Economic and commercial reality: Newey distinguished

The FTT has held that arrangements for the outsourcing of loan broking services to a UK intermediary from a Gibraltar company were abusive and that the commercial reality was that the business was carried on by the UK intermediary: Wilmslow Financial Services plc v HMRC [2020] UKFTT 516. As such, advertising services received by the business were received in the UK and were subject to UK VAT.

The case provides a contrast to the recent decision in HMRC v Newey (t/a Ocean Finance), in which the FTT (after references to the ECJ and consideration by the Court of Appeal) found that very similar arrangements were not abusive. Whilst the FTT considered that the contractual arrangements in Newey matched the economic reality of the arrangements in practice, in Wilmslow the FTT considered that there was a large discrepancy between the contractual terms of the relationships and what happened in practice.

Background

The case concerns supplies of advertising services to a Gibraltar entity, Karakus, which was a licensed credit broker and carried on loan broking services in the UK. To do so, it sub-contracted the operation of the UK loan broking business to WFS.

Until 1997, the loan broking business in the UK was performed by WFS itself and it received advertising services in the UK from Mediability. These advertising services were subject to VAT which could not be recovered by WFS as its supplies of loan broking services were VAT exempt. Following advice received from accountants, Mr Webb (the main shareholder in WFS) set up Karakus in Gibraltar. The loan broking business was transferred to Karakus but services outsourced back to WFS as Karakus (at least initially) had no employees. Mediability henceforth made its supplies of advertising services to Karakus. In this way, it was argued that the supplies of advertising were now outside the scope of UK VAT, resulting in a significant cost saving.

HMRC contended that the economic and commercial reality of the arrangements were that WFS continued to carry on the loan broking business in the UK and that the supplies of advertising continued to be made to WFS and were subject to UK VAT. Alternatively, the arrangements which were entered into amounted to an abuse of law and should be recharacterised in a way which removed the VAT saving, which, in these circumstances, was contrary to the VAT Directives.

Decision of the FTT

The FTT agreed with HMRC on both of its arguments. The FTT accepted that the fact that the arrangements were tax driven and the fact that the operation of the business was outsourced to WFS was not determinative of the issue. It is open to a business to arrange its affairs in the most tax efficient manner making use of the choices of business structure open to it. Equally, the fact that Mr Webb owned Karakus was not a matter which of itself indicated that the arrangements were abusive.

However, in this case, it was clear to the tribunal that the the commercial reality of the arrangements was that loan broking was conducted by WFS and that no true outsourcing by Karakus ever occurred. The contractual arrangements entered into were not reflective of the economic and commercial reality and was artificial. Those arrangements lacked important commercial features and included commercially perverse features. For example, there was no evidence that the directors of Karakus had the necessary experience to carry on a loan broking business. Karakus did not have the necessary resources to evaluate the loan applications. And, in particular, whilst the contractual arrangements may have allowed for Karakus to forward loan applications approved by WFS, in practice there was no evidence that this happened. Instead, completed applications were forwarded directly by WFS to lenders without any involvement from Karakus.

"However, more notably, Karakus appears to have no control or veto in respect of the applications; the Appellant is the business with the necessary knowledge, experience and infrastructure but given that Karakus is the purported principal, there are no explicit provisions by which it has the power to make the ultimate decision or even to be involved in the business of loan broking; on the face of it, it's role is limited to forwarding applications that have already been checked and approved by the Appellant to the lenders. I agreed with the submissions on behalf of HMRC that this feature implies that the use of Karakus was artificial and which is the reason, therefore, for the limited value added by it in the business of loan broking."

The FTT noted a number of other key features of the arrangements between Karakus and WFS which were uncommercial or contrary to what would have been expected between a principal and agent. For example, the sourcing and agreement on advertising continued to be made by WFS in practice with no involvement from Karakus. There was no evidence to show that Karakus ever monitored the effectiveness of advertising, how this was done or by whom. This was despite the fact that the original service agreement contained no provision for WFS to undertake this activity and as such WFS appeared to carry out the activity for free. HMRC contended that this lacked commercial credibility and demonstrated the reality that WFS procured advertising services on its own behalf and was therefore the recipient of those supplies. The FTT accepted this argument.

As a result of these finding, the tribunal concluded that the economic and commercial reality of the arrangements was that the advertising services were provided to WFS and not Karakus, despite the contractual arrangements. In the alternative, the tribunal agreed with HMRC that the arrangements were artificial and the structure adopted was abusive. The essential aim of the arrangements was the obtaining of a VAT advantage which was manifestly contrary to the purposes of the VAT Directives.

Comment

The arrangements put in place in this case are largely identical to those in Newey directed to the same VAT saving. As such, the decision in this case highlights how fact specific the application of the principles of abuse and the operation of the economic and commercial reality tests are. The tribunal in this case largely departed from the approach in Newey due to the lack of any evidence that Karakus took any meaningful part in the operation of the business, despite contractually being the principal operator.

It is clear that the success or failure of tax planning in this area depends heavily on the substance of the arrangements. It is not sufficient for the contractual arrangement to put in place a tax saving structure - it is also necessary for the practical operation of those arrangements to match those contractual arrangements in a way which does not involve any artificiality.