In this article we will discuss about:- 1. Introduction to Anti-Avoidance Doctrines 2. Common Law for Anti-Avoidance Doctrines 3. Civil Law 4. Various Countries.

Introduction to Anti-Avoidance Doctrines:

International tax avoidance is also affected by the interpretations of judicial bodies in various countries. The practice varies considerably. The Courts in many countries take a literal view towards statutory interpretation.

Many of them also apply the purposive doctrine of the abuse of law or rights to counter serious cases of tax avoidance. These Court decisions have helped to evolve certain broad principles or judicial GAAR “doctrines” that differentiate acceptable from unacceptable tax avoidance.

These doctrines tend to be more flexible than the statutory rules under the domestic law and often overlap with one another. However, they are based on after-the-fact interpretations. As a result, they take a long time to evolve and may not always comply with the legislative intent.

Common Law for Anti-Avoidance Doctrines:


Many doctrinal or overriding GAAR principles are noticeable in the judicial decisions on anti-avoidance cases in common law countries.

The two main guiding principles are:

i. Motive test — the business purpose rule.

ii. Artificiality test — the substance over form rule.


These rules may be applied to a transaction or a series of connected or stepped transactions. In some countries, the principles have been incorporated in the domestic law.

Business Purpose Rule:

The business purpose rule attacks tax avoidance schemes that do not have a business purpose. It makes a distinction between transactions with a valid or bona fide commercial purpose and those designed primarily to avoid tax. The focus is on business or non-tax reasons for entering into the transactions. It balances tax and non-tax reasons.

Under the business purpose doctrine, a transaction must serve a business purpose (i.e. commercial justification) other than tax avoidance. The mere tax advantage cannot be the sole or main business purpose; it must also have a main or predominant commercial or non-tax purpose.


Therefore, there must be a valid business or economic purpose other than the reduction of tax liability. If the primary purpose is something other than tax avoidance, the transaction represents acceptable tax planning.

On the other hand, if the primary purpose is to obtain tax benefits and the transaction would not be carried out without those benefits, the transaction is treated as unacceptable tax avoidance.

In Gregory v Helvering, the US Supreme Court held that a corporate reorganization under the law solely for tax purposes did not qualify for tax benefits. The reorganization must be done for a legitimate business purpose other than tax avoidance.

Judge Learned Hand held that “in construing words of a statute which describe commercial or industrial transactions, we are to understand them to refer to transactions entered upon for commercial or industrial reasons and not to include transactions entered upon for no other motive but to escape taxation”.


There is no legal definition of a business or commercial purpose. The Courts take a common-sense view based on facts. However, several UK decisions have attempted to define the business purpose rule.

For example:

(a) The commercial or business purpose need not be financial, e.g., defence from a takeover is a justified business purpose. The tax advantage needs to be weighed against the commercial benefits that may or may not be quantifiable.

(b) The main purpose must be a genuine commercial purpose and not a tax advantage. However, obtaining a tax advantage can also be a bona fide commercial purpose.


(c) The motive is distinct from purpose. The purpose does not mean the subjective motive or intention in the mind of the taxpayer but the objective result of the transaction. It is the ultimate objective or aim.

The approach to business purpose rule may take a wide or narrow view. A wide view implies that if a transaction would not take place without tax relief, no relief should be granted.

A narrow view maintains that if the relief was proper and intended by Parliament, the exclusion would only apply if there was something improper about the transaction. Besides the United States, several other countries have also adopted the business purpose doctrine.


Substance Over form Principle:

Under the substance over form principle, the facts must be assessed according to bona fide substance and not the formal content. The 1987 OECD Report defines it as “the prevalence of economic or social reality over the literal wording of legal provisions”.


The substance over form principle is wider than the business purpose test. It allows the tax authorities to look through the legal form of the transaction and either ignore them or re-characterize them to establish the underlying reality.

It deals with artificial or contrived transactions that have an apparent business purpose but are tax-motivated. This doctrine may also cover situations where the rights and obligations are real but they are not enforced legally by one or both of the contracting parties.

Many countries differentiate legal substance or reality from economic substance. Legal reality refers to the facts about the legal rights and obligations actually created between the parties, or the legal acts actually performed, and their characterization (and sometimes interpretation) based on the legislative intent.

Therefore, the choice is between differing legal forms, and not the economic form, to define substance. Thus, there are several variations of this doctrine.

For example:

(i) Legal Over Economic Substance:


The definition applies to situations where due to the legal form used for the transaction a taxpayer has the real economic power over the taxable income without the tax liability. An example of the lack of economic substance (i.e. form over substance) is the sale of all the shares in a company. From an economic perspective, it can be regarded as the sale of the company’s assets.

One of the most quoted examples of lack of economic substance is the Duke of Westminster case in 1936 (UK). The taxpayer executed tax-deductible deeds of covenants to pay selected employees without affecting their non-deductible wage entitlements.

Under separate non-contractual arrangements with the employees, it was assumed that they would not expect to be paid their existing wages but be content with payments under the covenant plus such additional amount as required to increase their income to their current salary levels. The Inland Revenue denied the Duke the tax deduction for the covenanted payments and deemed them as wage payments.

The UK House of Lords held that they must be regarded as covenanted payments and not as wages in law, and the taxpayer was entitled to deduct them in computing his taxable income. The Court accepted the legal form of the covenanted payments, although they could be treated in substance as the economic equivalent of wages.

The Duke of Westminster case also established its own legal principle. Under it, the tax treatment is determined by reference to the legal substance rather than economic substance. The tax authorities cannot levy tax on the basis of legal facts which are not that adopted by the parties but which would achieve the same economic effect but at a higher tax cost, if adopted. This judicial doctrine permits tax planning.

(ii) Sham Transaction (“cover-up”):

Sham transactions refer to transactions where the parties say one thing while intending another. In a sham transaction, they give effect to a transaction, which they do not carry out, or do not intend to carry out, or are a cover up for another transaction or relationship.

In short, they do not create the legal rights and obligations, since the relationships that are alleged to exist do not exist. All parties to a sham are usually aware of the pretence at the time the transaction is executed.

A sham transaction conceals the true nature or reality of a transaction that exists in form only. The documents or actions give the appearance of a particular transaction having taken place but actually another transaction or no transaction is intended or has occurred.

They are transactions that never actually happened or those that happened but lacked the substance of the alleged form. It is “a transaction constructed to create a false impression in the eyes of the tax authority”. The legal form is retained but the underlying substance is not genuine in law.

The sham may or may not be a deliberate attempt to deceive third parties. However, while an ulterior motive, dishonesty or artificiality is not a proof of sham by themselves, there is normally an element of deception or “cover-up” by the party or parties in the arrangement.

For example, an entity may be legally set up as a partnership but it is not intended to operate as a partnership. Similarly, an employee may be deemed as an independent contractor.

In a sale and leaseback transaction, the transfer of the related rights and obligations of ownership may not accompany the sale of assets. A gift may be documented as a sale (or vice versa) without appropriate transfer of value. A transfer to a nominee who is not the real party to the contractual rights and obligations is a sham.

A “letter-box company” in a tax haven for tax avoidance purposes may be regarded as a sham. It may also include transactions where the parties do not intend to enforce the contractual terms, even though the rights and obligations are real.

In the United States, the term “sham” is applied to any transaction where the underlying substance (factual or economic) differs from the form. In Knetsch v US, a taxpayer borrowed money at 3.5% to make a return of 2.5% from an investment in an annuity issued by an insurance company. The investment income was taxed at a lower capital gains rate and the interest payments were fully deductible for tax purposes.

The net result after tax, therefore, provided a tax benefit. The US Supreme Court treated the transaction as a sham and disallowed the interest paid on the loan. It held that “there was nothing of substance to be realized (by the taxpayer) from his transaction beyond a tax deduction…”

Where the Courts hold that a transaction is a sham, they normally apply the tax rules based on the true economic position. The form of the transaction is disregarded when compared with the underlying substance in an otherwise legally effective transaction.

The facts and circumstances external to the document or transaction are often used to examine the lack of genuineness. Although the burden of proof lies with the tax authorities, the taxpayer has the duty to provide information. By its nature, sham is generally difficult to prove.

(iii) Doctrine of the label (“wrong characterization”):

The parties use an incorrect “label” or description to classify or characterize a transaction or relationship for tax purposes.

Unlike a sham, the transactions are real and do create legal rights and liabilities which do exist or which are not different from those that actually do exist. They are not artificial or fraudulent. However, the true legal rights and obligations differ from the characterization by the taxpayer.

For example, a sale contract may be wrongly characterized as a lease transaction, or a loan may have a non-arm’s length rate of interest and no repayment terms. The label may describe the transaction as a loan when it should be treated as equity or gift.

In Ridge Securities v IRC, the Court rejected a loan with interest at over 400% per annum as a loan transaction. In another case, the Court rejected a purchase consideration described as an annuity payable over a period of 47 years.

The doctrine has also been invoked to decide the price allocations in composite transactions. In Vestey v IRC, the taxpayer had agreed to sell his shares at a consideration payable over 125 yearly instalments, and treated the entire price as a capital receipt.

The Court held that a proportion should be treated as an interest payment. The label that the parties choose to attach to their payments was not conclusive of their character for tax purposes.

In many countries, the characterization by the taxpayer is denied by the authorities. The taxation is often based on legal or economic substance, as opposed to the form given by the taxpayer. The tax authorities are entitled to use their own characterization in a tax assessment that can then be decided by the Courts subsequently when in dispute.

Step Transaction Doctrine:

Certain common law countries have evolved a step transaction doctrine to regard a series of connected transactions as a single transaction under the “substance over form” principle (Examples: Canada, Japan, United Kingdom, and United States).

In a step transaction, the intermediate steps in a chain of preordained, even if bona fide, transactions may be disregarded and several related transactions may be treated as a single composite transaction.

Alternatively, the transaction may be broken into its distinct steps to determine their acceptance for tax purposes. The step transaction doctrine maintains that “purely formal distinctions cannot obscure the substance of a transaction”.

The examples of the step transaction doctrine include the US Supreme Court decision in Gregory v Helvering, and W T Ramsay Limited v IRC in the United Kingdom. In Ramsay, each step in the circular arrangement was legal in its own right. The transactions and the documents that were executed with legal effect were not a sham, and money passed between the parties.

However, the multi-step transactions as a whole were circular and self-cancelling. The taxpayer began and ended in the same financial position and still claimed a tax loss. The House of Lords disallowed the loss as fiscal nullity since the taxpayer had made no real financial loss.

In another case (Furniss v Dawson), the British Courts extended the Ramsay principle to a restructured sale, ignoring a purported sale by an intermediary. The taxpayer had sold the shares on a share-for-share exchange basis at its current market value to a wholly- owned nonresident company set up for this purpose.

This company then sold the same shares to a third party on a no-gain no-loss basis. The House of Lords denied the taxpayer the capital gains deferral and imposed a tax as a direct sale by the taxpayer.

The judge held that any intervening step or steps should be ignored if they formed part of a preordained series of transactions or a single composite transaction (“pre­ordination doctrine”), and if the steps were inserted without any commercial or business purpose other than the overall avoidance of a tax liability (“business purpose rule”).

An artificial time delay does not prevent the linking of separate transactions as step transactions.

The step transaction may be circular or linear. A circular or self-cancelling transaction denotes an arrangement solely for tax avoidance where the taxpayer achieves no other commercial benefit. An example would be the sale and immediate buyback of the same asset.

The transactions are legitimate but artificial and would not satisfy the business purpose test when taken as a whole. On the other hand, a linear transaction refers to an arrangement in which the taxpayer achieves a commercial benefit after one or more tax minimizing steps, for example a sale through an intermediate subject.

The linear transaction can have both business and tax avoidance objectives.The steps taken by a taxpayer are subject to judicial scrutiny and disregarded only if they serve no purpose other than tax avoidance. The examples of such linear arrangement include Esmark Inc v Commissioner in the United States, and Craven v White in the United Kingdom.

In Esmark, the US Court decided that the step doctrine was not applicable since the steps were not individually meaningless and the sale could not be treated as a sham. In Craven v White, it was held that the transactions that have a substantial commercial purpose, and where there were no artificial preordained steps, could not be struck down unless they were caught by a specific tax provision.

In the latter case, each linear transaction had a business purpose other than tax, and the steps were not preordained or practically certain to take place.

The Court held that it was only justified to link the beginning with the end to make a single composite transaction, provided:

(a) The series of transactions had been preordained at the time when the intermediate transaction was entered into, to produce a given result;

(b) The intermediate transaction had no other purpose than tax mitigation;

(c) There was no practical likelihood that the pre-planned events would not take place in the order ordained, so that the intermediate transaction was not even contemplated as an independent transaction; and

(d) The preordained events did take place.

The UK Court rejected the step transaction doctrine. It held that the “step transaction doctrine did not apply when a series of transactions possessed at least one business purpose and the effect of the series was not preordained”. Similar decisions have subsequently been given in several other UK cases.

Rights and Obligations not Likely to be Enforced:

The taxpayer’s characterization reflects the legal relations and real rights and obligations under the contract but the contract is not likely to be enforced by the parties. In most countries, transactions not enforced are disregarded.

In the United States, the transaction is re-characterized for tax purposes. In Canada, it will be challenged. In the UK, the rule will apply subject to the “Ramsay principle”. Civil law countries are likely to treat it as a sham or simulation.

Civil Law for Anti-Avoidance Doctrines:

Civil law countries follow statutes and, strictly speaking, do not observe the principle of case law (i.e. judge-made law) prevalent under common law. However, Court decisions do influence the application of statutes. The Courts apply rules under the civil law to control general tax abuse. These rules either disregard the transaction or rectify the transaction for tax purposes.

Abus de Droit (“Abuse of Right”):

Several jurisdictions apply the form and purpose rules of the abuse of right doctrine under the civil law (Examples: Argentina, Austria, Belgium, France, Germany, Netherlands, Portugal, and Spain). An abuse of right is the manipulation of the intention or spirit of the law.

The Courts disregard the legal form, where the transactions are undertaken solely or predominantly to avoid tax, i.e. without a bona fide business purpose. Under this principle, the taxpayer cannot exercise his right solely to avoid or reduce the liability to tax.

He has the right to enter into a particular legal transaction but the legal form must be the normal and regular method for achieving a particular economic result. The misuse of his rights by a taxpayer violates the rights of the state to collect the taxes due.

The abus de droit doctrine strikes a balance between the interests of the two parties where their interests differ. The countries recognize the right of the taxpayer to arrange or rearrange his affairs to pay the minimum tax and to choose the legal form most suited for that purpose.

However, if the result is contrary to the purpose of the law, it is an abuse of rights as there is a conflict with the meaning, purpose or the scope of the tax rules. Thus, the taxpayer may have an acceptable legal form but as the tax result is contrary to the legislative intent it is unacceptable. The abuse of rights principle can either disregard or re-characterize the transaction.

The abuse is normally assumed where the purpose of the applicable tax law has been defeated. In France and Germany, the fraudulent intent to avoid tax should be accompanied by the artificiality of the legal form, e.g. substance over form.

Moreover, in France, tax avoidance may be either a fictitious transaction or a misuse of the tax law. In Germany, the artificiality depends on the extent that the act deviates from the normal conduct followed by a sound and conscientious businessman.

Fraus Legis (“Abuse of Law”):

Many civil law countries apply the Roman law doctrine of “frauslegis” (abuse of law). It resembles the business purpose rule. The frauslegis principle allows the Court to disregard a transaction entered for tax avoidance purposes and to substitute it by a “normal” transaction. The tax is imposed as if the taxpayer did not carry out the “disregarded” transaction but a similar taxable transaction.

Based on a Dutch Supreme Court decision in 1926, the tax authorities in the Netherlands must satisfy three conditions before they can apply frauslegis:

(i) The avoidance of tax must be the only or the paramount motive or intention for the transaction, or for the step that avoids the tax, which is otherwise due;

(ii) The transaction must lack real, practical effect or purpose other than the avoidance of tax; and

(iii) The intended tax consequences must violate the intention and purpose of Dutch law.

Thus, there must be an intention to avoid tax, the result of the transactions must have no other purpose, and it must be against the legislative intent.

The transactions may be real but have no commercial purpose, except to minimize or avoid taxation. In a composite transaction, both the combined and the individual steps must meet the bona fide business test.

If a transaction (or transactions) would not be undertaken at all without the tax benefit, it is deemed to have a tax motive. The doctrine, however, differentiates between abusive and bona fide tax mitigation. The law does not deny the taxpayer the right to choose the most beneficial legal form to minimize his taxes provided it is not abnormal or unusual.

The examples of fraus legis include a Dutch parent company, which financed its Dutch subsidiaries through an offshore subsidiary to avoid the tax payable on the interest income in the Netherlands if the monies were loaned directly.

Since there is no withholding tax on interest paid to nonresidents under the Dutch domestic law, the amount can be paid tax-free to the foreign subsidiary. Another example relates to a foreign parent company with a wholly-owned Dutch subsidiary.

To avoid the 25% dividend withholding tax, it sold the shares of the subsidiary to another Dutch subsidiary for an interest-bearing loan as consideration. The two Dutch subsidiaries claimed tax consolidation to net off the dividend payment, and the parent company received the profits as a tax-free interest payment on the loan.

The Court held that the subsidiary could not deduct the interest payment to the parent company under frauslegis, and treated the amount as the payment of a dividend since it was the “normal” form of such a transaction.


Certain civil law countries (Examples: Belgium, France) apply the doctrine of simulation to ensure “substance over form”. It arises when there is no real transaction or there is a hidden real transaction or relationship. The apparent transaction differs from the real transaction, and has no basis in reality or in the actual or effective intent.

In such cases, the tax authorities can disregard the simulated transaction and replace it with the real one. This principle resembles a sham or the doctrine of the label, where the transactions are disguised or fictitious, and the true intent of the transaction differs from the legal form.

Examples of simulation include sale and leaseback transactions where the respective rights and obligations of the parties are not transferred in substance. Another example would be a US$ 10 million loan from the shareholders in a company with a low equity base, characterized as a loan for tax purposes when it is economically a capital contribution.

Anti-Avoidance Doctrines in Various Countries:


Over recent years, there has been a gradual shift from “literal” to “purposive” interpretation of tax legislation in Australia. Although the Australian Courts have traditionally shown no preference for substance over form, they have often struck down legal but artificial anti-avoidance schemes. Moreover, Section 15AA of the Acts Interpretation Act specifically requires a purposive interpretation of tax legislation.

It reads: “In the interpretation of a provision of an Act, a construction that would promote the purpose or object underlying the Act (whether that purpose or object is expressly stated in the Act or not) shall be preferred to a construction that would not promote that purpose or object”. Therefore, the Courts cannot depart from the Parliament’s clear statement.

Australia also has a GAAR in its Income Tax Act 1981 (Part IVA of the Act). A scheme with tax benefit as the dominant purpose can be disregarded by the tax authorities, and replaced by a taxable alternative.

The terms “scheme”, “dominant purpose” and “tax benefit” are defined in the Act. The law provides for compulsory tax disclosures under the threat of heavy penalties and criminal prosecution.

For many years the GAAR was relatively untested in the Courts. A series of High Court cases and legal cases in the lower Courts are shaping the limits of the provisions. Australian Taxation Office offers product rulings setting out the tax consequences of investment schemes marketed to the public.

There are stringent penalties for promoters of tax schemes that amount to tax exploitation schemes. Avoidance arrangements involving dividends and the use of franking credits under dividend imputation are targeted by specific legislation, with the GAAR acting as a catch-all provision.


Under the law, the taxpayer is free to arrange his affairs as he wishes. However, there are broad limitations under the Austrian general anti-avoidance rules (Bundesabgabenordnung Sec. 21 – 24) for cases when the transaction can be disregarded and the tax imposed on the underlying economic reality.

They include transactions that do not reflect the economic reality (e.g. substance over form, infringement under frauslegis, sham transactions, etc.) or if the recipient is not identified properly.

However, in such cases the tax avoidance must be the main or only motive for the arrangements. The Austrian Courts also require a strict burden of proof from the tax authorities (in practice difficult). It is irrelevant that the arrangements are unusual.


The Belgian Courts have traditionally applied the civil law doctrine of simulation in cases of tax avoidance. The Belgian law distinguishes between simulation and frauslegis (abuse of law). While/rawslegis relates to a transaction with no commercial or business purpose, simulation deals with a sham transaction.

Simulation is a situation where the taxpayer adopts a judicial form without the intent to accept the corresponding legal consequences. For a simulation, the Court must decide that the nature of the underlying transaction was fictitious or sham due to a concealed arrangement. Frauslegis has over the years been overtaken by the simulation principle in Belgium.

The doctrine of simulation is restricted under the “Brepols” doctrine. In this case, the Belgian Supreme Court decided that there was no illegal simulation, since the taxpayer had accepted all the legal consequences of his actions. The tax law can only assess the tax according to the legal form (not substance) of the transaction.

This doctrine grants the right to the taxpayers to structure the transaction in the least taxable manner to achieve their economic objective. It is irrelevant that the transaction or the legal structure is unusual. The Brepols doctrine allows the tax authorities to ignore a sham transaction, but not the legal form aimed at tax avoidance.

Belgium normally adopts a strict and literal interpretation of its tax laws. Under its Constitution, no tax can be levied except under the law and the burden of proof lies with the tax authorities. A taxpayer can arrange his affairs to minimize his tax liabilities, provided he accepts the legal consequences of the adopted legal structure, even if unusual, under the principle of “free choice of the least taxed route”.

Neither the intentions of the parties nor the underlying economic substance are significant considerations provided no legal obligations are infringed. The legal form normally overrides economic substance, but not legal substance. No analogy is permitted and in case of doubt the interpretation favours the taxpayer.

As from 1993, the Belgian tax laws contain a general anti-abuse rule (GAAR) that allows the authorities to declare non-opposable the characterization of a transaction or step-transaction if the choice of the characterization by the parties was motivated by tax avoidance.

However, the rule (ITC Article 344) permits the taxpayer to prove that the tax structure has legitimate financial and economic substance, besides tax benefits.

The Revenue can examine the actual underlying situation, i.e. the substance and not just the legal form of the transaction, but it must re-characterize the transaction respecting its legal effects. The taxpayer can obtain advance rulings on the tax status of such transactions.


In the Stubart case (1984), the Supreme Court of Canada expressly rejected the business purpose test. It held that a transaction might not be disregarded for tax purposes solely on the basis that it was entered into by a taxpayer without an independent business purpose.

The Court, therefore, reaffirmed the Duke of Westminster doctrine. It said: “…Lord Tomlin’s principle is far too deeply entrenched in our tax law for the Courts to reject it in the absence of clear statutory authority. No such authority has been put to us in this case”.

Canada enacted a GAAR in 1988 (Section 245 of the Income Tax Act). The rule denies the tax benefits on any transaction “which results either directly or indirectly in a tax benefit, unless the transaction is carried out primarily for bona fide purposes other than to obtain a tax benefit”.

A “tax benefit” is defined very broadly as “a reduction, avoidance, or deferral of tax or other amount payable (such as interest and estimated tax instalments) or an increase in a refund of tax or other amount payable under the Act”. Therefore, it covers tax avoidance as well as tax advantage unless the primary purpose of the transaction is not tax-driven.

The GAAR does not apply if the transaction does not “…result directly or indirectly in a misuse of the provisions of the Act, or an abuse having regard to the provisions of this Act, other than this section, read as a whole”.The tax authorities also give binding advance rulings on the GAAR compliance of proposed transactions.

The Supreme Court of Canada has set out the criteria for applying GAAR.

In essence, three requirements must be established:

(a) A tax benefit must result from a transaction or part of a series of transactions;

(b) The transaction must be an avoidance transaction, that is to say not undertaken for bona fide purposes; and

(c) It cannot be reasonably concluded that a tax benefit would be consistent with the object, spirit or purpose of the provisions relied upon by the taxpayer.

The burden of proof is on the taxpayer to establish the first two points and on the tax authorities to establish the last point. If the existence of abusive tax avoidance is unclear, the benefit of the doubt is given to the taxpayer. Moreover, the Courts must conduct a unified “textual, contextual and purposive analysis”.


Denmark applies substance over form doctrine under a “correct recipient of income” principle. The tax authorities can deem a person to be taxable if, for example, income is diverted to an offshore company.


Tax avoidance (evasion fiscale) lies between tax evasion (fraudefiscale) and tax planning (habiletefiscale). Tax avoidance normally means abusive tax planning and, therefore, is unacceptable; tax planning is legal.

The French Courts follow the general principle of abus de droit (abuse of rights) to curb tax avoidance. The doctrine is included in the French statute on tax procedures.It curbs legal structures or transactions considered as sham or designed exclusively to avoid or evade tax.

The abuse of rights doctrine is based on the judicial decisions of the Conseil d’Etat (Supreme Administrative Court of France) and the Cour de Cassation (Supreme Judicial Court of France).

The Conseil d ‘Etat has established two separate tests for tax avoidance:

(i) The sole purpose of the transaction is to avoid or reduce the tax burden (fraude a la loi), or

(ii) The transaction is fictitious (simulation). Whereas an act with no other motive than tax avoidance is treated as a fraudulent use of the tax law, simulation covers an act of the taxpayer that has a “fictitious character”, i.e., a sham.

Tax avoidance can be either fraude a la loi or simulation. The law places the burden of proof on the tax authorities. If either test is met, there is an abus de droit. If a taxpayer enters into a transaction exclusively to avoid tax and no other business purpose, it will be disregarded even if it is not fictitious or sham.

The tax authorities can also disregard acts that conceal the true tax significance of a business arrangement under the simulation test. Abus de droit may disregard or re-characterize a transaction. They can replace the acte apparent with the real aims sought by the parties.

The Courts also apply the judicial doctrine of “abnormal management act” (acteanormal de gestion). Unlike abus de droit, abnormal management is not based on the subjective intent of the taxpayer. A taxpayer cannot engage in any activity contrary to his own business interest, e.g. not to make a profit.

The Courts and the tax authorities do not replace the business decisions of the management or the owners. However, the transaction can be disregarded if it is deemed not to be in the commercial or economic interest of the taxpayer.

In several cases, the Courts have disallowed expenses that were “manifestly” not in the company’s interest. For example, the expenses relating to providing warehouse space and an employee’s services to a third party, free of charge, were held as not deductible. In another case, the payment of a debt of a former parent company was disallowed.

Generally, the Courts favour the taxpayer. A taxpayer has a right to arrange his affairs in any way that is legal, provided it is not solely for tax avoidance purposes.

If the transaction has an economic or financial rationale, the taxpayer can freely engage in tax planning, provided the legal documentation supports the true relationship between the parties and it is not artificial or sham. It is, therefore, not unlawful to choose the most economical, legal and financial way from a tax viewpoint.


The German general tax code (AO) contains GAAR to prevent the evasion or reduction of tax through legal forms that exploit the law. Legal structures with the primary intention to avoid tax can be disregarded under “the abuse of form and legal structures” provision. The abuse of legal forms depends on the deviation from ordinary business conduct.

If the transaction has an acceptable legal form and a business purpose, it cannot be challenged if the taxpayer chooses the legal form that minimizes his taxes. The German Bundesfinanzhof upholds the view that every taxpayer has the right to arrange his affairs to avoid or save taxes.

The Section 42 AO deals with transactions that lack a valid business purpose.

Under the German case laws, several features must be present in the arrangement for this Section to apply:

(a) There must be several ways for the taxpayer to achieve his economic goal;

(b) The legal arrangement must be inappropriate to the particular economic purpose of the arrangement; and

(c) There must be no other economic purpose (or other legitimate purposes) other than tax to justify its use.

The German Courts also apply the “substance over form” rule through a purposive interpretation of the tax law. The tax Courts have used the principles of analogy and teleological reduction in their decisions. In the former, they look at the intention of the law given the facts, while the latter applies when the wording of the statute exceeds the intent of the law.

The analogy applies the tax rules to the given facts, when the wording of a rule does not cover them but the intent of the law does so and there is an unintended gap in the wording of the law. The taxpayer can apply for an advance tax ruling before entering into a transaction.


There are no GAAR provisions in the tax laws, but the domestic law contains specific anti-avoidance provisions (SAAR). For example, the tax law disregards sham transactions and disallows excessive deductions either under the “wholly and exclusively” rule or under certain “disallowance” rules.

The underlying principles are implemented through administrative measures of the tax authorities and the judicial decisions of the Courts at various levels. In recent years, guidance on cross-border transactions is also provided by the decisions of the Authority for Advance Rulings.

The Courts have usually favoured the taxpayer and take a literal view. A decision of the Andhra Pradesh High Court in 1983 provides a more liberal treaty interpretation. In two decisions in the 1990s, the Indian Courts held that under the India-Malaysia tax treaty, the term “may be” was meant not only to give the source country the option to tax, but also to deprive the residence country of its right to tax.

As a result, “may be” was interpreted as “shall only be” and the taxpayer was granted tax exemption rather than tax credit under the treaty. These decisions were confirmed by the Indian Supreme Court in May 2004 in a similar case of CIT v P V A L Kulandagan Chettiar, India is not an OECD member and its recommendations are at best persuasive.

The Courts ignored the OECD MC 1977 and its Commentaries. India follows the UN Model as a treaty policy and supports source-based taxation in both its domestic law and tax treaties.

In the McDowell & Co. case, the Indian Supreme Court held that tax planning was legitimate but only provided it was within the framework of law. It was the obligation of every citizen to pay his taxes honestly without resorting to subterfuges. Colourable devices could not be part of tax planning, and it was improper for taxpayers to avoid tax by dubious methods.

Therefore, schemes devised to evade taxes could be struck down. In recent years, the Courts have moved to a slightly more flexible and purposive approach to discourage transactions contrary to the legislative intent.

This judgment was discussed by the Indian Supreme Court in the case of Azadi Bachao Andolan.It distinguished the previous decision in McDowell. It also accepted the view, which was taken by the House of Lords in the cases of IRC v Fisher and IRC v Duke of Westminster,that “every man was entitled to so arrange his affairs as not to attract taxes imposed by the Crown, in so far as he can do that within the law”.

For an anti-avoidance provision to be applied, it must be specifically enacted in the domestic law or stated in the tax treaties.


Israel has enacted specific measures to counteract tax planning involving foreign professional companies (FPC). A FPC is deemed to be controlled and managed in Israel and taxable in Israel.

A foreign company is a FPC if:

(a) It has five or fewer individual shareholders;

(b) It is owned 75% or more by Israeli residents;

(c) 10% or more shareholders conduct a special profession; and

(d) Most of its income is derived from the special profession.

The special professions include engineering, management, technical or financial advice, agency, law, medicine and many others. The purpose of this provision is to prevent tax avoidance by conducting the same business activity abroad as that conducted in Israel.

Israel requires its banks to withhold tax, usually at 25% rate, from most overseas payments unless they relate to import of goods or have an official approval in writing for a lower rate. Israel also has a GAAR (Income Tax Ordinance, Sec. 86) to counter fictitious and artificial transactions if their purpose is improper avoidance or reduction of tax, even when not illegal.

The Israeli Supreme Court has defined artificial as lacking commercial purpose while fictitious is non-existent and therefore illegal.

Israel also proposes to enact regulations in 2007 requiring residents, who own 25% or more of any “means of control” of an entity resident in a non-treaty jurisdiction (or receives NIS 500,000 or more from such an entity) to report it in their tax return.

The tax officer may make a best judgment assessment of any tax due, and impose a 30% fine on the shortfall and apply criminal sanctions in the case of artificial or fictitious transactions.


Italy normally follows the letter of the law where form takes precedence over substance.If a result can be obtained through different transactions, the taxpayer is free to adopt the contractual scheme that is least burdensome from the tax viewpoint.

Tax avoidance has so far been handled through statutory provisions intended to target specific tax-driven transactions that lack legitimate business purpose. The early efforts to introduce a general anti-avoidance provision by the government were unsuccessful.

Italy introduced specific anti-avoidance rules in 1997. The tax authorities can disallow the tax benefits on certain transactions undertaken without valid economic reasons.

For tax avoidance, the transaction should:

(i) Lack business purpose,

(ii) Abuse the tax system, and

(iii) Obtain tax benefits not due.

A constitutional rule on the ability to pay principle is also used by the tax authorities to apply the substance over form doctrine.


The Director of the Tax Office has the authority to re-compute the tax base of corporation income tax, the amount of net loss, or the amount of corporation tax payable, if transactions or book entries result in an improper decrease in the tax liability of:

i. A family corporation, which is a domestic corporation,

ii. A domestic corporation that owns three or more branches, factory or other places of business, and has a special relationship between the directors or individuals working in such places of business, provided the head office owns two-third or more of the total equity of such corporation; or

iii. A corporation due to a corporate reorganization; or

iv. A corporation due to a consolidated tax filing election.


Although Dutch law provides a GAAR under Article 31 of the General Taxes Act 1965, the Dutch tax authorities and the Courts rely on the doctrine of frauslegis (abuse of law) to counter abusive tax structures.

If a legal form has the dominant or decisive motive to avoid tax, frauslegis permits the tax authorities to disregard the legal form adopted, and to substitute it by another “normal” transaction. Its objective is to cancel the effect of the transactions designed mainly to avoid taxes.

Frauslegis is only applied as a last resort when the legal form of the transaction fails to achieve the legislative intent. The Dutch Courts uphold the right of the taxpayer to arrange his affairs to minimize his tax liability, provided the legal form is valid and no legal provisions have been infringed.

If the taxpayer has objective non-tax reasons for the transaction, frauslegis will not upset it, unless the transaction is purely tax driven.

The Dutch Supreme Court has allowed the frauslegis under domestic law but consistently rejected its application under tax treaties, other than the arrangements with the Netherlands Antilles and Aruba, which specifically include fraus legis.


A GAAR was introduced in 1999 for transactions undertaken with the sole or main purpose to reduce or eliminate tax. The provision allows the tax authorities to disregard them and tax their underlying economic substance. The burden of proof remains with the tax authorities to show that the primary intention was tax avoidance.


The Tax Code allows the taxation of transactions based on their real economic nature, irrespective of the legal form. The Civil Code has also codified the “abuse of law” principle. It has two special provisions, namely “frauslegis” and “simulation”. Both provisions stress on an economic interpretation of tax law and on substance over form.


Sweden has attempted several versions of the GAAR. The Tax Avoidance Act reintroduced in 1995 was amended in 1998.

The recent amendment disregards a transaction for tax purposes if:

(a) The tax benefit is the main reason for the transaction;

(b) The transaction (alone or collectively) forms part of a scheme that results in a significant tax benefit to the taxpayer;

(c) The taxpayer has directly or indirectly taken part in the transaction; and

(d) The form of the transaction would be in conflict with the purpose of the tax legislation.

A tax benefit is defined widely to include any relief or advantage for tax purposes. Under the law, the tax may be levied as if the transaction did not take place, or may be based on a transaction that has similar economic effect but not the tax benefit.

The burden of proof rests with the tax authorities and advance tax rulings are given. As a further safeguard, the law specifies that the GAAR can only be applied under a Court order by the tax authorities.

Generally, the Swedish Courts regard a transaction as unacceptable if:

(i) The taxpayer’s action is not the closest action to obtain the financial result except tax, i.e. artificial;

(ii) The tax benefit is the essential reason for the action, i.e. tax motive; and

(iii) The tax based on the taxpayer’s action conflicts with the rationale of the legislation, i.e. legislative intent.


Switzerland applies both the business purpose and the substance over form doctrines under its law. The tax authorities can challenge a transaction if they suspect tax avoidance.

The Swiss Supreme Court has held that there is tax avoidance if:

(a) The way a taxpayer has chosen to act appears to be unusual and inappropriate;

(b) It apparently has only been made to save taxes that under ordinary circumstances would have been payable; and

(c) It would lead to substantial tax savings. In tax avoidance cases, the tax authorities can substitute the customary construction for the transaction and tax accordingly.

United Kingdom:

Unlike the law in Scotland, the English Courts do not accept the principle of the abuse of rights as applied in civil law jurisdictions. In Chapman v Honig, the Court held that: “A person, who has a right under a contract or other instruments, is entitled to exercise it and can effectively exercise it for good reason or a bad reason or no reason at all”.

In principle, tax avoidance is legal and tax evasion illegal.

Acceptable tax avoidance requires that:

(i) The transaction (or series of transactions) must not be unlawful, sham or artificial or circular; and

(ii) The taxpayer’s purpose, motive or intention to avoid tax must not be affected by specific anti-avoidance provisions.

In preordained or composite transactions that avoid taxes, there must be no practical certainty of the steps taking place.

The UK Courts have traditionally followed a literal approach, based on the actual words rather than a purposive approach. They apply tax laws strictly under private or domestic law concepts. Early UK legal decisions favoured the taxpayer.

In Ayrshire Pullman Motor Service and Richie v CIR, it was held that:

“No man in this country is under the smallest obligation, moral or other, so to arrange his legal relations to his business or property as to enable the Inland Revenue to put the largest possible shovel in his stores”.

The 1936 decision of IRC v Duke of Westminster is still applicable as the “form over substance” rule, but has been increasingly questioned in recent legal decisions.

The Courts have also applied a purposive approach in several legal decisions. In Stock v Frank Jones (Tipton) Ltd, the judge held that the objective of the Court was to discover the intention of Parliament through the words used.

If the words were clear, they must be applied even if the result was absurd. Where the meaning was clear it must be given effect even if the true meaning involved hardship to the taxpayer. The Courts have also looked at the legislative history and Parliamentary proceedings when the law was unclear or ambiguous.

The best-known decisions on UK anti-avoidance rules are the Ramsay case and Furniss v Dawson. They were based on a series of transactions with no business or commercial purpose other than tax avoidance.

In Ramsay, the Court held: “The Commissioners are not under Westminster’s doctrine or any other authority bound to consider individually each separate step in a composite transaction intended to be carried through as a whole”. Both cases confirmed the “see-through” principle and disregarded the artificial steps used for tax purposes.

The Ramsay and Furniss v Dawson doctrine was confirmed in the McGuckian case.The trend towards a flexible approach to achieve the “right result” in cases of tax avoidance is also noted in other UK Court decisions.

In CIR v Burmah Oil Co Ltd (1981), one of the Law Lords (Lord Diplock) held that: “There was no actual rule of law demanding the use of a literal approach in tax; this approach is merely the practice. Furthermore, a precedent is not strictly a rule, but a statement of practice and this practice can change”.

The UK Courts, however, still maintain that it is not the role of the Courts to legislate, and apply the “look through rule” only in cases of blatantly artificial transactions. In Craven v White (1988), the judge held: “…to add a limitation or qualification which the legislature itself has not sought to express and for which there is no context in the statute is to legislate, not to construe, and that is something which is not in judicial competence”.

In his opinion, a moral view to render ineffective any step undertaken to avoid or minimize tax on an anticipated transaction would be an invitation to legislate. A motive cannot be judged with hindsight and the Revenue cannot re-characterize or reconstruct the transaction to arrive at the tax result.

The House of Lords decision in MacNiven v Westmoreland Investments Ltd again adopted a somewhat purposive construction. However, it did not apply the Ramsay principle, which only applies to certain step transactions.

It maintained that the role of the Courts was to interpret the relevant statute based on the facts (real and legal) and not to re­-characterize the transaction. It relied on legal substance and ignored the economic substance.

Moreover, it defined legal substance as “what parliament meant by using the language of the statute”. The meaning depended on whether the statute referred to a commercial or economic concept or to a legal concept to meet the legislative intent.

The United Kingdom relies primarily on the specific or general rules developed through judicial decisions. Statutory provisions are legislated by Parliament to counter abusive schemes (SAAR). There is no general anti-avoidance provision in the tax law. The UK Inland Revenue issued a consultative document on GAAR in October 1998.

The document discussed the possible legislation to deter or counteract transactions, which were designed to avoid tax. It defined tax avoidance to include the non-payment of tax, any increase in tax repayments or tax credits or the generation of losses for tax purposes.

It also provided for an advance tax clearance system within 30 days. The companies were free to pursue the transaction even if the clearance was denied. The government subsequently decided not to implement any GAAR legislation.

In 2004, the United Kingdom introduced a reporting system requiring advance disclosure of tax planning schemes by taxpayers. The information has been used to enact specific anti-avoidance measures.

United States:

The United States does not have a statutory GAAR. In principle, the taxpayer is allowed to choose the transaction with the least tax liability if the tax law imposes different liabilities on transactions that produce the same legal and economic results. He can also defend the choice of the transaction based on an economic purpose test where he can show that the economic results could not be obtained otherwise.

However, the domestic law applies specific legislation to counter unacceptable tax avoidance schemes. There are also provisions based on judicial decisions that examine the taxpayer’s purpose in tax-driven transactions.

The Courts in the United States take a purposive view and have evolved several anti- avoidance doctrines over the years. They look beyond the superficial formalities of a transaction to determine the proper tax treatment.

In interpreting the legislation, they examine the congressional records and the legislative history. Where the Courts are unable to discern the legislative intent, they act as statutory interpreters to resolve the ambiguity or the silence in the law.

The US Courts maintain that they should look at the purpose where the arrangement achieves a result inconsistent with the legislative intention under a statute, and the result was within the taxpayer’s control.

The US Supreme Court in Gregory v Helvering (1935) held that: “Any one may arrange his affairs that his taxes shall be as low as possible; he is not bound to choose the pattern which will best pay the Treasury; there is not even a patriotic duty to increase one’s taxes”.

However, the judge also mentioned that the choice must be between transactions that have a business or economic purpose. The Court rejected the taxpayer’s scheme because the arrangements constituted a mere device and not the “thing which the statute intended”.

Generally, the US tax authorities and the Courts also look at substance over form. Two well-known US cases relate to Aiken Industries and Johannson v United States. The US Revenue may also re-characterize transactions based on the judicial doctrines of business purpose rule or step transaction. Similarly, transactions or a series of transactions without a business purpose may be ignored.