20267

VAT – deduction of input tax – leasing of cars within UK by German subsidiary company – cars purchased within UK, remaining there and subject to VAT in UK – leasing deemed to be supply of services in Germany for UK tax purposes – no VAT exigible in Germany on these payments – whether input tax on purchase of motor cars deductible – Sixth Directive, Article 17 – Sections 24, 26, VATA – whether deduction precluded by abusive practice – appeal allowed.

EDINBURGH TRIBUNAL CENTRE

	RBS DEUTSCHLAND HOLDINGS GmbH	Appellant

	- and -

	THE COMMISSIONERS FOR 
	HER MAJESTY’S REVENUE & CUSTOMS	       Respondents

			Tribunal:	 (Chairman):  Mr Kenneth Mure, QC
				            (Member):    J Crerar, WS., NP
                                                                             I R Welch, CA., JP

Sitting in Edinburgh on the 4-8 December 2006 and 21-22 May 2007.

for the Appellant:		Roderick Cordara. QC., S.C., and Jern Fei Ng, 
Barrister

for the Respondents:	Heriot W Currie, QC., and Julian Ghosh, QC

© CROWN COPYRIGHT 2007.

DECISION

INTRODUCTION

The issue which arises in this appeal is whether the Appellant has right to a repayment of VAT paid on the purchase of new cars, later supplied by it in terms of a lease, and finally re-sold after about two years.

The Appellant is a subsidiary company in the Royal Bank of Scotland Group.  It is a company incorporated in Germany and registered as a non-established taxable person for VAT purposes within the UK.  The peculiarity which arises is that no VAT was chargeable on the rental payments under the lease.  While the cars were situated in the UK the supply of them in terms of the leasing arrangements was outside the scope of UK VAT as being a supply of services deemed to have been made in Germany where the Appellant has an establishment.  (It has no establishment within the UK).  In terms of German VAT Law the supply represents a supply of goods, but not one made in Germany as the vehicles remained in the UK.  Accordingly no VAT was exigible in Germany on the rental payments.

In essence while in terms of Community Law and the terms of the Sixth Directive the leasing of the cars represents a taxable supply, the VAT provisions of each of the two Member States concerned resulted in no output tax being charged on the rental payments in either territory.

In addition to arguments on the above (the Respondents’ “preferred analysis”) we heard submissions also on the “second alternative analysis” viz Abuse of Rights (see para 4 of the Stated Case).  We were not addressed on the “first alternative analysis” and we have not considered it in our Decision.

THE LAW
We were referred to the Sixth Directive (77/388 EEC), Article 17(2) and (3) anent the deduction and refund of input tax.  In particular Article 17(3) (a) provides:-

“Member States shall also grant every taxable person the right to the deduction or refund of the Value Added Tax referred to in paragraph 2 insofar as the goods and services are used for the purposes of:

(a)	transactions relating to the economic activities referred to in Article 4(2), carried out in another country, which would be deductible if they had been performed within the territory of the country; …”

The relative UK legislation is enacted in Sections 24, 25 and 26 VATA 1994.  In particular Section 26 provides:-

(1)	the amount of input tax for which a taxable person is entitled to credit at the end of any period shall be so much of the input tax for the period (that is input tax on supplies, acquisitions and importations in the period) as is allowable by or under regulations as being attributable to supplies within sub-section (2) below.
(2)	The supplies within this sub-section are the following supplies made or to be made by the taxable person in the course or furtherance of his business - 
(a)	taxable supplies;
(b)	supplies outside the United Kingdom which would be taxable supplies if made in the United Kingdom;
(c)	such other supplies outside the United Kingdom and such exempt supplies as the Treasury may by order specify for the purposes of the sub-section”.

While the correct interpretation of these provisions was controversial, it was accepted that the Appellant was not liable to account for VAT on the rentals received for leasing the cars in terms of Section 5(1) and Schedule 4, para 1, VATA.  Leasing the cars represented a supply of services (Schedule 4, para 1 (1)), the place of supply being within Germany (Section 7 (10)).

We were referred extensively to case law and we have considered in particular –

Etienne Debouche (C-302/93) ECR I-4495
C&E v Apple & Pear Developments Ltd [1988] STC 221
Bupa Purchasing Ltd v C&E [2003] STC 1203
Elida Gibbs [1996] STC 1387
Neuvale Ltd v C&E [1989] STC 395
Schemepanel Trading Ltd v C&E [1996] STC 871
BLP Group Plc v C&E [1995] STC 424
Abbey National plc v C&E [2001] STC 297
Halifax plc v C&E [2006] STC 919
Cadbury Schweppes plc v IRC [2006] STC 1908

THE FACTS
Parties did not lodge a Statement of Agreed Facts.  However, the broad narrative of the circumstances set out in paras 1-3 of the Stated Case (Doc 20-26) did not appear to be in dispute.  We heard additionally evidence from Mrs Elizabeth Halliday, an officer of HMRC, specialising in anti-avoidance work.  She confirmed the terms of her statement (Doc 349) and spoke to the accuracy of her notes in the course of her enquiries (Doc 350/4).  She indicated certain items of correspondence as having been approved by her (Docs 91, 101 and 181).  The contents of these letters had not been contradicted by the Appellant.  In cross-examination Mrs Halliday explained that the view taken by her and her colleagues about the transaction representing a supply of services made outside the UK had been formed without any reference to the German Tax Authorities.  What was critical to the Respondents’ stance was that no output tax had been levied on the leasing supply.  

The Appellant did not lead evidence but lodged an Admission (Suppl Doc 11) relating to tax advice received in relation to the transaction.  Details of the original advice could not apparently be traced.

We find as fact that:-

1.	The Appellant is a wholly owned subsidiary of the Royal Bank of Scotland Group.  It is based in Germany and carries on business providing banking and leasing services.  It is registered for UK VAT as a non-established taxable person.

2.	The Appellant purchased new motor cars from a UK supplier, which it then leased to a UK customer, Vinci plc (formerly known as Norwest Holst Group plc), for a period of two years.  The Master Lease Agreement is produced (Doc 273 et seq).  It is to be governed by German Law.

3.	No VAT was payable either in the UK or Germany on the rental payments.  Had it been charged Vinci plc would have been able to recover only 50% of it as relating to qualifying business use.  

4.	The Appellant seeks to reclaim the input tax paid on the new cars.  By their Decision letter dated 22 August 2003 the Respondents have refused to make any repayment.  (Docs 27 et seq).  This is the subject of this Appeal.

5.	At the expiry of the rental period the Appellant sold the cars and accounted for VAT due on the resale to the Respondents.  They have retained this.  The sale was in terms of a Put Option Agreement (Doc 284 et seq).

6.	Before the Appellant entered the leases it obtained professional advice as to the tax effects both in the UK and Germany.  Reference is made to the terms of the Appellant’s Admission (Suppl Doc 11) anent the duration and circumstances of the leasing arrangements.

7.	The Royal Bank Group selected the Appellant as lessor and determined the duration of the leasing arrangements with a view to obtaining the tax advantage of no VAT being payable on the rental payments.

PARTIES’ SUBMISSIONS
In addition to their oral submissions each side lodged written skeletal arguments.  The Appellant’s Counsel produced additional summary notes on the two arguments presented and an analysis of the cases relied on by the Respondents.

The essential issue between the Parties is how the rental payments should be classified within the VAT system.  They are not as a matter of procedural regulation in the UK and in Germany the subject of a tax charge.  The Appellant argues that notwithstanding the absence of a tax charge they remain “taxable” in the context of the VAT system.  (The eventual resale of the vehicles was, of course, taxable in fact and VAT was accounted for to the Respondents).  The Respondents argued that the rentals are analogous to an exempt transaction.  The mere fact that no tax was levied takes the rentals out of the VAT system.  

In relation to the “preferred analysis” the essence of the Appellant’s argument was that all of its activities represented economic activities and were “taxable” within the context of the VAT system.  None of its activities was exempt.  Its treatment of the cars represented a business activity.  This was not altered by the absence of a tax levy in Germany on the rental payments.  This did not cause any loss to the UK Exchequer.  (UK law deemed the supply to have been made in Germany).  While VAT was in a form prescribed by Community principles, it is collected on a national, not a supranational basis.  Mr Cordara referred to Article 17(3)(a) of the Sixth Directive and Sections 25-26 VATA.  Input tax on the purchase of the cars was recoverable even if only the ultimate re-sale, which was subject to VAT, were taken into account.  There is no need, he argued, for the output tax to exceed the input tax for the latter to be recoverable.  Non-recovery of the input tax by the Appellant offended against the principle of neutrality of the VAT system.  Car-leasing as an activity is taxable throughout the Community.

In respect of the secondary argument on Abuse of Rights Mr Cordara adopted his written submissions set out in paras 37 et seq of his Heads of Submissions.  For this argument to succeed, he argued, the arrangements under attack must be shown to be wholly artificial.  In Halifax the taxpayer was an exempt trader, the final consumer, and would not be able to reclaim input tax.  In order to obtain this, an artificial structure was created.  This was struck at as achieving nothing other than securing a tax advantage.  In the present case no extra “links” had been inserted between the lessor and lessee of the vehicles.  They were directly linked contractually in an “arms-length” commercial arrangement.  Such a direct contractual relationship on a commercial basis is not struck at just because it involves a tax advantage, Mr Cordara argued.  The Appellant itself was not a sham.  It was a company of substance.  There was nothing improper in its conducting business on a cross-border basis.  The absence of German output tax was not a matter for the UK tax authorities to “police” and should not affect the administration of VAT in the UK.  The attitude of the Defenders in refusing repayment of input tax to the Appellant was disproportionate in its consequences.  

Mr Cordara compared also the decision in Cadbury Schweppes.  While not involving VAT, it related to the obtaining of a corporation tax advantage by establishing a subsidiary company in a low tax area.  Such an arrangement would be undermined only if it were wholly artificial and not representing a genuine commercial activity.  (Note especially paras 37 and 68 of the Grand Chamber’s decision).  

Having regard to the terms of Article 17(3)(a) of the Sixth Directive and of Section 26(2)(b) VATA in implementation, the Appellant was entitled, Mr Cordara submitted, to recover input tax paid on the new vehicles.  The Defenders could not add to the relevant statutory provisions a further condition to the effect that output tax had to be accounted for in Germany on the rental payments.  An absence of synchronicity between Member States’ legislation on the imposition of VAT on rental payments should not deny the Appellant repayment of input tax on the new vehicles.  

In reply in respect of the “preferred analysis” the Respondents argued that the car-leasing activity falls outwith the VAT system.  Accordingly the VAT on the vehicles purchased by the Appellant is irrecoverable.  They are not an “input” contributing to a taxable supply and that irrespective of any ultimate re-sale by the Appellant of the vehicles.  The absence of any VAT charge levied on the rental payments meant that the leasing was not a taxable or business activity in the context of VAT legislation.  The leasing activity, while not exempt, was analagous to exempt.  It followed that it was not appropriate to apportion the VAT on purchase of the vehicles as an “input tax” between the leasing activity as “exempt” and the ultimate resale as “taxable”.

Crucially the term “business” where it occurs in Sections 24-26 VATA means the provision of taxable supplies, Mr Currie argued.  As no VAT was levied on the rental payments, this was not a taxable supply.  It followed that VAT on the purchase of the vehicles could not be recovered as input tax.  Mr Currie referred us extensively to case law in which deduction of input tax had been refused in circumstances where no output tax was due, including the supply of exempt outputs and outputs made pre-registration for VAT.  He argued that the circumstances of the present case were comparable.  He founded also on the decision in Etienne Debouche as illustrating a comparable trans-national context.

In any event, Mr Currie argued, the Appeal should be dismissed by reference to the Respondents’ “second alternative analysis”, the Abuse of Rights argument and he submitted that the principles set out in Halifax should be applied.  He adopted para 37 et seq of his Skeletal Argument.  On the basis of Mrs Halliday’s evidence and the correspondence (Docs 91, 101, 181 and PWC’s letter of 8 October 2001 – Supplementary/section 12) it was clear that the RBS Group made the decision that the Appellant should act as lessor and that and the selected duration of the lease, were sufficient to bring the circumstances of the case within the scope of the doctrine set out in Halifax.  It was not enough, he argued, for the Appellant to say that there were in fact cars which were leased.  It was a fundamental principle in terms of the Sixth Directive that a non-exempt supply should be subject to VAT.

Mr Currie continued that Halifax was not restricted to cases where there were “linked” transactions, with certain intermediate links having no commercial relevance.  The principle struck at the present case considering that the selection of the lessor and the duration of the lease were determined to achieve a tax advantage.  He referred also to Cadbury Schweppes and MMo2.  A situation in which VAT had not been charged on non-exempt services was contrary to the Sixth Directive.  The present case was distinguishable from circumstances in which two optional courses, both of which were taxable, were available, and the more tax efficient was selected.  

Further reference may be made to the terms of the written submissions produced by each of the Parties.

DECISION – “PREFERRED ANALYSIS”
There are in the Tribunal’s view four major considerations to be noted in resolving the primary argument (the “preferred analysis”) about recovery of the disputed input tax, viz:-

(i)	how should the car-leasing activity be classified within the VAT system?  Is it a taxable supply (whether standard or zero-rated) or an exempt supply? Or is it entirely outwith the VAT system?
(ii)	Crucially, what is the correct interpretation of the statutory provisions governing the deduction of input tax and the relative provisions of the Sixth Directive?
(iii)	how should the principle of neutrality of the VAT system be applied whereby the burden of the tax is borne by the ultimate consumer?  (It should not “stick” at an intermediate stage of the chain.)
And
(iv)	to what extent is the case-law to which we were referred apt in the particular circumstances of this case involving two Member States of the Community?

It is accepted that car leasing locally based is taxable for VAT purposes in both the UK and Germany.  It is a “business” for VAT purposes.  Rentals would be subject to output tax and input tax on cars purchased would be deductible.  In the present case because of the national tax systems’ provisions anent the nature of the supply as being one of goods or services, the place of supply and recovery of tax, no output tax was in fact payable on the rentals received by the Appellant.  In effect, as it appears to this Tribunal, the rentals as a matter of substantive Community law are taxable although because of the procedural laws of the two Member States, the UK and Germany, VAT is not actually imposed or recovered.  It is thus open to the national legislatures to better dovetail their procedural rules to secure a general tax charge having effect in such circumstances.

We accept that the VAT liability on a transaction may become non-recoverable in certain circumstances e.g. time-bar, but we would question whether that means necessarily that the relative supply is taken outside the VAT system.  So far as the Tribunal is aware, there is no case-law to date to the effect that the non-recovery of output tax per se alters the taxable nature of the supply and in particular thereby precludes the deduction of input tax.

We find attractive the Appellant’s argument that the nature of the car leasing activity as “taxable” in the context of the Community Law is not altered by VAT not being chargeable in the peculiar circumstances of this case in view of the terms of Member State regulations.  It is at least potentially taxable although not actually taxed.  We note that the Respondents do not say that it represents an exempt supply (their Counsel described it as being analogous to an exempt supply) in which event there would have been an apportionment of input tax under Regulations 101 and 102 (SI 1995/2518) having regard to the re-sale of the cars as being taxable.  We have difficulty accepting that the leasing activity should, simply because of the peculiarities affecting VAT imposition and recovery, be viewed as falling wholly outwith the VAT system.   

We were addressed extensively on the interpretation of Sections 24 and 26 VATA, which latter is the principal provision governing the deduction of input tax, and the relative provisions in the Sixth Directive viz Article 17.

If the leasing activity were considered “taxable” simpliciter, then these provisions would not strike at the deduction of input tax.  However, given the view that we have expressed in the immediately preceding paragraphs (ie that they are at least potentially taxable and have not been taken out of the VAT system), even if the rental payments are not subject to tax, we are still not persuaded that the deduction of input tax is precluded in view of particularly the terms of Section 26 (2) (b).

The terms of Section 26 (2)(b) seem particularly apt in the present case.  Input tax is deductible inter alia where a supply is made outside the UK (here, Germany) and would have been taxable had it been made in the UK (as the car-leasing activity would have been in the UK).  We agree with Mr Cordara that further wording cannot be implied to the effect that VAT must have been payable on the supply made abroad.

Notwithstanding, we have to consider whether Section 24 may preclude relief under Section 26(2)(b).  It defines input tax as being tax on “………….goods or services used or to be used for the purposes of any business carried on or to be carried on by …..” a taxable person.  The sense of “business” there is critical according to the Respondents and bars the deduction of input tax on the car purchases.  While the statutory definition of “business” in Section 94 VATA is not exhaustive, the term has been considered judicially as meaning a business which produces taxable outputs.  (Noted in Bupa at p.1217g, under reference also to Apple and Pear Development Council).  That consideration in the reported cases does not extend to the interaction of both these statutory provisions.  In that context we observe that para (c) of Section 26(2) refers to the deduction of input tax relative to certain specified exempt supplies.  Also, cross-border aspects did not arise for consideration in these cases.  In the context of Community and UK legislation the activity of car-leasing is in principle within the VAT system.  Accordingly, for purposes of the present case we consider that Section 24 does not preclude deduction of the input tax on the cars purchased.

The objective of economic neutrality in the VAT system is ensuring that the ultimate consumer bears the tax burden.  The ultimate consumers here would be the lessees of the vehicles and also, on the expiry of the leases, the purchasers of the vehicles second-hand.  The Appellant argues that it is not the ultimate consumer, and on this basis it should not bear the tax on the purchase of the vehicles new.  In effect, the tax should not “stick” at one of the intermediate links in the chain of consumption.  (See Elida Gibbs [1996] STC at p1402h).

In the present case the Appellant has accounted for VAT on the re-sale of the cars as second-hand.  So far as we are aware that tax has been retained by the Respondents.  The complaint of the Respondents is not that they, as the UK tax authorities, have lost output tax on the leases.  Rather that loss has been sustained by the German tax authorities within whose jurisdiction, according to UK rules, the taxable supply took place.  VAT on any local supplies in Germany relating to the leasing would, we understand, be recoverable.  To achieve tax neutrality in the context of such a cross-border transaction there is in the Tribunal’s view an illogicality in refusing the deduction of input tax on the purchase of the new vehicles.  It was not suggested that, had the German legislature imposed a tax charge on the rental payments, that would have been inconsistent with the Sixth Directive.

We were referred extensively to Case-Law affecting the deduction of input tax.  Essentially this was to the effect that input tax on supplies is allowable to the extent that the supplies are used for outputs which are taxable.  Thus the tax on inputs absorbed in making exempt supplies is not recoverable.  Also, tax on inputs used up pre-registration for VAT purposes is not recoverable.  We note particularly the judgments of Lord Brightman and Fox LJ in Apple and Pear Developments Limited and Mustill LJ in Neuvale Limited, which are referred to by Potts J in Schemepanel Trading Limited [1996] STC at p877e.  Essentially “………tax on inputs should be set against tax on the outputs to which the inputs related……”.  There, input tax was held deductible only to the extent that the inputs were “cost-components” of a taxable transaction.  Also, the right to deduct input tax depends on the supplies having a direct and immediate link with taxable outputs; See BLP Group plc, which related to an exempt supply and Abbey National plc.

However, the case law cited does not go further to assist in the peculiar circumstances of the present case.  It does not consider the application of Section 26(2)(b) and Article 17(3)(a) and the VAT treatment of taxed inputs and taxable outputs in a cross-border scenario.  As we have observed supra the structure of Sub-section (2) bears to contemplate “supplies….in the course or furtherance of [a] business” which fall into three distinct categories, being taxable supplies, non-UK supplies if taxable there, and other non-UK and exempt supplies as specified by Order.

Our difficulty with the Respondents’ stressing the need for the supply to be taxable in fact for relief to be granted for input tax, is that these three specified categories seem to extend more broadly, even to (certain) exempt supplies.  Also, the terms of para (b) of Section 26(2) seem especially apposite in the circumstances of the present case.

Reliance was placed by the Respondents also on the Decision of the ECJ in Etienne Debouche.  There a lawyer practising exclusively in Belgium and providing (only) exempt supplies there, sought a refund of input tax incurred on his leasing a car from a company in the Netherlands.  A refund was refused.  The Tribunal did not consider the circumstances there comparable with the present case.  It relates to a lawyer’s exempt supplies and is not complicated by the cross-border circumstances.

In conclusion the problem essentially is the classification within the VAT system of payments due in terms of leases as outputs.  These are in the Tribunal’s view potentially taxable but not actually taxed.  Does a procedural lacuna change a taxable supply into an exempt supply or remove it from the VAT system?  The Tribunal considers that it does not.  Our consideration of each of the four aspects tends towards this conclusion.  There are three interlinked transactions here, viz the purchase of the cars, their being leased and thereafter their being re-sold.  We consider that these transactions should be viewed in conjunction, and in the context of the Sixth Directive and the relevant national legal systems these are each in principle taxable.

Moreover, we consider that there is at least the germ of an argument that if only the resale of the cars were taxable and the leasing falls outwith the VAT system, then the VAT on the purchase might still be recoverable, and that on the basis that there is a sufficiently direct link between the first and final of the three transactions.

The case-law directs that input tax may be recovered only where the corresponding outputs are taxable, and not where these are exempt.  This distinction is not further developed, however, to explain how to categorise a supply taxable in terms of the Directive and also ordinarily under national laws, but which (as here) exceptionally falls out of the national charge.  The Respondents do not argue that it is exempt (in which case, of course, some apportionment of input tax would be necessary having regard to the taxable nature of the ultimate re-sale) but, rather, analogous to exempt.

A national tax charge could be extended to include the payments due in terms of the leasing arrangements without any violence to the spirit of the Directive.  As noted supra the loss of revenue is not suffered by the UK Exchequer but by Germany.

Accordingly we find in favour of the Appellant in respect of the “preferred analysis”.  We now have to consider the “second alternative analysis” viz the secondary argument on Abuse of Rights.  

“ABUSE OF RIGHTS”
Essentially the decision in Halifax introduces principles set out in the decisions of W T Ramsay Ltd v IRC [1982] AC 300 and Furniss v Dawson [1984] AC 474 into VAT.  Thus, where there is a contractual “chain” with intermediate “links” which in themselves serve no other purpose than tax avoidance, these can be removed to enable the Court to look at each “end” and accordingly apply tax to the overall result.  In the present case there are no such intermediate “links”.  There is an immediate contractual connection between the two parties intimately involved i.e. the lessor and lessee.  There is nothing artificial about the contract in our view.  Commercial considerations dictated its terms.  It was for full commercial value.  We consider that the aspect of tax saving which resulted from differences in Member State internal legislation does not amount to an “abuse of rights” in the Halifax context.  Indeed, we would refer to the decision of the Grand Chamber at paragraph 73 which tends to confirm that it is perfectly proper to elect to take such a tax advantage – 

“Where the taxable person chooses one of two transactions, the Sixth Directive does not require him to choose the one which involves paying the highest amount of VAT.  On the contrary ……… taxpayers may choose to structure their business so as to limit their tax liability”.

Accordingly we consider that the decision Halifax does not strike at any tax saving or advantage which results in the present case.

We consider that the decision in Cadbury Schweppes supports this view although, of course, that decision relates to direct taxation.  The issue in that case involved the diversion of profits to a subsidiary company set up in a low tax jurisdiction.  The decision of the Grand Chamber criticises “wholly artificial arrangements”.  That, we consider, to be quite distinct from the circumstances of the present case.  We do not consider that that test strikes at “arms-length” commercial transactions albeit involving an element of tax saving.

For these reasons therefore we find that the VAT on the new vehicles purchased by the Appellant is repayable to it as recoverable input tax.  The decision taken by the Respondents was incorrect in our view.

COSTS
It was agreed by Counsel that costs should be awarded to the successful Party.  Accordingly in view of our decision we award costs to the Appellant, to be taxed, failing agreement, in terms of Rule 29(3) of the VAT Tribunals Rules 1986 (as amended).

KENNETH MURE, QC

CHAIRMAN

RELEASE:  24 JULY 2007

EDN/04/77