[Home] [Databases] [World Law] [Multidatabase Search] [Help] [Feedback]
	England and Wales Court of Appeal (Civil Division) Decisions
You are here: BAILII >> Databases >> England and Wales Court of Appeal (Civil Division) Decisions >> Vodafone 2 v HM Revenue & Customs [2009] EWCA Civ 446 (22 May 2009) URL: http://www.bailii.org/ew/cases/EWCA/Civ/2009/446.html Cite as: [2009] STC 1480, [2010] 2 WLR 288, [2009] EWCA Civ 446, [2009] BTC 273, [2010] Bus LR 96, [2010] Eu LR 110, [2009] STI 1795, [2010] Ch 77

[New search] [Printable RTF version] [Buy ICLR report: [2010] 2 WLR 288] [Buy ICLR report: [2010] Ch 77] [Help]

IN THE SUPREME COURT OF JUDICATURE
COURT OF APPEAL (CIVIL DIVISION)
ON APPEAL FROM THE HIGH COURT, CHANCERY DIVISION
MR JUSTICE EVANS-LOMBE
CH 2007 APP0603

		Royal Courts of Justice Strand, London, WC2A 2LL
		22 May 2009

The Chancellor

Introduction
1. In March 2000 Vodafone Group plc, one of the leading mobile telecommunications companies, acquired Mannesmann AG through its wholly owned subsidiary Vodafone 2 Ltd ("V2"), a company incorporated and resident in England. For that purpose a company incorporated and resident in Luxembourg, Vodafone Investments Luxembourg SARL ("VIL"), was interposed between V2 and Mannesmann as the wholly owned subsidiary of the former to hold the shares in the latter and other European telecommunication companies. In the accounting period ended 31st March 2001 VIL derived substantial income from its various assets and, no doubt, accounted for it to the tax authorities in Luxembourg.
2. In November 2002 HMRC gave notice to V2 of its intention to enquire into its tax return for that accounting period and sought further information designed to entitle it to assess V2 to tax in the United Kingdom on the income of VIL, giving credit for the tax paid by VIL in Luxembourg. The statutory basis for such an assessment is contained in the Controlled Foreign Companies ("CFC") legislation in Chapter IV of Part XVII of the Income and Corporation Taxes Act 1988 ("ICTA"). V2 contended that such legislation, to which I shall refer in some detail later, did not apply for a number of reasons, one of which was that the imposition of UK tax on V2 in respect of the profits of VIL would constitute an unlawful restriction on V2's freedom of establishment conferred by Art 43 EC. Its request for a closure notice was refused and it appealed to the Special Commissioners.
3. By then the same issue had arisen between Cadbury Schweppes plc and HMRC in respect of which, on 29th April 2004, the Special Commissioners had referred various questions to the European Court of Justice ("ECJ"). In the event the judgment of the ECJ in respect of that reference, given on 12th September 2006 (see [2006] ECR I-7995 ("Cadbury Schweppes")), rendered a similar reference made by the Special Commissioners in the appeal of V2 redundant. Accordingly it is unnecessary to refer to the various appeals and applications in the appeal of V2 before the substantive hearing before the Special Commissioners (John Walters QC and Theodore Wallace) in March 2007.
4. The issue with which the Special Commissioners were then concerned relevant to this appeal was whether the CFC Legislation could be interpreted, as required by s.2(4) European Communities Act 1972, in a manner which did not unlawfully restrict V2's freedom of establishment, as declared by the ECJ in Cadbury Schweppes. One of them, Mr Walters QC, thought that it could; the other of them, Mr Wallace, concluded that it could not. As the former was in the chair he was entitled to a second or casting vote and his view prevailed.
5. V2's appeal to the High Court came before Evans-Lombe J. He agreed with the view of Mr Wallace. He held that it is not possible to interpret the CFC Legislation so as to conform to the freedom of establishment of V2 under Article 43 EC as declared by the ECJ in Cadbury Schweppes. In those circumstances he "disapplied the CFC Legislation as contrary to Community Law". This is the appeal of HMRC from the order of Evans-Lombe J. It is common ground that the freedom of establishment of V2 under Art 43 EC, as declared in Cadbury Schweppes, is of direct effect and that, pursuant to s.2 European Communities Act 1972, the CFC Legislation must be either construed or, if that is not possible, 'disapplied' so as not unlawfully to restrict that freedom. Thus there are two issues:

(1) Is it possible to interpret the CFC Legislation so as not unlawfully to restrict V2's freedom of establishment? And if not

(2) To what extent (and in what manner) should it be 'disapplied'?

I will deal with those two issues in due course. First it is necessary to describe in some detail the CFC Legislation, the conclusions of the ECJ in Cadbury Schweppes and the consequences of that conclusion.

The CFC Legislation
6. Part XVII of ICTA is headed "Tax Avoidance". Chapter IV of that part contains the CFC Legislation. As provided by s.747 the Chapter applies:

"(1) If in any accounting period a company-

(a) is resident outside the United Kingdom, and

(b) is controlled by persons resident in the United Kingdom, and

(c) is subject to a lower level of taxation in the territory in which it is resident,"

The concept of residence is expanded in s.749, control in s.747(1A) and territories with a lower level of taxation in s.750. Such a company is defined in s.747(2) as a controlled foreign company ("CFC"). It is not disputed, for the purposes of this appeal at least, that VIL is such a company and is controlled by V2.

7. If the Chapter applies the consequence is that under s.747(3) HMRC is entitled to apportion the chargeable profits of the CFC and the tax paid in the lower tax territory to all those who are interested in the CFC, whether resident in the UK or not, in accordance with the provisions of s.752. It is not disputed that V2 is interested in VIL for the purposes of any such apportionment. S.747(4) imposes a charge to a sum equal to corporation tax at the appropriate rate on such apportioned chargeable profits but gives credit for the tax on those profits paid in the lower tax territory. But the ability to apportion and consequently the liability to tax are "Subject to section 748...".
8. S.748 is headed "Cases where s.747(3) does not apply. S.748(1) provides:

"No apportionment under section 747(3) falls to be made as regards an accounting period of a controlled foreign company if –"

There follow in paragraphs (a) to (e) a series of exceptions. They relate to the CFC and may be summarised as those CFCs as pursue (a) an acceptable distribution policy, (b) engage in exempt activities, (c) satisfy a public quotation condition, (d) make profits of less than £50,000 or (e) are resident in a territory specified in regulations to be made by HMRC subject to any conditions HMRC might specify. The exceptions specified in paragraphs (a), (b) and (c) are further elaborated in the applicable parts of Schedule 25. It is clear that these exceptions are not mutually exclusive.

9. The exception in paragraph (d) is self-explanatory. With regard to the exception in paragraph (e) regulations were made by HMRC in December 1998 entitled Controlled Foreign Companies (Excluded Countries) Regulations 1998/3081. The schedule to the regulations has two lists of specified territories. The other conditions to be satisfied in order to be entitled to the benefit of this exception differ according to which list the territory falls in to. A number of member states of the EU come within the first list. Luxembourg and other member states fall within the second but the relevant conditions are not satisfied by VIL.
10. Section 748(3) confers a further exception in these terms:

"(3) Notwithstanding that none of paragraphs (a) to (e) of subsection (1) above applies to an accounting period of a controlled foreign company, no apportionment under section 747(3) falls to be made as regards that accounting period if it is the case that –

(a) in so far as any of the transactions the results of which are reflected in the profits arising in that accounting period, or any two or more transactions taken together, the results of at least one of which are so reflected, achieved a reduction in United Kingdom tax, either the reduction so achieved was minimal or it was not the main purpose or one of the main purposes of the transaction or, as the case may be, of those transactions taken together to achieve that reduction; and

(b) it was not the main reason, or, as the case may be, one of the main reasons for the company's existence in that accounting period to achieve a reduction in United Kingdom tax by a diversion of profits from the United Kingdom."

Thus the exception conferred by s.748(3) differs from those contained in subsection (1) paragraphs (a)-(e) in that it depends on the subjective intention behind the relevant transactions or the existence of the CFC, not the objective existence of specific circumstances.

Cadbury Schweppes
11. In view of the submissions made to us it is necessary to set out the facts, the opinion of the Advocate-General and the judgment of the ECJ in some detail. Cadbury Schweppes Overseas Ltd (CSO) was a wholly owned subsidiary of Cadbury Schweppes plc and the holding company of, amongst others, Cadbury Schweppes Treasury Services Ltd ("CSTS") and Cadbury Schweppes Treasury Services International Ltd ("CSTI"). Those subsidiaries had been incorporated and were resident in the Republic of Ireland. HMRC sought to apportion the chargeable profits of CSTS and CSTI to their parent company CSO and to charge the latter with corporation tax thereon, giving credit for the lower rate of tax payable in the Republic. CSO disputed the right of HMRC to do so and appealed to the Special Commissioners on the ground, amongst others, that the CFC Legislation is contrary to the freedom of establishment laid down in Article 43 EC. The Special Commissioners referred to the ECJ the question:

"Do Articles 43 [EC]....preclude national legislation such as that in issue in the main proceedings, which provides in specified circumstances for the imposition of a charge upon a company resident in that Member State in respect of the profits of a subsidiary company resident in another Member State and subject to a lower level of taxation?"

12. The Advocate-General (M.Léger) considered this question under three headings, namely "A. Abuse of freedom of establishment" (paragraphs 39 to 61), "B. Hindrance to freedom of establishment" (paragraphs 62 to 84) and "C. Justification relating to counteraction of tax avoidance" (paragraphs 85 to 150). Under the first heading he concluded in paragraph 60 for the reasons examined in detail in earlier paragraphs of that part that:

"I therefore find that the establishment by a company which is resident for tax purposes in a Member State of a subsidiary in the International Financial Services Centre for the avowed purpose of enjoying the more favourable tax regime applicable there does not, in itself, constitute an abuse of freedom of establishment."

13. In relation to the second heading the Advocate-General considered in some detail the submissions made by a number of Member States and concluded in paragraph 83:

"The difference in treatment provided for by the United Kingdom legislation on CFCs depending on the tax rate of the Member State of establishment suffices, in my opinion, for that system to be regarded as constituting a hindrance to freedom of establishment, so that its compatibility with the rules of the Treaty must necessarily be subject to review by the Court."

14. The Advocate-General then turned to consider the third heading under which he was determining how the question posed by the Special Commissioners should be answered by the ECJ. He started by pointing out (paragraph 89) that the case law of the ECJ lays down that Member States' legislation restrictive of freedoms conferred by amongst others Article 43 EC cannot be justified as the counteraction of tax avoidance if it "applies to a situation which is defined too generally". Thus (paragraph 92):

"It follows that, in order to be capable of being justified by counteraction of tax avoidance, national legislation must not merely refer to a given situation in general terms but must enable the national court to refuse, case by case, the benefit of Community law to certain taxpayers or certain companies which have made use of an artificial arrangement for the purpose of avoiding tax."

He then considered three grounds advanced as justifying the CFC Legislation in Marks & Spencer [2005] ECR I-10837 and other criteria advanced by the UK Government and the Commission.

15. In paragraph 122 the Advocate-General turned to consider whether the CFC Legislation is "suitable for counteracting tax avoidance or whether it goes beyond what is necessary for that purpose". He referred to the exemptions conferred by s.748(1) in paragraph 128 and 132 and to that conferred by s.748(3) in paragraphs 128 to 131. He considered that only the motive test allowed by s.748(3) permitted the national authorities to take account of the circumstances of each taxpayer and was, thus, not too general. He concluded in paragraph 150:

"At this stage I am of the opinion that it is for the national court, which has the task of determining the compatibility with Community law of its national law on CFCs, to assess whether the motive test may be given an interpretation which makes it possible to limit the application of that law to artificial arrangements intended to circumvent national tax law."

16. He considered that the answer to the question posed by the Special Commissioners should be answered by the ECJ as follows:

"Articles 43 EC and 48 EC do not preclude national tax legislation which provides for inclusion in the tax base of a resident parent company profits of a controlled foreign company established in another Member State where those profits are subject in that State to a much lower level of taxation than that in effect in the State of residence of the parent company, if that legislation applies only to wholly artificial arrangements intended to circumvent national law. Such legislation must therefore enable the taxpayer to be exempted by providing proof that the controlled subsidiary is genuinely established in the State of establishment and that the transactions which have resulted in a reduction in the taxation of the parent company reflect services which were actually carried out in that State and were not devoid of economic purpose with regard to that company's activities."

Thus the Advocate-General regarded "wholly artificial arrangements intended to circumvent national law" as the opposite of companies "genuinely established in the State of establishment" and "transactions which have resulted in a reduction in the taxation of the parent company and reflect services which were actually carried out in that State and were not devoid of economic purpose with regard to that company's activities".

17. The judgment of the ECJ set out the basic structure of the CFC Legislation in paragraphs 3 to 12, the underlying facts in paragraphs 13 to 27 and the question referred by the Special Commissioners in paragraph 28. In paragraphs 31 to 38 the ECJ considered whether there had been an abuse of the freedoms conferred by the EC Treaty. They concluded:

"37. As to freedom of establishment, the Court has already held that the fact that the company was established in a Member State for the purpose of benefiting from more favourable legislation does not in itself suffice to constitute abuse of that freedom (see, to that effect, Centros, paragraph 27, and Case C-167/01 Inspire Art [2003] ECR I-10155, paragraph 96).

38. .....it follows that the fact that in this case CS decided to establish CSTS and CSTI in the IFSC for the avowed purpose of benefiting from the favourable tax regime which that establishment enjoys does not in itself constitute abuse. That fact does not therefore preclude reliance by CS on Articles 43 EC and 48 EC (see, to that effect, Centros, paragraph 18, and Inspire Art, paragraph 98).

18. In those circumstances the ECJ proceeded to consider whether Articles 43 and 48 precluded legislation such as the CFC Legislation as a restriction on freedom of establishment. They concluded (paragraph 46) that it did because:

"...the separate tax treatment under the legislation on CFCs and the resulting disadvantage for resident companies which have a subsidiary subject, in another Member State, to a lower level of taxation are such as to hinder the exercise of freedom of establishment by such companies, dissuading them from establishing, acquiring or maintaining a subsidiary in a Member State in which the latter is subject to such a level of taxation."

The ECJ then considered whether the restriction was justified.

19. They considered that the advantage derived from incorporating a subsidiary in a low tax territory could not of itself provide justification for a higher tax burden on the parent (paragraph 49); nor could the mere fact of the setting up of such a subsidiary justify any presumption of tax evasion (paragraph 50). On the other hand (paragraph 51) a measure specifically relating to "wholly artificial arrangements aimed at circumventing the legislation of the Member State concerned" might be justified. The ECJ then considered what the freedom of establishment conferred by Article 43 entailed and concluded that (paragraphs 54 and 55):

54......Consequently, it presupposes actual establishment of the company concerned in the host Member State and the pursuit of genuine economic activity there.

55. It follows that, in order for a restriction on the freedom of establishment to be justified on the ground of prevention of abusive practices, the specific objective of such a restriction must be to prevent conduct involving the creation of wholly artificial arrangements which do not reflect economic reality, with a view to escaping the tax normally due on the profits generated by activities carried out on national territory."

20. The ECJ then considered the essential elements of the CFC Legislation to determine whether it is justified "on the ground of prevention of wholly artificial arrangements and, if so, whether it is proportionate in relation to that objective" and whether it went further than what is necessary to achieve that purpose. In that connection they referred (paragraphs 61 and 62) to the exceptions. They rejected them as providing sufficient justification because (paragraphs 63 and 64):

"63....the fact that none of the exceptions provided for by the legislation on CFCs applies and that the intention to obtain tax relief prompted the incorporation of the CFC and the conclusion of the transactions between the latter and the resident company does not suffice to conclude that there is a wholly artificial arrangement intended solely to escape that tax.

64      In order to find that there is such an arrangement there must be, in addition to a subjective element consisting in the intention to obtain a tax advantage, objective circumstances showing that, despite formal observance of the conditions laid down by Community law, the objective pursued by freedom of establishment, as set out in paragraphs 54 and 55 of this judgment, has not been achieved (see, to that effect, Case C-110/99 Emsland-Stärke [2000] ECR I-11569, paragraphs 52 and 53, and Case C-255/02 Halifax and Others [2006] ECR I-1609, paragraphs 74 and 75)."

21. The ECJ then turned to what those objective circumstances are. They concluded that, in summary, they are that the incorporation of the CFC reflects an economic reality (paragraph 65), that it is intended that the CFC shall carry on genuine economic activities (paragraph 66) and that those factors can be objectively ascertained (paragraph 67). But:

"If checking those factors leads to the finding that the CFC is a fictitious establishment not carrying out any genuine economic activity in the territory of the host Member State, the creation of that CFC must be regarded as having the characteristics of a wholly artificial arrangement. That could be so in particular in the case of a 'letterbox' or 'front' subsidiary (see Case C-341/04 Eurofood IFSC [2006] ECR I-3813, paragraphs 34 and 35)."

22. The ECJ concluded (paragraphs 72 to 74):

"72. In this case, it is for the national court to determine whether, as maintained by the United Kingdom Government, the motive test, as defined by the legislation on CFCs, lends itself to an interpretation which enables the taxation provided for by that legislation to be restricted to wholly artificial arrangements or whether, on the contrary, the criteria on which that test is based mean that, where none of the exceptions laid down by that legislation applies and the intention to obtain a reduction in United Kingdom tax is central to the reasons for incorporating the CFC, the resident parent company comes within the scope of application of that legislation, despite the absence of objective evidence such as to indicate the existence of an arrangement of that nature.

73. In the first case, the legislation on CFCs should be regarded as being compatible with Articles 43 EC and 48 EC.

74. In the second case, on the other hand, the view should be taken, as submitted by the applicants in the main proceedings, the Commission and, at the hearing, the Cypriot Government, that that legislation is contrary to Articles 43 EC and 48 EC."

23. In those circumstances the ECJ ruled in response to the question referred by the Special Commissioners that:

"Articles 43 EC and 48 EC must be interpreted as precluding the inclusion in the tax base of a resident company established in a Member State of profits made by a controlled foreign company in another Member State, where those profits are subject in that State to a lower level of taxation than that applicable in the first State, unless such inclusion relates only to wholly artificial arrangements intended to escape the national tax normally payable. Accordingly, such a tax measure must not be applied where it is proven, on the basis of objective factors which are ascertainable by third parties, that despite the existence of tax motives that controlled company is actually established in the host Member State and carries on genuine economic activities there."

The Consequences of Cadbury Schweppes
24. In the instant case the Special Commissioners concluded from their review of Cadbury Schweppes (paragraph 33) that the guidance given by the ECJ in that case is that:

"....the CFC legislation itself introduces a restriction on freedom of establishment which can be justified on the basis that it enables the United Kingdom to "thwart practices which have no purpose other than to escape tax normally due on the profits generated by activities carried on in national territory" (the United Kingdom). The restriction must however be proportionate to the achievement of that objective. The CFC legislation is proportionate in relation to that objective if and to the extent that it confines the restriction to wholly artificial arrangements intended to escape the United Kingdom tax normally payable - such wholly artificial arrangements being arrangements in relation to which, in addition to there being a subjective element consisting in the intention to obtain a tax advantage, the resident company has not proved, on the basis of objective factors which are ascertainable by third parties, that the CFC is actually established in the host Member State and carries on genuine economic activities there."

Evans-Lombe J accepted that summary as accurate and adopted it. Neither party to this appeal has criticised it.

25. It follows, and was not disputed, that the consequence of the decision in Cadbury Schweppes is that there is a conflict between the freedom of establishment conferred on V2 by Article 43 EC and the prima facie entitlement of HMRC under the CFC Legislation to tax V2 on the profits of VIL. That conflict must be resolved in accordance with the provisions of s.2 European Communities Act 1972. It is not disputed that the freedom of establishment conferred on V2 by Article 43 EC is an enforceable Community right within subsection (1) to be given legal effect without further enactment. Likewise it is not disputed that in accordance with subsection (4) the CFC Legislation "shall be construed and have effect subject to" that right.
26. Accordingly the first issue relates to such 'construction' and the second to such 'effect'. I shall refer to the principles applicable to such construction in relation to the first issue. If such a construction is impossible the process by which effect is given to the enforceable community right is described as 'disapplication'. Disapplication involves treating the relevant provision in the CFC Legislation as if it were expressed to be "without prejudice to" V2's freedom of establishment, see Factortame Ltd v Secretary of State for Transport [1990] 2 AC 85, 140 and Fleming/Conde Nast v HMRC [2008] 1 WLR 195 para 24.
27. HMRC contends that on either construction or disapplication it is entitled to maintain its enquiry into the tax return submitted by V2 in relation to the accounting period ended 31st March 2001. By contrast V2 maintains that not only is it impossible to construe the CFC Legislation as HMRC contends but its disapplication would necessarily deprive the enquiry into its tax return of any legitimate purpose.
Interpretation
28. The Special Commissioners had to decide whether the guidance provided by Cadbury Schweppes required them to consider the interpretation of only the motive test in s.748(3) or of the CFC Legislation as a whole. After considering Cadbury Schweppes in detail they concluded (paragraph 36) that they should consider the motive test alone. They then considered the principles of conforming interpretation and decided (paragraph 60) that s.2 European Communities Act 1972 required them to construe the motive test if and insofar as possible in conformity with Cadbury Schweppes. As I have already indicated they did not agree on this issue.
29. Mr Walters considered that s.748(3) should be interpreted as if it provided, as alternative to (a) and (b), a second condition to the effect that:

"..there will be no such apportionment (despite the presence of an intention to obtain a tax advantage) if there are also objective circumstances showing that the objective pursued by freedom of establishment in Community law has been achieved and the establishment of the CFC reflects economic reality (cf. the judgment in Cadbury Schweppes, at paragraph 55). This second, alternative, condition would specifically relate to wholly artificial arrangements (or to the absence of them) and would, in effect, ensure that the motive test, as defined by the CFC legislation, would be applied without prejudice to the directly enforceable Community rights of companies established in the Community…"

30. Mr Wallace did not agree as he did not see how the motive test could be interpreted as restricted to wholly artificial transactions. He concluded (paragraph 80) that:

"…the motive test is not amenable to a conforming interpretation such as would confine its application to wholly artificial arrangements. This is because the criteria on which the motive test is based mean that, where none of the exceptions laid down by the CFC legislation applies and the intention to obtain a reduction in United Kingdom tax is central to the reasons for incorporating the CFC, the resident parent company comes within the scope of application of that legislation, even where there is no objective evidence such as to indicate the existence of a wholly artificial arrangement…"

31. On appeal, Evans-Lombe J described (paragraph 34) the principal issue before him as being whether it is possible to construe Sections 747 and 748 of ICTA so that the charge to tax resulting from Section 747(3) is limited in its application to the profits of CFCs resident in Member States which are not bona fide "established" in those Member States. In paragraphs 36 to 73 of his judgment he limited consideration of that question to the motive test in s.748(3). His conclusion in that respect was that it was impossible to construe s.748(3) so as to make it conform to the right of establishment under article 43 EC. In paragraphs 74 to 79 Evans-Lombe J considered similar arguments directed to the definition of 'chargeable profits' in s.747(6)(a) and 'exempt activities' dealt with in s.748(1)(b) and Part II of Schedule 25 and arrived at the same conclusions.
32. The first issue for our determination is to ascertain which part or parts of the CFC Legislation is or are open to a conforming interpretation. Counsel for V2 submits that only the motive test contained in s.748(3) may be considered in that context. He bases this submission on passages in the opinion of the Advocate-General and in the judgment of the ECJ in Cadbury Schweppes. The passages in the opinion of the Advocate-General relied on are those to which I have referred in paragraphs 13 to 15 above. The passages in the judgment of the Court are those to which I have referred in paragraphs 20 to 22 above. Counsel relies, in particular, on paragraph 72 of the judgment of the court where the ECJ stated:

"In this case, it is for the national court to determine whether, as maintained by the United Kingdom Government, the motive test, as defined by the legislation on CFCs, lends itself to an interpretation which enables the taxation provided for by that legislation to be restricted to wholly artificial arrangements..."

33. Counsel for V2 submits that this explicit reference to the motive test is explained in the passages in the opinion of the Advocate-General relied on, namely the need for case by case consideration. He contends that the national courts are bound by the statement of the ECJ in paragraph 72 only to consider the motive test.
34. I do not accept that submission. The jurisdiction of the ECJ to give preliminary rulings relates to the interpretation of the EC Treaty and the other matters referred to in Article 234 EC. They do not include the interpretation of the legislation of a Member State, see Pfeiffer v Deutsches Rotes Kreuz [2004] ECR I-8835 para 115 and Criminal Proceedings against Pupino [2005] ECR I-5285 para 47. Further, as those citations show, the obligation of the national court is to examine the whole of the national law to consider how far it may be applied so as to conform to enforceable Community rights.
35. Moreover all the passages on which counsel for V2 relied come within the sections of the opinion of the Advocate-General and of the judgment of the ECJ dealing with justification. It may be that if the only question is justification of the CFC Legislation as it stands the best candidate is the motive test in s.748(3). But that cannot be the only consideration. Conformity of the CFC Legislation to the freedom of establishment for which article 43 EC provides might just as well be provided by an interpretation which removed the hindrance to which the Advocate-General referred in Part B of his opinion or the restriction referred to by the ECJ in the passages to which I have referred in paragraphs 18 and 19 above. That may require consideration of the CFC Legislation as a whole.
36. Finally the limitation expressed in paragraph 72 of the judgment of the ECJ to the motive test in s.748(3) seems to have arisen from the submissions made to the ECJ by the UK. We were not referred to any authority for the proposition that a party, even if it is an emanation of the Member State, is limited in the proceedings in which the reference is made to the submissions made to the ECJ on the reference by a member state. In my view, the Special Commissioners were wrong to conclude that their consideration of a conforming interpretation was limited to the motive test in s.748(3). This court is entitled and bound to consider all parts of the CFC Legislation in ascertaining whether it is amenable to a conforming interpretation.
37. We were referred in the parties' respective written arguments and orally to a number of reported cases on the principles to be observed in looking for a conforming interpretation in either the European Community or Human Rights contexts. In chronological order they are Pickstone v Freemans [1989] AC 66; Marleasing SA v La Comercial Internacional de Alimentacion SA [1990] ECR I-4135; Litster v Forth Dry Dock [1990] AC 546; ICI v Colmer [1999] 1 WLR 2035; Ghaidan v Godin-Mendoza [2004] 2 AC 557; HMRC v IDT Card Services Ireland Ltd [2006] STC 1252; HMRC v EB Central Services Ltd [2008] EWCA Civ 486 and Fleming/Conde Nast v HMRC [2008] 1 WLR 195. The principles which those cases established or illustrated were helpfully summarised by counsel for HMRC in terms from which counsel for V2 did not dissent. Such principles are that:

"In summary, the obligation on the English courts to construe domestic legislation consistently with Community law obligations is both broad and far-reaching. In particular:

(a) It is not constrained by conventional rules of construction (Per Lord Oliver in Pickstone at 126B);

(b) It does not require ambiguity in the legislative language (Per Lord Oliver in Pickstone at 126B; Lord Nicholls in Ghaidan at 32);

(c) It is not an exercise in semantics or linguistics (See Ghaidan per Lord Nicholls at 31 and 35; Lord Steyn at 48-49; Lord Rodger at 110-115);

(d) It permits departure from the strict and literal application of the words which the legislature has elected to use (Per Lord Oliver in Litster at 577A; Lord Nicholls in Ghaidan at 31);

(e) It permits the implication of words necessary to comply with Community law obligations (Per Lord Templeman in Pickstone at 120H-121A; Lord Oliver in Litster at 577A); and

(f) The precise form of the words to be implied does not matter (Per Lord Keith in Pickstone at 112D; Lord Rodger in Ghaidan at para 122; Arden LJ in IDT Card Services at 114)."

38. Counsel for HMRC went on to point out, again without dissent from counsel for V2, that:

"The only constraints on the broad and far-reaching nature of the interpretative obligation are that:

(a) The meaning should "go with the grain of the legislation" and be "compatible with the underlying thrust of the legislation being construed." (Per Lord Nicholls in Ghaidan at 33; Dyson LJ in EB Central Services at 81) An interpretation should not be adopted which is inconsistent with a fundamental or cardinal feature of the legislation since this would cross the boundary between interpretation and amendment; (See Ghaidan per Lord Nicholls at 33; Lord Rodger at 110-113; Arden LJ in IDT Card Services at 82 and 113) and

(b) The exercise of the interpretative obligation cannot require the courts to make decisions for which they are not equipped or give rise to important practical repercussions which the court is not equipped to evaluate. (See Ghaidan per Lord Nicholls at 33; Lord Rodger at 115; Arden L in IDT Card Services at 113.)"

39. Without in any way suggesting that it is incumbent on he who contends for a conforming interpretation to spell out exactly what it is, for that would be to gainsay the proposition set out in paragraph 37(f), it undoubtedly assists in the consideration of whether or not it is a permissible interpretation to see on paper how it is suggested that it would be effected, whether by interpolation, deletion, rewording or otherwise. Counsel for HMRC disclaimed any intention or requirement to produce any precise formulation. He contended that the 'grain' or 'thrust' of the legislation was to cast the initial net wide as in s.747(3) and then narrow it by the overlapping exceptions set out in s.748(1)(a) to (e) and (3). In that context, he submits, all that is required is to introduce an additional exception in respect of a controlled foreign company

"if it is, in that accounting period, actually established in another member state of the EEA and carries on genuine economic activities there."

Such an exception could be an additional lettered paragraph in s.748(1) or an additional alternative in s.748(3) as suggested by Mr Walters. The effect of such an amendment would be to remove from the CFC Legislation the 'hindrance' or 'restriction' with which the Advocate-General and the ECJ were concerned in Cadbury Schweppes. In that event there would be no need for the case by case consideration which was considered to be necessary if the CFC Legislation was to be justified as it stood. Were it considered desirable it would be simple to provide for an exception to the exception in relation to "wholly artificial transactions".

40. These submissions are opposed by counsel for V2. He makes three basic submissions: (1) such an interpretation would not conform with the scheme and essentials of the CFC Legislation, (2) such an interpretation would create two regimes, one for controlled foreign companies established within the EEA and another for those established elsewhere contrary to the decision of the House of Lords in ICI v Colmer [1999] 1 WLR 2035, and (3) any such interpretation would be retrospective in its operation, involve legal or economic policy decisions and would fail to satisfy the test of legal certainty.
41. In relation to the first submission counsel submits that the result of such an interpretation as counsel for HMRC advances would be to render the CFC Legislation inapplicable to all those companies who comply with its terms in flat contradiction to the evident purpose of the legislation as it stands that it should apply to all companies wherever established which are not entitled to one or more of the present exceptions. He submits that such an outcome would be inconsistent with views of Lord Rodger of Earlsferry in Ghaidan para 110 where he said:

"[s.3 Human Rights Act 1998] does not allow the courts to change the substance of a provision completely, to change a provision from one where Parliament says that x is to happen into one saying that x is not to happen. And, of course, in considering what constitutes the substance of the provision or provisions under consideration, it is necessary to have regard to their place in the overall scheme of the legislation as enacted by Parliament."

That was said in relation to the provisions of s.3 Human Rights Act 1998. The terms of that section are in substance the same as the terms of s.2(4) ECA 1972 although the consequence of an inability to find a conforming interpretation is a declaration of incompatibility not disapplication in the manner I have explained.

42. The issue in and outcome of Ghaidan has to be considered in order to appreciate what Lord Rodger meant by "x". The issue was whether the survivor of a homosexual partnership was entitled to succeed to a protected tenancy of which the other partner was the tenant. The right of succession was conferred by para 2 of Schedule 1 to the Rent Act 1977 on the 'spouse' of the tenant. By further definition the word spouse was enlarged to include a person who was living with the tenant "as his or her wife or husband". It had been held that the limitation of the right of succession to heterosexual partnerships infringed the defendant's rights under articles 8 and 15 of the ECHR as constituting discrimination on grounds of sex. The question then arose whether in accordance with s.3 HRA it was possible to give the Rent Acts a meaning which was compatible with the defendant's human rights. The House of Lords (Lord Millett dissenting) concluded that it was. The extension of the right of succession to the defendant did not affect its availability to those on whom it had been conferred by the express terms of the Rent Acts.
43. Further the nature of the interpretation referred to in paragraph 39 above is no more incompatible with the original legislation than that which found favour with the Court of Appeal in HMRC v IDT Card Services Ireland Ltd [2006] STC 1252. That case concerned the treatment of credit vouchers for the purposes of VAT. The relevant statutory provision, para 3(2), required the face value of a credit voucher to be disregarded in relation to a supply. Paragraph 3(3) provided for that disregard not to apply if the person who supplied the goods for which the voucher was used failed to account for the relevant VAT. On the face of it paragraph 3(2) would exempt phone cards issued in the Republic of Eire altogether which would be inconsistent with the Sixth Directive. The Court of Appeal interpreted the provisions of Paragraph 3(3) as extending to cases such as that in which the effect of Paragraph 3(2) would result in the non-taxation of the relevant supply. The extension of paragraph 3(3) to cases to which it did not, if construed in accordance with normal domestic rules of statutory interpretation, apply gave rise to a liability to tax where none existed.
44. To my mind the extension of the exceptions to the CFC Legislation for which counsel for HMRC contends is as permissible as either of those which found favour in Ghaidan or IDT. It does not alter the impact on other CFCs which are not excepted by any other exception. Certainly it provides an additional exception but, as counsel for HMRC submitted, the grain or thrust of the legislation recognises that the wide net cast by s.747(3) is intended to be narrowed by s.748. Further the terms of various exceptions were not intended to be either mutually exclusive or immutable as the ability to amend the conditions contained in various parts of Schedule 25 and the terms of paragraph (e) show. For my part I would reject this objection to the conforming interpretation put forward by counsel for HMRC.
45. The second objection summarised in paragraph 41 above is to the effect that the conforming interpretation advanced by HMRC involves the conversion of a single regime applicable to all subsidiaries wherever formed to two regimes, one applicable to subsidiaries established in the EEA and the other to subsidiaries established elsewhere. It is submitted that to do so is contrary to the judgment of the House of Lords in ICI v Colmer [1999] 1 WLR 2035.
46. To explain this point it is necessary to trace the history of that case in some detail, which is more easily done by reference to the report of the case in all courts to be found in the Reports of Tax Cases (72 TC 1). The case concerned what was called 'consortium group relief' allowed by s.258 Income and Corporation Taxes Act 1970 (72 TC 6). The consortium consisted of ICI and Welcome Foundation Ltd. They held the issued shares of Cooper's Animal Health (Holdings) Ltd ("CAHH"). CAHH held the shares in 23 trading subsidiaries of which 4 were resident in the UK, 6 in other member states and 13 in non-EC Member States. One of the UK resident subsidiaries was Cooper's Animal Health Ltd ("CAH"). CAH made trading losses and sought to surrender them to ICI so that the latter might set them off against its profits.
47. The question at issue was whether CAHH was a holding company within the definition contained in s.258(5)(b). That definition required its business to consist wholly or mainly in the holding of shares or securities of companies which were its 90% subsidiaries and were trading companies. Sub-section (7) added that

"References in this and the following sections of this Chapter to a company apply only to bodies corporate resident in the United Kingdom..."

48. The Inland Revenue contended that this provision was not satisfied by CAHH because 19 of its subsidiaries were not resident in the UK. That argument prevailed before the Special Commissioner (72 TC 5). But a different view was taken by Millett J (72 TC 11) and the Court of Appeal (72 TC 15). Each of those courts considered that the residence requirement applied only to the companies seeking to surrender the losses and the company seeking to use them and had no application to the residence of the companies referred to in the definition of holding company.
49. The Inland Revenue's appeal to the House of Lords first came on in late 1995. In their reserved judgment given in March 1996 Lord Nolan with whom the other members of the Appellate Committee agreed took a different view (72 TC 26). He considered (72 TC 35) that, but for the Community law point taken by ICI for the first time in the House of Lords, the argument of the Inland Revenue to the effect that subsection (7) applied to the definition of holding company as well as to the claimant and surrendering companies was to be preferred. The Community law point was to the effect that if that was the correct construction of the definition of holding company then it infringed the freedom of establishment conferred by Article 43 EC. In the event the House of Lords referred to the ECJ the questions whether their construction to the effect that subsection (7) applied to the definition of holding company infringed the freedom of establishment afforded by Article 43 EC, and, if so, whether such infringement could be justified (72 TC 39).
50. The ECJ considered (72 TC 52 para [14]) that that question did not arise because on any view the majority of the holding companies of CAHH were resident outside the EU. But they went on to answer the questions referred. In respect of the first question the ECJ considered (72 TC 54 para [23]) that the unequal treatment involved in applying a residence test to the EU subsidiaries but not others engaged the freedom of establishment accorded by Article 43 EC but was not justified (72 TC 55 para [30]). They also dealt with a second question relating to the duty of the national court which is relevant to any question of disapplication but not conforming construction.
51. When the appeal of the Inland Revenue returned to the House of Lords (72 TC 56) Lord Nolan, with whom the other members of the Appellate Committee agreed, noted that Community law presented no obstacle to the application of s.258(7) in accordance with the construction put upon it by the House of Lords in its previous decision (72 TC 59F). But counsel submitted that the answers of the ECJ rendered that construction unsustainable as a matter of domestic law because the provision was ambiguous and should be construed so as to conform to Community law. Lord Nolan held that there was no ambiguity. He continued:

"The second and more fundamental objection is that, while the construction adopted by the courts below would certainly avoid the difficulty raised by article 52, it can scarcely be described as conforming with the article, because it draws no distinction between companies resident within and those resident outside the Community. There is no way in which such a distinction can be read into the words used. It is impossible to construe section 258 as permitting a company such as Holdings to include in the head count non-United Kingdom resident subsidiaries which are established in other Community countries in conformity with article 52, but not to include those established outside the Community which are unprotected by Community law. For substantially the same reasons Mr. Whiteman`s argument that the doctrine of severance could be invoked to separate the permissible from the impermissible elements of section 258 cannot in my judgment succeed. The language of the crucial provisions is indivisible."

52. In my view it is plain that when Lord Nolan referred to the fact that 'it' did not conform to Article 43 EC he was referring to the 'domestic' construction of s.258(7) favoured by Millett J and the Court of Appeal to the effect that that subsection only applied to the companies claiming or surrendering the tax losses. It could not be a conforming interpretation in relation to the Community law point raised in the House of Lords because the definition of holding company remained as before without distinction between companies resident in the UK, the EU or elsewhere. In the second sentence Lord Nolan accepted that no such distinction could be read into the relevant subsection if the construction originally favoured by the House of Lords in 1996 was preferred. Accordingly the answers of the ECJ to the questions referred did not indicate any reason to prefer the construction favoured by either Millett J and the Court of Appeal on the one hand or the House of Lords on the other. Accordingly the House of Lords adhered to the construction they had originally favoured.
53. For my part I do not consider that that decision assists V2. First, the need to construe a statutory provision compatibly with directly enforceable community rights did not arise in that case because on any view more than half CAHH's subsidiaries were resident outside the EEA. Second, the freedom of establishment of neither ICI nor CAH was affected either way. Third, the application of s.258(7) preferred by the House of Lords could not be split so as to divide the class of non-UK residents into those resident in a Member State and those resident elsewhere without substantially altering the availability of consortium loss relief for all who might seek it. The decision does not in my view establish the proposition for which counsel for V2 contended, namely, that a geographically based distinction is always impossible.
54. Returning to the circumstances of this case, it is plain that geographical distinctions are consistent with the grain of the CFC Legislation because, for example, s.748(1)(e) provides for exactly that distinction. The insertion of another such exception in s.748(1) on the lines suggested by counsel for HMRC would leave unaffected the impact of the CFC Legislation on those companies to which it continued to apply. For my part I would reject this objection to the conforming interpretation advanced by counsel for HMRC.
55. The third objection summarised in paragraph 41 above is to the effect that the suggested conforming interpretation would be retrospective in operation, would involve legal or economic policy decisions and would fail to satisfy the test of legal certainty. Counsel for V2 points out that a conforming interpretation necessarily applies retrospectively and in the tax field has to be applied by Inspectors of Taxes and taxpayers up and down the country. As such it must be sufficiently certain both from a practical and legal point of view. Counsel for V2 contends that the conforming interpretation advanced by counsel for HMRC is not only insufficiently certain but has involved a decision on legal, economic and policy grounds which should be left to Parliament.
56. There are a number of points wrapped up in that submission. I will take them in turn. First, it is inevitable that a conforming interpretation will be retrospective in its operation. Unless and until it is averred that the legislation is inconsistent with some enforceable Community right there is no occasion to consider a conforming interpretation. The fact that the effect of such an interpretation is felt retrospectively is no more an objection in the field of conforming interpretation than it is in the case of domestic statutory construction.
57. Second, it is not a requirement of a conforming interpretation that it should be capable of precise formulation. That is precisely the point summarised in sub-paragraph (f) in paragraph 37 above. The dicta there referred to were made in such widely diverse situations as equal pay, right to succession of a protected tenancy and the imposition of a liability to VAT. It is inevitable that the conforming interpretation will lack the crispness to be expected of properly considered legislation; but, that cannot be a sufficient objection.
58. Third, the conforming interpretation advanced by counsel for HMRC reflects and excepts from the operation of the CFC Legislation precisely that element of it which the ECJ held to constitute the hindrance to freedom of establishment. That is, by definition, sufficiently certain for a conforming interpretation whether or not the exclusion from the exception of wholly artificial transactions is included. There can be no objection to such an exclusion for the like reason. It follows precisely the formulation of the justification for the hindrance which the ECJ found to be acceptable.
59. It is the case that there are likely to be other ways of achieving conformity, for example s.751A inserted into the CFC Legislation by the Finance Act 2007, and the choice of one rather than another may well involve policy decisions. But if that consideration alone could render a conforming interpretation illegitimate it would considerably restrict the occasions in which a conforming interpretation could be adopted and lead to an increase in disapplications. The choice of a conforming interpretation which faithfully follows a conclusion of the ECJ, as in this case, does not in my view trespass on the forbidden ground of legislation.
60. For all these reasons I would reject the third objection advanced by counsel for V2 in opposition to the conforming interpretation submitted by counsel for HMRC. Evans-Lombe J arrived at a different conclusion for, basically, two reasons. First, the conforming interpretation argued before him was limited to the motive test in s.748(3). There are obvious difficulties in seeking to graft on to a subjective test, such as that subsection contains, the objective test which the justification, which the ECJ considered to be essential, requires. Second, the nature of the conforming interpretation submitted by counsel for HMRC in this court is substantially different to that put before Evans-Lombe J. The conforming interpretation I would accept deals with the element of the CFC Legislation which provides the hindrance or restriction on freedom of establishment as opposed to the elements of justification for that hindrance or restriction on which the interpretation put before Evans-Lombe J concentrated. For all these reasons I would allow the appeal.
Disapplication
61. If the other members of the court agree with my conclusion on conforming interpretation then the issue of disapplication does not arise. But in case they do not, and in deference to the arguments of counsel I should make brief reference to the arguments. By paragraph 4 of his order Evans-Lombe J ordered that the CFC Legislation "be disapplied as being contrary to Community law". It is common ground that such order cannot stand because it goes beyond the obligation of a member state and disapplies the CFC Legislation in situations falling outside the scope of Community law, see IRC v Colmer 72 TC 56 paras 34 and 35.
62. The consequence of disapplication as referred to in paragraph 26 above is that it is necessary to identify those entitled to the community rights to be protected, see Autologic Holdings plc v IRC [2005] STC 1357, 1365 para 17 and Fleming/Conde Nast [2008] 1 WLR 195, 216 para 49. It was clear from the parties' written arguments that there was disagreement as to the extent and nature of the disapplication which would be appropriate. At our request the parties formulated what they submitted was the appropriate form of order on the assumption, in each case, that we had concluded that a conforming interpretation is impossible and on the further assumptions that their arguments on disapplication had or had not been accepted.
63. Counsel for the HMRC submitted that no order for disapplication would be required but the consequence of our judgment would be that the enquiry into the tax return of V2 would just continue. If that submission was not accepted it was suggested that the form of disapplication might be one of two alternative forms, namely:
A

"The CFC Legislation shall be disapplied in favour of V2 insofar as it relates to VIL in respect of the accounting period ended 31st March 2001."

Or B

"[As in the first alternative with the addition of] only where it is proven, on the basis of objective factors which are ascertainable by third parties, that despite the existence of tax motives VIL was during that accounting period actually established in Luxembourg and carrying on genuine activities there."

The first alternative was on the basis that his arguments on disapplication had not been accepted by us.

64. Counsel for V2 also put forward two alternatives, dependent on whether we accept their submissions that the enquiry should now be concluded as serving no proper purpose. They are:
A

"The CFC Legislation be disapplied as being contrary to Community Law in the case of V2 insofar as it relates to VIL and the accounting period 13th December 2000 to 31st March 2001"

Or B

"[As in the first alternative with the addition of] if it is proven, on the basis of objective factors which are ascertainable by third parties, that VIL was during that accounting period actually established in Luxembourg and carrying on genuine economic activities there."

In relation to the second alternative counsel for V2 contemplates that the addition might be illustrated by reference to 'wholly artificial transactions' or 'letterbox' or 'front' subsidiaries. In the case of V2 the second alternative was suggested as the proper form of disapplication if their arguments on disapplication were rejected.

65. It seems to me that the essential difference between the two versions put forward by each party is whether the limitation on the freedom of establishment constituted by the justification found by the ECJ to be permissible is to be read into it so as to restrict the class of person who, in the words of Lord Walker of Gestingthorpe in Fleming/Conde Nast, "are so circumstanced that the offending provisions must not be invoked against them, either in particular cases or at all".
66. In that connection there was much dispute and citation of authorities, including Autologic Holdings plc v IRC; Fleming/Conde Nast; ICI v Colmer; Centros [1999] ECR I-1459 and Inspire Art [2003] ECR I-10155. Given my conclusion on the first point it is unnecessary for me to reach any conclusion on the second. Suffice it to say that, given the issue as posed by Lord Walker of Gestingthorpe in Fleming/Conde Nast para 49, I would need a good deal of persuading that it was appropriate simply to disallow the CFC Legislation in favour of V2 in relation to VIL in the relevant accounting period, as in paragraphs 64A and 65A above, for that would be to ignore the justification for the CFC Legislation the ECJ upheld in Cadbury Schweppes and to disallow the CFC Legislation more extensively than the ECJ considered to be necessary to preserve the relevant freedom of establishment.
Conclusion
67. I would allow this appeal on the ground that the CFC Legislation is susceptible to a conforming interpretation for all the reasons set out above. In those circumstances it is unnecessary for me to reach any concluded view on the issue of disapplication and I do not do so. If the other members of the court agree with me I would invite counsel to agree a form or order to give effect to our conclusions.

Lord Justice Longmore:

68. It is never easy to ascertain the critical boundary between interpretation (which is within the court's remit) and legislation (which is not). Section 2 of the European Communities Act 1972 requires any legislation to "be construed and have effect subject to" community rights including, of course, freedom of establishment.
69. This obligation is not dissimilar to the obligation laid on the courts under section 3 of the Human Rights Act 1998 to read and give effect to legislation in a way which is compatible with convention rights.

"so far as it is possible to do so."

70. In the human rights context it has been said that the boundary between interpretation and legislation will have been crossed if it is proposed to give a statute a meaning which departs substantially from a fundamental feature of the Act (In re S [2002] 2 AC 291, 313 para. 40 per Lord Nicholls of Birkenhead), if the proposed meaning would remove the "core and essence" or "the pith and substance" of the Act or if it would insert something inconsistent with one of the Act's "cardinal principles" (Ghaidan v Godin – Mendoza [2004] 2 AC 557, 597 para. 111 and 598 para. 114 per Lord Rodger of Earlsferry). Nor can the process of interpretation create a wholly different scheme from any scheme provided by the Act (page 596 para. 110).
71. In the present case the words which the Revenue suggest should be inserted into the Act to ensure its compliance with Article 43 of EU Treaty do not create a new and different scheme nor do they offend any of the Act's cardinal principles; still less do they remove the core and essence of the Act. Mr Glick QC for V2 submitted that an exemption from the avoidance provisions in favour of CFCs which are not artificial creations or arrangements would result in a different scheme from that envisaged in the Act in its originally enacted form. But I cannot agree. The proposed insertion merely adds a further exemption which is allied to (although different from) the exemption granted to subsidiaries created or used without the motive of reducing the UK company's liability to tax. Any inquiry as to motive as originally envisaged by the Act, is likely to encompass the question whether the resulting CFC is an artificial arrangement; the proposed insertion merely makes clear that CFCs which are not artificial arrangements will be exempt from the provisions of section 747(1) of ICTA. To my mind this is permissible interpretation of the statute and not impermissible legislation by the court.
72. It follows that I agree with the reasons given by the Chancellor for allowing this appeal. I also agree that on any view the bald order of the judge that the CFC legislation is to "be disapplied as being contrary to Community law" is too wide to stand even in the event of disapplication being required. Since it is not required, I say no more about it.

Lord Justice Goldring:

73. I also agree.