Cross-Border Tax Arbitrage—Policy Choices and

Political Motivations

MARK BOYLE*
Abstract
The Government’s recent introduction of measures designed to restrict cross-border tax arbitrage
is one of the bolder legislative forays of recent years into the international tax arena. This
article examines some of the political motivations and policy choices behind these measures:
why should cross-border arbitrage opportunities be limited, provided existing laws are not being
contravened? Is there any rational, policy-led basis for the Government’s actions, and if so what
is it? Why has the Government chosen now as the time to act? What criticisms can be levelled
against the Government in relation to these new provisions, and how fair are they? And how
do other international anti-abuse techniques enter into the equation? The article recognises that
there are no clear-cut answers to these questions and notes that without a clearer understanding
of the politics and policies behind the new rules, it is difficult to conclude what the lasting impact
of the measures will be.

THE recently published provisions in the Finance (No.2) Act 2005 dealing with ‘‘Avoidance
Involving Tax Arbitrage’’1 will no doubt have caused consternation throughout the City
of London and beyond as people have asked themselves the question: is this the end
of international tax arbitrage for UK corporate taxpayers? Various commentators2 have
already sought to address this question by means of detailed forensic analysis of the
relevant Finance (No.2) Act provisions and discussion of case studies where we have
already seen, or are soon likely to be seeing, the impact of the new rules.
However, while it is clearly of the greatest importance to understand the technical
requirements of the new provisions and their likely effect on the cross-border tax arbitrage
industry, it may also be helpful to know a little more about the background to these
new rules and to put the Government’s approach in this area in context. This paper is
intended to provide a (by no means exhaustive) introduction to the topic of cross-border
tax arbitrage, drawing on a variety of sources to enable an investigation of the policies
behind the measures designed to prevent the spread of this form of arbitrage, and (sticking
a little closer to home) possible answers to the question as to why HMRC have chosen
now as the moment to attack cross-border tax planning of this kind.

* MA (Cantab), Freshfields Bruckhaus Deringer. The views expressed in this article are the author’s
own.
1
FA (No.2) 2005, ss.24–31 and Sched.3.
2
M. J. Clayson, ‘‘English LLPs, Other Partnerships and Hybrid Entities in Cross-Border Planning,
Including the Impact of the United States-United Kingdom Treaty’’ a paper delivered at the IFA New
York Branch Meeting, April 2005; D. Haworth and H. Buchanan, ‘‘Clamping Down on International
Arbitrage’’ 16 International Tax Review at 34.

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What is cross-border tax arbitrage?

Cross-border tax arbitrage has been defined as:
‘‘taking advantage of inconsistencies between different countries’ tax rules to achieve
a more favourable result than that which would have resulted from investing in a
single jurisdiction.’’3
This is to be distinguished at the outset from two other avoidance-based initiatives
that have given rise to much concern in the international tax arena—cross-border tax
competition and tax shelters. Unlike the former, international tax arbitrage can occur
even where two countries operate rigorous and comprehensive systems of taxation. It is
the differences or inconsistencies between the two systems that give scope for arbitrage,
independent of any more traditional understanding of competition between strong and
weak, or strict and permissive, tax regimes. Tax shelter abuses, on the other hand, are
typically concerned with the ambiguous margins of tax rules, sometimes flirting with
legality by engaging in transactions with little or no economic substance. While it is
certainly possible that a cross-border arbitrage may have no true economic substance, this
is not essential to such transactions, which seek a more solid tax benefit derived from
‘‘inconsistencies between different countries’ tax rules’’ than the dubious rewards of sham
transactions.
It may be useful as a starting point to examine briefly two simple examples of
international tax arbitrage.

Dual-resident companies
Different countries define the concept of residence in different ways. Let us imagine
that Narnia bases its determination of corporate residence on where a given company is
incorporated, while over in Lilliput they treat a company as resident where it is centrally
controlled and managed. A company could therefore be resident in both countries. Let
us also imagine that the domestic tax rules of both Narnia and Lilliput permit resident
companies to consolidate the tax returns of their domestic group as if that group were a
single taxpayer. If the dual-resident company is loss-making, but both the Narnian group
and the Lilliputian group have taxable profits, it may be possible for the dual-resident
company’s tax losses to be deducted twice, against the income of both groups, resulting
in a double benefit for the worldwide group in respect of the same initial loss.

Double-dip leases
As well as having their residence and group tax consolidation rules exploited by
international tax planners, Narnia and Lilliput are also the unfortunate victims of
another classic form of cross-border tax arbitrage, this time due to the interaction of
their rules governing depreciation deductions. Both countries agree that depreciation
deductions in respect of property should only be afforded to the owner of that property.
In Narnia the owner of a Magic Circle partner’s Learjet is the holder of the legal title to
3 H. D. Rosenbloom, ‘‘International Tax Arbitrage and the International Tax System, David R.
Tillinghast Lecture on International Taxation,’’ (2000) 53 Tax Law Review 137.

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the jet, while in Lilliput ownership is given to whomever has the true economic ownership
of the asset. If a Magic Circle partner in Narnia who owns a jet were to grant a long
lease over it (perhaps with a purchase option) to another partner resident in Lilliput,
thereby giving that second partner the full economic ownership of the jet, the aeroplane’s
acquisition cost may end up being deductible in full by both the legal owner in Narnia
and the economic owner in Lilliput.
Although there are many different forms of arbitrage structures, and countless variations
on each of those forms, the key in each case, it is submitted, is the different definition
given in different countries to similar legal concepts. Countries often share very similar
legal concepts but define those concepts in dissimilar ways, with the two situations
outlined above being prime examples: consolidation between entities (whether express
consolidation, as in the US, or the ability to surrender losses between members of the
same group, as in the UK) is often limited to companies that are resident in the taxing
jurisdiction; depreciation deductions are often reserved to owners of assets. Whether these
definitional disparities are intentional, reflecting differences in policy choices between the
certainty of prescribed rules and the flexibility of general standards, or merely accidental,
seems to matter little. The very fact that there are gaps between the building blocks of
international tax legislation provides the scope for tax planners to seek out and exploit
arbitrage opportunities.

The problem with cross-border tax arbitrage

Accustomed, as many readers will be, to advising multinational corporations for whom
international tax arbitrage possibilities are an important and potentially highly rewarding
area of interest, we might be forgiven for feeling that there should be no limitations on
the use of arbitrage opportunities. Certainly there is a strong argument that governments
should leave taxpayers alone to seek out and exploit differences and inconsistencies
between national tax regimes, so long as in doing so the domestic laws of each of the
countries involved are not offended. Taking our earlier examples, why should Narnia
have any interest in whether or how much tax is paid in Lilliput? So long as the Narnian
tax rules are followed (and assuming that we are not here in the area of sham transactions,
where the arguments against the taxpayer are more compelling), then surely no further
governmental action or intervention is called for? Indeed, might the Narnian authorities
not in fact be happy that domestic taxpayers are reducing their foreign tax bills, thus
allowing them more scope for increased investment and, perhaps, even leading to increased
overall revenue receipts to swell the Narnian exchequer’s coffers?
It would, however, be naıve in the extreme to assume that just because a given
country’s tax revenue may not itself be adversely affected by the practice of cross-border
arbitrage, that country’s revenue authorities will have no interest in eliminating arbitrage
opportunities. The very Finance (No.2) Act provisions that prompted this paper might
be viewed as a case in point. Similarly, the avowed policy of the US Internal Revenue
Service (IRS), as stated in 2000 by Deputy US Treasury Secretary Eizenstat,4 is to
counter cross-border tax arbitrage on the grounds that (notwithstanding that the relevant
practice may be entirely within the law):
4 ‘‘Eizenstat on Global Taxation Standards’’, report of an address to the Coalition of Service Industries
and Tax Council, Washington, July 26, 2000: available at www.useu.be.

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‘‘Tax arbitrage achieves many of the same results as harmful tax competition, but
can be more insidious because, typically, arbitrage exploits a jurisdiction’s laws in an
unintended manner.’’
However, against the background of the argument that the existence of cross-border tax
arbitrage warrants no government intervention, it seems only fair that any government
response be premised on the demonstration of a problem.
One leading commentator5 has identified four criteria (borrowed from the literature
exploring domestic arbitrage) which may be used to distinguish and evaluate problems
with cross-border tax arbitrage that would help legitimise any governmental response.
These criteria are distortion,6 equity, political accountability and revenue impact.

Distortion
The main question is how, if at all, cross-border tax arbitrage distorts taxpayer behaviour.
Most international tax theorists identify two main ways in which international tax rules
may distort behaviour.7 The first is by favouring investment either at home or abroad
(thereby violating ‘‘capital export neutrality’’); the second is by favouring certain species
of investors in a single economic setting, so distorting savings decisions and impacting
the competitiveness of business (violating ‘‘capital import neutrality’’). The problem with
international tax arbitrage, as identified by Ring,8 is that where an arbitrage proves to be
more tax advantageous than a parallel domestic transaction, several effects are likely to
follow:
— some domestic transactions will be replaced with cross-border ones;
— cross-border transactions will be conducted with those countries with which the
tax advantage is most marked; and
— there will be a disproportionate increase in those business activities for which an
attractive arbitrage exists.
A standard economic enquiry, the argument continues, would view these arbitrage effects
as indicators of inefficient and undesirable (from the viewpoint of the effects diverging
from the underlying policy goals of the relevant tax rules) investment decisions by the
offending taxpayers.

Equity
From the viewpoint of the equity of their actions, the first argument levelled against
cross-border tax arbitrage practitioners is that only a select group of taxpayers have the
5 See n.4 at 102.
6 In fact, Ring talks in terms of ‘‘efficiency’’ rather than ‘‘distortion’’. The author’s view, however, is
that, at least from the perspective of the non-economist, the argument may be better understood when
framed in terms of the distortive effects of cross-border arbitrage.
7
T. Dagan, ‘‘The Costs of International Cooperation’’ (2002) Michigan Law and Economics Research
Paper No.02–007 and University of Michigan Law, Public Law Research Paper No.13; and M. J.
Graetz, ‘‘The David R. Tillinghast Lecture. Taxing International Income - Inadequate Principles,
Outdated Concepts and Unsatisfactory Policies’’, (2001) 54 Tax Law Review 261.
8 See n.4 at 109.

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ability to reduce their taxes through arbitrage. If the scale of the arbitrage activities were
wide enough to affect the tax revenue in a given jurisdiction, other parts of the tax base
may be forced to bear a greater tax burden to maintain revenue levels.9 The second
concern from the viewpoint of equity considerations relates to the perceptions of abuse.
As noted above, international tax arbitrage is generally the preserve of a limited number
of taxpayers. To the extent that the taxpaying public at large perceives this to be the case
(although it is accepted that, in practice, the public may have only a limited awareness, if
any, of the existence of cross-border tax arbitrage), public support for and confidence in
the tax system may be adversely affected.

Political accountability
This criterion is closely linked to the equity argument (and in particular the second
limb of that argument), dealing as it does with the question of the inchoate suspicions
of the electorate that there exists one set of tax rules for those equipped to plan around
the legislation (generally, large corporations and a very few high-net-worth individuals),
while another set of rules holds true for everyone else. This situation is identified in the
literature10 as undesirable for a number of reasons, including that a democratic system
relies on transparency in the law—like Caesar’s wife, the law must be above suspicion.

Revenue effects
In the final analysis, this may be the most important element in the equation.11 A, or
maybe the, major goal of any tax system is to collect revenue. If this function is impaired
by cross-border tax arbitrage (see the opposing arguments outlined above: i.e. if the
arbitrage is lawful, is the tax base actually adversely affected, or is the exchequer merely
denied revenue which it might otherwise enjoy if the rules were different? But contrast
the efficiency arguments which show how the overall, if not the specific, tax base might
be reduced) the effect is important for two reasons. First, cuts in government expenditure
may be necessary, with the resulting social and political difficulties that such cuts may
bring. Secondly, as postulated above, a shift in the tax burden may be required to produce
supplemental revenue—a shift that may well disproportionately affect those people who
are unable to avoid tax, and, moreover, who are innocent of any of the questionable
arbitrage practices that may have necessitated this shift in emphasis. This represents both
an equity concern and a revenue concern, to which the replacing of lost tax revenues by
shifting the burden of taxation is not necessarily a feasible response.
9 It is perhaps worth noting that it is generally accepted that cross-border tax arbitrage is a pursuit
enjoyed by taxpayers with income from capital, not labour. The ability of taxpayers engaging in
arbitrage to minimise their tax bills and thereby reduce revenue collection seems likely to have the
greatest detrimental impact on those taxpayers with income sourced from labour—precisely those
taxpayers who are least likely to be involved in the practice of arbitrage. See n.4 at 121 and n.3
at 146. It is beyond the scope of this article to consider whether reducing marginal government
expenditure provides a better economic return than reducing private sector investment which ceases
to be productive on an after-tax basis after the removal of the tax benefits of arbitrage.
10
J. W. Wetzler, ‘‘Notes on the Economic Substance and Business Purpose Doctrine’’, (2001) 21
Insurance Tax Review 257.
11 Although, interestingly, some commentators seem to ascribe less weight to revenue effects than to the
efficiency/distortion and equity criteria. See n.4 at 102.

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Shaviro suggests a simple scenario which helps place the application of these concepts
in context, and indicates how a government might sustain an argument for the denial of
arbitrage possibilities.12 He asks us to imagine a proposal to tax supermarkets on their
gross sales without allowing them deductions for the costs of selling their goods, while
all other businesses continue to be taxed as at present. It seems likely not only that
this would disadvantage supermarkets relative to other business undertakings, but that it
might also prompt avoidance. Neither of these outcomes would normally be desirable.
If, however, it were shown to be the case that the effect of denying supermarkets these
deductions, (a) increased equity and efficiency, and (b) actually increased national tax
revenues, then several positive outcomes (each of which would be endorsed by the policy
arguments outlined in this section) would have been achieved. Similarly, so the example
goes, doubling the deductions available in tax arbitrage transactions provides a preference
for those transactions that may increase economic distortions and lead to inequitable
redistributions of the tax burden. Accordingly, denying the benefits of the tax arbitrage,
just as in the supermarket hypothetical, is potentially a win-win proposition from a policy
standpoint.

Why now?
We have thus far discussed what is meant by the term ‘‘cross-border tax arbitrage’’, and
examined why governments might legitimately seek to close down opportunities to engage
in arbitrage practice. Turning from the general to the more specific, we might now be
minded to ask why the UK Government has chosen this particular moment in time to
launch what is probably the single most sustained legislative attack on international tax
arbitrage that has been seen in this country.
As an initial comment, it is worth noting that this is not the first time that the
Government has sought to rein in galloping arbitrage-based avoidance schemes. One
previous example of this approach was the closing down of the dual-resident company
schemes that formed the basis of the first Narnia/Lilliput arbitrage opportunity described
above.13 Another previous example of anti-arbitrage rules by the Government was the
introduction of the cross-border perpetual (or equity) note rules in 1992.14 As soon as
the Inland Revenue discovered that US multinationals were using perpetual debt as a
hybrid to create dividend income not subject to the same regime as interest income in the
UK they changed the rules to deny the UK deduction. The result was simply that such
structures were quickly closed down and replaced by regular debt, producing the same
UK tax result as under the original rule.15
12 D. Shaviro, ‘‘Corporate Tax Shelters in a Global Economy’’ (AEI Press, Washington D.C., 2004),
Ch.2.
13 Interestingly for our later discussion, however, there are indications that the UK’s actions in this
regard were in fact prompted by the prior action of the US in enacting, in 1986, a rule that denied
the use of dual-resident company losses on consolidated returns. Having seen the approach adopted
by the US Treasury, the argument goes, the UK simply followed suit in 1987 with a similar rule—see
what is now ICTA, s.404.
14
ICTA, s.209(2)(e)(vii).
15
S. Edge and W. Watson, ‘‘The Hundred-Headed Hybrid’’, (2001) The Tax Journal, Issue 596 at
11. Note also that the introduction of the ‘‘check the box’’ concept in 1996 opened up the use of
partnerships in transactions of this kind, when previously the entity classification rules had to be
negotiated.

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But the UK’s responses to the problem of dual-resident companies and equity notes
were relatively limited and focused reactions—surgical strikes in comparison to the
Finance (No.2) Act provisions, which seemingly ‘‘carpet bomb’’ the structured financial
products industry. So again, we ask ourselves—why now?
There is, essentially, no simple answer to this question. We cannot look to one
particular transaction that has so offended HMRC that they have decided to discontinue
any previous concessions they were previously prepared to tolerate; nor can we point to
one particular academic paper or economic analysis that proves beyond all doubt that
cross-border tax arbitrage represents such an egregious abuse of the tax system that it
must be stopped immediately. Rather, it seems that the decision to act now is the result of
a number of different factors, supported, one would expect, by the kind of policy-based
arguments we touched upon in the previous section of this paper (distortion, equity,
political accountability and revenue impact). Three factors in particular seem most likely
to have spurred on the Government’s efforts in this area.

International co-operation
Back in 2000, Deputy US Treasury Secretary Eizenstat remarked that key US policy
goals in the area of tax included efforts to ‘‘[m]aximise the coordination of our tax rules
and policies with those of other countries so as to prevent both double taxation and
unintended double non-taxation.’’ He went on to say that the United States was ‘‘working
in both the treaty context and in multinational fora like the OECD to address [the growing
phenomenon of cross-border tax arbitrage].’’16
Similar sentiments have been expressed from time to time by the UK Government
and revenue authorities. It was not, however, until last year that the long-anticipated
internationally co-ordinated approach really took off, with the establishment of
JITSIC—the Joint International Tax Shelter Information Centre.
JITSIC was established between the tax authorities of the UK, the US, Australia
and Canada, ‘‘to supplement the ongoing work of tax administrations in identifying
and curbing abusive tax avoidance transactions, arrangements, and schemes.’’ The key
objectives of this international task force are as follows:
— to provide support to the parties through the identification and understanding
of abusive tax schemes and those who promote them;
— to share expertise, best practice and experience in tax administration to combat
abusive tax schemes;
— to exchange information on abusive tax schemes, in general, and on specific
schemes, their promoters and investors, consistent with the provisions of bilateral
tax conventions; and
— to enable the parties to address better the abusive tax schemes promoted by firms
and individuals who operate without regard to national borders.17
Although still only one-year old, initial indications are that JITSIC’s efforts are working.
Mark Everson, the head of the IRS, was quoted earlier this year as saying:
16
See n.7.
17 ‘‘Joint International Tax Shelter Information Centre Memorandum of Understanding’’ available at
www.irs.gov.

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‘‘We have seen things we either would never have picked up or would have picked
up years down the road . . .. We have seen a series of kinds of transactions, or in
some cases particular transactions, that merit follow-up by the individual taxing
authorities.’’18
Similarly, Australian Tax Commissioner Michael Carmody has said:
‘‘. . . this joint international approach is a significant step forward in enabling the
Tax Office to better identify and address the more complex aggressive tax planning
arrangements.’’19
Despite such positive reports from the members of JITSIC, which are perhaps only to be
expected, the actual output and practical impact of the organisation have thus far been
difficult to ascertain. This is in part due, no doubt, to the nature of the taskforce. While
its membership20 and mission are public knowledge, the rest of JITSIC’s operations seem
shrouded in secrecy. The dates of its meetings, for instance, are not announced ahead
of time—rather, we are told that the JITSIC members will meet ‘‘periodically’’.21 More
importantly, no formal reports of the meetings appear to have been published yet. Even
in the US, where the rights of freedom of information are far stronger than in the UK,
intelligence as to what JITSIC has been talking about and where we can expect its steely
gaze to turn next is scarce.
Despite the lack of official pronouncements, it is widely believed that the hand of
JITSIC is to be discerned at the heart of the new UK anti-arbitrage rules. Ernst & Young
suggest in their 2005 Budget report that:
‘‘this legislation could be a direct result of the collaboration between the Revenue
and the US, Canadian and Australian tax authorities on cross-border avoidance
transactions.’’22
Deloitte take an even stronger line, stating:
‘‘This proposal appears to be the first result of the Multinational Task Force,
established at the time of Budget 2004, between representatives of the US, Australia,
Canada and the UK.’’23
While there has been no official confirmation that the proposed anti-arbitrage legislation
does indeed stem from the JITSIC information sharing process, it is suggested that this
would not be a surprising result. What is, perhaps, surprising is that the other members
of JITSIC do not appear (as yet, at any rate) to have followed suit. Instead, the UK looks
to be going it alone. Given that this is the case, how much weight should be afforded
to the claim that the UK’s new approach has been prompted by what it has learned in
the JITSIC forum? Due to the secretive nature of JITSIC’s processes, this is a difficult

18 Financial Times, February 28, 2005.

19 Australian Taxation Office Media Release, May 4, 2004. Available at www.ato.gov.au.
20
The UK delegates are believed to be Tony Attwood and Eileen Rafferty.
21
See reports of the organisation’s secrecy in both Accountancy Age, July 1, 2004, and the Mail on
Sunday, June 27, 2004.
22
Available at pitt.butterworths.co.uk/articleitem.asp?ID = 6162.
23 Available at pitt.butterworths.co.uk/articleitem.asp?ID = 6171.

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question to answer, and what little information is available (much of which appears to be
contradictory) has been cobbled together from rumour and anecdotal evidence.
On the one hand we have rumours coming out of certain investment banks, which claim
that the UK’s new rules are simply the first to be published in a wave of international
anti-tax arbitrage legislation that we can expect to be enacted elsewhere in the world in
the future. The driving force behind this shift in emphasis, so the rumour goes, has been
the JITSIC task force, which has identified cross-border arbitrage as a high priority issue.
One recent piece of intelligence suggests that one of the other JITSIC member states
(thought to be Australia, although this might simply be because Australia has previously
taken leading policy initiatives with financial transactions) will soon be bringing in similar
legislation to the UK’s proposed rules. On the other hand we have the contradictory
rumours emanating from other investment banks, which claim that there is absolutely no
indication that the JITSIC meetings have led to a concerted and unified change in attitude
vis-à-vis international tax arbitrage; and in fact there is very little chance of there ever
being such a joint effort, at least involving the IRS. The US, according to this particular
school of thought, has no interest in policing other states’ domestic tax laws, so long as
they do not negatively impact on US interests. For the US, JITSIC provides a useful
forum for gathering intelligence about abusive tax schemes, but it is certainly not seen
as a platform for future closely-orchestrated attacks against such abusive practices on a
multi-jurisdictional scale.
The third rumour falls somewhere between the poles of the previous two. This rumour
suggests that the members of JITSIC have in fact agreed on a unified, multilateral
approach to the issue of cross-border tax arbitrage, but that the UK has jumped the gun
by publishing its new rules ahead of the other jurisdictions. This rumour may in fact be the
closest we have to the truth, as there have been various reports of a letter written by John
Snow, the US Treasury Secretary, to HMRC complaining about the new rules (whether
the complaint is as to their detail, the unilateral nature of their implementation, or both,
is unclear) and the likely effect they will have in the multi-jurisdictional environment
in which much of today’s structured tax planning occurs. Unfortunately no further
information about this alleged letter appears to be easily and publicly available on either
side of the Atlantic. It will be interesting to watch this space and see if more details emerge
in due course.

The US experience
It is, at this juncture, perhaps worth turning our attention across the Atlantic towards
the US, which has also grappled with anti-international-tax arbitrage rules, to see how
they have tended to deal with the issue. It was noted earlier in this paper that in
1986 the US imposed rules to counter the classic dual-resident company arbitrage. In
1998 the IRS issued Notice 98-1124 addressing the treatment of hybrid entities under
the so-called ‘‘subpart F provisions’’ of the Internal Revenue Code.25 The details of
the relevant legislation are fairly complex, and so beyond the scope of this paper, but
broadly the hybrid arrangements identified in Notice 98–11 involved structures that were
characterised for US tax purposes as part of a controlled foreign company (CFC), but
24
Notice 98–11, issued on January 16, 1998.
25 Internal Revenue Code, ss.951–964.

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which were characterised for the purposes of the tax law of the country in which the CFC
was incorporated as a separate entity. The Notice trailed regulations that were to be issued
to prevent the use of hybrid branch arrangements to reduce foreign tax while avoiding the
corresponding creation of subpart F income. These regulations would have provided that
the branch and the CFC be treated as separate corporations for the purposes of subpart F.
These proposals met with considerable adverse political reaction and were swiftly
withdrawn.26 The precise reasons for the withdrawal of the proposed provisions are
unclear, but it is evident from the 1998 US Congressional Conference Committee report
explaining the history of congressional reaction to Notice 98–1127 that Congress was
particularly concerned by both the international ramifications of the proposed rules: ‘‘. . .
Congress will consider the international tax policy issues relating to the treatment of
hybrid transactions’’; and the likely domestic impact: ‘‘. . . Congress will consider the
impact of any legislation or administrative guidance in this area on affected taxpayers
and industries.’’ What this means for the US approach to anti-arbitrage legislation in the
future is hard to say, but it is submitted that if anything it points to the conclusion that,
mindful of the damage that may be done to both international relations and international
and domestic trade by imposing measures that seek to curtail cross-border tax arbitrage,
the US is unlikely to implement any new rules of the kind presently proposed in the
UK.28 At the very least, this would be in line with the attitude of the US Treasury and
the IRS, as represented by the rumours emanating from the investment banks.

The disclosure regime

In the Finance Act 2004 the Government implemented a new ‘‘disclosure regime’’
requiring details of tax avoidance schemes to be disclosed to the Inland Revenue (now
HMRC). The stated aim of the new regime was to ‘‘provide real time monitoring of the
avoidance industry enabling swifter, more targeted responses from the Revenue.’’29 The
regime appears to be having the desired effect. Hundreds of structures have already been
reported, many of them surely previously unknown to the authorities, and HMRC is
responding in short order—we have seen a marked increase in the number of specifically
targeted rules and regulations (often in the form of press releases stating an intention to
legislate in a certain direction, with the new legislation expressed to have effect from the
date of publication of the press release) designed to close down the schemes that are being
disclosed.
It may well be the case, therefore, that the Government has been (at least, partly)
spurred into action against international cross-border arbitrage schemes as a result of the
disclosure to it of the number, scope and variety of such schemes. While, as noted above,
the Government and HMRC have known for some time about the existence of such
schemes, the full scale of the arbitrage industry may not have been known until now.

26 Notice 98–35, issued on June 19, 1998.

27
IRS Restructuring and Reform Bill of 1998—Conference Report as released on June 24, 1998.
28
Query whether this in turn suggests that in a different economic or political climate, the UK might be
forced to, or find it helpful to, withdraw the provisions or, more pragmatically, use them less and less.
29 Inland Revenue: Avoidance Intelligence Unit disclosure regime guidance notes: available at
www.hmrc.gov.uk.

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Focus on results
Another possible reason, linked to the two preceding factors, why the Government has
chosen now as the time to attack may simply be a desire to show results from recent
initiatives. The JITSIC and disclosure initiatives will have cost the Government both
time and money, and one can well understand the pressure that may be being brought
to bear in certain quarters to ensure that these initiatives show some fruit. Allied to the
stated intention of the Government to raise over £1 billion from the anti-arbitrage and
double tax relief measures over the next three years (compare this with President Bush’s
2006 Budget request for an 8 per cent (equating to $500 million)30 increase for IRS
enforcement), it is not perhaps very surprising that the Government has resolved to act
so swiftly and decisively.

Criticism of the UK approach

It was mentioned in passing in the previous section that the US has ‘‘no interest in
policing other states’ domestic tax laws’’. This allegation of meddling in others’ affairs is
just one of the criticisms that might be levelled against the UK’s approach to the issue at
hand. It is worth examining some of the more powerful criticisms in some detail.

Global policeman
‘‘In the present Bill . . . the UK Government would appear to be taking on the role
of policing other tax systems as well as that of the UK.’’31
‘‘Our impression is that HMRC are taking on the role of policing other tax systems
as well as the UK’s.’’32
‘‘We reiterate the point made in our representations on the Finance Act that it is not
the job of HMRC to police the tax systems of other countries.’’33
The belief that the UK, in enacting the proposed new measures, will be inappropriately
acting as an ‘‘international policeman’’ is clearly a deeply-felt concern. And, it is submitted,
it is not a concern that is easily dismissed—from the viewpoint of many multinational
companies it must appear that the UK is taking it upon itself to decide the tax treatment
of cross-border transactions, instead of leaving the matter to be dealt with by the
investing company’s domestic tax system. There is a valid argument that this attitude is
fundamentally wrong. While it may be proper for the UK to decide the tax treatment of
a UK multinational doing business overseas, is the Government not stepping outside the
boundaries of its sovereignty and jurisdictional competencies in seeking to decide how
overseas multinationals should be taxed?34
In this regard, Bill Dodwell of Deloitte has suggested that where an overseas
multinational has set up a financing structure for its UK activities, transfer pricing
30 16 International Tax Review 2.
31
ICAEW Budget Representations published as Taxrep 15/05.
32
CIoT Representations on the 2005 Finance Act and Finance Bill provisions to be re-introduced
available at www.tax.org.uk.
33
See n.34.
34 HMRC are known to be sensitive to these accusations of ‘‘global policing’’ and tend to deny them.

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rules should determine how much of an interest deduction should be allowed in the UK,
not whether the multinational is able to achieve a double deduction or avoid tax on an
income element.35

The likely response of other international players

It is not at all clear that the Government will have properly thought through the likely
response of other countries to a denial of UK tax benefits to a multinational company by
reason of an international tax arbitrage (and if there is any truth at all in the rumours
of the letter from the US Treasury Secretary to HMRC, it only goes to support this
concern). The fear must surely be that the UK’s actions might in practice amount to an
open invitation to other countries to reconsider their rules in the light of the UK’s—it is
the UK, after all, which has raised the subject of the rules’ interacting effects and denied
benefits specifically because the other country is or may be granting them.
There is no reason to believe that other countries are not entirely capable of enacting
their own responses to the transactions targeted by the UK approach albeit that their
current policy may be not to worry about arbitrage practices that do not directly affect
their domestic revenues. Even if these foreign jurisdictions are sympathetic to the end
result of eliminating double non-taxation, they would surely be forgiven for wondering
why the UK should capture the entire direct fiscal benefit. Why, they might ask, should
the UK ‘‘free-ride’’ on the fact that other jurisdictions offer deductions that both sides
agree should be taken only once, when those other jurisdictions could just as easily
free-ride on the UK? As Shaviro puts it:
‘‘[the UK] could be viewed as aggressively grabbing nearly all the available joint
surplus from a bilateral monopoly (involving the welfare gain that the countries can
reap by co-ordinating their tax rules).’’36
Moreover, as Ring points out, if one nation were unilaterally to eliminate the domestic
tax advantage realised by cross-border tax arbitrage (precisely what the UK proposes
doing), the net effect is entirely unpredictable, and may in the most extreme cases lead to
retaliatory responses that are outside the scope of the arbitrage provisions in question.37
Although it may be the case that were, say, the US to respond to the UK’s new
rules with an overlapping arbitrage–benefit disallowance rule, the overall distortion would
be less than that from allowing the double benefit to continue, nonetheless, a double
disallowance of benefits may not be appropriate. Shaviro reverts to the classic example of
a dual resident company, and suggests that a double disallowance of deductions:
‘‘may amount to overkill given the possibility of cases where one has business reasons
for establishing a DRC that is making risky investments with the possibility of loss.’’
Even if both the jurisdictions that are (to some extent at least) being exploited by reason of
a cross-border tax arbitrage would benefit, no matter what the other jurisdiction did, from
unilaterally denying benefits, it is certainly conceivable that they would do better still by
co-ordinating these rules to allow only one deduction, and then splitting the benefit.38
35
See n.26.
36
See n.15 at 46.
37
See n.4 at 125.
38 See n.15 at 47.

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Risks to national policy

Ring identifies various objections to anti-arbitrage measures based on sovereignty and
diversity grounds. These are particularly relevant to the extent that the UK’s decision to
implement the new Finance (No.2) Act provisions at this time has its roots in policy-level
decisions made in an international forum such as JITSIC.39
Each country is an independent actor on the world stage, whose primary focus and
attention should be on its domestic laws. The fear, as articulated in the literature on
the subject,40 is that as a country relinquishes its power to design its own tax policy,
either by generally basing its taxation on foreign treatment or by pursuing multilateral
options, its sovereignty is undermined as its tax rules cease to reflect national policy goals.
It is probably correct to assert that a democratically-elected government should design
tax policy in accordance with the mandate handed it by the electorate. As the centre of
policy level decision-making shifts from the domestic to a more globalised setting, the
connection between the electorate and the rule makers is (assuming that the Government’s
mandate does not expressly approve such a shift in competencies and powers) necessarily
weakened. Furthermore, when decisions (be they tax-related or not) are made at the
national level the assumption is that domestic interests are paramount and the goal is to
maximise the national interest. However, as Ring points out,41 the shift of rule-making
power—either explicitly to a multilateral forum such as JITSIC, or implicitly by reacting
to and matching foreign developments—raises the distinct possibility that the resulting
tax rules will not maximise a nation’s domestic interests.
The other policy objection identified by Ring concerns the impact on diversity.42
Not only is the existence of differing tax systems throughout the world a natural and
unsurprising outcome, but the opportunity for different countries to experiment with
different tax policies and rules without any immediate direct impact on their international
neighbours allows a range of ideas to circulate, with the cream rising to the top. The recent
experience of introducing flat-tax regimes in many Central-European and Baltic states,
with the increased revenue streams and revitalised foreign investment that these regimes
have seemingly inspired, is a case in point. If, however, responses to cross-border tax
arbitrage demand a high degree of conformity, opportunities for gains from jurisdictional
diversity will be lost.

Miscellaneous concerns
There are various other concerns that have been voiced in objection to the new anti-
arbitrage rules. While arguably less grounded in policy than those outlined above, they
are arguably of greater interest to UK Industry.

International competition
In his letter to Gordon Brown accompanying the CBI’s representations on the 2005
Budget, Sir Digby Jones highlighted the fear that the proposed changes will scare off
39
See n.4 at 129.
40
S. Piciotto, ‘‘The Regulatory Criss-Cross: Interaction between Jurisdictions and the Construction of
Global Regulatory Networks’’ (1996) International Regulatory, 89, as cited by Ring, above, n.4.
41
See n.4 at 130.
42 See n.4 at 131.

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international investment, as those who stand to lose most turn their attentions from the
UK towards other countries with more attractive tax regimes, stating:
‘‘If the proposals are enacted as they stand, there would therefore be very severe and,
it is suspected, unintentional consequential damage to the UK’s competitive position.
This would of course be completely contrary to our shared aim of maintaining and
enhancing our international competitiveness.’’

The EU aspect
This concern has perhaps been less well articulated and less fully explored than many of
the others, but it has nonetheless been raised in a variety of quarters as a worrying issue:
‘‘The case law of the European Court of Justice would suggest that [the UK’s attitude
of policing other tax systems] is in breach of the EU treaty.’’43 And in addition: ‘‘Time
will tell whether [the UK’s approach to anti-arbitrage legislation] is lawful within the EU
(case law of the ECJ would suggest it is not) and in other jurisdictions as well . . .’’.44
While no supporting reasoning is advanced for these propositions, it seems likely that
the argument would be that it would unjustifiably restrict the free movement of capital
within the EU for the UK to prohibit a deduction or impose a charge on receipts because
of a beneficial tax treatment that is available in another Member State in circumstances
where that treatment would not apply for a UK counterparty. Significant litigation is
perhaps to be expected if these rules are enacted in their current form.

Other international anti-abuse techniques

Having examined in some detail the political and policy background to the sort of
anti-cross-border tax arbitrage measures due to be enacted by the Government, it may be
interesting, as a final step, to compare this approach with the approach adopted in double
tax treaties.
Double non-taxation is a keenly debated issue in the treaty arena, as evidenced most
clearly by the fact that double non-taxation of income was one of the main topics discussed
at the International Fiscal Association’s (IFA) 2004 Vienna Congress. Increasing focus
is also being concentrated upon the issue of double non-taxation in the OECD reports;
indeed, article 23A(4) of the OECD Model Convention was added as an explicit provision
aiming to ensure that, in certain qualification conflicts, tax will be levied at least once.45
While the primary role of tax treaties may be to prevent (or at least, regulate) incidences
of double taxation, it is often assumed that they also serve to prevent double non-taxation
in much the same way. The country-specific reports prepared for the IFA 2004 Cahiers de
Droit Fiscal International (Cahiers)46 suggest, however, that this assumption may not in
fact be warranted. Furthermore, the reporters found that treaties ‘‘are by no means based
on the idea of preventing double non-taxation and that this is true only for certain cases at
the most.’’47 The reports indicate that treaties deal with double non-taxation in a variety
of ways.
43 See n.33.
44
See n.34.
45
See also, for instance, Art.24(4)(c) of the UK-US tax treaty.
46
Vol.89a (Sdu Fiscale & Financiële Uitgevers, The Netherlands, 2004).
47 See n.48 at 81.

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Double non-taxation as a result of a legal obligation

Some treaty provisions prevent both states from imposing taxes in certain situations,
resulting in full or partial double non-taxation. An example would be the tax sparing or
matching credit provisions contained in treaties between states at different development
levels. According to these provisions, the state of residence must credit a higher amount
of taxes of the source state than the source state may levy pursuant to the treaty. This
approach creates an incentive for certain investments in these states, and accordingly can
clearly be seen as being of a socio-political character.48

Double non-taxation as an express aim

Aside from incidents of double non-taxation that result from asymmetric tax sparing and
credit provisions, some treaties deliberately provide for double non-taxation in certain
circumstances. One example cited by the IFA General Report is the Norwegian approach
of tolerating double non-taxation in order to avoid the economic double taxation of
income. Another common example is the practice of many treaties in allowing the income
of teachers, researchers and students not to be taxed in either of the Contracting States in
order to stimulate the exchange of knowledge across borders.
It should be pointed out that these treaties do not represent some utopian haven of
non-taxation that can be exploited by people and companies seeking to take advantage of
inconsistencies between different countries’ tax rules. In the first place, the circumstances
in which double non-taxation is tolerated are highly regulated and normally predicated
on very specific socio-political policy decisions; the emphasis in all of these cases is on
the term ‘‘tolerated’’ (see below). To date Contracting States have not gone so far as to
integrate obligatory double non-taxation in their treaties. At least one of the two states
retains its right of taxation, but may elect not to make use of that right.

Double non-taxation as a tolerated outcome

The IFA General Report suggests that there are frequent examples of treaties where
the Contracting States have agreed to divide the right to tax certain income between
themselves. In these cases, the treaties simply assign the right to tax to one of the
Contracting States but do not provide for an obligation to exercise this right. The IFA
reports conclude that the failure by a Contracting State to exercise the right to tax can lead
to double non-taxation. By way of protection, however, most treaties include provisions
on information exchange and mutual assistance to help ensure that double non-taxation
does not ensue from unlawful evasion of taxation, or because the tax authorities of either
Contracting State do not tax a given transaction because they are unfamiliar with it, or
fail fully to establish their right to tax.
The IFA General Report concludes that treaties do not serve any general purpose of
preventing double non-taxation. There is not even any consensus as to whether or not the
OECD Model Convention pursues the objective of preventing double non-taxation—some
commentators believe the Model can (and, implicitly, should) be interpreted so as to
48 It is interesting to note that the OECD Fiscal Committee is critical of these provisions—see the
Commentary to the OECD Model Convention, Art.23B, para.72 et seq.

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prevent double non-taxation, while others point to the variety of practices in the various
states that show the provisions are understood differently around the world and do not
appear to pursue a uniform objective. The country reports in the Cahiers suggest that
there are no cases where double non-taxation triggered by a unilateral waiver of the right
to tax by both sides would constitute a treaty violation; indeed, we have already seen
examples of cases in which treaties oblige double non-taxation on certain income. The
conclusion that the author of the General Report draws from all this is that it is right to be
sceptical of the view (adopted by some tax authorities as well as the OECD Partnership
Report)49 that there is some over-arching and pervasive policy that the objective of double
non-tax prevention is inherent in all treaties. Practice would indicate that this simply is
not the case.

Conclusion
Due to the wide-ranging and (at times) cursory nature of this paper’s examination of the
policies and politics behind the laws relating to cross-border tax arbitrage, it is difficult to
draw any firm conclusion as to why any given government would choose to allow or to
deny the benefits of such arbitrage.
Having initially defined cross-border tax arbitrage and briefly examined why arbitrage
opportunities can emerge, we discussed some of the policy issues that militate in favour
of greater controls being imposed on arbitrage practice, including concerns relating to
distortion, equity, political accountability and revenue effects. We turned to examine
why the UK Government might have chosen this moment to attack cross-border tax
arbitrage, which involved a brief discussion of the role of international co-operation (and
in particular of the newly formed JITSIC) and some comments on the disclosure regime.
Next we examined some of the criticisms that have been levelled against the Government
in relation to the new provisions, including accusations of unwarranted ‘‘international
policing’’, mention of the risks to national policy, and a number of miscellaneous concerns
that are of particular concern to UK industry. Finally, we briefly examined other, related,
international anti-abuse techniques, which show that while in theory treaties are intended
to prevent double non-taxation, this intention is not reflected in reality.
Stepping back, it appears that the key question50 for domestic tax authorities is whether
they should regard their competencies as being limited simply to protecting their own
jurisdiction with an eye to ensuring that cross-border structures are not used to erode
their own tax base, or whether they should be concerned to act more widely (whether
unilaterally or multilaterally) against any transaction which produces the ‘‘wrong result’’
in global taxation collection terms. The difficulty with the latter approach, which appears
to be the one currently being pursued by the Government, is that there is often no clear
answer, either in policy or practical terms, as to what is ‘‘right’’ or ‘‘wrong’’. For any
authority to move beyond the scope of its natural jurisdiction and its own domestic policy
and legislative framework and seek to impose its rules on a wider international audience
leads to a lack of certainty and a great deal of subjectivity in the application of those rules.
49
The Application of the OECD Model Tax Convention to Partnerships, Issues in International
Taxation No.6 (OECD, Paris, 1999).
50 This question has perhaps been put most clearly by Edge and Watson, see n.18 at 12. Their formulation
has been adopted here.

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There is also likely to be a lack of consistency of approach between different domestic tax
authorities.
Striving to extinguish all international tax arbitrage is a Sisyphian task—arbitrage
opportunities are always likely to exist because (at least until we have achieved total
worldwide harmonisation of tax systems) people, their domestic concerns and thus their
tax systems are going to be different. Yet that is not to say that this is a task which should
not be attempted—we have seen a number of persuasive arguments that indicate that
cross-border tax arbitrage is not necessarily a win-win game (despite the arguments of
those who would concentrate simply on the domestic tax revenue, which may itself not
be directly impacted). Without a clearer understanding than we have so far been afforded
of the political motivations and policy decisions behind the Government’s anti-arbitrage
proposals, however, it is very difficult to conclude whether or not they are a step in the
right direction, or a measure that will, in the final analysis, serve to do more harm than
good.

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