<p> ABUSE OF LAW ORIGINS & HISTORY IN EU LAW. Roderick Cordara QC Abuse of law: nomenclature There are many names in play for this concept or group of overlapping concepts: see inter alia ‘abuse of law’, ‘abuse of right’, ‘abus de droit’, ‘fraus legis’, ‘fraud on the law’, ‘abusive practice’. Abuse of law: origins outside EU law Roman law The underlying Roman law origins are not straightforward: See: Fraus legis but cf “nullus videtur dolo facere, qui suo iure utitur” Gaius Digest 50.17.55 International law The concept of abuse of right is certainly discussed in international law, though it may not be accepted as a fully fledged principle recognised by all nations. See C Rousseau, Principes generaux du droit international public, 1944, 1, pg 44, citing a 1870 reference in an arbitral decision (President of Chile): “il est de jurisprudence universelle que celui qui fair usage de son droit ne lese personne” France and the rest of Europe It is essentially a concept of French law, with varying reflections in many, but not all, continental European systems. In its basic form, it may be defined as the exercise of a person’s rights in a manner which is unreasonable, with consequent harm to another, whether there was an intent to harm or mere carelessness or indifference as to harm resulting. It is related to proportionality – at least in its private law manifestations. The excessive or inappropriate use of private rights is not to be supported by the law. It seems to have begun in France in a tortious context, then spreading to controlling the exercise of rights in civil procedure, and beyond. There seems always to be some statutory basis for it. Different nuances exist. See: · Civil Code Art 1382 (no tort of nuisance concept in French law?) · ‘Troubles de voisinage’ cases: Coquerel c. Clement - Baynard Req 3 Aug 1915 (airships and large spikes), C 1920 1. 300; cf Civ 20 Jan 1964 D 1964, 518 (giant ferns). St Galmier (CA Lyons: Dalloz Periodique 1856.2.1999) (Bradford v Pickles facts, but decided the other way: Art 641 CC). The concept in its basic form is clearly focussed on abuse of rights, not avoidance of obligations/duties. Concepts of malice and/or sham/collusion are strong in the doctrine in its basic form – and were strongly present in its early Community manifestations. The extent of malicious intent necessary varies between European states: · Actual intent of harm, or likelihood of harm obvious to reasonable man: France, Belgium, Netherlands · Requiring a subjective intent to harm: Italy, Austria · Objective harmful effects sufficient: Germany, Greece, Portugal, Spain, Luxembourg Abuse concepts in a tax context See France: general tax anti-avoidance provision, Art L 64 under the heading “procedure de repression des abus de droit”. “Acts which conceal the true nature of a contract or of an agreement are ineffective against the tax administration if they employ clauses: (a) which give rise to lower registration duties or real estate registration tax; (b) or which disguise either the generation or the transfer of profits or income; (c) or which permit the avoidance, either in whole or in part, of turnover taxes on the transactions carried out pursuant to the contract or agreement. The tax administration is authorised to restore the true nature of the transactions challenged.” Clearly, malice is not required in a tax situation. It may be that in this context abus de droit is merely referring to unacceptable tax avoidance – in France evasion fiscale (either simulation (sham) or fraude a la loi (evasion of the law)). Habilite fiscale is acceptable planning. In 1981, the Article was held by the Conseil d’Etat to extend to transactions which either “..have a fictitious character, or if not, that .. have no other motive than to avoid or alleviate the tax burden on the taxpayer which the taxpayer, if he had not carried out these acts, would normally have had to bear having regard to his actual situation and activity.” English law One can be confident that English law has not contributed in any way to the origins of the doctrine (save to supply facts for its recent application by the ECJ). There is clearly no equivalent doctrine in English common law: Bradford v Pickles [1895] AC 587 continues to be definitive. If a right exists, no enquiry is made as to the motives with which it is exercised, nor the harm it will cause (assuming proper exercise). This is perhaps an aspect of the ‘legal Wild West’ that Maduro A-G identifies in Halifax (paragraph 77): ie a society in which you may do whatever is not expressly against the law. Such a primitive system also easily tolerates the Bradford v Pickles view of rights. But note: · ‘clean hands’ and ‘clear conscience’ concepts in English equity law and practice · Human Rights Act 1998 Sched 1, part 1, Art 17 ‘Prohibition of abuse of rights’ · sed quaere the position in Scotland: ie doubts whether Bradford v Pickles is the law there; re: neighbours, the tort of use of land in aemulationem vicini. Community law The concept of abuse of right has taken root in Community law relatively recently. As late as 1993, it was possible for a learned author to conclude that it was not a principle of Community law (see Prof N Brown ‘Is there a general principle of abuse of rights in European Community law?’). Perhaps this is not surprising in the wake of Factortame and the success of the quota-hopping Spanish fishermen. Yet, within a decade, the situation had completely altered. It is not easy precisely to track the influence of the continental concepts clustered around abuse of right. However, the influence of the French approach is clearly very powerful. In Emsland-Starke a reference was made by the Commission to the law of Member States in the area of abuse: see A-G Opinion paragraph 41 quoting the submission (‘..This legal principle exists in almost all Member States and has already been applied in appropriate circumstances in the case-law of the Court ..’). In Halifax, the A-G made express reference to comparative research at the tax avoidance level: 77 “However, a comparative analysis of the Member States’ legal rules is sufficient to make it clear that such concerns [ie legal certainty] do not exclude the use of certain general provisions and indeterminate concepts in the realm of tax law to prevent illegitimate tax avoidance. Legal certainty must be balanced against other values of the legal system. Tax law should not become a sort of legal ‘wild-west’ in which virtually every sort of opportunistic behaviour has to be tolerated so long as it conforms with a strict formalistic interpretation of the relevant tax provisions and the legislature has not expressly taken measures to prevent such behaviour.” The position as a matter of EC law pre-Halifax The relevant case law of the ECJ is drawn from a number of very different areas of Community law and therefore some caution may be required when seeking to transpose the dicta in one case to the facts of another.</p><p>However, broadly speaking there are three strands of abuse of rights cases in the ECJ. They share a common feature: in all of these cases it was alleged that the individual in question (whether natural or legal person) was seeking to rely directly on Community legislation. Strand 1: In those cases where the “abuse” was purportedly designed to circumvent national law (see e.g. Case 33/74 Van Binsbergen [1974] ECR 1299, Case 115/78 Knoors v Secretary of State for Economic Affairs [1979] ECR 399, Case C-23/93 TV 10 v Commissariaat voor de Media [1994] ECR I-4795, Case C-148/91 Veronica v Commissariaat voor de Media [1993] ECR I-485, Case C-212/97 Centros [1999] ECR I-1459 and Case C-36/96 Günaydin v Freistaat Bayern [1997] ECR I-5143), the individual in question sought to rely on directly effective provisions of Community law in order to avoid the limitations or restrictions of domestic law which would otherwise be applicable to him. Strand 2: In those cases where the “abuse” was purportedly designed to dishonestly or fraudulently seek an advantage provided by Community law itself (and possibly to derive benefit from Community funds) (see e.g. Case C-441/93 Parfitis et al v TKE et al [1996] ECR I-1347, Case C-367/96 Kefalas v Greek State [1998] ECR I-2843, Diamantis v Greek State [2000] ECR I- 1705, Case C-8/92 General Milk Products v Hauptzollamt Hamburg-Jonas [1993] ECR I-779, Case C-110/99 Emsland Stärke v Hauptzollamt Hamburg-Jonas [2000] ECR I-11569 and Case C-206/94 Brennet v Paletta [1996] ECR I-2357), the individual in question either sought to rely on a directly effective provision of Community law in order to achieve a benefit to which he was not entitled or, while achieving a prima facie legitimate benefit, would cause such serious damage to the legitimate interests of others so as to be manifestly disproportionate. Strand 3: Those cases where there was a national abuse of law concept in existence (eg the Greek company law cases, such as Kefalis, Diamantis, etc [loc cit]).</p><p>All or nothing Once an abuse has been established the Community right is withdrawn. (As will be seen, in applying the abuse process to tax, Halifax has pushed this aspect of the doctrine into a more complex process.)</p><p>Some quotes from the pre-Emsland-Starke cases The Court said in Kefalas: “Although the Court cannot substitute its assessment for that of a national court, which is the only forum competent to establish the facts of the case before it, it must be pointed out that the application of such a national [abuse of rights] rule must not prejudice the full effect and uniform application of Community law in the Member States. In particular, it is not open to national courts, when assessing the exercise of a right arising from a provision of Community law, to alter the scope of that provision or to compromise the objectives pursued by it.” (In Kefalas, the Court was concerned with the interaction between the applicant’s reliance on an EC Directive and the operation of Article 281 of the Greek Civil Code which provided that “the exercise of a right is prohibited where it manifestly exceeds the bounds of good faith, morality or the economic or social purpose of that right”.) In Diamantis, the Court (concerned with the identical provisions as in Kefalas) applied the test thus: “In this case it would not appear that the uniform application and full effect of Community law would be compromised if it were to be held an abuse of rights for a shareholder to rely on Article 25(1) of the Second Directive on the ground that, of the remedies available for a situation that has arisen in breach of that provision, he has chosen a remedy that will cause such serious damage to the legitimate interests of others that it appears manifestly disproportionate. Such a determination would not alter the scope of that provision and would not compromise its objectives.” (para. 43)</p><p>In other non-tax cases, the European Court of Justice has made clear that an “abuse” can only exist where there is no genuine exercise of the right in question. In General Milk Products the Court held that: “The plaintiff company in the main proceedings and the Commission take the view essentially that, in the light of the applicable Community provisions, the re-exportation of that cheese in such circumstances may continue to give rise to the application of monetary compensatory amounts, unless there is evidence of fictitious transactions effected solely for the purpose of wrongfully obtaining monetary compensatory amounts. These observations are well founded.” (paras. 13 and 14, emphasis added) and “As stated by the plaintiff company in the main proceedings and the Commission, the position would be different only if it could be shown that the importation and re-exportation of that cheese were not realised as bona fide commercial transactions but only in order wrongfully to benefit from the grant of monetary compensatory amounts. The bona fide nature of those transactions is a question of fact to be decided by the national court.” (para. 21, emphasis added)</p><p>Centros In this case, the importance of ensuring that the supposed abuse is truly contrary to the intent of the law was stressed (see Case C-212/97 Centros [2000] All ER (EC) 481). Danish company law requirements as to corporate formation were circumvented by forming in UK, and then trading in Denmark. Abuse was unsuccessfully suggested by the Danish Government in connection with Arts 52 & 58 of the Treaty (freedom of establishment) . The Court acknowledged the abuse of right case-law as it then stood (paragraph 24). However, it made the point that the freedom of establishment provisions were not offended by what had happened. Accordingly, no policy was offended by what had occurred – the relevant treaty provisions were not sensitive to the allegations being made by the Danish authorities. Key passage: 25 However, although, in such circumstances, the national courts may, case by case, take account - on the basis of objective evidence - of abuse or fraudulent conduct on the part of the persons concerned in order, where appropriate, to deny them the benefit of the provisions of Community law on which they seek to rely, they must nevertheless assess such conduct in the light of the objectives pursued by those provisions (Paletta II, paragraph 25). 26. In the present case, the provisions of national law, application of which the parties concerned have sought to avoid, are rules governing the formation of companies and not rules concerning the carrying on of certain trades, professions or businesses. The provisions of the Treaty on freedom of establishment are intended specifically to enable companies formed in accordance with the law of a Member State and having their registered office, central administration or principal place of business within the Community to pursue activities in other Member States through an agency, branch or subsidiary. 27. That being so, the fact that a national of a Member State who wishes to set up a company chooses to form it in the Member State whose rules of company law seem to him the least restrictive and to set up branches in other Member States cannot, in itself, constitute an abuse of the right of establishment. The right to form a company in accordance with the law of a Member State and to set up branches in other Member States is inherent in the exercise, in a single market, of the freedom of establishment guaranteed by the Treaty. [emphasis added] As Advocate General La Pergola stated in his opinion in Centros: “ According to the recent judgment in Kefalas, a person abuses the right conferred on him if he exercises it unreasonably to derive, to the detriment of others, ‘an improper advantage, manifestly contrary to the objective’ pursued by the legislator in conferring that particular right on the individual. On this aspect of the abuse of rights, there appears to be a certain affinity between the general principle regarding such abuse and the principle of proportionality as a criterion for limiting the exercise of power. Furthermore, as learned authors have pointed out, the famous statement of the French authority on civil law, Planiol, that ‘law ceases where abuse begins’ (le droit cesse là où l'abus commence) still holds good and shows very clearly that the problem of abuse is resolved in the last analysis by defining the material content of the particular situation and thus the scope of the right conferred on the individual concerned. In other words, it is claimed that to determine whether or not a right is actually being exercised in an abusive manner is simply to define the material scope of the right in question.” (para. 20)</p><p>“ According to the recent judgment in Kefalas, a person abuses the right conferred on him if he exercises it unreasonably to derive, to the detriment of others, ‘an improper advantage, manifestly contrary to the objective’ pursued by the legislator in conferring that particular right on the individual. “ (ibid (emphasis added)). This approach is also confirmed by the requirement that the abuse of rights principle must not: · detract from the full effect and uniform application of Community law; · alter the scope of the Community law provision in issue; or · run counter to the objectives of the provision of Community law in issue. Thus, it is clear that not only must there be some objectionable characteristic in the exercise of the right in question, but its objectionability must be manifest. The reason for this is obvious: before statutory Community rights are curtailed, a Court must be absolutely sure that it is not acting against the overarching intent of the Community legislators: it is a very high hurdle to cross. Emsland-Starke This case was of the greatest importance. It concerned claims for export refunds, pursuant to Regulations, based on movements of agricultural goods out of the Community, by road. However, the goods returned to the Community fairly promptly, and by pre-arrangment. The claims fell within the letter of the relevant provisions. The abuse concept was deployed in its most developed form yet, in order to defeat the claims. At paragraphs 38-43 of the Judgment, the Court records the Commission proposing, for the first time, what is now recognisably the doctrine of abuse of rights as a developed principle of Community law. The Commission noted its existence at national level in certain Member States (A-G paragraph 41), but said that it had not yet been recognised as a principle of Community law. It proposed a three-stage approach, involving a subjective and objective analysis, which became the two stage approach that is now familiar. The Court accepted that submission: Key passage 50 “However, in the light of the specific circumstances of the operation at issue in the main proceedings, which might suggest an abuse, that is to say, a purely formal dispatch from Community territory with the sole purpose of benefiting from export refunds, it must be examined whether Regulation No 2730/79 precludes an obligation to repay a refund once granted. 51. In that regard, it is clear from the case-law of the Court that the scope of Community regulations must in no case be extended to cover abuses on the part of a trader (Cremer, cited above, paragraph 21). The Court has also held that the fact that importation and re-exportation operations were not realised as bona fide commercial transactions but only in order wrongfully to benefit from the grant of monetary compensatory amounts, may preclude the application of positive monetary compensatory amounts (General Milk Products, cited above, paragraph 21). 52. A finding of an abuse requires, first, a combination of objective circumstances in which, despite formal observance of the conditions laid down by the Community rules, the purpose of those rules has not been achieved. 53. It requires, second, a subjective element consisting in the intention to obtain an advantage from the Community rules by creating artificially the conditions laid down for obtaining it. The existence of that subjective element can be established, inter alia, by evidence of collusion between the Community exporter receiving the refunds and the importer of the goods in the non-member country. 54. It is for the national court to establish the existence of those two elements, evidence of which must be adduced in accordance with the rules of national law, provided that the effectiveness of Community law is not thereby undermined (see, to that effect, in particular, Joined Cases 205/82 to 215/82 Deutsche Milchkontor and Others v Germany [1983] ECR 2633, paragraphs 17 to 25 and 35 to 39; Case 222/82 Johnston v Chief Constable of the Royal Ulster Constabulary [1986] ECR 1651, paragraphs 17 to 21; and Case C-212/94 FMC and Others v Intervention Board for Agricultural Produce and Ministry of Agriculture, Fisheries and Food [1996] ECR I-389, paragraphs 49 to 51, and Joined Cases C-418/97 and C-419/97 ARCO Chemie Nederland and Others v Minister van Volkshuisvesting [2000] ECR I-0000, paragraph 41).” [Emphasis added] This is clearly the moment when the doctrine reach maturity. The A-G (paragraph 63) notes that “The Commission refers in this connection to Article 4(3) of Regulation No 2988/95 concerning the protection of the European Communities financial interests, (25) which codifies a general principle of Community law. That paragraph states: 'Acts which are established to have as their purpose the obtaining of an advantage contrary to the objectives of the Community law applicable in the case by artificially creating the conditions required for obtaining that advantage shall result, as the case shall be, either in failure to obtain the advantage or in its withdrawal.” He accepted the argument readily but within careful limits: “65. The Court has often had occasion to state its views on the question of abuse of rights in various contexts. 66. In the context of fundamental freedoms the Court has held on more than one occasion that the circumvention of a Member State's rules by an abusive exercise of rights under Community law is inadmissible. (26) The Court has also had to deal with the phenomenon of abuse of rights in other contexts. For example, it has held an assignment of a claim to be invalid under Community law where the assignor and assignee were acting together to the disadvantage of other creditors. (27) On the other hand, the Court has also held that a blanket clause (28) in a Member State intended to prevent abuses of law was invalid in instances where its application would detract from 'the full effect and uniform application of Community law in Member States.” (The earlier cases were cited.) The two stage analysis – described in Emsland-Starke as objective and subjective elements - are clearly here to stay. Statements concerning the degree of ‘culpability’ that needs to be present (pre- Halifax cases) These early cases contain strong themes of moral culpability, which must have their roots in the private law origins of the doctrine  Parfitis et al v TKE et al [1996] ECR I-1347, Case C-441/93 (Greek shareholders rights) Ct paras 67-70 - the Greek AOR provision in play read: “the exercise of a right is prohibited where it manifestly exceeds the bounds of good faith or morality or the economic or social purpose of that right.” · Brennet v Paletta [1996] ECR I-2357), Case C-206/94 (Greek shareholders rights) - Ct para 25: “Although the national courts may therefore, take account - on the basis of objective evidence - of abuse or fraudulent conduct on the part of the worker concerned in order, where appropriate, to deny him the benefit of the provisions of Community law o n which he seeks to rely, they must nevertheless assess such conduct in the light of the objectives pursued by those provisions.” · Kefalas v Greek State [1998] ECR I-2843, Case C-367/96 (Greek shareholders rights) Ct paras 20 : “abusive or fraudulent ends” ; 22 “in particular it is not open to national courts, when assessing the exercise of a right arising from a provision of Community law, to alter the scope of that provision or to compromise the objectives pursued by it.”, 28: “an improper advantage, manifestly contrary to the objective of that provision” (see also Ct. paras 33-35, and paras 38-39, 42-44; A-G 20, 24, 25(first sentence), 27-29) · Centros Ltd v Erhverves-og Selskabsstyrelsen (Case C212/97) [2000] AII ER (EC) (Danish company regulation) Ct. paras 24: “improperly or fraudulently taking advantage of provisions of Community law”; 25: “abuse or fraudulent conduct” ; 26-29, 34, 37-8; A-G paras 16(first 3 sentences), 20-38 · Emsland-Strake GmBH v Hauptzollamt Hamburg-Jonas (Case 110/99) (Export refunds) - Ct paras 52-end; para 52 “A finding of abuse requires, first, a combination of objective circumstances in which, despite formal observance of the conditions laid down by the Community rules, the purpose of those rules has not been achieved.” para 53 “It requires, second, a subjective element consisting in the intention to obtain an advantage from the Community rules buy creating artificially the conditions laid down for obtaining it. The existence of that subjective element can be established, inter alia, by evidence of collusion between the Community exporter receiving the refunds and the importer of the goods in the non-ember country. ” A-G para 42-46 (Commission’s case) & 72-74 - para 72: “No genuine intention to export the goods”; para 74: “The order for reference mentions the good faith of the plaintiff...In order for the advantage to be withdrawn from the plaintiff, there would have to have been collusion between the plaintiff and the purchaser of the goods, a bogus transaction for the purposes of wrongfully benefiting the Community refund rules.” · Gemeente Leusden [C-487/01] (the first tax case in the line (VAT)) - Ct: paras 78-79: para 78: “As regards abuses, the Court has held that a finding of an abuse requires, first, a combination of objective circumstances, in which, despite formal observance of the conditions laid down by the Community rules, the purpose of those rules has not been achieved and , second a subjective element consisting in the intention to obtain an advantage from the Community rules by creating artificially the conditions laid down for obtaining it (Emsland Starke)” para 79 “As regards tax evasion, ...., under the law of a Member State, a taxpayer cannot be censured for taking advantage of a provision or a lacuna in the legislation which, without constituting an abuse, has allowed him to pay less tax, ...” A-G para 97 “..’dans les situations frauduleuses ou abusives’..” ABUSE AND TAX Pre-Halifax The issue of whether the concept could function in a taxation situation was open when the references in Halifax [C-255/02] and associated cases were made. The importance of the Halifax trilogy was to see how the doctrine as formulated in Emsland- Starke could be transposed to the very different problems of tax planning. Between reference and judgment A measure of the rapid growth of the abuse principle is the fact that when the Halifax series of cases was begun (in 2000), it was not known whether abuse of right was even a real part of European law: that was confirmed in Emsland Starke [C-110/99] in December 2000. Then, it was still not known whether abuse could enter the world of VAT: that was later confirmed in Gemeente Leusden [2004] ECR I-5337. There had been some doubt as to whether the intentions of the parties could affect status as an economic activity under Article 4: but Opitgen [2006] ECR I-0000 and Bondhouse [C-484/03] sorted that out earlier in 2006. The question of what form the abuse principle might take if applied to VAT was also trailed briefly in Gemeente Leusden. Halifax – ECJ Judgment Summary (A diagram of the Halifax facts is appended.) In essence, a taxpayer which normally had little or no turnover of a type which entitled it to recover input tax on supplies consumed by it, faced a large input bill (re construction costs). By using group companies and non-arms’ length contracts, it created a supply chain which achieved deduction. The UK attacked this on the basis that inter alia an abuse of right had occurred since the transactions were wholly tax-driven (though not shams) and that therefore (a) the transactions were not business transactions at all as defined by Article 4 of the Sixth VAT Directive (‘the economic activity issue’) and/or (b) even if they were such, they did not engage the right to deduct tax which such transactions usually brought under Article 17 of the Sixth Directive (‘the abuse point’). The Court was clearly of the view that an abuse had occurred. Yet it rejected the UK’s argument on the economic activity issue, though accepting its point on the abuse issue. Accordingly, both are important for the purposes of the present discussion. ECJ’s key reasoning The key reasoning of the Court was this: · first (as to the economic activity point), there is no basis for treating a transaction as not being an economic activity or a supply for the purposes of Article 4 of the Sixth Directive just because it was wholly motivated by tax considerations (paragraphs 48-60); · however, secondly (as to the abuse point), such a transaction will not provide a basis for a taxpayer to assert an EU law right if: (i) the enjoyment of that right, though consistent with the letter of EU law, would offend against a basic objective of the VAT system and (ii) the transaction which prima facie supported the claim to such a right was in fact artificial (paragraphs 67-98). ‘ Abuse-sensitive’ and ‘-insensitive’ provisions of the Directives Thus, a primary aspect of the Halifax judgment is that it neatly exposes the dichotomy between ‘abuse-sensitive’ and ‘abuse-insensitive’ provisions of Community law. It is only the former group whose operation is affected by an abusive transaction. The others are indifferent, presumable because they do not contain or represent a policy to offend, and/or offer no right to abuse. ECJ rejection of the economic activity argument The concepts supporting the rejection of the economic activity analysis were: (i) the great width of the concept of economic transaction and supply in VAT law, as expressed in Article 4 of the Sixth Directive and the Court’s case-law (paragraphs 49, 54-55) combined with, (ii) the apparent irrelevance of motive or purpose of the taxpayer to the question of status of the transaction as a supply (paragraphs 59-60). The Court stressed the objective nature of the factors that affect the answer to the Article 4 question (paragraph 56). As a result, the Court apparently rejected the thesis that a tax-driven transaction was a non-event in VAT terms, and should be ignored in any VAT analysis. Key passage: “58 It follows that transactions of the kind at issue in the main proceedings are supplies of goods or services and an economic activity within the meaning of Article 2(1), Article 4(1) and (2), Article 5(1) and Article 6(1) of the Sixth Directive, provided that they satisfy the objective criteria on which those concepts are based. 59 It is true that those criteria are not satisfied where tax is evaded, for example by means of untruthful tax returns or the issue of improper invoices. The fact nevertheless remains that the question whether a given transaction is carried out for the sole purpose of obtaining a tax advantage is entirely irrelevant in determining whether it constitutes a supply of goods or services and an economic activity. 60 It follows that the answer to Question 1(a) must be that transactions of the kind at issue in the main proceedings constitute supplies of goods or services and an economic activity within the meaning of Article 2(1), Article 4(1) and (2), Article 5(1) and Article 6(1) of the Sixth Directive, provided that they satisfy the objective criteria on which those concepts are based, even if they are carried out with the sole aim of obtaining a tax advantage, without any other economic objective.” [Emphasis added] This reasoning is of interest as an example of a set of ‘abuse-insensitive’ provisions. It has taken an ultra objective stand point, ignoring motive altogether. It is pure Bradford v Pickles. Clearly, there is not perceived to be any policy underlying Articles4 et al which abusive practices offend. It is analogous to the freedom of establishment provision in Centros: too blunt an instrument to tinker with. Further, though not said, the Articles in question did not afford any rights, expressly. Once within them, one has entered the system, but rights and obligations result from other provisions. However, having let the taxpayers into the system, the Court then had to deal with the rights/obligations problem. Significantly, the Court did not echo the comment of the A-G that an additional reason for rejecting the Tribunal’s thesis was the difficulty in reconstituting the sequence of events if one chose to ignore one link in the chain as a non-event (Opinion: paragraph 55). Thus, it prepared the ground for its later conclusion that, where the abuse doctrine applies, a rewriting of the sequence of events was permissible/necessary (see below). This process is one of the most significant divergences between the answers proposed by the A-G, and the Court’s views. This represents a reaction to the fact that abuse of right traditionally only seems to have operated in respect of rights. Such as rights to input tax recovery. It has its effect by withdrawing the rights, no more. But by rejecting the economic activity argument, the Court declined to treat it as a doctrine of ‘fiscal nullity’ in the sense used in UK anti-avoidance cases in the Furniss v Dawson tradition. Something, therefore can be both ‘artificial’ and ‘genuine’. The Court thereby created a problem: if a transaction has status as a supply under Article 4, it will obviously generate output tax liabilities. How is one to deal with those in an abuse situation? This has no real precedent in the non-tax abuse case-law. Further, given the chain nature of commercial transactions, there will be the rights of others to consider (both those who are party to the abuse (active or passive) and not). How does one unravel all this, without leaving an unfair situation in which the State can collect liabilities, but refuse benefits? This is an area in which the abuse concept has apparently been expanded to accommodate the fiscal nature of the situation. It has moved from being simply ‘no, you can’t have it’ to ‘let’s pretend you never asked for it, and that you had asked for something less objectionable”. If the problem of output tax liability had not been present, this development would not have occurred. It may only be relevant, within and beyond tax cases, where the right that has been abused brought with it obligations, intimately connected to it. ECJ’s acceptance of the abuse argument regarding Article 17 As to the core elements of the abuse doctrine, the Court’s formulation was as follows: (i) the doctrine is one of Community law (paragraph 68) (ii) it is to the effect that “Community law cannot be relied on for abusive or fraudulent ends.” (paragraph 68) (iii) it includes situations where instead of “normal commercial transactions” a taxpayer engenders a transaction “solely for the purpose of wrongly obtaining advantages provided by Community law.” (paragraphs 69, 74). (Note that this last phrase encapsulates both the sole purpose test, and the contrary-to-policy test – ie the two steps next described.) (iv) Within this framework, the familiar two-step analysis was maintained, with subtle adjustments (paragraph 80- 81). The conceptual strain of directing the doctrine into tax shows, perhaps, in its re-branding as concerning “abusive practices” (eg paragraph 69) rather than abuse of right. However, its language cannot take it far from that central concept of rights (see eg paragraph 85). Key passage 74 ‘In view of the foregoing considerations, it would appear that, in the sphere of VAT, an abusive practice can be found to exist only if, first, the transactions concerned, notwithstanding formal application of the conditions laid down by the relevant provisions of the Sixth Directive and the national legislation transposing it, result in the accrual of a tax advantage the grant of which would be contrary to the purpose of those provisions. [‘Step 1’] 75 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 advantage. As the Advocate General observed in point 89 of his Opinion, the prohibition of abuse is not relevant where the economic activity carried out may have some explanation other than the mere attainment of tax advantages.’ [‘Step 2’] Two step analysis: step one - policy/purpose Step 1 involves a policy analysis of the part of EU that the taxpayer says gives it some right that it wishes to exercise (paragraph 80). That analysis requires the reaching of a conclusion that, although the taxpayer can claim the right as a matter of form, its enjoyment of that right would be contrary to the objectives of the VAT Directives. The operative elements here are: · Articles 17-20, Sixth VAT Directive are expressed to be a set of rights which taxpayers can exercise, and as such are particularly amenable to the abuse of right doctrine. · The ‘right-giving’ nature of the provisions ipso facto is fertile ground for discerning a policy objective onto which the doctrine can then fasten in order to conclude that step 1 is satisfied. Cf ‘dumb’ Article such as 4, which are purely descriptive, creating neither liabilities nor rights on their face (though granting entry into the system). · Also, there is already a well-known policy story surrounding Article 17 and input tax deduction, derived from numerous cases and the First Directive that the intention of the VAT system is to award input tax recovery only to those who make taxable supplies. Where, as in the Halifax cases, there were no significant levels of such supplies, it is an easy matter to identify a well-established agenda behind Article 17 that informed one as to the wider policy picture. · Thirdly, it is psychologically easy to label a taxpayer as ‘exempt’ by reason of what it does and so as a ‘non- recoverer’ of input tax (see paragraph 12). For the same reason the concept of a taxpayer’s ‘normal commercial operations’ (eg paragraph 80) is easier to formulate in an Article 17 context than it may be in others. Abuse step two: the transaction analysis The second step in the abuse analysis involves assessing the actual transaction: is it artificial (paragraph 81)? Here the Court has adopted elements of the approach of the A-G, though in its own formulation (paragraph 81). It is some way from the earlier formulations of the doctrine. It endorsed the view of the A-G that before a transaction can be deemed to be artificial, it must have no explanation other than merely obtaining a tax advantage. The supporting concepts underlying the second step of the abuse analysis were: (i) the concept of the normal commercial operation of the taxpayer – a comparative yardstick (paragraph 69); (ii) the sole or essential aim of the transaction and the existence of some explanation for the transaction other than tax advantage (paragraph 75); (iii) the concept of tax advantage; (iv) the objective factors from which the above questions can be answered, including legal, economic and personal links between participants in the chain and the real and substantial nature of the transaction(s) in question (paragraph 81). It is noteworthy that each of these concepts raises unanswered questions. What is the normal commercial operation? How is tax advantage to be defined – for example does it include cash-flow planning, particularly if it leads to a greater net liability overall? How substantial does the commercial justification need to be to defeat the abuse doctrine? Is it really true that only objective factors are in play? How far is it legitimate to probe the subjective intent of the directors? What does the phrase the ‘aim of the transaction’ mean? The working out of the answers to these questions will be a slow process to be addressed in future cases. Their meaning and extent will have a powerful influence on the width of application of the abuse doctrine. In connection with the abuse analysis, the Court stressed the great importance of: (i) maintaining legal certainty for taxpayers (paragraph 72) (ii) the ability of taxpayers to choose how to structure their businesses so as to reduce their VAT liabilities (paragraph 73) (iii) tax authorities showing restraint (paragraph 92) penalties not being levied on taxpayers as a result of the application of the abuse doctrine (paragraph 93). Further, and importantly, the Court did not endorse any suggestion that the concept is a rule of construction only. Synthesis Key passage 1: 80. To allow taxable persons to deduct all input VAT even though, in the context of their normal commercial operations, no transactions conforming with the deduction rules of the Sixth Directive or of the national legislation transposing it would have enabled them to deduct such VAT, or would have allowed them to deduct only a part, would be contrary to the principle of fiscal neutrality and, therefore, contrary to the purpose of those rules. 81. As regards the second element, whereby the transactions concerned must essentially seek to obtain a tax advantage, it must be borne in mind that it is the responsibility of the national court to determine the real substance and significance of the transactions concerned. In so doing, it may take account of the purely artificial nature of those transactions and the links of a legal, economic and/or personal nature between the operators involved in the scheme for reduction of the tax burden (see, to that effect, Emsland Stärke, paragraph 58). 82. In any event, it is clear from the order for reference that the VAT and Duties Tribunal considers that the sole purpose of the transactions at issue in the main proceedings was to obtain a tax advantage. [Emphasis added] Key passage 2: 85. Accordingly, the answer to be given to the second question must be that the Sixth Directive must be interpreted as precluding any right of a taxable person to deduct input VAT where the transactions from which that right derives constitute an abusive practice. 86. For it to be found that an abusive practice exists, it is necessary, first, that the transactions concerned, notwithstanding formal application of the conditions laid down by the relevant provisions of the Sixth Directive and of national legislation transposing it, result in the accrual of a tax advantage the grant of which would be contrary to the purpose of those provisions. 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 advantage. Abuse: tax and non-tax cases compared The two-step analysis comes from the earlier cases in the area, principally Emsland-Starke (paragraphs 52-53). Unlike the A- G (Opinion paragraphs 68, 70), the Court has not expressly tried to distance the VAT version of the abuse doctrine from that expressed in the non-tax cases, such as Emsland-Starke, on the ground that they speak of the subjective intent of the alleged abuser as being relevant. The A-G tried to do that in order to stress that objective rather than subjective considerations should be in play in a tax case – one can hardly have the same objective conduct treated differently depending on the mind-set of the taxpayer. However, the Court has not quite said this. It may be anxious to minimise the differences between the abuse test in tax and non-tax cases – in order to avoid any divergent sub-species of the doctrine springing up in different parts of EU law. Its language in paragraphs 80-83 definitely makes no mention of a subjective test, and speaks of objective factors, but without using the word ‘objective’. The effect of this is two-fold: (i) it may lead to subjective factors being more present than anticipated and (ii) it will also facilitate reliance on the principles set out in the non-VAT cases, including the principle in the Centros case that abuse gives way to higher Treaty objectives such as freedom of establishment. This will help keeping the doctrine within bounds, and prevent disorder. Rewriting the story The most striking aspect of the judgment is the Court’s statement that once abuse has been found to apply, the transactions involved must be “redefined so as to re-establish the situation that would have prevailed in the absence of the transactions constituting abusive practice” (paragraph 94). It is unclear what this means, except that it means trouble – perhaps for both sides. It is in contrast to the comment of the A-G in his Opinion on the economic activity point that “this reconstruction poses serious problems.” (Opinion paragraph 55), inter alia because “it assumes the existence of one normal way to carry on” business (Opinion paragraph 56) which is not the case (in his view). The A-G then added a list of other third party related concerns in the event of a finding of non-economic activity status. It seems that the Court has taken some or all of these points to heart, but in connection with a situation in which abuse has been held to apply. It seems to have done this because otherwise there might have been output tax liabilities left in tact, while abuse would have removed the right to claim input tax. That would have led to the very imbalance, and fiscal non-neutrality that the Court stated it was anxious to avoid (paragraphs 93-97). There is to be an accounting of input and output tax in both directions by reference to the ‘re-established’ (‘rebalanced’?) story. This is a first for the Community abuse doctrine, and marks out the tax abuse doctrine as a sub-species different from non-tax abuse doctrine, at least in this area. Key passage 3: 94 It follows that transactions involved in an abusive practice must be redefined so as to re-establish the situation that would have prevailed in the absence of the transactions constituting that abusive practice. 95 In that regard, the tax authorities are entitled to demand, with retroactive effect, repayment of the amounts deducted in relation to each transaction whenever they find that the right to deduct has been exercised abusively (Fini H, paragraph 33). 96 However, they must also subtract therefrom any tax charged on an output transaction for which the taxable person was artificially liable under a scheme for reduction of the tax burden and, if appropriate, they must reimburse any excess. 97 Similarly, it must allow a taxable person who, in the absence of transactions constituting an abusive practice, would have benefited from the first transaction not constituting such a practice, to deduct, under the deduction rules of the Sixth Directive, the VAT on that input transaction. 98 It follows that the answer to Question 1(b) must be that, where an abusive practice has been found to exist, the transactions involved must be redefined so as to re-establish the situation that would have prevailed in the absence of the transactions constituting that abusive practice. [Emphasis added] Oddly, this appears to bring us back to where the UK Tribunal left matters, albeit by a different route: ie the offending transaction drops off the VAT radar screen for both input and output tax purposes. This must, of course, apply to all those in the chain who are affected by the finding of abuse (and there will always have to be more than one). So, the ‘counter-factual’ will need to be established in each case. In other words, what would have happened but for the abusive transaction which took place? If the taxpayer can show it would have done some other kind of planning, which was acceptable, then it may well escape some of the consequences of the finding of abuse. For example, in VAT, if a partially exempt entity (eg college) were found to have entered into an abusive transaction to reduce or postpone input tax on acquiring a new building, it may argue that it would otherwise simply have exercised a Lennartz option (acceptable cash-flow planning which secures immediate input tax deduction and then a trickle back of output tax over time), with the consequence that it would still have recovered its input tax, subject to an on-going duty to account for output tax from year to year. This is likely to spread into non-tax abuse cases, where alternative transactions could be contemplated. Conclusion This is a marvellous example of the impact of the Community in terms of bringing disparate legal traditions and principles together. From early French neighbour disputes through to 21st century tax planning, a new set of principles is being permitted to evolve in order to capture some quite basic human concepts of fairness. The process is at its most delicate where the relationship between state and citizen is concerned, as it is in all the ECJ cases – above all in the tax context. It is an ambitious project to balance legal certainty, purposive construction, respect for taxpayer choice, and the need to tax similar transactions in the same way (irrespective of the mind set of the supplier). No doubt there will be the usual ebb and flow of decisions as the respective sides inevitably push their arguments too far, and need to be beaten back by the Courts. However, with or without regular pruning, one can only expect the doctrine now to flourish in both the non-tax and tax areas. In particular, there is likely to be further activity in the UK Courts to explore the limits of abuse in the tax context. It is ironic, but also inevitable, that the scope of what constitutes abusive behaviour is likely to be worked out by the Courts of the Member State with the least tradition of dealing in these concepts (and, hence, of course the most vigorous tradition of tax planning). Unlike the French, the British do not know the rules. Also, in the absence of any statutory intervention (and apparently there is to be none) they have no rule book (except the case law of the ECJ). One can expect turbulence. RODERICK CORDARA QC ESSEX COURT CHAMBERS 26 May 2006 DIAGRAM OF ‘HALIFAX’ FACTS</p><p>NB the interesting concept in French labour law of ‘legerite blamable’. Conseil d’Etat, 10 June 1981, no 19.079 ‘Nothing in this Convention may be interpreted as implying for any State, group or person any right to engage in any activity or perform any act aimed at the destruction of any of the rights and freedoms set forth herein or at their limitation to a greater extent than is provided for in the Convention. “ See, for example, in Germany Article 42 of the Abgabenordnung (see Kruse and Düren, in Tipke and Kruse, Abgabenordnung, Finanzordung, Otto Schmitdt, Köln, 2003, § 42), which embodies the concept of abuse of legal institutions (‘Steuerumgehung durch Miβbrauch von Gestaltungsmöglichkeiten’); in Austria, Article 22 of the Bundesabgabenordnung (BGBl. Nr. 194/1961), as amended, which also incorporates a similar concept of abuse of civil law forms and legal structures (‘Missbrauch von Formen und Gestaltungsmöglichkeiten des bürgerlichen Rechts’); in Finland, Article 28 of the Laki verotusmenettelystä 1558/1995, which likewise applies a notion of abuse of civil law structures in tax law; in Luxembourg, Article 6(1) of the Loi d’adaptation fiscale, 1934, which again applies a similar concept of abuse. In Portugal, Article 38(2) of the Lei Geral Tributária (Decreto Lei 398/98 of 17 December), as amended by Lei No 100/99 of 27 June and subsequent legislation, contains a general anti-avoidance provision according to which ‘legal acts essentially or mainly designed, by the use of artificial means … or by the abuse of legal forms’, to reduce tax obligations may not produce effects in the tax domain. In Spain, Article 15 of the Ley General Tributaria (Ley 58/2003, of 17 December 2003) concerning conflicts in the application of tax law provisions (‘Conflicto en la aplicación de la norma tributaria’) relies on concepts such as that of manifestly artificial acts or transactions; in France, Article L. 64 of the Livre des procédures fiscales applies the notion of abuse of rights in tax law, comprising the abuse of rights by sham operations and abuse of rights by evasion of the law; in Ireland, section 811(2) of the Tax Consolidation Act 1997 contains a general anti-avoidance provision under the heading of transactions to avoid liability to tax, making use of notions such as that of transactions ‘not undertaken or arranged primarily for purposes other than to give rise to a tax advantage’ (see section 811(2)(c)(ii)); in Italy, Article 37bis of Decreto Legge 600/1973, introduced by the Decreto Legislativo No 358 of 8 October 1997 (Gazzetta Ufficiale n. 249 of 24 October 1997) contains a general anti-avoidance provision based on the notion of legal acts without legitimate economic justification (‘atti privi di valide ragioni economiche’); in Sweden, Article 2 of the Lag om skatteflykt (1995:575) (Law on tax avoidance) contains a general anti-avoidance provision, referring to the notion of tax advantage as the main reason for a legal act. In the Netherlands, the courts frequently refer to the case-law concept of fraus legis in tax law, so that the question must be considered whether the sole or decisive aim underlying a transaction is to gain a tax advantage.” [Emphasis added] Ie BUPA Hosptials & Goldsborough [C-419/02] and Huddersfield University [C-223/03] 4(1) ‘ “Taxable person” shall mean any person who independently carries out in any place any economic activity specified in paragraph 2, whatever the purpose or results of that activity. 4(2) The economic activities referred to in paragraph 1 shall comprise all activities of producers, traders and persons supplying services including mining and agricultural activities and activities of the professions. The exploitation of tangible or intangible property for the purpose of obtaining income therefrom on a continuing basis shall also be considered an economic activity.’ 17(1) ‘The right to deduct shall arise at the time when the deductible tax becomes chargeable. 17(2) In so far as the goods and services are used for the purposes of his taxable transactions, the taxable person shall be entitled to deduct from the tax which he is liable to pay: (a) value added tax due or paid within the territory of the country in respect of goods or services supplied or to be supplied to him by another taxable person; ……….’ Unless otherwise stated, all references henceforth are to paragraph numbers of the Judgment of the ECJ in the Halifax case itself. Financial service providers, such as Halifax, make exempt supplies, which do not usually carry the right to reclaim input VAT. A concept rejected as of little use by the A-G: para 56 This is amply confirmed by the remarks of the ECJ in BLP: “26. In that respect it should be noted that a trader's choice between exempt transactions and taxable transactions may be based on a range of factors, including tax considerations relating to the VAT system. The principle of the neutrality of VAT, as defined in the case-law of the court, does not have the scope attributed to it by BLP. That the common system of VAT ensures that all economic activities, whatever their purpose or results, are taxed in a wholly neutral way, presupposes that those activities are themselves subject to VAT (see in particular Rompelman v Minister van Financiën (Case 268/83) [1985] ECR 655; (1985) 2 BVC 200,157, para. 19).”</p>