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Anti-avoidance - the courts' experiments

Category Technical Articles
AuthorTechnical Department
Article by Roderick Cordara QC, specialist in VAT advisce and litigation, which appeared in the May 2002 issue of Tax Adviser.
It has been an interesting time for those who follow the limits of what is permissible in the world of tax planning.
Key points

  • Constitutional differences between the UK and Europe have led to different outlooks towards tax-planning
  • Company and contract law within the UK are very laissez faire
  • Separation of steps in a transaction is an important tool of tax planning.
  • It has been an interesting time for those who follow the limits of what is permissible in the world of tax planning
  • Scope for tax planning being challenged by courts ignoring the precise terms of relevant contracts

In the leading input tax case of BLP Group plc v C&E Commrs (Case C-4/94) [1995] BVC 159, the European Court of Justice (ECJ) commented at p. 173 that :

‘In that respect it should be noted that a trader’s choice between exempt transactions and taxable transactions may be based on a range of factors, including tax considerations relating to the VAT system.’

However, the same court had no hesitation in concluding in another UK (United Kingdom) case, Direct Cosmetics v C&E Commrs (Case C-138/86 (1988) 3 BVC 354) that the concept of tax avoidance in Directive 77/388, the sixth VAT directive is objective, not subjective. That is one can be guilty of avoiding the tax, even if transactions are not structured with this intent.

Amid this confusion, what does the law permit one to do in terms of minimising one’s VAT bill, by way of re-arrangement of one’s affairs?

Doubtless the answer to this question has never been more difficult to give with confidence than today. All have heard of the Halifax plc case [2001] BVC 2,240) and of the newly mooted doctrine of abuse of law. These are hot legal topics in the area of tax-planning and are of very recent vintage. They may survive or disappear from the scene as suddenly as they emerged.

At the outset it is helpful to look past them, at the deeper and more enduring forces which are at work in the UK legal scene which provide the setting for the headline grabbers mentioned above.

First, there is a clear gap between European and British attitudes to tax planning. We are constantly told that things which are done regularly in the UK would be unthinkable in other European countries. This may be because they have subtly different constitutional backgrounds,based on written constitutions. Constitutions give people rights. Rights can be abused. Therefore, it is much more likely that the legal systems of such countries will evolve concepts limiting people’s ability to use their rights in ways that are not foreseen by those who gave them the rights in the first place. Thence, a doctrine of abuse of rights can emerge and a general tone can emerge wherein one does not ‘push it’ too far when planning.

In contrast the British constitutional experience is without any written constitution. The British have no rights. They have only obligations – that is to say the things which UK law forbids them to do. Apart from that, they can do anything which is not forbidden. We live happily enough in the ample cracks allowed to us between what is forbidden. There is no need to evolve a concept of abuse of rights in such circumstances. It is merely necessary to have a doctrine of abuse of power – ie for use against the government on judicial review.

This leads to a culture which is far looser in its attitudes to what can be done by citizens in their relationships with the state.. The only question is ‘Is it expressly forbidden?’. If the answer is ‘no’ it can be done.

A second, and important, reason is that both UK contract law and UK company law are very laissez faire. One can pretty much make what agreements one likes. It is very easy to form and dissolve companies. Making new contracts and companies is the stuff of tax planning. Put these freedoms together with a legal culture of the sort described above, and one gets a powerful cocktail which leads to heady thoughts of such planning opportunities as entry and exit schemes, leases and lease-backs, and much else with which we are familiar.

A third factor which is at work, rendering the VAT field a fertile one for planning, is exemplified in the views of the House of Lords in the Scottish VAT appeal of Robert Gordon’s College v C&E Commrs [1996] BVC 27. In this well-known case, the Lords had to consider a lease and lease-back arrangement by an educational institution which was designed to secure input tax recovery notwithstanding the exempt nature of the business carried on by the institution. The arrangement was held to succeed, outflanking an anti-avoidance provision on the way. A key element in the success of the arrangement was summarised in the speech of Lord Hoffmann as follows:

‘But that decision [BLP] makes it clear that for the purposes of European VAT legislation, it is not permissible to take a global view of a series of transactions in the chain of supply’.

This is important. Separation of steps in a transaction is an important tool of tax planning. This is underlined by the recent tribunal case of Centralan Property Ltd (No. 17,564). In this case, also against the background of an educational institution and property transactions, an arrangement designed to permit recovery of input tax in the context of the Capital Goods scheme was held to be ineffective. The taxpayer had made two disposals in respect of land it owned. The first was by way of an exempt lease to A. The other – which occurred a few days later – was by way of a taxable supply of the freehold to B. In order to defeat the arrangement, the tribunal held that the two supplies should be treated as one. It did so with little or no statutory justification – but it was the only way it could see of defeating the arrangement. Robert Gordon’s College (see above) does not appear to have been cited.

The case is a classic example of a judicial anti-avoidance technique of collapsing parts of a transaction together.

A related anti-avoidance technique which has emerged is to be found in such cases as Reed Personnel v C&E Commrs [1995] BVC 222 and Eastbourne Town Radio Taxis v C&E Commrs [2001] BVC 271.

These were both tripartite cases. The latter was a scheme. In each of these, the courts held that the VAT answer was not necessarily to be derived from the words of the contracts alone. Thus, an important inroad was made into the ability of those making planning arrangements to rely on freedom of contract as a tool. This is a very fundamental development, which has not received the attention it deserves.

It is no coincidence that in the last part of the Halifax case (para. 56-60), the Tribunal relied on Reed and Eastbourne to justify its concluding that there was a supply from one end of the contractual chain set up as part of the planning to the other, direct – thereby ignoring the intervening steps in that chain. Without these cases, the tribunal would have faced the problem of re-characterisation, which is familiar to direct tax practitioners as a limitation on Furniss v Dawson [1984] BTC 71 type anti-avoidance principles.

The Halifax case itself represents a further development of anti-avoidance techniques by the Courts. As is well-known, it involved the new proposition that where a transaction is solely performed for motives of a fiscal nature – e.g. as part of a tax scheme – it will be ignored on the ground that the concept of economic activity and of supply under the sixth directive do not apply to such transactions.

This approach is radical. Combined with Eastbourne and Reed, it gives the Courts a powerful tool to re-write transactions.

It has been applied in the more recent Tribunal case of BUPA Hospitals Ltd (No. 17,378). In that case the Chairman, Mr Oliver, stated the principle as follows:

‘If the transaction in question is carried out for avoidance of tax and, viewed alone or as part of a wider arrangement, has no demonstrable commercial or business purpose, those features will disqualify it from ranking as an economic activity or as a supply(as the case may be).’

That case involved a substantial pre-payment arrangement ahead of expected changes in the law concerning the continued zero-rating of drugs.

It remains to be seen whether this approach is correct. It does not give apparent weight to the wording of Art. 4 of the sixth directive:

‘'“Taxable person” shall mean any person who independently carries out in any place any economic activity specified in paragraph 2, whatever the purpose or results of that activity.’

Many would say that those words are to be given their ordinary meaning and that tax driven transactions are nonetheless valid forms of economic activity.

There may be limits to the application of the doctrine. It is expected that the Tribunal would not hold that the Halifax principle applies where there is an on-going business restructuring, even if tax driven. It only applies to ‘one hit’ arrangements such as Halifax or BUPA.

One tool of judicial anti-avoidance technique which the courts have firmly rejected in the UK tax context is the doctrine of abuse of rights. This rather exotic European law concept has been recently recognised by the ECJ to exist, although it has never been applied in a tax case. The VAT Tribunal has so far steadfastly refused to apply it in such cases as Halifax and BUPA.

In summary, there are many new and powerful weapons being experimented with at present in the Courts in terms of a response to tax avoidance. Unfortunately, it will be some considerable time before it is revealed whether they are here to stay or merely a passing phase.

Technical Department
020 7235 9381
May 2002 by Roderick Cordara QC


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