Tax Cases

Tax Cases

High Court overruled

The High Court had allowed DFS Furniture's application for a judicial review of Customs' decision not to repay VAT of £6.2 million which Customs had clawed back under section 80(4A), VAT Act 1994. So Customs appealed to the Court of Appeal.

The Court of Appeal ruled that the High Court was wrong in finding that the taxpayer and Customs had come to an agreement within section 85, VAT Act 1994. The taxpayer had not made an offer which Customs could accept.

Customs' appeal was allowed.

(R (on account of DFS Furniture Co plc) v Commissioners of Customs and Excise, Court of Appeal, 6 December 2002.)

Affinity is exempt

Both BAA plc and the Institute of Directors had entered into separate agreements with banks whereby 'co-branded' or 'affinity' credit cards would be issued. These would bear the names of the company or Institute and the name of the bank. Basically these 'non-bank' organisations would endorse their cards and obtain applications from their customers and members. The 'non-bank' receives fees and commission from the card-issuing bank, which earns interest, etc. on the credit granted. The question in both cases was whether the commission, etc. earned by the non-bank was subject to VAT or covered by the financial services exemption of Group 5 of Schedule 9 to the VAT Act 1994. Item 5 extends the exemption to 'the provision of intermediary services'.

The tribunal and High Court had held that the exemption did apply to BAA plc, but the tribunal had held that it did not apply to the Institute of Directors.

The Court of Appeal heard the appeals of Customs in the first case and the Institute in the second case and held that the exemption applied in both cases. The introductory services of the 'non-banks' (BAA and the Institute) did fall within the term 'negotiation of credit' (Article 13B(d)(1) of the Sixth Directive). It was not necessary that in a 'negotiation', the negotiator should have the power to alter the legal terms of the credit agreement as contended by Customs.

(Commissioners of Customs and Excise v BAA plc; Institute of Directors v Commissioners of Customs and Excise, Court of Appeal, 11 December 2002.)

Still no reorganisation

In 1998, Unilever sold a subsidiary company and was liable to tax on the gain that arose. It claimed that it was entitled to set against this gain a loss that it calculated had arisen on a disposal of shares in another subsidiary company in 1992. In calculating the loss, the company used the value of the shares in April 1965, which is understood to be as much as £40 million higher than its acquisition cost. The basis for this claim was that the shares had, in April 1965, been the subject of a reorganisation within the meaning of section 126, Taxation of Chargeable Gains Act 1992 so that paragraph 19(2) of Schedule 2 to that Act applied to prevent time apportionment and instead rebase the cost to 6 April 1965 market value.

The Special Commissioners (see Taxation, 12 July 2001at page 374) and the High Court (Taxation, 21 March 2002 at page 611) had held that there was no reorganisation within section 126 and the company appealed against those decisions.

The Court of Appeal upheld the previous decisions. In 1965, Unilever had purchased and then cancelled the preference shares in the company. This meant that its holding of ordinary shares, which had previously represented 62 per cent of the combined voting power, now comprised 100 per cent.

Lord Justice Parker held that, for there to be a reorganisation, there had to be an alteration to the rights of the shares of any class. The reference in section 126(2)(b) to the alteration of the rights attached to any shares must mean an alteration to the rights themselves, not just their commercial significance. A reduction of capital on its own was not sufficient, as the cancellation of the preference shares did not alter the rights attaching to the ordinary shares.

(Unilever (UK) Holdings Limited v Smith (Inspector of Taxes), Court of Appeal, 11 December 2002.)

Up the pole

An employee of a scaffolding business used a company vehicle to carry back alcohol and tobacco from France. He was stopped by Customs officers who decided that the goods were not for his personal use. The goods and vehicle were seized.

The business requested that the vehicle be returned to it, but Customs replied that, having considered the matter, it would not be returned as it had become forfeit under section 141(1), Customs and Excise Management Act 1979. Section 152(2) of that Act did allow Customs to restore seized goods to their owner, but despite a request from the business, Customs refused to review their decision. The company appealed to the tribunal which decided that, because Customs had not informed the company of the reasons for the decision, this was an error of law and breached the principles of natural justice. Customs appealed.

In the High Court, Mr Justice Park allowed the appeal. Under section 16, Finance Act 1994, the subject matter which should be under appeal was Customs' decision not to return the vehicle, not the manner in which this was communicated to the business. While Customs' letter to the company advising that it would not be reviewing the matter could be criticised, this was not a subject for appeal and the tribunal's decision was overturned.

(Commissioners of Customs and Excise v Telford Tower and Scaffolding Limited, High Court, 12 December 2002.)

Another Ramsay case

The taxpayer company, a member of a banking group, claimed capital allowances under section 24(1), Capital Allowances Act 1990 in respect of a finance lease arranged in relation to a gas pipeline. Briefly, the banking group purchased the pipeline from the Irish Gas Board for £91 million, leased it back to the Board for a rental stream and there were other transactions by which the £91 million found its way back as a deposit with the bank. The idea was, it appears, to gain the benefit of the capital allowances which would otherwise not be available to the Irish Gas Board. The Revenue contended that the various transactions involved in the purchase and lease back of the pipeline were designed to gain a tax advantage, and it refused relief quoting the principle in WT Ramsay Limited v Commissioners of Inland Revenue [1981] STC 174. The Revenue's decision was upheld by the Commissioners and by Mr Justice Park in the High Court who agreed the Revenue's view that the £91 million was expended on 'financial engineering' rather than on plant or machinery (see 'The Real World', Taxation, 28 November 2002 at page 218). The taxpayer appealed.

The Court of Appeal held that the purpose of the capital allowances legislation was to encourage expenditure on plant and machinery. The Court referred to the test in what was section 24, Capital Allowances Act 1990 (now section 11(4), Capital Allowances Act 2001), i.e. was it 'capital expenditure on the provision of machinery or plant wholly and exclusively for the purposes of the trade'. It was only necessary to look at what the taxpayer had done; how it had acquired the funds and how the vendor had applied the funds were immaterial. The Court also held that the fact that there was an express reference in section 75(1)(c), Capital Allowances Act 1990 to the disallowance of first year allowances meant that, unless the particular circumstances relating to that section applied, capital allowances should not be denied in other cases where there was an expectation of, or intention to obtain, allowances. The concept of incurring expenditure here was legal rather than commercial and the transaction was held to be a genuine trading transaction. The appeal was allowed.

The case is no doubt destined to go further on appeal and will in that event provide further clarification of their Lordships' current thinking with the Ramsay approach.

(Barclays Mercantile Business Finance Limited v Mawson (Inspector of Taxes), Court of Appeal, 13 December 2002.)

VAT and advertising costs

Dial-a-Phone Limited marketed mobile phones, accessories and phone insurance services and its three main sources of income were as follows.

The sales were promoted by advertising and marketing and Customs contended that the cost of this should be attributable to both taxable supplies (1 and 2 above) and exempt supplies (3 above the commission from insurance companies). The tribunal dismissed the taxpayer's appeal and the company appealed, arguing that the tribunal had drawn the wrong conclusion on the facts.

In the High Court, it was held that the tribunal's findings could not be successfully challenged. The taxpayer had argued that the advertising costs, etc. should be totally allocated to the commission from the sale of phones and airtime. It contended that the insurance commission was subsidiary to this, especially as it was not guaranteed when the phone contract was sold and only arose after a free three-month period when (and if) the payment of insurance premiums began. The Court held that the advertising costs related to all of the supplies and the fact that the commission from the insurance companies was a subsidiary source of income did not detract from this finding. It rejected the taxpayer's argument that it could only make a supply to the insurance company when the premium was first paid.

(Dial-a-Phone Limited v Commissioners of Customs and Excise, High Court, 13 December 2002.)

Thin capitalisation rules undermined

A German subsidiary of a Netherlands company was granted a loan by its parent to enable it to reduce bank borrowings and hence interest charges. The subsidiary was assessed to corporation tax on the interest that it paid on the loan and appealed. The German court sought an opinion as to whether the German law infringed Article 43 of the European Community Treaty, which states that 'restrictions on the freedom of establishment of nationals of a Member State shall be prohibited. Such prohibitions shall also apply to restrictions on the setting up of subsidiaries'.

The court found that interest paid by a German subsidiary to a German parent company was treated as an expense, but if paid to a non-German parent it was treated as a covert dividend. This would infringe Article 43 unless it could be justified.

The United Kingdom Government made a submission to the court stating that such a provision was needed to prevent tax evasion by means of 'thin' or 'hidden' capitalisation, where subsidiaries are financed by loans rather than capital contributions.

The court, referring to Metalgesellschaft Limited v Commissioners of Inland Revenue [2001] STC 452, held that the possibility of a reduction in tax revenue could not justify over-ruling Article 43, which embodied a fundamental freedom. In addition, in this case, the parent would be taxable on the interest and there was a commercial reason for the loan, being the reduction in bank interest. Nor was there any justification that the law was necessary to maintain the coherence of the tax system. Article 43 therefore precluded the German law and the appeal was upheld.

See Taxation, 19/26 December 2002 at pages 292 to 294 for initial comment concerning this important decision which is set to have major impact on our thin capitalisation rules.

(Lankhorst-Hohorst GmbH v Finanzamt Steinfurt, European Court of Justice, 12 December 2002.)

Best judgment

The Court of Appeal had to issue guidance on the proper approach of VAT tribunals on appeals under section 83(p), VAT Act 1994. Lord Justice Chadwick said that usually the tribunal would have the information enabling it to see why Customs had raised an assessment. In such cases, the tribunal should concentrate on finding out the amount of tax due from the taxpayer, using the material before it and applying its own judgment. If it believed that the tax was wrong, it should investigate why and seek an explanation, which might lead it to think that Customs had not exercised best judgment. It could then discharge the assessment or, under its powers in section 84(5), VAT Act 1994, give a direction as to the correct amount of tax.

The taxpayer's appeal was dismissed.

(Rahman v Commissioners of Customs and Excise, Court of Appeal, 20 December 2002.)

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