UK Court of Appeal puts Vodafone on hold
 

Summary
On 22 May 2009, the UK Court of Appeal released its judgment in the Vodafone 2 case, which concerns whether a UK-resident company, Vodafone 2, can disapply the UK’s controlled foreign company (“CFC”) provisions in their entirety, in respect of its Luxembourg-resident subsidiary.

In allowing HMRC’s appeal, the Court of Appeal has now held that it is not possible to disapply the CFC rules in this manner. Instead, the CFC rules may in principle be applied to an EU/EEA-resident CFC, but that a new “EU/EEA exemption” should be introduced into the existing CFC rules. This EU/EEA exemption states that the CFC rules will not apply in respect of an EU/EEA-resident CFC if, in the relevant accounting period: it is “actually established” in another EU/EEA member state; and. it carries on “genuine economic activities” there.

UK companies, which have EU/EEA-resident CFCs and are relying on the disapplication of the CFC rules to avoid an apportionment, may now wish to consider whether those CFCs satisfy the “actual establishment” and “genuine economic activities” tests.

Background
Following the ECJ's judgment in Cadbury Schweppes, UK CFC rules are in general terms considered to be compatible with the EC Treaty, but where the relevant CFC is an EU/EEA-resident company, the CFC rules could only apply if that CFC forms part of "wholly artificial arrangements intended to escape the national tax normally payable". This is a question of whether the CFC is “actually established” in its EU/EEA state of residence and whether it carries on “genuine economic activities”. The UK courts are yet to conclude on whether the “actually established” and “genuine economic activities” tests are satisfied by Cadbury Schweppes, as the UK First-Tier Tribunal is yet to give its decision.

The Vodafone 2 case does not consider what these tests mean. Instead it considers whether it is possible for the UK's CFC legislation to be interpreted in a manner consistent with the ECJ's judgment in Cadbury Schweppes, or whether the rules are so divergent from the ECJ's judgment that they must be disapplied in their entirety (for potential CFCs that are EU/EEA-residents).

The High Court had ruled that it was impossible to construe the CFC rules consistently with the ECJ's judgment, and that it was for the UK Parliament rather than the courts to amend the rules. Under this approach, it follows that the CFC rules could not be applied to UK-resident companies in respect of EU/EEA-resident CFCs in any circumstances.

The Court of Appeal decision
The Court of Appeal upheld HMRC’s appeal, finding that it was possible to adequately protect Vodafone 2’s EC Treaty rights without disapplying the CFC rules in their entirety, but by reading in an entirely new exception from a CFC apportionment.

In its judgment, the CFC rules can apply with respect to EU/EEA resident CFCs as a matter of principle, but the legislation will not require any CFC apportionment in respect of an EU/EEA-resident CFC if, in the relevant accounting period:

• it is “actually established” in another EU/EEA member state; and
• it carries on “genuine economic activities” there.

In reaching this view, the Court held that in construing UK domestic law consistently with European law, the courts are not constrained by conventional rules of construction, will be permitted to depart from the strict and literal words in the relevant legislation, and may impute words into that legislation that are necessary to comply with EU law.

Implications and next steps
Vodafone 2 may now need to show that its subsidiary is “actually established” and carrying on “genuine economic activities” in Luxembourg. Similarly, other UK companies that have EU/EEA-resident CFCs and are relying on the disapplication of the CFC rules to avoid an apportionment, may now need consider whether those CFCs satisfy the “actual establishment” and “genuine economic activities” tests.

This decision may be appealed to the House of Lords.