Is the Channel Island’s VAT abuse going to end?

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The announcement last week of new moves by HM Revenue & Customs to crack down on tax evasion through banks was extremely welcome.

However, as the Guardian has noted today, the abuse of VAT Low Value Consignment Relief (LVCR) by major retailers despatching orders from the Channel Islands to the UK for the sole purpose of blatantly abusing our VAT laws goes on.

But maybe not forever:

Leaked letters from Treasury minister Stephen Timms reveal the government now privately believes British companies marketing goods sourced in the UK to UK customers at VAT-free prices may be "abusing" rules.

Treasury estimates suggest VAT-free sales to the UK from the Channel Islands grew to £620m last year, creating a £110m dent in Treasury coffers. Some industry insiders believe these figures are a substantial under-estimate: market research firm TNS says 28% of DVDs and 23% of CDs purchased by customers in Great Britain are bought on the internet.

Customs officials are seeking to establish a test case supporting their belief that the wilfully circuitous shipping arrangements at the heart of the loophole amount to an abusive tax structure. In order to qualify as VAT-free transactions, goods destined for UK customers are taken on a long journey out to the Channel Islands and back again.

HM Revenue and Customs believes it can use the precedent set in a 2006 test case involving mortgage bank Halifax. In that judgment, the European Court of Justice established an "abuse of rights" principle that invalidates complex tax structures essentially designed to secure an extraordinary advantage.

A letter from Timms states HMRC regards certain arrangements "for goods to be imported from a Channel Island to benefit from LVCR [low value consignment relief]" to be "an abusive practice". Timms explains customs officials have already challenged one business, but that "unfortunately, no precedent was set ... as the business in question accepted ... they had accounted for VAT incorrectly."

The leaked letter will make uncomfortable reading for HMV, which four years ago relocated its UK distribution centre for to Guernsey. Investors were told the move was made "to improve prices relative to our internet-based competitors" - a reference to the offshore VAT advantage.

But HMV said it was "confident it could not be challenged" under the Halifax ruling. A spokesman stressed: "We hold a significant amount of stock in Guernsey. It is not shipped there upon receipt of customer orders, so we do not 'round-trip'. All product is picked, packed and labelled in Guernsey."

Timms appears to accepts that HMV's Guernsey centre complicates any potential challenge. His letter states: "It is less clear whether, and in what circumstances, the principle of abuse can apply where a business chooses to locate distribution centres [in the Channel Islands] in order to benefit from LVCR."

I have seen the Timms letter.

I also take courage from a very recent EU hearing, here. Ignore the fact LVCR was granted: it is pretty clear that if the goods had left an EU state to then return (a point not considered in this hearing) the decision would have been different: LVCR would have been denied.

That is what is happens with the Channel Islands’ abuse.

I think a combination of the Halifax principle and this new hearing could kill this pernicious and abusive trade that has just two intentions: unjust enrichment of selected traders and abuse of the UK tax system.

And please don’t tell me consumers win: reducing consumer choice through tax abuse is not a consumer win.

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