Ocean Finance (C-653/11)
On 20 June 2013, the Court of Justice of the European Union (CJEU) published its decision in the Ocean Finance Case (C-653/11) and stated that the consideration of economic and commercial realities is a fundamental criterion for the application of the common system of VAT which may be more decisive than the contractual terms for identifying the recipient of a supply of services.
In the case at hand, Paul Newey, a loan broker established in the United Kingdom (UK) supplied VAT exempt broking services not entitling to any input VAT recovery right within the UK. At the same time, he received advertising services for the promotion of his business, which were subject to VAT in the UK. In consequence, the VAT paid by Paul Newey for the advertising services was not recoverable.
In order to avoid the non-recoverable tax burden, Paul Newey incorporated the offshore broking company Alabaster (CI) Ltd (Alabaster) based and managed in Jersey, a territory in which the Sixth Directive does not apply by persons with no broking experience. He was the sole shareholder of Alabaster and granted the company an exclusive right to use the name Ocean Finance.
Henceforth, the broking agreements were concluded between the borrowers and Alabaster and the broking commissions were paid directly to Alabaster in Jersey and not to Paul Newey in UK.
Alabaster outsourced all the processing tasks for the loan broking business to Paul Newey in the UK and he was also entitled to negotiate the terms of the broking agreements concluded between Alabaster and lenders. In return, he received remuneration from Alabaster.
Alabaster purchased advertising services, which were provided by a UK based agency to a Jersey based agency which then provided the advertising services to Alabaster. Paul Newey was in no contractual relationship with the Jersey based agency, but he was entitled to discuss the content of the advertisements with the UK based agency.
Consequently, no VAT was charged on the advertising services received by Alabaster.
The UK tax authorities challenged this structure arguing that Paul Newey avoided paying VAT on taxable advertising services by going offshore. Based on their opinion, Paul Newey was providing the loan broking services within the UK territory and received the advertising services for this business in the UK. Thus, the advertising services should have been subject to UK VAT, which would be non-deductible for Paul Newey.
In this context, the main aspect of the questions referred to the CJEU was whether the contractual terms are to be considered as decisive in determining the supplier and recipient in a supply of services for VAT purposes.
The CJEU stated that contractual terms normally reflect the economic and commercial reality of transactions and that to satisfy the requirements of legal certainty, the relevant contractual terms constitute a factor to be taken into consideration, when the supplier and the recipient in a taxable transaction have to be identified.
At the same time, the Court stressed that preventing possible tax evasion, avoidance and abuse is an objective recognized and encouraged by the Sixth Directive and that the effect of the principle that the abuse of rights is prohibited is to bar wholly artificial arrangements which do not reflect economic reality and are set up with the sole aim of obtaining a tax advantage.
As a consequence, contractual terms may be disregarded in certain cases, in particular, when it becomes apparent that they do not reflect the economic and commercial reality, but constitute a wholly artificial arrangement which does not reflect economic reality and was set up with the sole aim of obtaining a tax advantage.
The CJEU left it to the referring court to determine whether the contracts reflected the economic reality. If not, the 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. In this case, Paul Newey could be regarded as the supplier of the loan broking services and the recipient of the supplies of advertising services at issue.
This case reinforces the position of the tax authorities when fighting against tax fraud and abusive practice. For businesses, it stresses out the importance of having a well structured documentation reflecting the economic reality and warns again against temptation to use commercial agreements to artificially decrease the VAT weight.
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