CJEU's decision in Ocean Finance case supports "substance over form" of VAT arrangements, says expert

In its judgement, the Court of Justice of the European Union (CJEU) said that it was now up to the UK courts to decide whether loan broker Ocean Finance had used "wholly artificial" arrangements "set up with the sole aim of obtaining a tax advantage" in relation to its advertising costs.

The CJEU had been asked by the Upper Tax Tribunal to consider a number of questions in relation to the business activities of loan broker Ocean Finance and its owner, Paul Newey. Newey had granted a Jersey-based company, Alabaster, exclusive use of the name, and any loans processed by his UK employees were approved by Alabaster. HM Revenue and Customs (HMRC) alleged that he had done this in order to avoid paying VAT on advertising costs, as Jersey operates outside of the common EU system of VAT and Alabaster entered into contracts with the advertising providers while Mr Newey retained control over the content of the advertising.

"Taking into account the economic reality of the business relationships [in this case] ... it is conceivable that the effective use and enjoyment of the services at issue in the main proceedings took place in the United Kingdom and that Mr Newey profited therefrom," the CJEU said.

"It is for the referring court, by means of an analysis of all the circumstances of the dispute in the main proceedings, to ascertain whether the contractual terms do not genuinely reflect economic reality and whether it is Mr Newey, and not Alabaster, who was actually the supplier of the loan broking services at issue and the recipient of the supplies of advertising services provided by Wallace Barnaby. If that were the case, those contractual terms would have to be redefined so as to re-establish the situation that would have prevailed in the absence of the transactions constituting that abusive practice," it said.

The supply of advertising and marketing services is subject to VAT under EU law. However, as the supply of loan broking services is exempt from VAT, a UK-based company carrying out these activities would have had to have paid VAT on any advertising costs which it would not have been entitled to recover.

Indirect tax expert Darren Mellor-Clark of Pinsent Masons, the law firm behind Out-Law.com, said that the CJEU had appeared to follow a "well-travelled thread of case law focussing on the commercial and economic realities of transactions". Recent UK examples included the decisions of the Supreme Court in relation to motor insurer WHA and Loyalty Management UK (LMUK), administrators of the Nectar points retail loyalty scheme.

"A clear finding of the First-Tier Tribunal in the UK was that, as a matter of fact, the Jersey company both made the supplies of loan broking and received the supplies of the advertising services," he said. "While not commenting conclusively on the matter, the CJEU held it was 'conceivable' that the advertising services were effectively used and enjoyed in the UK. As such, the contracts could be recharacterised to represent the commercial realities and so subject the advertising services to UK VAT."

"We appear to be left largely in the position from which we started -–that contracts are but one matter to consider when determining questions of supply. If they do not reflect the underlying commercial and economic realities then they should be set aside in favour of those realities, especially in situations where they represent a wholly artificial arrangement set up with the sole aim of gaining a tax advantage. The clear judicial support for a substance over form analysis should put businesses on notice, if they are not already, to ensure consistency between documentation and reality," he said.

Tax expert Suzanne McMahon of Pinsent Masons added: "Although the CJEU helpfully confirmed that an objective view of transactions should be taken when considered abuse, it did not add to the guidance we already have from the existing line of abuse cases."