HM Revenue and Customs v Isle of Wight Council & Ors

This is the resumed hearing of an appeal against orders of the Value Added Tax and Duties Tribunal that I heard over 27 to 29 November 2006 and on which I gave my reserved judgment on 16 February 2007 ([2007] EWHC 219 (Ch); [2008] STC 614). By that judgment I explained why I considered it not to be possible to decide the appeal without first obtaining the benefit of answers to three questions from the Court of Justice of the European Communities (“the ECJ”). The parties drafted the questions, I approved them and stayed the proceedings until after they had been answered. On 16 September 2008 the ECJ delivered its judgment, which answered the first and third questions and answered the second question in a sense that was strictly an answer to a different question. On 30 January 2009 the ECJ rectified its judgment in a formal respect.

The appeal has been restored to me for final disposal. There is no dispute that, in light of the ECJ’s answers, the appeal must be allowed to the extent of setting aside the orders of the tribunal below. The issue is whether, as the appellants contend, I can and should go further and answer in their favour the substantive question that is in issue; or whether, as the respondents contend, I should remit the case for a re-hearing by the tribunal.

The appeal is from a decision dated 23 January 2006 of the tribunal (Stephen Oliver QC, Chairman, and Kenneth Goddard MBE) [2006] UK VAT V19427. Before the tribunal were appeals by four local authorities: the Isle of Wight Council, the Mid-Suffolk District Council, the South Tyneside Metropolitan Borough Council and the West Berkshire District Council. All four provide off-street car-parking facilities of a nature similar to the type of like services provided by the private sector. The relief sought by the appellants was an order for the repayment of value added tax (“VAT”) paid on its revenue from that activity. The case turned on the provisions of article 4.5 of EC Council Directive 77/388, the Sixth Directive. I set out the relevant provisions in paragraphs 8 and 9 of my reserved judgment and do not propose to set them out in full again, although in order that this judgment may be intelligible on a stand-alone basis, I will at least set out the first three unnumbered subparagraphs of article 4.5, which, as before and for ease of reference, I will number. They provide:

“5(1) States, regional and local government authorities and other bodies governed by public law shall not be considered taxable persons in respect of the activities or transactions in which they engage as public authorities, even where they collect dues, fees, contributions or payments in connection with these activities or transactions.

(2)

However, when they engage in such activities or transactions, they shall be considered taxable persons in respect of these activities or transactions where treatment as non-taxable persons would lead to significant distortions of competition.

(3)

In any case, these bodies shall be considered taxable persons in relation to the activities listed in Annex D, provided they are not carried out on such a small scale as to be negligible.”

The essence of the local authorities’ case before the tribunal was that as (which was not disputed) they were providing their parking facilities in their capacity as public authorities, they were excluded by article 4.5(1) from being considered as taxable persons for VAT purposes. The essence of the case for the Commissioners of Her Majesty’s Customs & Excise (“HMRC”) was that they were to be considered as taxable persons in respect of their parking activities, because otherwise that “would lead to significant distortions of competition” within the sense of article 4.5(2). HMRC’s case was thus that article 4.5(2) applied on the facts to the relevant activities and deprived the local authorities of the benefit of article 4.5(1).

In resolving that difference, there was an issue before the tribunal as to whether the question posed by article 4.5(2) required, as the local authorities claimed, an assessment of the competition question on a “local authority by local authority” approach, being one focused on the impact of the car-parking activities of each authority upon markets within a local geographic area; or whether, as HMRC claimed, it required an approach on a so-called “activities” basis involving instead a nationwide assessment as to the economic impact on the private sector of the car-parking facilities provided by local authorities. The tribunal answered that question in favour of the local authorities.

Another issue was what was meant by “would lead to” in article 4.5(2). The tribunal discussed this briefly but did not identify with clarity what test it applied (see paragraphs 44 and 45 of its judgment). A third issue was what was meant by “significant” in article 4.5(2). The tribunal’s conclusion, in paragraph 40, was that it meant that HMRC had to show that there was “some distortive effect that is exceptional in comparison with the normal consequences of removing the local authority’s service from the scope of VAT”.

The outcome was that the tribunal upheld the appeals of all four appellant authorities. HMRC’s appeal to the High Court against that decision put in issue the tribunal’s approach to each of the three issues just described. I referred to the ECJ questions in relation to each of them.

The ECJ answered the first question -- whether article 4.5(2) requires a “local authority by local authority” approach or a national “activities” approach -- in favour of the “activities” approach. Its answer, in paragraph 53, was that:

“… the significant distortions of competition, to which the treatment as non-taxable persons of bodies governed by public law acting as public authorities would lead, must be evaluated by reference to the activity in question, as such, without such evaluation relating to any local market in particular.”

The explanation for that conclusion is in paragraphs 25 and following of the ECJ’s judgment. It was as follows. The general rule is that the supply of services for a consideration is to be subject to VAT. It is only by way of derogation from that rule that certain activities of an economic nature are not so subject. Such a derogation is to be found in article 4.5(1), which, in paragraph 31, the ECJ explained as covering:

“… principally activities engaged in by bodies governed by public law acting as public authorities, which, while fully economic in nature, are closely linked to the exercise of rights and powers of public authority. In those circumstances, the fact that such bodies are not subject to VAT on those activities does not potentially have an anticompetitive effect, inasmuch as they are generally engaged in exclusively, or almost exclusively, by the public sector.”

There will, however, be cases in which the economic activities so carried on by a public authority will also be carried on in parallel by private operators, with the consequence that to treat the public authority as non taxable may give rise to distortions of competition. That undesirable result was sought to be avoided by article 4.5(3) (relating to the Annex D activities), which derogates from the article 4.5(1) exception in specified classes of case, save in any such case in which the scale of the activity carried on by the public authority is so small as to be negligible. The ECJ explained in paragraph 35 that the sense of article 4.5(3) is that, save where the scale of the activity is negligible, there is a presumption that the public authority’s position as a non-taxable person will lead to distortions of competition. In paragraph 36 the ECJ explained that the Annex D activities are not, however, exhaustive of the activities of an economic nature in which a public authority may engage and which also may be carried on by private operators. Its judgment continued:

“37.

It is precisely to those activities that the second subparagraph of Article 4(5) of the Sixth Directive applies, in providing that bodies governed by public law, even when they act as public authorities, are to be considered taxable persons where their treatment as non-taxable persons would lead to significant distortions of competition.

38.

The second and the third subparagraphs of Article 4(5) of the Sixth Directive are, consequently, closely linked since they pursue the same objective, namely the treatment of bodies governed by public law as taxable persons, even when they are acting as public authorities. Those subparagraphs are thus subject to the same logic, by which the Community legislature intended to limit the scope of the treatment of bodies governed by public law as non-taxable persons, so that the general rule stated in Articles 2(1) and 4(1) and (2) of that directive, under which any activity of an economic nature is, in principle, to be subject to VAT, is observed.

39.

Consequently, the second and third subparagraphs of Article 4(5) of the Sixth Directive are to be interpreted as a whole.

40.

It follows that the treatment of bodies governed by public law as taxable persons, either on the basis of the second subparagraph of Article 4(5) of the Sixth Directive, or on that of the third subparagraph of that provision, results from the carrying-on, as such, of a given activity, irrespective of whether or not those bodies face competition at the level of the local market on which they engage in that activity.’”

The ECJ went on to explain how that conclusion was supported by the general principles of community law relating to fiscal neutrality and legal certainty. As for the former, whilst the Directive provided for certain derogations that may interfere to some extent with it -- like the derogation under article 4.5(1) -- such derogation must be interpreted so as to inflict the least possible damage on the principle. If the distortions on competition referred to in that subparagraph

“46.

… are analysed by reference to the activity as such, irrespective of the conditions of competition prevailing on a given local market, compliance with the principle of fiscal neutrality is ensured, given that all bodies governed by public law are either taxable or non-taxable persons, the sole strain on that principle concerning only relations between those bodies and private operators, and that to the extent that the distortions of competition remain insignificant.”

The second question posed for the court (set out in paragraph 12 of its judgment) was as to the meaning of the expression “would lead to” in article 4.5(2): in particular, what degree of probability or level of certainty was required for that condition to be satisfied. In paragraph 54 the ECJ embarked on that question by re-expressing it as being whether “in essence [the relevant phrase] is to be interpreted as encompassing only actual competition or as extending also to potential competition”, although it recognised that the court was also being asked “for clarification as to what degree of probability is required for that condition to be satisfied”. In paragraphs 55 to 59 the ECJ summarised the arguments put before it, which focused almost entirely on the question actually posed. It then gave its answer to the second question in paragraphs 60 to 65, which I should set out:

“60.

It is important to record, as is clear from paragraph 30 of the present judgment, that the treatment of bodies governed by public law as non-taxable persons under the first subparagraph of Article 4(5) of the Sixth Directive constitutes a derogation from the general rule that any activity of an economic nature be subjected to VAT, and that this provision must, therefore, be interpreted strictly. But the second subparagraph of Article 4(5) restores that general rule in order to avoid such treatment of those bodies leading to significant distortions of competition. The latter provision cannot therefore be construed narrowly.

61.

The scope of the first subparagraph of Article 4(5) of the Sixth Directive would be enlarged unduly if the treatment, under the second subparagraph of Article 4(5), of those bodies as taxable persons had to be confined to cases of distortion of actual competition, which would, were they confronted only with potential competition, permit their treatment as non-taxable persons.

62.

In addition, the treatment of those same bodies as non-taxable persons is liable, by itself, to discourage potential competitors from entering the market for the provision of off-street car-parking facilities.

63.

It follows that the expression ‘would lead to’, for the purposes of the second subparagraph of Article 4(5) of the Sixth Directive, encompasses not only actual competition, but also potential competition.

64.

However, the purely theoretical possibility of a private operator entering the relevant market, which is not borne out by any matter of fact, or by any objective evidence or by any analysis of the market, cannot be assimilated to the existence of potential competition. To make such an assimilation, that possibility must be real, and not purely hypothetical.

65.

Consequently, the reply to the second question must be that the expression ‘would lead to’ is, for the purposes of the second subparagraph of Article 4(5) of the Sixth Directive, to be interpreted as encompassing not only actual competition, but also potential competition, provided that the possibility of a private operator entering the relevant market is real, and not purely hypothetical.”

The third question was as to the meaning of “significant” in article 4.5(2). The ECJ’s approach was again coloured by its consideration of article 4.5(3). Its reasoning and conclusion are sufficiently explained by citing from three more paragraphs of its judgment:

“75.

… under the third subparagraph of Article 4(5) of the Sixth Directive, bodies governed by public law are taxable persons for the activities listed in Annex D thereto, provided they are not carried out on such a small scale as to be ‘negligible’. In other words, the treatment of those bodies as non-taxable persons is permitted provided that those activities are negligible, assuming thus that the distortions of competition which would result would also be negligible.

76.

Since, as is clear from paragraph 38 of the present judgment, the second and third subparagraphs of Article 4(5) of the Sixth Directive are closely linked since they pursue the same objective and since they are subject to the same logic, the word ‘significant’ is to be interpreted as meaning that the treatment of public bodies as non-taxable persons can be permitted only in cases where it would lead only to negligible distortions of competition. …

79.

Therefore the reply to the third question must be that the word ‘significant’ is, for the purposes of the second subparagraph of Article 4(5) of the Sixth Directive, to be understood as meaning that the actual or potential distortions of competition must be more than negligible.”

The present issue.

The rival arguments before me as to how, in the light of the ECJ’s judgment, HMRC’s appeal should be disposed of fell within a small compass. For HMRC, Mr Vajda QC submitted that the combination of the facts recorded in paragraph 10 of the tribunal’s judgment with the guidance now given by the ECJ requires me here and now to allow HMRC’s appeal, to set aside the orders of the tribunal and to make substitute orders dismissing the local authorities’ appeals to the tribunal. Mr Vajda said, in effect, that I can now decide that none of the local authorities nor, I think he would say, any other local authority in the United Kingdom, is entitled to be considered a non-taxable person in respect of its off-street car-parking activities.

The facts relied upon by Mr Vajda are that in the United Kingdom 70% of off-street car parking is provided by local authorities (providing them with a gross revenue of £440 million in 2002/2003) and 30% of off-street car parking is provided by private operators, whose estimated gross revenue for the same period was £500 million. That shows that the level of activity carried out by local authorities nationally in the relevant field is not negligible, so that were such activity to fall within the annex D activities covered by article 4.5(3), the local authorities would not be considered as non-taxable persons under article 4.5(1). Mr Vajda argued from that starting point that, because the ECJ regarded the interpretation of the scope of article 4.5(2) as covered by the same logic as that underlying article 4.5(3), it followed that there is similarly a presumption that, once the scale of activity of an article 4.5(2) activity exceeds the “negligible” threshold, a different tax treatment of that activity will give rise to distortions of competition; and his submissions included that paragraph 62 of the ECJ’s judgment supported the presumption of relevant distortion. Thus, he said, there is no need for a remission of the appeal to the tribunal; I can decide it finally here and now.

Cogently though Mr Vajda advanced the argument, Mr Ghosh QC for the local authorities satisfied me that it is unsupported by a single utterance in the ECJ’s judgment. Not only is it so unsupported, the plain sense of the ECJ’s judgment is that there is no question of any such presumption arising even in a case in which the scale of the article 4.5(2) activity is more than negligible.

It is of course the case that the ECJ’s consideration of article 4.5(3) lent colour to its interpretation of article 4.5(2). It is also the case that a clause 4.5(3) activity that is carried on at more than a negligible scale will be presumed to lead to distortions of competition. The ECJ said so in terms in paragraph 35. The assistance that the ECJ derived from article 4.5(3) was that article 4.5(2) should likewise be interpreted in a way that does as little damage as possible to the principle of fiscal neutrality. What it nowhere said, however, was that article 4.5(2) was in some manner to be treated as subsumed into article 4.5(3) so as to produce the result that a public authority carrying on an article 4.5(2) activity will automatically be considered to be a taxable person if the scale of that activity is more than negligible.

The difference in language as between articles 4.5(2) and 4.5(3) shows why the ECJ said no such thing. I recognise that, by itself, that difference might not have been of materiality since it may be that, had the ECJ wanted to interpret article 4.5(2) as so subsumed, it would not have allowed the difference in language to stand in its way. But it did not do so. Had it been disposed to do so, it would not have answered the third question. Its answer to that question was not to the effect that the extent of the relevant inquiry is whether the scale of the 4.5(2) activity is more than negligible. Its answer was that the inquiry is whether the treatment of the relevant public authority as a non-taxable person would lead to actual or potential distortions of competition of a more than negligible dimension. That is an inquiry that requires a factual investigation, not the application of a presumption. The same point was underlined by what the ECJ said in paragraphs 62 and 64. Contrary to Mr Vajda’s submission, paragraph 62 was not saying, and does not mean, that the treatment as a non-taxable person of a public authority carrying on a car-parking activity would be presumed to discourage potential competitors from entering the market. It was saying no more than that it may do so, with paragraph 64 underlining that this sort of question is not a matter of presumption but is a matter of fact.

I therefore respectfully reject Mr Vajda’s submission. Neither the tribunal below nor the ECJ has found facts that enable me to say that the car-parking activities of the four local authorities would lead to a more than negligible actual or potential distortion of competition. Nor has it been suggested that I can or should make such a finding of fact myself. It follows, in my judgment, that, in addition to allowing the appeals and setting aside the orders of the tribunal, I must remit the local authorities’ appeals to the tribunal for a re-hearing in the light of the guidance of the ECJ.

Making that order is, however, the easy part. The difficult part is as to how the parties and the tribunal are supposed to carry it out. The ECJ has ruled out a “local authority by local authority” approach involving an inquiry as to the actual or potential economic consequences on identifiable geographic markets of treating the local authorities as non-taxable persons in respect of their off-street car-parking activities. The nationwide “activities” approach which the ECJ has laid down as the applicable gospel presumably means that the article 4.5(2) economic question must (at any rate on one view) instead be approached at a high level of abstraction. Mr Ghosh has asked me to give some guidance as to this. I do not propose to do so, because I confess to an unawareness of how the type of exercise expected by the ECJ might be carried out. It appears to involve an inquiry as to the impact upon local authorities’ car-parking activities on markets said to be affected by them without any investigation into actual markets. I did suggest to Mr Ghosh that one possibility would be to take a number of sample representative geographic areas and investigate the economic position in relation to each of them on the basis that that might provide some sort of guidance as to how to assess the national position. Mr Ghosh, however, politely rejected that idea as out of line with the ECJ guidance, and it may be that he was right about that. It might anyway provide no helpful or reliable guidance as to the national position. Suppose six sample areas were taken and there was a 3/3 split in the answers?

I propose to say no more about the matter beyond recording that, at any rate as far as HMRC is concerned, they apparently have no difficulty with the notion of an across the board nationwide “activities” investigation. That was what they wanted before the tribunal, and it was their case at the hearing of this appeal before me that such an inquiry is possible and practicable; and Mr Ghosh’s written and oral argument identified a number of general considerations that would or might be considered in such an inquiry. According to the ECJ, it is only if such an inquiry is conducted that the principles of fiscal neutrality and legal certainty will be ensured (see paragraphs 46 and 47 of the judgment). The parties and their advisers will have to consider how they can make their respective cases, and they will no doubt be able to have recourse to the tribunal for directions as to the areas to be covered by the expert evidence.

The result is that I allow HMRC’s appeal, set aside the orders of the tribunal and remit the local authorities’ appeals to the tribunal for re-hearing.