The Court of Appeal held that a scheme designed to minimise the overall liability to VAT, in the context of motor breakdown insurance, amounted to an abusive practice under Community law since its essential aim was to obtain a tax advantage contrary to the purpose of the relevant provisions of Council Directive 77/388 (the sixth directive).

Facts

The taxpayer companies (‘WHA’ and ‘V’) were members of the Oriel group, along with ‘W’ and ‘C’. The group entered into a scheme designed to enable it to recover VAT charged on garage services of labour and parts, which were supplied in response to claims under motor breakdown insurance (‘MBI’) policies. Under the scheme, when a consumer purchased an MBI policy from ‘NIG’ (a company independent from the group) through NIG's agent (‘W’), NIG reinsured the risk of the policy with C, a Gibraltar-based reinsurer, and appointed C to handle claims relating to the policy. C reinsured the risk of the policy with V, another Gibraltar-based reinsurer, and appointed V to handle claims relating to the policy. V then appointed WHA, an English company, to handle the claims. Customers who had claims arising under an NIG policy contacted WHA, which directed the customers to a list of garages approved by the policy. The garage of the customer's choice supplied the repair services and the parts and invoiced WHA for the covered amount, including VAT. WHA passed the title to the parts on to V. V passed the title to C, which passed it on to NIG.

The scheme was designed to allow WHA to recover input tax on the supply of the garage services and parts while not charging output tax on the further supply to V. The scheme assumed that if WHA was required to charge output tax to V, V could recover the tax by virtue of art. 13(B) of Council Directive 77/388 (‘the sixth directive’). WHA claimed input tax on the repair services and parts supplied under the garage invoices. WHA did not charge output tax to V on the onward supply of the title to the parts, because it assumed that it was only supplying V with exempt insurance services.

Customs determined that the garages were not supplying parts and labour to WHA, but rather to the insured customers. They assessed both the taxpayer companies to VAT. The taxpayers appealed to the VAT and Duties Tribunal which upheld the assessments and dismissed the appeal ([2002] BVC 4,061).

The High Court ([2003] BTC 5,481) allowed the taxpayers’ appeal holding that there was a supply by the garage to WHA for VAT purposes and that the claims handling service which WHA provided to V fell within the phrase ‘related services’ in art. 13(B) and was an exempt supply.

The Court of Appeal held that the scheme, if taken at face value, achieved its tax-saving aim but on the basis that V, rather than WHA, was entitled to claim repayment of tax ([2004] BTC 5,425). At a further hearing, the Court of Appeal was asked to decide whether, as the Revenue contended, the scheme amounted to an abusive practice as explained by the European Court of Justice in Halifax plc v C & E Commrs (Case C-255/02) [2006] BTC 5,308.

Issues

Whether the scheme resulted in the accrual of a tax advantage which was contrary to the purpose of the sixth directive; whether it was the essential aim of the scheme that a tax advantage be obtained; whether there were any special features of the scheme which should prevent the abuse argument succeeding; and whether the scheme could and should be redefined.

Decision

The Court of Appeal (Waller and Latham L JJ and Lord Neuberger of Abbotsbury) (allowing the Revenue's appeal) said that fiscal neutrality required the conclusion that an insurer, which provided in the EU insurance services which were exempt for VAT purposes, could not recover input tax attributable to those services. Therefore, in transactions in the context of ‘normal commercial operations’ of an insurer and a claims handler, such as that embodied in the arrangements which were replaced by the scheme, there would be no question of the input tax attributable to the cost of repairs and parts being recoverable. Given that the effect of the scheme, according to the court's 2004 decision, was that input tax incurred in the provision of exempt insurance services was recoverable, the scheme was, at least to the extent that it had such an effect, contrary to the legislative purposes of the VAT legislation, as embodied in the sixth directive (Halifax plc v C & E Commrs (Case C-255/02) [2006] BTC 5,308 applied). Furthermore, it was the sole purpose of the scheme, in particular the retrocession arrangement between C and V and the creation of the claims handling chain so as to include V, to avoid, or at least to minimise, any net liability to VAT, by enabling the input tax paid by WHA to be reclaimed by V. When considering the purpose of the scheme for present purposes, one had to address primarily the aspects of the scheme which were artificial. Otherwise, many schemes, however abusive, would succeed. It was plainly envisaged in the Halifax judgment that a scheme might be abusive while having a genuine underlying commercial purpose. There was no reason in principle or logic why the applicability of the abuse principle, as considered in Halifax, should be limited to schemes which depended for their efficacy solely on Community law, whether transposed into domestic legislation or of direct effect. Since abuse was a relatively new concept in the field of VAT, the court was uneasy about the possible ramifications of basing a conclusion on a wider ground than was strictly necessary. Given that the two requirements identified in Halifax were satisfied, namely the accrual of a tax advantage contrary to the purpose of the legislative provisions and the fact that the essential aim of the transactions was to obtain the tax advantage, the scheme was abusive.

There was no need to ‘redefine’ the scheme. The only reason for a formal redefinition would be to work out the VAT consequences, bearing in mind the rights of the tax authorities to demand tax, the rights of taxpayers not to be over-taxed, and the rights of third parties. Where, as in this case, the consequences of the scheme in question being abusive involved no such rights, because the tax due had been fully paid, but not overpaid, and not refunded and no third party rights needed protection, redefinition had no purpose.

Court of Appeal (Civil Division).
Judgment delivered 17 July 2007.