The Guardian and The Telegraph have posted articles in the last week picking up the quandary of buy-to-let landlords. By a combination of changes in the summer budget and autumn statement, the previously lucrative venture whereby landlords would purchase property with the sole intention of renting has now been placed “in the red”. Landlords could previously claim tax relief on mortgage interest payments at the marginal rate, but from April 2017 to 2020, this will gradually be reduced to 20% (the ‘Clause 24’ change). “Wear and tear allowance” previously allowed landlords to deduct 10% from rental profits, but from April 2016 will only be granted for costs actually incurred. Meanwhile, George Osborne used the autumn statement to increase stamp duty on purchases of buy-to-let and second homes by 3%.
Landlords unsurprisingly are less than happy with the legislative changes. A group representing 250 landlords is seeking to launch a legal challenge by way of judicial review of the Finance (No. 2) Act 2015 enacting the ‘Clause 24’ change to mortgage relief (see: s. 24). As The Guardian reports, the group claims that the measure breaches Human Rights Law and EU Law, whilst The Telegraph reports the group as claiming that the move flouts “a long-established principle of taxation that expenses incurred wholly and exclusively for the purposes of the business are deductible when calculating the taxable profits”. It would seem from these statements that the claims pivot upon establishing that the new legislation breaches either Article 1, Protocol 1 of the European Convention on Human Rights (‘A1P1’), some common law right or EU State Aid Law. These are my rough guesses based upon very rough information. Although the former two will have little prospect of success in the courts, the latter EU Law point could well have some bite. This will be used as a springboard for a more general discussion about the development of EU State Aid Law.
Human Rights Law
A1P1 provides as follows:
“Every natural or legal person is entitled to the peaceful enjoyment of his possessions. No-one shall be deprived of his possessions except in the public interest and subject to the conditions provided for by law and by the general principles of international law.
The preceding provisions shall not, however, in any way impair the right of a State to enforce such laws as it deems necessary to control the use of property in accordance with the general interest or to secure the payment of taxes or other contributions or penalties.”
Although facially it would appear that A1P1 is engaged every time there is a tax change, the hurdles for satisfying the threshold necessary for a claim to succeed are in fact “very high” (Stanley Burnton J in R (on the application of Federation of Tour Operators, TUI UK Limited, Kuoni Travel Limited) v Her Majesty’s Treasury  EWHC 2062, paragraph 154). Member States are granted a “very wide margin of appreciation” in matters of economic and social policy (James v UK (1986) 8 EHRR 123, paragraph 42) and in order to succeed under A1P1, it must be proved that a tax increase was “devoid of reasonable foundation” (National & Provincial Building Society and Others v United Kingdom (1997) 25 EHRR 127, paragraph 80; Gasus Dosier-und Fördertechnik GmbH (1995) 20 EHRR 403, paragraph 62)).
When applied to the case at hand, the argument that the tax change on buy-to-let properties breaches A1P1 seems unsustainable. There is a clear policy initiative underlying the change, in addition to the fact that it will raise revenue. Landlords might be aggrieved but that is very far from the threshold of lacking any reasonable foundation.
The reason why economic and social policies enshrined in primary legislation are almost immune from challenge under the ECHR relates to the primary constitutional principle of Parliamentary Sovereignty (that Parliament should have the ultimate say, in this case, upon national matters of social and economic policy). This will also be sufficient to neuter any potential challenge on the basis of the common law. It is not possible that a common law right that “expenses are wholly and exclusively deductible” could constrain Parliament’s constitutional power to enact primary legislation (Wheeler v Office of the Prime Minister  EWHC 1409 (Admin), paragraph 41; Rowe v HMRC  EWHC 2293, paragraph 95).
It is under EU State Aid provisions however that the landlords might actually have a case. I’ve blogged elsewhere about State Aid Law (here, here and here) and am fascinated by what I see as an overextension of the law in the area. It might seem strange that a provision originally introduced to prevent states from intervening in the single market by favouring their own national undertakings and industries over others could be used to challenge (effective) tax hikes, but that is the strange direction that the law has been taken.
State aid arises where:
- there has been an intervention by the State or through State resources
- the intervention gives the recipient an advantage on a selective basis
- competition has been or may be distorted;
- the intervention is likely to affect trade between Member States.
The first condition would be satisfied here by reason of the fact that the Government has introduced the change in primary legislation (Cases T-211/04 Commission v Government of Gibraltar  ECR I-11113). The third and fourth conditions are today to be taken almost as read according to the caselaw (Case C-730/79 Philip Morris Holland  ECR 2671; though see Joined Cases T-515/13 and T-719/13 Spain and Lico Leasing v Commission where the Commission was scolded by the General Court for not sufficiently demonstrating distortion or effect on trade h/t @AislingTax). For instance, in Eventech (C-518/13 Eventech v The Parking Adjudicator), the Court of Justice found that the policy of permitting black cabs to use London bus lanes could affect trade between Member States.
It is the second condition – the need for a “selective advantage” – where the contest for State Aid arises. There is essentially a two-stage test that is adopted in relation to this assessment (although this is sometimes broken down into three or even four stages). The first question is whether a “State measure is such as to favour ‘certain undertakings or the production of certain goods’… in comparison with other undertakings in a comparable legal and factual situation in the light of the objective pursued by the measure concerned”. The second is whether the measure “is justified by the nature or general scheme of the tax system of which it is part” (Case C-143/99 Adria-Wien Pipeline  ECR I-8365, paragraphs 41 and 42).
Two cases in particular illustrate the susceptibility of the current tax change to infringing State Aid Law, namely GIL Insurance and British Aggregates. The former concerned Insurance Premium Tax (‘IPT’). This was introduced on insurance premiums generally in 1994. The Finance Act 1997 however introduced a new higher rate of 17.5% of IPT on insurance premiums relating to domestic appliances, motor-cars and travel. The UK sought to justify the differentiated rates by reason of the need to compensate for the fact that these activities were exempt from VAT.
The General Court refrained from discussing the first step in detail but reasoned with the assumption that the measure is specific. However, the Court nevertheless concluded that the measure is justified by the nature and overall structure of the system. The Court mentioned in particular the fact that the higher rates of IPT and VAT form part of an inseparable whole.
The British Aggregates scandal meanwhile took some 13 years to be resolved. The case concerned a UK levy on aggregates – inert granular materials such as sand, gravel or crushed stone. The levy only applies to virgin aggregates – aggregates that are newly mined. It does not apply to recycled aggregates (aggregates already used) or secondary aggregates (such as slate waste, china clay waste, colliery spoil, ash, blast furnace slag, waste glass and rubber). The General Court initially agreed with the Commission that there was no selectivity provided to the competitor of the applicant ‘British Aggregates’ (who benefited from using recycled aggregates). It held that Member States are empowered by reason of Article 11 of the Treaty on the Functioning of the EU to consider environmental protection in the interpretation of Treaty provisions.
The Court of Justice of the European Union overturned the General Court’s decision and remitted it for reconsideration. Environmental protection ought to have come within the second limb of the test and not the first, it was held.
The General Court on reconsideration found that there were factual and legal similarities between virgin, secondary and recycled aggregates, despite the fact that they were subject to different rates of tax. Virgin aggregates and secondary aggregates could be used for the same purposes for instance. Moreover, the environmentally harmful nature of extraction does not depend on the type of aggregates extracted. The extraction of a secondary product could be just as harmful as extraction of a virgin aggregate. Finally, the court noted the possibility that the exemption for clay, slate, china clay, ball clay and shale aggregate “creates greater demand for those aggregates in the construction industry, or even an economic incentive to extract more (‘primary’) aggregates from those exempt materials. Yet this steering of demand towards (‘primary’) aggregates obtained from exempt materials would reinforce the unequal economic effects produced by the tax differentiation itself as regards the commercial exploitation of alternative taxed aggregates”.
The Court then moved to the second question of whether the differentiation was justified by reference to the overall environmental objective. This was also rejected. The environmental objective was undermined by the fact that the scheme created a market for secondary aggregates, the extraction of which was just as harmful as the extraction of virgin aggregates.
Relating these cases and principles to the Clause 24 change, the following remarks can be made:
- Firstly, tax measures are not immune from State Aid Law even if enshrined in primary legislation.
- Secondly, they demonstrate that National Legislatures should be cautious not to accidentally differentiate between undertakings in legally and factually similar situations. Undertakings that are engaged in the market of renting properties could be held to be in similar legal and factual situations. They are subject to the same regulatory regimes and provide the same services. However, “Clause 24” differentiates between entities/individuals engaged in the renting of property whose assets are encumbered by mortgages and those that are not (admittedly any State Aid link here is tenuous). The change also, importantly, distinguishes between individual landlords and companies, with the latter continuing to obtain relief for mortgage interest. It is accepted that the idea that there is State Aid at play here by denying relief is far from the more orthodox case of a Member State granting relief or exemptions (h/t @hselftax), although the Commission decision of 26th January 2011 (OJ 2011, L-235/26) dealing with an exemption to an exemption to a relief comes close. Nevertheless, the question is whether there is an advantage provided to some and denied to other parties in similar legal and factual situations. Favouring companies over individuals would arguably do this. As such, the Government’s first flaw is its potential engagement of the State Aid provisions. (For reference, Conor Quigley QC in a video here from 18.15 explains why the “Bankers Bonus” could have engaged State Aid law)
- Thirdly, any differentiation must be done with careful scrutiny of the underlying objective of the general scheme. In the case of “Clause 24”, the general scheme could be argued to be the expenses regime, the underlying rationale of which might be argued to allow for the deduction of expenses wholly and necessarily incurred for the purposes of the business (an argument which seems to be suggested by the coverage in The Telegraph). That expenses should not be subject to taxation is accordingly undermined by the differentiation. Of course, it could well be countered that the general overarching tax system distinguishes, for myriad reasons, between Corporate and Income Taxes and that this asymmetry of treatment is a natural consequence (indeed, GIL Insurance would support this) (h/t @SatwakiChanda @AislingTax). Alternatively again, it might be argued that the policy underlying the change justifies the differentiation. The market for properties, particularly in the Southeast, has been overheated and a particular risk to the economy at the moment is mortgaged buy-to-let properties. Six out of 10 buy-to-let landlords could be vulnerable if interest rates rise by 3%, according to the Bank of England. However, that the property market is overheated cannot be solved by simply dissuading newcomers. Nor does the change necessarily bring this about given that newcomers can simply incorporate to obtain the relief. Similarly, that the mortgage-backed buy-to-let owners are a risk to the economy is not eliminated by the change. To this end, the Government’s second flaw could be said to be not having thought clearly about the justification for differentiating between undertakings in the market.
It should be stressed that my purpose in writing this post is to highlight the breadth of State Aid Law and to make the case that even relatively benign tax changes can come within the scope of the State Aid provisions. It is accepted further that the argument in relation to Clause 24 would even then fall at very outer limit. Intuitively it seems wrong that any such claim would succeed.
Ultimately, I hope that future State Aid cases clarify the scope of Member States’ competence over tax matters. The same reason that the Legislature should not be thwarted by the common law in its attempt to introduce social and economic policy to combat genuine problems particular to that State should be similarly why EU Law should not be allowed to do so. The ability of the State to remove benefits from certain undertakings, entities or individuals or to impose exceptional burdens to encourage change is an important policy instrument. State Aid should be concerned with interventions by the State which positively favour certain entities over others. Focusing instead upon relative favouritism blurs its boundaries and would be more aptly dealt with by the non-discrimination principle of EU Law.
*As a postscript to the British Aggregates saga, the Commission reopened the case in 2013 and in 2015 concluded that the exemptions for shale and spoil of shale represent State aid that is incompatible with the internal market, as shale is the only exempted material that is deliberately extracted to produce aggregates. Exempting shale and spoil for shale extraction from the aggregates levy therefore would not contribute to the environmental objective of the tax. The British Aggregates Association has appealed the case and it will be heard before the General Court sometime in 2016