In the Media

VAT ruling creates 'abuse' law

PUBLISHED June 29, 2006

Business advisers warn of far-reaching implications as HMRC hints at push to extend the abuse of rights principle

The Halifax judgment handed down on 21 February establishes in UK VAT law the principle of an ?abuse of rights?, that where a tax arrangement is set up with the essential aim of avoiding tax, it will not be effective for tax purposes.

Some advisers doubt how far the judgment actually goes, while HM Revenue & Customs has said on the record that it wishes to push the principle as far as possible, potentially across the range of taxes.

The case, more than anything, is set to cause uncertainty in the minds of businesses and deter them from entering into tax planning that may come within Halifax?s remit.

The case, or rather the series of cases, decided by the European Court of Justice (ECJ) related to complex tax arrangements. Halifax had set up a series of companies designed to reclaim VAT, which it would not normally be able to claim.

Bad medicine

There were two other cases put before the court testing the same principle.

In the first case, involving BUPA, the private medical supplier had anticipated a change in the law regarding its reclaim of VAT that would have meant it paid a higher rate. It entered into an arrangement with a subsidiary that, for invoicing purposes, pushed through orders of supplies on a certain date, even if the goods did not arrive until later. To do so, its subsidiary, Goldsborough Developments, took on a loan worth seven times its turnover, to place an order for drugs that would last between 50 and 100 years.

A second case involved the University of Huddersfield, which had set up a trust to refurbish two mills that it owned in Huddersfield. The trusts could claim VAT advantages that it, as a university, could not.

Double trouble

HMRC had tried to pursue two different arguments in relation to the cases.
The first alleged that, since the activities were entered into for avoidance of tax and not for any legitimate business purpose, they did not, therefore, constitute ?economic activity?.

EU VAT directives require an economic activity to have occurred for VAT to be reclaimable, so the ECJ rejected HMRC?s argument. It said that an ?economic activity? must be objective in nature. It cannot be a question of the intention or purpose of a transaction.

Introducing such a subjective principle would undermine the basis of the VAT directives, it said, frustrating the need for certainty. It concluded: ?The fact remains that the question whether a given transaction is carried out for the sole purpose of obtaining a tax advantage is entirely irrelevant in determining whether it constitutes a supply of goods or services and an economic activity.?

But the ECJ did accept HMRC?s second argument, that the arrangements could be frustrated in that they were an abuse of rights. The principle of an abuse of rights had been developed in relation to an Austrian taxpayer, who had been exporting powdered milk to obtain an export subsidy, then re-importing it and paying a lower tariff on the goods.

In the Halifax cases, too, the court held that an abuse of rights principle did exist in community law. It expressed it as follows: ?For it to be found that an abusive practice exists, it is necessary, first, that the transactions concerned, notwithstanding formal application of the conditions laid down by the relevant provisions of the Sixth Directive and of national legislation transposing it, result in the accrual of a tax advantage, the grant of which would be contrary to the purpose of those provisions.

Second, it must also be apparent from a number of objective factors that the essential aim of the transactions concerned is to obtain a tax advantage.?

The national courts would have to decide, paying heed to the question of what the transactions were essentially about, and what their real substance and significance were.

The cases themselves are likely to now return to the UK courts to establish facts and other issues, while the principle established by the ECJ in relation to them has already been enthusiastically embraced by HMRC.

The department issued a statement on the cases at the end of February, saying that there were around 175 cases pending the ECJ judgment. They are being held over until 22 April, 60 days after the judgment was issued, and both the tax authorities and taxpayers are using the time to consider how to proceed.

Far reaching judgment

HMRC would also like to push the judgment as far as it would go. In an interview with Financial Director?s sister magazine Accountancy Age in October, Dave Hartnett, director general of HMRC, strongly hinted that the case could be used more widely. ?We will certainly be looking at the potential scope of using abuse of law arguments if the court confirms the view,? he said. Advisers have not known exactly which emphasis of the judgment to take most seriously.

The strong defence of the argument that avoidance activities constitute economic activities has encouraged some. Advisers at Grant Thornton have suggested it means that ?tax authorities can attack VAT avoidance using an ?abuse? doctrine, but only if it would offend the underlying policy of the legislation to give the business the benefit?.

Derek Allen, director of taxation at ICAS, focused on the fact that the court was suggesting tax arrangements could now be judged purposively. ?Clearly, there is nothing unlawful about tax avoidance, but this verdict seems to me to judge the motivations behind setting up avoidance schemes,? he said.

Whatever the exact meaning of the judgment, it is clear that it will create confusion, a win, in other words, for HMRC.

As Penny Hamilton, an indirect tax barrister, said: ?This creates uncertainty. Businesses like certainty.?