In July 2008, we reported on the High Court decision in the Vodafone 2 case. Overturning a Special Commissioners decision, the judge held it was impossible to construe the motive test in the UK’s CFC rules (s748(3) ICTA) as conforming to Community law by limiting its application to CFCs that were bona fide “established” in the relevant Member State. Instead, the judge held that CFC rules should be disapplied as being contrary to Community law. HMRC appealed.
On 22 May 2009, judgment was handed down by the Court of Appeal, which has held unanimously that the CFC rules can and should be interpreted consistent with Community law.
The Court of Appeal found that it was wrong to limit the consideration of a conforming interpretation to the motive test and, instead, held that it was bound to consider all parts of the CFC legislation in determining whether it was amenable to a conforming interpretation.
In the leading judgment, the Chancellor accepted HMRC’s submission that the legislation could be read as containing an additional exception to the initial wide net cast on CFCs, namely that the CFC was actually established in another Member State and carried on genuine economic activities there. This in itself removed the restriction in the legislation that had concerned the ECJ and removed the need to consider on a case by case basis whether the CFC rules were justified as they stood.
The Court rejected Vodafone’s argument that it would be unlawful to allow this additional condition to be “read in” to the legislation as it would essentially result in two regimes, one for CFCs in Member States and another for CFCs in third countries.
The Chancellor held further that, even if the legislation could not be so read, he did not think it appropriate to disapply the legislation unless the taxpayers concerned were so circumstanced that the offending provisions could not be invoked against them, i.e. unless they were properly established.
We have previously mentioned our concern that in order to succeed with CFC claims it will ultimately be necessary to show that the CFCs were genuinely established. Our concern was in essence this: Vodafone were relying on the freedom of establishment; but, if the CFC was not properly established, how could Vodafone invoke that freedom? The Court of Appeal has now confirmed the need to demonstrate that the CFC is genuinely established. Either the UK legislation contains that requirement; or it will not be disapplied if it is not met.
It is unlikely that this judgment will have an adverse impact beyond the context of the interpretation of the motive test. It will however no doubt be relied upon more broadly by HMRC.
It is possible for Vodafone to seek leave to appeal to the House of Lords. The outcome of that application should take a couple of months. If unsuccessful the case returns to the FirstTier Tribunal to determine whether or not its Luxembourg subsidiary was properly established.