Vodafone Scores Key Goal For UK Multinationals In Luxembourg Tax Case

by Robert Lee, Tax-News.com, London

08 July 2008

Vodafone has won a key legal battle against the UK tax authority, HM Revenue and Customs, in a judgment that has cast major doubt on the compatibility of the UK's controlled foreign companies (CFC) regime with European Union law.

Mr Justice Edward Evans-Lombe ruled in the High Court on 4th July that Vodafone does not have to pay UK corporation tax on income attributed to its Luxembourg holding company Vodafone Investments Luxembourg Sarl (VIL). Consequently, he ordered HMRC to shut an ongoing tax inquiry into Vodafone's tax for the year to March 2001.

Vodafone has estimated that the court victory has saved it more than GBP2bn (USD4bn) in tax and interest that it might have been ordered to pay had the judgment gone against the company. However, the ruling also has ramifications that go much wider than Vodafone's corporate arrangements, and several UK-based multinationals with subsidiaries in favourable EU tax jurisdictions such as Ireland, Luxembourg and the Netherlands, who are said to be under a similar type of scrutiny from HMRC, are likely to be breathing a sigh of relief as a result.

The case dates back to 2002 after Vodafone set up VIL to dispose of its shares in the German telecommunications group Mannesman, which it acquired in 2000. VIL is also used to circulate cash and profits around the group and as a vehicle to fund other acquisitions.

HMRC argues that under the UK CFC rules, it has the right to tax the difference between rate a subsidiary pays in a low tax jurisdiction overseas and the rate it would have paid on that income in the UK - a principle that it attempted to apply in the Vodafone case.

However, Justice Evans-Lombe referred back to a precedent set in 2006 by the European Court of Justice (ECJ) in a case involving Cadbury-Scweppes, which said that the UK CFC rules were incompatible with EU law because they were too restrictive and should only be applied in cases where companies set up artificial arrangements aimed solely at avoiding tax.

While the UK Treasury moved to amend CFC regulations in the wake of the Cadbury-Schweppes ruling, Justice Evans-Lombe argued that these amendments have not gone far enough to address their incompatibility with EU law, and he urged the government to revisit the legislation.

"In my judgement, the CFC legislation must be disapplied so that, pending amending legislation or executive action, no charge can be imposed on a company such as Vodafone under the CFC legislation," he said, going on to add that:

"It seems to me that all UK taxpayers, including Vodafone, were and are entitled to be told by legislation, of which the meaning is plain, what the tax consequences for them will be if they decide to incorporate a controlled foreign company in a (EU) member state."

The UK government is currently in the process of reviewing its stance on the taxation of multinationals' international income, but tax experts have said that the latest judgment has thrown the situation into chaos, and may have left the UK with a completely unenforceable set of CFC legislation.

“The High Court has expressed ‘some doubt’ as to the efficacy of sticking plaster amendments introduced in 2006,” Mark Persoff of Clifford Chance, the legal firm was quoted as saying by the Financial Times. “This means, as matters now stand, the UK probably has no enforceable CFC legislation so far as EU/EEA subsidiaries are concerned.”

Peter Cussons, a tax partner at PriceWaterhouseCoopers, described the ruling as a "blockbuster judgement."

"This is big news because there are thousands of UK companies with foreign subsidiaries in the European Union," he told the Telegraph. "There will have been CFC tax paid over the years, hundreds of millions of pounds per annum, and potentially, upon claims being made, all that tax is up for grabs," he added.

It is unclear at this stage whether HMRC will appeal the ruling, although it has the right to do so. However, Cussons thinks that the government stands little change of overturning "such a well-argued judgment" in the House of Lords.

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