Victory for Vodafone in battle with taxman

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The Independent Online

Vodafone won a crucial victory in the High Court yesterday in a £2bn dispute with the Government over its tax liability from an overseas subsidiary.

Mr Justice Edward Evans-Lombe ruled against government claims that the mobile phone giant's Luxembourg holding is a "controlled foreign company" (CFC) and should therefore be taxed as if it were part of the UK business. Vodafone says that because the division is a genuine operating subsidiary, rather than an artificial creation, it is not caught by the regulations.

The case has been running since 2002, and is focused on one of the company's main international holding companies, which was created in 2000 as part of the acquisition of Mannesmann, the German operator. The company is used to hold investments, circulate cash and profits around the group, and fund or leverage overseas investments.

This week's decision relates not only to Vodafone, but also to the broader question of how far the UK law is compatible with fundamental European legal principles. It applies a precedent set by the European Court of Justice (ECJ), and strikes a serious blow at the enforceability of UK CFC tax regulations, say experts.

Under current law, HM Revenue & Customs (HMRC) can claim tax on profits from overseas subsidiaries in countries with a lower level of taxation. But in 2006, in a similar case related to Cadbury Schweppes' Irish subsidiaries, the ECJ ruled that the UK regulations did not comply with European law. Despite government attempts to restructure the relevant regulations, the High Court has upheld the precedent.

Peter Cussons, a tax partner at PricewaterhouseCoopers, said: "This is a seminal judgment because it is the first UK judgment ordering the suspension of a block of UK direct tax law that was found in the earlier ECJ case to be inconsistent with the EU Treaty and incapable of being cured by interpretation."

HMRC is likely to appeal against the High Court decision in the House of Lords. "But after 30 years in tax, I have rarely seen such a well-argued judgment, so I wouldn't expect a successful appeal," Mr Cussons said.

Last month a spate of multinational corporations, including United Business Media and Shire Pharmaceuticals, announced plans to relocate to Ireland to avoid the UK's punitive regime. The Chancellor has set up a high-level forum to address the long-term competitiveness of the corporate tax regime, and the group had its first meeting last month. But the CFC debate has been rumbling for years. An official review was instigated in 2006, after the ECJ ruled that the UK rules breached the EU principle of freedom of establishment, but progress is glacial.

Mr Cussons said: "This may slow down the exodus at least temporarily because the judgment says the UK CFC regime is unenforceable so it might give remaining UK plcs more room for hope."