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VAT and fraus legis doctrine

by Technical Department at 00:00 23/06/01 (Technical Articles)
Article by John McCarroll LLB(Hons) ATT ATII, published in the June 2001 issue of Tax Adviser.
Increasingly, fraus legis is being thrown into the melting pot of arguments and disputes between taxpayers and the Commissioners of Customs and Excise. The commissioners are increasingly setting out arguments based upon it in their decision letters and statements of case. But what is it? What is the authority for its use? What is its application to VAT? Why is it being put forward in the face of technical VAT arguments based on established law?

The determination of these questions is now before tribunals and courts of law. However, the tax practitioner should be aware of fraus legis. Although a fledgling concept in VAT, it is increasingly an issue to be addressed.

Background

Fraus legis is a legal principle developed by the Court of Justice of the European Communities (CJEC) that prevents a person from relying on a right in law where such reliance would constitute an abuse of that right (see Note (1)). The case law demonstrates two circumstances when the principle has been applied, or its potential applicability recognised:

  1. a person seeks to rely on a European legal right to circumvent or displace national law; and
  2. a person seeks to take advantage of a right in European law, but in a manner running contrary to its spirit.

The CJEC is recognising the full and proper construction of the European right upon which a person wishes to rely, but prevents its use in any event.

This principle of fraus legis sits alongside other developed principles of law that maintain fundamental rights already accepted in the legal systems of the member states and in internationally recognised treaties. These general principles are not closed and include equality, proportionality, neutrality, and legal certainty. The main thrust of the application of fraus legis by the commissioners has been in relation to tax avoidance but one might consider that this abuse of law or fraus legis principle has a potentially vast application to a European tax such as VAT. However, to date no VAT cases have been referred to the CJEC on this point.

Caselaw

Although there is a lack of VAT referrals to the CJEC on the fraus legis principle, a sample (see Note (2)) of the cases where it has been considered, enables us to put the principle in context. In the case of TV10 SA v Commissariaat voor de Media (Case C-23/93) (1994) ECR I 4795, TV10 is a company registered in Luxembourg that primarily, but not exclusively, produces programmes for audiences in the Netherlands. TV 10 sought to rely on the freedom to provide services enshrined in the former art. 59 (now art. 49) of the EC Treaty when the Dutch regulatory authority refused TV10 authorisation to transmit programmes via the Dutch cable network. The regulatory authority considers that the establishment that TV10 has in Luxembourg is an attempt to evade the requirements and obligations that domestic broadcasters must undertake to transmit through the cable network. Advocate General Lenz and the court held that a member state could impose restrictions upon a person where the latter is wrongfully exercising freedoms guaranteed by the EC Treaty to avoid obligations under national law.

In General Milk Products GmbH v Hauptzollamt Hamburg-Jonas (Case-8/92) (1993)1 ECR I 779, the CJEC considered monetary compensation payments made under the Common Agricultural Policy. General Milk imports cheese from New Zealand to Germany with some quantities being shipped onward from Germany to Denmark and France. Under EC regulations (see Note (3)), General Milk qualifies for monetary compensation on the cheese exported from Germany. However, the German authorities refused the claim submitted by the exporter on the grounds that the initial importation to Germany enabled General Milk to wrongfully take advantage of compensation payments for the onward shipment to other member states. Advocate General Darmon and the Court held that the claim was valid, but that such a claim for compensation would not be allowed for the sole purpose of wrongfully securing an advantage under EC regulations.

Application

In the TV10, General Milk and other cases, the parties involved have been relying on provisions of the EC Treaty or EC regulations (see Note (4)) that have direct applicability. This means that the rules, upon their enactment, automatically become part of the law of all member states. The position of VAT is different. The member state must implement the sixth VAT directive, Directive 77/388, on to the domestic statute book to give it legal effect. Therefore, one has, in lay terms, the ground rules for the European VAT system, in the directive, and the UK interpretation and implementation of those rules in the Value Added Tax Act 1994. The latter is not a mirror image of the former and therefore, given the circumstances where fraus legis has been recognised, one must be precise in applying it to VAT.

The commissioners have put a fraus legis argument in the face of what they consider to be avoidance of VAT. Therefore, as taxpayers structure their affairs for efficiency, within a legal framework, the authorities consider this to be an abuse of law. The commissioners consider that the support for such an approach is provided by the words of Advocate General Colomer in R v C & E Commrs, ex parte EMU Tabac SARL (Case- 296/95) judgment delivered 2 April 1998. In this case regarding excise duties, the Advocate General stated:

‘In the same way, if it were necessary to do so as a last resort, the national court could decline to apply the rule contended for by the appellants (taxation by origin) on the basis that to apply it to the present case would clearly run counter to the spirit and purpose of the Directive and would be inimical to the effectiveness of the other provisions in it. By doing so it would merely be applying the general legal principle prohibiting acts in fraud of the law.’

It is agreed that the Advocate General is recognising the existence of the principle and its potential application in that case. Interestingly, the judgment of the court does not mention the principle and answered the referred questions without recourse to fraus legis.

Assistance in applying the fraus legis principle has been provided by Advocate General Le Pergola in Centros Ltd . Erhvervs-QG Selskabsstyrelsen (Case-212/970) [2000] WLR 1048. This is a case that concerned the place of establishment for a body corporate and whether there was an abuse of that right of establishment. Advocate General Le Pergola considered that the right would have to be identified, and to determine whether that right had actually been exercised in an abusive manner was simply to define its material scope. Therefore, for the purposes of VAT one must identify whether the taxpayer is seeking to rely on European law or on the UK interpretation of it. From established case law it would appear that sole reliance on the sixth VAT directive could be sufficient to advance a valid abuse of law argument. However, one would have to question whether the articles of Directive 77/388, are to be read in light of the implied term, subject to fraus legis.

A step too far

The use of the fraus legis principle, where the taxpayer relies on the wording of the UK legislation, is one that the author considers to be a step too far. First, the UK statute is the interpretation and implementation by the UK member state of the European directive. The reliance by the commissioners on a fraus legis principle against a taxpayer maintaining the UK law must place into question the domestic execution of the European law. Moreover, the adoption of this principle by the CJEC is due to its use within those member states with a civil law system. Although, in administrative common law it is accepted that a court will not tolerate an applicant abusing his prima facie legal entitlement (lacking clean hands), such an approach has not been tested and may have no grounds of applicability for the taxpayer. One might even go as far as to say that it is contrary to the principles set out in Ayrshire Pullman Motor Services & Ritchie v IR Commrs (1929) 14 TC 754 and IR Commrs v Duke of Westminster (1936) 19 TC 490, when a taxpayer had relied on the UK legislation to structure his tax affairs in an efficient manner. Beyond the possibility of any common law alternative, the CJEC has never provided any ground for this principle to apply beyond reliance on a European right. To do so is to stretch the doctrine too far. Given the uncertainty of scope, the commissioners may seek to rely on a more precise method of preventing what they consider to be VAT avoidance. Article 27(1), of the sixth VAT directive provides that member states may receive a derogation to simplify the procedure for charging tax to prevent tax evasion or avoidance. The use of this provision would enable the commissioners to act with far more accuracy and effect to halt alleged avoidance. In addition, such action would maintain another European legal principle by providing taxpayers with greater legal certainty in a European VAT regime far from harmonisation.

Conclusion

As stated at the outset, this is an issue to be resolved in the domestic courtrooms and probably Europe. If use of the fraus legis principle is accepted then the commissioners may regard it as filling a void in anti-avoidance legislation. However, if its use is unsuccessful in their eyes one may see further specific, or the initiation of general, anti-avoidance legislation.

Notes
(1) CJEC adoption of the principle based essentially on the common law of member states with a civil law system: see LN Brown Is there a General Principle of Abuse of Rights in European Community Law? in Essays in honour of Henry G Scherrners (1994) vol. II Institutional Dynamics of European Integration (D Curtin and T Heukels (ed)).
(2) Other cases referring to the abuse of law principle include:
Alexandros Kefalas v Elliniko Dimosio (Greek State),
Organismos Ikonomikis Anasinkrotisis Epikhiriseon AE (OAE) (C-367/96) [1996] ECR I 2843;
Zunis Holdings SA v Commission of the European Communities (C-480/93) [1996] ECR I 1;
Lair v Universitat Hannover [1988] ECR 3161;
Leclerc v Au Ble Vert (229/83) [1985] ECR I 1;
Brennet v Paletta (C-206/94) [1996] ECR I 2357.
(3) Commission Regulations No. 1371/81 and No. 900/84.
(4) The author is aware that certain regulations, such as those relating to agriculture, require some implementation by member states.

Technical Department
020 7235 9381

June 2001 by John McCarroll

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