The world’s biggest mobile phone group has won a billion-pound battle with Revenue & Customs over the tax on one of its foreign subsidiaries.

The High Court on Friday ordered Revenue & Customs to close a long-running inquiry into Vodafone’s 2001 tax return after ruling that it would be unlawful to apply UK rates of corporation tax to a subsidiary based in Luxembourg.

Vodafone, which set up the unit as part of its 1999 acquisition of Germany’s Mannesmann, had estimated the cost of losing the case at more than £2bn ($4bn).

The judgment is a setback for the Treasury in its confrontation with multinationals over their ability to shift profits to lower-tax jurisdictions.

Its desire to tighten anti-avoidance rules has prompted threats by several large companies to move their tax domicile overseas.

Bill Dodwell of Deloitte said that, while he expected the financial impact of the case on the Treasury to be limited, the decision was embarrassing. “It is un­doubtedly a setback.”

The ruling is also likely to strengthen the incentive for the Treasury to sweep away its “controlled foreign company” legislation, which imposes tax on subsidiaries in low tax countries.

It has already proposed replacing the CFC rules, in an effort to shore up its defences against avoidance if it goes ahead with plans to allow the tax-free repatriation of foreign profits.

Revenue & Customs said it would appeal: “The government will continue to defend its ability to enforce the CFC rules, which are designed to counter tax avoidance through artificial shifting of profits to offshore subsidiaries.”

Vodafone’s victory will come as a relief to other multinationals facing disputes with Revenue & Customs over anti-avoidance rules. Advisers said a number of UK-based multinationals have financing structures in European Union countries, notably the Netherlands, Ireland and Luxembourg, which have been challenged by Revenue & Customs on the grounds they did not comply with the CFC rules.

Revenue & Customs is now bogged down in arguments with multinationals over the stringency of its proposed alternative, which would bring passive income – such as royalties and intellectual property – into the tax net. The Treasury is considering issuing an update on its thinking later this month, but a full consultation paper has been postponed pending further discussions with business.

Friday’s ruling, over Vodafone’s tax returns for the year to March 2001, concerned legislation which has since been amended.

But Mark Persoff of Clifford Chance, the legal firm, said the judgment cast doubt on the efficacy of minor changes made to the CFC rules after a 2006 European Court of Justice case involving Cadbury Schweppes. This ruled that anti-avoidance rules could only be allowed to interfere with businesses’ freedom of establishment in the EÛ if they were proportionate and only attacked wholly artificial arrangements.

“The High Court has expressed ‘some doubt’ as to the efficacy of sticking plaster amendments introduced in 2006,” Mr Persoff said. “This means, as matters now stand, the UK probably has no enforceable CFC legislation so far as EU/EEA subsidiaries are concerned.”

Source:ft.com