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Retrospective taxation

What is retrospective taxation?

Tax legislation that is retrospective imposes or increases a tax charge on income earned, gains realised or transactions concluded some time before the legislation to implement that charge has been introduced.

Retrospective taxation runs contrary to one of the principles of a good tax system, set out by Adam Smith in the Wealth of Nations published in 1776. Smith argued that a tax system should have four characteristics: equity, certainty, convenience, efficiency. He defined the principle of certainty as follows:

The tax which each individual is bound to pay ought to be certain and not arbitrary. The time of payment, the manner of payment, the quantity to be paid, ought all to be clear and plain to the contributor and to every other person.

Why do governments introduce tax measures that are retrospective?

Retrospective taxation is both controversial and relatively rare. However, governments may decide to diverge from the principle of certainty to counter the financial risks from tax avoidance, where taxpayers may be able to take action – ‘forestalling’ – to avoid the impact of a change in the law before it can take effect. For many years governments have taken a consistent approach to the circumstances in which retrospective legislation can be used to counter tax avoidance, an approach codified in the ‘Rees Rules’ in 1978.

In December 2004 the Labour government announced provisions to counter several schemes designed to avoid tax on employment income. At the same time Treasury minister Dawn Primarolo made a written statement giving notice that the government would introduce retrospective legislation to tackle any similar avoidance schemes that came to light.

At the time there was widespread consensus that the ‘Primarolo Statement’ marked a major change in the revenue authority’s approach – an attempt to halt the ‘arms race’ that had characterised the tax planning industry over the previous twenty years.

Have there been any recent examples of retrospective taxation?

In 2008 the Labour government introduced provision to counter tax avoidance schemes that sought to exploit double taxation treaties and to frustrate avoidance legislation that had been introduced in 1987: section 58 of the Finance Act 2008.

At the time there were many complaints that this was unfairly retrospective. The government’s position was that this provision clarified the law as it stood. Efforts to change the government’s position, or to mount a legal challenge to overturn the legislation as being incompatible with the European Convention on Human Rights, proved unsuccessful.

Following this in 2011 the Coalition government published a protocol on its approach to retrospective tax legislation, as part of a wider strategy on tackling tax avoidance.

More recently in the 2020 Budget the Conservative government introduced legislation with retrospective effect relating to HMRC’s use of automated processes, though this proved far less controversial than section 58.

This briefing discusses the origin of the Rees Rules, and subsequent debates as to the use of retrospective changes in tax law in relation to ‘section 58’ and automated processes.

One further measure which has been criticised as being retrospective taxation or having retrospective effect has been the 2019 Loan Charge. This measure was announced in the 2016 Budget to tackle a type of disguised remuneration tax avoidance schemes. These schemes seek to prevent salaries and bonuses being classified as taxable income by making payments in a variety of different ways – in this case, by structuring payment in the form of a loan, often made through an offshore trust. The Library briefing the 2019 Loan Charge discusses this issue in detail.