The UK's highest court has focused on the purpose of arrangements and their essential aim, in finding that abuse of rights under the Halifax principle applied to a VAT avoidance scheme.


In HMRC v. Pendragon, Pendragon bought cars from a wholesaler then sold them internally to four captive leasing companies which immediately leased the cars to Pendragon dealerships. Input VAT was recovered on these transactions. The leases and title in the cars were then assigned to a Jersey bank. The Jersey bank then transferred as a going concern the lease agreements, title in the cars and the bank's leasing business to Captive Co 5, part of the Pendragon group. Neither of these transactions were within the scope of VAT. The demonstrator cars were sold to customers by the dealerships, acting as undisclosed agents for Captive Co 5. Customers paid VAT only on Captive Co 5’s profit margin on the sale, rather than on the total sale price, under the profit margin scheme (available under UK law where goods are acquired as part of a business transferred as a going concern).

HMRC accepted that the scheme technically worked, as the conditions for exemption from VAT and for the margin scheme were satisfied. However, it argued that the scheme breached the EU law principle of abuse of law and so the VAT advantages should be denied and misdeclaration penalties charged.

The UK First Tier Tribunal (FTT) held that the abuse of law principle could not be applied. It found that the scheme had real commercial objectives and did not accept that use of the margin scheme had only been made in order to avoid double taxation. The Upper Tribunal reversed that decision, but the Court of Appeal reinstated the decision of the FTT and HMRC appealed.


The Supreme Court allowed HMRC's appeal, unanimously holding that there had been abuse and that, therefore, the transactions should be redefined for VAT purposes.

The CJEU, in the 2006 case of Halifax, said two conditions had to be satisfied for the abuse of rights principle to apply. The first condition was that the transactions concerned, notwithstanding the formal application of the EU and domestic legislation, "result in the accrual of a tax advantage the grant of which would be contrary to the purpose of those provisions". The second condition was that "it must also be apparent from a number of objective factors that the essential aim of the transactions concerned is to obtain a tax advantage."

The Supreme Court held that, in the present case, the first condition was met: the transactions were contrary to the purpose of the legislation. The aim of the legislation enacting the profit margin scheme was to avoid double taxation, whereas the effect of Pendragon's scheme was to avoid taxation altogether.

In relation to the second Halifax condition, it was held that the application of the abuse of law principle to tax avoidance schemes "calls for a difficult balance to be drawn" as schemes are rarely directed exclusively to tax avoidance and generally have a genuine commercial objective. The Court said the question was "whether the commercial objective is enough to explain the particular features of the contractual arrangements which produce the tax advantage".

The choice of an offshore funding institution which was not a taxable person "cannot in itself be regarded as objectionable". However, it was essential to Pendragon's scheme that Captive Co 5 acquire the cars as part of a business as a going concern thus the transferor of the business (the offshore bank), had to have acquired the cars by assignment. These steps were "manifestly included" not for the purpose of obtaining credit from the offshore bank, but had no commercial rationale other than the achievement of a tax advantage. The Court therefore held that the second Halifax condition was also satisfied.


The Supreme Court concentrated on the original Halifax decision of 2006 and questioned the purpose of the VAT scheme and the essential aim of the transactions. The decision may be an indication of movement back towards theHalifax principle and it is suggested that the recent Upper Tribunal decision inOcean Finance might be overturned on appeal.

As a point of procedure, the Court said that the Upper Tribunal had been entitled to substitute its own decision, including by making further findings of fact, where the FTT has erred in law. This could lead to issues of fact being reopened in a greater number of hearings. It also brings into question whether the Upper Tribunal reached the appropriate decision in Ocean Finance or whether they approached the abuse doctrine in too narrow a fashion.