This Court of Justice of the European Union (CJEU) case looked at the meaning of ‘supply of services’ (advertising and loan broking services) and the economic and commercial reality of transactions, specifically in relation to abusive practices and transactions with the sole aim of obtaining a tax advantage.

Background

Mr Newey was a loan broker, established in the UK and trading under the business name Ocean Finance. The broking services supplied by him were, in accordance with Article 13B(d) of the Sixth Directive, exempt from VAT. By contrast, the advertising services supplied to Mr Newey in the UK, which were intended to attract potential borrowers, were subject to VAT, with the result that the VAT thereon was not recoverable.

Mr Newey incorporated the company Alabaster (CI) Ltd (‘Alabaster’), which was established in Jersey, a territory in which the Sixth Directive does not apply, and granted that company the right to use the business name Ocean Finance. Mr Newey was the sole shareholder of that company. Alabaster employed at least one person on a full-time basis and had its own management, comprising of persons resident in Jersey with no direct experience of broking. Under Alabaster's constitution and the law in force in Jersey, those directors were responsible for managing and exercising the powers of Alabaster and Mr Newey played no direct part in its management.

Broking contracts were concluded directly between the lenders and Alabaster, with the result that the broking commissions were paid not to Mr Newey, but to that company. However, Alabaster did not itself process the loan applications, but used Mr Newey's services for that purpose. These services were provided, under a sub-contract agreement by his employees carrying on their business activities in the UK.

That agreement contained a list of services Mr Newey was to provide which essentially covered all the processing tasks for the loan broking business. Under that agreement, Mr Newey also had the power to negotiate the terms of the contracts concluded between Alabaster and the lenders.

In practice, potential borrowers contacted Mr Newey's employees directly in the UK and they then processed each file and sent the applications satisfying the credit eligibility criteria onwards to Jersey to Alabaster's directors for authorisation.

The advertising services were provided by a company not connected with Alabaster but also established in Jersey. That company itself obtained those advertising services from advertising agencies established in the UK. Under the law in force in Jersey, the payments made by Alabaster to the Jersey advertising company were not subject to VAT.

Under the arrangement, Mr Newey was not entitled to use the advertising services on behalf of Alabaster and he assumed no liability for payment of the services provided by the Jersey based advertising company. However, he had the power to approve the content of the advertisements and in practice actually met with one of the advertising company's employees working in the UK to do so.

Following those meetings, that employee made recommendations to the Jersey based advertising company who in turn made recommendations to Alabaster's directors. Those directors met each week after receiving those recommendations to determine the proposed advertising expenditure. Again, none of those recommendations were rejected by Alabaster.

HMRC submitted that, for VAT purposes, first, the advertising services concerned were supplied to Mr Newey in the UK and were therefore taxable in the UK and, secondly, the loan broking services were supplied in the UK by Mr Newey. Accordingly, in 2005, HMRC issued a VAT assessment to Mr Newey for the period 1 July 2002 to 31 December 2004 in the sum of £10,707,075 in order to recover from him the VAT on the advertising services supplied to him during that period.

By way of alternative argument HMRC submitted that, if Alabaster had to be regarded as being, in Jersey, the recipient of the advertising services as well as the supplier of the loan broking services, the arrangements entered into for the purpose of bringing about this were contrary to the principle of prohibition of the abuse of rights, as stated by the Court in Case C–255/02 Halifax and Others [2006] ECR I–1609 and as a result must be recharacterised.

Mr Newey maintained that the loan broking services at issue were supplied from Jersey by Alabaster and that Alabaster was the recipient of the advertising services. Furthermore he contended that the principle of prohibition of the abuse of rights was not applicable if the services are supplied by a person established in the European Union to another person established outside the European Union.

Consequently, he appealed against that assessment before the First Tier Tribunal (FTT) which allowed that appeal. That court held that the loan broking business was carried on by Alabaster, by means of services provided by Mr Newey under the services agreement. Alabaster could not therefore be categorised as a ‘brass plate’ company.

The FTT also held that Alabaster had supplied the loan broking services concerned to the lenders and that it was the recipient of the advertising services. There was no direct transaction for consideration between Mr Newey and the lenders or between Mr Newey and the Jersey advertising company. Although the essential aim of Alabaster was to obtain a tax advantage, there was, according to that court, no abuse since the arrangement involving Alabaster was not contrary to the purpose of the Sixth Directive.

HMRC appealed that decision to the Upper Tribunal which decided to stay proceedings and to refer a number of questions to the CJEU for a preliminary ruling. Among the key questions brought to the CJEU was:

• What weight should a national court give to contracts in determining the question of which person made a supply of services for the purposes of VAT?
• What factors are relevant when considering the contractual position?
• If the contractual position is not decisive, in what circumstances should a national court depart from the contractual position?

CJEU Ruling

The CJEU considered a number of the questions together. In essence the court was being asked to examine whether contractual terms are decisive for the purposes of identifying the supplier and the recipient in a ‘supply of services’ transaction within the meaning of Articles 2(1) and 6(1) of the Sixth Directive.

Under Article 2(1) of the Sixth Directive, ‘the supply of goods or services effected for consideration within the territory of the country by a taxable person acting as such’ is subject to VAT. A supply of services is effected ‘for consideration’, within the meaning of Article 2(1) of that directive, and hence is taxable, only if there is a legal relationship between the provider of the service and the recipient pursuant to which there is reciprocal performance.

Given that the contractual position normally reflects the economic and commercial reality of the transactions and in order to satisfy the requirements of legal certainty, the relevant contractual terms constitute a factor to be taken into consideration when the supplier and the recipient in a ‘supply of services’ transaction within the meaning of Articles 2(1) and 6(1) of the Sixth Directive have to be identified.

However, sometimes it may become apparent that certain contractual terms do not wholly reflect the economic and commercial reality of the transactions. That is the case if those contractual terms constitute a purely artificial arrangement which does not correspond with the economic and commercial reality of the transactions.

In this case, it was not disputed that in accordance with the contractual terms, Alabaster provided the lenders with loan broking services and that it was the recipient of advertising services provided by the Jersey advertising company.

However, taking into account the economic reality of the business relationships between, on the one hand, Mr Newey, Alabaster and the lenders and, on the other hand, Mr Newey, Alabaster and the Jersey advertising company, the Court found that the effective use and enjoyment of the services took place in the UK and that Mr Newey profited therefrom.

The answer then was that contractual terms, even though they constitute a factor to be taken into consideration, are not decisive for the purposes of identifying the supplier and the recipient of a ‘supply of services’ within the meaning of Articles 2(1) and 6(1) of the Sixth Directive.

Contractual terms may be disregarded where they do not reflect economic and commercial reality and are a wholly artificial arrangement set up with the sole aim of obtaining a tax advantage.

The full text of the case is available at http://curia.europa.eu