Update: corporate tax

Cases on the VAT classifications of food products often have a wider relevance than the obvious implications on those who consume the product. This was notoriously so with the Marks & Spencer 'tea cakes' litigation (Case C-309/06), which had two references to the ECJ and two hearings before the House of Lords. A similar case is the recent Court of Appeal judgment in HMRC v Procter & Gamble UK [2009] EWCA Civ 402.

The case concerned whether 'regular Pringles' fell within the exception to zero-rating of food in item 5 of group 1 in schedule 8 to the VAT Act 1994. Item 5 reads:

'Any of the following when packaged for human consumption without further preparation, namely, potato crisps, potato sticks, potato puffs and similar products made from the potato, or from potato flour, or from potato starch, and savoury products obtained by the swelling of cereals or cereal products; and salted or roasted nuts other than nuts in shell.'

The VAT and Duties Tribunal had found that regular Pringles fell within item 5 and so did not benefit from zero-rating. This was overturned on appeal to the High Court; however, the Court of Appeal (Mummery, Jacob and Laws JJ) reinstated the judgment of the tribunal.

Three important principles emerge from the judgment. First, where a statutory test has several limbs, the test in one limb can be relevant in determining whether the test in another limb is satisfied. Secondly, giving words their ordinary meaning will often be preferred to an over-analysed linguistic construction. Finally, it is only rarely that an appellate court will overturn the factual findings of a tribunal and on a second appeal the primary focus will still be on the tribunal's decision rather than the judgment in the first appeal.

In the High Court, Warren J had held that the tribunal erred in taking account of potato content in deciding whether regular Pringles were a 'similar product' to potato crisps, sticks and puffs on the basis that whether it was a 'similar product' was a separate part of the test to whether it was 'made from' potato etc. The Court of Appeal disagreed, holding that, although the statutory test did indeed have two limbs, in such a composite test the tribunal was entitled to take account of the extent to which the product was 'made from' potato in determining whether it was 'similar'.

The Court of Appeal was critical of the argument that Pringles were not made from potato because potato only comprised 42 per cent of the ingredients. This strict linguistic argument was thought to be 'over elaborate', a 'complex analysis' and (perhaps most disparagingly) an 'advocate-type point'. Rather, because the legislation used 'everyday English words', the Court of Appeal preferred an interpretation of the legislation 'in a sensible way according to (its) natural meaning'. Indeed, Mummery LJ wryly remarked that: 'The 'made from' question would probably be answered in a more relevant and sensible way by a child consumer of crisps than by a food scientist or a culinary pedant. On another aspect of party food I think that most children, if asked whether jellies with raspberries in them were 'made from' jelly, would have the good sense to say 'yes', despite the raspberries.'

Most importantly, the Court of Appeal emphasised that the tribunal is the primary fact finder and primary maker of value judgments on those facts. Accordingly, it is not for an appeal court to intervene unless the tribunal made a legal error in so doing or misconstrued the statutory test. The effect of this principle according to the Court of Appeal is that on a second appeal it is necessary for the party that lost before the tribunal to show that the tribunal erred in law, even if they succeeded on the first appeal.

This shows the importance of getting the facts right before the tribunal as, save in the most exceptional of circumstances, the taxpayer has only one opportunity to do so. Accordingly, any taxpayer with a serious tribunal appeal must be sure of having the right advice, evidence gathering and project management.

Liability under the CFC regime

The Court of Appeal's decision in Vodafone 2 v HMRC (CA, 22 May 2009) is the latest development in the litigation concerning the compatibility with EC law of the UK's controlled foreign company (CFC) regime, which in certain circumstances imputes the profits of subsidiaries in low tax jurisdictions to their UK resident parent. In Cadbury Schweppes (Case C'“196/04, 12 September 2006) the ECJ held that the CFC regime could infringe the principle of freedom of establishment in circumstances where the CFC is 'actually established in the host member state and carries on genuine economic activities there'. It was, however, left for the national court to apply this test to the legislation.

HMRC opened an enquiry to determine whether Vodafone 2 should be liable to tax under the CFC regime on the profits of its Luxembourg subsidiary. The litigation concerned an application by Vodafone 2 for a 'closure notice' requiring HMRC to conclude their enquiry on the basis that the CFC regime was incompatible with EU law. By the casting vote of the presiding Special Commissioner it was held that the CFC regime was capable of a conforming interpretation and so compatible with EC law. Accordingly, Vodafone 2 was not entitled to a closure notice. However, on appeal the High Court held that a conforming interpretation was not possible, so the CFC regime was to be disapplied for all subsidiaries established in the EU.

The Court of Appeal (Sir Robert Morritt and Longmore and Goldring LJJ) held that a conforming interpretation of the CFC regime was possible. Further, they suggested that, even if a conforming interpretation was not possible, the legislation would not (as the High Court had held) automatically be disapplied for Vodafone 2, as Vodafone 2 would still have to prove that its subsidiary was actually established in Luxembourg and carrying on genuine economic activities there.

In determining whether a conforming interpretation was possible, the Court of Appeal applied principles previously articulated by courts in applying the court's interpretive obligation under section 3 of the Human Rights Act 1998, as well as other cases on adopting a conforming interpretation to implement EU law. The court noted that in such circumstances statutory construction is not an exercise in semantics or linguistics and permits a departure from the strict words that the legislation has used. However, any such interpretation must go with the grain of the legislation.

Although the ECJ judgment had referred to it being for the national court to determine if one particular part of the national legislation (the 'motive test') was compatible with EU law, the Court of Appeal held that its task was to review the whole of the national law to see if it may be applied as to conform to EU law. This is because the jurisdiction of the ECJ to give preliminary rulings does not extend to the interpretation of legislation of a member state.

Interestingly, the Court of Appeal was unusually quick to deliver its judgment, which was handed down only a fortnight after the hearing. Perhaps this indicates a keenness to suppress the radical preposition in Evans-Lombe J's judgment that the CFC legislation was to be disapplied.

Undoubtedly, given the divergence between the courts and tribunal on the consequence of the ECJ's decision in Cadbury Schweppes for the UK's CFC regime, there is definitely a point of general public importance here which it would be useful for the House of Lords to clarify. However, in these times of recession, given the immense harm to the public revenues that a win for Vodafone 2 could inflict, the House of Lords may well choose to decline even permission to appeal.

Overpayment of VAT

In FJ Chalke Ltd and AC Barnes (Wokingham) Limited v HMRC [2009] EWHC 952, the claimants were car dealers who had overpaid VAT due to UK law failing properly to conform to EU law. The failings in question were due to rules concerning the VAT treatment of demonstrator cars and the VAT treatment of the bonus payments paid by car manufacturers to dealers that sold their cars.

The judgment of the High Court (Henderson J) held that the claimants were entitled to recover compound interest (rather than the simple interest usually offered by HMRC) where HMRC collects any tax, including VAT, in breach of EU law. This is the first time a court has held that compound interest is available for overpayments of VAT in breach of EU law and could well have huge implications for HMRC and cost the exchequer billions of pounds, as compounding over several years yields a far higher rate of return than simple interest.

Unfortunately for the claimants, their particular claims for restitution were held to fail because they were not made within six years of the discovery of the mistake. The discovery that compound rather than simple interest was available was found not to be a 'mistake' for these purposes, though this particular issue may yet be challenged before a higher court.

The claimants also pleaded a claim for damages. As established in Factortame, (R v Secretary of State for Transport, ex p Factortame (No 2) [1990] UKHL 13), to qualify for damages: (i) the rule of Community law infringed must have been intended to confer rights on individuals; (ii) the breach in question must have been sufficiently serious; and (iii) there must have been a direct causal link between the loss sustained and the breach. However, the court held that in this case there was no causation and the breach was not sufficiently serious to qualify for damages.