VAT ‘abuse’ post-Lower Mill Estate

HMRC has recently tended to treat the ‘abuse of right’ doctrine (aka Halifax doctrine, see [2006] STC 270) as a panacea that allows it to challenge any VAT planning at all. In our minds, the high water mark perhaps came with the First Tier Tribunal judgment in Lower Mill Estate Ltd (2009] UKFTT38 (TC)) which we disagreed with for the reasons set out in our previous article (‘Trouble at t'Mill’, Tax Journal, 13 July 2009, p20). The recent Upper Tier Tribunal judgment in that case together with the ECJ's RBS Deutschland judgment (ECJ Case C-277/09) confirm that the scope of this doctrine is considerably more limited than HMRC have recently been arguing. This article looks at the judgments in those two cases in detail after a few preliminary points. Readers will be familiar with the two limbs of the Halifax test set out below:

 

 

If one considers the structures held to be abusive in, for example, Halifax, Huddersfield (University of Huddersfield Higher Education Corporation v CCE Case C-223/03 [2006] STC 980) and WHA (WHA Ltd v HMRC [2007] STC 1695), those all required the insertion of transaction steps which complicated the transaction as against the more natural structure. In RBS Deutschland, no extra steps have been inserted and the transaction was an arm's-length one. In Lower Mill Estate there was a conceivable simpler transaction structure but the structure chosen made commercial sense and one could realistically imagine that genuine third parties could have chosen to enter the relevant arrangements on analogous terms; all of which would be arm's-length (c.f. the unconnected intermediate leasing company in Weald which entered both leases but would not have entered just one lease).

 

 

The Lower Mill Estate Limited (LME) granted long leaseholds of bare land to purchasers. Those grants were standard rated because planning permission had been given for the construction of a holiday home. At the same time as contracting to acquire the lease, the purchaser contracted for a sister company, Conservation Builders Limited (CBL), to build a holiday home on the plot of land supplied by LME (the ‘self-build structure’). CBL's construction services were zero-rated supplies of building services. The aggregate effect was that purchasers only suffered VAT on that part of the total price attributable to the land. By way of contrast, if they had bought completed holiday homes the entire purchase price would have been subject to VAT.

 

Purchasers thus ended up with completed holiday homes. Purchasers never chose to use anyone other than CBL to construct those holiday homes. Moreover, the same individual (JMP) owned 100% of the shares in both LME and CBL. In HMRC's view then, the ‘reality’ (a term much used by their counsel, and indeed the judge at the First Tier Tribunal) was that the sale of a completed home was the relevant comparator transaction. After all, that was what people ended up with. If that is the correct comparator then this self-build structure clearly delivered a tax advantage and HMRC said that was in itself contrary to purpose because it distorted competition and therefore satisfied limb one. Although the First Tier Tribunal accepted HMRC's arguments, the Upper Tier Tribunal has now demolished them. That may sound like hyperbole, but the judgment really does read like that.

 

 

The Upper Tier Tribunal was clear that the first limb of Halifax cannot be satisfied by the mere fact that a transaction has been structured in a way which reduces the overall VAT cost (see para 96(e)(viii)). That is not necessarily contrary to the purposes of the VAT Directive. Neither did the fact that the product obtained by the customer was, in practice, a completed house trouble the judges; Halifax is not a ‘substance over form’ rule.

 

The tool used by the Upper Tier Tribunal for determining whether the first limb was satisfied was to find the appropriate comparator transaction. HMRC contended this should be the supply of a completed holiday home. LME, by contrast, advocated a structure where LME supplied the land and an unrelated company then carried out the building works. An interesting part of the factual background was that JMP could not have raised the working capital to build holiday homes before selling them. In the business model he adopted, the group received payment for the land on day one and payment for the building works as those progressed. Thus the Tribunal held that a supply of a completed holiday home could not be the correct benchmark and favoured LME's comparator. The Tribunal also rejected the contention that you should look at this question from the customer's perspective (who presumably did just want a completed holiday home). As the VAT consequences of the chosen comparator transaction were identical to those of the actual transaction, the activities of LME and CBL did not breach the first limb of Halifax.

 

Since an unconnected builder could have built the homes in place of CBL with the same VAT consequences as LME contended for, HMRC had ‘to rely on the unique relationship between LME and CBL’ to invoke the Halifax doctrine (para 92). This was not enough. This perhaps provides a contrast between the facts in Lower Mill and those in Part Service (where it seems the leasing company could not have made an economic profit without Part Service paying over the ‘surety charges’ to the leasing company).

 

This may be a useful approach for other cases as it could be a sufficient condition to avoid a finding of abuse that the arrangements could genuinely be replicated between unconnected third parties (paras 102 and 122). For this reason (and for the other reasons in our earlier article), we believe the same decision would have been reached even if the LME group had had access to much more working capital.

 

 

RBS Deutschland Holdings GmbH (RBSD) is a German subsidiary of RBS, which purchased vehicles in the UK and leased them to unconnected UK customers. RBSD was registered for VAT in the UK as a ‘non-established taxable person’. No output tax was charged in either the UK or Germany on the lease rentals because of the following mismatch – the UK treated the lease as a supply of services in Germany whereas Germany treated the lease as a supply of goods in the UK.

 

RBSD made a claim for deduction of the UK input tax on its purchase of the cars on the basis that input tax suffered in relation to supplies made outside the UK is recoverable where those supplies would be taxable if made in the UK (in accordance with the provisions of Article 17(3)(a) of the Sixth Directive). HMRC denied RBSD credit, contending that to allow it was contrary to the principles of fiscal neutrality and that the transactions were abusive as no output VAT had been accounted for under the leasing transactions.

 

 

On the abuse question, the ECJ quoted the above two-limb test from Halifax. They then noted that ‘the various transactions concerned took place between two parties which were legally unconnected. …those transactions were not artificial in nature and ... they were carried out in the context of normal commercial operations.’ On that basis they concluded that there was no abuse here.

 

Whilst the court did not analyse a comparator at all, it is instructive to consider the natural comparator transaction. That would have involved a UK incorporated company acquiring and leasing the cars. That UK company would have been able to recover the UK input tax so, from an input tax perspective, using a German incorporated company does not put one in a better position. How then can that be abusive? As with Lower Mill, the arrangements made commercial sense.

 

The much more interesting question of whether RBSD should have charged output tax on the lease rentals was not raised before the ECJ. That surprises us slightly; surely that is the ‘tax advantage’ that potentially accrues through using a German incorporated subsidiary rather than a UK one. Having said that, it seems to us that the ECJ would probably have come to the same conclusion on abuse for the same reasons if this issue had been raised (though there is insufficient space here to discuss how this might interact with Mary Arden's judgment in IDT).

 

 

As the A-G in RBSD pragmatically notes, there are a number of areas which could give rise to cross-border VAT mismatches. For example, in the world of investment funds, the different definitions of ‘special investment fund’ in different jurisdictions can give rise to possible VAT efficiencies or inefficiencies. Having said that, where a structure is the natural way to do a deal between unconnected companies, the RBSD judgment provides comfort (if any were needed) about the treatment of any VAT efficiencies generated.

 

 

There are a number of other abuse cases working their way through the courts currently, some of which raise difficult issues. Whilst not disposing of all such issues, these cases will provide useful ammunition if similarly spurious ‘abuse’ arguments are raised going forward.

 

 

 

Paul Miller, Tax Partner, Ashurst LLP

 

 

 

Tom Cartwright, Tax Senior Associate, Ashurst LLP