Third part of my thoughts from 2005 on the emerging jurisprudence at the time.
EC law - The concept of abuse
32. The German case of Emsland Stärke Case C-110/99 [2000] ECR I-11569 heard by the European Court of Justice (ECJ) bore striking similarities in principle to the case of BMBF considered above. Commission Regulation (EEC) No 2730/79 of 29 November 1979 provided that an export refund was payable to exporters of specified goods, the key condition being that the goods were released for home use in a third country outside the EU (i.e. formally imported on any payment of any necessary duties etc). In Emsland, the goods were indeed exported by road to Switzerland and released for home use there, but the truck turned round without even being unloaded and the goods were immediately re-imported into the Community unaltered.
33. The court was asked whether an exporter could be divested of its right to an export refund despite the fact that the formal legal conditions for the grant of the refund were met. If one had applied principles like those used by the House of Lords in BMBF, these would seem to allow an exporter in such a case to hold on to the refund on the basis that the legislation was not couched in terms of any different or wider result than that the goods were imported into a third country. The fact that the law intended to grant refunds only if the goods were actually used or consumed in the third country could not possibly be inferred from the words of the statute.
34. However, the ECJ took a very different line, finding that because there had been only ‘a purely formal dispatch from Community territory with the sole purpose of benefiting from export refunds’ the right to the refund should be forfeited on the grounds of abuse. Abuse was defined by two tests, firstly ‘a combination of objective circumstances in which, despite formal observance of the conditions laid down by the Community rules, the purpose of those rules has not been achieved’ and secondly a ‘subjective element consisting in the intention to obtain an advantage from Community rules by creating artificially the conditions laid down for obtaining it’ (paras 52 and 53 of the judgement).
35. Following this decision, HMRC has been arguing in three joined cases before the ECJ that this principle of abuse should also apply to the VAT system irrespective of the absence of provisions expressly setting it out, either in the Sixth Directive or in national law (Case C-255/02 ‘Halifax’, Case C-419/02 ‘ BUPA’ and Case C-223/03 ‘ University of Huddersfield’). The Advocate General (AG) gave his opinion on 7 April 2005 and while this will not necessarily be followed by the full Court, it illustrates sufficiently for the purposes of this paper potential key issues of difference between taxes based on EC law and those governed wholly by domestic legislation. This is not a simple split between direct and indirect taxes. For example on the direct tax side there is a EC directive on Interest and Royalties, while on the indirect tax side Insurance Premium Tax is a UK national tax.
36. The AG’s Opinion extensively reviewed Community case law before suggesting that “this notion of abuse operates as a principle governing the interpretation of Community law” and “Such a rule, conceived as a principle of interpretation, constitutes an indispensable safety-valve for protecting the aims of all provisions of Community law against a formalistic application of them based solely on their plain meaning”. He then says how this principle should apply to VAT, asserting “the Community law notion of abuse, applicable to the VAT system, operates on the basis of a test comprising two elements”.
37. These elements are described by the AG in ways subtly but critically different from the court in Emsland. “The first corresponds to the subjective element mentioned by the Court in Emsland, but it is subjective only in so far as it aims at ascertaining the purpose of the activities in question. That purpose – which must not be confused with the subjective intention of the participants in those activities – is to be objectively determined on the basis of the absence of any other economic justification for the activity than that of creating a tax advantage”.
38. Why must the purpose not be so confused? The AG was concerned that the second of the Emsland tests (he has reversed their order in his own Opinion) would not prevent abuse involving an unwitting third party, giving the example of “a case where A confines himself without further reflection to following the advice of B and to carrying out an activity for which there is no explanation other than securing a tax advantage for A. The fact that A did not have any subjective intention of abusing Community law will certainly not be material for the assessment of the abuse. What matters is not the actual state of mind of A, but the fact that the activity, objectively speaking, has no other explanation but to secure a tax advantage”. For this reason he concluded that the “finding of artificiality should not be based on an assessment of the subjective intentions of those claiming the Community right”, but rather than disagreeing with the principle, he is venturing that there is no point in seeking to establish that subjective intention for the simple practical reason that it might not be found in the person whose activity actually effects the abuse.
39. In continuing “In my view it is not therefore a search for the elusive subjective intentions of the parties that ought to determine the existence of the subjective element mentioned in Emsland. Instead, the intentions of the parties to improperly obtain an advantage from Community law are merely inferable from the artificial character of the situation to be assessed in the light of a set of objective circumstances” he is confirming that the key criterion is the existence of that subjective element, but that it can only be determined by inference from the objective facts of the case.
40. This is clearer in the original Portuguese, the second sentence in the passage quoted above being “Pelo contrário, a intenção de as partes obterem ilegitimamente um benefício do direito comunitário pode simplesmente ser inferida do carácter artificial da situação a apreciar à luz de um conjunto de circunstâncias objectivas”, meaning that the intentions can be simply (i.e. easily or certainly) inferred. And the French “les intentions des parties …… peuvent être simplement déduites” is the same. The ‘simply’ suggests that this criterion determines cases beyond doubt, and it is because they are beyond doubt that they can be struck down by an interpretative principle of abuse without the risk of harm to any innocent person. The AG’s logic might seem shaky here, because the principle would require that if there were no other economic justification for the activity then this innocent would be the one caught by the ‘objective’ determination of this subjective element of the test.
41. However, arguably any gap in the reasoning can be ignored on the grounds of the practical improbability of a transaction entered into by an innocent having no economic effect for him other than the gaining of a tax advantage. The UK’s MTIC fraud case of Bond House - also before the ECJ – is a good example. The activities undertaken by Bond House did have an economic effect because Bond House bought and sold real goods in return for real consideration – it was not just a ‘money-go-round’. If you pay £100,000 for computer parts from a wholly independent third party, the exchange of money for goods has a real economic effect – and by inference justification - that is unaffected by the fact that the people from whom you buy the goods do not hand over the VAT you paid them to the tax authority.
42. The second element of the proposed test of abuse the AG puts forward is “in fact a teleological element whereby the purpose and objectives of the Community rules allegedly being abused are compared with the purpose and results achieved by the activity at issue. This second element is important, not only because it provides the standard upon which the purpose and results of the activity in question are to be assessed. It also provides a safeguard for those instances where the sole purpose of the activity might be to diminish tax liability but where that purpose is actually a result of a choice between different tax regimes that the Community legislature intended to leave open.”
43. Putting the two together, the conclusion of the AG’s opinion is “there is a Community law principle of interpretation prohibiting the abuse of Community provisions, which is also applicable to the Sixth Directive. According to that principle, the provisions of the Sixth Directive must be interpreted as not conferring the rights that might appear to be available by virtue of their literal meaning, when two objective elements are found to be present. First, that the aims and results pursued by the legal provisions formally giving rise to the tax advantage invoked would be frustrated if that right were conferred. Second, that the right invoked derives from economic activities for which there is objectively no other explanation than the creation of the right claimed”.
44. While the AG gives considerable weight throughout to the importance of objectivity and safeguarding the rights of the various parties potentially involved – including the tax authority – his Opinion does not specify in any new way how the aims and results pursued by the legal provisions are to be determined. He does say “The normative goal of the principle of prohibition of abuse within the VAT system is precisely that of defining the realm of choices that the common VAT rules have left open to taxable persons”, and it is instructive to see how he goes about this.
45. In the cases of Halifax and Huddersfield, for example, the AG appears first to look at the statute, saying “It is clear from Article 17(2) of the Sixth Directive that where a taxable person makes VAT exempted supplies he has no right to deduct the input VAT paid on goods or services used for those exempt supplies”. But he does not actually refer at all to the words of the legislation, mentioning instead three previous cases and two academic works, his footnote saying “See BLP Group, paragraph 28; Case C-302/93 Debouche [1996] ECR I-4495, paragraph 16; Case C-291/92 Armbrecht [1995] ECR I-2775, paragraphs 27 and 28. See also B. Terra and J. Kajus, A Guide to VAT, p. 802 and P. Farmer and R. Lyal, EC Tax Law, pp. 190 and 191”.
46. He then carries on in ‘scheme of the tax’ terms “The right of a taxable person to deduct from the output VAT payable the input VAT incurred for making the taxable supplies constitutes a corollary of the principle of neutrality.” footnoted with “As held both in Case C-50/87 Commission v France, paragraph 17, and in Rompelman, paragraph 19: ‘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 … provided that they are themselves subject to VAT, are taxed in a wholly neutral way”. (his emphasis). Continuing with “VAT is, in effect, an indirect general tax on consumption meant to be borne by the individual consumers. Correspondingly the same principle requires that a taxable person must not be entitled to deduct or recover the input VAT paid on supplies received for its exempted transactions. As long as no VAT is charged on the goods or services provided by taxable persons, the Sixth Directive necessarily seeks to prevent them from recovering the corresponding input VAT”.
47. So in contrast to the recent judgements of the House of Lords on UK provisions, the realm of choices open to taxpayers under the EC directives is different from the range of possibilities allowed by the statute. Firstly because the purpose and objectives of the Community rules are not inferable only from the words of the statute, and secondly because there is an over-riding interpretative principle preventing defined abuse.
48. So while there might be superficial similarities between the recent approach of the UK courts and the AG’s opinion, they represent very different philosophies, one seemingly determined to infer nothing beyond the words of the statute, the other determined not to be bound by them. In many cases the application of either principle would give the same result, but the outcomes in Emsland and in BMBF suggest that there is a set of cases where the principles will give opposite results on similar facts.
For those with the patience to get this far, only the final and shortest part to come ...
Musings on tax avoidance and most recently on the 'Boys' behind it ... here.
Interesting new paper about perception of risk and influence on avoidance behaviour, here
The Professor. A number of her papers available here
A founder of Tax Justice Network here.