The Supreme Court, reversing the decision of the Court of Appeal, has found that arrangements designed to avoid VAT on the resale of demonstrator cars was abusive for VAT purposes.


The case concerned a complex arrangement involving the creation of leases over cars which were then used as security for obtaining finance from a Jersey bank. The arrangements were designed to enable car dealerships in the group to recover all of the input VAT incurred on the purchase of new cars from manufacturers. The application of the profit margin scheme on the eventual sale of the cars meant that VAT was only accounted for on the profit element.

It was common ground between the parties that the arrangements achieved the intended fiscal result, and satisfied the conditions for exemption from VAT and application of the margin scheme. However, HMRC challenged the arrangements arguing that it was abusive (in the Halifax sense) and contrary to the purpose of the legislation.

The First-tier Tribunal and Court of Appeal found in favour of the taxpayer, agreeing that the arrangements were a tax efficient means of obtaining finance. The Upper Tribunal, however, disagreed, finding in favour of HMRC. It concluded that the sole aim of the arrangements was to obtain a tax advantage.

HMRC appealed the Court of Appeal’s decision to the Supreme Court.

Supreme Court’s decision

The Supreme Court allowed HMRC’s appeal and held that the arrangements were abusive.

The Supreme Court considered that there was no separate test of whether the relevant transaction constituted “normal commercial operations”. The normality of the transactions was relevant to the operation and purpose of the relevant legislation, which in this case was the profit margin scheme. The aim of the profit margin scheme was to avoid double taxation, whereas the effect of the arrangements in this case was to avoid taxation for Pendragon altogether. The Supreme Court therefore concluded that the arrangements were contrary to the legislation and the first limb of the Halifax test was met.

The Supreme Court commented that the application of the principle of abuse of law to tax avoidance is that of concurrent purposes. Tax avoidance schemes are rarely directed exclusively to tax avoidance. They are usually directed to achieving a commercial purpose, in a way which avoids a tax liability that would otherwise be associated with it. The potential for abuse consists in the method chosen to achieve the commercial purpose. Identifying the “essential aim” (the second limb of the Halifax test) therefore depends on an objective analysis of the method used to achieve the commercial purpose.

In assessing the “essential aim” of the transaction the Supreme Court referred to the First-tier Tribunal’s findings which showed that the overall result of the arrangements was to achieve a number of rational commercial objectives. The arrangements did, however, have two special features, both of which were essential to the tax efficacy of the arrangements. Critically, neither feature had any commercial rationale other than the achievement of a tax advantage. The Supreme Court therefore concluded that the second limb of the Halifax test was also satisfied.

As the arrangements were an abuse of law, it fell to be redefined. Redefinition had to deprive Pendragon of the illegitimate advantage of paying VAT only on its profit margin. The Supreme Court did this by redefining the transaction as a sale and leaseback transaction, followed by a sale to customers.


The various judicial interpretations at the different stages of the UK court and tribunal system illustrate the difficulty in determining the boundaries of the principles of abuse to a given set of facts.

The decision does however shed further light on the scope of Halifax and provides guidance on the factors to be considered in an objective assessment of the essential aim of the arrangements under consideration. The Supreme Court commented that relevant evidence might include evidence not just of the background knowledge available to the parties, but of the financial position and objective commercial requirements of the party obtaining the tax advantage, the relationship between the parties, reasonableness of consideration and the normal course of  relevant business.

Whilst the Supreme Court has (in line with the UK courts and tribunals below) confirmed that taxpayers are entitled to structure their businesses in a tax-efficient way, the decision demonstrates that there are limits on this right.

The judgment can be read here.