Judgment was today handed down in the High Court in the Vodafone 2 case. Overturning a Special Commissioners decision, the judge has held that it is impossible to construe the motive test in the UK’s CFC rules (s748(3) ICTA) as conforming with Community law by reading in a “second condition” that the CFC was properly established in the relevant Member State. Instead, the provision as it stands is contrary to Community law and the CFC rules should be disapplied.

HMRC had opened an enquiry into Vodafone’s 2000/2001 accounting period to establish whether Vodafone should incur a CFC apportionment in relation to the profits of its wholly owned subsidiary resident in
Luxembourg. Vodafone applied for a closure notice on the basis that any such apportionment would be unlawful as the CFC legislation breached Community law. Applying Cadbury Schweppes, the Special Commissioners held that the CFC legislation should be read as containing a second condition that it should not be applied where the UK parent proves that the CFC is actually established in the host Member State and carries on genuine activities there.

Mr Justice Evans-Lombe has overturned the Special Commissioners decision, holding that it is impossible to interpret the motive test as being compatible with Community law. To do so, in his view, would be to turn a subjective test into an objective test and would thereby render the whole of the original test redundant. In these circumstances, the judge has held that the CFC legislation should be disapplied so that no charge can be imposed on Vodafone (or any company in a similar position) pending the introduction of amending legislation.

This decision is almost certain to be appealed by HMRC. However, if it is upheld, it will be very positive for all claimants challenging legislation that has been held by the ECJ to be disproportionately restrictive.