Channel Islands make last bid to save VAT-free music retailing

After years of downplaying its significance, Guernsey and Jersey will admit to the high court this week that losing tax-exempt status would be devastating

Lawyers for the Channel Islands will travel to the high court in London this week in a last-ditch effort to block a move to clamp down on the islands’ VAT-exempt e-commerce operations, which sell hundreds of millions of pounds of CD, DVDs and other goods over the internet.

After years of playing down the scale of VAT-avoiding websites based on Jersey and Guernsey, the islands are now claiming the closure of this industry would be a “catastrophe”. They are taking their case to a judicial review in the hope of blocking imminent plans to close a tax loophole that has allowed their offshore mail-order business to quietly mushroom to a substantial scale over almost a decade.

Among the retailers with the most active arrangements involving the Channel Islands are four of the UK’s largest online shopping sites: Amazon, Play.com, Tesco and HMV.

The Channel Islands want the UK courts to stop the chancellor using this month’s budget to push through a crackdown on the VAT dodge, which would outlaw it from 1 April.

Goods that are purchased and imported from outside the EU for less than £15 currently qualify for a VAT waiver under a European tax rule called low value consignment relief (LVCR), drafted almost 30 years ago. The relief was originally designed to expedite trade, ensuring that perishable items did not get stuck for too long in the postal system.

In papers filed ahead of this week’s hearing, lawyers for Jersey’s economic development minister Alan Maclean says: “If this proceeds it will result in more than a 50% increase in the overall level of unemployment in Jersey, with the consequent social and economic consequences – that is to say, a catastrophe.”

It is a dramatic shift from Jersey’s past position, which for years saw Maclean’s predecessors claiming to have weeded out UK retailers operating websites on the island solely for tax purposes.

This week’s court hearing is expected to force the UK Treasury to explain why it has allowed the tax loophole to balloon unchecked for almost a decade despite an obligation under European law for it to prevent activities designed to abuse VAT rules and avoid tax.

Many struggling high street stores – from independent music shops to health food group Holland & Barrett – believe they have suffered because of years of intransigence by Treasury officials. Music chain Fopp had been preparing to take legal action against ministers over their failure to act but the business went into administration in 2007 and was later bought by HMV.

Given the growing public anger over the controversial deals struck between HM Revenue and Customs and major corporations such as Vodafone and Goldman Sachs, some MPs on the public accounts committee are now keen to take a closer look at why tax officials seemed so apparently unwilling to close a glaring loophole.

Meanwhile, lawyers for Jersey will argue the proposed crackdown would result in “severe consequences and hardship for Jersey as a whole”, hitting ferry companies, hotels, postal groups and business travel firms.

They will also warn the high court that two of the island’s biggest employers — Play.com, now owned by the Japanese firm Rakuten, and Indigo Starfish, Amazon’s main partner on the island — are already carrying out “detailed business and logistics planning” before a likely transfer of their Jersey operations to other tax havens where they can continue to target British customers and exploit the VAT loophole.

They claim, therefore, that “the proposed measure will completely fail to produce the VAT revenues which Revenue & Customs have projected – or any material benefit to the UK whatsoever.”

HMV boss Simon Fox last month admitted the group’s decision to set up a warehouse in Guernsey in 2005 had been a reluctant one, but had become necessary because of moves by its rivals and the Treasury’s inaction.

He told the games industry magazine MCV: “It can’t be helpful to have your VAT rate as a determinant of where you put your warehouse. It’s a basic distortion to fair competition … [The situation] is absolutely nuts.”

Latest Treasury estimates suggest the loophole is costing the exchequer £110m a year in lost tax, though industry experts think the true figure is likely to be far higher.

In 2006 Jersey very publicly expelled Tesco, Amazon and other UK retailers that ministers said had been using the island as part of “a scam” to dodge UK sales tax. In the following budget, then chancellor Gordon Brown said: “The government welcomes the commitment made by the Jersey authorities to limit the activities of [VAT-free web] companies continuing to operate on the island.”

For years afterwards, however, the Observer and Guardian highlighted how the Treasury was ignoring the fact that VAT-free mail-order sales continued to boom on the Channel Islands.

Market research data produced by Kantar in 2009 showed that 28% of DVDs bought in Britain were purchased on the web – almost all of them at VAT-free prices. Two years later that figure rose to 40%.

Tesco and Amazon found ways back on to the Channel Islands via third-party agents, while many more joined the dodge by either setting up their own warehouses or using agents to do so. Among the more prominent operators were Asda, Play.com, Argos, Moonpig.com, WH Smith and HMV.

Meanwhile, some of Britain’s highest profile business executives became investors in agency firms specialising in helping big retailers to exploit the loophole. Among them were former Marks & Spencer chief executive Sir Stuart Rose, former Tesco boss Sir Terry Leahy, Stagecoach founders Brian Souter and Ann Gloag and Cairn Energy founder Sir Bill Gammell.

Also with a financial interest in this controversial trade is Jersey’s deputy minister for economic development, James Baker, who co-founded Grafters, a recruitment agency specialising in placing temporary staff at warehouses on the island.

Meanwhile, on Guernsey, commerce and employment minister Carla McNulty Bauer has also had close ties to the industry. She was formerly senior manager at VAT-dodging Healthy Direct, a health supplements mail order firm since acquired by rival Healthspan.

Her colleague, education minister Robert Sillars, is chairman of Sigma Group, a firm involved in shipping printer cartridges, again some of them at VAT-free prices.

Perhaps surprisingly, Scottish Enterprise, a UK government-funded investment quango, has also invested in the parent company behind Indigo Starfish.

Many firms involved in VAT-free Channel Islands websites have claimed tax is not an issue for them. “It’s really a little bit of a red herring,” said Stuart Rowe, who set up HMV’s Guernsey operations before being poached to be managing director of Play.com in 2009. “We are not really concerned because [the VAT loophole] has less of an effect on the company that it did in times gone by.”

In 2009, then Treasury minister Stephen Timms ordered Revenue officials to investigate claims made in Guardian and Observer articles. He then wrote to a concerned fellow MP assuring him that those reports were misleading. “The article by implication has exaggerated the level of exports made by some businesses it mentions … There are still only two major exporters in the audio visual market in the Channel Islands.”

Timms repeatedly refused to speak to this newspaper on this subject, but Treasury officials issued a further statement attacking the reports. “The implication that businesses are simply setting up on the Channel Islands to take advantage of this relief is not true. In fact exports from the Channel Islands account for a very small percentage of the CD/DVD market.”

George Osborne has long taken a different view. In opposition, he wrote to one frustrated small business: “The Conservatives intend to hold the government to account for the effect on domestic business if nothing is done.” In his budget a year ago he signalled a determination to make good on that pledge. “We’re going to tackle the exploitation of low value consignment relief that has left our high-street music stores fighting a losing battle with warehouses in the Channel Islands.”

The Channel Islands have just one opportunity left to try and stop him. Their chances may look slim, but whatever the outcome it is likely to be embarrassing for longstanding officials at the Treasury and HMRC.


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