Commissioners for Her Majesty’s Revenue and Customs v Pendragon plc and others

A formally compliant VAT arrangement is abusive where it produces a tax advantage contrary to the purpose of the applicable provisions and objective factors show that obtaining that advantage was its essential aim. A concurrent commercial objective does not prevent abuse. The court must ask whether ordinary business aims explain the particular contractual features producing the advantage, examining both the individual transactions and the scheme as a whole.

Taxpayers remain free to select a less-taxed route genuinely accommodated by the legislation. The second-hand goods margin scheme, however, exists to prevent double taxation where earlier input tax was irrecoverable. It cannot be used artificially to eliminate any net tax on the goods. Abusive transactions are notionally redefined for VAT purposes to remove the illegitimate advantage.

The Pendragon group used a scheme devised by KPMG for demonstrator cars. The scheme interposed captive companies and an offshore bank between the acquisition of the cars and their eventual retail sale. Assignments and a transfer of a business as a going concern were treated as outside the scope of VAT, while the final sales were taxed only on the profit margin under the Value Added Tax (Cars) Order 1992.

The First-tier Tribunal held that the scheme was not abusive: [2009] UKFTT 192 (TC). The Upper Tribunal reversed that decision: [2012] UKUT 90 (TCC). The Court of Appeal restored the First-tier Tribunal’s decision: [2013] EWCA Civ 868; [2014] STC 844.

The central issue was whether the scheme satisfied the two requirements for abuse identified in Halifax plc v Customs and Excise Commissioners: whether the advantage contradicted the purpose of the VAT provisions and whether obtaining it was the essential aim of the relevant transactions.

1. Appeal allowed unanimously. Lord Sumption delivered the principal judgment, with which Lord Neuberger, Lord Reed, Lord Carnwath and Lord Hodge agreed. The scheme was an abuse of law. The Court of Appeal’s decision was reversed.

2. The EU abuse principle requires two conditions. First, formal application of the relevant provisions must produce an advantage contrary to their purpose. Secondly, objective factors must show that obtaining the advantage was the essential aim of the transactions. Where fiscal and commercial purposes coexist, the question is whether ordinary business aims explain the particular contractual features producing the advantage. Both the individual transactions and the scheme as a whole must be examined. This applied the test in Halifax plc v Customs and Excise Commissioners Case C-255/02.

3. Taxpayers may choose between genuine alternatives which the VAT legislation intends to leave available, including exempt and taxable transactions. Selecting an offshore commercial counterparty was not itself objectionable. Abuse arose because the captive leasing companies and the transfer of the purported leasing business had no commercial rationale apart from navigating between successive VAT gateways.

4. The purpose of the second-hand goods margin scheme was to prevent double taxation where goods had previously borne VAT which could not be recovered. Its deliberately broad categories did not alter that purpose. The scheme enabled the group to recover the input tax paid on acquiring the cars and then pay output tax only on the small or non-existent resale margin. A system intended to prevent double taxation had therefore been used to prevent taxation of the consideration altogether. The first Halifax condition was satisfied.

5. The financing and use of demonstrator cars served genuine commercial objectives. Those objectives did not explain the interposition of the captive companies or the particular assignments and transfers which generated the tax result. Those features existed solely to recharacterise the transfers for VAT purposes. The second Halifax condition was therefore satisfied. The First-tier Tribunal had erred in law by examining the arrangements at too high a level of generality and failing to address that critical question.

6. The transactions were notionally redefined for VAT assessment by removing the captive companies and treating the arrangements as an ordinary sale and leaseback through the dealership companies. The dealerships were consequently accountable for VAT on the full second-hand sale price. Any consequential VAT issues not agreed by the parties were to be referred to the First-tier Tribunal.

7. Lord Carnwath, with the agreement of the whole court, added that once the Upper Tribunal identifies an error of law, section 12 of the Tribunals, Courts and Enforcement Act 2007 permits it to remake the decision and make appropriate findings of fact. As a specialist appellate tribunal, it may develop structured guidance on questions of principle. An appeal under section 13 is from the Upper Tribunal, so the Court of Appeal should ordinarily examine the Upper Tribunal’s reasoning directly for legal error.

1. United Kingdom Supreme Court: The court unanimously allowed HMRC’s appeal from [2013] EWCA Civ 868, held that the scheme was abusive and directed a notional redefinition of the transactions.
2. Court of Appeal: In [2013] EWCA Civ 868; [2014] STC 844, the court restored the First-tier Tribunal’s decision. It held that the tribunal’s conclusion was evaluative and one which it had been entitled to reach.
3. Upper Tribunal: In [2012] UKUT 90 (TCC), the tribunal reversed the First-tier Tribunal and held that both requirements of the abuse test were satisfied.
4. First-tier Tribunal: In [2009] UKFTT 192 (TC), the tribunal held that neither requirement was satisfied and that the scheme was not abusive.