VAT deferral and abuse of rights
The Court of Appeal has referred questions to the ECJ concerning the application of the abuse of rights principle to a VAT deferral scheme involving leasing arrangements: HMRC v Weald Leasing Ltd (Court of Appeal, 14 May 2009). The questions referred seek guidance on whether deferral of VAT using a leasing structure involving an intermediate third partyis contrary to the purposes of the Sixth Directive and the relevance of references to "normal commercial operations" to the determination of that question. (As yet, there is no judgment, just the questions referred.) The eventual decision of the ECJ should add useful jurisprudence to the growing body of law on the application of the abuse of rights principle to VAT situations.
Background
The Churchill VAT group, which made supplies which were 99 per cent exempt, obtained the use of assets for its business by arranging for their purchase by Weald, a wholly owned subsidiary outside the VAT group. Weald was financed with cash loaned interest free by the Churchill group on the footing that Weald would lease the assets to Suas (an independent company owned by a VAT consultant to the Churchill Group) at a quarterly rental of one fortieth of their cost and that Suas would lease them on to Churchill group companies at a small agreed mark up. The leases were operating leases which could be terminated without a penalty in less than a month.
The result of the transactions was that Weald recovered the excess of the input tax incurred by it on purchasing the assets over the output tax payable by it on the rentals charged to Suas, which rentals were based on an assumed life for the assets of 10 years (no matter what the actual asset). The companies in the Churchill VAT group incurred VAT, which was largely irrecoverable, on the rentals paid to Suas. The interposition of Suas in the transactions prevented HM Revenue & Customs (HMRC) from giving a direction under Schedule 6, paragraph 1 requiring the VAT on the rentals to be based on open market values.
It was clear that the only reason for the transactions to be structured in this way was to achieve a VAT deferral for the Churchill Group (although Weald put forward other justifications before the tribunal, these were dropped before the High Court). HMRC argued that these arrangements therefore fell foul of the abuse of rights principle as expounded in the Halifax case.
In the Halifax decision, the ECJ held that VAT rules precluded a right to deduct input VAT where the transactions that give rise to that right constitute an "abusive practice". And for these purposes, an abusive practice exists where (a) the transactions result in the accrual of a tax advantage contrary to the purpose of the VAT rules, and (b) the essential aim of the taxpayer (objectively viewed) was to obtain that advantage.
HMRC accepted that, to apply the abuse of rights principle, it was not enough simply to show that the essential aim was to obtain a tax advantage. However, HMRC argued that where the essential aim was to obtain a tax advantage and that was combined with transactions which were not "normal commercial operations", then the test of abusive practice was met.
High Court
In the High Court, Lindsay J rejected this argument. HMRC's heavy reliance on the importance of the transactions being outside "normal commercial operations" was not justified by the language of the ECJ in the Halifax case (where that phrase appeared twice only and not in the formal formulation of the test of abuse). It was necessary to determine whether the VAT advantage was contrary to the purposes of the VAT rules and that test was not the same as asking whether the transactions were not commercial.
On the question of whether the VAT advantage was contrary to the Sixth VAT Directive, Lindsay J examined the principle of fiscal neutrality (finding it a somewhat variable and elusive concept). Nevertheless, he concluded that, "whatever the full content of the principle, I fail to see that what was done here was contrary to it". The supplier charged VAT to Weald, Weald charged Suas VAT (rental by rental) and Suas charged the Churchill Group VAT (rental by rental), which therefore incurred irrecoverable input VAT as contemplated by the Sixth VAT Directive. The VAT on the rentals would be less than had the leases been on commercial terms, but the judge rejected the contention that a difference in mere quantum could be described as "contrary to principle".
Accordingly, the High Court rejected HMRC's appeal and held that HMRC's attempt to apply the abuse of rights principle to a deferral scheme such as this must fail.
There was no suggestion, of course, that had Churchill chosen to lease the items from independent third parties on normal commercial terms, rather than purchase them, solely to benefit from the VAT deferral that there would be any suggestion of such arrangements being contrary to the Sixth VAT Directive. That was a major stumbling block for HMRC, as it makes clear that VAT deferral per se is not offensive. To distinguish this case from third party leasing, HMRC were forced to put great emphasis on the non arm's length nature of the arrangements. However, the High Court refused to regard non arm's length arrangements as per se contrary to the VAT rules. For that, an extra ingredient, such as the recovery of input VAT being contrary to fiscal neutrality, was needed.
Interestingly, both the tribunal and the High Court indicated that HMRC might have had more success had they simply argued that the introduction of Suas into the structure to avoid the imposition of the market value rules combined with the low rentals constituted abuse (rather than the existence of the leases). However, HMRC had failed to argue the case on that basis.