THE DECISION GIVEN BY THE HIGH COURT IN Â Vodafone 2 v Revenue and Customs Commissioners [2008] (published 4 July 2008) is the latest subplot to the ongoing uncertainty surrounding the application of the controlled foreign company (CFC) rules and the taxation of foreign profits.
EXTENSION TO THE DEFINITION OF Â 'CONTROL' IN FINANCE ACT 2008Â
It is worth noting that in spite of the uncertainty  surrounding the CFC regime as a result of the  pending hearing before the Special Commissioners  of Cadbury Schweppes after the European Court of  Justice (ECJ) decision in 2006 (Cadbury Schweppes  plc & anor v Inland Revenue Commissioners [2007])  and the decision of the High Court in Vodafone 2,  the Finance Act 2008 actually increases the scope  of the CFC rules by extending the definition of  control to companies who control the economic  rights of a subsidiary (being the entitlement to  dividends, proceeds on a sale of shares or assets on  a winding up).
 Prior to 12 March 2008, the control test for CFC  purposes turned only on voting control. Although  beyond the scope of this article, companies who  previously have not fallen within the CFC regime will  need to consider whether the extended definition of  control brings any of their overseas subsidiaries  within it.
 VODAFONE 2 AND CADBURY
 In Vodafone 2 HM Revenue & Customs (HMRC) raised  an enquiry into Vodafone's tax return regarding  interest received by one of Vodafone's subsidiaries,  Vodafone Investments Luxembourg Sarl (VIL). VIL  was established as part of the acquisition by  Vodafone of Mannesmann AG and received interest  on loans made to Mannesmann in connection with  the acquisition. One of the grounds for Vodafone's  appeal to the Special Commissioners was that the  imposition of the CFC rules on Vodafone would  amount to an unlawful restriction on the freedom  of establishment and free movement of capital  under the EC Treaty. The Special Commissioners  referred the case to the ECJ and stayed Vodafone's  application for a closure notice into the enquiry until  the case was heard.
 In the meantime, the ECJ had the opportunity to  consider the compatibility of the UK CFC legislation  (the Income and Corporation Taxes Act 1988) with  the EC Treaty in Cadbury. The guidance provided by  the ECJ in Cadbury was that the restriction on the  freedom of establishment introduced by the CFC  rules can only be justified to the extent that it  enables the UK to 'thwart practices which have no  purpose other than to escape tax normally due on  the profits generated by activities carried on in a  national territory'. Accordingly, the CFC regime was  only a proportionate restriction (and therefore  compatible with the EC Treaty) if it could be shown  that the legislation 'lends itself to an interpretation  which enables the taxation provided for by that  legislation to be restricted to wholly artificial  arrangements'.
 In summary, EC law would only permit the  anti-avoidance legislation contained in the CFC  rules if the legislation is targeted at artificial  arrangements whose sole purpose is the avoidance  of tax in relation to companies that are not  conducting bona fide commercial activities in a  member state.
 The reference to the ECJ in Vodafone 2 was  withdrawn following the decision in Cadbury, and  the decision by the High Court in Vodafone 2 is the  first application of the guidance provided by the ECJ  in Cadbury in UK courts.
 As a result of the ECJ decision in Cadbury, the Finance  Act 2007 introduced additional provisions to the CFC  regime in an attempt to bring the legislation within  the guidance provided by the ECJ. It should be noted,  however, that the decision in Vodafone 2 is based on  the CFC legislation prior to the amendments made by  the Finance Act 2007, which are yet to be tested in  UK courts.
 VODAFONE 2 IN THE HIGH COURT
 In Vodafone 2 Evans-Lombe J followed the guidance  given by the ECJ in Cadbury by stating that the  decision turned primarily on whether the CFC  legislation can be construed so as to apply a charge  only on profits of a CFC that are not bona fide  'established' in a member state.
 After considering in detail the extent to which the  judiciary may interpret UK legislation in line with EC  law, Evans-Lombe J concluded that it was not  possible to interpret the CFC rules in line with the  guidance provided by the ECJ in Cadbury. In order to  do this, an additional objective condition would need  to be added to the CFC legislation such that a CFC  charge would only arise where the kind of artificial  arrangements described in Cadbury were used by  the taxpayer for the sole purpose of avoiding UK  tax. It was therefore not within the scope of the  judiciary's powers to essentially amend the CFC  rules so as to comply with the guidance provided  by the ECJ.
 A final argument was raised by HMRC that the CFC  legislation should only be disapplied in cases where  the companies involved were bona fide established  in a member state. However, Evans-Lombe J  rejected this argument on the grounds that  taxpayers are entitled to certainty over the  meaning and consequences of legislation. To agree  with this argument would simply beg the question  as to when the CFC rules apply. Evans-Lombe J was  unequivocal in his decision by stating that the CFC  legislation 'must be disapplied so that, pending such  amending legislation or executive action, no charge  can be imposed on a company such as Vodafone  under the CFC legislation'.
 Although Vodafone 2 did not address the  compatibility of the provisions introduced by the  Finance Act 2007 with the EC Treaty, it is worth  noting that Evans-Lombe J did comment that there  is some doubt over whether the new provisions are  also an infringement of EC Treaty rights.
 END OF THE CFC REGIME?
 Although the decision by the High Court in Vodafone 2  appears to sound the death knell of the CFC  legislation, the consequences of the decision are not  so clear. On one hand, it is difficult to find fault with  the judgment as Evans-Lombe J directly addressed  the question set by the ECJ in Cadbury and thoroughly  reviewed the ability of the judiciary to interpret the  legislation. On the other hand, the conclusion that a  company such as Vodafone could escape a CFC  charge regardless of whether it has entered into the  kind of artificial arrangements described in Cadbury must surely be open to further scrutiny.
In the meantime, Vodafone 2 certainly places  considerable pressure on the current CFC rules,  which may, unless the decision is overturned on  appeal, be a thing of the past. HMRC and HM  Treasury have been considering amending the  CFC regime to include UK subsidiaries, thereby  avoiding the argument that the regime  discriminates against establishing subsidiaries  in other member states. (The same tactic was  used when the transfer pricing rules were  extended to UK-to-UK transactions by the Finance  Act 2004). It is therefore likely that the current  CFC rules will need to be amended, regardless of  the future of Vodafone 2 and the wider decisions  to be made on the taxation of foreign profits as  a whole.
 By Anthony Whall, associate, Jones Day.
