Judicial general anti-avoidance rules (GAAR) have emerged in Thailand, so its time to refresh your mindset on taxation.
In the recent decades, many countries and international organizations have been very active in developing tools to tackle tax avoidance. These tools can be divided into specific anti-avoidance rules (SAAR) which address specific taxpayers or transactions and the much broader GAAR.
In the strict sense, a GAAR can be described as “statutory” anti-avoidance rules legislated to combat any perceived tax-avoidance situation. It principally enables the tax authorities to deny tax benefits or disregard the legal form of any transaction for tax purposes, regardless of its legality and reality.
It can also be used to challenge those circumstances in which SAAR would normally be applied—for example thin capitalization, transfer pricing, controlled foreign companies—in the absence of the applicable SAAR.
Certain legal principles were applied by some countries to tackle tax avoidance in the absence of or in replacement of statutory GAAR. These include the “substance over form” doctrine developed in common law countries. There is also the “abuse of law”, “abuse of right” or “fraus legis” doctrine which originated from Roman law and is embedded in the Civil law system.
Though differently described, these overlapping principles have been interchangeably used by tax authorities and courts for the same purpose—denying tax benefits or disregarding the form of transaction for taxation. Therefore, they are also called judicial or court-based GAAR, but are much worse than statutory GAAR if misused, as they bring about much more legal uncertainty than a well-designed statutory GAAR.
In certain countries where the courts rely on the principle of legality and the strict or literal interpretation of law, e.g. Belgium and Brazil, the courts have been denying application of these judicial GAAR for taxation.
In Thailand, the “abuse of law” principle can be found in certain provisions of the Civil and Commercial Code, especially Section 5, which prohibits any person from abusing their rights. The law, however, lays the burden of proof on the abusiveness alleging party, presuming that everyone acts in good faith.
In the long history of Thai judicial system, courts used to generally rely on the principal of legality and literal or strict interpretation of tax law. The court rarely denied any tax exemption or other tax benefits if the transaction was deemed valid and lawful, even though it was noticeable that the transaction had been initiated or designed in order to avoid tax. The court also applied tax laws only to the extent of the fair meaning of the language or the meaning that is reasonably justifiable by its terms.
The Supreme Court made a turnabout in their judicial practice in 2009. In the case of Minor Group, as a franchisee of Pizza Hut, the Court put aside the “legal” form of the payment of advertising costs by the franchisee to media agencies and other third parties and instead regarded the advertising costs as royalty payable to the franchisor.
The court said that the franchisor had obtained benefits from the advertising by the franchisee in the form of the increase in royalty payable by the franchisee and the enhancement of franchisor’s goodwill, which would eventually increase the amount of the upfront franchise fees chargeable from Minor Group and other franchisees.
An opinion given by the court in this judgment reflects its negative attitude toward tax planning in general: “… companies or other juristic entities established under the laws of other countries … may implement tax planning to avoid tax by contractually requiring the other party to make payment to them in the form of other benefits … This may be a model for other foreign companies or juristic entities … to conduct their own tax planning. This would eventually result in the Revenue Department’s inability to collect tax properly and justly according to the intent of Section 70 of the Revenue Code …” said the Supreme Court.
The Supreme Court clearly demonstrated the judicial GAAR in the recent landmark case of Siam Electrochemical.
The Court ruled among other arguable issues that the share premium was not paid for the same purpose as normal payment of shares by shareholders, i.e. to seek benefits or profits from the operation of the company. The plaintiff lacked the intent to increase its registered capital for the business as usual but had the hidden agenda, i.e. to avoid the income tax imposable in case of the parent company directly settling the debt on behalf of the plaintiff.
The Court looked through the legal form of the capital increase in the course of winding-up of the company and re-characterized the injected capital as a subsidy from the shareholder. The capital was deemed as the company’s income and thus taxable.
This Court ruling affects not only the debtor, but their creditors, the guarantor of the debt, the parent and any affiliate companies, who may also be discredited because of the bankruptcy or insolvency of the debtor, and likewise.
Given these two landmark cases, the Court has left no room for tax mitigation which is deemed lawful and permissible worldwide.
This article will not discuss whether the rulings in those two landmark cases were right or wrong, but attempt to shed some light on how the courts of other countries decided whether to cross the capital borderline into other account types.
In the famous Vodafone case, the Bombay High Court ruled that “Absent express legislation, no amount received, accrued or arising on capital account transaction can be subjected to tax as income.”
In contrast to the Thai Supreme Court, the Indian Court gave high priority to foreign investment and also the multi-tiered holding structures of multinational enterprises. It also ruled as such in the defense of a basic level of legal certainty, especially respecting the expectations of taxpayers.
The other two cases are more interesting as they were just ruled by the Dutch Supreme Court in 2014.
The Netherlands is a Civil law country like Thailand and appears to be a core model for the courts and tax authorities of Thailand and other countries applying judicial GAAR for taxation.
The Dutch Supreme Court and tax authorities have been applying the judicial GAAR in place of the statutory GAAR, which has been in place since 1925 but never been put into use because of the much more effective judicial GAAR.
These two cases involve exploitation of the participation exemption according to the Dutch corporate tax law.
In the Netherlands, if a shareholder owns at least 5% of the nominal paid-in share capital in the subsidiary and the shares are not held as a portfolio investment, the income derived from equity investment or shares in the subsidiary will be exempted from tax. This exemption is called “participation exemption”.
The first Dutch case involved transformation of shareholder loan, subject to tax on interest, into redeemable preference shares, which render more or less the same benefits as the loan to the shareholder, but subject to no tax on dividend owing to the statutory participation exemption.
The Dutch Supreme Court held that as a starting point the classification of a financial instrument is decided by the civil law on qualification of the instrument and judged that if a shareholding exists under Dutch civil law, the participation exemption should apply. They also added that “the fact that the shares have the characteristics of a debt instrument should not have any adverse consequence on the Dutch participation exemption.”
The second case featured more complex transactions apparently made to enable enjoyment of the tax exemption rule as in the first case. The Dutch Supreme Court overruled the tax authority’s appeal on the fraus legis doctrine.
The Dutch court judged that under Dutch civil law, a shareholder is subordinated to all creditors, and any contributions made by shareholders are therefore available for recourse by creditors of the company. This is not affected if (i) the shareholder has to right to terminate its financing after a certain period, and (ii) such financial instruments (shares) has certain economic similarities to a loan.
“Taxpayers are free to finance a subsidiary with either debt or equity.” ruled the Dutch Supreme Court.
Needless to say, the rationales and decisions given by both of the Dutch Supreme Court and the Bombay High Court completely differ from those given by Thai Supreme Court.
The GAAR appears to be an effective anti-avoidance tool which should be handled with the utmost care. GAAR without proper safeguards against its abuse and sufficient confidence of taxpayers may discourage business, which might unintentionally result in the decrease of tax revenues as well other non-tax benefits to the economy.
“The loss of tax revenues could be insignificant compared to the other non-tax benefits to their economy,” said the Indian Supreme Court in Azadi Bachao Andolan Case in 2003.
The UN recognizes the importance of striking a reasonable balance between the need to protect tax revenue from the misuse of tax treaties and the need to guarantee legal certainty and to preserve the taxpayer’s legitimate expectations.
Having gone through numerous other judicial and statutory GAAR cases in many countries, all of them entail blatant, contrived or artificial transactions, palpably initiated or taken to exploit the gaps or loopholes in the relevant tax law. None of them addressed normal commercial or business transactions.
If the GAAR, either statutory or judicial, is applied to challenge even normal business or those palpably non-abusive transactions, all taxpayers appear to live with a sword of Damocles hanging over their heads.
Nowadays, many Thai taxpayers faced weird challenges from certain tax officers, owing to the application of the judicial GAAR, despite their lack of experience with it.
With the judicial GAAR emerging in Thailand, the rulings previously laid down by the court as well as the tax authorities, based on the principle of legality and strict interpretation, can be overrode at any time. It is even unnecessary for the Thai tax authority to enact statutory GAAR or SAAR. All they need to do is to follow in the footsteps of the Netherlands, Italy and certain other countries.
Now might be the time for all taxpayers and tax practitioners to reset their mindsets regarding taxation in Thailand.