Pendragon Plc v HM Revenue and Customs

In VAT abuse-of-rights cases, two conditions must both be satisfied. The tax advantage must conflict with the purpose of the legislation, and objective factors must show that obtaining it was the essential or principal aim. The second condition is not a balancing exercise between the tax saved and the commercial benefit. The proper question is whether the transactions, or allegedly artificial elements, have a substantial economic or commercial explanation apart from the tax advantage. A specialist first-instance tribunal’s evaluative conclusion may be overturned on a point of law only for legal error or where no properly directed tribunal could have reached it.

The Pendragon Group used intra-group leases, assignments to a Jersey bank and a transfer of a hire business as a going concern before retail sales of used demonstrator cars. The arrangements recovered input VAT on purchase while applying the margin scheme on resale. The First-Tier Tribunal held that the essential aim was to obtain finance, not an abusive tax advantage, and allowed the appeals, setting aside assessments and penalties: [2009] UKFTT 192 (TC). The Upper Tribunal allowed HMRC’s appeal and reinstated the assessments: [2012] UKUT 90 (TCC). The central issue was whether the Upper Tribunal had identified an error of law in the First-Tier Tribunal’s evaluative conclusion.

Appeal allowed. Lord Justice Lloyd gave the leading judgment. Lord Justice Lewison and Lady Justice Gloster agreed. The First-Tier Tribunal’s decision was restored.

1. The abuse-of-rights principle requires both conditions identified in Halifax: the tax advantage must be contrary to the purpose of the relevant provisions, and objective factors must show that obtaining the advantage was the essential or principal aim. The second condition is assessed objectively by reference to the real substance and significance of the transactions, not the parties’ subjective intentions.
2. The tax advantage should be treated as present for the purposes of the second condition. The court should not balance its amount against the commercial benefits of the arrangements. The relevant question is whether the transactions, or the elements said to be artificial, have a realistic and substantial economic or commercial explanation apart from the tax advantage. A merely ancillary benefit may not suffice.
3. Taxpayers may choose a structure producing more favourable VAT consequences. An unusual structure is not artificial merely because it uses subsidiaries, leases or an offshore bank. Artificiality depends on whether an element lacks an independent commercial rationale. The First-Tier Tribunal was entitled to find that the captive leasing companies, hybrid leases and Jersey bank could be explained by financing, security and continued use of the cars.
4. On an appeal limited to errors of law, the First-Tier Tribunal was the primary fact-finder and maker of the evaluative judgment. The Upper Tribunal could not substitute its own assessment merely because it would have reached a different conclusion. The First-Tier Tribunal’s inaccurate description of its evaluative conclusion as a primary fact, its failure to quantify the tax advantage and its less detailed description of the scheme did not establish legal error.
5. The observations on abuse of rights in WHA were persuasive but not ratio because the Supreme Court disposed of that litigation on construction. No error of law was shown in the First-Tier Tribunal’s decision. The assessments and penalties were therefore set aside.

1. Court of Appeal (Civil Division) allowed Pendragon’s appeal and restored the First-Tier Tribunal’s decision: [2013] EWCA Civ 868.
2. Upper Tribunal (Tax and Chancery Chamber) allowed HMRC’s appeal and reinstated the assessments: [2012] UKUT 90 (TCC).
3. First-Tier Tribunal (Tax Chamber) allowed the appellants’ appeals, holding that the arrangements were not abusive and setting aside the assessments and penalties: [2009] UKFTT 192 (TC).