Tax Journal’s pick of the top ten tax cases of 2015.
Case of the year:
Pendragon on VAT abuse
In Pendragon and others v HMRC [2015] UKSC 37 (10 June), the Supreme Court, reversing the decision of the Court of Appeal, found that a scheme to avoid VAT on the resale of demonstrator cars was abusive.
The object of the scheme was to ensure that companies in a car distributor group were able to recover input tax incurred on the price of new cars acquired as demonstrator cars, while avoiding the payment of output tax on the sale of these cars to consumers. The issue was whether it was abusive under the Halifax principle.
The KPMG scheme involved the sale by the distributors of newly acquired cars to captive leasing companies (CLCs); the leasing of the cars by the CLCs to the distributor’s dealerships; the assignments of the leasing agreements and titles to the cars to a Jersey bank (SGJ); the sale by SGJ of its hire business as a transfer of a going concern (TOGC) to a company of the distributor group (Captive Co 5); and, finally, the sale of the cars by Captive Co 5 to customers.
The success of the scheme relied primarily on the VAT (Cars) Order, SI 1992/3122, article 8, which provides that dealers in second-hand goods are allowed to charge VAT not on the whole consideration for the sale of the goods, but on their profit margin only.
The Supreme Court thus observed that the effect of the KPMG scheme was to enable the Pendragon Group to sell demonstrator cars second hand under the margin scheme, in circumstances where VAT had not only been previously charged but fully recovered, so ‘that no net charge to VAT was ever suffered, except on the small or non-existent profits realised on the resale’. The Supreme Court concluded that a system designed to prevent double taxation on the consideration for goods had been exploited so as to prevent any taxation on the consideration at all. The first limb of the Halifax test was therefore satisfied; the scheme was contrary to the purpose of the legislation.
As for the second limb, the Supreme Court found that the transaction had the essential aim of obtaining a tax advantage. Two steps had been inserted which had had no commercial rationale other than the achievement of a tax advantage. The first one was the leasing of the cars by the CLCs to ensure that one of the gateways of article 8 applied: the assignment of rights under a hire purchase or conditional sale agreement. The second one was the acquisition of the business by Captive Co 5, so that the acquisition of the cars was brought within the gateway for assets acquired as part of a business transferred as a going concern.
As the scheme was an abuse of law, it fell to be redefined as a sale and leaseback transaction, followed by a sale to customers to which article 8 did not apply.
Why it matters: The court highlighted two difficulties of the Halifax principle. The first arose from the assumption that the principle will not apply to ‘normal commercial transactions’, as ‘the VAT Directives must be assumed to have been designed to accommodate them’. This had led the Court of Appeal to find that the arrangements were not abusive. The second difficulty resulted from concurrent purposes. The question was then whether the commercial objective was enough to explain the particular features of the arrangements.
Tax Journal’s coverage: ‘HMRC is likely to take great comfort from Pendragon and to attack existing and future VAT planning structures. The continued efficacy of offshore structures, as in Newey [2015] UKUT 0300, must be in doubt … One may also expect a degree of mission creep in the willingness of the Upper Tribunal to take an intrusive approach to factual evaluation by the FTT’ (Michael Conlon QC and Rebecca Murray, Tax Journal, 26 June 2015).
Why it’s our case of the year: This case has it all – it went all the way to the Supreme Court; it may be about VAT but it is also an example of HMRC’s 80% success rate before the courts and tribunals in avoidance cases; and it contains some rather ground-breaking comments about the jurisdiction of the Upper Tribunal.
Tax Journal’s pick of the top tax cases of 2015, listed in chronological order:
European Commission v UK
In European Commission v UK (C-172/13) (3 February), the CJEU found that the UK legislation on cross-border group relief complies with EU law principles.
The European Commission was applying for a declaration by the CJEU that CTA 2010 s 119(4) makes it virtually impossible in practice to obtain cross-border group relief, so that the UK has failed to fulfil its obligations under TFEU articles 31 and 49.
Cross-border group relief is only available if the ‘no possibilities test’ is satisfied; that is, if the losses are not relievable in the country where the loss-making subsidiary is established. Under CTA 2010 s 119(4), the determination as to whether losses may be taken into account in the future must be made ‘as at the time immediately after the end’ of the accounting period in which the losses were sustained. According to the Commission, cross-border relief can therefore only be available if either carry forward of losses is not possible under the legislation of the country of residence of the subsidiary; or if the subsidiary is liquidated at that time.
However, the CJEU observed that the first situation mentioned by the Commission was irrelevant for the purpose of assessing the proportionality of s 119(4). In such a situation, the member state in which the parent company is resident may not allow cross-border group relief without thereby infringing article 49 (K (C-322/11)). As for the second situation, the CJEU considered that s 119(4) does not require the subsidiary to be put into liquidation before the end of the accounting period in which the losses were sustained. The provision only imposes a requirement to make an ‘assessment’ at that time. The Commission also submitted that the UK was in breach of TFEU articles 49 and 31 in that its legislation precludes cross-border group relief for losses sustained before 1 April 2006. The CJEU found, however, that the Commission had not established the existence of situations in which cross-border group relief for losses sustained before 1 April 2006 was not granted. The CJEU therefore rejected both complaints.
Why it matters: ‘This judgment does limit claims for time expired losses. It will also at least delay settlement of claims for terminal losses where it only became evident at a later stage that the losses were terminal. But that part of the judgment is arguably narrow and may not do what HMRC will hope’ (Rupert Shiers, Tax Journal, 12 February 2015).
Eclipse 35
In Eclipse Film Partners No. 35 v HMRC [2015] EWCA Civ 95 (17 February), the Court of Appeal found that Eclipse 35 had not been trading.
Eclipse 35, a partnership, and its members had entered into a complex series of transactions for the acquisition, distribution and marketing of film rights.
The members had borrowed money to contribute to the capital of the partnership. They could only claim tax relief in respect of the interest if the loan was used wholly for the purpose of a trade carried on by Eclipse 35 (ITTOIA 2005 s 863 and ICTA 1988 ss 353, 362).
The FTT had found that Eclipse 35 had not played ‘a meaningful part in the marketing and distribution of the films’; it had therefore not carried on a trade. The FTT’s decision had been upheld by the UT.
The Court of Appeal noted that the transactions had two aspects. One aspect was that a payment by Eclipse 35 of £503m would be repaid with interest over a 20 year term and would produce a profit unrelated to the success of the exploitation of film rights. That aspect had the character of an investment. The second aspect was the possibility for Eclipse 35 to obtain a share of ‘contingent receipts’. The court accepted the FTT’s finding that the possibility of receiving such receipts was too remote for this aspect to be significant.
Finally, the court rejected the contention that the activity of entering into a licence and sub-licence inherently constituted the carrying on of a trade.
Why it matters: Like the tax tribunals, the Court of Appeal accepted that the transactions were not ‘shams’. However, this finding did not prevent the court from holding that ‘on a realistic view of the facts’ (applying the Ramsay doctrine), Eclipse 35 had acquired an investment rather than carried on a trade.
‘The court has confirmed that in assessing whether an activity amounts to a trade, it is necessary to consider the totality of what is done. The court has indicated that the concept of trade has a variety of meanings or shades of meaning’ (Chris Bates and Judy Harrison, Tax Journal, 11 March 2015).
Samarkand
In Samarkand Film Partnership No. 3, Proteus Film Partnership and three partners v HMRC [2015] UKUT 211 (29 April 2015), the UT found that the partners were not entitled to loss relief and that they had not had a legitimate expectation that the relief would be available.
The issue was whether two partnerships, which had acquired and leased films under sale and leaseback arrangements, were entitled to loss relief in respect of losses which arose on the acquisition of the films. If so, their partners could claim sideways relief under ICTA 1988 ss 380 and 381 to set the losses against their taxable income from other sources.
The purchase of an asset which a person intends to exploit over a period of time is normally treated as capital expenditure. However, ITTOIA 2005 s 134 provides that in the case of a film, the expenditure should be regarded as revenue in nature. Furthermore, ss 138 and 140 allow loss relief to be claimed in advance of the normal rules. Relief is not available, though, if the expenses are not incurred wholly and exclusively for the purposes of a trade or if the losses are not connected with or arising out of a trade.
The UT found that the FTT had been entitled to conclude that the partnerships had not been carrying on a trade, so that no loss relief was available to the partners. This was so, even though a transaction of that type could have constituted a trade. In particular, it accepted the FTT’s factual finding that the commercial nature of the agreements was ‘the payment of a lump sum in return for a series of fixed payments over 15 years’.
No further arguments were required following the release of the Court of Appeal’s decision in Eclipse Film Partners [2015] EWCA Civ 95 (see above), which recommended a ‘realistic approach to the transaction’. Even if the partnerships had been conducting a trade, they would not have been doing so on a commercial basis, as the transactions were intended to produce a loss in net present value terms. This analysis was not affected by the fact that the individual partners were accruing ‘extra benefits’ as a result of the tax reliefs. Those reliefs were obtained by ‘deliberately causing the partnership to trade in an uncommercial manner’.
The two judges disagreed as to whether, in any event, one of the partnerships had incurred the expenditure for the acquisition of a film (as opposed to that of an income stream). The president exercised its casting vote on this issue, finding that the partnership had incurred the expenditure for the purchase of a film. This was because it had acted bona fide in the belief that it was acquiring valuable rights.
The taxpayers also claimed judicial review on the ground that HMRC’s denial of relief was at odds with its own published guidance in HMRC’s Business Income Manual (BIM). The UT pointed out that unlike IR20, which was aimed to give taxpayers guidance on residence, the BIM was intended for the use of HMRC staff – although it was made available to the public. The UT observed that the BIM stressed in several places that the relief was aimed at tax deferral only.
Furthermore, the BIM included clear statements that transactions involving tax avoidance would be closely scrutinised and that the guidance may not be applied to them. The argument that this statement suggested that HMRC reserved the right to treat similar transactions differently was robustly rejected. ‘Taxpayers may not like that statement but they could not say that they derived a legitimate expectation that was at odds with it.’ Finally, the UT found that HMRC had reasonably thought that tax avoidance was at play. Several features indicated that the aim of the transactions was not tax deferment but tax avoidance.
Why it matters: The appeal failed on both the ‘trading issue’ and the legitimate expectation issue. On the trading issue, the UT simply reiterated the points made by the FTT on the basis of its factual findings. On the legitimate expectation issue, the taxpayers could not rely on HMRC’s description of a plain vanilla transaction (claiming that their arrangements were similar) and ignore the general statement about tax avoidance. They could not ‘take out the plums they liked and ignore the duff they did not’.
‘The decision serves as a reminder to taxpayers of the extent to which they can rely on HMRC’s manuals ... No matter how clear or unqualified a statement in HMRC’s manuals might appear to be, it will be open for HMRC to depart from that guidance if it considers that tax avoidance is or may be involved, leaving the taxpayer in question with an uphill struggle to prove that it has a substantive legitimate expectation that should be protected’ (Jeanette Zaman & Owen Williams, Tax Journal, 22 May 2015).
Littlewoods Ltd
InLittlewoods Ltd and others v HMRC [2015] EWCA Civ 515 (21 May), the Court of Appeal found that Littlewoods was entitled to compound interest on VAT wrongly paid.
Littlewoods had paid VAT which was not due. HMRC had repaid the principal amount together with simple interest. Littlewoods claimed that it was also entitled to compound interest. There were four issues. First, were Littlewoods’ restitution claims excluded by VATA 1994 ss 78 and 80 as a matter of English law and without reference to EU Law? The CA found that the net effect of the provisions was that the only cause of action available to the taxpayer for the repayment of the principal sums was that afforded by s 80(1) and so restitutionary claims for repayment of VAT were barred by s 80(7). Furthermore, s 78(1) excluded common law claims for interest.
Second, did the exclusion of the claim by VATA 1994 violate the principle of effectiveness by depriving Littlewoods of an adequate indemnity for the loss occasioned through the undue payment of VAT? The court noted that ‘adequate indemnity’ was not a rigid ‘straitjacket’ which required compound interest in every case. However, s 78 did deprive Littlewoods of an adequate indemnity.
Third, ss 78 and 80 could not be construed so as to conform with EU law as the exclusion of common law claims for interest was a cardinal feature of the legislation. The provisions must therefore be disapplied. Furthermore, the court did not have the power to disapply the domestic bar to the enforcement of Littlewoods’ rights on a selective basis. The choice of remedy therefore belonged to Littlewoods who chose to make a mistake-based restitution claim as this was not time-barred whereas a Woolwich claim would have been time-barred.
Finally, on quantum, the court found that HMRC should not be treated as if it were an involuntary recipient of overpayments of tax. Consequently, ‘objective use value’ applied to the valuation of the time value of the overpayments made to HMRC and compound interest was payable. Finally, interest should continue to run after the date of the repayment of the principal amounts of overpaid VAT on such amounts of accrued interest as remained outstanding.
Why it matters: This is the latest instalment of a judicial saga which includes two high court decisions and a preliminary ruling by the CJEU. The tax at stake is colossal; £1.2bn in compound interest. ‘In rejecting HMRC’s ingenious arguments, the court confirmed that even a substantial payment of statutory interest may not always provide a substantive safeguard for a claimant’s EU law rights. Such rights must be asserted not by way of VATA 1994 but by a claim for restitution at common law. But, the battle continues…’ (Michael Conlon QC, Tax Journal, 5 June 2015). Following the decision, the government introduced a new 45% rate of corporation tax on restitution interest payments (CTA 2010 ss 375YA–375YW inserted by F(No. 2)A 2015 s 38).
Anson
In Anson v HMRC [2015] UKSC 44 (1 July), the Supreme Court found that a member of a US limited liability company (LLC) was eligible for double tax relief in the UK on his share of the profits.
Mr Anson was resident but not domiciled in the UK for UK tax purposes. He was liable to UK income tax on foreign income remitted to the UK. He was a member of an LLC, which was classified as a partnership for US tax purposes. He was therefore liable to US federal and state taxes on his share of the profits. Mr Anson remitted the balance to the UK, and was therefore liable to UK income tax on the amounts remitted, subject to double tax relief. HMRC considered that Mr Anson was not entitled to double tax relief, on the basis that the income which had been taxed in the US was not his income but that of the LLC. Mr Anson contended that, even assuming that US tax was charged on the profits of the LLC and that he was liable to UK tax only on distributions made out of those profits, the US and UK tax were nevertheless charged on ‘the same profits or income’, within the meaning of the UK/US double tax treaty. He also argued that, as a matter of UK tax law, he was liable to tax in the UK on his share of the profits of the trade carried on by the LLC, which was the same income as had been taxed in the US.
The Supreme Court rejected the first ground, noting that the context of the treaty and its history did not suggest such a wide approach to the concept of income. However, in relation to the second ground, it found that Mr Anson was entitled to the share of the profits allocated to him, rather than receiving a transfer of profits ‘previously vested in the LLC’. His ‘income arising’ in the US was therefore his share of the profits, which was the income liable to tax both under US law and under UK law – to the extent that it was remitted to the UK. His liability to UK tax was therefore computed by reference to the same income as was taxed in the US and he qualified for double tax relief.
Why it matters: The classification of foreign entities and of the profits they generate continues to raise difficult questions. In this case, the FTT had found that the members of the LLC had an interest in the profits as they arose; therefore, the Supreme Court found that double tax relief was due. Following this decision, HMRC published Brief 2015/15, which confirms that HMRC will continue to treat US LLC’s as companies. This is on the basis that the decision was fact specific so that it does not need to be applied generally. The brief also explains that individuals relying on the decision in order to claim double tax relief will be considered on a case by case basis.
Larentia + Minerva
In Beteiligungsgesellschaft Larentia + Minerva mbH & Co. KG v Finanzamt Nordenham (C-108/14) and Finanzamt Hamburg-Mitte v Marenave Schiffahrts AG (C-109/14) (16 July), the CJEU found that holding companies can deduct input tax to the extent that they are involved in the management of their subsidiaries.
Larentia + Minerva had acquired 98% of the shares in two subsidiaries – constituted in the form of limited partnerships – which it provided with administrative and business services. Marenave had increased its capital and acquired shares in four ‘limited shipping partnerships’, and was involved in their management. The issue was the extent to which deductions were allowed, in relation to input tax incurred on acquisition and issue costs.
The CJEU observed that the holding of shares is not an economic activity, unless the holding is accompanied by direct or indirect involvement in the management of the company. Furthermore, for VAT to be deductible, the input transactions must have a direct and immediate link with the output transactions giving rise to a right of deduction.
The CJEU concluded that the expenditure connected with the acquisition of shareholdings in subsidiaries incurred by a holding company which involved itself in their management – and which, on that basis, carried out an economic activity – must be regarded as attributed to that company’s economic activity; and therefore that VAT incurred on that expenditure was deductible. The deduction of VAT would only be limited if the costs were attributed in part to other subsidiaries, in the management of which the holding companies were not involved. Finally, the CJEU found that the Sixth Directive article 4 precludes national legislation which reserves the right to form a VAT group solely to ‘entities with legal personality and linked to the controlling company of that group in a relationship of subordination’; except where those two requirements are appropriate and necessary to prevent abusive practices or to combat tax evasion or tax avoidance.
Why it matters: This decision confirms that VAT incurred by holding companies involved in the management of their subsidiaries is deductible. ‘The decision is another dramatic shift in the recovery of VAT on costs incurred in the acquisition of subsidiaries’ (Michael Conlon QC and Rebecca Murray, Tax Journal, 6 August 2015).
Rowe
In Nigel Rowe and others v HMRC [2015] EWHC 2293 (31 July), the High Court found that partner payment notices (PPNs) had been validly issued by HMRC.
The 154 claimants had all participated in Ingenious Media schemes, which HMRC alleges, were designed to generate tax losses. The claimants’ substantive appeals are being litigated in the FTT and HMRC has issued PPNs (under FA 2014 ss 219–229). The taxpayers contended that the PPNs were unlawful and of no effect for the following reasons: (1) The statutory scheme was unfair, as the claimants had not been afforded the opportunity to make representations as to why the sums demanded under the notices were not due and owing. (2) The notices were ultra vires because Condition B (s 219) was not satisfied. The amounts claimed were shares of losses and did not result directly from an increase or reduction of an item in the partnership return. (3) The notices had been given in breach of the claimants’ legitimate expectations that they would not have to pay any tax in dispute until after the FTT had decided all relevant issues. (4) The decision to give notices was irrational, as HMRC had not properly exercised its discretion. (5) The issue of the notices had been in breach of the European Convention for the Protection of Human Rights (ECHR) article 1 of the First Protocol (right to protection of property) (A1P1) and article 6 (right to a fair trial).
The High Court found that the statutory scheme was not unfair, since the situation created by the PPN was only temporary. Furthermore, recipients of PPNs were afforded the opportunity to make representations; however, such representations could not extend to the merits of the substantive appeal as contended by the appellants.
The court also found that the PPN scheme operated regardless of the mechanics of the tax advantage. The offset loss claimed by the taxpayers therefore fell within the scope of the legislation.
Additionally, no legitimate expectation was established, in the absence of a well recognised practice by HMRC of making ‘carry back’ repayments. In any event, the new provisions expressly removed pre-existing rights.
The ground that HMRC’s decision had been irrational also failed, on the basis that ‘there is nothing wrong with a general rule that when the statutory criteria are met, the discretion will be exercised by issuing the notice, save in exceptional circumstances’. Furthermore, the requirement to pay tax which had been avoided for ten years through the implementation of a scheme did not amount to ‘significant human suffering’. Finally, the taxpayers’ claim under their substantive appeal was not a property right for the purpose of ECHR; and art 6 did not apply when the state determined a person’s liability to pay tax.
Why it matters: The taxpayers essentially challenged the legality of the advance payment statutory scheme. They were robustly rejected by a High Court, which reiterated the notion that taxpayers who engage in tax planning should make provision for the eventuality that the tax may become payable. ‘Rowe is an important watershed. It provides an opportunity to consider whether the grounds of appeal should be refined. Should further information be requested from HMRC? Should claimants provide further evidence of their individual circumstances? ... Will the new regime encourage HMRC to delay matters once the moneys are sitting in its bank account?’ (Michael Conlon QC and Julian Hickey, Tax Journal, 4 September 2015). The taxpayers have since been given leave to appeal and the case will be heard by the Court of Appeal by 12 December 2016.
Lloyds Bank Leasing (No. 1) v HMRC
In Lloyds Bank Leasing (No. 1) v HMRC [2015] UKFTT 401 (14 August), the FTT found that the obtaining of capital allowances had been one of the main objects of a transaction, so that tax relief was not available.
Lloyds Bank Leasing (LBL), a finance leasing company, had incurred nearly £200m in expenditure on the purchase of two ships. The issue was whether the main object, or one of the main objects, of the relevant transaction – which had included the letting of the ships – had been to obtain writing-down allowances. If this was the case, capital allowances should be denied under CAA 2001 s 123(4).
The FTT noted that the draftsman had not intended to confine the application of s 123(4) to those who enter into artificial or contrived arrangements, or to transactions with no other purpose than the securing of an allowance. It added that the subjective purpose of the ‘shaper’ of the transaction must be examined.
The FTT explained that in the paradigm case (a case which unambiguously falls under the common definition of the term), s 123(1) was intended to apply to a ship purchased outright by an established UK shipping company and leased to an overseas customer. The purpose of s 123(4) was to exclude from the benefit of the allowance those transactions which did not fall within the paradigm. The FTT found that the evidence could only lead to the conclusion that the agreements were structured as they were not only for commercial reasons, but also in order that the requirements of s 123(1) should be met; therefore, the securing of the allowances was a main object of the transactions.
Why it matters: Here is a tax case in which it was agreed that the transactions had a ‘paramount’ commercial purpose, and yet the FTT (at its second attempt) held that a main object of ‘at least some of the transactions’ was to obtain capital allowances, and so those allowances would be denied. ‘The discussion on what constitutes a “main object”’, and the approach of the FTT to the evidence, is likely to be useful in other disputes. However, a large proportion of current disputes relate not to capital allowances but to loan relationships [where there is a separate test]. This case may, therefore, not take HMRC quite as far as it would like in challenging transactions where a special purpose company has been inserted into a financing transaction’ (Heather Self, Tax Journal, 11 September 2015).
Murray Group Holdings
In Murray Group Holdings and others v HMRC [2015] CSIH 77 (4 November), the Court of Session found that monies paid via trusts were taxable as earnings.
The Murray Group had implemented a scheme designed to avoid PAYE and NICs on payments of benefits to two categories of employees: executives; and footballers. Under the scheme, a group company would make a cash payment to a principal trust, which would resettle the amount to a sub-trust for the income and capital to be applied according to the wishes of the employee. The monies would then be lent by the sub-trust to the employee. The issue was whether the monies were earnings for the purpose of ITEPA 2003 s 62.
As a preliminary issue, the Court of Session had to decide (inter alia) whether it had judicial knowledge of English law. It found that it did, as any other interpretation would be ‘highly artificial’. Furthermore, this would not lead to any practical difficulties as the relevant concepts of trust, contract and loan are ‘broadly similar’ under Scottish and English law, and the parties would present ‘careful and informed submissions on English law’.
The court noted that ‘the critical feature of an emolument and of earnings as so defined is that it represents the product of the employee’s work – his personal exertion in the course of his employment’. This remained so even if the income was paid to a third party. It was also irrelevant that the redirection of the income took place through the medium of trusts. Both the FTT and the UT had overlooked this principle. ‘The redirection of earnings occurred at the point where the employer paid a sum to the trustee of the principal trust, and what happened to the monies thereafter had no bearing on the liability that arose in consequence of the redirection.’ It was also immaterial that the employee had no contractual entitlement to the sums paid to the trustees of the principal trust, as gratuities are subject to income tax.
Furthermore, following Arrowtown Assets [2003] HKCFA 46, it was ‘imperative to determine the true nature of the transaction viewed realistically’.
Why it matters: This latest instalment in the Rangers EBT case may not be the final one, as the Murray Group may appeal to the Supreme Court. In any event, such arrangements may now be caught by FA 2011 Sch 2. However, ‘HMRC is likely to use it to vigorously pursue companies which did not take up the EBT settlement opportunity’ (Karen Cooper and Mairi Granville-George, Tax Journal, 20 November). ‘The court applied a redirection of earnings principle to treat payments made by the employer to EBTs as taxable earnings. The decision does not introduce a new principle but is instead a classic application of a 1904 case. Furthermore, the disguised remuneration rules may not apply to an EBT resulting from the redirection principle. Under that principle, the employee is the settlor, not the employer. HMRC is unlikely to agree, however, so some caution is required about future developments’ (Nigel Doran, Tax Journal, 4 December 2015).
Tax Journal’s pick of the top ten tax cases of 2015.
Case of the year:
Pendragon on VAT abuse
In Pendragon and others v HMRC [2015] UKSC 37 (10 June), the Supreme Court, reversing the decision of the Court of Appeal, found that a scheme to avoid VAT on the resale of demonstrator cars was abusive.
The object of the scheme was to ensure that companies in a car distributor group were able to recover input tax incurred on the price of new cars acquired as demonstrator cars, while avoiding the payment of output tax on the sale of these cars to consumers. The issue was whether it was abusive under the Halifax principle.
The KPMG scheme involved the sale by the distributors of newly acquired cars to captive leasing companies (CLCs); the leasing of the cars by the CLCs to the distributor’s dealerships; the assignments of the leasing agreements and titles to the cars to a Jersey bank (SGJ); the sale by SGJ of its hire business as a transfer of a going concern (TOGC) to a company of the distributor group (Captive Co 5); and, finally, the sale of the cars by Captive Co 5 to customers.
The success of the scheme relied primarily on the VAT (Cars) Order, SI 1992/3122, article 8, which provides that dealers in second-hand goods are allowed to charge VAT not on the whole consideration for the sale of the goods, but on their profit margin only.
The Supreme Court thus observed that the effect of the KPMG scheme was to enable the Pendragon Group to sell demonstrator cars second hand under the margin scheme, in circumstances where VAT had not only been previously charged but fully recovered, so ‘that no net charge to VAT was ever suffered, except on the small or non-existent profits realised on the resale’. The Supreme Court concluded that a system designed to prevent double taxation on the consideration for goods had been exploited so as to prevent any taxation on the consideration at all. The first limb of the Halifax test was therefore satisfied; the scheme was contrary to the purpose of the legislation.
As for the second limb, the Supreme Court found that the transaction had the essential aim of obtaining a tax advantage. Two steps had been inserted which had had no commercial rationale other than the achievement of a tax advantage. The first one was the leasing of the cars by the CLCs to ensure that one of the gateways of article 8 applied: the assignment of rights under a hire purchase or conditional sale agreement. The second one was the acquisition of the business by Captive Co 5, so that the acquisition of the cars was brought within the gateway for assets acquired as part of a business transferred as a going concern.
As the scheme was an abuse of law, it fell to be redefined as a sale and leaseback transaction, followed by a sale to customers to which article 8 did not apply.
Why it matters: The court highlighted two difficulties of the Halifax principle. The first arose from the assumption that the principle will not apply to ‘normal commercial transactions’, as ‘the VAT Directives must be assumed to have been designed to accommodate them’. This had led the Court of Appeal to find that the arrangements were not abusive. The second difficulty resulted from concurrent purposes. The question was then whether the commercial objective was enough to explain the particular features of the arrangements.
Tax Journal’s coverage: ‘HMRC is likely to take great comfort from Pendragon and to attack existing and future VAT planning structures. The continued efficacy of offshore structures, as in Newey [2015] UKUT 0300, must be in doubt … One may also expect a degree of mission creep in the willingness of the Upper Tribunal to take an intrusive approach to factual evaluation by the FTT’ (Michael Conlon QC and Rebecca Murray, Tax Journal, 26 June 2015).
Why it’s our case of the year: This case has it all – it went all the way to the Supreme Court; it may be about VAT but it is also an example of HMRC’s 80% success rate before the courts and tribunals in avoidance cases; and it contains some rather ground-breaking comments about the jurisdiction of the Upper Tribunal.
Tax Journal’s pick of the top tax cases of 2015, listed in chronological order:
European Commission v UK
In European Commission v UK (C-172/13) (3 February), the CJEU found that the UK legislation on cross-border group relief complies with EU law principles.
The European Commission was applying for a declaration by the CJEU that CTA 2010 s 119(4) makes it virtually impossible in practice to obtain cross-border group relief, so that the UK has failed to fulfil its obligations under TFEU articles 31 and 49.
Cross-border group relief is only available if the ‘no possibilities test’ is satisfied; that is, if the losses are not relievable in the country where the loss-making subsidiary is established. Under CTA 2010 s 119(4), the determination as to whether losses may be taken into account in the future must be made ‘as at the time immediately after the end’ of the accounting period in which the losses were sustained. According to the Commission, cross-border relief can therefore only be available if either carry forward of losses is not possible under the legislation of the country of residence of the subsidiary; or if the subsidiary is liquidated at that time.
However, the CJEU observed that the first situation mentioned by the Commission was irrelevant for the purpose of assessing the proportionality of s 119(4). In such a situation, the member state in which the parent company is resident may not allow cross-border group relief without thereby infringing article 49 (K (C-322/11)). As for the second situation, the CJEU considered that s 119(4) does not require the subsidiary to be put into liquidation before the end of the accounting period in which the losses were sustained. The provision only imposes a requirement to make an ‘assessment’ at that time. The Commission also submitted that the UK was in breach of TFEU articles 49 and 31 in that its legislation precludes cross-border group relief for losses sustained before 1 April 2006. The CJEU found, however, that the Commission had not established the existence of situations in which cross-border group relief for losses sustained before 1 April 2006 was not granted. The CJEU therefore rejected both complaints.
Why it matters: ‘This judgment does limit claims for time expired losses. It will also at least delay settlement of claims for terminal losses where it only became evident at a later stage that the losses were terminal. But that part of the judgment is arguably narrow and may not do what HMRC will hope’ (Rupert Shiers, Tax Journal, 12 February 2015).
Eclipse 35
In Eclipse Film Partners No. 35 v HMRC [2015] EWCA Civ 95 (17 February), the Court of Appeal found that Eclipse 35 had not been trading.
Eclipse 35, a partnership, and its members had entered into a complex series of transactions for the acquisition, distribution and marketing of film rights.
The members had borrowed money to contribute to the capital of the partnership. They could only claim tax relief in respect of the interest if the loan was used wholly for the purpose of a trade carried on by Eclipse 35 (ITTOIA 2005 s 863 and ICTA 1988 ss 353, 362).
The FTT had found that Eclipse 35 had not played ‘a meaningful part in the marketing and distribution of the films’; it had therefore not carried on a trade. The FTT’s decision had been upheld by the UT.
The Court of Appeal noted that the transactions had two aspects. One aspect was that a payment by Eclipse 35 of £503m would be repaid with interest over a 20 year term and would produce a profit unrelated to the success of the exploitation of film rights. That aspect had the character of an investment. The second aspect was the possibility for Eclipse 35 to obtain a share of ‘contingent receipts’. The court accepted the FTT’s finding that the possibility of receiving such receipts was too remote for this aspect to be significant.
Finally, the court rejected the contention that the activity of entering into a licence and sub-licence inherently constituted the carrying on of a trade.
Why it matters: Like the tax tribunals, the Court of Appeal accepted that the transactions were not ‘shams’. However, this finding did not prevent the court from holding that ‘on a realistic view of the facts’ (applying the Ramsay doctrine), Eclipse 35 had acquired an investment rather than carried on a trade.
‘The court has confirmed that in assessing whether an activity amounts to a trade, it is necessary to consider the totality of what is done. The court has indicated that the concept of trade has a variety of meanings or shades of meaning’ (Chris Bates and Judy Harrison, Tax Journal, 11 March 2015).
Samarkand
In Samarkand Film Partnership No. 3, Proteus Film Partnership and three partners v HMRC [2015] UKUT 211 (29 April 2015), the UT found that the partners were not entitled to loss relief and that they had not had a legitimate expectation that the relief would be available.
The issue was whether two partnerships, which had acquired and leased films under sale and leaseback arrangements, were entitled to loss relief in respect of losses which arose on the acquisition of the films. If so, their partners could claim sideways relief under ICTA 1988 ss 380 and 381 to set the losses against their taxable income from other sources.
The purchase of an asset which a person intends to exploit over a period of time is normally treated as capital expenditure. However, ITTOIA 2005 s 134 provides that in the case of a film, the expenditure should be regarded as revenue in nature. Furthermore, ss 138 and 140 allow loss relief to be claimed in advance of the normal rules. Relief is not available, though, if the expenses are not incurred wholly and exclusively for the purposes of a trade or if the losses are not connected with or arising out of a trade.
The UT found that the FTT had been entitled to conclude that the partnerships had not been carrying on a trade, so that no loss relief was available to the partners. This was so, even though a transaction of that type could have constituted a trade. In particular, it accepted the FTT’s factual finding that the commercial nature of the agreements was ‘the payment of a lump sum in return for a series of fixed payments over 15 years’.
No further arguments were required following the release of the Court of Appeal’s decision in Eclipse Film Partners [2015] EWCA Civ 95 (see above), which recommended a ‘realistic approach to the transaction’. Even if the partnerships had been conducting a trade, they would not have been doing so on a commercial basis, as the transactions were intended to produce a loss in net present value terms. This analysis was not affected by the fact that the individual partners were accruing ‘extra benefits’ as a result of the tax reliefs. Those reliefs were obtained by ‘deliberately causing the partnership to trade in an uncommercial manner’.
The two judges disagreed as to whether, in any event, one of the partnerships had incurred the expenditure for the acquisition of a film (as opposed to that of an income stream). The president exercised its casting vote on this issue, finding that the partnership had incurred the expenditure for the purchase of a film. This was because it had acted bona fide in the belief that it was acquiring valuable rights.
The taxpayers also claimed judicial review on the ground that HMRC’s denial of relief was at odds with its own published guidance in HMRC’s Business Income Manual (BIM). The UT pointed out that unlike IR20, which was aimed to give taxpayers guidance on residence, the BIM was intended for the use of HMRC staff – although it was made available to the public. The UT observed that the BIM stressed in several places that the relief was aimed at tax deferral only.
Furthermore, the BIM included clear statements that transactions involving tax avoidance would be closely scrutinised and that the guidance may not be applied to them. The argument that this statement suggested that HMRC reserved the right to treat similar transactions differently was robustly rejected. ‘Taxpayers may not like that statement but they could not say that they derived a legitimate expectation that was at odds with it.’ Finally, the UT found that HMRC had reasonably thought that tax avoidance was at play. Several features indicated that the aim of the transactions was not tax deferment but tax avoidance.
Why it matters: The appeal failed on both the ‘trading issue’ and the legitimate expectation issue. On the trading issue, the UT simply reiterated the points made by the FTT on the basis of its factual findings. On the legitimate expectation issue, the taxpayers could not rely on HMRC’s description of a plain vanilla transaction (claiming that their arrangements were similar) and ignore the general statement about tax avoidance. They could not ‘take out the plums they liked and ignore the duff they did not’.
‘The decision serves as a reminder to taxpayers of the extent to which they can rely on HMRC’s manuals ... No matter how clear or unqualified a statement in HMRC’s manuals might appear to be, it will be open for HMRC to depart from that guidance if it considers that tax avoidance is or may be involved, leaving the taxpayer in question with an uphill struggle to prove that it has a substantive legitimate expectation that should be protected’ (Jeanette Zaman & Owen Williams, Tax Journal, 22 May 2015).
Littlewoods Ltd
InLittlewoods Ltd and others v HMRC [2015] EWCA Civ 515 (21 May), the Court of Appeal found that Littlewoods was entitled to compound interest on VAT wrongly paid.
Littlewoods had paid VAT which was not due. HMRC had repaid the principal amount together with simple interest. Littlewoods claimed that it was also entitled to compound interest. There were four issues. First, were Littlewoods’ restitution claims excluded by VATA 1994 ss 78 and 80 as a matter of English law and without reference to EU Law? The CA found that the net effect of the provisions was that the only cause of action available to the taxpayer for the repayment of the principal sums was that afforded by s 80(1) and so restitutionary claims for repayment of VAT were barred by s 80(7). Furthermore, s 78(1) excluded common law claims for interest.
Second, did the exclusion of the claim by VATA 1994 violate the principle of effectiveness by depriving Littlewoods of an adequate indemnity for the loss occasioned through the undue payment of VAT? The court noted that ‘adequate indemnity’ was not a rigid ‘straitjacket’ which required compound interest in every case. However, s 78 did deprive Littlewoods of an adequate indemnity.
Third, ss 78 and 80 could not be construed so as to conform with EU law as the exclusion of common law claims for interest was a cardinal feature of the legislation. The provisions must therefore be disapplied. Furthermore, the court did not have the power to disapply the domestic bar to the enforcement of Littlewoods’ rights on a selective basis. The choice of remedy therefore belonged to Littlewoods who chose to make a mistake-based restitution claim as this was not time-barred whereas a Woolwich claim would have been time-barred.
Finally, on quantum, the court found that HMRC should not be treated as if it were an involuntary recipient of overpayments of tax. Consequently, ‘objective use value’ applied to the valuation of the time value of the overpayments made to HMRC and compound interest was payable. Finally, interest should continue to run after the date of the repayment of the principal amounts of overpaid VAT on such amounts of accrued interest as remained outstanding.
Why it matters: This is the latest instalment of a judicial saga which includes two high court decisions and a preliminary ruling by the CJEU. The tax at stake is colossal; £1.2bn in compound interest. ‘In rejecting HMRC’s ingenious arguments, the court confirmed that even a substantial payment of statutory interest may not always provide a substantive safeguard for a claimant’s EU law rights. Such rights must be asserted not by way of VATA 1994 but by a claim for restitution at common law. But, the battle continues…’ (Michael Conlon QC, Tax Journal, 5 June 2015). Following the decision, the government introduced a new 45% rate of corporation tax on restitution interest payments (CTA 2010 ss 375YA–375YW inserted by F(No. 2)A 2015 s 38).
Anson
In Anson v HMRC [2015] UKSC 44 (1 July), the Supreme Court found that a member of a US limited liability company (LLC) was eligible for double tax relief in the UK on his share of the profits.
Mr Anson was resident but not domiciled in the UK for UK tax purposes. He was liable to UK income tax on foreign income remitted to the UK. He was a member of an LLC, which was classified as a partnership for US tax purposes. He was therefore liable to US federal and state taxes on his share of the profits. Mr Anson remitted the balance to the UK, and was therefore liable to UK income tax on the amounts remitted, subject to double tax relief. HMRC considered that Mr Anson was not entitled to double tax relief, on the basis that the income which had been taxed in the US was not his income but that of the LLC. Mr Anson contended that, even assuming that US tax was charged on the profits of the LLC and that he was liable to UK tax only on distributions made out of those profits, the US and UK tax were nevertheless charged on ‘the same profits or income’, within the meaning of the UK/US double tax treaty. He also argued that, as a matter of UK tax law, he was liable to tax in the UK on his share of the profits of the trade carried on by the LLC, which was the same income as had been taxed in the US.
The Supreme Court rejected the first ground, noting that the context of the treaty and its history did not suggest such a wide approach to the concept of income. However, in relation to the second ground, it found that Mr Anson was entitled to the share of the profits allocated to him, rather than receiving a transfer of profits ‘previously vested in the LLC’. His ‘income arising’ in the US was therefore his share of the profits, which was the income liable to tax both under US law and under UK law – to the extent that it was remitted to the UK. His liability to UK tax was therefore computed by reference to the same income as was taxed in the US and he qualified for double tax relief.
Why it matters: The classification of foreign entities and of the profits they generate continues to raise difficult questions. In this case, the FTT had found that the members of the LLC had an interest in the profits as they arose; therefore, the Supreme Court found that double tax relief was due. Following this decision, HMRC published Brief 2015/15, which confirms that HMRC will continue to treat US LLC’s as companies. This is on the basis that the decision was fact specific so that it does not need to be applied generally. The brief also explains that individuals relying on the decision in order to claim double tax relief will be considered on a case by case basis.
Larentia + Minerva
In Beteiligungsgesellschaft Larentia + Minerva mbH & Co. KG v Finanzamt Nordenham (C-108/14) and Finanzamt Hamburg-Mitte v Marenave Schiffahrts AG (C-109/14) (16 July), the CJEU found that holding companies can deduct input tax to the extent that they are involved in the management of their subsidiaries.
Larentia + Minerva had acquired 98% of the shares in two subsidiaries – constituted in the form of limited partnerships – which it provided with administrative and business services. Marenave had increased its capital and acquired shares in four ‘limited shipping partnerships’, and was involved in their management. The issue was the extent to which deductions were allowed, in relation to input tax incurred on acquisition and issue costs.
The CJEU observed that the holding of shares is not an economic activity, unless the holding is accompanied by direct or indirect involvement in the management of the company. Furthermore, for VAT to be deductible, the input transactions must have a direct and immediate link with the output transactions giving rise to a right of deduction.
The CJEU concluded that the expenditure connected with the acquisition of shareholdings in subsidiaries incurred by a holding company which involved itself in their management – and which, on that basis, carried out an economic activity – must be regarded as attributed to that company’s economic activity; and therefore that VAT incurred on that expenditure was deductible. The deduction of VAT would only be limited if the costs were attributed in part to other subsidiaries, in the management of which the holding companies were not involved. Finally, the CJEU found that the Sixth Directive article 4 precludes national legislation which reserves the right to form a VAT group solely to ‘entities with legal personality and linked to the controlling company of that group in a relationship of subordination’; except where those two requirements are appropriate and necessary to prevent abusive practices or to combat tax evasion or tax avoidance.
Why it matters: This decision confirms that VAT incurred by holding companies involved in the management of their subsidiaries is deductible. ‘The decision is another dramatic shift in the recovery of VAT on costs incurred in the acquisition of subsidiaries’ (Michael Conlon QC and Rebecca Murray, Tax Journal, 6 August 2015).
Rowe
In Nigel Rowe and others v HMRC [2015] EWHC 2293 (31 July), the High Court found that partner payment notices (PPNs) had been validly issued by HMRC.
The 154 claimants had all participated in Ingenious Media schemes, which HMRC alleges, were designed to generate tax losses. The claimants’ substantive appeals are being litigated in the FTT and HMRC has issued PPNs (under FA 2014 ss 219–229). The taxpayers contended that the PPNs were unlawful and of no effect for the following reasons: (1) The statutory scheme was unfair, as the claimants had not been afforded the opportunity to make representations as to why the sums demanded under the notices were not due and owing. (2) The notices were ultra vires because Condition B (s 219) was not satisfied. The amounts claimed were shares of losses and did not result directly from an increase or reduction of an item in the partnership return. (3) The notices had been given in breach of the claimants’ legitimate expectations that they would not have to pay any tax in dispute until after the FTT had decided all relevant issues. (4) The decision to give notices was irrational, as HMRC had not properly exercised its discretion. (5) The issue of the notices had been in breach of the European Convention for the Protection of Human Rights (ECHR) article 1 of the First Protocol (right to protection of property) (A1P1) and article 6 (right to a fair trial).
The High Court found that the statutory scheme was not unfair, since the situation created by the PPN was only temporary. Furthermore, recipients of PPNs were afforded the opportunity to make representations; however, such representations could not extend to the merits of the substantive appeal as contended by the appellants.
The court also found that the PPN scheme operated regardless of the mechanics of the tax advantage. The offset loss claimed by the taxpayers therefore fell within the scope of the legislation.
Additionally, no legitimate expectation was established, in the absence of a well recognised practice by HMRC of making ‘carry back’ repayments. In any event, the new provisions expressly removed pre-existing rights.
The ground that HMRC’s decision had been irrational also failed, on the basis that ‘there is nothing wrong with a general rule that when the statutory criteria are met, the discretion will be exercised by issuing the notice, save in exceptional circumstances’. Furthermore, the requirement to pay tax which had been avoided for ten years through the implementation of a scheme did not amount to ‘significant human suffering’. Finally, the taxpayers’ claim under their substantive appeal was not a property right for the purpose of ECHR; and art 6 did not apply when the state determined a person’s liability to pay tax.
Why it matters: The taxpayers essentially challenged the legality of the advance payment statutory scheme. They were robustly rejected by a High Court, which reiterated the notion that taxpayers who engage in tax planning should make provision for the eventuality that the tax may become payable. ‘Rowe is an important watershed. It provides an opportunity to consider whether the grounds of appeal should be refined. Should further information be requested from HMRC? Should claimants provide further evidence of their individual circumstances? ... Will the new regime encourage HMRC to delay matters once the moneys are sitting in its bank account?’ (Michael Conlon QC and Julian Hickey, Tax Journal, 4 September 2015). The taxpayers have since been given leave to appeal and the case will be heard by the Court of Appeal by 12 December 2016.
Lloyds Bank Leasing (No. 1) v HMRC
In Lloyds Bank Leasing (No. 1) v HMRC [2015] UKFTT 401 (14 August), the FTT found that the obtaining of capital allowances had been one of the main objects of a transaction, so that tax relief was not available.
Lloyds Bank Leasing (LBL), a finance leasing company, had incurred nearly £200m in expenditure on the purchase of two ships. The issue was whether the main object, or one of the main objects, of the relevant transaction – which had included the letting of the ships – had been to obtain writing-down allowances. If this was the case, capital allowances should be denied under CAA 2001 s 123(4).
The FTT noted that the draftsman had not intended to confine the application of s 123(4) to those who enter into artificial or contrived arrangements, or to transactions with no other purpose than the securing of an allowance. It added that the subjective purpose of the ‘shaper’ of the transaction must be examined.
The FTT explained that in the paradigm case (a case which unambiguously falls under the common definition of the term), s 123(1) was intended to apply to a ship purchased outright by an established UK shipping company and leased to an overseas customer. The purpose of s 123(4) was to exclude from the benefit of the allowance those transactions which did not fall within the paradigm. The FTT found that the evidence could only lead to the conclusion that the agreements were structured as they were not only for commercial reasons, but also in order that the requirements of s 123(1) should be met; therefore, the securing of the allowances was a main object of the transactions.
Why it matters: Here is a tax case in which it was agreed that the transactions had a ‘paramount’ commercial purpose, and yet the FTT (at its second attempt) held that a main object of ‘at least some of the transactions’ was to obtain capital allowances, and so those allowances would be denied. ‘The discussion on what constitutes a “main object”’, and the approach of the FTT to the evidence, is likely to be useful in other disputes. However, a large proportion of current disputes relate not to capital allowances but to loan relationships [where there is a separate test]. This case may, therefore, not take HMRC quite as far as it would like in challenging transactions where a special purpose company has been inserted into a financing transaction’ (Heather Self, Tax Journal, 11 September 2015).
Murray Group Holdings
In Murray Group Holdings and others v HMRC [2015] CSIH 77 (4 November), the Court of Session found that monies paid via trusts were taxable as earnings.
The Murray Group had implemented a scheme designed to avoid PAYE and NICs on payments of benefits to two categories of employees: executives; and footballers. Under the scheme, a group company would make a cash payment to a principal trust, which would resettle the amount to a sub-trust for the income and capital to be applied according to the wishes of the employee. The monies would then be lent by the sub-trust to the employee. The issue was whether the monies were earnings for the purpose of ITEPA 2003 s 62.
As a preliminary issue, the Court of Session had to decide (inter alia) whether it had judicial knowledge of English law. It found that it did, as any other interpretation would be ‘highly artificial’. Furthermore, this would not lead to any practical difficulties as the relevant concepts of trust, contract and loan are ‘broadly similar’ under Scottish and English law, and the parties would present ‘careful and informed submissions on English law’.
The court noted that ‘the critical feature of an emolument and of earnings as so defined is that it represents the product of the employee’s work – his personal exertion in the course of his employment’. This remained so even if the income was paid to a third party. It was also irrelevant that the redirection of the income took place through the medium of trusts. Both the FTT and the UT had overlooked this principle. ‘The redirection of earnings occurred at the point where the employer paid a sum to the trustee of the principal trust, and what happened to the monies thereafter had no bearing on the liability that arose in consequence of the redirection.’ It was also immaterial that the employee had no contractual entitlement to the sums paid to the trustees of the principal trust, as gratuities are subject to income tax.
Furthermore, following Arrowtown Assets [2003] HKCFA 46, it was ‘imperative to determine the true nature of the transaction viewed realistically’.
Why it matters: This latest instalment in the Rangers EBT case may not be the final one, as the Murray Group may appeal to the Supreme Court. In any event, such arrangements may now be caught by FA 2011 Sch 2. However, ‘HMRC is likely to use it to vigorously pursue companies which did not take up the EBT settlement opportunity’ (Karen Cooper and Mairi Granville-George, Tax Journal, 20 November). ‘The court applied a redirection of earnings principle to treat payments made by the employer to EBTs as taxable earnings. The decision does not introduce a new principle but is instead a classic application of a 1904 case. Furthermore, the disguised remuneration rules may not apply to an EBT resulting from the redirection principle. Under that principle, the employee is the settlor, not the employer. HMRC is unlikely to agree, however, so some caution is required about future developments’ (Nigel Doran, Tax Journal, 4 December 2015).
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