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Upper Tribunal: Ocean Finance VAT arrangements could stand as not 'wholly artificial'

Out-Law News | 05 Jun 2015 | 2:37 pm | 3 min. read

HM Revenue and Customs (HMRC) should not look beyond the contractual arrangements that govern a company's structure when establishing liability for VAT unless those arrangements do not reflect "economic and commercial reality", a tribunal has ruled.

The Upper Tier (Tax) Tribunal backed an earlier decision by the first-tier tribunal that loan broker Ocean Finance was within its rights to restructure its business even though that restructuring meant that it obtained a tax advantage in relation to its advertising costs (124-page / 440KB PDF). Its ruling followed a referral to the Court of Justice of the European Union (CJEU) in 2013, which HMRC claimed had laid down new guidance on the treatment of contractual arrangements when the economic and commercial reality of the underlying transactions was in question.

Ultimately, Mr Justice Warren backed the interpretation of the CJEU decision put forward by the lawyer for Ocean Finance's owner, Paul Newey. Newey said that the CJEU had merely re-stated existing established principles, which had already been applied correctly by the first-tier tribunal.

Tax expert Catherine Robins of Pinsent Masons, the law firm behind Out-Law.com, said that it was "refreshing" to see a taxpayer succeed in a challenge to a structure put in place to save tax.

"Mr Justice Warren did not accept that the CJEU's decision was as wide as HMRC was contending," she said. "HMRC was arguing that wherever contractual terms do not wholly reflect the economic and commercial reality of the transactions they can be departed from. However the judge said that the CJEU decision was not saying anything significantly new – it was just giving some further guidance in a different factual situation. He said there was no scope for departure from the contractual terms unless the arrangements did not reflect the economic and commercial reality and were wholly artificial."

Newey, the owner of loan broker Ocean Finance, had granted exclusive use of the business name to a Jersey company, Alabaster. In addition, any loans processed by the company's UK employees were approved by Alabaster. HMRC claimed that Newey had done this in order to avoid paying VAT on advertising costs, as advertising supplies made in Jersey were not subject to UK VAT, whereas advertising supplied to Newey in the Uk was subject to irrecoverable VAT. Alabaster entered into contracts with the advertising providers, while Newey retained control over the content of the advertising.

In 2013, the CJEU said that it was "conceivable" that the contractual terms in dispute did not "genuinely reflect economic reality". However, it was up to the national court to decide whether or not this was the case based on analysis of all the facts. If the contractual arrangements were not genuine, then they would have to be "redefined so as to re-establish the situation that would have prevailed in the absence of the transactions constituting that abusive practice", the CJEU said.

Mr Justice Warren said that the CJEU had been "well aware" from the evidence provided to it that "the arrangements concerned were not shams, that money flowed in accordance with the contractual provisions and that Alabaster was not simply rubber-stamping everything put before it".

"Accordingly, the guidance found in the judgment was given by the CJEU on the basis of the actual transactions in place and the actual behaviour of the parties," he said.

"In the context of the facts in the present case, the CJEU did not, in my view, perceive any scope for departure from the contractual terms unless the arrangements were wholly artificial and did not reflect the economic and commercial reality although the judgment should not be taken as ruling out the possibility of some other abuse which would justify departure from these terms. A situation in which the contractual terms did not genuinely reflect economic reality was precisely a situation which the CJEU saw as potentially falling within the abuse principle in the first place," he said.

The judge said that although some of HMRC's criticisms of the first-tier tribunal's original ruling were valid, its decision "must be read as a whole".

"It is not right to read the tribunal as saying the contractual position was that Alabaster received and paid for the advertising services and that therefore the supply was to be taken as made to Alabaster regardless of other consideration," he said.

"Unless HMRC can successfully attack the finding that Alabaster was a commercial enterprise carrying on its own economic activities, I consider that [the tribunal was] entitled to reject HMRC's argument based on the indirect commercial benefit to Mr Newey of the provision of advertising services to Alabaster," he said.

Having applied the correct approach, the tribunal's assessment of the evidence was "unassailable: they reached conclusions which they were entitled to reach on the evidence before them", he said.

"The tribunal took everything into account: their conclusion was that the contractual position was not to be disturbed as a reflection of the reality," he said.