Leasing transactions are
not necessarily VAT abusive, but open market terms apply, writes
The European Court of Justice
(ECJ) has given its judgment in the Weald Leasing Ltd (Weald
Leasing) case, broadly following the opinion of the Advocate
General, concerning the scope of the abuse principle in the context
of the recovery of UK input tax.
This is an important decision
which demonstrates there are limits to the scope of the
anti-avoidance doctrine developed in Halifax and other
The leading case on VAT
abuse is Halifax plc and others vs Commissioners of Customs
& Excise (case C-255/02) where the ECJ held that
transactions with a tax avoidance motive can constitute supplies
for VAT purposes, but should nonetheless be disregarded if they
constitute an abuse of rights.
The Halifax test for a
finding of abuse is as follows: first, the transactions must result
in the accrual of a tax advantage which would be contrary to the
purposes of the Sixth Council Directive 77/388/EEC (the
Second, it must also be
apparent from a number of objective factors that the essential aim
of the transactions concerned is to obtain a tax
In Weald Leasing, an
insurance group was unable to reclaim VAT incurred when it bought
goods in the course of its business. It entered into a scheme which
was designed to ensure that the upfront irrecoverable VAT cost was
spread over ten years, thereby securing a timing advantage for the
Under the scheme, a wholly
owned group company (W) bought goods from third parties, leased the
goods for a period of ten years to an unconnected company (S), and
S sub-leased the goods for 10 years back to companies within the
Weald Leasing group.
HM Revenue & Customs
(HMRC) challenged the ability of W to recover the VAT incurred on
the acquisition of the goods.
It argued in front of the VAT
and Duties Tribunal (the tribunal) that the deferral of tax which
arose as a result of the assets being leased to the group, rather
than being acquired outright, was contrary to the purposes of the
HMRC lost at the tribunal,
which opined that abuse could only arise in relation to
arrangements designed to avoid an open market value
HMRC appealed to the High
Court, asserting the scheme was an abusive transaction and it
should be re-characterised as one in which the group companies
acquired the goods directly from the third parties.
At the High Court, it was
accepted that the main aim of the scheme had been to confer a tax
timing advantage, but W denied that because the transaction was not
part of its normal commercial operations, that tax advantage was
contrary to the Directive.
The High Court dismissed
HMRC’s appeal, holding that the Halifax principle does not go so
far as to provide that the absence of “normal commercial
operations” is enough to find that a transaction aimed at securing
a tax advantage can be abusive.
HMRC appealed to the Court of
Appeal, which stayed proceedings and referred four questions to the
First, does the leasing of
assets, as opposed to their purchase, by a largely VAT exempt
trader give rise to a tax advantage which is contrary to the
purpose of the Directive within the meaning of the decision in
Second, is it abusive for a
largely VAT exempt trader to enter into leasing transactions when
in the context of its normal commercial operations it does not
usually undertake such transactions?
Third, if the answer to the
second question is “yes”: what is the relevance of “normal
Fourth if the asset leasing
structure or any part of it is found to constitute an abusive
practice, what is the appropriate redefinition?
The ECJ has broadly followed
the Advocate General’s opinion in this case, wholly rejecting the
idea that leasing assets, as opposed to purchasing them, could be
abusive simply because this gives a VAT advantage to an exempt or
partly exempt taxpayer.
W could not be criticised for
choosing a leasing transaction over an outright purchase of the
However, the ECJ made it
clear that interposing an artificial lease and leaseback structure
under which assets were leased to intermediate third parties
(thereby preventing HMRC from making a direction to substitute open
market value) for a rent which was “unusually low or did not
reflect any economic reality” could be abusive.
The question of whether this
was in fact the case would be a question for the national courts to
If the national courts found
that the transactions were abusive, they would need to go on to
determine the correct re-characterisation of the transaction to
re-establish the position had the abusive practice not taken
The ECJ did not describe what
this re-characterisation should be, but said the redefinition must
go no further than is necessary for the correct charging of the VAT
and the prevention of tax evasion.
It is now clear the Halifax
principle should not apply to arm’s length commercial transactions,
albeit involving an element of tax saving or a timing advantage,
although the national courts retain the power to strike down wholly
artificial structures if they wish.
It is the commercial
justification for a transaction, and its object and effect, which
is important and not any tax motive.
The outcome of the key
factual issues in this case will have to wait for a decision of the
The ECJ clearly recognises
the need for businesses to structure transactions in a tax
efficient, but commercial, way but has attempted to balance that
against the need for member states to raise revenues.
Julia Lloyd is a senior
associate at Norton Rose