Section 274

The taxpayer’s daughter who had recently turned down a gift of a car from her father, became aware that her mother needed a car. In quick succession, she received a gift of the car from her father and gifted it to her mother. Both transfers benefited from a Quebec sales tax exemption for vehicle transfers by way of gift between related persons, whereas a direct gift would not have been exempted because the father and mother (the taxpayer) were divorced.

In finding that these transfers were not avoidance transactions for purposes of s. 480 of the general anti-avoidance rule in the Quebec Sales Tax Act, Poirier JCQ stated (at para. 37, TaxInterpretations translation):

The context does not indicate that the transaction was effected in two stages simply to avoid the payment of tax. The testimony of Madame Soucy instead indicated that the purpose in proceeding in this manner was to obtain the vehicle. Nothing indicates that Monsieur Rivard would have accepted or welcomed a gratuitous transfer of his vehicle to his ex-wife. The evidence reveals instead that he was prepared to give it to his daughter and that she was prepared to give the same vehicle to her mother.

In also finding (at para. 37) that there was no abuse within the meaning of s. 481 of the QSTA, he stated that "utilizing the exemptions provided by the Act cannot constitute an abuse within the meaning of the Act."

The taxpayers jointly owned a development site in Ireland, on which they constructed 15 holiday homes. Before making sales, in March 2002 they entered into two leases with a company associated with them (Shamrock Estates Limited), namely (i) a lease by which they granted it those properties for a term of 20 years and one month from that date (‘the long lease’) and (ii) a lease under which Shamrock Estates leased the properties back to them for a term of two years. On 3 April 2002 those two leases were extinguished by mutual surrender of the lessees, and the taxpayers therefore recovered full ownership of the properties. In May 2002 the taxpayers sold all the properties to third parties. Under section 4(9) of the VAT Act, no VAT was payable on those sales, as the properties had previously been the subject of a first supply on which VAT was chargeable, when the long lease was granted. According to the national legislation at issue, VAT was chargeable only on the long lease. The Commissioners assessed the taxpayers to pay additional VAT on the sales on the basis that providing for the lease and lease back of the properties constituted a first supply artificially created in order to avoid the subsequent sales being liable to VAT and that supply should therefore be disregarded for the purposes of assessing VAT. The High Court of Ireland ruled that, as those leases had lacked commercial reality, they constituted an abusive practice in accordance with the judgment of 21 February 2006, Halifax and Others (C‑255/02, ‘the judgment in Halifax’, EU:C:2006:121). The Supreme Court decided to stay the proceedings, and its questions referred to the Court of Justice included, inter alia, whether the principle that abusive practices are prohibited must be interpreted as meaning that, in order to determine, on the basis of paragraph 75 of the judgment in Halifax, whether the essential aim of the transactions was to obtain a tax advantage, account should be taken of the objective of the leases preceding the sales of immovable property in isolation, or of the joint objective of those leases and sales as a whole.

The Court stated (at paras 53, 60- 61):

…[T]he case-law stemming from the judgment in Halifax does not require it to be established that the accrual of a tax advantage is the only objective of the transactions at issue. …

In order to determine the substance and real significance of the leases at issue in the main proceedings, the referring court may, in particular, take account of the purely artificial nature of those transactions and the links of a legal, economic and/or personal nature between the operators at issue … . Such aspects are capable of demonstrating that the accrual of a tax advantage constitutes the essential aim pursued, notwithstanding the possible existence, in addition, of economic objectives … .

…[T]he leases … had no commercial reality and were entered into … with the aim of reducing the VAT liability on the sales of immovable property … which they envisaged carrying out subsequently. As regards the fact that, as the appellants… have contended…, those leases were intended to achieve the sales in the most tax efficient way, that objective cannot be regarded as constituting an aim other than obtaining a tax advantage, as the desired effect was to be achieved specifically by a reduction of the tax liability.

The Court found (at para 62):

…[T]he principle that abusive practices are prohibited must be interpreted as meaning that, in order to determine, on the basis of paragraph 75 of the judgment in Halifax, whether the essential aim of the transactions at issue in the main proceedings is to obtain a tax advantage, account should be taken of the objective of the leases preceding the sales of immovable property … in isolation.

The Pendragon Group, the largest car sales group in Europe, used a scheme (devised and marketed to it by KPMG) to reduce its VAT liability. Under the scheme:

• Step 1: Pendragon bought cars (destined for use as demonstrators in Steps 3 and 4) from a wholesaler, then sold them to four captive leasing companies ("CLCs"). Pendragon paid input tax on the wholesale purchase price but recovered it by accounting for output tax received when the cars were sold to the CLCs.
• Step 2: The CLCs immediately leased the cars to Pendragon dealerships. The CLCs paid input tax on the purchase of the cars from Pendragon but recovered it by accounting for output tax paid by the Pendragon dealerships on their rental payments under the leases.
• Step 3: The CLCs then assigned the leases and their title in the cars to an offshore bank Soc Gen Jersey ("SGJ"), in consideration for £20m (financed by SG London, which received a further assignment of the assets as security). This assignment, which qualified as an assignment of leased goods to a financial institution, was therefore "de-supplied" (deemed not to be a supply) so that no VAT was payable.
• Step 4: Some 30 to 45 days later, SGJ transferred its leasing business including the lease agreements and cars to Captive Co 5 for over £18M. This sale of the business as a going concern was de-supplied.
• Step 5: The demonstrator cars were sold to customers by the dealerships, acting as agents for Captive Co 5. Customers paid VAT only on Captive Co 5's profit on the sales, rather than on the total sale price, under the "margin scheme" applicable to second-hand goods, which was available here because the goods had been acquired as part of a business transferred as a going concern.

The scheme was abusive, so that the Commissioners' appeal was allowed.

In Halifax plc v Customs and Excise Commissioners [2006] EUECJ C-255/02, [2006] STC 919, the Grand Chamber stated (paras. 74-5, quoted at para. 7):

[I]n the sphere of VAT, an abusive practice can be found to exist only if, first, the transactions concerned, notwithstanding formal application of the conditions laid down by the relevant provisions of the Sixth Directive and the national legislation transposing it, result in the accrual of a tax advantage the grant of which would be contrary to the purpose of those provisions.

…Second, it must also be apparent from a number of objective factors that the essential aim of the transactions concerned is to obtain a tax advantage. ….[T]he prohibition of abuse is not relevant where the economic activity carried out may have some explanation other than the mere attainment of tax advantages.

Respecting the first condition, Lord Sumption noted (at para. 14) that the VAT "broad principle is that tax on the ultimate value of the product is levied only once, albeit that it may be collected at different stages of the process of manufacture and distribution," and (at para. 20) that normally "the reseller seeking to avail himself of the margin scheme will have acquired the goods from someone with no right to recover input tax in respect of their own acquisition of them" so that "the object and effect is to avoid double taxation," whereas "the effect of the KPMG scheme was to enable the Pendragon Group to sell demonstrator cars second-hand under the margin scheme in circumstances where VAT had not only been previously charged but fully recovered…[so that a] system designed to prevent double taxation on the consideration for goods has been exploited so as to prevent any taxation on the consideration at all" (para. 30).

Respecting the second condition, although the involvement of an offshore bank as "it is no part of the policy of the legislation that a party should be restricted in its freedom to select as its commercial partners firms whose place of residence gives dealings with them a tax advantage, even if that is the only reason for their selection" (para. 33) it was essential to the scheme that Captive Co 5 acquire the cars as part of a business as a going concern, and for that to be possible, it was essential that the transferor of the business have acquired the cars by assignment. "[N]either of these two special features of the scheme had any commercial rationale other than the achievement of a tax advantage" (para. 33).

The appellant ("Michelin") sold its inventory of imported tires to an affiliated corporation ("Uniroyal") on December 28, 1990 and repurchased the inventory on January 2, 1991. As Uniroyal had been registered as a manufacturer, Michelin generated a full refund under s. 68.2 of the 13.5% federal sales tax it had paid; whereas if it had continued to hold this inventry, it would have received a rebate under s. 120 only at a rate of 8.1% as the owner of the tires on Janauary 1, 1991. In confirming the Minister's application of s. 274 to deny a refund of more than 8.1%, the Tribuanl stated (at p. 17-23) that s. 68.2:

allows refunds in case where a manufacturer, wholesale or importer, that has paid FST on the purchase of certain goods, subsequently sell these goods under tax-exempt circumstances. In this case, the Tribunal is of the view that, by allowing the appellant its refund, the overall intent of the provision…would not be met.