The UK Crown Dependency and an EU member state have drawn fire from the European Commission over tax breaks involving purchases of jets and yachts.

The European Union is taking action against Italy – a member state – and the Isle of Man (a British Crown Dependency but not an EU member) over of what it claims are illegal tax breaks given to high net worth individuals over purchases of private jets and yachts.

The European Commission has written to the UK government complaining about what are allegedly “abusive VAT practices” in the Isle of Man. The Commission said that it intends to shut a tax loophole. The IoM falls in the EU’s tax net because of its ties to the UK which is, at least for the moment, still in the EU.

“The Commission believes that the UK has not taken sufficient action against abusive VAT practices in the Isle of Man with regard to the supplies and leasing of aircraft,” the organisation said in a statement late last week. 

Italy and the UK have two months to respond to the Commission’s complaints about the jurisdictions’ VAT treatment of yachts and aircraft, respectively. It warned that if the countries do not act within those two months, the Commission may send a reasoned opinion to their authorities. In Italy’s case, the matter could go before the EU’s European Court of Justice, it said.

The case sheds light on how EU member states’ freedom to set their own tax laws conflict with notions of “harmful tax competition”. As the UK moves towards independence from the EU, a question remains of how much freedom of action the country will have if a Brexit deal requires the UK to continue respecting certain European rules.

Paradise Papers leak
The IoM’s practices emerged through publication of the Paradise Papers leak of data from Appleby, the offshore law firm, which were published by the International Consortium of Investigative Journalists, a Washington DC-based group.

The Commission claims that the tax avoidance schemes in the IoM, used by figures such as F1 motor racing driver Lewis Hamilton, violate EU law. (Hamilton paid no VAT when importing his red £16.5 million jet plane. According to an account by the Guardian, Hamilton said at the time that he had instructed a senior lawyer to check his arrangements and he had been told that they were lawful.)

In Italy, meanwhile, the Commission said that8/ it has given formal notice to the EU state for not levying the correct amount of VAT on the leasing of yachts.

"It's simply not fair that some individuals and companies can get away with not paying the correct amount of VAT on products like yachts and aircraft. Favourable tax treatment for private boats and aircraft is clearly at odds with our commonly agreed tax rules and heavily distorts competition in the maritime and aviation sectors. With this in mind, the Commission is taking action to clamp down on rules that try to circumvent EU law in these areas,” Pierre Moscovici, Commissioner for Economic and Financial Affairs, Taxation and Customs Union, said.

Italy is guilty, the EU said, of several breaches of its rules.

“Current EU VAT rules allow member states not to tax services when the effective use and enjoyment of the product is outside the EU. But the rules do not allow for a general flat-rate reduction without proof of where the service is actually used. Italy has established VAT guidelines according to which the larger the boat is, the less the lease is estimated to take place in EU waters. As a consequence, such rules greatly reduces the applicable VAT rate,” the Commission said. 

“Excise duty rules for fuel in motor boats in Italy. Current EU excise duty rules allow member states not to tax fuel used by a navigation company for commercial purposes, i.e. the sale of sea navigation services. However, an exemption should only apply if the person leasing the boat sells such services to others. In breach of EU rules, Italy allows chartered pleasure crafts such as yachts to qualify as 'commercial' even when being enjoyed for personal use, which may allow them to benefit from excise duty exemption on fuel used to power its engines,” it continued.