4.29 Retroactive Taxation

Primary Reference to Article 18 – Retroactivity of Legislation

There is an increasing trend for tax laws to have retroactive effect. This is potentially problematic for all stakeholders. Taxpayers and tax advisors should be entitled to some reasonable certainty as to the tax implications of transactions undertaken. Moreover, tax administrations require reasonable certainty as to the interpretation of tax laws in order to appropriately assess taxpayers.

Certain countries have limitations on what is permitted in terms of retroactive legislation, but most do not. Retroactive legislation has the potential to undermine the fairness of a tax system and the respect which taxpayers and tax advisors have for the system. Unless the legislation is relieving in nature, retroactive passage of legislation is on any view unfair and should be avoided. It may also violate constitutional rights. Thus, the Taxpayer Charter seeks to place limitations on the use of retroactive legislation, particularly if it is not relieving in nature. Also, adequate transitional rules should be placed in the legislation where legislation will have retroactive effect.

Retroactivity can come in many forms. One aspect is a retroactive increase in tax rates or in the tax base (subjecting something to tax which previously was not included) and doing this back to a date in the past. But retroactivity can also be prospective. It can apply to arrangements which have been carried out before the legislation was enacted, making the arrangement subject to tax in the future to a greater extent than in the past. In many instances, so-called grandfathering will apply, so that arrangements put in place before the date of application of the legislation will be permitted to pay taxes on the basis of the previous law. However, this is far from universal, and the results can be very detrimental.

Gaius Caesar, better known as the Emperor Caligula, is reputed in literary tradition to have made a practice of depositing his criminal edicts on top of a monument so that he would have them available for punishment of the luckless victims who transgressed them in ignorance of their existence, and with no opportunity of discovering their provisions. But he was also a wayward autocrat, given to impersonating Jupiter, and openly declaring his wish that the whole people of Rome had only one head that he might cut it off at a single stroke.

One only needs to consider such a state of affairs for its injustice to be immediately apparent. But retrospective legislation goes beyond this: at least, through judicial and other processes, laws fixed at a particular point of time eventually will become known and can be determined. On the other hand, retrospective legislation necessarily involves law which is both unknown and unknowable. For these reasons, most civilised countries accept the notion that laws should operate prospectively only.

This notion has a long history. In the words of the Institutes of Justinian (from 533 A.D.):

Freedom from which men are called free, is a man's natural power of doing what he pleases, so far as he is not prevented by force or law...

That freedom cannot exist in a society where what is legal or tax effective according to the law as it stands today may be rendered illegal or ineffective at a later time retroactively.  The same principle is recognised in Article 1, section 9 of the Constitution of the United States of America, which provides amongst other things that:

No Bill of Attainder or ex-post facto law shall be passed

The French Civil Code, in civil matters, provides:

La Loi ne dispose que pour l'avenir; elle n'a point d'effet rétroactif

The Law only provides for the future; it has no retroactive effect

In the context of the criminal law, the entitlement not to be subjected to retrospective legislation has been characterised as a fundamental human right. Article 11 of the Universal Declaration of Human Rights provides, in part:

(2) No one shall be held guilty of any penal offence on account of any act or omission which did not constitute a penal offence, under national or international law, at the time when it was committed. Nor shall a heavier penalty be imposed than the one that was applicable at the time the penal offence was committed.

While taxation laws are generally not laws creating penal offences, as noted elsewhere they frequently do impose penal type sanctions and in this respect at least, retrospective taxation laws with penal consequences contravene an internationally acknowledged fundamental human right. And retrospective revenue legislation more generally may well also to constitute an arbitrary deprivation of property, inconsistent with article 17 (2) of the Declaration.

Notwithstanding this, retrospective legislation is increasingly seen by governments as a legitimate device when dealing with revenue matters, and it is sometimes justified by stating that the legislation is anti-avoidance legislation, its function being to retroactively close a tax loophole. This assumption should be challenged.

Retrospective laws:

  • are contrary to the rule of law;
  • engender business uncertainty; and
  • create adverse perceptions of sovereign risk in relation to taxation laws generally.

A retrospective law undermines the rule of law, because it:

  • cannot itself guide action; and
  • undercuts the integrity of existing and prospective rules, since it puts them under the threat of retrospective change.

Even where there is clear avoidance behaviour, it still is not appropriate to apply any legislative fix retrospectively.

It is not to the point to argue that tax avoidance is immoral, and a dereliction of civic duty by those who engage in it. Even assuming for present purposes that it is so, fundamental principles of law must nonetheless be preserved in the interests of the community generally. The use of torture might well be argued to assist the police in combating crime. So might dispensation with the privilege against self-incrimination. Yet few would suggest that in the interest of the suppression of crime (which is at least as desirable a social objective as the suppression of tax avoidance) these fundamental elements of the rule of law should be dispensed with.

History has shown that once a precedent is set in relation to retrospective legislation, it becomes increasingly easy for legislatures to accept a lower and lower bar whereby legislation of this nature is seen as acceptable. In many cases the need for change arises because of deficiencies in the original legislation which could easily have been identified if the process we discuss elsewhere had been adopted. For this reason, retrospective legislation which increases a taxpayer's liability to tax is not, in any circumstance, acceptable.

The nature of tax legislation, and the consequences to the state generally of tax changes, are such that legislation which is retrospective to the date upon which it was announced is acceptable. Provided that the legislation fairly gives effect to an announcement which is made with some precision as to the intended nature of the legislation, and it is introduced and enacted within a short period after the announcement is made, the objections discussed above would not normally be considered to apply.

In addition to legislation which is formally retrospective (that is, it changes for the past the tax consequences of transactions which have occurred in the past), legislation which is formally prospective can nonetheless be economically counter-productive for similar reasons in relation to uncertainly. A useful example is provided by the circumstances of altered tax treatment of capital allowances for assets acquired prior to the change, and the treatment of losses carried forward from earlier years. Jurisdictions which engage in such practices are likely to find themselves less attractive destinations for direct foreign investment, since much foreign investment depends on long lead times between the initial investment and the receipt of the investment return. As a matter of good practice, therefore, it would be wise to also avoid this type of retrospectivity (if it be so regarded).