England and Wales High Court (Administrative Court) Decisions

IN THE HIGH COURT OF JUSTICE
QUEEN'S BENCH DIVISION
ADMINISTRATIVE COURT

		Royal Courts of Justice Strand, London, WC2A 2LL
		15 March 2007

Mr Justice Burton :

1. This has been the hearing of three applications for judicial review, in each of which the Defendants have been the Commissioners of HM Revenue and Customs ("the Revenue"). Although they were ordered to be heard consecutively, since there was one issue of law to be resolved common to all three, I directed that there be legal submissions on that issue only once; and in the event, not least because the other issues in each application were resolved during the course of the hearing as I shall describe, the three applications were heard together. The first is brought by Just Fabulous (UK) Ltd ("JF"), pursuant to permission granted by Dobbs J; the second by Evolution Export Trading Ltd and Greystone Export Trading Ltd ("Evolution"), by permission of Davis J; and the third by Brayfal Ltd ("Brayfal"), by permission of Sullivan J. All three claims arise out of the fact that the Revenue has not paid sums claimed by them as due in their VAT returns: JF claimed repayment of VAT totalling £19.5 million in respect of their VAT returns for March, April and May 2006, relating to their acquisition of mobile phones from four suppliers; Evolution claimed total repayment of VAT of £30.3m in VAT returns in January, February and March 2006, with regard to mobile phone transactions relating to seven suppliers including Blackstar UK Ltd ("Blackstar"); Brayfal claimed repayment of VAT in the sum of £914,000, in their March 2006 VAT return, again in respect of the acquisition of mobile phones, in their case all from one supplier, Future Communications Ltd ("Future"). In each case the Defendants have been represented by Rupert Anderson QC, leading Peter de Verneuil Smith in the JF case, Andrew MacNab in the Evolution case and Mario Angiolini and Alan Bates in the Brayfal case. Michael Patchett-Joyce appeared for the Claimants in both the JF and Brayfal cases, and Paul Lasok QC appeared for the Claimants in the Evolution case. All their written submissions were extremely thorough, clear and helpful, as were the oral submissions, and I was greatly assisted by the co-operative way in which a hearing, or series of hearings, listed for four days was completed in two.

VAT

2. The provisions in respect of Value Added Tax, VAT, which originated in the First Council Directive of 11 April 1967 (67/227/EEC) and the Sixth Council Directive (77/388/EEC), are now contained in Council Directive 2006/112/EC of 28 November 2006 ("the 2006 Directive") to which, for convenience, the parties referred, and I shall in this judgment refer. It is not suggested that there is any material change so far as this case is concerned. The Value Added Tax Act 1994 ("the 1994 Act") is the relevant statutory implementation by the United Kingdom. The relevant Articles of the 2006 Directive to which attention was drawn in the course of the hearing are as follows:

"Article 1

1. This Directive establishes the common system of …VAT.

2. The principle of the common system of VAT entails the application to goods and services of a general tax on consumption exactly proportional to the price of the goods and services, however many transactions take place in the production and distribution process before the stage at which the tax is charged.

On each transaction, VAT, calculated on the price of the goods or services at the rate applicable to such goods or services, shall be chargeable after deduction of the amount of VAT borne directly by the various cost components …

Article 2

1. The following transactions shall be subject to VAT:

(a) the supply of goods for consideration within the territory of a Member State by a taxable person acting as such …

Article 167

A right of deduction shall arise at the time the deductible tax becomes chargeable.

Article 168

Insofar as the goods and services are used for the purposes of the tax transactions of a taxable person, the taxable person shall be entitled, in the Member State in which he carries out these transactions, to deduct the following from the VAT which he is liable to pay:

(a) the VAT due or paid in that Member State in respect of supplies to him of goods or services, carried out or to be carried out by another taxable person …"

Article 167 was formerly Article 17(1) of the Sixth Council Directive.

3. It is common ground that when the taxable person charges a customer VAT and receives it, it does so in broad terms as agent for the Revenue to whom, after lawful deductions, it must account: see the judgment of the European Court in Elida Gibbs Ltd v Customs and Excise Commissioners [1996] STC 1387:

"22. It is not, in fact, the taxable persons who themselves bear the burden of VAT. The sole requirement imposed on them, when they take part in the production and distribution process prior to the stage of final taxation, regardless of the number of transactions involved, is that, at each stage of the process, they collect the tax on behalf of the tax authorities and account for it to them."

4. Unfortunately the common system of VAT has been very open to abuse and manipulation by fraud. The simplest such example, described as "missing trader fraud" is where a trader receives VAT, but fails to account for it to the Revenue, whether because it goes into liquidation with the monies untraceable or because it was never a real entity at all. In the first instance, of course, that is a loss to the person who has paid over the VAT, for which the missing trader is supposed to account, but as that customer is itself then ordinarily able to recover VAT paid over to its supplier, the loss is incurred by the Revenue as and when it is forced to reimburse what it has not in fact received. Such simple missing trader fraud becomes more sophisticated and complex, once goods are sourced from abroad. When the goods enter into the United Kingdom, they arrive free of VAT and the first purchaser in the United Kingdom is liable to pay what is loosely called an 'acquisition tax': if the system operates lawfully then that importer charges VAT to the next purchaser and receives it from that purchaser, and then accounts to the Revenue for what he has received (his 'output tax') less what he has paid out (his 'input tax').

MTIC and Carousel Fraud

5. In what is called a Missing Trader Intra-Community ("MTIC") fraud, the goods – if indeed they exist – are then the subject matter of a series of successive transactions within the United Kingdom, being onsold, usually at a markup, with VAT returns completed by each purchaser, resulting in a small payment to the Revenue, after setting off the input tax against the output tax, until eventually the goods are acquired by an exporter. As goods when exported are no longer the subject of the VAT regime of the Member State, the exporter can claim as a credit, and thus prima facie is entitled to receive from the Revenue, the total sum of VAT due and purportedly paid in respect of the goods exported. Of course, if VAT were indeed 'common' throughout the European Union, such that it did not fall to be repaid and paid on the frontier, this opportunity would not arise.
6. The description given by way of an attachment to Mr Anderson's skeletons of what is called a "simple" MTIC fraud is set out below: a diagram which explains it is attached as Annexure 1 to this judgment:

"Trader A, in an EU member state (say France), sells taxable goods to Trader B, in another member state (say the UK). In effect, Trader B acquires those goods free of VAT.

Trader B, who is the defaulting trader in the UK (i.e. a trader who incurs liability to VAT but who goes missing without discharging that liability) or the trader using a hijacked VAT number (i.e. a trader using a VAT number belonging to someone else), sell the goods to a UK "buffer" (UK Buffer 1).

Trader B charges VAT on the supply to UK Buffer 1. Trader B is liable to account to HMRC for the output VAT it has charged to its customer (UK Buffer 1), but goes missing before discharging that liability to the tax authorities.

The goods can then be sold through a number of UK Buffer companies.

The last UK Buffer company (UK Buffer 3 in this example) sells the goods to the UK Broker 1 (Trader C). UK Buffer 3 pays HMRC the output VAT charged after having deducted the input VAT paid.

UK Broker 1/Trader C exports the goods to another Member State or outside the EU. Exports are exempt from VAT, but UK Broker 1 /Trader C is entitled to claim a refund of the input VAT paid on the purchase of the goods from HMRC. The resulting tax position is shown in the right hand column [in the diagram] ("VAT returns"). Should HMRC make this repayment, the loss of VAT by Trader B Is crystallised and goes on to fuel the next round of MTIC transactions.

When UK Broker 1/Trader C's purchaser is Trader A, there is what is known as a "carousel fraud". The process can be repeated again and again. It is not necessary, however, to have a carousel for there to be MTIC fraud.

However, for MTIC fraud to be as prolific as it is, it does require an export which generates the repayment claim."

7. As can be seen from this description, this kind of MTIC fraud is called a "carousel fraud" because it can be repeated as often as required, because the goods are "returned" to a destination outside the United Kingdom which may well be the same country or even the same, or an associated, source as the original supplier, ready to be sent round again. The individual transactions need not take at all long – they can be a matter of moments – and the goods may not in fact move from a warehouse or freight forwarder either on the occasion of any one transaction or possibly at all, except that there will need to be evidence of export to support the claim for repayment of input VAT credits. The fraud is plainly committed, if the participants in such chain are dishonest, at the stage of the missing trader, although the loss may not crystallise until the Revenue has to pay out in full in respect of the return filed by the exporter. Figures produced for the purposes of these proceedings by the Revenue indicate that, in the year 2005-2006 alone, MTIC and carousel fraud cost the Revenue between £2 billion and £3 billion. The Revenue has also estimated that MTIC and carousel frauds would have cost them between £3.75 and £4.75 billion in that year, had a significant proportion of those frauds not been baulked inter alia by the steps taken by the Revenue to which I shall refer.
8. The steps taken by the Revenue in response to the growth of MTIC and carousel frauds included the refusal to make payment to the 'exporter' at the end of a suspect chain –often referred to as a 'defaulter chain', because of the missing trader – so that the Revenue, provided such refusal to allow the input tax was not successfully challenged on appeal to the Value Added Tax Tribunal, avoided having to pay monies out at the end of the chain. The Revenue suggests that what they now allege to be occurring – possibly in the case of these Claimants and in many other similar situations – is a new variation of the scam, in order to overcome the fact that it is now realised that the Revenue has woken up to the main scam, and has started to refuse to pay on returns submitted by the suspect exporters.
9. This new variation is described as a "contra-trading" fraud. In summary, it is suggested that, instead of the exporter simply putting in a return and failing to persuade the Revenue to repay, it finds an occasion to enter into a fresh transaction, in relation purportedly to different goods, with a different trader, for which purpose the exporter acts as a broker or contra-trader, in buying in those goods from abroad and selling them on to such new trader: in the course of such sale the exporter/broker/contra-trader is thus enabled to set off in his return the input tax against the output tax, being the VAT paid to it by the new trader, and thus recovering, by reference to the VAT paid to it by the new purchaser in respect of the new goods, a VAT credit which it would not be able to obtain by straightforwardly submitting the return to the Revenue.
10. This contra-trading fraud is described in a further attachment to Mr Anderson's skeletons, as follows – again the relevant diagram is attached to this judgment, as Annexure 2:

""The arrangement centres around UK Broker 1 and its appearance, in this example, as a broker in one set of transactions and as an acquirer in a second set of transactions.

The left hand column of transactions from bottom left to top left [in the diagram] ("Defaulter chain") possesses the normal MTIC fraud characteristics, as described in the first example. UK Broker 1 appears as a normal broker in the defaulter chain and, having sold the goods outside the UK, is in a repayment position.

The contra trade appears in the middle column [of the diagram] ("Contra trading chain") where UK Broker 1 now acts as an acquirer and purchases goods directly from another Member State.

UK Broker 1 then sells the goods (plus VAT) to UK Broker 2, who then sells the goods outside the UK to create a repayment claim.

The resulting tax position is shown in the right hand column [of the diagram] ("VAT returns"). By off-setting its net output tax as an acquirer in the middle column with its net input tax as a broker in the left-hand column, UK Broker 1 ends up owing HMRC £1.

It has, therefore, disguised its own repayment claim by creating the contra trading chain with no (apparent) VAT loss. This does not matter to UK Broker 1, as another broker (UK Broker) appears not to be participating in a transaction chain that commences with a defaulting trader and who would therefore argue that there are no grounds for HMRC to withhold payment of his input VAT credit repayment claim pending verification.

The "Contra-trading chain", however, forms part of the overall scheme to defraud HMRC, as it forms no more than an extension of the original transaction chain commencing with a defaulter ("Defaulter chain").

Should HMRC make this repayment to Broker 2, the loss of VAT by Trader B is crystallised and goes on to fuel the next round of MTIC transactions."

11. The Revenue has now concluded that they must take steps to prevent what they see as this new method of achieving the same fraudulent ends, and consequently, where they are able to show that the transaction, ostensibly in different goods from those in the defaulter chain, is entered into by the broker for the purposes of obtaining such set off, and the contra-trader then exports these new goods and claims in its VAT return as input tax the VAT that it has paid to the broker, such claim is refused. As I understand it, unless there is some specific doubt about a service purportedly supplied in respect of those (contra-traded) goods, the denial of the output tax is simply in respect of VAT on the goods themselves.
12. These proceedings arise because the Revenue has failed to pay the very substantial sums claimed on their VAT returns described above to these Claimants, although they have not yet made a Decision not to pay, as they assert that they are still investigating what they conclude to be the sufficiently suspicious circumstances in relation to the contra-trading and the connections between those on the defaulter chain, culminating in the broker, and the Claimants: until there is a Decision, then there cannot be an appeal to the VAT Appeal Tribunal by these Claimants against it.

The Issues

13. There are three issues in all three of these proceedings. The first is that it is said to be an error of law by the Defendants to assert that they can seek to justify investigating, and in the event refusing, if so they do, the Claimants' entitlement to the VAT claimed, because the VAT claimed relates to different goods from those in the defaulter chain, to which these Claimants are not suggested to have been party. The second and third issues, which are inter-related, concern the case, made in each of the proceedings, that the Defendants have both delayed in respect of their investigation and have given inadequate explanations in respect of, or grounds for, the course they have taken. The second and third issues arise by virtue of the clear exposition of the law by Lightman J in R (on the application of UK Tradecorp Ltd) v Customs and Excise Commissioners [2005] STC 138. Lightman J made clear that, although, and indeed just because, the factual enquiry would be for the VAT Appeal Tribunal, there was a need for judicial control of the steps being taken by the Revenue where no appealable decision had yet been taken. In paragraphs 18 to 27 of his judgment, which is accepted by all parties, he makes clear that the judicial control extends to ensuring that there has been a reasonable and proportionate investigation by the Revenue, and one which is carried out diligently, and as expeditiously as possible, and during and in respect of which the Revenue must give reasons for its actions.
14. In the event, so far as the second and third issues are concerned, perhaps because of the very issue of these proceedings, but in any event by virtue of the passage of time, an ever enlarging picture of the Revenue's case has been revealed in the evidence, particularly in a series of lengthy and detailed witness statements, made in each of the proceedings, by Mr Roderick Stone, one of the Revenue's Senior Policy Advisers. Perhaps as a result of that ever fuller exposition, but also by virtue of the Revenue's agreement, after discussion with, and to some extent under pressure from, the Court to reach a Decision earlier than they would otherwise have wished, and at a time when, they expressly warned, they may still not have completely concluded their investigations, agreement was reached in the course of the proceedings which rendered it unnecessary for these issues to be canvassed further, or to become the subject of decision in this judgment. Only the first issue therefore remains live for my decision, to which I turn.
15. This issue is effectively a strike-out application by the three Claimants. There are certain disputes about the contra-trading transactions themselves, at any rate in two, if not all three, of the proceedings, which remain for separate consideration: but so far as what I have called the strike-out is concerned, it amounts to a case put forward by the Claimants that, even if the Revenue's case is established, it is unable to take the course of declining to pay the VAT on the contra-trading transactions. For the purpose of such 'strike-out', as is normal in the courts, the facts must be assumed against the Claimants; i.e. it must be assumed that the Revenue's case is to be established on the facts at its highest. For the purpose of these facts, it was simpler to use, for cross-reference, one name – in the event, Blackstar – for the hypothetically assumed fraudulent exporter/broker at the end of the defaulter chain, and one company – say Evolution (although there was in fact an associated company between it and the broker) – as the hypothetically fraudulent trader/contra-trader.
16. The case that must be assumed is that Blackstar is dishonestly involved in the defaulter chain and knows that, if it puts forward a VAT return to the Revenue claiming back its input tax in respect of the mobile phones which have gone round the defaulter chain, it will not receive that money because the Revenue will refuse to pay. Hence, it is to be assumed, it persuades Evolution to enter knowingly into and/or to execute a "contra-trading" transaction in respect of cameras which will be or are being imported. Evolution must be assumed to know of, and thus participate in, Blackstar's dishonest purpose. In this regard, it would not matter whether Evolution is already intending to acquire cameras by import and is prepared to use that transaction for the dishonest set off, or whether the import of the cameras is constructed solely for the purpose of establishing the transaction. Evolution then knowingly agrees to buy the cameras from or through Blackstar, pays Blackstar VAT which thus allows Blackstar dishonestly to recover off-set VAT which it would not have received direct from the Revenue, and then claims back what it has paid to Blackstar in its own VAT return on exporting the cameras. The contra-trading chain is likely to be relatively short. Indeed Brayfal, for example, in the March 2006 accounting period purchased stock from only one supplier, Future, and sold to only one customer, in Austria.
17. The question then is, whether, in respect of such an (assumed) deliberate dishonest transaction by these Claimants, the Revenue could lawfully decide to withhold payment pursuant to receipt of their VAT returns claiming repayment.

Bond House and Kittel

18. It appears that the decision in Bond House (Optigen Ltd, Fulcrum Electronics Ltd and Bond House Systems Ltd v Commissioners of Customs and Excise [2006] Ch 218) arose in the context of the Revenue's initially unsuccessful attempts to take steps to prevent the simple MTIC or carousel fraud. The facts related to three different cases in which there were alleged carousel frauds, of which transactions involving the three companies formed part. In relation to two of those companies, their innocence/ignorance of the fraud was assumed, and in relation to Bond House such had been found at the VAT Appeal Tribunal. Nevertheless the Revenue sought to assert that, because the transactions in respect of which they were claiming back input tax were in fact, albeit unknown to those companies, part of a defaulter chain of transactions, they were entitled to decline their VAT claims in respect of their transactions.
19. The case was put forward, it seems, primarily on the basis that those who took part in such a carousel, even innocently, were not taking part in an "economic activity", so not qualifying as a taxable person in accordance with what was then Article 4(1) of the Sixth Directive. The Court held however:

"43. … an analysis of the definitions of taxable person and economic activities shows that the scope of the term economic activities is very wide, and that the term is objective in character, in the sense that the activity is considered per se and without regard to its purpose or results."

20. Hence the attempt of the Revenue to resist payment of input tax claimed in its VAT returns by a non-fraudulent party in a defaulter chain failed:

"46. An obligation on the tax authorities to take account, in order to determine whether a given transaction constitutes a supply by a taxable person acting as such and an economic activity, of the intention of the trader other than the taxable person concerned involved in the same chain of supply and/or the possible fraudulent nature of another transaction in the chain, prior or subsequent to the transaction carried out by that taxable person, of which that taxable person had no knowledge and no means of knowledge, would a fortiori be contrary to those objectives.

…

51. It follows that transactions such as those at issue in the main proceedings, which are not themselves vitiated by VAT fraud, constitute supplies of goods and services effected by a taxable person acting as such and an economic activity …, where they fulfil the objective criteria on which the definitions of those terms are based, regardless of the intention of the trader other than the taxable person concerned involved in the same chain of supply and/or the possible fraudulent nature of another transaction in the chain, prior or subsequent to the transaction carried out by that taxable person, of which that taxable person had no knowledge and no means of knowledge.

52. Nor can the right to deduct input VAT of a taxable person who carries out such transactions be affected by the fact that in the chain of supply of which those transactions form part another prior or subsequent transaction is vitiated by VAT fraud, without that taxable person knowing or having any means of knowing. " [My underlining.]

21. Kittel (Axel Kittel v Belgian State C-439/04, Belgian State v Recolta Recycling SPRL C-440/04, judgment delivered 6 July 2006) is still dealing on the facts with a carousel fraud involving a defaulter chain. There were, as can be seen from the title, two conjoined cases. In the Recolta case, the national court had found that the company was innocent of any fraud, as had been the case in relation to Bond House. The national court had nevertheless concluded that the company could not recover VAT, by reference to a provision of the Belgian Civil Code declaring incurably void any contract designed to avoid payment of VAT simply when one party contracts with that aim, even if the other party was unaware (paragraphs 10 and 11 of the Advocate General's opinion). The result in relation to Recolta was the same as it had been with regard to the three companies in Bond House, as is plain from paragraphs 51 to 52 of the judgment of the Court:

"51. In the light of the foregoing, it is apparent that traders who take every precaution which could reasonably be required of them to ensure that their transactions are not connected with fraud, be it the fraudulent evasion of VAT or other fraud, must be able to rely on the legality of those transactions without the risk of losing their right to deduct the input VAT …

52. It follows that, where a recipient of a supply of goods is a taxable person who did not and could not know that the transaction concerned was connected with the fraud committed by the seller, Article 17 of the Sixth Directive must be interpreted as meaning that it precludes a rule of national law under which the fact that the contract of sale is void, by reason of a civil law provision which renders that contract incurably void as contrary to public policy for unlawful basis of the contract attributable to the seller, causes that taxable person to lose the right to deduct the VAT he has paid. It is irrelevant in this respect whether the fact that the contract is void is due to fraudulent evasion of VAT or to other fraud."

22. However, the national court had concluded that the company, of which Mr Kittel was receiver, had "knowingly participated in a VAT 'carousel' fraud intended to recover one or more times amounts of VAT invoiced by suppliers for the same goods" (paragraph 10 of the judgment). Consequently it was permissible for the Belgian Revenue to refuse to repay input VAT or allow deductions in respect of those transactions. It was on the basis of that finding and conclusion that the UK Revenue has been able to justify such refusal in respect of exporters seeking to recover input VAT at the end of the defaulter chain – hence at least in substantial part the very considerable amount of further losses avoided, as referred to in paragraph 7 above; and it is on that same principle, as expounded by the European Court, that the Defendants rely as against the Claimants in these proceedings.
23. The passages in the judgment in Kittel are as follows, and, as will be seen, the conclusions of the European Court fall to be contrasted with their immediately precedent conclusions with regard to the innocent Recolta:

"53. By contrast, the objective criteria which form the basis of the concepts of 'supply of goods effected by a taxable person acting as such' and 'economic activity' are not met where tax is evaded by the taxable person himself …

54. As the Court has already observed, preventing tax evasion, avoidance and abuse is an objective recognised and encouraged by the Sixth Directive …Community law cannot be relied on for abusive or fraudulent ends …

55. Where the tax authorities find that the right to deduct has been exercised fraudulently, they are permitted to claim repayment of the deducted sums retroactively …. It is a matter for the national court to refuse to allow the right to deduct where it is established, on the basis of objective evidence, that that right is being relied on for fraudulent ends.

"56.  In the same way, a taxable person who knew or should have known that, by his purchase, he was taking part in a transaction connected with fraudulent evasion of VAT must, for the purposes of the Sixth Directive, be regarded as a participant in that fraud, irrespective of whether or not he profited by the resale of the goods. "

57. That is because in such a situation the taxable person aids the perpetrators of the fraud and becomes their accomplice.

58. In addition, such an interpretation, by making it more difficult to carry out fraudulent transactions, is apt to prevent them.

59. Therefore, it is for the referring court to refuse entitlement to the right to deduct where it is ascertained, having regard to objective factors, that the taxable person knew or should have known that, by his purchase, he was participating in a transaction connected with fraudulent evasion of VAT, and to do so even where the transaction in question meets the objective criteria which form the basis of the concepts of 'supply of goods effected by a taxable person acting as such' and 'economic activity'.

60. It follows from the foregoing that the answer to the questions must be that where a recipient of a supply of goods is a taxable person who did not and could not know that the transaction concerned was connected with a fraud committed by the seller, Article 17 of the Sixth Directive must be interpreted as meaning that it precludes a rule of national law under which the fact that the contract of sale is void - by reason of a civil law provision which renders that contract incurably void as contrary to public policy for unlawful basis of the contract attributable to the seller - causes that taxable person to lose the right to deduct the VAT he has paid. It is irrelevant in this respect whether the fact that the contract is void is due to fraudulent evasion of VAT or to other fraud.

61. By contrast, [my underlining] where it is ascertained, having regard to objective factors, that the supply is to a taxable person who knew or should have known that, by his purchase, he was participating in a transaction connected with fraudulent evasion of VAT, it is for the national court to refuse that taxable person entitlement to the right to deduct."

24. On the basis of the assumed facts, whether or not Evolution knew of the precise nature of the defaulter chain or of the goods purportedly dealt with in that chain or the identities of the participants in that chain, Evolution knew of the fraudulent aim of Blackstar in acquiring, through the off-set on the contra-trading transaction, the opportunity to receive, by such off-set, VAT which it would not be able to recover direct from the Revenue. The Revenue asserts, relying on Kittel, that it is entitled to refuse the input tax when Evolution exports the cameras it has acquired from Blackstar, and enters into its return, as input tax, the VAT it has paid to Blackstar. The Claimants' case is that Kittel only legitimises a refusal by the Revenue to pay VAT due in respect of the goods the subject matter of the defaulter chain. That is the issue which I am asked to decide.
25. It has not been the subject matter of High Court decision prior to now. In a short judgment by Charles J in Megantic Services Ltd v HM Revenue & Customs [2006] EWHC 3232 (Admin), he touched on the question, which had not in fact been raised by the Claimants before him, as to whether Kittel could apply to contra-trading transactions, and, without the benefit of argument, he was plainly of the view that it could:

"38. … if one asks whether, if contra-trading as so described is established, it would satisfy the Kittel test, my answer is yes it would. It has the relevant connection. Indeed such trading is put in place for the express purpose of providing a diversion or a smokescreen."

26. In a decision in the VAT Appeal Tribunal, chaired by Dr David Williams, Dragon Futures Ltd 25 October 2006, there are the following passages in the judgment, relating to the applicability of Kittel:

"67. The tribunal has little hesitation in applying the test potentially across the whole of any relevant chain of transactions, and not limiting it to the contract of sale to, and the contract of sale by, the taxable person. It does so bearing in mind the evidence it has seen of the deals in these appeals already. It is over-simplistic to look only at the individual contract of sale or purchase. … Kittel was also concerned with the contract of sale itself. But the Court did not blind itself, and its judgments should not be used to blind others, to the context of what it decided.

…

71. The tribunal therefore does not accept that there is any specific limit "up" or "down" the chain to the knowledge to be considered by a taxable person. More specifically, the taxable person may be alerted to third party elements in its contracts by the terms of those contracts, by its counterparties, or by others of the web of supporting contracts that facilitate the trade. …

75. [The test is] … Has the taxable person, at the time of entering a transaction involving payment of value added tax by or to that person, and taking into account the actual knowledge of the taxable person at that time … taken all proportionate steps available to it to ensure that, on the balance of probabilities, no aspect of the transaction is connected with any other party involved in, or any other transaction involving, fraud on the public revenue through the value added tax system?"

27. This last paragraph in particular is drawn widely, and it was referred to, and seemingly relied upon, in another VAT Appeal Tribunal decision Calltell Telecom Ltd and Opto Telelinks (Europe) Ltd v HMRC, chaired by Mr Colin Bishopp, 23 January 2007, as supporting the proposition that Kittel extends to contra-trading. However, Tribunal decisions are in any event not binding upon me, and Mr Patchett-Joyce, who was Counsel in Dragon Futures, tells me that once again there was no express addressing of contra-trading, and that the reference to the need to look at other contracts, or at the "web of contracts", was specifically referable to what he himself is quoted as referring to in paragraph 68 of the judgment, namely the web of contracts surrounding each contract for sale, being ancillary warehousing, insurance, transport contracts etc.
28. I shall decide the question therefore upon the basis of my own conclusions, in the light of the very helpful and thorough submissions made before me.

The Claimants' Case

29. Mr Patchett-Joyce addressed me first, on behalf of JF and Brayfal, and he relied entirely on the first two submissions summarised below, although he adopted the subsequent submissions of Mr Lasok, so that, in the event, all the submissions were relied upon by both. There is no doubt that Mr Patchett-Joyce found it a difficulty to be required to make the assumption against his clients to which I have referred, and much of his argument inevitably sought to track back into fact. It must be emphasised, again, that any facts that are assumed for the purposes of this judgment will be entirely at large in the VAT Appeal Tribunal. Further, there are bound to be evidential difficulties with regard to precisely what needs to be proved in respect of what might be loosely described as mens rea – "knew or should have known" (paragraph 56 of Kittel), as contrasted with having "no knowledge and no means of knowledge" (paragraph 46 of Bond House) – and the extent to which such mens rea must be proved:

(i) The common system of VAT

30. The primary submission, both of Mr Patchett-Joyce and of Mr Lasok, is that the effect of Kittel is limited to transactions within the defaulter chain, and in relation to the same goods. There was considerable emphasis by Mr Patchett-Joyce upon the "common system of VAT" and the sanctity of its operation. Reference was made to the judgment of the European Court in Garage Molenheide BVBA and Others v Belgium [1998] STC 126, in which the Court said, at paragraph 47 of its judgment:

"Accordingly, whilst it is legitimate for the measures adopted by the member states to seek to preserve the rights of the treasury as effectively as possible, they must not go further than is necessary for that purpose. They may not therefore be used in such a way that they would have the effect of systematically undermining the right to deduct VAT, which is a fundamental principle of the common system of VAT established by the relevant Community legislation."

At paragraph 47 of its judgment in Kittel the Court said:

"In fact, the right to deduct provided for in Article 17 et seq of the Sixth Directive is an integral part of the VAT scheme and in principle may not be limited."

31. The facts both of Bond House and of Kittel were expressly related to consideration of a defaulter chain and a carousel fraud, and hence the conclusions as to the Revenue's right to refuse repayment of VAT input must be seen in such context. Mr Lasok relied upon two decisions of the European Court, ASSIDER v High Authority of the European Coal and Steel Community [1954-56] ECR 135 and Robert Bosch GmbH v Hauptzollamt Hildersheim [1978] ECR 855 in support of a proposition that a decision of the European Court must be seen by reference to the matters submitted to it, and understood in the light of the grounds of the judgment.

(ii) Legal Certainty.

32. Mr Patchett-Joyce also relied upon the principle of legal certainty, as emphasised by Advocate General Maduro in paragraph 41 of his Opinion in Bond House. Parties must be entitled to formulate their conduct by reference to well understood and enunciated rules, which did not permit unregulated interference into private affairs, a concept as well understood in European law as in the United Kingdom.

(iii) Multiple Recovery

33. Mr Lasok emphasised that Kittel should not be extended beyond the facts which founded it for another reason also, namely that it would thus be being applied in circumstances which had not been thought, or argued, through by or before the European Court. If it were permitted to the Revenue to widen the ambit of its refusal of repayment of VAT, it might end up making multiple recovery of its original loss. He focused on the submissions of Mr Anderson at paragraph 32(e) of his skeleton in the Evolution case:

"(e) The CJE's analysis in Kittel focuses on the circumstances in which a taxable person's entitlement to the right to deduct is to be refused. It focuses on the amount the taxable person seeks to deduct. The judgment makes no reference to the amount of tax originally lost from the fraud or that entitlement to the right to deduct is to be calculated by reference to the amount of that original tax lost."

34. He then refers to the words of Mr Stone in paragraph 14 of his third witness statement in the Evolution case:

"14. If the input tax claim of the second broker (trader B) were denied by HMRC because trader B knew or should have known he was an accomplice in a VAT fraud, and/or there was no genuine supply, and the transaction put back as though no supply had taken place, it would result in the output tax of the broker (trader A) being cancelled and the contra-broker (trader A) reverting back to the status of a 'ordinary' broker in an MTIC VAT carousel fraud."

35. Mr Lasok interpreted that, by reference to an explanatory diagram, as leading to a situation in which all the outputs of a whole series of parties could be cancelled, resulting in a reclaim by the Revenue of a whole series of unoffset inputs.

(iv) Penalty

36. Developing his concept of the possibility of multiple recovery, and emphasising again the exposition by Mr Anderson himself in his skeleton, he submitted that, if and insofar as the operation of Kittel was, or would if extended be, directed towards recovery by the Revenue irrespective of the amount of its original loss, then this would or could offend against the concept of a penalty, which is as alive in European law as it is in other contexts in UK law. Mr Lasok referred to the European Court judgment in Halifax plc and Others v Commissioners of Customs and Excise [2006] Ch 387 at paragraph 93:

"It must also be borne in mind that a finding of abusive practice must not lead to a penalty, for which a clear and unambiguous legal basis would be necessary, but rather to an obligation to repay, simply as a consequence of that finding, which rendered undue all or part of the deductions of input VAT."

37. A penalty at European law requires to be specifically authorised. In certain circumstances in the VAT context it could be authorised, viz pursuant to the provisions of what is now Article 205 of the 2006 Directive:

"In the situations referred to … Member States may provide that a person other than the person liable for payment of VAT is to be held jointly and severally liable for payment of VAT."

38. Thus by virtue of Commissioners of Customs and Excise v Federation of Technological Industries ("FTI") [2006] STC 1483 a Member State is authorised (and in the case of the UK this is by s77A of the 1994 Act) to recover input tax, not paid by the missing trader from other participants in the defaulter chain.
39. In seeking to understand his submission, I put to him the question as to whether he would apply this concept of a penalty to a situation which might arise (although we do not know whether it does arise in this case) in relation to a contra-trading transaction. I asked him to consider a case where the hypothetical Blackstar wished to lose/launder/offset £1m, which it knew it could not recover direct from the Revenue in a VAT return at the end of a defaulter chain, where perhaps the original "loss", by virtue of the missing trader, of £800,000 had increased through the subsequent transactions, involving mark-ups between various buffers, to £1m. I then asked whether it would be relevant to his argument if the contra-trading transaction, into which the rogue £1m VAT were injected by way of offset, were a much larger one, such that the VAT return of Evolution rejected by the Revenue, resulting from the contra-trading transaction, claimed £2m. On the assumption that, in accordance with Mr Anderson's proposition, the Revenue would in those circumstances be disallowing the whole £2m in respect of the contra-trading transaction, a sum considerable larger than the 'loss' suffered at the outset of the defaulter chain, Mr Lasok submitted that this would indeed amount to the imposition of a penalty by the Revenue.

(v) Prevention

40. Finally Mr Lasok rejected any suggestion that the disallowance of a contra-trader's tax repayment was in fact in pursuance of the laudable aim of preventing tax evasion, because, he submitted, the fraud, and hence the loss, had already occurred at the outset of the defaulter chain, when the missing trader disappeared.

The Revenue's Answer

(i) Kittel

41. The contra-trading method of sidestepping the need for the exporter to put in a tax reclaim direct to the Revenue, and thus recovering VAT, otherwise non-recoverable direct from the Revenue, by 'laundering' it into a contra-trade, had not been thought of at the time of the facts underlying Kittel: indeed to an extent it could be said that it has only become necessary as a result of the legitimisation by Kittel of the action by the Revenue, which had not been validated in Bond House.
42. The facts may be different, but, submits Mr Anderson, the principles are overwhelmingly apparent. It is, as paragraph 55 of the judgment in Kittel makes clear, a "matter for the national court to refuse to allow the right to deduct where it is established, on the basis of objective evidence, that that right is being relied on for fraudulent ends". Paragraph 56 records that "in the same way, a taxable person who knew or should have known that by his purchase he was taking part in a transaction connected with fraudulent evasion of VAT must, for the purposes of the Sixth Directive, be regarded as a participant in that fraud". In paragraph 61 it is recorded that "where it is ascertained, having regard to objective factors, that the supply is to a taxable person who knew or should have known that, by his purchase, he was participating in a transaction connected with fraudulent evasion of VAT, it is for the national court to refuse that taxable person's entitlement to the right to deduct". That latter paragraph is word for word repeated as the Ruling of the Court.
43. The words which record these definitive statements are untrammelled by any reference to the need for establishing that the taxable person must be a member of a defaulter chain, or that he must be dealing in the same goods as had been the subject of a defaulter chain. The only such references in the judgment are for the purpose of differentiating the result in relation to Kittel from that with regard to Recolta, where the taxable person was innocent but was said to be rendered liable to sanctions by the Revenue because of his participation in the defaulter chain in relation to the same goods.

(ii) If necessary, extension of Kittel

44. In those circumstances there is no question of any need for an extension, but the Revenue is inviting me here simply to follow the European Court in Kittel. If however it is necessary to extend Kittel, by applying those principles for the first time in relation to a participant in a contra-trade chain deliberately assisting in the fraudulent recovery of VAT reclaimed at the end of the defaulter chain, then Mr Anderson submits that such is a natural and inevitable extension. There is nothing in the cases either of ASSIDER or Robert Bosch which prevents the application of principles, set out in the way they were by the European Court, to a different set of facts, and those principles, in particular as set out in paragraph 42 above as further enshrined in the last paragraph of the European Court's Ruling, arise persuasively and logically out of the entire reasoning of the European Court's judgment.

(iii) Legal Certainty

45. The principle of legal certainty must be trumped by the "objective recognised and encouraged by the Sixth Directive" (paragraph 54 of the judgment in Kittel) of preventing tax evasion, avoidance and abuse. In FTI at paragraph 33 of the judgment of the Court, it is persuasively emphasised (though in a different context) that it is the non-fraudulent party who is entitled to expect legal certainty, whereas by implication the fraudulent party is entitled to expect that steps will be taken to defeat his fraudulent ends:

"Traders who take every precaution which could reasonably be required of them to ensure that their transactions do not form part of a chain which includes a transaction vitiated by VAT fraud must be able to rely on the legality of those transactions …"

(iv) Multiple Recovery

46. Mr Anderson makes it clear that there is no intention to achieve multiple recovery. It is here that common sense takes a hand. Mr Lasok points out that there is the remedy referred to in paragraph 38 above of making a taxpayer jointly or severally liable with the missing trader. There is always the remedy of seeking to recover monies back from a fraudulent party. But all such steps require active recovery steps to be taken by the Revenue, which might well be floored by the disappearance or the insolvency of the relevant party, together with the appropriate covering of tracks. A refusal to refund inputs is a very straightforward remedy for the Revenue, provided of course that it can justify its position in the Tribunal.
47. It was in this context that I referred in argument to the difference between a sword and a shield. Mr Lasok's diagram, to which I referred in paragraph 35 above, assumes that not only will the Revenue refuse to pay when presented with a tax return purportedly in credit by an alleged exporter, but that it will also seek to recover, by cancelling or disregarding outputs, monies from those who are not expecting a repayment. That is not the course being taken in this case. If it were to be taken, or if it proves that it has been taken, then no doubt ways can be found by the Tribunal or by the courts to prevent double or multiple recovery. For the moment Mr Anderson rests on his statement in his skeleton in the Evolution at paragraph 33(d) that "HMRC are not seeking 'multiple recovery'".

(v) Penalty

48. Mr Anderson refers to and relies on the passage from his skeleton in the Evolution case at paragraph 32(e) quoted in paragraph 33 above, which has been the subject of Mr Lasok's scrutiny. The Revenue is simply exercising a right, sanctioned by Kittel, in circumstances covered by Kittel, to refuse payment of a return apparently in credit, by reference to the contra-trade transaction, which has been used impermissibly to pay off the VAT to Blackstar (on the assumed facts). Though there was a fraud at an early stage of the defaulter chain, there has been a further fraud at the end of the defaulter stage, by virtue of Blackstar receiving money to which it had no entitlement or which, at any rate, it would never have got from the Revenue. As to the imagined scenario that the transaction the subject of the contra-trading was a much larger one, such that by refusing the entire VAT on that transaction more than the VAT which Blackstar impermissibly received is recouped, the consequence of that might or might not need to be considered, depending upon the facts, which have not yet been found. It is not accepted by the Revenue, however, that this would constitute a penalty, any more than the fact that, by refusing to pay on an exporter at the end of the defaulter chain, recoupment of a sum more than the loss caused by the original defaulter, simply by virtue of the markups on each buffer transaction along the chain, constitutes a penalty either.

(vi) Prevention

49. Mr Anderson takes considerable issue with Mr Lasok's submission referred to in paragraph 40 above that declining to pay the fraudulent exporter at the end of the chain or, once (on the assumed facts) an alternative fraudulent route to recover that VAT is found by enlisting a fraudulent contra-trader, then refusing repayment to that contra-trader, is not effective in the prevention of such frauds. He points to the quantum of attempted carousel fraud, referred to in paragraph 7 above, and to the very fact, as appears to be the case if the Revenue be right, that the contra-trading scam has been invented to seek to get round the effective closing up of the first route by the Revenue. Certainly the European Court in paragraph 58 of the Kittel judgment concluded that refusing a taxable person who knowingly aided the perpetrators of a fraud the right to deduct "by making it more difficult to carry out fraudulent transactions, … is apt to prevent them".

Conclusion

50. I am wholly persuaded by the submissions of Mr Anderson.
51. With regard to Kittel, it seems to me, albeit that the facts may have been different, and indeed the questions from the Belgian national court may have been differently framed, the European Court crystallised what it called the essential questions in paragraphs 27 and 28 of the judgment:

"27. By its questions, which must be considered together, the referring court asks essentially whether, where a recipient of a supply of goods is a taxable person who did not and could not know that the transaction concerned was part of a fraud committed by the seller, Article 17 of the Sixth Directive must be interpreted as … [precluding the rule of national law which caused such innocent taxable person to use his right to deduct that tax].

28. The referring court also asks whether the answer to that question is different where the taxable person knew or should have known that, by his purchase, he was participating in a transaction connected with fraudulent evasion of VAT."

52. The answer to the second question, fully rationalised in paragraphs 53 to 61, cited above, and enshrined in the Ruling, is that – on the assumed facts – Evolution is "a taxable person who knew … that by his purchase, he was taking part in a transaction connected with fraudulent evasion of VAT". In those circumstances, I am satisfied that the Revenue would have the right to refuse to pay the input claimed, and my concluded view is the same as was the untutored response of Charles J in Megantic: and the same as the provisional view of Mr Bishopp in Calltell (at paragraph 18) that "if the Respondents can show that the transactions were what they claim them to be, … they have at least an arguable case that a trader who, knowingly or with means of knowledge, engages in conduct designed to conceal, or avoid the consequences of discovery of, a fraud should be in no better position than the perpetrator of the fraud".
53. I entirely accept the importance of the sanctity of the common system of VAT, which Mr Patchett-Joyce so emphasised. However it is plain that the European Court had the Sixth Directive (now the 2006 Directive) well in mind in expressly permitting the right to refuse deductions/payment (paragraphs 55, 60, 61). It seems to me that the common system of VAT is much more at risk if firm steps are not taken by the Revenue to prevent the fraudulent abuse of it which, on the assumed facts, would have taken place. I echo the persuasive words of Mr Anderson at paragraph 36(d) of his skeleton in JF:

"If JF were correct, then HMRC would be powerless to prevent massive fraudulent claims involving multiple chains in different goods. It cannot be right that Community law sanctions sophisticated VAT fraud. It is an absurd proposition that the Sixth Directive permits for instance a defaulter, contra-trader and broker to conspire to create a tax loss, offset that loss into another supplier and then deliberately and fraudulently claim an input tax refund."

54. If, as I conclude, Kittel sanctions the action by the Revenue in this case, on the assumed facts, then Mr Lasok is right that the effect of those principles will need to be worked through, depending upon the precise facts, in the slightly different circumstance of a contra-trade chain. Even in relation to a defaulter chain itself, where the right to refuse deductions is expressly sanctioned by Kittel, the kind of questions which Mr Lasok canvasses, of penalty and multiple recovery, might arise, but it is certainly true that they are more likely to arise once the principle applies to an additional chain. However, I am far from persuaded that, once the facts of these three cases are analysed, it will necessarily be the case that any questions of multiple or double recovery or penalty will arise, and I am certainly not persuaded that they are bound to arise. Some contra-trades may be structured so as to offset the exact amount of 'irrecoverable' input (although that would make discovery of fraud, if such it be, the more obvious) some structured so as to offset a lesser amount than the contra-trade VAT or some a greater. I am far from convinced that issues of penalty will hang on the precise formulation of a (necessarily) fraudulent transaction. In any event, as I have said, all these matters can be considered, once the facts are known, by the Appeal Tribunal.

Reference to Europe

55. Mr Lasok submitted that I should make a reference to Europe if I were otherwise against him, so that the European Court can both conclude whether it is indeed the case that Kittel covers contra-trading and/or to invite the European Court to consider the necessary consequences in terms of issues of penalty, multiple recovery etc. Not only was this proposal opposed by Mr Anderson for the Revenue, but it was also opposed by Mr Patchett-Joyce for JF and Brayfal, both of whom wish rather to get on with, and take their chance of success in, the VAT Appeal Tribunal. Mr Lasok submitted that the matter should go off to Europe and should best go now, before further time and expense is incurred in investigation of the facts, and by reference to hypothetical facts, perhaps even the same assumed facts as have been adopted for the purpose of this 'strike-out' application. He referred to R v Minister of Agriculture, Fisheries and Food and Others [1988] 3 CMLR 661, where Henry J referred to Lord Denning's guidelines in Bulmer v Bollinger [1974] Ch 401, to the effect that judges should decide the facts before making references as being no more than a general rule, concluding that in that case a ruling could make it unnecessary to review a substantial amount of evidence. I am entirely satisfied that in this case a reference at this stage is inappropriate:

i) I do not believe there is any doubt as to the application of Kittel to the right claimed by the Revenue, if they can establish the facts that these Claimants knew or should have known that they were entering into the contra-trade transactions to facilitate a fraud on the Revenue, by the recovery, for the originator of the contra-trade, of input VAT by offsetting which, emanating as they did from a defaulter chain, would have been irrecoverable by direct claim upon the Revenue.

ii) If there be any consequential working out that is needed of the consequences of the application of Kittel to contra-trading, that is best done once the facts are found. The assumed facts, upon which I have been satisfied, put the case at the highest against these Claimants; but of course there may well be gradations of knowledge which would need to be considered by the Tribunal, and in any event, before issues such as multiple recovery and penalty fall to be considered, the facts would need to be established, as intimated in paragraphs 47 and 48 above.

iii) Interesting though it may be as a matter of law to know what might occur in the European Court, Mr Patchett-Joyce is persuasive in his case that his clients wish to proceed with the Appeal Tribunal hearing in the event that they were unsuccessful before me – and even if the contra-trading points had been decided in their favour, there remain issues which might still need to be resolved with the Revenue – and in any event of course, no Decision has yet been taken. Thus a European reference at the instance of these Claimants may be rendered nugatory and happily pointless, either by the Revenue making a Decision to pay, or, in the event of their making a Decision to refuse to pay, then by virtue of success for the Claimants before the Tribunal.

iv) In all those circumstances I am faced with what would be a very substantial delay, if there were a reference to Europe, before there could be a decision at the Appeal Tribunal; and I am, in the circumstances, not at all sure that there will necessarily be a reference in any event in relation to these Claimants at any time.

Result

56. I consequently resolve in favour of the Revenue the first issue, namely as to whether the Revenue can base its Decision, on whether it can refuse to pay on the VAT returns referred to in paragraph 1 above, on the connection of those transactions with the transactions the subject of the defaulter chain, and I refuse Mr Lasok's application for a reference to Europe.
57. I referred in paragraph 13 above to the way in which the second and third issues were resolved. The timescale which was agreed was that the Revenue would, save in the event of material unforeseen circumstances, reach a decision by 30 April. That timescale might have been affected had I resolved the question of contra-trading against them, but that does not now arise. As can be seen from the formulation of the agreement, Mr Anderson makes it clear that the Revenue's intention is to make a decision in all three cases by 30 April, and hence they have agreed to do so, with only the saving of unforeseen circumstances. Against that background I have every expectation that the decisions will be so made. A date has been provisionally fixed for a possible emergency hearing on Thursday 3 May at 10.00am. I shall if necessary hear Counsel on the form of the appropriate draft Order.