European Court of Justice

Sosnowska v Dyrektor Izby Skarbowej we Wroclawiu Osrodek Zamiejscowy w Walbrzychu (Case C-25/07)

VAT – refund of overpaid VAT

The taxpayer submitted a tax return reporting a payment of excess VAT. She sought repayment of that overpayment within a period of 60 days from the date of submission of her VAT return. The tax office rejected her application on the basis that she could not obtain the repayment of the excess VAT within the period of 60 days, because she had commenced her activities less than 12 months earlier and she had not supplied to the tax office a special deposit; hence she did not satisfy the conditions established for entitlement to the repayment sought.

The taxpayer appealed to the Regional Administrative Court of Wroclaw. The Court referred the decision to the ECJ on whether the National legislation was in accordance with the Sixth Directive.

The key question was whether the Sixth Directive must be interpreted as precluding national legislation, which extends from 60 to 180 days, the period available to the national tax office for repayment of excess VAT to a category of taxable persons (unless those persons lodge a security deposit), in order to allow inquiries necessary to prevent tax evasion and avoidance.

The ECJ found in favour of the taxpayer – the Sixth Directive did preclude such national legislation.

The Sixth Directive provides that the taxpayer should be entitled, in appropriate circumstances, to recover the excess VAT, and key to this argument – within a reasonable time period. The National legislation did not provide for the repayment within a reasonable time period. In addition, the provisions which were designed to deal with tax evasion did not fall within “special measures for derogation” as the amount of the deposit did not reflect the amount of the overpayment.

For further information, see page 22.

UK Court of Appeal

R (on the application of Davies & Anor) v R & C Commrs

Judicial Review

Revenue had claimed that the taxpayer was ordinarily resident in the UK for a particular tax year and as a result was liable to capital gains tax. The taxpayer argued that he was not resident in the UK and he appealed to the Special Commissioners. In addition, the taxpayer sought permission for judicial review.

The issue was whether the two actions could go ahead in parallel. The High Court had ruled that the appeal to the Special Commissioner should proceed first. The taxpayer appealed this decision to the Court of Appeal.

The Court of Appeal ruled that the taxpayer's application for judicial review should go ahead. The reason for this decision was that if the application was stayed and the Special Commissioner found against the taxpayer, then the application for judicial review would be pre-empted.

For further information, see page 23.

Johnston Publishing (North) Ltd v R & C Commrs [2008] EWCA Civ 858

Intra-group transfers – associated companies

This case revolves around the construction of legislation.

Shares were transferred from one group company to another – at this stage the transferor company and transferee company were not associated. A chargeable gain did not arise at this time as it was an intergroup transaction. The company that had received the shares left the group. At the time of leaving the group, it was associated with the company that it had received the shares from. For clarity's sake it is important to note that the company that it was associated with was also it's subsidiary at the time of leaving the group.

The taxpayer argued that no chargeable gain arose on leaving the group because it was associated with the transferor company at that time. The Revenue argued that the two companies must have been associated at the time of the transfer AND on leaving the group.

The key issue in the decision is the interpretation of the section 179 (2) TCGA 1992, and in particular the need for the second reference to “associated” –

“Where 2 or more associated companies cease to be members of the group at the same time, subsection (1) above shall not have effect as respects an acquisition by one from another of those associated companies.”

It was decided by the Court of Appeal to uphold a decision of the High Court that it was necessary that associated companies should have been associated not only at the time of leaving the group but also at the time of the previous intra-group transfer. The key issue in the construction of the legislation was whether or not the second use of associated was intended or not – the taxpayer contended that it was redundant but the Revenue argued that it was there for a purpose. Detailed discussion took place on the drafting and construction of legislation. It was held that the second use of the word “associated” was intended.

The corresponding Irish legislative provision, section 623 (3) TCA 1997, has almost identical wording so this case should have relevance for Ireland as well. Also, as this case revolves around the construction of legislation, it could have more wide-ranging relevance than just inter-group transfers.

For further information, see page 26.

UK High Court (Chancery Division)

Procter & Gamble (UK) Ltd v R & C Commrs [2008] EWHC 1558 (Ch)

VAT – Pringles as a potato crisp?

The VAT Tribunal had decided that “Regular Pringles” were standard-rated as being within the words “potato crisps, potato sticks, potato puffs and similar products made from the potato, or from potato flour, or from potato starch”.

For VAT purposes, “Food of a kind used for human consumption”: subject to some exceptions, is zero rated. One such exemption is:

“Any of the following when packaged for human consumption without further preparation, namely, potato crisps, potato sticks, potato puffs and similar products made from the potato, or from potato flour, or from potato starch, and savoury products obtained by the swelling of cereals or cereal products; and salted or roasted nuts other than nuts in shell.”

These items are standard-rated.

The Court found in favour of the taxpayer, Regular Pringles are not, on the facts found, “potato crisps, potato sticks, potato puffs and similar products made from the potato, or from potato flour, or from potato starch “ and hence should be zero-rated.

In reaching this decision, the following approach was taken in interpreting the legislative provision: the product must be wholly, or substantially wholly, made from the potato. In other words, the product must contain nothing, or substantially nothing, other than potato. The percentage of potato varies in Regular Pringles: at the time of the hearing it was about 39.48%, currently it is around 42.2% though it may drop again to 35% to 38%.

For further information, see page 29.

Vodafone 2 v R & C Commrs [2008] EWHC 1569 (Ch)

Controlled Foreign Companies (CFCs)

Vodafone Investments Luxembourg Sarl (‘VIL’) was incorporated as part of the project by which the Vodafone Group acquired the German company Mannesmann AG in March 2000. VIL is the intermediate holding company of Mannesmann AG and other European telecommunications companies in which the Vodafone Group has an interest. VIL's annual accounts showed equity investments valued at €38 billion and debt investments amounting to €35 billion representing loans made by VIL to the Mannesmann Group and other telecommunications companies of which it was the holding company.

It was HMRC's contention that the interest earned by VIL on its loans to the German subsidiaries for the accounting period, fell to be taxed as if it was the income of Vodafone as a result of the application to it of the CFC legislation.

The Taxpayer appealed against the Revenue's determination on the basis of EU freedom of establishment.

The compatibility of the CFC legislation with EC law, had been made in the case Case C-196/04 Cadbury Schweppes v Commissioners of Inland Revenue. It had been held that the UK CFC rules were incompatible with EC law.

The High Court relied on the ECJ decision in deciding that UK CFC legislation was disapplied in imposing on the Vodafone group a charge to tax in respect of the Luxembourg company. It was not possible to give the UK CFC provisions a construction which would make it compliant with EC law. In addition, it was not the duty of the UK Courts to amend UK legislation.

For further information, see page 31.

R & C Commrs v Khawaja [2008] EWHC 1687 (Ch)

Penalties on underpaid tax

The taxpayer was the controlling director of a company which ran a restaurant. He received remuneration from the restaurant and submitted tax returns in which he declared the amounts he had received in respect of remuneration from the restaurant, benefits-in-kind and rental income.

HMRC considered that he had under-declared his income and raised its own assessments, estimating the amounts it believed he had obtained. He appealed those assessments first to the General Commissioners and then to the High Court. He reduced the income assessed under each of the heads, but left significant sums owing on the assessments.

HMRC served penalty notice on the taxpayer in respect of “negligently submitting incorrect returns”. The taxpayer appealed the penalty notice to the General Commissioner who reduced the penalty due. HMRC appealed to the High Court.

The High Court remitted the appeal to the General Commissioner on the basis that the General Commissioner had erred in applying the incorrect standard of proving beyond reasonable doubt – they had used the criminal standard of proof, instead of the civil standard.

This is an interesting case which looks at the standard of proving beyond reasonable doubt – where the proceedings are civil (such as negligence), then the proof should be civil; on the other hand where the proceedings are criminal (such as fraudulent tax evasion), the standard of proof must be criminal. Try using this explanation the next time a Revenue official gets mixed up between tax evasion and tax avoidance!

For further information, see page 32.

Drummond v R & C Commrs [2008] EWHC (Ch) 1758

Tax avoidance scheme – capital loss

The realisation of policies of insurance and of assurance by surrender is both a disposal for capital gains tax purposes and an event giving rise to a charge to income tax. This case concerned the interrelationship between these two sets of provisions.

A small corporate finance and investment company operated as a market maker in second hand life assurance policies. The taxpayer bought five policies from the company on 4 April 2001. On 5 April 2001 (as had been intended from the outset) the taxpayer surrendered the five policies for £1.751 million, part of the surrender money being used to discharge the obligation to pay the outstanding consideration payable that day. The process had cost the taxpayer about £210,000. The object of the process had been to create an allowable capital gains tax loss of £1.962 million (which the taxpayer had paid in acquiring the policies) to offset against a separate capital gain of £4.875 million which the taxpayer had made on the sale of shares.

The surrender of the policies was both a “disposal” for capital gains tax purposes and a “chargeable event” for income tax purposes. The legislation deals with this situation as follows:

“There shall be excluded from the consideration for a disposal of assets taken into account in the computation of the gain any money or money's worth charged to income tax as income of, or taken into account as a receipt in computing income or profits or gains or losses of, the person making the disposal for the purposes of the Income Tax Acts.”

The taxpayer's key argument was that the surrender value of the policies had been taken into account as a receipt for income tax purposes. As the surrender value and the original cost of acquiring the policies were equivalent, a minimal amount was subject to income tax.

The Revenue disallowed the £1.9m capital loss.

It was held that the taxpayer was not entitled to exclude the surrender proceeds from the consideration in the capital gains tax computation. It should be noted that the Judge gave a purposive construction to the legislation – the provision was intended to ensure a taxpayer did not suffer double taxation in relation to a single event, i.e. proceeds not taxed twice; it was not intended that proceeds should not be taxed at all.

For further information, see page 33.

UK High Court (Administrative Court)

Japan Post & Ors v R & C Commrs [2008] EWHC 1511 (Admin)

Income Tax – repayment supplement

This case deals with a very specific claim for nonresidents: a repayment supplement as a result of an overpayment of tax by virtue of an entitlement to tax credits in respect of a qualifying distribution, which is income of any sovereign power or of the government of that foreign power or of any international organisation.

The taxpayer met the condition of entitlement to the tax credit as it was an arm of the Japanese Government.

The High Court found against the taxpayer, i.e. it ruled that the taxpayer was not entitled to interest on the tax credit. The reason being, that the relevant provisions dealt with UK resident individuals only. The provisions allowing tax credits had been extended to non-residents but the corresponding repayment supplement provisions had not been extended.

Presumably the EU fundamental freedoms were not helpful as the case dealt with a non-EU country.

For further information, see page 34.

Special Commissioners

Alternative Book Co Ltd v R & C Commrs

IR35

The taxpayer company was appealing against determinations which were made under what is commonly known as the IR35 legislation which was enacted for the purpose of curbing the tax advantages enjoyed by some individuals who supplied their services through a personal service company to a client.

The IT consultant provided his services to the final company through a series of two connected contracts: the first was a contract between the taxpayer company and a recruitment agency. The second was a contract between the agency and the final company to supply the services of the taxpayer using the IT consultant.

The Special Commissioners ruled against the taxpayer company by deciding that the IT consultant would have been regarded as an employee of the final company.

The reason being, that the hypothetical contract between the IT consultant and the final company would have been an employment contract. The following were facts which indicated a contract of service:

• The IT consultant was obliged to provide his services personally and exclusively during the hours contracted;
• The final company was required to provide work of 36 hours per week under the contracts which could only be terminated early by four weeks notice or on exceptional grounds;
• There was an obligation on the IT consultant to obtain prior authorisation for extra hours and absence, and the obligation on the final company to provide equipment.

For further information, see page 35.

GC Trading Ltd v R & C Commrs

Wholly unreasonable behaviour?

This decision concerned the taxpayer's application for the costs of the appeal – the taxpayer won the appeal. The issue here was whether the Special Commissioner should make an order awarding the taxpayer the costs of or incidental to the appeal on the basis that the Revenue “ has acted wholly unreasonably in connection with the hearing ” of the appeal.

• Taxpayer argument: the Revenue should not have proceeded with the case as it was a “flagrant attempt to bully the taxpayer into submission with arguments which never had any chance of success”. It was wholly unreasonable for the Revenue to pursue a case in which the argument advanced had no statutory or case law support.
• Revenue argument: it had acted properly and in good faith. Accordingly, it had not acted wholly unreasonably in connection with the hearing of the appeal.

It was decided that the Special Commissioner did not have jurisdiction to award costs to the taxpayer as it had found that the Revenue had acted reasonably.

For further information, see page 36.

Executors of Piercy (deceased) v R & C Commrs

Inheritance tax – business property relief

This was an appeal raising the single question of whether the shares in a company, were shares in a company “whose business consisted wholly or mainly in making or holding investments”.

If the shares were shares in such an investment company then business property relief would be denied in relation to the value of the shares on the relevant death. If the argument that the company was a property development company whose holdings of land ranked as stock, and if the substantial amounts of rental income received by the company did not undermine this claim, then the shares will have qualified for 100% relief from Inheritance Tax.

The company unquestionably commenced its life as a property development, and not as an investment, company. The Special Commissioner was equally satisfied that it never formed a deliberate intention to acquire properties as investments, or to hold properties for their income potential as a deliberate policy act, and thus to change its deeply engrained business model.

Due to planning delays the few developments that the company was progressing in the 1980s and early 1990s dragged on for very long periods. Notwithstanding these delays and the resultant slow level of trading, the Special Commissioner was convinced that the company continued to trade at all times. Also, property was never acquired as an investment.

On this basis, the Special Commissioner decided that the company was not an investment company and a claim for business property relief could be made.

The following is an interesting comment from the case which shows the pragmatic approach taken:

“the objects clause of its Memorandum of Association contained the classic objects for an investment company. I regard this as being no more than an unfortunate mistake made by the solicitor who formed the company (possibly the same solicitor who appeared to have been something of a property law expert) because there is not the faintest doubt that the business of the company commenced as a trading and property development business and not that of investment.”

For further information, see page 37.

Bailhache Labesse Trustees Ltd v R & C Commrs

Discretionary trusts appointment to charities following death

The deceased had bequeathed his free estate to two relatives and 25% to each of the National Trust and the National Trust for Scotland. It was accepted that to the extent that his property was given to charities (also to “national bodies”), transfers of value were turned into exempt transfers for Inheritance Tax purposes.

The deceased had also made a settlement in 1985, in which he was the life tenant, with the trustees holding the property on his death on discretionary terms for a class of beneficiaries defined in the settlement. The class included the National Trust and the National Trust for Scotland and other non-charitable persons. Within the twelve-month period following the death of the deceased, the trustees appointed 25% of the trust property to each of the two National Trusts.

The Inheritance Tax Acts contains a number of provisions in relation to the availability of the charitable exemption in respect of events that have occurred within twelve months of death. As a result, it was contended by the Appellants that, as the appointments to the two trusts had been made within that period, it followed that the appointments to the two National Trusts were “exempt transfers”. In addition, the trustees tried a different argument: had the deceased settled the trust property on discretionary trustees in his will, the appointments made by the trustees within a two year period could all be treated as having been made on his death by the deceased.

The Special Commissioner rejected both arguments and found in favour of the Revenue.

The following reasons were given:

Argument 1 [12 months] – In order for this argument to work, the two National Trusts had to actually receive conditional gifts on the death of the deceased. As this was clearly not the case, this argument was not allowed.

Argument 2 [2 years] - While there may have been slight oddities in the legislation (relief available where disposition made in a will but not available when not in a will), as the deceased had not made provision in his will for the transfer of the property to the Trusts, exemption was not available.

For further information, see page 38.

Barkers of Malton Ltd v R & C Commrs

Acquisition of business with losses carried forward

The Appellant had acquired a trade with trading assets and liabilities of a company. That company had previously (within the same day) acquired the trade of another company which had substantial trading losses. It was resolved that the company with the original losses would continue to run the trade as an undisclosed agent on the Appellant's behalf. The Appellant had claimed the benefit of trading losses which accrued to the other company.

The Special Commissioner decided that the Appellant was not entitled to the benefit of the trading losses accrued by the original company. The key issue in the decision was that in the initial transfer, the acquiring company had not carried on the trade of the original company which was necessary for the losses to be available to the Appellant. Even though in the initial transfer, the acquirer had owned the business for a mere ninety minute period, the Special Commissioner focused on this part of the reorganisation – that company had to have carried on the trade (not just owned it) during that ninety minute period in order for the Appellant to be allowed use the losses. However, as it was known that the trade would be transferred to the Appellant in a matter of minutes, the parties did not contemplate that the initial acquirer of the trade would have to carry on the trade during those minutes.

The facts in the report of the Special Commissioner outline the level of planning involved. This case is a warning of how the best made plans can go wrong where just one step in those plans doesn't work.

For further information, see page 39.

Lewis v R & C Commrs

Travel expenses between home and office

The issue in this appeal was the deductibility of the Appellant's travelling expenses between her home where she worked for two or three days a week and her office in London where she worked the remainder of the week.

Initially I thought “this old chestnut” until I noticed that the Appellant was a Revenue employee.

This case is distinguished from the usual “travel expenses from home to work” in that it deals with the typical case of an employee working from home in an office which is as good if not better equipped than the “regular” office. When one reads the details of the work arrangement, one can understand why the taxpayer had appealed.

Details were given of the work arrangements in the Appellant's home office at the Appellant's home:

• it comprised a laptop, a docking station, a computer monitor screen, a printer, a keyboard and mouse;
• the employer (which happened to be the Revenue) arranged for the installation of a high speed ISDN line for computer data and a BT business phone line with phone and voicemail in the name of the Inland Revenue to a room at the Appellant's home;
• bills for provision of these services were sent quarterly directly by BT to The resource Manager, Inland Revenue Management Services Unit;
• the employer provided a desk extension, an office chair, a four-drawer lockable filing cabinet, a first aid kit and a fire extinguisher for the office at the Appellant's home;
• work was allocated to the Appellant at both workplaces by email and telephone;
• the Appellant had files and post delivered to a named pigeon-hole at the Coventry Tax office post-room;
• the Appellant collected post from there and deposited any outgoing post;
• the Appellant disposed of confidential waste at the Coventry office and had access to photocopying facilities there.

The Appellant was reimbursed for the receipted amounts spent on travel to and from London (her “regular” office). Her reimbursement was taxed under PAYE. The Appellant argued that the travelling expenses were necessarily expended on travelling in the performance of the duties of the office or employment.

The Special Commissioner found against the Appellant. The key issue was to look at the job and not at the location. To be allowable, travel expenses must be necessarily expended in the performance of the taxpayer's duties – this condition was not met as there were no duties that could only be performed at home. Also, to show that the expenses were necessarily incurred, it had to be shown that all such holders were required to have two places of work – the job was international tax specialist based in London, but with an exception that working from home was permitted for part of the week.

This case was an interesting development in a usual “non-deductible” expense as it considers old rules for new work practices, but the taxpayer still lost.

For further information, see page 40.

Aumchareon (t/a Bangkok Thai Restaurant) v R & C Commrs

Jeopardy assessments – appellant no longer in UK

The Appellant was a sole trader owning a Thai restaurant between 1 May 2002 and 30 September 2003. The Revenue started an enquiry into his 2002–03 and 2003–04 returns.

The Revenue had carried out observations on the restaurant on 11 October 2002 and made test purchases. On a subsequent examination of the records none of the test purchases were in the records.

A Revenue officer made an analysis of the records and using a business economics model calculated the expected takings. Based on those estimates, jeopardy assessments were made.

The Special Commissioner upheld the assessments stating that the burden of proof was on the Appellant to displace them. At the time of the hearing, the Appellant had returned to Thailand and there was no known address for him.

For further information, see page 41.

Corbally-Stourton v R & C Commrs

Discovery assessment – out of time – tax avoidance scheme

This appeal was about the discovery assessment provisions. According to the Special Commissioner's report, these provisions permit an officer of HMRC to make an assessment where he discovers that an assessment was or has become insufficient. There are restrictions on his ability to make such an assessment; the restriction relevant to this appeal prohibits the making of a discovery assessment after the close of the ‘self-assessment enquiry window’ if at that time an officer could, on the basis of information then available to him, reasonably have been expected to have been aware of the insufficiency.

The Appellant participated in a scheme intended to deliver to her a capital loss of about £1m. She applied this loss in her 1998/99 tax returns to eliminate the capital gains she had made in that year, and carried a small balance forward which she used in her returns for 1999/2000 and 2000/2001 to reduce gains occurring in those years.

When HMRC became aware of the Scheme, they began to investigate a number of taxpayers involved, including the Appellant. They disallowed the capital losses and made discovery assessments. The taxpayer appealed on the basis that HMRC were not permitted to make discovery assessments outside of the time limit.

The Special Commissioner found in favour of the Revenue that they were entitled to issue discovery assessments. The restriction did not apply in this case as the taxpayer had failed to make it known that she was involved in a tax avoidance scheme.

For further information, see page 41.

Kellogg Brown & Root Holdings Ltd v R & C Commrs

Capital loss – connected persons

The issue in the appeal was whether the Appellant and another company were connected persons with the result that the loss on the sale of shares by the Appellant to that company was not available against the Appellant's gains generally.

The Appellant was a UK incorporated and tax resident company. The Appellant was and had at the time been a wholly-owned subsidiary of a US-based multinational company carrying on engineering and other operations worldwide whose shares were at the time listed on the New York Stock Exchange. During 1995, the US company decided to spin off its global insurance division into a new company. In the UK, the intention was that the shares in the insurance companies would be transferred to a newly incorporated and UK tax resident company.

It was decided that the two parties were connected with the result that the capital loss was not available for general use but only against a capital gain from the same connected party.

The wording of the relevant legislative provisions: “A company is connected with another company—(b) if a group of 2 or more persons has control of each company, and the groups consist of the same persons ”.

The Special Commissioner found as a fact, that one could identify a collection of shareholders who owned the greater part of the share capital of both companies. It followed that the group of shareholders holding the greater part of the share capital of the two companies were a group of persons consisting of the same persons having control of each company, and also having control of the two companies. Therefore the Appellant and other company were connected with each other.

For further information, see page 43.

McKelvey v R & C Commrs

Inheritance tax – gifts for maintenance

The deceased died on 14 March 2005. She had never married and had no children. She lived with her mother for the whole of her life. Her mother, who was born in 1917, was widowed in 1983 and did not remarry. On 31 March 2003 the deceased transferred an investment property she owned to her mother by way of gift and on 20 May 2003 she transferred another similar property to her, also as a gift. Neither the deceased nor her mother lived in either property, but, following the transfers, her mother benefited from the income the properties generated. Her mother died on 3 February 2007.

The sole question was whether the transfers were chargeable transfers or represented reasonable provision for the mother's care or maintenance (which would have been exempt). It was accepted that what the deceased had given to her mother was capable, in principle, of being applied for the purpose of “care or maintenance”.

The Special Commissioner allowed the appeal in part by determining that, of the value of the properties transferred by the deceased to her mother, a certain figure represented reasonable provision for her care, and hence the gifts were exempt to that extent, while the remainder were be regarded as a chargeable transfer.

The key issue in the decision was the meaning of “reasonable” and the gifts were apportioned in the light of the deceased's death within seven years.

For further information, see page 44.