Vodafone 2 v HM Revenue & Customs

Section 2(4) of the European Communities Act 1972 requires domestic legislation to be construed, so far as possible, consistently with directly effective Community rights. The exercise is broad and may involve implying words, but the result must remain compatible with the legislation’s underlying scheme and must not alter a fundamental feature.

The controlled foreign company regime could therefore be read as containing a further exception for a company genuinely established in another EEA member state and carrying on genuine economic activity there. That construction went with the legislation’s scheme of a broad charge qualified by overlapping exceptions, and gave effect to freedom of establishment. Disapplication was consequently unnecessary.

Vodafone 2 Ltd, a United Kingdom resident company, held a Luxembourg subsidiary, Vodafone Investments Luxembourg SARL. HMRC sought to investigate and potentially charge Vodafone 2 to United Kingdom corporation tax on the subsidiary’s profits under the controlled foreign company provisions in Chapter IV of Part XVII of the Income and Corporation Taxes Act 1988.

Following the ECJ decision in Cadbury Schweppes [2006] ECR I-7995, the Special Commissioners divided on whether the legislation could be construed consistently with Article 43 EC. The chairman’s casting vote favoured construction. On Vodafone 2’s appeal, Evans-Lombe J held that conforming construction was impossible and disapplied the legislation.

HMRC appealed. The central issue was whether the legislation could be given a conforming interpretation, rather than disapplied.

1. Appeal allowed. The Chancellor held, with whom Longmore and Goldring LJJ agreed, that the controlled foreign company legislation was capable of a conforming interpretation. The judge’s contrary order was therefore set aside.

2. The ECJ’s reference in Cadbury Schweppes [2006] ECR I-7995 to the motive test in section 748(3) did not limit the national court’s task to that provision. Under section 2(4) of the European Communities Act 1972, the court had to examine the domestic legislation as a whole to determine how far it could be applied consistently with directly effective Community rights.

3. The interpretative obligation was broad. It could depart from literal wording and imply words, without a prior ambiguity. Its limits were that the reading must go with the grain and underlying thrust of the legislation, must not contradict a fundamental or cardinal feature, and must not require judgments unsuitable for a court.

4. The proposed reading met those limits. Section 747 cast the charge widely, while section 748 narrowed it through overlapping and variable exceptions. It was permissible to read in a further exception for a controlled foreign company which, in the relevant accounting period, was actually established in another EEA member state and carried on genuine economic activities there. Such a reading removed the restriction on freedom of establishment identified by the ECJ, while leaving the regime applicable to companies outside the exception.

5. The decision in ICI v Colmer [1999] 1 WLR 2035 did not prevent that result. Its statutory setting and the Community-law issue were materially different. Nor did retrospective effect, lack of legislative precision, or the existence of other possible solutions make this conforming interpretation impermissible.

6. The court held that the High Court’s blanket disapplication order was, in any event, too wide. Since conforming interpretation succeeded, however, it was unnecessary to decide the correct scope or form of any disapplication. Counsel were invited to agree an order giving effect to the court’s conclusions.

• Court of Appeal (Civil Division) Allowed HMRC’s appeal and held that the controlled foreign company legislation could be construed consistently with freedom of establishment: [2009] EWCA Civ 446.

• High Court, Chancery Division Evans-Lombe J held that conforming construction was impossible and disapplied the controlled foreign company legislation. The Court of Appeal reversed that conclusion.

• Special Commissioners The Commissioners divided on conforming construction. The chairman, Mr Walters QC, exercised a casting vote in favour of construction; Vodafone 2 then appealed to the High Court.