Article by Zigurds Kronbergs MA BSc ARCS ACA FCCA, tax adviser and author. The article was published in the November 2002 issue of Tax Adviser. The battleground
What might be described as the ‘Halifax war’- in which Customs & Excise has launched an assault on tax avoidance with its new weapon of mass destruction, the economic activity test coupled with the abuse of rights doctrine - has entered a new phase with the decision of the Edinburgh VAT and Duties Tribunal in RBS Property Developments Ltd and the Royal Bank of Scotland Group plc v C & E Commrs (No. 17789).
Readers will be aware that after many largely fruitless attempts at applying the Ramsay doctrine to VAT avoidance, Customs scored a palpable hit with the London Tribunal in Halifax plc, Leeds Permanent Development Services Ltd and Country Wide Property Investments Ltd (No. 17124)  V&DTR 73, with the argument that transactions with no purpose other than tax avoidance were not economic activities (Directive 77/388, sixth VAT directive , art. 4(1)) and hence did not constitute taxable supplies. Although the tribunal’s decision was subsequently quashed and referred back, the High Court did not dissent from that finding. The principal question has since been referred up to the European Court of Justice (ECJ).
The same Tribunal subsequently cited Halifax in support of its decision against the taxpayer in BUPA Hospitals Ltd and Goldsborough Developments Ltd (No. 17,588), in which case the abuse of rights principle was also advanced by Customs. Put briefly, this is a long-established principle found in many civil-law jurisdictions, to the effect that transactions or actions that purport to take improper advantage of the law contrary to its purpose and spirit may be held not to have achieved that advantage even if the formal conditions for so doing may have been satisfied. The tribunal held that this could not be applied where reliance was being placed on a purely domestic, United Kingdom (UK), provision. However, in Blackqueen Ltd, No. 17,680, the tribunal went as far, although obiter, as to imply that it ought to be applied as against a purely UK provision also.
In the face of this withering fire, a return salvo from north of the border has now opened the account for the opponents of this line of interpretation. The tribunal, under the chairmanship of Mr T Gordon Coutts, QC, expressed itself in characteristically forthright terms, to which I shall return.
RBS Developments, a wholly owned subsidiary of the Royal Bank of Scotland Group (but not a member of its VAT group), constructed a building (the Younger Building) in Edinburgh for the bank’s own occupation (although initially, there was an intention to let part of the building to third parties) on land owned by the bank.
The transaction was carried out in three parts on the advice of tax consultants. First, the land was sold by the Royal Bank to Developments. Second, Developments had the building constructed and incurred input VAT on supplies made by the contractors. |Finally, when the building was complete, it and the land was sold back to the bank by Developments. The purchase price was to be paid in instalments, but the majority fell to be paid after three years had elapsed (so that the building was no longer ‘new’ within the meaning of Value Added Tax Act 1994 (VATA 1994), Sch. 9 Grp. 1 Item 1(a)(ii) and Note 4). The effect, as the appellants wished it to be, was that Developments would recover the whole of the input value added tax (VAT) on the development and that the Royal Bank would incur irrecoverable input VAT only on the partial-exemption proportion of the VAT payable on the first three years’ instalment payments.
Customs assessed Developments and the Royal Bank Group with the purpose of recovering the input VAT they had sought to recover.
For Customs, a broad purposive construction had to be given to European Community (EC) legislation and to UK legislation implementing the same. Applying that construction to the transactions in this case, the sole purpose of the transactions was to circumvent the spirit and purpose of the VAT legislation, which was both the result and the intention. Transactions motivated by tax-avoidance should have no greater standing than fictitious transactions or those where there could be no competition in any lawful economic sector. Accordingly, on the basis of Halifax, BUPA and Blackqueen, they were not supplies nor made in the course or furtherance of an economic activity, within the meaning of the sixth VAT directive. Even if the transactions were not solely motivated by tax avoidance, that was their predominant purpose, which was equally sufficient. Finally, since there had been an artificial creation of formal conditions for gaining an advantage not intended by the legislation, there was an abuse of rights, which rendered the claim to deduct input tax non-effective.
For the appellants, it was argued that the transactions were not shams and hence, prima facie, the claim to recover input tax should succeed, unless it could be proved in fact and law that their sole purpose was to circumvent the spirit and purpose of the VAT legislation. There was in any case no support in EC case law for treating even transactions with a sole avoidance motive as not being supplies or as wholly alien to the objectives of the Directive. Only the Tribunal in Halifax and Blackqueen had held it so, but no court whose decision was binding. Neither purpose nor motive was relevant in deciding whether a transaction was an economic activity. As for the abuse of rights principle, it was not relevant, as there was no Community regulation at issue, per BUPA. There was no basis for the belief that a general principle of ‘acts in fraud of the law’ could apply to legitimate steps taken by a taxpayer to minimise its VAT liability.
The Tribunal found as a fact that the transactions had an independent business purpose and could not be said to have been entered into or carried out with the intention solely of obtaining a tax advantage. It had been agreed that the sale to Developments would be made whether or not the VAT scheme took place. The development had also begun before the consultants were engaged. Therefore the decision in Halifax was not relevant, as tax avoidance was there found to be the sole motive of the transactions.
Whereas there was a substantial avoidance motivation, the tribunal did not consider it relevant. Unless it could be established, as was not the case here, that the element of business purpose was so small as to be de minimis, there was no room for challenging the proposition that the transaction had a business purpose and was therefore an economic activity. It followed that Customs were not entitled to ignore what did in fact happen on the assertion that the taxpayer sought subjectively to mitigate its tax liability.
The tribunal also agreed with the appellants that the abuse of rights doctrine was not relevant. There was nothing improper, illegal or artificial about the transactions in question, so the reasoning in Blackqueen did not apply.
The tribunal expressed quite forcefully the old-fashioned (but not necessarily therefore no longer valid) view of the boundary between acceptable tax mitigation and unacceptable tax avoidance and the rôle of the judicial arm in this respect.
‘A taxpayer is entitled so to construct his activities as to obtain favourable tax consequences. To suggest otherwise ... could create a concept of a duty on a taxpayer not to minimise but to maximise his tax liability by seeing to it that he paid any tax which might on any view of the situation be due. Persons do not conduct their business with a view to providing finance to the authorities.’
There was also the hint that this Tribunal would have decided differently in Halifax and express disapproval of Blackqueen – ‘... and accordingly the reasoning in Blackqueen, with which we would not wish to be taken as agreeing ...’ (although this may be referring solely to the argument on the abuse of rights doctrine).
On the other hand, there was a hint that if an argument had been made solely that the reconveyance to the bank was wholly artificial, the tribunal may have decided differently on that point.
Sole or predominant purpose
Looked at dispassionately, it does certainly seem that Customs were bound to be on a losing wicket once it was established as a fact that there was a business purpose – or in the words of the tribunal, ‘real and understandable business purposes for structuring the transactions’, and hence that the transactions could not be described as being solely motivated by tax avoidance. For despite counsel’s assertion that there was authority for the proposition that a transaction was not an economic activity if it had a sole or predominant business purpose, there is, at least yet, no such clear authority. At no point in BUPA or even in Blackqueen, did the tribunal explicitly or implicitly accept that a predominantpurpose of tax avoidance disqualified a transaction from being an economic activity, although it was given repeated encouragement to do so. In Blackqueen for example, the tribunal formulated the Halifax principle thus (at para 67): ‘... where the sole reason for transactions is the avoidance of liability for VAT, those transactions have no business purpose and so do not constitute economic activities ...’ (my emphasis).
That much is clear. What is not quite so clear, is whether the principle in Halifax is well founded or not. Counsel for the appellants in this case certainly attempted a comprehensive demolition of the tribunal’s reasoning in Halifax. Thus: ‘there is no support in EC case law for treating transactions solely with a VAT avoidance motive as not being supplies or being “wholly alien”’ [(in the words of Advocate -General Jacobs in Fischer v Finanzamt Donaueschingen (Case C-283/95)  STC 708])and, sweepingly: ‘purpose is generally irrelevant to VAT’.
Although there are certainly weak links in the chain of reasoning in Halifax and beyond, this proposition is itself highly contentious. As the tribunal pointed out in BUPA, the decision in Wellcome Trust Ltd v c & E Commrs  (Case C-155/94) BTC 5,332 hinged on the motive of the trustees in carrying out the share sales, and in Breitsohl  STC 355, intention had a key part to play in deciding whether a person had commenced economic activities. Even more questionable was the claim that the ECJ was neutral towards VAT avoidance, except insofar as it led to distortion of competition. But since the question is to be decided by the ECJ, further discussion here may be of little value.
Abuse of rights
What has not yet been referred to the ECJ, however, and is still evolving is the applicability in principle and the extent in practice of the abuse of rights principle. Although the decision in BUPA did not require the principle to be brought into play, the tribunal found it to be a freestanding and independent principle that had gone beyond being merely an aid to interpretation. The tribunal in BUPA specified in what circumstances the principle could apply, but limited it to circumstances where the right said to be abused was one of Community law and not of domestic law. Taken this as given, there is plenty of scope for argument as to what extent a provision of domestic law giving effect to Community law needs to be construed in the same manner as Community law. In an obiter remark, the Tribunal in Blackqueen stated:
‘In any event we bear in mind the need for a uniform basis of assessment of VAT throughout the Community. That would indicate to us that ... the abuse of rights should be applied in a uniform manner throughout the Community and that any restrictions on ... [its] application should be kept to a minimum’ (para. 133).
The tribunal in this case disassociated itself from this remark, but the proposition that Community law demands a purposive interpretation that applies with equal force across the whole Community and goes beyond national interpretative principles (so that citing the authority of a House of Lords decision in a non-Community matter in a direct tax case, as counsel for the appellants and the tribunal itself did, with reference to MacNiven v Westmoreland Investments  BTC 44, may not be in point) is one that still has some way to run, one feels.
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November 2002 by