HMRC v Pendragon plc [2015] UKSC 37 gives tax advisers some useful guidance on when VAT planning will be viewed as an abusive practice, with any VAT advantage obtained through the planning being disallowed.




The case related to VAT on ‘demonstrator cars’, which had been displayed in car dealership showrooms run by the Pendragon group. The group consisted of a holding company, Pendragon plc (“Pendragon”), four ‘dealership companies’, three ‘captive leasing companies’ and a further sales subsidiary.

The dealership companies sold the demonstrator cars as second hand cars; under the VAT (Cars) Order 1992, dealers in second-hand goods are allowed to charge VAT only on the profit margin in certain circumstances, including under a transfer as a going concern.

Pendragon put in place a complex structure which enabled Pendragon to recover input tax on the price of the cars while avoiding output tax on the onward sale of these cars to consumers.

HMRC argued that, although the scheme technically worked, the transactions were an abusive practice under the Halifax principles, namely:
• The transactions resulted in a tax advantage to the taxpayer contrary to the purpose of the Sixth VAT Directive and national implementing legislation; and
• Objectively, the essential aim of the transactions was to obtain that tax advantage.
(Halifax v HM Customs and Excise (C-255/02))

HMRC sought to recover VAT on the full sale price of the cars and charged penalties.

Court of Appeal Decision

The First Tier Tax Tribunal held that the essential aim of the transaction was not to avoid VAT, and therefore allowed Pendragon’s appeal. This decision was overturned by the Upper Tribunal, which disagreed and substituted its own judgment on the facts that the essential aim of the structure was to avoid VAT.

The question before the Court of Appeal was whether the UT was right in substituting its own judgment as to what the essential aim of the structure was. The Court of Appeal determined that this question was partly a matter of fact and partly a matter of law and, as there had been no error of law by the FTT, HMRC had to show that no reasonable tribunal could have reached the decision that the FTT reached.
The Court of Appeal considered that the UT had overstepped its proper appellate role by substituting its own decision for that of the FTT based on an evaluation of competing factors (both fact and law).

Supreme Court Decision

First limb of Halifax

The Court considered this question afresh. The problem with the first limb of the test is that, as the principle of abuse of law doesn’t apply to ‘normal commercial transactions’, the VAT directives must be assumed to have been designed to accommodate such transactions.

The Court emphasised that there was no separate test of what was a ‘normal commercial operation’; the point was simply whether it was ‘normal’ in relation to how the VAT legislation in question operated. Here, the purpose of the profit margin scheme was to avoid double taxation. Lord Sumption stated, “A system designed to prevent double taxation on the consideration for goods has been exploited so as to prevent any taxation on the consideration at all.” Therefore it could not be a ‘normal’ transaction in light of the purpose of the margin scheme.

Pendragon argued that there were cases where, legitimately, the margin scheme would apply where there was no earlier VAT, and therefore the prevention of double taxation could not be the “exclusive target” of the scheme. The Supreme Court disagreed, considering that this was simply the consequence of designing a workable scheme, but that the purpose of the legislation was clear.

Pendragon also attempted to argue that the abuse principle could not apply because the margin scheme was a domestic, rather than an EU, measure, in that it went further than any equivalent message in the VAT directives. Lord Sumption rejected this, stating that the directives leave various matters to member states to determine, but the domestic schemes were nonetheless part of a scheme for implementing an EU tax. Therefore the general principles of EU law, including the abuse of law principle, still apply; the Supreme Court considered that “it must have been intended” that the abuse of law principle should apply even as a matter of English domestic law.

Second limb of Halifax

The Supreme Court noted that tax avoidance schemes are rarely directed exclusively to avoiding tax; generally there will be concurrent purposes, namely a commercial purpose which is achieved in such a way as to avoid tax. The question is whether the commercial objective was enough to explain the particular features of the arrangements.

The relevant evidence to consider when determining the ‘essential aim’ of the arrangements, according to the judges, is not limited to what would be admissible as an aid to construction of a contract. The court should consider the objective commercial requirements of the party obtaining the tax advantage, the involved parties’ background knowledge, the relationship between the parties, their financial positions, the reasonableness of consideration and the normal course of the relevant business. The Supreme Court emphasised that the ‘essential aim’ was to be determined by reference to objective factors, not subjective intentions.

The ‘essential aim’ was the aim of the scheme as a whole, and of each step in the scheme. The court is not “confined to considering the artificiality or purpose of each individual step, since these will commonly be individually unassailable but designed to produce the tax advantage in combination.” In this case, the Supreme Court looked at each step of the scheme. The FTT’s findings had shown that the scheme achieved a number of rational commercial objectives. The economic substance of the sale and lease-back operation, and the choice of an offshore bank for funding, was not objectionable in itself. However, there were two steps to the scheme (both crucial for the tax advantage to apply) which had no commercial rationale other than tax avoidance. Aside from these two steps it was a “perfectly ordinary” sale and leaseback operation.

The Supreme Court considered that the FTT had approached the question with “too high a level of generality”, as they did not consider whether the identified commercial objectives explained the particular features of the scheme. This had been an error of law, and the UT had been right to overturn its decision.

As both limbs of Halifax were met, the Supreme Court found the scheme to be an abuse of law, which meant it had to be redefined to re-establish the situation which would have prevailed had the abusive practice not been involved. The Supreme Court redefined it as a sale and leaseback transaction, thus giving rise to VAT on the full sale value of the cars.

Role of the UT

The Supreme Court also gave some additional guidance on the role of the UT. Lord Sumption considered that the UT had been entitled to intervene because the FTT had erred in law. Lord Carnwath expanded on this. Where the FTT has erred in law, given the specialist role of the UT, they may remake that decision, including by making further findings of fact in light of the correct approach to the law. Particularly, where a key principle was involved (such as the abuse of law principle), it was appropriate for the UT to do this in order to give appropriate guidance. Rather than focusing on which issues were law and which were fact, the Court of Appeal should have instead focused on the UT’s decision on its own merits.


The guidance on how a scheme will be analysed by the courts is helpful. Tax advisers should bear in mind that the courts will consider the commercial aim of scheme overall, and each constituent part of the scheme. The Supreme Court also made some interesting general comments on tax avoidance, recognising that avoidance (as opposed to evasion) was legal, but that it could have “significant” and “controversial” social costs. Nonetheless, they explicitly recognised that it is not the role of the judiciary to increase the scope of tax legislation.

The comments on the role of the UT (although not part of the ratio or leading judgment) may have an impact on the UT’s approach to appeals from the FTT, making it more willing to assess issues of fact.