A court has ruled that the transfer of a business offshore, although entered into to avoid irrecoverable VAT, was not wholly artificial and reflected economic reality, so did not have to be disregarded on the grounds of abuse of process.
In HMRC v. Newey (trading as Ocean Finance), Mr Newey originally operated a UK based loan brokering business, Ocean Finance. As his services were exempt from VAT, Mr Newey was unable to recover VAT on advertising services supplied to him. In 1997 he transferred the business to a Jersey based company, Alabaster, which outsources its loan processing operations back to the UK. It was claimed that Alabaster, and not Mr Newey, made the supplies of loan brokerage services to other UK based lenders. Alabaster therefore received the supplies of advertising services, provided by a Jersey advertising agency, which were not subject to UK VAT as the services were being provided in Jersey.
Mr Newey was involved in discussing advertising content and had a right of veto over any advertising proposals, however approval from an Alabaster director was required to sign off on any decisions.
HMRC claimed that it was Mr Newey who should have been treated as receiving the advertising services, and these should have been subject to a reverse charge in the UK. Alternatively, the arrangements amounted to an abuse of process and should be recharacterized.
The UK First Tier Tribunal (FTT) held that while Alabaster may have lacked the necessary infrastructure to carry out a loan brokering business themselves, it had equipped itself to conduct its business by outsourcing the required processing functions. While the essential aim of the restructuring was to obtain a tax advantage, the arrangements did not amount to an abuse of process.
The Upper Tribunal referred certain questions to the CJEU. The CJEU ruled that contractual terms, although a factor to consider, are not decisive in identifying the supplier or the recipient of goods and services. Contractual arrangements may be disregarded where it is apparent that they do not wholly reflect the economic and commercial reality, however this is for the national courts to determine, and the question was referred back to the Upper Tribunal.
In the Upper Tribunal's view, the CJEU decision did not offer any scope for departure from the contractual terms unless the arrangements were wholly artificial and did not reflect the economic and commercial reality. Whilst it was clear that the contractual arrangements were entered into to obtain a tax advantage, the FTT had been entitled to conclude that they were not wholly artificial and thus not abusive. Alabaster not merely rubber stamping Mr Newey's decisions and Mr Newey not being involved in Alabaster's management were robust findings of fact which the FTT had been entitled to reach on the evidence before it.
The decision confirms that the CJEU’s judgment is not as wide as HMRC were contending. Additionally, it suggests that the concept of redefinition of economic reality is limited unless an abuse actually exists. However, the Upper Tribunal's decision should be viewed in light of the more recent Supreme Court decision inPendragon, in which a different test was applied, namely whether the commercial objective is enough to explain the particular features of the contractual arrangements which produce the tax advantage. In Pendragon, the scheme put in place was recharacterized for being abusive because, on an objective view, there was no commercial rationale for it. In the light of this, it is possible that theNewey decision will be overturned on appeal.