Legal Positivism and Tax Law: Kelsen, Is/Ought and Capital/Revenue; Hart, Open Texture and GAARs

Abstract

AbstractPositivism, as a theory of law, is primarily a description of what the law is – or is not. And, speaking roughly, positivism holds that law is to be distinguished from morality by certain formal structures characteristic of law. The formal structure of tax law would seem to make it a useful example for the elucidation of positivism as a descriptive theory. In this chapter, we show, through the work of two leading positivists, Kelsen, and Hart, that matters are not so simple.Kelsen distinguished between “is” and “ought”, for instance in the conditional syllogism that he propounded as the canonical form of the legal norm: “If fact X exists then consequence Y ought to follow”. Readers know that his observation is fundamental to a number of Kelsen’s insights. Nevertheless, there is a more fundamental question: can a rule that breaches Kelsen’s canon and that instead takes the form: “If X ought to be then Y ought to follow”, qualify as valid law?The question seems ridiculous. How could there be a rule that not only omits a conditional factual statement but that comprises “ought” statements on both sides of the syllogism? In principle, such a rule is nonsense; yet such rules serve as foundations of income tax law. All rules that depend on distinguishing capital from revenue are of this kind.For example, the rule, “An expense that is capital ought not to be deducted in calculating income” observes Kelsen’s canonical form only if the question of whether a particular expense is capital or is revenue is a matter of fact. But courts aver that the distinction between capital and revenue is a matter of law. As a result, in respect of the many questions that fall into the capital–revenue divide, we can establish fact X of Kelsen’s syllogism only as a fictional construction of the law. Intuitively appreciating the logical flaw thus revealed, courts fall back on holding that the capital/revenue distinction is a question of degree. But as Kelsen explained, “[A] graduation of an objective value is not possible because a behavior can only conform or not conform with an objectively valid norm, but cannot do so more or less” (Kelsen H, Pure Theory of Law (trans: Knight M). University of California Press, 1967, p 21) Nevertheless, tax law breaches Kelsen’s canon, replacing fact with fiction when framing many rules.Tax avoidance often operates by clothing economic substance with contrived, essentially fictional, legal transactions. If a rule involves a fiction in the first place, it is relatively easy to replace that fiction with another in avoiding tax.Many rules of income tax law, such as the debt/equity distinction, have the capital/revenue divide at their foundation. It is not surprising that such rules are prone to exploitation by tax avoiders: deficient law may be expected to have sub-optimal results at best.As for Hart and tax law, we investigate the complicated relationship between tax law and positivism through the lens of General Anti-Avoidance Rules, or GAARs. Such anti-avoidance standards, the application of which can lead to the retroactive change of tax results that appear to follow from a strict application of the tax law, are not straightforwardly analyzed under Hart’s rubric. We conclude that, at the very least, and perhaps surprisingly, there is a strong argument that GAARs are consistent with the description of law developed by Hart.KeywordsKelsenHartLegal positivismIncome taxRevenueCapitalGAAR