A convincing victory for Vodafone puts further pressure on the Government to come up with a workable solution for CFCs

Monday 14 July 2008

The High Court judgment in the 'Vodafone 2' case was released on 4 July 2008. This is an important case on the UK's Controlled Foreign Companies (CFC) legislation. What are the implications for UK multinationals?

What does the CFC legislation aim to do?

The CFC rules apply to offshore companies that are owned by UK companies. The aim of the legislation is to prevent the avoidance of UK corporation tax on the profits of low taxed foreign resident, but UK-controlled, companies.

What was the Vodafone case about?

Vodafone argued that the UK CFC rules were contrary to European Union (EU) law in particular the 'freedom of establishment'. In reaching its decision the High Court considered the judgment of the European Court of Justice (ECJ) in the Cadbury Schweppes case. In broad terms, in the Cadbury Schweppes case, the ECJ said that the UK CFC legislation would only comply with EU law if it could be shown that it only applied to wholly artificial arrangements and asked the UK courts to consider this further. 

In Vodafone 2 the High Court considered whether the CFC rules can be interpreted only to apply to artificial arrangements. In this case the judge said that there were no words within the CFC rules that could lead to this interpretation, nor was it possible to imply additional words that would achieve this aim. Even if this could be done, it would not give sufficient certainty to taxpayers. Further, the judge implied in passing that the amendments to the CFC rules, introduced by the Government in 2006 in response to the ECJ's decision in the Cadbury Schweppes case, may themselves be contrary to EU law.

The High Court concluded that the legislation must be disapplied and so HM Revenue and Customs’ (HMRC's) enquiry into Vodafone’s tax return must be closed. This is a convincing victory for Vodafone, even though an appeal is certain to take place.

What are the implications of the decision?

The decision found that the UK’s CFC rules, at least for periods up to 2006, do not comply with EU law. The judgment concluded by saying that the CFC rules must be disapplied and that no charge can be imposed on a company such as Vodafone under the CFC rules. Although HMRC will undoubtedly appeal, this is still a crucial judgment and blows a huge hole in the Government’s strategy. It also has implications for the ongoing consultation process on the taxation of foreign profits.

Roopa Aitken, an International Tax Partner at Grant Thornton says: "The decision could have wide application, as it sets out in detail the principles that the UK Courts will use in deciding whether UK law properly complies with EU requirements. It also shows the urgent need for the consultation process on foreign profits to address deficiencies in the CFC rules. It is hoped that any new rules will be supportive of UK headquartered groups."

She continues: "Taxpayers who have open enquiries on CFC rules in relation to EU subsidiaries should seek to have those closed without any tax charge. Taxpayers who have suffered a tax charge in the past on CFCs, where there were genuine economic activities within the EU, should consider whether a repayment should be claimed."

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