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ROBERT VENABLES QC continues his assault on the VAT Tribunal decision in the Halifax case.
ROBERT VENABLES QC continues his assault on the VAT Tribunal decision in the Halifax case.
In the first part of this article, published in last week's issue of Taxation, Robert Venables explained the VAT avoidance scheme carried out by Halifax plc, Customs' case against it and the correct interpretation of the relevant authorities in the field of direct tax. This concluding part of the article discusses VAT planning and supplies in the broad context of other European and United Kingdom decided cases.
LEAVING THE DECISION of the tribunal for the moment, I now consider the matter as if it were res integra. What does the Sixth Directive say of 'tax avoidance' in the context of 'supply' and 'economic activity'? Nothing! – which makes the tribunal's decision all the more amazing. Both the European Court of Justice and the United Kingdom authorities show that 'supply' is a word of the widest meaning.
The Sixth Council Directive of 17 May 1977 on the harmonisation of the laws of the Member States relating to turnover taxes common system of VAT: uniform basis of assessment (77/388/EEC) provides:
'Article 4
'1 "Taxable person" shall mean any person who independently carries out in any place any economic activity specified in paragraph 2, whatever the purpose or results of that activity.
'2 The economic activities referred to in paragraph 1 shall comprise all activities of producers, traders and persons supplying services including mining and agricultural activities and activities of the professions. The exploitation of tangible or intangible property for the purpose of obtaining income therefrom on a continuing basis shall also be considered an economic activity.'
The phrase in Article 4.1 'whatever the purpose or results of that activity' is telling. It suggests in the clearest terms that a supply does not cease to be a supply because of the purpose, such as the avoidance of taxation, with which it is made.
The tax is a tax on consumption. The tax is in reality borne by the consumer, although the responsibility for payment of the tax to the fiscal authorities rests on the supplier. In the case of some supplies of services, the service is literally consumed by the recipient of the supply and ceases to exist. In other cases, such as the sale of goods, the goods may well continue to exist and thus are capable of being re-supplied. Once, however, the goods have been acquired by a consumer, i.e. a person not carrying on an economic activity, the tax has been paid once and for all. It is similar to excise duty, which is payable once and for all when goods are 'realised for consumption', no matter who subsequently actually consumes them.
What is the scope of the requirement that, for a supply to be taxable, it must be made by a person independently carrying on an economic activity? Article 4.1 and 4.2 shows that prima facie this is to be interpreted very widely.
What is the relevance of motive? Prima facie, none. Article 4.1 stresses 'whatever the purpose'. (These words were conveniently ignored by the tribunal in Halifax.) If there is an economic activity, then purpose is irrelevant.
It is admittedly not enough to take each of the possibilities in Article 4.2 and see if they are satisfied. The words have to be read eiusdem generis and in the context of the Sixth Directive.
It is established that the following are not taxable persons: firstly, employees (and, possibly, quasi-employees) who render services. That is made clear by Article 4.4 of the Sixth Directive:
'4 The use of the word "independently" in paragraph 1 shall exclude employed and other persons from the tax in so far as they are bound to an employer by a contract of employment or by any other legal ties creating the relationship of employer and employee as regards working conditions, remuneration and the employer's liability.'
This express exclusion shows how wide indeed the concept of economic activity would otherwise be. Employees render services for a consideration. This is prima facie enough to amount to an 'economic activity'.
Secondly, certain persons are not taxable persons in so far as they carry on governmental functions. Article 4.5 of the Sixth Directive provides:
'5 States, regional and local government authorities and other bodies governed by public law shall not be considered taxable persons in respect of the activities or transactions in which they engage as public authorities, even where they collect dues, fees, contributions or payments in connection with these activities or transactions.
'However, when they engage in such activities or transactions, they shall be considered taxable persons in respect of these activities or transactions where treatment as non-taxable persons would lead to significant distortions of competition.
'In any case, these bodies shall be considered taxable persons in relation to the activities listed in Annex D, provided they are not carried out on such a small scale as to be negligible.
'Member States may consider activities of these bodies which are exempt under Article 13 or 28 as activities which they engage in as public authorities.'
Again, this shows, that 'economic activity' is prima facie wide enough to cover state services, the provision of which will not be by way of trade or even commercial. Supplies can be made on a subsidised basis. There is no need for a profit motive. All that matters is that the supply has been effected for a consideration.
Thirdly, 'activity' does prima facie import a measure of continuity, so that one-off supplies are unlikely to be made in the course of an economic activity. The wording of Article 4.2 further supports this interpretation. Moreover, this impression is confirmed by Article 4.3, which expressly extends the concept to certain occasional transactions.
European Court of Justice case law
In brief, there are no decisions of the European Court of Justice which support the proposition that a supply is not a taxable supply for VAT purposes when it is made for the purpose of tax avoidance. By contrast, there is no shortage of authority that the scope of VAT is very wide, as is the scope of 'economic activity'.
EC Commission v United Kingdom
A recent example is European Community Commission v United Kingdom [1999] STC 777 (Case C-359/97), where the European Court of Justice held that the United Kingdom had failed to fulfil its obligations under the Sixth Directive in not subjecting to VAT tolls collected for the use of toll roads and toll bridges. Advocate General Alber said in his Opinion:
'Article 4.2 of the Sixth Directive defines economic activity as "all activities of producers, traders and persons supplying services".
'The court has consistently held that the scope of the term "economic activities" is very wide, and that the term is objective in character, in the sense that the activity is considered per se and without regard to its purpose or results. (See European Community Commission v Netherlands (Case 235/85) [1987] ECR 1471, Stichting Uitvoering Financiële Acties v Staatssecretaris van Financiën (Case 348/87) [1989] ECR 1737 at 1752, paragraph 10, and Van Tiem v Staatssecretaris van Financiën (Case C-186/89) [1993] STC 91 at 106, [1990] ECR I-4363 at 4386, paragraph 17.)
'Under this wide definition of economic activity it is not necessary for services to be primarily or exclusively orientated towards the market or economic life. It is sufficient that they are actually connected with economic life in some way or other (See the opinion of the Advocate General (Lenz) of 12 February 1987 in European Community Commission v Netherlands at 1481, paragraph 22, and the judgment in that case.)... The objective nature of the definition of economic activity also calls for the classification of the activity in this case as an economic one as the activity itself must be considered, regardless of its purpose or result.'
But for the decision of the tribunal in Halifax, one would have thought the position could not be stated more clearly.
Sofitam
In Sofitam SA (formerly Satam SA) v Ministre chargé du Budget [1997] STC 226, Case C-333/91, the question was whether dividends received formed part 'turnover' for the purpose of calculating the deductible proportion of input tax. The European Court of Justice held that 'Since the receipt of dividends is not the consideration for any economic activity within the meaning of the Sixth Directive, it does not fall within the scope of VAT. Consequently, dividends must be excluded from the calculation of the deductible proportion referred to in Articles 17 and 19 of the Sixth Directive, if the objective of wholly neutral taxation ensured by the common system of VAT is not to be jeopardised'.
The Court stated:
'It is settled case law (see, inter alia, European Community Commission v France (Case 50/87) [1988] ECR 4797 at 4817, paragraph 15) that the deduction system is meant to relieve the trader entirely of the burden of VAT payable or paid in the course of all his economic activities. The common system of VAT consequently ensures that all economic activities, whatever their purpose or results, provided they are themselves subject to VAT, are taxed in a wholly neutral way.'
The Advocate General Van Gerven commented on nature of economic activity at paragraph 11 of his Opinion:
'Under Article 4.1 of the [Sixth] Directive a taxable person means "any person who independently carries out in any place any economic activity specified in paragraph 2, whatever the purpose or results of that activity". Article 4.2 explains that the economic activities referred to comprise all activities of producers, traders and persons supplying services, in particular the exploitation of tangible or intangible property for the purpose of obtaining income therefrom on a continuing basis. The court has given the concept of "exploitation" a wide interpretation: it includes all transactions, whatever their legal form, by which it is sought to obtain income from the goods in question on a continuing basis (see, inter alia, the judgments in Van Tiem v Staatssecretaris van Financiën (Case C-186/89) [1993] STC 91 at 106, [1990] ECR I-4363 at 4386, paragraph 18 and Polysar Investments Netherlands BV v Inspecteur der Invoerrechten en Accijnzen Arnhem (Case C-60/90) [1993] STC 222 at 238, [1991] ECR I-3111 at 3137, paragraph 12).'
Harnas & Helm
In Harnas & Helm CV v Staatssecretaris van Financiën [1997] STC 364 (Case C-80/95), Advocate General Fennelly said:
'It must be recalled, in the first instance, that the court has consistently held that Article 4 of the Sixth Directive confers "a very wide scope on VAT, comprising all stages of production, distribution and the provision of services"(see, inter alia, Van Tiem [1993] STC 91 at 106, [1990] ECR I-4363 at 4386, paragraph 17 of the judgment).... I share the view, expressed by the Advocate General (P VerLoren van Themaat) in relation to the concept of a taxable person under Article 4 of [the Second Directive] that "it is not the aim but rather the nature of the activities in question which is relevant" when determining what constitutes an economic activity (see Staatssecretaris van Financiën v Hong Kong Trade Development Council (Case 89/81) [1982] ECR 1277 at 1293).'
That the aim is the facilitation of tax avoidance is irrelevant.
BLP Group
In the European Court of Justice decision in BLP Group plc v Commissioners of Customs and Excise [1995] STC 424 (Case C-4/94), BLP incurred input tax on taxable supplies made to it for the direct purpose of what was agreed by the parties to be an exemption transaction, namely a sale of shares, and for the indirect purpose of reducing its indebtedness which derived from taxable transactions it had effected. The Court held that it did not have the right to deduct the input tax. It was considering not whether a supply ceased to be a taxable supply because of the motive of the person making it but whether input tax incurred for the purpose of making an exempt supply could nevertheless be recoverable, depending on the motives, intention or ultimate aim of the recipient of the supply. The Court held, at paragraph 19 of the judgment:
'Paragraph 5 [of Article 17 of the Sixth Directive] lays down the rules applicable to the right to deduct VAT where the VAT relates to goods or services used by the taxable person "both for transactions covered by paragraphs 2 and 3, in respect of which VAT is deductible, and for transactions in respect of which VAT is not deductible". The use in that provision of the words "for transactions" shows that to give the right to deduct under paragraph 2, the goods or services in question must have a direct and immediate link with the taxable transactions, and that the ultimate aim pursued by the taxable person is irrelevant in this respect.'
The Court also held, at paragraph 24 of the judgment:
'Moreover, if BLP's interpretation were accepted, the authorities, when confronted with supplies which, as in the present case, are not objectively linked to taxable transactions, would have to carry out inquiries to determine the intention of the taxable person. Such an obligation would be contrary to the VAT system's objectives of ensuring legal certainty and facilitating application of the tax by having regard, save in exceptional cases, to the objective character of the transaction in question.'
In my view, these remarks are equally applicable to the question at issue in the Halifax decision. Whether or not a supply is a taxable supply and whether or not it is made in the course of a business/an economic activity must be in general an objective question and cannot turn on the ulterior motives of the person making the supply.
The United Kingdom authorities
So far as I am aware, the proposition which the tribunal accepted has not, before Halifax, been advanced anywhere in Europe in the period of more than a quarter of a century since the United Kingdom has been a member of what is now the European Community. It has certainly not been advanced in the United Kingdom. One would not therefore expect to find any direct United Kingdom authority on the point. There is, however, indirect authority.
Morrison's Academy
Commissioners of Customs and Excise v Morrison's Academy Boarding Houses Association [1978] STC 1 was a case decided by the Inner House of the Court of Session of Scotland. The taxpayer was a charity, the principal objects of which were 'To establish, carry on and maintain … properly equipped boarding houses … in Scotland … for the accommodation of resident pupils or scholars at Morrison's Academy'. The terms of the association's memorandum provided that the income and property of the association was to be applied solely towards the promotion of its objects and was not to be available for distribution to its members by way of dividend, bonus or otherwise by way of profit. In promotion of its objects the association owned and operated six boarding houses in which, during the school terms, some 240 pupils of the academy were accommodated. The association charged fees in respect of the goods and services provided for the pupils accommodated. The association's affairs were managed so that neither a profit was made nor a loss incurred in the conduct of its activities.
The association contended that it did not make supplies of accommodation to pupils 'in the course or furtherance of a business'. It argued unsuccessfully:
'(a) the test of a "business" is a qualitative test and since the association did not go out to win custom the test was not satisfied;
'(b) in any event there must be a commercial element in a business and there was none present;
'(c) in any event, profit motive is an essential feature of any form of business.'
Lord Emslie said:
'The definition [of business] in section 45(1) [of the Finance Act 1972] is, however, not unhelpful, for, by providing that business includes any trade, profession or vocation, a clear hint is given that a wide meaning is intended, and I observe that nowhere in Part I of the 1972 [Finance] Act is there any use of the word "commerce" or "profit" in association with the word business, or otherwise.... I can discover nothing in the natural meaning of the word business so to restrict its scope and there is nothing in the context of the taxing provisions as a whole to require one to read business in such a narrow way. The tax is, after all, not a tax on profit or income but on taxable supplies by taxable persons and to make liability to tax depend on the motive with which activities were continuously carried on would lead to the unreasonable result that where two taxable persons make identical taxable supplies in course of carrying on an identical activity or occupation, in which each makes the same loss, or neither a profit nor a loss, and one has sought to make profit and the other has not, only the former would be accountable for VAT.'
Lord Cameron agreed:
'The tax with which this appeal is concerned is levied not on the profits and gains of a trade, profession or vocation but on turnover calculated on the value, actual or notional, of the supply of certain goods and services known as 'taxable supplies' which are supplied by the registered taxpayer.... Neither the purpose for which the supplies are made nor the expectation or hope of gain or profit arising therefrom are matters which prima facie are relevant to the issue of liability to tax.... Section 2(2) which Lord Emslie has already quoted is silent as to the purpose for which the business is carried on or as to the profit or gain realised or expected from making the taxable supplies.'
Reductio ad absurdum
One of the Aristotelian principles of reasoning is to posit a proposition and see if it leads to an absurd consequence. If it does, then it must be wrong. Let us consider the absurd consequences which flow from the tribunal's decision.
The making of a supply is the event which precipitates a charge to VAT. It is indeed paradoxical that if what would otherwise be a supply is made with the purpose of avoiding liability to VAT, then no tax is due on that supply! On closer examination, it will be seen that, while ignoring a supply can, in certain circumstances, such as those of the Halifax case, result in more VAT being paid overall, yet in other cases, less tax would be payable!
Take the facts of the Direct Cosmetics case. Suppose that Direct Cosmetics had set up its sales system for the avoidance (in the strict sense of the word) of VAT and not for bona fide commercial reasons. Before the United Kingdom changed the law, there would have been a leakage of VAT on the mark-up of the sales ladies, VAT being charged only on the consideration given by them to Direct Cosmetics and not on the consideration given to them by their customers. It would follow, on the tribunal's view, that as the supplies made by Direct Cosmetics were being made for the purpose of tax avoidance, they were not supplies at all. Thus no VAT at all would have been payable! The result of the application of the so-called rule is 'If you try to avoid paying some VAT, you will thereby escape liability to pay a lot more'!
Ab absurdo ad absurdius
The tribunal also decided, ostensibly in reliance on the English decision of the English Queen's Bench Division in Commissioners of Customs and Excise v Reed Personnel Services Ltd, that the outside contractors made supplies directly to Halifax! This part of the decision must, with respect, proceed from a complete misunderstanding of that English authority and the later decision of the House of Lords in Commissioners of Customs and Excise v Redrow Group plc [1999] STC 161.
The decision on this point was actually helpful to Halifax as it at least ensured that it recovered the same proportion of input tax as if the supplies had been made to it directly. Customs had won completely once the tribunal had decided that Developments and Country Wide made no taxable supplies as the input tax they suffered was thus totally irrecoverable. The same result would have followed if it had held merely that Developments made no taxable supplies. One is thus left wondering why Customs put the point forward and whether counsel for Halifax would have argued at all strenuously that it was wrong.
New gospel
The tribunal may be likened to the voice of one crying in the wilderness. It is preaching a new gospel which denies taxpayers the power so to arrange their affairs as to be liable to pay the least amount of tax. Whether that gospel will become the orthodox religion of tomorrow or whether it will fall on deaf ears and remain the heresy I believe it to be, only time and the appeal courts will tell.
This is a condensed version of an article in the current issue of the EC Tax Journal, published by Key Haven Publications plc.
Robert Venables QC is a bencher of the Middle Temple and council member of The Chartered Institute of Taxation. Chambers: 24 Old Buildings, Lincoln's Inn, London WC2A 3UP, tel: 020 7242 2744.
