Article by Stanley Dencher, Senior Technical Editor, Croner.CCH Group Ltd, published in the July 2001 issue of Tax Adviser. Customs are apparently involved with several test cases in the campaign against VAT avoidance. One such case is
Halifax plc No. 17,124.
The Halifax's supplies are generally VAT exempt because it is a bank (VATA 1994 Sch 9 Grp 5). During the relevant periods, its VAT recovery rate was under five per cent. For the purpose of its banking business it needed to construct call centres. If it had directly constructed the call centres, most of the VAT on the construction costs would have stuck. However, it used a scheme which involved three other companies and which used the standard method of calculating a partically exempt person's recoverable VAT. If the scheme had worked, the Halifax and the three companies would together have recovered all of such VAT which amounted to over £5m. Each of the three companies was separately VAT-registered and was a subsidiary of the Halifax.
Summary of the scheme
Generally, the scheme is summarised as follows:
Company A took an interest in the sites from the Halifax but contracted such that Company B designed and built the call centres. Both the contract for the design and build and the payment to Company B arose in a prescribed accounting period ending shortly before the termination of Company A's partial exemption year. Company A agreed to supply the Halifax with certain work related to the land and thus it claimed to have made a low-value standard-rated supply during that period, the tax point for which was fixed by the Halifax promptly paying for that apparent supply. When Company A's accounting period ended it had incurred significant VAT on the construction costs, although its only supply during both that accounting period and the partial exemption year was the low-value standard-rated supply to the Halifax. By using the standard method, the excess of input tax over output tax for the period was shown on Company A's VAT return for the period to March 2000. The input tax apparently arose in that period because Company A prepaid Company B using money lent by the Halifax.
Company B met its obligations to build the call centres by using an arm's-length builder. On its VAT return it delared the output on the invoices issued to Company A and reclaimed the VAT charged by the builder.
In the following year for partial exemption purposes, Company A transferred its interest in the sites to Company C, ie it made an exempt supply. This exempt supply needed to be delayed until this following partial exemption year and Company A's interest in the sites had to avoid being caught for an adjustment under the capital goods scheme. Company C leased the sites to the Halifax.
The claim to recover the significant amount of VAT exceeded the threshold in Customs' computer and the VAT return was pulled out for verification. The Halifax acknowledged that the purpose of the scheme was VAT avoidance. Perhaps the Halifax confidently believed that Ramsay does not apply to VAT. When Customs had considered the scheme they refused to refund the VAT, but did not rely on Ramsay.
The tribunal's decision
None of the transactions was found to be a sham; each was genuinely carried out, but each owed its existence to the scheme only. The tribunal upheld Customs' refusal to refund the VAT:
1. On a transaction-by-transaction basis, rather than on a global basis, there was no business or commercial rationale for the scheme's transactions other than to make the scheme work. The concept of a business has a boundary. In FA & AB Ltd v Lupton [1972] AC 634, the House of Lords held in a direct tax case that if the only aim of a transaction was tax avoidance, the transaction was not a trading transaction for taxing company profits. This is the key part of the tribunal's decision and is the question of fact from which the Halifax could not escape. In deciding whether a transaction is avoidance, objective criteria were apparently used by the tribunal, but some wonder if subjectiveness is involved in such a decision. As Balcombe LJ said in the Court of Appeal in Card Protection Plan v C & E Commrs [1994] BVC 20 at p28:
"At the end of the day this is necessarily a matter of impression on which different minds may reach different conclusions."
VAT is a transaction-based tax and VAT is charged and recovered at each step in the chain. This has apparently stopped Ramsay being used to take an overall view of transactions and to disregard inserted steps leaving the real transaction VATable;
2. The scheme sought to cut the incidence of VAT without incurring the economic consequences that the law intended. If the scheme had worked, it would distort competition because the Halifax's rivals would be disadvantaged if they refrained from implementing the scheme;
3. Company A made no standard-rated supplies to the Halifax and similarly Company B made no standard-rated supplies to Company A. This was because the transactions were not undertaken in pursuit of a business or an economic activity and thus were outside the scope of VAT with:
a) no output tax arising on the alleged supply by Company A to the Halifax; and
b) no input tax recoverable on the alleged supply by Company B to Company A; and
4. The supplies by the arm's-length builder went direct to the Halifax for VAT purposes. These supplies were the only supplies left within the scope of VAT because these were the real transactions. The builder accounted for output tax on its supplies but the Halifax only recovers a small proportion of the VAT charged by the builder.
Abuse of rights
A general principle of European law is that a trader cannot abuse an apparent legal right (see the article on p20 of the June issue of Tax Adviser). Customs claimed that:
1. the Halifax had abused rights to reclaim VAT by entering into transactions for the sole purpose of VAT avoidance; and
2. the related transactions should be disregarded for VAT purposes.
However, the tribunal did not consider this claim because it decided against the Halifax for the reason discussed above. Hopefully, this argument will be considered shortly.
Concluding comments
The VAT world is in a period of significant uncertainly, but Customs are already enthusiastically using the decision to reject transactions which apparently lack a commercial purpose. There is probably less work for Customs and the tribunals and courts if Customs use the Halifax decision than if they try to find a technical reason using the literal words in the legislation as to why a complex scheme fails. Usually, the trader's advisers and administrators will have found and carefully tried to exploit an apparent loophole backed up with suitable paperwork. With over £5m at stake, they would be careful. There could also be less work for the Parliamentary draftsman if the Halifax case introduces a judicial equivalent to a general anti-avoidance rule (GAAR) for VAT, which Customs use against unacceptable VAT avoidance (in contrast to Customs-condoned avoidance while treating all VAT payers the same way).
It is generally understood that a tribunal decision, unlike a court judgment, only binds the parties to that case even though this decision was by Judge Stephen Oliver, President of the VAT and Duties Tribunals. Some Customs officers may claim that already the Halifax case has widespread application.
Determined to crack down
The Paymaster General, Dawn Primarolo, said in the context of an avoidance scheme used by high street retailers (Press Release 14/2001 (12 March 2001)):
"If left unchallenged, this sort of scheme allows large companies to undercut small business rivals by hundreds of millions of pounds, and means less money from VAT for schools and hospitals. We are determined to crack down on tax avoidance of this kind and I would urge companies to think twice about adopting such schemes which benefit no-one in the end but accountants and lawyers."
Time will tell if the Paymaster General is as good as her word.
An appeal by the Halifax is most likely to be heard in the courts and the case could be as relevant for VAT as WT Ramsay Ltd v IR Commrs [1982] AC 300 is for direct tax. Some naturally regard Halifax as Ramsay dressed up in a slight disguise. The House of Lords has recently extensively considered Ramsay in the direct tax case MacNiven v Westmoreland Investments Ltd [2001] BTC 44 but this was after the Halifax decision.
VAT avoidance not an economic activity
However, Halifax and other cases which are understood to be bubbling over will probably make life more difficult for those running avoidance schemes where significant amounts of VAT are at stake. Judges may be very willing to stamp on complex, tortuous avoidance schemes by using a simple argument such as that a transaction, which only aims to avoid VAT, does not involve a supply made in the course or furtherance of a business and therefore is outside the scope of VAT. To put this conclusion another way: VAT avoidance is not an economic activity under European law. Some may go further and describe VAT avoidance as a counter-economic activity. Certainly the courts and tribunals could have an easier life if less effort went into avoidance. Reality has forcibly caught up with some VAT avoiders, but the battle between Customs and the VAT payers will probably carry on for many years in several forms varying in the extent of the aggressiveness and artificiality.
Perhaps Customs will consider:
1. seeking a derogation under Directive 77/388, the sixth VAT directive, art 27 to counter certain avoidance;
2. amending the rules on partial exemption so that a much longer period is used in calculating the recoverable VAT; and
3. extending the capital goods adjustment scheme to catch the land transactions involved in the Halifax case. European law seems not to stop such an extension.
In summary, where a transaction is found to be outside the scope of VAT:
1. no output tax is correctly chargeable by the alleged supplier; and
2. the recipient of a non-supply cannot legitimately recover as input tax any purported VAT which is apprently charged and shown on an invoice.
Presumably Customs have only recently thought of this argument or they would have used it many years ago. However, most general practitioners have never received a letter from an inspector of taxes which quotes Ramsay. Probably most general practitioners can continue working without being affected by Halifax. Meanwhile, somebody is probably trying to think up a reverse-Halifax argument or to explain how somebody's human rights have been abused.
Technical Department
020 7235 9381
July 2001 by Stanley Dencher
