The special commissioners decided (by the chairman's casting vote in accordance with reg. 18(2) of the Special Commissioners (Jurisdiction and Procedure) Regulations 1994 (SI 1994/1811)) that they should withdraw a reference to the ECJ but concluded that the CFC legislation was compatible with art. 43 and 48 EC, on the basis that the motive test as defined in the CFC legislation lent itself to the conforming interpretation of national statutes in relation to international obligations.

Facts

This case concerned a further development in the application by the taxpayer for a closure notice under para. 33 of Sch. 18 to the Finance Act 1998. At the earlier stage the special commissioners made a reference to the ECJ ((2005) Sp C 512). The ECJ subsequently gave judgment in the reference in Cadbury Schweppes plc & Anor v R & C Commrs (Case C-196/04), which, like the present application, concerned the compatibility with Community law of the legislation on controlled foreign companies (ICTA 1988, s. 747 to 756 and Sch. 24 to 26). After that, the Registrar of the European Court asked the special commissioners whether, in the light of the judgment in Cadbury Schweppes, they wished to maintain the reference in the present application. At a hearing before the commissioners, the taxpayer argued that the ECJ's judgment in Cadbury Schweppes gave clear guidance to the effect that the CFC legislation was not compatible with Community law and that therefore the commissioners should dispose of the application without more ado by directing the Revenue to issue a closure notice. In those circumstances they should withdraw the reference. The Revenue invited the commissioners to withdraw the reference on the grounds that the ECJ's judgment in Cadbury Schweppes gave clear guidance that the CFC legislation was compatible with art. 43 EC and 48 EC if and to the extent that, in the context of a controlled foreign company (CFC) resident in a member state other than the UK, it related only to wholly artificial arrangements intended to escape the national (UK) tax normally payable. They further submitted that the CFC legislation could, and should, be interpreted by the commissioners as the national court, as a matter of conforming interpretation, so that it could not be applied in circumstances where to do so would infringe Community law as declared by the ECJ in Cadbury Schweppes, but otherwise stood and was generally applicable according to its terms.

Issue

Whether the guidance in Cadbury Schweppes required the commissioners to consider the interpretation of the motive test alone or whether it put in issue the interpretation of the CFC legislation as a whole; and whether the reference should be maintained.

Decision

The special commissioners (John Walters QC and Theodore Wallace) (deciding by the Chairman's casting vote that the reference should be withdrawn) said that it appeared that the guidance given by the ECJ was that the CFC legislation itself introduced a restriction on freedom of establishment which could be justified on the basis that it enabled the UK to thwart practices which had no purpose other than to escape the tax normally due on the profits generated by activities carried on in the UK. However, the restriction had to be proportionate to the achievement of that objective. The CFC legislation was proportionate in relation to that objective if and to the extent that it confined the restriction to wholly artificial arrangements intended to escape the UK tax normally payable.

The guidance in Cadbury Schweppes was that the commissioners should consider whether the motive test, as defined by the legislation on CFCs, lent itself to an interpretation which enabled taxation provided for by that legislation to be restricted to wholly artificial arrangements, so that the CFC legislation applied in the case of a CFC established in a member state, only in a case where there were such wholly artificial arrangements intended to escape the UK tax normally payable.

The motive test in terms prevented an apportionment where the two stated conditions requiring the absence of a tax avoidance purpose were present (see ICTA 1988, s 748(3)). The ECJ had stated that the CFC legislation could be regarded as compatible with art. 43 and 48 EC only if the motive test, as defined by the CFC legislation, lent itself to an interpretation which enabled the taxation provided for by that legislation to be restricted to wholly artificial arrangements.

Wholly artificial arrangements for those purposes were such arrangements where, in addition to a subjective element consisting of the intention to obtain a tax advantage, objective circumstances showed that, despite formal observance of the conditions laid down by Community law, the objective pursued by freedom of establishment had not been achieved.

Clearly the motive test in terms effectively restricted the application of the CFC legislation to cases where there was a subjective element consisting of the intention to obtain a tax advantage. The exceptions under ICTA 1988, s. 748(1) broadly excluded the application of the CFC legislation in a series of other circumstances which were objectively defined. The exclusion of the application of the CFC legislation in cases where, although there was a subjective intention to obtain a tax advantage, there was objective evidence that the arrangements were not wholly artificial would be consistent with the purpose of the CFC legislation and would also achieve the objective pursued by freedom of establishment.

On the question whether the motive test as defined by the legislation on CFCs lent itself to an interpretation enabling the taxation provided for by the CFC legislation to be restricted to wholly artificial arrangements, the commissioners were unable to agree. By the chairman's casting vote, a restriction in the application of the motive test as defined in the CFC legislation to its application only to wholly artificial arrangements could be ‘read down’ into ICTA 1988, s. 748(3) as a matter of conforming interpretation, and the result would not be inconsistent with the scheme or ‘grain’ of the motive test as defined by the CFC legislation. In particular, the scheme or ‘grain’ of the motive test as so defined served as part of the legislative mechanism in place to ensure that the CFC legislation was not applicable in situations which were not abusive (or to ensure that the CFC legislation was only applicable in abusive situations). Accordingly the CFC legislation could not be applied where it was proven by the UK-resident controlling person(s), on the basis of objective factors which were ascertainable by third parties, that despite the existence of tax motives, the CFC concerned was actually established in the host member state and carried on genuine activities there. Therefore there would have to be a further hearing to decide whether the circumstances of the present case showed wholly artificial arrangements.

(2007) Sp C 622.
Decision released 26 July 2007.