Tax law, body of rules under which a public authority has a claim on taxpayers, requiring them to transfer to the authority part of their income or property. The power to impose taxes is generally recognized as a right of governments. The tax law of a nation is usually unique to it, although there are similarities and common elements in the laws of various countries.
In general, tax law is concerned only with the legal aspects of taxation, not with its financial, economic, or other aspects. The making of decisions as to the merits of various kinds of taxes, the general level of taxation, and the rates of specific taxes, for example, does not fall into the domain of tax law; it is a political, not a legal, process.
Tax law falls within the domain of public law—i.e., the rules that determine and limit the activities and reciprocal interests of the political community and the members composing it—as distinguished from relationships between individuals (the sphere of private law). International tax law is concerned with the problems arising when an individual or corporation is taxed in several countries. Tax law can also be divided into material tax law, which is the analysis of the legal provisions giving rise to the charging of a tax; and formal tax law, which concerns the rules laid down in the law as to assessment, enforcement, procedure, coercive measures, administrative and judicial appeal, and other such matters.
The development of tax law as a comprehensive, general system is a recent phenomenon. One reason for this is that no general system of taxation existed in any country before the middle of the 19th century. In traditional, essentially agrarian, societies, government revenues were drawn either from nontax sources (such as tribute, income from the royal domains, and land rent) or, to a lesser extent, from taxes on various objects (land taxes, tolls, customs, and excises). Levies on income or capital were not considered an ordinary means for financing government. They appeared first as emergency measures. The British system of income taxation, for example, one of the oldest in the world, originated in the act of 1799 as a temporary means for meeting the increasing financial burden of the Napoleonic Wars. Another reason for the relatively recent development of tax law is that the burden of taxation—and the problem of definite limits to the taxing power of public authority—became substantial only with the broadening in the concept of the proper sphere of government that has accompanied the growing intervention of modern states in economic, social, cultural, and other matters.
The taxing power
The limits to the right of the public authority to impose taxes are set by the power that is qualified to do so under constitutional law. In a democratic system this power is the legislature, not the executive or the judiciary. The constitutions of some countries may allow the executive to impose temporary quasi-legislative measures in time of emergency, however, and under certain circumstances the executive may be given power to alter provisions within limits set by the legislature. The legality of taxation has been asserted by constitutional texts in many countries, including the United States, France, Brazil, and Sweden. In Great Britain, which has no written constitution, taxation is also a prerogative of the legislature.
The historical origins of this principle are identical with those of political liberty and representative government—the right of the citizens
to take cognizance, either personally or through their representatives, of the need for the public contributions, to agree to it freely, to follow its use and to determine its proportion, basis, collection and duration
(in the words of the Declaration of the Rights of Man and the Citizen proclaimed in the first days of the French Revolution, August 1789). Other precedents may be found in the English Bill of Rights of 1689 and the rule “no taxation without consent” laid down in the Declaration of Independence of the United States.
Under this principle all that is necessary is that the rights of the tax administration and the corresponding obligations of the taxpayer be specified in the law; that is, in the text adopted by the people’s representatives. The implementation of the tax laws is generally regulated by the executive power (the government or the tax bureau).
There have been many encroachments on the principle of the legality of taxation: Sometimes the base or the rate of taxation is determined by government decree rather than by law. The encroachment of the executive power on the territory reserved to the legislature in matters of taxation is generally explained by the need to make tax policy more flexible; urgent amendments may be required by sudden changes in the economic situation, changes so sudden that recourse to relatively slow parliamentary procedure would take too long. A compromise may be reached between the orthodox doctrine of the legality of taxes and the need, under special circumstances, to amend texts on taxation almost immediately, by modifying the text through a decree or an order of the executive (treasury) and ratifying it by the legislative power as soon as possible thereafter.
Limitations on the taxing power
Restraints on the taxing power are generally imposed by tradition, custom, and political considerations; in many countries there are also constitutional limitations. Certain limitations on the taxing power of the legislature are self-evident. As a practical matter, as well as a matter of (constitutional) law, there must be a minimum connection between the subject of taxation and the taxing power. The extent of income-tax jurisdiction, for example, is essentially determined by two main criteria: the residence (or nationality) of the taxpayer and his source of income. (The application of both criteria together in cases where the taxpayer’s residence and his source of income are in different countries often results in burdensome double taxation, although the problem can be avoided or restricted by international treaties.) Taxes other than income taxes—such as retail-sales taxes, turnover taxes, inheritance taxes, registration fees, and stamp duties—are imposed by the authority (national or local) on whose territory the goods are delivered or the taxable assets are located.
Another self-evident limitation on the taxing power of the public authority is that the same authority cannot impose the same tax twice on the same person on the same ground.
Taxes are generally not levied retroactively, except in special circumstances. One example of retroactive taxation was the taxation of wartime benefits in some European countries by legislation enacted in 1945 when the war and enemy occupation were over.
A common limitation on the taxing power is the requirement that all citizens be treated alike. This requirement is specified in the U.S. Constitution. A similar provision in other constitutions is that all citizens are equal and that no privileges can be granted in tax matters. The rule is often violated through the influence of pressure groups, however; it is also difficult to enforce and to interpret unambiguously. In countries in which local governments are under the control of the national government, a local tax can be nullified by the central authority on the ground that it violates the national constitution if it transgresses the rule of uniformity and equality of taxpayers.
Aside from the foregoing constitutional, traditional, or political limitations, there is no restraint on the taxing power of the legislative body. Once enacted by the legislature, a tax cannot be judicially restrained. There is no way of mounting a legal attack upon a tax law on the ground that it is arbitrary or unjust, but the application of the law must be correct.
The problem of double and concurrent income taxation by overlapping governmental authorities has become increasingly important, particularly in international law. The growth of international contacts has multiplied the possibility of an individual or corporation being taxed in several countries. Moreover, the expanding financial needs of states have led them to extend their powers of taxation, with the result that cases of double taxation are becoming increasingly frequent and serious.
International tax law has two parts. One consists of the provisions of internal tax law whereby national taxes are made applicable to nonresidents and to facts or situations located outside the frontiers. The other part has its source in the growing number of international agreements designed to prevent double taxation, either by defining the field of application of the tax laws of each of the contracting states or, without limiting the field of application, by providing for the granting of credits in each of the contracting states for taxes paid under the legislation of the other.
Nearly all the agreements aimed at preventing international double taxation are bilateral; that is, between two countries. Many bilateral conventions are intended not only to prevent double taxation but also to enable cooperation between the fiscal administrations of the contracting states in combating tax evasion.
Potential problems of internal double taxation exist in federal countries (including the United States, Switzerland, and Germany). A state legislature may, for example, tax all income arising in the state, whether received by residents or nonresidents, or all income received by residents, even when the source of income is located outside the state borders. Therefore, arrangements for interstate tax coordination may be made, similar to international conventions. Alternatively, a credit for the state tax may be allowed in calculating the federal tax paid on the same object. During the 1980s the “unitary” system used by some U.S. states to tax the whole income of multistate corporations created considerable animosity in other countries. These states employed a formula to apportion between themselves and the rest of the world the entire worldwide income of affiliated firms—one of which did business in the state—that as a group were deemed to be engaged in a unitary business. This system departed radically from standard international practice, which is based on separate accounting for the corporations chartered in each country. Bowing to pressure from foreign governments, the U.S. federal government, and the international business community, most states have abolished or restricted use of this method.
Special tax problems arise when countries are involved in economic integration with each other. When two or more countries form a customs union (free-trade zone), each member state keeps its own system of taxation. The aims of an economic union are more ambitious, entailing far-reaching limitations on the sovereignty of the member states; when countries decide to form an economically integrated area, as have the member countries of the European Union, they agree to establish a unified economic and financial market. In tax terms, this means the abolition of tax (and other) discriminations and distortions, on the basis that they are likely to impede or distort normal movements of goods and capital. To this end the sales and turnover taxes of the (then) European Communities were replaced with value-added taxes (VATs), which were “harmonized,” as provided in the Rome Treaty of March 1957; all member countries have had to bring their value-added taxes into conformity with a model prescribed by the organization.
Whereas the right to impose taxes and to determine the circumstances under which they will be due is a privilege of the legislative power, administration of the tax law is the responsibility of the executive power. The head of tax administration in a central government is the minister of finance, secretary of the treasury, or chancellor of the exchequer. The actual administration is generally separated into departments because taxes differ so greatly in their bases and methods of collection. In most countries the ministry of finance has three branches charged with the levying of taxes. One collects income taxes; another levies taxes on the transfer of goods and on such legal transactions as stamp fees, inheritance taxes, registration dues, and turnover taxes; a third is responsible for customs and excise duties.
The levying of taxes can be divided into three successive phases: (1) assessment, or the definition of the exact amount subject to taxation under the statute; (2) computation or calculation; and (3) enforcement.
The definition of the amount subject to taxation under a particular statute requires an analysis of the taxpayer’s situation and of the legal provisions that apply to him. With the income tax (and also some taxes on the transfer of property, such as the inheritance tax), the taxpayer submits a tax return providing information as to his occupation, his real and personal property, his professional expenditures, and other pertinent matters; a corporation supplies, additionally, copies of the balance sheet, profit and loss statement, and minutes of the general meeting that approved these financial reports. The return, with the attached reports and statements, is meant to provide such complete information that the assessing tax official can rely on it to compute the correct tax. In the United States, the income taxpayer’s liability is computed by himself subject to review by the taxing authority. Most tax systems also collect information in other ways, in order to inform the authorities as to potential tax liabilities. Records are kept of such matters as the allocation of income by partnerships, trusts, or estates, and the payment of fees, interest, dividends, and other sums exceeding a certain minimum amount. Particularly important are the statements of amounts paid as wages and salaries, which constitute the bulk of the income tax base for individuals in most countries; these are submitted as part of the withholding (pay-as-you-earn) system.
In the case of an annual levy such as the income tax, a return must be filed every year. In many countries, however, individuals who, on the basis of the return previously filed, appear to earn an income below the taxable limit do not have to file a new return annually (this facility is subject to revision at any time). Because it is not easy for some categories of taxpayers to determine the precise amount of their occupational net income, the tax administration frequently reaches an agreement with professional associations, fixing an estimated basis on which the net taxable income of their members will be determined for a period usually exceeding one year; members are then allowed to provide the tax administration with simplified factual information (e.g., for farmers the area of land cultivated, for butchers or bakers the amount of goods sold), instead of filing the standard return.
In many countries a separate assessment procedure has been organized for income from real property; such is the case in the various European countries in which the French system of land register (cadastre) was introduced at the end of the 18th century. The theoretical income of each piece of real property is then determined by the administration of the land register and remains fixed for a relatively long period, except when important changes are made in the property.
In examining tax returns, the basic principle is that a return is assumed to be correct until the assessing official determines otherwise. In countries such as the United States, where the self-assessment method prevails, a minority of returns is selected for audit; most, however, are only checked as to timely arrival, inclusion of all required forms and attachments, and arithmetical accuracy. Except in special circumstances—when, for example, the statute introduces a suspicion of fraud (e.g., if no return has been filed) or creates certain presumptions (as when personal living expenses exceed the reported income)—the administration has no right to shift onto the taxpayer the burden of the proof that he has complied with his liabilities. The golden rule of the tax administrator consists not only in getting as much money as possible for the treasury, but in displaying fairness. The rules of taxation naturally have an authoritarian character, but tax law does not grant the taxing authority a privileged position nor deprive the individual of means of defense against arbitrary taxation.
Assessing officials have extensive powers in determining the amount subject to taxation. In addition to the routine check, there are numerous sources of information. The return of one taxpayer can be checked against that of another: in some countries whenever an individual or a corporation includes within deductible expenses the interest paid on borrowed money or the fee paid to a professional expert, the return must show the name and address of the payee, and when this information is placed before the appropriate assessing official he can readily determine whether the payee has included the payment in his declared income. Similarly, in countries employing value-added taxes invoices can be cross-checked to be sure that tax claimed as a credit by a business purchaser has actually been remitted by the seller. This ability to cross-check is often said to be a major advantage of value-added tax over other forms of sales taxes, but the advantages are easily overstated, since even with sophisticated computers cross-checking is difficult.
The procedure varies from one country to another and depends largely on the circumstances of the case. An audit may be performed either in the office of the tax agent, by correspondence, or in the taxpayer’s office. Tax agents are entitled to examine the books and records kept by the taxpayer, within reasonable limits. They are, within the same limits, entitled to question not only the taxpayer but other persons acquainted with the case. There are, however, legal guarantees, protecting confidential communications and prohibiting disclosures of financial information about the taxpayer. In the United States, for example, federal and common law protect communications between husband and wife or between a client and his attorney acting as such. Under Belgian income-tax law, certain taxpayers, in the course of the assessing official’s interrogation, may assert that they are bound by professional secrecy and unable to communicate what they claim to be privileged information; the assessing officer may then consult a special advisory board, composed of the president and two members of the taxpayer’s professional or occupational group (lawyers, doctors, notaries, etc.), which will give its opinion as to the taxpayer’s probable income.
Banks in most countries are required to make reports of cash deposits or similar transactions. In most countries, a safe-deposit box in a bank cannot be opened after the death of the client unless a tax official is present. On the other hand, some countries, such as Switzerland, Panama, and various nations in the Caribbean, have turned the guarantee of bank secrecy into a national asset. In such countries banks are legally entitled, or even required, to refuse information to tax agents concerning their clients. Funds from both legal and illegal activities are often channeled through countries with strict bank secrecy laws in order to escape taxation (as well as for other reasons).
Tax authorities do a great deal of intelligence work, using tips from informers such as employees, competitors, and neighbours of the taxpayer. In the United States, informers are encouraged by the payment of fees. But it is a fundamental principle of tax law that information cannot be used against the taxpayer if it has been obtained by unlawful means, and that no evidence or testimony is a valid proof of tax liability unless the taxpayer has had the opportunity to discuss it.
The assessor may find himself in disagreement with the taxpayer, either as to the facts (the amount of income, of deductible expenses, etc.) or as to the manner in which the taxpayer has resolved a question of law or a mixed question of law and fact. The tax agent may use his discretion as to questions of fact, and frequently a compromise is reached on those questions between the taxpayer and the tax agent.
Whenever the tax agent decides questions of law, he is bound by the treasury’s position on the particular problem. On unresolved issues, lower taxation officers (field offices) usually request the advice of a higher echelon. Allowing lower-level fiscal authorities discretion in interpreting tax laws runs the risk of encouraging corruption. In some countries, including the United States, written rulings are issued by the administration in advance, thus avoiding disputes at the level of the assessment official. In countries in which this is not done, officials at all levels are free to give informal advice concerning the tax effects of proposed transactions. The taxpayer can file a petition with the competent administrative or judicial authority whenever he believes that the interpretation of the law by the assessing official is wrong.
Computation of the tax
The second phase in levying taxes is the calculation of the amount to be paid. In the American self-assessment method, the liability for income tax is primarily established by the taxpayer himself. Under this method, as a rule, the tax liability reported on the return forms the basis of the assessment record. If the tax administration discovers that additional tax is due, a deficiency statement is issued. Virtually all countries that levy income taxes require withholding on wages and salaries. In some cases the withheld tax discharges the taxpayer’s liability and there is no obligation (and sometimes no opportunity) to file a tax return. Many countries provide for prepayment of the withholding tax on dividends and other income from personal property and have set up a “pay-as-you-go” system for professional income. Such provisional payments are calculated by the taxpayer. Advance payment of all or part of the income tax (on a voluntary or compulsory basis) before the return is filed, on the basis of expected income or of the taxable income of the previous year, is also provided for in some countries. In general, however, the final computation of taxes levied on income, on inherited property, or on the transfer of property is made by the tax administration. Sales taxes and value-added taxes are calculated by the taxpayers.
If the taxpayer fails to pay within the legally prescribed period, or within a very short time afterward, the competent tax office undertakes to collect the amount due. In proceedings against the taxpayer, the tax administration is not in the position of an ordinary creditor suing an ordinary debtor. The law confers a privileged position on the tax administration among the creditors of the taxpayer.
In addition to interest charges on the amount due, various kinds of coercive measures are available to ensure payment. Civil penalties consist generally of a fine added by the collecting agent when the violation is the result of negligence rather than of willful neglect or bad faith. Examples of negligence are the failure to file a required return on time and understatement or underpayment of the tax liability without intent to mislead. Civil penalties are fixed by assessment, so that the procedural remedies of the taxpayer are identical with those provided for the assessment of the tax itself.
Criminal tax fraud is severely punished in some countries; in others failure to fulfill one’s fiscal obligations is seen as no different from failure to meet other financial obligations. Certain tax crimes are classed as misdemeanours (such as willful failure to pay certain taxes, to file certain returns, to keep proper records, and to supply proper information); these are punishable by fines or imprisonment or both. Heavier punishment is provided for crimes classed as felonies (such as the making of false statements and, in the United States, tax evasion). In most countries the criminal penalties can be combined with the civil penalties.
Criminal penalties cannot be imposed by the tax administration. Offenses against tax law, whether misdemeanours or felonies, must be tried by courts. The procedure in criminal tax cases is almost identical with that in other criminal cases. The accused is deemed to be innocent until proved guilty; the burden of the proof inevitably rests upon the prosecutor and not upon the taxpayer-defendant.
The judiciary and tax law
The taxpayer has a guarantee against unfairness or error in the application of taxes in the right to appeal to competent, impartial authorities when he disagrees with the determination of the assessing officer.
In some countries disputes between taxpayers and the tax administration are settled by special commissions consisting of high-ranking civil servants (and also of members of various occupational organizations). In others, the decision is the privilege of the judiciary power. In the vast majority of countries, however, a combination of both systems prevails. “Out-of-court” jurisdictions—commissions composed of tax officials and laymen—frequently act as preliminary settlement committees that decide factual questions, leaving the interpretation of the tax law to the courts. In general, when a taxpayer disagrees with the amounts of the tax as calculated by the administration, or thinks he has paid too much, he files a petition with a tribunal, which may be either a specialized court or the ordinary court competent for civil litigation. Even if he must exhaust the administrative processes before he may take a dispute with the tax authorities to court, he can still invoke the jurisdiction of a judicial court to reexamine the case, in respect both of the facts and of the legal arguments.
In almost all countries, the judiciary is headed by a supreme court whose jurisdiction is limited to questions of law. The supreme court is generally competent in tax matters, but an appeal to the court must be based solely on an alleged misapplication of law; should it appear that questions of fact or mixed questions of law and fact are involved, the claim, under most judicial systems, is dismissed. (The U.S. Supreme Court can also decide on the constitutionality of an act of the legislative power.) The judiciary thus has final authority to interpret the tax statute. This interpretation is binding only in the matter submitted to the tribunal. But, in any legal system, reference to interpretative decisions of the courts in comparable cases, especially of the supreme court, is obviously the best argument in a litigation about a disputed point of tax law.
When a legal text—in tax law or in other law—requires interpretation because there is a reasonable doubt as to its meaning or scope, the first step is to determine the meaning of the words used, according to the rules of grammar and syntax, not in isolation but in their context and taking into account the subject discussed. As stated by U.S. Treasury tax lawyer Randolph E. Paul, “the meaning of a sentence may be more than that of the separate words, as a melody is more than the notes” (Taxation in the United States, 1954). This is the necessary “literal” interpretation of the law: when the current sense of a term is its wide sense, then it must be accepted in its wide sense in a tax law as in any other, unless it can be shown that the legislature used the term in a narrower sense. If the meaning of the text cannot be determined with certainty by the literal method, then the interpreter, in seeking the legislature’s intention, will resort to the “historical” method (the study both of the preparatory work and of the place occupied by the text in successive laws on a specific matter) and to the “systematic” or “teleological” interpretation (the position occupied by a legal provision in a legal system as a whole, and the object pursued by the legislature in producing that system).
In addition to these general principles common to the interpretation of all legal texts, some special rules apply to the interpretation of tax laws. One rule is the autonomy of tax law, meaning that tax laws pursue aims that are different from those of other bodies of law. The tax claim is a claim under public law. Its cause lies not in a contractual obligation but in an expression of unilateral will, a decision by the public authority. The function of taxes in the organization of the budget is incompatible with the principles of the law of contracts; such principles apply only to relationships under private law and, therefore, cannot be invoked to interpret provisions of tax law.
Other special rules of interpretation of tax laws derive from the nature of the tax obligation. In a democratic system, a tax can only be imposed by law. Thus the courts or the administration do not have a “creative power” to make things or operations taxable through an analogic interpretation of the text, in cases where it is not proved that the legislature wished them to be taxable. On the other hand, the rule of legality of taxation does not always operate in favour of the taxpayer: the person or body entrusted with the task of applying or interpreting the law cannot introduce any attenuation or relaxation of its effect, even though this might be more than amply justified by circumstances, except in cases where the legislature has authorized the judge or the administration to apply the rules of equity within certain legally prescribed limits.