Some of the UK's largest retailers face a potentially damaging Government crackdown on the sale of VAT-free entertainment goods shipped through the Channel Islands.
Online divisions of HMV, Tesco, WH Smith, Asda, Argos, Amazon, Play.com and Woolworths.co.uk currently dodge millions of pounds of tax on CDs, DVDs and games that are sold for less than 18. In order to qualify as VAT-free transactions, goods destined for UK customers can be taken on a long journey out to the Channel Islands and back again.
However, according to The Guardian, a leaked Treasury letter reveals that this popular setup is under review” and suggests that British companies marketing goods sourced in the UK to UK customers at VAT-free prices may be "abusing" rules.
Treasury minister Stephen Timms reveals that the Government now privately believes that "for goods to be imported from a Channel Island to benefit from LVCR [low value consignment relief]" is an "an abusive practice".
Timms explains customs officials have already challenged one business, but that "unfortunately, no precedent was set ... as the business in question accepted ... they had accounted for VAT incorrectly."
Treasury estimates suggest VAT-free sales to the UK from the Channel Islands grew to 620m last year, creating a 110m dent in Treasury funds.
Some believe these figures are an under-estimate: market research firm TNS says 28 per cent of DVDs and 23 per cent of CDs purchased by customers in Great Britain are bought on the internet.
HMV, which four years ago relocated its UK distribution centre for HMV.com to Guernsey. Investors were told the move was made "to improve prices relative to our internet-based competitors" - a reference to the offshore VAT advantage.
But HMV said it was "confident it could not be challenged" under the Halifax ruling. A spokesman stressed: "We hold a significant amount of stock in Guernsey. It is not shipped there upon receipt of customer orders, so we do not 'round-trip'. All product is picked, packed and labelled in Guernsey."
Timms appears to accepts that HMV's argument. His letter states: "It is less clear whether, and in what circumstances, the principle of abuse can apply where a business chooses to locate distribution centres [in the Channel Islands] in order to benefit from LVCR."
HM Revenue and Customs believes it can use the precedent set in a 2006 test case involving mortgage bank Halifax. In that judgment, the European Court of Justice established an "abuse of rights" principle that invalidates complex tax structures essentially designed to secure an extraordinary advantage.