European Court of Justice

R & C Commrs v Isle of Wight Council (Case C-288/07)

Local authorities as taxable persons

Historically, the local authorities in the UK accepted that they were accountable for VAT on their revenue from the provision of off-street parking. However, following an ECJ decision, some local authorities made claims for repayment of the VAT they had previously paid on the basis that they should not have been accountable for that VAT. The current case is a test case.

The UK Customs had appealed a VAT Tribunal decision that the Sixth Directive did not intend any real world investigation but rather a nationwide review of the impact of the private sector on the treatment of local authorities as non-taxable persons in the area of supplies of off-street car-parking.

The UK High Court referred the following questions to the ECJ:

1. Is the expression “distortions of competition” to be ascertained on a public body by public body basis such that, in the context of the present case, it should be determined by reference to the area or areas where the particular body in question provides off-street parking or by reference to the totality of the national territory of the Member State?
2. What is meant by the expression “would lead to”? In particular, what degree of probability or level of certainty is required for that condition to be satisfied?
3. What is meant by the word “significant”? In particular, does “significant” mean an effect on competition that is more than trivial or de minimis, a “material” effect or an “exceptional” effect?’

In summary, this case deals with the treatment of local authorities as taxable persons where their treatment as non-taxable persons would lead to significant distortions of competition.

It was found that:

1. Significant distortions of competition, to which the treatment as non-taxable persons of bodies governed by public law acting as public authorities would lead, must be evaluated by reference to the activity in question, as such, without such evaluation relating to any local market in particular.
2. The expression ‘would lead to’ is to be interpreted as encompassing not only actual competition, but also potential competition, provided that the possibility of a private operator entering the relevant market is real, and not purely hypothetical.
3. The word ‘significant’ is, for the purposes of the second subparagraph of Article 4(5) of Sixth Council Directive 77/388, to be understood as meaning that the actual or potential distortions of competition must be more than negligible.

In summary, the ECJ found that the treatment of local authorities as taxable persons was as a result of the activity that they carried on and not the level of competition in the market. On the other hand, the treatment of local authorities as non-taxable persons was a derogation from the general rule that any activity of an economic nature had to be subjected to VAT. The general rule had to be restored where the treatment as a non-taxable person would lead to significant distortions of competition – “lead to” deals with actual and potential competition; “significant” means material and not negligible. The determination of the level of competition should not be an evaluation of the local market in particular. According to the judgement, the evaluation on a local level would be likely to jeopardise the principles of fiscal neutrality and legal certainty.

Finanzamt für Körperschaften III in Berlin V Krankenheim Ruhesitz am Wannsee-Seniorenheimstatt GmbH

Freedom of establishment

This ECJ case involves a dispute between the German Tax Authority and the taxpayer concerning the tax treatment in Germany of losses incurred by a permanent establishment situated in Austria and belonging to the taxpayer.

The taxpayer had used losses incurred (from 1982 to 1990) in the permanent establishment to reduce its German profits. When the taxpayer disposed of the permanent establishment, the profits of the permanent establishment (from 1991 to 1994) were added to the profits of the taxpayer and hence the losses which had been deducted taxed retrospectively, which was in accordance with German tax law. The permanent establishment had been subject to Austrian tax up to but not including 1994, the losses in the preceding years had not been offset against the profits – as the losses had to be used in the State of the parent prior to using in Austria.

The taxpayer brought an action against the tax notices for the years 1992 to 1994, requesting deduction of the sums which had been reintegrated into the basis for calculation of the tax drawn up in Germany. The taxpayer argued that by reason of the carrying forward of losses in Austria being limited to seven years, reintegration of those sums on the basis of the provisions of the Austrian tax law was unlawful.

The question referred to the ECJ was whether art 31 of the EEA Agreement prohibits a restriction as per those outlined above, i.e. the tax situation of a company which had its registered office in Germany and a permanent establishment in Austria were less favourable than if the permanent establishment had been situated in Germany.

While the freedom of establishment was restricted, it was found to be justified by overriding reasons in the public interest. In addition such measures should not go beyond that which is necessary. In this case it was found that the restriction which followed from the reintegration was justified by the need to guarantee the coherence of the German Tax System.

The case is important in understanding the meaning of restriction of freedom of establishment – it does not mean that in all circumstances the tax treatment in the Member State should be identical for those businesses established in that State in comparison to another Member State. However, where there is a difference in treatment, that difference must be reasonable.

Note: Austria entered the EU in 1995, hence the EEA Agreement applied in this case.

Kollektivavtalsstiftelsen TRR Trygghetsrådet v Skatteverket

VAT – economic activity

According to its statutes, the objects of the taxpayer were twofold:

• the provision of severance pay and the promotion of any measures likely to facilitate the occupational redeployment of employees who, for certain reasons, have lost their jobs or who run that risk, and
• the provision of advice and assistance to companies which are in a situation of over-manning, or likely to find themselves in such a situation, and the promotion of human resources management training for companies.

In addition to the activities above, the taxpayer supplied services to businesses wishing to operate through outsourcing, for which it was registered as a taxable person for VAT purposes and which account for approximately 5% of its income.

The taxpayer wished to purchase consultancy services supplied by a service provider established in Denmark, which were to be used exclusively in the context of the taxpayer's activities under an agreement. In order to obtain clarification of the tax consequences of that transaction, the taxpayer sought a preliminary decision from the Revenue Law Commission in order to resolve the question whether its activities under the tax law were of a commercial nature or not.

It was held that where the customer for consultancy services supplied by a taxable person established in another Member State carried out both an economic activity and an activity which fell outside the scope of those directives, that customer was to be regarded as a taxable person even where the supply is used solely for the purposes of the latter activity.

This may seem like an unusual ruling until you read the reason for the decision: the place of supply for consultancy services where the supplier is in a different State, is the place where the customer is established; the VAT Directive does not specify that the taxable person must be using the services for its economic activity.

UK High Court (Chancery Division)

Tower MCashback LLP 1 & Anor v R & C Commrs [2008] EWHC 2387 (Ch)

Capital allowances

This case dealt with the quantification of capital allowances available in respect of a purchase of software, where the purchase was substantially funded by non-recourse loans indirectly made available by the vendor of the software.

The taxpayer had devised some clever and novel software that it believed would revolutionise the loyalty cards often promoted by food and drink producers and supermarkets, providing, as its reward to “customers”, free air-time on mobile phones.

The scheme adopted involved the creation of four LLPs. Each of the four LLPs was to purchase software related to taxpayer's system, the aggregate price for the purchase by all four LLPs being £143 million. With a view to the LLPs claiming 100% first year capital allowances for tax purposes, the four LLPs entered into contracts to buy discrete elements of software on 31 March 2004, on the basis that the purchases would be completed before the expiry of a four-month period. The contracts all envisaged that while the LLPs would pay the whole of the allocated slices of the £143 million total purchase price on completion, the taxpayer would procure that two banks would be interposed in a chain to provide the investing partners with non-recourse loans to fund 75% of their capital contributions to the LLPs, the taxpayer providing the ultimate security and all of the funding to those intermediate banks.

The High Court allowed the taxpayer's appeal by allowing the taxpayer first-year allowances in respect of the full amount of first-year qualifying expenditure. The Special Commissioner had only allowed 25% of the expenditure, i.e. expenditure incurred at the outset. The key issue in the decision was the fact that the taxpayer had expended the whole of the purchase price in acquiring the asset – it was irrelevant how the purchase was funded.

As a separate issue, the Revenue had issued a closure notices contending that the taxpayer was not entitled to full capital allowances – only 25% allowed. The Special Commissioner had allowed Revenue to raise further contentions. The High Court ruled that Revenue could not raise additional contentions – it was up to Revenue to include all issues in the closure notice.

Elizabeth Court (Bournemouth) Ltd v R & C Commrs

Stamp duty land tax relief

Elizabeth Court was a block of 133 flats.

• On 3 April 1967 the owner of the freehold granted a long lease (the headlease). The lessee of the headlease then granted leases of the individual flats to what were referred to as the flat owners.
• In 2003 117 out of 131 of the flat owners decided to acquire the freehold and the headlease. Each flat owner entered into a Participation Agreement with the Appellant and agreed to exercise the right to collective enfranchisement under the 1993 Act and to appoint a company limited by shares with the same name as the Appellant as nominee purchaser.
• The Appellant was incorporated on 22 December 2004 as a company limited by guarantee. By notice dated 24 December 2004 it replaced the company of the same name but limited by shares as the nominee purchaser.

While the transaction was subject to stamp duty land tax, the taxpayer argued that it was entitled to relief on the grounds that it met the definition of a right to enfranchise (RTE) company. The High Court upheld the decision of the Special Commissioners that the provisions of the relevant legislation had not come into force at the time of the transaction, hence it was not a transaction entered into by an RTE company in pursuance of a right of collective enfranchisement.

There is a valuable lesson to be learned in this case that it is crucial that the date of the commencement of legislation is known, e.g. if the legislation is subject to a commencement order, or the interaction of other legislative provisions which could delay the commencement date.

Holland t/a The Studio Hair Co v R & C Commrs; Vigdor Ltd t/a Michael Jane v R & C Commrs [2008] EWHC 2621 (Ch)

VAT – Self-employed hairdressers

The case involved two appeals dealing with the same issue: whether supplies by the taxpayers to self-employed hairdressers (or stylists) should be treated as “the leasing or letting of immovable property”; and that even if they did, the supplies were properly to be characterised as single supplies of hairdressers’ facilities which were standard-rated for VAT purposes. If the supplies were standard-rated then the taxpayers should have been registered for VAT.

In Holland, the premises was owned by the taxpayer. Two of the floors were occupied by stylists and the third was used by the taxpayer for training. During the period in question, there were seven stylists at the premises, including the taxpayer; and four “juniors” who acted as assistants to the stylists. The taxpayer had an agreement with each stylist, which provided that the stylist may occupy the Designated Area with the benefit of the facilities and services for the purposes of conducting his own hairdressing business and activities normally ancillary thereto. Each stylist agreed to pay two amounts to the taxpayer: a “licence fee” and a “service charge”.

In Vigdor, the ground floor, which was open plan, consisted of a reception area, a till, a number of seats and sink units and a “mixing” room. The other floor, the basement, consisted of an administrative office, four self-contained beauty rooms and a separate room in which there were chairs, two wash basins, a dye-mixing area and a client waiting area with its own chairs. The dispute concerned the supplies made by the taxpayer in respect of this separate room.

The High Court upheld the decision of the VAT Tribunal, by finding in favour of Revenue, that supplies by the two taxpayers did not include “the leasing or letting of immovable property and that even if they did, the supplies were properly to be characterised as single supplies of hairdressers’ facilities which were standard-rated for VAT purposes. The key issue was that there was a single supply of several elements (licence to use a chair and space in the salon, which combined to enable the stylists to carry on a business as self-employed hairdressers) which were interdependent; and supplied under a single agreement. The licence was not the predominant element of the supply and hence it was concluded that the supplies were not the leasing or letting of immovable property.

Grace v R & C Commrs [2008] EWHC 2708 (Ch)

Residence

The Appellant was a British Airways pilot and received income from that employment which was paid into his bank in the United Kingdom.

He was born in South Africa, moved to Kenya, and then returned to South Africa. He trained as a pilot in South Africa. He had lived in the UK but decided to return to South Africa, while continuing to work as a British Airways pilot (working from the UK).

For the Revenue it was argued that the taxpayer was resident in the UK. The word “resident” was not defined in the 1988 Act and so should be given its natural and ordinary meaning. The taxpayer claimed that he had departed from the UK on 6 August 1997 to live outside the UK permanently and that thereafter he was not resident in the UK. He had removed the centre of his life to South Africa in 1997 and since then he had kept his visits to the UK to a minimum. He was in the UK for a temporary purpose only to rest before or after his flights. His visits to the UK were short and only on three occasions were they longer than seven days.

The High Court found in favour of the Revenue by not upholding the decision of the Special Commissioners. The High Court ruled that the Special Commissioner had made errors of law-the question for the Special Commissioner was whether the reason for the taxpayer's presence in the UK was casual or transitory. He had been in the same employment since 1987, and had thus been in that employment for a decade before the first of the relevant years of assessment. Performance of his duties under his contract of employment was part of his settled pattern of life. The judge agreed with Revenue that presence in the UK in order to fulfil duties under a permanent (or at least indefinite) contract of employment cannot be described as casual or transitory. The only possible conclusion from the facts was that the taxpayer was resident.

Test Claimants in FII Group Litigation v IR Commrs [2008] EWHC 2893 (Ch)

Follow-on from ECJ ruling Case 446/04

UK High Court (Administrative Court)

R (on the application of Mercury Tax Group Ltd & Anor) v R & C Commrs & Ors [2008] EWHC 2721 (Admin)

Revenue – enter and search premises

There were two claimants in this case – a company which provided tax consultancy services and a solicitor who was the principal shareholder and managing director of the company.

The company operated a tax avoidance scheme which worked by generating losses which could be used against other tax liabilities. Revenue were of the view that the scheme had been implemented dishonestly and applied to the Courts for a warrant to enter and search a number of the premises associated with the company or its clients. The Court issued the necessary warrants and Revenue carried out searches on 31 premises. The claimants issued judicial review proceedings that the decision of the Court and the actual warrants were unlawful.

The High Court ruled in favour of the claimants, that the decision of the Court and hence the actual warrants was unlawful. The key issue in the decision was that a warrant could only be issued where the Court was satisfied that there were reasonable grounds to suspect dishonesty on the part of the claimants. It was the view of the High Court that Revenue did not provide evidence of such reasonable grounds.

It is interesting to note the level of evidence/persuasion required by the High Court in a situation such as this is governed by the extent of the power being provided to the Revenue. The more intrusive the power, the greater the onus on the judge to ensure it should be used.

Special Commissioners

Peter Eley Partnership v R & C Commrs

Failure to attend hearing

In this Special Commissioners’ decision, the appellant did not attend nor did he withdraw his appeal.

The Appellant contended that his grandchildren were partners in the partnership. The Revenue contended that there was no evidence that the grandchildren were partners:

• Their names were not on the partnership notepaper
• the partnership bankers were not aware that they were partners, nor were any of the partnership creditors
• there was no partnership agreement and
• there was no evidence that the grandchildren acted as partners

Only the accounts and tax returns show them as partners. In the Special Commissioner's view this fell short of evidence that that they were partners. Accordingly he dismissed the appeal. In addition, the Special Commissioner has said that he would award costs unless the Appellant provided him with an explanation of why he neither withdrew his appeal nor appeared at the hearing.

This decision is useful where Revenue contend that having/not having something on a tax return is necessary to qualify for some relief, e.g. where a business has been in joint names and it is clearly a matter of fact that both spouses worked in the business, but the tax returns were in the name of one spouse only, then are Revenue in a position to deny retirement relief to the spouse in whose name the income was not returned on the basis that (s)he was not working full time in the business?

Mason v R & C Commrs

Artificial pay – reduction of NICs

In this Special Commissioners decision, “artificial” pay arrangements had been in place which reduced the amount of National Insurance Contributions (NICs) paid on behalf of an employee.

In relation to the “artificial” pay arrangements, the employee worked 12 hour shifts for 14 days with 14 days off. Instead of being paid monthly, the employee was paid most of his salary (with the exception of a retainer) at one point in the month. Two weeks later he was paid the retainer. As a consequence, the employee was treated as having two-week rather than four-week periods for NIC purposes. The employee's pay period were technically two-week pay periods, there was no NICs on the retainer element, and the NICs on the bulk of the salary were roughly halved.

The reduced NICs meant that when the employee retired he was not entitled to a full pension. The retired employee explained that he had been unaware of the reduced NICs.

The taxpayer sought redress through the tax appeals system on his entitlement to a full pension. His approach was that full NICs should have been payable and hence he should be receiving his full pension.

The Special Commissioners decided (on an interim basis) that the correct amount of NICs had been paid. The taxpayer was given a further opportunity to advance the case. It was acknowledged that the taxpayer had a grievance and that it would be appropriate that those responsible for the tax system (HMRC) should rectify the situation. However, this could not be decided by the Special Commissioners.

VAT and Duties Tribunals

The Camping and Caravanning Club

The taxpayer was the oldest camping and caravanning club and the second largest operator of camp sites in the world. The dispute concerned whether the taxpayer's supplies to its members in return for a subscription were exempt from VAT. To be exempt, the taxpayer's aims had to be of a philanthropic nature.

The Tribunal found in favour of Revenue, i.e. the taxpayer's aim was not philanthropic. In reaching this conclusion, the Tribunal compared the taxpayer's aims of providing a wide range of camping opportunities and membership services and having a highly satisfied membership with those of being philanthropic, the aims should be that of promoting the well-being of mankind by serving ones fellow men, i.e. the good of members versus the good of mankind.