Vodafone faces tough tax call

Vodafone victory may be challenged

The taxman is expected to try to smoke Vodafone out in its £2bn row over the controlled foreign companies rules, moving the court battle on to a question of what exactly happened in the company’s Luxembourg subsidiary.

The mobile giant won in the High Court last week, but the case, the largest on CFCs ever, is expected to go all the way to the House of Lords given its significance and value.

The government’s controlled foreign company rules prevent corporates from channelling UK profits through overseas subsidiaries.

But companies say this is inconsistent with EU free market rules. In the Cadbury Schweppes case the European Court of Justice established that such rules are valid where they are designed to prevent artificial structures.

Vodafone claims that since the UK’s rules do not meet those criteria, the rules do not stand.

But it is thought HM Revenue & Customs will seek to argue in the Court of Appeal that Vodafone should show why its subsidiary is not artificial. If it is artificial, then it cannot argue that its rights under European law have been infringed.

Vodafone bought German mobile giant Mannesmann through the Luxembourg company, meaning no capital gains will accrue on the increase in the value of the shares.

Vodafone would be forced to prove that the subsidiary is controlled from Luxembourg and that it serves a genuine economic purpose, a point it has so far declined to argue in court.