Vodafone, the world’s largest telecoms group, has won a £2 billion tax battle with Revenue and Customs (HMRC) that could lead to billions of pounds of savings for other UK-based multi-nationals.

The High Court ruled that it was illegal for HMRC to impose UK rates of corporation tax on a Vodafone subsidiary in Luxembourg, where taxes are lower.

Vodafone, which set up the subsidiary as part of its takeover of Germany’s Mannessman in 2000, had set aside £2.2 billion in case it lost the case.

But Mr Justice Evans-Lombe ruled that UK tax laws on Controlled Foreign Companies (CFC) were incompatible with European law and ordered HMRC to close its inquiry into Vodafone’s tax affairs.

Mark Persoff, a tax partner at Clifford Chance, said: "This is potentially a major blow to HMRC, as one of the key planks of tax avoidance legislation has been badly damaged."

HMRC said: "We intend to appeal this decision, and the Government will continue to defend its ability to enforce the CFC rules, which are designed to counter tax avoidance through artificial shifting of profits to offshore subsidiaries.

In 2006, the European Court of Justice, Europe’s highest court, ruled that the UK’s policy of seeking corporation tax from foreign subsidiaries was restrictive and could only be justified when the subsidiaries were “wholly artificial” - or set up for the sole purpose of exploiting differing tax rates across the EU.

The CFC rules, introduced in 1988 to prevent UK companies from taking advantage of lower tax rates in other EU countries, treat earnings at foreign subsidiaries as UK profits.

Under the rules, companies paying lower rates of corporation tax abroad have to make top-up payments to HMRC so their overall tax payment is the same as if the company had been based in the UK.

Mr Justice Evans-Lombe said the law would have to be changed before any charge could be imposed on a company such as Vodafone under the CFC legislation.

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