Treasury wins ruling to close VAT loophole

The government yesterday won a significant breakthrough in its crackdown on VAT avoidance when Europe's highest court ruled that schemes operated by two leading British firms breached EU laws. It could render all such avoidance schemes illegal. The European court of justice (ECJ) ruled that the then Halifax building society, now HBOS bank, was not allowed to claim back all of the VAT on services for which it normally paid no tax by setting up intermediaries as channels to avoid normal rules.

In a separate but conjoined case, the court ruled that BUPA, the private health care provider, could not escape pending new rules to tighten VAT payments by bringing forward orders for the future supply of drugs and prostheses.

Dawn Primarolo, the Treasury minister, welcomed the ECJ judgments as "underscoring our determination to tackle artificial VAT avoidance schemes" and as "ensuring fairness in the VAT system".

She added: "The government takes VAT avoidance extremely seriously and is fully committed to tackling it through the use of all available measures."

Etienne Wong, head of the international VAT unit at lawyers Clifford Chance, said VAT had been the "Wild West of tax planning" but businesses should now expect the Revenue to "aggressively chase" the tax. In 2000 Revenue & Customs challenged a series of schemes set up by companies to reduce their VAT liability and won cases at the VAT and duties tribunal - which in turn referred significant questions of law under the EU's sixth VAT directive to the ECJ.

The Halifax case involved the then building society and the University of Huddersfield cooperating in the construction of four call centres costing £48m. Neither is normally liable for VAT but they set up two intermediaries to recover all the VAT - about £7m - paid out during the building works.

The case is important because it enshrines the issue of "abuse of rights", a concept familiar in continental law but very new in English jurisprudence. It embraces actions which are technically within the letter of the law but breach its spirit and has been used by Revenue & Customs for the first time in English courts.

In effect, the ECJ ruled that the scheme operated by Halifax and Huddersfield university was, contrary to the government's argument, an economic activity even though its sole objective was to obtain a tax advantage.

However, it said, in upholding the government's central thesis, that EU law banned the fraudulent or abusive exploitation of legal provisions and ruled that the Halifax-Huddersfield scheme was inadmissible on those grounds. Tax lawyers say this in effect closes a VAT loophole used by firms solely to avoid payments.

In the BUPA case the court of justice ruled that the operator of private hospitals had breached EU rules by pre-paying well in advance for goods and services - without precisely identifying them at the time the payment on account was made. Lump sum payments, it added, did not fall under the allowed exceptions from the VAT rules.