The High Court held that, where a series of transactions appeared to confer a tax advantage by way of deductibility of input tax and the accrual of that tax advantage was admittedly the essential aim of the series, the grant of that tax advantage was not to be taken to be abusive, contrary to the purpose of Council Directive 77/388 (‘the sixth directive’), where the only further proven ingredient was that the series of transactions between the parties was not in the context of their normal commercial operations.

Facts

The taxpayer was a member of the Churchill group, which made predominantly exempt supplies of insurance and was therefore able to recover less than one per cent of its input tax. The taxpayer, which was not part of the VAT group, bought assets using funds provided by companies in the Churchill group which it then leased to an unconnected company (S). In turn, S leased the goods to group companies, CML and CARC. VAT on the purchase of the goods was recovered as input tax by the taxpayer and VAT was charged on the lease rentals to S. S reclaimed the VAT and charged VAT on the lease rentals to CML and CARC. The taxpayer did not pay interest on the loans received from the group, but surrendered the corporation tax losses arising out of capital allowances on the purchase of the leased assets. CARC and CML paid VAT on the sublease rentals as they fell due.

Customs took the view that the scheme was artificial and uncommercial and that its essential aim was to obtain a tax advantage. On the basis that the scheme was abusive, Customs purported to ‘redefine’ the arrangement so as to undo any tax advantage which it might otherwise have conferred upon the group or upon the taxpayer (as a subsidiary of CML) as part of it, and made assessments accordingly to recover the VAT reclaimed by the taxpayer. The taxpayer appealed.

The VAT tribunal allowed the taxpayer's appeal on the basis that the arrangements were not contrary to the purpose of the Community or domestic legislation.

Customs appealed arguing that the arrangements were abusive within the decision of the European Court of Justice in Halifax plc v C & E Commrs (Case C-255/02) [2006] BTC 5,308; [2006] ECR I-1609 because they were not carried out in the context of the taxpayer's normal commercial operations.

Issue

Whether the transactions entered into by the taxpayer with the intention of avoiding or deferring VAT on the provision of assets to connected exempt companies were contrary to the purpose of the sixth directive and amounted to an abusive practice.

Decision

Lindsay J (dismissing the appeal) said that, where one was looking at a series of transactions the essential aim of which was to confer a tax advantage by way of the deductibility of input tax, it did not suffice to brand the series as abusive simply to prove that the series was not in the context of the parties’ normal commercial operations. Even when the essential aim was admitted and where the arrangements made were artificial, not at arm's length commercially and devoid of commercial motive other than as to the attainment of the essential aim, the first part of the strict definition of abusive practice laid down in para. 86 of the Halifax decision was not satisfied merely by pointing to the arrangements made not having been normal commercial operations unless, in the circumstances viewed as a whole, the grant of the tax advantage concerned would be contrary to the purposes of the sixth directive and the national legislation implementing it (Halifax above applied).

Whether one regarded the tax advantage in question as being simply a spreading of the VAT over a period as rentals or sublease rentals were paid or, as a composite made up of the taxpayer having deducted 100 per cent of its input tax when it made the purchase, of using Sso as to avoid a valuation under VATA 1994, Sch. 6 and as mitigation of VAT by way of its being spread by drip feeding over the life of the leases, given that the VAT exigible upon the supply of the goods, upon their leasing by the taxpayer and upon their subleasing to CML and CARC was all duly paid, it was difficult to see that the accrual of the tax advantages in issue would be contrary to the purpose of the relevant provisions of the sixth directive and of the national legislation transposing it.

Although the tribunal had failed to address the question whether the scheme constituted normal commercial operations when viewed as a whole, their decision would not have been any more favourable to Customs had they done so than it was. The tribunal would have been entitled to have regarded the scheme as exempt traders acquiring goods, as they were entitled to do, by way of lease rather than purchase and hence bearing VAT referable to the rentals and by instalments, as the legislation provided, which VAT they paid. The transactions were artificial, commercially hollow and not normal commercial operations and regard had to be paid to elements that were artificial (WHA Ltd v R & C Commrs [2007] BTC 5,748 considered). Even so, such facts of themselves did not justify the consequence that a grant of the tax advantage prima facie gained would be contrary to the purposes of the sixth directive, but rather pointed more to the limited reach of VATA 1994, Sch. 6 as to who were connected persons and to Customs’ failure to have argued that it was the interposition of S coupled with the lowness of the rentals which (if there was any) was the real abuse.

That was far from saying that a combination of the essential aim described in the second part of para. 86 of Halifax coupled with the transaction in question not being a normal commercial operation would never require the transaction concerned to be regarded as abusive and as such that the accrual of a tax advantage from it would be contrary to the purpose of the sixth directive and of national legislation transposing it.

There would, no doubt, be cases where that combination, with some added factors such as a breach of the principle of fiscal neutrality, would suffice. But here, on the case as put by Customs, there was no added factor. It followed that the ‘normal commercial operations’ argument did not open a door, which the tribunal had failed to spot, to a ‘redefinition’ of the scheme. Even had redefinition been available, the court would have declared that there should be a reassessment for VAT to yield such VAT as would have been payable had fully commercial open market rents been payable as between the taxpayer and S and S and CML or CARC. Redefinition was not intended to open the door to penalty and did no more than undo the advantage which should never have been gained.

Chancery Division.

Judgment delivered 16 January 2008.