The Court of Appeal has recently found in favour of the Revenue in the controversial case of Vodafone 2 v HMRC.
In 2006, in the case of Cadbury Schweppes v HMRC (Case C – 196/04), the European Court of Justice (ECJ) decided that the Controlled Foreign Companies (CFC) legislation in the United Kingdom cannot be applied to tax profits of a foreign subsidiary if the CFC is actually established in another EU Member State and carries on genuine economic activity there. The fact that it may have done so for tax reasons is irrelevant. The CFC legislation can be applied only if the CFC is a wholly artificial arrangement intended to escape tax and there is no genuine economic activity.
Vodafone 2 took this argument a stage further last year. The High Court said it was impossible to construe the CFC legislation in a way that enabled it to comply with EC law, even in the absence of an establishment with genuine economic activity. Section 748 Taxes Act 1988 could not be interpreted otherwise, and amending legislation would be necessary for the rules to work.
However, the Court of Appeal has taken a rather less robust view. They said that the issue was whether it was possible to interpret the CFC legislation so that it did not unlawfully restrict the taxpayers’ freedom of establishment. HMRC contended that the legislation was cast widely, but was subject to a number of overlapping exceptions and all that was necessary was to introduce an additional exception in respect of companies in EU states that carried on genuine economic activities there.
The Court of Appeal decided that the jurisdiction of the ECJ did not include the interpretation of the legislation of a Member State. The obligation of the National Court was to consider how far the domestic law might be applied so as to conform with EC law. This could be done through an interpretation that removed the hindrance referred to by the ECJ. The Court of Appeal was entitled and bound to consider the whole of the CFC legislation in ascertaining whether it could be interpreted in a manner conforming with EC law. They decided that it was permissible to extend the exceptions to which the CFC legislation was subject to bring this about. The insertion of another exception in Section 748 along the lines suggested by HMRC would leave the impact of the CFC legislation unaffected on those companies to which it was intended to apply. The interpretation advanced by HMRC reflected and excepted from the operation of the CFC legislation precisely that element which the ECJ had found unacceptable.
So we are back to the decision in Cadbury Schweppes.
I find this all very puzzling. The powers of the Court to make “an emendation” to a statute are legendary, but inserting a whole new exception to the statutory provision? I will look forward with interest to the analysis of the House of Lords, which will surely be the next step in this saga.