VAT Abuse of Rights: The Halifax Principle and TOGC Disputes

HMRC has three separate tools for attacking a VAT structure (abuse of rights, connection with fraud, and economic reality), and correspondence routinely confuses them. This guide sets out the Halifax two-limb test, the consequence of redefinition rather than denial, and the transfer of a going concern conditions where artificiality allegations bite hardest.

Introduction: Three Different VAT Doctrines That Are Constantly Confused

HMRC has three quite distinct tools for attacking a VAT position it regards as unacceptable, and correspondence routinely runs them together. Separating them is the first step in any defence, because each has a different test, a different burden and a different consequence.

The Foundation: Halifax plc v Customs and Excise Commissioners (C-255/02)

The facts

Halifax plc is a bank. As a largely exempt supplier of financial services, it could recover only a small proportion of its input VAT, in the region of 5%. It needed to construct four call centres and would ordinarily have suffered almost the whole of the VAT charged by the builders as an absolute cost.

It therefore interposed two wholly-owned subsidiaries between itself and the third-party builders. Through a carefully sequenced series of loans, prepayments, construction contracts and grants of interests in land, the arrangement was engineered so that the VAT charged by the builders was incurred by a subsidiary with full recovery rights, rather than by Halifax itself. Every step was legally effective. Every step was performed. The result was that the great bulk of the input VAT became recoverable.

The judgment

The Grand Chamber of the Court of Justice held, on 21 February 2006, that the Sixth Directive precludes a taxable person from deducting input VAT where the transactions from which the right derives constitute an abusive practice. The Court set out a two-limb test.

The consequence: redefinition, not denial

Where an abusive practice is found, the transactions involved must be redefined so as to re-establish the situation that would have prevailed in the absence of the transactions constituting the abusive practice. This is the feature that most distinguishes Halifax from Kittel, and it cuts both ways: HMRC must give credit for the VAT position that would have obtained on the redefined basis, including any corresponding input tax entitlement. The Court was explicit that the finding of abuse must not lead to a penalty, for which a clear and unambiguous legal basis would be required.

What the Court left to national courts

The Court held that whether the essential aim of a transaction was to obtain a tax advantage is an evidential matter for the national court, which should take into account the purely artificial nature of the transactions and the legal, economic and personal links between the operators involved.

How the Test Has Been Refined

Part Service Srl (C-425/06)

Clarified “essential aim”. Abuse can be found where the accrual of a tax advantage is the principal aim of the transaction, even if there are also some other economic objectives. It does not have to be the sole aim. This is the answer to the common submission that any identifiable commercial purpose defeats the doctrine. It does not, unless it is more than marginal.

Weald Leasing Ltd (C-103/09)

Important for the taxpayer. Where a business obtains a cash flow advantage by leasing assets rather than buying them outright, that is not in itself abusive: leasing is a normal commercial operation and the deferral of VAT is a consequence the Directive contemplates. Abuse arises only where the terms of the leasing transactions differ from normal commercial conditions, for example where an artificial intermediary is inserted or the rentals are set at levels no arm’s length party would agree.

RBS Deutschland Holdings GmbH (C-277/09)

Where a taxpayer structures a genuine commercial activity so as to take advantage of differences in the way Member States implement the Directive, and the transactions are real economic activities, that is not abuse. A taxpayer is entitled to choose the structure of its business so as to limit its tax liability.

Newey (t/a Ocean Finance) (C-653/11)

On the relationship between contract and reality. Contractual terms normally reflect the economic and commercial reality of the transactions and are the starting point. But they may be disregarded where they do not reflect that reality, in particular where they constitute a wholly artificial arrangement not corresponding with economic reality and set up with the essential aim of obtaining a tax advantage.

HMRC v Pendragon plc [2015] UKSC 37

The leading domestic application. A motor dealer group used a captive offshore leasing structure so that demonstrator vehicles could be sold to the public under the second-hand margin scheme, in circumstances where the input tax had already been recovered in full. The Supreme Court held the arrangement abusive: the essential aim was the tax advantage, and the advantage was contrary to the purpose of the margin scheme, which exists to prevent double taxation of goods on which VAT has already stuck. Pendragon is also an important authority on the appellate function, because the Supreme Court restored the FTT’s decision after the Court of Appeal had interfered with it, a point discussed in our analysis of Edwards v Bairstow.

Does Halifax Survive Brexit?

Yes. The abuse of rights principle continues to apply as part of assimilated law and is regularly deployed by HMRC and applied by the tribunals. Practitioners should nonetheless keep two developments in view. First, the Retained EU Law (Revocation and Reform) Act 2023 altered the status of general principles of EU law, while s28 of the Finance Act 2024 made specific provision preserving the interpretation of VAT and excise legislation consistently with assimilated case law. Second, and more practically, the tribunals have continued to apply Halifax, Kittel and the related jurisprudence without material change of approach. The safe working assumption is that the doctrine is intact.

Transfers of a Going Concern: Where Artificiality Arguments Bite Hardest

TOGC disputes are the most common context in which HMRC alleges that a VAT structure lacks reality, particularly in property transactions where the SDLT and cash flow consequences of getting it wrong are severe.

The framework

Article 19 of the Principal VAT Directive permits Member States to treat the transfer of a totality of assets or part thereof as not being a supply. The United Kingdom has done so in Article 5 of the Value Added Tax (Special Provisions) Order 1995. Where the conditions are met, treatment as a TOGC is mandatory, not elective, a point that catches out parties who purport to opt in or out by agreement.

The conditions

• The assets transferred must be used by the transferee in carrying on the same kind of business as the transferor.
• Where the transferor is a taxable person, the transferee must be, or immediately become, a taxable person.
• There must be no significant break in the normal trading pattern before or immediately after the transfer.
• Where only part of a business is transferred, that part must be capable of separate operation.
• For land and buildings which would be standard-rated (new commercial buildings, or where the transferor has opted to tax), the transferee must have opted to tax with effect from the relevant date, must notify that option to HMRC, and must notify the transferor that the option will not be disapplied by the anti-avoidance provisions in Schedule 10 VATA 1994.

Zita Modes Sarl v Administration de l’enregistrement et des domaines (C-497/01)

The governing authority on what constitutes a transfer of a totality of assets. The Court held that the concept covers the transfer of a business or an independent part of an undertaking capable of carrying on an independent economic activity, and that the transferee must intend to operate the business rather than immediately liquidate it. The transferee does not need to have carried on the same type of business before the transfer.

Common failure points in practice

• The option to tax notification is late or defective. The transferee’s option must have effect from the relevant date and must be notified. HMRC’s change of practice on option to tax acknowledgements has made evidencing this harder, and the notification email or receipt should be preserved.
• The Schedule 10 disapplication notification is overlooked. This is a separate written notification from the transferee to the transferor and is missed with striking regularity.
• A property letting business is transferred to a purchaser who intends to develop or occupy. If the purchaser will not carry on the same kind of business, the conditions fail.
• A surrender or grant of a new interest rather than an assignment. The nature of the interest transferred matters.
• Group registration and connected party structures. Where the transferee joins a VAT group, the analysis changes and HMRC may argue that no separate business is being carried on.

The consequences of getting it wrong

• VAT charged where the transaction was a TOGC. The amount charged is not VAT properly due and is therefore not input tax in the transferee’s hands. HMRC will deny recovery, and the transferee’s remedy is against the transferor in contract or restitution, which is worthless if the transferor has been dissolved or has distributed the proceeds.
• VAT not charged where the transaction was not a TOGC. The transferor is liable for the output tax, often on a VAT-inclusive basis if the contract is silent, plus interest and potentially a Schedule 24 penalty.
• SDLT. SDLT is charged on the VAT-inclusive consideration, so an incorrect TOGC treatment produces an SDLT error as well, with its own enquiry window and penalty exposure.
• Capital goods scheme. On a TOGC the transferee inherits the transferor’s CGS obligations, which are frequently not identified at the time and surface years later.

Practitioner Application

Responding to an abuse allegation

• Make HMRC plead both limbs. HMRC must identify the specific provision, articulate its purpose, and explain why the advantage obtained is contrary to that purpose. An assertion that the arrangement was “artificial” is not a pleaded case.
• Evidence the commercial aim. Under Part Service the tax advantage must be the essential aim. Contemporaneous board minutes, funding papers, commercial modelling and third-party negotiations are the evidence that displaces it.
• Use Weald Leasing and RBS Deutschland. Normal commercial operations that happen to produce a VAT benefit are not abusive. A taxpayer may structure its affairs to limit tax.
• Insist on proper redefinition. If abuse is established, the consequence is reconstruction of the counterfactual, including any input tax that would have been recoverable. HMRC sometimes assesses the output tax and stops there.
• Resist penalty drift. The Court of Justice held that abuse must not lead to a penalty absent a clear legal basis. A Schedule 24 penalty requires a separate finding of careless or deliberate behaviour, which does not follow from a construction loss.

Preventive steps on a TOGC

• Run a written TOGC checklist against each condition and retain it on file.
• Obtain and preserve evidence of the transferee’s option to tax and of the Schedule 10 notification, both dated before completion.
• Include a VAT clause dealing expressly with the consequences if HMRC later disagrees, with an indemnity and a mechanism for issuing a VAT invoice.
• Consider a non-statutory clearance where the position is genuinely uncertain and the sums are material.

Frequently Asked Questions