The Court of Appeal has held that the Upper Tribunal was wrong to conclude, on the grounds set out in Halifax v HM Customs and Excise (C-255/02), that the First-tier Tribunal (FTT) had erred in law in holding that a financing scheme entered into by a car trading group selling demonstrator cars was not abusive for VAT purposes. The Court of Appeal held that the FTT was entitled to conclude that, although the scheme was structured to be VAT efficient, the structure, viewed objectively, was not abusive.

VAT treatment of second-hand cars

Under Article 26A of the Sixth Directive, dealers in second-hand goods (which includes second-hand cars) are subject to special arrangements under which, broadly, they may charge VAT only on their profit margin rather than on the full sale price of the car. This has been transposed into UK domestic legislation, in relation to cars, by the VAT (Cars) Order 1992 (SI 1992/2832) (1992 Order). Under the 1992 Order, if the dealer takes possession of the cars by a transfer of a business as a going concern (TOGC), the dealer may only apply the margin scheme if, assuming the transferor had sold the goods, the transferor could have used the margin scheme. These circumstances include where the dealer acquires the cars under a transaction that is treated as outside the scope of VAT. The assignment by an owner to a financial institution of goods comprised in a hire purchase or conditional sale agreement of his rights under the agreement and his rights to the goods is treated as being outside the scope of VAT (Article 5(4) Special Provisions Order).

The facts

The appellant taxpayers were members of the same group of companies. The main business of the group was selling new and used cars, servicing cars and selling car parts. The group comprised a holding company, Pendragon PLC (Pendragon), four dealership companies, three captive leasing companies, and Pendragon Demonstrator Sales Limited (PDS). The dealership companies sold demonstrator cars.

On 8 October 2000, when the appellant group was renegotiating its loan facilities, its professional advisers introduced the group to a "tax-efficient demonstrator finance" scheme to finance demonstrator company cars. The transactions required the involvement of a third-party bank and Société Générale (SocGen) was chosen for this role. Under the structure, which was implemented in late 2000 and early 2001:

Pendragon purchased new cars from a manufacturer, paying VAT on acquisition, which it reclaimed as input tax. Pendragon sold those cars to one of the captive leasing companies, charging VAT on the sale. The dealership companies hired the cars from the captive leasing companies. The dealership companies had options to buy the cars seven days after the end of the hire agreement, with title passing 14 days after exercise of the option. The captive leasing companies charged VAT on the services provided under the leasing agreements and reclaimed the input VAT they incurred on the acquisitions from Pendragon. The dealerships incurred VAT on the rental payments but recovered that VAT in full as it was attributable to their taxable sales activities.

The following day, each of the three captive leasing companies assigned their interests in the leasing agreements, together with the cars to which they related, to a Jersey subsidiary of SocGen, SG Hambros (SGH) for £20. No VAT was due on this transaction because it was not a supply for VAT purposes by virtue of Article 5(4) of the Special Provisions Order.

On the same day, SGH assigned the benefit of the lease agreements and the cars themselves to SocGen as security for a £20m loan facility made available by SocGen to the appellant group.

After a month, PDS acquired SocGen’s car hire business for £18m (apportioned as to £100,000 for the sale of goodwill and virtually all of the remainder for the sale of the vehicles). This was treated as a TOGC.

From this time onwards, cars were sold by the dealership companies to final consumers as undisclosed agent for PDS. VAT was charged on the profit margin on the basis that Article 26A and the 1992 Order applied.

Accordingly, at each stage of the transaction until the cars were sold to final consumers, each party was able to recover the VAT charged to it or no VAT was charged.

HMRC rejected PDS’s claim that it was entitled to use the profit margin scheme on the basis that the transactions were an abuse of law. It sought to recover VAT on the full sale price of the cars and to charge mis-declaration penalties.

The taxpayers appealed to the FTT, which held that there was no abuse and that the taxpayers were entitled to benefit from Article 26A and the 1992 Order.

HMRC appealed to the Upper Tribunal, which allowed their appeal and held that there was abuse. Accordingly, the transactions were redefined for VAT purposes.

The taxpayer appealed to the Court of Appeal.

The decision of the Court of Appeal

The Court of Appeal allowed the appeal, holding that the FTT had not erred in law in concluding that the transactions were not abusive. The Court of Appeal confirmed that the essential aim of a transaction had to be considered objectively and not by reference to the actual intentions of the parties. The Court limited its examination of the FTT’s decision to the second requirement of the Halifax test, namely, what was the essential aim of the transactions, and considered each of the Upper Tribunal’s reasons for holding that the FTT had erred in law. These were:

  • The FTT’s treatment of the evidence of Mr Forsyth, Pendragon PLC’s finance director.
  • The FTT’s treatment of the professional adviser’s involvement in formulating the VAT saving arrangements implemented by Pendragon.
  • The FTT’s failure to have regard to the scale of the tax advantage.
  • The FTT’s failure to consider whether the group needed short-term financing.
  • The three artificial elements of the transactions, namely, the use of the captive leasing companies to create leases, the use of an offshore bank rather than its UK parent and the terms of the hire agreement.

FTT’s treatment of Mr Forsyth’s evidence

The Upper Tribunal had concluded that the FTT "must have under-estimated the difficulty of leaving out of account much of what Mr Forsyth had said and of confining themselves to objective factors which would have occurred to a reasonable observer." The Court noted, however, that the Upper Tribunal had failed to identify any specific misdirection on the FTT’s part or any specific part of Mr Forsyth’s evidence that the FTT had wrongly taken into account. Examining the FTT’s decision, the Court noted that the FTT had correctly accepted that Mr Forsyth’s evidence was inadmissible insofar as it went to his subjective intention, but was admissible as regards objective factors relevant to the transactions. On that basis, the FTT had not erred in law.

FTT’s treatment of the professional adviser’s involvement

The FTT had expressed the view that evidence of the adviser’s involvement (specifically, that it had devised what it had considered to be an "aggressive" scheme, and that an element of its fees were contingent on the scheme’s success and calculated by reference to the VAT saving achieved) was inadmissible as subjective evidence and not relevant to the objective assessment of the essential aim of the transactions. While the Upper Tribunal considered that the adviser’s involvement could be relevant to an objective assessment of the scheme’s aim, it did not materially disagree with the FTT on its significance. The Court agreed that the fact that a tax adviser draws attention to the tax advantages and consequences of the course that he recommends does not assist in determining the objective aim of the transactions.

FTT’s failure to consider the scale of the tax advantage

The Upper Tribunal had criticised the FTT for failing to mention the size of the tax advantage gained or to compare the tax advantages with the commercial benefits of the transactions. The Court, however, considered that there was nothing in case law to suggest that a balancing exercise is necessary or appropriate for determining the essential aim of a transaction. Rather, it agreed with the appellant that the tax advantage "should be taken as read" and the focus of the enquiry should be on whether there is another explanation for the transactions.

FTT’s failure to consider the group’s short-term financing needs

The Upper Tribunal determined that the FTT had failed to refer to the "fact that the finance was relatively expensive at a time when Pendragon had unused committed facilities". The Court agreed with the Upper Tribunal in principle, that if the Pendragon group had not needed the £20m credit, and if that credit was obtained on expensive terms, those facts would have been relevant to ascertaining the essential aim of the transaction. Further, it would have been legitimate to draw the inference that the essential aim was not to obtain short term-finance, but something else, and the tax saving would have been the most obvious explanation. However, the Court considered that the Upper Tribunal had disregarded the FTT’s finding of fact that the Pendragon group was renegotiating its borrowing facility.

The artificial elements of the transactions

The Upper Tribunal had identified three aspects of the transactions, which it considered to be artificial:

  • The use of the captive leasing companies to create leases before the leases were assigned to the bank.
  • The terms of the leasing agreements, which deferred the point at which the hirer acquired title to the goods having made all payments due under the agreement.
  • The use of an offshore bank.

The Upper Tribunal considered that the use of the captive leasing companies and an offshore bank was artificial. However, the Court disagreed. As to the use of the captive leasing companies to create leases, it considered that if finance was to be obtained from a bank, security would be taken over the cars. Further, security would need to be given in a way which enabled the group to continue to use the cars. The choice was, therefore, between putting a lease in place before assignment or agreeing the form of the lease with the bank before the assignment and effecting the lease immediately after. Viewed in these terms, there was nothing artificial in the choice adopted.


This case illustrates the strictness of the ‘abuse’ test and confirms that it is not abusive for an undertaking to choose to enter into commercial arrangements in a way that results in greater tax efficiency. The abuse principle applies only if there is an element in the arrangement, which is needed to obtain the tax advantage, that has no independent commercial rationale or explanation. The decision also confirms that a tax adviser’s view of a scheme is of no assistance in determining objectively the essential aim of the transactions.

The decision confirms the appellate court’s role, as set out in Procter & Gamble v HMRC [2009] EWCA Civ 407, in relation to evaluating findings (based on findings of primary fact) of the fact-finding tribunal. The appellate court should be slow to interfere with such findings and only do so if there has been an error of law. The decision demonstrates the importance, particularly in cases of this nature, of carefully presenting the evidence and highlighting for the FTT the appropriate conclusions that should be drawn from the evidence.

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