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abuse of rights. British Tax Review, 1985(2), 68-123.

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THE BUSINESS PURPOSE TEST AND ABUSE OF
RIGHTS

DAVID A. WARD (Canada), JOHN F. AVERY JONES (United Kingdom),

HENRI-ROBERT DEPRET (Belgium), MAARTEN J. ELLIS (Netherlands),
PIERRE FONTANEAU (France), RAOUL LENZ (Switzerland), TOSHIO
MIYATAKE (Japan), DONALD G. ORROCK (Australia), SIDNEY 1.
ROBERTS (United States), CLAES SANDELS (Sweden), JAKOB STROBL
(Germany), VICTOR UCKMAAR (Italy)

THE business purpose test has been accepted in a growing number of

common law jurisdictions as a tool to counteract what is perceived to
be unacceptable tax avoidance. In civil law jurisdictions, the business
purpose test has usually been applied under the labels of abuse of
rights orfraus legis,' doctrines of civil law that also have traditionally
had wide application in private and public law outside the field of
taxation.
The business purpose test, where it is used, is a test applied by the
courts to strike down, or sometimes to recharacterise, transactions
for purposes of determining a taxpayer's liability for tax where a
transaction, or certain steps in a transaction, although genuine, has
or have been carried out substantially without a business purpose and
for the purpose of obtaining a beneficial tax result.
The abuse of rights doctrine, where that has been applied, generally
involves a recognition that although a taxpayer has a right to enter
into any contract or undertake any transaction which is legal, he
abuses that right if he exercises it solely to avoid or reduce taxes.
Sometimes the intention to avoid taxes is inferred by the court where
the transaction is highly structured, is artificial or is otherwise
I It may be more appropriate to use the expression fraud on the law, fraude d la loi, avoidanceof
law or fraus legis rather than "abuse of rights" in tax cases because the taxpayer attempts to
circumvent a law (the taxation statutes) by his various devices which, in general terms, is the
essence of the concept of fraud on the law. See L. Josserand, "Les mobiles dans les actes juridiques
de droit priv6" (Paris, 1928). We, however, generally refer to "abuse of rights" in this article
because that is the expression most often used by the publicists and the courts. Abuse of rights, in
general terms, is a concept which gives a remedy to a person who is injured by another person who
exercises a right but in doing so acts with malice or other improper motive. We do, however, refer
to fraus legis in relation to the Netherlands as that is the expression used by their courts and
authors. Perhaps in tax cases the concepts are related because the taxpayer, in exercising his rights
to organize his affairs within the bounds of commercial law, does so for no business or commercial
purpose but solely to avoid taxation imposed by a public statute. The relationship between these
two concepts is considered by M. A. Wisselink in Volume A, International Tax Avoidance, a study
by the Rotterdam Institute for Fiscal Studies (Kluwer, 1979) at p.209 (hereinafter referred to as
"The Rotterdam Study on International Tax Avoidance") and by M. A. Kakebeeke-van der Put,
Wetsontduiking (diss. Leiden, 1961, Kluwer), p.101 etseq. (hereinafter referred to as "Kakebeeke"),
who quotes from various authorities in whose views the concepts are related. Kakebeeke, although
finding a connection between the two concepts, is of the view that each covers its own territory.
68
 THE BUSINESS PURPOSE TEST AND ABUSE OF RIGHTS

considered to be an unnatural way of achieving an economic or

business result.
There is a striking similarity in approach and result in civil law
jurisdictions that apply the doctrine of abuse of rights in taxation
cases to those adopted and applied in common law jurisdictions that
apply the business purpose test. The effect of the application of these
doctrines in tax law restricts a taxpayer from being able to reduce his
liability to pay tax by arranging or rearranging his affairs as permitted
by private law where such arrangements or rearrangements are carried
forward with the object and intent of tax avoidance and substantially
without a bona fide business purpose.
In all countries which we have reviewed, the underlying basis of
the liability for taxation generally follows from the legal structures
within which the taxpayer earns his income. For example, if a taxpayer
is a corporation the income tax law will usually apply a different rate
of tax to its earnings from that applicable if the taxpayer is an
individual. The laws recognise the right of an individual to incorporate
a company.2 If an individual has a right to incorporate, then does he
abuse that right if he incorporates for the purpose of attracting the
corporate rate of tax to earnings that would otherwise have arisen in
his hands and been taxed at personal rates of tax? More generally,
does a taxpayer abuse his rights if he has a wide freedom of choice in
the mechanics of carrying through particular transactions and he
exercises that choice in a manner which will attract the least amount
of tax or, at least, will avoid what he may consider to be excessive tax
penalties or tax traps?
What we consider here are transactions that are genuinely carried
out and are effective for all commercial and legal purposes. It is not
part of the subject matter of this paper to deal with the notions of
sham or simulation. We generally use the word "sham" as being
synonymous with simulation: the sense in which it was used in Snook
v. London & West Riding Investments Ltd.
"It means acts done or documents executed by the parties to the
'sham' which are intended by them to give to third parties or to
the court the appearance of creating between the parties legal
rights and obligations different from the actual legal rights and
obligations (if any) which the parties intend to create."'
In civil law and common law jurisdictions, the doctrines of abuse
of rights on the one hand and the business purpose test on the other
2 In many jurisdictions a one-man company is not permitted but even in those jurisdictions one
shareholder is often entitled to hold substantially all the shares in a corporation.
[1967] 2 Q.B. 786 (C.A.). The importance of the distinction between simulation on the
one
hand and abuse of rights or fraud on the law on the other has been noted by Kakebeeke at p.94 et
seq. cited in Volume A of the Rotterdam Study on International Tax Avoidance, at p.210.
69
 BRITISH TAX REVIEW

have been imposed by the enactment of broad statutory anti-tax-

avoidance provisions or through the evolution of legal principles in
the courts, or both. In the common law jurisdictions the business
purpose test has manifested itself under various labels, including the
step transaction doctrine, the principle that substance overrides
4
form, the extended concept of a "sham" and the doctrine of
recharacterisation.
ABUSE OF RIGHTS
(a) Development in Civil Law Countries
In those civil law jurisdictions in which it is recognised as a principle
of private law, the doctrine of abuse of rights is applied to cases in
which one person has exercised a right with the intention or the
purpose of causing harm to another person.
The concept of abuse of rights is regarded by some scholars as
having its origins in Roman law' and was recognised in decisions of
the French courts during the Ancien R6gime. In part influenced by
the views of legal writers and in part by jurisprudence, the doctrine
of abuse of rights in its modem form seems to have re-emerged after
the adoption of the Civil Code in the middle of the nineteenth century
in France with the decision of the Court of Appeal of Colmar.' The
case involved the owner of a house who erected a tall dummy chimney
on his roof for the sole purpose of annoying a neighbour by depriving
him of access to light. The defendant was required to remove it. The
court reasoned that although, in constructing a chimney, the defendant
was exercising a right given to him by law, he had acted with a spiteful
intent and without a legitimate interest. In consequence, his act was
wrongful.
Another decision of the Court of Appeal of Lyon' during the same
period also dealt with the abusive use of property rights. The court
"Sham" here is not used in the sense of a pretence. It is used in the sense sometimes adopted
by the United States courts in applying the business 'purpose test. It is a means of describing a
transaction which is given no effect for tax purposes because the taxpayer did not carry it out to
achieve a business purpose although the taxpayer accepts the legal consequences of the transaction.
I See Andr6 Tunc, "The French Concept of Abus de Droit", The Cambridge Lectures, 1981
(Butterworths, Toronto) at p.151.
6 H. C. Gutteridge, "Abuse of Rights" (1933), 5 C.L.J. 22 at p.31, citing the statements of
Marcellus, D.39.1.12 (de acqua) and D.6.1.38 (de rei vindicatione). For a contrary view, see
Planiol, Traitd didmentaire de droit civil (12th ed., 1939) at paragraph 870. Kakebeeke, at p.17 et
seq. finds the origins of the fraus legis doctrine in Paulus, D.1.3.29 and Ulpianus, D.1.3.30 and at
p.102, the origins of abuse of rights in D.39.5.14; D.39.2.7. pr; D.7.1.17.1; Inst. Just. IV-16; and
Inst. Just. I-8-2.
7 1 mai 1855, Dalloz Pdriodique, 1856, 2. 9. Kakebeeke, referring to "fraude Ala loi" and
quoting Ligeropoulo, cites at p.71, as one of the earliest cases in France, a decision of the Cour de
Paris of 24 f6vrier 1817, S. 17.2.354 and 26 janvier 1818, S. 18.2.360, confirmed 11 janvier 1820, s.
20.1.157, where a marriage between a physician and his patient was considered to constitute a
fraud on the law because it circumvented article 909 of the Civil Code which prohibited a doctor
from benefiting from the will of his patient.
I Dalloz Pdriodique, 1856, 2. 199. See also a decision to the same effect by the Cour de
Cassation, Req. 10 juin 1902, Sirey, 1903.1.11.
70
 THE BUSINESS PURPOSE TEST AND ABUSE OF RIGHTS

held that a landowner committed a wrong against his neighbour when

the landowner installed powerful pumps on his land solely for the
purpose of damaging springs on neighbouring lands where a famous
mineral water was produced. In this case the spiteful intent was
inferred from the fact that the defendant had no use for and therefore
merely wasted the water which he pumped from his land.
Perhaps the most celebrated of the seminal cases developing this
concept is the decision of the Cour de Cassation in Cldment-Bayard.9
Here the court found that the defendant, who owned property
adjoining an airport, wronged his neighbour by building high wooden
structures on his land with iron pegs for the purpose of impaling
dirigibles using the airport, with the object of motivating his
neighbour, the Cl6ment-Bayard Company, to purchase his land at an
inflated price.
The doctrine of abuse of rights thereafter found its way into many
other fields of law including the law of contracts, 0 labour law,"
family law,' 2 administrative law," and company law. 1 4
In Belgium, the first appearances of the doctrine of abuse of rights
occurred in family law" and commercial law.' The doctrine in
Belgian law was fully developed by a leading case of the Supreme
Court dealing with real property law17 where the court explained that
the concept of abuse of rights has its foundation in tort law, giving
remedies to the plaintiff where the exercise of a right is done with the
intention of harm but also giving remedies where the exercise of a
ITrib. Civ. Compi6gne, Dalloz Pdriodique, 1913.2.177; Amiens et Req. Dalloz P6riodique,
1917.1.79.
n Tunc, op. cit. pp.152 and 153.
" Dalloz. 1908.2.73. Generally there is an abuse when a wage earner is dismissed without
compliance with the rules of dismissal applicable to a contract of labour made for an indefinite
period by art. 122-4 et seq. of the Labour Code.
12 Dalloz, 1908.2.73. There is no abuse of rights by application of art. 179 of the Civil Code
when ascendants oppose the marriage of their minor children. This, of course, is a contrary rule.
12 24
n1 Conseil d'Etat, 11 d6cembre 1970, Crdit Foncier de France, Rev.dr.pub., 1971, p.
.

14 Piquard, Cour de Cassation, 18 avril 1961, Recueil Dalloz, 1961, 56; Fruehauf, Cour d'appel
de Paris, 22 mai 1965, D.1968, p.147; J. Borel, Cour d'appel de Paris, 15 mars 1968, J.C.P. 1969 II,
15814 and Cassegrain, Cour d'appel de Rennes, 23 fdvrier 1968, J.C.P. 1969 II, 16122 reversed by
the Cour de Cassation, 21 janvier 1970, J.C.P. 1970 II, 16541.
15 Cour de Cassation 11 novembre 1909, Pas., 1909 1, 435, which applied the doctrine although
it used the label of "fraude d la loi" where a husband in his capacity of legal manager of the joint
estate of husband and wife had disposed of it in a manner detrimental to the wife and her heirs to
his own benefit and that of his heirs. Later applications to family law are: Cour d'appel de Tournai,
30 janvier 1956, Pas. 1956, III, 120 and Cour d'appel de Gand, 18 f6vrier 1950, R.C.J.B. 1951, 113
and note of J. Baugniet.
16 Cour de Cassation, 12 juillet 1917, Pas., 1918, I, 65, where a trader had affixed a lighted sign
projecting so as to hide the sign of identical size previously affixed by a neighbouring trader on his
own premises and was therefore held to have abused the commercial right of competition and his
right of ownership.
"1 Cour de Cassation, 10 septembre 1971, Pas., 1972 1, 28. The doctrine has been applied often
in real property law: Tr.Civ.Namur, 24 ddcembre 1935, Pas., 1937, III, 58; Trib.Civ. Charleroi, 8
novembre 1941, R.G.A.R. 1942, 3672; Trib.Civ.Dinant, 12 fWvrier 1941, R.G.A.R. 1941, 3559;
Gand 20 novembre 1950, R.C.J.B. 1953, 270; Civ.Courtrai 19 juin 1958, Pas., 1960, III, 23; Appel
Lidge 12 f6vrier 1980, R.J.I. 1981, 7; J.P. Etterbeek 18 aoOt 1978, Entr.Dr. 1983, 91.
71
 BRITISH TAX REVIEW

right is done in a way that is beyond the normal exercise by a prudent

man. 8
The doctrine of abuse of rights, as built up by the Belgian
jurisprudence and established by the Supreme Court, has been
favoured over that of fraude d la loi in general law.19 Through an
approach similar to that of the French author Josserand, the doctrine
developed from the view that a right has a social purpose and that it
can be abused when exercised in a way that is detrimental to that
purpose. It has spread to all the areas of the law where such rights
are to be found: real property law, family law, commercial law,
contract law or labour law. On the other hand, the doctrine is not
applied when the right concerned is perceived as a discretionary one
although this category of rights is rapidly disappearing. 20
The doctrine of abuse of rights, however, has never been used in
Belgium to pierce the corporate veil. 2 ' In company law, its application
has been restricted to deciding that the voting rights of minority or
majority shareholders have been abused when they are used for the
exclusive and personal benefit of such shareholders and in a manner
detrimental to the corporate life, purpose or interest. 22
The abuse of rights doctrine has been applied widely in commercial
law; for example, to limit the exercise of a landlord's rights in a
commercial lease, 23 and the rights of secured creditors or mortgagees
against their debtors, 24 and to strike down a year to year termination
clause of an independent agent's (distributor) contract where the
plaintiff actually acted as a dependent agent and was therefore entitled
to compensation for damage as if the contract were concluded for an
indefinite period of time.25 In labour law, the doctrine is applied
mainly to the abuse of the right to dismiss an employee 26 and
18 Compare with previous decisions of the Cour de Cassation: 11 avril 1958, Pas., 1968, I, 867 in
a family law case (intention to harm) and 16 novembre 1961, Pas. 1962, I, 332 in a real property
law case. For a thorough analysis on this point see "Abus de droit, fraude aux droits des tiers et
fraude A la loi", P. Van Ommeslaghe in R.C.J.B. 1976, pp.303-350 (hereinafter referred to as
"Van Ommeslaghe").
1 Van Ommeslaghe p.336 etseq. plus note 147.
a Van Ommeslaghe p.322 et seq. Examples of discretionary rights are the right to ask the
division of undivided property (Appel Lidge, 13 fdvrier 1980, Jur. Liege 1981, 109) and the right to
make a will or to disinherit or to sell property depriving one's heirs of their expectancies (see note
88 and 89 of Van Ommneslaghe citing relevant case law).
1 See: Cour de Cassation, 11 juin 1957, Rep. fisc. p.750.
* Van Ommeslaghe p.318 etseq.; Trib.Comm.Bruxelles 23 novembre 1981, J.Comm. Bruxelles
2 octobre 1981, R.P. Soc. 1981, 271, 273.
1 J. P. Saint-Gilles 23 novembre 1981, J.J.P. 1982, 200.
24 J. Saisies Liege, 4 f6vrier 1981, J. Lidge 1981, 309; Appel Lifge, 9 mars 1983, J. Lidge 1983,
255; Trib.Civ.Namur 18 fdvrier 1983, Rev.Reg.Dr. 1983, 329; Trib.Comm.Lidge 2 juin 1983,
R.Dr.C. 1984, 70; Tr.Civ.Mons 10 f6vrier 1984, Rev.Reg.Dr.1984, 197.
3 Tr.Comm.Br. 21 janvier 1981, J.Comm.Br. 1981, 493.
* Van Ommeslaghe, p.316 and case law cited at note 53; more recently C.Trav.Bruxelles 12
d6cembre 1980, R.G. 10.660 and 1 avril 1981, J.T.T. 1983, 25; C.Trav.Bruxelles 26 fdvrier 1982,
R.G. 9236; C.Tr.Bruxelles 4 mai 1981, J.T.T. 1983, 24; C.Tr.Bruxelles 5 janvier 1981, J.T.T.
1983, 25; Tr.Tr.Charleroi 16 juin 1982, J.T.T. 1983, 26; Tr.Tr.Bruxelles 3 mars 1982, J.T.T. 1983,
27; C.Tr.Lifge 20 octobre 1982, R.Dr.Credoc; C.Tr.Anvers 21 mars 1983, J.T.T. 1983, 373.
72
 THE BUSINESS PURPOSE TEST AND ABUSE OF RIGHTS

sometimes to the abuse of the right to strike.2 It has also been applied
in farm leases,' contract law, 29 and the right to bring an action.30
The principle that rights must not be abused has also been firmly
embedded in the private law of other civil law jurisdictions. For
example, it is reflected in Article 2 of the Swiss Civil Code":
"Every person is bound to exercise his rights and fulfil his
obligations according to the principles of good faith.
"The law does not sanction the evident abuse of a man's
rights. "32
As in France, the doctrine of abuse of rights in Switzerland found
its origins in real property law cases 33 and has spread into other fields
of the law. 34 For example, the second paragraph of Article 2 of the
Swiss Civil Code has long been interpreted by the courts as giving
them a right to adapt a contract to new circumstances when the
contract has become "unbalanced" by subsequent circumstances if
four conditions exist: (a) the occurrence of an external unforeseeable
event, (b) a breach of the balance of the contract, (c) the resulting
lack of balance is notable, evident and excessive, and (d) the contract
has been in existence for a certain length of time.s
In Germany, the doctrine of abuse of rights is reflected in various
provisions of the Civil Code. In developing the concept, judicial
decisions have played only a subsidiary role. 36 It is stipulated, for
example, that: "The exercise of a right is forbidden if it can have no
other purpose than to harm some other person"" and that contracts
should be interpreted and performed according to the requirements
of good faith. 3 8 These provisions were held to require the nominal
2 Van Ommeslaghe p.325 plus note 103.
2 Cour de Cassation 28 avril, 1972, Pas., 1972 I, 797, where a farmer, beyond the forfeitary
legal penalty granted to the landlord, was also held liable to the evicted third party because he had
abused his pre-emptive rights in buying his landlord's farm and reselling it at an inflated price
before the five year legal holding period.
29 Van Ommeslaghe p.323 plus notes 92 and 93 and p.325; also Cour de Cassation 19 septembre
1983, R.W. 1983-1984, 1480; Appel Bruxelles 5 septembre 1983, R.Dr.Comm. 1984, 353;
Trib.Comm.Bruxelles 8 d6cembre 1983, R.Dr.Comm. 1984, 397.
1 Cour de Cassation 29 novembre 1962, Pas. 1963, I, 406; Van Ommeslaghe p.327; Appel Liege
28 octobre 1980, Rev.Reg.Dr. 1981, 63; Appel Anvers 1 octobre 1980, R.W. 1980-1981, 1836.
31 In this article, unless otherwise noted, translations into English are our own.
32 In 1912, the Swiss Civil Code unified the laws of the different cantons into one federal law. At
that time the principle of abuse of rights had already been incorporated into local law. The first
time the expression "abuse of rights" is found expressly is in a decision of 1905, (Hans Merz,
Berner Kommentar 1/1 Einleitung Art. 1-10 ZGB).
* See Articles 679 and 680 of the Swiss Civil Code.
See ATF 93 1111, JT 1967/542 and ATF 38 II 459.
s See ATF 59 11372, 62/1936 1142.
See Gutteridge, op. cit., p.36.
Art. 226 German Civil Code. Gutteridge, op. cit. at page 89 notes that German law differs
from Swiss law in that, in Germany, there must be proof of the intention to harm another person,
whereas the Swiss Civil Code allows the court more latitude in determining what is an abuse in
terms of justice and equity (see Art. 4 of the Swiss Civil Code).
" Arts. 133, 157, 226 and 242 of the German Civil Code. Cases involving the application of
Article 226 are not as frequent as those involving Article 242.
73
 BRITISH TAX REVIEW

amount of a debt to be increased to reflect the effect of inflation in

the period immediately following the First World War."
Article 117 of the German Civil Code provides that the use of legal
forms is an abuse if it disguises the legal consequences that were
actually intended. This, however, is close to a rule which denies the
legal consequences of a simulation.'
In The Netherlands (as in other countries) the concepts of abuse of
rights and of fraus legis have developed separately. The doctrine of
fraus legis first appeared in a tax case in 192641 while the first
appearance in private law of the doctrine of abuse of rights occurred
in 193742 in a case in which the facts were virtually identical to the
French Colmar case.43 A currently accepted principle is that an abuse
of rights exists where there is such a disproportion between the
interests of the injuring party and those of the injured party, that the
former could not reasonably have decided to exercise his rights in
this way."
Japan also recognises the fundamental importance of the abuse of
rights doctrine. Article 12 of the Constitution of Japan provides:
"The freedom and rights guaranteed to the people by this
Constitution shall be maintained by the constant endeavour of
the people, who shall refrain from any abuse of these freedoms
3 Reichsgericht (RG), German Supreme Court for Civil Matters, Decision of September 21,
1920.
1 Kakebeeke at p.86 provides an interesting comparison in the application of the concept of
fraus legis (as she describes it) in Germany, Switzerland and The Netherlands to attempts in the
three countries to circumvent provisions of the Civil Code that prohibit the creation of a lien on
personal property without the creditor taking possession of the property. In all three countries the
practice developed of transferring the ownership of the property as security for the debt. In all of
these countries this method of procedure was attacked. In Germany (R.G. September 24, 1880,
Bd.2 Nr.45) this attack failed. It also failed in The Netherlands (HR, January 25, 1929, N.J. 1929,
Nr.616). However, in Switzerland the court found the construction to be an "avoidance of the law"
so that the security was invalid against third parties. (Gesetzesumgehung) (B.G.E. November 16,
1913, 39, 691f).
41 The so-called "three day" case, HR, May 26, 1926, N.J. 1926, nr.723.
63 9
4 Supreme Court decision of April 2, 1937, N.J. 1937, p.
.

4 There is no general provision in the Civil Code (B.W.) concerning "abuse of rights," although
there are some provisions that contain specific rules. For example, Article 625 B.W. prohibits an
owner from inflicting damage to the rights of others. The courts have developed an "abuse of
rights" doctrine based on the general tort provision of Article 1401 that causing excessive hindrance
can be a tort. The first case in this development was H.R., January 30, 1914, (N.J. 1914, p.497).
Earlier civil law decisions in The Netherlands reflected reasoning that strongly resembles the
applicati6n of the fraus legis principle. In H.R., April 9, 1903, W. 7906, a contract between
shareholders agreeing to guarantee a 10% dividend in the first year of operation of a company was
set aside on the grounds that it was an indirect avoidance of the statutory prohibition to include
such a guarantee in the articles of incorporation. There are other areas of civil law where abuse of
right decisions can be found, for example, in the law of procedure. In the law of contract in The
Netherlands, the prevailing opinion is that the principle of good faith contained in Article 1374
B.W. is sufficient to cover abuse of rights situations.
" This was pronounced in H.R. April 17, 1970 (N.J. 1971, p.89). For further discussion of the
Dutch concept of abuse of rights, see Helmich, De theorie van het rechtsmisbruikin het Romeinsche,
Fransche en Nederlandsche recht, (diss. Nijmegen, 1945) and Okma, Misbruik van Recht, (diss. V.
U. Amsterdam, 1945).
74
 THE BUSINESS PURPOSE TEST AND ABUSE OF RIGHTS

and rights and shall always be responsible for utilizing them for
the public welfare."
Article 1, paragraph 3 of the Japanese Civil Code also recognises the
doctrine and provides: "No abuse of right is permissible." In Japan
the doctrine has been applied in property cases analogous to the spite
fence cases and also in actions involving wrongful dismissal.45
The doctrine has given rise to defences in actions on promissory
notes' and the Supreme Court has also suggested that the doctrine
might possibly be applied in a case of alleged malicious prosecution.47
In contrast to the experience in other civil law countries, the courts
in Sweden have not given independent recognition to the doctrine of
abuse of rights. However, in certain civil law statutes, the rule has
been inserted to provide for cases of abuse. For example, the text of
the law of contracts states:
"A legal act, that otherwise would be valid, may not be enforced,
if the circumstances prevailing at its coming into being were such
that it should be against faith and honour to invoke the act with
knowledge of these circumstances and the person to the benefit
of whom the act was made must be supposed to have had such
knowledge."'
The abuse of rights doctrine has very limited scope in Italy. The
Civil Code does not contain any general abuse of rights provision4 9
but does contain a specific abuse of rights article (Article 833) dealing
with the rights of an owner of property.
"The owner cannot perform acts that have no other purpose
than that of harming or causing annoyance to others."
Scholars have argued that the doctrine can also be discerned in
other provisions of the Code.o Apart from these specific instances
where the doctrine has or may have been provided for in the Civil
5 Decision of Anotsu District Court, August 10, 1926, H6ritsu Shimbun No. 2648, 11; Decision
of the Supreme Court, April 25, 1975, 29 Minshei 456.
6 Decision of the Supreme Court, December 25, 1968, 22 Minsha 3548; Decision of the Supreme
Court, July 16, 1970, 24 MinshO 1077.
4 Decision of the Supreme Court (dictum), December 17, 1980, 34 Keishfi 672.
1 33 Avtalslagen (1915:218) (Law of Contracts).
4 A general provision was proposed in a draft of the 1942 Civil Code but was dropped in favour
of dealing with specific areas of the law.
5 A. Torrente-P. Schlesinger, Manuale di diritto privato (XI ed. Giuffrd, Milano, 1981) at
p.66, discuss other specific sections in the context of abuse of rights, namely, Article 844 (emission
of smoke, noise, vibration, etc. from land) and Article 1175 (debtor and creditor shall behave
according to the rule of fairness). See also A. Candian, Nozioni istituzionali del diritto privato
(Giuffrk, Milano, 1953) p.53 and following, F. Santoro-Passarelli, Dottrinegenerali del diritto civile
(Napoli, 1957) p.60, M. Rotondi, Istituzioni di diritto privato, (Pavia, 1954) pp.101 to 105,
F.Messineo, Manuale di diritto civile e commerciale, (8th ed. Giuffrk, Milano, 1954) Vol. I, III.
Contra V. Giorgianni, L'abuso del diritto nella teoria della norma giuridica, (Giuffrk, Milano,
1963) at p.166 and U. Natoli, "Note preliminari ad una teoria dell'abuso del diritto nell'ordinamento
27 29
giuridico italiano", in Rivista trimestrale di diritto e proceduracivile (1958) pp. -
.

75
 BRITISH TAX REVIEW

Code, the abuse of rights doctrine is not regarded as having any

application in Italian law as it is considered to be dangerous to grant
the courts wide discretionary powers to discriminate between a normal
and an abnormal use of a right. It is considered that recognition of
such discretionary powers would seriously infringe the principle that
the law should be certain.
Whether codified"1 or developed by judicial decisions and doctrinal
writings,52 the concept of abuse of rights imposes what are considered
to be reasonable limitations on a person's liberty in order to prevent
him from injuring others by exercising his rights with "spitefulness,
or bad faith, or gross mistake equivalent to bad faith".53
(b) Development in the Common Law Countries
While the courts in most continental jurisdictions were developing
the concept of abuse of rights, the English courts were clearly moving
in the opposite direction. The Commonwealth countries which take
their common law from England have also moved in the same
direction. It is suggested that the divergence of the common law from
the civil law in this important respect arises because when, as in the
continental systems, legal rights are codified and declared in absolute
terms, it is inevitable that the courts will place some reasonable
limitation upon the exercise of such rights. On the contrary, in
common law jurisdictions, rights were not usually defined in absolute
terms by the courts but evolved on a case by case basis and usually
without regard to any motivation or purpose of the person whose
actions were challenged. In consequence, the courts were rarely
confronted with the necessity of placing limitations on rights that had
been previously declared in absolute terms. The issue became one of
defining in each case the extent of a person's right to do a particular
thing.
"To a common law lawyer there may be a temptation to dismiss
the doctrine [of abuse of rights] as involving some obvious
confusion of thought. How can it be meaningful to say that an
act that abuses a legal right is unlawful? Either one has a right to
do an act or one does not, and to speak of an act that is an
unlawful exercise of a legal right to do the act seems to be self-
contradictory nonsense."54
s As, for example, in Switzerland, Germany and Japan.
s2 As, for example, in France, Belgium and The Netherlands.
s See Tunc, op. cit. p.154.
* See Ward and Cullity, "Abuse of Rights and the Business Purpose Test as Applied to Taxing
Statutes" (1981) 29 Can. Tax J. 451 at p.453; also published in The Cambridge Lectures 1981
(Butterworth's, Toronto) 120 at p.122. As noted by Tunc, op. cit., at p.155, the French author
Josserand tried to escape from this paradox by pointing out the ambiguity of the word droit in the
phrase abus de droit. He explains that someone may have a right (un droit) and still use it in a
manner contrary to law (le droit). His position is that because rights have a social purpose, they are
"relative" and not "absolute", and to exercise a right beyond its social purpose is an abus de droit.

76
 THE BUSINESS PURPOSE TEST AND ABUSE OF RIGHTS

Whatever may be the historical reason, the doctrine was considered

and firmly rejected by English courts at an early date. In a leading
early case, Bradford Corporationv. Pickles, which involved property
rights, it was said of the defendant: "If it was a lawful act, however ill
the motive might be, he had a right to do it. If it was an unlawful act,
however good his motive might be, he would have no right to do
it."" The rule was also expressed in these terms: "No use of property,
which would be legal if due to a proper motive, can become illegal
because it is prompted by a motive which is improper or even
malicious."s" In later cases, the English courts have refused to apply
the doctrine of abuse of rights not only to property cases but also to
contract cases. In Allen v. Flood," perhaps the leading case, the
doctrine was rejected in litigation involving labour law.
"It is certainly a general rule of our law that an act prima facie
lawful is not unlawful and actionable on account of the motive
which dictated it." 58
"Equally any right given by contract may be exercised against
the giver by the person to whom it is granted, no matter how
wicked, cruel, or mean the motive may be which determines the
enforcement of the right. It is hardly too much to say that some
of the most cruel things that come under the notice of a judge
are mere exercises of rights given by contract.""

Therefore, it has been said that in English law, "an act that is legal
in itself will not be made illegal because the motive of the act may be
bad."'
In Canada, the common law is in force in 9 of the 10 provinces.
Following the English tradition, the common law as applied in Canada

Josserand's views have been further developed by Prof. G. Ripert, "Abus et relativit6 des droits",
3 35
Revue Critique 1929, p. and analysed by A. Pirovavo, "La fonction sociale des droits: rdflexions
67
sur le destin des thdories de Josserand", Recueil Dalloz Sirey, 1972, p. . See also the Belgian
author, Campion, La thdorie de l'abus des droits, at p.320, who explained the concept as "furnishing
a means of transmuting individual into social rights". On the other hand, the French author Planiol,
op. cit. at paragraph 871, takes the position that the doctrine is self-contradictory as an act cannot,
at the same time, be lawful and unlawful. "[T]he right ceases where the abuse commences, and
there cannot be an 'abusive use' of a right of whatever sort, because of the irrefutable reason that
one and the same act cannot at the same time be in conformity to law and contrary to law."
ss [18951 A.C. 587 (H.L.) at p.594, per Lord Halsbury, L.C.
56 Ibid., at p.598, per Lord Watson.
57 [1898] A.C. 1 (H.L.). The case of Allen v. Flood was first argued before seven law lords
(rather than the normal five) and then on a second occasion before the same seven, with two
additional law lords together with eight other judges who were summoned to attend and express
their views.
5 Per Lord Herschell at p.123.
* Per Wills, J. at p.46.
a Sorrell v. Smith, [1925] A.C. 700 (H.L.), per Lord Dunedin. Salmond On Torts (17th ed.,
Sweet & Maxwell, London, 1977) cites Chapman v. Honig, [196312 Q.B. 502 (Q.B.D.) and Wyld
v. Silver, [1963] Ch. 243 (Ch.D.) as more recent examples of cases where the "bad" motive of a
person in exercising his rights provides no foundation for a cause of action in English law.
77
 BRITISH TAX REVIEW

also does not recognise the abuse of rights doctrine.6 ' However, in
the Province of Quebec, which bases its law on civil law, the doctrine
has been applied.62
Australia also follows the English common law in rejecting the
abuse of rights doctrine.
In the United States the law has developed differently from that in
England and the Commonwealth.' There, the concept of abuse of
rights has appeared as a judicial doctrine, and has occasionally been
used in statutes." In its judicial form it is most often used in the
"interpretation" of a statute or of a contract, or as an element in the
development of the law of torts. In each instance it is used to strike a
balance between the strict application of the statute, the contract or
the. rights of a person and some wider perceived social purpose which
is inconsistent with such strict application. For example, Prosser'
explains the development of the American law of torts in terms of
social engineering, namely, a means of balancing the interests of the
plaintiff for which he demands protection against the defendant's
claim to untrammelled freedom in pursuing his own desires. As
Prosser explains, "the interest of the public is thrown into the scale
and allowed to swing the balance for or against the plaintiff." Prosser
discusses American jurisprudence in terms entirely consistent with
the continental concept of abuse of rights, stating:
"Thus the erection of a spite fence, with no other purpose than
the vindictive one of shutting off the plaintiff's view, or his light
and air, is now held by most courts to be actionable as a nuisance,
where the same fence serving some useful end would not. Quite
in line with such cases are the modern decisions holding
6' Associated Growers of B.C. Ltd. v. Edmunds, [1926] D.L.R. 1093 (BCCA); Divers v. Burnett,
[1930] W.W.R. 150 (BCCA); Murray v. Smith's Estate, 32 Nfld. & P.E.I.R. 191 (PEISC) and
Stubart Investments Ltd. v. The Queen, [1984] C.T.C. 294,84 D.T.C. 6305 (SCC). See also Pugliese
v. National CapitalCommission, (1977) C.C.L.T. 18 (OntCA), rev'd. (1979) 8 C.C.L.T. 69 by the
Supreme Court of Canada, on the ground that even if it is assumed that the common law which
formed the basis of the decision in Bradford Corpn. v. Pickles was applicable in Canada, the rights
of a landowner to remove subterranean water were limited by statute in Ontario.
62 Brodeur v. Choinidre [1945] Que.S.C. 334. This affirms a view given earlier by George B.V.
Nicholls, The Responsibility for Offences and Quasi-offences under the Law of Quebec, McGill
Legal Studies, No. 1 at p.23 et seq. See also Mignault, "The Modem Evolution of Civil
Responsibility", (1927) Can. Bar Rev. 1 at 10.
I Martell v. Victorian Coal Miners' Association, (1903) 29 V.L.R. 475 at pp.513 et seq. (VSC);
The Brisbane Shipwrights' Provident Union et al v. Heggie, [1906] 3 C.L.R. 686 (HC) and Bond v.
Morris, [1912] V.L.R. 351 (VSC) at p.358, where Madden C.J. said: ". . . We think therefore, that
Allen v. Flood is a binding decision, warranting the view we take of this case."
" It should be recognized that in the United States, the law of contracts, property and torts has
reflected the actions of 50 independent State judicial systems.
s In the United States the concept of abuse of rights (although not described as such) was used
very early in the development of the law. An analysis of rights and obligations created by contract
in terms of the limitations on such rights imposed by society was postulated as early as 1827 by
Justice Johnson in the Supreme Court in a contract case, Ogden v. Saunders, 25 U.S. (12 Wheat.)
213 at p.279 etseq.
* W. Prosser, The Law of Torts (4th ed., 1971) at pp.14 to 16.
78
 THE BUSINESS PURPOSE TEST AND ABUSE OF RIGHTS

defendants liable for accumulating checks drawn on the plaintiff

and presenting them all at once for payment, or buying up his
note and transferring it to a bona fide purchaser who can enforce
it against him, where the sole motive is to ruin him financially."67

The same trend in the United States in the law of contract has
been recently commented on by Professor Kennedy" in terms of
social engineering. 69
The recognition of the separate existence of a corporation from its
controlling shareholder illustrates well the divergence between the
English common law on the one hand and the civil law and American
law on the other. Circumstances in which a corporate entity may be
ignored will vary from jurisdiction to jurisdiction. The issue whether
rights have been abused usually arises in the context of the use
of corporations to avoid contractual obligations incurred by the
shareholders, the position of the shareholder of an undercapitalised
corporation and the treatment of the property of a corporation as if it
were the property of the sole beneficial shareholder.
For example, in a decision of the Federal Court of Switzerland in
1946, the court indicated that the shareholder would be identified
with the corporation where this was reflected by the economic reality:
"This will be the case every time when reliance on the difference
in the legal personalities would constitute an abuse of rights or
would have the effect of infringing legitimate interests, e.g., the
purpose of escaping from a prohibition of competition."1o
In Germany, a number of cases recognise that loans of money
and other property made by a shareholder to a thinly-capitalised
corporation may be treated as part of the capital of the corporation
available to outside creditors in priority to the rights of the shareholder
as creditor. In circumstances of thinly-capitalised corporations the
shareholder is not permitted to assert his rights to reacquire the funds
loaned to the company where he has "abused the forms of law in
order to prevent creditors from obtaining satisfaction"."

6 Prosser, op. cit. p.25. Compare this emphasis on motive with that of English law as laid down
in Bradford Corporation v. Pickles and Allen v. Flood.
I Duncan Kennedy, "Form and Substance in Private Law Adjudication", 89 Harv. L.R. 1685
(1976).
1 Both Prosser and Kennedy acknowledge the original use of the social engineering analysis by
Dean Roscoe Pound. See, "The Theory of Judicial Decision, III", 36 Harv. L.R. 940 (1923). The
social engineering analysis is, of course, similar to that used by Josserand (see footnote 54) in
explaining the civil law concept of abuse of rights.
70 Judgment of 22 January, 1946, S.A. Cira v. Ruttiman, ATF 72 II 67.
1 See Cohen and Simitis, "Lifting A Veil in the Company Laws of the European Continent"
(1963) 12 I.C.L.O. 189 at 195. The law has now been codified: section 32a GmbH Gesetz (Statute
on Companies with Limited Liability).
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 BRITISH TAX REVIEW

In Sweden, the courts rarely lift the corporate veil, but the Supreme
Court did so in two cases involving special facts, which we suggest
amounted to a finding of agency.72
As has been previously noted, in Belgium where the abuse of rights
concept has been widely applied in general and commercial law, it
has not been applied in company law to pierce the corporate veil.
The corporate veil is pierced in some cases where the doctrine of
simulation can be applied.
In Japan, a number of cases also illustrate the lifting of the corporate
veil where the corporate personality is used as a shell, or is abused to
avoid the application of law, or where there is otherwise a need to
pursue the individual who exists as the substance behind the form of
a corporation, or where the interest of a third party would be
unreasonably damaged by the use of the corporate form.
In contrast, in the leading English case of Salomon v. Salomon

&
Co.7 1 the House of Lords (reversing the Court of Appeal) rejected
the suggestion that the shareholder of a thinly-capitalised company
could not prove his secured claim as a creditor in the bankruptcy of
the corporation ahead of the unsecured creditors. In the Court of
Appeal, Lindley L.J. had stated:
"The company must . . . be regarded as a corporation, but as a
corporation created for an illegitimate purpose . . . [Mr.
Salomon's] liability does not arise simply from the fact that he
holds nearly all the shares in the company . . . His liability rests
on the purpose for which he formed the company, on the way he
formed it, and on the use he made of it . . . I will add that I
regard the so called sale of the business to the company as a
mere sham, and that in my opinion it might, if necessary, be set
aside by the company in the interest of its creditors, although all
the shareholders, such as they were, knew of and assented to the
arrangement. "76
` The first instance (N.J.A. 1967, s.647) involved an undercapitalised corporation which, by
altering the water flow over land, caused damage to a third party. When the corporation was
unable to pay the judgment, the shareholders were held liable on the ground that the corporation
did not carry out an independent activity. In the second instance (N.J.A. 1975, s.45) an
undercapitalized subsidiary operated for the account of its parent, and the parent became
responsible for the debts of the subsidiary.
11 Cour de Cassation, 11 juin 1957, Rep. fisc. p.750.
4 Decision of the Supreme Court, 27 February, 1969, 23 Minshu (No. 2), p.511 at p.513. This
concept has also been applied in the decisions of the Tokyo District Court, 27 November, 1969,
Hanrei Taimuzu (No. 244), p.260; Tokyo District Court, 27 May, 1976, Hanrei Taimuzu (No. 345)
p. 29 0; Sendai District Court, 27 December, 1969, Hanrei Taimuzu (No. 243) p.223; Fukuoka High
Court, 22 July, 1974, Hanrei Jih6 (No. 760) p.95; Nagoya High Court, 10 February, 1972, 25
Kosaiminsh (No. 1) p.48; Osaka District Court, 13 February, 1974, Hanrei Jih6 (No. 735) p.99;
Fukuoka High Court, 16 October, 1968, 19 KaminshO (Nos. 9-10) p.607; Tokyo High Court, 29
July, 1974, Hanrei Jih6 (No. 755) p.103; Matsue District Court, 22 September, 1975, 26 Kaminshfi
(Nos. 9-12) p.797, Sendai District Court, 26 March, 1970, 21 R6d6 Minji Hanreishu (No. 2), p. 3 30
and Tokushima District Court, 23 July, 1975, 26 R6d6 Minji Hanreishf (No. 4) p.580.
7 [1897] A.C. 22 (H.L.), reversing [189512 Ch. 323 (C.A.) (sub nom.) Broderip v. Salomon.
76 [189512 Ch. quoted from pp.337, 338 and 339.
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 THE BUSINESS PURPOSE TEST AND ABUSE OF RIGHTS

This was rejected in the House of Lords.

". . . [TIhe statute enacts nothing as to the extent or degree of
interest which may be held by each of the seven [shareholders],
or as the proportion of interest or influence possessed by one or
the majority of the shareholders over the others. One share is
enough. Still less is it possible to contend that the motive of
becoming shareholders or of making them shareholders is a field
of inquiry which the statute itself recognises as legitimate . . . I
will for the sake of argument assume the proposition the Court
of Appeal lays down-that the formation of the company was a
mere scheme to enable Aron Salomon to carry on business in
the name of the company. I am wholly unable to follow the
proposition that this was contrary to the true intent and meaning
of the Companies Act. I can only find the true intent and meaning
of the Act from the Act itself; and the Act appears to me to give
a company a legal existence with, as I have said, rights and
liabilities of its own, whatever may have been the ideas or
schemes of those who brought it into existence."'I

The law, as stated in Salomon v. Salomon & Co., has also been
consistently applied in Canada" and in Australia."
Certain United States jurisprudence also seems to embrace the
abuse of rights principle as applied in company law matters. In this
respect, the American cases are closer to the legal reasoning of the
Court of Appeal in the Salomon case and to the civil law concepts
than to the approach that is now well established in other common
law jurisdictions. In summarising this approach, Professor Ballantine
has said:

" Per Lord Halsbury, [1897] A.C. at p.30. This reasoning, of course, is in the same vein as the
substantially contemporaneous decisions of the House of Lords in Bradford Corporationv. Pickles
and in Allen v. Flood. The refusal to lift the corporate veil was applied by the Privy Council in an
appeal from New Zealand, Lee v. Lee's Air Farming Ltd., [1961] A.C. 12 (P.C.) where the
shareholder of a one-man company of which he was the sole governing director and chief pilot was
held nonetheless to be an employee of the company for purposes of the Workmen's Compensation
Act. Successful attempts to lift the corporate veil, although rare in English law, are not unknown
where an inference can be drawn from the facts that the company was an agent or trustee for its
shareholder. See Gower, Modern Company Law, (4th ed., Stevens & Sons, London) pp.11 2 -138.
These cases, however, are not examples of any general application of the abuse of rights principle
but rather are based on particular findings of fact. D.H.N. Ltd. v. Tower Hamlets, [197611 W.L.R.
852 (C.A.), a decision of Lord Denning, M.R., is an example of the rare circumstances where an
English court will pierce the corporate veil, in this case for the limited purpose of establishing the
fair compensation to be paid on the expropriation of property of a subsidiary which was used by
the parent corporation and had a special value to the parent. Tower Hamlets was not applied in the
later case of Lonrho Ltd. et al v. Shell et al, [1980] 1 Q.B. 358 (C.A.) where Lord Denning, M.R.
said (at p.372): "I may say that on occasions the courts do lift up a corner of the veil: but that does
not mean that they alter the legal position between the companies."
I Fraser and Stewart, Company Law of Canada(Carswell, Toronto, 1962) at pp.18 and 19.
79 Hobart Bridge Co. Ltd. v. F.C. of T. (1951), 82 C.L.R. 372 and Walker v. Wimborne (1975),
3 A.C.L.R. 529.
81
 BRITISH TAX REVIEW

"The attempt to do corporate business without providing any

sufficient basis of financial responsibility to creditors is an abuse
of the separate entity and will be ineffectual to exempt the
shareholders from corporate debts."'
The willingness of the United States courts to pierce the corporate
veil is not confined to circumstances of thin capitalisation but can
arise where the corporation is brought into existence for other abusive
purposes.
"[W]hen the notion of legal entity is used to defeat public
convenience, justify wrong, protect fraud, or defend crime, the
law will regard the corporation as an association of persons. "81
Professor Lattin,82 commenting on this quotation, says:
"The principle is too broad to be of practical use in specific cases,
but it does put moral content into the law concerning the use of
the corporate privilege. It might be paraphrased thus:
'. . . [T]he entity will be disregarded when it is necessary to
promote justice or to obviate inequitable results.' Again, as a
definite yardstick it has the fault of Judge Sanborn's statement
but the merit of warning users of the corporate form that there
are equitable limitations attached to the privilege. More useful
because it points out some specific instances where the 'corporate
veil will be pierced' is Professor Warner Fuller's statement that
where 'the corporate devise [sic] has been used to defraud
creditors, to evade existing obligations, to circumvent a statute,
to achieve a monopoly, or to protect knavery or crime,' courts
have held that the corporation may not be used for that purpose.
A 1967 decision in the State of Connecticut expresses the view:
"When . .. the corporation is so manipulated by an individual or
another corporate entity as to become a mere puppet or tool for
the manipulator, justice may require the courts to disregard the
corporate fiction . . ."83

a Ballantine, Law of Corporations (rev. ed. 1946), at p.302. This view was cited with approval
by the Supreme Court of California in Minton v. Cavaney, 364 P. 2d 473 (1961) in a case where the
capital of a corporation was "trifling compared with the business to be done and the risks of
loss . . .". The weight of U.S. authority, however, is that undercapitalization alone is not enough
to pierce the corporate veil. Usually the courts also require it to be shown that there is "such unity
of interest and ownership that the separate personalities of the corporation and the individual
[shareholder] no longer exist": Stap v. Chicago Aces Tennis Team, Inc., 379 N.E. 2d 1298
(IlI.App.Ct. 1978). See too: DeWitt Truck Brokers, Inc. v. W. Ray Flemming Food Co., 540 F. 2d
681 (6th Cir. 1976).
" United States v. Milwaukee Refrigerator Transit Co., 142 F. 247 at 255 (C.C.E.D. Wis. 1905),
opinion of Judge Sanborn. 72 7 3
8 Lattin, The Law of Corporations (2d ed., The Foundation Press, Inc., 1971) pp. -
(footnotes omitted).
* Zaist v. Olson, 227 A. 2d 552 at p.558 (Conn. 1967).
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 THE BUSINESS PURPOSE TEST AND ABUSE OF RIGHTS

This has also been expressed in the Alabama courts:

"The courts will not permit a person, acting under the guise of a
corporation formed for that purpose, to evade his individual
responsibility. "I
It is suggested that although the connection between these aspects
of the United States corporation law and the continental principle of
abuse of rights has not normally been acknowledged, the similarity in
approach and result would indicate that the doctrine of abuse of
rights, at least as applied to corporations and probably also in other
fields of law, has developed in the United States independently of
civil law influences. Consider this statement of Cardozo, J.8:
"The logical consistency of a juridical conception will indeed be
sacrificed at times when the sacrifice is essential to the end that
some accepted public policy may be defended or upheld. This is
so, for illustration, although agency in any proper sense is lacking,
where the attempted separation between parent and subsidiary
will work a fraud upon the law. . . . At such times unity is
ascribed to parts which, at least for many purposes, retain an
independent life, for the reason that only thus can we overcome
86
a perversion of the privilege to do business in a corporate form."

In a clear contrast with the decision of the House of Lords in the

Salomon case, American law has established a precise rule that claims
of the controlling shareholder (usually, but not always, a holding
company) may be subordinated to claims of outside creditors,
including the claims of preferred shareholders, in certain circum-
stances.' Justice Douglas has stated the rationale of the doctrine in
the following terms:
"Though disallowance of such claims will be ordered vWhere they
are fictitious or a sham, these cases do not turn on the existence
or non-existence of the debt. Rather they involve simply the
question of order of payment. At times equity has ordered
disallowance or subordination by disregarding the corporate
entity. That is to say, it has treated the debtor-corporation simply
* Dixie Coal Mining and Manufacturing Co. v. Williams, 95 128 So. 799 at p.800 (Ala. 1930).
* Berkey v. Third Avenue Railway Co., 244 N.Y. 84 at p. (1926).
* It is interesting that Cardozo, J. used the term "fraud upon the law". In Packard Clothes, Inc.
53 1
v. Director of Division of Employment Security, 318 Mass. 329, 61 N.E. 2d 528 at p. (1945) it
was said:
"It is competent to pierce the veil of the corporation and to disregard the corporate form, and
to consider substance rather than form in order to carry out the legislative intent."
The appeal to substance over form appears widely in United States tax cases. We suggest that the
resemblance of terminology reflects less a borrowing from the law of another country or another
area of the law than a reflection of similarity of a judge's reaction to the case before him.
* Taylor v. Standard Gas & Electric Co., 306 U.S. 307 (1939).
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 BRITISH TAX REVIEW

as part of the stockholder's own enterprise, consistently with the

course of conduct of the stockholder. But in that situation as
well in others to which we have referred, a sufficient consideration
may be simply the violation of rules of fair play and good
conscience by the claimant; a breach of the fiduciary standards
of conduct which he owes the corporation, its stockholders and
creditors. "88
Subsequent cases have indicated that under-capitalisation of the
corporation constitutes a breach of the equities discussed by Justice
Douglas."9
It is seen therefore that although in traditional fields of private law
the concept of abuse of rights has consistently been rejected by the
courts in England and the Commonwealth, it has to a considerable
extent been accepted and applied by American courts.

APPLICATION OF ABUSE OF RIGHTS TO TAXATION MATTERS

(a) Civil Law Jurisdictions
In arguing against the application of the abuse of rights doctrine in
taxation matters, a Belgian author said:
"The choice made by the taxpayer is nothing else than the
exercise of the freedom given to the citizens by the civil law and
the constitution under which they can do anything which is not
forbidden. It is therefore surely not forbidden to avoid a situation
under which tax is due. The desire to escape taxation is normal.
It is even inconceivable that the taxpayer could have a different
attitude. What would one think of a taxpayer who in the course
of a commercial transaction would start by wondering what he
can do to pay the highest amount of taxes? Is it not natural that
he ask the reverse question? And in so doing, one must admit
that he will act as a good 'paterfamilias' in the Latin sense of the
word, i.e. as a 'prudent man'."'
In those civil law jurisdictions that recognise the concept of abuse
of rights in the general law there is a question whether it is also to be
applied in taxation matters.
In Belgium, the abuse of rights doctrine has traditionally been
rejected in fiscal matters. In the leading case it was said:
"There is neither a prohibited simulation with regard to the fisc
nor fiscal fraud merely because the parties, in order to obtain
* Pepper v. Litton, 308 U.S. 295 at p.310 etseq. (1939).
" See, for example, In re Multiponics, Inc., 622 F. 2d 709 (5th Cir. 1980).
0 Professor Victor Gothot, Confdrence prononcfe A l'Ecole Supdrieure des Sciences Fiscales le
3 mars 1962. Also in "Probldmes fiscaux d'aujourd'hui", sdrie no. 2, 1962, p. 89
.

84
 THE BUSINESS PURPOSE TEST AND ABUSE OF RIGHTS

the benefit of a favourable tax provision, have exercised their

freedom to contract, without violating any legal obligation, and
created relationships all the consequences of which they have
accepted, even if the form which they have followed is not the
most normal.""

The traditional rejection of the abuse of rights doctrine may,

however, no longer reflect the present position. The Belgian courts
have recently sometimes ignored or recharacterised for tax purposes
transactions which are considered not to be "genuine" as a "simula-
tion", even though the parties have accepted all the legal conse-
quences. In determining whether the transaction is genuine for this
purpose, the courts have considered all the surrounding circumstances,
including the economic purpose of the transaction and the question
whether or not there was a tax avoidance motive behind it. Although
the courts have not expressly referred to the abuse of rights doctrine
in imposing limits to the freedom of the taxpayer to enter into
contracts which have the purpose of reduction of taxes otherwise
payable, it is suggested that the doctrine has therefore been applied,
but without the label.92
On the other hand, in France there appears to be clear authority to
apply the concept of abuse of rights in taxation matters although the

91 Brepols case, Cour de Cassation, 6 juin 1961, Pas. 1961, 1, 1082. In Brepols case, the Court of
Appeal had applied the concept of fraud on the law to a transaction designed to reduce taxes
through interest deductions. The Cour de Cassation, reversing the decision of the Court of Appeal,
refused to apply the concept of fraud on the law and confirmed the taxpayer's right to implement
plans designed to reduce his tax burden. See too to the same effect Cour d'appel de Bruxelles, 1
50
mars 1939, Joural pratique de droit fiscal 1940, p. plus note, V. Gothot; Cour d'appel de Lifge,
187
14 mars 1944, R.C.J.B. 1948, p. plus note, J. Van Houtte; cour d'appel de Bruxelles, 22 janvier
1963, R.G.E.N. 1964, no. 20752; Cour de Cassation, 14 avril 1964, Pas. 1964, I, p.875; Cour de
Cassation, 12 janvier 1965, Revue fiscale 1965, p.252; Cour de Cassation, 20 septembre 1966,
87
Revue fiscale 1967, p. plus note de Longueville and Cour de Cassation, 18 juin 1968, Revue
fiscale 1968, p.570. See also Thomas Delahaye, Le choix de la voie la moins imposde (Bruylant,
Brussels, 1977) at p.49 (who cites Article 110 of the Belgian Constitution as support for the
conclusion reached in the 6 juin 1961 case) and also at p.131, and the same author in Volume
LXVIIIa, Cahiers de droit fiscal international (International Fiscal Association, 1983) (hereinafter
referred to as the "IFA Cahier") at p.171.
I Cour d'appel de Gand, 26 mars 1965, Revue pratique des socidtds, 1968, p.161, plus note of
H.-R. Depret; Cour d'appel de Gand, 31 janvier 1975, confirmed, Cour de Cassation, 9 juin 1976,
179
R.G.F. 1977 at p. etseq.; Cour d'appel d'Anvers, 2 mars 1978, confirmed, Cour de Cassation, 7
344
d6cembre 1979, J.D.F. 1979, p. and J.D.F. 1980, p.154; and Cour d'appel de Bruxelles, 26
octobre 1982, F.J.F. 82/153. See also C. Scailteur, who explains the latest decisions in Belgium as
an extension to the concept of sham; the act may also be a sham when it does not reflect the actual
intention of the parties or when it diverges strongly from business reality: "Le Choix de la voie la
moins imposde-R6flexions A propos d'un arret de Cassation r6cent", Rdflexions offertes d Paul
Sibille (Bruylant, Bruxelles, 1981). Prof. J. Defoort has criticized this thesis in "De Simulatie
1 11
Voorbij" in Liber Amicorum Albert Tiberghien (Kluwer, CED Samson, 1984) p. . As explained
in footnote 1, in fiscal matters the correct doctrine to be applied in those civil law countries that
recognise the anti-avoidance doctrines for tax purposes is actually fraus legis orfraude a la loi, not
abuse of rights. Although Belgium recognises the doctrine of abuse of rights in its general law, it
does not recognise the doctrine of fraus legis or fraude a la loi. Therefore, these recent Belgian
cases may not be soundly based on recognised Belgian legal principles.
85
 BRITISH TAX REVIEW

procedures are somewhat complex.93 The abuse of rights doctrine in

France was introduced in the course of a judicial interpretation by
the Supreme Court of Article L64 of the Book of Fiscal Procedures
which some authors have suggested has a literal application only to
simulations or shams in the strict sense of those words.
Article L64 provides:
"Acts which dissimulate the true nature of a contract or of an
agreement under the appearance of provisions giving rise to
lower registration duties or disguising either a realization of a
transfer of profits or income or permitting the avoidance, either
wholly or partly, of payment of turnover taxes on the transactions
carried out pursuant to the contract or agreement, are not valid
against the tax authorities, on whom the burden lies before the
tax judge of proving the true nature of the transaction challenged,
if the authorities do not take the advice of the consultative
committee constituted under Article 1653 C, or if they have
raised the assessment of tax contrary to that committee's advice."
In a 1981 Supreme Court94 case the court clearly found the abuse
of rights concept was embraced within these procedures under Article
L64, saying:
"Whereas when the tax administration uses the right it is given
under this provision in circumstances in which it has the burden
of proof, it must, in order to set aside the acts of the taxpayer as
being ineffective towards the administration, prove that these
acts have a fictitious character or, if not, that they have no other
motive than to avoid or alleviate the tax burden which the
taxpayer, if he had not carried out these acts, would normally
have had to pay having regard to his actual situation and
activity."'
" Maurice Cozian, Les grands principes de la fiscalitd des entreprises (Librairies Techniques,
Paris, 1983) at p.31. Tunc, op. cit., at p.154, expressed a contrary view but so also did Prof. Cozian
in an earlier work, R.J.F. 1980, No. 5 at p.202. In a more recent article, Cozian expresses the view
that most abuse of rights cases involve fictitious acts, but a few deal with what he describes as
"fraude d la loi". In his view, the Cour de Cassation and the Conseil d'Etat are reluctant and
extremely cautious in this area because of the effect of juridical certainty. The tax administration,
however, has a totally different attitude: Cozian, "Abus de droit, simulation et planning fiscal",
"Abus de droit, simulation et planning fiscal", Bulletin Fiscal, Francis Lefebvre, d6cembre 1984,
623 at p.626.
I Conseil d'Etat, 7e, 8e et 9e, s. sect. 10 juin 1981, req. 19079: Dr. fiscal 1981, n. 4&-49, com.
2187, concl. Lobry; R.J.F. 1981, no. 9, p. 42 9
.

11 There are several recent illustrations of the abuse of rights doctrine being applied, or sought
to be applied, in France. See, Cour de Cassation, 7 mars 1984, reviewed in Taxes International,
July 1984, p.25; Conseil d'Etat, 21 mars 1983, no. 29742, reviewed in Taxes International, July
1984, p.26; Conseil d'Etat, 22 juin 1983, no. 32956, reviewed in Taxes International, November
26
1983, p. (which confirms the principle that the Revenue must show that the transaction is either
a simulation, or is solely motivated by tax considerations); Conseil d'Etat, 22 d6cembre 1982, no.
27846, reviewed in (1983) 23 European Taxation, p.229 and Tax Ruling of 30 d6cembre 1981,
published no. 7 D-6-81, Bulletin officiel de la direction g6ndrale des imp6ts, no. 239 of 30 ddcembre
1981 at p.14 and discussed in (1982) 22 European Taxation, p.57.
86
 THE BUSINESS PURPOSE TEST AND ABUSE OF RIGHTS

In a recent case in the Supreme Court96 it was held that the abuse
of rights principle could not be applied by the tax administration to
challenge a transaction which had the effect of reducing taxes but
which was carried out for the principal purpose of overcoming
certain provisions of the French legislation applicable to insurance
companies. 97
The Conseil d'Etat98 also in a recent case refused to apply the
abuse of rights doctrine to a taxpayer, a consulting engineer who
entered into a contract to lend his practice, without fee, to a
company of which he was both director and shareholder in order
to gain the benefit of the corporate rate of tax on his earnings."
In three decisions, all rendered in 19841 the Cour de Cassation
overturned decisions of the lower courts in similar cases where the
lower court, following a ruling of the tax authorities of March 3,
1981, had held that where there is a transfer of substantially all of
the shares of a corporation holding immovable property which is
accompanied by major changes in the corporate structure, the
transaction can be considered as the equivalent of the liquidation
of the corporation and the sale of underlying assets with tax
imposed accordingly. In all three cases the Cour de Cassation
reversed the decisions on the ground that under corporate law no
such winding-up had occurred and therefore the tax consequences
should follow the actual legal consequences of the particular
transactions. In each of these three cases, however, neither the tax
authorities nor the lower courts had applied the principle of abuse
Cozian, op. cit. at p.32 also mentions the following cases which appears to be earlier illustrations
of the application of the doctrine: Conseil d'Etat, 7e et 9e,18s.5 sect. 27 fevrier 1980, req. 13239: Dr.
fiscal 1980, no. 22-23, com. 1267 R.J.F. 1980, no. 4, p. and Conseil d'Etat 7e et 9e sect. 4
d6cembre 1981, req. 29742: Dr. fiscal 1982, no.19, com. 1069 concl. Schrameck; R.J.F. 1981, no.
1, page 54 and Conseil d'Etat, 7e, 8e et 9e s. sect. 3 fevrier 1971, req. 74352: Dr. fiscal 1971, no.
23, com. 933, concl. Dufour, 1971, no. 5, p.190.
' Conseil d'Etat, 7e et Se, s.sect. 22 juin 1983, req. 32956: Dr. fiscal 1983, n.50, com. 2380;
Revue de jurisprudence fiscale 1983, n.8-9, p.423, chr. Racine.
I Under the insurance legislation stocks and other securities which constitute the reserves of an
insurance company are valued at cost. The taxpayer in this case, to overcome this restriction, sold
and immediately purchased back a block of securities which had appreciated value in order to
increase its legal reserves. For tax purposes the company realized a long-term capital gain taxable
at only 10%. The tax authorities claimed that the increase in value should have been taxed at 50%
on the basis that, in reality, the company had revalued its assets, although this was contrary to the
insurance legislation. The Revenue authorities succeeded before the consultative committee, but
failed in the court on the ground that although there may have been a fraud on the Insurance Act,
there was no abuse of rights for tax purposes or fraud on the tax legislation.
* Decision of 11 mai 1984 (No. 37522; R.J.F. 7/84, p.408, Concl. Fouquet).
9 The transaction took the form of a contract of commodat to avoid capital gains tax and
transfer tax that would have been payable if his practice had been sold. It is noteworthy that the
Revenue authorities proceeded in this case in attempting to impose the capital gains tax and
transfer tax without having requested the advice of the consultative committee, discussed below.
I Cassation commerciale, judgment No. 246 (Le Joncour), 7 mars 1984, published in Revue
de jurisprudence fiscale, No. 804 of juin 1984 at p.396; Cassation commerciale, judgment No.
245 (Naturana), 7 mars 1984, published in Revue de jurisprudence fiscale, No. 805 of juin 1984
at p.396; and Cassation commerciale, judgment No. 365 (Otto Lazar), 26 avril 1984 (not yet
reported).
87
 BRITISH TAX REVIEW

of rights. Although opinions may be divided on the subject, it

would appear that these three cases should not be considered as
indicating that the French courts will no longer apply the principle
of abuse of rights in tax cases.'
In France, where the Revenue seeks to apply the abuse of rights
doctrine, the burden of proof during the court proceedings lies
with the administration to prove that there is an abuse.
Alternatively, the administration before going to the court may ask
for the advice of the consultative committee' for the repression of
abuse of rights but in this proceeding it also bears the burden of
proof. If the administration succeeds before the consultative
committee, the taxpayer must prove the legality of his transactions
in the court. If the taxpayer's transaction is set aside then the
transaction is reversed for tax purposes so that the tax sought to be
avoided becomes payable and, in addition, a penalty of 200 per
cent. of the amount of such tax is imposed.'
Sweden has not adopted the abuse of rights doctrine in the
interpretation of its income tax law.' However, with effect from
January 1, 1981, Sweden passed a statute against tax avoidance
which remains in force until January 1, 1986.6 Under this statutory
provision (as amended in 1983), transactions are not recognised for
tax purposes if they form part of an arrangement to circumvent tax
rules. A transaction is not so recognised if:

(a) the transaction, alone or combined with another transaction

to which the taxpayer-or a legal person the income of
which wholly or partly is taxed to the taxpayer-has been
an accessory, is a part of a course of action that provides
an important tax benefit to the taxpayer;
(b) considering all the circumstances, obtaining the benefit can
be assumed to be the main reason for carrying out the
transaction; and
(c) an assessment of tax based solely on the arrangement

2 See, for example, Henry Lazarski "Tax Implications of the Takeover of Private Companies",
(1984) 24 European Taxation, p.347; the note that the French tax authorities may in future
similar cases argue that there has been an abuse of rights in order to obtain a contrary decision:
Tax News Service, 15 January, 1985 (Inter. Bureau of Fiscal Documentation); and the case
commentary on Le Joncour and Naturana cases cited in the previous footnote.
Consisting of a member of the Conseil d'Etat, a member of the Cour de Cassation, a
professor of law and general manager of the Tax Department.
Art. 1732 of the Tax Code.
For a discussion of the position in Sweden see H.S. Garde, Swedish National Reporter, Tax
Avoidance, Tax Evasion, a publication of the International Bar Association (Sweet & Maxwell,
London, 1982) (hereinafter referred to as the "IBA Report") at p.70.
6 Lag (1980:865) mot skatteflykt (Law against tax avoidance).
88
 THE BUSINESS PURPOSE TEST AND ABUSE OF RIGHTS

would be contrary to the fundamental intent ("grunder")

of the tax legislation.'
In contrast, Switzerland has long recognised the application of
the abuse of rights doctrine in taxation matters. Perhaps the best
known instance is the Decree of the Federal Council Concerning
Measures Against the Improper Use of Conventions Concluded by
the Confederation for the Avoidance of Double Taxation, passed
on December 14, 1962.' Under this Decree it is "deemed to be an
abuse" when a claim for the benefits of reduced foreign taxes
withheld at source under a Swiss income tax treaty would result in
a material part of the tax relief accruing directly or indirectly to the
benefit of persons resident outside Switzerland who are deemed
not to be entitled to take advantage of the treaty. The Decree
introduces a minimum dividend distribution rule to limit excessive
accumulations of income having enjoyed reduced treaty rates9 and
also limits deductions for payments abroad as a safeguard against
the use of a Swiss company as a mere conduit for income that
receives a privileged treatment under Switzerland's treaties."o It is
generally accepted in these cases that the Decree applies the
principle of abuse of rights to situations where the benefit of a
Swiss treaty has been improperly and excessively invoked." The
Decree involves a recognition by the Swiss that the abuse of rights
doctrine can apply not only to domestic law but also to tax treaties.
Construed in that way, the Decree should not be considered to be
a unilateral amendment of the treaty but rather a recognition that
the treaty negotiators must be taken implicitly to have agreed that
the doctrine was part of the fabric of Swiss law by which treaties
would be interpreted and applied. 12

I In Tax Evasion and Avoidance, a Report by the OECD Committee on Fiscal Affairs
(OECD, 1980) (hereinafter referred to as the "OECD Report") at p.78, it is indicated that the
record of the Swedish courts was not all one-sided and that some transactions, in the absence of
an express statutory provision, were invalidated for tax purposes even though they were made
in a legally correct form while other transactions (and sometimes very complicated transactions)
were allowed although the only (or almost only) result of the transactions was a reduction in the
tax for one or more taxpayers. Contrary to what is said in the OECD Report, in fact, an
invalidation of transactions by the Swedish courts has been very rare and, where it has
occurred, it usually involved a civil law flaw in the transaction.
R.O. 1962, p. 16 80
.

The classic example is the case of a Swiss Holding Company paying no taxes or reduced
taxes on dividends which have in addition been subjected to a reduced foreign withholding tax
under a Swiss treaty and are theresfter merely accumulated and reinvested.
1o For example, a Swiss Holding Company receiving foreign royalties tax exempt abroad
under a Swiss treaty and remitting this royalty to its foreign shareholder, leaving only a small
spread for Swiss taxation.
" Heinz Masshardt-Gendre Commentaire, p.46.
12 Prof. Maxime Chrdtien in A la Recherche du Droit International Fiscal Commun (Recueil
Sirey, Paris, 1955) at page 234 et seq. examined the question whether there is a generally-
accepted principle in international law which applies the concept of I'abus de droit to States that
enter into treaties, including treaties and agreements in relation to taxes. He concluded, writing
in 1955, that although there are some indications that the concept had occasionally been
89
 BRITISH TAX REVIEW

In addition to the 1962 Swiss Decree (which is a legislative use

of the abuse of rights doctrine), the Swiss courts consistently apply
the doctrine in domestic tax law." In so doing, it has been
recognised that the principle that "the State cannot levy taxes
which are not established by law", becomes difficult to apply when
the tax laws are based on civil law notions to determine the
applicable economic circumstances of a taxpayer. Therefore, as
mentioned above, it has become the practice for the tax authorities
and the courts in Switzerland to apply an "economic approach to
the facts." The courts have limited this approach to certain
conditions: the tax authority must prove that the taxpayer has used
a "strange and abnormal instrument, which is not justifiable under
the circumstances and which does not correspond to the economic
reality."14 If the tax authority does not so prove, then it must
accept the legal forms of the civil law which have been used by the
taxpayer.
"

The Swiss representatives on the working party of the Committee

on Fiscal Affairs on Tax Avoidance and Evasion of the OECD
have summarised the Swiss law in the following terms in the
OECD Report:`
"In general, tax is avoided where the taxpayer has chosen for
a legal transaction an unusual form of civil law where such
unusual situation entails a notable saving in tax without it
being possible to attribute such a state of affairs to any other
motive.
recognised, the doctrine was to be distinguished in international law from the well-recognised
principle that States must carry out their obligations under a treaty in good faith and that there
was not sufficient support for the view that abuse of rights was a recognised principle of
international law.
11 More precisely, in Switzerland two concepts are recognised, "abuse of rights" and the
principle of an "economic approach to the facts" although the distinction between the two is not
clearly made by the Federal Tribunal. It is suggested that the use of the two different concepts
stems from the fact that the doctrine of abuse of rights was transported to the tax law from civil
law, whereas the doctrine of an economic approach to the facts was a purely pragmatic rule of
interpretation of tax law developed while the tax law was in its infancy and strictly within the
jurisdiction of the 25 cantons. It is suggested, therefore, that the concept of an economic
approach to the facts is a rule of interpretation available to be used by the taxing authorities as
a means to counteract tax avoidance and its limits are set by the abuse of rights theory. See
Lenz, National Reporter for Switzerland, IBA Report at p.75 and Zuppinger, Swiss National
Reporter, IFA Cahier, at p.628. Recent case law of the Federal Tribunal has confirmed also a
broader meaning to the "economic approach to the facts" as an autonomous rule of
interpretation for concepts not derived from civil law but from business or economics. (Archives,
Vol. 53, p.54.)
The principle of abuse of rights was also applied in tax cases in the taxpayer's favour and
against the Revenue in 1908 court decisions, ATF 34-1-28 and 34-1-625, in which it was found
that because the taxing authority had intentionally not taxed a corporation in one case and an
individual, during his lifetime, in the other, it could not subsequently impose the withheld taxes
on the corporation or upon the heirs of the individual after death.
14 See Lenz, op. cit. at p.76.
1s Maurice Pichon, Imp6ts directs des cantons romands et imp6ts fiddraux, p.23 (para. 81) and
Walter Ryser, Introduction au droitfiscal international de la Suisse, pp.114-121.
16 At p.80.
90
 THE BUSINESS PURPOSE TEST AND ABUSE OF RIGHTS

"According to the decisions of the Federal Court, a tax is

avoided when:
-the form of civil law chosen by the parties appears unusual,
inappropriate or strange, and in any case unadapted to the
economic circumstances;
-grounds exist for holding that this choice has been improperly
made with the sole object of saving taxes which would have
been due had the legal relation been arranged in an
appropriate manner;
-the procedure chosen would effectively result in a notable
saving of tax insofar as it was allowed by the taxation
authorities."

The tax authorities may, however, presume that tax avoidance

was intended if the taxpayer chooses to carry out a transaction
which may be regarded as unusual."
There are several recent examples of the application of the
abuse of rights doctrine by the Swiss courts. One such case decided
by the Swiss Federal Court involved a transaction in which a Swiss
corporation owned by Swiss residents carried out a complicated
scheme which was designed to avoid taxes on dividends which
would otherwise have been paid out of substantial surplus funds of
the Swiss corporation. The court found that the structure by which
the Swiss tax was sought to be avoided was an unusual structure
and constituted an abuse and, on that ground, that the taxpayer
was not entitled to a refund of the tax that had been withheld on
the dividends."
Another recent case also involved a scheme to avoid tax on
dividends that, if paid in accordance with the structure proposed,
were not payable. The Swiss tax administration ruled that, viewing
the substance of the transaction rather than the form, the
withholding tax was, however, applicable. The Federal Tribunal
upheld the ruling."
Like many of the other civil law jurisdictions that embrace the
concept of abuse of rights, Germany also applies the concept in its
tax law. However, the abuse of rights concept is embodied
specifically in the General Tax Code20 in the following terms:
" ATF 102 lb 151; Archives 42, p.400.
I See the decision of the Federal Tribunal of 3 October, 1980, noted at (1981) 21 European
Taxation, p.329, Archives 50, p.146.
11 Decision of the Federal Tribunal of Switzerland, December 11, 1981, discussed in Tax
31
Management International Journal, August 1982, p. and (1982) 22 European Taxation, p.261;
38 6
Archives 50, p.583. See also S.J. 1982, p.
.

2 Paragraph 42 Abgabenordnung, 1977. Prior to 1977 it was contained in paragraph 6 of the

Tax Adaptation Law (Steueranpassungsgesetz). For a discussion of the differences between
these two provisions, see J. Killius, (1983) 23 European Taxation, p.360.
91
 BRITISH TAX REVIEW

"The tax law cannot be evaded by an abuse of structures

offered by law. In the event of an abuse, the tax claim arises
as if a legal structure had been used which is appropriate to
the economic substance of the transaction." 2 1

In Germany the courts frequently resort to and apply the abuse

of rights doctrine as contained in the Code but, for the revenue
authorities to succeed, the court must be clearly satisfied that an
intention to avoid taxes has been established and the onus of
proving this is on the tax administration. As interpreted by the
courts," three factors must be present for the application of
paragraph 42, namely:
(1) The concept of law used by the taxpayer is inadequate for
the economic purposes of the transaction which he seeks to
accomplish;
(2) There are no economic or other significant reasons which
would justify the use of the concept of law adopted by the
taxpayer; and
(3) The existence of the intent to avoid taxes can clearly be
established.
It has been stated that, in the interpretation and application of
these conditions, the courts have developed the notion of abuse of
rights to a point where it is now difficult, if not impossible, to
predict the outcome for German tax purposes of even modest tax
planning efforts.23
Although a general rule of German tax law permits a taxpayer to
structure his activities in a way that would allow the least amount
of tax to be payable, 24 in 1975 and 1976 this rule may have been
altered when the Supreme Tax Court held that the interposition of
foreign (usually tax haven) corporations by resident taxpayers to
hold foreign and domestic assets could constitute an abuse within
the meaning of paragraph 42.
A three part article published in 1977 and 1978 illustrates some
of the applications of the abuse doctrine in the following termS 25 :
21 Paragraph 42 of the General Tax Code is broader in its application in the tax law than the
doctrine of simulation expressed in Article 41(2) of the General Tax Code. Paragraph 42 would
deny the intended result of a contract which the parties actually intend will have legal effect,
whereas Article 41(2) is limited to denying the legal effect of contracts which the parties do not
really intend to have legal consequences.
I Supreme Tax Court decision of July 17, 1968; BStBl. 1968, II, p.695.
2 Killius, (1983) 23 European Taxation 360 at p.362 and (1985) 25 European Taxation, 19 at
p.21. See also Dr. J. C. L. Huiskamp, German National Reporter, Volume B, The Rotterdam
Study on International Tax Avoidance, at p.310.
2 Supreme Tax Court decision of 29 November, 1966.
15 E. Jehle, with the assistance of the staff of the International Bureau of Fiscal
Documentation, (1977) 17 European Taxation, p.364 et seq.
92
 THE BUSINESS PURPOSE TEST AND ABUSE OF RIGHTS

"(a) [F]oreign base companies represent an abuse of legal

forms and methods if the necessity of their creation cannot be
proven through economic or other important arguments and if
there is no own economic activity26 ;
"(b) whether there were economic or otherwise important
arguments for the foundation of the base company must not
be judged according to the functions mentioned in the statutes
of the foreign base company; the functions must actually be
carried out and the reasons for the foundation of the base
company have to be proved through the own economic
activities of its management personnel 27;
"(c) the holding of capital as such or the formal holding of
participations and property assets cannot be regarded as an
own economic activity28;
"(d) in order to find an own economic activity it is necessary
that the base company take part in general business life as any
other enterprise, unless the low grade of activity is restricted
to a limited duration. At the same time, however, steps must
be taken to bring about the necessary extent of own economic
activities29;
"(e) if economic arguments cannot be given for the
foundation of a base company, only other arguments can be
accepted which are of equal importance, i.e. those which refer
to the seat and the legal structure and both of these arguments
must be based on reasons other than taxation." 0

Although Germany has enacted substantial rules in dealing with

foreign base company operations 3 1 it would appear that the courts
more frequently deal with tax haven companies not by the
application of these complex rules but rather through the more
simple application of the abuse of rights doctrine.32
Unlike the case of Switzerland, in dealing with tax treaties, the
German courts at one time appeared to be reluctant to apply the
I Citing a decision of the Supreme Tax Court of 29 January, 1975, BStBl. 1975, II, p.553.
See also: Federal Finance Court decisions of 29 July, 1976, BStBl. 1977, II, pp.261 and 263. J.-
D. Kramer in December, 1983 Taxes International, p.27, notes that there is less chance of the
doctrine being applied where the owner of the foreign base company is not resident in
Germany. This trend has been criticised by H. Rauer, 1983 Der Betrieb, p.2276. The more
recent decision (discussed, infra) of the Supreme Tax Court, 4th Chamber of 10 November,
1983, BStBl. 1984, II, p.605, however, seems to correct this impression, indicating that the
abuse rules will be applied equally to both residents and to non-residents.
" Citing a decision of the Supreme Tax Court of January 16, 1976, BStBl. 1976, II, p.401.
I Citing a decision of the Supreme Tax Court of July 29, 1976, BStBl. 1977, II, p.263.
2 Ibid.
a Citing decision of the Supreme Tax Court of February 24, 1976, BStBl. 1976, II, p.265.
31 The Aussensteuergesetz (1972), which became generally effective on January 1, 1972.
32See Killius, (1983) 23 European Taxation, at p.361 and the five cases cited by him in his
footnote 2.
93
 BRITISH TAX REVIEW

abuse of rights doctrine to taxpayers who intentionally structure

their affairs to take advantage of treaty provisions." Under the
German-Netherlands Tax Treaty of June 16, 1959, a 15 per cent.
withholding tax rate applied to dividends paid to a Dutch
corporation, provided it held less than 25 per cent. of the voting
stock of the German company. Where the ownership of 47J per
cent. of the German company was divided between one Dutch
corporation as to 24 per cent. and its wholly-owned subsidiary as
to 231 per cent., the Supreme Tax Court 34 found that, notwithstand-
ing the fact that the Dutch corporations were considered to be one
entity for purposes of taxation in The Netherlands, this was
immaterial for the purposes of the application of German tax law
and the Treaty. The Court therefore gave recognition to the legal
form without an application of the concept of abuse of rights.
A similar result was reached more recently, also in the Supreme
Tax Court, where a Dutch corporation which held over 85 per
cent. of the shares of a German corporation sold sufficient shares
to each of three subsidiaries so that no one Dutch corporation held
25 per cent. or more of the German corporation. When the
German corporation paid a dividend to each of the Dutch
corporations, the issue arose whether the withholding tax rate of
15 per cent. should be applied as opposed to a rate of 25 per cent.
In applying the lower rate of tax, the court did not accept the
argument of the Revenue that the arrangement amongst the
members of the Dutch corporate group was an abuse of legal form.
Refusing to apply the judicial precept of abuse of rights, the court
noted that there would be a danger inherent in doing so and that
there should be no unilateral application by one State of such a
precept without the agreement of the other State. The court
therefore concluded that the Treaty provisions in general should be
interpreted literally.
The 4th Chamber of the German Supreme Tax Court has,
however, recently stated3 7 that the abuse rule of paragraph 42 of
the General Tax Code can apply to an abuse of treaties through

" A decision of the Supreme Tax Court of October 29, 1981, BStBl. 1982, II, p.151, appears
to support the view that the abuse doctrines of paragraph 42 of the General Tax Code cannot
be used against non-resident taxpayers in treaty shopping cases. 57
3 In a decision dated September 13, 1972, BStBl. 1973, II, p. , noted in (1973) 13
European Taxation at p.58.
3 Decision of February 19, 1975, BStBL. 1975, II, p.584, commented on in (1975) 15
European Taxation at p.276.
I For further discussion in Germany of the abuse of rights principle, see Prof. Dr. Heinrich
List "Recent Cases of the Germany Supreme Tax Court on International Tax Law" (1981) 35
Bulletin for International Fiscal Documentation (International Fiscal Association, Amsterdam)
p. 3 4 8
.

' Decision of November 10, 1983, BStBl. 1984, II, p.605.

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 THE BUSINESS PURPOSE TEST AND ABUSE OF RIGHTS

the incorporation of a treaty-based "letter-box" company by a non-

resident. In so holding, the Court did not follow the decision of the
1st Chamber of the Court of October 29, 1981, as to do so would,
in its view, result in an unequal application of the tax law between
resident and non-resident taxpayers."
As is the case with Germany, in the Netherlands the courts
apply the abuse of rights doctrine in tax areas (under the label of
fraus legis) with regularity." As explained in the OECD Report,4
the fraus legis concept is available if the actions undertaken for the
purpose of tax avoidance are unusual or artificial and give rise to a
situation where the letter of the tax regulation does not apply but
which differs so little from a situation provided for under the
regulations that the purpose and spirit of the regulations would be
frustrated if it were to be declared inapplicable. The Dutch courts
are permitted to examine the parliamentary record to ascertain the
purpose of the applicable record to ascertain the purpose of the
applicable fiscal legislation. In the end, tax is levied as if the
transaction had not taken place or, as the case may be, as if
another transaction had taken place so that the result is in
accordance with the perceived purpose and spirit of the law.4 1
In addition to the general fraus legis concept, Article 31 of the
General Law for National Taxes (which was introduced in 1965)
provides:
"No regard shall be paid, for the levying of direct taxes, to
legal acts of which it must be assumed, based on the
circumstances, that they would not have been performed had
they not had the effect of totally or partially frustrating the
levying of tax." 42
" This case is discussed by Killius, (1985) 25 European Taxation, 19.
. Robert van de Water regards the doctrine of fraus legis and the doctrine of abuse of law as
synonymous: IBA Report at p.56. The concept is discussed by Delahaye, Le Choix de la voie la
moins imposee, (Bruylant, Brussels) at p.115 et seq. and by Wisselink, Netherlands National
Reporter, Volume B, The Rotterdam Study on International Tax Avoidance, at p.35. The first
case in which it was clearly applied is the so-called "three day" case (H.R. May 26, 1926, N.J.
1926, p.723). To frustrate a provision of the Succession Duties Act that levied tax on gifts that
were subject to annuities ending with the death of the donor, the appellant had arranged for an
annuity ending three days before his death. The court held that the tax should be levied
considering:
". . . that no other reasons can be assumed to have existed, and no other purpose than
to frustrate the relevant statutory provision; and that the annuity thus created is practically
equivalent to one continuing until the death of the beneficiary, while the legal relationship
between the parties that has thus been created resembles so closely that which is subject to
tax on the basis of the statute, that the purpose and intent of the laws would be
contravened if the transaction completed by the parties in fraudem legis would not be
equally taxed as that covered by the statute."
4 At p.66.
11 See also Wisselink, op. cit. It is said that the result is that tax is levied on what is
considered to be the true economic circumstances. (See the OECD Report).
I For further discussion of the doctrine of fraus legis and Article 31 of the General Taxes
Act: see Prof. A. Nooteboom, Netherlands National Reporter, IFA Cahier, p.545.
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 BRITISH TAX REVIEW

The Supreme Court refused to apply this Article in 39 of 40

cases brought prior to 1978 and by that time it was thought to be
ineffective. However, between 1978 and January 1, 1982, the
article was applied by the Revenue a total of 560 times in virtually
all of which it was supported by the courts.43 There are differences
between the application of the fraus legis doctrine and Article 31
because in the case of fraus legis, the tax law is extended to impose
taxes on a structure which otherwise avoids tax when an almost
identical structure would attract tax, whereas in the case of Article
31 the actual acts (or structures) are ignored."
In a recent decision,4 5 the Supreme Court ruled that, subject to
certain procedural differences, the courts may apply the fraus legis
doctrine even to cases where Article 31 would have been applicable.
It is anticipated that, in view of the powers given to the Revenue
under Article 31 and the support which the courts have recently
given the Revenue in the exercise of these powers, the Revenue
may in the future rely on Article 31 as often as fraus legis whereas,
in the past, Article 31 was considered to be a dead letter.
Obviously, the general thrust of Article 31 is quite similar to the
abuse of rights concept. The more lengthy procedures required to
apply it may be some deterrent to the Revenue even though the
powers of the Revenue under this Article seem to be greater than
those they could exercise when relying upon the doctrine of fraus
legis.
The application of the fraus legis concept in cases involving tax
treaties has not been considered by the Dutch courts. However, in
a recent case,6 the Hague court considered its application to the
Act of the Realm dealing with the tax relationship between the
Netherlands and the Netherlands Antilles. The court concluded
that the act did not leave any room to apply fraus legis because of
a provision in it allowing each country unilaterally to cancel the
dividend tax exemption in the event of abuse.
In spite of the powerful influence of the German legal system
upon that of Japan, the abuse of rights doctrine, described as such,
has not found its way into Japanese tax law to the same extent as
has been the case in Germany. There is, however, one case in
which the doctrine of abuse of rights was applied by a lower court
(but reversed on appeal) against the tax authorities for issuing
a See K. M. van Lochem (with the assistance of the staff of the International Bureau of
Fiscal Documentation), (1983) 23 European Taxation, at p.27.
I See van Lochem, op. cit. at footnote 8.
1 HR November 21, 1984, VN 1985, p. 2 5
.

4 Hof den Haag, April 5, 1984, FED 1985/80.

96
 THE BUSINESS PURPOSE TEST AND ABUSE OF RIGHTS

corrective assessments three times in respect of the same tax

return .47
The explanation is perhaps that the doctrine of abuse of rights as
applied for tax purposes in civil law countries in Europe connotes
the abuse of law or legal forms and it is not exactly the same as the
Japanese concept of abuse of rights in the narrow sense. In Japan,
the concept of abuse of legal forms, which would be the proper
doctrine applied to taxation matters, is not settled in the general
law. Also, it should be noted that Japan, unlike Germany, does
not have a general statutory provision expressly providing an
authority to deny efficacy to a transaction where a legal form has
been abused."
In Japanese tax law, a doctrine that substance overrides form
has, however, been well recognised by the courts and there are
two statutory provisions which apply the substance over form
concept in determining to whom particular items of income
belong.49 The courts have regarded the doctrine of substance over
form as a general unwritten law relating to interpretation of the tax
legislation. The Supreme Court has said:
"It is reasonable to interpret that the principle of taxation in
accordance with substance is the basic leading concept which
has been long recognised as the rule of reason inherent in the
tax law of our country." 5 0
We suggest that the doctrine of substance over form is similar to
the abuse of rights doctrine and the business purpose test in that,
in Japan, it is considered that, in principle in dealing with taxation,
the revenue authorities may ignore artificial phenomena appearing
I Decision of Shizuoka District Court, October 13, 1970, 17 Shomu Gepp6 (No. 3), 471.
This decision was later reversed by the Tokyo High Court as not being an abuse: Decision of
the Tokyo High Court, October 29, 1971, 22 Gydsai Jiken Saiban Reisha (hereinafter referred
to as "Gy6sai") (No. 10), 1692. The reversal was affirmed by the Supreme Court: Decision of
the Supreme Court, December 14, 1973, Zeimu Sosh6 Shiry6 (No. 71), 1160.
1 The Tax System Investigation Council, an advisory committee to the Prime Minister, at the
time the present National Tax Common Rules Law was enacted, recommended the adoption of
a statutory provision which would have generally denied the tax effect of a transaction where a
legal form is abused: Zeisei Ch6sa Kai (Tax Investigation System Council), Kokuzei Tsfisoku
Ho No Seitei Ni Kansuru T6shin (Report Concerning the Enactment of the National Tax
Common Rules Law) 4 (July, 1961). However, this recommendation was not adopted because it
was felt that taxpayers' interests might be prejudiced by giving too much discretion to the tax
authorities. See, K. Shiba, et al, Kokuzei Tsassoku H6 Seikai (Detailed Elucidation of the
National Tax Common Rules Law) 50 (rev. ed. 1971).
1 Article 11 of the Corporation Tax Law provides:
"In the event that revenue accruing from an asset or business appears legally to belong to a
merely nominal recipient who does not enjoy the revenue and another corporation does enjoy
the revenue, the revenue shall be treated as belonging to the corporation enjoying it and the
provisions of this Law shall apply accordingly."
Although the above provision only refers to corporations, Article 12 of the Income Tax Law
has an identical provision with respect to individuals. These statutory provisions do not limit the
judicial approach of applying the substance over form doctrine in wider areas.
a Decision of the Supreme Court, June 29, 1962 Saibansho Jih6 No. 359, 1.
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 BRITISH TAX REVIEW

on the surface of a given transaction in favour of the economic

substance which lies behind." However, the doctrine is subject to
various definitions and it is not always clear where its peripheral
limits may be. Some scholars comment that the doctrine of
substance over form is ambiguous and elusive and that it sometimes
encompasses situations where a tax avoidance act is denied.52 A
prominent scholar asserted that since the tax burden must be
equitable in substance, regardless of legal forms or names, those
who enjoy a benefit which should be an object of taxation in
economic substance should be taxed in accordance with that
substance.
In a case where a borrower leased a piece of land to a lender for
20 years with an agreement that the rentals would be offset against
interest on the loan, the Tokyo District Court upheld the taxation
office's decision that the lease should be disregarded for tax
purposes and stated:
"In the event a corporation wrongfully brings about the
avoidance of the burden of the Corporation Tax by conducting
an especially unnatural, unreasonable act or accounting for the
purpose of avoiding or reducing taxes, it is appropriate for the
commissioner of a regional taxation office to deny such act or
accounting and to tax the corporation in accordance with the
act or accounting it would normally have performed if it had
acted on the basis of economic rationality." 5 4
The court did not use any label to describe the theory or
doctrine being sought to be applied. In our view, although Japanese
courts have not announced such doctrines as the business purpose

s T. Hayashi, Shotokuzei No Kihonmondai (Basic Problems in Income Tax) 77 (1966).

52 K. Kiyonaga, Jisshitsushugi to sozei kaihi (The Doctrine of Substance Over Form and Tax
Avoidance), 39 H6ritsu Jih6 (No. 10), 24, 26, 27-28 (September, 1967).
11 J. Tanaka, SozeihO (Tax Law), 85-86 (1968). There are certain lower court cases
supporting this line of reasoning.
I Decision of the Tokyo District Court, March 30, 1971, 22 Gy6sai 399, 407. In an analogous
case involving an inheritance, the Tokyo High Court reached an opposite conclusion. The
deceased had contracted with a department store to create a superficies on a piece of land for
the store for an annual fee of Yen 1,290,000 for 60 years and borrowed from the store in the
amount of Yen 129,000,000 with annual interest of Yen 1,290,000 payable for five years but
renewable at either party's option. The deceased died approximately nine years later and the
tax officials challenged the rights of the heirs to deduct the amount of the entire principal debt
from their tax base for the purpose of the Inheritance Tax. The tax office set up two alternative
arguments: first, the debt did not exist because the transaction was in fact a sale of the land and
second, the principal amount should be devalued to its current value because the interest rate of
one per cent. per annum was too low. The court accepted the second argument but not the first.
In dismissing the first argument, the Tokyo High Court held:
"Under our tax law, which has no provision generally allowing the denial of acts avoiding
taxes other than the denial of a family company's acts or accounts (Corporation Tax Law art.
132, Income Tax Law art. 157, Inheritance Tax Law art. 64), the principle of taxation by
statute does not permit us to deny the above tax avoiding act, select the ordinary form of the
transaction and to impose tax accordingly."
See Decision of the Tokyo High Court, April 25, 1972, 23 Gy6sai 238, 240.
98
 THE BUSINESS PURPOSE TEST AND ABUSE OF RIGHTS

test, the sham transaction doctrine, the step transaction doctrine,

etc., the broad doctrine of substance over form really encompasses
all such doctrines.
There is, however, a constitutional limit on the extent to which
the doctrine of substance over form may be applied. Article 84 of
the Constitution declares that taxes may be imposed only by
statute. Applying the doctrine of substance over form without limit
would violate this constitutional protection because such applications
could amount to creating law by interpretation. 6
Although there are conflicting court decisions, a majority of
scholars of tax law takes the view that the principle that taxation
can only be imposed by statute places severe limitations on the use
of judicial doctrines or techniques to override the form of a
transaction and impose taxation.5 7 Specifically, it is the prevailing
scholarly view that Article 84 requires that acts undertaken to
avoid taxation may not be ignored in the absence of a specific
statutory provision authorizing this to be done." On this view of
the law, it is possible that the doctrine of substance over form may
be accepted as an interpretative principle which falls within the
constitutional limitations, but the complete denial of efficacy to a
transaction, for whatever reason, clearly exceeds those constitutional
boundaries.
The abuse of rights doctrine is not usually applied in Italy in
taxation matters. The OECD Report" says:
"[Legitimate avoidance] occurs when the taxpayer takes
advantage of a provision of the law, the formulation of which
is obscure or incomplete or very complex, so that he can
reduce or avoid his liability while remaining within the limits
of the law. In this case, the taxpayer is acting against the will
of the legislators, even if he remains within the literal
interpretation of the law. These cases are frequent in practice
and the Italian legislators have decided that the relevant
commissions for dealing with disputed claims may declare that

5 There is one lower court case in which the abuse of legal form s was referred to: Decision
of the Kobe District Court, July 7, 1970, 16 Sh6mu Gepp6 (No. 12), 1513. This is a case where
real property owned by the plaintiff was transferred in a chain of sales through two parties to
the ultimate purchaser. The court ignored two intermediate sales, treating the transaction as if it
were, in substance, one sale to the ultimate purchaser. The court's reasoning was that legal
forms were abused for the purpose of tax avoidance. This case stands alone and there is no
other case following this line of thinking. It is suggested that it was not necessary to bring the
abuse of legal forms into the conclusion reached in this case and that it may be considered to be
one where the principle of substance over form was applied in interpreting the factual situation.
56 H. Kaneko, Zeihd to shiha (Tax Law and Private Law), Sozeiha Kenkya (Japan Tax Law
Review) (No. 6), 1, 19 (1978).
-1 H. Kaneko, op. cit.
I H. Kaneko, Sozeih6 (Tax Law) 107 (1976).
s9 At p.63.
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 BRITISH TAX REVIEW

the fines, which in Italy are called 'pecuniary penalties', are

not due when obscure or very complex provisions are involved.
"Consequently, these provisions need to be sought out and
improved. Accordingly, the amendments made in the Italian
taxation law are aimed, in several cases, at improving such
provisions and such changes might be considered as constituting
the combatting of tax avoidance."

The conclusion that the abuse of rights doctrine is not applied in

tax matters is, of course, based on the fact that the taxing
legislation does not contain any provision authorising the courts or
the tax authority to apply the doctrine. In the absence of such a
provision, the Italian constitutions prevents the courts from
developing such an autonomous, non-statutory doctrine and such a
6
doctrine has not generally been developed in Italian civil law.

'
(b) Common Law Jurisdictions
As has previously been discussed, in the development of the
common law in England the courts have consistently rejected any
recourse to the concept of abuse of rights. It is not surprising,
therefore, that English courts adopted, at least traditionally, an
approach which gives full legal effect for tax purposes to transactions
and series of transactions which may have been carried out or
arranged for the purpose of avoiding tax. Lord Atkin, in the
leading English case, said:
"It is not, I think, denied-at any rate it is incontrovertible-
that the deeds were brought into existence as a device by
which the respondent [taxpayer] might avoid some of the
burden of surtax. I do not use the word device in any sinister
sense, for it has to be recognised that the subject, whether
poor and humble or wealthy and noble, has the legal right so
to dispose of his capital and income as to attract upon himself
the least amount of tax." 62

60 Article 23.
61 See, however, M. Cogliati Dezza, National Reporter, IFA Cahier, p.453. Gangemi, the
Italian National Reporter, IBA Report, at p.43, cites the decisions of the Court of Cassation,
No. 2658 of May 9, 1979 and No. 5563 of October 6, 1980, as possible applications of the abuse
of rights doctrine in tax cases. See also Court of Cassation, No. 2115 of May 5, 1978, Diritto e
pratica tributaria 1979, II, p.163, where the court found that a dividend had been paid out of
accumulated income of a corporation and was taxable to the shareholders notwithstanding that
the corporation purported to pay the dividend out of contributed surplus, which would have
avoided shareholder tax. The court did not, however, use the label "abuse of rights" in
imposing taxation.
2 I.R.C. v. Duke of Westminster, [1936] A.C. 1 at p.7 (H.L.). To the same effect see I.R.C.
v. Fisher's Executors, [1926] A.C. 395 (H.L.), per Lord Sumner at p.412; Ayrshire Pullman
Motor Service v. I.R.C. (1929) 14 T.C. 754 (Ct. of Sess.) per the Lord President at p.763; and
Griffiths v. Harrison [1962] 1 All E.R. 909 (H.L.), per Viscount Simonds at p.912.
100
 THE BUSINESS PURPOSE TEST AND ABUSE OF RIGHTS

Lord Russell of Killowen, in the same case, expressed the English

law in the following terms:
"I confess that I view with disfavour the doctrine that in
taxation cases the subject is to be taxed if, in accordance with
a Court's view of what it considers the substance of the
transaction, the Court thinks that the case falls within the
contemplation or spirit of the statute. The subject is not
taxable by inference or by analogy, but only by the plain
words of a statute applicable to the facts and circumstances of
his case." 63

From time to time the English judges have sounded some

cautionary notes reflecting more their personal dislike of tax
avoidance schemes than the legal ineffectiveness of the techniques.
For example, Viscount Simon said:
"There is, of course, no doubt that they were within their
legal rights, but that is no reason why their efforts, or those of
the professional gentlemen who assist them in the matter,
should be regarded as a commendable exercise of ingenuity or
as a discharge of the duties of good citizenship."'

It was not, however, until 1978 that there appeared to be some

break in the consistency of the English courts in rejecting the
abuse of rights or business purpose test doctrines in dealing with
taxation matters. In Floor v. Davis," Eveleigh, L.J. in a dissenting
judgment held that where a series of transactions was carried out
for the purpose of avoiding what would otherwise have been the
tax applicable to a single transaction, the fact that each step was
genuine in the series of transactions did not prevent the court from
I Duke of Westminster case, at page 24. In an earlier case, Lord Macnaughten expressed the
traditional reluctance of the English judiciary to depart from the strict construction and
application of taxing (and other) statutes:
"Your Lordships were warned by the learned counsel for the appellant of the appalling
consequences of the decision under appeal. 'Here', they said, 'is a tremendous hole in the
Finance Act discovered by the ingenuity of a Scotch solicitor. The great fishes which the
Commissioners look upon as their own will swim through the gap one by one. The duller-
witted Southron will follow the lead. And what will become of the revenue of the country?'
My Lords, I do not think the prospect so gloomy, nor can I see that any extraordinary
astuteness was required to recommend the course which the late Duke adopted. I should
think the eminent solicitor who was the Duke's adviser would be the first to disclaim the left-
handed compliments lavished on his skill." See A.G. v. Duke of Richmond et al, 11909] A.C.
466 (H.L.), at p.473.
* Latilla v. I.R.C., [1943] A.C. 377 (H.L.) at p.381.
e [1978] Ch. 295 (C.A.). The majority decision was reversed and Eveleigh, L.J. was upheld
(but on a different basis) [1979] 2 W.L.R. 830 (H.L.). The judgment of Eveleigh, L.J. was,
however, referred to with approval in Ramsay v. C.I.R., [1982] A.C. 300 (H.L.) and Furniss v.
Dawson, [1984] A.C. 474 (H.L.). Arguably, the first break in the traditional English rejection
of business purpose test doctrines may have been as early as 1975 in Black Nominees v. Nicol,
11975] S.T.C. 372 (Ch.).
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 BRITISH TAX REVIEW

regarding the series to be a single transaction and to impose tax on

that basis.
What must be taken to have been the real point of departure
from the traditional approach of English courts in tax cases (and
what may ultimately lead to the adoption by English courts of
some kind of a general abuse of rights principle) occurred in
Ramsay Ltd. v. I.R.C.' The House of Lords followed the lead of
the United States Supreme Court,67 which had adopted the
proposition that transactions designed solely to avoid tax and
lacking otherwise any economic or commercial reality are to be
denied their efficacy for tax purposes. In referring to the American
jurisprudence, Lord Wilberforce indicated that the English courts
might not go the whole distance, stating:
"It is probable that the United States courts do not draw the
line precisely where we with our different system, allowing less
legislative power to the courts than they claim to exercise,
would draw it, but the decisions do at least confirm me in the
belief that it would be an excess of judicial abstinence to
withdraw from the field now before us."'
The importance of the Ramsay case was emphasized in the later
House of Lords decision in I.R.C. v. Burmah Oil Company Ltd.
where Lord Diplock said:
"It would be disingenuous to suggest, and dangerous on the
part of those who advise on elaborate tax avoidance schemes
to assume, that Ramsay's case did not mark a significant
change in the approach adopted by this House in its judicial
role to a pre-ordained series of transactions (whether or not
they include the achievement of a legitimate commercial end)
into which there are inserted steps that have no commercial
purpose apart from the avoidance of a liability to tax which in
the absence of those particular steps would have been
payable."69
The novelty of this adoption of the business purpose test in
English law was further underlined in the more recent decision of
Furniss v. Dawson where Lord Scarman stated:
". . . I am aware, and the legal profession (and others) must
understand, that the law in this area is in an early stage of
development. Speeches in your Lordships' House and judgments

" [1982] A.C. 300.

6 Knetsch v. U.S., 364 U.S. 361 (1960). See also the American case, Gilbert v. Commissioner,
248 Fed. 2nd 399 (2nd. Cir. 1957), which was also cited.
I Per Lord Wilberforce, p.327.
69 (1981) 54 T.C. 200 at p.214.
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 THE BUSINESS PURPOSE TEST AND ABUSE OF RIGHTS

in the appellate courts of the United Kingdom are concerned

more to chart a way forward between principles accepted and
not to be rejected than to attempt anything so ambitious as to
determine finally the limit beyond which the safe channel of
acceptable tax avoidance shelves into the dangerous shallows
of unacceptable tax evasion." 7 0

At the present stage, the business purpose test in the United

Kingdom has only been applied to a series of transactions either
for the purpose of totally cancelling the series or of treating one or
more steps in the series to be ineffective for tax purposes.
"My Lords, in my opinion the rationale of the new approach
is this. In a pre-planned tax-saving scheme, no distinction is to
be drawn for fiscal purposes, because none exists in reality,
between (i) a series of steps which are followed through by
virtue of an arrangement which falls short of a binding
contract, and (ii) a like series of steps which are followed
through because the participants are contractually bound to
take each step seriatim. In a contractuar case the fiscal
consequences will naturally fall to be assessed in the light of
the contractually agreed results. For example, equitable
interests may pass when the contract for sale is signed. In
many cases equity will regard that as done which is contracted
to be done....
"The formulation by Lord Diplock in Inland Revenue
Commissioners v. Burmah Oil Co. Ltd. [19821 S.T.C. 30, 33
expresses the limitations of the Ramsay principle. First, there
must be a pre-ordained series of transactions; or, if one likes,
one single composite transaction. This composite transaction
may or may not include the achievement of a legitimate
commercial (i.e. business) end. The composite transaction
does, in the instant case; it achieved a sale of the shares in the
operating companies by the Dawsons to Wood Bastow. It did
not in Ramsay. Secondly, there must be steps inserted which
have no commercial (business) purpose apart from the
avoidance of a liability to tax-not 'no business effect.' If those
two ingredients exist, the inserted steps are to be disregarded
for fiscal purposes. The court must then look at the end result.
Precisely how the end result will be taxed will depend on the
terms -of the taxing statute sought to be applied.""
7o [1984] A.C. 474 at p.513 (H.L.).
Per Lord Brightman in Furniss v. Dawson at pp.526 and 527.

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 BRITISH TAX REVIEW

At present the limits that will ultimately be imposed upon the

application of the business purpose test in the United Kingdom
have not been determined with precision. In Furniss v. Dawson,
Lord Scarman said:
"The law will develop from case to case. Lord Wilberforce in
[Ramsay's case] referred to 'the emerging principle' of the law.
What has been established with certainty by the House in
Ramsay's case is that the determination of what does, and
what does not, constitute unacceptable tax evasion is a subject
suited to development by judicial process. The best chart that
we have for the way forward appears to me, with great respect
to all engaged on the map-making process, to be the words of
my noble and learned friend, Lord Diplock in [the Burmah
Oil case quoted above], which my noble and learned friend,
Lord Brightman, quotes in his speech. These words leave
space in the law for the principle enunciated by Lord Tomlin
in Inland Revenue Commissioners v. Duke of Westminster,
[1936] A.C. 1, 19 that every man is entitled if he can to order
his affairs so as to diminish the burden of tax. The limits
within which this principle is to operate remain to be probed
and determined judicially. Difficult though the task may be for
judges, it is one which is beyond the power of the blunt
instrument of legislation. Whatever a statute may provide, it
has to be interpreted and applied by the courts: and ultimately
it will prove to be in this area of judge-made law that our
elusive journey's end will be found."72
It therefore is a matter of speculation whether the approach will
be expanded and, in due course, be applied to single transactions
73
and single structures designed to provide a tax benefit. If this
occurs, the earlier repudiation of the abuse of rights principle in
English law will have been overturned at least for tax purposes.
In the United States the business purpose test has been given
wide application in cases under the Internal Revenue Code. It is
suggested that the business purpose test is at the foundation of the
74
various judicial techniques such as the sham doctrine, the step
7 At p.513.
7 We suggest that the House of Lords cannot, without reversing the Duke of Westminster
case, which they are unlikely to do now, apply the doctrine to single transactions. In practice,
however, a fact pattern which is sufficiently unusual to constitute an abuse of rights will likely
involve more than one step. Since the House of Lords issued the "Practice Statement" in 1966,
it has reserved the right to overrule its prior decisions, but the power is to be exercised
sparingly and usually on the ground of a significant change in conditions or that the prior
decision was anomalous or contrary to principle in analagous fields. See Prof. Patrick S. Atiyah,
"Lawyers and Rules: Some Anglo-American Comparisons", 37 S.W.L.J. 545 at p.547 (1983).
1 Not "sham" in the sense of a pretence, but sham in the sense often used in the United
States, a transaction which is intended by the parties to have the legal consequences that it
purports to create, but which the court finds to have no effect for tax purposes.
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 THE BUSINESS PURPOSE TEST AND ABUSE OF RIGHTS

transaction doctrine, the doctrine that substance overrides form

and the doctrine of recharacterisation, all of which are widely used
by United States courts in applying the tax law.
The application of these doctrines has not been without criticism.
A strong and thought-provoking analysis of these concepts was
recently published by Professor Isenbergh" in which he reviewed
the leading United States tax cases where the business purpose test
had been adopted, or applied, and concluded that many were
wrongly decided.
"The courts have been too quick to recast transactions that in
fact deserved the character assigned them by the taxpayers.
This in itself is not a serious problem, except for the taxpayers.
A bad result in any given case is correctable later as
transactions become better understood and more carefully
managed. But there are also errors of principle in these cases,
more troublesome in their permanent effect.""

It has been said by some authors that cases involving the

application of these doctrines may border on tax evasion and may
justify the imposition of a penalty tax and, in egregious cases,
criminal procedures." The business purpose test is so important
that one author has described it as "a technique of statutory
interpretation difficult to apply but essential to [the United States]
tax system as it now operates".7 8
It is generally accepted that the business purpose test was first
introduced as part of the taxation law of the United States in the
case of Gregory v. Helvering.79 However, in that case the court's
attention was directed to the question whether a statutory concept,
namely, a corporate "reorganisation", could apply to a corporate
transaction designed to achieve tax benefits without any business
11 Joseph Isenbergh, "Musings on Form and Substance in Taxation", 49 U.Chic.L.R. 859
(1982) (hereinafter referrtd to as "Isenbergh".)
6 Isenbergh, at p.871.
' Bischel, Gann & Klein, United States National Reporters, IFA Cahier at p.333. The
authors refer to artificial tax avoidance techniques lacking economic substance or a business
purpose. See too, David T. Maguire "Scamelot: The Land of Tax Shelter Prosecutions",
Amer.Bar.Ass.J., July 1984, 52 at p.55, who says: "The criminal sham has evolved from the
business purpose rule of Gregory v. Helvering to impose criminal liability when there is such a
discrepancy between the form and the substance of a transaction that an allegation of fraud is
justified."
7 Surrey et al, Federal Income Taxation, Cases and Materials (Foundation Press, 1973), at
p.646. For discussion of the business purpose test, see: Michaelson, " 'Business Purpose' and
Tax-Free Reorganization", 61 Yale L.J. 14 (1952); Cohen, "Taxing the State of Mind", XII The
Tax Executive 200 (1960); Hellerstein, "Judicial Approaches to Tax Avoidance"; 1964
Conference Report, Canadian Tax Foundation, 63; Bittker, Federal Taxation of Income, Estates
and Gifts (1981), p.4-25 and A.C. Warren, Jr., "The Requirement of Economic Profit in Tax
Motivated Transactions", 59 Taxes 985 (1981).
' 69 F. 2d 809 (2d Cir. 1934), 293 U.S. 465 (1935). See the discussion of this case by
Hellerstein, op. cit. and by Isenbergh.
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 BRITISH TAX REVIEW

purpose. It was held by the Circuit Court and the Supreme Court
that the tax consequences should be determined by the ultimate
result of the transaction without regard to the intervening transitory
steps. In. the Circuit Court, Learned Hand, J. said:
"All these steps were real, and their only defect was that they
were not what the statute means by a 'reorganization,' because
the transactions were no part of the conduct of the business of
either or both companies; so viewed they were a sham, though
all the proceedings had their usual effect.""
The same view was expressed by Sutherland, J. in the Supreme
Court.
"When [the statute] speaks of a transfer of assets by one
corporation to another, it means a transfer made 'in pursuance
of a plan of reorganization' . . . of corporate business; and not
a transfer of assets by one corporation to another in pursuance
of a plan having no relation to the business of either, as
plainly is the case here." 8
'

In the Circuit Court, however, Justice Learned Hand did not

confine his comments to the narrow issue before him but rather
expanded on the application of the business purpose doctrine.
"But the underlying presupposition is plain that the readjust-
ment shall be undertaken for reasons germane to the conduct
of the venture in hand, not as an ephemeral incident, egregious
to its prosecution. To dodge the shareholders' taxes is not one
of the transactions contemplated as corporate 'reorganisations'."
From these last quoted two sentences has sprung much of the
82
United States jurisprudence involving the business purpose test.
There are many cases in which the Revenue in the United States
has been successful through the use of the business purpose test
and the related concepts in treating income received by a
corporation as taxable in the hands of the shareholder. A
1961 memorandum 83 indicates the Revenue's position on the
incorporation of subsidiaries and tax havens.
"If we determine that the foreign subsidiary has no substance,
but is merely a shell, we attempt to disregard its existence and
to tax its purported earnings to the parent corporation.
However, courts have disregarded the corporate entity only in

s 69 F. 2d 809 at p.811 (2d Cir. 1934).

8t 293 U.S. 465 at p.469 (1935).
1 See Isenbergh, at p.869.
I Hearings of the President's 1961 Tax Recommendations before the House Committee on
Ways and Means, 87th Cong. 1st sess. Vol. 4 at 3546 (1961).
106
 THE BUSINESS PURPOSE TEST AND ABUSE OF RIGHTS

unusual cases. For example, they have done so where it was

shown that the corporation was a mere agent for its owners or
where the businesses of the separate entities were so
commingled as to constitute a single business enterprise.
"It is the position of the Service that in order for a foreign
subsidiary to be recognized as a separate entity from its parent
for tax purposes, it must be engaged in some industrial,
commercial, or other business activity. Escaping taxation is not
such a business activity."

Another application of the business purpose test is found in

Kocin v. U.S.' where a corporation failed in its claim to deduct
commissions paid to a partnership of which its shareholders were
the general partners when the court found that the partnership had
not been created for an independent business purpose. The business
purpose test was extended significantly in Goldstein v. The
Commissioner" where a taxpayer who had borrowed money at 4
per cent. to purchase tax-exempt U.S. Treasury Notes yielding less
than 2 per cent. failed in the claim to deduct interest since the loan
was acquired solely for the purpose of using the interest deduction
to reduce her marginal tax rates.
In Commissioner v. Court Holding Co.' the Supreme Court
dealt with a case involving the same kind of question that arose in
the English case of Furniss v. Dawson, namely, whether the
taxpayer, after having started negotiations leading up to a
commercial transaction, could effectively change the tax result by
altering the structure of the transaction prior to its legal
implementation. In holding that a taxpayer could not successfully
do so, the Court endorsed the recharacterisation concept which has
been widely developed in the United States.
A current unresolved controversy in the United States is the
quantum of business purpose that bars judicial frustration of tax
avoidance. Earlier judicial intervention (in the United States and
elsewhere) struck down transactions on a finding of no business
purpose, and some anticipated that the same result might apply
where the business purpose was remote or negligible, bordering on
the spurious. This appeared to be the general understanding of the
United States law in 1981 in respect of transactions that were not
motivated by a recreational or other personal objective, so-called

* 187 F. 2d 707 (2d Cir. 1951).

a 364 F. 2d 734 (2d Cir. 1966), cert. denied 385 U.S. 1005 (1967).
* 324 U.S. 331 (1945), critically discussed by Isenbergh, at p.872.
a See, e.g., A. Warren, "The Requirement of Economic Profit in Tax Motivated
Transactions", 59 Taxes 985 (1981).
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 BRITISH TAX REVIEW

"hobby losses." In the hobby loss area, some decisions appeared to

require a primary investment motive but not all courts agreed."
Commencing around 1981, the language of some opinions in non-
hobby loss cases stated a test that required a primary profit
motive. 9
In Fox v. Commissioner,' a case not involving a hobby loss, a
judge of the Tax Court clearly adopted the position that a loss
incurred in connection with an options spread (which is similar to a
commodities "straddle") is not deductible in the absence of "a
primary profit motive" apart from the saving of tax." In a later
opinion written by another judge of the Tax Court,92 the Court did
not apply a test that looked to the primary or dominant motive of
the taxpayer but took into account, along with other factors, the
substantial lack of proportion between the amount of the tax
benefits sought to be obtained and the amount of the anticipated
pre-tax profit ($365,000 net tax benefits to $70,000 potential pre-
tax profit) in determining whether the taxpayer had a profit motive
independently of the desire to achieve tax benefits.
A similar approach is reflected in recent Rulings of the Internal
Revenue Service94 that involved loans to a corporation entitled to
benefits of the United States tax treaty with the Netherlands
Antilles, followed by loans by the treaty corporation to a related
corporation (so-called "back-to-back" loans). In an earlier case,9 5
where the terms of the back-to-back loans were virtually identical
and the only purpose of the transaction was to obtain an advantage
of a tax treaty, the Tax Court had held that the treaty corporation
did not have sufficient dominion and control over the interest on
the loan receivable to be treated under the treaty as the payee of
the income. In these recent Revenue Rulings, the Service expanded
I See Faulconer v. Commissioner, 84-2 USTC, paragraph 9955, at p.85, 918, note 10 (4th
Cir. 1984), reversing the U.S. Tax Court.
50 5
* E.g., Brannen v. Commissioner, 78 T.C. 471, at p. (1982), aff'd. 722 F.2d 695 (11th
Cir. 1984); Lemmen v. Commissioner, 77 T.C. 1326 (1981), acq., 1983-1 C.B. 1; Hager v.
Commissioner, 76 T.C. 759 (1981).
" 82 T.C. 1001 (1984).
91 The opinion expressly recognised, however, that the rule would be otherwise "for those
essentially tax motivated transactions which are unmistakably within the contemplation of
congressional intent."
' Estate of Baron v. Commissioner, 83 T.C. No. 28 (1984).
9 In the United Kingdom, there may be evidence of a similar view: Thomson v. Gurneville
Securities Ltd. (1971) 47 T.C. 633, a case involving a commercial profit of £91,000 with a claim
for repayment of tax of £413,000. Lord Simon stated: "Looking at the transaction as a whole,
was it, on the one hand, one whereby a true commercial profit was taken in a fiscally
advantageous way or, on the other, one in which a 'commercial profit' was merely a by-product,
or a disguise for what was really a tax recovery device? Whichever way the question is put, I
have no doubt that, judged both qualitatively and quantitatively, the transaction falls into the
latter category in each case."
' Rev. Rul. 84-152, 1984-42 Int. Rev. Bull. 8, and Rev. Rul. 84-153, 1984-42 Int. Rev.
Bull. 9.
s Aiken Industries v. Commissioner, 56 T.C. 925 (1971).
108
 THE BUSINESS PURPOSE TEST AND ABUSE OF RIGHTS

the application of the earlier case to cases where the loan receivable
bore an interest rate one percentage point higher than the interest
rate on the loan payable. The rulings expressly assumed that the
treaty corporation was not a "sham" corporation that could be
ignored but stated that it "was merely a conduit for the passage of
. . . interest payments," noting that "the primary purpose" of the
treaty corporation was to obtain the benefits of the treaty exemption
and that the arrangement lacked "sufficient business or economic
purpose to overcome the conduit nature of the transaction, even
though it [could] be demonstrated that the transaction [might have]
serve[d] some . . . economic purpose." As in the Fox case, 96 the
relative importance of profit motive in comparison with the tax
motive was also taken into account by the Service.
After some earlier hesitation, Canada, as a commonwealth
country drawing heavily upon English law (except, of course, in
Quebec which bases its law on the Civil Code), now seems to have
firmly rejected a general application of the business purpose test in
taxation matters. In Stubart Investments Ltd. v. The Queen,"
Estey, J. of the Supreme Court of Canada, after referring to all
of the relevant recent English jurisprudence, much American
jurisprudence, some Australian, and earlier Canadian jurispru-
dence," said:
"I would therefore reject the proposition that a transaction
may be disregarded for tax purposes solely on the basis that it
was entered into by a taxpayer without an independent or
bona fide business purpose. A strict business purpose test in
certain circumstances would run counter to the apparent
legislative intent which, in the modern taxing statutes, may
have a dual aspect. Income tax legislation, such as the federal
Act in our country, is no longer a simple device to raise
revenue to meet the cost of governing the community. Income
taxation is also employed by government to attain selected
economic policy objectives. Thus, the statute is a mix of fiscal
and economic policy. The economic policy element of the Act
sometimes takes the form of an inducement to a taxpayer to
undertake or redirect a specific activity. Without the inducement
offered by the statute, the activity may not be undertaken by
the taxpayer for whom the induced action would otherwise

* See footnote 89.

* [1984] C.T.C. 294, 84 D.T.C. 6305.
* Included amongst the references were the English cases of Bradford Corporation v.
Pickles, I.R.C. v. Duke of Westminster, Ramsay v. I.R.C., I.R.C. v. Burmah Oil and Furniss v.
Dawson, the American cases of Gregory v. Helvering, Knetsch v. U.S., Kocin v. U.S., Goldstein
v. Commissioner, Berkeley v. Third Avenue Railway Co., and Singer v. Magnavox and the
Australian case, Cridland v. F. C. of T.
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 BRITISH TAX REVIEW

have no bona fide business purpose. Thus by imposing a

positive requirement that there be such a bona fide business
purpose, the taxpayer might be barred from undertaking the
very activity Parliament wishes to encourage. At minimum, a
business purpose requirement might inhibit the taxpayer from
undertaking a specified activity which Parliament has invited in
order to attain economic and perhaps social policy goals.
Examples of such incentives I have already enumerated.
"Indeed, where Parliament is successful and a taxpayer is
induced to act in a certain manner by virtue of incentives
prescribed by the legislation, it is at least arguable that the
taxpayer was attracted to those incentives for the valid business
purpose of reducing his cash outlay for taxes to conserve his
resources for other business activities.""

Wilson, J. in a separate and much more brief judgment said:

"I am also of the view that the business purpose test and the
sham test are two distinct tests. A transaction may be effectual
and not in any sense a sham (as in this case) but may have no
business purpose other than the tax purpose. The question
then is whether the Minister is entitled to ignore it on that
ground alone. If he is, then a massive inroad is made into
Lord Tomlin's dictum that 'Every man is entitled if he can to
order his affairs so that the tax attaching under the appropriate
Acts is less than it would otherwise be': I.R.C. v. Duke of
Westminster. Indeed, it seems to me that the business purpose
test is a complete rejection of Lord Tomlin's principle....
"I think 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."I

In arriving at its decision, the court was strongly influenced by

the fact that the Canadian Income Tax Act contains what the court
indicated was a broad anti-avoidance provision2 which states:
"In computing income for the purposes of this Act, no
deduction may be made in respect of a disbursement or
expense made or incurred in respect of a transaction or
operation that, if allowed, would unduly or artificially reduce
the income."

(1984] C.T.C. at p.314, 84 D.T.C. at p.6322.

[1984] C.T.C. at p.318, 84 D.T.C. at p.6325.
Section 245(1) of the Act.
110
 THE BUSINESS PURPOSE TEST AND ABUSE OF RIGHTS

Finding no comparable broad anti-avoidance provision in the

income tax legislation in force in either England or the United
States, the court was not persuaded that it should follow the recent
English cases or the long line of American authorities that have
introduced the business purpose test into the tax law of those
countries. 3 In so holding, the court found that some earlier
Canadian cases in lower courts where the test had been applied
were probably not correctly decided on that basis,' cast doubt
upon the correctness of other decisions in which the business
purpose test had been referred to' and found that certain other
decisions should be considered merely as findings of fact that
particular purported transactions had not legally been implemented
and were therefore ineffective for all purposes. 6
In disposing of the Stubart case, Estey, J., while rejecting a
broad business purpose test, nevertheless laid down "some
guidelines" for the future use of Canadian courts when faced with
the question of the relevancy of a business purpose:
"1. Where the facts reveal no bona fide business purpose for
the transaction, section [245] may be found to be applicable
depending upon all the circumstances of the case ...
2. In those circumstances where section [245] does not apply,
the older rule of strict construction of a taxing statute, as
modified by the courts in recent years, . . . prevails but will
not assist the taxpayer where:
(a) the transaction is legally ineffective or incomplete; or
(b) the transaction is a sham within the classical definition.
3. Moreover, the formal validity of the transaction may also
be insufficient where:
(a) the setting in the Act of the allowance, deduction or
benefit sought to be gained clearly indicates a legislative
intent to restrict such benefits to rights accrued prior to

The presence, or absence, of anti-avoidance statutory provisions can be a two-edged sword.

As Lord Wilberforce indicated in his speech in the Ramsay case ([1982] A.C. 300 at pp.325-6)
it had been argued that the absence of any general anti-avoidance provision in the U.K. capital
gains tax legislation indicated a Parliamentary intention that only Parliament, and not the
courts, should develop rules to cover loopholes that might be found in the legislation. Lord
Wilberforce did not accept that argument. In Australia, the presence of a general anti-avoidance
provision has also been held to be evidence that Parliament did not intend the courts to develop
any separate anti-avoidance doctrines of their own: F.C. of T. v. Patcorp Investments Limited,
76 A.T.C. 4225, per Gibbs J. at p.4232.
4 In particular, M.N.R. v. Leon [1976] C.T.C. 532; 76 D.T.C. 6299 (FCA). At least not
correctly decided if the decision was based on a general business purpose test.
s In particular, Lagacd v. M.N.R. [1968] 2 Ex.C.R. 98; [19681 C.T.C. 98; 68 D.T.C. 5143
(Ex.Ct.).
I Richardson Terminals Ltd. v. M.N.R. [1971] C.T.C. 42; 71 D.T.C. 5028 (Ex.Ct.) and
Dominion Bridge v. The Queen, [1975] C.T.C. 263; 75 D.T.C. 5150 (FCTD).
111
 BRITISH TAX REVIEW

the establishment of the arrangement adopted by the

taxpayer purely for tax purposes 7 ;
(b) the provisions of the Act necessarily relate to an
identified business function. The idea has been expressed
on articles on the subject in the United States:
'The business purpose doctrine is an appropriate tool
for testing the tax effectiveness of a transaction where
the language, nature and purpose of the provision of
the tax law under construction indicate a function,
pattern and design characteristic solely of business
transactions.'8
(c) 'the object and spirit' of the allowance or benefit
provision is defeated by procedures blatantly adopted
by the taxpayers to synthesize a loss, delay or other tax
saving device, although these actions may not attain the
heights of 'artificiality' in section [245]. This may be
illustrated where the taxpayer, in order to qualify for an
'allowance' or a 'benefit', takes steps which the terms of
the allowance provisions of the Act may, when taken in
isolation and read narrowly, be stretched to support.
However, when the allowance provision is read in the
context of the whole statute, and with the 'object and
spirit' and purpose of the allowance provision in mind,
the accounting result produced by the taxpayer's actions
would not, by itself, avail him of the benefit of the
allowance."'
Although we do not survey the law of New Zealand here, it is
interesting to note that the High Court in that country recently
cited with approval and followed the Stubart case.'o
The same tradition against applying a business purpose test was,
at least until very recently, even more strongly entrenched in the
From what Estey, J. said previously in his reasons for judgment, it is reasonably clear that
what he had in mind is that the court would not consider as necessarily effective attempts made
by a taxpayer retroactively to revise or alter the characterisation of income or of other rights
and obligations after they have already been created. This was said in the context of a reference
to the House of Lords decision in Furniss v. Dawson.
Citing Jerome R. Hellerstein, "Judicial Approaches to Tax Avoidance", 1964 Canadian Tax
Foundation Conference Report, p.66. In this article Mr. Hellerstein discusses particularly the
case of Gregory v. Helvering in so far as it represents a judicial interpretation of the word
"reorganisation" as implying a business purpose reorganisation. It is suggested, therefore, that
this "guideline" endorses the narrow finding of the U.S. courts in Gregory v. Helvering which is
discussed, supra.
9 It is thought that the learned judge here had in mind, for example, the type of "blatant"
transaction designed to create the appearance of an offsetting capital loss which, if recognized,
would be deductible by virtue of specific statutory provisions that the taxpayer adopted, and
which the House of Lords refused to consider to be fiscally effective, in the case of Ramsay v.
I.R.C.
1o Challenge CorporationLtd. v. C.IR., (1984) 6 N.Z.T.C. 61, 807.
112
 THE BUSINESS PURPOSE TEST AND ABUSE OF RIGHTS

tax law of Australia. This was so despite the existence of a

very broadly-worded anti-avoidance section in the Income Tax
Assessment Act which read as follows:
"260. Every contract, agreement or arrangement made or
entered into, orally or in writing, whether before or after the
commencement of this Act, shall so far as it has or purports to
have the purpose or effect of in any way, directly or
indirectly-
(a) altering the incidence of any income tax;
(b) relieving any person from liability to pay any income tax
or make any return;
(c) defeating, evading or avoiding any duty or liability imposed
on any person by this Act; or
(d) preventing the operation of this Act in any respect,
be absolutely void, as against the Commissioner, or in regard
to any proceeding under this Act, but without prejudice to
such validity as it may have in any other respect or for any
other purpose."n
Until recently the Australian jurisprudence gave section 260 very
little significance. In one case it was said:
"The taxpayer is entitled to create a situation by entry into a
transaction which will attract tax consequences for which the
Act makes specific provision and the validity of the transaction
is not affected by Section 260 merely because the tax
consequences which it attracts are advantageous to the taxpayer
and he enters into the transaction deliberately with a view to
gaining that advantage."12
Although section 260 had been given very little significance, the
fact that it continued to exist in the Australian legislation was
regarded by some of the judges as a sufficient reason to exclude
the development of any judicial approach to nullifying tax avoidance
schemes.
"However, the scheme of the English legislation is very
different from that of the Australian Act. In particular, the
English legislation does not contain a provision like section
260 of the Act which is aimed generally at tax avoidance. The
n Since 1877 the Australian Taxing Statutes have contained general anti-avoidance provisions.
limited
Section 260 was first enacted in 1936. Interpreted narrowly, the scope of section 260 is
to voiding the tax result of a transaction but not substituting any other transaction for it in order
to impose taxation on any kind of recharacterisation analysis.
'2 Cridland v. F.C. of T., (1978), 52 A.L.J.R. 96 at pp.98 and )9 (HCA). The trend against
applying section 260 was given early strong support by Lord Denning in Newton v. F. C. of T.,
Court in Oakey
[1958] A.C. 450 (PC), a decision recently criticised by the Australian Federal
Abattoir Pty. Ltd. v. F.C. of T., 84 A.T.C. 4718.
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 BRITISH TAX REVIEW

presence of section 260 makes it impossible to place upon

other provisions of the Act a qualification which they do not
express, for the purpose of inhibiting tax avoidance. In other
words, it is not permissible to make an application which does
what section 260 fails to do in preventing the avoidance of tax.
If it is suggested that a taxpayer has engaged in a device to
secure a fiscal advantage, and the relevant provisions of the
Act do not expressly deal with the matter, the case depends
entirely upon section 260.""1

Lower Australian courts, at least, have recently indicated some

willingness to depart from their previous position in rejecting the
business purpose test in tax cases and to give section 260 more
significance.14
Because of the previous general recognition of the failure of
section 260 to counter tax avoidance devices, Australia moved to
more specific legislation aimed at specific problem areas but,
because of the inevitable time lag between the adoption of these
tax avoidance schemes and knowledge of them being received by
the Revenue, it was made clear that the Government would be
prepared to introduce retrospective legislation to deal with this
kind of issue. In 1981, a new general anti-avoidance provision was
inserted as Part IVA of the Income Tax Assessment Act to replace
section 260 and a statutory provision was enacted" to direct the
Australian courts, in interpreting statutes, to recognise the purpose
or object underlying the statute. Under Part IVA, a taxpayer is
precluded for tax purposes from obtaining a benefit which flows
from entering into a "scheme", the object or purpose of which may
be that of enabling the taxpayer to obtain that tax benefit. When
apprehended, the taxpayer not only is required to pay the taxes he
13 Per Gibbs, J., as he then was, in F.C. of T. v. Patcorp Investments Limited, 76 A.T.C.
4225 at p.4232, quoted with approval by Fox, Fisher and Beaumont, J.J. in Oakey Abattoir Pty.
Ltd. v. F.C. of T., 84 A.T.C. 4718.
14 In Ilbery v. F.C of T., 81 A.T.C. 4661, the Federal Court indicated that the
principles of
Ramsay's case could be applied in Australia. In Oakey Abattoir v. F.C. of T., 84 A.T.C. 4406,
the Queensland Supreme Court applied the doctrine known in Australia as "fiscal nullity" as
distinct from section 260 whereas, on appeal to the Full Federal Court (84 A.T.C. 4718), the
Court applied section 260 and rejected the idea that the principles developed in Ramsay,
Burmah Oil and Furniss v. Dawson could be applied in Australia. In Gulland v. F.C. of T., 84
A.T.C. 4587, the Federal Court, affirming the Supreme Court of Western Australia (83 A.T.C.
4352) also applied section 260 to a fact situation which bore "ex facie the stamp of tax
avoidance". This case has been appealed to the High Court. In Lau v. F.C. of T., 84 A.T.C.
4618, the Queensland Supreme Court also refused to apply what has been described in
Australia as the fiscal nullity doctrine but rather applied section 260, stating that because of the
presence of the section in the Act in the relevant taxation year, the "fiscal nullity" doctrine was
not applicable in Australia. This case has been upheld on appeal: 84 A.T.C. 4929. In Tupicoff
v. F.C. of T., 84 A.T.C. 4367, the Queensland Supreme Court applied section 260 to a
transaction which was carried out for the purpose of reducing taxes. An appeal was subsequently
rejected by the Federal Court without reference to fiscal nullity.
I Section 15AA of the Acts Interpretation Act.

114
 THE BUSINESS PURPOSE TEST AND ABUSE OF RIGHTS

sought to avoid but also is subject to a penalty tax of up to double

the amount of such taxes.
At the present time it is not clear what judicial attitudes in
Australia will ultimately prevail'" in the interpretation of this new
general anti-avoidance provision or even whether cases involving
former section 260 which are now grinding through the courts will
ultimately confirm an apparent change in judicial thinking. Nor is it
clear what ultimate effect the recent English jurisprudence may
have upon the Australian judges, although it is interesting that, at
present, it appears likely that the presence of section 260 (and
presumably its replacement, Part IVA) will continue to exclude the
judicial development of a general anti-avoidance doctrine based on
business purpose, or abuse of rights." A noted author"8 has
summed up the present position in Australia as follows:
"Further, there has been a long course of decisions in the
High Court that is inconsistent with the application in Australia
of a doctrine of fiscal nullity. A departure from those decisions,
and an assumption of extraordinary legislative powers by the
judiciary, would involve an exercise by judges of political
functions. In a strict sense it would involve a loss of judicial
integrity; and this loss would be suffered for the purpose of
accomplishing an object which particular judges may or may
not personally hold to be desirable and which has in any event
now been accomplished in a more carefully and elaborated
conceived manner, by the legislature."

CONCLUSIONS
This survey reflects, in the area of private law, the trend in many
civil law countries and in the United States in its unique position
amongst common law countries, of limiting the rights of an
individual in property, contract, corporate and other fields of the
law by balancing the individual's rights against the benefits to
I6 The Solicitor-General stated on the application for leave to appeal in the Gulland case that
there are 986 Australian cases pending involving similar issues. See Financial Review, October
5, 1984, at page 2. Included amongst these cases are the so-called "bottom of the harbour"
cases, which are also currently being proceeded with in Australia.
17 Although Estey, J. in the Stubart case in the Supreme Court of Canada did not refer to the
reasoning of Gibbs, J. in the Patcorp case (above cited) in rejecting the broad business purpose
test in Canada, the court did refer to the Australian jurisprudence generally and adopted similar
reasoning, that is, because of a broad anti-avoidance provision in the Canadian statute, the
courts should not develop independently a general anti-avoidance doctrine. This contrasts,
interestingly, with the position in The Netherlands, where the courts are apparently willing to
apply the fraus legis doctrine to cases where Article 31 of the General Law for National Taxes
could also apply.
18 I.C.F. Spry, Q.C., in an article, "Fiscal Nullity in Australia", September, 1984, Australian
Tax Review, 150 at p.156.
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 BRITISH TAX REVIEW

society that are achieved by such limitations. The extent of the

similarity of result in civil law countries and the United States is
remarkable in view of the fact that some civil law countries have
codified the abuse of rights principle although, as we have noted,
in others the doctrine has developed judicially. In the United
States, similar results are often achieved judicially with different
20
labels, for example, judicial legislation,19 social engineering or
21
creative judicial interpretation. In this respect the development of
the common law in the United States departs from the earlier
tradition there of literal interpretation of contracts and statute law.
The direction in which the United States common law has
developed was, however, firmly rejected in the 19th century in
English law and this rejection seems to have continued, at least
outside of taxation law, not only in England, but also in other
Commonwealth countries.
This survey also reviews the extent to which the courts have
applied anti-tax avoidance tools, whether they are legislatively
provided or judicially developed, in order that the Revenue should
be entitled to disregard the consequences of transactions genuinely
carried out in cases where the purpose of the transaction is to
avoid tax that would otherwise be applicable rather than for some
business purpose. In civil law countries that have historically
recognised the concept of abuse of rights either because it was
developed jurisprudentially or expressly embodied in the Civil
Code at an early stage, the issue is whether or to what extent such
a concept should be applied in tax law.22 In common law countries,
the issue is somewhat more complex and is whether such a doctrine
(under the label of the "business purpose test", the "fiscal nullity
doctrine" or any other label) should be developed by the judiciary
and applied solely in the area of tax law when it is unknown in any
other area of the law.' The United States developments are similar
to those in the civil law countries that have long known the abuse
9 Which, of course, has a far wider application than abuse of rights.

* Roscoe Pound, "The Theory of Judicial Decision, III," 36 Hary.L.R. 940 at p.954 (1923).
Dickerson, The Interpretation and Application of Statutes (Boston, Little, Brown
&

2 1
Company, 1975), p.
.

I In Belgium, the issue is more precisely stated to be whether a doctrine of fraus legis, or
fraud on the law, which has not developed in the general law, should be adopted for tax law
purposes only. As has been mentioned, in the Netherlands the fraus legis doctrine developed
first in a tax case and in Switzerland the use of the "economic approach to the facts" developed
in tax law and influenced the use of the abuse of rights concept there.
I In the three cases with which it has already dealt, the House of Lords appears clearly to
have departed from the traditional precepts that had been well-known and often applied both in
taxation law and in general law. The extent and ultimate effect of the departure from traditional
views is not yet clear and, of course, no case has yet come before the Lords in which either of
the litigants has claimed successfully that the new doctrines are to be applied outside the field of
taxation. C. N. Beattie, in a note on Furniss v. Dawson in [1984] B.T.R. 109 at p.116 notes:
"The principle in Furniss v. Dawson is probably not confined to tax matters
.

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 THE BUSINESS PURPOSE TEST AND ABUSE OF RIGHTS

of rights concept. As similar doctrines have traditionally been

applied in the United States in other fields of the law, it is not
surprising that the concepts, under various labels, are regularly
applied in tax law.
As is the case with the development of private law in various
countries, results achieved are not uniform. However, our survey
indicates a discernible growing trend internationally in the
application of the abuse of rights and business purpose doctrines in
many countries.
Viewing the United States and the United Kingdom experience,
one can say that at least in these two common law countries, which
traditionally have considered tax law as a legislative creature, the
trend toward the expansion of the business purpose doctrine has
had a long history, having early been adopted by the judiciary in
the United States, long been rejected in the United Kingdom and
only recently accepted there under acknowledged influences from
the United States. After some flirtations in the lower courts with
the business purpose test,24 Canada has clearly rejected the doctrine
as one of general application in the tax area and presumably in any
other area of the law. With the active judicial developments in
Australia, it is not yet certain whether the doctrine will be
developed and, if so, whether the courts will embrace it within the
statutory framework of section 260 and its successor, Part IVA, or
will develop a free-standing judicial doctrine, or both. 25
At an early stage in the development of the United States law
the judiciary clearly favoured a literal interpretation of the tax
laws, closely resembling its attitude to its interpretation of criminal
laws.
"In the interpretation of statutes levying taxes it is the
established rule not to extend their provisions, by implication,
beyond the clear import of the language used, or to enlarge
their operations so as to embrace matters not specifically
pointed out. In case of doubt, they are construed most strongly
against the Government, and in favor of the citizen.", 6
Although this statement was quoted in a recent case,27 the
widespread application of the business purpose doctrine, the judicial
I "In my view, for the [taxpayers] to be successful in this appeal, they must establish a bona
fide business purpose in the transaction, which on the evidence . . . they have failed to do. It is
the agreement or transaction in question to which the Court must look. If the agreement or
transaction lacks a bona fide business purpose, it is a sham." Per Heald, J. in M.N.R. v. Leon,
76 D.T.C. 6299 (FCA).
2 We have previously noted the development of both statutory and free-standing judicial
doctrines in the Netherlands.
* Gould v. Gould, 245 U.S. 151 at p. 153 (1917).
2 In re Sapphire Steamship Lines, Inc. v. I.R.S., 84-2 U.S.T.C. 85,867 (S.D.N.Y. 1984).
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 BRISH TAX REVIEW

activism of the Supreme Court in interpreting other issues in tax

law28 and other areas and the reliance of the judiciary on legislative
history belies that the above quotation accurately reflects current
attitudes. 29
The position in the United Kingdom and other Commonwealth
countries is, however, substantially different. In the United
Kingdom, as late as 1965, Lord Reid commented:
"[The] rule [is] that the words of a taxing Act must never be
stretched against a taxpayer. And there is a very good reason
for that rule. So long as one adheres to the natural meaning of
the charging words the law is certain, or at least as certain as
it is possible to make it. But if courts are to give to charging
words what is sometimes called a liberal construction, who can
say just how far this will go?"30

The same views prevail in Canada:

"Fiscal legislation does not stand in a category by itself.
Persons whose conduct a statute seeks to regulate should
know in advance what it is that the statute proscribes. A court
should ask-what would the words of the statute be reasonably
understood to mean by those governed by the statute?
Unnatural or artificial constructions are to be avoided . .

.
Although a court is entitled in the case of fiscal legislation as
with other enactments, to look to the purpose of the Act as a
whole, as well as the particular purpose of a given section, it
must still respect the actual words which express the legislative
intention.""

While aggressive tax avoidance is difficult to defend, the judicial

development of the business purpose test or the application of the
abuse of rights doctrine in the tax area invites consideration of the
question whether frustration of tax avoidance is the proper province
only of the legislature or whether the judiciary should also intervene
in this area. In all countries which we have surveyed it is, of
course, an overriding principle that income taxation varies according
to a taxpayer's particular circumstances and income. The question
arises, therefore, how far the court is legitimately entitled to go in
recharacterising, disregarding or altering those facts solely for the

* For example, see Corn Products Refining Co. v. Commissioner, 350 U.S. 46 (1955).
9 Indeed, in the Sapphire case, which involved a close issue of statutory interpretation, the
Internal Revenue Service prevailed despite the quotation by the court from the decision of
Gould v. Gould.
* William Cory & Son Ltd. v. I.R.C., [1965] A.C. 1088 (H.L.).
" Dickson, J. (as he then was) in Jodrey Estate v. Min. of Finance, (Nova Scotia), [1980] 2
S.C.R. 774 (SCC).
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 THE BUSINESS PURPOSE TEST AND ABUSE OF RIGHTS

purpose of altering the incidence or amount of taxation.32 In both

civil and common law countries, there is an issue whether the
legislature should adopt anti-avoidance legislation, whether it be
general or confined to specific matters, that is so broadly worded
or is so ambiguous that it confers upon the judiciary a significant
discretion with respect to the time, manner and extent of its
application.3
Particularly in most civil law countries where traditionally the tax
code is less detailed in its provisions, the abuse of rights concept
has become a necessary tool to permit the administration and the
courts to fill the legislative gaps and to give the legislation a degree
of flexibility required to meet changing circumstances without
constant amendments.
The principal problem in permitting the tax law to be resolved
and applied by judicial legislation is that the law becomes
unpredictable, varying from time to time and often dependent
upon the individual intuition of judges, with the result that
taxpayers do not know what the law is and cannot determine the
extent of their liability until the judiciary has finally decided the
issues in their particular case.3 4 There is some sentiment that a
taxpayer should know what the law is, and therefore what his tax
liability is, before he acts. In other words, there is a view, which
we share, that tax consequences of transactions should be reasonably
predictable. On the other hand, some tax administrators and
academicians have applauded the unpredictability of the tax law on
the ground that it discourages taxpayers in their efforts to achieve
the avoidance of tax." One leading United States author has said:
"Some of these judicial rules [directed against tax avoidance]
have been incorporated in the statute . . . But most of them
remain as they originated-judicial safeguards devised to

" In dealing with tax treaties there is an additional question, namely, whether the abuse
doctrine should be applied either to recharacterize, disregard or alter the facts, or to provide a
means to read into the treaty additional provisions that are not written into it, or both. The
1962 Swiss Decree shows that Switzerland would answer at least the second part of the question
affirmatively.
1 Legislative provisions that do not have clear limitations in their application are not
uncommon in the tax area. Our earlier discussion has dealt with Article 31 of the Netherlands
General Law for National Taxes, paragraph 42 of the German General Tax Code, section 245
of the Canadian Income Tax Act and section 260 and Part IVA of the Australian Income Tax
Assessment Act.
I Prof. V. Uckmar, General Reporter, IFA Cahier, p.25 also discusses the advantage of
certainty which a strict legal application of the law provides. Killius in his articles: (1983) 23
European Taxation, p.360 and (1985) 25 European Taxation, p.19 expressed the same view.
I Some authorities apparently take the position that the threat of excessive taxation is
positively desirable. "According to them, this danger acts as a deterrent force to discourage
multinational groups from attempting to shift profits among affiliated companies." P. L. Kelly,
"Transfer Price Adjustments and Double Taxation: A Sword of Damocles for Multinationals",
(1984), 38 Bulletin for Inter. Fiscal Doc. 448 at p.449.
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 BRITISH TAX REVIEW

protect the underlying statutory policy. Nor is the role of the

judiciary confined to enforcing rules previously announced.
Anyone applying for passage through the corridor [of tax
avoidance] runs the risk of the judicial policeman inventing a
new rule on the spot if he thinks such action is demanded . .

.
Some have criticised the judicial vigilance on this score. Others
believe that any effort to prescribe statutory rules covering all
of the everyday transactions of the business world is bound to
fail unless courts and administrators are able to cope with
transactions that would otherwise involve a distorted application
of those rules." 36
Moreover, the cost of administering the tax law, especially the
cost of litigation for both taxpayers and the government, is
increased where the limits of tax avoidance are left for resolution
by the judiciary." Such a practice imposes an inordinate burden on
the tax administration to determine the purpose of the transactions,
or more precisely perhaps the purpose of the taxpayer in carrying
out the transactions, and it also enormously increases the power
granted to the tax administration to apply, or not to apply, a
particular provision of a tax law whose application is dependent on
38
a particular purpose of the taxpayer in carrying out a transaction.
The situation is aggravated by the inability under the law of some
countries, and the reluctance of countries where it is permitted, to
ensure that judicial decisions that result in startling and unanticipated
changes in the development of the law are applicable only on a
non-retroactive basis even where the legislature may accept the
9
principle of non-retroactivity in introducing new tax legislation.
I Stanley S. Surrey et al, 2 Federal Income Taxation, Cases and Materials, at p.666 (1980). A
similar statement in an earlier edition of the late Prof. Surrey's work elicited this response:
"The allegory is instructive. Unnoticed is the horror with which tax reformers would surely
react to a policeman inventing a new rule on the spot if he thinks such action is demanded,
even if the offence were only a parking violation, much less a government exaction of a
substantial portion of the taxpayer's earnings." S.I. Roberts, "Simplification Symposium
Overview: The Viewpoint of the Tax Lawyer", 34 Tax L.R. 5 at p.19 (1978). Consider the
candour of the American court (Judge Goffe, concurring) in Carriage Square, Inc. v.
Commissioner, 69 T.C. 119 (1977) in saying:
"All members of the Court recognise that the tax avoidance scheme ... cannot be allowed to
stand. It is an obvious attempt, and a somewhat crude attempt, lacking in legitimate business
purposes, to spread large anticipated sums of ordinary income among several taxpayer[s] ...
The only disagreement among the members of the Court is how best to set aside the tax
avoidance scheme."
" Isenbergh at p.883 makes the same point, saying:
"If not the taxpaying public or the fisc, who ultimately benefits from this approach? The only
unequivocal beneficiary is the tax bar. The heavier the layers of judicial divination
superimposed on the Internal Revenue Code, the richer tax lawyers are apt to get. The
development of an exquisite set of intuitions about what kinds of transactions the courts 'like'
and 'don't like' has become a large part of what tax lawyers sell."
I See J. F. Avery Jones, "The Mental Element in Anti-Avoidance Legislation", [1983]
B.T.R. 9 and 113 at p.43 where a similar point is made.
* An American view is that, "[w]hen a court overrules a prior decision, considerations of
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 THE BUSINESS PURPOSE TEST AND ABUSE OF RIGHTS

Also relevant is the capacity of a court, confronting only the

facts in a particular case and the obligation to render a decision, to
"legislate" or otherwise intervene without the benefit of a full
examination and understanding of the practical and administrative
problems that its decision entails and how it fits into the purpose of
the tax system enacted by the legislature. Specifically, one may
question the capacity of the court, in applying its intuition to
frustrate what it perceives to be a tax avoidance transaction, to
identify correctly the intention of the legislature, particularly in
those jurisdictions where tax legislation frequently involves economic
incentives, tax benefits and intended tax expenditures.' The
situation is especially difficult for the judiciary in those countries
where it is traditionally barred from determining the legislative
purpose of statutory law by reference to the debates in Parliament.4 1
In the United States, the reliance by the judiciary on legislative
history, despite its dubious authenticity42 as a legislative pronounce-
ment, may be of some assistance in seeking to determine whether
transactions which are not motivated by a business purpose are or
are not intended to be caught by legislative provisions that do not
on their face impose taxation under the particular facts of the
taxpayer's transaction. The current position of the United States
judiciary on using legislative history to depart from the literal
terms of the statute has been summarised in a recent decision of
the United States Tax Court.
"Although there was at one time a fairly clear rule foreclosing
any inquiry into legislative purposes where a statute is clear on
its face, there has been a gradual erosion of that rule . . . and
this Court has followed the lead of the Supreme Court's
decision in Amer. Trucking Ass'ns. . . . Nevertheless, where a

fairness may induce it to abstain from applying the new rule even to the parties to the litigation
before it-the so-called prospective . . . technique". See S.I. Roberts et al, "A Report on
Complexity and the Income Tax", 27 Tax L.R. 325 at p.360 (1972). In the United Kingdom and
Commonwealth countries there is no real basis to withhold the application of judge-made law to
cases coming before the courts, regardless of the timing of the transactions in question. See J.
F. Avery Jones, "Decisions with Prospective Effect: A Less Drastic Solution for the House of
Lords", [1984] B.T.R. 203 and [1985] B.T.R. 14.
1 This was not an unimportant ground for the rejection of the business purpose test in
Canada in the Stubart case. Isenbergh, at p.878 offers this illustration in the United States. In
Waterman Steamship Corp. v. Commissioner, 430 F. 2d 1185 (5th Cir. 1970), cert. denied, 401
U.S. 939 (1971), the Court of Appeals perceived a transaction as opening "[a] new horizon of
tax avoidance" and struck it down. Shortly thereafter the consolidated return regulations were
amended expressly to allow it. France also offers an interesting example. Article 7 of Statute
No. 83-1179 of 29 d6cembre 1983, grants tax incentives to new businesses. The statute expressly
permits the administration to use the abuse of rights procedures against those who through
"juridical stunts" present existing enterprises as new ones (Inst. 16 mars 1984, 4 A-3-84; FR 19/
83, p.3).
4 England the Commonwealth countries.
42 It is generally written by administrators or lower level legislative staff and not by the
legislators themselves.
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 BRITISH TAX REVIEW

statute is clear on its face, we would require unequivocal

evidence of legislative purpose before construing the statute so
as to override the plain meaning of the words used therein.
And this is particularly so in a case like the present, where we
have a complex set of statutory provisions marked by a high
degree of specificity." 43

The rule is, of course, different in the United Kingdom where

Hansard and other similar sources cannot generally be reviewed by
the judiciary.
"In construing any Act of Parliament we are seeking the
intention of Parliament and it is quite true that we must
deduce that intention from the words of the Act . . . For
purely practical reasons we do not permit debates in either
House to be cited.""

In light of the diversity of legal traditions in the various countries

which we have surveyed, in an international survey such as this it is
not possible to draw many broad general conclusions applicable to
all countries as to the application of the anti-avoidance doctrines
which we have discussed. It should be said, however, that in those
countries which have not recognised the abuse of rights doctrine,
its full implications should be carefully considered before it is
introduced in tax cases.
Nearly 50 years ago Professor Gutteridge, writing from the point
of view of an English lawyer, said of the abuse of rights concept
that it resembled:

4 Huntsberry v. Commissioner, 83 T.C. No. 42 (1984).

" Per Lord Reid in Beswick v. Beswick [1968] A.C. 58 at p.73 (H.L.). Now that the English
courts have started down the road of attempting to ascertain what the legislature was really
intending to tax, or to exempt, it is interesting to speculate how they will determine the "true"
legislative intent. For a discussion of the restrictive English law on the use of Parliamentary
debates by the courts see M. Rawlinson, "Tax Legislation and the Hansard Rule", [1983]
B.T.R. 274. Very early, on rare occasions, some English judges referred to the intention of
Parliament by reference to their own experience there (when they were politicians and prior to
elevation to the bench): See Year Book of 33 Edw.I, M. Term (Rolls Ed.), 82; Ash v. Abdy
(1678) 3 Swanst. 664 and Re Mew (1862) 31 L.J.Bk. 89. However, these cases are not reflective
of the present law which developed from the old case of Millar v. Taylor (1769) 4 Burr 2303,
cited by Craies, Statute Law (7th ed.) p.128, Halsbury Laws of England (4th ed.) Vol. 44 §901
and Rawlinson at p.275 as the earliest authority. English law clearly excludes reference to
Parliamentary debates in determining the meaning of a statute. See Maxwell, On The
Interpretation of Statutes (11th ed., Sweet & Maxwell, London) at p.26 et seq. In Canada the
Hansard rule is also generally followed: A.G. Can. v. The Readers' Digest Association (Canada)
Ltd. 61 D.T.C. 1273 (SCC) although in a few rare Canadian cases some judges have broken
this "rule". See Babineau v. Babineau (1981) 32 O.R. (2d) 545 at p.548 (Ont. HC); Re Reed
(1980) 35 C.B.R. (N.S.) 149 at p.166 (QueSC) and Edmonton Liquid Gas Ltd. v. The Queen 84
D.T.C. 6526 (FCA).
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 THE BUSINESS PURPOSE TEST AND ABUSE OF RIGHTS

". . . a drug which at first appears to be innocuous, but may

be followed by very disagreeable after effects. Like all
indefinite expressions of an ethical principle it is capable of
being put to an infinite variety of uses, and it may be employed
to invade almost any sphere of human activity for the purpose
45
of subordinating the individual to the demands of the State."
a Gutteridge, op. cit. at p.44.

123