On June 20, 2013, the ECJ ruled that contractual terms, even though they constitute a factor to be taken into consideration, are not decisive for the purpose of identifying the recipient of a "supply of services" within the meaning of articles 2(1) and 6(1) of the Sixth VAT Directive.
In the case at hand, a UK loan-broker ("Ocean Finance") suffered non-recoverable input VAT on advertising costs, due to the fact that Ocean Finance was a VAT exempt financial intermediary.
In order to mitigate the amount of irrecoverable input VAT, Ocean Finance incorporated a subsidiary outside the EU VAT territory, namely in Jersey. The Jersey company provided loan-broking services to UK customers. The consequence was that no UK VAT was chargeable under the litteral reading of the statute provisions, since the supply of advertising services is taxed where the VAT registered client is established.
The UK tax authorities argued however for the set-up to constitute an abusive arrangement considering that under a substance over form approach it was Ocean Finance - and not the Jersey company - that was the real supplier of the loan broking services and the recipient of the supplies of advertising.
The ECJ ruled that national courts may look beyond contractual terms; they may ignore the contractual position under certain circumstances, if and when the contract does not reflect the economic reality such as the question as to the place where the services are used. In other words, contracts may be set aside where they do not wholly reflect the economic and commercial reality of the transactions, but constitute a purely artificial arrangement that had been set up with the sole aim of obtaining a tax benefit.
In light of this case law, the consecration of "substance over form" in this area will urge businesses, which have implemented tax-efficient structures, to ensure conformity between papers and reality. Otherwise they could face a recharacterisation of the transactions and structures formally adopted in order to have the transactions getting taxed according to their economic and commercial reality.
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