The European Court of Justice (ECJ) (Grand Chamber) ruled that lease and leaseback transactions carried out as part of a tax avoidance scheme to enable the taxpayer to recover the whole of the input tax on future construction services provided to it by a non-VAT group subsidiary constituted supplies of goods or services and an economic activity for VAT purposes within Directive 77/388 (‘the sixth directive’).

Facts

The taxpayer was a provider of education with a small value of taxable supplies. Consequently it was able to recover a relatively small proportion of the VAT incurred. In 1995, the taxpayer decided to refurbish two leasehold listed buildings known as East Mill and West Mill. A scheme was devised scheme to enable the taxpayer to recover the whole of the input tax on future construction services provided to it by a non-VAT group subsidiary. Under the scheme, a discretionary trust was established by deed and, on the same date, the taxpayer entered into a deed of indemnity with the trustees, indemnifying them against any liabilities arising. The taxpayer elected to waive exemption in respect of West Mill and granted a taxable underlease to the trust for 20 years at an initial rent of £500,000. The underlease contained provision for the taxpayer to break the term on the sixth, tenth or fifteenth anniversary. The trust also elected to waive exemption and granted a taxable sub-underlease back to the taxpayer for 20 years less three days at an initial rent of £520,000. The scheme envisaged the collapse of the arrangements short of the term of each lease to obtain a substantial VAT saving. However the taxpayer did not proceed to collapse the West Mill scheme.

A similar arrangement was entered into in respect of East Mill, with both leases being at a nominal rent. A subsidiary of the taxpayer (‘Properties’), issued an invoice to the University for £3.5m plus VAT of £612,500 for future construction services at East Mill. That VAT was reclaimed by the taxpayer as input tax and was duly repaid by the commissioners. Work on East Mill was completed on 7 September 1998 and the taxpayer occupied the building on the same day. Prior to completion, the taxpayer asked the commissioners for confirmation that the surrender of the sub-underlease by the trust to the taxpayer for no consideration would not create a supply either by the taxpayer or the trust, and that the termination of the underlease granted by the taxpayer to the trust would, likewise, not be a supply by either party. The commissioners took the view that there was no commercial purpose to the arrangements entered into by the taxpayer and raised an assessment for £612,500 to recover VAT claimed as input tax.

The VAT tribunal held that the assessment under appeal was valid and, in so far as it was made under VATA 1994, s. 73(1), it was made to best judgment. The transactions were entered into by the taxpayer with the sole intention of obtaining a fiscal advantage: they had no independent business purpose. The tribunal refer the case to the ECJ for a preliminary ruling (Decision No. 17,854; [2003] BVC 2163).

Issue

Whether transactions under the scheme constituted supplies of goods or services and an economic activity within art. 2(1), 4(1), (2), 5(1) and 6(1) of the sixth directive, where they were carried out with the sole object of obtaining a tax advantage, without any other economic aim.

Decision

The ECJ (Grand Chamber) (ruling accordingly) said that the sixth directive established a common system of VAT based, inter alia, on a uniform definition of taxable transactions. The scope of VAT was very wide in that art. 2 of the sixth directive, which concerned taxable transactions, referred not only to imports of goods but also to the supply of goods or services effected for consideration within the territory of the country by a taxable person acting as such. Article 5(1) of the sixth directive stated that any transfer of the right to dispose of tangible property as owner constituted a supply of goods. That term covered any transfer of tangible property by one party which empowered the other party actually to dispose of it as if he were the owner of the property. It was clear from art. 6(1) that a supply of services covered all transactions not constituting a supply of goods within art. 5. According to art. 4(1), any person who independently carried out any economic activity, whatever the purpose or results of that activity, was regarded as a taxable person. Finally, the term ‘economic activity’ was defined in art. 4(2) as comprising ‘all’ activities of producers, traders and persons supplying services and included all stages of production, distribution and the provision of services.

An analysis of those definitions showed that the scope of the term economic activities was very wide, and that the term was objective in character, in the sense that the activity was considered per se and without regard to its purpose or results. Accordingly, the terms which defined taxable transactions under the sixth directive, were all objective in nature and applied without regard to the purpose or results of the transactions concerned (Optigen Ltd & Ors v C & E Commrs (Joined Cases C-354/03, C-355/03 and C-484/03) [2006] BTC 5,050 referred to). An obligation on the tax authorities to carry out inquiries to determine the intention of the taxable person would be contrary to the objectives of the common system of VAT of ensuring legal certainty and facilitating application of VAT by having regard, save in exceptional cases, to the objective character of the transaction in question. It followed that transactions of the kind at issue in the main proceedings were supplies of goods or services and an economic activity, provided that they satisfied the objective criteria on which those concepts were based. Whilst those criteria were not satisfied where tax was evaded, for example by means of untruthful tax returns or the issue of improper invoices, the fact remained that the question whether the transaction concerned was carried out for the sole purpose of obtaining a tax advantage was irrelevant in determining whether it constituted a supply of goods or services and an economic activity. However, it should be noted that the sixth directive precluded any right of a taxable person to deduct input VAT where the transactions from which that right derived constituted an abusive practice.

European Court of Justice (Grand Chamber). Judgment delivered 21 February 2006.