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BUPA’s discomfort

Category Technical Articles
AuthorTechnical Department
Article by Stanley Dencher, Senior Technical Editor with CCH, published in the September 2002 issue of Tax Adviser.

Customs & Excise’s view of value added tax (VAT )avoidance has led to several important cases which could significantly affect VAT planning. The saga will probably run for years because much VAT and a vital principle are at stake.

Summary of BUPA’s scheme

In BUPA Hospitals Ltd (BHL) [2002] BVC 2,155, the issue was whether input tax was deductible on prepayments for the future purchase of drugs and prostheses from connected companies prior to an announced change in the VAT treatment of supplies of the goods.

BUPA Hospitals Ltd and related companies ran private hospitals. In January 1997, the Court of Appeal dismissed Customs’ claim that exemption applied to supplies of drugs and prostheses to private patients by the hospitals (see [1997] BVC 251). However, in August 1997 a Customs’ press release revealed that the law would change from 1 January 1998 to remove the zero-rating relief in Value Added Tax Act 1994, Sch. 8, Grp. 12 for such supplies. Thus, attributable input tax would generally no longer be recoverable being related to exempt supplies rather than zero-rated supplies. In response, BHL with assistance from Ernst & Young set up a complex prepayment scheme, by which it contracted to purchase goods for £100m (VAT-exclusive) before the change in law applied from a BUPA company in a different VAT group. The scheme aimed to crystallise a right to reclaim input tax at the time of the prepayment, although the goods would be used after the law had changed and indeed often many years after the change. Value added tax charged on the goods to BHL was reclaimed for the VAT return period during which the prepayment was made. BUPA Medical Supplies Ltd (BMSL), another BUPA group member, was the vehicle for making the supplies. In order to avoid creating a large repayment claim, which Customs would probably investigate and promptly reject, a counter-party prepayment arrangement was made with Goldsborough Developments Ltd (GDL), a member of a second BUPA VAT group. Under that arrangement, BHL's VAT group received an equal prepayment from GDL’s VAT group in relation to expected future supplies. BHL probably decided that it could not prepay its third-party suppliers, because there were too many of them and some could have been reluctant to assist in what some might regard as aggressive VAT planning - which could easily attract the unwanted attention of Customs.

The documents indicated that the purpose and implementation of the scheme was to cut irrecoverable VAT on purchases of drugs and prostheses. If the law had not changed as anticipated, the arrangements could effectively have been neutralised.

The arguments

BHL argued that:

  • taxable supplies had been received; and
  • the related input tax was recoverable as VAT on goods to be used in making zero-rated supplies. The arrangements were claimed to be to centralise purchasing and obtain price discounts.

Customs responded with several arguments summarised as follows:

  • the companies did not carry on any economic or business activities for VAT purposes;
  • the contracts, payments and invoices had failed to create taxable (zero-rated) supplies of goods;
  • the companies had not received taxable supplies;
  • even if the companies had received such taxable supplies, those supplies were used for making exempt supplies, rather than zero-rated supplies; and
  • the companies had lost a right to VAT recovery due to abuse of that right.

Tribunal’s decision

Stephen Oliver QC held in Customs’ favour and said at para. 73:

‘motive or purpose of a person effecting a transaction will be relevant to the question of whether that transaction is disqualified from ranking as an economic activity on the grounds that there was no motive or purpose other than the avoidance of tax

74. So, bearing in mind that the person seeking to deduct input tax has the burden of showing that he is carrying on an economic activity, it will be incumbent on the appellants to demonstrate that they are not excluded on the grounds that tax avoidance was the motive or purpose for which the transactions in question were effected.’

Although BHL claimed that the arrangements had a commercial purpose, the tribunal scathingly said at para. 87:

‘A number of points struck us. Any arrangement that involves one company borrowing £100m at interest and then passing it on interest-free as the so-called prepurchase price for goods (to be chosen from a large list) that might be needed at some unspecified time in the future is so uncommercial that it calls aloud for a convincing explanation. And when the so-called sellers have no drugs licences and cannot therefore supply any drugs for some months, the incredulity increases. And when it has apparently been done in the interests of centralization, but the orchestration of the arrangements has deliberately involved the setting up of two so-called purchasing companies, the incredulity is even greater. And when it turns out that the company selected as the main centralized supplier has just been purchased without any due diligence checks, without any operational system to handle deliveries of prostheses and with no staff, the assertion that the company has or can have any settled intention to commence a business or an economic activity ceases to be credible. The conclusion that the arrangements were put in place for tax avoidance and no other reasons becomes irresistible.’

In relation to whether the prepayment was a sham, the tribunal decided that a prepayment of £100m was out of all proportion to GDL’s realistic needs: it would take up to 100 years for GDL to use up its credit. However, although the arrangements were clearly steps taken in pursuit of major VAT avoidance, they did not amount to a sham. Too much VAT was at stake for the planners to neglect the finer details of implementing the scheme.

An important doctrine of European Community (EC) law is that a trader cannot successfully abuse a Community right. Although the tribunal agreed that:

  • the doctrine exists; and
  • the conditions for abuse were satisfied;

the doctrine did not apply because the abuse concerned a United Kingdom (UK) right. Some judges must be tempted to hold that if a right is in national law and if it clearly derives from an EC directive, then such a right can be abused and consequently lost.

The doctrine was applied in a leading case: Emsland-Stärke v Hauptzollant Hamburg-Jonas (Case C-110/99), where an exporter of goods from Germany to a non-EC country (Switzerland) lacked an entitlement to export refunds because, immediately after the release of the goods for home use in Switzerland, the goods went back into the EC (Italy) under the external Community transit procedure and there were released for home use although after paying import duties. That arrangement constituted an abuse by the German exporter. The result was that a finding of abuse stopped the trader from obtaining an export refund, even though that trader complied with the specified conditions. The Emsland-Stärke decision goes beyond deciding that abuse is a mere aid to interpretation. It is an independent doctrine: actions aiming to obtain an advantage contrary to the objectives of Community law by artificially creating the conditions for that advantage result in failure to obtain the advantage. That case involved the real movement of goods, and so it is easier to apply the doctrine to an arrangement which principally involved issuing pieces of paper, signing contracts and making circular payments. BHL tried to recover VAT on inputs which would be used to make exempt supplies which is contrary to the clear aim of the Directive 77/388, the sixth VAT directive. .

In Centros Ltd v Erhvervs-og Selsskabsstyrelsen [1999] ECR 1-1459, the Companies Board of Denmark refused to register the Danish branch of an English company formed by Danish nationals on the ground that the Danish nationals were seeking to abuse the rights of establishment in order to circumvent the Danish provisions on minimum capital requirements. The court rejected this defence because the conduct of the Danish shareholders did not amount to an abuse. At para. 24, the Advocate General said:

‘the problem with abuse is resolved in the last analysis by defining the material content of the particular situation and thus the scope of the right conferred on the individual concerned. In other words, it is claimed that to determine whether or not a right is actually being exercised in an abusive manner is simply to define the material scope of the right in question.’

Also, GDL claimed that the appeal should be upheld because the assessment reason code had been given as 19 (being input tax disallowed -; not for business purposes), rather than 22 (being input tax disallowed - other). However, the tribunal not surprisingly decided that nothing was misleading in the use of the reason code and a misdescription of the reason code failed to amount to a ground for discharging an assessment.


Although events started as long ago as at least 1997, it is noteworthy that the matter has only just been heard at first instance. The tribunal’s reasoning generally follows that in Halifax plc v C & E Commrs [2002] BVC 370, which is not surprising because both of those robust decisions were made by Stephen Oliver QC, President of the VAT and duties tribunals. In summary, if a transaction is found to be outside the scope of VAT:

  • no output tax is correctly chargeable by the alleged supplier; and
  • the recipient of a non-supply cannot legitimately recover as input tax any purported VAT which is apparently charged and shown on an invoice.

Other cases are understood to be bubbling along. Although it is generally understood that a tribunal decision, unlike a court judgment, only binds the parties to that case, some tough times lie ahead for VAT planners. Customs are likely to use this decision to try to counter artificial avoidance, which lacks a commercial purpose and could distort competition between businesses. Indeed there is probably significantly less work for Customs and the courts if there is a judicial equivalent to a general anti-avoidance rule (GAAR) along the seemingly easily-understood basis that a transaction, which only or principally aims to avoid VAT, cannot involve a supply made in the course or furtherance of a business and so is outside the scope of VAT. Thus, VAT avoidance is not an economic activity under European law. However, in WHA LTD and Viscount Insurance No. 17,605, Stephen Oliver subsequently placed some limits on Customs’ argument where an avoidance arrangement involved a large number of supplies rather than a one-off transaction. Yet, BHL’s scheme could involve many supplies over a very long period. As usual drawing the line between successful and unsuccessful planning is uncertain and will keep planners in business for the foreseeable future, but in an unpredictable environment.

The good news is that most general practitioners can continue working without being affected by these cases. After all few direct tax practitioners have received a letter from the Inland Revenue which quotes landmark cases such as Furniss v Dawson [1984] BTC 71.

Technical Department
020 7235 9381

September 2002 by Stanley Dencher


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