tax Law: The Case of Leopold Maxse  309 but one which dated from the Triple Assessment Act 1798.8 Such a distinction gives tangible monetary effect to the functional differentiation of modern society, where a professional had a privileged status, maybe even a virtue, and professional status underpinned social stratification.9 These themes will be explored by, first, examining Leopold Maxse’s background and beliefs to contrast the war-mongering polemist with the reluctant taxpayer; secondly, outlining excess profits duty and the background to its introduction; thirdly, dissecting Maxse’s successful argument for exemption from the tax on the basis of professional status; fourthly, analysing the place of the professional in income tax as a reflection of, and contribution to, social norms and attitudes towards professionals, as exemplified by their portrayal in literature. A theoretical explanation of professional status, as a manifestation of exclusion, will be proffered. Finally, the conclusion will examine the elevation of intellectual skill as a determinant of favourable tax treatment, and the implications of the persistent distinctiveness of professional status. LEOPOLD MAXSE: BACKGROUND AND BELIEFS

Born in 1864, Leopold James Maxse was the son of an admiral, and was educated at Harrow and Cambridge University. In 1893, his father, Augustus Maxse, spent £1500 in purchasing a monthly review in decline, the National Review, for his son’s occupation. The National Review was described as Maxse’s labour of love, and it was to become an eloquent and influential organ of Conservative opinion.10 Maxse’s time in Cambridge closely followed JR Seeley’s lectures on the ‘Expansion of England’,11 delivered in 1882, in which was developed the idea of an England not bound by geography, but spread over the map of the colonies.12 The studied amateurism of the Englishman resonates in Seeley’s proud observation that ‘We seem, as it were, to have conquered and peopled half the world in a fit of absence of mind’,13 followed by his exhortation that England continue to vest itself with foreign colonies to rival the USA and Russia and remain a Great Power. This is not England as idyll: this is England as an enlarged geography, literally extending England over swathes of land. Consistent with this aim of enlarged geography, Maxse was a supporter of the imperial preference and tariff reform became one of the National Review’s

8 38 Geo 3, c 16, Sch, 8th case. 9 N Luhmann, KA Ziegert and F Kastner, Law as a social system (Oxford, Oxford University Press, 2004); R Stichweh, ‘Professions in modern society’ (1997) 7 International Review of Sociology 95. 10 AS Thompson, Imperial Britain: The Empire in British Politics, C. 1880–1932 (Harlow, Longman, 2000). 11 JR Seeley, The Expansion of England: Two Courses of Lectures (London, Macmillan, 1884). 12 Thompson, above n 10, notes that Maxse’s time in Cambridge coincided with Seeley’s series of lectures. 13 Seeley, above n 11, 8.

310  Emer Hunt rallying cries.14 Tariff reform, intended to strengthen the British Empire, was advocated by Joseph Chamberlain in 1903 and was supported by a section of the Conservatives, although not by Arthur Balfour.15 While there were diverse views as to why tariff reform was a desirable policy,16 Maxse advocated the imperial preference as a mechanism of drawing in the colonies to the mother country,17 or in terms Seeley might enjoy,18 spreading England throughout the world. A challenge to achieving this aim was generally believed, in the Radical Right circles in which Maxse moved, to be German militarism and, in particular, the rearmament of the German navy which might challenge the supremacy of the British navy.19 Writing pseudonymously in 1901, Maxse described the position vis-à-vis Germany: ‘Great Britain is therefore confronted with the development of a new sea power founded on the same economic basis as herself, and impelled by a desire to be supreme … We have secured in the past the sovereignty of the seas, and our sceptre cannot be wrested from us without a bloody struggle.’20 In this context, Maxse’s vehement Germanophobia is to be understood as a type of preference for English exceptionalism, evinced through imperial might and ‘a bloody struggle’.21 This can be put best by Kipling, with whom Maxse shared much of his anti-German stance,22 who wrote poems about the vileness of the Hun (The Rowers, 1902), the dangers of German barbarity, and the slowlystirred, but terrible to behold, hatred of the English: It was not suddenly bred, It will not swiftly abate, Through the chill years ahead, When Time shall count from the date That the English began to hate. (Kipling, The Beginnings, 1914)

In prose rather than poetry, Maxse was relentless in his criticism of politicians who ignored what he identified as Germany’s over-weaning ambition, and marvelled at politicians’ ‘powers of self deception when for many years a war against the barbarous Boches has been staring us and striking us in the face’.23 The febrile atmosphere of Edwardian England, engendered by the

14 Hutcheson, above n 3. 15 Thompson, above n 10. 16 AS Thompson, ‘Tariff reform: an imperial strategy, 1903–1913’ (1997) 40 The Historical Journal 1033. 17 Thompson, above n 10. 18 Seeley, above n 11. 19 Hutcheson views Maxse’s Germanophobia to be the frame within which Maxse’s support for tariff reform must be seen, see Hutcheson, above n 3. 20 Morris, above n 2, 43. 21 ibid. 22 ibid. 23 LJ Maxse, ‘Germany on the Brain’, Or the Obsession of ‘a Crank’; Gleanings from the National Review 1899–1914. With an Introd. Note by LJ Maxse (London, The National Review Office, 1915) 6.

Professional Status in Tax Law: The Case of Leopold Maxse  311 radical  right,24 of which Maxse was an eloquent participant, viewed Liberal policies of disarmament as ‘suicidal folly’25 when viewed against the backdrop of Anglo-German rivalries. Retrenchment was viewed as akin to treason: Maxse wrote of Richard Haldane, Liberal War Minister and Lord Chancellor (1905–11), ‘We devoutly wish that he would take up his permanent abode in Germany.’26 The historical development of Germanophobia from 1871 to 1914 has been posited as a study of the growing awareness in Britain of Germany’s claim to its place among the great powers.27 As early as 1905 Maxse stated: ‘It is insane of British statesmen to go whining for disarmament, all the more as it is exceedingly distasteful to the French Government’.28 For the decade before the outbreak of the World War I in August 1914, Maxse raged against the perfidy and untrustworthiness of the Germans (in the Venezuelan crisis and the Baghdad railway affair).29 He was chief amongst those who, eloquently and consistently, sought to portray ‘the bloody struggle’30 with Germany as inevitable and necessary. In sum, Maxse was an agitator, a man of conviction whose views were influential, self-described as a crank with Germany on the brain,31 who could be viewed as having foreseen the outbreak of war in 1914. Just as plausibly, however, Maxse could be said to have championed war through, as Morris put it,32 scaremongering about German militarism. From a financial point of view, he was alert to the difficulties of paying for war, railing against the international financiers who were leading the Chancellor on the road to ruin and continuing: ‘our sinews of war are paralysed and our defensive resources atrophied by the terrible flight of men and money abroad [because of free trade], and the appalling slump in British credit which makes even an emergency loan difficult to float at a reasonable price, though it must be floated if we are to attempt to maintain that naval supremacy which figures so largely in the perorations of our public men, but occupies so small a portion of their thoughts.’33 When war came, in August 1914, it proved expensive and socially divisive, conditions which led to the enactment of excess profits duty in 1915.34 24 GR Searle, ‘Critics of Edwardian Society: The Case of the Radical Right’ in A O’Day (ed), The Edwardian Age: Conflict and Stability 1900–1914 (London, Macmillan Education UK, 1979). 25 ibid 80. 26 Morris above n 2, 39. 27 This is perhaps most notably expressed by AJP Taylor, The Struggle for Mastery in Europe. 1848–1918 (Oxford, Clarendon Press, 1957). 28 Morris, above n 2, 80. 29 Hutcheson, above n 3. 30 Morris, above n 2, 43. 31 Maxse, above n 23. 32 Morris, above n 2. 33 The National Review, vol 60 (London, WH Allen 1912–13) 28. 34 See generally MJ Daunton, ‘How to Pay for the War: State, Society and Taxation in Britain, 1917–24’ (1996) 111 The English Historical Review 882, P Ridd, ‘Excess Profits Duty’ in J Tiley (ed), Studies in the History of Tax Law (Oxford, Hart, 2004), M Billings and L Oats, ‘Innovation and pragmatism in tax design: Excess Profits Duty in the UK during the First World War’ (2014) 24 Accounting History Review 83.

312  Emer Hunt EXCESS PROFITS DUTY

Faced with the popular perception that profiteering was rampant, and with even the Tory press agitating for a war profits tax,35 the government introduced, in September 1915, a tax on ‘excess’ profits. This was designed to demonstrate that profiteering, benefiting financially through exploiting the war to make excessive profits, would not be tolerated. The Finance (No 2) Act 1915 introduced excess profits duty to tax the increase in profits of a trade or business from a baseline pre-war amount. Section 38 Finance (No 2) Act 1915 provided: There shall be charged, levied, and paid on the amount by which the profits arising from any trade or business … exceeded … the pre-war standard of profits.

The duty was levied on such excess in profits, beyond a de minimis of £200 per annum, and with an adjustment for capital employed or withdrawn. In 1915, the rate was 50 per cent, increasing to 60 per cent in 1916 and to 80 per cent in 1917. There was a move to increase it to 100 per cent of excess profits but this was resisted by Andrew Bonar Law, Chancellor of the Exchequer in succession to Reginald McKenna, who argued that this would pose a disin­ centive to businesses to increase production or decrease costs.36 The parliamentary debates are quite illuminating as to the concerns of politicians in introducing the new tax. Thomas Lough MP, a Liberal representing a London constituency but hailing from Cavan in Ireland, asked the Chancellor of the Exchequer, Reginald McKenna, whether ‘the following businesses and professions will be included under the proposed taxes on excess profits: bankers, bill discounters, insurance companies, accountants, trades unions, friendly and co-operative societies, and all branches of the medical and legal professions’. To this long list, Mr McKenna shortly replied that detail would have to await publication of the Bill, but that ‘trades, manufactures, and business concerns (including agencies) assessable to Income Tax Schedule D are within the scope of the tax.’ Undeterred, Lough asked again, and McKenna replied, no doubt drily, that ‘I think any banker will know whether he is included under ­Schedule D or not. I do not think any banker or bill discounter will have the slightest doubt about it.’37 While a banker or bill discounter might not have had any difficulty, others did and the boundary of the tax was the subject of quite a lot of litigation.38 The essence of a tax on ‘excess’ profits is that normal must be distinguished from excess. In 1917, Stamp, writing generally about taxation of war profits, said ‘The potentiality of each group of assets is stereotyped at its pre-war



35 GR

Searle, Corruption in British politics, 1895–1930 (Oxford, Clarendon Press, 1987). and Oats, above n 34. 37 HC Deb 29 September 1915 vol 74 co 826–8826. 38 Ridd, above n 34. 36 Billings

Professional Status in Tax Law: The Case of Leopold Maxse  313 results, which are assumed to be what were right and proper in its particular circumstances. There is, however, little to show how far such basic considerations have really been responsible in the general systems actually in force.’39 In sum, therefore, the stereotype of normal informed, in an entirely quantitative manner, the concept of excess. The malleability of normal, (and by extension, excess), was noted by Stamp,40 who recognised that taxpayers had an economic incentive to raise pre-war profits, and so reduce excess profits duty and who had, in several cases, sought not to take pre-war deductions. The difficulty of pinning down the elusive excess is recognised by allowing the Inland Revenue to alter the pre-war standard of profits where ‘the amount of capital actually employed in the trade or business is, owing to the nature of the trade or business, small compared with the capital necessarily at stake for that trade or business, by reference to some factor other than the capital of the trade or business or to some additional factor’.41 This was to be done on a sectoral basis, rather than on an individual basis, and the newly formed Board of Referees,42 composed of ‘persons sufficiently experienced in general business to appreciate the issues involved’,43 was given the task of reducing (not increasing) the capital used in particular sectors. Excess profits duty was fiscally innovative insofar as it was the first time a company was charged separately from its shareholders.44 It was intended to be temporary, which left the British government with a problem as, by 1918/19, it produced a net revenue of £284 million, or 36 per cent of the total revenue of central government.45 In fact, it was repealed in 1921. Turning to a more detailed examination of the reasons for the introduction of the tax, paying for the war was a clear motivation in the introduction of the excess profits duty. Fighting a war is a drain on national resources,46 and many jurisdictions introduced a war profits tax.47 This much is clear. Yet D ­ aunton describes taxation under consideration in 1915 as much for political as for financial reasons.48 There was a perception of profiteering, which was injurious to national solidarity. During a parliamentary debate in April 1915, William Anderson, Labour MP for Sheffield Attercliffe, brought to public attention the case of ‘Messrs. Spillers and Bakers, the Cardiff milling firm, … issued a balance 39 JC Stamp, ‘The taxation of excess profits abroad’ (1917) 27 The Economic Journal 26, 34. 40 JC Stamp, Taxation During the War (London, Milford, 1932). 41 F (No 2) A 1915 s 42. 42 D De Cogan, L Oats and M Billings, ‘The Board of Referees: “A Most Useful Addition to Fiscal Machinery”’ in P Harris and D De Cogan (eds) Studies in the History of Tax Law (Oxford, Hart, 2015). 43 Stamp, above n 40, 170. 44 S Broadberry and M Harrison, The Economics of World War I (Cambridge, Cambridge University Press, 2005). 45 Daunton, above n 34. 46 Broadberry and Harrison, above n 44. 47 Stamp, above n 39. 48 M Daunton, Just Taxes: The Politics of Taxation in Britain, 1914–1979 (Cambridge, Cambridge University Press, 2007).

314  Emer Hunt sheet showing a profit of £367,865, as against £89,352 for the previous year’,49 and asking what action was proposed by the government in regard to rising food and coal prices. Tim Healy, Irish MP for Cork North East asked ‘What we want to know is – this is a serious matter – how long this gang is to be allowed to sweat the faces of the poor, while the common people are giving their blood for the country. Why are the Government not taking any action in this matter?’50 Patriotic fervour was often expressed as a hatred of war profiteers, and was articulated by many.51 The poet Wilfred Owen, who was to die in November 1918, expressed it venomously in a 1918 letter to his mother: ‘I wish the Boche would have the pluck to come right in & make a clean sweep of the Pleasure Boats, and the promenaders on the Spa, and all the stinking Leeds & Bradford War-profiteers now reading John Bull on Scarborough Sands’.52 Profiteers were the enemy within, and the aim of deterring profiteering during wartime was one with which varying political interests could agree, albeit for complex and disparate motives.53 Indeed, the political critics of war profiteering have been divided into ‘four main groups: Socialists, Tory aristocrats, intellectual Liberals, and the Radical Right’.54 A view that the war disentitled the taxpayer to make additional profits is identified by Lord Hanworth, in a judgment in 1927, who found that the tax was ‘to secure to the Revenue a portion of the profits being made in the course of the War which were said to be enhanced by the circumstances of the War and, being so enhanced, to be beyond the sum which the subject was entitled to keep free of taxation, inasmuch as he ought not to be entitled to make a larger profit due to the misfortune of the nation at large in being at war’.55 Lord Hanworth writes in terms of entitlement – a taxpayer is not entitled to make additional profits during the misfortune that is war – whereas James views this as an articulation of a moral and patriotic duty to pay excess profits duty.56 Notwithstanding the ‘misfortune of the nation at large in being at war’,57 there were many taxpayers who, evidently, felt entitled to challenge an a­ ssessment to excess profits duty. Among the many litigants58 challenging excess profits duty is Leopold Maxse who, despite his long career as a proponent of rearmament and war to counter German militarism, did not seem to recognise an assessment to excess profits tax as an occasion of any moral or patriotic duty. 49 HC Deb 29 April 1915 vol 71 cols 811–16. 50 ibid. 51 J Maltby, ‘Showing a strong front: Corporate social reporting and the “business case” in Britain, 1914–1919’ (2005) 32 The Accounting Historians Journal 145. 52 J Breen, Wilfred Owen (Routledge Revivals): Selected Poetry and Prose (London, Taylor & ­Francis, 2014) 160. 53 Maltby, above n 51. 54 Searle, above n 35, 289. 55 Birt, Potter & Hughes v CIR [1927] 12 TC 976, 990. 56 M James, ‘Humpty Dumpty’s guide to tax law: Rules, principles and certainty in taxation’ (2010) 21 Critical Perspectives on Accounting 573. 57 Birt, Potter & Hughes v CIR, above n 55, 990. 58 See generally on litigation in relation to excess profits duty, Ridd, above n 34.

Professional Status in Tax Law: The Case of Leopold Maxse  315 IRC v MAXSE

The facts of the case are reasonably quickly recited. Maxse was the editor, journalist and proprietor of the National Review. It appears from the report of the case that the reasons for Maxse generating excess profits are twofold: first, Maxse wrote the vast bulk of the National Review during the war, whereas prior to the war he had paid contributors as well as writing himself; and, secondly, practically no capital was needed to produce the magazine during the war. Reduced expenses to other contributors, together with a reduction in the utilisation of capital from the pre-war period, resulted in increased profits and, therefore, liability for excess profits tax.59 The lucid pastures of the National Review did not ‘sweat the faces of the poor’,60 but liability to excess profits duty was based on quantum of profits, not on any motivation to profit from the war. Maxse was assessed to excess profits duty of £1,000 for the year ending 31  May 1915 and appealed against this assessment on the basis that he fell within the exemption for professions contained in section 39(c) Finance (No 2) Act 1915.61 It is worth repeating the exact exemption provided for in section 39(c) Finance (No 2) Act 1915. A person ordinarily resident in the United Kingdom, carrying on a trade or business in the United Kingdom was liable to excess profits duty excepting: any profession the profits of which are dependent mainly on the professional qualifications of the person by whom the profession is carried on and in which no capital expenditure is required, or only capital expenditure of a comparatively small amount, but including the business of any person taking commissions in respect of any transactions or services rendered, and of any agent of any description (not being a commercial traveller, or an agent whose remuneration consists wholly of a fixed and definite sum not depending on the amount of business done or any other contingency).

The exclusion from the exception is not felicitously drafted – ‘puzzling’62 was one way in which it was described – and was the subject of some litigation.63 A profession can be seen as a subset of a business or, as Rowlatt J put it: ‘All professions are businesses, but all businesses are not professions.’64

59 F (No 2) 1915 s 42(2). The report of the judgment in Maxse states ‘At the present time practically no capital was required for the carrying on of a magazine’: Maxse, above n 4, 648. 60 HC Deb, above n 49. 61 Maxse, above n 4. 62 per Scrutton LJ, Robbins v CIR [1920] 2 KB 677, 689. 63 Barker & Sons v CIR [1919] 2 KB 222, Burt v IRC [1919] 2 KB 650, Currie v CIR [1920] 1 KB 801, Durant v CIR (1921) 12 TC 245. 64 Barker & Sons v CIR, above n 63.

316  Emer Hunt The court heard that Maxse wrote a large part of the National Review, and that the sales of the magazine were largely due to the popularity of his writings. The Revenue contended that Maxse was quite different from a journalist who is paid for his contribution, and does not have an interest in the profits of the magazine. Sankey J, in the High Court,65 held that Maxse could not be said to be carrying on a profession, as he was in the business of selling a commodity in the open market. Maxse appealed. In the Court of Appeal, there was unanimous agreement that Maxse was a journalist, an editor and a publisher and that it was possible to sever the role of journalist and editor, professions, from the role of publisher, a trade. This was not expressly provided for in the legislation, but objections to severance of the roles by the Crown were dismissed by the Court of Appeal. Profits of a profession were exempt from excess profits duty, whereas profits from publication of the magazine would be subject to excess profits duty. Swinfen Eady MR opined that a ‘fair and reasonable sum’ should be deducted in respect of payment to Maxse as journalist and editor, and Scrutton LJ said that ‘no fictitious or artificial operations’ should reduce the amount subject to excess profits duty, and that regard should be had to the overall profitability of the magazine. No publisher would continue a magazine without remuneration, noted Scrutton LJ, and the profits could not be siphoned out through excessive deductions to Maxse, as journalist and editor. Interestingly, both Swinfen Eady MR and Warrington LJ refer to the fact that severance of profits between trade and profession had been proposed, but rejected by the Crown. There is a somewhat smug footnote from the National Review, where the judgment of the Court of Appeal is welcomed but the point made that the proposal for severance had been made by Maxse prior to litigation, but rejected by the Solicitor-General.66 The interesting articulation of the meaning of profession is to be found in the judgment of Scrutton LJ, where he states that a comprehensive definition might not be possible. Having demurred from certainty, Scrutton LJ goes on to say that a profession involves ‘the idea of an occupation requiring either purely intellectual skill, or of manual skill controlled, as in painting and sculpture, or surgery, by the intellectual skill of the operator, as distinguished from an occupation which is substantially the production or sale or arrangements for the production or sale of commodities. The line of demarcation may vary from time to time. The word “profession” used to be confined to the three learned professions, the Church, Medicine and Law. It has now, I think, a wider meaning. It appears to me clear that a journalist whose contributions have any literary form, as distinguished from a reporter, exercises a “profession”; and that the editor of a periodical comes in the same category.’67 Maxse, the proprietor publisher, was liable for excess profits duty whereas Maxse, the journalist and editor, was not.

65 CIR

v Maxse [1918] 2 KB 715 (HC). National Review, vol 73 (London, WH Allen, 1919) 836. 67 CIR v Maxse, above n 4, 657. 66 The

Professional Status in Tax Law: The Case of Leopold Maxse  317 There is other case law on the exemption within section 39 for profits from a profession. In Burt v IRC,68 the question arose as to whether agents and market advisers for the UK distribution of foreign products came within the exemption from excess profits duty under section 39. This was ultimately a question of fact as to how the agents were remunerated, and they were paid a fixed annual sum, plus commission, and so were held liable to excess profits duty. Scrutton LJ again opined on the meaning of professional, saying: ‘If it be treated as a profession, whatever may be the limitation of a profession, I do not think it applies to the exercise of commercial knowledge in connection with the sale of goods, or export or import of goods.’69 It was on this ground that Rowlatt J also found that stockbrokers are not professionals.70 Rowlatt J also decided that it was of the essence of a profession that the profits should be dependent mainly upon the personal qualifications of the person by whom it is carried on, and that can only be an individual and not, in that case, a company carrying on a business of naval architects.71 Professional status was not a matter of professional qualification, at least in principle.72 This may be an opportune moment to consider Thomas E Scrutton, judge of the Court of Appeal, and seek the background to the elevator of intellectual skill beyond commercial knowledge. Scrutton was alert to the requirements of impartiality and in advance of contemporaneous thinking in that he recognised the implications of both conscious and implicit partiality.73 Admired by the legal theorist, Karl Llewellyn, Scrutton was described by him as having a ‘hound-nose flair for sense and practice’.74 As an experienced revenue judge, Scrutton had a history of checking executive power and had been involved in challenges to the system of land valuation introduced in the Finance (1909–10) Act 1910,75 where he found against the state and in favour of the taxpayer. These were judgments of financial import, noted by The Times: ‘It is hardly possible to overrate the economic and political importance of these decisions by the High Court’,76 and there was a degree of fiscal confusion after the judgments.77 This is a judge at the heart of the British establishment, experienced in tax matters, and alert to the implications of taxing overreach by the executive.78 He was, perhaps,

68 Burt v IRC, above n 63. 69 ibid 668. 70 Barker & Sons v CIR, above n 63. 71 William Esplen, Son and Swainston, Limited v CIR [1919] 2 KB 731. 72 Currie v CIR, above n 63, Durant v CIR above n 63. 73 D Foxton, The Life of Thomas E Scrutton (Cambridge, Cambridge University Press, 2013). 74 ibid, 267. 75 CIR v Smyth [1914] 3 KB 406. 76 The Times, 2 March 1914, editorial, page 7. 77 Foxton, above n 73. 78 In AG v Wiltshire United Dairies Ltd (1921) 37 TLR 884, Scrutton LJ specified that clear words were needed before it could be concluded that Parliament had delegated its power to tax to the executive, stating that ‘excessive claims by the Executive Government are, at the present time, quite as dangerous and require as careful consideration and restriction from the Courts of Justice’.

318  Emer Hunt an apt student of distinction, being himself conscious of the impact of class, telling Cambridge University law students that ‘It is very difficult sometimes to be sure that you have put yourself into a thoroughly impartial position between two disputants, one of your own class and one not of your class.’79 Unfortunately, the exact criteria whereby Scrutton might recognise his own class are not known but, on the evidence of his judgments, he had a highly nuanced view of intellectual skill; journalists and editors had it, commercial agents and reporters did not.80 Manual labour is not an indicator one way or the other,81 nor is the absence of professional qualifications.82 CONTESTING THE PROFESSIONAL

The historical antecedents of the distinction, for tax purposes, between professionals and other occupations lie in the schedular system of taxation. This was the bedrock of the taxing model espoused by Addington in 1803, as it provided for the categorisation of income, and the imposition of tax on each category.83 Both trades and professions were charged under Schedule D, Cases I and II respectively. It is a necessary feature of the schedular system of taxation that different sources of income be described and categorised differently. Addington’s classification of income into schedules was remarkably enduring.84 The curiosity is that the distinction between professionals and traders was continued into excess profits duty and beyond.85 Mallet and George note that critics of the tax emphasised the injustice of excluding professional income.86 They cite the Chancellor of the Exchequer as saying that few professionals were expected to exceed the £200 de minimis limit below which excess profits duty was not leviable, and that the income of professionals was consequent upon their ‘energy, brain power and health’ rather than capital.87 In this reference to health and energy, there is a resonance of the longstanding debate about the equity of taxing different types of wealth and income; earned income being reliant upon the absence of ill-health or trade depression, whereas unearned income was supported by more robust and enduring

79 TE Scrutton, ‘The Work of the Commercial Courts’ (1921) 1 CLJ 6, 8. 80 Maxse, above n 4, Burt v IRC, above n 63. 81 Maxse, above n 4. 82 In Currie v CIR the taxpayer was an income tax repayment agent, not a member of any professional body. Rowlett J held that he was carrying on ‘a purely intellectual occupation, dealing with figures, as to which he has experience and knowledge’: Currie v CIR, above n 63, 806. 83 BEV Sabine, A History of Income Tax (London, Allen & Unwin, 1966). 84 Lord Colwyn, Report of the Royal Commission on the Income Tax (Cmd 615, 1920). 85 This is despite the question posed by Thomas Lough MP raising the possibility of excess profits duty applying to ‘all branches of the medical and legal professions’: see above n 37. 86 B Mallet and CO George, British Budgets: Second Series, 1913–14 to 1920–21 (London, ­Macmillan and Company, 1929). 87 ibid 87.

Professional Status in Tax Law: The Case of Leopold Maxse  319 capital assets.88 In the reference to professionals possessing brain power, we hear an echo of Scrutton LJ’s bifurcation of occupation according to the possession of intellectual skill. Furthermore, a de minimis limit, if there is to be one, can in principle apply to all businesses and not all businesses are capital-intensive. Other businesses, presumably, also relied upon energy, brain power and health. Above all, there is nothing pre-ordained above dividing occupations into professionals and others. There are no persuasive tax policy reasons for the differing categorisations of professionals and traders ‘which developed out of historical, nontax rationale’.89 The unexamined distinction persisted through the general review of income tax by a Royal Commission in 1919/192090 but, once again, there is implicit acceptance of the otherness of professions. When considering taxation of overtime payments, and responding to representations that these should be untaxed,91 there is reference to the work ethic of the professional producing financial reward: ‘many a professional man works abnormally long hours and so earns a larger income’.92 The implication is that only professional men would work long hours by inclination; others might be required to do overtime. This reference to a larger income ensuing from hard work is viewed by Tawney as a by-product of professional activity. Writing in 1920, Tawney emphasised the beneficent example that professionals would exercise: an absence of speculative motive, pecuniary self-interest and the taming of the excesses of capitalism. He wrote: The difference between industry as it exists to-day and a profession is … is simple and unmistakable. The essence of the former is that its only criterion is the financial return which it offers to its shareholders. The essence of the latter, is that, though men enter it for the sake of livelihood, the measure of their success is the service which they perform, not the gains which they amass … The meaning of their profession, both for themselves and for the public, is not that they make money but that they make health, or safety, or knowledge, or good government or good law. They depend on it for their income, but they do not consider that any conduct which increases their income is on that account good.93

There is a resonance of this distinction, the otherness of professions, in the literature of the nineteenth century.94 So for instance, Jane Austen, social commentator 88 M Daunton, Trusting Leviathan: The Politics of Taxation in Britain, 1799–1914 (Cambridge, Cambridge University Press, 2007). 89 L Burns and R Krever, ‘Individual income tax’ in V Thuronyi (ed) Tax Law Design and Drafting, vol 2 (Washington DC, IMF, 1998) 495, 525. 90 Colwyn, above n 84. 91 This was described as a subject about which ‘a considerable amount of feeling exists’: ibid 21. 92 ibid 22. 93 RH Tawney, The Acquisitive Society (New York, Harcourt, Brace and Howe, 1920) 94. 94 For a defence of the use of contemporaneous literature in historical analysis as effective evidence of social mores, see, for example, J Rutterford and J Maltby, ‘Frank must marry money: men, women, and property in Trollope’s novels’ (2006) 33 Accounting Historians Journal 169, J Frecknall-Hughes and M McKerchar, ‘Tax and the Tax Profession: Assessing Social Standing and Prestige’ in P Harris

320  Emer Hunt par excellence, writes delicately of the Bingley sisters: ‘The Netherfield ladies would have had difficulty in believing that a man who lived by trade, and within view of his own warehouses, could have been so well-bred and agreeable.’95 This is a delicious irony, as the reader has imbibed the lower social caste of the same Bingley sisters through references to the slightly disreputable source of their own family wealth as also being in trade from the north of England. The entire plot of Dickens’ Great Expectations is based on Pip’s upward mobility from the trade of blacksmith to the heights of law, ironically facilitated by a convict, Magwitch. Richard Carstone, the pathetic naïf of Bleak House, flits between choosing professions: doctor, soldier, lawyer. That some occupations were less valuable than others was pithily expressed by Burke, where he defends the making of such a distinction: ‘The occupation of a hairdresser or of a working tallow-chandler cannot be a matter of honour to any person – to say nothing of a number of other more servile employments. Such descriptions of men ought not to suffer oppression from the state; but the state suffers oppression if such as they, either individually or collectively, are permitted to rule.’96 Margaret Hale, the heroine of North and South, by Gaskell, is revealing of views towards trade – in this case coachmakers – when she asks her mother: ‘Are those the Gormans who made their fortunes in trade at Southampton? Oh! I’m glad we don’t visit them. I don’t like shoppy people. I think we are far better off, knowing only cottagers and labourers, and people without pretence.’ ‘You must not be so fastidious, Margaret, dear!’ said her mother, secretly thinking of a young and handsome Mr. Gorman whom she had once met at Mr. Hume’s. ‘No! I call mine a very comprehensive taste; I like all people whose occupations have to do with land; I like soldiers and sailors, and the three learned professions, as they call them. I’m sure you don’t want me to admire butchers and bakers, and candlestick-makers, do you, mamma?’97

The geographical and cultural journey of the novel moves from the soft south to the industrious and commercial north. The profession is viewed as an exalted calling, and Frederick Hale is criticised by the newspapers for his mutinous behaviour in the Royal Navy as being a ‘traitor of the blackest dye’, ‘a base, ungrateful disgrace to his profession.’98 George Osborne, son of a tallow merchant but educated for the ‘learned professions’,99 woos Amelia Sedley in Vanity Fair by likening her to a lady, and

and D de Cogan (eds), Studies in the History of Tax Law vol 7 (London, Bloomsbury Publishing, 2015). For an examination of trades and professions in the novels of Jane Austen, see ‘Tax and Taxability: “Trade, profession or vocation” seen through the eyes of Jane Austen’, discussed by John Avery Jones in ch 5 of this book. 95 J Austen, Pride and Prejudice: A Novel in Three Volumes (London, T Egerton, 1813) 16. 96 E Burke, Reflections on the Revolution in France (London, J Sharpe, 1821) 69. 97 EC Gaskell, North and South (London, Chapman & Hall, 1855) 23. 98 ibid 166. 99 WM Thackeray, Vanity Fair: A Novel Without a Hero (Philadephia, JB Lippincott, 1866) 474.

Professional Status in Tax Law: The Case of Leopold Maxse  321 evincing unease at the tallow trade ‘… “our trade,” George said, with an uneasy laugh and a blush. “Curse the whole pack of money-grubbing vulgarians!”.’100 Contrast this with Galsworthy’s description of Soames Forsyte in The Forsyte Saga: ‘Tradition, habit, education, inherited aptitude, native caution, all joined to form a solid professional honesty, superior to temptation – from the very fact that it was built on an innate avoidance of risk.’101 This is a highly partial account of the portrayal of occupation in a sparse sample of novels; it is a colourful selection, rather than systematic. It does, however, provide a context for the drawing of a distinction in tax law between professions and other occupations. THE EXCEPTIONALISM OF PROFESSIONALS: EXCESS PROFITS DUTY

We now have two points which are potentially relevant to the analysis of the exceptional status of professionals; the first is the longevity of the distinction between professionals and others, which dates to the inception of income tax in 1803 and is discernible in literature; the second is the historical, non-tax rationale for the distinction. That the distinction endured for so long recalls to mind Schumpeter’s rationale for studying the history of tax law. Writing in the immediate aftermath of the first world war, Schumpeter wrote: ‘The spirit of a people, its cultural level, its social structure, the deeds its policy may prepare – all this and more is written in its fiscal history, stripped of all phrases. He who knows how to listen to its message here discerns the thunder of world history more clearly than anywhere else’.102 Fiscal demands are the first sign of life of the modern state. Likhovski considers Schumpeter’s view of taxation as both a symptom and a cause of societal change and argues that this is a false dichotomy but that, instead, law and culture are mutually constitutive. In this way, tax law reflects the culture of society, embedding ‘unconscious notions about the proper relationship between individual and state, about the scope of rights and duties of taxpayers, and about the purpose of social institutions such as the family, corporations, or the market’.103 Kornhauser sees tax law as a rhetorical presence, signalling conflicting views of society on attitudes to wealth.104 Daunton writes about fiscal policy defining, as well as expressing, identities.105 What is interesting about excess profits duty is that the boundary between professional and non-professional, included and excluded, is so fiscally consequential, both for the taxpayer and the state. 100 ibid 163. 101 J Galsworthy, The Forsyte Saga. The Man of Property (New York, C. Scribner’s Sons, 1928) 208. 102 JA Schumpeter, ‘The crisis of the tax state’ in JA Schumpeter, The Economics and Sociology of Capitalism, R Swedburg (ed) (Princeton NJ, Princeton University Press, 1991) 101. 103 Likhovski, above n 7, p856. 104 Kornhauser, above n 7. 105 Daunton, above n 48.

322  Emer Hunt A theoretical explanation for this longstanding, non-tax rationale might be found by examining the distinct position of professions in modern society. This is a large topic, where agreement on what constitutes a professional is as hard to find106 as agreement on the ineluctable essence of professionalism.107 We are concerned here only with seeking a theoretical understanding whereby intellectual skill informs professional status, and where others are excluded from favourable tax treatment by virtue of not possessing such intellectual skill. We have seen how Scrutton LJ crafted this exclusion in reasonably subtle terms – the absence of manual labour not being sufficient to qualify for professional status, nor the presence of manual labour so disqualifying.108 It is not a formalistic requirement as professional membership was not necessary.109 These inchoate criteria inevitably create an area of inclusion/exclusion and the necessity of identifying on which side of the line taxpayers fall. Scrutton LJ, and his associate, Rowlatt J, scythed through the war occupations to decide which was included, and which excluded. A reporter does not, seemingly, exercise sufficiently ‘purely intellectual skill’ to enter the confines of a profession.110 Nor does a stockbroker,111 nor somebody skilled in the importation of goods,112 nor an insurance broker.113 A schoolmaster, on the other hand, has the requisite skill and experience to be a professional and thus benefit from the exemption from excess profits duty, notwithstanding that he was at once the owner of, and worker in, the school.114 So too does an income tax repayment agent, despite having no professional qualifications.115 Conceptualising professions as excluding others correlates with Luhmann’s diagnosis of the functional differentiation of modern society, dating from the eighteenth century,116 as producing ‘a stark difference between inclusion and exclusion’ which could be confused with a pronounced form of social ­stratification.117 Luhmann sees functional differentiation as an organisational principle of a later evolutionary date than a stratified society, although the

106 For an overview of tax practitioners ascending to professional status, see Frecknall-Hughes and McKerchar, above n 94; J Frecknall-Hughes and M McKerchar, ‘Historical perspectives on the emergence of the tax profession: Australia and the UK’ (2013) 28 Austl Tax F 275. 107 See, in relation to the legal profession, HM Kritzer, ‘The Professions Are Dead, Long Live the Professions: Legal Practice in a Postprofessional World’ (1999) 33 Law & Society Review 713, M Deflem, Sociology of law: Visions of a scholarly tradition (Cambridge, Cambridge University Press, 2008). 108 Maxse, above n 4. 109 Currie v CIR, above n 63. 110 ibid. 111 Barker & Sons v CIR, above n 63. 112 Burt v IRC, above n 63. 113 Durant v CIR, above n 63. 114 IRC v North and Ingram [1918] 2 KB 705. 115 Currie v CIR, above n 63. 116 N Luhmann, ‘Differentiation of Society’ (1977) 2 The Canadian Journal of Sociology/Cahiers canadiens de sociologie 29. 117 Luhmann, Ziegert and Kastner, above n 9.

Professional Status in Tax Law: The Case of Leopold Maxse  323 purity of this development is apparently muddied by the evidence of case law and literature, where professional status has both a (reasonably) distinct function, but is also (possibly) a marker of class and exclusivity. Exclusivity implies both inclusion and exclusion: a profession is formed on the basis of membership, ie meeting conditions and exercising functional competence.118 Thus the very essence of a profession is to exclude, although the mechanics of exclusion are often arcane. Braeckman argues that organisations, of which professions are a subset, mediate the societal exclusion of individuals from the ostensibly accessible functional systems of law, politics etc.119 Luhmann puts it thus: ‘To the extent that inclusion conditions are specified as a form of social order, however, the opposite can also be identified, namely, who is excluded’.120 Stichweh utilises this ‘inclusion-exclusion’ distinction to divide members of society into professions and clients.121 Professionals have one function, and each profession is (at that time) pre-eminent in its own functional sub-system. So, for example, lawyers are the professionals, or high priests, of the legal system, doctors of the medical system and so on. Non-professionals are excluded from this function but form the clientele for the professional.122 At a theoretical level, such a conceptualisation of professionals as the included, the chosen or the elect, and the non-professionals as their clientele, has explanatory, if not empirical value.123 Bearing in mind the distinction between excluded and included, we can now turn to the drawing of the boundary; the crafting of a marker to give effect to this distinction. The core profession of each subsystem is dependent upon its ‘action-oriented knowledge system on scientific foundations’.124 Leaving aside the somewhat nebulous requirement for scientific foundations, the delineation of which would require unpicking the ontological claims of science, Stichweh himself acknowledges that claims for scientific foundations vary according to geography and history.125 While casting doubt on whether any single profession can continue to dominate a functional system, and noting that media is rendering knowledge more diffuse, Stichweh sees a profession as possessing a corpus of specialised knowledge with an intellectual foundation.126

118 A Braeckman, ‘Niklas Luhmann’s systems theoretical redescription of the inclusion/exclusion debate’ (2006) 32 Philosophy & Social Criticism 65. 119 ibid. 120 N Luhmann and R Barrett, Theory of Society (Stanford CT, Stanford University Press, 2013) 18. 121 Stichweh, above n 9. 122 ibid; Luhmann, Ziegert and Kastner, above n 9. 123 Doubt has been cast on the usefulness of systems theory in detecting or analysing particular social problems. See, for example, Braeckman, above n 118, H Rottleuthner, ‘A Purified Sociology of Law: Niklas Luhmann on the Autonomy of the Legal System’ (1989) 23 Law & Society Review 779. 124 Stichweh, above n 9, 97. 125 ibid, 98, where Stichweh sees social work as institutionalised altruism without any claim to ­scientific knowledge. 126 ibid.

324  Emer Hunt Exploring this intellectual foundation, Stichweh sees the essence of a profession, separate from other occupations in the crafts and trades, as possessing a ‘learned knowledge’127 which gives rise to professions’ most ‘contested a­ ttribute’: a disinterestedness that is to dominate personal and financial interests.128 This is professionals as men worthy of their hire: honest, educated, competent, trustworthy ethical and disinterested.129 Stichweh puts it thus: ‘orientation to clients, possession of an intricate knowledge system, service ideals, claims to professional monopolies’.130 This could be Soames Forsythe, a superior professional man with a special place in the tax system. At a superficial level, such intellectual foundation is not dissimilar to ­Scrutton LJ’s adherence to ‘intellectual skill’ as a marker for professional status and commercial knowledge, dismissed by Scrutton LJ as a marker of a profession, perhaps lacking the presumed rigour of a scientific foundation. A further similarity is Stichweh’s examples of professionals,131 which resembles those of Scrutton LJ insofar as he refers to law, medicine and the church, education and the military. On this basis, taxing a taxpayer designated as a professional, in place since 1803, both reflected an existing identity, but also developed that identity through distinguishing professionals from other occupations. A resonance of this d ­ istinction is to be found in Scrutton LJ’s rhetorical doubtfulness as to the ambit of professions: the ‘I think’ that there exists a wider meaning of profession immediately precedes a casting out of a reporter from the ambit of professional.132 The nuances of these judgments provide a truly fascinating insight into the distinctions read into occupations by society, acting through the judiciary as proxy. That such a financial benefit could follow an assessment of occupation as requiring an intellectual skill necessitates an acceptance that professionals were indeed elevated beyond the trader, or person carrying on a business, who, in the judgment of Scrutton LJ did not possess intellectual skill. CONCLUSION

Leopold Maxse succeeded in his tax case and his own verdict, quoted at the beginning of this paper, is that ‘needless to say’, he did not wish to evade tax, but could not acquiesce in the Revenue’s interpretation of the law. There is a certain irony in the Germanophobe Maxse, champion of the inevitability of war, denouncer of the ‘international financiers’ who were not 127 ibid, 95. 128 ibid. 129 EC Hughes, ‘The Professions in Society’ (1960) 26 The Canadian Journal of Economics and Political Science/Revue canadienne d’Economique et de Science politique 54. 130 Stichweh, above n 9, 97. 131 ibid, 95. 132 Maxse, above n 4, 657.

Professional Status in Tax Law: The Case of Leopold Maxse  325 helpful to Britain’s fund-raising capacity,133 argued against liability to pay a war tax. While, to quote Maxse, ‘needless to say’ a taxpayer enjoys rights of appeal against an assessment to tax, it is somewhat disingenuous to conclude that paying excess profits duty would have meant that Maxse was denied a salary.134 This would not have been the case: Maxse was arguing that his ability to decide on the form of his return on his investment (broadly defined, financial and occupational) should not dictate his tax treatment for the purposes of computing excess profits duty. In this argument, he was successful: the Court of Appeal accepting the principle and merely pointing out that the sums deducted, for the purposes of computing the duty, should be ‘reasonable’135 and not ‘fictitious or artificial’.136 So much for the technical basis of the judgment; we can now move to consider any wider points that Maxse’s case might illustrate. At its most basic, the case provided a taxpayer, carrying out a particular function, with a financial advantage. The observation of inclusion and exclusion, and the articulation of the boundary by Scrutton LJ, is a vignette of how distinctions in function and occupation are reinforced through the long extant recognition of such distinction in succeeding tax laws.137 Taxpayers are differentiated, some included, and most excluded, in an example of the tax system paying homage, and reinforcing, the functional differentiation of modern society. Nonetheless, the pains of differentiation are to be found in the value-laden interpretation of ­professionals – Scrutton LJ himself recognised the importance of class.138 This renders the financial benefit quite hard to predict, dependent as it is on intellectual skill – commercial knowledge not being enough. It is indeed tempting to conflate professional status with class, and to view the elevation of professionals within the tax code as an example of legislative and judicial obeisance towards class. This approach is possibly bolstered by historical, non-tax rationale139 for the distinction between professions and other occupations. It might also be discerned from the absence of reported argument on the meaning of ‘personal qualifications’ in section 39: the Court of Appeal was apparently not even invited to consider limiting personal qualifications to those professions which required qualifications (law, medicine, clergy).140 Professional status was accepted as being denatured from professional qualifications, and was instead equated to the more subjective, nebulous possessor of intellectual skill. 133 The National Review, vol 60 (London, WH Allen, 1912–13). 134 The National Review, vol 73 (London, WH Allen 1919) 836. 135 Per Warrington LJ, Maxse, above n 4, 656. 136 F (No 2) A 1915, s 44(3). 137 MA Livingston, ‘Law, Culture, and Anthropology: On the Hopes and Limits of Comparative Tax’ (2005) 18 Canadian Journal of Law & Jurisprudence 119; Likhovski, above n 7. 138 Scrutton, above n 79. 139 Burns and Krever, above n 89, 525. 140 Counsel for the Inland Revenue Commissioners are reported in the High Court proceedings as accepting that journalism was a profession; CIR v Maxse, above n 65, 717.

326  Emer Hunt It is invidious to cull such a personal selection of literature, and assert an awareness of the status of professions. Nonetheless, the culturally amorphous respect for professions, evident throughout the literature referred to, can be advanced to Scrutton LJ’s snobbish, and financially consequential, rejection of stockbrokers, agents and reporters as achieving the status of professionals. By his own assessment, professions relied upon some intellectual skill, but by implication, other occupations lacked intellect. What can be gleaned from the historical and social context in which excess profits duty was introduced is the exceptionalism of professionals; the high status in which they were held in the early twentieth century was at the expense of other occupations – trades and non-professional businesses. It was given effect to in the Finance (No 2) Act 1915 and led to argument, with fiscal effect, as to the boundary of professions.

12 The UK Capital Gains Tax: The Conception of the 1965 Act DAVID COLLISON

ABSTRACT

The 1965 UK capital gains tax has a basis in a concept of gains being a category of income and a concept of integrated taxation. This paper looks at how these concepts developed and influenced political thought. The origin of official consideration of a tax charge on gains is identified in the 1920 Inland Revenue Departmental Report. Using the personal papers of the socialist economist Nicholas Kaldor, the paper considers the development of the ideas on taxing gains. Kaldor was a direct influence on James Callaghan, the Chancellor of the Exchequer who introduced the 1965 Act. The history continues with the Memorandum of Dissent to the 1955 Royal Commission on the Taxation of Profits and Income, written by the Labour Party members of the Commission, and which a Conservative Treasury minister found ‘most convincing’ in its advocacy of a tax on gains. Over the subsequent 10 years, both Labour and Conservative governments considered enacting a tax charge. The paper concludes with a consideration of the tax charge that was enacted and how the UK tax charge differs from the broad-based concept of taxing gains as income. Detail is given of the arguments within the Treasury that illustrate the tension between principle and politics. Comments are made on how this tension is inherent in the 1965 tax. Subsequent writings are proposed to show how the competing pulls of principle and politics led to fundamental subsequent changes to the formulation of the tax.

328  David Collison INTRODUCTION

O

n 6 April 1965, James Callaghan, in his Budget speech, announced that capital gains made from that day would be subject to a new tax, called capital gains tax. This paper looks at the discussions, arguments and events that led to the birth of this new tax.1 The introduction of a tax charge on capital gains generally was not a surprise in 1965. The Labour Party, led by Harold Wilson, won the election on 15 October 1964, having stated in its election manifesto: ‘We shall tax capital gains; and block up the notorious avoidance and evasion devices that have made a mockery of so much of our tax system.’ Only 27 days after the election, James Callaghan, Chancellor of the Exchequer, delivered his Autumn Statement and told the House that the 1965 Finance Bill would contain provisions for taxing capital gains arising on assets, whenever they had been acquired.2 In his Budget speech, Jim Callaghan described the failure to tax capital gains as ‘The greatest blot on the existing system of direct taxation.’3 Taxing capital gains was a central plank of Labour Party fiscal policy, as declared in its 1964 election manifesto. But the history of the conception of the UK tax shows that both major parties had leading politicians supporting the taxation of capital gains and others opposing the concept. In 1955, Edward Boyle, Conservative Economic Secretary to the Treasury wrote to his senior colleague that he considered the arguments advanced by the socialist economist Nicholas Kalder for taxing capital gains ‘most convincing.’4 Both Winston Churchill5 and Harold Macmillan6 showed that they were not against the principle of taxing gains. Within the Labour movement, Hugh Dalton, former Labour Chancellor of the Exchequer in the Labour government, wrote that he was ‘still unconvinced’ of the case for a capital gains tax. ‘It might easily turn out to be another case of much cry and little wool.’7 Co-founders of the Fabian society, Sidney and Beatrix Webb, had, also, not been convinced of the need for a tax on capital gains.8

1 I do not regard the income tax charge to Sch D Case VII as a capital gains tax. It was an antiavoidance measure to tax speculation. In introducing this income tax charge on short-term gains in his 1961 Budget, Selwyn Lloyd declared that he had considered, and rejected, a capital gains tax, see below n 120. 2 Hansard HC 11 November 1964, vol 701, cols 1039–41. 3 Hansard HC 6 April 1965,vol 710, col 245. 4 PRO T171/471. For an interesting account of Boyle’s subsequent advocacy within government of taxing capital gains, see Stopforth, below n 94, 123–27. 5 See below n 102. 6 See below n 112. 7 Article in the New Statesman, 2 July 1955, 5. 8 N Kaldor Reports on Taxation I (London, Duckworth, 1980).

The UK Capital Gains Tax: The Conception of the 1965 Act  329 If not simply a creature of party political allegiance, what gave rise to the 1965 UK capital gains tax? I believe that the historical narrative supports the analysis that the conception of the tax was the coming together of three elements: 1. a theory of taxation that equates gain and income; 2. political will to establish a new tax; 3. popular demand for change. In 1965, these three elements came together and the UK capital gains tax was born. EARLY MOVES TO TAX CAPITAL GAINS

As well as its human cost, the First World War was a huge financial cost to Britain. Not only did the government spend enormous sums on fighting the war, but its income was reduced by industrial activity being limited by the workforce being sent away. A year after the armistice, the Inland Revenue was asked by the government, the Lloyd George Coalition, to look into possible new sources of tax revenue. In 1919 the Inland Revenue set up a Departmental Committee on New Taxation. The report published in 1920 includes the conclusions of a sevenmember sub-committee established to consider a tax on aspects of capital ‘in supplement to, or part substitution for, the income tax’. Representations to this sub-committee included the Valuation Officer for Reading proposing ‘a tax on capital profits arising from sales of houses and land … Collection by means of an additional Increment Value Duty’.9 A more detailed proposal was by H Ovenden, District Valuer for Finsbury Square. Under the heading ‘Tax on capital or casual profits’, he wrote: Scope Tax to fall on capital or casual profits not assessed to income tax, e.g. sale of property. Capital profit is to be regarded as amount by which the selling price exceeds the price of acquisition if purchased or exceeds the figure to which the property is valued for estate duty, or value if acquired by voluntary disposition. Profits up to, say, £10 exempt. Collection Vast bulk of property transformed [sic] by deeds, contract notes, transfers, receipts, or documents of some kind. Suggests ‘particulars delivered’ or ‘tax paid’ stamp be required to make such documents valid. Where no document is involved, e.g. sale of pictures, furniture, etc responsibility for accounting for the tax to be thrown on the purchaser.10 9 Board of Inland Revenue, Report of the Departmental Committee on New Taxation, 1920 (London, Inland Revenue, 1920) 65. Internal Departmental report, held in Centre for Tax Law, University of Cambridge. 10 IR (1920), above n 9, 106.

330  David Collison The 1920 Departmental Committee considered that taxing gains was ultra vires its remit, which was declared to be the consideration of a tax that is ‘complementary to the existing income tax’.11 However, the sub-committee recorded its opinion in the following Resolution: That yearly income does not of itself provide a completely just measure of ‘ability to pay’, and that an annual tax on capital, if workable, would mitigate some of the anomalies of the income tax charge.12

The report notes: With speculative investments, there is often no income, or only a small and inadequate income as compared with the capital invested. Accordingly a tax on annual income only does not sufficiently tax the capitalist in accordance with his ‘ability to pay’.13

A submission by McGowan, with numerical examples and a schedule of proposals, is submitted as an appendix to the report. This includes the proposal that a capital gains tax be imposed, based on annual accretion, not just realisation. McGowan wrote: Suggested Capital Accretions Tax All capital accretions and casual gains however arising should de facto be liable to a 50% capital accretions tax, i.e. a rate 10% lower than for income tax and supertax together. [An option to pay full income tax and super-tax is provided.] The tax would require to be paid within 12 months of the date of making the gain, and may be handed over to the Department in kind in those cases where the reward is by way of shares or other payment in kind. [An option to spread payment over three years is provided, interest at 5% per annum being charged on tax spread.]14

McGowan proposed a charge at death on the increase of value up to that date.15 During the inter-war period, as well as in the 20 years following the Second World War, there was much reference in Britain to the manner in which the US code subjects capital gains to income tax. Much of the comment was adverse. In 1938 Lecatsas wrote: The USA imposes a tax under false pretences. Is the gain it taxes real or latent, or just apparent? … When the capital gain is agreed upon to mean a capital value, and not an income value, then a tax system which hits capital gains under income tax

11 IR (1920), above n 9, 385 para 1. 12 IR (1920), above n 9, 385 para 2. McGowan presented a suggestion to the sub-committee that a tax should be levied on expenditure above the level judged to be necessary, the tax being termed to be imposed on expenditure on ‘wasteful luxury’ (p 404 para 8). This is an interesting precursor to Kaldor’s proposals for expenditure tax. 13 IR (1920), above n 9, 408 para 18. Thus, the 1920 Report anticipates the argument presented by the Royal Commission Minority Report 35 years later. 14 IR (1920), above n 9, 440–41 paras 34–38. 15 IR (1920) above n 9, 441 para 42.

The UK Capital Gains Tax: The Conception of the 1965 Act  331 provisions seems absurd … Such taxation involves double taxing too … So it becomes obvious that a capital gains tax of the American type which strikes at only realised capital gains, but not accrued, is iniquitous.16

THE PRINCIPLE OF TAXING GAINS

The proposals in the 1920 Departmental Report were driven by a desire to increase tax revenue, but within the proposals there is a discernible thread – it is appropriate to tax gains because they are of a similar nature to income. This is clearest in McGowan’s formulation, which has as its principle that increase of wealth is to be taxed, whether it arises from income received or the increase in value of capital assets. This is a concept that was to be promulgated and developed over the subsequent 45 years leading to the 1965 Act. The justification for taxing capital gains is expressed in terms of ‘equity’, or ‘fairness’. In this, capital gains tax (CGT) may be unique in owing more to principle than to pragmatism. Even in the year when the tax collected was at its highest, capital gains tax contributed only 1.9 per cent of taxes collected centrally.17 The argument for taxing gains can be derived from the principle, as attributed to Socrates, that justice is ‘an essential virtue of both a good political state and a good personal character’.18 Aristotle claims that, in addition to its beneficial effect on the individual, the essence of natural justice is the cultivation of those virtues which promote the well-being of the healthy state.19 Derived from this is a generalised concept that government should act with equity. For taxation, this can be broken down into horizontal equity and vertical equity. Horizontal equity requires that two people who receive the same should suffer the same tax charge. The concept of vertical equity is that there should be fairness between people enjoying differing levels of receipts. In his writing on tax equity in 1776, Adam Smith wrote: ‘the subjects of the state ought to contribute towards the supply of government, as nearly as possible, in proportion to their respective abilities’.20 US writers embraced the concept early, some arguing that Smith expounded the principle of horizontal equity, which comports with ‘equal protection under law’, as set forth in the United States Constitution.21 In 1874, Sidgwick wrote: ‘In laying down the law,

16 PJ Lecatsas, ‘The Taxing of Capital Gain’, paper presented at the Joint Oxford-LondonCambridge economic seminar held in Oxford on 6 November 1938 (King’s College Archive Centre, Cambridge, The Papers of Nicholas Kaldor NK/2/34/14). 17 2008/09: £8bn CGT out of £439bn taxes collected by HM Revenue & Customs: www.gov.uk/ government/collections/capital-gains-tax-statistics. Accessed 30 December 2018. 18 Socrates, Plato’s Republic, www.iep.utm.edu/justwest/. Accessed 30 December 2018. 19 Aristotle, Politicia Book III, headnote to ch 10, p 596. 20 A Smith, The Wealth of Nations Book IV, ch II, Pt II. 21 JJ Cordes, RD Ebel & JG Gravelle (eds), The Encyclopaedia of Taxation and Tax Policy, entry ‘Horizonal Equity’ (USA, Urban Institute Press, 1999).

332  David Collison no less than carrying it out, all inequality affecting the interests of individuals which appears arbitrary, and for which no sufficient reason can be given, is held to be unjust.’22 He, then, declares that horizontal equity is an ultimate principle of distributive justice. A sophisticated algebraic measure of horizontal equity is proposed by Musgrave.23 There are two problems with the proposition that horizontal equity requires capital gains to be taxed in a like manner to income. The first problem is that capital gains arise at differing times and in different ways. It is easy to equate gains with income when they are made in an active share portfolio. It is less easy to equate income and gain when an elderly person sells the home and moves into expensive care, or when a gift is made to enable a son or daughter to make a start in life, or when the value of property increases without a disposal. Because of this first problem, recent writers have cast doubt on the usefulness of the concept of horizontal equity. Holmes argues that horizontal equity is only possible by adopting an accretion basis of taxation: the increase in value triggers a tax charge.24 But it is widely regarded as unacceptable to require payment of tax without a receipt from which the payment is to be made. Burton observes that general agreement to the concept of horizontal equity disguises the substantial disagreements as to what circumstances are to be taken into account in determining whether people are equal or unequal. ‘These disagreements … are ultimately traced to the emphasis which the particular commentator places upon substantive notions of fairness.’25 In the context of capital gains, do we equate the receipt of income of £1,000 to the receipt of capital sale proceeds of £1,000, or the receipt of £1,000 more than the sum invested, or the receipt of £1,000 more than the sum invested, expressed at today’s prices, or £1,000 used by the recipient as freely spendable cash? The second problem is that focusing on the perceived equity of equating gain and income ignores the detrimental effects of taxing capital gains. Many economists argue that maximising economic efficiency requires investors to be free to move their funds easily; thus, high-performing business attracts investment, which enables growth. A tax charge whenever an investor moves financial support from a low-performing business to a higher-performing business is a clog in the system and makes the country’s economic performance sub-optimal. Bruce Sutherland describes the effect of taxing gains in the following terms: ‘The market for equities must be inhibited … There must be very substantial

22 H Sidgwick, The Methods of Ethics 1874 (republished University of Chicago Press, 1962) 267. 23 RA Musgrave, ‘Horizonal Equity, Once More’ (June 1990) 43(2) National Tax Journal 113 at 117, written in response to L Kaplow, ‘Horizontal Equity: Measures in Search of Principle’ (1989) 42 National Tax Journal 139–55. 24 K Holmes, The Concept of Income – a multi-disciplinary analysis (Wellington, New Zealand, IBFD Publications BV, 2000), ch 2. 25 M Burton, ‘Economic Income and the Search for a Fair and Simple Income Tax’, unpublished paper presented to Conference of the Australian Tax Teachers’ Association (Brisbane 24 January 1996) 3, manuscript held in Centre for Tax Law, University of Cambridge.

The UK Capital Gains Tax: The Conception of the 1965 Act  333 amounts of equity investments … which the owners feel they cannot change or sell however much such a course of action would be prudent for commercial or other reasons.’ He comments, further: ‘Holdings of quoted investments by individuals have fallen as a percentage of the total throughout the post-war period … The reasons for this [are] excessively high levels of taxation on … individuals … and the substantial tax advantages enjoyed by institutional investment.’26 Sutherland’s view, published in 1992, that CGT adversely affects the market, is an echo of the warning expressed in a letter dated 21 December 1964 from the Bank of England, in which the Governor, Lord Cromer, states: If exemption is not given [for gains on gilts], the result will be … the infliction of positive damage. Turnover in gilt-edged will inevitably drop sharply, robbing the market of the breadth and resilience which make it unique amongst the fixed interest capital markets of the world … In such a narrowed market the probability is that the Government would ultimately pay more for its borrowings.27

Another adverse economic effect of taxing gains is that it may increase the nation’s productivity if workers move to locations with high income, but a tax charge on the sale of the worker’s house may deprive the worker of sufficient cash to purchase a home in a higher-cost area and lead to the worker refusing the move and, hence, again, economic performance will be sub-optimal. ENTER KALDOR

In order to formulate a new tax charge, popular conceptions of fairness and equity are not enough. There needs to be a carefully considered conceptual basis for the charge. It was Kaldor who gave the taxing of capital gains a place within economic theory that attracted the attention of socialist politicians. Kaldor was attracted to ideas expressed by Irving Fisher in 1906,28 who regarded income and capital as essentially correlative: ‘a stock of wealth existing at a given instant of time is called capital, a flow of benefits from wealth through a period of time is called income.’29 Kaldor developed Fisher’s concept into a proposal for political action. Kaldor advocated that the state should tax, and tax equally, all that falls within Fisher’s formulation of ‘income’. This, said Kaldor, gives taxation that satisfies John Stuart Mill’s description of ‘an ideal tax’, as ‘it succeeds in reducing a person’s spending power but without leading him to behave any differently

26 B Sutherland, A discredited tax: the capital gains tax problem and its solution (London, Institute of Economic Affairs, 1992). 27 Finance Bill 1965 Memoranda vol 2 p 501. See below n 92 regarding access to the Memoranda. 28 I Fisher, The Nature of Capital and Income (New York, Macmillan, 1906). 29 Fisher, above n 28, quoted in Nicholas Kaldor An Expenditure Tax (London, Unwin, 1955) 56. Kaldor recognised that Fisher’s delineation of ‘income’ ‘does not accord with everyday notions on the subject’ (Kaldor, 57), which may have influenced him into accepting a more pragmatic, politically acceptable approach to tax policy in later years.

334  David Collison from the way in which he would have behaved if he had not been taxed at all, but his spending power had been correspondingly smaller.’30 Wages, profits, gifts or inheritances received, increases in value, gains on sale, all were, for Kaldor, income, if available for the recipient to spend. But if those incomings were used for savings and investment, they cease, in Kaldor’s analysis, to be income that should be taxed. In his early writings, Kaldor promoted a tax that embraced all spendings, as spending was the most reliable measure of income. Within the academic community, Kaldor was a revisionist economist.31 Through his willingness to engage in the actualities of governance, he became the most influential economist of his day. As his influence grew, so his ideas developed. Without abandoning his concept that the aim is to tax spendable incomings, his focus moved from advocating taxing income by an expenditure tax, to advocating interrelated tax charges that, taken together, taxed spendable incomings. This he called ‘integrated taxation’. One of the taxes in this integration was a capital gains tax. For Kaldor, in order to fulfil its role in taxing a category of incomings, a capital gains tax had to encompass all gains, accrued as well as realised, on real estate, on business and on personal investment. Without Kaldor, the charge enacted may have been a tax on gains made in investment transactions; a re-enactment of Selwyn Lloyd’s 1962 charge, with the time limit removed. Kaldor’s contribution was to present to legislators a theoretical framework in which capital gains tax is a widely based charge on the increase of wealth. Thus, the 1965 Act taxes, not just investment transactions, but gifts (s 22(4)(a)), gains up to death (s 24), and gives a charge each 15 years on the latent gains within a fund in trust (s 25). Kaldor was the latest in a line of socially aware economists at Cambridge. He ‘treated economics as a moral science … as a means to the end of attempting to make the world a more humane and civilised place.’32 Born Káldor Miklós in Hungary in 1908, he was a student at the University of Berlin and, simultaneously, an accredited journalist for Hungarian newspapers. He continued his studies at the London School of Economics, where he taught from 1932 to 1947. In 1949, he was made a fellow of King’s College, Cambridge and later given a Cambridge professorship. He was a professed and committed socialist who came to public prominence in 1939, with a paper in The Banker in which he laid down principles

30 JS Mill, Principles of Political Economy (London, John Parker, 1848) quoted in Kaldor, above n 29, 81. 31 Cambridge Journal of Economics (1989) vol 13 is a memorial edition following Kaldor’s death. In his article ‘Kaldor as a policy adviser’, AP Thirlwall, Kaldor’s literary executor, speaks of his ‘sparkling originality’ and describes him as ‘a first rate theorist and applied economist’. He writes: ‘Even within academe he was a controversial figure, holding unorthodox views on a variety of subjects.’ Ibid, 121. 32 Thirlwall, above n 31. As ‘socially aware economists, Thirlwall lists Henry Sidgwick (Trinity, 1959 to 1900), Alfred Marshall (St John’s, 1865 to 1924), Arthur Pigou (King’s, 1902 to 1959), John Maynard Keynes (King’s, 1911 to 1946) and Nicholas Kaldor (Fellow of King’s College, 1949 to 1986).

The UK Capital Gains Tax: The Conception of the 1965 Act  335 to govern war finance: first, that the aggregate real burden should be as small as possible; second, that the distribution of the burden should be equitable, advocating expenditure financed by government borrowing rather than taxation.33 Kaldor believed in the power of taxation to alter economic welfare and performance for the better.34 From 1964 to 1970, and again from 1974 to 1976, he held an official role as ‘Special Adviser to Chancellor of the Exchequer on the economic and social aspects of taxation policy’ to, in succession, Jim Callaghan,35 Roy Jenkins, and Denis Healey.36 From July 1974 until his death in September 1986, he sat in the House of Lords as Baron Kaldor of Newnham, where he made frequent contributions on economic and fiscal policy. Robinson and Sandford assess Kaldor’s legacy as: ‘Seldom, if ever, can one man, who was neither politician nor permanent civil servant, have exercised so much influence on a particular aspect of policy-making over so long a period.’37 Crossman wrote that everything he had ever said about taxation came from Kaldor.38 For Kaldor, taxing capital gains was not his aspiration. Rather, he wanted to tax what an individual has available for spending, whether that derives from income, gains, inheritance or winnings. In 1952 he gave a lecture to the Fabian Group, in which he spelt out his opposition to a tax on capital gains, preferring a tax on expenditure. His lecture notes state: Socialists will wish to make influence on future distribution of property and income, looking towards equalising, and to prevent heavy dis-saving and demoralisation through expectations of future work, saving and consumption.

Candidates include (a) tax on [realised] capital gains…. As to (a), such gains, if spent, would be picked up, within its range, by a general expenditure tax. And this would be all right. But would it be worthwhile, if no expenditure tax, to tax such gains, whether spent or saved, separately? 33 N Kaldor, ‘Principles of emergency finance’, The Banker, August 1939, vol 149, 149–156. Kaldor argued that defence expenditure should be financed primarily out of government borrowing in preference to taxation, as the government spending the borrowed funds generates additional demand; see Thirlwall, above n 31, 123. 34 Thirlwall, above n 31, 128. 35 Jim Callaghan suggested his title should be ‘Adviser to the Chancellor of the Exchequer’, but the permanent secretary pointed out that the Chancellor’s adviser is the Treasury (memo 23 October 1964, King’s College Archive Centre, Cambridge, The Papers of Nicholas Kaldor, NK/10/1/2). The closeness of the relationship with Jim Callaghan is demonstrated by Callaghan’s letter to Kaldor, dated 17 April 1976, in response to Kaldor’s congratulations on Callaghan becoming prime minister: ‘Dear Nicky … I often think about our days at the Treasury and how differently I would do the job if I were back there again – which pray Heaven I never shall be!’ (King’s NK/10/49/1). 36 Kaldor was also Special Advisor to Dick Crossman at the Department of Health and Social Security. 37 A Robinson and C Sandford, Tax Policy-making in the United Kingdom (London, Heinemann, 1983) 69. The authors continue: ‘Kaldor played a significant and generally pre-eminent role in all the new mainstream taxes for which Labour governments were responsible, of which all but selective employment tax were adopted as party policy. Kaldor’s opposition to the Conservatives’ tax measures was also significant.’ 38 J Morgan (ed) and R Crossman, The Backbench Diaries of Richard Crossman (London, Jonathan Cape, 1981) 763: entry for 2 June 1959.

336  David Collison I doubt it, since (i) it would, I think, need a disproportionate administrative effort, (ii) its yield would be uncertain and variable (very small in last few years), (iii) it would not fall on the rich as such, but on a small section of the population, some of whom not very rich, (iv) it would discourage enterprising investment, (v) it wouldn’t equalise distribution much, but (vi) would create an impression that something was being done, and to discourage other stronger measures. On the other hand (vii) it would be a good demagogic line and (viii) it was in our last election manifesto.39

It was Kaldor, more than any other single individual, who gave a coherent theoretical basis for the concept and purpose of taxing capital gains. His opportunity for presenting this outside academic or socialist circles arose from his appointment in 1951 to the Royal Commission on the Taxation of Profits and Income. ROYAL COMMISSION ON THE TAXATION OF PROFITS AND INCOME 1951–55

In 1919, it was the need for significant expenditure to pay for the ravages of the First World War that drove the government to ask the Inland Revenue to set up a Departmental Committee charged with investigating new sources of tax revenue. In 1951, it was not directly the ravages of the Second World War, but the cost of large-scale rearmament in the new nuclear age that provided the background to the Labour government establishing a Royal Commission to investigate direct taxation. As the Labour government stated in its 1951 Economic Survey: ‘With post-war recovery so near completion, we would normally have looked forward to an easing of the economic situation in 1951. Unhappily, we now face the new task of large-scale rearmament.’40 The Commission had 13 members, three of whom were Labour Party members: Nicholas Kaldor, an academic economist, and George Woodcock and Herbert Bullock, respectively Assistant General Secretary and former President of the Trade Union Congress. These three soon found themselves in difficulty over the terms of reference given to the Commission. They were not permitted to discuss an expenditure tax, but succeeded in obtaining a declaration from Hugh Gaitskell, the newly appointed Labour Chancellor of the Exchequer, that considering taxing capital gains fell within the scope of their report.41 39 King’s, above n 35, NK/11/14/5. I have merged the first two paragraphs in Kaldor’s notes, slightly reordering, while giving a true account of what, I believe, Kaldor intended to say in his lecture. The paper is undated, but it appears from adjacent documents that the lecture was delivered in May 1952. 40 HM Treasury, Economic Survey 1951, 4. 41 In setting up the Commission, Clement Attlee, the Prime Minister, had said: ‘the inquiry should be a wide one covering the incidence and effects of all the taxes on income and extending to the taxation of wages and salaries as well as of business profits’ (Hansard HC 27 July 1950 vol 478 col 691). Gaitskell, separately, asked the Department of Inland Revenue to give its views on taxing capital gains. The Chairman of the Board of Inland Revenue responded: ‘It would hardly be possible to take action while the matter is under consideration by the Royal Commission’. PRO T171/405, BC(51)26, 8 February 1951.

The UK Capital Gains Tax: The Conception of the 1965 Act  337 Kaldor continued to favour an expenditure tax, in preference to a tax on capital gains, but he came to accept that, if he was to influence the developing shape of UK taxation, it had to be in the context of being able to promote a tax on capital gains. After three years working in the Commission, it was apparent to Kaldor that his ideas on taxation were at odds with the thinking of the majority of the members of the Commission. The majority firmly rejected taxing any gains, unless they had all the marks of income. Kaldor wrote to a fellow Labour Party member of the Commission, George Woodcock: I realise that you cannot be present at the next meeting of the Commission when the paper on Capital Gains will be discussed. I find myself completely out of sympathy with that paper which seems to me to be full of specious arguments, but I would very much like to know how you stand in the matter of taxing capital gains. As you know I would have been in favour of an Expenditure Tax which would have automatically taxed savings out of capital, but failing this I definitely feel that a system which exempts capital gains from taxation altogether is bound to be highly inequitable. I should prefer a capital gains tax to leaving things as they are … I should be very glad if you could let me know your general view on whether you would support me to the point of making a dissenting report.42

Just seven days later, on 31 May 1954, George Woodcock replied: I am myself far from impressed by the arguments used in this paper and in general I would prefer to search for a method of bringing capital gains into the computation of income for tax purposes. My difficulty at the moment is to find sufficiently convincing solutions to the obviously very great administrative difficulties … It would not be much use to stick to a principle if we had no satisfactory means of applying it.43

In Kaldor’s reply to Woodcock, on 5 June 1954,44 Kaldor spells out the fundamentals of a system of taxing capital gains, which formed the basis of the tax treatment advocated in the Memorandum of Dissent the following year, and the charge that would be ultimately imposed by Finance Act 1965. Meanwhile, the Report of the Commission was being written. This Report included the recommendation that taxation should not be extended to capital gains, this being the opinion of 10 out of the 13 members of the Commission, the Chairman being a member of the majority. The minority, Kaldor, Woodcock and Bullock, had to decide what to do. On 10 December 1954, Kaldor wrote to Woodcock: A meeting is to be called on the 12th of January … I feel that we are expected to reveal our attitude on that occasion and to state the points on which we dissent.45



42 Letter

dated 24 May 1954; King’s, above n 35, NK/8/12/113. above n 35, NK/8/12/111. 44 King’s, above n 35, NK/8/12/109–10. 45 King’s, above n 35, NK/8/12/40. 43 King’s,

338  David Collison Woodcock hesitated. Kaldor wrote:46 ‘Tax charged on capital gains would come to at least £600 million.’47 Kaldor stated that this figure was for tax charged on gains made on selling shares; tax on sales of property would be in addition. At the meeting of the Commission on 12 January 1955, Kaldor, Woodcock and Bullock declared that they could not support the Report, as drafted. The writing of a Memorandum of Dissent by the minority, then began in earnest. The process greatly irritated the Commission Chairman.48 Publication of the Report was delayed,49 in order for the Memorandum of Dissent to be incorporated. Thirteen pages of the main Report are devoted to capital gains.50 The suggestion that an accruals basis be used was summarily dismissed, the Report declaring that the law requires actual receipt to be taxable income and, moreover, an accruals basis would have been unworkable.51 The majority were clearly influenced by what they saw as undesirable aspects of the American approach, where, since 1913, capital gains had been taxed as a category of income. In particular, they noted four areas of great difficulty: 1. It would be illogical to tax to progressive rates the profit on a capital sale in the year of sale, when the property had been held for many years. To avoid hardship a complex structure of provisions was required, which introduced a new group of difficulties.52 2. Taxing a capital gain requires allowance for a capital loss. This would allow a taxpayer to set off losses at his marginal rate while retaining assets that had appreciated in value.53 3. If an owner-occupier sold his house, a gain would be very likely, but it was very likely that he would have to spend all the proceeds of sale if he was to buy another house of similar quality and location. Tax should not be charged on the gain arising in such a situation, although the logical argument for taxing capital gains as income did not call for such an exemption.54 46 King’s, above n 35, NK/8/12/93. 47 It is interesting to note the inaccuracy of Kaldor’s estimate. In its first 12 years, the average tax take from CGT was £253m; in only four of the 12 years did it exceed one half of Kaldor’s estimate. Kaldor was, however, correct in predicting that the take would vary widely from year to year. The figures were supplied to the author on 16 April 2018 by HMRC KAI Personal Taxes, in response to a request by the author under the Freedom of Information Act 2000. 48 Kaldor requested information from the Inland Revenue. On 11 March 1955, Radcliffe, the Commission Chairman, wrote to Kaldor saying that he had been informed that on 3 March Kaldor had asked questions of the Clerk to the Commission (a civil servant), which he had no right to do: King’s, above n 35, NK/8/12/417-419. 49 Cmd 9474 Final Report of the Royal Commission on the Taxation of Profits and Income. The Report was published on 22 May 1955 and presented to Parliament in June 1955. 50 Cmd 9474, 25–26 paras 80–108. 51 Cmd 9474, 26 para 83. 52 Cmd 9474, 29 para 90. 53 Cmd 9474, 30 para 91. 54 Cmd 9474, 30 para 92.

The UK Capital Gains Tax: The Conception of the 1965 Act  339 4. Realisation may merely be a change of investment. It by no means follows that larger income follows from a gain. This is particularly the case with gilt-edged investments, where a change in the rate of interest in the market changes the capital value of a holding, without any change in the income it produces.55 The majority stated: ‘We are not at all impressed by the argument that the taxation of capital gains would achieve a more equitable distribution of the tax burden between one taxpayer and another.’56 Taxing capital gains was seen as necessitating undesirable complexity.57 More Revenue officials would be required.58 The effect would be to reduce the take of estate duty.59 The majority report concluded: We do not recommend therefore that capital gains should be brought under a general charge to income tax or surtax as constituting income. Nor do we recommend the introduction of any supplementary scheme for charging them or some of them to a flat-rate tax as constituting a special category of income.60

MEMORANDUM OF DISSENT TO THE 1955 ROYAL COMMISSION REPORT

The 45,000-word Memorandum of Dissent has three signatories, but can fairly be described as the work of Kaldor, to which Woodcock and Bullock record their agreement.61 Their agreement was not passive; the correspondence makes it clear that Woodcock, at least, while out of sympathy with the conclusions of the majority, did not agree to dissent from them until Kaldor had persuaded him that he had a practical scheme for taxing capital gains. The section of the Memorandum that addresses capital gains starts by distinguishing Kaldor’s view from that of both the 1920 Departmental Commission,62 and the argument advanced by the majority in the 1955 Report:63 We consider a test based on motive to be not merely defective, but irrelevant. The sole relevant test, in our view, as to whether a gain is to be taxable or not is whether it secures a net material benefit to the recipient. From the point of view of taxable capacity it is irrelevant whether an increase in spending power occurs as a result of

55 Cmd 9474, 30–31 para 93. 56 Cmd 9474, 33 para 99. 57 Cmd 9474, 33–34 para 100. 58 The Report notes the Inland Revenue estimate of requiring around 500 more staff in the Chief Inspector’s Branch, plus additional staff for valuation in the Valuation Office (for land valuation) and the Estate Duty Office (for unquoted shares): Cmd 9474, 34 para 100. 59 Cmd 9474, 34 para 101(2). 60 Cmd 9474, 37 para 108. 61 Of which, 55 pages look at the taxation of capital gains. 62 Cmd 9474, Memorandum of Dissent, 359 para 13. 63 Cmd 9474, Memorandum of Dissent, 359–360 paras 135–18.

340  David Collison an unexpected windfall, or whether it was expected, planned or achieved in the course of a business organised for the purpose.64

This is Kaldor declaring his belief in integrated taxation,65 writing in the Memorandum of Dissent: The tax exemption of the so-called capital profits of various kinds represents the most serious omission in our present system of income taxation … Capital gains increase a person’s taxable capacity by increasing his power to spend or save; and since capital gains … are concentrated in the hands of property owners … their exclusion constitutes serious discrimination.66

For the dissenters, the widening of the income tax net to catch profits from single transactions was irrelevant, as was the concept that tax is paid when a source is identified, but not otherwise: It seems to us that the motor engineer who buys and sells bonded whisky is in no different position from the Stock Exchange operator who buys and sells particular shares. If the one is deemed to have committed his capital to a venture, so has the other.67

The dissenters proposed that capital gains be taxed, as follows:68 1. 2. 3. 4.

A capital gain is charged to income tax, but not to surtax. Gains are taxed as realised. Realised losses are deducted from realised gains before tax is charged. When losses exceed gains, the excess losses are carried forward and relieved against gains in future years, not against ‘other’ income. 5. Length of ownership is irrelevant; no distinction is made between shortand long-term gains 6. A gift, a transfer into settlement and death are each treated as triggering a capital gain, in the same way as a sale. 7. The sale of an owner-occupied house is exempt from tax.69 The dissenters then addressed the arguments advanced by the majority for not taxing capital gains. It is interesting that first place is given to the criticism

64 Cmd 9474, Memorandum of Dissent, 359 para 13. 65 The most succinct statement of the concept is in Kaldor’s note of May 1959 to a Labour Party committee: ‘“Ability to pay” essentially consists of spending power … Income in this context should of course be based on a comprehensive notion of income, and include capital gains as well as dividends’. King’s, above n 35, NK/11/1/66 Labour Party ref: Re.605/Oct. 1959. 66 Cmd 9474, Memorandum of Dissent, 365 paras 34 and 35. 67 Cmd 9474, Memorandum of Dissent, 359 para 16. 68 The Memorandum of Dissent also makes proposals for the taxation of capital gains made by companies. In order to focus attention on the conception of capital gains tax, without diversionary reference to gains of companies, in this paper I look solely at the taxation of individuals. 69 Cmd 9474, Memorandum of Dissent, 418–19 para 217. There are further recommendations dealing with the introduction of the tax charge, including time apportionment and Budget Day value (ultimately enacted, in essence, as FA 1965, Sch 6 paras 22–24).

The UK Capital Gains Tax: The Conception of the 1965 Act  341 that taxing a gain is taxing inflation. This is an issue that has bedevilled CGT throughout its history, and continues to do so. When Nigel Lawson changed the nature of CGT and established Kaldor’s system of a common rate of tax for income and gains,70 he specifically disagreed with Kaldor’s view that gains due to inflation should be taxed. Kaldor’s view, as expressed in the Memorandum of Dissent,71 was that tax should be based on taxable capacity. A worker who saves out of his earnings will see his savings diminish in ‘real’ value by inflation, but income tax is applied to his earnings without reference to inflation. So, too, a property owner who makes capital gains due to inflation should suffer tax on the capital gains without reference to inflation. If we were to give relief for an inflationary gain, argued Kaldor, then we should give a tax repayment to a holder of fixed interest securities, for which inflation has the effect of reducing their ‘real’ value. The second criticism levied at taxing capital gains was that an increase in the value of a fixed-interest security resulting from a fall in interest rates in the market is not a ‘real’ gain, as the income generated by the fixed-interest security is unchanged.72 To this, Kaldor replied, first, that the holder of the security has increased spending power, and, again, that security holder would have gained a relative advantage over the worker who saves his earnings.73 The third criticism was that irregular, perhaps unexpected, capital gains are different in kind from regular, expected income. Kaldor noted that four-fifths of gains taxed under the US system are of shares, and the bulk of the tax-take is from the long-term trend of rising share prices, hence, the criticism simply does not fit the facts. Furthermore, ‘we … unreservedly reject the view that by virtue of being a windfall, incidental and unforeseen, a gain ought to be exempt from tax. Windfall gains confer material benefit just as expected gains do.’74 The fourth and final criticism addressed by the dissenters was that taxing a gain when it is realised subjects to the tax rate of an individual year a gain that has accrued over, perhaps, many years. This was, of course, a very live issue in 1955, when the combination of income tax and surtax took the potential charge to a total of 95 per cent. Kaldor noted that trading profits are calculated on a realisation basis; closing stock is valued at its historic cost, not its value at the end of the accounting period. In a system of taxing all gains – ­including charges on gifts and death – a realisation system gives the same liability as an economist’s ideal accrual system, but the liability to pay tax is delayed. For a taxpayer with a diversified share portfolio, taxation at full income tax rates on realisations is not harsh.75 When the sale is of a single indivisible



70 Finance

Act 1988, s 98. 9474, Memorandum of 72 Cmd 9474 31 para 93. 73 Cmd 9474, Memorandum of 74 Cmd 9474, Memorandum of 75 Cmd 9474, Memorandum of 71 Cmd

Dissent, 366–67 paras 37–38. Dissent, 367 para 39. Dissent, 368 para 43. Dissent, 372 para 57.

342  David Collison and not easily marketable asset, such as the sale of a long-established business at retirement, the dissenters recognised that imposing the tax rates of the year of realisation was unfair. One solution could be to average the gain over the whole period of ownership, but the dissenters accepted that this might be administratively impracticable.76 The dissenters accepted that the effect of tax being levied at 1955 rates would ‘be bound to have a destructive effect on the willingness to assume risks and would have a negative effect on the incentive to save and [would] encourage capitalists to dissipate their capital’.77 With, it is clear, some reluctance, the dissenters recommended that capital gains be subjected to income tax and not surtax.78 The dissenters deal, at some length, with tax avoidance.79 Both the authors of the majority report and the dissenters agreed that action was required. The difference was method. The majority looked to targeted legislation.80 The dissenters considered that specific legislation would never fully tackle the problem. They saw a major argument for an all-encompassing tax on capital gains being that it attacks the conversion of taxable income into non-taxable capital. The final argument advanced by the dissenters was that a very large proportion of the value in shares is never distributed and, hence, never taxed in the hands of the shareholder. The Department of Inland Revenue was not solely an implementer of policy instructions; the Department, at least at its senior level, had strong views on the taxation of capital gains, which it was fully prepared to express, when asked. ANNEX TO 1955 COMMISSION REPORT: THE VIEW OF THE DEPARTMENT OF INLAND REVENUE

A paper issued by the Board of Inland Revenue was published as an annex to the Report. This gave the Department’s view on taxing capital gains. The paper was produced at the request of the Commission. It was not a response to the Memorandum of Dissent, which it pre-dates by three years.81

76 Cmd 9474, Memorandum of Dissent, 373 para 60 footnote. 77 Cmd 9474, Memorandum of Dissent, 374 para 61. 78 Cmd 9474, Memorandum of Dissent, 374 para 62. For 1954/55 the standard rate of income tax was 45%; with reduced rates of 12½% on the first £100, 25% on next £150 and 35% on next £150. For the same year the rates of surtax (levied in addition to income tax on large incomes) ranged from 10% to 50%. 79 Cmd 9474, Memorandum of Dissent, 368–70 paras 45–48. There is detailed discussion of: (1) sales cum div and repurchase ex div; and (2) dividend stripping. 80 As subsequently enacted as FA 1960, ss 21–26 and the short-term gains scheme in FA 1962, ss 10–16. 81 The Department’s paper is dated 7 January 1952.

The UK Capital Gains Tax: The Conception of the 1965 Act  343 The views expressed in this paper can be summarised as: 1. The Department considers that some gains add to taxable capacity, but some do not. 2. The distinction in 1. above is too subtle for legislation to make the distinction. Hence, if a tax on capital gains is introduced, it will have to tax all capital gains, even those that the public does not consider add to taxable capacity. 3. Taxation on an accruals basis is impracticable. 4. It follows from 3., that taxation would be on a realisation basis. 5. To avoid anomalies, gifts and death would be treated as realisation, but this would create hardship in certain cases. 6. The rate of tax on capital gains should be graduated according to the taxpayer’s total income. However, there would need to be abatement when either (1) the gain has accrued over a long period, or (2) the taxpayer’s total capital is small. Such provisions can only be rough and ready, otherwise the tax would ‘be complicated beyond reason’. 7. Any scheme to tax capital gains ‘would be extremely complex’, it would give rise to ‘obvious anomalies and objections … likely to be continuously criticised and to be the subject of proposals for amendment. Amendment would lead to increased complexity and administrative cost and to reduced yield.’82 8. A tax on capital gains may yield, on average, £50m, but the yield would be very variable. In some years, the yield could be £250m; in other years, if losses are carried back, the yield could be negative, as much as £(250m).83 9. 500 additional staff in the Office of the Chief Inspector of Taxes would be required to administer the tax, plus additional staff for valuation and the imposition of surtax. This would be difficult at the time in question, as the additional work would adversely affect the current work by the Department on under-assessed traders.84 The majority report treated the administrative problems, as stated by the Department, as a substantive reason for not recommending the general taxation of capital gains. This paper, plus one assumes subsequent advice given in private, influenced successive governments of both colours from 1955 to 1963 to avoid the taxation of capital gains.85

82 This is, of course, one of the arguments in Sutherland, above n 26, which looks at the experience of 27 years of capital gains tax. The other major argument in that book is that CGT is a clog on the market for shares. 83 This is calculated, I assume, at 1951/52 tax rates. 84 Cmd 9474, 452–53 Annex para 4. My numbering of points differs from that in the Board’s paper. 85 Selwyn Lloyd, when Chancellor of the Exchequer 1961 to 1962, was not against taxing capital gains, but concluded it to be too complex, see below n 121. Sir Alec Douglas-Home, as chief Conservative spokesman on financial affairs in 1965, did not oppose the introduction of CGT, saying only that it should be at a low rate and one element in a reform of income tax, surtax and death duty: Hansard HC 6 April 1965 col 315.

344  David Collison Reaction to the Memorandum of Dissent in the press followed the political leanings of its editors. The News Chronicle ran the headline ‘10 – 3 vote turns down capital gains tax’.86 The Economist gave a long, and very balanced, summary of the arguments for taxing capital gains,87 in which the majority’s view that income is the fruit of the capital tree was parodied: ‘One has to be something of a tax metaphysician to distinguish fruit from trees’ and saying, of the minority’s suggestion that capital gains should be charged to income tax, but not to surtax: ‘This lets at least half the cat out of the bag. One must forbear from heavy taxation, lest capitalists should be discouraged from saving and encouraged to dissipate their capital.’ THE OPPOSING VIEW: TAX ON THE ACCRUALS BASIS

As Tiley noted in 1976, taxing ‘gains only as they are realised gives rise to the so-called “lock-in effect” – the taxpayer is reluctant to realise the gain for fear of the consequent tax liability.’88 If gain in capital is the increase in a person’s wealth from one point in time to another, the logical conclusion is that a capital gains tax imposed on an annual basis should levy a charge on the amount by which an asset increases in value from the start of the year to the end of the year. This concept was advocated by Merrett in his paper written in opposition to the charge at realisation proposed by Kaldor’s Memorandum of Dissent.89 For Merrett, there were seven difficulties in taxing capital gains on realisation only: 1. Realised gains are often bunched in one year. If gains are taxed at income tax rates, there is serious inequity in charging progressive rates on bunched (and unrepeated) gains. 2. The solution to bunching suggested in the Memorandum of Dissent, that gains be averaged over a five-year period, creates a considerable burden of additional administration, and would, still, produce high taxation on high gains that might occur only once in a lifetime, and would be inequitable where the gain has accrued over a long period.90 3. The proposal that death be an occasion of charge would impose extreme inequity. Gains accrued over a whole lifetime would be taxed as if realised over only five years. 86 8 June 1955. 87 25 June 1955, 1145–46. 88 J Tiley, Revenue Law 1st edn (London, Butterworths, 1976) 679. By the time Tiley wrote, the charge at death had been abolished, which Tiley notes makes the prospect of a tax liability consequent on the lifetime disposal ‘even less attractive’. 89 AJ Merrett, ‘Capital Gains Taxation: The Accrual Alternative’, in Oxford Economic Papers, vol 16, no 2 (1 July 1964), 262–74. 90 The misalignment between high progressive tax rates in the year of the tax charge and a lengthy period of the gain’s accrual is identified by Inland Revenue in its note, published in Cmd 9474 425–28.

The UK Capital Gains Tax: The Conception of the 1965 Act  345 4. A well-advised taxpayer with easily realised assets, could make disposals over a lengthy period of years and pay a moderate amount of tax, but a taxpayer who dies prematurely, or has assets that cannot be marketed, would be seriously penalised. 5. The problems listed above, which arise from progressive tax rates, could be solved by taxing at a flat rate. However, a flat rate maintains the inequity of taxpayers receiving capital gains paying less tax than those receiving earned income. Further, a flat rate perpetuates artificial schemes to convert income to a capital gain. 6. A tax on gains must, in equity, provide for the offset of capital losses against total income. But, ‘such provisions would be an invitation to the taxpayer to realise losses only’.91 7. There is inequity if the real burden of tax varies according to the investment opportunities, and market rates, available at the date of realisation. After declaring that the accruals basis more closely accords with the essential purpose of a capital gains tax than the realisation basis, Merrett addressed four objections to the accruals basis of taxing capital gains: 1. The valuation of assets such as unquoted shares, that is required annually under the accruals basis, is imperfect, expensive, causes delay and is ‘the occasion for ill will and litigation’. 2. Determining these values is a wasted effort, as the value will change, and may disappear in subsequent years. 3. There is inequality when accrued gains are subjected to progressive taxation. 4. Financial and non-financial sacrifice may result from a taxpayer being forced to realise assets to meet a capital gains tax liability. Merrett gave a detailed specification for a capital gains tax based on what he termed ‘the progressive accrual basis’, which, he claimed, is a solution to these four criticisms, and avoids the seven problems he identified in the realisation basis. The progressive accrual basis would, he claimed, require little more cost in enforcement and administration than the realisation basis, and would be, in his view, more equitable than either the realisation basis or the simple accrued basis. Under Merrett’s scheme, the capital gains tax liability is computed as follows: 1. You calculate the capital gain for the year as: The value of assets at the end of the year plus receipts on realisations less the value of assets at the start of the year. 2. You add the capital gain for the year to the aggregate of capital gains thus calculated for previous years, less the aggregate of gains on which tax has been paid.



91 Merrett,

above n 89, 563.

346  David Collison 3. You calculate the fraction of: Receipts on realisations in the year divided by the value of assets at the end of the year. 4. You pay tax on the year-end aggregate in 2. above multiplied by the fraction in 3. above, with a minimum payment of tax on 10 per cent of the sum in 2. above. In support of his progressive accruals basis, Merrett declares three advantages of his progressive accruals basis over the realisation basis: 1. The inequity of unfair taxation at progressive rates of gains accrued over long periods is avoided. 2. It is less capricious in its incidence, mainly as a consequence of the rule requiring payment on 10 per cent of aggregate gains each year. 3. It is a more stable, higher-yielding and flexible source of revenue.

A  LABOUR GOVERNMENT

Winston Churchill had led a coalition government for the conduct of the Second World War, but had always promised an election as soon as the war ended. In fact, the country was still at war with Japan when the election was called; that was neither party leader’s choice, but a result of a miscalculation by Conservative Central Office electoral strategists.92 The strategy was, for the Conservatives, disastrously wrong. When the votes of the 5 July 1945 election were finally declared on 26 July 1945,93 Labour had 395 seats in the House of Commons (61.7 per cent), and the Conservatives and their allies only 215. Clement Attlee became Prime Minister and Clive Dalton Chancellor of the Exchequer. In spring 1946, wealth tax and a capital gains tax were mentioned to the Chancellor for possible incorporation in the tax proposals for the following year. The Chancellor turned down a wealth tax, but asked for examination of the possibility of taxing capital gains.94 A working party within Inland Revenue was

92 Both Churchill and Attlee would have preferred an election after the defeat of Japan, and looked to a date in October 1945, but the strategists ‘wanted an early cashing in of the cheque of Churchill’s victory popularity’. R Jenkins, Churchill (London, Macmillan, 2001) 790. 93 Remarkably, Churchill, as Prime Minister, had attended the critical Potsdam Conference on 15 July 1945 with Stalin and Truman, Attlee being in attendance but not contributing, neither being aware that the electorate had voted Churchill out of office and Attlee in. 94 Board of Inland Revenue, History of the Finance Act 1965 (London, Inland Revenue, 1966) 13 para 14. The collator of the CGT section of this bound volume is E McGivern. This volume is declared to be for confidential use in the Inland Revenue and marked as: ‘It should not at this stage be seen by anyone outside the Department’. Indeed, the book includes memos with caustic comments on the shortcomings of ministers (eg see below n 152). One of the limited number of bound volumes of this work is available in the National Archives, ref TNA: IR 75/158, where it is referred to as ‘Official History’. The copy consulted by the author, as well as the Inland Revenue volumes of materials on Finance Bills is in University of Cambridge Faculty of Law. In D Stopforth and A Goodacre, ‘The Birth of Capital Gains Tax – the Official View’ (2005) 6 British Tax Review 584–608, the authors give a perspective on the material in History of the Finance Act 1965 that differs from mine.

The UK Capital Gains Tax: The Conception of the 1965 Act  347 set up on 8 August 1946 and gave a five-page report to the 1947 Budget Committee on 1 November 1946.95 The advice was that capital gains could be taxed on the US model, but because of the chronic staff shortage facing the Department at that time, it would not be possible to cope with the additional work burden without imperilling the administration of the existing taxes. Further, the Chancellor was advised, more revenue could be gathered from chasing underdeclared income tax than ‘we could ever get by chasing capital gains’. The Chairman of the Board of Inland Revenue, Sir Cornelius Gregg recommended that the idea of a capital gains tax should be dropped. The Chancellor and his Budget Committee agreed.96 The same report was presented to Cripps, when he became Chancellor in November 1947 and, again, to Gaitskell, when he was appointed in October 1950.97 Gaitskell convened a special meeting of the 1951 Budget Committee,98 at which the paper was discussed, which reached the same conclusion.99 13  YEARS OF CONSERVATIVE GOVERNMENTS100

Clementine Churchill is said to have told her husband over luncheon on 26 July 1945 that his defeat in the general election might well be a blessing in disguise, and encouraged her husband to retire from leading the Conservative Party. Winston Churchill replied: ‘At the moment it’s certainly very well disguised’, and refused to retire, continuing as Conservative leader for a further 11 years.101 Thus, it was Churchill who became Prime Minister when, on 25 October 1951, a Conservative government was elected, with 51.4 per cent of the vote, and the Conservatives began 13 years’ rule. Conservative governments from 1951 to 1964 did not reject the concept of taxing capital gains. Only 37 days after coming into office, Rab Butler, the new Chancellor of the Exchequer, told the Inland Revenue that he had had a conversation with Winston Churchill, the re-elected Prime Minister, on raising revenue by establishing a capital gains tax.102 The Department of Inland Revenue took this as an opportunity to express its opposition to taxing capital gains.

95 PRO T171/391. In a long appendix, the Department reports its view on the US experience, which includes a quote from a US critic: ‘No feature of the American income tax is subject to more complaint than the tax on capital gains and no part of the system of the tax has been so often and so radically changed’. 96 IR (1966), above n 94, 13 paras 14–15. 97 D Stopforth, ‘Deliberations over taxing capital gains – the position up to 1955’, in J Tiley (ed), Studies in the History of Tax Law, Vol 1 (Oxford, Hart, 2004) 134. 98 Minutes of Roffey Park Weekend PRO T171/403; for an account, see Stopforth, above n 95, 139–40, who comments: ‘The Chancellor clearly felt suspicious of the advice he was being given.’ 99 See decision of both 1950 and 1951 Budget Committees: IR (1966), above n 94, 13–14 para 16. 100 25 October 1951 to 15 October 1964. 101 Recounted by Mary Spencer-Churchill, their 22-year-old daughter: Jenkins, above n 92, 798. 102 IR (1966), above n 94, 15 para 22.

348  David Collison Just two weeks later, on 14 December 1951, a paper was given to ministers giving a pessimistic view of the yield to be expected and the cost of the additional staff required. Winston Churchill’s government dropped the idea of taxing capital gains.103 The issue of tax-free gains came to public prominence in 1953, when Charles Clore took over J Sears & Co. The perception that a wealthy speculator was making massive profits without a tax charge generated much adverse press comment. The Treasury conducted a confidential internal enquiry but concluded that there were no grounds for the government to intervene, or even express disapproval.104 Much adverse comment on the inadequacy of the tax take on takeovers was made in a long debate in the House of Commons.105 The mid-1950s was a period of strength for trade unions, displayed in their frequent conflict with government. The Conservative government sought wage restraint. Why, asked some, should trade unions advise acceptance of restraint of workers’ pay, which was fully and highly taxed, when the wealthy enjoyed tax-free gains?106 The point was taken up by the Labour opposition in 1964, when Jim Callaghan told MPs that a tax on capital gains was essential for trade union participation in an effective incomes policy.107 In 1955 came the publication of the report of the Royal Commission,108 with its Memorandum of Dissent issued in the names of Kaldor and the two trade union members of the Commission.109 Edward Boyle, Conservative Economic Secretary to the Treasury considered the minority’s arguments for taxing capital gains ‘most convincing’.110 A confidential departmental document notes that the Inland Revenue warned the Chancellor in the autumn of 1955 of the possible dangers of using for the purposes of propaganda a tax which would become a permanent feature of the tax code, and for which the economic justification had still to be proved.111 In December 1955, Harold Macmillan was appointed Chancellor of the Exchequer. Included in his ‘First Thoughts’ memoranda to his Permanent Secretary Bridges, he wrote: ‘We should be in a position to consider capital gains tax,

103 PRO IR40/16364 para 22 and IR (1966), above n 94, 15 para 22. 104 See Stopforth, above n 97, 141. The Treasury asked the Inland Revenue to ‘keep a close watch on these operations’: PRO IR 63/199 p 247. Inland Revenue replied: ‘There will not be much more than a one in a million chance of our being able to catch these birds’: PRO IR 63/199 p 249. 105 75 columns of Hansard HC 11 February 1954 cols 1383–1458. 106 IR (1966), above n 94, 15 para 23. 107 Hansard HC 15 April 1964 cols 447–48; echoed by Tom Iremonger MP: Hansard HC 11 ­November 1964 col 1115. 108 Cmd 9474, above n 49. 109 Herbert Bullock, past President of the Trades Union Congress and George Woodcock, Deputy Secretary of the Trades Union Congress. 110 PRO T171/471. For an interesting account of Boyle’s subsequent advocacy within government of taxing capital gains, see Stopforth, above n 97, 123–27. 111 IR (1966), above n 94, 15 para 23.

The UK Capital Gains Tax: The Conception of the 1965 Act  349 pros and cons and practicability.’112 The Inland Revenue response accepted that capital gains ‘are disliked by the workers’ and taxing gains might encourage workers’ organisations to join the fight against inflation, but gave the Inland Revenue opinion that arguments against taxing gains are ‘very strong’.113 Despite the Revenue view, in January 1956, Ministers informed the Department that they would like, the following month, to announce that the Budget would contain proposals for a tax on capital gains. Again, Inland Revenue was quick to respond with negative comment. A paper was given to Ministers on 17 January 1956 ‘which drew attention to the strong appeal of the tax as an instrument of social justice’.114 Further, by operating on realised gains it would provide an additional weapon to combat inflation; and it might in the long run allow some reduction in the tax chargeable on ordinary income. On the other hand, the paper noted that the effect of the tax on savings and risk-taking was unpredictable; it would impose a heavy work burden on staff already extended; and it could be administered only at the ‘expense of valuable back duty enquiries’.115 The paper was discussed with Harold Macmillan, then Chancellor of the Exchequer on 29 June 1956, who left a decision open until the Department had studied the US experience. Discussions with their US counterparts were reported in an Inland Revenue paper given to the Chancellor on 12 November 1956.116 [The paper] concluded that the task of introducing such a tax was not impossible. But the tax would not be popular and the necessary legislation would be long and complex. Further the cost in terms of staff would be heavy, and in the early years the additional work could only be undertaken at the expense of very profitable back duty enquiries.117

At a meeting on 2 January 1957, Treasury Ministers decided against taxing capital gains ‘in view of the very small yield expected in the early years and the fact that there was insufficient time to prepare the legislation for the April Budget’.118 Harold Macmillan replaced Eden as Prime Minister on 10 January 1957. Macmillan appointed Peter Thorneycroft as Chancellor of the Exchequer. Macmillan told his Chancellor that he favoured taxing capital gains, but the tax should be introduced in a Budget that included other politically difficult changes, and that the 1957 Budget did not provide such an opportunity for its introduction. Thorneycroft agreed.119



112 PRO

IR63/203 at 28. T171/1471 paras 4 and 6. 114 Inland Revenue unpublished paper ref M.139, reproduced in IR (1966), above n 94, 15 para 24. 115 IR (1966), above n 94, 15 para 24. 116 Inland Revenue unpublished paper ref M.165, reproduced in IR (1966), above n 94, 15 para 25. 117 IR (1966), above n 94, 15–16 para 25. 118 IR (1966), above n 94, 16 para 26. 119 PRO IR63/205 at 46 and 54. 113 PRO

350  David Collison It was to tax speculation, not capital gains, that Selwyn Lloyd, as Conservative Chancellor of the Exchequer, introduced the 1962 short term gains tax.120 He was at pains to make it clear that he was not introducing a capital gains tax. His opposition was not on principle, but on practicality. In his 1961 Budget speech, Selwyn Lloyd said: I have carefully examined this possibility. From a practical point of view, the complexity of the legislation and the administrative machine required present difficulties. Also the allowance for losses and the many exemptions that, in my view, would be required would reduce the proceeds to a much smaller proportion than publicly estimated. I am, therefore, not proposing a capital gains tax in my Budget … I am not at present satisfied that what is called a capital gains tax is worthwhile.121

Again, in the Budget debates, Selwyn Lloyd declared: Reference has been made to a capital gains tax. I say to the Committee quite frankly that from my point of view it is a practical matter as to whether it is to the advantage of the country to have a capital gains tax. In America they think it is and they have a schedule about a foot high of all the rules and regulations. It would involve a new and complicated system and a considerable drain on the administrative resources available. We should find that all the best brains in the country would be concentrating at once on how legally to get round it.122

Despite Selwyn Lloyd’s statement, capital gain and speculation became equated in popular thought. Labour politicians frequently proclaimed that a man who makes a big quick buck pays less tax than a man who attends his employment day after day. 1955 TO 1964: LABOUR, IN OPPOSITION, DETERMINES ITS TAX PROPOSALS

As the three dissenters in the Royal Commission report were the Labour Party members of the Commission and, moreover, Kaldor was building up his reputation as the economics guru in the party, one may have expected that the introduction of capital gains tax would have been in the forefront of Labour’s proposals. In fact, the divide between those who favoured taxing capital gains and those who did not did not follow the division of party loyalty.123 The Labour 120 Legislation had been enacted in FA 1960 to charge income tax when the profits of a building project had been converted into a capital gain. The income tax charge was on the gain made from the increase in the share price. This was found to be deficient, as a company limited by guarantee, without a share capital, could be used, as could a deeply discounted debenture, see Inland Revenue briefing note PS 2005/61, in Board of Inland Revenue Short Term Gains Tax 1962 Memoranda vol 1 (London, Inland Revenue, 1962) 55–56. 121 Hansard HC 17 April 1961 vol 638 col 821. 122 Hansard HC 18 July 1961 vol 644 cols 1192–93. 123 See, for example the statement of Selwyn Lloyd above, in which he declares himself not to be against a capital gains tax, if administrative difficulties can be overcome. When asked directly by Jim Callaghan, Edward Heath, then Leader of the Opposition, refused to say if he would repeal CGT: Hansard HC 15 July 1965 vol 716 col 916.

The UK Capital Gains Tax: The Conception of the 1965 Act  351 Party was slow to give its full support to the taxation of capital gains proposed by its members of the Commission. Following the publication of the Memorandum of Dissent within the Commission Report, Hugh Dalton, who from 1945 to 1947 had been Chancellor of the Exchequer in the Labour government, wrote that he was ‘still unconvinced’ of the case for a capital gains tax. ‘It might easily turn out to be another case of much cry and little wool.’124 Co-founders of the Fabian society, Sidney and Beatrix Webb, had, also, not been convinced of the need for a tax on capital gains.125 The Labour Party manifesto for the 26 May 1955 election made no mention of taxing capital gains (nor of Kaldor’s concept of integrated taxation and his preferred expenditure tax). On the contrary, Labour’s aim for taxation was stated solely as: ‘We shall review the working of the tax system to ensure that it is efficient and just.’ In these early writings, Kaldor sees integrated taxation in terms of taxing all receipts, tax being levied on all, it would seem, at the same rate. Thus, Jim Callaghan, while in opposition, followed Kaldor’s theme and spoke of the distinction between taxation of income during life and of capital at death as ‘an unreal golden curtain’.126 By 1959, Kaldor had developed his ideas on equitable fiscal policy, which are neatly stated in a paper to a Labour Party Working Party: The Case for an Integrated Tax Structure The main purpose of a system of graduated personal taxation is to secure the equitable distribution of taxation in accordance with ‘ability to pay’. If it were not for the need to secure social justice and the reduction in economic inequality, it would be much simpler to collect all revenue by means of sales or purchase taxes. But ‘ability to pay’ essentially consists of spending power, and this cannot be measured by any single criterion such as income, however comprehensive the definition of ‘income’ is made to be…. A tax levied on both [income and disposable wealth] … will give a much better approximation to an equitable system of taxation … A further important consideration, from the point of view of the equity of the tax system, is that the part of a person’s spending power which is actually exercised for personal ends ought to be more heavily taxed than that part which is not so exercised. It is only by spending, and not by saving, risk-taking or earning money in personal effort, that an individual imposes a burden on the rest of the community in attaining his own ends … It follows that a comprehensive personal tax based on four different criteria – income, net wealth, expenditure and gifts – gives the best approximation to a really equitable

124 Article in the New Statesman, 2 July 1955, 5. 125 N Kaldor, Reports on Taxation I (London, Duckworth, 1980) preface x. 126 M Daunton, Just Taxes: The Politics of Taxation in Britain 1914–1979 (Cambridge, Cambridge University Press, 2002) 286.

352  David Collison system of personal taxation. Income in this context should of course be based on a comprehensive notion of income, and include capital gains as well as dividends … For the above reasons the introduction of an integrated tax structure containing the following major features deserves consideration: (i) Income Tax: Surtax should be abolished and the standard rate of income tax should become the highest marginal rate on income. Capital gains should be taxed as income on the occasion of every change of ownership (whether by sale, gift, bequest, transfer into a trust, etc) … (ii) Annual tax on wealth … (iii) Personal expenditure tax … (iv) A universal gift tax …127

This long extract gives a summary of Kaldor’s concept of integrating tax charges. His thinking had matured since 1952 and he accepts different taxes, but sees them as being part of an integrated whole. His use of the phrase ‘ability to pay’ reads like the Inland Revenue phrase ‘taxable capacity’. However, the focus is different. For Kaldor, what should determine the tax levy was incomings enjoyed by the individual. Equating receipt with income raises the knotty problem of determining what element of a capital receipt is spendable income, so that the tax charge is levied on the element that can be viewed as equivalent to income. If I sell a shareholding, should I be taxed on the entire sum I receive, as I could spend that sum as easily as I could spend earned income? Or should I be taxed on the amount I receive that is in excess of what I invested; that is, I maintain my capital and pay tax on only the capital gain? And, if so, is the gain the excess over the amount invested at historic values or at today’s values? Or should I be taxed on the amount I receive less what I reinvest? Behind these questions are competing concepts of the socio-economic function taxation is to play. Do we seek to engender investment to advance wealth of the whole populace? Or do we seek redistribution of wealth to reduce disparities in the populace? These are questions that the conceptual model does not address. Nor, until he took up his ministerial advisory post five years later, did Kaldor appear to address the critical political question: what are the behavioural effects of these different taxation models? Kaldor did not restrict himself to academic analysis. Kaldor’s integrated tax structure was a ‘package linked with a rhetoric of modernisation; it was designed to appeal to productive, salaried members of the middle class against speculators and recipients of socially created wealth.’128

127 Labour Party Working Party on Profits Taxation and Tax Avoidance, ref 556/May 1959 (King’s above n 35 NK/11/1/78). The paper adds two further points. First, that assessment should be based on the family unit, aggregating the income, wealth, expenditure and gifts of husband, wife and minors. Second, there should be a single comprehensive annual tax return disclosing income receipts, capital receipts, investments made, gifts and the assets at the start and end of each year. All taxes to be assessed simultaneously. 128 Daunton, above n 126, 286.

The UK Capital Gains Tax: The Conception of the 1965 Act  353 Kaldor was not the only economist to influence the socialist movement. Thomas Balogh, at Oxford, wrote extensively on the need to control prices more effectively and reduce excessive incomes, in order to create equality. Balogh had no enthusiasm for taxing capital gains. He advocated nationalisation of industry, as, he argued, social ownership would eliminate senseless stimulation of demand. Balogh viewed consumption as in some sense irrational.129 Kaldor and Balogh became what newspapers came to refer to as ‘the Hungarian twins’,130 Balogh being the economic adviser to Harold Wilson, when Kaldor was ­Callaghan’s adviser. Balogh (1905–85) was, like Kaldor, born in Budapest and taught at University College London, when Kaldor taught at the London School of Economics. Balogh was a fellow of Balliol College, Oxford, Kaldor being a fellow of King’s College, Cambridge. A man’s ideas develop. The long extract above is of Kaldor’s thoughts in 1959. His ideas developed during the six years before capital gains tax was enacted, the six months before the introduction of the tax in April 1965 being a period in which, perhaps reacting to the challenges of practicality, he declared refinements in his concept. Over the same period, there was a change, also, in his attitude to politicians. In 1959, Crossman wrote: ‘Kaldor is utterly contemptuous of the politicians’ attitude to his tax proposals.’131 Describing Kaldor’s style after his government appointment in October 1964, Leo Pliatzky wrote: ‘[He] would cultivate anyone, regardless of grade, who had a part to play in the schemes dear to his heart.’132 The 1959 Labour Party Working Party on Profits Taxation and Tax Avoidance accepted the proposals in Kaldor’s paper.133 Kaldor summarised his approach to integrated taxation as: ‘A comprehensive personal tax based in four different criteria – income, net wealth, expenditure and gifts – gives the best approximation to a really equitable system of personal taxation. Income in the context should, of course, be based on a comprehensive notion of income, and include capital gains as well as dividends.’ Kaldor suggests taxing income (including capital gains) at tax rates that progressed up to 40 per cent,134 a wealth tax that progressed from 0.5 per cent up to 1.5 per cent, and an expenditure tax levied on expenditure above that deemed necessary for a reasonably comfortable existence at rates that progressed from 20 per cent to 100 per cent. ‘Capital gains should be taxed as income on the occasion of every change of ownership

129 Daunton, above n 126, 287. 130 See, for example, London Evening News 5 October 1979; King’s, above n 35, NK/12/1/2030. 131 Morgan, above n 38, 762 entry for 24 June 1959 reporting: ‘The old partnership of the H ­ ungarian born “Whitehall Twins” is back in business’. 132 L Pliatzky, Getting and Spending: Public Expenditure, Employment and Inflation (Oxford, Oxford University Press, 1982) 74. 133 Labour Party Archives ref Re 556/May, 1959; King’s, above n 35, NK/11/1/78. 134 Income was, at that time, taxed at rates that progressed to a marginal rate of 90 per cent. Hence, Kaldor is suggesting a very considerable reduction in the tax rate charged on income, which, in fact, was not achieved until 1988/89, 29 years after Kaldor was writing.

354  David Collison (whether by way of sale, gift, bequest, transfer into trust, etc).’135 Thus, the 1959 Working Party adopted the proposals of Kaldor, Woodward and Bullock in the 1955 Memorandum of Dissent for taxing capital gains. The Labour Party manifesto for the 8 October 1959 election has 224 words on taxation. Almost as an aside, it proposes taxing at least certain capital gains, stating: ‘We shall tax the huge capital gains made on the Stock Exchange and elsewhere.’ Nothing is said of the form of the tax charge, its extent, or whether the proposal is for the taxation of short-term, speculative gains or for a full capital gains tax. If the former, it can be fairly stated that the provisions enacted by the Conservative government the following year (plus the wider charge in 1962) satisfied the demands expressed in the Labour manifesto. In preparation for the 1964 election, the Labour Party reconvened its Taxation Working Party. This, now, included in its 10 members five future cabinet members,136 and two leading academics.137 The immediate political imperative of the time was agreement to an incomes policy.138 The working party declared: ‘All the general tax reforms proposed in our report are designed to bring about a fairer tax structure and they may accordingly be expected to help an incomes policy by creating a more favourable climate of opinion.’139 Kaldor’s concept of taxing spending power was formulated, but only on a realisation basis: ‘We consider realised capital gains to be a form of beneficial receipt conferring spending power like other taxable receipts and in principle they should be made liable to tax on the same basis as other forms of income.’140 The rates of surtax, to be applied both to income and to capital gains, were, however, to be reduced.141 Proposals for taxing capital gains were made specific: ‘The excess of sale price (or imputed sale price) over purchase price (or valuation … where appropriate) should be treated as income of the vendor for all tax purposes.’142 Tax was to be charged on disposal of assets held on the day the tax charge is introduced, the gain being measured from the value on that date. By the time of the fifth meeting of the working party, views on the rate of tax had mellowed. At its meeting on 7 February 1964,143 Kaldor suggested that capital gains be taxed at the current rate of income tax (then 38.75 per cent), without a charge to surtax. A contrary view was expressed by Thomas Balogh, 135 King’s, above n 35, NK/11/1/79. 136 Jim Callaghan, Roy Jenkins, Michael Stewart, Douglas Houghton (Chairman) and Anthony Crosland. 137 Nicholas Kaldor and Robert Neild. 138 Income policy was a preoccupation of government at this time. In the six years from 1964 there were five separate income policies: B Donoughue, Downing Street Diary: With Harold Wilson in No 10 (London, Pimlico, 2006) 49. 139 Labour Party Archives ref RD 742/April 1964; King’s, above n 35, NK/11/1/13. 140 King’s, above n 35, NK/11/1/14. 141 King’s, above n 35, NK/11/1/15. 142 King’s, above n 35, NK/11/1/13. 143 King’s, above n 35, NK/11/1/35.

The UK Capital Gains Tax: The Conception of the 1965 Act  355 who favoured a rate lower than the standard rate of income tax. In the working party report, the recommendation was that the rate was to be left to the judgement of the Chancellor when he introduced a tax on capital gains.144 It was noted that applying the same rate to gains as to other income would limit litigation. The Labour Party manifesto for the 15 October 1964 election shows the influence of Kaldor had then been established. The manifesto promised ‘a major overhaul of our tax system. Taxation must be fair and must be seen to be fair … In particular we shall tax capital gains; and block up the notorious avoidance and evasion devices that have made a mockery of so much of our tax system.’145 On Labour winning the 15 October 1964 election, Harold Wilson appointed Jim Callaghan as Chancellor of the Exchequer. The appointment was at a time of ferocious economic conditions giving a severe imbalance of trade, which supported aspirations for tax change.146 One of Jim Callaghan’s first acts was to appoint Kaldor as his Special Adviser. Kaldor attended all Budget meetings and was one of the four-man New Taxes Committee.147 YOURS OBEDIENTLY

Prior to the 1964 Election, the Department of Inland Revenue had produced a scheme for a capital gains tax, based on what they had read and heard of Labour’s proposals. The Department’s suggestions were formulated in a 10-page memorandum.148 On 20 October 1964, five days after the election, this memorandum was presented to Jim Callaghan, prefaced by a two-page note from Sir Alexander Johnston, Chairman of the Board of Inland Revenue, telling the new Chancellor of the Exchequer what he needed to do.149

144 King’s, above n 35, NK/11/4/80; Labour Party ref RD.695/February 1964. 145 Labour Party 1964 Manifesto Section 6: ‘Plan for Tax Reform’ www.politicsresources.net/area/ uk/man/lab64.htm. Accessed 30 December 2018. 146 R Whiting, The Labour Party and Taxation (Cambridge, Cambridge University Press, 2000) 159. 147 The other ‘permanent’ attenders were Jim Callaghan, Chancellor of the Exchequer, John Diamond, Chief Secretary and Alexander Johnston, Chairman of the Board of Inland Revenue. The other eight members who attended when the subject for discussion was relevant to their areas of expertise were: Roy Jenkins, Financial Secretary, William Armstrong, Denis Rickett, Richard Clarke, Alex Cairncross, Robert Neild, Samuel Goldman and Giles Radice. 148 Inland Revenue unpublished paper ref M 341, para 24, reproduced in IR (1966), above n 94, 217–27. The Department of Inland Revenue had, in June 1964, written a memorandum (ref PS 2589/66, see IR (1966), above n 94, 17 para 29) giving the suggestion of a four-man committee, established in October 1963 and chaired by Sir Edward Norman, Chief Inspector, on the form to be taken of a tax levied on capital gains made by companies only. The defeat of the Conservative government on 15 October 1964 made this report redundant. 149 IR (1966), above n 94, 215–16.

356  David Collison The memorandum gives a scheme for taxing all capital gains made after the ‘appointed day’.150 John Diamond, Chief Secretary to the Treasury, expressed surprise when he discovered that the Department had drafted a scheme with taper relief. Sir Alexander pointed out that the Labour Shadow Chancellor had tabled an amendment to the Conservative short-terms gains provisions of FA 1962 that tax be charged on all gains at rates that decreased with increased lengths of ownership. Jim Callaghan, who denied that a taper system of relief was ever part of the preferred scheme of taxing capital gains, said that taper relief was ‘concocted by Lord Mitchison one wet Thursday afternoon’ solely as a way of criticising Selwyn Lloyd’s short-term proposals.151 Sir William Armstrong later commented: ‘One of the surprises was how few deep thoughts [the Labour Party] had had.’152 In 1966, McConnachie (perhaps reporting Sir Alexander Johnston), wrote: The scheme for a long-term capital gains tax outlined by the Department in M.341 was translated virtually intact into the Finance Bill. More important, the differences between the scheme in M.341 and that which emerged in the Finance Act were accounted for to a large extent by considerations of politics rather than logic or equity … Seen against the trenchant criticism and hostility which the capital gains tax provoked and the small Government majority with which the tax was carried through the House, M.341 may be described as an eminently successful piece of preliminary planning.153

In summary, the scheme in the Department’s memorandum is: 1. 2. 3. 4. 5. 6. 7.

A charge on realisations after the appointed day – enacted as FA 1965, s 19(3). Calculate the gain by time apportionment generally, but use the value on Budget Day to calculate the gain for quoted shares and land – enacted as FA 1965, Sch 1 paras 22–24. A charge on all assets – enacted as FA 1965, s 22. A charge on UK residents, non-domiciled persons being charged on a remittance basis – enacted as FA 1965, s 20. Non-residents charged on assets of UK permanent establishments only – enacted as FA 1965, s 20(2). Charities and pension funds exempt – enacted as FA 1965, ss 35 & 36. Owner-occupied houses exempt – enacted as FA 1965, s 29.

150 This was, later, declared to be 6 April 1965, which was, I assume by design, both the start of the fiscal year and the date of the Budget. 151 IR (1966), above n 94, 24 para 55. 152 IR (1966), above n 94, 24 para 55. 153 IR (1966), above n 94, 16 Conclusion. A different slant was given in a comment to the author many years ago by a serving member of the Department of Inland Revenue. He said that the excessive workload for Revenue officials engaged on the Bill led to at least one heart attack. The subsequent internal review changed the staffing of all subsequent Finance Bills, there being more staff engaged on the Bill, each being allocated a smaller part of the Bill. In 1967, speaking of the work created by taxing capital gains, Wheatcroft wrote: ‘The Revenue have already been faced with a threatened strike by their officials which was bought off, despite the Government’s income policy, with a taxfree bonus of £50 a head.’ GSA Wheatcroft and AEW Park, Wheatcroft on Capital Gains Taxes (London, Sweet & Maxwell, 1967) 5. Writing with the benefit of 40 years’ hindsight, Stopforth

The UK Capital Gains Tax: The Conception of the 1965 Act  357 The concepts underlying this prescription can fairly be viewed as accurately reflecting those in the 1955 Memorandum of Dissent, and Kaldor’s 1959 summary of the proposed tax charge. What has been added by the Inland Revenue is, first, giving a formula for the measurement of the base cost and, second, copying the scheme of income tax exemptions into the proposed tax on capital gains. It is interesting to note that the Labour government, and Kaldor, accepted these, largely without question. Thus, the shape of the legislation that was enacted derives from this Inland Revenue paper. Seven Questions for Ministers The Department’s Memorandum posed seven questions for ministers to answer: 1. Is tax charged at a flat rate, or at income tax and reduced surtax rates? 2. Is ‘realisation’ to include gift and death? 3. Is rollover relief to be given for share-for-share exchange and/or replacement of business assets? 4. Is the gain on a principal residence to be fully exempt, or only insofar as the proceeds are reinvested? 5. Should there be a £1,000 chattel exemption? 6. Should there be an annual exempt amount? 7. Is Budget Day value for listed shares and land,154 and time apportionment for all other assets, acceptable? On 1., the Department gives a two-page discussion of the respective merits of a flat rate and of applying income tax rates, referring to the 1955 Memorandum of Dissent and later statements by Labour Party leaders and Kaldor. The Memorandum comments that, if income tax rates are used, some form of reduction is necessary to avoid the hardship of taxing a large gain in one year when it has accrued over many years. On 2., the Department notes, with numeric example, that a CGT charge at death would bear more heavily than estate duty on some small estates. On 4., a strong lead to full exemption for private residences is given by the Department’s memorandum, which, after noting the unfairness of taxing a house sale when down-sizing on retirement, comments: ‘Ministers may think that … exempting … the taxpayer’s principal residence would … [make] the tax more readily acceptable.’155

wrote of Finance Bill 1965: ‘The Revenue performed a Herculean task with diligence, intelligence, pragmatism and professionalism to stage manage the bringing of their ideas to a successful fruition in such a short time: Stopforth, above n 94, 607. 154 The memorandum refers to value on the appointed day, see above n 150. 155 M.341 para 25 in IR (1966), above n 94, 224.

358  David Collison On 7., the Department states: ‘Ministers may … share our view that increases in land values in recent years have been accelerating too fast to make [time apportionment] produce results which are fair to the Exchequer.’156 The Department’s scheme used the Stock Exchange price of listed shares as Budget day value (and for gifts and at death). Kaldor questioned this automatic use of the published prices, listing five ways in which the market could be rigged: 1. a majority shareholder in a listed close company could increase the price on 6 April 1965 by buying operations; 2. a private company could float in order to have a higher share price; 3. a company could adopt current value accounting for its assets; 4. a company could enhance its share price by increasing dividends; 5. a company could report inflated profits in the time between the December statement and Budget day. The Department responded that scenarios 2. and 3. were unobjectionable; it was for the Stock Exchange Council to police scenarios 1. and 5; scenario 4., the Department suggested, would not achieve a higher market price and would lead to the shareholders paying surtax on the dividends received.157 The incoming Labour administration delivered its first Autumn Statement on 11 November 1964, in which Jim Callaghan told the House that the 1965 Finance Bill would contain provisions for taxing capital gains arising on assets, whenever they had been acquired.158 In order to quell rumours to the contrary, the following day, John Diamond, Chief Secretary to the Treasury, announced that the taxpayer’s main residence would be exempt.159 Considerable details for the forthcoming capital gains tax were announced in a parliamentary written statement on 8 December 1964.160 In his Budget speech, Jim Callaghan described the failure to tax capital gains as: ‘The greatest blot on the existing system of direct taxation.’161 The 1965 Budget proposals generated four days of debate in the House of Commons, the Bill was 15 days in Committee of the whole House and five days on report.162 This contrasts to no more than nine days in the full House for any other Bill between 1961 and 1973.163 Some 1,222 amendments were tabled to the Finance Bill 1965, which led to 211 hours of debate, with speeches by 240 MPs and 108 divisions in the House.164 On only one vote was the Government defeated,

156 M.341 para 29 in IR (1966), above n 94, 225. 157 IR (1966), above n 94, 251–52. 158 Hansard HC 11 November 1964 vol 701 cols 1039–41. 159 Hansard HC 12 November 1964 vol 701 col 1236. 160 Hansard HC 8 December 1964 vol 701 Written Answers cols 165–67. 161 Hansard HC 6 April 1965 col 245. 162 As regard Inland Revenue matters. Further time was spent on Customs & Excise matters. 163 Robinson & Sandford, above n 37, table 5.1, 136–42. The length of debating time was not exceeded until Denis Healey’s 1974 Finance Bill (14 days in the full House). 164 Speech by Edward Heath, then shadow Chancellor, Hansard HC 15 July 1965 col 805.

The UK Capital Gains Tax: The Conception of the 1965 Act  359 that being on a new clause.165 Most unusually, the Queen said, in her speech opening Parliament on 8 November 1965: ‘Important reforms have been effected in the taxation of companies and capital gains.’166 TWO POLICY ISSUES THAT DIVIDED THE 1965 BUDGET COMMITTEE

Of the seven questions posed in the Department of Inland Revenue memorandum, two go to the heart of the tax charge. The first question, the rate of tax, highlights the conflict between Kaldor’s concept of integrated taxation, with the same rate being charged on income and gains (and, in the pure form of the concept, on all receipts, however defined) and the supporters of a flat rate of tax on capital gains, There is a further conflict amongst the supporters of a flat rate over the rate to be charged. The second question, taxation of gains arising from the owner-occupied house, gave less conflict but greater difficulty over the scope of the tax and the number of taxpayers who are called to pay it. Inland Revenue Question 1: The Rate of Tax The Department suggested that there are only two administratively ­practical approaches. Either the full rate of tax (income tax plus surtax) be charged on the gain (or the gain scaled down according to length of ownership), or a flat rate is charged. Kaldor responded, saying that a capital gain does not become less like income the longer the asset has been held. He favoured taxing all gains to income tax and charging surtax on gains that are not reinvested.167 Not all members of the Labour Party accepted his approach. Balogh had argued that ‘in view of the impact that might be expected … it would be preferable for this tax to be introduced initially at a rate lower than the standard rate of income tax’.168 Lord Cromer, Governor of the Bank of England strongly favoured a flat rate charge, as only that would enable an investor to know in advance what tax he would pay.169

165 Statistics in Inland Revenue unpublished internal memorandum T.2001/5/65 recorded in IR (1966), above n 94, 7 para 2. 166 Hansard HL 8 November 1965 vol 269 col 874. 167 IR (1966), above n 94, 22 para 48. 168 Dr Thomas (later Lord) Balogh was Harold Wilson’s economic adviser. His comment was made at the Labour Party Working Party on Taxation meeting 7 February 1964. King’s, above n 35, NK/11/1/35. 169 Telephone conversation 23 October 1964 between the Governor and the Chairman of the Board of Inland Revenue, repeated in a letter from Lord Cromer dated 2 December 1964: IR (1966), above n 94, 24 and 26 paras 53 and 60.

360  David Collison The Department submitted a paper to ministers on 6 November 1964 giving the conflicting arguments on the rate of tax. Kaldor exercised his right to make his views known direct to ministers by submitting his own paper 13 days later. Kaldor argued that the whole case for taxing capital gains rests on the ground that they confer the same benefits on the recipient as other forms of income. A flat rate would be wrong, in principle, as would tapering rates. Subjecting to income tax but not surtax would, he said, be acceptable. Kaldor argued vigorously that the new capital gains tax should replace FA 1962 short-term gains tax and that the two taxes must not coexist.170 At a meeting of the New Taxes Committee on 21 January 1965, the three Treasury Ministers decided that the FA 1962 short-term gains tax would continue, charging full income tax and surtax rates on gains made on any asset sold within 12 months, but a flat rate of tax would be levied by the new capital gains tax.171 The argument that proved crucial to ministers was that a shortterm gains tax provided a defence against devices that convert income to capital gains.172 The Treasury argued for the flat rate to be 25 per cent, arguing that ‘it would be unfortunate if it were thought to be in any sense a punitive or doctrinaire tax.’173 The Treasury considered that it would be advantageous for capital gains tax to be at a different rate from income tax, as at any later date the rate of one could be changed without affecting the other. Given that a flat rate was to be charged, Kaldor argued for 40 per cent.174 He kept to his concept of integrated taxation, and sought a rate of 40 per cent to be applied to income tax, the withholding tax on dividends, corporation tax and capital gains tax. He repeated the argument he had put in the Memorandum of Dissent: ‘No concept of income can be really equitable that stops short of the comprehensive definitions that embraces all receipts.’175 Kaldor did not accept that a rate of 40 per cent would blunt the incentive to risktaking and impair the capital market. Neild agreed with Kaldor. He wrote to Armstrong on 1 January 1965: ‘I am shocked by this paper by the Treasury. It manages to make recommendations … without ever saying that the choices are a matter of equity … The value judgements are all wrapped up in technical rags.’176

170 IR (1966), above n 94, 25–26 paras 58 and 59. 171 IR (1966), above n 94, 28 para 71. 172 This argument had been put forcibly by the United States Treasury to Inland Revenue officials during their 1956 visit: IR (1966), above n 94, 28 and 27 paras 72 and 64. 173 Treasury paper 8 January 1965, ref NT4; recorded in minutes of meeting of New Taxes Committee, 21 January 1965: PRO T 171/804. 174 IR (1966), above n 94, 31 para 79. 175 Cmd 9474 Memorandum of Dissent 359 para 5. 176 Board of Inland Revenue, Finance Bill 1965 Memoranda vol 1 (London, Inland Revenue, 1965) 446. Robert Neild was, like Kaldor, an academic economist who later became, as did Kaldor, a professor of economics at the University of Cambridge.

The UK Capital Gains Tax: The Conception of the 1965 Act  361 Inland Revenue argued for a rate of 30 per cent, on the grounds that charging tax at 40 per cent, when previously gains had been tax-free, was too severe a change.177 The decision was left to Jim Callaghan. In his Budget speech on 6 April 1965, he announced a rate of 30 per cent,178 with the option of charging two-thirds of the year’s gains to income tax and surtax.179 Inland Revenue Question 4: Taxation of the Principal Residence The largest gain made by the largest number of taxpayers is that on the owneroccupied residence.180 Although taxation of private residence gains is a logical constituent of a scheme of integrated taxation, Kaldor had accepted some years previously that imposing an undiluted tax charge would trigger widespread opposition to a tax on capital gains and, for reasons of political acceptability rather than economic theory, some modification of the tax burden was necessary. In its Memorandum, Inland Revenue assumed that there would be relief for an owner-occupied house.181 The choice was between: (1) deferral, so that a gain is rolled over into a new house purchased, and (2) exemption. The Labour working party on taxation had suggested exemption up to a specified maximum.182 A rollover provision is closer to the concept of integrated taxation. A person who invests in his house and makes a gain of £1,000 pays the same tax a person who invests in shares and makes a gain of £1,000; the difference being solely the former pays the tax later. For many, later means at death, when the quantum of tax payable could be very large. The Department of Inland Revenue argued for exemption. Concern was expressed that a person who sells his house in London on retirement and moves to an area with lower-priced housing could face a large tax bill at just the time he is seeking to obtain a nest egg to fund his retirement. Similarly, a person whose financial circumstances have weakened and sells his house to move into rented accommodation could have his circumstances made worse by a capital gains tax bill. Situations such as this would, Inland Revenue suggested, ‘antagonise a

177 IR (1966), above n 94, 31 para 78. 178 Hansard HC 6 April 1965 col 250. 179 This is a relief for taxpayers on small incomes with moderate gains. The example given in the Chancellor’s speech is that it would be beneficial to a married couple aged over 65 with income and two-thirds of their gains aggregating less than £2,500. 180 This is the most costly of all tax reliefs, costing £27.2bn (HMRC calculation, January 2018). By comparison, the cost of ISA reliefs is calculated at £2.9bn: www.gov.uk/government/stastics/maintax-expenditures-and-structural-reliefs, accessed 10 May 2019. 181 M.341, 20 October 1964 para 25 in IR (1966), above n 94, 223. 182 Minutes of 7th meeting 21 February 1964; King’s, above n 35, NK/11/1/23.

362  David Collison large section of the community who would otherwise find the new tax entirely acceptable.’183 At the meeting with Ministers on 2 November 1964, it was agreed that gains on an individual’s only or main residence would be exempt without limit.184 The following day, John Diamond, Chief Secretary to the Treasury, announced to the House of Commons that the taxpayer’s main residence would be exempt.185 Concern that tax would be payable if employment took a home-owner away for a period was widely expressed. Formal representations for relief were made by six government departments with employees in job-related accommodation: Board of Trade, Department of Economic Affairs, Home Civil Service, Foreign Office, Ministry of Defence and Ministry of Overseas Development.186 Labour MP Donald Chapman tabled an amendment to give the tax exemption for periods of job-related absence.187 Roy Jenkins, Financial Secretary, was sympathetic, saying that exemption should be given without time limit.188 Jim Callaghan agreed. In his minute he wrote: ‘This is a case for generosity’ and suggested an exemption, also, for a house occupied by an aged parent.189 Inland Revenue felt that it was time to rein in the enthusiasm of ministers. On 21 June 1965, the Revenue warned that too generous provisions would be open to exploitation, suggesting restricted periods of absence to leave the exemption unaffected.190 Ministers accepted the Department’s advice.191 THE TAX THAT RESULTED

In 1965 the rationality of the economist met the reason of the politician. Kaldor had a concept of integrated taxation. That concept calls for all capital gains, computed on an accruals basis, to be aggregated with income (and other receipts), and that aggregate is, then, subjected to a single set of tax rates. The 1965 capital gains tax excluded the largest gain made by the largest number of individuals,192 it was charged on realisations, it was charged without reference to income and it imposed a rate that was different from any other. What had

183 IR (1966), above n 94, 58 para 188. 184 IR (1966), above n 94, 58 para 189. 185 Hansard HC 12 November 1964 vol 701 col 1236. 186 Board of Inland Revenue, Finance Bill 1965 Parliamentary Papers vol 2 – Amendments (London, Inland Revenue, 1965) 770–71. 187 Hansard HC 27 May 1965 vol 713 cols 990–1002. 188 Minute, 21 May 1965 reproduced in IR (1966), above, n 94, 91 para 307. 189 Minute from Callaghan to his private secretary, 24 May 1965 reproduced in IR (1966), above n 94, 92 para 307. 190 IR (1966), above n 94, para 310. 191 Enacted as Finance Act 1965, s 29(4), Jim Callaghan’s suggestion of dependent relative relief was enacted as FA 1965, s 29(10). 192 That is, the owner-occupied house.

The UK Capital Gains Tax: The Conception of the 1965 Act  363 Kaldor achieved? In 1965, we have a tax that satisfies the popular demand to tax speculation but fails the concept of integrated taxation.193 Underlying the new capital gains tax was a concept that tax should be charged on a very wide definition of income. But it is politicians who enact fiscal legislation, and politicians are alive to popular feelings that a tax charged on a small number who make windfall profits is acceptable whereas the same tax on gains made when moving home is not. A former senior member of HMRC put it in a snappy form: ‘When principle meets politics, politics always wins.’ Within the 1965 capital gains tax charge is a tension between (1) the concept of the fiscal theorist that gains are a category of ‘income’ and should be taxed as such, and (2) recognising the damaging effects (sometimes economic, sometimes political, sometimes both) of charging tax on certain categories of gain.194 This tension between concept and acceptability has characterised the tax throughout its history. Overlying this tension have been outbursts of popular distaste for those avoiding tax, whether that expressed in 1953 by Tawney:195 ‘The immunity from taxation speculative plunder continues to enjoy has as much justification as a close season for sharks’, or the newspaper reports in 2009 of MPs avoiding CGT by flipping their private residence elections. Changes to the fundamentals of the tax charge have been made eight times since 1965, without ever achieving widespread acceptance that the formulation of the charge works as it should. The Revenue likes to keep away from concepts and principles. In Revenue booklet IR 560, sent to taxpayers in 1965 to explain the new capital gains tax, the Department of Inland Revenue gives the justification for taxing capital gains simply as ‘a new source of revenue’.196

193 The assessment of Richard Whiting differs, but is complementary with that of the author: ‘While the capital gains tax might have sounded like a radical, egalitarian measure, its true nature was more as an anti-avoidance device.’ R Whiting, The Labour Party and Taxation (Cambridge, Cambridge University Press, 2000) 171. 194 A tax on private residences would be politically unacceptable and would be perceived as giving hardship. CGT on investment portfolios is now widely accepted, but has adverse effects on investment behaviour. There is also damage caused by administrative complexity. 195 RH Tawney, Equality (London, Allen & Unwin, 1960) 243. 196 Prof Robert Neild probably screamed (see above at n 176).

364

13 The Early Proposals for a European Corporate Tax Policy CHRISTIANA HJI PANAYI

ABSTRACT

This paper examines the history and development of European direct tax law, with a particular focus on corporate taxation. The paper first looks at the early reports from the 1960s–70s (Neumark Report, Segrè Report, Van den Tempel Report), which set out far-reaching harmonisation recommendations and the historical context in which these reports were published. It will be shown that whilst some of the earlier recommendations laid the seeds for the system we have today, some of the important legislative measures adopted recently were precipitated and facilitated by political developments affecting the international tax community at large, such as the OECD/G20’s Base Erosion and Profit Shifting (BEPS) project. The author will compare the various recommendations made throughout the years with the current status quo. Has the Commission really abandoned its initial corporate tax strategy – as guided by these early reports – or is it effectively materialising it in a piecemeal and selective manner through legislative and quasi-legislative measures? The author will attempt to answer these questions. INTRODUCTION

T

he coordination of tax policy has always been perceived as an important component for stronger economic integration in the European Economic Community (EEC), now called the Union.1 Article 2 of

1 Following the Lisbon Treaty, the Treaty on European Union (TEU) was amended and the Treaty establishing the European Community (EC Treaty) was amended and renamed as the Treaty on the Functioning of the European Union (TFEU). Thereafter, the ‘European Union’ replaced and succeeded the ‘European Community’.

366  Christiana HJI Panayi the now renamed Treaty of Rome, which set out the legal framework for the European Economic Community (EEC) for 30 years,2 states that: The Community shall have as its task, by establishing a common market and progressively approximating the economic policies of Member States, to promote throughout the Community a harmonious development of economic activities, a continuous and balanced expansion, an increase in stability, an accelerated raising of the standard of living and closer relations between the States belonging to it.

Article 3 of the Treaty of Rome set out some activities which were needed to fulfil the tasks listed in Article 2. Among these activities, the following were included: (a) the elimination, as between Member States, of customs duties and of quantitative restrictions on the import and export of goods, and of all other measures having equivalent effect; (b) the establishment of a common customs tariff and of a common commercial policy towards third countries; (c) the abolition, as between Member States, of obstacles to freedom of movement for persons, services and capital …

… (h) the approximation of the laws of Member States to the extent required for the proper functioning of the common market …

At the time of the establishment of the EEC, Member State corporate tax systems were varied, but broadly fell into one of the following categories: the classical system, the split rate system, and the imputation system. The tax treaty network of Member States was also varied, with some Member States (eg the UK) having a large network of treaties, and others not. The simultaneous application of these corporate tax systems, however, often caused (and still causes) juridical and economic double-taxation and created obstacles to cross-border trade and the cross-border movement of people. From early times, efforts were made to address some of these problems, but finding ways to deal with the underlying issues has never been easy. What exacerbated the situation was the fact that the European Community had no competence over direct taxation – it still, technically, has no such competence. The European Community (and now the European Union) only enjoys competence in the areas of law assigned or conferred to it. There are no direct tax provisions in the European Treaties. While all EU Treaties dealt with indirect taxes to some extent,3 there was never any reference to direct taxes. This point was confirmed and reiterated in the TFEU. 2 The Treaty of Rome was officially the Treaty establishing the European Economic Community, which brought about the creation of the European Economic Community. It was signed on 25 March 1957 by Belgium, France, Italy, Luxembourg, the Netherlands and West Germany, and came into force on 1 January 1958. 3 See Art 28 TFEU, which provides for a customs union. See Arts 30 and 110 TFEU, which led to the harmonisation of excise duties.

The Early Proposals for a European Corporate Tax Policy  367 There have never been any Treaty legislative bases for direct tax harmonisation. By contrast to indirect taxes and the explicit tax base for harmonisation found in ex-Art 93 EC (now Art 113 TFEU), there are no specific legislative bases for the harmonisation of direct taxes. Instead, general legislative bases found in ex-Arts 94 and 308 EC (now Arts 115 and 352 TFEU) have been used for direct tax legislation. However, unanimity was (and still is) required under both of these provisions, making it difficult for proposals to succeed. As a result, the regulation of direct taxes is left within the competence of Member States and as such, Member States have the competence to design their corporate regimes as they see fit. Several attempts to curb this competence were made since the 1960s, though it would seem that up until now, comprehensive solutions have been eschewed for ad hoc ones. In examining these attempts, it is crucial to place them in the historical context in which they arose. From the 1960s until the 1990s, there were tensions between an intergovernmental view of the Community where state interests were seen as paramount, and the more supranational/integrationist approach where the overall Community good was seen as the primary objective, ‘even if this required sacrifice by particular Member States’.4 Broadly, there was a tension between the visions of Jean Monnet and Charles de Gaule which reflected not just their personal preferences but general differences on the desirable policy and the extent of integration to be reached in the EEC.5 This is also evinced in the proposals made in this period to deal with corporate tax obstacles to the attainment of the common market. Proposals for the harmonisation of corporate taxes have a long history. Tax harmonisation was thought of as essential for the completion of the common market from the beginning of the EEC. In the early years, the main concern of the Community, as far as corporate tax law was concerned, seemed to be the degree of harmonisation needed, rather than whether there should be harmonisation at all. What is evident early on is that the Community oscillated between the classical system and the imputation system, with its main focus being harmonisation rather than coordination. This is reflected in the recommendations of the various reports produced in the last 50 years. Although in the area of corporate tax law many developments were precipitated by decisions of the Court of Justice as well as political exigencies,6 it is still important to examine these early reports, as they shed some light on the Commission’s initial thinking in this area and show the extent to which its aims were adjusted.

4 Craig and De Burca, EU Law: Text, Cases, and Materials, 6th edn (Oxford, OUP, 2015) 6. 5 EB Haas, ‘The Uniting of Europe and the Uniting of Latin America, 5 (1967) 4 Journal of Common Market Studies 315–43. 6 C HJI Panayi, European Union Corporate Tax Law (Cambridge, Cambridge University Press, 2013) chs 5–8.

368  Christiana HJI Panayi THE NEUMARK REPORT

The Neumark Committee was set up by the Commission in 1960 under the chairmanship of Professor Fritz Neumark. The Neumark Report was released in 1962 but the official text of the report was eventually published on 1 ­February 1963, together with six Appendices.7 The report was published in the four official EEC languages at the time: Dutch, French, German and Italian. Interestingly, there is no official English translation, but an unofficial translation was produced by British economist Dr Hugh Thurston. The Neumark Committee was asked to study the various possibilities for the harmonisation of turnover taxes. In Book II of the report, the questions that the committee had to study were set out as follows: (a) Study if and to what extent the differences currently existing in the finances of Member States partly or even entirely hinder the establishment of the Common Market bringing into being and guaranteeing conditions analogous to these of an internal market. (b) Study to what extent it is possible to eliminate these differences which more considerably hinder the development and functioning of the Common Market.8

The fundamental idea was that there should be ‘establishment of a Common Market bringing into being and guaranteeing conditions analogous to those of an internal market’.9 This had to be, in every way ‘the result of the general evolution of the EEC’10 – when the characteristics of the common market ‘coincide with those pertaining to the internal market of a country’.11 The Neumark Report was concerned with disparities arising from tax systems of Member States, such as disparities bearing on the overall level of taxes, the composition of the tax burden, the types of taxes in different countries etc.12 Another objective was the avoidance of all taxation and other discrimination based on nationality or tax domicile.13 The Neumark Committee broadly recommended the harmonisation of income tax, capital gains tax, corporation tax and indirect taxes, though as pointed out, the recommendations were designed for the original six-country 7 ‘Report of the Fiscal and Financial Committee’, in The EEC Reports on Tax Harmonisation: The report of the Fiscal and Financial Committee and the reports of the Sub-groups A, B and C (IBFD, 1963) – henceforth, the Neumark Report. For general commentary, see A Easson, ‘Harmonisation of Direct Taxation in the European Community: From Neumark to Ruding’ (1992) 40 Canadian Tax Journal 604; S James and L Oats, ‘Tax Harmonisation and the Case of Corporate Taxation’ (1998) 8 (1) Revenue Law Journal (epublication) 50; and S Eden, ‘Corporate tax harmonisation in the European Community’ (2000) 6 British Tax Review 624–52, 627. 8 Neumark Report, Book II, 98. 9 ibid. 10 ibid. 11 ibid. 12 ibid, 100. 13 ibid, 101.

The Early Proposals for a European Corporate Tax Policy  369 community.14 The Neumark Committee insisted that the aim was not unification. Acknowledging the historical and socio-economic grounds for the differences in Member State tax systems but also at the same time the need to eliminate tax distortions to cross-border movement, it was found that there should be harmonisation but not unification – the latter not being politically feasible, nor capable of eliminating distortions to competition.15 Without really explaining the difference between the two terms, the committee argued that harmonisation was not a synonym for unification,16 and that the aim was ‘not uniformity but solely harmonisation of tax systems’.17 Tax harmonisation was considered as ‘merely an intermediate objective whose achievement will serve to eliminate or prevent all financial measures taken in Member States which would be likely to hinder or distort competition within the EEC’.18 It was further stated that complete unification of the tax systems of the Member States was not considered to be ‘as necessary from the aspect of integration policy, since experience proves that on many grounds moderate differences limited to the nature (structure) and to the rate of taxes do not hinder the free play of competition’.19 What the Neumark Report contemplated was a long process of convergence, the desired conclusion of which would be the introduction of common rules with regard to the taxable base.20 The Neumark Committee considered it desirable to levy ‘the same type of single tax on income, with the same structure of scales, even if the rates are different’.21 This solution was thought to be the best and achievable, ‘although certain transitional difficulties will have to be overcome’.22 As far as company taxation was concerned, the Neumark Committee recommended a special tax on companies.23 ‘This special tax would bear on all income of a share company … as constituent factors of the income subject to company tax, which would not moreover, exclude measures tending to prevent the double taxation of income that a company draws from dividends and similar income originating from participations in another company’.24 It was recommended

14 W Schon, ‘The European Commission’s Report on Company Taxation: A Magic Formula for European Taxation?’ (2002) 42 European Taxation 8, 276. 15 Neumark Report, 31. 16 Also see analysis in AM Jímenez, Towards Corporate Tax Harmonization in the European Community (Series on International Taxation, Kluwer Law International, 1999) 108. 17 Neumark Report, 102. 18 ibid. 19 ibid. 20 L Cerioni, ‘Company Taxation in the European Union: A Key Challenge 20 Years after the Ruding Report’, (2013) 67 Bulletin for International Taxation 10. 21 Neumark Report, 119. 22 ibid. 23 ibid, 122. 24 ibid.

370  Christiana HJI Panayi that the ­structure of the rate should be uniform in all the Member States and that ‘the part of the profits retained for self-financing be taxed more heavily than that which is distributed’.25 Broadly, the Neumark Committee recommended that retained profits should be taxed at 50 per cent,26 whereas distributed profits should be taxed, in the form of withholding tax at source, at a recommended rate of 25 per cent and not less than 15 per cent. Later on in the report, it was clarified that for distributed profits, withholding taxes should be imposed on the basis of two rates: a relatively low rate – which could, for example, fluctuate between 10 and 20 per cent – would be applied to profits distributed to persons having their domicile in the EEC and who own either registered shares or bearer shares, but who at the time of collecting the dividends provide information on their identity. For all other persons, withholding tax would be imposed at a far higher rate – 25 per cent minimum – which contrary to the first-mentioned rate would be the same in all Member States.27

It was further suggested that in order to ensure equality of treatment, ‘it would be appropriate to apply a corresponding differentiation for withholding tax on interest of all types’.28 The Neumark Committee recommended that dividends distributed from subsidiaries to parent companies should be exempt from withholding tax, ‘otherwise the tax exemption necessary to avoid double taxation would not be complete’.29 This principle was, however, to be applied ‘with shaded differentiations’ in order to avoid abuses. There would be no exemption if the parent company was established outside of the EEC, or there was uncertainty whether the beneficiary of the dividends was a company or an individual. Also, under certain circumstances,30 dividends received by parent companies from their subsidiaries would be exempt, to the extent that the parent company intended to distribute the dividends received to its shareholders. As noted, ‘the tax exemption for the company which receives the dividends is fully justified if it does itself distribute the dividends in question to its own shareholders, given that these shareholders are then subject to personal income tax with regard to the dividends’.31 For practical reasons, it was recommended that to benefit from the exemption, the redistribution had to be within two to four years from receipt

25 ibid. 26 Similar to the a split-rate system as it was then in Germany. See Neumark Report, 122–23, 139. Also see more detailed discussion by Professor Bernard Schendstok on how specific elements of the proposed system can be applied, in Appendix F: Harmonization of the Taxes on Companies and on Dividends. 27 ibid, 139–40. 28 ibid, 140. 29 ibid. 30 For the exemption to apply, it was recommended that there should have been a participation of at least 15–20 per cent in the capital of the distributing company, held at least one or two years before distribution of the dividend. See generally 140–41. 31 ibid.

The Early Proposals for a European Corporate Tax Policy  371 of those dividends.32 These recommendations led to the Parent-Subsidiary Directive, which was narrower in scope. For example, it did not apply to shareholders (recipients of dividends) who were individuals, nor was there a beneficial ownership provision, nor any time limits for redistribution etc. Quite innovatively at the time, the Neumark Committee recommended some sharing/reimbursement of the withholding tax levied between the state of residence and the state of source. The committee was of the opinion ‘that withholding taxes normally constitute a sort of tax instalment or advance payment on the shareholders’ personal income tax’.33 As such, it seemed ‘equitable that the State by which the tax is withheld reimburses the State in which the shareholder has his domicile’.34 It was conceded that such reimbursement could only be made in cases where the beneficiaries of the dividends were holders of registered or bearer shares, who provided information on their identity. ‘Even if such a solution for technical reasons cannot be applied in the immediate future, it would be advisable to consider it as the ultimate objective to be attained as soon as possible.’35 Whilst reimbursement, as envisaged by the Neumark Committee, has not been achieved and there are no plans to attain this objective, it is interesting to see that incentives for information exchange were suggested very early on. From a legislative perspective, the closest we got to some sharing of withholding taxes between the states of residence and source was in the context of the Savings Directive,36 now abolished. Furthermore, under the Common Consolidated Corporate Tax Base (CCCTB) proposal, the withholding tax on interest and royalties is also to be shared under the formula.37 The Neumark Committee recognised the importance of double tax treaties and the OECD Model in resolving double taxation.38 The committee was convinced that in the interests of the Community, the problem of double taxation had to be solved by harmonised if not uniform rules between the Member States at the time.39 The solutions proposed by the OECD Model were a good basis for such uniform rules but they could also ‘be amended and supplemented in such a way that they respond more adequately to the specific needs of the 32 ibid, 141. 33 ibid. 34 ibid. 35 ibid. 36 Council Directive 2003/48/EC of 3 June 2003 on Taxation of Savings Income in the Form of Interest Payments. 37 See Proposal for a Council Directive on a Common Consolidated Corporate Tax Base, COM(2016)683 final, 10. It is proposed that the proceeds of withholding taxes charged on interest and royalty payments made by taxpayers should be shared according to the formula of that tax year. However, withholding taxes charged on dividends are not to be shared since, contrary to interest and royalties, dividends are distributed after-tax and do not lead to any previous deduction borne by all group companies. The same treatment was proposed in the 2011 proposal. Proposal for a Council Directive on a Common Consolidated Corporate Tax Base (CCCTB) COM(2011), 121/4 2011/0058 (CNS). See, generally, C HJI Panayi, above n 6, ch 3. Also see C HJI Panayi, The Common Consolidated Corporate Tax Base and the UK (Institute for Fiscal Studies, 2011). 38 Neumark Report 143. 39 ibid.

372  Christiana HJI Panayi Common Market’.40 Through the suggestions made, it was obvious that the Neumark Committee favoured the expansion of the tax treaty powers of the country of residence.41 It was further recommended that a multilateral tax convention that would be uniformly interpreted and applied by all the Member States should replace the network of bilateral conventions.42 This multilateral convention would be broadly aligned with the OECD Model, but Member States could agree to depart from it in some situations, in line with the suggestions made to boost the taxing powers of the country of residence. It was emphasised that ‘it will not merely be sufficient to have a multilateral convention; it will still be necessary to ensure its uniform application and interpretation’.43 To that effect, it was ‘necessary to envisage the setting up of a common system of amicable procedure and of a common tax court for double taxation litigation’.44 In connection with this, it was recommended that an agency attached to the Commission should be set up to advise Member States on the conclusion or revision of tax treaties, or the operations for dispute resolution.45 A multilateral treaty was something the Commission considered in the past but without much success. However, as explained below,46 the new Tax Dispute Resolution Directive is a good step towards a largely procedural multilateral convention between Member States, even though it only covers specific issues. The Neumark Committee argued that it was not just double taxation that had to be avoided – it was important that each taxpayer should be ultimately taxed in their state of domicile.47 This was to be achieved by adopting either exemption with progressivity or ordinary credit, as under the OECD Model. It was argued that ‘a “just” tax system could only be set up following an alignment of national legislations and only on condition of a good and efficient exchange of information’.48 Tax harmonisation was seen as a dynamic process.49 Three phases for tax harmonisation were identified. The first phase would entail the reform of turnover taxes and would consist of measures needed to prepare the reforms that should be achieved in the later phases.50 The second phase would entail

40 ibid. 41 ibid, 144. For example, it was recommended that artists and sportsmen should be taxed in the country of domicile and that there should be a narrow interpretation of the concept of permanent establishment. Also see 145, where it is admitted that there is a preference for taxation in the country of tax domicile, because, among other things, of the ‘desire to ensure taxation at a progressive rate’. 42 ibid, 143–144. 43 ibid, 45. 44 ibid. 45 ibid. 46 Under the final heading of this paper. 47 ibid. 48 ibid. 49 ibid, 152. 50 ibid, 154.

The Early Proposals for a European Corporate Tax Policy  373 the harmonisation of company taxes and personal income taxes, as well as the conclusion of a multilateral convention for the avoidance of double taxation. In the third phase, all proposed reforms would be put into application. In addition, it was suggested to take measures to create a common information service ‘with the end of ensuring efficient tax inspection’,51 as well as a specialist European tax court for appeals.52 The European Community never went past the first phase, though as discussed under the final heading of this paper, recent developments suggest that efforts are being made to move to the (or a) second phase. This is not surprising given the hostility of Member States against rules that seek to harmonise corporate tax rates – not just back then but throughout the history of the EEC and the EU. Notwithstanding this well-known fact, subsequent reports also recommended the imposition of uniform corporate tax rates. Unsurprisingly, again, none of these proposals were eventually adopted. THE SEGRÈ REPORT

The Segrè Report was produced by a committee of experts, under the chairmanship of Professor Claudio Segrè.53 This committee had the mandate to examine the general measures that should be taken to develop a European capital market. Tackling existing tax obstacles to the development of ‘a capital market of truly European dimensions’ was considered as a subset of these more general measures that needed to be taken.54 Avoiding the contentious distinction between unification and harmonisation found in the Neumark Report, the committee stated that the general aim was the attainment of a ‘degree of fiscal neutrality that will allow capital movements to take place within the Community in conditions similar to those on a domestic market’.55 For this aim to be achieved, the tax system had to be neutral as to the location of the investment, the type of investment (ie whether it is direct investment or through an intermediary), and methods of financing.56 Similar to the Neumark Report, major obstacles to the attainment of fiscal neutrality were identified in the Segrè Report,57 such as double taxation,58 the

51 ibid, 155. 52 ibid, 154–55. 53 EEC Commission, The Development of a European Capital Market (Brussels, EEC Commission, 1966) 11. Henceforth, the Segrè Report. 54 Segrè Report, ch 14, 293. 55 ibid, 293. 56 ibid. 57 ibid, 294. 58 This included international double taxation and double taxation of investments made through a financial intermediary. See 294–96.

374  Christiana HJI Panayi preferential treatment of investments made in the country of residence59 and the different treatment (from Member State to Member State) of income paid to non-residents.60 These obstacles still plague the internal market. Also similar to the conclusions of the Neumark Report, it was argued in the Segrè Report that the ideal way of eliminating double taxation was through the conclusion of a multilateral convention. As this was likely to take some time, unilateral or bilateral solutions – temporary and ad hoc – were recommended,61 without the committee needing to address the fact that distortions arose not just because of the cross-border element but also because of differences of approach on the taxation of company profits at corporate and shareholder levels.62 As regards dividends paid to non-residents, it was recommended that host states should impose a withholding tax, provided a full credit was given in the country of residence of the shareholder. This meant that any excess would be refundable.63 In a way, the withholding tax would be an advance payment of tax, ‘and hence would hardly influence his choice of country of investment whatever the rate of the tax’.64 As regards foreign-sourced dividends, rather than exemption – which was the recommendation of the Neumark Report – the Segrè Report recommended the extension of the tax credit to such dividends. The reasoning was that without an extension of tax credit, there would be discrimination ‘between income from “national” shares and income from foreign shares, and between residents and non-residents’.65 An even better solution was to give non-residents a refund of corporation tax equivalent to the tax credit.66 These drastic – at the time – recommendations were not followed up. THE PROGRAMME FOR THE HARMONISATION OF DIRECT TAXATION

Indicative of its intentions, in 1967, the Commission launched a programme for the harmonisation of direct taxation.67 The programme was a follow-up to 59 ibid, 296–97. 60 ibid, 297–98. 61 ibid, 296. 62 C HJI Panayi, above n 6, ch 1; P Farmer and R Lyal, EC Tax Law (Oxford, Oxford University Press, 1998) 11. 63 ibid 300. It was preferable if the rate was the same in all countries and identical with that of the withholding taxes levied on resident shareholders. There was a similar suggestion in the conclusions in that Member States in their capacity as host states or home states should either tax income in one country only or divide revenue between the two by imposing a withholding tax in the host state and systematically allow it for tax purposes in the beneficiary’s home state. Ibid 311. 64 ibid. 65 ibid, 301. 66 ibid. 67 European Commission, ‘Programme d’harmonisation des impôts directs’, Commission Communication of 26 June 1967, Bulletin Supplement No 8. See Jímenez, above n 16, 109–11.

The Early Proposals for a European Corporate Tax Policy  375 the more general programme on tax harmonisation.68 To the Commission, the harmonisation of corporate tax systems remained a precondition for further development towards the single market. The 1969 programme proposed a number of measures such as the harmonisation of tax rates, the harmonisation of withholding taxes on dividends and interests, elimination of discriminatory tax rules against non-residents, removal of tax obstacles to cross-border corporate restructurings, the elimination of double taxation in parent-subsidiary relationships and the use of tax incentives.69 The Commission proposals eventually led to the Merger Directive and the Parent-Subsidiary Directive, enacted 20 years later. Arguably, limited proposals were easier to push through Council than more comprehensive harmonisation proposals. Later developments buttress this – comprehensive harmonisation proposals and/or proposals showing a preference for a major policy position were not very successful whereas ad hoc solutions were more likely to be enacted. THE VAN TEMPEL REPORT

At the request of the Commission, another report on corporate taxation was produced by Professor AJ van den Tempel in 1970.70 Again, there was a clear pro-harmonisation bias in this report. As stated in the report’s foreword, tax harmonisation involved ‘the important and urgent task of aligning the structures of corporation tax in the Community, and consequently the question of the taxation of undistributed versus that of distributed corporate profits’.71 It was admitted that tax harmonisation was ‘an exceedingly difficult subject’.72 The report attempted to provide technical information and consider the advantages and disadvantages of different methods of taxation applicable to the distribution of dividends: namely, the classical system, the split rate system and the imputation system.73 Contrary to the Segrè Report, in this report there was clear preference for the classical system, as this was ‘the most suitable to be adopted as a harmonised system in the European Communities’,74 offering the possibility of attaining capital export and capital import neutrality (ie, neutrality between investing abroad and domestically).75 The classical regime ensured there was no discrimination against foreign shareholders. It was also argued that the

68 European Commission, above n 67. 69 Jímenez, above n 16, 110–11. 70 AJ van den Tempel, Corporation Tax and Individual Income Tax in the European Communities (Competition: Approximation of Legislation Series, 1970). 71 ibid, 3. 72 ibid. 73 ibid, 10 et seq. 74 ibid, 4. 75 Farmer and Lyal, above n 62, 21.

376  Christiana HJI Panayi double taxation generated by the classical system was countered by the simplicity and neutrality of the system. This proposal was not followed up, as several Member States had, by then, abandoned the classical system in favour of imputation systems.76 However, what this report shows is that the policy environment in the early 1970s was still favourable to tax harmonisation. Thereafter, motivated by the early achievement of the customs union, Member States came to an agreement on a further ambitious project: that of an economic and monetary union. This project gave the excuse to the Commission to ‘defend the need of having a harmonised company tax even more vigorously than in the 1960s’.77 Tax harmonisation had to accompany such economic and monetary union. This was reiterated in the Werner Report on the Economic and Monetary Union in 197078 and a Council Resolution in 1971.79 THE COMMISSION’S 1975 PROPOSAL

The link between movement of capital, tax harmonisation and the economic and monetary union was seized upon by the Commission to revive the objectives defined in the 1967 programme and to justify its centralised approach to corporate taxation.80 Under this favourable environment, the Commission produced its 1975 Action Programme for Taxation,81 which included a proposal for a directive on harmonising corporate tax systems and arrangements for ­withholding taxes on dividends.82 Contrary to the recommendations of the Van den Tempel Report, the ­Com­­mission recommended a partial imputation system whereby Community share­holders would receive a (reimbursable) tax credit. A narrow band of rates was set both for the tax and the credit. In the explanatory memorandum to this proposal, the Commission argued strongly against the classical system as a basis for corporate tax harmonisation, as it did not relieve economic double taxation of dividends and in fact made distributions more expensive.83 By discouraging the distribution of profits and their reinvestment through the market, the Commission argued, this prevented a better allocation of resources.84 As such, it 76 Jímenez, above n 16, 111. 77 ibid, 115. 78 Report to the Council and the Commission on the Economic and Monetary Union of 8 October 1970 ([1970] OJ C136/1). 79 Council Resolution on Economic and Monetary Union ([1971] OJ C28/1). 80 Jímenez, above n 16, 116. 81 COM (75) 391 final, 23 July 1975. 82 Proposal for a Council Directive concerning the harmonization of systems of company taxation and of withholding taxes on dividends. Transmitted to the Council by the Commission on 1 August 1975. COM (75) 392 final, 23 July 1975. Bulletin of the European Communities, Supplement 10/75. 83 ibid 7, [5]. 84 ibid [6].

The Early Proposals for a European Corporate Tax Policy  377 made debt more advantageous, due to the deductibility of interest.85 By contrast, the imputation system offered neutrality as regards the legal form of company financing. It encouraged distributions and also put debt and equity financing on an equal footing.86 Furthermore, the imputation system promoted neutrality with regard to the various legal forms of undertakings.87 It also prevented tax avoidance by persons subject to high personal tax rates, who would shelter profits in a company.88 The Commission also invoked fairness reasons. Under the classical system, shareholders subject to low personal taxes were disadvantaged compared to those subject to higher personal taxes, as dividends were taxed in the same way and no tax credit was given to reduce the excessive tax burden.89 As it made distributions more expensive, this created a bias in favour of the self-financing of firms rather than financing from outside sources. It also created a bias in favour of major shareholders as opposed to small shareholders who preferred distributions.90 Broadly, under the Commission’s proposal, Member States would apply a rate of corporation tax within the range of 45–55 per cent to both distributed and undistributed profits,91 with the possibility of derogations in certain cases.92 Dividends distributed would be subject to 25 per cent withholding tax, ‘no matter who is the recipient of those dividends’.93 No withholding tax would apply to dividends distributed to a parent company. As regards the tax credit rate on distributed dividends, this would be fixed by the Member State of the recipient, but remain within the range of 45–55 per  cent.94 The tax credit would be set off against the final tax liability of the dividend recipient.95 Quite ahead of its time but similar to the idea first floated in the Neumark Report, the Commission proposed that when withholding taxes collected by a Member State were set off or refunded in another Member State, the Member State which collected the withholding taxes would have to refund them to the other Member State.96 Member States could share the withholding tax under bilateral agreements.97 85 ibid. 86 ibid [5]–[7]. 87 As reasoned in the report, usually, individuals and partnerships were subject to high personal tax rates compared to the corporate tax rate. The difference under the imputation system was smaller. Ibid 7–8, [8]. 88 ibid 8, [10]. 89 ibid 8, [9]. 90 ibid. 91 Art 3(1). There were also provisions for a compensatory tax to be levied in situations where the corporation tax had not been charged at the rate normally applicable in the Member State. See Art 9. 92 Art 3(2). 93 Art 14(1). This would be subject to different provisions under tax treaties between Member States and a third country. Ibid. 94 Arts 4 and 8. 95 Art 16. 96 Art 17(1). 97 Art 17(3).

378  Christiana HJI Panayi The Commission’s proposal was initially endorsed by both the Committee on Economic and Monetary Affairs and the Committee on Budgets of the ­European Parliament, subject to certain reservations. In the recommendations of the Committee on Economic and Monetary Affairs, released in 26 ­January 1977, it was suggested that only the Community institutions could decide Member State derogations on the level of the corporation tax rate. The need for overall fiscal harmonisation was raised, including the harmonisation of the basis of assessment and the tax rates. It was emphasised that it was important to avoid creating a situation more favourable to income from capital than to income from employment. The Committee on Budgets, adopting the proposal with amendments on 22 September 1977, also stressed the need to embark on harmonisation of systems in a way that does not affect revenue and to leave the approximation of bases of assessment, taxation rates and tax credits for later on. The proposed withholding tax was considered to be essential.98 Notwithstanding the endorsements of these committees and their recommendations, the Commission proposal was eventually rejected by the European Parliament as the latter institution wanted to harmonise the corporate tax base as well. Thereafter, the Commission began to study ways for greater crossborder cooperation, since harmonisation of taxes would be ineffective if there continued to be differences in the level of collection and, as a corollary, in the effective tax burden. This led to a Council resolution in 1975 on the measures to be taken by the Community in order to combat international tax evasion and avoidance,99 and the mutual assistance directives in 1977. In 1979, the European Parliament adopted the Nyborg Report, which recommended not only the harmonisation of tax rates and tax credits, but also of the tax base.100 The European Parliament invited the Commission to draw up guidelines to that effect.101 However, the Commission’s response from that point onwards was much more embedded in pragmatism. In its 1980 report to the Council on the scope for convergence of tax systems,102 the Commission talked of the difficulties of ­framing a common tax policy, in the absence of substantial progress made towards ­integration.103 Tax harmonisation was not intended ‘to serve the

98 See analysis in European Parliament Working Documents 1979–1980, Interim Report drawn up on behalf of the Committee on Economic and Monetary Affairs on the harmonisation of company taxation and of withholding taxes on dividends. Rapporteur: Mr K Nyborg (2nd May 1979, Doc 104/79). 99 Council Resolution of 10 February 1975 on the measures to be taken by the Community in order to combat international tax evasion and avoidance ([1975] OJ C35/1–2). 100 European Parliament document 104/79 of 2 May 1979, above n 98. 101 M Vascega and S Thiel, ‘The CCCTB Proposal: The Next Step towards Corporate Tax Harmonization in the European Union?’ (2011) 51 European Taxation 9/10, 374. 102 ‘Report from the Commission to the Council on Scope for Convergence of Tax Systems in the Community’, Brussels, 23 April 1980, COM(80)139 final 2. 103 ibid 5–6, [3].

The Early Proposals for a European Corporate Tax Policy  379 purpose of instituting a Community tax policy’ but rather ‘formed part of the means and powers granted to the Community to carry out its responsibilities’.104 The Commission recognised that aligning Member States’ tax policies was not as straightforward, due to their tax sovereignty and the different economic and social underpinnings of their tax systems.105 The harmonisation of tax rates was especially difficult and could only occur at a much more advanced stage of economic integration.106 ‘Then, however, it will be absolutely necessary, since the harmonisation of structures and bases of assessment will no longer be ­sufficient.’107 The Commission reverted to its 1975 proposal but also identified the need for some coordination of investment incentives granted by Member States.108 Overall, as far as legislative proposals were concerned, this report was imbued by a sense of realism. It was obvious that the Commission had begun to tone down the harmonisation rhetoric, opting for more realistic ad hoc solutions and a loose form of coordination. Eventually, the 1975 proposal was withdrawn. Draft proposals for the harmonisation of loss relief rules presented in 1984–85109 and 1990110 were also subsequently withdrawn. Furthermore, a proposal for the harmonisation of the tax base of enterprises drafted in 1988 was never even tabled for formal deliberation to the European Parliament and the Council, due to the reluctance of most Member States.111 It would seem that the combination of the unanimity requirement and the Commission’s striving for comprehensive harmonisation measures led to scarce legislative results. What followed the 1975 proposal was a more cautious approach focusing on targeted solutions and initiatives for more coordination rather than harmonisation. It was obvious that the Commission had put its tax harmonisation ambitions on hold. This later era of de minimis legislation with emphasis on coordination is not considered in this paper.

104 ibid. 105 ibid 6–7, [5]. 106 ibid 8, [7]. 107 ibid. 108 ibid 14, [19]. Also see conclusions at 64–65, [101]–[110]. 109 Proposal for a Council Directive on the harmonization of the laws of the Member States relating to tax arrangements for the carry-over of losses of undertakings, Official Journal (EC) C 253, 20 September 1984, p. 5. This proposal was amended in 1985. See Amendment to the Proposal for a Council Directive on the harmonization of the laws of the Member States relating to tax arrangements for the carry-over of losses of undertakings, Official Journal (EC) C 170, 9 July 1985, p. 3. For general commentary, see C HJI Panayi, ‘Reverse Subsidiarity and EU Tax Law: Can Member States be Left to Their Own Devices?’ [2010] 3 British Tax Review 261–301. 110 Proposal for a Council directive concerning arrangements for the taking into account by enterprises of the losses of their permanent establishments and subsidiaries situated in other Member States, COM (90) 595 final. This proposal was later withdrawn. 111 A preliminary draft was produced by the Commission in 1988: Preliminary draft proposal for a Directive on the harmonisation of rules for determining the taxable profits of undertakings, XV/27/88-EN. Also see H Kogels, ‘Unity Divided’ [2012] 3 EC Tax Review 117, 120–21.

380  Christiana HJI Panayi THE EU’S CORPORATE TAX POLICY: PAST, PRESENT AND FUTURE

Whilst initial proposals recommended the harmonisation of Member States’ corporate tax systems with a single tax rate (or a band of rates) and a uniform tax on distributed profits (or again a band of rates), subsequent proposals moved away from harmonisation to coordination and ad hoc legislative solutions. Furthermore, the Community, now to be called the Union, abandoned the quest of proposing rules following either the classical system or the imputation system, as ideal systems for corporate tax policy. However, from the issues and ideas floated in these early reports, has anything been materialised? What can one gain from the study of these reports? Much, it is respectfully submitted. It is useful at this point to categorise some of the common themes raised in these reports, and consider whether the Commission has managed to address them in its current policy. Double Taxation One issue that arose in all the reports is the problem of double taxation, especially in relation to dividends. The divergences of approach shown in the reports as regards which system is most suitable are reflective of the general divergences of approach on the topic in international tax law.112 For example, the Neumark Report recommended a split-rate system, the 1970 Van den Tempel Report recommended a classical system, the Commission’s 1975 proposed directive and the Ruding Committee (not considered in this paper) recommended a (partial) imputation credit system etc. As the Council (or, more accurately, Member States in Council) could not agree on any of these suggestions, it was left to the Court of Justice to tackle discriminatory aspects of the different corporate income tax systems.113 However, what is obvious is that an effort was made to promote a common system in these early reports – rather unsuccessfully, as shown above, as it was linked with broader recommendations for the general harmonisation of the corporate tax system. What we got in the end – or in the interim, if one sees the current situation as a transitional point in time – is a hybrid system of coordination and ad hoc harmonisation. For example, the Parent-Subsidiary Directive seeks to eliminate economic and juridical double taxation as qualifying profit distributions are not taxed (under strict conditions). This is because the profits have already been taxed as corporate profits at the level of the d ­ istributing company.

112 See P Harris, Corporate/Shareholder Income Taxation and Allocating Taxing Rights Between Countries: A Comparison of Imputation Systems (IBFD, 1996). 113 C HJI Panayi, above n 6, chs 6–7.

The Early Proposals for a European Corporate Tax Policy  381 The 2014 amendment to this directive ensures that the provisions of it do not lead to double non-taxation.114 Similarly, the Interest and Royalties Directive allows interest or royalty payments arising in a Member State to be exempt from withholding tax in that state.115 This is subject to the condition that the beneficial owner of the interest or royalties is a company in another Member State or a permanent establishment situated in another Member State of a company of a Member State which is subject to tax in that state. By taxing the beneficial owner in the Member State of residence, ‘it is guaranteed that such income is taxed in the same jurisdiction where the related expenditure is deductible (i.e. the cost of raising capital in the case of interest income, and research and development expenditure in the case of royalties)’.116 Furthermore, the Arbitration Convention117 establishes an arbitration procedure to eliminate double taxation in the course of transfer pricing disputes between Member States. The Arbitration Convention is based on the arm’slength principle. It applies when profits of an enterprise of a Member State are included (or are likely to be included) in the profits of an enterprise in another Member State. The objective of the Arbitration Convention, as set out in Article 4, is to establish a procedure to eliminate double taxation arising from profit adjustments made by contracting states because of a violation of the arm’slength principle between associated enterprises; or the attribution of profits to a permanent establishment not equivalent to what it might be expected to derive if it were a distinct and separate enterprise engaged in the same or similar activities under the same or similar conditions and dealing on an arm’s-length basis. The Arbitration Convention is superseded by the new directive on tax dispute resolution mechanisms.118 The Tax Dispute Resolution Directive renders these mechanisms mandatory and binding, with clear time limits and an obligation to reach results. The directive provides for the elimination of double taxation by agreement between the Member States including, if necessary, by resorting to the opinion of an independent advisory body (ie arbitration). The Tax Dispute Resolution Directive focuses on business and companies. Whilst it builds on the

114 Commission proposal for a Council Directive on the taxation of parent companies and subsidiaries of different Member States, COM(2013) 814. See C HJI Panayi, Advanced Issues in International and European Tax Law (Oxford, Hart, 2015) ch 5. 115 Council Directive 2003/49/EC of 3 June 2003 on a common system of taxation applicable to interest and royalty payments made between associated companies of different Member States, amended by Council Directive 2004/66/EC of 26 April 2004, Council Directive 2004/76/EC of 29 April 2004 and Council Directive 2006/98/EC of 20 November 2006. 116 Report from the Commission to the Council in accordance with Article 8 of the Council Directive 2003/49/EC on a common system of taxation applicable to interest and royalty payments made between associated companies of different Member States, COM(2009) 179 final, [3.1]. 117 Convention 90/436/EEC of 23 July 1990 on the Elimination of Double Taxation in Connection with the Adjustment of Profits of Associated Enterprises. 118 See Council Directive (EU) 2017/1852 of 10 October 2017 on tax dispute resolution mechanisms in the European Union – henceforth, Tax Dispute Resolution Directive.

382  Christiana HJI Panayi Arbitration Convention, the Tax Dispute Resolution Directive broadens the scope to areas that are not currently covered, by applying to all instances of double taxation of income from business. In addition, this directive applies to disputes arising from the interpretation and application of tax treaties. As such, the Tax Dispute Resolution Directive enhances the enforceability and effectiveness of tax dispute resolution mechanisms in the EU. Under the Tax Dispute Resolution Directive, any person who is a tax resident of a Member State and whose taxation is directly affected by a matter giving rise to a dispute, may within three years from the receipt of the first notification of the action resulting in, or that will result in the dispute, submit a complaint simultaneously to each of the concerned EU competent authorities.119 The directive will apply to ‘any complaint submitted from 1 July 2019 onwards relating to questions of dispute relating to income or capital earned in a tax year commencing on or after 1 January 2018’.120 However, competent authorities of Member States could agree to apply this directive with regard to any complaint that was submitted prior to that day or to earlier tax years. Overall, the Tax Dispute Resolution Directive is expected to go some way in improving the procedural means for the resolution of double taxation disputes. However, it should be emphasised that it does not provide any substantive allocation rules which could tackle economic and juridical double taxation. Therefore, whilst the problem of double taxation has (in very limited circumstances) been tackled by the EU legislator through these legislative instruments, the Court of Justice has also dealt with economic and juridical double taxation but in a different way. As far as juridical double taxation was concerned, the Court of Justice has consistently found that the results of juridical double taxation are a consequence of the parallel exercise of tax competences by different Member States. As such, EU law does not interfere with this exercise of taxing powers. It has been found in several cases that to the extent that such an exercise is not discriminatory, juridical double taxation is not prohibited under EU law. In Kerckhaert-Morres121 and Damseaux,122 the Court found that a home state was not in breach of the free movement of capital in failing to prevent (juridical) double taxation of dividends paid by a company resident in another Member State. The Court stated that it had no jurisdiction to rule whether Belgium’s inaction in entering (or amending) its tax treaties to avoid double taxation was in breach of EU law. Nor could it examine the relationship between a national measure and the provisions of a tax treaty.123 The disadvantages arose from the parallel exercise



119 See

Art 3(1). 23. 121 Case C-513/04 Mark Kerckhaert and Bernadette Morres v Belgian State [2006] ECR I-10967. 122 Case C-128/08 Jacques Damseaux v Etat Belgique [2009] ECR I-6823. 123 ibid [22]. 120 Art

The Early Proposals for a European Corporate Tax Policy  383 of taxing powers by different Member States. To the extent that such an exercise was not discriminatory, there was no restriction prohibited by EU law.124 Member States were not obliged to adapt their own tax systems to different Member State tax systems in order to eliminate this type of double taxation. By contrast, the Court of Justice has dealt with economic double taxation in a very bold manner, at least in the area of dividend taxation. As far as inbound dividends (ie, foreign-sourced dividends) are concerned, it has been found that shareholders (corporate or non-corporate) receiving such dividends should be treated the same way as shareholders receiving domestic dividends if they are in an objectively comparable situation, unless different treatment is justified. If the country of residence of the shareholder chooses to provide relief for domestic dividends, then it must provide the same relief at least for EU-sourced dividends. In other words, the case law provides for extension of an imputation credit for foreign-sourced dividends.125 Case law on the taxation of outbound dividends starts from a similar premise. The source state (ie the state of the distributing company) has to ensure equal tax treatment of resident and non-resident recipients of dividends, if they are in a comparable situation. From the source state’s perspective, resident and non-resident shareholders are in a comparable situation if they are both subject to source state taxes. Therefore, exemption from withholding taxes and credits are extended to non-resident recipients of ­dividends.126 The same principles would seem to be applied to interest payments.127 Harmonisation of Corporate Tax Bases and Rates Another issue that the early reports tried to address was the harmonisation of corporate tax bases and rates. In its 1967 Programme for Harmonisation, the Commission first alluded to the need for a uniform definition of taxable

124 ibid [27]. The case was followed in Joined Cases C-436/08 and Case C-437/08 Haribo & Österreichische Salinen and Case C-67/08 Block [2009] ECR I-0883. For commentary, see chs 4 and 6 in C HJI Panayi, above n 6; C HJI Panayi ‘Tax Treaties post-Damseaux’ [2009] Tax Journal, 14 September 2009, 9; L Cerioni, ‘Double Taxation and the Internal Market: Reflections on the ECJ’s Decisions in Block and Damseaux and the Potential Implications’ [2009] 63 Bulletin for International Taxation 11, 543. 125 See Case C-35/98 Staatssecretaris van Financiën v BGM Verkooijen [2000] ECR I-4071; Case C-315/02 Anneliese Lenz v Finanzlandesdirektion für Tirol [2004] ECR I-7063; Case C-319/02 Petri Manninen [2004] ECR I-7477; Case C-35/98 Verkooijen, [34] (CJEU) etc. Also see C HJI Panayi, above n 6, ch 6, 237 et seq; C HJI Panayi, ‘EU Tax Law and Companies: Principles of the Court of Justice’, in Gore-Browne, EU Company Law (London, LexisNexis, looseleaf) ch 19, 19[11]. 126 Case E-1/04 Fokus Bank ASA v The Norwegian State, represented by Skattedirektoratet (The Directorate of Taxes) [2005] 1 CMLR 10, EFTA; Case C-374/04 Test Claimants in Class IV of the ACT Group Litigation [2006] ECR I-11673; Case C-170/05 Denkavit [2006] ECR I-11949; Case C-379/05 Amurta SGPS v Inspecteur van de Belastingdienst [2007] ECR I-9569. 127 See Case C-387/11 Commission v Belgium, ECLI:EU:C:2012:670.

384  Christiana HJI Panayi corporate profits and – as in the Neumark Report – a certain approximation of the corporate tax rates. By 1975, the Commission proposed the harmonisation of corporate tax rates, and almost 20 years later, the Ruding Report recommended an initial minimum corporate tax rate of 30 per cent to apply on both retained and distributed income, followed by a maximum rate of 40 per cent. The recommendations for common rates (or a band of rates) were dropped but those for a harmonised tax base were picked up by the Commission in its 2001 Company Tax Study,128 which eventually led to the design of a Common (Consolidated) Corporate Tax Base. The first official proposal for a common consolidated corporate tax base was the 2011 CCCTB Directive,129 which was never approved in the end.130 This proposal was promoted as offering companies a ‘one-stop-shop’ system for filing their tax returns and the opportunity for consolidation. The first important aspect of this proposal was the common tax base – the directive provided uniform rules for the calculation of the tax base of group members that elected to adopt the CCCTB. The second salient feature was consolidation; ie the automatic set-off of profits and losses and the elimination of intra-group transactions for the consolidated group members. It should be emphasised that in the 2011 version, the new common tax base was optional; companies could choose whether to become CCCTB groups. Once they chose to become a CCCTB group, consolidation was compulsory. By contrast, the 2016 proposal for a CCCTB became bifurcated. The Commission proposed a two-step approach: Member States would first agree on rules for a Common Corporate Tax Base (CCTB), after which agreement would be reached on the consolidation element. Indeed, the proposals relaunched in October 2016 consisted of two separate directives: one for a CCTB131 and the other for a CCCTB.132 The difference between the CCTB and the CCCTB was the availability of cross-border consolidation of profits and losses, as well as the elimination of intra-group transactions. Under the 2016 proposals, the formula for consolidation was identical to the one proposed in the 2011 CCCTB Directive and was based on three

128 European Commission, ‘Company Taxation in the Internal Market’, SEC(2001) 1681. 129 Brussels, COM(2011) 121/4, 2011/0058 (CNS); SEC(2011) 316 final. This was accompanied by a detailed impact assessment. See Commission Staff Working Document Impact Assessment Accompanying document to the Proposal for a Council Directive on a Common Consolidated Corporate Tax Base (CCCTB), Brussels, 16.3.2011, SEC(2011) 315 final. Also see Commission Staff Working Paper, Summary of the impact assessment – Accompanying document to the proposal for a Council Directive on a Common Consolidated Corporate Tax Base (CCCTB), SEC(2011) 316 final (henceforth, Summary Report of the Impact Assessment). 130 Even though there was some build-up following the release of the 2011 proposal, technically, Member States were never asked to officially vote for it in Council. 131 Proposal for a Council Directive on a Common Corporate Tax Base, COM(2016)685 final. 132 Proposal for a Council Directive on a Common Consolidated Corporate Tax Base, COM(2016)683 final.

The Early Proposals for a European Corporate Tax Policy  385 equally weighted factors: labour, assets and sales. As in the 2011 proposal, intangible assets were excluded from the base of the asset factor. Also, as in the 2011 proposal, there were detailed administrative provisions for consolidated groups. As mentioned, the CCCTB purports to offer qualifying groups a one-stop-shop approach, in that the group would deal with one EU tax administration, which would usually be the Member State of residence of the group’s parent company. Interestingly, in the spirit of the post-BEPS era, the focus of attention of the 2016 proposals shifted from the objective of facilitating corporate groupings and simplifying compliance (which was pre-eminent in the 2011 proposal), to countering tax avoidance. Unsurprising, therefore, the 2016 CCTB/CCCTB Directives contain provisions that are similar to those already adopted under the Anti-Tax Avoidance Directive, but with less flexibility. Another major difference between this proposal and the 2011 CCCTB proposal is that the new rules are mandatory for large corporate groups, which are defined as groups with a consolidated revenue exceeding €750m. Companies falling outside the scope of the directive may opt to apply its rules under certain conditions (voluntary opt-in). The 2016 CCTB/CCCTB proposals are an important development, but they do not go as far as proposing common tax rates for the apportioned income. Therefore, we have not yet reached the stage where common corporate tax rates (or at least a band of rates) are being considered. Perhaps this will be affected by the Commission’s initiative for a common EU list of non-cooperative tax ­jurisdictions – colloquially called the EU blacklist. One of the benchmarks of this blacklist is the requirement of fair taxation. This is a very vague requirement which is not really explained in the context of this initiative, and is used interchangeably with fair tax competition.133 Although this blacklist only applies to third countries, the fact that no or zero-rate corporate tax rates are potential indicators for lack of fair taxation/competition may have a spill-over effect for Member States. In other words, the demands made on third countries to comply with certain criteria are likely to drive an (unofficial) policy of acceptable corporate tax rates. Interestingly, the Commission’s proposal for a Digital Services Tax might pave the way for some ad hoc harmonisation of tax rates.134 The proposed Digital Services Tax was presented by the Commission as a short-term measure to address the difficulties of taxing the digital economy.135 However, the proposal 133 See Q&A sheet, available at: http://europa.eu/rapid/press-release_MEMO-17-5122_en.htm. Also see C HJI Panayi, ‘The Europeanisation of Good Tax Governance’ (2018) 36 (1) Yearbook of ­European Law 442–95. 134 Proposal for a Council Directive on the common system of a digital services tax on revenues resulting from the provision of certain digital services, COM(2018) 148 final. 135 The proposal was part of a package of proposals. See Communication from the Commission to the European Parliament and the Council, ‘Time to establish a modern, fair and efficient taxation standard for the digital economy’, COM(2018)146 final.

386  Christiana HJI Panayi sets out a certain taxable base and a certain rate (3 per cent).136 Whilst there is, at the time of writing, strong opposition to this proposal, the risk of unilateral action by Member States is likely to lead to the eventual adoption of it (or a modified version) of it. Furthermore, recently, there have been reports that the Commission will propose to abandon the unanimity rule on tax issues in 2019.137 In a letter of intent accompanying his annual State of the Union address, the Commission President Jean Claude Juncker said that the Commission would begin a new initiative towards more efficient law-making in the field of taxation. Juncker had first announced his desire to end the practice of unanimity voting on tax issues in September 2017, A more comprehensive proposal to move away from unanimity to qualified majority voting in this area was made in January 2019.138 This proposal contains a roadmap for the adoption of qualified majority voting in four stages. Whilst this matter is highly political, a complete abandonment of Member States’ fiscal veto is highly unlikely. Multilateral Tax Convention A common tax treaty policy was another recommendation made in the Neumark Report, as well as the Segrè Report. It was proposed that the existing network of bilateral tax treaties should be replaced by a multilateral tax treaty that would be uniformly interpreted and applied by Member States. In these early reports, the focus of such multilateral tax treaty was to be the avoidance of double taxation. Later on, any efforts for a multilateral (or model-like) instrument were not only for the avoidance of double taxation but also for alignment of the OECD Model with the principles derived from the case law of the Court of Justice, and more recently, the BEPS Project. For example, in 2005, the Commission set up a working group to study the impact of EC tax law on tax treaties. The group produced a working document which contained a proposed annex to the articles of the OECD Model, offering 136 The digital services tax would apply at the rate of 3 per cent on gross revenues created from activities where users play a major role in value creation, including revenues from the following activities: (1) selling of online advertising space; (2) making available to users of a multi-sided digital interface; (3) transmission of data collected about users and generated from users’ activities on digital interfaces. Under the proposed directive, only entities with total annual worldwide revenues of €750 million and EU taxable revenues of €50 million will be subject to this tax, irrespective of whether they are established in a Member State or third country. 137 E Lamer, ‘EU to Identify Tax Matters for Qualified Majority Voting’, 91 Tax Notes International 1250 (17 September 2018). 138 Commission Communication, Towards More Efficient and Democratic Decision Making in EU Tax Policy, COM (2019) 8 final, 15/1/2019. For more information see C HJI Panayi, ‘The Relationship Between EU and International Tax Law’ in Research Handbook in European Union Taxation Law, ch 5 (Elgar Publishing, forthcoming).

The Early Proposals for a European Corporate Tax Policy  387 the Community perspective.139 This working document did not expressly indicate which country should be entitled to tax and what income should be subject to tax but made suggestions as to how to make the OECD Model more compliant with EU law. Some of the suggestions made were the inclusion of the permanent establishment in the scope of persons covered140 and of a resident (when in a comparable situation),141 the inclusion of inheritance and gift taxes in the taxes covered,142 adapting the dividends, the interest and the royalties articles to the provisions of the Parent-Subsidiary Directive and the Interest and Royalties Directive respectively,143 amending the provisions on income from employment and on pensions in line with the case law of the Court of Justice on border w ­ orkers,144 and pensions,145 etc. In essence, what this document proposed was how to adapt the OECD Model in order to be aligned with the principles derived from the case law of the Court of Justice up to that point in time. It was not followed up though, nor updated in line with more recent case law. Interestingly, in the preamble to this proposed convention it was recommended ‘for Member States to make explicit reference in the preamble [of their tax treaties] to the objective set out in Article 293 of the EC Treaty of securing “the abolition of double taxation within the Community” for Community nationals’. However, Article 293 EC was not carried over in the TFEU. Whether or not this has an impact on the role of the EU on tax treaties has not been determined.146 Insofar as the Tax Dispute Resolution Directive applies to disputes arising from the interpretation and application of tax treaties, this comes as close to a multilateral convention as we have in the EU. As mentioned above, this new directive does not deal with allocation of taxing rights (as double tax treaties and the OECD Model do), nor does it have any anti-abuse provisions (as the OECD’s multilateral instrument does).147 What may eventually lead to a common tax treaty policy (though not necessarily an EU Model Treaty or a multilateral EU treaty) is the Commission’s initiative for good tax governance. In its 2016 Anti-Tax Avoidance Package,148 the Commission published a Communication on an External Strategy for ­Effective Taxation.149 In this Communication, it was argued that a coordinated 139 Annex A, ‘The Article of the OECD Model Convention – A Community Perspective’, TAXUD E1/FR DOC (05) 2306/A, 9 June 2005. 140 ibid Art 1, p 2. 141 Art 4, p 4. 142 Art 2, p 3. 143 ibid, pp 6–7. 144 Art 15, p 9. 145 ibid, Art 18, p 10. 146 C HJI Panayi (2013), above n 6, 157 et seq. 147 See the Multilateral Convention to implement tax treaty related measures to prevent base erosion and profit shifting, available at: www.oecd.org/tax/treaties/multilateral-convention-toimplement-tax-treaty-related-measures-to-prevent-BEPS.pdf. 148 See http://ec.europa.eu/taxation_customs/business/company-tax/anti-tax-avoidance-package_en. 149 Commission Communication on an External Strategy for Effective Taxation (COM/2016/024 final).

388  Christiana HJI Panayi EU external strategy on tax good governance was ‘essential to boost Member States’ collective success in tackling tax avoidance, ensure effective taxation and create a clear and stable environment for businesses in the Single Market’.150 This Communication proposed a framework for a new EU external strategy for effective taxation, based on a revised tax good governance clause. In this Communication, the EU standards for tax good governance which were first set out in the 2008 ECOFIN conclusions151 and reiterated in the 2012 Recommendation on Good Tax Governance152 – namely, transparency, exchange of information, and fair tax competition – were re-examined in light of fundamental changes in the global tax environment.153 It was recommended that an updated EU tax good governance clause should be negotiated and included in agreements with third countries, as this would help promote tax good governance internationally. Bilateral and regional agreements with third countries were recommended as ‘particularly useful legal instruments [which] offer an opportunity to frame, in a consensual agreement, each side’s commitment to adhere to international standards of transparency, information exchange and fair tax competition’.154 It was argued that such agreements would allow the EU to ensure that its tax policy priorities vis-à-vis third countries were appropriately integrated into its wider external relations. Therefore, whilst the revised good tax governance clause focuses on antiBEPS measures and does not technically extend to other aspects of Member States’ tax treaty policies,155 a common stance in this area may also lead to commonality in other areas of external tax treaty policy. Furthermore, this might have a spill-over effect on tax treaty policy amongst Member States too. External and internal (intra-EU) tax treaty policies are already heavily circumscribed by international rules on exchange of information, assistance in the collection of taxes and other emerging BEPS minimum standards, as well as (for internal policy) the EU corporate tax directives and the case law of the Court of Justice. This partial pre-emption of Member States’ tax treaty powers is buttressed by other more recent Commission soft law initiatives, such as the proposals on the

150 ibid, 2. 151 Press Release, 2866th Council Meeting, Economic and Financial Affairs (8850/08 (Presse 113), Brussels, 14 May 2008) 22. 152 Commission Recommendation of 6 December 2012 regarding measures intended to encourage third countries to apply minimum standards of good governance in tax matters (C (2012) 8805 final). 153 See C HJI Panayi, above n 133, 442–95. 154 2012 Recommendation on Good Tax Governance, above n 152, 5. 155 The revised tax good governance clause includes reference to the original core minimum standards of good governance (transparency, exchange of information and fair tax competition), the new OECD/G20 Global Standard on Automatic Exchange of Information in relation to financial account information (ie, the Common Reporting Standard), additional standards based on the G20/OECD BEPS project; and the Financial Action Task Force international standards on Combating Money Laundering and the Financing of Terrorism and Proliferation.

The Early Proposals for a European Corporate Tax Policy  389 taxation of digital economy,156 as well as the earlier recommendations of the Anti-Tax Avoidance Package to align the proposals under BEPS Actions 6 and 7 with EU law.157 Therefore, whilst we may not have an EU multilateral tax convention, the existing legal framework (albeit a patchwork of rules derived from directives and case law) is, arguably, becoming a good substitute. Although the current status quo does not come close to the vision of a uniform or harmonised EU corporate tax system revealed in the early reports, it would seem that for the Commission, this is still a work-in-progress. Through imperceptibly small (and sometimes not so small) steps, the Commission seems to be materialising some of the ideas suggested in the early days.158

156 See especially the recommendation for a proposal to amend existing double tax conventions concluded by Member States with non-EU jurisdictions in order to introduce both the concept of a significant digital presence and the rules for attributing profits to such significant digital presence. See Commission Recommendation of 21 March 2018 relating to the corporate taxation of a significant digital presence, C(2018) 1650 final, Brussels, 21.3.2018. Available at: https://ec.europa.eu/ taxation_customs/sites/taxation/files/commission_recommendation_taxation_significant_digital_ presence_21032018_en.pdf. 157 See Commission Recommendation of 28 January 2016 on the implementation of measures against tax treaty abuse, C(2016) 271 final, Brussels, 28.1.2016. Available at: https://ec.europa. eu/taxation_customs/sites/taxation/files/resources/documents/taxation/company_tax/anti_tax_ avoidance/c_2016_271_en.pdf. 158 See C HJI Panayi, ‘The Peripatetic Nature of EU Corporate Tax law’, (2019) Deakin Law Review (forthcoming).

390

14 How The Netherlands Became a Tax Haven for Multinationals JAN VLEGGEERT AND HENK VORDING

ABSTRACT

The Netherlands’ tax environment for multinational foreign directive investment (FDI) has been characterised as a tax haven or, perhaps more accurately, as a ‘conduit financial centre’. Anyway, with a share of onethird in the worldwide market for tax-driven FDI diversion, the Dutch tax planning industry has become a prominent target of recent OECD and EU anti-avoidance measures. Adaptations in many of the relevant Dutch tax rules are now under way. The paper looks at the interactions between (a) the making of the relevant tax environment and (b) the rise of a specialised industry for FDI tax planning over the last century. The basic mechanism will be shown to be simple. A century ago, Dutch rules for taxation of cross-border FDI started to develop from a consistent view: FDI should not be hindered by tax borders. This served the interests of a small open economy hosting many internationally successful enterprises. A specialised tax planning industry only emerged in the second half of the twentieth century as a by-product of international tax policies aimed at substantial business interests. But as this industry grew, its role in shaping and reshaping the relevant rules increased. Only very recently has this role begun to decline, due to both international policy pressure and national public opinion. Issues to be discussed from this perspective include the development of Dutch tax treaty policy, the Dutch position in international tax coordination processes, and the development of relevant rules in Dutch tax law, starting with the first Dutch income tax law (1893/4) and with a focus on post-1945 developments.

392  Jan Vleggeert and Henk Vording INTRODUCTION

T

oday, the Netherlands plays a prominent role in multinational enterprises’ (MNE) tax planning schemes. For decades, resident corporations engaged in MNE tax planning have been able to conclude rulings with the Dutch tax authorities concerning their tax treatment. The sizeable Dutch tax planning industry has come under close international scrutiny in the aftermath of the G20/OECD base erosion and profit-shifting (BEPS) project. The EU Anti-Tax Avoidance Directive ATAD will likely have significant impact. And the current government has announced that it wants to do away with Dutch ‘letterbox companies’. In this contribution, we describe the historical evolution of the Dutch tax planning sector against the background of the Dutch position in international tax law.1 This position has, over the last century at least, always been dominated by the desire to reduce tax borders for international businesses. Within the corporation income tax, for example, the participation exemption is important to avoid double taxation of corporate profits. In addition, the Netherlands has developed a comprehensive tax treaty network, and it has never had withholding taxes on interest and royalties. The possibility of making agreements with the tax authorities (the tax ruling practice) is another pillar of the Dutch tax environment for international corporations. Taken together, these characteristics used to be regarded as the crown jewels of the Dutch tax system.2 The role of the Netherlands in MNE tax planning has become more visible over the last decade, as the availability of FDI data has considerably improved. The Netherlands has now become the global market leader in the provision of tax planning opportunities for multinationals, with a ‘market share’ of about one-third.3 It should therefore come as no surprise that the Netherlands is one of the top-three FDI (foreign direct investment) sources

1 The second and partially the third sections of this contribution are based on J Vleggeert, ‘Van patentregt naar base erosion and profit shifting: 200 jaar internationaal belastingrecht in Nederland’, in H Vording (ed), Tweehonderd jaar Rijksbelastingen (Den Haag, Sdu, 2015) 153–85. The fourth section is partially based on J Vleggeert and H Vording, ‘Is Nederland een belastingparadijs?’ (2018) 139 NJB. Internal memorandums as quoted throughout the third and fourth sections were published under the Freedom of Information Act, often at the request of Vleggeert. The ‘Kamerstukken’ references refer to the official reports of parliamentary procedures, and usually to government positions as defended in parliament. 2 Kamerstukken I 2015/16, 25 087, L, 13. 3 This follows from a comparison of data provided by the IMF, UNCTAD and the OECD. According to the IMF, in 2017, worldwide FDI stocks amounted to $34,000 bn, data.imf.org/regular. aspx?key=60564263, accessed 17 January 2019. UNCTAD estimated (for the year 2012) that around 30 per cent of worldwide FDI was held through intermediary countries (ie, tax havens or countries that host Special Purpose Entities); see UNCTAD, World Investment Report 2015 (Geneva, 2015) 189–90. Extrapolating this figure to 2017 results in some $10 bn in ‘diverted’ FDI. The OECD reports that in 2017, around $3,500 bn in FDI was held through Dutch Special Purpose Entities, which makes for a ‘market share’ of one-third. See oecd/stats/org, Globalization, FDI Positions, Main Aggregates BMD4, accessed 17 January 2019.

How The Netherlands Became a Tax Haven for Multinationals  393 for many countries. The Netherlands is the most important source of FDI for Brazil and Nigeria, number two for all major EU member states, but also for Russia and South Africa, number three for Mexico and for Greece. As a destination country for FDI, the Netherlands has been number one for the United States for years.4 The Netherlands is pre-eminently a conduit offshore financial centre (conduit OFC): Conduit-OFCs typically have low or zero taxes on the transfer of capital to other countries, whether through interest payments, royalties, dividends or profit repatriation. In addition, such jurisdictions have highly developed legal systems that are capable of catering to the needs of multinational corporations. Conduits play a key role in the global corporate ownership by enabling the transfer of capital without taxation.5

The Dutch position in the letterbox sector developed gradually after 1945.6 What was initially only a ‘bycatch’ of a tax policy aimed at real international business activities, has developed into a flourishing industry with its own lobbying position in politics. Its contribution to Dutch GDP increased from about 0.5 per cent in the mid-1980s to over 3 per cent in recent years. The political defence of the sector as developed over the past decades used to be: ‘this happens just as well elsewhere, and if we would stop, other countries will fill the gap.’ The data now available have made this position untenable. We briefly discuss the development of international tax law in the N ­ etherlands (both the international dimension of tax laws, and tax treaty policy) with a focus on policy aims. We then turn to the emergence of tax planning facilities under Dutch law and treaties and to the Dutch responses to BEPS. Our conclusion is that the Dutch government position on facilitating MNE tax planning is shifting – but that it is too early to evaluate the practical impact of this changing attitude.

4 The Netherlands is also the number 1 location of subsidiaries for US-resident corporations, see R Phillips, M Gardner, K Kitson, A Robins and M Surka, ‘Offshore shell games 2016: The use of offshore tax havens by Fortune 500 Companies’, Citizens for Tax Justice, Institute on Taxation and Economic Policy and US PIRG Education Fund, October 2016, www.ctj.org/pdf/offshoreshellgames2016.pdf. 5 J Garcia-Bernardo, J Fichtner, F Takes and E Heemskerk, ‘Uncovering Offshore Financial Centers: Conduits and Sinks in the Global Corporate Ownership Network’, Nature, published online 24/7/2017 at 2, www.nature.com/articles/s41598-017-06322-9. 6 The process can to some extent be observed in the statistics collected by the Dutch Central Bank (DNB) which supervises the corporate service providers sector. Consistent data go back to 2003, showing a steady increase of pass-through activities that clearly exceeds real economy performance (Dutch GDP growth) statistiek.dnb.nl/en/downloads/index.aspx#/details/specialfinancial-institutions-balance-sheet/dataset/b9514410-3b36-4812-9013-3d3862a098d2/resource/ efbc3c99-f381-411f-b9dd-b1ded6549e16, accessed 17 January 2019. From 1991 on, there are other DNB data confirming the image that international tax planning has been a very successful export service of the Netherlands, see De Nederlandsche Bank, ‘Special Financial Institutions in the Netherlands’, Statistical Bulletin March 2000, 19–29.

394  Jan Vleggeert and Henk Vording THE EMERGENCE OF INTERNATIONAL TAX LAW IN THE NETHERLANDS

Dutch Tax Law Developments Dutch international tax law started to develop with the adoption of income taxes in 1892/93, though a forerunner, a nineteenth-century business tax called ‘patent’ did make some provision for cross-border business, eg, international shipping.7 It was Finance Minister Nikolaas Pierson who introduced a ‘dual’ income tax at the end of the nineteenth century, after many years of political stalemate on the issue.8 The tax consisted of separately enacted levies on labour and business income, and on presumptive revenues from capital, both based on worldwide tax liability of residents. Non-residents were not liable to the capital tax (not even for immoveable property held in the Netherlands). However, proceeds from engaging in a trade or business in the Netherlands were taxable, also when undertaken by non-residents. Resident corporations were subject to income tax on their distributed profits (as previously under the patent tax). The unlimited tax liability of residents evidently created a risk of international double taxation. Two provisions were adopted to unilaterally reduce this risk. One allowed deduction of income taxes paid in the Dutch colonies, the other was aimed at international shipping. From the turn of the twentieth century, the attention for the problem of double taxation increased. As the government argued in parliament: ‘The legislator cannot and should not be indifferent to this. It is in the line of general development that the disadvantages of political boundaries are removed or reduced as much as possible, and there is no reason to except tax matters in the pursuit of that goal.’9 Bilateral tax treaties were considered the preferable solution: Unilateral regulation of the subject is less advisable, because it is not certain and not even probable that foreign tax legislations affecting Dutch interests will be adjusted to Dutch tax law, in order to prevent both double taxation and purposeless nontaxation. As long as the same tax principles are not honoured everywhere, a good solution can generally only be achieved through international agreement.10

The replacement of the dual income tax by a single synthetic tax in 1914 did not bring important changes in the taxation of non-residents – apart from an 7 Notitie Algemeen fiscaal verdragsbeleid, Kamerstukken II 1987/88, nr 2, 6. On the patent tax see OIM Ydema and H Vording, ‘Dutch Tax Reforms in the Napoleonic Era’, in J Tiley (ed), Studies in the History of Tax Law vol 6 (Oxford, Hart Publishing, 2013) 489–521. 8 On the income tax see H Vording and OIM Ydema, ‘The Rise And Fall Of Progressive Income Taxation in The Netherlands (1795–2001)’, in J Tiley (ed), Studies in the History of Tax Law, vol 3 (Oxford, Hart Publishing, 2009) 3–33; on Nikolaas Pierson see JLM Gribnau and H Vording (2017), ‘The Birth of Tax as a Legal Discipline’, in P Harris and D de Cogan (eds), Studies in the History of Tax Law, vol 8 (Oxford, Hart Publishing, 2017) 37–66. 9 Kamerstukken II 1907/08 nr 22, ondernr 1, 23. 10 Kamerstukken II 1907/08 nr 22, ondernr 1, 23.

How The Netherlands Became a Tax Haven for Multinationals  395 adjustment to the developing consensus on taxation of immoveable property. The emerging international norm, embodied in early tax treaties, was that this property should be taxable in the state where the property was located. As a result, the Netherlands would lose tax revenue (on immoveable property held by residents in treaty partner countries). In compensation, it became inevitable to start taxing non-residents for their Dutch immoveable properties.11 But the legislative documents express a clear ambivalence with respect to taxation of non-residents.12 While it has become internationally accepted practice to tax non-residents for their domestic proceeds, this limited tax liability does not fit in with an unlimited ability-to-pay income tax. And by asserting its right to tax non-residents, a state ignores the problems of double taxation that may well arise. In the end, it was agreed, the Netherlands should indeed tax non-residents on their domestic income, as part of ‘a fruitful international tax policy.’ The Netherlands only introduced a corporation income tax in August 1940 – under German occupation, albeit based on a draft that had nearly completed its parliamentary procedure prior to this, in May 1940. As corporations up to that moment had only been taxable on their distributions,13 large-scale tax deferral had become common practice. Under the profits tax, resident corporations were subject to a tax on their profits at a rate of 10 per cent. Foreign profits of resident corporations were taxable for 10 per cent of their amount (considered a kind of headquarters service fee).14 A similar rule applied to dividends received from and capital gains on the sale of participations (a participation exemption). The law was replaced by a Corporation Tax Ordinance in 1942, inspired by the German model. The Ordinance introduced the rule that a corporation is deemed to be a resident if it was incorporated under Dutch law. The general idea of the Ordinance was that natural persons and legal persons should be taxed in the same way; therefore, the participation exemption was explicitly considered a tax advantage (and limited for that reason).15 During the German occupation, the income tax of 1914 was replaced by the Income Tax Ordinance 1941 (again, preparations to that purpose had been undertaken just before 1940). The permanent establishment concept made its appearance as a threshold for tax liability of non-residents businesses. Another novelty was the tax liability for non-resident shareholders with a substantial shareholding in a domestic corporation. As far as the prevention of double taxation is concerned, the arrangements made under the income tax of 1914 were 11 Kamerstukken II 1907/08 nr 22, ondernr 1, 23. 12 Kamerstukken II, 1911/12, nr 144, ondernr 3, 16/17. 13 From 1917 onwards by a dividend withholding tax, as the income tax no longer included resident legal entities. 14 Kamerstukken II 1939/40 nr 239 ondernr 5, 32. 15 Para 10(5) van de Leidraad bij de vennootschapsbelasting en de vermogensbelasting 1942. As a consequence, only dividends received from (active) participations were exempt; capital gains on the sale of participations were taxable.

396  Jan Vleggeert and Henk Vording broadly continued – as was the case for the Income Tax 196416 and the Income Tax 2001. The Corporation Tax Ordinance 1942 remained in force after the war, and was replaced only in 1969. The legislative process leading to the Corporation Income Tax 1969 generated a new perspective on the participation exemption. As the (German) analogy between natural and legal persons was now rejected, the government proposed a broad exemption, to avoid double taxation whenever a corporation was actively participating in a subsidiary. This exemption was to include all gains from the participation, including capital gains on disposal of the shares. It was explicitly noted that the Netherlands was now adopting an exemption much broader than in many other countries. This, it was argued, reflected ‘a particular attention for the interests of the many Dutch companies with substantial foreign participations’.17 Two limitations were adopted to preclude abuse. One was that the participation should be active (ie, not just a portfolio investment). The second was that a foreign participation should be subject to some form of profits taxation – a purely formal requirement however, without any effective tax test. As to dividend withholding tax, there is a fairly straight line starting with the nineteenth-century patent tax (which taxed corporations on their distributions), continued by the Income Tax Acts of 1892/93, pursued by the Dividend Tax of 1917, the Decree on Dividend Tax 1941, up to the Dividend Tax of 1965. As of 1941, for residents, the dividend tax worked as a withholding tax creditable against their (individual or corporation) income tax. The tax rate, however, increased from a mere 2 per cent under the patent tax, to 15 per cent and eventually to 25 per cent under the Dividend Tax 1965. This latter rate was explained in parliament with reference to the changing international opinion on taxation of dividends in the source state. The traditional position of the Netherlands, it was argued, was that dividend withholding taxes were to be reduced to (preferably) zero in bilateral tax treaties. But, it was noted, source state entitlement to taxation of dividends was now increasingly accepted. Conforming to this trend, the Dutch tax treaty policy should be aimed at making (Dutch) dividend withholding tax creditable in treaty partner countries.18 The Netherlands would still be prepared to conclude withholding tax rate reductions in tax treaties, and the rate increase to 25 per cent would actually strengthen the Dutch leverage in treaty negotiations. Only for intragroup dividend payments, tax treaty policy would continue to aim at zero withholding tax: ‘the major interests of Dutch entities with participations abroad are a compelling reason for the Netherlands to continue to adhere to this line of conduct.’19 As of 2007, the rate of dividend tax was reduced to 15 per cent.

16 On the basis of that law, a unilateral decision for the prevention of double taxation was published in 1965; it had forerunners from 1953. 17 Kamerstukken II 1959/60, 6000, nr 3, 13 rk. 18 Kamerstukken II 1959/60, 5380, nr 9, 12. 19 Kamerstukken II 1959/60, 5380, nr 9, 13.

How The Netherlands Became a Tax Haven for Multinationals  397 Apart from some temporary measures, the Netherlands has never had withholding taxes on interest and royalties. The explanation – at least in the 1987 white paper on tax treaty policy20 – is that in the Netherlands tax policy has always been aimed at unhindered international investment flows. It is not quite clear why the same goal – facilitating tax treaty negotiations on reduction of treaty partners’ withholding taxes – would lead to a dividend withholding tax but not to such taxes on interest and royalty flows. The Development of the Dutch Tax Treaty Network Though during the nineteenth century, trade agreements could have some bearing on taxation,21 in the last decades of the century, double taxation was primarily a problem in the German states and the Swiss confederation. This was where the first treaties for the reduction of double taxation came into being.22 As an early attempt (in 1904) to conclude a general tax treaty with Germany did not lead to results, the Dutch-Belgian treaty (1933) was the first of its kind. The treaty was based on the League of Nations models. Next came treaties with Sweden (1935) and Hungary (1938), and a limited treaty with the United Kingdom (1935, only with respect to profits obtained by an agent). After 1945, the tax treaty network was quickly expanded: the United States (1948), the United Kingdom (1948), France (1949), Norway (1950), Switzerland (1951), Sweden (1952), Finland (1954), Italy (1957), Denmark (1957), Canada (1957) and Germany (1959). Then the pace slowed down, due to the low dividend tax rate (15 per cent) and the (then) Dutch position that the source country should not be entitled to withhold dividend tax. After the adoption of the Dividend Tax 1965, the further expansion of the treaty network proceeded. Today the Netherlands has concluded around a hundred tax treaties. These conventions are generally based on the OECD model convention.

20 Notitie Algemeen fiscaal verdragsbeleid, Kamerstukken II 1987/88, nr 2, 8. 21 K van Raad, Nondiscrimination in International Tax Law, Series on International Taxation no 6 (Deventer, Kluwer, 1986) 214. For example, the treaty that the Netherlands concluded in 1899 with Germany for the construction of a cross-border railway contains a tax provision. On the basis of this provision (Art 14), each of the states may levy taxes on the profits made with the operation of this railway line. The profits are distributed according to the number of kilometres of railway that is in the territory of each of the states. 22 A Spitaler, Das Doppelbesteuerungsproblem bei den direkten, Steuern 2. (Köln, Auflage Verlag Dr Otto Schmidt KG, 1967); J Hattingh, ‘On The Origins of Model Tax Conventions: 19th Century German Tax Treaties and Laws concerned with the Avoidance of Double Taxation’, in J Tiley (ed), Studies in the History of Tax Law, vol 5 (Oxford, Hart Publishing, 2013) 31–79; and S Jogarajan, ‘Prelude to the International Tax Treaty Network: 1815–1914 Early Tax Treaties and the Conditions for Action’ 31(4) Oxford Journal of Legal Studies 679–707.

398  Jan Vleggeert and Henk Vording THE NETHERLANDS AS A TAX PLANNING COUNTRY

The early development of the Dutch tax planning industry is not welldocumented. Around the mid-1980s, the sector became subject to political debate, and at that time, it had already drawn the attention of treaty partners. We discuss two examples (the 1957 Dutch-Canadian tax treaty, and the DutchNetherlands Antilles tax route) and then turn to the practice of tax rulings. Much of that practice has come to light only quite recently. The 1957 Dutch-Canadian Tax Treaty An interesting prelude to the development of the Dutch tax planning industry can be found in the Dutch-Canadian tax treaty. The 1957 treaty provided for a mutual 15 per cent dividend withholding tax, but with a zero rate for intragroup dividends. By amendments in 1959 and 1965, the rate applicable for intragroup payments was increased to 15 per cent, with the exception of flow-through dividends to which a zero rate still applied. The purpose of the provision was not to facilitate Dutch conduit companies, but to allow profits earned by Dutch corporations in the Americas during the Second World War, and held in Canadian corporations, to be repatriated to the Netherlands.23 However, in the 1970s it became apparent that the flow-through provision was mainly used to pay dividends from the Netherlands to Canada without levying Dutch tax: the treaties that the Netherlands has concluded with a large number of countries almost always provide for substantially lower withholding taxes than the treaties that Canada itself has concluded with those countries. In this context, many Canadian parent companies have decided to create a Dutch intermediate holding company … the resulting practice is not beyond criticism and contrary to the reason why this provision was created at the time.24

The flow-through provision was then revised – but only in 1986. At that time, the development of conduit activities was starting to draw criticism. As the government said in parliament: ‘other industrialised countries are now observing argus-eyed the enormous increase in large money-flows through the N ­ etherlands. It hardly yields the Dutch state anything, as it usually involves holding companies with a minimum of substance, but it does damage the good reputation of the Netherlands.’25



23 Kamerstukken

II 1985/86, 19614, nr 1, 2. II 1985/86, 19614, nr 1, 2/3. 25 Kamerstukken II 1986/87, 19614, nr 6, 5. 24 Kamerstukken

How The Netherlands Became a Tax Haven for Multinationals  399 The Antilles Route The position of the Netherlands as a conduit country also plays an important role in the relationship with the Netherlands Antilles. Since 1965, a dividend tax exemption applied for intra-group dividends paid from the Netherlands to the Netherlands Antilles.26 In other countries, however, strong resistance to this exemption arose. Withholding tax rates on intragroup dividends concluded in Dutch bilateral tax treaties tended to be lower than comparable rates in treaties between other countries. And residents of third countries could gain access to Dutch tax treaties by establishing a Dutch letterbox company whose shares were held by an Antillean letterbox company. The Dutch letterbox company functioned in this structure as a holding company of the subsidiaries of the group. The foreign withholding tax on dividend payments by these subsidiaries was then reduced by the Dutch tax treaties. In the Netherlands, the dividends were exempt from corporation tax on the basis of the participation exemption. The payment of the dividend to the Antillean holder of the Dutch intermediate holding company was exempt from Dutch dividend tax. The Antilles did not tax the Antillean holding company on the dividends and did not impose tax on distributions because the Antilles did not have a dividend tax: ‘The objection of the tax treaty partners of the Netherlands is that through the intermediary of an Antillean company the reduction of the dividend tax of the other country is enjoyed not only by residents of the Netherlands but also by residents of third countries.’27 As one Cabinet Secretary later quipped: ‘As a result, a treaty with the Netherlands could be called a treaty with the world.’28 In 1985, an adjustment of the dividend tax exemption became inevitable, as the ‘Antilles route’ became a burden on Dutch treaty renegotiations. Tax Rulings: A ‘Shadowy Practice’ By the end of the twentieth century, the worldwide reputation of the ­Netherlands’ tax ruling practice was well established.29 Starting in the post-WWII years, foreign investors were offered advance agreements on their tax treatment, so as to encourage investments. These agreements were concluded with the Ministry of Finance until the mid-1970s, and subsequently with corporation tax inspectors. There was no transparency as to what the agreements entailed. One author observed: ‘A small number of specialised ruling inspectors, a small circle

26 This exemption was introduced by the Tax Arrangement for the Kingdom of the Netherlands, which included the Netherlands Antilles. 27 Kamerstukken II 1984/85, 18747 (R1271), nrs 1–3, 6. 28 Kamerstukken II 1984/85, Handelingen, 5475 (lk). 29 C Romano, Advance Tax Rulings (IBFD, Amsterdam, 2002) 22–23.

400  Jan Vleggeert and Henk Vording of i­nternationally operating advisers, no publicity. Here are the elements that created an atmosphere of secrecy, of horse trading within the tax world, including within the tax administration itself.’30 Another observer added: ‘An area that … has only been entered for decades by some initiates who know the way in this mandarin world … uncontrolled policies, which have evident characteristics of arbitrariness’.31 As was shown above, the mid-1980s saw political reflection on the evolving Dutch position in international tax planning. Fitting in with that atmosphere, the Netherlands Court of Auditors investigated the tax ruling practice and published a critical report in 1986. It acknowledged that some efforts at coordination had been made, but in practice tax ruling inspectors, working solitarily, make different decisions in specific cases. Fully aware of this difference, stakeholders try to make use of this by submitting the same request to various inspections. This phenomenon has been given the name ‘inspector shopping’, which, in the opinion of the Court of Auditors, is undesirable.32

In response, the government published a white paper on tax ruling policy. It set out the different types of rulings, aiming at a standardisation within the framework of the substantive tax law. Next came a centralisation in the form of a national tax ruling team; inspector shopping disappeared. The 1990s saw a liberalisation – and a swift backlash. In 1995, tax ruling policy was considerably relaxed. In addition to the available standard tax rulings, ‘the ruling team, given the available expertise, can search within law and jurisprudence in various directions for solutions tailored to the individual case.’33 Critical responses by both the OECD and the EU resulted in a further adjustment of the tax ruling policy in 2001. This was a cosmetic adjustment, however: ‘It could be argued that, apart from the changes in the terminology, in the legal labels given to the rulings, and probably in a more prudent approach by the ruling authority, the rulings practice has not changed substantially.’34 Two recent government documents provide more detail on the tax ruling practice as it has developed over recent years. One is an internal memorandum of the Ministry of Finance (further referred to as ‘the 2015 tax ruling practice document’), made public under the Freedom of Information Act in 2017. It provides a further explanation of the term ‘ruling’: An APA or ATR relates to the explanation of the Dutch tax regulations for a specific body of facts and is therefore expressly not a favourable relaxation of the tax base or the tax rate for taxpayers. Via an ATR, certainty is obtained regarding the Dutch tax

30 JM Schellekens, ‘Inzicht in de rechtsbasis’, in ‘Rulings’, Lustrumcongres georganiseerd ter gelegenheid van het eerste lustrum van de Groninger Fiscale Eenheid, Groningen 1987, 8–9. 31 N Nobel, ‘Openbaarheid in belastingheffing’, in Rulings, above n 30, 33. 32 Kamerstukken II 1986/87, 19700 IX B, nr 71, 3. 33 Kamerstukken II, 1994–1995, 24086, nr 1, 4. 34 Romano, above n 29, 48.

How The Netherlands Became a Tax Haven for Multinationals  401 treatment in respect of a number of topics in connection with an international group structure. An APA … is issued regarding the determination of transfer prices at the international level.35

The report describes the different types of rulings, their use in practice, and the way these rulings are being, will be, or may be affected, by OECD and EU actions against tax avoidance. A second memorandum followed quickly, which was basically an update of the 2015 tax ruling practice document (‘the 2015 tax ruling practice document’). This document describes the most common forms of APAs and ATRs. The document covers APAs and ATRs on intermediate holding companies (‘letterbox companies’ or, alternatively, cooperative associations), the tax position of non-resident taxpayers (such as foreign private equity funds), the qualification of hybrid financial instruments and hybrid entities, CV/BV structures, routine functions, informal capital, principal–agent structures, financing and royalty activities, attribution of profit to a permanent establishment and reinvoicing. All of the above are used by multinationals for tax planning purposes, though it should be noted that some of the instruments have been or will be affected by the introduction of new anti-abuse measures.36 The 2015 and 2017 tax ruling practice documents provide the first comprehensive overview of the Dutch ruling policy. However, the documents raise an important question: should the Dutch tax authorities continue to issue these rulings bearing in mind that the main purpose of the Base Erosion and Profit Shifting (‘BEPS’) project is to counter tax avoidance? This contribution covers three forms of APAs and ATRs: ‘informal capital’ rulings, conduit company rulings, and rulings regarding the application of the participation exemption to a group financing company based in a low-taxed country. Informal Capital Rulings The 2015 tax ruling practice document explains the informal capital doctrine: In the Netherlands, arm’s length remuneration for the functions performed, risks incurred and assets used must be taxed, on the basis of the arm’s length principle. If a Dutch company is given an advantage merely on the basis of shareholder motives, i.e. without any consideration, then pursuant to established Supreme Court case law (since 1957), this non-arm’s length element must be eliminated when fixing the taxable amount in the Netherlands. In other words, the taxable profit is set at a lower level than the commercial profit.37

35 Unofficial translation by Somo: www.somo.nl/structures-secret-dutch-tax-rulings-detail-revealed/, section 1. 36 By the EU in the Anti Tax Avoidance Directive, or in the OECD context, in the Multilateral Instrument. 37 Unofficial translation by Somo, above n 35, section 6.

402  Jan Vleggeert and Henk Vording For example, when a (foreign) shareholder sells an intangible asset like a trade mark to its Dutch subsidiary at a below-market price, the difference with the fair market value is not taxable at the subsidiary’s level because it is considered a contribution of capital. The asset may be depreciable for tax purposes. A 1978 Supreme Court decision broadened the scope of the doctrine to interest-free loans.38 Informal capital rulings have been an important attraction of the Dutch ruling climate since the 1950s. The nature of the ruling is unaltered: it ascertains the mismatch between the Dutch corporate tax and the profit tax of the shareholder’s country. The Netherlands allows deduction of a (fictitious) royalty or allows capitalisation and amortisation of the intangible asset while no corresponding taxation takes place in the other country. In retrospect, the government conceded that up to the mid-1980s, informal capital rulings had been issued that went even beyond the scope of the Supreme Court decisions.39 Again, around 1985 there was a moment of political reflection (in this case, spurred by another Supreme Court decision which was ambiguous on the relevance of a mismatch) and the Finance Cabinet Secretary suspended the informal capital ruling practice. And again, 10 years later there was a return to the liberal pre-1985 attitude. Informal capital rulings have been issued up to the present day. The informal capital doctrine is not evidently in line with internationally accepted thought on the meaning of the arm’s-length principle, as it allows for unilateral downward adjustment of profits.40 In a memorandum to the Finance Cabinet Secretary of 20 October 2004 that was released under the Freedom of Information Act, the Ministry’s director of international tax affairs toned down the risk that other countries would object: ‘informal capital often involves [too low] reimbursements for elements that are difficult to identify and quantify, such as brand names, business models, technology rights and [sales] organization.’ Even if, at the request of another country, the ruling were to be made available, for that other country ‘[it will] not be immediately clear that there is a non-arm’s length element and, if so, to which transactions it relates.’ Therefore, the director of international tax affairs advised to give certainty in advance in such cases: ‘Given the preference for a minimalistic interpretation of the good faith requirement, certainty can be provided in advance.’41 38 HR 31 mei 1978, nr 18230, BNB 1978/252. The case concerned an interest-free loan provided by a Swedish corporation to its Dutch subsidiary. The Supreme Court ruled that the arm’s-length interest forgone by the shareholder should be considered an informal capital contribution (hence, that amount was deductible for the Dutch subsidiary). 39 Kamerstukken II 1994/95, 24086, nr 2, 6. 40 In the Belgian excess-profits ruling case, the European Commission states that Belgium may only adjust the profit downwards if a corresponding upward adjustment of the profit takes place in the other country. European Commission Brussels, 3.2.2015 C(2015) 563 (final). This principle also seems to follow from the literal text of OECD Model Convention Art 9, the provision in which the arm’s-length principle is laid down. 41 All quotes in the paragraph: Internal Ministry of Finance memorandum dated 20 October 2004 (unofficial translation).

How The Netherlands Became a Tax Haven for Multinationals  403 The 2015 tax ruling practice document recognises that creating international mismatches causes tension, especially if certainty is provided beforehand: On the one hand, these deals create favourable conditions for establishing businesses but on the other hand they can raise international tensions. The Achilles heel of the informal capital deals was that the Netherlands did not actively share them with other countries. Assuming that future rulings of this kind will be shared with other countries, the tensions mentioned above will no longer play a part. As far as the Dutch government is concerned, the risk profile connected with making such deals is therefore considerably reduced.42

In 2017 the Finance Cabinet Secretary noted that a mismatch can be resolved by the other country by providing that country with a complete picture of the activities and their tax treatment in the Netherlands. This is because the information that is exchanged to the other country explicitly describes the non-arm’s-length element.43 If the other country uses this information to resolve the mismatch, informal capital rulings would become obsolete. However, informal capital rulings were still being issued in 2017.44 Informal capital rulings are not the only rulings that respond to international mismatches. In the previous decade, structures that use hybrid entities and forms of financing have become increasingly popular and the Dutch tax authorities have been prepared to provide advance rulings. Internationally, however, these structures have met with increasing criticism. In the framework of the BEPS project, it has been proposed to rule out mismatches that are the result of the use of hybrid entities and financing forms.45 Curiously, this proposal does not deal with mismatches created by informal capital rulings. Letterbox Tax Rulings A letterbox company is a company that, for tax reasons, is established in the Netherlands without any significant commercial or operational presence. This usually concerns holding companies, finance companies and royalty companies. MNEs use Dutch letterbox companies to divert intragroup dividends, interest and royalties in order to be able to make use of Dutch tax treaties.

42 Unofficial translation by Somo, above n 35, section 6. The Dutch policy of not informing other countries because of a presumed lack of relevance was, according to the Finance Cabinet Secretary, shared by the tax authorities of other countries: ‘With the insights from now, that judgment would have led to a different outcome and thus to more exchange. In the meantime, automatic exchange of information about rulings is the norm.’ Letter of 14 April 2017 from the Finance Cabinet Secretary to Parliament, no 2017-0000079175, 6. 43 Annex to the letter of 14 April 2017 from the Finance Cabinet Secretary to Parliament, no 20170000079175, 8. 44 21e halfjaarsrapportage Belastingdienst, bijlage III, 2. 45 OECD, Neutralising the Effects of Hybrid Mismatch Arrangements, Action 2 – 2015 Final Report, OECD/G20 Base Erosion and Profit Shifting Project (OECD Publishing, Paris, 2015). Available at http://dx.doi.org/10.1787/9789264241138-en.

404  Jan Vleggeert and Henk Vording This practice depends on several characteristics of the Dutch tax environment for corporate income flows. One is access to low or zero withholding tax rates. As explained above, Dutch tax treaty policy has always, and with success, been aimed at reducing withholding tax rates. In addition, the Netherlands has no withholding tax on outbound interests and royalties. The Netherlands does have a dividend tax, but until 1986 this tax could easily be circumvented by having the shares in the Dutch letterbox company held by an Antillean letterbox company. Moreover, some treaties with other countries used to provide for an exemption from Dutch dividend tax (for example, the flow-through provision in the old treaty with Canada). A second characteristic, relevant to holding companies in particular is the broad participation exemption which (from 1970 onwards) applies to both dividend receipts and capital gains. In this area, the Netherlands has been a forerunner for a long time. Letterbox company rulings were already in use around 1970. These rulings provided certainty to the taxpayer as to the amount of profits to be imputed to flow-through activity. It was obvious from the start that letterbox company rulings were at the expense of other countries’ tax revenues. Some tax inspectors therefore believed that the practice should not be encouraged; others took the position that the letterbox tax ruling is nothing other than the description of a company’s position under normal Dutch tax law.46 The latter position won the day; and a mid-1980s analysis showed that letterbox companies paid a considerable amount of corporate tax (suggesting sizeable activity, as these companies were typically taxable on just the arm’s-length fee for handling income flows). Again, there was some backlash from treaty partners: ‘A number of countries have expressed objections to the fact that non-residents of the Netherlands use Dutch tax treaties by establishing a Dutch entity. Other countries acquiesce, or consciously allow the total or partial exemption from their withholding taxes obtainable through, for example, a Dutch entity.’47 The formal government position, however, remained that it is up to the source country to inquire whether a Dutch letterbox company correctly invokes its tax treaty with the ­Netherlands. In case of doubt, the source country can request the Netherlands for information. The Netherlands need not impose substance criteria on letterbox companies, it was argued – a low level of economic activity will simply translate into low taxable profits.48 This reticence regarding substance requirements has not significantly changed until very recently. It is true that in the course of time, substance requirements have been introduced, but these can easily be met with the help of



46 Kroon,

Het Nederlandse rulingbeleid, MBB 1987/6, 142. II, 19881989, 20365, nr 10, 11. 48 Kamerstukken II 1988/89, 20365, nr 10, 11. 47 Kamerstukken

How The Netherlands Became a Tax Haven for Multinationals  405 a corporate services provider.49 Until recently, the official government position remained that these substance requirements are not out of step with international norms. Meanwhile, the letterbox tax ruling practice has resulted in other countries becoming more reluctant to grant treaty benefits to residents of the Netherlands: ‘An increasing number of tax treaties include provisions that allow one or more treaty benefits to be denied.’50 In this context the Netherlands is struggling with its role as conduit-OFC. A clear example is the text on holding company tax rulings in the 2015 tax ruling practice document, which is quoted here at some length: American groups of companies often use a Dutch holding company to hold non-US participations. For various foreign groups of companies, this has resulted in the fact that substantive European headquarters have been established in the Netherlands. This produces a ‘snowball effect’: companies start with a small intermediate holding company in the Netherlands, but then also opt for the Netherlands to establish activities that generate jobs …. Intermediate holding companies with little substance are criticised by some countries and certain sections of the Dutch Parliament. This is due, for instance, to the fact that they have little connection with the Netherlands and, in particular, damage the Netherlands’ image abroad. The effect of international developments might be such that the Netherlands loses its attractiveness as a location for holding companies. This applies not only to holding companies that have little substance, but also to holding company structures that have evolved into local head offices providing serious employment. The extent to which this will be the case depends on the scope of anti-abuse stipulations that will be incorporated into bilateral tax treaties, in the EU’s Parent-Subsidiary Directive or a possible multilateral instrument. In case of a broad application of the anti-abuse stipulations, source states can in an extreme case take the position that even holding shares by an active company with employees was inspired in whole or in part by tax motives and for that reason withholding tax may be applied. In other words, in case of a broad application of the anti-abuse stipulations, this will have consequences for the Dutch investment climate as well as employment.51

The use of the term ‘investment climate’ is noteworthy. Holding company rulings are primarily about pass-through activities. A sizeable ‘snowball’ effect would be required to make such rulings relevant to real investments in the ­Netherlands. The size of the snowball effect is, however, not known, and it may well be modest. In the context of the BEPS project, it is proposed to include a provision preventing treaty abuse in tax treaties as a standard. The ongoing implementation of this proposal, through the multilateral instrument, could affect the viability of letterbox companies.

49 Algemene Rekenkamer, Belastingontwijking: een verdiepend onderzoek naar belastingontwijking in relatie tot de fiscale regels en het verdragennetwerk, herziene versie, 2014, 89. 50 Kamerstukken II 2010/11, 25087, bijlage bij nr 7, 70. 51 Above n 35, section 2.

406  Jan Vleggeert and Henk Vording Rulings on the Application of the Participation Exemption to Low-Tax Group Financing Companies This third type of ruling was probably developed before the 1970s as well. But while the previous types were aimed at foreign groups, this one was also in use by resident corporations. They would use their equity to fund a Netherlands Antilles subsidiary, which then used the funds to finance group entities. This reduced the parent’s taxable profits, while the gains of the subsidiary were low-taxed in the Netherlands Antilles and could be repatriated under the participation exemption. The ruling made sure that it, indeed, could. In 1996, the Finance Cabinet Secretary observed that Dutch groups had been using foreign corporate finance companies for years. He noted that these companies were no longer solely located in tax havens such as the Netherlands Antilles, but also in member states of the OECD that had a preferential regime for group financing activities, like Belgium. That caused the Dutch legislator to respond (in 1997) by a preferential regime with an effective rate of 7 per cent on the profits of group financing activities. The first result was that Dutch companies brought their financing centres back to the Netherlands. The second result was that the regime was qualified as state aid by the European Commission (2003) and had to be abolished. In the absence of Dutch tax facilities, resident companies again resorted to foreign subsidiaries in countries with low effective tax rates for group financing activities. In the period 2007–16, the tax authorities, in those cases, provided certainty on request regarding the tax treatment of these structures.52 The typical situation was that the treasury functions remained predominantly in the Netherlands and the corporate financing capacity was brought to a low taxing jurisdiction, often Belgium or Switzerland. The tax rulings confirmed that a large part of the profit on the financing was made by the foreign financing company (which owned the group receivables). Only a small part of the profit was attributed to the Dutch parent company as a remuneration for treasury services provided to the foreign finance company. In addition, the tax rulings confirmed that, provided that the conditions were met, the participation exemption applied to the dividends paid by the foreign group company. In the period from 2011 up to and including 2014, the provision of certainty for these financing structures was reconsidered against the background of the OECD BEPS project. In anticipation of international developments in the OECD, it was decided to allocate only a low risk-free return to foreign group finance companies with no or very little substance. Because international developments had not yet fully developed, it was decided that companies that had received certainty about their financing structure could apply a phasing-out

52 See Annex III to the letter of 18 February 2018 of the Finance Cabinet Secretary, www. government.nl/documents/parliamentary-documents/2018/03/05/study-of-rulings-with-an-internationalcomponent.

How The Netherlands Became a Tax Haven for Multinationals  407 period of two years on request so that they had the opportunity to adapt to these developments. This means that as of 2017, taxpayers had to find other ways to reduce corporation tax on their group financing activities. THE BEPS AFTERMATH: A TURNING OF THE TIDE?

Should the Dutch tax authorities facilitate international structures whose main aim is to reduce the foreign tax burden? In the mid-1970s, tax inspectors were divided on the matter; and in the mid-1980s, criticism in parliament was evident. But from the mid-1990s on, a liberal policy was pursued, and the attitude of the tax authorities was increasingly characterised by pragmatism: letterbox companies contribute to the state treasury and provide employment for corporate service providers, tax advisers and lawyers. The revenue loss to treaty partners was ignored. Only the international change in public attitude towards MNE tax behaviour, started off with the 2008 financial crisis, has begun to bring about a policy chance which was reinforced by the OECD BEPS project. The MNE Tax Avoidance Debate: Initial Resistance in the Netherlands The emerging international debate on MNE tax avoidance met initially with defensive scepticism in the Netherlands. NGOs had some success in arguing that the Netherlands had acquired a hub function in MNE tax planning. But in political circles, the response remained: our tax system meets all the international standards. A remarkable illustration is the question whether or not the Netherlands is a ‘tax haven’. The question could be called a semantic one but, at least within the national borders, it has also proven a sensitive one. The previous Cabinet warned explicitly that any public discussion regarding that qualification would have a negative effect on investment.53 And in 2012, parliament accepted a motion (originating from the major populist party) calling on the government to reject the qualification of the Netherlands as a tax haven in international discussions. More recently, a parliamentary motion to the opposite effect, that the Netherlands should be considered a tax haven, was rejected. The defensive response can also be found in a large number of internal documents of the Ministry of Finance, which became public in 2016 under the Freedom of Information Act. These documents shed light on the involvement of the tax advisory sector and the business community in the development of 53 ‘It is evident that criticisms about the status of the Netherlands as a tax haven in recent years are increasingly being expressed in national political discussions and in the national media. The government regrets that because discussions about our tax rules and the inherent uncertainty about any tightening of them, cause unnecessary unrest. This unrest makes the Netherlands less attractive for investments.’ Letter from the Minister for Foreign Trade and Development Cooperation and State Secretary for Finance, Kamerstukken II 2012/13, 25 087, no 60, 10.

408  Jan Vleggeert and Henk Vording Dutch international tax policy. It is evident that the Ministry of Finance shared the attitude of tax advisers and business representatives: a business-friendly tax environment includes a pass-through friendly climate. The underlying idea is that this policy attracts investments and thereby promotes employment. The proposals by the OECD and the EU to combat tax avoidance are seen in these internal documents as annoying interferences with Dutch affairs. The outward presentation was different. During the Dutch Presidency of the Council of the European Union, in the first half of 2016, the government tried to position itself as a pioneer in the fight against tax avoidance. When in the autumn of 2016, however, it was proposed to include a provision in the Anti Tax Avoidance Directive that would effectively make a popular Dutch tax planning tool obsolete, the government tried to postpone the entry into force of this provision until 1 January 2024. This concerns the so-called CV/BV structure, which has been used by Starbucks, among others. The CV/BV is a structure in which, for example, intangibles are contributed by a US MNE to a Dutch partnership (CV) in which the multinational becomes a limited partner. The managing partner is usually another group company. The CV makes the intangible assets available to a BV – a Dutch private corporation – of which it is a shareholder. The BV therefore pays royalties to the CV. These royalties are ­deductible from the profit of the BV and are not subject to Dutch corporation tax at the recipient’s level. That is because the CV is, for Dutch tax purposes, transparent and therefore not subject to corporation tax in the ­Netherlands. The American multinational – as a shareholder in the CV – is also not subject to Dutch corporation tax. This is usually confirmed in a ruling. The US does not impose its corporate income tax on the royalties received by the CV because the multinational may choose to consider the CV as non-­transparent. Until recently, only if the CV repatriated the income to the American shareholder would the United States charge 35 per cent corporation tax. Consequentially, the CV/BV structure was used by US-resident MNEs to accumulate profits tax-free outside of the United States. There is double non-taxation of the royalties resulting from a difference in qualification of the CV by the Netherlands and the United States. In the end, the Dutch lobby to protect the CV/BV structure failed. The structure will lose its attractiveness with effect from 2020 as a result of ATAD II – not considering the impact of the US Tax Cuts and Jobs Act on the tax planning behaviour of American MNEs. One other defensive policy move is to be noticed: effective from 2018, the dividend withholding tax rate for qualifying (5 per cent) corporate participations is set to zero for treaty partner countries, provided that the treaty has a dividend clause. An anti-abuse rule is added, denying the zero rate when artificial structures are used with the aim of avoiding dividend tax. Structures are, however, considered non-artificial whenever a simple economic substance test is passed (one that can easily be met by using a corporate service provider). Basically, this means that the tax is abolished for intragroup dividends to most non-tax haven countries.

How The Netherlands Became a Tax Haven for Multinationals  409 Political Developments Since 2017 The Dutch 2017 coalition agreement announced a major reorientation of international tax policy. It states first and foremost that the Netherlands should remain an attractive country for companies to settle and engage in trade around the world. The agreement makes a distinction between companies that ‘really add value’ in terms of employment and innovation, and ‘companies that only use the Netherlands as a mailbox’. The latter category does not belong to the target group of the tax policy to be pursued; in fact, it is no longer desirable: We want to put an end to the situation that companies only settle on paper in the Netherlands in order to be able to circulate tax-free millions. We will levy taxes from them, just like any other company. Internationally, we are committed to tackling tax havens. We ourselves are going to set a good example through a withholding tax on interest and royalties on outgoing flows to countries with very low taxes (low tax jurisdictions).54

In addition to the new withholding taxes on interest and royalties, it is proposed that the existing dividend withholding tax is ‘abolished’, ie, effectively replaced by a tax on dividend flows to low-tax jurisdictions. With these measures, the new Cabinet hopes to polish the Dutch tax reputation in the rest of the world. The language used in the coalition agreement indeed suggests a drastic change in the Netherlands’ international tax policy, as do the proposed measures. Withholding taxes on interest and royalties on payments going to low tax jurisdictions have been debated within the EU for several years. Until recently, the Netherlands has opposed such levies. For example, an internal memorandum, ‘BEPS follow-up strategy’ of June 2015, prepared for the Deputy Minister for Taxation, stressed ‘we must keep bringing forward the objections clearly’. And in a comparable internal paper for the Dutch EU Presidency (first half of 2016): ‘Withholding tax on interest & royalty: Oppose’. Recent Policy Letter on Tackling Tax Avoidance and Tax Evasion In his policy letter on tackling tax avoidance and tax evasion dated 27 February 2018 (‘the 2018 policy letter’),55 the current Finance Cabinet Secretary reconfirmed that the government wanted to tackle tax avoidance: ‘I see this as a policy priority. I am also keen to overturn the Netherlands’ image as a country that makes it easy for multinationals to avoid taxation. This stubborn image undermines the investment climate.’56 The Cabinet Secretary recognised that the 54 Vertrouwen in de toekomst, Coalition Agreement 2017/2021, Kamerstukken II, 34700 nr 34. 55 Policy letter on tackling tax avoidance and tax evasion of 27 February 2018, www.government. nl/documents/policy-notes/2018/02/27/policy-letter-on-tackling-tax-avoidance-and-tax-evasion. 56 The 2018 policy letter, above n 55, 2.

410  Jan Vleggeert and Henk Vording downside of the Dutch tax system’s international orientation is that it is open to abuse: The Netherlands is therefore sometimes (incorrectly) labelled a tax haven. This damages the country’s image and makes it less attractive to real businesses. Furthermore, it can undermine taxpayer compliance and weaken support for tax facilities that are important to multinationals, such as the extensive treaty network and the provision of certainty in advance. This is undesirable.57

The 2018 policy letter provides further details of the measures the new government intends to take to prevent the Netherlands tax system from being used to channel funds to (other) OFCs. Withholding Tax Legislation In September 2018, the government submitted a draft Withholding Tax Law to parliament, as a part of its annual Budget. It contained the rules pertaining to taxation of dividends flowing to entities resident in low tax jurisdictions, with the clear intention that the rules would be extended to interest and royalty payments in 2021. The proposal was to apply the tax on entities established in the Netherlands that pay dividends, interest or royalties to a group entity if that group entity is established in a country with a low statutory rate (9 per cent or less), in a country on the EU list of non-cooperative countries, or in cases of evident abuse. In December 2017, EU Member States agreed on this list containing 17 countries. It has been adjusted since, eg Panama is delisted; on the other hand, Bermuda is still not listed. It seems that the statutory rate test or the black list may be an arbitrary way to identify a low tax jurisdiction, especially in comparison to an effective tax test broadly applied to all foreign jurisdictions. On top of that the new government recognises that existing structures can easily be adapted by adding a letterbox company in another EU jurisdiction that has no withholding tax on interest and/or royalties, such as Luxembourg or Hungary. In that case, outbound interest and royalty payments cannot be taxed under the Dutch tax treaties with these countries. The government had high expectations of the withholding taxes: ‘This measure will have an impact on the size of the legal, financial and consultancy sectors that provide advice to their clients on conduit arrangements.’58 However, the government strongly modified its tax proposals, to the extent that the dividend tax was not to be abolished. This made the withholding tax proposal redundant as far as dividend flows to low-tax jurisdictions are 57 Factsheet: Tax policy agenda and letter on tackling tax avoidance and tax evasion of 1 March 2018, www.government.nl/documents/policy-notes/2018/03/01/factsheet-tax-evasion-and-tax-avoidance. 58 The 2018 policy letter, above n 55, 10.

How The Netherlands Became a Tax Haven for Multinationals  411 concerned (the proposal will be resubmitted for interest and royalty flows). The reason for this drastic change was that the Cabinet was no longer able to resist strong and increasing political pressure for maintaining the dividend withholding tax. The problem was that there was no obvious reason to abolish the tax, apart from (reported) heavy lobbying by Royal Dutch Shell and by Unilever. In fact, the dividend tax as from 2018 applies almost solely to portfolio investments (natural persons plus pension and investment funds) and yet still generates some €2 bn. When Unilever, in October 2018, announced that it would not relocate its headquarters to the Netherlands, the case for abolishing the dividend withholding tax was lost. Further Policy Changes under Consideration The 2018 policy letter announced some further measures. One is to try and include in all bilateral treaties a provision to prevent treaty abuse, the principal purpose test (‘PPT’). The multilateral instrument has an important role to play in this respect. The PPT prevents improper use being made of the Netherlands’ extensive treaty network by examining whether obtaining a treaty benefit was one of the principal purposes of an arrangement or transaction: ‘If so, the PPT prevents the Netherlands’ treaty partners’ taxing rights being wrongly limited. The PPT thus helps makes the Netherlands unattractive for undesirable conduit arrangements.’59 Furthermore, there is an intention to examine whether the participation exemption can be modified in such a way that it need no longer be applied in cases where the presence of a group in the Netherlands is limited to one or more (interim) holding companies that have practically no substance. The government will also assess whether the arm’s length principle should be modified as this principle can currently lead to a unilateral downward adjustment of the taxable profit (see above, discussion on informal capital rulings). An interesting new development regards economic substance requirements. The 2018 tax policy letter stuck to a threshold that could simply be catered for by corporate service providers. A recent letter of the Finance Cabinet Secretary to parliament does show an ambition to improve on that threshold.60 The letter sets out how the ruling practice is to be adjusted to current international standards and norms. It sets new standards for transparency and exchange, and it also reflects on the substance required from entities that ask for rulings. The new practice will be that rulings are available only to entities within an MNE group that have economic nexus with the Netherlands; these entities have to run real

59 ibid, 11. 60 Letter of 22 November 2018 from the Finance Cabinet Secretary to Parliament, Vernieuwde rulingpraktijk, 2018-0000185524.

412  Jan Vleggeert and Henk Vording risks on operational activities, reflected by relevant and substantial staff and by the level of operational costs. This new practice reflects a broad political agreement that trivial substance requirements will no longer do. A second policy change announced in this letter is even more interesting, as it implies that policy justifications provided over the last decades have been double-tongued. The new policy will be that the tax administration will not provide a ruling whenever the principal aim of the structure is to reduce taxes – to date, it had only been Dutch taxes. In addition, the tax administration will no longer provide rulings in cases that include transactions with entities resident in low-tax jurisdictions – implying that to date, such rulings are being provided. SUMMING UP

Dutch international tax policy has always been aimed at reducing tax borders for international business. The Netherlands started early in developing a bilateral tax treaty network, and a leading Dutch aim in treaty negotiations was consistently to reduce withholding taxes. As a by-product, the Netherlands became a hub for MNE tax planning. Specific characteristics of the Dutch tax environment, such as the broad participation exemption and the ‘informal capital’ doctrine, resulted in specialised tax planning instruments. Tax ruling practice was only centralised and coordinated after the 1980s, and has always tended towards a lack of transparency. The claim that all tax rulings remain within the framework of Dutch tax law and are fully based on the arm’s-length principle can be rejected for the early years, up to the mid-1980s; nor can it be verified for the years after. There have been signs of resistance from tax treaty partners since around 1980 – that is, ever since we can be certain that transaction volumes in the Dutch tax planning industry had become sizeable. These signs have, every now and then, been translated in adjustments in treaty policy, in substantive tax law, and in tax ruling practice. But as the economic weight of the tax planning sector increased, so did the weight of arguments that ‘nothing was wrong’. The sharp policy turn taken by the new government since late 2017 can be understood as a way to assuage the many critics of Dutch international tax policy. It remains to be seen how the measures that were announced will work out. That is not a trivial matter to the rest of the world. The success of the BEPS measures, and indeed the Anti Tax Avoidance Directive, depends to a substantial degree on what a limited number of countries, the Netherlands first and foremost, will do with them.

15 The Origins and Architecture of the 1942 Canada–United States Income Tax Treaty ROBERT RAIZENNE AND COLIN CAMPBELL*

ABSTRACT

Canada’s 1942 treaty with the United States stands as an important landmark in the evolution of the international tax treaty template. The paper focuses on the final version of the treaty, with discussion of the origins of its provisions and its overarching purposes. It includes archival references. Aspects of the prehistory of the 1942 Treaty are examined in detail, e.g. changes to Canadian domestic law relating to cross-border issues in the pre-war years, the 1936 Canada– US Income Tax Treaty and resulting treaty shopping, and Canada’s emergent policy on exchange of information (EOI). INTRODUCTION

C

anada’s 1942 treaty with the United States1 was the first comprehensive tax treaty entered into by Canada, and one of the first by the United States.2 It was one of the earliest tax treaties influenced by the

* The authors wish to acknowledge the assistance of the Canadian branch of the International Fiscal Association in funding archival research relating to this paper. 1 56 Stat 1399; Treaty Series 983; Canada Treaty Series, 1942, No 2, signed 4 March 1942, entered into force 15 June 1942 with effect from 1 January 1941 (the ‘Treaty’). 2 After the US treaties with France (59 Stat 893, Treaty Series 988; signed 25 July 1939, entered into force 1 January 1945 (the ‘1939 France Treaty’)) and Sweden (54 Stat 1759; Treaty Series 958; signed 23 March 1939, entered into force 14 November 1939 with effect from 1 January 1940 (the ‘1939 Sweden Treaty’)). The Franco-American Convention on Double Taxation, signed in 1932 and ratified in 1935, was less comprehensive, though similar in its treatment of business profits.

414  Robert Raizenne and Colin Campbell work done by the Fiscal Committee of the League of Nations3 to develop a model tax treaty and was the first double taxation treaty to take into account the ­‘unified’ model developed by the Fiscal Committee between 1940 and 1943.4 It was therefore arguably the precursor of most modern tax treaties. For both Canada and the United States it provided a jumping-off point for treaty negotiations with other states. The Treaty also marked Canada’s emergence as a player in the international tax world and was an important step in Canada’s journey to full diplomatic independence.5 By 1939, when negotiations for the Treaty began, Canada’s domestic income tax system under the Income War Tax Act addressed in a fairly comprehensive manner cross-border economic activities and investment.6 Canada had an open economy, dependent on high volumes of exports and imports, substantial in relation to its overall domestic product. Canada also enjoyed significant inbound capital flows until well into the twentieth century, but these were beginning to flow outward as well by 1917. Prior to 1917, the only tax measure which affected these cross-border flows of goods and capital were the tariffs levied on imported goods.7 The imposition of the income tax in 1917 significantly changed this situation, raising issues both of the taxation of the Canadian income-earning activities of non-residents (‘inbound’ issues) and taxation of such activities by Canadian residents offshore (‘outbound’ issues). It also raised the issue of cross-border transfer pricing in computing income from a business carried on in Canada. Although Canada was a founding member of the League of Nations, it did not participate directly in the work of the Fiscal Committee until 1937.8 3 The work of developing a model double taxation treaty was first undertaken by a ­committee of technical experts, culminating in the General Meeting of Government Experts in 1928. The Fiscal Committee was formed in 1929 to continue their work. Canada did not participate in the early discussions leading up to the three initial versions of a model treaty elaborated in 1928 and was largely uninvolved with subsequent efforts to refine them into a single prototype. Generally regarding the development of the 1928 model treaties, see S Jogarajan, ‘The “Great Powers” and the Development of the 1928 Model Tax Treaties’, in P Harris and D de Cogan D (eds), Studies in the History of Tax Law, vol 8 (Oxford, Hart Publishing, 2017) 341–62. 4 At meetings in 1940 at The Hague and Mexico City and in 1943 at Mexico City. The US treaties with France and Sweden signed in 1939 did not conform to the Fiscal Committee model but had a substantial effect on the drafting of the Treaty. 5 Canada’s full independence from the United Kingdom was formally recognised by the Statute of Westminster (UK) in 1931; its first foreign legations and independently negotiated and ratified treaties date from the 1920s. 6 SC 1927, c 28, as amended (the ‘Act’). Originally enacted in 1917 in rather skeletal form, by 1939 the Act had been substantially expanded. The Act was consolidated in 1927 and section references are to the 1927 consolidation unless otherwise noted. The 1917 Act, containing a mere 28  sections, had been imposed in response to political pressure, in considerable haste. See R Raizenne and C  Campbell, ‘The 1917 Income War Tax Act: Origins and Enactment’, in J Li, S Wilkie and LF Chapman (eds), Income Tax at 100 Years (Toronto, Canadian Tax Foundation, 2017) 2:1–2:96. 7 Ignoring municipal property taxes on real property held by non-residents. 8 Canada was, however, a corresponding member of the Fiscal Committee. Corresponding members were individuals who served in their private capacity as experts. Watson Sellar, executive

Origins and Architecture of the 1942 Canada–US Income Tax Treaty  415 By 1939, however, officials in the Departments of Finance and National Revenue were fully conversant with the work of the Committee in addressing international double taxation and, as discussed below, agreements of a limited nature had been entered into with the United Kingdom and the United States in 1935 and 1936, respectively. By the late 1920s and early 1930s, Canada had also entered into a number of agreements to exempt international shipping activities from tax. Because a double tax treaty is essentially a kind of template laid over and modifying the domestic law provisions of the contracting states, we begin by reviewing those provisions in Canada as they stood when negotiation of the Treaty commenced.9 INBOUND TAXATION

Individuals not ordinarily resident in Canada (and who had not ‘sojourned’ in Canada for 183 days or more in the year) were taxable only if they were either employed in Canada at any time in the year,10 carried on business in the year11 or derived income from providing services in Canada for a person resident or carrying on business in Canada where the services were provided outside the ‘course of regular or continuous employment’.12 Dual residence, whether of individuals or corporations, was not addressed. Corporations not resident in Canada were taxable if they carried on business in Canada.

assistant to Minister of Finance James Robb in the mid-1920s and Assistant Deputy Minister of Finance from 1930 to 1932, was succeeded in 1932 as the Canadian corresponding member by Fraser Elliott. Elliott was the Commissioner of Income Tax from 1932 to 1946 and subsequently Canadian Ambassador to Chile and then Australia. Elliott’s eponymous son was the founder, with Heward Stikeman, the former Assistant Deputy Minister of National Revenue, of the Canadian law firm now known as Stikeman Elliott. Elliott contributed a description of the Canadian method of taxing both domestic and foreign business enterprises and of allocating the related income in the report discussed below. See MB Carroll, Global Perspectives of an International Tax Lawyer (Hicksville, Exposition Press, 1978) at 48 for Carroll’s account of his first meeting with Fraser Elliott and his subsequent recruitment of Elliott as a corresponding member. 9 The ‘inbound’ provisions dealing with activity or investment by non-residents in Canada and ‘outbound’ provisions dealing with cross-border activities of Canadian residents. 10 Defined as performing personal services in Canada for remuneration directly or indirectly received from a Canadian source. 11 In which case they were taxable on the ‘net profit or gain’ from the business. 12 Provision of services outside of an employment relationship was enumerated separately from employment or business income presumably because of uncertainty about the existence of an employment relationship or a lingering assumption that provision of services in the course of a profession was not a ‘business’. This distinction was made in the UK income tax legislation and may have influenced the Canadian view. Plaxton commented that the reference in para 9(1)(c) to a person employed in Canada was a reference to ‘regular and continuous’ employment and that the provision was intended to apply to services of a ‘technical or professional nature’. See HAW Plaxton, The Law Relating to Income Tax of the Dominion of Canada; Being an Analysis of the Provisions of the Income War Tax Act, R.S.C., 1927, Chapter 97, and Amendments Thereto with Reference to and Notes Upon Pertinent Decisions (Toronto, Carswell, 1939) 151.

416  Robert Raizenne and Colin Campbell The omission of persons employed, but not resident, in Canada from the charge to tax was rectified in 1918 by the addition of the words ‘or employed in Canada’ in subsection 4(1) of the 1917 Act.13 The following year a definition of ‘persons employed in Canada’ was added – those persons ‘who receive, directly or indirectly, salary, wages, commissions, fees or other remuneration derived from sources within Canada for personal services, any part of which is performed in Canada.’14 The amendment was evidently intended to limit taxation to employment income derived from a Canadian source, an early application of the base erosion principle. The requirement that services be at least partly performed in Canada prefigured language which later appeared in Canadian tax treaties. Section 25 of the Act, in substance added in the 1920 amendments,15 confirmed that the income of a non-resident of Canada from providing services, other than in the course of a regular or continuing employment with a Canadian resident or a business carried on in Canada,16 was the non-resident’s Canadian source income. Stikeman suggested that section 25 was added to negate any suggestion that the definition of ‘employed in Canada’ included income earned outside Canada.17 From 1930, an anti-avoidance provision operated in respect of non-resident individuals employed in Canada by a corporation controlled by the individual to include in income any dividends or interest received by the individual from the corporation or any of its subsidiaries.18 In 1930, such dividends or interest would not have been otherwise subject to Canadian tax. WD Euler,19 speaking for the government, explained that a judgment could be obtained in a Canadian court and enforced, if necessary, against the shares held by the individual.20 The non-resident withholding tax imposed in 1933 (discussed below) under section  9B on dividends and interest paid or credited to non-residents was presumably credited against the general liability for tax under section 9.21 13 The amendment was made in the Senate at the instance of Sir James Lougheed, who remarked that ‘I understand that in some of the border towns there are a great many people employed who reside on the other side of the boundary.’ Senate Debates, 22 May 1918, p 663. 14 Para 2(j) in the 1917 Act; para 2(c) in the Act. 15 As cl 4(1)(v) of the 1917 Act. 16 In the absence of any definition of ‘business’ in the Act, the common law meaning applied, which was ‘anything which occupies the time, attention and labour of a man for the purpose of profit’ but not the ‘liberal arts or professions’. See the discussion in Plaxton, above n 12, 132–33 and the cases cited there, particularly Smith v Anderson (1880) 15 ChD 247 at 258 and Bank of India v Wilson (1877) 3 Ex D 108. 17 Special Lectures of the Law Society of Upper Canada on Taxation 1944, delivered by HH ­Stikeman, ML Gordon and LA Richard (Toronto, de Boo, 1944) 15–16. 18 Section 25A applied to any non-resident providing services as a ‘director, officer or employee’ and thus employed in Canada and subject to tax under para 9(1)(c). 19 (1875–1961) Liberal MP for Waterloo North 1917–40; Minister of Customs and Excise 1926–27; Minister of National Revenue 1927–30; Minister of Trade and Commerce 1935–40; ­Senator 1940–61. 20 Debates of the House of Commons (‘Debates’), 27 May 1930, p 2652. 21 There is no statutory provision addressing this or any reference in the departmental rulings collected in the 1947 edition of Plaxton. (See HAW Plaxton, The Law relating to Income Tax and Excess Profits Tax of the Dominion of Canada, 2nd edn (Toronto, Carswell, 1947) 495 ff.

Origins and Architecture of the 1942 Canada–US Income Tax Treaty  417 Carrying on Business By 1927, the Act contained an extended definition of carrying on business in Canada, expanding the common law rule which looked to the place where the contracts in the business were made.22 Section 26 of the Act deemed the production or processing23 of anything within Canada followed by its export prior to sale, to be carrying on business in Canada and the non-resident to have earned in Canada a proportionate part of the resulting profit. Section 27 deemed soliciting orders or offering anything for sale in Canada, regardless of where the relevant contracts were made, and letting or leasing anything used in Canada for a royalty or other payment to be carrying on business in Canada. In each case the Minister had ‘full discretion’ to determine the portion of such income earned in Canada. Section 27 applied whether the contract or transaction resulting from the activity was completed within or without Canada or partially so. In the latter case, the Minister was given discretion to determine the proportionate part of the income derived in Canada.24 The extended definition of ‘carrying on business’ in section 27 was moved in 1934 to section 27A (1) and a provision was added (in section 27A (3)) which contemplated double taxation agreements, allowing the exemption from the extended definition by regulation of residents of a country which had entered into a ‘reciprocal agreement’ with Canada to exempt similarly situated ­Canadian residents. The 1933 Report Although Canada did not participate directly in the work of the Fiscal Committee in the early 1930s, Fraser Elliott, as a corresponding member, responded to Mitchell Carroll’s request to provide a description of the way in which Canada taxed foreign enterprises, including allocation of income, which was published in 1933 by the Fiscal Committee.25 The 1933 Report is important because it describes the manner in which, in practice, the issues which were to be addressed in the Treaty were dealt with at the time negotiations began and, as such, provides the practical context for significant portions of the Treaty. A review 22 The 1933 Report (see n 27 below) summarised the common law rule at p 63. The extended ­definition was added in 1924. 23 Referring to a person who ‘produces, grows, mines, creates, manufactures, fabricates, improves, packs, preserves or constructs, in whole or in part.’ 24 In Pope Appliances Corp Ltd v Minister of Customs and Excise [1927] Ex CR 17, a US r­ esident licensing patents in Canada was found to be carrying on business under this provision and the royalties received income from that business. The court rejected the taxpayer’s argument that the transaction was in substance the sale of a patent giving rise to a capital receipt (an issue which was to recur in the future). 25 Taxation of Foreign and National Enterprises, vol III, Ser L o N P 1933 II A 19 (Geneva, League of Nations, 1933) 51–72 (the ‘1933 Report’).

418  Robert Raizenne and Colin Campbell of the 1933 Report discloses that the Treaty for the most part did not represent so much a break from the past but a formalisation and rationalisation of the ­existing practice. Elliott set out the bases for taxing non-residents, both in the long-established common law test of looking to where the contracts underlying the business were habitually made26 and the statutory provisions discussed above. These he enumerated as follows: —— Non-resident producing raw materials in Canada and shipping them abroad (s 26). —— Non-resident soliciting orders or offering goods for sale through an agent or employee (s 27). —— Non-resident leasing or letting anything in Canada (s 27). —— Non-resident receiving a royalty or similar payment for anything used or sold in Canada (s 27). In describing the practice flowing from these principles, Elliott, in a departure from the rule subsequently established in the Treaty, did not explicitly distinguish between agents of independent status and dependent agents. Thus, a travelling salesman (clearly assumed to have authority to contract) and a local agent with power of attorney (‘He who acts by another acts by himself’) attracted liability to tax on the non-resident. Similarly, an agent selling out of a stock maintained in Canada27 or the activity of a local commission agent or broker in Canada, would make the non-resident liable to tax. By contrast, the purchase of goods by a local dealer or distributor was dealing with and not by, the non-resident. However, Elliott identified two situations which effectively involved agents of independent status. First, a foreign enterprise selling goods in Canada ‘through a broker who merely acts as an intermediary’ with payment being made directly to the non-resident would not attract tax. Secondly, a non-resident selling through a ‘commission agent who is operating on a produce exchange and who disposes of the consignment for anyone wishing to use his services’ would ‘seldom’ be taxed.28 The Treaty, arguably, merely clarified and confirmed this practice. Elliott also confirmed that the display of goods or carrying out research or statistical activity would not constitute carrying on business nor would the maintenance of an establishment for the purchase of goods for export.29 The latter was also confirmed by the Treaty. A subsidiary corporation was itself a separate taxpayer and, generally, a non-resident parent would only be liable to withholding tax on 26 With reference to the jurisprudence, largely from the United Kingdom, which applied whether or not delivery of goods or services or making and receipt of payment occurred in Canada (1933 Report, above n 25, 63). 27 It is unclear whether Elliott assumed that the agent in this case was in Canada or outside. 28 1933 Report, above n 25, 64. 29 ibid 69.

Origins and Architecture of the 1942 Canada–US Income Tax Treaty  419 dividends paid.30 While Elliott used the term ‘permanent establishment’ in the 1933 Report, he equated it with an agent or broker, and not the more general concept of a fixed place of business. The general definition subsequently adopted in the Treaty, however, was consistent with the rule in section 26 governing the production or processing and export of goods from Canada. Part III of Elliott’s report discussed in more detail the methods of allocating income to branches of non-residents (or subsidiaries where there were transfer pricing issues), including the requirement that books and records be kept adequate to give a ‘reasonably true reflection’ of profit, failing which the auditor would demand a ‘full disclosure’ of profits made abroad.31 In auditing the accounts of the foreign enterprise, Canadian officials might ‘by arrangement go abroad’ to satisfy themselves that the invoice price of goods shipped to Canada had not been inflated by ‘undue’ costs. Where a ‘fair price’ for goods could not be arrived at from the separate accounts of the Canadian branch or by agreement with the taxpayer, the Department would apportion profit on the basis of the ratio of sales in Canada to total sales of the enterprise of a similar nature.32 In determining branch profit, deductions could be allowed for head office expenses which went beyond ‘general control and direction’ and conferred benefit on the Canadian branch (such as ‘international advertising which stimulates sales in Canada’). Where the ­Canadian branch realised a loss but the enterprise as a whole was profitable due in part to the activity of the branch, a portion of the enterprise profit could be taxed in Canada. Elliott stressed, however, that the Department did not have any specific rules, dealing with each case on its facts. He confidently asserted that determining the merits of a case was ‘easy’, because all such returns went through head office and ‘difficult problems’ were then dealt with by ‘a centralized body of skilled officials’.33 Not surprisingly, Carroll, in his summary volume,34 described the Canadian practice as ‘very flexible’: The authorities first examine the books of the local branch of a foreign enterprise in order to check the accuracy of its declaration. When the fairness of the import price of imported articles is doubted, the authorities often request information concerning the cost of manufacture, and, if necessary, they endeavor to arrive at a fair price

30 Similarly, a Canadian corporation doing business abroad through a foreign subsidiary would only be liable for tax on dividends paid by the subsidiary. See 1933 Report, above n 25, at 68 and 70. 31 Elliott noted that the majority of foreign enterprises carrying on business in Canada were ­British or American which had no motivation to avoid Canadian tax because of foreign tax credits available either in the United Kingdom or the United States. 32 Elliott also stated that the Canadian subsidiary of a non-resident enterprise could effectively be treated as a branch by virtue of the transfer pricing provision of section 23 of the Act; 1933 Report, above n 25, 68. 33 ibid 67. 34 Taxation of Foreign and National Enterprises, vol 4, Methods of Allocating Taxable Income, LoNP 1933 II A 20 (Geneva, League of Nations, 1933).

420  Robert Raizenne and Colin Campbell by discussion with the taxpayer. If this procedure proves to be futile, they may have recourse to apportionment.35

Carroll described the Canadian practice as ‘limited fractional apportionment’, with apportionment only used for items of income from activities carried on jointly with establishments outside Canada, as follows: if the authorities consider it necessary to resort to an apportionment of income, they take into account only those [items of income] which have a direct connection with the activities of the branch … Suppose an enterprise manufactures abroad and sells at its branch in Canada … If the price is shown to be unfair and if the authorities cannot arrive at a fair price by discussion with the taxpayer, they often resort to apportionment on the basis of the ratio of sales in Canada to total sales. They include, however, in the denominator of the fraction only the income of the entire enterprise which has a direct reference to the joint activities of the enterprise and the Canadian branch.36

Carroll also noted that the Canadian practice, while only existing in the administrative practice of the Department of National Revenue, was ‘in accordance with the principle’ applied in the United States.37 The congruence between Canadian and American practice may well have had an effect on the eventual timing of the Treaty. When the limited 1936 treaty with the United States discussed below was under consideration, the Department of Finance38 downplayed the need for a ‘general’ treaty with the United States, partly on the grounds that issues arising in respect of the taxation of business profits were being resolved satisfactorily under the existing arrangements and a formal treaty was not necessary: It may be suggested that the present instance might well provide the occasion for entering upon ‘a general taxation treaty’ with the United States. It is not known here what is contemplated by this expression, but presumably it may refer to a variety of terms such as, for example, those covered by the recent treaty between the United States and France. This treaty deals primarily with the taxation of industrial, commercial and financial profits, or income, a matter which, under present practices of the United States and Canada, appears to be operating satisfactorily and needs no special treatment in a formal agreement.39

The 1932 Franco-American Convention on Double Taxation to which Eaton referred allowed taxation of business profits of a foreign enterprise only to the extent they were allocable to its permanent establishment in the other state, and reflected the ongoing development of the permanent establishment

35 ibid [132]. 36 ibid [245]. 37 ibid [244]. 38 Memorandum of Ken Eaton to the file, dated 31 July 1936, Library and Archives Canada (LAC), RG25, vol 1800. 39 ibid at 8.

Origins and Architecture of the 1942 Canada–US Income Tax Treaty  421 concept by the Fiscal Committee.40 It was prompted by the French dividend tax, which purported to impose tax on dividends paid by (as well as to) the US parent corporations of French subsidiaries or branches.41 The situation between Canada and the United States was, as Carroll had noted, quite different and it is not surprising that Canada felt no particular need for a general treaty. In 1936, the withholding tax issue was the principal Canadian preoccupation and, as discussed below, it is likely that the eventual occasion for the Treaty was the prospect of significantly higher US withholding tax rates after the termination of the 1936 treaty in 1941. The 1935 UK Treaty The parliamentary debate on the 1934 amendments produced the first public reference to Canada’s nascent involvement in the emerging international tax order. In response to opposition accusations that the amendments were designed to channel Canadian trade to certain countries, Edgar Rhodes,42 the Minister of Finance, replied that the amendments came, not from the government, but from Elliott and reflected an emerging international consensus: The commissioner of income tax informs me that this principle is found in the taxation of practically every country, and so far as it obtains with respect to the principle of double taxation it has been recognized through the fiscal committee of the League of Nations, and has been the subject of action by them.43

The first agreement under the 1934 amendments was made on 3 October 1935 with the United Kingdom. It exempted from tax the profits or gains of a resident of one state from a sale of goods through an agency in the other state to a resident of that other state, unless the sale was from a stock of goods maintained in the other state and was made through a ‘branch or management’ in that state or through an agent ‘where the agent has and habitually exercises a general authority to negotiate and conclude contracts’.44 The agreement thus anticipated in a minor way the concept of permanent establishment emerging through the work of the Fiscal Committee.

40 And, in particular, the 1928 draft model convention. See Report on Double Taxation and Tax Evasion, League of Nations Document No C562M178 1928 II. 41 See the discussion in Mitchell B Carroll, ‘The Development of International Tax Law: ­Franco-American Treaty on Double Taxation – Draft Convention on Allocation of Business Income’ (1935) 29 The American Journal of International Law 586, 593–94. 42 (1877–1942), Conservative MP for Cumberland 1908–21; Richmond-West Cape Breton ­1930–35; Premier of Nova Scotia 1925–30; Minister of Finance 1932–35; Senator 1935–42. 43 Debates, 20 June 1934, p 4014. 44 As discussed below, this provision was consistent with, though with slightly different wording, the relevant portion of the definition of permanent establishment in the Treaty. A similar agreement was reached with New Zealand in 1945.

422  Robert Raizenne and Colin Campbell Non-Resident Withholding Tax The 1933 budget proposed the imposition of a 5 per cent withholding tax on dividends and interest from Canadian sources received by non-residents of Canada, collected by deduction at the source. The government was forced, almost immediately, to modify the proposal, in part because of contractual obligations to not impose tax on Dominion debt obligations and in part because of negative reaction in international debt markets. In explaining the retreat, Rhodes said that ‘humble little Canada’ was ‘breaking new ground’ with the proposal, but had to retreat somewhat: ‘we must dodge the big stick’.45 Rhodes argued that it was a ‘fair tax’ and the 5 per cent rate was ‘humble’ in comparison to the 25 per cent tax in the United Kingdom. He also pointed out that the tax would effectively be borne by the foreign treasuries concerned through the availability of foreign tax credits to security holders. As amended, the tax was not imposed in respect of Dominion debt obligations or debt obligations payable other than in Canadian currency. It thus applied to: —— dividends received from Canadian payors46 regardless of currency; —— interest payable in Canadian dollars received from (and from 1936, credited by) Canadian debtors; —— interest received, regardless of currency, by a non-resident parent corporation from a Canadian subsidiary; —— from 1934, income received from a Canadian estate or trust including income accruing to the benefit of non-resident beneficiaries (whether or not received); —— from 1935, all payments directly or indirectly received from Canadian debtors in respect of copyright material used in Canada or other works produced or reproduced in Canada.47 The 1936 US Treaty In the Revenue Act of 1936, the United States imposed a similar withholding tax, but at a rate of 10 per cent. Because of concern that Canada would ­retaliate by raising its withholding tax (which increase US foreign tax credit claims

45 Debates, 5 May 1933, p 4640. 46 Other than from a Canadian subsidiary to a foreign parent corporation (or from a non-residentowned investment corporation, as discussed below). The exemption was apparently granted, as Eaton noted, ‘on the argument advanced that levying the tax … imposed a penalty on incorporating in Canada as against operating merely a branch office’, the after-tax income from which could be distributed free of tax. See Eaton memorandum, above n 38, 8. 47 s 9B(2)(a) to (e) of the Act.

Origins and Architecture of the 1942 Canada–US Income Tax Treaty  423 at the cost of the US Treasury), the United States offered ‘contiguous countries’ a reduction from 10 per cent to 5 per cent in the rate of withholding tax applied to non-business income of non-resident aliens and to dividends paid to non-resident corporations not engaged in business in the United States.48 The reduction was contingent on the United States entering into a treaty with either Canada or Mexico which provided for reciprocal treatment. Entering into such a treaty was an obvious benefit for Canada given that its withholding rate was already 5 per cent. Despite some discussion in the Department of Finance as to whether additional concessions could be negotiated,49 in December 1936 Canada entered into an agreement with the United States50 solely to confirm the US concessions. The rate of withholding tax imposed on Canadian individuals receiving investment income from the United States and on dividends received by a Canadian corporation from a corporation in the United States was reduced to 5 per cent.51 The latter concession was limited to a corporation not resident in the United States or carrying on a trade or ­business in the United States but incorporated in Canada. Because the treaty only required Canadian incorporation, and not Canadian residence, it appeared to create opportunities for treaty-shopping, since Canada taxed on the basis of r­ esidence and eligibility for benefits under the treaty did not require Canadian residence. In addition, Canadian resident corporations exempt from Canadian tax under paragraph 4(k) (discussed below) could also benefit. Canada was, of course, indifferent because the issue only involved foreign tax and it was not raised by Eaton.52 The 1936 treaty emerged against the background of Roosevelt’s decision to make tax reform a major feature of his 1936 re-election campaign, targeting ‘economic royalists’, ‘business and financial monopoly’ and other ‘forces of ­selfishness and of lust for power’.53 Although the 1936 treaty did not contain any 48 Revenue Act of 1936, 49 Stat 1648, 22 June 1936, ss 211a and 231a. 49 The US tax rate on business income earned by Canadian corporations in the United States or the US rate on passive income other than dividends earned by Canadian corporations. For example, see the Eaton memorandum, above n38, 6–7. 50 50 Stat 1399; Treaty Series 920, Canada Treaty Series, 1937, No 13; signed 30 December 1936; ratified 13 August 1937. 51 Mitchell Carroll reported that the American legislation authorising the agreement was enacted to prevent Canada increasing its withholding tax rate to match the American rate. The contiguous country concept was used because ‘it was thought that such a concession could be made to persons in adjoining countries without it being considered discriminatory against the taxpayers in third countries’. See MB Carroll, ‘The New Tax Convention Between the United States and Canada’ (August 1942) 20 Taxes: The Tax Magazine 459 at 460. 52 It is of interest that Canada has consistently maintained this position, for example, in the ‘double dip’ transactions explicitly allowed under the modern foreign affiliate rules. 53 MH Leff, The Limits of Symbolic Reform. The New Deal and Taxation, 1933–39 (Cambridge: Cambridge University Press, 1984) 187. Leff discusses the 1936 election campaign at 185–93 (although without any reference to international tax issues or the 1936 treaty). See also JJ Thorndike, Their Fair Share. Taxing the Rich in the Age of FDR (Washington DC, The Urban Institute Press, 2013), which also discusses the Roosevelt tax policy proposals in the mid-1930s at ch 7. Neither Leff nor Thorndike make any mention of US treaty negotiations during the 1930s, or the exchange of ­information issue.

424  Robert Raizenne and Colin Campbell anti-avoidance provisions, Canada agreed to adopt administrative p ­ rocedures to combat treaty shopping. It is unclear whether Canada agreed as a precondition of making the treaty itself, or to reassure American legislators during the ratification process,54 or both. Herbert Marler, the Canadian ambassador in Washington55 reported56 that Fraser Elliott and certain of his officials, together with representatives of ‘trust companies and stock exchanges’, had visited Washington to consider regulations ‘whereby the provisions of the Convention could be made most effective in the interests of the United States and Canada’. The discussions remained ‘in abeyance’ at the time the United States ratified the treaty (10 August 1937) but the United States suggested the talks resume immediately. Canada duly made regulations effectively limiting the benefit of the reduced treaty rate to Canadian residents and preventing non-residents from treaty-shopping into Canada using the treaty. In 1938, the Fiscal Committee of the League of Nations circulated a questionnaire to its members dealing with their treatment of fiscal evasion. In his reply,57 Elliott summarised the relevant administrative provisions of the Act, with no suggestion that they were in any way inadequate.58 He pointed out that, although Canada had not entered into any agreements for cross-border exchange of information, Canada did assist in the collection of US tax in connection with the 1936 treaty: The United States as a safeguard to their revenue reports dividends and interest paid to Canadian addresses in order that Canada can check that the beneficial ownership is in Canada. Canada requires her citizens to collect an additional 5% if the beneficial owner is not a resident of Canada and to remit the additional tax to the United States Treasury.59

This was a one-sided process, as Elliott later described: the United States today is supplying us with information pertaining to dividends and interest but they know we are using it to check Canadian income tax returns although it was designed to preclude the dividend being passed out of Canada without the additional deduction of 5%. We then refused reciprocal information because it was supplied for the protection of United States revenue and not for the protection of Canadian revenue on a reciprocal basis.60

54 The treaty was subject to the normal US ratification process; it was not submitted to the ­Canadian Parliament, presumably because it fell within the scope of the 1934 amendments relied on in respect of the 1935 UK treaty. 55 Strictly speaking, Envoy Extraordinary and Minister Plenipotentiary. 56 Letter of Marler to Oscar Skelton, dated 13 August 1937, LAC, RG25, vol 2454. 57 League of Nations, Doc C 490 M 331 1937 II A (the Questionnaire); F Fiscal Evasion/24 (the Reply dated 23 August 1938). 58 Elliott had taken a similar position in a 1938 article: F Elliott, ‘The Administration of the ­Canadian Income Tax Law’ (1938) 4(3) Canadian Journal of Economics and Political Science 377–90. 59 Reply, above n 56. 60 Letter of Elliott to Clifford Clark, Deputy Minister of Finance, 7 December 1938, LAC, RG19.

Origins and Architecture of the 1942 Canada–US Income Tax Treaty  425 There was evidence that Canada was being used as a jurisdiction of incorporation for foreign personal holding companies by US residents seeking to avoid the more onerous tax obligations imposed under the Roosevelt administration. Testimony by Roswell Magill,61 Under Secretary of the Treasury (and Acting Secretary of the Treasury) before the House Ways and Means Committee in July of 1937 revealed that, between 1 January 1935 and 1 May 1937, ­Americans had incorporated 202 personal holding companies in Newfoundland and 243 in Prince Edward Island.62 To the extent they were non-resident by virtue of central management and control being exercised outside Canada, and invested in non-Canadian securities, they would not be subject to Canadian (or presumably Newfoundland) tax. The same would be true of the Canadianincorporated subsidiaries of foreign operating business concerns exempt under ­paragraph 4(k). The United States did not limit its pressure on Canada to undertake antiavoidance measures directed at tax evasion and avoidance by US citizens to the treaty-shopping issue raised by the 1936 treaty. In mid-1937, Magill met with the Minister of Finance, Charles Dunning in Ottawa and received assurances that Canada would enter into negotiations in respect of broader but unspecified anti-evasion measures. On 31 July 1937, Marler reported to Skelton that he had telegraphed to Herbert Feis, the Economic Advisor to the State Department: … the assurance we agreed to in Mr. Dunning’s office last Monday afternoon [26 July 1937] as follows. ‘The Canadian Government undertake [sic] to enter into negotiations as to increased co-operation in administration – which will include a discussion as to rates.’63

The cooperation desired by Washington related principally to the exchange of information about income and assets of American taxpayers held in Canada. At the same time, the Fiscal Committee was considering (at meetings in which Elliott apparently participated) the same exchange of information issue. In March of 1937, Clark acknowledged receipt from Skelton of the request of the Fiscal Committee to consider agreements under which a state would report payments made in it to residents of the other contracting state.64 This would include details of payments made by Canadian debtors to residents of the other

61 Leff described Magill as a ‘Republican law professor … [who] faithfully presented the Roosevelt case in 1937–38 for loophole closing and the undistributed profits tax.’ Leff, above n 54, 224. 62 Magill testimony to the House Ways and Means Committee. Hearings before the Committee on Ways and Means, House of Representatives, Seventy-Fifth Congress, No 1, August 9 and 10, 1937 (Washington DC, United States Government Printing Office) 36–37. 63 Letter of Marler to Skelton, dated 31 July 1937, above n 56. 64 League of Nations document CL31, 1937, II.A, dated 18 February 1937, referring to League of Nations document C450, M226, 1936, IIA dated 21 October 1936.

426  Robert Raizenne and Colin Campbell state and of all amounts received in Canada on behalf of beneficial owners in the other state. In principle, Clark was sympathetic: With regard to the general principle of co-operating with other nations in the prevention of tax evasion we cannot do well otherwise than agree in principle to the idea. It would be unfortunate if we put ourselves in the position of blocking the way to a very desirable step in international co-operation in dealing with an extremely grave and growing problem.65

Clark also noted that Canada had a ‘key position’ in assisting the United States and the United Kingdom in combatting tax evasion, and its failure to act would ‘seriously undermine’ their efforts. On the other hand, Clark noted that Canada ‘probably had less to gain from the proposed agreements than the larger capital exporting countries’ and would have ‘less to gain and more to lose’ than them and it was uncertain whether Canada would obtain ‘absolute net benefits’. Because of the ‘major administrative problems’ involved, he recommended a joint meeting with the Income Tax Department. Skelton’s reply to the League’s request of 18 February 1937 for a response to the Fiscal Committee report was set out in a telegraph to WA Riddell, ­Canada’s representative at the League.66 Consistent with Canada’s general approach to the League, it made no commitments. Canada was in ‘general agreement with the principles’ in the Report and in the event of a ‘substantially unanimous agreement among nations for action on a uniform basis’ would participate in ‘appropriate and feasible steps’. It then suggested that further study was necessary.67 By the time the 1936 treaty was ratified in August of 1937, then, Canada had committed in general terms to discussion of broader cross-border anti-avoidance measures, though with significant reservations about their net benefit to Canada. As discussed below, the issue resurfaced in early 1939 when Canada agreed to discuss a comprehensive tax treaty with the United States. Non-Resident-Owned Investment Corporations In 1936, the Act was amended to provide for non-resident-owned investment corporations (NROs), which allowed non-residents to make passive investments in Canada through a Canadian-incorporated company which was at least 95  per cent non-resident-owned, while enjoying the same tax treatment as a

65 Letter of Clark to Skelton, dated 20 March 1937, LAC, RG25, vol 1671. 66 Telegraph No 17, dated 22 April 1937, LAC, RG25, vol 1671. 67 The reply also set out Canada’s approach to one of the basic design issues in a double taxation treaty. Income should be taxable in the first instance in the state of source, with ‘reciprocal tax allowances’ in the state of residence.

Origins and Architecture of the 1942 Canada–US Income Tax Treaty  427 direct investment. In computing its income, the NRO was not allowed to deduct interest on its debt or foreign taxes; it was allowed to deduct dividends or interest from another NRO and one third of dividends received from a Canadian corporation. Its taxable income was subject to tax at half of the normal ­corporate rate (15 per cent), or 7.5 per cent. Dividends or interest paid by an NRO were not subject to the 5 per cent withholding tax imposed in 1933. An NRO was also allowed to deduct in computing its tax payable the lesser of one-third of its tax otherwise payable and foreign tax paid. The effect of these provisions was to place the non-resident investors in an NRO in more or less the same position as if they had invested directly in the underlying investments. Shipping Exemption In 1927, the Act had been amended to exempt from Canadian tax the income of a non-resident exclusively earned from foreign-registered ships,68 provided the foreign country granted a similar exemption to Canadian residents and to ­corporations organised in Canada.69 In 1928, the provision was rewritten to follow the language of the corresponding exemption in the United States. In particular the reference to corporations organised in Canada was removed to limit the reciprocal exemption to persons or corporations not resident in Canada. Under the original provision, a corporation organised in Canada, but not resident, would only have been taxable in Canada if it carried on business in Canada. Under the 1927 provision a corporation organised but not resident in Canada might have enjoyed exemption from tax both in Canada and the other jurisdiction. Under the revised provision, the Minister was given ­discretion to determine whether the foreign exemption was ‘fairly reciprocal’ and was empowered to make the exemption retroactive. By 1932, Canada had entered into 11 agreements70 providing for reciprocal treatment, the agreement with the United States having been made in 1928.71

68 Curiously, the provision referred to ‘a non-resident person or a non-resident corporation’, notwithstanding the definition of ‘person’ which included any body corporate. See para 4(m). 69 At the same time, para 4(k) had been added to the Act, exempting from tax ‘incorporated companies’ whose business and assets were entirely outside Canada. Such a company carrying on a shipping business entirely outside Canada would thus have not been subject to Canadian tax. 70 Germany, Japan and Sweden in 1928; Greece, The Netherlands, Norway, Denmark and the United Kingdom in 1929; France in 1931; and Italy in 1932. See the 1933 Report, above n 25, 57. A similar agreement was reached with respect to British Guiana in 1943. 71 See Canada Treaty Series, 1928, no 9. As Arnold and Sasseville point out, these agreements were affected by exchange of notes because they were thought to be specifically authorised by para 4(m) of the Act. The 1935 and 1936 agreements with the United Kingdom and the United States, on the other hand, were effected by statute. See BJ Arnold and J Sasseville, ‘A Historical Perspective on Canada’s Tax Treaties’, in Income Tax at 100 Years (Toronto, CTF, 2017) [11.43], nn 7 and 8.

428  Robert Raizenne and Colin Campbell Dispositions of Capital Property Because capital gains were not taxable in Canada until 1972, dispositions of Canadian property by non-residents outside the course of carrying on a business were not taxable. OUTBOUND TAXATION

An individual or corporation resident in Canada was taxable on all income (but not capital gains) on a world-wide basis, under the expansive definition of income in section 3 of the 1927 Act, including income from employment, providing services or otherwise carrying on business, and any interest, dividends or other profit from stocks or other securities or investments. Foreign Tax Credits Foreign tax credits for taxes paid by a Canadian resident to the United Kingdom or one of its ‘self-governing colonies or dependencies’ or to a foreign country were instituted in 1919 on an explicitly reciprocal basis for foreign taxes.72 The credit was limited to the Canadian tax which would otherwise have been payable on the foreign-source income. An explicit proportioning provision was added in 1939, fixing the limit on the credit as the proportion of the Canadian tax otherwise payable that net income from sources in the particular country bore to the taxpayer’s income from all sources (less certain personal deductions).73 To receive the credit the taxpayer also had to substantiate the foreign tax paid and the amount of the relevant foreign-source income.74 Canadian diplomats and federal or provincial government employees resident outside Canada were entitled to deduct from Canadian tax the foreign tax paid. Territorial Taxation under Section 4(k) By 1939, Canada employed a partially territorial system of taxation in respect of certain Canadian corporations and certain non-resident subsidiaries of 72 Reciprocal treatment by the United Kingdom and Commonwealth countries was apparently assumed to be a known fact. 73 Between 1919 and 1939, the credit was limited to Canadian tax payable on all income from nonCanadian sources, rather than a country-by-country basis. 74 There was no requirement for any agreement with the other taxing state, but notes were exchanged with the Netherlands in 1938 to confirm the designation of Canadian qualification for foreign tax credits in the Netherlands Indies (for which the Netherlands apparently required formal Canadian notification that the Netherlands Indies tax qualified for the Canadian credit). See Treaty Series I, Canada, No 2, 1938.

Origins and Architecture of the 1942 Canada–US Income Tax Treaty  429 ­Canadian corporations.75 The income of a Canadian resident corporation76 (other than a personal corporation)77 whose business was carried on and whose assets were situated entirely outside Canada (whether directly or through subsidiaries) was exempt from Canadian tax. Where the business was of an ‘industrial, mining, commercial, public utility or public service nature’, bank deposits and securities of subsidiaries could be held in Canada. Where the corporation’s business was of ‘an investment or financial’ nature, its shares must have been offered to the public or listed on a stock exchange as well as its assets (other than bank deposits and shares of other qualifying section 4(k) corporations) held outside Canada. For these corporations, securities of Canadian issuers were deemed to be situated in Canada regardless of where registered. Dividends paid by such corporations remained fully taxable in the hands of Canadian shareholders, whether individual or corporate, and were reportable by the corporation. While the jurisprudence suggested that this required the business to be managed and controlled outside of Canada, as well as carried on outside Canada,78 the administrative practice only required the working assets and profit-making processes to be outside Canada. Thus, the board of directors could meet in Canada and non-working assets, such as profits, could be sent to and held in Canada. This provision addressed the double taxation issue in a simpler and more direct manner and had some similarity to the provisions of the modern Act which exempt from Canadian tax most active business income earned outside Canada through a foreign affiliate. To qualify for the exemption, the corporation was required to file a ‘fully completed’ tax return annually and pay a filing fee. Dividends from Wholly-owned Subsidiaries While dividends from non-resident corporations were generally taxable, from 1938 dividends from a non-resident wholly-owned subsidiary received by a public corporation were exempted from tax where at least 75 per cent of the combined capital of the Canadian parent and all of its wholly-owned ­subsidiaries was employed directly or indirectly outside Canada. There were two limitations on this relief – the country in which the subsidiary carried on business had to grant substantially similar relief in respect of its corporation’s subsidiaries carrying on business in Canada, and the amount of the exemption was limited to the profits of the subsidiary in the fiscal period in which the dividend was declared and the immediately preceding fiscal period.

75 The provision in substance dated from 1919; it had been revised in 1932 and 1936. 76 While para 4(k) did not specifically refer to Canadian residence, it would not have been ­necessary in the case of a non-resident corporation not carrying on business in Canada. 77 See n 84 below. 78 See Sao Paulo (Brazilian) Railway Company v Carter [1896] AC 31 (HL).

430  Robert Raizenne and Colin Campbell JL Ilsley, the Acting Minister of Finance, explained that the provision had been long sought to ‘remove an obvious and severe burden of double taxation on Canadian companies which have been enterprising enough to extend their business activities into other countries to an extent that the foreign operations far exceed the Canadian business’.79 This in turn created an incentive for the Canadian parent to leave Canada. This was particularly true with respect to the United States because it allowed a full credit for foreign tax paid by the whollyowned subsidiaries of American corporations. Consequently, the requirement for reciprocity was already satisfied with respect to the United States. When asked to relax the requirement that 75 per cent of the capital be employed abroad, Ilsley replied that ‘the loss would be very great’.80 Offshore Corporations and Trusts The definition of ‘personal corporation'81 was amended in 1933 to confirm that the personal corporation rules applied to corporations incorporated outside Canada, but controlled directly or indirectly by a family resident in Canada.82 Such a corporation might have been found to be resident in Canada under the common law central management and control test (though careful planning would likely avoid that result); the amendment avoided any uncertainty as to the application of the rules. Where the income of such a corporation was deemed to be distributed to its shareholders, no credit was available for foreign tax.83 The corporation itself was liable to pay normal corporation tax in respect of any dividends paid to non-resident shareholders. The attribution rules governing transfers of property to minors84 were amended in 1934 in a manner which suggests a similar concern. The original rule, enacted in 1924, extended only to direct transfers of property.85 The 1934 amendment added the words ‘directly or indirectly or through the intervention of a trust’ without limiting the residence of the trust or location of the trust

79 Debates, 24 June 1938 p 4228. 80 ibid p 4229. 81 A private corporation wherever incorporated, controlled by a person or family resident in Canada and realising more than 25 per cent of its gross income from passive investments. Income of a personal corporation was attributed to its Canadian shareholders and taxed in their hands, in what was conceptually similar to the modern foreign accrual property income regime, though very limited in scope. 82 The addition of the words ‘whether in Canada or elsewhere, and irrespective of where it carries on its business or where its assets are situated’ to the definition in 1933 was directed at arguments that the personal corporation rules applied only to Canadian corporations or corporations operating in Canada. 83 It would be generally assumed that such a corporation would be incorporated in a jurisdiction which imposed little, if any, tax. 84 Whether or not related. 85 ‘Where a person transfers property to his children …’

Origins and Architecture of the 1942 Canada–US Income Tax Treaty  431 property, so that the provision would have applied equally to a non-resident trust.86 The 1936 amendments added the rule attributing to the transferor of property to a trust income from the property where the property might revert to the transferor or to a person designated by the transferor or where the transferor continued to control disposition of the property.87 This also was not limited to a Canadian-resident trust. The 1936 amendments were a response to the decision of the House of Lords in Perry v Astor and Adamson v Duncan’s Executors.88 In each case, a UK resident had settled property on a trust resident outside the United Kingdom for his sole benefit and with the power to cause the property of the trust to revert to him. The issue was whether the trust income was income from ‘stocks, shares or rents’ (in which case it was taxable in the settlor’s hands regardless of remittance to the United Kingdom) or income from something else (in which case it was taxed on a remittance basis).89 On the basis of the decision in Garland v ­Archer-Shee90 the settlor was found to have no proprietary interest in the trust property and in Perry and Adamson the courts found that the power to cause reversion of the trust property did not alter that conclusion. The amendment prevented reliance on the cases by Canadian taxpayers. Avoidance Transactions with Non-Residents In 1938, section 32A was enacted, applying91 to any ‘transaction, procedure or arrangement’ between a person resident in Canada and a non-resident which would reduce the tax liability of the Canadian resident, where the Treasury Board (a committee of the Cabinet) had ruled that the purpose of the transaction was to avoid tax. The decision of the Treasury Board was reviewable by the Exchequer Court. RB Bennett, the former prime minister, commented that ‘This section is a distasteful one, but from necessity it is desirable’ and proceeded to give an ­example ‘from the point of view of principle’: A has income of $4,000,000 derived from the resources of the Dominion of Canada. Under existing law that means a contribution of very large sums to the dominion exchequer. But A says: I am not going to do that; it is too large a sum to pay out of my income. I therefore – in the language of the statute – although ordinarily resident in Canada will effect a transaction by which I make use of a trust company

86 The amendment changed ‘children’ to ‘a minor’ without any required relationship. Curiously, the corresponding rule applying to transfers to a spouse continued to apply only to direct transfers. 87 The ancestor of subs 75(2) of the modern Act. 88 (1935) 19 TC 255 (HL). 89 The former fell within r 1 of Case V of Sch D of the UK income tax; the latter within r 2. 90 (1927) 15 TC 693 (HL). 91 For the 1936 and subsequent fiscal periods.

432  Robert Raizenne and Colin Campbell ordinarily resident abroad, which will have the effect of reducing my liability to taxation …92

Bennett went on to suggest that the provision be widened to impose tax on former residents rather than be limited to ‘one case, that of the man who continues to live here’. When Ilsley replied that taxing non-residents was ‘very difficult’, Bennett characteristically offered to draft the necessary legislation himself – ‘I shall be glad to sit down with the minister and in an hour we shall produce the legislation.’ Ilsley’s objection to Bennett’s suggestion was not the ‘unpleasantness’, as Bennett put it, to the taxpayer but the prospect of reciprocal treatment by the foreign government concerned: the objection to taxing non-residents at high rates is that we must expect similar legislation to be enacted against persons who are resident in Canada … Our whole attempt with the United States has been to keep the non-resident tax down. The United States had legislation by which they would have taxed Canadians receiving payments from the United States ten per cent, but we concluded an agreement with them by which we kept that down to five per cent, and we kept ours down to five per cent.93

Anticipating the argument that Bennett was not thinking of the United States, but ‘men in the Bahamas or places like that’, Ilsley asked if you can discriminate in rates of non-resident tax by jurisdiction. Bennett suggested it was possible to do so if the purpose test was met. Ilsley merely replied that he had ‘given a great deal of thought to the matter’.94 It is perhaps worth noting that the Act did not contain, nor had it been suggested it should contain some kind of tax on migration like section 128.1 in the modern Act.95 Payments to Affiliated Non-Residents In 1935 the deduction of certain amounts paid by a ‘Canadian company, branch or organization’ to a non-resident ‘company or organization’ was denied where either the Canadian or foreign party were under common control (whether from inside or outside Canada).96 The prohibition extended to amounts in respect of management fees, ‘patents, processes or formulae’ or the letting or leasing

92 Debates, 24 June 1938 pp 4225–26. 93 ibid. 94 ibid pp 4226–27. 95 In 1939, the provision was applied in a case where a corporation had substantial accumulated surplus and had been threatened with the application of the rule against excessive accumulation of investment income. The shareholders transferred their shares to a newly incorporated company in the Bahamas and sold the shares in that company to an accommodation party, using the funds to pay the sale price for the Canadian company shares. Memorandum of Elliott to Ralston, 27 November 1939, LAC, RG19, vol 269. 96 Para 6(1)(i).

Origins and Architecture of the 1942 Canada–US Income Tax Treaty  433 anything used in Canada. It was, however, subject to exception at the discretion of the Minister, where the services were actually rendered or the things used in Canada and the Minister was satisfied the charge was reasonable. Royalties Paid by Non-Residents Paragraph 6(1)(l) was enacted in 1938 to prevent the deduction by a non-resident of a royalty paid out of a royalty received from a Canadian resident. Plaxton described its purpose as: to prevent evasion of tax on the part of non-resident companies in receipt of royalties by means of setting up an intermediary company which receives the royalties and then deducts payments made for the use of the royalties.97

Transfer Pricing The transfer pricing provision in section 23 of the Act applied to purchases or sales of a ‘commodity’ to or from a parent, subsidiary or associated corporation by a corporation carrying on business in Canada at prices greater or less than ‘fair market price’. The Minister was then empowered to determine the ‘fair price’. A similar anti-base erosion provision, though not strictly a transfer pricing situation, was added in 1939 as paragraph 6(1)(m) prohibiting the deduction by a Canadian corporation of salary or other remuneration in excess of $14,000 unless the remuneration was taxable in Canada.98 This was apparently directed at the distribution of surplus in a form designed to avoid the non-resident withholding tax on dividends and interest. From 1934, where an interest-free or unreasonably low interest loan was made by a Canadian corporation to a non-resident corporation, the Minister could determine an amount of interest which was then deemed to have been received as income by the Canadian recipient.99 In 1939, the transfer pricing rules were extended to payments by a person carrying on business in Canada as a price, rental or royalty for the use or reproduction of property. The test applied was ‘conformity with similar payments

97 Plaxton, above n 12, 109. 98 The $14,000 amount was derived from the threshold for the investment income surtax introduced in 1935 (which treated all income in excess of $14,000 as investment income subject to the surtax). See Dunning’s explanation, Debates, 22 May 1939 p 4336. 99 In Kayser & Co Ltd v MNR [1940] Ex CR 66, the court considered the taxpayer’s argument that s 18 deemed an advance to a shareholder to be a dividend and therefore outside the reach of s 23A. The court found that s 18 is only relevant in determining the income of the shareholder, not the corporation and that s 23A applied, upholding the Minister’s assessment of interest income to the taxpayer.

434  Robert Raizenne and Colin Campbell made by other persons in the same kind of business’,100 failing which the ­Minister could adjust the price accordingly, unless satisfied that the parties were not ‘associated’101 – controlled one by the other or under common control. The Exchange of Information Issue and the Origins of the Treaty For the Roosevelt administration, concerned with tax avoidance and evasion in the United States, the informal administrative arrangements entered into in connection with the 1936 treaty were not sufficient. In his testimony to the House Ways and Means Committee, Roswell Magill reported that the United States had entered into discussions with several countries for treaties providing for mutual exchange of information. In particular, he stated that ‘Canada has already expressed its willingness to undertake the negotiations looking toward a treaty of this character.’102 Presumably this referred to the undertaking given in July of 1937 in the meeting in the office of Charles Dunning, the Minister of Finance. Mitchell Carroll discussed the same issue in reporting on discussions fostered by the Fiscal Committee in the 1930s about the desirability of a multilateral convention on administrative and judicial assistance. Carroll reported that the response from governments was ‘not encouraging’, as the Fiscal Committee had reported in 1938: Governments showed reluctance to change their domestic legislation merely to meet the requirements of foreign administrations, and they were unwilling to ask their nationals to supply information not needed for domestic purposes.103

In practice, governments had only agreed to exchange information in the wider context of a double taxation treaty which provided the benefit of removing the ‘inequitable burden of double taxation’: Exchange of information is considered appropriate to prevent evasion of taxes ­resulting from the abuse of provisions to avoid double taxation. [In their absence] exchange of information would only tend to force the liquidation of investments across frontiers, or the diversion of the flow of capital to States not parties to Conventions, or recourse to more devious methods of escaping the confiscatory accumulation of taxes.104 100 The bill as introduced included an alternative test – ‘or which is unreasonable’. It was objected that this allowed too much discretion to the Minister and Ilsley (who was somewhat uncomfortable with the extent of ministerial discretion in the Act) agreed to the deletion, leaving what, in effect, was a fair market value test. See Debates, 24 May 1939 pp 4482–83. 101 The term was not defined. 102 Magill, above n 62, at fn 65. 103 See MB Carroll, Prevention of International Double Taxation and Fiscal Evasion: Two Decades of Progress under the League of Nations League of Nations (Geneva, League of Nations, 1939) 36–37. Other states, notably Switzerland, had actively worked to limit exchange of information in the interwar period to protect its position as a tax haven. See C Farquet, ‘The Rise of the Swiss Tax Haven in the Interwar Period: An International Comparison’, EHES Working Papers in Economic History, No 27, 2012, p 17 ff. 104 Carroll, above n 103, 37.

Origins and Architecture of the 1942 Canada–US Income Tax Treaty  435 Although Canada had agreed, as Magill reported, to discuss ‘increased co-operation’ it soon became evident that this did not extend to a formal treaty or large-scale exchange of information. The Canadian resistance does not appear to have come from Elliott,105 who favoured certain exchanges of information about income flows, but from the Department of Finance. In late 1938, Canada agreed to enter into discussions with the United States about an agreement both for the exchange of information and mutual assistance in ­collection. In early December, Elliott wrote to Clifford Clark, the Deputy Minister of Finance, apparently in some haste,106 to set out an ‘incomplete indicative statement’ of his reasons for favouring exchange of information about cross-border income flows.107 In the letter he referred to the ‘present submission from the United States and France’, which apparently proposed wider disclosure.108 Notwithstanding, Elliott rejected any exchange ‘pertaining to capital in Canada, capital gains or financial statements of assets and liabilities of Canadian companies, partnerships or individuals.’ Elliott’s position was partly based on the distinction he drew between capital investments ‘of a permanent nature’ in physical assets, represented by corporate securities and capital investments in ‘extant securities’, or ‘floating capital’. The latter, which he also described as ‘flight capital’, might be scared off by the exchange of information, but this ‘is an advantage, not a detriment’, because flight capital ‘leaves in time of stress, seeking a low tax haven’. Canada could not compete in this arena because there were jurisdictions as safe as Canada which imposed no tax, many ‘under the British flag and protection’. He enumerated a number of other reasons for exchanging information about income flows: —— non-exchange of information was in effect assisting fraud, which was ‘in a wider sense detrimental to both jurisdictions’; —— it was ‘not compatible with national dignity’ to refuse to cooperate in eliminating fraud with a neighbouring country; —— wealthy foreigners looking for a safe place to invest could do so through a Canadian holding company which would pay Canadian tax on its earnings. So long as there were no distributions from the company, there would be no information exchanged.109

105 Elliott had attended the 1937 meeting of the Fiscal Committee at which France raised exchange of information issues. There is no record of any discussion by Elliott, but his subsequent discussion suggests he was sympathetic to the French position. 106 It would appear that Elliott had little or no advance knowledge of the pending negotiations. 107 Letter of Elliott to Clark, dated 7 December 1938. A handwritten notation indicates a copy was sent to Oscar Skelton, the Under-Secretary of State for External Affairs. LAC, RG25, vol 2641. 108 The government of France was also concerned with tax evasion. 109 Elliott was likely referring to wealthy Europeans seeking to protect assets from unstable or discriminatory foreign governments, particularly fascist regimes.

436  Robert Raizenne and Colin Campbell Elliott’s principal concern, however, was that refusing to exchange information: brings our relationship with the United States into jeopardy, that is, our 5% advantage over the rest of the world [flowing from the 1936 treaty] … A refusal to reciprocate will bring a new attitude toward Canada from the United States on tax matters. Our present reciprocal 5% basis will probably be abandoned and our citizens will be called upon to pay 10% at the source where they now pay 5%.

In addition, Elliott noted that, in their efforts to combat tax evasion, the United States and France had imposed ‘special laws that are really extraterritorial in their effect and result’ which, in the absence of assistance from Canada, could become more onerous. Finally, Elliott distinguished the case of assistance in collection: ‘we cannot offer judicial assistance because constitutionally we are precluded from so doing.’ Unlike the American negotiations with France and Sweden, which in each case resulted in a comprehensive tax treaty signed in 1939, the negotiations with Canada in early 1939 did not produce any agreement. The stumbling block from the Canadian viewpoint was the American demand for exchange of ­ information: A draft general agreement was under negotiation at the beginning of 1939, providing, on a reciprocal basis, for the relief against double taxation, protecting Canadian taxpayers from the oppressive effect of the extra-territorial provisions of the United States laws and setting up machinery for the exchange of fiscal information. At the time, it was the view of the Government that the exchange of fiscal information was not in the general interest of the Canadian economy and that the prejudice to the general interest outweighed any advantages that might be gained under the other provisions of the draft agreement.110

That prejudice came from three factors: —— exchange of information would be one-sided; the cost would disproportionately fall on Canada, the benefits on the United States; —— Canada was a large borrower and exchange of information would frighten off foreign capital; —— it violated the ‘basic principle’ that each country should collect its own taxes without outside aid. The failure of the 1939 negotiations may well have been reflected in Carroll’s observation that exchange of information was tied to other treaty benefits. With the 5 per cent withholding rate in hand, Canada did not need, for example, provisions dealing with business income because difficulties were being ­satisfactorily resolved at the administrative level, as Elliott had described in the 1933 report. 110 Memorandum to the Ministers of Finance and National Revenue dated 24 July 1941; LAC, RG25, vol 2905.

Origins and Architecture of the 1942 Canada–US Income Tax Treaty  437 Elliott’s fear of American retaliation was not borne out in 1939 and the outbreak of war appears to have temporarily distracted the Canadians. The situation changed materially when Canada, in the 29 April 1941 budget, increased the Canadian withholding tax rate from 5 per cent to 15 per cent, effective 30 April 1941. This automatically terminated the 1936 treaty.111 At the time, the normal US withholding tax rate was 16.5 per cent, so there was a rough equality of treatment.112 This situation changed almost immediately when the US rate was increased to 27.5 per cent, effective on 30 September 1941.113 Carroll’s calculus then came into play: Canada now needed a treaty, not to deal with double taxation of business income, but to reduce US withholding tax rates and exchange of information, effectively a concession made by Canada to obtain the desired treaty benefit. A high-level meeting was held on 7 July 1941, including both Clark and E ­ lliott and chaired by Skelton’s successor as Under Secretary for External Affairs, Norman Robertson, to discuss re-engaging with the United States. Clark argued that ‘it might not be very effective’ for Canada to reverse its stance from 1939 because of the 27.5 per cent withholding rate and it would be better to seek a limited agreement to eliminate withholding tax on subsidiary-parent dividends. Canada should also, he argued, only offer to revisit exchange of information if the United States was willing to consider a comprehensive agreement addressing a ‘wide range’ of issues. Elliott suggested offering exchange of information as the best way to obtain American concessions on withholding taxes. Clark’s reply was to list again the arguments against exchange of information: —— It was more ‘burdensome’ for Canada than the United States. —— The US should be willing to give up ‘excessive demands’ for extra-territorial taxation without any Canadian quid pro quo. —— There were persons who had ‘some justification’ for avoiding US tax and who should not be ‘sacrificed’ to the US interest. The meeting decided to refer the issue of commencing negotiations with the United States to the Cabinet, and the memorandum of 24 July1941, referred to above, was prepared. It set out the issues which had arisen between Canada and the United States: —— Exemption of shipping and aircraft profits. The former had been dealt with in the 1928 agreement; mutual exemption of aircraft profits had been agreed and the only question was whether it was to be the subject of a

111 Formal notification of the Canadian action and release of the United States from its obligations under the treaty was made by letter of Leighton McCarthy, Canadian Ambassador the United States to Cordell Hull, the Secretary of State, dated 2 May 1941. LAC, RG25, vol 1800. 112 The US withholding rate had been increased from 10 per cent to 16.5 per cent on 26 June 1940. 113 After the making of the Treaty, the US withholding rate was increased again, to 30 per cent, effective 31 October 1942.

438  Robert Raizenne and Colin Campbell separate agreement or included in a ‘general agreement’ (the proposed comprehensive treaty). —— Mutual exemption of earnings of employees of international carriers remained to be negotiated. —— Exemption from US tax of annuity payments to retired Canadian academics (paid by a US pension corporation). —— Mutual limitation of withholding tax rates remained to be negotiated. —— Exemption of Canadian taxpayers from the operation of US extra-territorial laws,114 including settlement or cancellation of past claims. —— Exemption or limitation of tax imposed on dividends paid by a subsidiary in one country to a parent corporation in another. The ‘draft general agreement’ under negotiation in 1939 provided for relief of double taxation and relief from extra-territorial legislation but foundered on American demands for exchange of information. The memorandum requested guidance on this issue from the Cabinet, setting out the objections made previously but noting there was ‘a definite indication of unwillingness [on the part of the United States] to bring about any arrangement without provision for exchange of information’. The memorandum noted that there was a ‘possibility’ the United States would not insist on it if Canada confined its demands to the limitation of withholding tax.115 The memorandum in effect suggested that the exchange of information issue now had to be balanced by the threatened increase in the United States withholding tax to 27.5 per cent which would impose ‘real hardship’ on Canadian taxpayers and a ‘substantial loss’ to the Canadian treasury (from the increased foreign tax credits which would ensue). A related issue was the parent-subsidiary dividend tax. C ­ anadian retaliation would result in disproportionate costs for US taxpayers and might therefore be a ‘lever’ to be used in negotiation but would also threaten the Canadian policy of encouraging US enterprises to establish Canadian subsidiaries. While the memorandum, presumably reflecting the views of the participants of the 7 July meeting (which included the most senior officials of the Canadian government) did not make a recommendation, the tide was clearly turning in favour of conceding the central issue of exchange of information. Once that bridge was crossed, negotiations proceeded and the Treaty was signed on 4 March 1942.

114 For example, the United States treated all of a corporation’s income, wherever derived, to be US source income if more than 50 per cent of the corporation’s income was derived from US sources. The memorandum acknowledged that the United States had a legitimate concern where a Canadian corporation had a branch in the United States and, while paying normal US tax on the branch earnings, paid no tax on repatriating the earnings to Canada. 115 The memorandum did note that the exchange of information issue was less pressing in wartime when there was less prospect of foreign investment and less expectation of privacy by businesses.

Origins and Architecture of the 1942 Canada–US Income Tax Treaty  439 THE ARCHITECTURE OF THE TREATY

When negotiations commenced in 1939, the United States was engaged in parallel negotiations with France and Sweden. The similarity of significant portions of the Treaty as finally agreed to, in particular the US treaty with Sweden, suggests that the negotiators in 1939 were dealing with a text of US origin. That was also the starting-point when negotiations resumed in 1941. At the time, there was no unified League of Nations model treaty to work from. As Carroll described, the experts in 1928 had been unable to agree on a single model, and produced three variants.116 The subsequent work of the Fiscal Committee at meetings in 1940 at The Hague and 1943 in Mexico had not succeeded in producing a unified model. Carroll himself continued the task and in 1940 produced a draft unified model, set out in his 1940 study, which was later adopted with some changes in 1943. The American negotiators in 1939, then, had the three 1928 variant models and the Canadians, and in particular Elliott, would have been familiar with them. The two 1928 variants which principally informed the Treaty were what Carroll designated as 1b and 1c. The principal difference between them was in the method of eliminating double taxation. Under variant 1b, the country of source generally had priority; the country of fiscal domicile of the taxpayer levied its full tax on all income but allowed credit for tax paid at source. Under variant 1c, different categories of income were assigned exclusively to either the source or domicile country. Dividends and interest were generally assigned to the latter although the model allowed for source country taxation and tax credits in some circumstances. The US treaty with Sweden followed variant 1c and Carroll favoured it in his work on a unified model. The US treaty with France followed variant 1b. As noted above, Canada had clearly indicated its preference for the variant 1b model, and the United States evidently agreed. Having said that, the Treaty borrowed from both prior US treaties and used provisions from the emerging unified draft. Eligibility for Treaty Benefits Residence was the test for eligibility for treaty benefits for individuals, modified in some instances to take into account American citizenship as a factor.117 There were no tie-breaking rules in the case where an individual was resident in both states (but presumably the competent authority consultation provided for 116 ‘Study by Mr Mitchell B Carroll on The Draft Conventions Prepared by The General Meeting of Government Experts on Double Taxation and Tax Evasion of 1928’, Fiscal Committee, League of Nations, Geneva: 3 April 1940, F/Fiscal/123. 117 For example, Art XII, which limited the extra-territorial application of US tax to Canadian resident individuals receiving dividends from certain Canadian-incorporated companies, did not apply with respect to such residents who were US citizens.

440  Robert Raizenne and Colin Campbell in Article XVI might address such a conflict). For corporations and ­partnerships, however, the test was the American test – the jurisdiction under which a corporation or partnership existed. Canada taxed on the basis of residence exclusively, for corporations determined by the location of central management and control, and for partnerships determined by the residence of its members.118 For the treatment of business profits, the difference was not as material because both countries imposed tax on the basis of carrying on business. Corporations or partnerships organised under Canadian law but which were not resident in Canada, or whose partners were not resident in Canada, and which did not have a permanent establishment in the United States would, however, appear to have escaped tax purely on the basis of residence in both countries. The limitation of withholding rates in Article XI also accrued to the benefit of corporations organised under the laws of the other state.119 Business Profits By 1939, as a result of the work done by Carroll and the Fiscal Committee, the use of the concept of permanent establishment to determine the source country’s right to tax business income (‘industrial and commercial profits’) was well established,120 and Article I of the Treaty which so limited the source country’s right to tax was similar to the corresponding articles in the French and Swedish treaties,121 and Carroll’s draft model.122 The Treaty followed the French treaty in allowing the country of domicile to also tax profits attributable to the permanent establishment while recognising the primacy of the source country.123 It  differed from the Swedish treaty in allowing the residence state to also tax

118 The 1933 Report, above n 25, did not contemplate a partnership composed of both resident and non-resident persons 119 Art XI contained an anti-avoidance rule directed at the 5 per cent rate available on subsidiaryparent dividends but no apparent treaty-shopping rule otherwise. 120 The definition of permanent establishment used in the Treaty had been substantially produced by the Fiscal Committee in 1933 (with some revision in 1935). Its use in the Treaty also led to its use in the Canadian domestic law context. In connection with the postwar restructuring of the fiscal relationship between the Canadian federal and provincial governments it was necessary to devise a formula for allocating corporate income among the provinces. The formula produced in 1946 was based on the concept of permanent establishment and substantially used the definition in the Treaty. See EH Smith, ‘Allocating to Provinces the Taxable Income of Corporations: How the Federal-Provincial Allocation Rules Evolved’ (1976) 24(5) Canadian Tax Journal 543–59, 548–50. 121 Arts 2 and I, respectively. 122 Art II(1). As Carroll pointed out, ‘The rules for the apportionment of income between the establishments of the same enterprise in the two contracting States are, in general, those contained in the model allocation convention drafted by the Fiscal Committee [in 1933 and revised in 1935].’ See Carroll, above n 51, 462. 123 Although the Treaty rejected the ‘territorial’ principle embodied in the Swedish treaty, para 4(k) of the Act did exempt the income of a Canadian corporation all of whose operations were outside Canada and para 4(r) of the Act allowed the tax-free repatriation of the offshore earnings of whollyowned subsidiaries of Canadian public companies.

Origins and Architecture of the 1942 Canada–US Income Tax Treaty  441 profits of the permanent establishment. The rules in Article III of the Treaty about the allocation of income to a permanent establishment and application of the separate accounting principle had no counterpart in the Swedish treaty and little similarity to the French treaty provisions. They were largely identical to the provisions in Carroll’s 1940 draft and the 1943 Model.124 Article II of the Treaty, which distinguished industrial and commercial profits from passive investment income such as interest, rents or dividends had no counterpart in either the 1943 Model, Carroll’s draft or the Swedish treaty but was very similar to Article 3 of the French treaty. The transfer pricing provisions of paragraph 1 of Article IV of the Treaty were largely identical to those in the French and Swedish treaties,125 and Carroll’s draft.126 The definition of permanent establishment in the Treaty was very similar in substance to that in both the French treaty and the Swedish treaty.127 Carroll’s draft model was more detailed but not different in substance. As with the rest of these provisions, it is not surprising that there was little difference in substance. Withholding Tax Rates Canada’s principal reason for entering into the treaty process, to avoid the effect of the pending increase in US withholding tax rates, was achieved in Article XI which imposed a 15 per cent limit on the rate of tax which a state could impose on income of a person who was not carrying on a trade or business in that state or had an office or place of business in it. Because the Treaty had effect from 1 January 1941, the 27.5 per cent US rate was entirely avoided. In addition, a 5 per cent limit was placed on subsidiary to parent dividends, again satisfying Canadian desire. Article XI had no real counterpart in either of the other treaties or the models, which, to one degree or another sought to allocate exclusive jurisdiction. It allowed Canada, as a debtor nation, to impose tax on all such payments to residents of the United States, including rents and royalties.128 ­Article XI also allowed either state to terminate its provisions without notice at any time more than three years after the Treaty went into effect by increasing either the 15 per cent or 5 per cent rates. The provision for subsidiary to parent dividends contained an anti-avoidance provision allowing the competent authority of the state imposing the tax to suspend the concession if it was

124 Paras 1, 2, and 3 of Art III of the Treaty; paras 1, 2 and 3 of Art III of Carroll’s draft. Carroll’s draft and the 1943 Model also included specific allocation rules for banking and insurance ­enterprises, which were a product of the work Carroll spearheaded in the 1930s. These were absent in the Treaty and the French and Swedish treaties. 125 Arts 5 and III, respectively. 126 Art IV. 127 In all three treaties, defined in the Protocol. 128 The US treaty with France, for example, did not allow source state taxation of payments in respect of intellectual property and the Swedish treaty only addressed dividends and interest.

442  Robert Raizenne and Colin Campbell satisfied that ‘the corporate relationship between the two corporations has been arranged or is maintained primarily with the intention of taking advantage of this paragraph.’ Exchange of Information The exchange of information provisions, contained in Articles XIX and XX of the Treaty, conceded by Canada in the face of the looming increase in withholding tax rates, were broadly similar to those in the French and Swedish treaties.129 Canada agreed to provide the names and addresses of: —— persons in the United States receiving Canadian source investment income;130 —— non-residents of Canada deriving American source income through a nominee or agent and not eligible for the low treaty rate; —— non-residents receiving dividends from Canadian corporations deriving more than 50 per cent of their gross income from US sources; and —— US residents who owned shares of a non-resident-owned investment corporation. There was no assistance in collection provision (in contrast, for example, to Article XVII of the Swedish treaty). Foreign Tax Credits Consistent with following the variant 1b pattern, the Treaty provided for foreign tax credits where the other state had primacy in taxation. The provisions of Article XV of the Treaty referred specifically to the domestic legislation granting foreign tax credits and were thus sui generis. Personal Services Article VII of the Treaty, dealing with compensation for personal services, was very similar to the corresponding provision in the Swedish treaty though with different time and money thresholds. Both contained an exclusion from benefits for artists and athletes (which was absent in the Model). It applied to persons

129 Arts 20 to 22 and XV–XVI, respectively. The 1943 model treaty on administration and a­ ssistance in collection contained somewhat similar provisions of this nature. 130 Dividends, interest, rents, royalties, salaries, wages, pensions or other fixed or periodical profits or income.

Origins and Architecture of the 1942 Canada–US Income Tax Treaty  443 carrying out professional services under a contract for services in addition to employees.131 Other Provisions The remaining provisions of the Treaty tended to follow the provisions of the Swedish treaty or Carroll’s draft (which often consisted of amended versions of the Swedish treaty provisions). Thus, Article VIII dealing with capital gains, Article IX dealing with students and paragraphs 11 and 12 of the Protocol dealing with non-discrimination were identical to the Swedish provisions. A ­ rticle V dealing with shipping and aircraft was essentially Carroll’s revision of the ­Swedish provision. Article VI dealing with pensions, Article XVI, dealing with double taxation, and Article XVIII, dealing with competent authorities, were similar to the corresponding provisions in the Swedish and French treaties and the Carroll draft model. Article X of the Treaty exempted the income of educational and charitable organisations realised in the other state on a reciprocal basis. This was unique to the Treaty and doubtless reflected the particular connections between Canada and the United States and similar treatment of such bodies. A ­ rticle XIII substantially addressed Canadian concerns about the extra-territorial application of US law, exempting Canadian organised corporations that were more than 50 per cent beneficially owned (on the basis of voting shares) by ­Canadian residents other than US citizens from US tax with respect to undistributed income or surplus. Where a Canadian corporation was not eligible for this relief, the competent authorities agreed to consult. As desired by Canada, ­Article XIV provided for the settlement or cancellation of past claims. CONCLUSION

The making of the Treaty confirmed and furthered changes both in the architecture of the international tax system and of the emerging model treaty. Up to 1939, Canada, though a member of the League of Nations, had only participated passively in the work of the Fiscal Committee and had avoided any comprehensive double taxation agreements. The United States was not a member of the League of Nations and Mitchell Carroll, at one time a special counsel to the US Treasury, participated in the work of the League, in later years on an unofficial basis. Prior to 1939, its only significant treaty was the partial, 1932 agreement with France. By 1942, both Canada and the United States, for different reasons,

131 Carroll’s draft only taxed income from the ‘liberal professions’ attributable to a permanent establishment in the other state.

444  Robert Raizenne and Colin Campbell had entered the modern treaty world at the same time as each had abandoned its isolationist foreign policy. At the same time, the pre-war treaty order, with its centre of gravity in central Europe, had been largely disrupted by the war.132 After 1945, the United States and Canada were to play a much larger role in the international tax world. They had, in a sense, served their apprenticeship for that role between 1939 and 1942. The Treaty also changed the architecture of the emerging model treaty. It rejected the use of mutually exclusive jurisdiction over different types of income in favour of taxation by both source and residence states with reciprocal tax credits used to prevent double taxation. While this diverged from Carroll’s unified draft of 1940 and the 1943 model produced by the 1943 Mexico conference, it was the conceptual approach which eventually prevailed. The Treaty also included anti-avoidance measures (principally the exchange of information article) in the treaty itself rather than in a separate administrative treaty. That too, has become the norm.133

132 See the list of treaties in Annex II of Carroll, above n 103, for the predominance of treaties between continental European states. 133 The only significant exception being the Common Reporting Standard measures recently adopted under the Strasbourg Convention. The anti-avoidance measures in the recently adopted Multilateral Instrument operate by amending existing bilateral treaties.

16 The Drafting of the First Model Treaties on Tax Evasion SUNITA JOGARAJAN

ABSTRACT

This paper is a follow-up to my paper presented at the Seventh Conference in 2014. That paper examined how the League of Nations came to study the question of tax evasion, and the League’s deliberations which resulted in the publication of the 1925 resolutions on tax evasion. This paper will conclude the story of the League’s work on tax evasion in the 1920s by examining the drafting of the first model tax treaties on tax evasion. In 1927, the League published two draft model treaties on administrative assistance and judicial assistance. When finalising the model treaties in 1928, these treaties were changed to model treaties on administrative assistance and the collection of taxes. This paper will examine the deliberations of the League’s Experts between 1926 and 1928 which resulted in the publication of those first model treaties related to tax evasion. Despite the League’s focus on measures to target tax evasion, the 1920s and 1930s have been described as ‘something of a golden age of opportunity for avoiding taxation through the relocation of assets’.* The history reveals that the countries represented at the League had mixed views as to the importance of addressing tax evasion and the need to attract capital. As most countries, led by the OECD and the G20, continue to develop measures to target tax evasion, it is hoped that the detailed history of the League’s work in the 1920s in this regard will provide useful insights to support future reform.

* C Farquet, The Rise of the Swiss Tax Haven in the Interwar Period: An International Comparison, Working Paper No 27 (European Historial Economics Society, 2012) 3.

446  Sunita Jogarajan INTRODUCTION

I

n 1928, the League of Nations published two model conventions targeting tax evasion: the Bilateral Convention on Administrative Assistance in Matters of Taxation, and the Bilateral Convention on Assistance in the Collection of Taxes.1 The publication of the model conventions followed the publication by the League of a series of resolutions on tax evasion in 1925.2 This paper is a follow-up to an earlier paper which analysed the drafting of the 1925 Resolutions on tax evasion.3 Following the publication of the 1925 Resolutions, the League convened a larger conference of experts in 1926–27 to develop draft conventions based on the resolutions, and an even broader conference of experts in 1928 to finalise the draft conventions as model conventions. This paper completes the narrative by examining the League’s deliberations, which resulted in the conversion of the 1925 Resolutions to model conventions in 1927 and 1928. However, it should be noted at the outset that, unfortunately, much of the discussion in relation to tax evasion was undocumented (ie the minutes state ‘after undocumented discussion’). It is not clear why this was the case and although some of the experts’ discussion in relation to double taxation was undocumented, it was the exception rather than the rule. It could simply be due to the fact that the discussions in relation to tax evasion were generally done under significant time pressure, as they were usually towards the end of the proceedings, or it could have been due to political sensitivities. It is more likely to be due to the former rather than the latter given the completeness of the minutes in relation to the discussion on double income taxation which was also politically sensitive at times. The next section provides a brief background to the League’s work in 1927 and 1928 by reproducing the 1925 Resolutions on tax evasion and highlighting the key issues in the development of those resolutions. The 1925 ­Resolutions were the basis for the later work on drafting the model conventions. This is followed with a discussion of the deliberations which resulted in the publication of the first draft model conventions on tax evasion, and then

1 Double Taxation and Tax Evasion: Report Presented by the General Meeting of G ­ overnment Experts on Double Taxation and Tax Evasion (Geneva, League of Nations, 1928) (‘the 1928 Report’). The 1928 Report also included two model conventions on double taxation (on income tax and succession duties), but those conventions are not discussed here. For discussion of the League’s work on double income taxation, see S Jogarajan, Double Taxation and the League of Nations (Cambridge, Cambridge University Press, 2018). 2 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’). 3 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 Publishing, 2015) 253–92.

The Drafting of the First Model Treaties on Tax Evasion  447 an examination of the finalisation of those model conventions in 1928. Finally, the paper draws together some concluding remarks regarding the League’s work on tax evasion. BACKGROUND

The resolutions in the 1925 Report addressed two issues – assessment of tax, and collection of tax. The resolutions on assessment of tax were as follows: The experts consider that the effective method of avoiding tax evasion is for the ­revenue authorities to undertake to supply on a basis of reciprocity to other countries, in respect of persons or companies domiciled in those countries, such information as may be required for tax assessment, for which purpose it is necessary to ascertain both the income and capital value of: 1. Immovable property; 2. Mortgages; 3. Industrial, commercial or agricultural undertakings; 4. Movable securities, deposits and current accounts as determined by means of affidavits or any other documents proving the existence of capital or the payment of the income; 5. Earned income, including directors’ fees. Nevertheless, having regard to circumstances of different kinds, the experts recognise that this exchange should be limited actually to the information which is in the possession of States or which the States can obtain in the course of their fiscal administrations. In the opinion of the Committee, it is essential that agreement on the subject of tax evasion should be reached, if not universally, at least by a majority of States, in order to obviate the serious disadvantages which might result for certain countries, if the procedure in question were adopted by a minority of States only.4

The resolutions relating to the assessment of tax were the result of extensive debate and many compromises.5 In particular, the Swiss and British representatives were concerned that the resolution on exchange of information would involve violation of bank secrecy. The British representative, while recognising Great Britain’s geographical advantage with regard to tax evasion as compared to the Continental European countries, also opposed the measures on the basis that tax evasion was not a significant revenue concern for the British government and therefore the proposed measures, especially information exchange, would

4 1925 Report, above n 2, 34–35. 5 Jogarajan, ‘The Drafting of the 1925 League of Nations Resolutions on Tax Evasion’, above n 3, 271–89.

448  Sunita Jogarajan not be accepted by the British public. Some experts were also concerned as to the efficacy of the proposed measures, as it was thought that capital would simply move to countries which did not enter into exchange of information agreements. In order to obtain unanimous agreement on the resolutions and address these concerns, the following preamble, which severely diminished the utility of the resolutions on tax evasion, was inserted into the 1925 Report: In view of the very special nature of the problem of tax evasion, the experts consider that they must, at the outset, submit the following observations, which should be read together with the text of their recommendations: 1.

Unlike double taxation, in connection with which any problems arising between two States can be settled appropriately by means of bilateral conventions, the question of tax evasion can only be solved in a satisfactory manner if the international agreements on this matter are adhered to by most of the States and if they are concluded simultaneously. Otherwise, the interests of the minority of States, which would alone have signed the conventions, might be seriously ­prejudiced. 2. As regards the carrying out of the recommendations, which the members of the Committee, in their capacity of technical experts submit, as being in their opinion the most suitable for counteracting tax evasion, the experts desire to emphasise the fact that it will only be possible to carry out these recommendations in any given country if, in the first place, public opinion in that country is sufficiently prepared, and secondly, if the Government of the country considers that the measures advocated are not only compatible with public opinion, but also are required for the collection of its own taxes.6

The resolutions regarding the collection of tax (administrative and judicial assistance) were as follows: States might consider the possibility of allowing their administrative and judicial authorities to act for other States for the recovery of fiscal debts the liability for which can be shown to be res judicata. If this principle was adopted, states would conclude with one another, for its application, Conventions which might contain the following provisions: 1.

Each State shall recover within its territory, in accordance with its own law, taxes due in another State, including taxes due from persons not nationals of the latter State. The State to which such an application is made may not, however, be requested to apply any method of execution not provided for under the law of the State making the application. 2. Taxes to be recovered shall not, in the State to which application is made, be regarded as privileged debts. 3. Prosecutions and other measures of execution shall be carried out, without exequatur, on the production of documents proving that the liability in question



6 1925

Report, above n 2, 34.

The Drafting of the First Model Treaties on Tax Evasion  449 is res judicata. If the fiscal debt may still be the subject of an appeal, conservatory measures may be taken on the production of a decision executable against the debtor.7

The resolutions relating to the collection of tax were less controversial but not without objection. The British representative could not agree to the resolutions on the basis that the collection of foreign taxes was not permitted under domestic law and would require the British government to amend its legislation. Further, the British representative thought that governments would lose the goodwill of the people regarding the payment of domestic taxes if governments were to collect taxes on behalf of another country. To address the British position regarding collection of foreign tax, it was contemplated that these resolutions could be enacted through bilateral treaties rather than a multilateral convention. As discussed elsewhere,8 the Chairman of the 1925 Experts, d’Aroma of Italy, preferred unanimous approval of the resolutions rather than majority approval or alternative positions. This was the case even where he recognised that the compromises would mean that the resolutions were not immediately effective. Ultimately, the 1925 Experts were compelled to reach agreement on the resolutions relating to tax evasion, as they had already reached an agreement on resolutions addressing double taxation, and the 1925 Experts did not think it appropriate that they address double taxation, which was for the benefit of taxpayers, without addressing tax evasion, which was for the benefit of ­governments. The 1925 Experts concluded their report by recommending that the League convene a broader conference of government experts to develop the resolutions into draft treaties.9 The recommendation was accepted by the Financial Committee, but with one condition – that the expanded conference ‘take into consideration the disadvantage of placing any obstacles in the way of the international circulation of capital, which is one of the conditions of public prosperity and world economic reconstruction’.10 The League ­Council accepted the Financial Committee’s recommendation and invitations were issued to Argentina, Germany, Japan, Poland, the United States and ­Venezuela to join the original seven countries (Belgium, Czechoslovakia, France, Great Britain, Italy, Netherlands and Switzerland) in an expanded conference. The next section discusses the work of the expanded conference with regard to tax evasion.

7 1925 Report, above n 2, 35. 8 Jogarajan, Double Taxation, above n 1, 83–84. 9 1925 Report, above n 2, 29. 10 Report to the Council by the Financial Committee on the Work of Its Eighteenth Session held at Geneva from June 4th to 8th, 1925 (League of Nations Archives, United Nations Geneva: C. 335. (1). M. 116. 1925. II).

450  Sunita Jogarajan 1927  REPORT AND FIRST DRAFT CONVENTIONS

The expanded conference involved three sessions in May 1926, January 1927 and April 1927, and resulted in the publication of the ‘Report Presented by the Committee of Technical Experts on Double Taxation and Tax Evasion’.11 The 1927 Report included the first draft of two model conventions on tax evasion – the Draft of a Bilateral Convention on Administrative Assistance in Matters of Taxation and Draft Bilateral Convention on Judicial Assistance in Collection of Taxes. As discussed below, the 1927 draft model conventions were in fact almost identical to the final 1928 Models, the only differences being minor amendments to the text for clarity. The expanded conference was attended by the following delegates (‘1927 Experts’): Argentina – Oria, Secretary of State in the Ministry of Finance, Member of the Board of the National Mortgage Bank) for the first two sessions and Encisco, Councillor of Legation in Geneva, for the third session; Belgium – Clavier, Director-General of Direct Taxation and Land Survey in the Ministry of Finance, who attended all three sessions and was also one of the authors of the 1925 Report; Czechoslovakia – Valnicek, Chief of Section in the Ministry of Finance, who attended the first session and was also one of the authors of the 1925 Report and Vlasak, Minister Plenipotentiary, Head of Department in the Ministry of Finance, who attended the third session following Valnicek’s sudden death in December 1926; France – Borduge, Councillor of State, Director-General of Taxation and ­Registration, Ministry of Finance, who attended all three sessions and was also one of the authors of the 1925 Report; Germany – Dorn, Director in the Ministry of Finance, who attended all three sessions;12 Great Britain – Thompson, Deputy Chairman, Board of Inland Revenue, who attended all three sessions and was one of the authors of the 1925 Report; Italy – d’Aroma, Vice-Governor of the Bank of Italy, Director-General in the Ministry of Finance, who attended the first and third sessions and was one of the authors of the 1925 Report and Bolaffi, Head of Section in the Ministry of Finance, Department of Direct Taxation, who attended the second session when d’Aroma was busy with domestic duties;

11 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’). 12 Dorn was a renowned expert in international taxation: C Bräunig, Herbert Dorn (1887–1957): Pionier und Wegbereiter im Internationalen Steuerrecht (Tübingen, Mohr Siebeck, 2016); Jörg-Dietrich Kramer, ‘FRG Federal Finance Academy’s Tax Museum Honors Former Tax Officials’ (1989) 1 Tax Notes International 489, 490.

The Drafting of the First Model Treaties on Tax Evasion  451 Japan – Mori, Financial Commissioner of Japan in London, who attended the first session and Aoiki, Representative in London of the Bank of Japan, who attended the second and third sessions; Netherlands – Damste, Director-General of Taxation, who attended all three sessions and was one of the authors of the 1925 Report and van der Waals, Director in the Colonial Department, who attended all three sessions but only in relation to any colonial questions; Poland – Zaleski, Professor of Political Economy at the University of Posen, attended all three sessions; Switzerland – Blau, Director of the Federal Taxation Department, attended all three sessions and was one of the authors of the 1925 Report; United States – Adams, Chairman of the American Economic Association and former Economic Adviser to the US Treasury Department and Professor at Yale University, attended the third session only;13 and Venezuela – Feo, Professor of Finance at the University of Caracas, attended the first session only. The work of the 1927 Experts was very much seen as a continuation of the work of the 1925 Experts, as evidenced by the fact that the first session of 1927 Experts was officially referred to as the sixth session of the Committee of Technical Experts on Double Taxation and Tax Evasion. The discussion regarding measures to address tax evasion followed similar lines to that of the 1925 Experts, despite the addition of so many new experts and the inclusion of representatives from Argentina, Japan and Venezuela with different economic and tax systems. The first session of the 1927 Experts was largely spent examining the 1925 Resolutions and developing the draft conventions in sub-committees. The draft conventions were examined in detail in the second session and ­finalised in the third session. The discussion at the third session was limited to a few outstanding issues in ­relation to the draft conventions and finalising the accompanying commentary. International Chamber of Commerce It should be noted that delegates from the International Chamber of Commerce (‘ICC’) also attended all of the meetings of the 1927 Experts.14 However, they chose not to be involved in the discussions on tax evasion, as the ICC objected to all measures which could affect the freedom of the monetary exchange

13 American participation in the League’s work on double taxation and tax evasion was delayed by the fact that the United States was not a member of the League. See further S Jogarajan, ‘The “Great Powers” and the Development of the 1928 Model Tax Treaties’, in P Harris and D de Cogan (eds), Studies in the History of Tax Law, vol 8 (Oxford, Hart Publishing, 2017) 348–58. 14 ICC delegates had limited involvement in the development of the 1925 Resolutions and only in regard to double taxation: Jogarajan, Double Taxation, above n 1, 90–95.

452  Sunita Jogarajan and bank secrecy.15 Further, the ICC thought that if measures to target tax evasion were considered necessary, such measures should be implemented domestically, rather than through international treaties. Julliard, the ICC representative, further noted that the ICC was not interested in protecting tax evaders, but rather considered capital movement to be the consequence of higher returns from investment, fear of excessive currency depreciation and social and political unrest, not tax avoidance. In the ICC’s experience, capital generally returned to countries once there was economic and social stability, even though tax rates in that country might be higher than the country where the capital was located. The ICC also opposed international measures to address tax evasion, as it did not consider such measures achievable practically, as it was necessary for a large number of countries to agree to them. Julliard asked that the 1927 Experts limit their action to only those situations which they considered absolutely essential, so as not to prevent the free circulation of capital. The ICC’s comments were initially positively received by the 1927 Experts, and d’Aroma (Chairman, Italy) noted that the 1927 Experts were particularly mindful of not adversely affecting the economic activity of countries. ­Thompson (Britain) agreed with the ICC’s statement as to the importance of ensuring that the measures regarding tax evasion did not prevent the free movement of capital but noted that the 1925 Resolutions did not create this danger. Clavier (Belgium) also wholeheartedly agreed with Julliard’s statement. He especially supported the comments regarding the reasons for capital movement and asked that the report of the 1927 Experts include the ICC’s comments.16 The 1927 Experts’ response to the ICC’s comments highlights the overall constraints which governed their work on tax evasion. Once the conventions on administrative and judicial assistance in the collection of taxes were drafted, the ICC reiterated their opposition to the measures on tax evasion in quite strong and lengthy comments.17 The ICC declared that the proposed conventions amounted to government interference in economic life, which the ICC considered to be one of the principal reasons for the present problems. The ICC suggested that the actions of the 1927 Experts would increase the instances of tax evasion and did not address their cause. The 1927 Experts expressed their regret that the ICC did not support their work on tax evasion, but considered the draft conventions necessary. 15 Minutes of the Fifth Meeting of the Sixth Session of the Committee on Double Taxation and Fiscal Evasion held at 4 pm on 19 May 1926 (League of Nations Archives, United Nations Geneva: Double Imposition et Evasion Fiscale, vol V 6 Sessions Du Comité Des Experts Gouvernmentaux (1518), D.T./6th Session/P.V.5(1)). 16 The 1927 Report does not address the reasons for capital flight but states that ‘the adoption of [the Committee’s] recommendations could not, in any circumstances, hamper the free circulation of wealth or the working of economic laws’: 1927 Report, above n 11, 25. 17 Minutes of the Fifth Meeting of the Eighth Session of the Committee on Double Taxation and Fiscal Evasion held at 3:30 pm on 8 April 1927 (League of Nations Archives, United Nations Geneva: Double Imposition et Evasion Fiscale vol VII 8 Sessions Du Comité Des Experts Gouvernmentaux (1520), DT/8th Session/PV5 (1)).

The Drafting of the First Model Treaties on Tax Evasion  453 1925  Resolutions on Tax Evasion The first session of the 1927 Experts was largely spent discussing the 1925 ­Resolutions, particularly the proposal for the simultaneous conclusion of treaties to address assistance in the assessment of tax. The Experts did not consider the proposal practicable due to the difficulties in concluding agreements for the exchange of information.18 Although the issue was initially raised by a new Expert, Zaleski (Poland), the discussion was largely between Clavier (Belgium), Blau (Switzerland) and Damste (Netherlands), who were also 1925 Experts. The discussion raised similar issues to their previous discussion regarding the categories of income to be subject to information exchange, potential violation of bank secrecy, and whether the exchange of information would be automatic or on request in relation to specific taxpayers. Ultimately, the key question for the 1927 Experts was whether the 1925 Resolutions allowed for countries to continue to conclude bilateral treaties to address tax evasion in the likely absence of broader international action. Blau opposed bilateral information exchange agreements on the basis that capital would simply flow to those countries which did not conclude such treaties. However, Damste and Clavier highlighted that an 1845 treaty between Belgium and the Netherlands for the exchange of information between those two countries had not negatively impacted crossborder investment in the two countries.19 Similarly, Borduge (France) noted that a treaty providing for the automatic exchange of information between France and Great Britain with regard to succession duties had not impacted crossborder investment in immovable property in either country.20 The 1927 Experts also noted the conclusion of mutual assistance treaties between Poland and Czechoslovakia,21 Germany and Czechoslovakia,22 and Germany and Italy.23 Valnicek ­(Czechoslovakia) highlighted the fact that the ability to conclude bilateral treaties meant that Czechoslovakia could conclude a treaty providing for

18 Minutes of the Fifth Meeting of the Sixth Session of the Committee on Double Taxation and Fiscal Evasion, above n 15. 19 Convention Regulating the Relations between the Administrative Services of Netherlands and Belgium (signed 24 May 1845), reproduced in League of Nations, Double Taxation and Fiscal Evasion: Collection of International Agreements and Internal Legal Provisions for the Prevention of Double Taxation and Fiscal Evasion (Geneva, League of Nations, 1928) 213. 20 Agreement for the Prevention of Frauds in Connection with Succession Duties (France–Great Britain) (signed 15 November 1907), reproduced in League of Nations, Double Taxation and Fiscal Evasion, above n 19, 214. 21 Treaty between Poland and Czechoslovakia Regarding Protection and Legal Assistance in Taxation Questions (signed 23 April 1925), reproduced in League of Nations, Double Taxation and Fiscal Evasion, above n 19, 221. 22 Treaty between the German Reich and the Czechoslovak Republic Concerning Legal Safeguards and Legal Assistance in Matters of Taxation (signed 31 December 1921), reproduced in League of Nations, Double Taxation and Fiscal Evasion, above n 19, 215. 23 Convention between the German Reich and Italy for the Avoidance of Double Taxation and the Settlement of Other Questions Connected with Direct Taxes (signed 31 October 1925), reproduced in League of Nations, Double Taxation and Fiscal Evasion, above n 19, 80.

454  Sunita Jogarajan the exchange of information in relation to income from immovable securities with Germany, for example, but not include that category of income in a treaty with Switzerland, which would be unable to reciprocate due to domestic laws on bank secrecy. Clavier proposed the addition of the following paragraph to the 1925 ­Resolutions: In the meanwhile bilateral conventions might cover under the above conditions the furnishing by a State of information requested from it at least as far as the income referred to in Nos. 1, 2, 3 and 5 is concerned.

Borduge supported the addition but preferred not to refer to specific categories of income. However, Oria (Argentina) considered the amendment unnecessary, as the 1925 Resolutions did not preclude the conclusion of bilateral treaties and he preferred to retain the existing text which had been agreed to after extensive examination and debate. In response, Thompson opined that the existing text did not favour the conclusion of bilateral treaties and supported Clavier’s proposal. Borduge proposed the following modification: The question of fiscal evasion can only be completely solved, if international arrangements include the majority of States or if, at least for certain classes of income, bilateral arrangements are concluded simultaneously.

Dorn put forward the following text, but only if Clavier’s proposal was not adopted: The resolutions of this article do not exclude the conclusion of bilateral treaties confined to the regulation of administrative assistance on demand in concrete cases of taxation.

In the spirit of conciliation, Borduge withdrew his proposal and supported Clavier’s text, which had been modified not to refer to specific categories of income but read ‘so far as certain classes of taxable assets’. Like Oria, Blau preferred that there be no change to the 1925 Resolutions, which had been the result of long deliberations. Further, he did not think the proposed amendments necessary, as the current text allowed for the conclusion of bilateral treaties, as evidenced by the conclusion of a bilateral treaty between Italy and Germany for administrative and legal assistance (negotiated by d’Aroma, Chairman of the 1925 and 1927 Experts) following the publication of the 1925 Report.24 However, if an amendment was considered necessary, Blau preferred Dorn’s proposal which introduced a new element – administrative assistance in concrete cases of taxation. Clavier insisted that his amendment was necessary, as the text of the 1925 Resolutions absolutely excluded bilateral treaties. Further, he did not consider Dorn’s amendment practicable. For example, if a Swiss national had property in Belgium, the Swiss government would not be aware of it to make

24 ibid.

The Drafting of the First Model Treaties on Tax Evasion  455 a request for information. Clavier thought that only a system, such as in force between Great Britain and France, whereby a country automatically provided information to the other country regarding ownership of immovable property, etc based on that country’s records could work. To reconcile the different views, Borduge proposed the adoption of a modified version of Dorn’s text: The results of this article do not exclude the conclusion of bilateral treaties which are confined to the regulation of reciprocal assistance between two fiscal administrations as regards the exchange of information on certain classes of income.

Dorn did not agree with the new text and proposed further amendments, at which point d’Aroma suspended the meeting and asked that a sub-committee comprising Blau, Borduge and Dorn develop an agreed text for discussion. The sub-committee presented the following compromise text for consideration: Just as bilateral agreements concerning certain of the categories abovementioned, as well as other treaties regulating administrative assistance, have already been concluded in the past, similar agreements may, pending the conclusion of a general convention, be concluded in the future, within the limits of the information in the possession of States, or of that which the States may procure under their present fiscal practice.25

Blau noted that he still preferred to retain the original text of the 1925 ­Resolutions as it was the result of long deliberations and compromise, but he agreed to the proposed text in the spirit of cooperation. Clavier responded that the 1925 Resolutions were being revised in response to the input of the new experts, and although the 1925 Resolutions were the result of long negotiations and compromise, they were not a final text. D’Aroma ‘eased the tension’ by inviting the new experts to provide their views. Unsurprisingly, Dorn agreed to the new text. Feo pointed out that Venezuela did not have any capital invested abroad and therefore had minimal interest in relation to tax evasion. Further, Venezuela would not be able to enter into any bilateral treaties as any information exchange would be one-sided. Nonetheless, he preferred the original text of the 1925 Resolutions in order to prevent any interference with the free circulation of capital. Zaleski and Oria also preferred the original text without amendment. Mori (Japan) agreed to the new text if the proposed measures were limited to a recommendation that bilateral agreements should be concluded. Clavier explained why he considered the amendment necessary. As drafted, the 1925 Resolutions proposed bilateral treaties for double taxation but a multilateral convention for tax evasion. Further, the conclusion of bilateral treaties on tax evasion was precluded by the Resolutions even though such 25 Minutes of the Sixth Meeting of the Sixth Session of the Committee on Double Taxation and Fiscal Evasion held at 2:30 pm on 20 May 1926 (League of Nations Archives, United Nations Geneva: Double Imposition et Evasion Fiscale vol V 6 Sessions Du Comité Des Experts ­Gouvernmentaux (1518), DT/6th Session/PV6(1)).

456  Sunita Jogarajan treaties had already been concluded by various countries. Thompson, Borduge and Damste supported the new text. Van der Waals (Dutch Colonies) noted that tax evasion was not of great importance to debtor countries. Further, capitalists were more likely to invest in debtor countries which did not sign mutual assistance agreements. Therefore, van der Waals preferred the adoption of a general convention. He supported the new text which was clear in this regard. In view of Clavier’s comments, Zaleski supported the new text. Blau and Oria maintained their preference for the original text but did not object to the new text. The 1927 Experts adopted the following text, as amended by Borduge: Just as bilateral agreements relating to certain of the above mentioned categories as well as other treaties regulating administrative assistance, have been concluded in the past, similar agreements may, pending the conclusion of a general convention, be concluded in future within the limits allowed by the information in the possession of States, or the information which they can obtain in the course of their present fiscal administration.26

The new paragraph replaced the following paragraph in the 1925 Resolutions: Nevertheless, having regard to circumstances of different kinds, the experts recognise that this exchange should be limited actually to the information which is in the possession of States or which the States can obtain in the course of their fiscal ­administrations.

Although the issue arose out of the statement in the preamble, the amendment to the text of the 1925 Resolutions highlights the significance placed on the issue. The 1927 Experts amended the text in the preamble from ‘the question of tax evasion can only be solved in a satisfactory manner’ to ‘the question of tax evasion can only be solved completely’.27 While the amendment itself may seem insignificant, as it is unlikely that the text of the 1925 Resolutions precluded the conclusion of bilateral treaties on tax evasion (as evidenced by the conclusion of the treaty between Germany and Italy), the fact that the amendment was made is significant. Despite more ­extensive discussions on the 1925 Resolutions on double taxation, the 1927 Experts ultimately chose to largely maintain the text of those resolutions as drafted, as they were the result of long deliberations and compromise.28 The amendment to the resolutions on tax evasion is attributable to Clavier’s conviction in his viewpoint and his persuasiveness.29

26 Text of the Resolution adopted in February 1925 by the Committee of Technical Experts, as amended in May 1926; 25 May 1926; (United Nations Geneva: Box R368, Doc No 5198, DT 59(1)). 27 ibid. The amended text is italicised. 28 Jogarajan, Double Taxation, above n 1, 117. The 1927 Experts did make some amendments to the text of the 1925 Resolutions on double taxation, but none were substantive. 29 Clavier was also influential with regard to double taxation: ibid 252–53.

The Drafting of the First Model Treaties on Tax Evasion  457 Outcome of the 1927 Experts’ Work The second key issue discussed by the 1927 Experts at their first session was the outcome of their work. The issue came about because Sub-Committee B on legal assistance (comprising Damste, Mori, Oria and Valnicek) submitted a draft bilateral convention, while Sub-Committee C on administrative assistance (comprising Blau, Borduge, van der Waals and Zaleski) submitted a statement of principles.30 After some discussion, there was general agreement that the outcome of the 1927 Experts’ work should be draft model bilateral conventions if they were to make progress on the work done by the 1925 Experts who had developed the resolutions which were the basis for the draft model conventions. The draft model conventions were presented to the 1927 Experts during their first session, but the detailed consideration of the conventions was left to their second session, approximately seven months later. Draft Bilateral Convention on Administrative Assistance in Matters of Taxation The 1927 Experts examined the Draft Convention on Administrative Assistance, drafted by Sub-Committee C, article-by-article. The original text of the draft convention is presented here, followed by the discussion of the 1927 Experts. Article 1 of the draft convention was as follows: With a view to obtaining a better yield from taxes, the Contracting Parties undertake, subject to reciprocity, to give each other administrative assistance. Such assistance may consist in: a)

the exchange of fiscal information available in one of the contracting countries and required by the services of the other country. Such an exchange may take place following a request concerning a concrete case, or, without any special request, for a whole class of particulars defined in a special agreement. b) co-operation between the administrative services of the two countries in carrying out certain procedural measures and in preparing certain records of information.31

Zaleski (Poland) did not think that the object of the convention was ‘to obtain a better yield from taxes’, but rather, to achieve a more equitable distribution

30 Minutes of the Seventh Meeting of the Sixth Session of the Committee on Double Taxation and Fiscal Evasion held at 3 pm on 21 May 1926 (League of Nations Archives, United Nations Geneva: Double Imposition et Evasion Fiscale vol V 6 Sessions Du Comité Des Experts Gouvernmentaux (1518), DT/6th Session/PV7(1)). 31 Report of Sub-Committee C, 21 May 1926 (United Nations Geneva: Box R368, Doc No 51585, DT 52).

458  Sunita Jogarajan of fiscal charges.32 After undocumented discussion, the 1927 Experts amended the text to ‘with a view to obtaining a better apportionment of fiscal burdens in the interest both of Governments and taxpayers’. This text appears in the final version of the convention. Thompson queried the scope and meaning of the words ‘administrative assistance subject to reciprocity’. He provided the example of a convention between Belgium and Great Britain and a situation where, under existing procedures, the Belgian government had information regarding business profits and immovable property, whereas the British government only had information regarding business profits. Thompson queried whether under a convention between the two countries, the Belgian government would provide information regarding the business profits and immovable property of ­British nationals in Belgium whereas the British government would only provide information regarding the business profits of Belgian nationals in Britain. He suggested that the draft convention should include a list of the classes of income and that contracting countries could indicate which information they could provide. Clavier (Belgium, Chairman)33 agreed that reciprocity implied that countries would share information of the same nature. Clavier proposed adding the following note to Article 1: ‘the exchange may be limited between the States according to circumstances’. The proposal was adopted by the 1927 Experts, but the note does not appear in the final text of the convention. Article 2 of the draft convention was as follows: In no case shall the effect of applying the provisions of the preceding article be to impose upon either of the contracting countries the obligation of supplying particulars which its own fiscal legislation does not allow it to procure, or of carrying out administrative measures at variance with its own regulations or practice.34

Article 2 was not discussed by the 1927 Experts and the final version is almost identical to the first draft with minor amendments to the text. Article 3 of the draft convention was as follows: Assistance may be refused on the mere affirmation of the competent authorities of the country to which application is made that they are unable to accede to this request for reasons of public policy.35

Unfortunately, the minutes simply record that after undocumented discussion between Damste, Thompson, Dorn and de Bordes, the following text was

32 Minutes of the Eighth Meeting of the Seventh Session of the Committee on Double Taxation and Fiscal Evasion held at 10 am on 10 January 1927 (League of Nations Archives, United Nations Geneva: Double Imposition et Evasion Fiscale vol VI 7 Sessions Du Comité Des Experts Gouvernmentaux (1519), DT/7th Session/PV8(1)). 33 Clavier was Chairman of the 1927 Experts at their second session as d’Aroma was unable to attend due to domestic responsibilities. 34 Art 3 in the final model convention, following the insertion of a new Art 2 (see below). 35 Art 4 in the final model convention, following the insertion of a new Art 2 (see below).

The Drafting of the First Model Treaties on Tax Evasion  459 submitted and adopted: ‘the State to which application is made may refuse to carry out such application if it considers that it is contrary to public policy’.36 This text is unchanged in the final model convention. Article 4 was drafted as follows: The fiscal authorities of the two contracting countries shall be empowered to communicate with each other direct for the purpose of giving effect to the provisions of the present Convention. In principle administrative assistance shall be given without payment, subject to the refund of any exceptional expenditure (investigations, expert opinions, etc), which may be incurred in special cases.37

Initially, Article 4 was adopted with only a minor amendment from ‘fiscal authorities’ to ‘competent administrative services’, on the suggestion of Dorn.38 However, in the final version, Article 4 was split into two provisions – Article 5 dealing with the power to communicate and Article 6 regarding the provision of administrative assistance without payment. ‘Competent administrative services’ was amended to ‘appropriate administrative authorities’. The minutes do not record any discussion regarding these changes. In the draft convention, Article 5 was as follows: The administrations shall without delay, and immediately following official publication, communicate to each other any enactments amending their fiscal laws or affecting their powers of investigation and control in fiscal matters.39

Van der Waals (Dutch Indies) strongly objected to the inclusion of this article, as he thought that administrative assistance could be provided without authorities knowing the tax laws of the other country.40 From a practical perspective, he did not see the benefit of sharing amendments to the laws when countries would not have the original text of the laws. Finally, he did not see the utility of including this provision in the convention on administrative assistance. The minutes do not record any discussion of van der Waals’ comments, but the final version does not contemplate the exchange of laws and simply states that ‘the administration shall from time to time communicate to each other statements regarding their powers of investigation and control in fiscal matters and their administrative procedures’.

36 Minutes of the Eighth Meeting of the Seventh Session of the Committee on Double Taxation and Fiscal Evasion, above n 32. 37 Art 5 in the final model convention, following the insertion of a new Art 2 (see below). 38 Minutes of the Eighth Meeting of the Seventh Session of the Committee on Double Taxation and Fiscal Evasion, above n 32. 39 Art 7 in the final model convention, following the insertion of a new Art 2 (see below) and the splitting of the previous provision into two separate provisions. 40 Minutes of the Eighth Meeting of the Seventh Session of the Committee on Double Taxation and Fiscal Evasion, above n 32.

460  Sunita Jogarajan Article 6 of the draft convention was as follows: The exchange of information as contemplated in paragraph (a) of Article I may have reference to: 1. Immovable property (capital value, actual income or income according to a fixed assessment, mortgage charges, servitude and usufruct). 2. Mortgages (description of the mortgaged property, amount and rate of interest). 3. Industrial, commercial or agricultural undertakings (capital value (assets and liabilities), business turnover, actual profits or profits according to a fixed assessment). 4. Transferable securities, deposits and current accounts (capital value and income); any information collected by an administration, more especially in connection with exemption or relief granted by that authority by reason of the taxpayer’s domicile or nationality. 5. Earned income, including directors’ fees. 6. Successions – date of decease – estate – name and address of heirs – legal share due to heirs.

On Clavier’s suggestion, it was decided that the article would be moved up and become Article 2 of the convention.41 Clavier also suggested that the exchange of information should be limited to ‘fiscal and moral persons domiciled or resident in one of the two contracting countries’. Thompson reiterated a point that he had made during the discussions of the 1925 Experts – that public opinion in Great Britain would not permit the British government to provide information regarding British nationals to enable them to be taxed in another country. The British government could provide information regarding the nationals of other countries to enable them to be properly taxed in their home jurisdiction. After some discussion as to the exact scope of the information to be exchanged, the final version of the new Article 2 was adopted as follows: The exchange of information as contemplated in paragraph (a) of Article 1 shall relate to natural or juristic persons taxable in one of the two contracting countries. The particulars given shall include the names, surnames and domicile or residence of the persons concerned, and their family responsibilities, if any, and shall have ­reference to:(1)

(1)

The following list may be curtailed or added to according to circumstances.

1.

Immovable property (capital value or income, rights in rem, charges by way of mortgage or otherwise); 2. Mortgages or other similar claims (description of the mortgaged property, amount and rate of interest); 3. Industrial, commercial or agricultural undertakings (actual or conventional profits, business turnover, or other factors on which taxation is based); 4. Earned income and directors’ fees;

41 Minutes of the Eighth Meeting of the Seventh Session of the Committee on Double Taxation and Fiscal Evasion, above n 32.

The Drafting of the First Model Treaties on Tax Evasion  461 5.

6.

Transferable securities, claims, deposits and current accounts (capital value and income); any information collected by an administration, more especially in connection with exemption or relief granted by that authority by reason of the tax payer’s domicile or nationality; Successions (names and addresses of deceased and heirs, date of death, estate shares of heirs and other bases of the tax).42

Vlasak (Czechoslovakia) thought it necessary to insert a clause regarding the language to which the communications between the two countries should be made.43 Dorn suggested the insertion of the following provision which was included in the draft convention on judicial assistance prepared by SubCommittee B: The highest authorities of the financial administrations of the two States shall concert measures to implement the present Convention.

Clavier did not think the provision needed to be repeated as the two conventions would necessarily go together but the final version includes this text as Article 8 of the convention. Finally, the title of the convention was also the subject of debate.44 Clavier preferred not to include the word ‘bilateral’ in the title given the comments in the preamble about the conclusion of simultaneous international agreements. However, Aoki (Japan) preferred to maintain the word ‘bilateral’ in the title as the 1927 Experts were developing a draft model bilateral convention due to the practical difficulties previously identified. Blau supported Aoki but Bolaffi (Italy) and Clavier thought that as bilateral conventions were only meant to be a preparatory step towards a general convention, ‘bilateral’ should be removed from the title. Van der Waals also supported removing ‘bilateral’ from the title as the 1927 Experts’ preference was for a multilateral convention.45 The matter was not discussed further, and the final version is titled ‘draft bilateral convention’. Draft Convention on Judicial Assistance in the Collection of Taxes Having considered the title of the draft convention on administrative assistance towards the end of their discussion of the convention, the 1927 Experts commenced their discussion of the draft convention on judicial assistance 42 Minutes of the Ninth Meeting of the Seventh Session of the Committee on Double Taxation and Fiscal Evasion held at 10 am on 11 January 1927 (League of Nations Archives, United Nations Geneva: Double Imposition et Evasion Fiscale vol VI 7 Sessions Du Comité Des Experts Gouvernmentaux (1519), DT/7th Session/PV9(1)). 43 Minutes of the Fifth Meeting of the Eighth Session of the Committee on Double Taxation and Fiscal Evasion, above n 17. 44 Minutes of the Ninth Meeting of the Seventh Session of the Committee on Double Taxation and Fiscal Evasion, above n 42. 45 Minutes of the Fifth Meeting of the Eighth Session of the Committee on Double Taxation and Fiscal Evasion, above n 17.

462  Sunita Jogarajan with the title.46 Again, Aoki (Japan) expressed a preference for the title to refer to a ‘bilateral convention’. He advocated this position on the basis that a general convention would likely take years to come to fruition and because he thought that there should be uniformity in the work of the 1927 Experts who had put forward draft bilateral conventions in relation to double taxation. The issue was not discussed by the 1927 Experts, and the final version is titled ‘draft bilateral convention’. The 1927 Experts did not consider the convention article-by-article but only discussed particular provisions. The initial discussion was directed at the first two provisions which were as follows: Article 1 The Signatory States to this Convention undertake to give each other mutual ­assistance in the recovery of direct taxes. Article 2 The Signatory States undertake to agree as between themselves by special Conventions upon the taxes which, within the meaning of the present Convention, shall be deemed to be direct taxes or taxes assimilated to them.47

There were three issues raised in relation to the first two provisions.48 First, Borduge did not think that the collection of taxes should be limited to direct taxes due to the difficulty in distinguishing between direct and indirect taxes. However, Clavier noted that the terms of reference for the work of the 1927 Experts was limited to direct taxes. After undocumented discussion, the 1927 Experts resolved that contracting countries would specify the particular taxes which would be the subject of the convention.49 Second, Dorn suggested that the draft convention should also cover the recovery of subsidiary payments, delayed interest, procedural costs, etc while Borduge thought that the draft convention should also cover the recovery of penalties. After undocumented discussion, the 1927 Experts amended Article 2 to ensure that the draft convention covered other charges such as costs and interest. Third, Zaleski suggested that the draft convention should also apply to the taxes of communes, provinces, etc. After an undocumented exchange of views, the 1927 Experts initially adopted the following additional text: ‘the contracting states shall come to an agreement on the question whether the convention is applicable to state taxes only, or also to provincial taxes, communal taxes, etc.’ However, Blau noted 46 Minutes of the Ninth Meeting of the Seventh Session of the Committee on Double Taxation and Fiscal Evasion, above n 42. 47 Proposal Submitted by Sub-Committee B on 21 May 1926 (League of Nations Archives, United Nations Geneva: Double Imposition et Evasion Fiscale Vol V 6 Sessions Du Comité Des Experts Gouvernmentaux (1518), DT 53). 48 Minutes of the Ninth Meeting of the Seventh Session of the Committee on Double Taxation and Fiscal Evasion, above n 42. 49 A similar approach was taken in relation to the draft convention on double income taxation: Jogarajan, Double Taxation, above n 1, 121–23.

The Drafting of the First Model Treaties on Tax Evasion  463 that as the draft convention was a bilateral convention, countries could always decide on the scope of a particular convention. Clavier agreed and noted that countries would need to determine the scope of their conventions based on their circumstances. The issue was not discussed further but the proposed addition does not appear in the final text of the convention. The final text of Articles 1 and 2 was as follows: Article 1 The Contracting States undertake to give each other mutual assistance in the collection of the following taxes: (a) … … … … … … (b) … … … … … … (c) … … … … … … Article 2 The assistance in question shall apply both to the principal of the tax and to charges incidental thereto (costs, interest).

The next provision that was the subject of discussion was Article 4 in the first draft of the convention, which stated: The request for execution can only be made in connection with a fiscal debt which is res judicata. If a fiscal debt is still subject to an appeal the State making the application may request the State to which application is made to take conservatory measures.

In response to a query from Blau, Clavier clarified that the convention would apply to fiscal debts which were res judicata prior to the conclusion of the convention.50 Thompson thought that the provision was ambiguous as, in the British Empire, a decision of a tribunal had the force of a decision even if it was the subject of an appeal.51 Borduge responded that in an international context, the question whether a matter was subject to appeal should not be taken into account. Thompson also queried whether action would only be taken by a country where a court decree was obtained in the country. He noted that in the case of the British Colonies, action would only be taken in Britain once a ­British court confirmed the original judgment. Dorn responded that there was no such procedure in Germany and there was no mechanism for the German courts to intervene in such situations. Clavier suggested that the provision could be amended to take into account the peculiarity of the British law, but no a­ mendment was made. At Clavier’s suggestion, the provisions of the draft convention were reordered

50 Minutes of the Ninth Meeting of the Seventh Session of the Committee on Double Taxation and Fiscal Evasion, above n 42. 51 Minutes of the Tenth Meeting of the Seventh Session of the Committee on Double Taxation and Fiscal Evasion held at 9:30 am on 12 January 1927 (League of Nations Archives, United Nations Geneva: Double Imposition et Evasion Fiscale vol VI 7 Sessions Du Comité Des Experts ­Gouvernmentaux (1519), DT/7th Session/PV10(1)).

464  Sunita Jogarajan chronologically, and Article 4 was split into two separate provisions. The first part, dealing with debts which were res judicata, became Article 3 of the final version while the second part, dealing with debts on appeal, became Article 11 of the final version. The only other provisions which were discussed by the 1927 Experts were the following: Article 7 The methods of execution contemplated in para. 3 of Article 3 do not imply for the State to which application is made the obligation to apply any method of execution not provided for in the law of the State making the application. Article 8 Subject to Article 7 and at the request of the State making the application the State to which application is made may, if it considers appropriate, adopt a special form of procedure if the latter is not contrary to the law of the State to which application is made.

Dorn explained that Article 8 provided an exception to the general rule that the procedure to be applied was that of the country to whom the application was made.52 However, Bolaffi doubted whether a method not contemplated in positive law could be permitted. Damste suggested that Article 8 should be deleted whereas Bolaffi, with whom Clavier agreed, suggested retaining the provision but adding a note that the provision could be deleted if necessary.53 This was accepted as an interim solution but on condition that the issue would be revisited at the next session. At the next session, Clavier submitted the following text to replace Article 8: Nevertheless, at the request of the State making the application, the State to which application is made may, if it thinks fit, adopt a special form of procedure, even if not provided for by its laws, subject to the condition that such procedure is not contrary to its laws.54

Damste explained that the text was based on the words used in the Hague Convention and he did not think that the 1927 Experts could do better than to reproduce that text.55 The new text was adopted without amendment. The remaining provisions, which were not discussed by the 1927 Experts, set out the procedure for the recovery of fiscal debts and the mechanics of such 52 Minutes of the Ninth Meeting of the Seventh Session of the Committee on Double Taxation and Fiscal Evasion, above n 42. 53 Minutes of the Tenth Meeting of the Seventh Session of the Committee on Double Taxation and Fiscal Evasion, above n 51. 54 Minutes of the Fifth Meeting of the Eighth Session of the Committee on Double Taxation and Fiscal Evasion, above n 17. 55 It is likely that Damste was referring to Art 14 of the Convention between Austria-Hungary, Belgium, Denmark, France, Germany, Italy, Luxembourg, the Netherlands, Norway, Portugal, Romania, Russia, Spain, Sweden and Switzerland respecting Civil Procedure (signed 17 July 1905, entered into force 17 July 1905) 199 ConTS 1.

The Drafting of the First Model Treaties on Tax Evasion  465 an action, and stipulated that the taxes to be collected were not to be regarded as privileged debts in the state to which application is made.56 Under Article 7, a state could refuse to comply with a request for assistance for reasons of public policy. The accompanying commentary explains that a state making a request would not be able to foresee or be aware of the general consequences that may arise as a result of its application for assistance and, therefore, the state to which an application is made must have the right to refuse such an application if it would ‘prejudice its vital interests’.57 1928  REPORT AND FIRST MODEL CONVENTIONS

The Financial Committee responded to the 1927 Report by suggesting that the League Council convene a general meeting of governments to provide the opportunity for countries not involved in the League’s work thus far to provide their views on the draft conventions.58 The Secretary-General wrote to all 68 countries requesting their observations on the 1927 Report and inviting them to attend a general meeting. Twenty-seven countries responded and sent representatives to the ‘General Meeting of Government Experts on Double Taxation and Tax Evasion’ held in Geneva on 22–31 October 1928. The 1928 Meeting resulted in the publication of ‘Double Taxation and Tax Evasion: Report Presented by the General Meeting of Government Experts on Double Taxation and Tax Evasion’ which included the finalised model conventions on tax evasion.59 The countries represented at the 1928 Meeting were Austria, Belgium, Bulgaria, China, ­Czechoslovakia, Free City of Danzig, Denmark, Estonia, France, Germany, Great Britain, Greece, Hungary, Irish Free State, Italy, Japan, Latvia, ­Netherlands, Norway, Poland, Romania, Spain, South Africa, Sweden, S­ witzerland, the United States of America and the Union of Soviet Socialist Republics. At the commencement of the meeting it was made clear by the Under Secretary-General of the League, Sugimura,60 that the purpose of the meeting was a practical one – to finalise the draft conventions – and that the time for

56 Some Experts did raise issues with specific provisions but as these were found to be due to the peculiarities of a particular country’s legislation, they were not discussed and were left to be addressed in bilateral negotiations: Minutes of the Fifth Meeting of the Eighth Session of the Committee on Double Taxation and Fiscal Evasion, above n 17. 57 1927 Report, above n 11, 29. 58 Financial Committee, Report to the Council on the Work of the Twenty-Seventh Session of the Committee held in Geneva from June 8th to 14th, 1927 (League of Nations Archives, United Nations Geneva: C 336 M 110 1927 II). 59 1928 Report, above n 1. 60 Sugimura was a career diplomat who had served as chief of the Japan Office of the League of Nations from 1924. He was described as a ‘colorful and beloved personality, of large physique and devoted to judo and swimming’. He was also a strong personality and an ardent believer in the League: TW Burkman, Japan and the League of Nations: Empire and World Order, 1914–1938 (Honolulu, University of Hawaii Press, 2008) 118.

466  Sunita Jogarajan t­ heoretical or academic considerations was over.61 During the airing of general views on the 1927 Report, the Russian and Polish representatives expressed general support for the 1927 draft conventions. The Bulgarian representative, while not opposed to the 1927 draft conventions, noted that Bulgaria was primarily interested in attracting foreign direct investment, even at the expense of revenue. The South African representative explained that the collection of income tax was new to South Africa, and the South African government were of the opinion that South African taxpayers mght be reluctant to share their information with the South African revenue authority to pay the South African income tax if they knew that the information might be shared with other countries to enable the taxation of South African taxpayers overseas. As such, the South African representative supported the draft convention on judicial assistance, but not the draft convention on administrative assistance. The Irish representative highlighted that the Irish Free State was only interested in concluding assistance treaties with Great Britain. The ICC maintained its earlier position that it did not support the draft conventions on administrative and judicial assistance, as it was of the view that tax evasion did not cause capital flight. Capital flight was the result of other factors such as double taxation, currency depreciation, social unrest, fear of confiscation of property and political considerations. The ICC preferred that these issues be addressed, rather than the introduction of what it considered to be ‘coercive’ measures in the draft conventions on tax evasion. The draft conventions on tax evasion were not considered again by the 1928 Experts until their 14th meeting (of 17). The draft conventions on double income taxation and double taxation in relation to succession duties were clearly a higher priority, as was a proposal to establish a future international tax organisation. When the draft conventions on tax evasion finally came to be considered by the meeting, the American representative, Adams, questioned the necessity for them.62 He argued that tax evasion was largely the result of double taxation and the League’s work in that regard would naturally eliminate the problem of tax evasion and remove the need for the draft conventions on tax evasion. Adams’ position was supported by the representatives from Norway and Switzerland, who thought that the draft conventions would be ineffective and difficult to achieve domestically. However, the French representative

61 Minutes of the First Meeting of the General Meeting of Government Experts on Double Taxation and Tax Evasion held at 11 am on 22 October 1928 in Geneva (League of Nations Archives, United Nations Geneva: Double Imposition et Evasion Fiscale vol VIII Reunion Generale Des Experts Gouvernmentaux (1521), DT/Reunion/PV1(1)). 62 Minutes of the Fourteenth Meeting of the General Meeting of Government Experts on Double Taxation and Tax Evasion held at 10 am on 30 October 1928 in Geneva (League of Nations Archives, United Nations Geneva: Double Imposition et Evasion Fiscale vol VIII Reunion Generale Des Experts Gouvernmentaux (1521), DT/Reunion/PV14(1)).

The Drafting of the First Model Treaties on Tax Evasion  467 ­ isagreed and thought that the 1928 Experts should not go so far as to scrap the d draft conventions on tax evasion. He considered the draft conventions equally important as the two draft conventions on double taxation. While it was fair to say that taxpayers should not pay tax twice, it was also fair to say that they should pay tax at least once. The Bulgarian representative supported this position and noted that psychologically, taxpayers who saw other taxpayers profit from fraud would be inclined to do the same. The discussion as to the necessity of the draft conventions on tax evasion was brought to an end by the Chairman who noted that several countries had only agreed to participate in the League’s work on double taxation on the condition that tax evaders would not benefit from such measures, and therefore the draft conventions on tax evasion were of equal importance and required consideration by the 1928 Experts. Nonetheless, the American representative abstained from voting on the two draft conventions on tax evasion.63 The 1928 Experts considered the provisions of the two draft conventions on tax evasion article-by-article, but the discussion was brief and limited to clarifications for the new experts.64 The discussions mainly resulted in minor textual amendments to the 1927 draft conventions and accompanying commentary. The only substantial change was to the title of the second draft convention on tax evasion regarding assistance in the collection of taxes. The word ‘judicial’ was removed from the title at the suggestion of the Austrian expert, as it was recognised that the collection of taxes was done through administrative rather than judicial mechanisms in some countries. Despite the inclusion of so many new countries in the work of the 1928 Experts, it is impossible to say that the first model conventions on tax evasion had widespread support. As evidenced during the airing of general views, there was a diversity of viewpoints that were largely influenced by individual country circumstances. However, the 1928 Experts had limited time to review the draft conventions on tax evasion, and it would appear that a majority of Experts were willing to agree to the draft tax evasion conventions because they were not considered a priority. Some Experts did not consider the measures contained in the draft conventions necessary while other Experts thought that they were impracticable.

63 Minutes of the Fifteenth Meeting of the General Meeting of Government Experts on Double Taxation and Tax Evasion held at 3:30 pm on 30 October 1928 in Geneva (League of Nations Archives, United Nations Geneva: Double Imposition et Evasion Fiscale vol VIII Reunion Generale Des Experts Gouvernmentaux (1521), DT/Reunion/PV15(1)). 64 ibid; Minutes of the Seventeenth Meeting of the General Meeting of Government Experts on Double Taxation and Tax Evasion held at 3:30 pm on 31 October 1928 in Geneva (League of Nations Archives, United Nations Geneva: Double Imposition Et Evasion Fiscale Vol VIII Reunion Generale Des Experts Gouvernmentaux (1521), DT/Reunion/PV17(1)).

468  Sunita Jogarajan CONCLUSION

Approximately 15 mutual assistance treaties were concluded between the ­publication of the model conventions in 1928 and 1950.65 By contrast, more than a hundred double taxation agreements, based on the 1928 Models, were concluded in the 1930s.66 The detailed study of the drafting of the model conventions on tax evasion in this paper provides an insight as to why the model conventions on tax evasion were not successful. At every stage of their work, the League’s Experts recognised the practical difficulties in their proposals, particularly with regard to exchange of information, but were ultimately unable or unwilling to resolve these differences. There was also a view among many of the Experts, most notably the American representative Adams, that treaties to address tax evasion were unnecessary as tax evasion was a consequence of double taxation and would be naturally eliminated by the League’s work to address double taxation. The concerns of the British and South African experts regarding public opinion on information exchange were also valid. The OECD’s ‘Convention on Mutual Administrative Assistance in Tax Matters’ was first opened for signature in 1988 but only gained a large number of ­signatories in recent years, particularly after the commencement of the work and media attention on base erosion and profit shifting. The detailed examination of the development of the first model conventions in relation to tax evasion in this paper highlights that many of the issues regarding administrative assistance which continue to arise today were already recognised by the League’s Experts almost a century ago. The narrative also demonstrates that model conventions are unlikely to be successful when they are simply the result of appeasement rather than genuine agreement. Understanding the history of the first model conventions on tax evasion provides useful insights into the continuing work on the development of model tax conventions at both the OECD and the League’s successor, the United Nations.

65 This number is based on the United Nations’ compilation of all known international agreements for the avoidance of double taxation and the prevention of fiscal evasion concluded since 1843: United Nations, Department of Economic Affairs, Fiscal Division, International Tax A ­ greements: World Guide to International Tax Agreements 1843–1951 vol III (Lake Success, New York, United Nations, 1951) 358–59. 66 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; ‘Part II: The Progressive Development of International Law by the League of Nations’ (1947) 41 American Journal of International Law Supplement: Official Documents 49, 55.

17 Income Tax in New Zealand, 1914–18: The World War I Watershed SHELLEY GRIFFITHS*

ABSTRACT

It has been noted that it was World War I that saw the transformation of income tax into the major source of tax revenue in New Zealand. In 1910, it was 7 per cent of total tax revenue, by 1919 it was 39 per cent, although by 1929 that percentage had reduced. That reduction might be accounted for by the long depression that gripped New Zealand through the 1920s. It was also clear in the early 1920s that there was general dissatisfaction with the level of company tax. A committee of Inquiry in 1922 was followed by a Royal Commission into Land and Income Tax in 1924. This paper will chart the transformation of income tax in New Zealand between the start of World War I and the 1924 Royal Commission. In other jurisdictions, the ‘WWI effect’ has been subject to examination and explanation. This paper proposes to do the same for New Zealand. INTRODUCTION

I

The huge increase which has taken place in the taxation of incomes in this country since the commencement of the war made the income-tax one of the most important subjects of this inquiry.1

n 1914, 14,277 New Zealand individuals, firms and companies paid income tax. They contributed 9 per cent of public revenue raised from taxation. In 1918, 37,989 individuals, firms and companies paid income tax and

* I wish to acknowledge the research and editing assistance from Luiz Buck and Kyla Mullen. 1 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) [24].

470  Shelley Griffiths contributed 46 per cent of revenue raised. As might be expected, there is no one simple cause of this change. Rates of income tax were increased, the income tax base was broadened and wage and income inflation brought more persons within the net. World War I changed the nature, amount and incidence of income tax. By the end of the War there were 2.5 times as many income tax payers as before, and from them 10 times more revenue was raised. In 1922, a Committee inquiring into taxation in New Zealand warned that there remained ‘practically no reserve of taxable capacity’.2 The rate of income tax had reached such a point that it was ‘drying up the sources of revenue’.3 It is not surprising that two years later there was a full Royal Commission into Land and Income Tax.4 While this change took place, not only did income tax emerge as the central mechanism of government revenue-raising, but two strands of political conversation about income tax emerged as well. First, tax generally, and income tax, in particular, were depicted as part of the sacrifice that New Zealanders had to make for the war effort. Secondly, and this was rather more attenuated, there also emerged some discussion about the fairness of the tax burden. This was more directed at all sharing in the burden and the design of a system that was fair in that sense. However, one Member of the House of Representatives was concerned that there could be no equality of sacrifice between a man who earned £10,000 and one who earned £150. In his speech he referred to a ‘­splendid’ article by Professor Pigou that he had recently read.5 The official estimate of the total cost of the war incurred by New Zealand was £79 million, a cost borne by a country of approximately 1.2 million people.6 It was not only the financial burden that was huge. About 100,000 New Zealanders served overseas in the New Zealand Expeditionary Force. That was approximately 40 per cent of all men of military age. Conscription was introduced in 1916, although about 80 per cent of those who served were in fact volunteers. The mortality and casualty rates were high: 18,000 died, mostly on the Western Front, although the Gallipoli debacle looms large in New Zealand’s history, and some 40,000 were injured in some way. These raw statistics alert us to the impact of World War I on New Zealand, and their starkness perhaps masks the ‘depth of the trauma’ that New Zealand suffered in the 1920s as a result of World War I.7 There is no doubt that World War I had a profound effect on New Zealanders. During the war, the mobilisation of a large army was, at the very least, a costly enterprise. It was for that reason that the National

2 ibid [13]. 3 ibid. 4 Report of the Royal Commission Appointed to Inquire into the Subject of Land and Income Taxation in New Zealand (Appendix to the Journals of the House of Representatives 1924, B–5). 5 New Zealand Parliamentary Debates 29 June 1916, vol 176, 336. 6 M Bassett, The State in New Zealand, 1840–1984: Socialism without Doctrines (Auckland, Auckland University Press, 1998) 128. 7 J Belich, Paradise Reforged. A History of the New Zealanders from the 1880s to the Year 2000 (Auckland, Allen Lane, 2001) 116.

Income Tax in New Zealand, 1914–18  471 (coalition) government, formed in August 1915, needed to raise significant amounts of r­ evenue. The Minister of Finance, Sir Joseph Ward, had only three weeks to prepare a budget after the coalition government was formed.8 He turned to taxation, and the changes that were made ‘profoundly change[d] the nature of taxation in New Zealand’.9 The 1915 Budget was not the end of the changes made through the war period, but the nature of those changes set the benchmark for the future direction of taxation generally and income taxation in particular. TAXATION REVENUE IN 1914

There was land and income tax in New Zealand from 1891. There were many amendments to the substantive legislation and some changes to rates between then and 1914.10 Although income tax rates did not change between 1892 and 1909, strong economic growth saw revenue from income tax grow. While income tax was a more efficient tax than land tax, it was nothing like as efficient as customs duties.11 In 1914, 56 per cent of central government taxation revenue came from customs and excise duties. Land tax and death duties each contributed 14 per cent, and income taxation only 9 per cent of the total.12 It is not surprising that both land and income tax remained relatively small contributors to central government revenue. Before World War I about 11,000 taxpayers, individuals, firms and c­ ompanies paid income tax.13 For taxpayers other than companies, the first £300 of income was exempt. In 1912, a skilled tradesman such as a plumber or a mason was earning about £3–4 per week.14 Parliamentary salaries before the war were £300.15 Income tax rates were low and, as we have noted, the income tax net was not large, and few individuals were subject to income tax. In 1913, for individuals 8 Sir Joseph Ward (1856–1930) had been a member of the Liberal government formed in 1891 and succeeded Richard Seddon as Premier in 1906. His government was defeated in 1912 and he became Minister of Finance in the government led by William Massey. After defeat in the election of 1919, he returned to Parliament in 1925 and became Prime Minister in 1928 until a few weeks before his death in 1930. See M Bassett, Sir Joseph Ward: A Political Biography (Auckland, Auckland University Press, 1993). 9 P Goldsmith, We Won, You Lost, Eat That! A Political History of Tax in New Zealand since 1840 (Auckland, David Ling, 2008) 124. 10 S Griffiths, ‘The Historical Meaning of “Income” in New Zealand Taxation Statutes, Cases and Administration, 1891–1925’, in P Harris and D de Cogan (eds), Studies in the History of Tax Law vol 8 (Oxford, Hart, 2017) 419. 11 Goldsmith, above n 9, 112. 12 New Zealand Official Year Book, 1914; http://archive.stats.govt.nz/browse_for_stats/snapshotsof-nz/digital-yearbook-collection.aspx (accessed 15 January 2019). 13 New Zealand Official Year Book, 1916; http://archive.stats.govt.nz/browse_for_stats/snapshotsof-nz/digital-yearbook-collection.aspx (accessed 15 January 2019). 14 New Zealand Official Year Book, 1913; http://archive.stats.govt.nz/browse_for_stats/snapshotsof-nz/digital-yearbook-collection.aspx (accessed 15 January 2019). The average daily rate for a plumber was 12s and for a mason 16s. 15 Goldsmith, above n 9, 125.

472  Shelley Griffiths and firms the rate on the first pound of taxable income was 2.5 per cent, rising to 6.6 per cent on incomes over £2,400. There was a simplification of the rate structure in 1913 when the four-band scale was introduced.16 Previously, there had been nine steps between £400 and £2,000, each step 1d higher than the last.17 The complexity of the calculation tells us something too about the numeracy skills there must have been in society.18 For example, part of the section imposing the income tax liability on an income band between £400 and £1,400, read: Where such income exceeds four hundred pounds but does not exceed fourteen hundred pounds, a duty for every pound of such income assessed at the rate of sixpence increased by three four-hundredths of a penny for every pound in excess of four hundred pounds.19

To the modern reader, such a calculation would seem an insuperable problem, absent at the very least a calculator. It must have been standard fare to a bookkeeper or clerk 100 years ago. Overall, it is clear that few individuals or firms were subject to income tax before World War I. For those that were, the calculations were somewhat complex and no doubt impacted on the training of accountants and the development of that profession. Company taxation was a little different. Prior to 1910, company tax was levied at a flat rate of 5 per cent. That year it was replaced by a progressive rate.20 In 1913, the company rate on the first pound of income was 5 per cent, rising gradually to a top rate of 6.6 per cent on incomes greater than £2,400.21 Thus, the company rate started higher and applied from the first pound earned, but ended at the same rate as individuals. This created more space for tax arbitrage between structures, but at a top marginal rate of 6.6 per cent it was possibly not something of much concern to taxpayers. Nonetheless, from 1910 the opportunity was there. Income tax therefore applied on a graduated basis to all taxpayers, but the slope of the graduation was different for different classes of taxpayer. Income tax was payable on income derived from employment and from ‘business’.22 ‘Business’ was further defined to include profits from a range of activities. These included from a business, from the disposition of personal property, from dealing in real property and from loans, other than mortgages.23 Mortgages were subject to land tax payable by the mortgagor. Two significant 16 Land-tax and Income-tax Act 1913, s 6. 17 Land-tax and Income-tax Act 1912, s 6. 18 This is likely also to be linked to the growth and professionalisation of accountancy and the teaching of taxation to accountancy students before World War I, see S Griffiths, ‘Tax as Law’ (2017) 15 Otago Law Review 49, 55; New Zealand Society of Accountants Act 1908. 19 Finance Act 1915, s 2(6)(b). 20 A Cho, ‘The Five Phases of Company Taxation in New Zealand: 1840–2008’ (2008) 14 A ­ uckland University Law Review 150, 157. 21 Land-tax and Income-tax Act 1913, s 5. 22 Land and Income Assessment Act 1908, s 78(a) and (b). 23 Land and Income Assessment Act 1908, s 79.

Income Tax in New Zealand, 1914–18  473 categories of profit were specifically excluded. First, the only company dividends that were included as taxable income were those from registered building societies. Dividends from other companies were not.24 Secondly, income from the ‘business of dealing in livestock’ and other agricultural and pastoral production was only included when the activity was conducted by a person other than the owner of the land on which the activity was carried out. A farmer who gained profit from such activities on land owned by that farmer was not included within the definition.25 Again the rationale for this would be that land was subject to land tax. Although the argument was not made in these terms, taxing land by the imposition of land tax and taxing the income generated from that land through an income tax, would be to double-tax land. About 25 per cent of persons classified as ‘breadwinners’ in the 1913 Official Year Book were working in the agricultural and pastoral sector.26 Many of those breadwinners would have been employees. Pastoral labourers were earning about £80 per year, which was well below the £300 exemption from income tax. Combined with that fact, excluding farmers who were working their own land from the reach of income tax, meant that a significant part of the New Zealand productive sector was excluded from income tax. Land ownership was a significant part of the New Zealand settlercapitalist dream. As Brooking notes, almost every witness ‘to the 1905 Land Commissioner made it clear that he or his father had come to New Zealand in order to own a piece of land and become his own master’.27 In this environment, absentee landowners were not much loved. Before World War I most direct taxation revenue was obtained from land tax – of the approximately £1 million raised in 1912 from land and income tax, about 60 per cent came from land tax. It could not be said that the rural sector was not contributing, but it was through land tax not income tax that any such contribution was being made. As noted above, dividends other than those accruing to any shareholder or member of a building society were specifically excluded from income for the purposes of levying income tax.28 In respect of interest on debentures, the company was deemed to be the agent of the debenture holder and was assessed accordingly, and was liable for the payment of income tax. If the borrowed money was invested in mortgages, the company was not liable as agent for income tax, mortgages being liable for land tax.29

24 Land and Income Assessment Act 1908, s 79(i). 25 Land and Income Assessment Act 1908, s 79(g). 26 In the 30 years between 1896 and 1926 the percentage of the workforce in the primary sector reduced from 42 per cent to 30 per cent. While this reduction is significant, the number engaged in the primary sector remained considerable; see T Brooking, ‘Economic Transformation’, in WH Oliver (ed), The Oxford History of New Zealand (Wellington, Oxford University Press, 1981) 228. 27 Brooking, above n 26, 237. 28 Land and Income Assessment Act 1908, s 79(j) and (k). 29 Land and Income Assessment Act 1908, ss 69 and 70.

474  Shelley Griffiths Ordinary land tax was levied on the unimproved value of all land. L ­ andowners were liable for the tax assessed on the unimproved value of land minus the value of any registered mortgages. The mortgagor was liable for land tax on the capital value of the mortgage.30 These were both assessed at the rate of 1d per £. The tax only applied where land was worth more than £1,500. That £1,500 exemption applied up to land valued at £2,500. In addition, a graduated land tax also applied to land with an unimproved value of more than £2,500. The graduated rate rose up to a rate of 55 6 d per £ (or 2.7 per cent) on land with an unimproved value of £200,000.31 By the outbreak of World War I, income tax and land tax had applied for just over 20 years. There had been a lot of tinkering with rates and with the substantive provisions. But in respect of income tax, by World War I not many taxpayers paid much income tax. However, the tax was relatively efficient to collect and it had made a steady but unspectacular contribution to government revenue. In 1910, when the flat company tax was replaced by a graduated income tax, the motivation for the change, shepherded through Parliament by Joseph Ward, came from a need to raise more revenue to fund New Zealand’s increased contribution to the British Navy.32 It was perhaps a lesson Ward had not forgotten five years later. NEW ZEALAND AND WORLD WAR I

As part of the British Empire, New Zealand joined the war in August 1914. New Zealand was not a reluctant participant, and the Governor read the King’s statement to an ‘excited crowd’ on the steps of Parliament. The leaders of the two main political parties, Massey and Ward, who were at that point engaged in the campaign for the 1914 election, took a break from political activity to make declarations of loyalty to the Empire and commitment to the cause.33 The result of the election was something of an impasse, and it was not until August 1915 that a National (coalition) government was formed. The growing urgency of the need for increased revenue was one of the reasons that Massey and Ward formed a national administration.34 In fact, the Minister of Defence subsequently wrote to the Commander of the New Zealand forces, saying that the main value of the coalition government was that it enabled the government to ‘introduce the amount of taxation necessary’. This would have proved impossible for ‘any Ministry with a strong opposition’.35 30 Land and Income Assessment Act 1908, s 37. 31 Land and Income Assessment Act 1908, s 50. 32 Cho, above n 20, 157. 33 Bassett, above n 8, 220. 34 R Kay, ‘In Pursuit of Victory; British-New Zealand Relations during the First World War’ (PhD thesis, University of Otago, 2001) 98. 35 ibid 113.

Income Tax in New Zealand, 1914–18  475 Although trading routes were initially upset by war, they recovered reasonably quickly and New Zealand’s primary producers soon prospered, as the supply of food and fibre were at least as significant as the supply of soldiers. Increased demand, not coupled with increased supply, led, as one might expect, to increased prices.36 Agricultural producers continued to prosper when the United Kingdom government purchased all New Zealand’s production of, first, frozen meat and wool, and then cheese and butter at robust prices, albeit at slightly lower prices than in the immediately preceding months.37 With guaranteed buyers at good prices, farmers were flush with cash, and domestic deposits in banks grew.38 The disruption of general trade, however, meant that customs revenue declined sharply. As prices generally rose in the economy, concerns about the impact on the cost of living in the inflationary environment grew apace. It is estimated that the cost of living increased by about 39 per cent between 1914 and 1918.39 That made the government wary about increasing duties. At the same time, the costs of the army, the expected costs of war pensions and the interest payments on borrowed funds were rising. In 1915, Ward estimated that the government needed to raise an additional £2 million from ‘fresh taxation’.40 The financial position created by the war had to be confronted by both the government and the people with ‘inflexible courage’; the country needed to do its ‘financial duty’.41 1915: Finding Revenue to Fulfil a ‘Financial Duty’ In the 1915 budget, Ward set about finding a source for this additional revenue. First, increases were applied to duties on various articles ‘commonly regarded as luxuries’. A new method of calculation of duty on beer was used so that lower alcohol beer was subject to a lower duty than that with a higher alcohol content, as well as a duty on non-alcoholic beverages. The increase with perhaps the broadest impact was the reimposition of a duty on kerosene. Overall, the increases in duty were not particularly large. Ward was reluctant to increase duties because of the feared impact on the cost of living.42 There were also some

36 J Watson, ‘Patriotism, Profits and Problems: New Zealand Farming during the Great War’, in J Crawford and I McGibbon (eds), New Zealand’s Great War: New Zealand, the Allies and the First World War (Auckland, Exisle Publishing, 2007) 534. 37 ibid 559. 38 Bassett, above n 8, 225. 39 S Loveridge, ‘Making Sense of World War One’ (National Library, 25 May 2015) https://natlib. govt.nz/blog/posts/making-sense-of-world-war-one (accessed 15 January 2019). 40 Financial Statement by the Right Honourable Sir Joseph Ward, in Committee of Supply, 26 August 1915 (Appendix to the Journals of the House of Representatives 1915, B–6) xxx and xxv. 41 ibid xxv. 42 This was an ongoing concern and an issue within the coalition; Bassett, above n 8, 227; Cost of Living Act 1915.

476  Shelley Griffiths increases imposed on the cost of postal and railway services. Secondly, there were changes to land and income tax. These were rather more significant and of relevance to this paper. Graduated land tax rates were increased by 50 per cent.43 This was obviously a significant increase to the graduated rate, but no adjustment was made to the ordinary rate of land tax. The changes to income tax were altogether much more significant. There was a significant increase in rates, but also there was a broadening of the tax base. Most notably, income derived from the use of land became subject to income tax. Changes were made to the income tax of both individuals and companies. In respect of individuals, the £300 exemption remained and the relatively simplified four-band structure from 1913 was retained. At the lower bands, the core rate remained the same. At the higher income level, a top rate of 10 per cent applied at £5,600. Companies also paid a top rate of 10 per cent for amounts over £5,600.44 So the highest rate of taxation had been increased, but the point at which such a rate applied was higher in 1915 than before. In addition, however, a 331 3 per cent increase was applied to all rates, so that the true top rate was 13.3 per cent.45 These increases applied to the tax year already completed on 31 March 1914. The retrospectivity of such increases drew no comment.46 Ward made an even more significant change than the increase of rates. In his Budget statement his description of his intent and the reasons for it were clear: I shall not be contradicted when I say that large profits have been derived from the sale of wool, meat, and dairy-produce. To provide for a reasonable contribution to defray a portion of the cost of the war, I propose that the income-tax shall apply to income derived from land.47

The Land and Income Assessment Act 1908 was amended.48 All ‘profits’ from the ‘use or occupation’ of land would be ‘income’ for the purposes of income tax. The usual £300 exemption applied to individuals and firms and, in addition, a deduction of 5 per cent of the capital value of the land was allowed from the amount of assessable income.49 While in a theoretical sense this blurred the capital/revenue distinction, it was a pragmatic recognition of the fact that the

43 Finance Act 1915, s 3(3). 44 Finance Act 1915, ss 2(5) and (6). 45 Finance Act 1915, s 4. 46 The Interpretation Act 1999, s 7 states that an enactment does not have retrospective effect. Although in New Zealand Parliament can ignore such a statutory provision, it has become an accepted principle that Parliament does not enact provisions with retrospective effect. The Acts Interpretation Act 1924 did not include a specific section such as s 7, but case law interpreted the Act as having that intent: Ewart v England [1993] 3 NZLR 489 (HC) and Foodstuffs (Auckland) Ltd v Commerce Commission [2002] 1 NZLR 353 (CA); generally, see CJG Sampford et al, Retrospectivity and the Rule of Law (Oxford, Oxford University Press, 2006). 47 Financial Statement 1915, above n 40, xxvii. 48 Finance Act 1915, s 11. 49 Finance Act 1915, s 18.

Income Tax in New Zealand, 1914–18  477 capital value of the land was also subject to a land tax, the rate of which had been increased. Ward estimated that including farming income would increase the amount of revenue collected by £250,000. But considering the high prices realised for agricultural and pastoral production this was ‘not a large contribution from those affected’.50 Some members of the House were rather more doubtful that that amount was likely to be realised.51 Two strands can be identified in the 1915 Statement. The first is that war was expensive and consumption taxes were simply not going to generate sufficient revenue. On one hand, the impact of the war on imports meant that cross-border transactions had simply declined and customs revenue had likewise declined. There was also a concern about the impact of increasing duties on the cost of living.52 Secondly, one can detect a forming thought that those who profit from the war, ought to share that benefit to pay for the cost of the cause of their increased income. That somewhat inchoate idea in 1915, would form the basis of more changes to income tax the following year. However, some Members of the House of Representatives were unenthusiastic about applying income tax to ‘ordinary farmers’ and, in any event, were rather doubtful that many farmers were earning enough for taxation on their incomes to yield much revenue.53 Overall, Ward estimated there would be an increase of £619,000 from land and income tax from these measures: £67,000 from land tax and £552,000 from income tax (about 45 per cent of that from extending income tax to farmers and the balance from increased rates and rising income levels). The amount collected exceeded these expectations, as Table 17.1 shows.54 Table 17.1  Actual and Expected Tax Receipts, 1914 and 1915 Actual

Expected

Actual

31/3/14

31/3/15

31/3/15

£000s

£000s

£000s

Land tax

818

886

1,048

Income tax

539

1,090

1,392

The changes in 1915 were significant, especially in the extension of income tax to those farmers working their own land. They were also significant in that we can identify the beginning of the use of moral language in respect of income tax. 50 Financial Statement 1915, above n 40, xxvii. 51 New Zealand Parliamentary Debates 31 August 1915, vol 173, 241 and 281. 52 The government passed many pieces of legislation designed to control the cost of living and limit profiteering: Regulation of Trade and Commerce Act 1914; Cost of Living Act 1915 (which established a Board of Trade). 53 New Zealand Parliamentary Debates 31 August 1915, vol 173, 240–41 and 281. 54 Financial Statement 1915, above n 40, xxvii and Financial Statement by the Right Honourable Sir Joseph Ward, in Committee of Supply, 16 June 1916 (Appendix to the Journals of the House of Representatives 1916, B–6) viii–ix.

478  Shelley Griffiths 1916: Taxing ‘Excess Profits’ In June 1916, Ward was able to report in his second war-time budget statement that the government accounts were in ‘a very sound condition’ and showed a healthy surplus. There had been a ‘revival of trade’ as the shipping lanes between New Zealand and Britain had been kept open. The community had been able to bear the burden of extra taxation without ‘inconvenience’. Trade routes were open and he reported that producers of primary products earned high p ­ rofits. However, Ward warned that the longer the war went on, the greater the annual burdens would become.55 By the end of 1915, finding sufficient men to meet the army’s ‘reinforcement’ rate of 3,000–5,000 recruits every two months became difficult, as the demand for reinforcements was greater than the number of volunteers could fill. Conscription began in August 1916.56 Ward warned that increased expenditure to meet the growing war burden of direct costs and the interest on war loans was certain to occur in future years. The link was clear. There had to be ‘conscription’ of men to meet the burden of war. There had also to be some conscription of wealth to meet the burden of war. For, as Ward said: Those who have made extra profits during the war, either from business or directly from primary products, cannot object to provide out of such profits a share of the finance necessary [for the war effort]. I will ask the House to give authority to take by way of taxation 45 per cent. of the excess profits earned during the last year.57

Ward therefore proposed an excess profits duty (EPD), similar to the EPD introduced in the United Kingdom the previous year.58 He also proposed some other changes, notably including returns on mortgages within the income tax base, rather than the value of mortgages being assessed for land tax, and a 5 per cent levy on all incomes other than ‘war profits’. Another possible source of increased income tax revenue was to reduce the £300 exemption to a lower amount. This exemption was, as Ward himself noted, ‘the highest in the world’.59 While he had no present intention of lowering the exemption, he suggested that it would become a matter for serious consideration if the war extended beyond the end of 1917. In the interim, it was ‘only right that those who are well-to-do or possessors of wealth should contribute the greater proportion of the cost of this war’.60 If the war did drag on much longer, he was sure that even the ‘most humblest’ in the land would probably take exception to being excluded from making some ‘slight contribution’ towards helping win the

55 Financial Statement 1916, above n 54, i. 56 Military Service Act 1916. 57 Financial Statement 1916, above n 54, xxii. 58 M Daunton, Just Taxes: The Politics of Taxation in Britain 1914–1979 (Cambridge, Cambridge University Press, 2002) 44. 59 Financial Statement 1916, above n 54, xxiii. 60 ibid.

Income Tax in New Zealand, 1914–18  479 war and support the widows and children of those who had sacrificed their lives in ‘fighting for the freedom of this country’.61 New Zealand politicians were keen to demonstrate that the smallest Dominion in the Empire would make the biggest contribution to the Empire’s war effort.62 Notions of sacrifice and being not just better Britons, but the very best Britons, lay at the heart of the need to increase taxation revenue as part of New Zealand politicians’ desire to enhance New Zealand’s special relationship with Britain. In the midst of this general clamour, one member of the House raised a word of warning. He said: Whether in the form of land-tax or income-tax, to talk of equal sacrifice was only to use a catchword that had no meaning. No matter what taxation was imposed … there could never be equal sacrifice between a man with £10,000 a year and one with £150.63

While this particular perspective was unusual, the use of moral language in relation to income tax was common in the debates in the House and outside it. Members believed in taxing war profits ‘as much as you can’64 for those making ‘clear war profits’ should pay their ‘fair share’.65 In 1916, the House sat from 9 May until 11 August 1916. Through early July 1916, members devoted in excess of eight days to debating the Land and Income Tax Act 1916 and the Finance Act 1916. The content was a far cry from the rather perfunctory discussion of the income tax part when the Land and Income Tax 1891 was debated.66 Much of the debate revealed a clear rural/urban divide, a fracture that was at the heart of the coalition government led by Prime Minister William Massey, ‘farmer Bill’, and Minister of Finance, Sir Joseph Ward the urban businessman.67 The specific measures adopted in 1916 were a mix of changes to the existing structures and the adoption of an EPD. It will be recalled that land tax was assessed in two ways. Ordinary land tax was assessed on the unimproved value of land and the capital value of mortgages68 and, in addition, a graduated land tax was assessed on higher valued land. In 1916, the value of mortgages was removed from the base for ordinary land tax69 and income tax applied to all interest income derived by a taxpayer who owned mortgages.70 The effect of the change was designed to give some relief to the owners of small sums invested in

61 ibid. 62 Belich, above n 7, 108–18. 63 New Zealand Parliamentary Debates 29 June 1916, vol 176, 336. 64 New Zealand Parliamentary Debates 6 July 1916, vol 176, 574. 65 New Zealand Parliamentary Debates 11 July 1916, vol 176, 638. 66 Griffiths, above n 10, 426. 67 Bassett, above n 8, 222–30. 68 The capital value of a mortgage was ‘the full amount owing’ but limited to the ‘capital value’ of the land which forms the security. The capital value of land was the sum that the owner might be expected to realise if the land were offered for sale by a bona fide seller (net of any mortgage or other charge): Land and Income Assessment Act 1908, s 2. 69 Finance Act 1916, s 2(1). 70 Land and Income Tax Act 1916, s 85(f).

480  Shelley Griffiths mortgages, while imposing a heavier burden on those with large investments.71 This is clearly consistent with the stated aim of making those who were ‘possessors of wealth’ bear more of the cost of the war. At the same time, it was a clear shift to prefer income as the preferred tax base. This passed not without a fair amount of comment in the debates in the House and it was in this that the clearest distinction between rural and urban members can be seen. Some were concerned about moving from the relatively straightforward position of income tax being levied on business and land tax applying to land and mortgages. This clear distinction was being muddied by applying income tax to farming and then to mortgage returns.72 Those who derived their income from ‘sources other than war profits’ ought to be required to contribute something further than they already were, and thus a 5 per cent special tax was levied on all incomes.73 It was, however, those who gained the most from the war through earning ‘extra’ profits because of the war, who ought to be required to contribute a significant proportion of those extra profits to the capital expenditure required of the government. An EPD of 45 per cent was proposed. Ward expected to raise about £2 million from this.74 The EPD was levied at the rate of 45 per cent on ‘excess profits’ as defined. The Finance Act 1916 defined ‘excess profits’ by reference to ‘standard income’. In simple terms, excess profits were the amount by which the current year’s income exceeded ‘standard income’. There were four alternatives for calculating ‘standard income’:75 —— —— —— ——

Average income for the three years ending 31 March 1914; Average income of two of those three years; The assessable income of one of those three years; or An amount of 7.5 per cent of the capital employed in the production of income at 1 April 1915 together with an amount that the Commissioner of Taxes considered ‘just and reasonable’ remuneration for personal exertion by the taxpayer, not to exceed £600.

If, in the opinion of the Commissioner, standard income could not be ascertained under any of the first three methods, it would be ascertained by reference to the return on capital method. There followed a further 23 sections, many of great complexity, to flesh out these core concepts. For example, sections 17 and 18 addressed the situations where the capital employed in the income year in which

71 Financial Statement by the Right Honourable Sir Joseph Ward, in Committee of Supply, 16 June 1916 (Appendix to the Journals of the House of Representatives 1916, B–6) xxii. 72 New Zealand Parliamentary Debates 26 June 1916, vol 176, 330. 73 Financial Statement by the Right Honourable Sir Joseph Ward, in Committee of Supply, 16 June 1916 (Appendix to the Journals of the House of Representatives 1916, B–6) xxii. 74 See Ward’s speech on the introduction of the measure to House of Representatives, New Zealand Parliamentary Debates 3 July 1916, vol 176, 410–12. 75 Finance Act 1916 ss 10 and 11.

Income Tax in New Zealand, 1914–18  481 the EPD was levied was greater than or less than the average amount in the ‘standard income’ period. There were provisions on the valuation of assets and the treatment of liabilities.76 There was a provision for the Commissioner’s discretion in cases of hardship and a process of objection.77 This is a very crude measure, but in the Land and Income Assessment Act 1908, there were only 19 sections in the ‘income’ Part VII of the Act, compared with the 24 EPD sections.78 The EPD brought a new level of complexity to land and income tax legislation. Underlying this complexity was the fact that this ‘duty’ was predicated on the rather elusive concept that there was such a thing as a ‘standard income’ year. The tax was based on a basic proposition: that those who earned ‘excess’ profits because of the war ought to pay tax at a very high rate. It focused overtly on those who earned more in the year ended March 1916 than they had in the year(s) ending 31 March 1914, and it presumed that any increase was attributable to the war. In predicting that £2 million would be collected from this tax, Ward made a presumption that there was about £4.4 million of profit in the economy that was attributable to the war. It was not long before some of the fallacies and absurdities of this tax were pointed out. ‘Fair Play’ wrote to a Christchurch evening newspaper, the Sun, in July 1917. ‘What’, he or she asked, ‘about the big firms, public and private, who had been making large profits all the time?’ What about the ‘man who had made £60,000 for many years and paid no excess profits tax’ because we might say his standard income had always been very high? Did it seem fair that such a person paid no excess profits tax, while a farmer who had had a series of poor income years and for whom 1916 was a good year, paid almost 50 per cent of that additional income in tax? Some businesses were in a development phase and when they finally hit peak performance in 1916, a tax of nearly 50 per cent was levied on their additional income. Was that fair, while breweries which had been making a return of 40 per cent per year on their capital for decades, paid no EPD?79 The public commentators reflected a strand of the comments made in Parliament. While few argued that those who did make ‘clear war profits’ should pay additional tax, they also warned that there was a risk that the EPD might tax the results of ‘energy and enterprise’.80 By then, farmers’ organisations and chambers of commerce had called for the end of this ‘inequitable and unjust tax’.81 Such organisations and commentators called for it to be repealed and the necessary revenue raised by extending the graduated land and income taxes. The EPD was predicated on the truth that farmers in particular were earning huge profits. In the early war years, the ‘prosperity enjoyed by farmers



76 Finance

Act 1916 ss 13–15 and 28. Act 1916 ss 19 and 29. 78 Land and Income Assessment Act 1908 ss 71–90. 79 Sun (Christchurch, 2 July 1916) 6. 80 New Zealand Parliamentary Debates 11 July 1916, vol 176, 638. 81 Press (Christchurch, 19 June 1917) 8; Wanganui Chronicle (Whanganui, 24 May 1917) 2. 77 Finance

482  Shelley Griffiths [had become] proverbial’.82 Subsequent analysis suggests that although farmers were prosperous during the war, the prices they received for their goods were not significantly higher than immediately prior to the war. Further, farmers faced considerable challenges with rising input costs and labour shortages. In March 2015 all meat production became subject to an imperial commandeer. In October that year, the New Zealand government purchased a third of all cheese production on behalf of the British government, and the following year all cheese and wool production became subject to the commandeer.83 Evidence suggests that the commandeer was not the cause of high prices for agricultural production during the war. The prices were probably higher than received in the immediate pre-war period, but certainly lower than in the period between the start of the war and the commencement of the commandeer. ‘The commandeer actually kept prices down.’84 The prices for products not subject to the commandeer, for example flax, enjoyed extremely high prices. At the same time, the producer of agricultural products was faced with increasing prices of inputs (such as grass seed, fencing wire and other staples), severe labour shortages and shortages of farm equipment.85 Against a background of calls for equality of sacrifice, of capital as well as human sacrifice, an EPD was symbolically important and probably inevitable. However, as a matter of tax policy, or more precisely revenue raising, it was doomed. The level of profit on which to levy it was probably illusory, it was complex to administer, putting additional strain on the private and public ‘clerk’ sector. It has been suggested that the clerical classes were actually overrepresented in enlistment in the forces.86 In 1911, the Income Tax Department was reported as having 24 staff in the ‘income’ section.87 While women entered the workforce in increased numbers during the war,88 it is not hard to imagine the strain these complex calculations placed on a weakened public service, as well as the depleted accounting support available in the private sector.89 82 Watson, above n 36, 535. 83 ibid 539. 84 ibid 535. 85 ibid 544–45. 86 ibid 536. 87 New Zealand Official Year Book, 1911; http://archive.stats.govt.nz/browse_for_stats/snapshotsof-nz/digital-yearbook-collection.aspx (accessed 15 January 2019). 88 E Olssen, ‘Waging War: The Home Front’ in J Binney, J Bassett and E Olssen (eds), The People and the Land: Te Tangata me Te Whenua: An Illustrated History of New Zealand, 1820–1920 (Wellington, Allen and Unwin, 1990) 309. 89 The only dispute about the application of the EPD that reached the courts concerned a bank: Union Bank of Australia v Commissioner of Taxes [1920] NZLR 649 (SC). The Commissioner assessed the bank as liable for EPD for the year ended 31 March 1916 under s 21 of the Finance Act 1916. Section 21 applied only to banks for whom the calculation of income for EPD purposes was effectively a return on assets calculation. During the course of the year, the bank had realised certain consols and similar assets as part of what it said were its usual operations. These assets were realised at a loss. The bank wished to deduct that loss to calculate the amount of ‘income’ for the purposes of the EPD calculation. The Court concluded that the term ‘income’ in s 21 must mean ‘net income’ and that could only be established by reference to ‘ordinary commercial concepts’. In the alternative, if the capital exclusion in the Land and Income Tax Act 1916 applied to the Finance Act, and

Income Tax in New Zealand, 1914–18  483 Between the Finance Act 1916, incorporating the EPD, and the Land and Income Tax Act 1916, incorporating amendments since the consolidating legislation in 1908, members spent many days in June and July engaged in fierce debate that filled more than one hundred pages of Hansard. The passion of the language and the engagement with the subject of taxation was rather different from the tone in the initial land and income tax legislation in 1891 and its many subsequent amendments. 1917 and 1918: The Decline of the ‘Financial Wizard’ and the End of the War Ward and Prime Minister Massey left for England in August 1916 and only returned after the end of the Imperial War conference in April 1917. Ward’s ‘imperial preoccupations’ and long time away from New Zealand ‘made it seem as though he had lost some of his old financial wizardry’.90 This was both reflected in, and exacerbated by, the decision to repeal the EPD in 1917. As Ward said in his 1917 Budget statement, ‘the difficulties in ascertaining exactly the actual profits resulting from the war were almost insuperable. The machinery needed for the purpose was too elaborate to enable the revenue to be collected when it was required.’91 Clearly, the calculation based on the collation of financial information and the mechanisms for collection were too much for the bureaucracy. It might be suggested it was a very high burden to place on the administrative support structures available to taxpayers. Ward had clearly over-estimated the extent of taxpayers earning ‘excess’ profits because of the War. In 1917, he said that even if he increased the rate to 90 per cent, the amount of revenue raised would be insufficient to meet the needs.92 Whatever methodology Ward had used to estimate that £2 million would be raised, it was clearly deficient, or perhaps it was that his ‘old financial wizardry’ was gone or perhaps that desire to conscript wealth as well as men had become irresistible. He also described how experience had shown the EPD to be ‘inequitable’. This of course, was the general criticism levelled at the tax. Ward noted that New Zealand had many ‘developing’ businesses and the tax pressed ‘unduly on them’. The guaranteed purchase of primary products for imperial purposes had been much heralded as providing farmers with increased profits. Now it seemed that this requisition had ‘reduced the profits’ that could be earned by primary producers.93 Problematic elsewhere, the court thought it did not because that section did not apply in calculating the ordinary income of a bank under that legislation, the principle in California Copper Syndicate v Harris (1903–11) 5 TC 159 applied because the realisation was part of the carrying on or carrying out of a business and was not a capital transaction. 90 Bassett, above n 8, 231–38. 91 Financial Statement by the Right Honourable Sir Joseph Ward, in Committee of Supply, 1 August 1917 (Appendix to the Journals of the House of Representatives 1917, B–6) xxiii. 92 ibid. 93 ibid.

484  Shelley Griffiths the EPD was an abject failure in New Zealand.94 Ward turned instead to graduated land tax, changes to the graduation of income tax and a special ‘war tax’ to raise more revenue. By maintaining the £300 exemption, Ward’s taxation policy confined income taxation to the middle classes and above. Ward resisted reducing this exemption, although it was, as far as he could ascertain, the highest in the world.95 One might conjecture that those in that income bracket were the ones Ward hoped would vote for his Liberal Party rather than be drawn to the embryonic Labour Party. The 1918 Year Book indicated that wages had increased on average by 17 per cent. The plumber who we used in an earlier part of this paper as an indicator of the incidence of income tax among tradespeople, would on average have had an increase of about 11 per cent in his wages. This hypothetical ‘average’ plumber would have been earning about £222 per year in 1918, still below the £300 exemption. So, it is fair to assume that when Members spoke in the House of ‘all paying’ that referred as much to lowering the exempt threshold as requiring the wealthy to pay more. As one commented, ‘I am of the opinion that everybody should pay something in the way of taxation. Today the great majority are not asked to pay anything in taxation.’ The war belongs to ‘every class, and all should bear some share of the burden of it’.96 This notion of spreading the burden of taxation and the rhetoric of the ‘excess’ profits duty brought a tone of morality to income tax for the first time. The linguistic choice of ‘excess profits duty’ rather than ‘tax’ might not be co-incidental. In the introduction of income tax and later, the rhetoric had been very dispassionate. Now tax was being used to ensure those who appeared to ‘benefit’ from the war, contributed a ‘fair share’ to the financial cost of the effort.97 Indeed, the very word ‘excess’ imports a moral flavour. This was a significant change in discourse about income tax. While it is the changes during World War I to the core income tax and its relationship with the land tax that lasted long after the war was ended and wrought the most significant long-term change, the moral and economic tone to the discussions are equally notable. The three changes in the 1917 Finance Act were to replace the existing ordinary (flat) and graduated land tax rates with one progressive land tax, alter the levels of graduation in income tax and levy a special war tax. There was a clear intention to increase the proportion of land tax in the total revenue raised. By 1917, land tax had decreased as a proportion of total revenue. The land tax change was to levy the unimproved value of land, without deduction for mortgages, at progressive rates between a minimum of 1½d and a maximum of 10½d, this rate including a 50 per cent addition across the board.98



94 Daunton,

above n 58, 55–57, 83–84 and 91–92. Statement 1916, above n 54, xxiii. 96 New Zealand Parliamentary Debates 10 August 1917, vol 179, 184. 97 New Zealand Parliamentary Debates 10 August 1917, vol 179, 187. 98 Finance Act 1917, First Schedule. 95 Financial

Income Tax in New Zealand, 1914–18  485 A £500 exemption was available on land with an unimproved value of less than £1,500 from where the exemption abated so as to be completely eliminated at £2,500. To prevent ‘hardship’ to owners of land of comparatively low value but who had mortgage liabilities, Ward proposed an exemption for all land with an unimproved value of less than £3,000 with the exemption abating until totally disappearing when the unimproved value reached £5,000. The two exemptions were not cumulative.99 There were other exemptions for particular classes of hardship, for example for a widow with dependent children.100 Income tax graduated rate was adjusted so as to ameliorate the ‘severity’ of income tax for those on lower incomes. Before the war, there were 8,000 taxpayers who earned less than £700; by 1918 that number was 28,000 taxpayers.101 Although the first £300 remained exempt and there were rebates for those who had dependent children, the reach of income tax extended in a quite spectacular fashion in a relatively short space of time. It is not surprising that at the same time, politicians began to become somewhat mindful of on whom the burden fell. The change was to replace the banded graduation to a smooth graduation, starting at 6d in the pound up to £400 and then increasing at 1 200 d for each pound over £400, to reach a maximum of 3s in the pound at £6,400. The exemption of 5 per cent of the capital value of land ‘used for producing income’ was replaced by an exemption of 5 per cent of the unimproved value of such land. It was expected that these changes would yield an additional £1.6 million. It was, however, the ‘war-tax, which replaced the excess profits tax’.102 If the EPD failed because of extraordinary complexity, the war-tax suffered from no such deficiency. This was a graduated tax in the same way as the ordinary income tax with an additional 50 per cent applied. The result was that the top rate of tax was 3s in the pound. The top rate of war tax was 3s plus another 50 per cent, that is 4s 6d. Together with the standard income tax this saw the combined top rate climb to 37.5 per cent. While only about 600 taxpayers would have been paying at this rate,103 the symbolism attached to this steep increase from the top rate in 1912 of 5.8 per cent, must have been significant. Two weeks after the Armistice in November 1918, Ward was ‘pleased’ to be able to tell the House that there was finally no need to further increase the burden of taxation to meet the ‘immediate requirements’ of the country.

99 Finance Act 1917, s 4. 100 Finance Act 1917, s 6. 101 Income-Tax: Particulars Relevant to Payments (Appendix to the Journals of the House of Representatives 1911, B–22) 1 and Income-Tax: Particulars Relevant to Payments (Appendix to the Journals of the House of Representatives 1918, B–22) 1–2. 102 Financial Statement by the Right Honourable Sir Joseph Ward, in Committee of Supply 26 November 1918 (Appendix to the Journals of the House of Representatives 1918, B–6) vi; note that in 1918, Ward referred to this as an excess profits ‘tax’ rather than the earlier, and statutorily mandated, expression ‘excess profits duty’. 103 Income-Tax (Persons Paying) and Amounts Paid (Appendix to the Journals of the House of Representatives 1918, B–22) at ii (of a total of about 38,000 taxpayers).

486  Shelley Griffiths However, the ongoing consequences of the war, the servicing of the loans, the cost of pensions, meant that he could not predict when it would be possible to reduce the burden of taxation. So much was unknown that it was impossible to determine what the ongoing effects of the war would be. He was, however, cautiously optimistic that the end of the war was unlikely to adversely affect the country’s prosperity and it would become possible to reduce the ‘heavy burden of taxation’ that has been so ‘cheerfully borne by the taxpayers’.104 CONCLUSION

This collection of essays is the ninth volume in the series based on tax history conferences held every second summer in Cambridge University. As the project comes towards the end of its second decade, not surprisingly, some scholars have begun to reflect on the significance of it – and whether there is, in Michael Littlewood’s words, a ‘Tiley School’ of tax history.105 It is a hundred years since the end of World War I. It is also exactly a century since the Austrian economist Joseph Schumpeter wrote the famous justification for writing about tax history. For as he said, ‘he who knows how to listen to [the] message [of fiscal history] discerns the thunder of world history more clearly than anywhere else.’106 As has been noted by those who use the term ‘new fiscal sociology’, in the wake of Schumpeter’s highlighting of the link between tax and social change, a host of scholars have used the ‘social relations of taxation’ as a lens through which to discover much and make new insights in accounts of social change.107 The aims of this paper are more modest, but it is possible to knit this account of income taxation in World War I into some of the more general themes of New Zealand historiography. In a thoughtful analysis of New Zealand historiography, Tony Ballantyne noted that while imperial relations and New Zealand’s place in the empire had once been of significant interest, by the mid-1980s imperial history was seen as irrelevant to the more ‘pressing project of filling in the gaps in national history traditions.’ The colonial period came to be seen as a sort of ‘national pre-history’, the things that happened before the ‘real story’ began.108 There was no real unanimity about when the colonial period ended; candidates in New Zealand included the 1890s Liberal government, Gallipoli (1915) or the 104 Financial Statement 1918, above n 102, xxv. 105 M Littlewood, ch 3 in this volume. 106 J Schumpeter, ‘The Crisis of the Tax State’ in JA Schumpeter and R Swedberg (ed) The Economics and Sociology of Capitalism (Princeton NJ, Princeton University Press, 1991) 101. 107 IW Martin, AK Mehrotra and M Prasad, ‘The Thunder of History: The Origins and Development of the New Fiscal Sociology’, in IW Martin, AK Mehrotra and M Prasad (eds), The New Fiscal Sociology: Taxation in Comparative and Historical Perspective (Cambridge, Cambridge University Press, 2009) 2. 108 T Ballantyne, ‘Culture and Colonization: Revisiting the Place of Writing in Colonial New Zealand’ (2010) Journal of New Zealand Studies 1, 2–3.

Income Tax in New Zealand, 1914–18  487 writings of literary nationalists in the 1930s. Whenever it ended, the colonial era was but the prelude to the story of the creation of national identity. More recently, this view of colonialism has been revisited and colonialism is now seen as an ongoing process, fundamentally a ‘cultural project’ and one which both ‘moulded’ and ‘delimited’ the nation-building process.109 This changed perception is both reflected in, and reflective of, the reappraisal of the relationship with, and impact on, Māori. Inevitably, reconsidering nationhood through a colonialism lens, means too that the relationships of empire became of renewed interest and different significance.110 World War I and the commitment to the Empire’s cause can be seen in a different light than mere blind patriotism.111 The military disaster at Gallipoli is more than a marker of national identity. Indeed, some more nuanced work indicates that during World War I, New Zealand policymakers had a ‘keen appreciation of their country’s own interests’, and London and Wellington were aware of the reciprocal nature of the relationship. By the end of war, both had come to recognise that ‘external imperial unity was a dream and that they enjoyed different interests within the imperial ­partnership’.112 However, what is also notable is that in New Zealand historiography, scant, if any, regard has been had for legal history. Boast observes that New  Zealand historians have largely neglected the law in their account of New Zealand history. Although there has been some important work on the role of law in the history of Crown/Māori relations, generally law has been ignored in general and specific work on New Zealand history. Sport has been given more attention.113 So, do we hear the ‘thunder of history’ in the changes to income taxation in New Zealand during World War I? It certainly plays out against one of the huge thunderstorms of the twentieth century. The emergence of rhetoric about taxation, the doomed adoption of a transplanted excess profits duty/tax, the shift in the tax base with the integration of urban and rural activities into one approach, all tell us something about evolving attitudes to taxation. They also tell us something about the nature of the society in which income taxation is being applied and something about the relations with the Imperial centre. Ballantyne argues that the time has come to ‘firmly reconnect New Zealand scholarship on colonisation with the history of capitalism’.114 Tax is both the lubricant and the engine room of capitalism in the modern state. Some understanding of the history of taxation must surely be an important part of that reconnection project. At the same time, taxation, firmly rooted in the law, might facilitate some of the 109 ibid 5. 110 ibid. 111 See for instance S Loveridge (ed), New Zealand Society at War: 1914–1918 (Wellington, Victoria University Press, 2016). 112 Kay, above n 34, iii. 113 R Boast, ‘New Zealand Legal History and New Zealand Historians: A Non-meeting of Minds’ (2010) Journal of New Zealand Studies 23, 23–26 and 29–30. 114 Ballantyne, above n 108, 17.

488  Shelley Griffiths conversation that Boast would like to see in the development of New Zealand historiography in its broadest ambit. Writing about the state in New Zealand in World War I, political historian Michael Bassett cited AJP Taylor’s famous statement referring to England: ‘Until August 1914 a sensible, law abiding Englishman could pass through life and hardly notice the existence of the state, beyond the post-office and the policeman.’115 While that probably overstates the case in England in 1914,116 it is recognised as more accurate in New Zealand, where state intervention had been a significant part of economic and social life since the 1840s. Many have noted New Zealand’s long-held ‘statute-based approach to legal development.’117 In that sense, many of the interventions by the government in World War I were much less novel in New Zealand than in many other places. But it seems clear that the role of the government in economic management increased during World War I. During 1915 and 1916, a Department of Ministries and Supplies was created for the arrangement of contracts and the letting of tenders,118 a Cost of Living Act established a Board of Trade to regulate the price of food and, more broadly, investigate any question relating to the ‘trade commerce or business of New Zealand’.119 A National Efficiency Board was established to investigate ways to mobilise labour and industry.120 Regulations made during the war did not confine themselves to economic management.121 There was, however, a strong strand of economic intervention and central management and some of it had long-lasting resonance. For instance, the Imperial commandeer formed the antecedents of the producer board established to control the export of New Zealand produce in the 1920s.122 Similarly, the changes made to the income taxation system during the course of the war were in part transitory (the excess profits tax and the war surcharge, renamed and finally removed by

115 AJP Taylor, English History, 1914–1945 (Oxford, Clarendon Press, 1965) 1, cited in M Bassett, The State in New Zealand, 1840–1984: Socialism without Doctrines (Auckland, Auckland University Press, 1998) 123. 116 HWR Wade and CF Forsyth, Administrative Law, 11th edn (Oxford, Oxford University Press, 2014) 3. 117 R Boast, ‘New Zealand Legal History and New Zealand Historians: A Non-meeting of Minds’ (2010) Journal of New Zealand Studies 23, 24; See also, Geoffrey Palmer, Unbridled Power: An Interpretation of New Zealand’s Constitution and Government (Wellington, Oxford University Press, 1979) 6. 118 War Regulations Amendment Act 1915. 119 Cost of Living Act 1915 ss 2 and 6. 120 The Board was established in 1917 by regulations made under the War Regulations Act 1914, New Zealand Gazette, 5 March 1917, 851; generally, see R Kay, ‘In Pursuit of Victory; British-­ New Zealand Relations during the First World War’ (PhD thesis, University of Otago, 2001) 114–15. 121 See for instance, the power granted under the War Regulations Amendment Act 1916, s 3(1)(h) for the control of alcohol sales, for the regulation of the sale of intoxicating liquor to women, and the ‘suppression of prostitution’ and the ‘prevention of venereal disease’. For a helpful and comprehensive reference for all wartime laws and regulations, see https://nzhistory.govt.nz/war/ index-wartime-laws-and-regulations-1914-21 (accessed 15 January 2019). 122 Meat-export Control Act 1921, Dairy-export Control Act 1923, and Fruit Control Act 1924.

Income Tax in New Zealand, 1914–18  489 the mid-1920s)123 and, in part, of lasting significance (the shift to the dominance of the income tax, the practice of continuous change and the incorporation of the farming sector within its ambit). The 1933 edition of a New Zealand textbook described the Land and Income Tax Assessment Act 1891 as substituting the property tax with:124 —— ordinary land tax; —— mortgage tax; —— graduated land tax; and —— income tax on various classes of income. The tax on mortgages was abolished in 1916 and the dual system of land tax was abolished in 1917. During the war, new taxes were introduced at various times – an excess profits duty, a special income tax, special war tax and super taxes on both land and income tax.125 In 1918, an earlier version of a similar, although rather slimmer, volume of the same name and by the same author described the three taxes on income then in force as:126 —— the ordinary tax; —— the debenture tax; and —— the special war tax. As indicated in the 1933 work, there was by 1918 only the ordinary land tax. The abolition of the mortgage tax hints at what was probably the most significant structural change during the war. Until 1915, the farming sector was taxed by land tax, and mortgages were treated as land. It was the unimproved value of land and the capital value of mortgages that were the base for the levying of ordinary land tax. In 1915, returns on mortgages became assessable for income tax, and income from the use of land became an item of assessable income. This was not without its critics. In the House, concern was expressed about moving from what was described as the relatively tidy position of income tax on business income and land tax on land and mortgages. As a result of those changes, it was being mixed up with income tax payable on farming.127 Whatever the positives or negatives about the change, it was a significant one structurally. The increase in the number of taxpayers earning between £300 and £700 must have been partly due to general income inflation. Wage inflation across a sample of

123 New Zealand Official Year Book, 1927; http://archive.stats.govt.nz/browse_for_stats/snapshotsof-nz/digital-yearbook-collection.aspx (accessed 15 January 2019). 124 HA Cunningham, Land and Income Tax Law in New Zealand (Wellington, Butterworths, 1933). 125 HA Cunningham, Land and Income Tax Law in New Zealand (Wellington, Butterworths, 1933) [2]. 126 HA Cunningham and EJR Cumming, Land and Income Tax Law and Practice (Wellington, Accountancy and Educational Publications Ltd, 1918) 39. 127 New Zealand Parliamentary Debates 26 June 1916 vol 176, 330.

490  Shelley Griffiths occupations was, on average, 20 per cent between 1913 and 1917.128 It would seem plausible to suggest that something of that order, or perhaps even more, given the frequent contemporary comments to that effect, would have been reflected in increases in business incomes. However, it seems unlikely that that would be the significant driver of the 300 per cent increase in the number of taxpayers in the lowest income band. The extension of the tax net to farmers must be a significant part of that. While in absolute terms the increase in the number of income taxpayers between 1911 and 1918 is truly startling, it must be remembered that still only a very few members of society paid income tax. The total population of New Zealand over the age of 20 in 1916 was 644,000. Only 5.89 per cent were income taxpayers. Even if one were to only include males over the age of 20, the percentage was just short of 12 per cent.129 The impact of these changes can be summarised in Table 17.2. Table 17.2  Selected Sources of New Zealand Government Revenue for the Years Ended 31 March 1914–31 March 1918130 1914 £000s

1915 £000s

1916 £000s

1917 £000s

1918 £000s

Land tax

767

800

Income tax

554

540

1,048

713

1,385

1,392

4,262

5,619

Customs duty

3,427

3,167

3,366

3,850

3,364

Stamp and death duties

1,221

1,417

1,470

1,699

1,892

The increase in revenue from income tax can be seen in the magnitude of the growth in the raw number (revenue increased by a factor of 10) and in the change in the percentage of revenue derived from income tax. In 1914, income tax was 9 per cent of the total from those four sources; in 1918 it was 46 per cent. Ward noted in his financial statement in 1916 that £270,000 had been raised from income tax ‘chargeable’ to farmers and there had generally been higher profits for those ‘dealing with primary products’.131 The decrease in the amount of land tax revenue between 1916 and 1917 was due to the abolition of the tax on mortgages.132 128 New Zealand Official Year Book, 1918; http://archive.stats.govt.nz/browse_for_stats/snapshotsof-nz/digital-yearbook-collection.aspx (accessed 15 January 2019). 129 New Zealand Official Year Book, 1917; http://archive.stats.govt.nz/browse_for_stats/snapshotsof-nz/digital-yearbook-collection.aspx (accessed 15 January 2019). 130 From (Appendix to the Journals of the House of Representatives 1914, B–6) iv; (Appendix to the Journals of the House of Representatives 1915, B–6) ii; (Appendix to the Journals of the House of Representatives 1917, B–6) i and (Appendix to the Journals of the House of Representatives 1918, B–6) i. 131 Financial Statement 1916, above n 54, ix. 132 Financial Statement 1917, above n 91, v.

Income Tax in New Zealand, 1914–18  491 In 1918 the statistics about the sources of income tax revenue were equally revealing, as Table 17.3 shows.133 Table 17.3  Sources of Income Tax Revenue in 1918 Number

Ordinary income tax £000s

Salaried persons

8,070

Professional

2,537

57

78

Traders, manufacturers

7,917

215

311

12,548

529

952

Deceased estates and other trust

2,211

79

131

Miscellaneous

2,721

65

104

Companies

1,945

1,245

1,862

Landowners

46

Special war tax £000s 70

It is immediately apparent that the burden of income taxation rested principally on two groups: landowners and companies. The fact that landowners became income tax payers was one of the major stories of income tax during World War I. The fact that companies were paying such a large proportion of the income tax raised became the story of the 1920s, as first a committee in 1922 and then a Royal Commission in 1924 considered whether the appropriate method was being used.134 It will be recalled that company dividends were for the most part exempt from income tax in the hands of the shareholder, on the rationale that the tax was being paid by the company. Companies were also liable to pay ‘debenture tax’ as agent for the debenture holder. Company tax was payable on a graduated basis. There was no equivalent of the individual £300 exemption for either company or debenture tax. In 1918, a company with taxable income of £4,000 paid £400 in ordinary income tax and with a 50 per cent super tax applied, a total of £600. A company with taxable income of £6,400 paid a total of ordinary and super income tax of £1,440 or 22.5 per  cent.135 The majority report of the Committee on Taxation concluded in 1922 that the system of imposing income taxes on companies in the same way as individuals (and absent any exemption) was wrong.136 The majority of witnesses

133 Income Tax (Persons Paying) and Amounts Paid (Appendix to the Journals of the House of Representatives 1918, B–22) 1. 134 It may also reflect the early origins of New Zealanders’ apparent love of the corporate form. In 2018, there was one company for every eight humans in New Zealand: S Watson and L Taylor, ‘Preface’, in S Watson and L Taylor (eds), Corporate Law in New Zealand (Wellington, Thomson Reuters, 2018) vii. 135 Finance Act 1918, Sch, Pt II, cl 2. 136 Report of the Committee, above n 1, [13].

492  Shelley Griffiths to the 1924 Royal Commission on Land and Income Taxation ‘condemned’ the present system and the report of the Commission agreed. The present system had ‘served a useful purpose during the war’. It had fulfilled the same objective as the English excess profits tax and had enabled ‘an astounding amount of revenue to be raised with a minimum of inconvenience to individuals and the general public’. Now, however, was the time to return to the more ‘ideally correct system’.137 That is a project for another day.



137 Report

of the Royal Commission, above n 4, [5].

18 The Development of Anti-Avoidance Rules and the Modernisation of China’s International Taxation System YAN XU*

ABSTRACT

Concomitant with China’s rapid economic development over the last three decades is the modernisation of its taxation system. The system has transformed from a rudimentary regime based on a planned economy to one with a set of modern taxes facilitating cross-border trade and investment. This paper focuses on the modernisation of China’s international taxation regime from a perspective of the development of anti-avoidance rules. The lack of a legal basis for anti-avoidance measures and the shortage of knowledge and experience in dealing with tax avoidance cases in China’s early development period prompted the government to take serious measures to establish an international taxation system. Ever since the issuance of the first anti-­ avoidance document, a series of legal documents have been issued by Chinese tax authorities, ranging from specific anti-avoidance rules, particularly transfer pricing rules, to general anti-avoidance rules. The paper explores the cause and the context for the creation of the anti-avoidance rules over the past 30 years (i.e. 1987–2017) and the evolution of China’s international taxation system. Building upon the examination, it discusses the policy and strategies adopted by the government during the development that may impact on China’s positions and practices in developing international taxation standards and norms in the contemporary world. * The work described in this chapter was substantially supported by a grant from the Research Grants Council of the Hong Kong Special Administrative Region, China (Project No. 24607815). The author would like to thank the Research Grants Council for funding support.

494  Yan Xu INTRODUCTION

W

ith the growth of cross-border investment and trade, international taxation emerged as a core area of tax law and policy. The development of an international taxation system in a country is intrinsically linked to the development of its economy. The more advanced and open the economy, the more mature and comprehensive the legal system on international taxation. In the field of international taxation,1 the soundness of rules and institutions for combating tax avoidance often reflects the level of modernisation of a country’s international taxation system. In an underdeveloped economy, the organisation and the form of business operations is usually simple and there is usually less cross-border trade and investment than is the case with more developed economies. Consequently, there would be few, if not no, tax avoidance activities that involve sophisticated strategies to minimise taxes in the relevant jurisdiction. The limited exposure to cross-border trade and investment often restricts the development of legal rules and institutions on tax avoidance that are comparable to those in more advanced economies. The legal system on international taxation in the underdeveloped economy, if any, can at best be described as a system with foreign elements. The experiences of many emerging economies, including China, attest to the relationship between the development of the economy and the modernisation of the international taxation system. The creation of a modern international taxation system in China closely relates to the country’s economic development over the last three decades, and the modernisation of the system has been shaped by the continuous development of the economy. Prior to the Opening-Up and Economic Reform policy, adopted in late 1978, China had only a rudimentary domestic tax system, with almost no international taxation, given that the foundation of China’s economy at the time was largely agrarian, relying on public ownership and central planning. In the country’s early transition to an industry-based market economy, there was limited foreign exposure. The first anti-avoidance legal document did not come up until the late 1980s. Ever since then, the rapid expansion of the domestic market and the steadfast increase in 1 There has been a debate among tax law scholars and commentators about whether an international taxation system does exist. Some argue that there is no such system, as what we commonly referred to as international taxation is more correctly the international aspects of a country or region’s income tax laws. There does not exist an overriding international law of taxation. Others however believe that a coherent international tax regime exists, embodied in both the tax treaty network and domestic tax laws, and that it forms a significant part of international law. Countries and regions comply with the basic norms of the international tax regime such as non-­discrimination. See generally, BJ Arnold, International Tax Primer 3rd edn (The Netherlands, Kluwer Law International, 2016) 21–22; RS Avi-Yonah, International Tax as International Law: an Analysis of the International Tax Regime (Cambridge, Cambridge University Press, 2007) 1–8. For the convenience of discussion, the article uses the conventional term ‘international taxation’ to refer to the international aspects of China’s enterprise income tax law.

The Modernisation of China’s International Taxation System  495 volume and scope of foreign direct investment (FDI) has driven the introduction of a series of anti-avoidance rules to the income tax system on enterprises, particularly the transfer pricing rules, one of the most sophisticated and complex issues in international taxation. The enactment of the Enterprise Income Tax Law (EITL) in 2007 replaced parallel income tax systems for enterprises with foreign investment and domestic enterprises with a single tax regime for all enterprises and at the same time included a chapter on anti-avoidance.2 This happened against a backdrop of China becoming the third-largest economy in the world in 2007.3 Following the implementation of the EITL, the tax authority issued a set of legal documents detailing the application of the statutory anti-avoidance rules. Meanwhile, China’s economy continued its rapid pace of growth, surpassing Japan to become the world’s second-largest economy in 2010, a position that had been held by Japan for more than 40 years.4 With the strengthening of China’s economy and the deepening of its integration within the global economy in recent years, China has transformed from merely a rule-taker to increasingly a rule-maker in the area of international taxation.5 Nothing can exemplify this better than China’s active participation in the anti-base erosion and profit shifting (BEPS) project led by the G20 and OECD. Since 2013, China has not only keenly joined, but has influenced, the process of modifying international taxation principles and norms. It has taken domestic measures to revamp the exiting anti-avoidance rules and to craft new rules to localise new standards and rules introduced by the project. The dynamic development of China’s international taxation system reflects how open and mature the country’s economy has become. Tax avoidance typically occurs in income taxes, and it also occurs in such other areas as value added tax and excise tax.6 This paper focuses on 2 Enterprise Income Tax Law of the People’s Republic of China ((National People’s Congress (NPC), passed 16 March 2007 and effective 1 January 2008, revised and effective 24 February 2017)), c 6. 3 World Bank, ‘GDP (current US$), 2006–2008’ (World Bank, 31 Dec 2008), https://data. worldbank.org/indicator/NY.GDP.MKTP.CD?end=2008&locations=CN-GB-US-RU-DE-JPBR-FR-IT-SA&start=2006&view=chart, accessed 13 November 2018. See also A Seager, ‘China Becomes World’s Third Largest Economy’, The Guardian (14 January 2009), www.theguardian. com/business/2009/jan/14/china-world-economic-growth, accessed 11 November 2018. 4 D Barboza, ‘China Passes Japan as Second-Largest Economy’, The New York Times (15 August 2010), http://archive.nytimes.com/www.nytimes.com/2010/08/16/business/global/16yuan.html, accessed 12 November 2018. 5 China’s attitudes towards making and shaping international rules are not unique to the tax area, but many other areas as well including trade, investment, environmental protection and politics. See, for example, H Gao, ‘China’s Ascent in Global Trade Governance: from Rule Taker to Rule Shaker and, maybe Rule Maker?’, in CD Birkbeck (ed), Making Global Trade Governance Work for Development (Cambridge, Cambridge University Press, 2011) 153–80; C Schlager et al, China and the Group 20: The Interplay between A Rising Power and an Emerging Institution (New Jersey, World Century Publishing Corporation, 2017) 5. 6 A Schenk et al, Value Added Tax: A Comparative Approach 2nd edn (Cambridge, Cambridge University Press, 2015) 311–46; PLL Mo, Tax Avoidance and Anti-Avoidance Measures in Major Developing Economies (Westport, Praeger, 2003) 82; and XP Liu, ‘Tax Avoidance through

496  Yan Xu anti-avoidance rules under China’s enterprise income tax as the development of the rules most vividly reflects the evolution of the international taxation regime in the country over the last 30 years. The EITL contains both specific and general anti-avoidance rules, which are commonly seen in the income tax laws of other jurisdictions. Building upon an examination of the cause and the context for the creation of these rules and the improvement of the international taxation system, this article discusses the policy and strategies adopted by the government during the development that may impact on China’s positions and practices in developing international taxation standards and norms in the contemporary world. The paper is organised into four sections. Following the Introduction, the second section surveys the creation, modification and improvement of China’s anti-avoidance rules over the four development stages, namely the initial phase, the early stage from the 1990s to 2007, the improvement stage from 2008 to 2015, and the post-BEPS era from 2015 onwards. The third section analyses the development path of the rules, arguing that while the process has been characterised by Westernisation – transplanting legal concepts, rules, and principles from Western income tax laws or international rules that are generally followed by Western countries into China, it has started to show modernisation features that more closely reflect its own needs and that are associated with a more assertive and confident country in the international arena. THE EVOLUTION OF CHINA’S ANTI-AVOIDANCE RULES

The income tax system in China is young compared with that in advanced jurisdictions. There was no enterprise income tax in the country during the period from the establishment of the People’s Republic of China (PRC) in 1949 to 1980. The first enterprise income tax law was enacted in 1980 for the purpose of providing legal certainty to attract FDI.7 As such, the law was applied to China-foreign equity joint venture enterprises only. The law existed in parallel with another income tax law for enterprises with wholly foreign investment for around a decade.8 The two separate income tax laws were unified in 1991.9 However, the income tax system for domestic enterprises was, from the outset, separated from the system for foreign enterprises, and such separation continued for nearly

Re-imports: The Case of Redundant Trade’ (2013) 104 Journal of Development Economics 152. In China, anti-avoidance rules did not exist in the individual income tax law until the most recent amendment. Individual Income Tax Law of the PRC (NPC, passed and effective 10 September 1980, revised for the seventh time 31 August 2018 and effective 1 January 2019), art 8. 7 Income Tax Law on Chinese-Foreign Equity Joint Ventures of the PRC (NPC, issued and effective 10 September 1980, invalidated 1 July 1991). 8 Income Tax Law on Wholly Foreign-owned Enterprises of the PRC (NPC, issued 13 December 1981 and effective 1 January 1982, invalidated 1 July 1991). 9 Income Tax Law on Enterprises with Foreign Investment and Foreign Enterprises of PRC (NPC, issued 9 April 1991 and effective 1 July 1991, invalidated 1 January 2008).

The Modernisation of China’s International Taxation System  497 three decades until 2008.10 Since then, the enterprise income tax system has been developed in a way that is increasingly in line with general international norms, though it has evolved distinctive features of its own. The publication of the BEPS Final Reports in 2015 has provided an important momentum for the country to improve its anti-avoidance regime to meet its needs for further economic growth. This section discusses the evolution of anti-avoidance rules in the country against the broad background. The evolution can be divided into four stages according to the economic conditions and the rules formulated at the time – the starting point, the early stage from the 1990s to 2007, the improvement stage from 2008 to 2015, and the post-BEPS era from 2015 onwards. The Initial Phase China started its economic opening-up in four coastal cities designated as special economic zones in 1979.11 The cities were granted power to introduce beneficial policies for the promotion of economic development. Of the four selected cities, Shenzhen was considered the most successful economic zone in terms of its impressive economic growth from the start. With a convenient geographic location and beneficial policies for foreign capital, Shenzhen attracted a flood of foreign investment from Hong Kong and other jurisdictions. Despite a continuous boom of the market, many of foreign-invested enterprises reported substantial losses, while growing larger.12 As reported, in 1985, the financial accounts of around 89 per cent of foreign-invested enterprises in the city with annual sales value above 10 million yuan showed revenue losses.13 This abnormality drew the attention of the local tax authority. It was found that many revenue loss cases were related to tax avoidance through the use of related party transactions with offshore entities.14 The normal way to avoid China taxes was to transfer profits from enterprises in Shenzhen to

10 The unified EITL has come into effect from 1 January 2008, above n 2. 11 The four cities are Shenzhen, Zhuhai, Shantou and Xiamen. Decision of China Communist Party Central Committee and State Council on Approving and Forwarding the Reports of Guangdong and Fujian Provincial People’s Congresses on Special Policies and Flexible Measures for Foreign Economic Activities (Zhongfa [1979] 5) (issued and effective on 15 July 1979). 12 YK Hu, ‘Discussion on Tax Avoidance and Anti-avoidance in Shenzhen Special Economic Zone’ (1990) 1 Special Zone Economy 30, 30–31; XH Ding and C Xu, ‘On the Transformation of Joint Venture Strategy’ (1995) 3 Foreign Economics and Management 3, 4. 13 Anonymous, ‘The 30 Years’ Development of Anti-avoidance Rules in Shenzhen’, Transfer Pricing Watch, 27 November 2017 [hereinafter ‘Shenzhen Development’]. According to some other research, 45% of the foreign-invested enterprises in Shenzhen reported revenue loss in 1990, but 60% thereof was allegedly attributed to tax avoidance. See ZY Zhang, HP Zhong and J He, ‘Analysis of the Losses Suffered by Foreign-invested Enterprises in Shenzhen’, (1992) 6 International Taxation in China 25, 25–26. 10 million yuan was equivalent of US$3.4 million as of end 1985. 14 M Markham and Y Liao, ‘The Development of Transfer Pricing in China’ (2014) 29(4) Australian Tax Forum 715, 716–17.

498  Yan Xu overseas affiliates, or to book costs of offshore affiliates in the accounts of ­Shenzhen entities. However, there was no directly applicable rule to counter such tax avoidance. The implementation rules of the income tax law on foreign enterprises did contain a provision on anti-avoidance,15 but it was seriously limited to the circumstances in which a foreign-invested enterprise located in China could not verify or authenticate its costs and expenses and thus could not accurately determine its taxable income. Bilateral tax treaties might be helpful as they usually include specific provisions dealing with related party transactions. The problem is, however, treaty provisions were limited to only transactions involving associated parties in the two contracting states or jurisdictions. In the mid-1980s, while major foreign investment was from Hong Kong, Taiwan, Japan and the United States, China only had treaties with Japan and the United States.16 The lack of an appropriate legal basis to target transfer pricing with related parties prompted the Shenzhen government to formulate the Shenzhen Special Economic Zone Provisional Measures for the Administration of Transactions between Foreign-invested Enterprises and Associated Companies (‘Provisional Measures’) in 1987,17 by reference to the relevant rules in other income tax systems. The Provisional Measures were the first ever anti-avoidance rules in China, which were subsequently endorsed by the State Administration of ­Taxation (SAT) via their incorporation into Circular 376 as a central document for nationwide implementation.18 The circular established a necessary basis for subsequent formal legislation of anti-avoidance rules. It is not surprising that China’s first anti-avoidance rules were introduced in Shenzhen, a city which had the most frequent cross-border transactions in the country. For many foreign-invested enterprises, the major form of doing business in Shenzhen was manufacturing through either a related China subsidiary or an entity directly under their control and instruction. As China adopted ­residence-based taxation, the easiest way for those foreign-invested enterprises to avoid China taxes was to shift profits to a related non-resident enterprise, and the easiest way to do so was transfer pricing.19

15 Implementation Rules of the Income Tax Law on Foreign Enterprises of the PRC (Ministry of Finance (MOF), issued 21 February 1982 and effective 1 January 1982, invalidated 1 July 1991). 16 China concluded 16 bilateral tax treaties between 1983 and 1986. See ‘Tax Treaties’ (State Administration of Taxation (SAT)), www.chinatax.gov.cn/n810341/n810770/index.html, accessed 13 November 2018. The China-Japan tax treaty was signed on 6 September 1983 and effective 26 June 1984, applicable since 1 January 1985. The China–US tax treaty was signed on 30 April 1984 and effective 21 November 1986, applicable since 1 July 1987. Both the treaties had an article on associated enterprises. China–Japan tax treaty, art 9. China–US tax treaty, art 8. 17 Provisional Measures (Shenfu [1987] 464) (Shenzhen Municipal People’s Government, issued 19 November 1987 and effective 1 January 1988). 18 See Markham and Liao, above n 14. The State Administration of Taxation was renamed as ‘State Tax Administration’ in early 2019. 19 This phenomenon is rightly noted in Avi-Yonah’s book on international tax, see Avi-Yonah, above n 1, 102.

The Modernisation of China’s International Taxation System  499 The Early Stage: From the 1990s to 2007 The Shenzhen practices and experience in combating tax avoidance contributed to the enactment of the formal anti-avoidance rules in 1991 in the unified Income Tax Law on Enterprises with Foreign Investment and Foreign Enterprises (ITLEF). Article 13 of the Law stipulates that the dealings between a foreign-invested enterprise (or an establishment or a place of a foreign enterprise) in China and its associated enterprises should be made in the same manner as independent enterprises; and where the transfer prices between associated enterprises resulted in a reduction of taxable income in China, the tax authorities were empowered to make reasonable adjustment. The statutory provision was the first attempt of China’s legislature to establish the arm’s-length principle and the transfer pricing mechanism that was commonly found in a modern tax system. The provision was further fleshed out in the detailed implementation rules of the law,20 which included definitions of associated enterprises and related party transactions, and several transfer pricing methods such as the comparable uncontrolled price, resale price and cost plus methods.21 The enactment of Article 13 and its detailed rules ‘marked the inauguration of transfer pricing laws and regulations’ in China.22 The application of the transfer pricing rules was however limited to only foreign-invested enterprises. In other words, there were no legal rules to attack related party transactions engaged by domestic enterprises. Such limitation and its consequent problems soon emerged. The continuous expansion of the economic reform in the late 1980s and the availability of preferential tax treatments to foreign-invested enterprises only allured many domestic enterprises into manipulating their business structures to take advantage of the preferential tax treatments.23 Tax avoidance spread to domestic enterprises and became increasingly prevalent. The scope of tax avoidance activities engaged in by these enterprises crawled out to involve such complicated issues as intangible assets and corporate group financing.24 As a response to the lack of necessary legal rules to tackle the problem, the national legislature introduced a provision on associated enterprises in the Law on Tax Collection and Administration (LTCA) in 1992. The provision expanded the scope of transfer pricing rules to domestic enterprises.25 Details of the provision in the LTCA implementation rules were 20 Implementation Rules of the Income Tax Law on Enterprises with Foreign Investment and Foreign Enterprises (State Council, issued 30 June 1991 and effective 1 July 1991, invalidated 1 ­January 2008), c IV. 21 ibid, arts 52–58. The transfer pricing methods were to be applied in sequence. 22 See Markham and Liao, above n 14, 715, 718. 23 ‘Merger of Enterprise Income Taxes on Domestic and Foreign Enterprises: “Fake Foreign Enterprise” Frustrated with Various Industrial Impacts’, China Business News (14 March 2007), www. lianghui.org.cn/economic/txt/2007-03/14/content_7956620_4.htm, accessed 14 November 2018. 24 ZT Wang, ‘The Legal System on China’s General Anti-Avoidance Rules’ (Doctorate Dissertation, Wuhan University, 2013) 219. 25 LTCA (NPC Standing Committee, issued 4 September 1992 and effective 1 January 1993), art 24.

500  Yan Xu rather similar to those in the ITLEF and its implementation rules.26 The extension of the transfer pricing rules to domestic enterprises was followed in the enactment of the Provisional Regulations on Enterprise Income Tax (PREIT) in 1993, a quasi-law applying to domestic enterprises.27 Only after the adoption of the LTCA and the PREIT did the transfer pricing rules, one of the most important anti-avoidance rules in international taxation, begin to apply to both foreign and domestic enterprises in China. The transfer pricing rules were further improved by subsequent regulations and rules. A particular set of administrative measures on taxation of related party transactions was issued by the SAT in 1998 and revised in 2004, providing concrete guidelines on transfer pricing issues related to trade and use of tangible assets, use and transfer of intangible property, and provision of services and financing.28 In the revised implementation rules of the LTCA in 2002, the use of transfer pricing methods was changed from an emphasis on the sequence of the methods to discretionary decisions. That is, the tax authority could choose any of the specified methods that they thought was appropriate to the transactions in question.29 The revised rules also included a statute of limitation provision, allowing up to three years for tax adjustment related to transfer pricing from the date when the transaction in question was completed.30 The three-year limitation may be extended to a 10-year limitation in some special circumstances with the relevant determination rules being clarified in a SAT circular in 2003.31 An important development included in the 2002 revision was the introduction of advanced pricing arrangements (APAs), a mechanism that allows the taxpayers to obtain more legal certainty on transfer pricing matters.32 The mechanism followed the international rules and practices at the time, in particular the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations (‘OECD TP Guidelines’). Details for implementing the mechanism were provided in a SAT circular, which covered a range of issues from application procedures, scope of pricing arrangements, mandatory documentations, to ex-post supervision.33 Following the introduction of APAs, Shenzhen

26 Implementation Rules of the LTCA (State Council, issued and effective 4 August 1993, invalidated 15 October 2002), arts 36–41. 27 PREIT (State Council, issued 13 December 1993 and effective 1 January 1994, invalidated 1 January 2008), art 10. 28 SAT Administrative Measures on Taxation of Related Party Transactions (Guoshuifa [1998] 59, issued and effective 23 April 1998; Gaoshuifa [2004] 143, revised and effective 22 October 2004). 29 Implementation Rules of LTCA (State Council, issued 7 September 2002 and effective 15 ­October 2002), art 55. 30 ibid art 56. 31 SAT Notice on Several Issues concerning Implementation of LTCA and Implementation Rules of LTCA (Guishuifa [2003] 47, issued and effective 23 April 2003), art 12. 32 Implementation Rules of LTCA, art 53. 33 SAT Notice on Distributing the Implementation Rules on Advance Pricing Arrangement for Related Party Transactions (Trial) (Guoshuifa [2004] 118, issued and effective 3 September 2004, invalidated 1 January 2008).

The Modernisation of China’s International Taxation System  501 tax authority concluded the first bilateral APA with Japan tax authority in 2005. The second bilateral APA was concluded between the United States and China for a US-invested enterprise located in Shenzhen in 2007. The second APA involved complicated transactions in intangibles and intra-company services, and, significantly, the methods established in this APA have continued to apply till the present day.34 Operational rules for tax administration in the field of transfer pricing were also developed in this period. The first set of such rules, Tax Administrative Procedures on Transactions between Associated Enterprises issued in 1998, were formulated by reference to the OECD TP Guidelines and conventional practices in the field. The Administrative Procedures were further revised and improved in 2004, establishing necessary rules on administration of important issues such as determination of associated enterprises, selection of transfer pricing methods, tax audit, and disputes resolution.35 Administrative capacity-building was developed too. In view of the lack of administrative capacity to address complicated tax avoidance cases, it is Shenzhen that once again took the lead in forming China’s first, formal Anti-Avoidance Unit in 1991. Such approach soon became the major administration model for other tax authorities in the country to adopt. The Shenzhen Unit investigated over 400 foreign-invested enterprises and sought tax repayment of about 100 million yuan over a period of five years since its establishment.36 Nonetheless, in combating tax avoidance, the tax authority often found it was constrained by a shortage of information about foreign investors’ offshore operational and financial conditions.37 Imposing reporting and verifying obligations on taxpayers was thus thought of vital importance to build an effective anti-avoidance system. It was due to this concern that the SAT started drafting rules on exchange of information in tax matters in the early 2000s. In 2006, it issued ‘The Administrative Procedures on International Exchange of Tax I­ nformation’,38 providing rules on key issues such as the scope and type of information to be exchanged, the use of exchange methods, and information protection. The Procedures remain effective.

34 M Godfrey, ‘US And China Reach Landmark Advance Pricing Agreement’, Wolters Kluwer Tax-News (17 January 2007), https://www.tax-news.com/news/US_And_China_Reach_­Landmark_ Advance_Pricing_Agreement____26071.html, accessed 18 January 2019; see also LT He and LX Zeng, ‘An Analysis of the Differences between Unilateral, Bilateral and Multi-lateral APAs’, Lexis China (31 July 2007), https://hk.lexiscn.com/law/prof_articles_content.php?article_id=21636& lang=en, accessed 18 November 2018. 35 Tax Administrative Procedures on Transactions between Associated Enterprises (Guoshuifa [2004] 143) (SAT, issued 23 April 1998 and revised 22 October 2004). 36 CD Huang, ‘Hong Kong Taxation System and Reflection on Anti-Avoidance in Shenzhen’ (1996) 12 China Opening Journal 38, 40. 100 million yuan was equivalent to US$12 million as of end 1995. 37 ibid. 38 SAT Notice on Issuing the Administrative Procedures on International Exchange of Tax Information (Guoshuifa [2006] 70, issued and effective 18 May 2006). This document consolidated two previous tax circulars on information exchange, namely Guoshuifa [2001] 3 and Guoshuihan [2002] 931.

502  Yan Xu As can be seen, significant progress was made in legislation (in a broad sense) and administration of anti-avoidance rules during this period. The rules were broadened to target new types of tax avoidance activities, and extended from foreign enterprises to domestic enterprises. Many tax circulars issued in the period were related to transfer pricing.39 As in many jurisdictions, transfer pricing in China was the most significant area of tax avoidance by multinational enterprises (MNEs), and as such transfer pricing rules must be robust enough to address it. The Improvement Stage: From 2008 to 2015 The enactment of the EITL in 2007 can be regarded, to a large extent, as a milestone in the modernisation of China’s tax law. It created a level playing field for all enterprises doing business in China. The unified legislation introduced a chapter on special tax adjustment to counter tax avoidance, and it is in this aspect that the legislation marked a new stage of the development of China’s anti-avoidance rules and its international taxation system. The EITL does not only include transfer pricing rules that had been applied in China for around twenty years, but for the first time set up thin capitalisation rules, CFC rules, and other specific rules that are typically applied in an advanced income tax system. Most importantly, it contains a general anti-avoidance rule (GAAR) in ­Article  47. Only from the legislation of the EITL can China be said to have created a comprehensive anti-avoidance regime. The statutory anti-avoidance provisions are rather general, however. In order to implement the rules, the SAT issued the Implementation Measures on Special Tax Adjustment (Trial) in 2009 (‘2009 Measures’), which have been retroactively applied from 1 January 2008, the date when the EITL came into effect. While the 2009 Measures are merely a normative document, they are of practical importance as they provide the most needed substantive and procedural rules for tax

39 For example, SAT Notice on Several Tax Issues concerning Enterprises with Foreign Investment and Chinese-Foreign Equity Joint Ventures Engaged in Exploitation of Petroleum Resources and Project Contracting Services (Guoshuifa [1991] 191, issued 27 November 1991 and effective 1 July 1991, invalidated 4 January 2011), which related to the application of arm’s-length principle on inter-company borrowing; SAT Notice on Tax Issues concerning Enterprises with Foreign Investment and Foreign Enterprises Engaged in Consultation Business (Guoshuifa [2000] 82, issued 12 May 2000 and effective 1 June 2000, invalidated 1 January 2009), which was about profits allocation of related party transactions between enterprises engaged in consultation business; SAT Notice on Tax Issues concerning Services Provided by Enterprise with Foreign Investment to Their Subsidiaries (Guoshuifa [2002] 128, issued 28 September 2002 and effective 1 January 2003, invalidated 4 January 2011), which was about services fee allocation methods between foreign-invested companies and their branches; and SAT Notice on Tax Administration of Transfer Pricing of Related Party Transactions (Guoshuihan [2006] 901, issued and effective 28 September 2006), which related to accounting adjustment of related party transactions. See also JY Nie, ‘Reflections on Anti-Tax Avoidance Legislation Process in China’ (2008) 2 Taxation Research 68, 68–69.

The Modernisation of China’s International Taxation System  503 administration and compliance. This section discusses the development of the statutory anti-avoidance rules with a particular focus on the GAAR. Development of the Transfer Pricing Rules A great deal of emphasis is placed on transfer pricing in the 2009 Measures: half of the total 12 chapters directly relate to transfer pricing issues, including general issues such as transfer pricing reporting and documentation, transfer pricing methods and APAs, and special issues on cost sharing agreements concerning intangibles and services.40 The chapter on tax adjustment and mutual agreement procedure is also applicable to transfer pricing. The design of many of the rules was influenced by the OECD TP Guidelines, the OECD and UN Model Tax Conventions and the US transfer pricing rules,41 and as such, China’s transfer pricing rules can be viewed as generally in line with international standards and practices. The rules by this stage have become more comprehensive and complicated than those created two decades ago. The evolvement can be attributed partly to the rapid development of the underlying economy that was characterised by increased volume and frequency of international trade and investment, and partly to the aggravation of sophisticated, aggressive transfer pricing manipulation by MNEs. The new law and particularly the 2009 Measures increase the standards on reporting and documentation, strengthen the penalties on non-compliance, and improve the rules on APAs.42 While the legal framework on transfer pricing was improved and transfer pricing investigations became stricter in this period, the implementation of the rules was still not very satisfactory at the local levels. The reason for local inefficiency was that local governments, especially those in lessdeveloped regions, generally lacked administrative capacity to deal with transfer pricing cases, which were usually complicated and required adequate knowledge and skills.43 Another reason was even if they had the capacity, they may be reluctant to do so due to concerns of discouraging foreign investment.44 To address the problem and to enhance anti-avoidance administration in general, the SAT started to create a national anti-avoidance information system in 2011 and the system has been continuously improved to meet the needs of law enforcement in taxation.45 Indeed, an information system has proved to be helpful in

40 2009 Measures, cc 2–6, 7, 11. 41 Markham and Liao, above n 14, 725–26, 728–30, 732. 42 JL Ho, ‘How to Train a Toothless Dragon: Finding Room for Improvement in China’s Transfer Pricing Regulations’ (2014) 54(2) Virginia Journal of International Law 437, 462. 43 ibid. 44 ibid. 45 SAT, ‘SAT Issued Opinions on the Construction of International Tax Administration System’ (23 May 2012), www.chinatax.gov.cn/n6669073/n11561411/11997820.html. Cited in Markham and Liao, above n 14, 721. SAT Opinion on Stepping up the Construction of International Tax Administration System (Guoshuifa [2012] 41, issued and effective 27 April 2012).

504  Yan Xu anti-avoidance audits and investigations as it provides necessary and up-to-date information for assessing whether associated enterprise transactions follow the arm’s-length principle. The SAT identified multinationals’ transfer pricing manipulation as a core factor causing base erosion and profit shifting, and accordingly it allocated more administrative resources to deal with it.46 The improved rules on exchange of tax information and the strengthened international cooperation in tax matters helped play a role in dealing with transfer pricing manipulation.47 Despite the improvement, transfer pricing rules alone could not address all forms of tax avoidance. The inclusion of other specific rules, typically the thin capitalisation and CFC rules, was necessary and could be used as an effective weapon to combat specific tax avoidance techniques relating to associated party borrowing and tax havens.48 Creation and Development of the GAAR One of the most significant elements of the international tax regime was the adoption of a GAAR during this development period.49 A GAAR has been recognised by many governments as a powerful instrument and also a last resort to attack tax avoidance activities that could not be effectively countered by specific anti-avoidance rules.50 The objective of adopting a GAAR is to ensure tax compliance with both the letter and the spirit of the law. Like most other GAARs, the Chinese GAAR is designed to attack transactions designed for the sole or main purpose of obtaining a tax benefit when the underlying transaction would normally be carried out using other arrangements that attract a higher tax liability. The statutory provision, Article 47 of the EITL, provides: Where an enterprise enters into other arrangements without reasonable commercial purpose and whereby resulting in a reduction of taxable income or taxable gross revenue, the tax authority shall have the authority to make adjustment using appropriate methods.

The scope of the provision is narrow compared to counterparts abroad, with no application to schemes that increase credits or, importantly, to arrangements that delay the recognition of gains or accelerate the recognition of deductions. However, the administration has attempted to overcome the limitations of the statutory provision by defining the critical term ‘without reasonable 46 QY Wu, ‘Annual Anti-Avoidance Contribution Tax Up to 46.8 Billion, Many Multinational Companies Shift Profits’ People’s Daily Online (13 October 2014), http://finance.people.com. cn/n/2014/1013/c1004-25820009.html, accessed on 11 December 2018) (46.8 billion yuan equalled approximately US$7.7 billion as on 31 December 2013). 47 Markham and Liao, above n 14, 721. 48 EITL, arts 45–46. 2009 Measures, cc 8–9. 49 For a detailed analysis of China’s GAAR, see Y Xu, ‘China’s General Antiavoidance Rule and Its Commitment to the Exchange of Information’ (2018) 91(4) Tax Notes International 345. 50 C Waerzeggers and C Hillier, ‘Introducing a General Anti-avoidance Rule (GAAR) – Ensuring that a GAAR Achieves Its Purpose’ Tax Law IMF Technical Note 2016/1 (IMF, 2016).

The Modernisation of China’s International Taxation System  505 c­ ommercial purpose’ in A ­ rticle 120 of the Implementation Regulations of the EITL as having the main purpose to reduce, avoid or delay tax payment. Achieving any of the tax ­benefits would suffice for the application of the GAAR unless taxpayers can prove there is a reasonable commercial purpose, which presumably outweighs the tax purpose.51 The statutory provision is legislated generally without necessary guidance on, among other things, the determination of tax benefits, the ascertaining of tax purposes, and the use of tax adjustment methods. The general legislation caused difficulty to tax administration and uncertainties to taxpayers.52 The 2009 Measures thus came into play. The chapter on GAAR under the Measure specifies four types of tax avoidance arrangements with one catch-all category, which includes abuse of preferential tax treatments, abuse of tax treaties, abuse of corporate organisation forms, use of tax havens to avoid taxes, and any other arrangement without reasonable commercial purpose.53 The Measures introduced the ‘substance over form’ principle – a principle that is not stipulated in the EITL – for determination of whether there exists a tax avoidance arrangement.54 A number of factors are provide for the application of the principle, including the timing and execution period of an arrangement, the manner by which an arrangement was materialised, changes in the financial situations of each party involved, and the tax results of the arrangement.55 The factors are not too dissimilar to those applied in other GAARs, such as the Australian GAAR, but the factors in other GAARs are typically used to determine whether the sole or main purpose is to obtain a tax benefit.56 For the GAAR to apply, a tax avoidance arrangement so determined must lead to a tax benefit, which was defined in the Implementation Regulations of the EITL as noted above. However, neither the law nor the 2009 Measures have provided guidance on how to identify the tax benefit in question. Similarly, in determining whether an arrangement’s main purpose was to obtain a tax benefit, there is no further guidance in the 2009 Measures, and the determination goes back to the assessment of whether there was a tax avoidance arrangement – an arrangement without reasonable commercial purpose but to obtain a tax benefit. The ascertaining of a main purpose for tax avoidance usually takes the largest part of a GAAR legislation and legal jurisprudence in other jurisdictions, but in China, the GAAR legislation in this aspect is redundant and inadequate. As regards tax adjustment, the 2009 Measures state that a tax adjustment can be made to recharacterise the arrangement or the activity in question according to its ‘economic substance’ and to cancel the tax benefits obtained therefrom, 51 Art 120 does not directly spell out the weighing between commercial purposes and tax purposes of an arrangement or transaction in question. But the wording seems to suggest the former should be more central or critical than the latter in order for the arrangement not to be caught by the GAAR. 52 Wang, above n 24, 231–32. 53 2009 Measures, c 10, art 92. 54 2009 Measures, c 10, art 93. 55 2009 Measures, c 10, art 93. 56 Xu, above n 49, 349.

506  Yan Xu and, an enterprise without ‘economic substance’, particularly the one located in a tax haven that caused tax avoidance of its affiliates, should be disregarded.57 It can be seen that the Implementation Measures use the term ‘economic substance’ to mean a variety of unrelated concepts – in terms of transactions, the economic outcome and in terms of entities, the absence of business activities or business assets. A difficult question is how ‘economic substance’ can be determined in these greatly different contexts. The concept of ‘economic substance’ in terms of outcome of transactions seems to be borrowed from the US judicial doctrines and subsequently codified doctrine of economic substance.58 The doctrine contains an objective test and a subjective test for the evaluation of whether a transaction has economic substance and the former test has been given much more weight than the latter in judicial practices.59 Unlike the US doctrine, the Chinese requirement of ‘economic substance’ is merely set out in the text without accompanying guidance for its application. The abstract drafting inevitably creates space for administrative discretion and arbitrary implementation thus could not be easily avoided in practice.60 Indeed, while the 2009 Measures have provided some necessary rules for the GAAR application, they seem to have raised more questions and caused more confusion than what they have solved. Particularly, the wording and the application of the ‘substance over form’ principle in practice seem to suggest that an arrangement would be regarded as a tax avoidance arrangement insofar as it was determined that the legal form of an arrangement was inconsistent with its economic substance. The particular emphasis on the principle would make the application of the statutory business purpose test marginal. Development of Anti-avoidance Rules on Indirect Transfers A rather important development during this period is to use the statutory GAAR to tax indirect transfers of equity interests in an overseas entity by non-resident taxpayers. For around 30 years since China’s economic reform launched in late 1978, many foreign investors had been using interposed intermediate subsidiaries in a low- or non-tax jurisdiction to hold their China investment and to exit from China through disposing of the shares of the interposed subsidiaries offshore. This mechanism could allow foreign investors not only to avoid Chinese capital gains tax but to enjoy benefits of reduced withholding tax rates on investment 57 2009 Measures, art 94. 58 The doctrine was developed by the US courts. One of most important cases is Coltec Industries, In. v United States 454F 3d 1340 (Fed Cir 2006). The judicial doctrine was enacted as section 7701(o) of the Inland Revenue Code 26 USC by s 1409 of the Health Care and Education Reconciliation Act of 2010 (Pub L 111-152) in the United States. 59 There have been discussions about various aspects of the application of the doctrine in the United States. See, generally, D Hariton, ‘When and How Should the Economic Substance Doctrine be Applied’ (2006) 60 Tax Law Review 29, 53. 60 Xu, above n 49, 351.

The Modernisation of China’s International Taxation System  507 income if the interposed subsidiaries were resident in a jurisdiction that had a tax treaty with China. The use of such an offshore holding structure may have some business purposes such as circumventing the very tight foreign currency control in China, but very often it had taxation motives too. In the view of the Chinese tax authority, the major purpose of engaging in such arrangements by non-resident enterprises was to avoid China tax, which caused significant revenue loss to the government. Such loss could be enlarged without specific measures to close the loophole. From their perspective, the only applicable rule against such tax avoidance is the GAAR. However, the statutory provision is too general to effectively deal with indirect share transfers. To address this obstacle, the SAT formulated Circular 698 in 2009, which became retroactively effective from 1 January 2008.61 The circular has been one of the most controversial tax circulars in China since its issuance due to its questionable legal validity and potential significant impacts on foreign investment. According to this circular, if an indirect transfer of shares of a Chinese resident enterprise was determined as having no reasonable commercial purpose but avoiding, reducing or deferring Chinese tax, the tax authority was empowered to recharacterise the transfer according to its economic substance and disregard the existence of the offshore holding subsidiary.62 The legality of Circular 698 is questionable in the sense that neither domestic law nor bilateral tax treaties concluded by China at the time allowed China to tax capital gains generated from offshore transfers of shares in an offshore company. The ETIL provides that a non-resident enterprise is only liable to China tax on income or profits sourced within China,63 and the source of capital gains derived from sale of shares or equity interests is to be determined according to the location of the invested enterprise.64 Logically, where a non-resident enterprise transferred the shares of an offshore holding subsidiary, the source of gains from the transfer was not within China and thus should not be subject to Chinese tax. However, the Chinese tax authority contended that the offshore holding company had to be looked through as it lacked ‘economic substance’ (in the sense of the second meaning of the term used by the tax administration) and its existence did not have a reasonable commercial purpose but for avoiding Chinese tax, and thereby warranting a GAAR application. Where there is a tax treaty between the country of residence of the offshore transferor and China, the treaty applies as China adopts a monist system for giving legal effect of tax treaties in the domestic legal system. However, although some bilateral tax treaties which China entered into at the time allowed China to tax capital gains from direct transfers of shares or equity interests of a Chinese resident enterprise, 61 SAT Notice on Strengthening the Administration of Enterprise Income Tax on Equity Transfers by Non-resident Enterprises (Guoshuihan [2009] 698, issued 10 December 2009 and effective 1 ­January 2008, invalidated1 December 2017) (hereinafter Circular 698). 62 ibid art 6. 63 EITL, art 3. 64 Implementation Regulation of EITL (State Council, issued 6 December 2007 and effective 1 January 2008), art 7(3).

508  Yan Xu none of the treaties allowed China to impose tax on capital gains from offshore transfers of shares or equity interests of non-resident companies. The treaty provisions could be overridden by domestic GAAR only if there was abuse of the treaty. It would be too great a stretch to argue an indirect share transfer abused a tax treaty. Applying the circular to tax indirect share transfers may cause taxation of the offshore transferor on the deemed sale and the actual sale of the holding company, which was contrary to the treaty.65 The trigger for Circular 698 was a number of transactions uncovered by tax officials prior to the introduction of the GAAR in 2008.66 It was not until Circular 698 that China for the first time laid down an administrative procedure on taxation of indirect share transfers.67 This circular had a de facto extraterritorial effect on foreign investors. Despite its controversial legality, the circular signalled that the China tax authority has become more assertive and capable in applying the anti-avoidance rules to target what they perceived as aggressive tax avoidance, however controversial the relevant rules may be. The change of practices in China can be considered as a response to the overall change of the global economic environment and the development of anti-avoidance rules after the global financial crisis around 2008. The crisis at the time posed significant revenue challenges to the governments around the world, driving them to try every means to protect their tax revenue interests.68 China was no exception in this respect. Development of Rules on Tax Treaty Abuse Since China concluded its first bilateral tax treaty with Japan in 1983, it has developed one of the most extensive treaty networks in the world. By 2013, it had 99 tax treaties with sovereign jurisdictions and two tax arrangements with its special administrative regions of Hong Kong and Macau.69 As tax treaties usually provide reduced withholding tax (WHT) rates on passive income including interest, dividends and royalties from the source state, foreign investors would always have the incentive to obtain reduced WHT rates through a treaty, and to utilise the treaty that contains the most favourable tax benefits. In China’s case, foreign investors could structure their business so as to have an 65 Some tax treaties recently concluded by China include specific articles allowing treaty override by domestic anti-avoidance rules, but treaty override is only available to the extent the domestic antiavoidance rules do not cause taxation contrary to the treaty. 66 For example, the Chongqing case was believed to be the first indirect share transfer case in China. In the case, an offshore special-purpose vehicle company was ignored on the ground that it had no economic substance and its existence was solely for the purposes of avoiding China tax. There were a number of other taxes prior to the issuance of Circular 698. DK Cheung, ‘Update on General Anti-Tax Avoidance Rules in China’ (2012) 38(1) International Tax Journal 35, 36–37. 67 For example, Circular 698 contained provisions on reporting requirements of the offshore transferor and on allocation methods of purchase price in a merger and acquisition transaction. Circular 698, arts 4, 5. 68 ‘China Reinforces Tax Administration of Share Transfers by Non-resident Enterprises’ (Mayer Brown JSM, 23 December 2009), www.mayerbrown.com/public_docs/China-Reinforces-TaxAdministration.pdf, accessed 14 November 2018. 69 SAT, Tax Treaties, www.chinatax.gov.cn/n810341/n810770/index.html, accessed 22 November 2018.

The Modernisation of China’s International Taxation System  509 entity located in the jurisdiction that has the most favourable tax treaty with China if their country of residence has no treaty with China or the tax benefits offered in the treaty between their country of residence and China are less beneficial than those in the most favourable treaty. Thus, treaty shopping or treaty abuse occurs. To combat such potential tax avoidance, China’s tax authority introduced Circular 601 in 2009, requiring the applicant for reduced WHT rates to be a ‘beneficial owner’ (BO).70 In defining the term ‘beneficial ownership’, the circular stipulated that the BO should usually carry on substantial business operations and an agent or conduit company is not a BO.71 It further explained that a conduit company was usually established for the purposes of avoiding or reducing taxes or shifting profits, and while it was located within the contracting state to satisfy the organisation form as required by law, it did not engage in such substantial business operations as manufacturing, trading or management.72 The ‘substance over form’ principle was adopted, once again, in the circular for the determination of whether an applicant was a BO,73 and, such determination, as provided in the circular, would go beyond a merely technical or domestic law interpretation to take into account the purpose of the tax treaty.74 From an international perspective, it is common to require an applicant for treaty benefits to be a BO. What distinguishes China from other jurisdictions is China put a particular emphasis on the economic substance an applicant must have (in the second meaning of the term used by the tax administration) for it to be recognised as a BO, whereas the international practices focus solely on the applicant’s degree of control over the income for which the reduced rates were sought.75 The China approach had huge impacts on non-resident investors in China. However, similar to Circular 698, Circular 601 did not explain how to assess ‘economic substance’, except for providing a number of negative factors that may lead an applicant to be disregarded as a BO. Unsurprisingly, the very general drafting of Circular 601 caused many uncertainties to taxpayers, and the lack of necessary administrative procedural rules caused difficulties to tax administration too. The SAT subsequently issued two circulars to address the problems caused by Circular 601.76 70 SAT Notice on the Understanding and Determining of ‘Beneficial Ownership’ in Tax Treaties (Guoshuihan [2009] 601, issued and effective 7 October 2009, invalidated 1 April 2018) (hereinafter Circular 601). 71 Circular 601, art 1. 72 ibid. 73 Circular 601, art 2. 74 ibid. 75 See KM Ho and L Lu, ‘China: Tax Treaty Relief Clarifications Issues’, International Tax Review, 27 February 2018), www.internationaltaxreview.com/Article/3790211/China-Tax-treatyrelief-clarifications-issued.html, accessed 14 November 2018; see also DM Qiu, ‘The Concept of ‘Beneficial Ownership’ in China’s Tax Treaties – The Current State of Play’, (2013) Bulletin of International Taxation 2. 76 SAT Notice on Issuing Provisional Measures on Non-residents’ Entitlement to Treaty Benefits (Guoshuifa [2009] 124, issued 24 August 2009 and effective 1 October 2009, invalidated 1 November 2015); SAT Announcement on Identification of ‘Beneficial Owners’ in Tax Treaties (Gonggao [2012] 30, issued and effective 29 June 2012, invalidated 1 April 2018).

510  Yan Xu Modification of the Anti-avoidance Rules around the BEPS Probably the most significant development in international taxation in recent years is the BEPS project led by the G20 and OECD. Many MNEs used various tax avoidance techniques, including treaty shopping and transfer pricing, to avoid taxes and to shift profit from high-tax jurisdictions to low- or no-tax jurisdictions. Some high-profile tax avoidance cases uncovered at the time provided a critical momentum for the launch of the project.77 The OECD estimated that the global revenue losses due to BEPS could be between 4 percent to 10 percent of global corporate income tax revenues.78 The estimated revenue losses were so enormous that the stakes combating BEPS ran high, particularly at a time when many governments fell into financial difficulty resulting from the global financial crisis. An overhaul of the then-existing international taxation rules was believed necessary to ensure that profits are taxed where economic activities take place and value is created.79 The OECD identified 15 action plans to deal with BEPS problems in its Final Reports in 2015, which were endorsed by the G20 and supported by many governments.80 China has actively participated in the BEPS project since its launch. The active involvement can partly be explained by the government’s concern about serious revenue loss due to BEPS and partly by its ever-increasing interests in, and integration with, the global economy. The participation allows China to have an opportunity to shape the modification of international taxation rules that may better protect its taxing rights and reflect its taxation interests. The OECD Final Reports have sweeping impacts on the development of international taxation rules in China, as in many jurisdictions. During the period from 2013 to 2015, the SAT issued a series of tax circulars to implement the measures introduced by the Final Reports and to address special problems occurring in the country. One of the most important circulars introduced in this period is the Administrative Measures for the GAAR (Trial) (‘GAAR Measures’).81 The GAAR Measures were issued in 2014 for the purpose of improving the rules on GAAR application and enhancing transparency in tax administration.

77 For example, the tax avoidance cases related to Google, Apple and Starbucks attracted great attention from governments and the general public. See, for example, A Melin and L Baker, ‘Factbox: Apple, Amazon, Google and Tax Avoidance Schemes’, Reuters (22 May 2013), www.reuters. com/article/us-eu-tax-avoidance/factbox-apple-amazon-google-and-tax-avoidance-schemesidUSBRE94L0GW20130522, accessed 9 December 2018; V Barford and G Holt, ‘Google, Amazon, Starbucks: The Rise of “Tax Shaming”’, BBC News Magazine (21 May 2013), www.bbc.com/news/ magazine-20560359, accessed 9 December 2018. 78 OECD, OECD/G20 Base Erosion and Profit Shifting Project Explanatory Statement: 2015 Final Reports (Paris, OECD, 2015) 4 (hereinafter OECD Final Reports). 79 OECD, ‘Addressing Base Erosion and Profit Shifting’ (12 February 2013), www.oecd.org/tax/ addressing-base-erosion-and-profit-shifting-9789264192744-en.htm, accessed 14 November 2018. 80 OECD, Action Plan on Base Erosion and Profit Shifting (Paris, OECD, 2013); see also OECD Final Reports, above n 78. 81 Administrative Measures for General Anti-Tax Avoidance (Trial) (SAT, issued 2 December 2014 and effective 1 February 2015).

The Modernisation of China’s International Taxation System  511 The GAAR Measures could not be issued at a better time: this tax circular would allow the statutory GAAR provision to be used more extensively in the midst of combating abusive tax practices identified by the BEPS project.82 The GAAR Measures are noteworthy in respect of both the substance of the Measures themselves and, equally significantly, the procedural rules developed to administer the GAAR. The substantive rules define a tax avoidance arrangement to have two ­characteristics – first, a sole or dominant purpose of obtaining a tax benefit, and, second, following the adoption of an ‘economic substance’ test in the 2009 Implementation Measures, the legal structure of the transaction is inconsistent with the legal form normally used to achieve a particular ‘economic substance’.83 In an explanation of the GAAR Measures, the SAT stated that ‘the fact that a tax advantage has been obtained does not necessarily make an arrangement subject to GAAR’.84 This suggests that if an arrangement could be shown to have economic substance, the arrangement would not be caught by the GAAR, even though it may have the main purpose of obtaining a tax benefit. Conversely, an arrangement that adopts a legal form inconsistent with the economic substance of the outcome and that consequently results in a tax benefit would likely be caught by the GAAR, even enough there is a bona fide purpose to the adoption of the particular arrangement.85 While the explanation might have improved the too simplistic definition of what amounts to a lack of ‘reasonable commercial purpose’ under the implementation regulations of the EITL, its emphasis on ‘economic substance’ leaves little room for the application of the ‘reasonable commercial purpose’ test set out in the primary legislation. The detailed procedural provisions for tax administration that accompanied the substantive GAAR provision established stringent rules on responsibilities and obligations of tax authorities at different phases and levels of investigation.86 The enhanced procedural control may help improve consistency and transparency in GAAR administration, which was a problem in previous practices. In addition, a mutual agreement procedure has been introduced to provide taxpayers with an alternative dispute resolution option where an investigation results in international

82 It was made clear in the promulgation of the GAAR Measures that China committed to the BEPS project, and the release of the Measures was to materialize the commitment made by China’s President Xi in the ninth G20 Summit in November 2014 on strengthening international tax cooperation and combating international tax evasion and avoidance. SAT, ‘SAT Regulates the Administration of the GAAR: Implementing the G20 Tax Reforms and Combating International Tax Avoidance’ (12 December 2018), www.chinatax.gov.cn/n810219/n810724/c1395201/content.html, accessed 14 November 2018. See also Xu, above n 49, 348. 83 GAAR Measures, art 4. 84 SAT, ‘Press Release: Replies to Questions on the Administrative Measures for the GAAR (Trial) by In-Charge SAT Officials’ (12 December 2014), www.chinatax.gov.cn/eng/n2367726/c2373898/ content.html, accessed 24 November 2018. 85 See Xu, above n 49, 350. 86 GAAR Measures, cc II–V.

512  Yan Xu double taxation or tax collection in a cross-border transaction involving a jurisdiction that has a tax treaty with China.87 This measure is consistent with current international practice on disputes resolution relating to tax treaties. As noted above, a special application of China’s GAAR is taxation of indirect transfers by non-resident investors. In response to the criticisms of Circular 698 for its controversial legal validity, vague drafting and de facto extraterritorial effect on non-resident taxpayers, the SAT replaced it with Circular 7 in 2015.88 While improving the rules on indirect transfers, the new circular broadens the scope of targeted assets to include not only previously covered shares, but similar interests, and immovable property and assets attributed to an establishment of a non-resident enterprise in China.89 It also widens the meaning of the term ‘indirect transfers’ to include straightforward transfers of offshore holding companies directly or indirectly owning Chinese taxable assets, and reorganisations that result in a change in the shareholders of the offshore holding company.90 Once an indirect transfer is determined as having no reasonable commercial purpose, it will be recharacterised as a direct transfer of shares or assets of a resident enterprise and thus be subject to the GAAR.91 The extension and recharacterisation could have a huge impact on the tax liability of foreign investors. Probably as a way to neutralise such impact, the new circular improves the rules on the assessment of reasonable commercial purpose, which increases the legal certainty on this issue.92 The new circular is sensibly designed to refocus on the ‘reasonable commercial purpose’ test rather than excessively relying on the ‘substance over form’ principle. This might help clarify the confusion caused by the 2009 Measures and the GAAR Measures, and prevent potential abuse of GAAR application. Despite the overall improvement in legal rules on indirect transfers, there are still questions and ambiguity in Circular 7 that need to be further addressed.93 Another development in this period is review of intra-group large payment of service fees and royalties to offshore related parties, particularly to those located in low- or no-tax jurisdictions. It was found by the SAT that intra-group payments to offshore related parties had been used as a mechanism by enterprises 87 GAAR Measures, art 21. See also SAT Press Release, above n 83. 88 SAT Announcement on Several Issues concerning Enterprise Income Tax on Income from Indirect Transfers of Assets by Non-resident Enterprises (Gonggao [2015] 7, issued and effective 2 March 2015). This circular can be retroactively applied to transfers that took place before the issuance of the circular but that have not yet been subject to tax assessment. Circular 7, art 19. 89 Circular 7, art 1 para 2. 90 ibid, art 1 para 3. 91 ibid, art 1 para 1. 92 ibid, arts 3–6. 93 A good example is the reporting requirement on offshore transferors and transferees as well as targeted resident enterprises in China. According to the circular, the parties to a transaction will have to perform self-assessment on whether an indirect transfer is chargeable to China enterprise income tax and to pay or withhold the tax accordingly, but their assessment would be different from that of the tax authority. See D Ho and A Ting, ‘New Tax Landscape for Cross-border Merger & Acquisition Transactions and Intragroup Reorganizations in China’ (2015) 41(4) International Tax Journal 37, 46.

The Modernisation of China’s International Taxation System  513 investing into China or going abroad to shift profits to tax havens or low-tax jurisdictions, which seriously impaired China’s tax revenue interests. To deal with the problem, the SAT started a large-scale, wide-range review of all enterprises that paid significant amounts of service fees and/or royalties to offshore related parties during the period from 2004 and 2013.94 Since 2014, intra-group large payments have become one of the focal areas of anti-­avoidance investigations by China’s tax authority. The examination of intra-group payments can be understood from China’s expression to the United Nations of its stance on the application of the arm’s length principle to intra-group service fees,95 reflecting a more active China that is willing to voice out its views in the development of international taxation rules. The Post-BEPS Era: From 2015 Onwards The publication of the BEPS Final Reports in 2015 has prompted notable changes to the international tax system in many countries and regions since 2015. The Final Reports identified four minimum standards, which were agreed upon by countries to address particular issues in a consistent and coordinated manner. The standards relate to rules on preventing treaty shopping, Countryby-­Country Reporting, fighting harmful tax practices and improving dispute resolution. The implementation of the standards in participating jurisdictions would be subject to targeted monitoring.96 The Final Reports also made recommendations and suggested best practices on other BEPS issues for countries and regions to adopt to limit tax avoidance and evasion opportunities in their jurisdictions. In the context of the BEPS package, China has responded to the four minimum standards and other measures through issuing a series of new regulations and rules, which have almost revamped the whole anti-avoidance framework established in the 2009 Measures. The responses were also based on China’s own domestic anti-avoidance needs. In a press conference for implementing BEPS 94 Notice of the General Office of SAT on Anti-Avoidance Examination of Outbound Significant Payment (Shuizongbanfa [2014] 146) (issued and effective 29 July 2014). 95 The UN requested participating jurisdictions to provide inputs on issues regarding intra-group services and management fees and intangibles after it published the UN Practical Manual on Transfer Pricing for Developing Countries in 2012. The SAT submitted its reply to the UN request in early 2014 and subsequently issued Circular 146 in July 2014. It was noticed by commentators that while Circular 146 generally follows the OECD framework on intra-group service fees, some of the tests adopted in the circular seem to be stricter than those in the OECD framework. See PwC, ‘SAT Focuses on Intra-group External Large Payment of Expenses by Multinational Companies’ (19 September 2014), www.pwccn.com/zh/china-tax-news/chinatax-news-sep2014-19.pdf; see also Deloitte, ‘BEPS Action 10: Low Value-adding Intragroup Services’ (14 November 2014), www. taxathand.com/article/1429/Hong-Kong/2014/Tax-AnalysisBEPS-Action-10-Low-value-addingintragroup-services, accessed 26 November 2018. 96 OECD, ‘Explanatory Statement’, OECD/G20 Base Erosion and Profit Shifting Project (OECD, Paris, 2015), www.oecd.org/ctp/beps-explanatory-statement-2015.pdf, accessed 26 November 2018.

514  Yan Xu measures in 2014, the SAT unveiled 15 types of ‘unacceptable’ tax avoidance activities from China’s perspective.97 While some of the unacceptable activities overlap those identified by the BEPS project, such as abuse of tax treaties, transfer pricing related to intangibles and hybrid mismatch, many other activities are more China-specific, such as abuse of business structure and use of arrangements without economic substance, making losses for single-purpose Chinese subsidiary companies, low return of high-tech enterprises, shifting of overseas costs to China, and non-cooperation in information disclosure.98 The SAT further explained its stance on the other various anti-avoidance measures introduced by the Final Reports in 2015, together with specifying the areas it purports to work on for further modernisation of the economy and promotion of the Road and Belt initiative launched in 2013.99 The work plan reflects the government’s intention to modernise not only the anti-avoidance regime but the overall international taxation system. Ever since the uncovering of the 15 unacceptable activities, the SAT has issued a series of tax circulars to materialise its own action plans by reference to the most updated standards and rules introduced by the OECD and United Nations. The basic legal framework for implementing the statutory anti-avoidance rules created in the 2009 Measures was believed to be outdated. To make it better suited to a changed tax environment, the SAT issued a draft revision of the Measures for public consultation in September 2015.100 Although the consultation draft is not yet passed into a new regulation, many of the suggested revisions have been introduced through separate, individual circulars on the relevant issues in very recent years. Two areas of modification of the framework are worth noting. First, the transfer pricing rules established in the 2009 Measures have almost been completely replaced by a set of new rules, which include Circular 42 on transfer pricing reporting and documentation as well as cost sharing agreements, Circular 64 on APAs, and Circular 6 on tax adjustment procedures and mutual agreement procedures.101 The three circulars cover a wide range of substantive and procedural rules on transfer pricing, and while updating and improving the rules they have broadened the previous framework to incorporate 97 TZ Liao, ‘SAT Press Conference on BEPS and China Responses’ (SAT, Beijing, 25 September 2014). 98 ibid. 99 TZ Liao, ‘SAT Press Conference on BEPS Final Reports and China Responses’ (SAT, Beijing, 10 October 2015). The Road and Belt is a going-abroad initiative advocated by the Chinese leaders. The initiative was formally announced in 2013 by China’s President Xi Jinping as a strategy to further China’s economic development in the twenty-first century. 100 The consultation draft was made public on 17 September 2015 through the SAT website. 101 SAT Announcement on Issues concerning Improvement in Administration of Reporting and Contemporaneous Documentation of Associated Party Transactions (Gonggao [2016] 42, issued and effective 29 June 2016); SAT Announcement on Issues concerning Improvement in Administration of Advance Pricing Arrangements (Gonggao [2016] 64, issued 11 October 2016 and effective 1 December 2016); SAT Announcement on Issuing the Measures for Administration of Special Tax Adjustments and Mutual Agreement Procedures (Gonggao [2017] 6, issued 17 March 2017 and effective 1 May 2017). The rules in ch 7 of the 2009 Measures on cost sharing agreements have largely remained unaltered, except for Articles 69 and 74 which were invalidated by the new rules.

The Modernisation of China’s International Taxation System  515 special transfer pricing rules on intangible assets and intra-group related party services. Many rules introduced by the three circulars are consistent with the 2017 OECD Model Tax Convention and the 2017 OECD TP Guidelines. Other more minor tax circulars have been issued to clarify various issues regarding the implementation of the three major circulars.102 Second, new rules have been introduced for the GAAR application, though the GAAR rules in the 2009 Measures remain effective. As noted earlier, the SAT issued the GAAR Measures in 2014 and Circular 7 in 2015 to reduce confusion and ambiguity caused by the statutory provision and the rules under the 2009 Measures. The applicable rules relating to tax collection from non-resident taxpayers were also updated by a new circular in 2017, which aims to improve withholding tax rules for payments to non-resident enterprises.103 These new circulars may make GAAR application more transparent and consistent in the country, especially in the field of indirect transfers. The other various rules under the 2009 Measures have been revised or strengthened also. The legal framework on anti-avoidance rules under EITL is now very much different than that a decade ago. Table 18.1 shows the new framework created since 2015 as compared to that established in 2009 and the suggested revised structure in the 2015 consultation draft. Table 18.1  Legal Framework of Anti-avoidance Rules Implementation Consultation draft on Measures on Special revision of the 2009 Tax Adjustment (2009) Measures (2015) Chapter I General Provisions

Chapter I General Provisions

Chapter II Associated Party Reporting

Chapter II Associated Party Reporting

Chapter III Contemporaneous Documentation

Chapter III Contemporaneous Documentation

New legal system since BEPS Final Reports

Gonggao [2016] 42 (TP reporting & documentation), Gonggao [2017] 6 (tax adjustments & MAP), Gonggao [2017] 26 (annual reporting), Gonggao [2017] 46 (CbC), Gonggao [2018] 14 (TP documentation master files) (continued)

102 These include SAT Announcement on Clarification of Filling and Submission of the Annual Report on Associated Party Transactions (2016 version) (Gonggao [2017] 26, issued and effective 2 July 2017), SAT Announcement on Clarification of Relevant Issues concerning Country-by-­Country Reporting (Gonggao [2017] 46, issued and effective 19 December 2017), and SAT Announcement on Clarification of Relevant Issues concerning Reporting and Administration of Contemporaneous Documentation Master Files (Gonggao [2018] 14, issued and effective 4 April 2018). 103 SAT Announcement on Issues concerning Withholding of Enterprise Income Tax at Source on Non-resident Enterprises (Gonggao [2017] 37, issued 17 October 2017 and effective 1 December 2017).

516  Yan Xu Table 18.1  (Continued) Implementation Consultation draft on Measures on Special revision of the 2009 Tax Adjustment (2009) Measures (2015) Chapter IV Transfer Pricing Methods

Chapter IV Transfer Pricing Methods

Chapter V Transfer Pricing Investigation and Adjustment

Chapter V Transfer Pricing Investigation and Adjustment

New legal system since BEPS Final Reports Gonggao [2017] 6 (tax adjustments and MAP)

Chapter VI Intangible Assets Chapter VII Associated Party Services Chapter VI Advance Pricing Arrangement

Chapter VIII Advance Pricing Arrangement

Gonggao [2016] 64 (APAs)

Chapter VII Cost-sharing Agreement

Chapter VIIII Cost-Sharing Agreement

2009 Measures, Gonggao [2015] 45 (administration of cost-sharing agreement), Gonggao [2016] 42

Chapter VIII CFCs

Chapter X CFCs

2009 Measures

Chapter IX Thin Capitalization Rules

Chapter XI Thin Capitalization Rules

Caishui [2008] 121, 2009 Measures, Gonggao [2016] 42, Gonggao [2017] 6

Chapter X GAAR

Chapter XII GAAR

2009 Measures, GAAR Measures, Gonggao [2015] 7 (indirect transfers), Gonggao [2017] 37 (tax withholding)

Chapter XIII Profit Level Monitoring

Gonggao [2017] 6

Chapter XI Corresponding Adjustment and International Negotiation

Chapter XIV Corresponding Adjustment and Mutual Agreement Procedure

Chapter XII Legal Liability

Chapter XV Legal Liability

The Modernisation of China’s International Taxation System  517 In addition to the overhaul of anti-avoidance rules in the 2009 Measures, the SAT has responded to tax treaty abuse through revising rules on beneficial ownership and updating rules on other treaty issues. As regards beneficial ownership, the SAT substituted Circular 9 for Circular 601 in early 2018.104 The new circular clarifies the meaning of BO and the way of determining whether an applicant is a BO under a tax treaty.105 Importantly, the new circular incorporates a principal purpose test (PPT) to prevent abuse of beneficial ownership rules in a tax treaty.106 As stated in the circular, the tax authority is empowered to invoke a GAAR investigation if it is in the view that a PPT or a domestic GAAR application is needed, even though an applicant has obtained a beneficial ownership. The PPT is in line with the recommendation on the prevention of treaty abuse in the BEPS Final Reports. Second, the SAT issued Circular 11 in 2018 to update a number of rules relating to treaty provisions, which include expansion of the definition of persons (Article 1), clarification of the term permanent establishment (Article 5), and new interpretation of Article 8 on air, sea and land transportation as well as Article 17 on entertainers and sportspersons.107 The updating is necessary, given the changes made to the various articles by the most recent OECD and UN Model Tax Conventions.108 Furthermore, the SAT has made significant effort to implement the new global standard for exchange of information, namely the automatic exchange of information standard (AEOI). The new standard was formulated by the OECD and endorsed by the G20 in 2014 for preventing tax avoidance and evasion as well as strengthening cooperation in tax administration among governments.109 The internationally created multilateral treaty, Multilateral Convention on Mutual Administrative Assistance in Tax Matters (‘Multilateral Convention’), was passed by China’s national legislature into law and has been effective since 1 February 2016.110 The Multilateral Convention establishes a legal basis for implementing the AEOI on a multilateral basis. The AEOI standard comprises two parts: the Common Reporting Standard (CRS) and the Model Competent Authority Agreement (MCAA). To utilise the multilateral legal instrument for

104 SAT Announcement on Issues concerning ‘Beneficial Ownership’ in Tax Treaties (Gonggao [2018] 9, issued 3 February 2018 and effective 1 April 2018), art 10 (hereinafter Circular 9). 105 Circular 9, arts 1–5. 106 Circular 9, art 9. 107 SAT Announcement on Several Issues concerning Implementation of Tax Treaties (Gonggao [2018] 11, issued 9 February 2018 and effective 1 April 2018). 108 OECD, OECD Model Tax Convention on Income and on Capital (2017), www.oecd.org/ tax/treaties/model-tax-convention-on-income-and-on-capital-condensed-version-20745419.htm, accessed 28 November 2018; UN, United Nations Model Double Taxation Convention between Developed and Developing Countries 2017, www.un.org/esa/ffd/wp-content/uploads/2018/05/ MDT_2017.pdf, accessed 28 November 2018. 109 OECD, ‘Automatic Exchange of Financial Account Information – Background Information Brief’ (January 2016), www.oecd.org/ctp/exchange-of-tax-information/Automatic-Exchange-­ FinancialAccount-Information-Brief.pdf, accessed 28 November 2018. 110 SAT, Tax Treaties, www.chinatax.gov.cn/n810341/n810770/index.html, accessed 28 November 2018.

518  Yan Xu information exchange with other jurisdictions, China’s government signed the Multilateral Competent Authority Agreement on Automatic Exchange of Final Account Information in December 2015, which provides a necessary legal basis for exchange on an operational level.111 The CRS stipulates the reporting and due diligence rules to be imposed on financial institutions. To localise the rules and obligations under the Multilateral Convention and the MCAA, the SAT, together with other relevant authorities, issued the Administrative Measures on Due Diligence of Non-resident Financial Account Information in Tax Matters in 2017.112 The joint Measures are largely in line with the OECD rules, and mirror the OECD standard in many major elements. However, as with other laws and regulations in China, the Measures are intended to be a high-level document and thus lack detailed implementation guidance. Nevertheless, the Measures can help increase tax transparency and make prevention of cross-border tax evasion and avoidance more effective in the country.113 THE PATH TO A MODERN INTERNATIONAL TAXATION SYSTEM

The anti-avoidance rules under the EITL have had a significant development over the last three decades in China. The volume and size of the rules has grown into a gigantic body, and tax administration as a whole has developed to a relatively sophisticated level. The unification and application of the EITL in 2008 inaugurated the formation of a modern anti-avoidance regime and marked the creation of a modern international taxation system that deals with cross-border trade and investment issues in accordance with international principles and norms. The development of anti-avoidance rules and other related rules in the last 10 years has significantly improved the basic legal framework of China’s international tax regime, aligning it more closely with international practice, although the application reflects some unique features. This section summarises how the antiavoidance rules are created and developed, explores the policy and strategies adopted for the development, and discusses challenges and prospects for further development.

111 ibid. See also SAT, AEOI Portal, www.chinatax.gov.cn/n810341/n810770/index.html, accessed 28 November 2018. China has activated the MCAA for information exchange starting on or after 1 January 2017. See OECD, Automatic Exchange Portal, www.oecd.org/tax/automatic-exchange/ international-framework-for-the-crs/exchange-relationships/, accessed 26 November 2018. 112 Announcement of SAT, the Ministry of Finance, the Peoples Bank of China, China Banking Regulatory Commission, China Insurance Regulatory Commission and China Securities Regulatory Commission on Issuing the Administrative Measures on Due Diligence of Non-resident Financial Account Information in Tax Matters (Gonggao [2017] 14, issued 9 May 2017 and effective 1 July 2017). 113 General office of SAT, ‘Automatic Exchange of Financial Account Information’ (30 June 2017), www.chinatax.gov.cn/aeoi_index.html, accessed on 14 November 2018.

The Modernisation of China’s International Taxation System  519 Building and Developing the Basic Rules When China started its economic opening-up policy in late 1978, it had no income tax law.114 As foreign investment was first allowed to enter into China via joint ventures with Chinese enterprises, the first income tax law was legislated for Sino-foreign joint venture enterprises. The expansion of the scope of foreign investment in the following years led to the passage of income tax law for wholly foreign-owned enterprises. However, in the very early development period, as the government only started to grapple with the operation of a market economy and administration of an income tax in a modern sense, it did not become aware of tax avoidance and evasion issues, though there was cross-border trade and investment. The intention of bringing in FDI was so strong that tax avoidance, if found, would be taken as a minor issue. The first anti-avoidance rule was not enacted until 1987 – almost 10 years later after the outset of the economic reform, and it was not made by any other city nor the central government but by the most developed city in China – Shenzhen. This implies that tax law development hinges upon the development of the fundamental economy, and only when the economy reaches a relatively sophisticated or mature level will there be a need to develop rules to prevent inappropriate tax avoidance activities. The first anti-avoidance rule related to transfer pricing between associated enterprises. The rules have become the most comprehensive and complete among all anti-avoidance rules in China 30 years later. The design and the development of the rules has generally followed, and kept pace with, international standards, particularly the OECD TP Guidelines and OECD and UN Model Tax Conventions, and has been influenced by tax practices in other jurisdictions. The rules have gradually but steadfastly extended from dealing with relatively simple issues arising from cross-border manufacturing and distribution to complicated issues such as intangibles and corporate group finance. The development is along the path of economic growth in the country, which is characterised by a transformation from a production- and exportation-based economy to a consumption- and technology-driven economy in recent years.115 It is not surprising that the first and the most comprehensive rules relate to transfer pricing, as noted by many commentators that transfer pricing is the easiest way for MNEs to shift profit from high-tax jurisdictions to low- or no-tax jurisdictions. China has been a high-tax jurisdiction in terms of corporate income tax, especially in the early development periods: statutory enterprise 114 This does not mean that enterprises paid nothing to the government at the time. Rather, their payment came in the form of profit remittance or delivery to the government, as China applied public ownership of enterprises during that period. 115 K Lomu, ‘On the Lookout for New Ideas in the US’, GBTimes (30 Jun 2015), https://gbtimes. com/lookout-new-ideas-us, accessed on 9 December 2018; A Saggu and W Anukoonwattaka, ‘China’s “New Normal”: Challenges Ahead for Asia-Pacific Trade’, (2015) United Nations ESCAP Trade Insights, Issue 11, 3, https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2628613, accessed 9 December 2018.

520  Yan Xu income tax rates for foreign-invested enterprises were around 33 per cent, while for domestic state-owned enterprises over 50 per cent in the 1980s.116 Further, a worldwide tax system has been applied from the start,117 which means non-­ resident taxpayers were only liable to income sourced within China while resident taxpayers had to pay tax on their worldwide income. This feature and the high tax rates, together with tax arbitrage opportunities from other jurisdictions, typically Hong Kong,118 motived taxpayers to manipulate their transaction prices to shift profit from China to low- or no-tax jurisdictions. Accordingly, transfer pricing rules are much needed to combat transactions that are non-compliant with the arm’s-length principle. With the rapid economic development in the 1990s and 2000s, tax avoidance activities became increasingly sophisticated and aggressive. TP rules alone could not effectively address all tax avoidance activities and additional rules were thus needed. In legislating the EITL in 2007, the government introduced thin capitalisation rules and CFC rules, two specific rules commonly applied in many income tax laws, as well as the GAAR. While the two specific rules are relatively abstract given their narrow application in practice, they have become more important in recent years owing to an ever-increasing volume of outbound investment made by Chinese resident enterprises. The statutory GAAR has had a wide application since it came into effect in 2008. The special application on indirect transfers has attracted great attention from many commentators and taxpayers around the world, given its potent feature of subjecting offshore transfers to China tax. The controversial application seems to signal a changed government’s attitude towards foreign investment: while investment is certainly always encouraged,119 it cannot be made in a way that erodes China tax base and harms China revenue interests. Brief as a period of 30 years is, anti-avoidance rules have been developed from nothing to a comprehensive and complex structure in that time. The significant development can be summarised in four aspects. First, the creation of anti-avoidance rules starts from specific rules to general rules and from 116 Income Tax Law on Chinese-Foreign Equity Joint Ventures of the PRC, above n 7, art 3; Income Tax Law on Wholly Foreign-owned Enterprises of the PRC, above n 8, art 4; Regulations on ­State-owned Enterprise Income Tax (Draft) (State Council, issued 18 September 1984 and effective 1 October 1984, invalidated 1 January 2008), art 4. However, many foreign-invested enterprises could utilise various tax incentives to reduce their effective tax rates in China during that period. See also Jinyan Li, ‘Fundamental Enterprise Income Tax Reform in China: Motivations and Major Changes’ (2009) CLPE Research Paper No 33/2007, 3, https://papers.ssrn.com/sol3/papers. cfm?abstract_id=1030656, accessed 9 December 2018. 117 The worldwide tax system was formally adopted in the legislation of EITL in 2007. 118 Hong Kong has adopted a territorial tax system to impose tax on profits of business entities derived from or arising in Hong Kong. Hong Kong Inland Revenue Ordinance, s 8. The profits tax rate for incorporated companies has been around 16% to 17% and for unincorporated entities around 15%. See Inland Revenue Ordinance, schs 8, 8A, 8B. 119 This can be reflected in tax policies and beneficial treatments that had been given to almost exclusively foreign-invested companies prior to the EITL application in 2008, and the most recent tax policy of deferral on withholding taxes for foreign investors’ re-investment in Chinese companies.

The Modernisation of China’s International Taxation System  521 s­ubstantive rules to procedural rules. While many of the rules were initially made with reference to international standards or borrowed from other jurisdictions, the development and application of the rules has had distinctive Chinese features that reflect China’s revenue interests and economic conditions. Second, tax administration of anti-avoidance rules has been strengthened and improved in leaps and bounds over the period. This is reflected in not only increased expertise, experiences, and skills of tax officials but improved ways and means to manage administrative matters. Tax administrative models have been changed from concentration on investigation to emphasis on both supervision, services, and investigation in recent years.120 However, inconsistent implementation still exists across the regions and levels of government, and there has been a shortage of personnel for anti-avoidance administration. Third, a nationwide anti-avoidance information system has been created and developed to enable tax authorities to obtain taxpayers’ information in a timely and accurate manner and to work with other government bodies, particularly customs and departments of industry and commerce, to effectively detect tax avoidance activities. Despite this improvement and the progress made to the implementation of the AEOI standard, there has been difficulty for the tax authorities to obtain information regarding taxpayers’ offshore transactions and foreign accounts. Fourth, international cooperation has been strengthened in recent years and the government has become more open and proactive in participating in global campaigns against tax avoidance and evasion. To a large extent, the development of anti-avoidance rules entails the development of international tax rules in general, especially those in key areas such as residence rules, source rules, determination of tax residence, characterisation of receipt, determination of source for various types of income, permanent establishment, foreign tax credits, tax exemption, tax treaty provisions, and offshore centres. Without those rules to build up basic elements for international taxation there would be no issue about tax avoidance, and where those rules were not robust and sufficient, there would be obstacles to attack tax avoidance. Moreover, the existence of tax avoidance activities reveals loopholes and gaps in the existing tax system, urging the government to take measures to close the loopholes and to modify the relevant rules beyond the enterprise income tax as well as to improve the tax structure. A good example in this regard is the introduction of anti-­ avoidance rules to individual income tax law in the most recent amendment as a response to the lack of rules to crack down on tax avoidance activities with underlying persons as individuals.121

120 EY, ‘Profit Monitoring and Management System on MNEs Launched in Jiangsu’ (2018), https://www. ey.com/Publication/vwLUAssets/ey-profit-monitoring-and-management-system-of-mnc-launchedin-jiangsu-cn/$FILE/ey-profit-monitoring-and-management-system-of-mnc-launched-in-jiangsu-cn. pdf, accessed 30 November 2018. 121 See n 6.

522  Yan Xu Last but not least, the application of anti-avoidance rules also ‘forced’ creation and improvement of modern information systems as information is vital to the achievement of effective suppression of tax avoidance. The effort to make legislation more concrete, consistent and transparent and the use of information systems to enhance tax administration can help foster the rule of law in taxation in general and improve tax equity for taxpayers. In short, the development of anti-avoidance rules in the last three decades has driven the modernisation of the overall international taxation system in the country. Policy and Strategy for the Development The creation and development of the international taxation system is achieved alongside the growth of the underlying economy in the country, which is not what it was 30 years ago. Despite notable changes to the legal framework on anti-avoidance, the policy underpinning the changes seems to have not been altered over the development period. A key policy relevant to the development is to attract FDI to promote economic growth. Such policy has been adopted and applied throughout the development period, which can be seen from the provision of preferential tax treatments exclusively for foreign-invested enterprises in the 1980s and 1990s and some special policies adopted for foreign investors in recent years.122 The development of an extensive tax treaty network over the past 30 years also helps attract FDI, and facilitate outward investment by Chinese enterprises most recently. Anti-avoidance rules had to be created and improved to prevent abuse of tax rules and to ensure that increased FDI can generate desired outcomes, including revenue contributions. Another related policy introduced more recently is to encourage Chinese enterprises to ‘go out’ to invest overseas so as to enhance their competitive edge in the international markets, thus contributing to China’s sustainable development.123 While promoting outward FDI, the government had to strengthen anti-avoidance rules to counter abusive activities that keep investment returns in offshore tax havens or low-tax jurisdictions, harming government revenue interests. 122 Notice of MOF, SAT, the National Development and Reform Commission (NDRC) and the Ministry of Commerce (MOC) on Issues concerning the Policy of Temporary Exemption of Withholding Income Tax for Foreign Investors Direct Reinvesting with Distributed Profits (Caishui [2017] 88, issued 21 December 2017 and effective 1 January 2017); Notice of MOF, SAT, NDRC and MOC on Applicable Scope of the Policy of Temporary Exemption of Withholding Taxes on Direct Reinvestment by Foreign Investors with Distributed Profits (Caishui [2018] 102, issued 29 September 2018 and effective 1 January 2018); SAT Announcement on Issues concerning Expanding the Application Scope of the Policy of Temporary Exemption of Withholding Taxes on Direct Reinvestment by Foreign Investors with Distributed Profits (Gonggao [2018] 53, issued 29 October 2018 and effective 1 January 2018). 123 The Central People’s Government of PRC, ‘Better Implementation of the Go Out Policy’ (15 March 2016), www.gov.cn/node_11140/2006-03/15/content_227686.htm, accessed 30 November 2018.

The Modernisation of China’s International Taxation System  523 Anti-avoidance rules are needed in the sense they ensure the desired policy goal can be achieved. Although it is a difficult task to strike a delicate balance between encouraging FDI and combating tax avoidance, the government has gained experiences over the years and become increasingly confident in asserting its revenue interests and taxing rights in the process. This is reflected in a changed government view on FDI with the government shifting from its original open welcome for all foreign investment to a more selective approach based on an objective valuation of the potential benefits to be derived from proposed investment. The strategies adopted during the development period are characterised by pragmatism. Anti-avoidance rules are introduced and improved step by step, based on the needs in tax practice at the time. In designing and strengthening the rules, the government has kept an open attitude to learn from other jurisdictions and to follow international guidelines in the relevant fields. With the accumulation of experience and expertise, the tax authority has become more sophisticated in making and implementing anti-avoidance rules and in dealing with taxpayers as well as the counterpart revenue authorities in other jurisdictions. The ascent of China’s economy in relative importance in the global economy in recent years lays a foundation for the government to become more active in expressing its views and opinions in the international arena, including international taxation matters. An obvious paradigm shift in the most recent years is to proactively join international dialogue in making or revising international rules to make them better suit China’s interests. This is different from the government’s previous practice of passively fitting domestic rules into international practices.124 The paradigm shift, together with the underlying policy of encouraging FDI while defending China’s revenue interests, is likely to impact on the furtherance of international taxation in the country. The active participation in the BEPS project and implementation of BEPS action plans suggests that the government will further improve the legislation of anti-avoidance rules to closely reflect international consensus on the relevant principles and norms and implement the rules in a more coherent, transparent and certain way. Aligning China’s domestic anti-avoidance rules with new international rules does not contradict China’s paradigm shift as it has moved to a rule-shaper or maker role in reforming international rules and standards. This role will, to a degree, help further modernise China’s international taxation system and improve the rule of law in taxation. 124 China’s active participation in the BEPS project well attests to the paradigm shift in recent years. See R Avi-Yonah and H Xu, ‘China and BEPS’ (2018) 7(1) Laws 4. In particular in the area of transfer pricing rules, China has long been advocating that profits should be taxed in the place where economic activities take place and value is created. It would not be too far-fetched to say that China’s view, together with the view from other developing countries, has been taken into account in the BEPS Final Reports on transfer pricing, which emphasises transfer pricing outcomes in line with value creation. See OECD, ‘Explanatory Statement, OECD/G20 Base Erosion and Profit Shifting Project’ (OECD, 2015), www.oecd.org/tax/beps-explanatory-statement-2015.pdf, accessed 30 November 2018.

524  Yan Xu Challenges Ahead Undoubtedly, the legal framework on anti-avoidance rules has been significantly developed in the last three decades. However, compared with advanced income tax systems, there are many problems that need to be addressed in the future improvement of the framework. In preventing abusive tax avoidance activities, two areas that require most attention are tax legislation and implementation. As noted earlier, basic regulations or policy documents on anti-avoidance rules are usually drafted in a very general manner without definition of key terms and concrete operational rules. Necessary operational details, including substantive and procedural rules, have to be supplemented by many subsequent circulars, which may be inconsistent with each other. Basic laws have not been updated in a timely fashion to reflect the development of anti-avoidance rules. Currently, the LTCA, the basic law on tax administrative procedures, only includes rules on transfer pricing and APAs,125 leaving the other rules blank. Some key terms of the transfer pricing rules in the LTCA are not in line with those adopted in the EITL. While the LTCA only provides three traditional transfer pricing methods, namely the comparable uncontrolled price method, resale price method and cost plus method,126 the EITL includes both the three traditional methods and new methods – transactional net margin method and profits split method.127 Both tax administration and taxpayers must cope with a dearth of either case law or administrative interpretation guidance in the application of the anti-avoidance rules. This stands in contrast with common-law jurisdictions or those civil-law jurisdictions that have relied on rulings from the courts, tax tribunals or tax authorities for interpretation of tax rules. Legal jurisprudence on anti-avoidance rules in those common-law and civil-law jurisdictions has been developed to an advanced level, and court interpretations of tax principles and rules through cases have played a particularly essential role in implementing tax laws, resolving tax disputes, and balancing government revenue interests and taxpayers’ rights.128 In China’s case, ambiguity in tax laws

125 LTCA, above n 25 (NPC Standing Committee, revised for the first time 28 February 1995, the second time 28 April 2001, the third time 29 June 2013, and the fourth time 24 April 2015), art 36. Implementation Rules of the LTCA, above n 29 (State Council, revised for the first time 9 November 2012, the second time 18 July 2013, and the third time 6 February 2016), arts 51–56. 126 Implementation Rules of the LTCA, art 55. 127 Implementation Regulations of EITL, art 111. 128 For example, there has been rich case law on applying anti-avoidance rules in common law jurisdictions such as Australia and UK, and civil law jurisdictions such as Germany and Taiwan. See GT Pagone, ‘Australian Tax Avoidance – A Comparative Approach’ (University of Munich, Munich, 27 June and University of Passau, Passau, 29 June 2017); EY, ‘Proposal for EU Directive against Tax Avoidance’ (2016) 16 German Tax & Legal Quarterly 1, www.ey.com/Publication/vwLU Assets/2016_EY_GTLQ_Q1/%24FILE/EY_GTLQ_Issue_1-2016.pdf, accessed 9 December 2018; W Kessler and R Eicke, ‘Closer to Haven? New German Tax Planning Opportunities’ (2006) 42(6) Tax Notes International 501, 505, 509.

The Modernisation of China’s International Taxation System  525 and regulations as well as numerous tax circulars cannot easily be resolved by the courts due to the fact that China’s civil law system has no doctrine of precedent. In practice, the final determination of most anti-avoidance disputes is made by the tax authority rather than the courts. Although the SAT and local tax authorities have been reporting disputes following assessment based on anti-avoidance measures, the reports usually disclose few details about the disputes and interpretations of relevant rules in the cases in question. On the other hand, the SAT has attempted to unify anti-avoidance investigations and improve disputes resolution by way of selecting and reporting typical cases for lower tax authorities to follow.129 To some extent, the SAT has assumed a role similar to courts in a common-law jurisdiction in interpreting tax rules and resolving disputes with taxpayers. The application of anti-avoidance measures remains far from consistent across the country. Tax administration is usually less transparent and certain in developing regions than in developed regions, and at lower levels than at higher levels. Significantly, direct contact between the tax authority and taxpayers is a feature of the resolution of many disputes, a process in marked contrast to the reliance on formal channels to mitigate disagreements and settle disputes in advanced tax systems. Such frequent, direct contact may lead similar rules to be interpreted and applied differently, and invite abuse of power. It places the SAT in the position of a tax administrator, a de facto rule maker, and the arbiter of the rules. Although the SAT has indicated its intention to reinforce a rule of law principle in taxation, its triple role and the inherent conflicts of interest these entail inevitably undermine this aim while leaving the protection of taxpayers’ rights protection problematic at best. In this regard, any future improvement in the anti-avoidance regime needs to take into account the role of the tax authority in achieving rule of law in taxation. CONCLUSION

If one takes into account that the anti-avoidance rules were developed from scratch in China and a relatively comprehensive system has still been established over a short period of 30 years, the achievement can be described as remarkable – especially within the context of the most rapidly changing large economy the world has seen. While the design of the rules has been heavily influenced by international principles and practices, the implementation does embody China’s own characteristics. It is true that the current legal framework on anti-avoidance

129 For example, the SAT issued the Notice on Issuing Xinjiang Uyghur Autonomous Region State Tax Bureau Correctly Dealing with Tax Treaty Abuse Case (Guoshuihan [2008] 1076, issued and effective 30 December 2008). Some following cases used the Xinjiang case as reference in making decisions.

526  Yan Xu rules is still less than coherent. Many details are given in tax circulars rather than in formal legal documents with higher legal validity and certainty. And adjudication is not yet comparable to that in most advanced systems. It is clear that China needs to further improve legislation and implementation of its antiavoidance rules and to modernise its international taxation system as a whole. However, modernisation does not simply equate with Westernisation or legal transplantation. China’s experiences in transplanting legal concepts, principles and rules from Western legal systems to its own have been in general unsatisfactory, as the exogenous environment for those concepts and rules was often treated as endogenous, losing necessary conditions for effective application.130 While international taxation, including anti-avoidance rules, is a highly technical area, the context for implementing tax laws and regulations and for resolving tax disputes is within the general legal system of a country. To the extent China has successfully implemented effective anti-avoidance rules, the success is attributable to the development of implementation rules that draw on international practices, but are fine-tuned to apply to China’s unique economic conditions. A prime example of the process of drawing from good practice abroad and then modifying in light of specific domestic conditions may be found in China’s transfer pricing rules for intangible supplies. While the rules use the OECD TP Guidelines as a foundation, the overseas rules have been modified based on cost saving and marketing intangibles considerations that take into account unique features of the Chinese market. They also draw on data assembled in both an enterprises database created by tax authorities using information from domestic companies and databases with information about foreign companies.131 The problems with tax legislation and implementation of ancillary tax rules are, however, not unique to taxation as these problems similarly occur in other areas of law. They cannot be fully addressed in the absence of further improvement of the country’s overall legal system. Modernisation of the international taxation system thus means that more effort needs to be made to improve China’s domestic legal system, rather than simply relying on foreign experiences to achieve the desired outcome. It is not possible for the tax authority alone to change the entire legal ecosystem, but what it can do is to improve legislative techniques in drafting tax rules and policies, making key terms as concrete, detailed and systematic as possible. Excessive administrative discretion in applying anti-avoidance rules must be controlled through improvement in tax legislation as well as enhancement of transparency in tax administration. Administrative rulings about anti-avoidance

130 DC Clarke, ‘Lost in Translation? Corporate Legal Transplants in China’ (2006) GW Law Faculty Publications & Other Works Paper 1068, http://scholarship.law.gwu.edu/faculty_publications/1068, accessed 9 December 2018. 131 Tizhong Liao, ‘Mainland China’s Anti-avoidance Work Review’ in Hong Kong Inland Revenue Department, www.ird.gov.hk/chi/pdf/liaotizhong.pdf, accessed 30 November 2018.

The Modernisation of China’s International Taxation System  527 audits and investigation need to be disclosed to the public, with details of cases and interpretations of relevant rules. Such information disclosure by the tax authority can help increase consistency in implementing anti-avoidance rules across the country. Lastly, significant efforts need to be made to build up taxpayers’ confidence and trust in courts so as to effectively resolve tax disputes. Most antiavoidance investigations and administration are related to non-resident enterprises and increasingly Chinese MNEs, and anti-avoidance investigations often involve large amounts of tax payment and complicated business structures. The stakes for taxpayers are high. Absent an effective disputes resolution system, the incentives to invest into China or to go overseas to compete in the international markets will be reduced, harming economic development, a goal that the government has been pursuing. It follows that in China’s context, any further effort made by the government to modernise the tax law system must seek a balance between the protection of taxpayers’ rights and government revenue interests. More weight probably needs to be given to the former, to achieve a fair tax environment benefiting all.

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