In November 2009, Mr Justice Henderson held that the ECJ, in its Thin Cap judgment, had concluded that the UK’s Thin Cap rules would offend Community law unless they could be interpreted as applying only to wholly artificial arrangements designed to obtain a tax advantage and protected genuine commercial arrangements from any thin cap adjustments even if beyond arm’s length terms.

By a majority of 2 to 1 the Court of Appeal has today reversed the decision of Henderson J and concluded that the UK Thin Cap provisions were lawful. In doing so, the Court has accepted HMRC’s argument that the ECJ’s judgment in Thin Cap merely required the UK to apply an arm’s length test and not an additional “commercial justification” test. Henderson J had concluded that HMRC’s case on this point was “threadbare” for two reasons: (1) if HMRC were correct Lankhorst-Hohorst would have lost and (2) HMRC’s case contradicts the clear words of the ECJ’s judgment in Thin Cap. In reaching the contrary decision the majority conclude that judgments by the ECJ in other areas lead to a different reading of the Thin Cap judgment than it appears to say.  

Lady Justice Arden, dissenting, makes the same observations as Henderson J and criticises the majority for its failure to consider the Lankhorst-Hohorst point and for borrowing from inapplicable case law. She points out that for the majority’s conclusion to be the correct one, the ECJ must have been intending to overrule Lankhorst-Hohorst in its Thin Cap judgment. There was however nothing in the Thin Cap judgment to suggest that this was their intention.

In consequence, the issue of whether the UK were in sufficiently serious breach did not arise. The Court however went on to say that if it had been clear that the UK’s legislation was incompatible with Community law as a result of the judgment in Lankhorst-Hohorst, the UK should have been given an extended period of time in which to make its legislation compatible. The period of 15 months from December 2002 to April 2004 would not have been excessive in the circumstances.  

The next stage in proceedings would be for the claimants to seek leave to appeal to the Supreme Court.