Though many accounts of the decision have focused upon the reduction in VAT payable to HMRC (described as a "windfall" for GMAC), placed in context, the ECJ's judgment represents a principled and sensible approach to the rights of the taxpayer in the face of a jumble of defective national legislation.
Straightforward business model
GMAC's principal business is the selling of cars on hire purchase (HP). The business model is straightforward: a customer picks the vehicle they want from a third-party dealer and requests an individual financing arrangement. Once terms have been agreed, the dealer sells the car to GMAC, who then supplies the car, under a HP contract, to the customer.
In the event that the customer and GMAC agree to the return of the car early, or if the customer defaults, GMAC repossesses the car and sells it at auction. The proceeds from that auction are then deducted from the balance of the customer's outstanding monthly payments under the contract and the customer either pays or defaults.
The sale of the car by the dealer to GMAC is subject to VAT at the standard rate, as is the provision of the car under the HP contract (excluding the finance charge). In circumstances where an amount of consideration for the supply is reduced (by agreement or default) Article 11C(1) of the Sixth Directive (77/388/EEC, Now Art. 90, Principal VAT Directive 2006/112/EC) comes into play:
"In the case of cancellation, refusal or total or partial non-payment, or where the price is reduced after the supply takes place, the taxable amount shall be reduced accordingly under conditions which shall be determined by the Member States. However, in the case of total or partial non-payment, Member States may derogate from this rule."
Inserted in UK law
Article 11C(1) was implemented into UK legislation by a relatively circuitous route. Specifically, by two sets of provisions. The first dealt with circumstances where there was a reduction in the amount of consideration. Regulation 38 Value Added Tax Regulations 1995 (Similar rules had applied in the period 1990 to 1995.) required the taxable person to make an adjustment to its VAT account to reflect the change in value (evidenced usually by credit note) which included the total costs applying to the supply inclusive of any proceeds derived from the auction sale (which were deducted from the sum owed by the HP customer).
The second related to bad debt relief. For supplies between October 1978 and July 1990, the "old scheme" (section 12 FA 1978 and section 22 VAT Act 1983) permitted the adjustment of a VAT account where there had been partial or total non-payment upon proof of the debt in the customer's insolvency. Section 11 Finance Act 1990 replaced these provisions (after a short period of overlap) with a "new scheme" for supplies made after April 1 1989, essentially removing a requirement for the proof mentioned above.
HMRC always accepted that on a consensual termination of a HP contract and subsequent sale of the car, Regulation 38 applied since the total consideration paid for the car (inclusive of the proceeds of the auction sale) formed part of the calculation. HMRC did not, however, accept that the regulation applied in circumstances of default. This was due to a provision in the Value Added Tax (Cars) Order 19923 (the Cars Order) which stated that in circumstances of repossession, any on-sales by auction were considered "de-supplied" for VAT purposes, that is, no VAT was chargeable. (The UK had allowed VAT deductions on the sale of second-hand vehicles in essentially the same terms in successive pieces of legislation.)
HMRC’s incompatible approach
In C&E Commissioners v GMAC ( STC 577), the High Court found that HMRC's application of Regulation 38 was incompatible with the direct effect of Article 11C and that Regulation 38 applied also to cases of default. The High Court considered the Cars Order also applied, with the effect that GMAC did not have to pay VAT on the auction proceeds. The combined effect of the transactions was to reduce the overall VAT base.
GMAC made a claim for bad debt relief in relation to HP agreements based on the direct effect of article 11C. HMRC rejected the claims on the basis that the taxpayer was not permitted to rely on directly effective rights because the consequences of doing so would partially defeat the purpose of the directive owing to the effect of defective provisions of the Cars Order.
To make good this argument HMRC was required to view the HP agreement and the auction sale as together, as "related supplies". This represented a significant departure from ECJ case law and had the potential, if accepted by the court, to inject considerable uncertainty into all manner of VAT transactions in other spheres subject to scrutiny by HMRC as forming part of "related supplies".
To complete the package, HMRC also ran the argument that GMAC's claim failed the test in Halifax and was abusive.
The main question of principle, however, was the extent to which taxpayers can rely on directly effective rights. The deeply unpalatable position of HMRC was that the taxpayer's rights in this regard could be restricted in this case because of the defects present in domestic legislation.
This case has generated interest because of the use of the word "windfall" to describe GMAC's claim. It is true that the UK did not intend for the Cars Order to operate in the way it has. That is unfortunate, but as the ECJ highlighted, in circumstances where a number of options are available to a taxpayer, he is free to structure his affairs in such a way so as to limit his liability to tax. This simple principle undermined all HMRC's arguments on the limitation of direct effect and the hopeless argument that in relying on the straightforward application of provisions of UK law the taxpayer was in some way acting abusively. In short, the UK was not permitted to rely on defects contained in its own legislation to bar taxpayers' ability to rely on EU rights.
GMAC's tax base is accordingly reduced in a manner not anticipated by HMRC, but on principle the decision is the right one and it is difficult to see how GMAC can be criticised for seeking to limit its liability in the way it has. Clearly the ECJ did not think so either.
Robert Waterson (Senior Associate, RPC) and Nigel Brook (Associate, RPC)
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