Tax Avoidance Scheme Complies With Law - But Still Fails

In an important decision, the Court of Appeal has underlined that tax avoidance schemes may be strictly in accordance with legislation – but still be ineffective. The case involved a university which made an ultimately abortive attempt to save itself more than £500,000 in VAT on a building project.

The university bought a derelict building which it intended to convert for academic use. On advice from an accountancy firm, the property was leased back and forth between the university and a trust which was created for the purpose. A company, which had no assets of its own, was established as a conduit through which building contractors were to be paid £3.5 million.

The Court noted that the steps taken were not a sham and that, if the terms of the VAT Act 1994 were formalistically applied, they would have achieved the desired VAT saving. However, in dismissing the university's appeal against an earlier ruling of the Upper Tribunal, the Court observed that the entire structure was controlled by the university and that its sole purpose was to facilitate VAT planning.

The essential aim of the artificial transactions was to secure an absolute saving on VAT which would otherwise have been payable. The scheme, although formally valid, was contrary to the underlying purpose of the Act. It had thus been abusive from the outset and was invalidated by the European law principle of abuse of rights.

HM Revenue and Customs are taking an increasingly robust approach to what they see as abusive tax planning and are challenging arrangements even when they are, as in this case, strictly compliant with the legislation if the overriding purpose is tax avoidance without any necessary commercial reason for the structure being adopted.