England and Wales High Court (Chancery Division) Decisions

IN THE HIGH COURT OF JUSTICE
CHANCERY DIVISION

		Royal Courts of Justice Strand, London, WC2A 2LL
		19 February 2002

Jacob J

1. Should procurers, pimps, panders, call them what you will, pay VAT? That is the question on this appeal. The appellants are HM Commissioners for Customs & Excise. The respondents are two individuals who conduct a business which they describe as an "escort agency." They do not, and never have, contended that they are not registrable because they are procurers. They do not accept that they are. They do not support the Commissioners' decision in their favour. Not surprisingly they were not present on this appeal. Their grounds for saying they do not need to register are much more mundane: that their relevant turnover is below the threshold for registration. The Commissioners do not agree about that, so the point remains to be determined if this appeal succeeds. Originally the Commissioners said that the respondents turnover should be assessed on the basis that the respondents acted as principals rather than merely as agents for the escorts and raised assessments accordingly. The respondents appealed to a VAT Tribunal (Mr Cornwell-Kelly, Ms de Alberquerque and Mr Hossain).
2. The Tribunal decided against the Commissioners on the agency point. But then, of its own motion, it took the point the subject of this appeal. Before then, by an interim decision of 20^th March 2001 it required submissions and any further evidence about the nature of the respondents' business. Both parties said they did not want to put in any more evidence. The Commissioners said that the nature of the business was not part of either side's case and was irrelevant. The respondents just said their business was lawful. Despite all this, the Tribunal pressed on with its own point. It concluded that the respondents' business was unlawful and as such was outside the VAT scheme altogether. The Commissioners contend that the Tribunal was wrong in law on the illegality point. They appeal only that finding. Whether or not the agency turnover brings the respondents above the threshold remains to be determined if this appeal is allowed. If it is refused, then that question goes away.
3. The grounds of appeal are not that the Tribunal took the point of its own motion. I therefore do not consider whether that of itself might have been a ground of appeal. There are, however, obvious dangers of a Tribunal striking out in a wholly independent way - it is apt to fall into error. Here I think it did, and in a number of ways.

The Tribunal's decision

4. When it came to the illegality point the Tribunal posed two questions:

"(i) Are the appellants' activities unlawful?

(ii) If so, is their type of activity necessarily and inherently unlawful so that there can be no lawful competition in it: in particular, is there lawful competition possible between an escort agency providing escorts for social purposes and one which, while called an escort agency, is in fact procuring prostitution?"

5. As to the first question it concluded:

"The answer to (i) is, we believe, quite clear. Our finding is, on the balance of probabilities – indeed, we would say beyond reasonable doubt – that the appellants' business consists wholly, or at least very substantially, of the procurement of women for the purposes of their becoming common prostitutes, a man living on the earnings of prostitution, a woman exercising control, direction or influence over a prostitute's movements for gain in a way which shows that she is aiding or abetting her prostitution."

6. It will be noted that there is no finding that every use of the respondents' services would necessarily involve an offence. It is not essential to the respondent's business that each and every girl on their books should be, or, when engaged through the respondent's services act as, a prostitute.
7. As to the second question the Tribunal said:

"The answer to question (ii) is even clearer. A lawful business may be conducted unlawfully, as where a solicitor embezzles his client's money, or where a builder constructs a house in defiance of the building regulations. But that is quite different from the appellants' activities, which are straightforwardly criminal, masquerading as a lawful business. If it were otherwise, the construction of the Sixth Directive laid down in the authorities would be defeated simply by the device of a criminal activity being given the colour of a lawful business. The question, however, is one of substance: Is there anything in common between the unlawful activity and a lawful counterpart which could give rise to the two being in competition? The answer plainly is that there is nothing that puts a genuine escort agency on the same plane as a prostitution racket: the two are not, and cannot be, in competition of any sort."

The legislation

8. The issue is governed by the Sixth Directive of 17^th May 1977 on the harmonisation of the laws of the Member States relating to turnover taxes (17/288/EEC). So there is no point in looking at our implementing domestic legislation (the Value Added Tax 1994). I go to Recital 4 of the Directive:

"Whereas account should be taken of the objective of abolishing the imposition of tax on the importation and the remission of tax on exportation in trade between Member States; whereas it should be ensured that the common system of turnover taxes is non-discriminatory as regards the origin of goods and services, so that a common market permitting fair competition and resembling a real internal market may ultimately be achieved."

Then there is the basic rule contained in Art. 2:

"The following shall be subject to value added tax:

1 the supply of goods or services effected for consideration within the territory of the country by a taxable person acting as such;

2 the importation of goods."

Finally there is Art. 6 which defines "Supply of Services"

"'Supply of services'" shall mean any transaction which does not constitute a supply of good within the meaning of Art. 5"

Art. 6 goes on to give a list of transactions which are included. The list shows just how general the concept is.

9. The decisions of the European Court of Justice have established the principles concerned by which these simple provisions are to be interpreted. The Commissioners say the Tribunal's reasoning violates three of these.

The principle of fiscal neutrality

10. This was identified in a pair of cases, Happy Family (case 289/86 [1988] ECR 3655) and Mol (case 269/86 [1988] ECR 3627). The cases were concerned with the supply of narcotic drugs. This was illegal throughout the EU. The Court said:

"16. It should be observed that the Sixth Directive is based on Articles 99 and 100 of the EEC Treaty and it objective is the harmonisation or approximation of the legislation of the Member States on turnover taxes 'in the interests of the common market'. According to the third and fourth recitals in the preamble to the directive, the establishment of a common system of value-added tax should assist the effective liberalisation of the movement of persons, goods, services and capital, the integration of national economies and also the achievement of a common market permitting fair competition and resembling a real internal market.

17. Since the harmfulness of narcotic drugs is generally recognised, there is a prohibition in all the Member States on marketing them, with the exception of strictly controlled trade for use for medical and scientific purposes. As the Court has already held with regard to the illegal importation of narcotic drugs into the Community, in its judgment in Einberger, such drugs are, by definition, subject to a total prohibition on importation and marketing in the Community. The Court added that such goods, whose release into the economic and commercial channels of the Community is absolutely precluded and whose illegal importation can give rise only to penalties under the criminal law, are wholly alien to the provisions of the Sixth Directive on the definition of the basis of assessment and, in consequence, to the provisions on the origination of a turnover tax debt."

And:

"20. The Sixth Directive, whose purpose is to achieve widespread harmonisation in the area of VAT, is based on the principle of fiscal neutrality. That principle, as the Court has stated, precludes a generalised differentiation between lawful and unlawful transactions, except where, because of the special characteristics of certain products, all competition between a lawful economic sector and an unlawful sector is precluded (see Case 269/86, paragraph 18, and Case 289/86, at paragraph 20).

11. In the present case the Tribunal simply ignored this principle. It failed to enquire whether or not what it conceived the respondents' business to be (namely procurement) was unlawful throughout the Community. So the decision is flawed for that reason.

The principle of the inherent nature of the service

12. But there is more. For even if procurement were illegal throughout the EU, that is not enough. A generalised differentiation between lawful and unlawful transactions is precluded. You have to show more and cases show that the illegality exclusion is very narrow indeed. Thus the following have been held to be within the VAT regime;

(a) Export of computers without a necessary permit and thus illegal. Lange v Finanzamt Fürstenfeldbruck (Case C-111/92 [1993] ECR 4677);

(b) Gambling without a licence and thus illegal (Case C-283/95 Fischer v Finanzamt Donaueschingen [1998] ECR 3369);

(c) Dealing in counterfeit perfumes (Case C-3/97 Goodwin & Unstead [1998] ECR 3257.

13. In all these cases the underlying activity concerned was not inherently unlawful. It was conditionally so, depending on whether or not a licence or permit was or might be given. Thus it was not the intrinsic or inherent nature of the activity which made it illegal. So it was not like the supply of narcotics (Happy Family). Nor was it like the importation of counterfeit money (the subject of Witzemann v Hauptzollampt München-Mitte Case C-343/89 [1990] ECR 4477). In those two cases (the only two cases where activities have been held outside the VAT system) it was the inherently illegal nature of the activities which took them outside VAT. The court expressed the principle thus in Lange:

"17. That is not the case where there is no absolute prohibition based on the nature of the goods or their special characteristics, but where only the export of those goods to certain destinations is prohibited, because of their possible use for strategic purposes. Such a prohibition cannot, therefore, be sufficient to remove those products from the scope of the Sixth Directive."

14. In the present case the Tribunal overlooked the fact that prostitution, as such is lawful. So the inherent nature of the procurement "service" is in competition with a lawful service. The possibility of such competition is regarded by the Court a key factor in considering the inherent nature of a service. For instance it said in Goodwin and Unstead:

"15. Furthermore - as the Commission also pointed out - the possibility of competition between counterfeit products and goods which are lawfully traded cannot be ruled out in a case such as that before the national court, insofar as there is a lawful market in perfume products on which counterfeit products have a specific impact. Accordingly, such goods cannot, like narcotics or counterfeit currency, be regarded as extra commercium."

The principle of sufficient proximity

15. The Tribunal overlooked this principle too. It is best illustrated by Coffeeshop Siberië (Case C-158/98 [1999] ECR 3971). The taxpayer's business was closely associated with the sale of narcotics. What it did was to supply coffee shop tables where the sale of cannabis would take place. But of course you could, if you wanted, just rent a table from the taxpayer and read a book. So the service was not inherently linked to the supply of narcotics. Advocate General Fennelly put it this way:

"Thus, although the Court could conceivably in future be asked to consider, for instance if the proceeds of under-age prostitution, paedophile pornography or trafficking in human beings were at issue, whether the activity were subject to the requisite unconditional prohibition to fall within the exclusion, as the activities of house dealers clearly fall within the scope of the Happy Family reasoning, it need here only decide whether their relationship with coffee shops is sufficiently proximate and intertwined so that the exclusion of VAT in respect of drug sales should also apply to assisting them."

The Court said this

"11. However, that criminal aspect does not alter the fact that making available a place of sale is in itself a supply of services for the purposes of the Community legislation on VAT which falls within the scope of Article 2 of the Sixth Directive."

"19 It should be noted that the activity to be taxed in this case is not the sale of narcotic drugs, but a supply of services consisting in making available a place where the sale of those products is effected with the agreement of the supplier of the service. Consequently, the reasoning in Happy Family cannot be transposed directly to the facts in this case.

20. It is therefore necessary to consider whether the reasoning is to be extended to activities linked in any way at all to dealings in drugs.

21 As noted in paragraph 14 of this judgment, the Court has consistently held that the principle of fiscal neutrality prevents any general distinction in the levying of VAT as between lawful and unlawful transactions. Consequently, the mere fact that conduct amounts to an offence is not sufficient to justify exemption from VAT. The exception applies only in specific situations where, owing to the special characteristics of certain products or certain services, any competition between a lawful economic sector and an unlawful sector is precluded."

22. In this case, however, there is no such special situation. Renting out a place intended for commercial activities is, in principle, an economic activity and therefore falls within the scope of the Sixth Directive. The fact that the activities pursued there constitute a criminal offence, which may make the renting unlawful, does not alter the economic character of the renting and does not prevent competition in the sector, including that between lawful and unlawful activities."

16. The present case is directly comparable with Siberië. The respondents provide the time of their escorts. That is a lawful and autonomous activity. The activities of the escorts and their customers are separable from the service of the taxpayers, just as the supply of tables for the sale of drugs and the actual sale of drugs were separable in Siberië.
17. I conclude that this case is not within the very narrow rules which "allow moral scruple by a paradox to reward criminality by exempting it from taxation" (per Fennelly AG in Siberië at p.3973. In this case, as the Latin poet said, pecunia non olet (money doesn't smell). I allow the appeal.