The decision of the London VAT and Customs Tribunal, presided over by the chairman Stephen Oliver QC in Halifax plc (LON/00/977) has been hailed by Customs as a landmark judgment which they intend to pursue in other tax avoidance schemes. Whether it is upheld in the long run will depend on the higher courts. It is a case of such importance for the future of VAT in this country and in the European Union, that the House of Lords, if not the Court of Justice, is likely to be the final arbiter.
The decision of the London VAT and Customs Tribunal, presided over by the chairman Stephen Oliver QC in Halifax plc (LON/00/977) has been hailed by Customs as a landmark judgment which they intend to pursue in other tax avoidance schemes. Whether it is upheld in the long run will depend on the higher courts. It is a case of such importance for the future of VAT in this country and in the European Union, that the House of Lords, if not the Court of Justice, is likely to be the final arbiter.
The background is a planning structure implemented (on the advice of Ernst & Young) in early 2000 by Halifax in respect of construction costs on new call centres to be built in Belfast, Dundonald and Livingston and the extension of an existing call centre in Leeds. Halifax has an input tax recovery rate of around 5 per cent. The VAT on the construction costs was around £7.1 million.
The structure
The structure involved the use of two subsidiaries, Leeds Permanent Development Services and Country Wide Property Investments, the first of which received an interest in the sites from its parent, and then contracted the second to carry out the work.
In February 2000, Leeds Permanent, the development company, agreed with Halifax to carry out certain construction works. In return Halifax paid Leeds Permanent £104,085 plus VAT of £18,214. It then prepaid VAT of £7.1 million on construction services invoiced by Country Wide on 29 February 2000 and 13 March 2000, and recovered that VAT as input tax in the year ended 31 March 2000 (i.e. year 1) under the terms of the partial exemption standard method; as it had no exempt supplies in the year, the input VAT was fully recoverable. Leeds Permanent had an agreement to sell or assign the interests in the four sites to another company in the Halifax group as exempt supplies on 6 April 2000 (i.e. in year 2), with the effect that Leeds Permanent would not make any exempt supplies until year 2. However, there was no adjustment of the VAT recovery in year one as the interests in the properties were designed so as not to fall within the capital goods scheme. Country Wide was to buy in the actual construction services, as supplied by what the decision describes as 'the arm's length builders' and recover the VAT on those services in full.
Customs' challenge
Customs principal challenge before the tribunal was that a transaction entered solely for the purposes of VAT avoidance was neither itself a 'supply' nor a step taken in the course or furtherance of an 'economic activity' under the Sixth Directive and the equivalent terms in United Kingdom law. The consequence of this is that neither Leeds Permanent nor Country Wide made supplies and the supplies from the arm's length builders were made direct to Halifax, with the VAT thereon subject to partial exemption restriction.
The tribunal's analysis
The tribunal chairman adopted a three stage approach, as follows:
Were the transactions carried out for tax avoidance reasons?
The chairman considered whether there was any business or commercial rationale for the transactions involving Leeds Permanent and Country Wide, focusing particularly on the comments of the European Court of Justice on 'tax avoidance' in Direct Cosmetics v Commissioners of Customs and Excise [1988] STC 540, including the distortion of competition angles. The chairman found there was not such a rationale, adding:
'we conclude that the scheme implementing the solution and every step and every transaction involved in it were tax avoidance in the sense contemplated by the Sixth Directive. They were tax avoidance in the United Kingdom sense of that expression as explained by Lord Nolan in Commissioners of Inland Revenue v Willoughby [1997] STC 995. By entering into the scheme the Halifax and the other participating companies reduced the incidence of VAT "without incurring the economic consequences that Parliament intended to be suffered by any taxpayer qualifying for such reduction in" its tax burden.'
Did Leeds Permanent and Country Wide make taxable supplies of construction services?
The chairman considered whether transactions such as those that formed part of the scheme comprised in the Halifax's tax avoidance solution can properly be classed as 'supplies' effected by a taxable person carrying out an 'economic activity', as those expressions are used in the Sixth Directive. He concluded:
'The inherent nature of the transactions with which the present appeal is concerned is, taking those transactions collectively and individually, tax avoidance. There was no business purpose. Even the profits allowed to Leeds Permanent and Country Wide, which were emphasised in the minutes of the meetings, were "built into the scheme"; they were not based on any real business activity. Adapting the Sixth Directive terms, the Halifax's tax avoidance activities were, we think, "counter-economic activities". They were, to use the European Court of Justice's words in Fischer v Finanzamt Donaueschingen (Case C-283/95) [1998] STC 708 "wholly alien to the provisions of the Sixth Directive and do not give rise to any tax debt".'
To whom did the arm's length builders make their supplies?
The chairman concluded that:
'the nature and destination of the arm's length builders VAT supplies are, applying Mr Justice Laws' approach in Commissioners of Customs and Excise v Reed Personnel [1995] STC 588, to be determined from all the relevant considerations of which the paperwork will be one … We see [the involvement of Country Wide in the chain of supplies as per the paperwork] as make-weights. The absence of reality is demonstrated by the ephemeral nature of the scheme, the property interest of Leeds Permanent, the funding arrangements and the warranties. Adopting the Reed Personnel approach the only conclusion that we can draw is that the supplies of construction works were made by the arm's length builders direct to the Halifax.'
As a result, he concluded that Leeds Permanent made no standard-rated supplies to the Halifax, Country Wide made no standard-rated supplies to Leeds Permanent and the arm's length builders supplies were made direct to the Halifax. The appeal was dismissed.
Radical departure
The judgment in this case marks a radical departure from the apparent constraints imposed by previous VAT case law. If confirmed by the higher courts, it will amount to a new line of authority in VAT avoidance cases. It has always been accepted that because VAT is a transaction tax based on a chain of supply to the final consumer, each part of that chain must be looked at separately and regarded as a completed event, without the ability to take a global view (see for example Robert Gordon's College v Commissioners of Customs and Excise [1995] STC 1093 and BLP Group plc v Commissioners of Customs and Excise [1995] STC 424). It is also a tax where senior judges have questioned whether the Ramsay principle has any application (see Lord Hoffmann in Thorn Materials Supply v Commissioners of Customs and Excise [1998] STC 725). There is also long-standing case law to the effect that transactions must be looked at objectively rather than subjectively, with no regard being paid to the motives of either the supplier or the customer. For example in British Railways Board v Commissioners of Customs and Excise [1977] STC 221, Lord Justice Brown made the following comment:
'Equally the motive or intention of the person supplying the service is in my view irrelevant, and the Board is therefore not helped by the finding of the tribunal's decision that the Board regarded as a two-part tariff. In my judgment, the transaction must be looked at objectively in order to decide whether or not the "supply" involved in it does or does not fall within Item 4 of Group 10 of Schedule 4.'
The decision seems to involve complete acceptance of Customs' submission that a transaction entered into solely for the purposes of VAT avoidance is not a supply made in the course or furtherance of an 'economic activity' as those terms in the Sixth Directive (and the equivalent terms in the VAT Act 1994) are properly to be interpreted. Note the carefully worded conclusion that both the scheme implementing the solution and every step and every transaction involved in it were 'tax avoidance' contemplated both by the Sixth Directive and in the United Kingdom sense in case law such as Willoughby. Although both Country Wide and Leeds Permanent were registered for VAT and so ranked as taxable persons, the issue was whether their purported supplies ranked as supplies for the purposes of section 4(1), VAT Act 1994, which involved the analytically antecedent question of whether they were made in the course or furtherance of any businesses carried out by those entities.
Crucial key roles
The tribunal accepted that the transactions were genuine rather than shams, but saw the problem lying in the fact that each one plays a key role in the Halifax's tax avoidance solution and owes its existence to that and nothing else. The central question was therefore whether transactions such as those that form part of the scheme in this solution could properly be classed as supplies made by a taxable person (such as Leeds Permanent and Country Wide) carrying out an economic activity as those expressions are used in the Sixth Directive.
In Mr Oliver's view, the inherent nature of the transactions with which the appeal was concerned was, taking them collectively and individually, tax avoidance, and that there was no business purpose in the ordinary sense in which that word is used, it being implicit that Mr Oliver regards the words as being used in 'an ordinary sense' rather than any special VAT or legal sense. He was therefore able to deny that this involved taking a global approach, but saw it as taking the law as found and adopting constructions of the statutory expressions 'supply', 'economic activity' and 'business' which recognised transactions that have some economic or business character and do not recognise tax avoidance transactions that lack that character.
Breaking new ground
Mr Oliver's approach seems deliberately intended to break new ground and it is worth noting immediately that his analysis appears on the face of it distinct from the Ramsay line of cases in direct tax, though echoing it in certain respects. Certainly the Ramsay doctrine of judicial statutory construction in certain kinds of avoidance cases, together with its limitations imposed by subsequent case law, is not mentioned; nor are those limitations, which are important, expressly considered. However, it is difficult to see how the higher courts could avoid grappling with the question whether Mr Oliver's analysis is compatible with the position on Ramsay, and in particular the state of the argument following the recent judgment (8 February 2001) of the House of Lords in MacNiven v Westmoreland Investments. That will be dealt with further below.
More immediately, the problem with the Halifax decision is that it almost proves too much. It can be read as suggesting that the existence of a sole tax avoidance motive on the part of the supplier in carrying out a transaction or series of transactions renders what would otherwise qualify as a supply not a supply because it was not an economic activity. It is difficult to see any justification for such a sweeping principle either in the European Union or domestic legislation, unless the sense in which those words are used must be interpreted in a purposive way as necessarily excluding tax avoidance steps. It also, at a practical level, goes against how a broadly based transaction tax like VAT is intended to function in the economy, i.e. as a tax on all supplies of goods and services which take place for consideration and by way of business, viewing those terms objectively. Indeed it is arguable that as it is the duty of directors of a company to maximise shareholder value, the mitigation or avoidance of VAT is a bona fide commercial purpose for a business, as was confirmed in Commissioners of Customs and Excise v West Yorkshire Hospital [1989] STC 539 prepayment case.
It is fundamental to VAT that the concept of supply and economic activity remain broad ones. The term 'supply' is a word of the widest import, and is intended to be as all encompassing as possible for obvious fiscal reasons. There are many occasions in VAT where transactions are routed through parties in a chain of supply without the underlying capacity to make the supply, and whatever the motive of the arrangement these are normally accepted – indeed in most cases required to be treated by Customs – as genuine supplies with economic consequences. The real difficulty in a transaction tax such as VAT is that treating a supply carried out only or mainly for tax mitigation or avoidance purposes as not being a supply in VAT terms could have far-reaching effects, which could in many cases be detrimental to the revenue. In other cases, such as Phillips Exports, the principle put forward by Mr Oliver might have produced a different result, leading to business solution in that case being ineffective.
At the heart of the argument is whether arrangements set up for an avoidance purpose fail to meet the test of being supplies for consideration and business or economic activities solely for that reason. In the MacNiven case, Lord Hoffmann made the following comment in considering the limits of Ramsay:
'Even if a statutory expression refers to a business or economic concept, one cannot disregard a transaction which comes within the statutory language, construed in the correct commercial sense, simply on the ground that it was entered into solely for tax purposes.'
Purposive test
In the Halifax case, the tribunal has applied a purposive test (i.e. was the step a 'business' one) to a series of transactions, to disregard the fact that the supplies of the construction service were factually made to a party in the chain and rule, against the facts of the transactions as they were structured contractually, that the supplies were really made to Halifax. The chairman finds therefore that supplies made in a factual sense are not supplies in a VAT sense; and then goes further and disregards the various factual supplies through the intermediaries, treating the whole supply as a simple supply by the arm's length suppliers of construction services to the Halifax.
This last part of the analysis may in practice be the hardest for the higher courts to accept, as it is one thing to strike down transactions and another to completely re-characterise them. This further step (not itself necessary to strike the scheme down) is clearly the adoption of a global approach to VAT analysis, even if Mr Oliver denies this.
Lord Hoffmann's concern in MacNiven was that the Revenue's formulation of Ramsay was unacceptably broad – it amounted to seeing it as a wide principle of striking down all transactions undertaken for no commercial purpose other than the obtaining of a tax advantage (i.e. there is an absolute rule of construction that the condition laid down in the statute for obtaining of the tax advantage has not been satisfied). He added that the courts had 'no constitutional authority to impose such an overlay upon the tax legislation'. He took a more conservative approach; his analysis of the Ramsay principle is that a transaction or series of transactions with inserted steps could fall outside the scope of the statutory provisions because the terms used in some cases must be interpreted in a business or economic sense rather than a strict legal or 'juristic' one.
The general problem with applying anything like the Ramsay doctrine to VAT is that it is analytically a one-stop tax – the question is always one with a narrow and short focus, for instance, was there a supply or not for consideration? There is one event of fiscal significance, i.e. a supply which has one value, the consideration. It either happens or not. If it does, it has VAT as well as commercial consequences for both maker and recipient. It is the basic unit of fiscal analysis, and it matters not what supplies precede or follow it (see Robert Gordon's College).
In that case, the House of Lords recognised that this involved 'a transaction which was at least in part for the purpose of creating a taxable supply against which input tax could be deducted', but rejected the proposition that a global view can be taken of the overall purpose or result of a series of transactions in a chain. Each transaction in the chain of supply must be examined separately and objectively, and given its appropriate tax treatment.
Juristic view
Perhaps the most important insight of Lord Hoffmann in his restatement of the Ramsay principle in MacNiven was that Ramsay in essence involves taking a commercial or businessman's view of expressions such as gain or loss rather than a narrow juristic view. Having taken this different view (which is purposive in nature), you then apply the statutory construction with no further elaboration or adjustment; and where the words in question have only a particular legal meaning in their context, this commercial view of them is not possible, so that while Ramsay can apply in a capital gains tax context where terms like gain or loss can properly bear their commercial meaning (i.e. would a businessman recognise this particular transaction or series of transactions as involving a real gain or loss), in areas like stamp duty it is much more difficult because if asked to define a land law term, for example, the businessman would respond 'I don't know, you'd better ask a lawyer'.
Arguably the same difficulty arises in VAT cases, because there are very strong arguments that the terms used: economic activity/business, entrepreneur/taxable person, supply of goods / supply of services, consideration, all have a particular technical and legal meaning for VAT purposes (in fact a Community meaning in most cases), which cannot be supplanted by the commercial view of the typical businessman. Again, if asked what a supply of goods was, the businessman might well respond 'if you mean in the VAT sense, you had better ask a VAT specialist'.
From the European Community law point of view, as the European Court of Justice has repeatedly stressed, it is particularly important that VAT terms are given a uniform Community meaning, to avoid inconsistencies of interpretation by the Member State, leading to loss of neutrality in the practical application of the tax. On this basis, Lord Hoffmann might well say of the Halifax case that the words used (supply, business/economic activity) are used in a special VAT/legal sense and for Ramsay purposes cannot be given a different commercial meaning.
Potential historical oddities
Whatever the answer to this, if Mr Oliver's decision is correct as a statement of how VAT avoidance should be treated where it is the sole motive for a transaction, it makes many of the judgments of the higher courts in past cases, including the House of Lords, look distinctly odd given that there was no attempt to apply the principle now put forward by Mr Oliver; rather the cases were argued on their technical merits. (Arguably, it creates much the same situation as a general anti-avoidance rule such as the one in Australia – but without there being such a general rule in place.)
If the 'sole purpose being avoidance' motive on the part of the supplier is enough to make a transaction or services of transactions not an economic activity, why is this principle not more widely known (outside anti-avoidance circles in Customs) and why was it not used to defeat the circular prepayments in Commissioners of Customs and Excise v Faith Construction Ltd [1989] STC 539, the value shifting in Thorn Granada and the prepayment and degrouping in Thorn Materials?
In the last case, Customs never pleaded (and arguably the higher courts would never have accepted) that the avoidance motive was in itself enough to defeat the scheme; while the case may have failed in the end on its technical merits, the Court of Appeal and House of Lords struggled to get this result, as is shown by their mutually contradictory answers. On Mr Oliver's analysis, a prepayment of VAT solely to preserve zero rating in anticipation of a change of the law could be argued not to create a tax-point (the avoidance motive meaning there was no economic transaction); but this is plainly against the reasoning of the Court of Appeal in the Faith Construction case, which remains a case law precedent binding on the tribunal. In Faith, the court refused to apply Ramsay in any event (so too did the House of Lords in Thorn Materials, preferring to invent a delivery tax-point at full value for the supply of goods by the de-grouped company, Lord Hoffmann dissenting).
European Community law
Turning to European Community jurisprudence and law, it is important to bear in mind that the Court of Justice has never ruled in a VAT case that a sole avoidance motive on the part of the supplier is sufficient to disqualify a transaction that is otherwise plainly within the VAT net from being an economic transaction. Its decisions in the cases Mr Oliver quotes, such as Wellcome Trust Ltd v Commissioners of Customs and Excise (Case C-155/94) [1996] STC 945, Polysar Investments Netherlands BV v Inspecteur der Invoerreechten en Accijnzen (Case C-60/90) [1993] STC 222 and the cases involving the supply of illegal drugs concern a quite different principle to do with the legitimate scope of the tax where passive or illegal receipts of income are concerned. There is no principle that your supplies do not have to bear output tax because you make them with a sole avoidance motive in mind – if this was the case it could itself be a source of avoidance, and would certainly in many cases lead to a loss of neutrality, as businesses making the same supply economically would receive different treatment.
In non-VAT cases such as Le Clerc, the Court found that an artificial re-import of milk under quota in a circular transaction was insufficient to gain the rights associated with a 'real' import, but this was really saying that the so-called re-import, though involving a movement of goods, was in effect a sham, so that the words of the regulation on which reliance was placed did not give the rights sought.
The European Court of Justice case law on avoidance and abuse of rights does not point convincingly in favour of Mr Oliver's solution to VAT avoidance. The Centros case, for example, makes clear that there can be no abuse of rights where duties rather than rights are involved, and where the supposed transgressor is following the intentions of the legislator and therefore the requirements of the statute; and there is some acknowledgement of this by Mr Oliver in Halifax, who refused to regard it as an abuse of rights case, despite the lengthy (and almost entirely erroneous) assertions of Customs on this point.
Real transactions
Perhaps the telling point in the Halifax case is that the series of complex transactions which Mr Oliver says are not to be regarded as economic activities involve real contracts, real supplies in the factual sense between the parties, and the payment of real consideration in the legal sense (more real than many situations where Customs insist on VAT being charged, for example intercompany management charges).
What disqualifies each transaction from being an economic activity in his view is that the avoidance motive behind it meant there was no business motive – but he insists this is not taking a global view of the series of transactions (contrary to BLP) or the scheme as a whole. In reality, the scheme works as an avoidance solution to the Halifax's avoidance problem through a loophole in the partial exemption rules – the ability to claim input tax in full in a clear partial exemption year and then make exempt supplies in the second year with no fear of claw-back.
The proper way of dealing with such a lacuna in law is surely to change it by modifying the partial exemption rules to prevent the advantage from arising. The European Community remedy for this situation lies not in a supposed abuse of rights principle, but specifically in Article 20 of the Sixth Directive – which gives Member States the right to apply a very wide subsequent adjustment régime to all capital goods, not just the limited ones the United Kingdom has chosen to include in our version of the scheme. In France, the adjustments apply to all goods and some services.
Incompatible
Finally, Mr Oliver's judgment must risk incompatibility at least with the Article 27 approval procedure in the Sixth Directive for specific measures to counter avoidance and evasion. If such avoidance or evasion can automatically be countered by disqualifying the activities in question and placing them outside the VAT system, why is the procedure necessary at all? If judicial intervention in one Member State allows the procedure to be avoided, but other Member States' courts apply different criteria, will that produce neutrality and certainty – particularly bearing in mind that approval for anti-avoidance derogations is far from being a rubber stamp?
Flaws and difficulties
In conclusion, there are flaws and difficulties with Mr Oliver's decision in Halifax which give an appeal to the High Court a strong chance of success. If it is to be seen as a first application of the Ramsay principle to the world of VAT, then there is a basic problem of incompatibility with Lord Hoffmann's restatement of that principle in MacNiven if it is correct to see the VAT concepts as juristic Community law terms rather than wider, commercial terms.
It may be that Mr Oliver is simply wrong as to what the words 'supply', 'economic activity' and 'business' mean. If it is a new non-Ramsay based doctrine of judicial construction applicable to VAT, will it be upheld by the higher courts, and if so, will that not mean contradicting a number of very senior past authorities and precedents? As Lord Hoffmann put it, the initial reaction to Ramsay was to see it as a 'broad spectrum antibiotic' against all forms of avoidance; and the initial reaction, particularly by Customs, to Mr Oliver's decision may be similar.
Even if it is upheld in part, in particular situations, for all the reasons described it seems to be going much too far to say that a sole avoidance motive per se disqualifies a transaction from being an economic activity.
Peter Jenkins is United Kingdom head of indirect tax at Ernst & Young.
