Tax avoidance is a major issue for developed, but even more for developing, countries and occurs in a variety of ways. In contrast to tax evasion, it is not illegal. Nonetheless, it takes away important revenue from tax administrations. Tax avoidance uses artificial but legal arrangements to abusively take advantage of loopholes and differences in tax systems, meaning that the arrangements are created not for business reasons and without economic substance, but solely for tax benefit reasons. So, in theory the only thing tax legislators need to do is close those loopholes. In reality, however, tax advisors around the world are constantly searching for ways to help their clients optimise their tax bills in a legal way. Consequently, with every new law that is introduced to close a certain loophole, another loophole will be found that can be used to reduce the overall tax bill.
Countries use a variety of anti-avoidance rules aimed at fighting tax avoidance, which can be divided into specific anti-avoidance rules (SAARs) and general anti-avoidance rules (GAARs). In addition to SAARs, which are created to close specific, i.e., known, loopholes that enable tax avoidance, many countries are using GAARs. SAARs give relatively little discretion to tax administrations on how to apply them, which makes it easier for companies to evaluate beforehand whether their tax planning structure is considered artificial and abusive.
In contrast, GAARs have a much broader scope, which produces both advantages and disadvantages. These rules are not intended to tackle a specific tax avoidance practice, but generally deny tax benefits in the event that a structure’s main purpose was to obtain such benefits without sound business reasons. These rules can be applied either domestically or internationally. The advantage of such general rules is that they also cover new and emerging abusive tax planning schemes that result in tax avoidance. Thus, having a GAAR in place allows the tax administration to act immediately instead of having to wait to tackle such new tax avoidance scheme practices until an appropriate law is passed. On the other hand, rules that are rather wide and unspecific are also relatively harder and more complex to implement; and due to the tax authorities’ high discretion in implementing such rules, they have the potential to decrease tax certainty considerably. Such uncertainty emerges because a GAAR may make it impossible for taxpayers to evaluate for beforehand whether the chosen arrangement is abusive and artificial at the time of the tax audit. For some countries, this uncertainty is a reason to refrain from introducing such rules.
Finding the right balance between rules that are broad and at the same time specific enough not to create uncertainty for taxpayers is challenging for every tax policy maker and tax administration, but even more challenging for low-capacity countries. With this in mind, German development cooperation supported the Centro Interamericano de Administraciones Tributarias (CIAT) and the University of Leiden in developing a toolkit for the design and effective implementation of GAARs with a special focus on low-capacity countries.
The toolkit aims to address the challenges faced by tax administrations in developing countries to generate proposals on how to implement GAARs efficiently and effectively. As mentioned above, the design and application of a GAAR is a complex matter and needs to consider some specific aspects in order to generate the desired effect. It must be designed in such a way that the taxpayer does not run the risk of not being able to predict at all in which cases tax administrations would apply the GAAR, thus creating huge uncertainty among taxpayers. Yet, it also needs to be framed in such a way that it is still considered a threat to taxpayers engaged in abusive tax planning and thus creates an incentive for taxpayers to be compliant. The toolkit will help developing countries strike a good balance in their laws, so the GAAR works to the best benefit of all stakeholders involved. In this regard, the toolkit not only looks at domestic GAARs, but also at treaty GAARs as proposed by the OECD BEPS Action Plan, the principle purpose test (PPT), and the limitation of benefits (LOB) standards. Lastly, it addresses doubts about the interaction of domestic and international GAARs and how both can be used in parallel to prevent tax avoidance.