Introduction
Central to the European Sixth VAT Directive 77/388/EC (“Sixth Directive”), and through it the VAT Act 1994, is the right to reclaim input VAT paid on supplies to set against output VAT due on sales. As part of its attack on tax planning and to raise the tax take HM Revenue & Customs (“HMRC”) have sought to restrict that right. In its judgment February 2006 in Halifax and others v Customs & Excise, C-255/02 the European Court of Justice ("ECJ") addressed whether certain transactions fell outside the right to reclaim input VAT because they involved a tax advantage and, if so, what the consequences were.
Taxable Transactions
The ECJ rejected a selective approach to recognising transactions holding instead that all transactions counted for VAT purposes, even if carried out with the sole aim of obtaining a tax advantage. This follows from the wide and objective meaning to be given to economic activity for VAT purposes; with an inquiry, by the tax authorities, into a taxpayer’s intention bring contrary to the VAT system.
Taxpayer Rights
Next the Court held that Community law could not be relied upon for abusive ends. In doing so though it did not adopt the HMRC “abuse of rights” argument but formulated a new doctrine for tax prohibiting what it termed “abusive practices” in VAT. Significantly this was set in the context of three vital rights or protections for taxpayers, against what some observers have seen as occasional over-taxation or tax extortion, being: legal certainty, the right to pay only tax due and the protection of tax planning.
On legal certainty the Court stated :-
“… legal certainty must be observed all the more strictly in the case of rules liable to entail financial consequences, in order that those concerned may know precisely the extent of the obligations they impose on them…”Although a fundamental principle in Community law it was a welcome rejection of over-taxation through over-complicated or unclear tax legislation.
As to paying only what is due the Court noted that :-
“Where the taxable person chooses one of two transactions, the Sixth Directive does not require him to chose the one which involves paying the highest amount of VAT.”
Finally the ECJ pointedly upheld the right of a business to lawfully plan for its own tax by stating :-
“… taxpayers may chose to structure their business so as to limit their tax liability”.Again there is nothing contentious in the ECJ’s approach but it was a welcome rebuff to the assault on the very act of tax planning.
Abusive Practice
The Court went on to hold an abusive practice exists where two conditions were met. The first was that the transactions concerned must give a tax advantage contrary to the purpose of the legislation. Secondly the “essential aim” of the transactions must be to obtain a tax advantage, though that did not apply where the activity in question may have some explanation other than getting a tax advantage.
Unpicking Abuse
Finally the Court held that where there was an abusive practice for VAT then the transactions involved had to be re-defined so as to re-establish the situation that would have prevailed otherwise, effectively unpicking the abusive elements. In doing so the tax authorities could demand repayment of sums deducted abusively but similarly had to refund any sums artificially due.
Future Tax Planning
The HMRC response has been to interpret the judgment to their advantage, so that their arguments against tax planning are now likely to claim abusive practices. For taxpayers and their advisers the Halifax judgment is a common-sense approach to defining the boundaries of tax planning. It is also a welcome rejection of both the extremes of tax abuse by some tax schemes and state tax extortion. Although it is likely that applying the ECJ’s ruling will be fiercely litigated by HMRC, so that the minor points are yet to be established, the broad themes of the judgment are clear and helpful to the taxpayer. In particular the assertion in tax of the rights of legal certainty, paying only what is due and tax planning are basic foundations to ensure that a business does not inadvertently over-pay tax.
Halifax - The Background Facts
The background facts in Halifax arise out of both the use of increasingly sophisticated tax schemes and HMRC’s drive to raise the tax take by attacking virtually all VAT planning. Here Halifax wished to build four new call centres, on which ordinarily it would only have been able to get back 5% of the input VAT because of the mainly exempt nature of its outputs in financial services. Halifax used a tax scheme involving associated companies and a series of transactions at the end of which it was effectively able to reclaim all of the input VAT. HMRC attacked this by claiming that the admitted aim to save tax was an “abuse of rights” under EC law, with the result that the transactions did not count for tax so that VAT could not be reclaimed. The problem with the HMRC approach was that it fostered a climate of uncertainty by blurring the boundary for lawful tax planning.