First-tier Tribunal (Tax)

[2010] UKFTT 63 (TC)

TC00375

Appeal number:  EDN/07/73

VALUE ADDED TAX – Deduction of input tax per Sections 25 and 26 VATA 1994 – repayment refused on basis that MTIC fraud involved – actual and imputed knowledge of taxpayer – Appeal Refused.

FIRST-TIER TRIBUNAL

TAX

                                          VIP (SCOTLAND) LTD                          Appellant

                                                                      - and -

                                 THE COMMISSIONERS FOR HER MAJESTY’S

                                             REVENUE AND CUSTOMS (VAT)         Respondents

                                                TRIBUNAL JUDGE:            Mr Kenneth Mure, QC

                                                (Members):                            James D Crerar, WS

                                                                                                I R Welch, JP CA

Sitting in public in Edinburgh on Monday 7 September to Tuesday 15 September and Thursday 17 September 2009.

Donald R Findlay, QC and Ms Frances Connor, Advocate, for the Appellant

Heriot Currie, QC and Mrs Sarah Wolffe QC, instructed by the General Counsel and Solicitor to HM Revenue and Customs for the Respondents

© CROWN COPYRIGHT 2010

DECISION

Preliminary

1. The Appellant company at the material time traded in mobile phones.  It seeks repayment of input tax on 7 batches of mobile phones which it purchased in April and May 2006 and re-sold to customers in Luxembourg free of VAT.  The Respondents argue that the repayment should be disallowed as these transactions were parts of fraudulent schemes to defraud the UK Revenue and that the taxpayer should have known of this.  Each of the 7 batches of phones was the subject of a series of purchases and sales concluded on the same day in circumstances in which another trader which had imported the goods had failed to account for output VAT in respect of their re-sale.

2. Such a “carousel” type fraud has been defined as follows:-

“… goods – commonly computer chips and mobile phones, … are imported into the United Kingdom by one trader and change hands, usually within the space of a single day, several times before they are exported again, usually but not always to another Member State of the European Union.  The importing trader does not account for the output tax due on its sale, … it is known as a ‘defaulter’.  The traders, known as ‘buffers’, between the defaulter and the exporting trader, who is known as the ‘broker’, account correctly for the output tax due on their respective sales while claiming credit for the input tax they have incurred on their purchases. … The broker pays VAT on the price of the goods to the buffer from which it has bought them, but (assuming the transactions are all genuine) is entitled to zero-rate its sale; it then seeks … payment from the Commissioners of input tax credit generated by its purchase.”  (per the Tribunal in Moblix Ltd, noted infra).

Certain features typical of “carousel” fraud have been identified.  Third party payments, ie payments made to a party other than to whom payment is due, the use of “freight forwarders” to enable “paper” transactions, and the lack of commercial rationale, have been highlighted.  Typically, high value commodities of small physical size are the subject of the sequence of transactions in the “chain”.  (Euro Stock Shop Ltd infra para 6). 

The Law

3. Sections 25-26 Value Added Tax Act 1994 provide that a taxpayer who makes taxable supplies, may deduct input tax paid by him on his relative inputs.  However, as a matter of Community Law the European Court of Justice has refused such repayments where there is fraud and an Abuse of Rights, and the party seeking repayment knew or should have known of the fraud. 

4. In the course of the Hearing particular reference was made to the following decisions of the ECJ –

Axel Kittel v Belgian State [2008] STC 1537

Optigen and Others [2006] ECR I-483, [2006] Ch 218

Further reference was made to the following decisions of the High Court in England and of the Tribunal, viz –

Dragon Futures Ltd v C&E Commissioners [2007] V&DR 348

Calltell Telecom [2009] EWHC 1081 (Ch)

Moblix Ltd v HMRC [2009] EWHC 133 (Ch)

HMRC v Livewire Telecom Ltd and Olympia Technology Ltd [2009] EWHC 15 (Ch)

Mobile Export 365 Ltd (2007) EWHC 1737

Euro Stock Shop Ltd v HMRC (2009) UKFTT 182 (TC)

R(re Application of Teleos Plc) v HMRC (C409/04) [2008] 1CMLR

Netto Supermarkt GmbH & Co [2008] STC 3280

Our Communications Ltd v HMRC (2008) Decision 20903

Twinsectra Ltd v Yardley [2002] 2 AC 164

Reference might also be made to the recent decision in –

Megtian Ltd (In Administration) v HMRC [2010] EWHC 18 (Ch)

Evidence

5. Parties negotiated an extensive Joint Minute of Admissions settling helpfully the non-controversial aspects in the case, including the 7 “chains” of transactions, and setting out the sequences of purchases and re-sales of the 7 batches of mobile phones and also the related cash transfers. 

As a result the evidence led focused on the 2 critical aspects for our determination, viz – whether the losses of revenue to the Respondents were as a result of fraudulent acts by the defaulting traders in each chain and, further, whether the Appellant was aware or reasonably should have been aware of the fraud.

6. Parties agreed also that the Respondents should lead but under reservation of all considerations relating to the onus of proof.  This, we understand, is the customary procedure in MTIC appeals and we found it helpful and appropriate in the present case.

7. Mr Currie for the Respondents led the evidence of six HMRC officers and an independent expert, a chartered accountant and partner in KPMG.  Their Witness Statements are produced.  Each of these witnesses adopted these subject to only limited revisals and amplification in certain cases.

8. Firstly, Roderick Stone gave evidence.  He is an established tax officer with special responsibilities for dealing with MTIC and “carousel” fraud.  He was not involved in the investigations in this appeal but he has reviewed the papers.  He spoke to the special characteristics of carousel frauds, the “chain” made up of the missing/default trader (at which the loss occurs), the intermediate or “buffer” traders, and then the “broker” who (as here) exports VAT free and then seeks repayment of input VAT.  These features arise relevantly in this appeal and have arisen in other MTIC cases.  He noted other tell-tales of such schemes including “third party payments” (ie not to the supplier but to a party outside the UK) and “freight forwarders” (who handle and transport the stock).  He referred also to pricing, terms of business, and the popularity of offshore banking.  The use of facilities of the First Curacao International Bank (“FCIB”) by participants in carousel fraud was noted.  (Businesses generally tend to have local banking arrangements).  He explained various measures adopted to combat this form of fraud.  He noted the circumstances in which VAT accounting periods may be shortened to one month and the consequent cash flow advantages to a broker in a carousel fraud.  He noted also the “grey” market, explained further in the report of Mr Fletcher, infra.

9. Mr Stone was cross-examined by Mr Findlay on various aspects of his evidence.  He was challenged about the level of HMRC’s estimate of the level of carousel fraud.  More particularly he was questioned about the level of guidance and assistance afforded to traders who were anxious not to flout the law and secure repayments of input tax paid.  Mr Stone explained that while guidance is given, there is no check-list or fail-safe procedure.  The responsibility rests ultimately with the individual taxpayer.  There is no system of rulings or any “clearance” procedure.  Mr Stone explained that monthly returns would be permitted where reasonable and proportionate and no suspicious factors were present.  He stressed, however, that HMRC’s concern related not to an innocent default (say attributable to business failure) but rather fraud.  Trading in mobile phones on the “grey” market, if honestly conducted, was perfectly legitimate.

10. The next witness was Peter Birchfield, an MTIC Technical Coordination Team Leader.  He was involved in analysing computer data of the First Curacao International Bank.  To investigate these records he relied on Bankmaster Plus and Datastore Systems, with both of which he was familiar.  He identified bank accounts of the businesses relevant to this enquiry and produced summaries of 7 “deal chains” ie successive transfers of the same quantity of particular mobile phones.  In relation to the 7 chains he spoke to a flowchart setting out the transactions in each (eg B-48 re chain 1).  In addition he spoke to money transfers in respect of each transaction and also supporting spreadsheets.  In each case he explained that after being imported into the UK the phones apparently were bought and sold by a series of “buffers” and then to the Appellant who exported them always to the same two purchasers in Luxembourg.  The defaulting trader, he believed, was in each case the importer (eg Appollo in Deal 1).  So far as payment for the phones was concerned, there was a circular movement of funds.  A company, Technology PLC (BVI), put the Appellant’s customers in funds.  Thereafter the same amounts approximately were paid apparently in exchange for the transfers of the phones all along the chain.  Apparently on Mr Birchfield’s analysis, payment did not, however, reach the importer.  (See, for example, fund flow diagram, Doc B-48, in which the circulating payment does not “reach” the importer, Appollo).  Before then the consideration was paid back to Technology PLC.  The individual transfers were noted in Mr Birchfield’s evidence.  There was no record of any contract or arrangement whereby Technology PLC should involve itself.  All bank transfers took place on the same day (eg in chain 1 20 April 2006), with a corresponding outgoing payment being made immediately after the incoming payment.  The quantities of phones bought and re-sold by the buffers did not vary along the chain.

11. Mr Birchfield concluded that the pattern of transactions indicated a “carousel” fraud with funds circulating in a closed circle.  Significantly none of the traders at the start of the chains, in particular those who imported the phones into the UK, apparently received any monies to enable them to meet their VAT liabilities.

12. In his original Written Statement and initial statements of money transfers there were certain shortfalls (small in percentage terms).  These were investigated by the Appellant’s expert, SKS, as a result of which Mr Birchfield on re-consideration could eliminate these shortfalls.  His second Witness Statement explains this.

13. Next Mr Currie led the evidence of John Fletcher, a chartered accountant and MBA, who is a partner in KPMG.  He has experience of the telecoms industry.  In his evidence he distinguished the “white” and “grey” markets in telecoms.  The white market is authorised and controlled by the manufacturers.  Mr Fletcher’s Written Statement and evidence concentrated on the nature of the “grey” market in telephones.  This market is unofficial, not formalised, but is perfectly legitimate.  It is largely outwith the control of the phone manufacturers.

14. Mr Fletcher had sight of the Appellant’s VAT returns and a statement prepared by its director, Mr Young, noting in particular para 142 thereof in which he acknowledged exploiting “arbitrage” opportunities between different markets.  Mr Fletcher considered this information in the context of the telecoms market.  The 7 “deals” represented 98% of the Appellant’s sales to the EU during the relevant time.  The turnover of the business in April and May 2006 was £9.8m and £9.4m.

15. Mr Fletcher considered the opportunities offered by the grey market to such a business as the Appellant company and then assessed the operation of the business in that context.  He describes particularly Arbitrage ie trading to take advantage of price variations between different markets.  (Significantly this is not available for Nokia products where one global wholesale price is set by the manufacturer).  Various aspects of the manner of trading were considered for their consistency with profitable arbitrage.  While certain characteristics were consistent, there were also substantial negative indicators.  Mr Fletcher concluded that it was very unlikely that a rational and profitable arbitrage business was being conducted.

16. Other grey market opportunities were considered too.  “Handset locking” (ie taking advantage of subsidies in particular markets) would require staff for the technical work of adapting units to suit other markets and storage facilities.  That support was not available in the Appellant company.

17. “Volume shortages” can arise where as a result of different model specifications by various manufacturers, certain models may become more popular than others.  That can produce business opportunities, but this factor did not arise here. 

18. Similarly “dumping” did not feature in the present case.  That arises where excess stock is left over in one territory and is sold at a loss in others. 

19. Thereafter Mr Currie led evidence of 3 technical officers of HMRC, Messrs Meynell, Letherby and Boyes, who were responsible for the uplifting of the FCIB computer records from the Dutch Authorities.  They all bear to be formidably qualified in IT skills, having achieved inter alia ACPO (Association of Chief Police Officers) standards.  The Letter of Request by the UK authorities to their Dutch counterparts was referred to.  (Doc B193).  We did not understand the authorisation for the uplifting and processing of these records to be challenged.  While Mr Letherby was cross-examined about possible contamination and alteration of the material on the hard disk which was handed over, we are satisfied from his answers that he was, indeed, familiar with this risk and had in fact so acted as to eliminate the risk of contamination.  All the information on FCIB’s records, so far as relating to the Appellant and others in the 7 “chains” was thus accessed by Mr Birchfield via the Bankmaster Plus and Datastore Systems for preparation of his statements of bank cash transfers.

20. Finally for the Respondents Mr Norman Morrison gave evidence.  He was the investigating officer and had liaised for some years with Mr Young, visiting him in relation to VIP and other companies owned by his family and writing to him also.  (Docs A-56 to 59).  On an early visit in August 2003 Mr Morrison had suspected that Mr Young had been less than frank about a transaction involving VIP’s trading in DVD’s and CD-roms (see para 14 of his Witness Statement – a matter, of course, which is not related to the subject of this present appeal).  In particular he informed Mr Young of the carousel fraud risk present in the grey market for mobile phones.  He explained its consequences and gave guidance on avoiding the risk of incurring liability relating to carousels. 

21. Mr Morrison has investigated carousels and related “chains”.  He advised Mr Young that he had traced the defaulting trader in various chains in which VIP was involved.  He had found defaults, which were wilful and fraudulent.  Accordingly he had warned Mr Young of these and in particular had advised him not to continue trading with Trans Global Trade Ltd (t/a T Mobile Ltd) and Maximus Complete Ltd.  Notwithstanding VIP continued to do so.

22. Mr Morrison investigated the 7 chains in which VIP had participated in April and May 2006.  All traced back to defaulters viz Apollo Communications, Colston Associates, USM IT Supplies and Golden Ltd.  The defaults had been fraudulent.  He had liaised with the case-officers concerned with the defaulters.  In none of these cases had there been an appeal or negotiation or other factor suggestive of an explanation other than a deliberate fraud.

23. Mr Morrison explained that the circumstances of the contracts which VIP had concluded in relation to the chains were obviously suspicious especially against the background of his warnings and guidance.  The contracts were “too good to be true”.  There was according to the invoice prices an assured, substantial profit.  The deals were for the same quantities (ie “back to back”).  VIP was paid by its customers before it paid its suppliers.  The contractual terms in any detailed sense were not specified.  VIP’s business structure seemed strangely minimalist in relation to the value of its turnover. 

24. We found Mr Morrison an impressive witness.  We considered him credible and fair-minded and his investigation bears to have been carried out thoroughly and conscientiously.  Similarly the other tax officers were considered by us to be credible and reliable.  Their evidence was perhaps less controversial.  Mr Fletcher gave his evidence in a competent and impartial manner and we accepted it without reservation.

25. Finally on behalf of the Appellant company Mr William Wylie Young gave evidence.  He is a director of the company and since November 2003 has effectively run its business.  He did so single-handed until 2005 when he engaged as an employee, Mark Wilson, who had worked with Maximus Complete Ltd in the telecommunications business.  Essentially he explained that his business plan has been to secure a low marginal profit on a high volume of goods.  The profit margin on the 7 deals varied between 5.1% and 7% (arguably not insubstantial!).  Mr Young’s skill is in matching (exactly) quantities of phones for sale and quantities being sought, on which he would make the company’s mark-up.  The company did not process or adapt the goods.  Indeed, it does not even have a service or repair staff or storage facilities of its own. 

26. Mr Young accepted that he had been advised about the risks in this type of trade by Mr Morrison at regular and frequent meetings.  Their relationship, while businesslike, appeared to be perfectly cordial.  Mr Young complained that the guidance given by the Respondents was insufficient.  Following that advice, he complained, was not a means of securing repayment of input tax without the risk of challenge.  There was no exhaustive “tick” or checklist.  (This, of course, corresponded with Mr Morrison’s evidence.  He feared that such a guaranteed checklist could be exploited). 

27. Mr Young accepted in particular that he had received the No 726 Notice and other warnings in writing about the prevalence of “carousel” fraud and the risk of involvement.  Moreover, the Appellant company had independent professional advisers who, given its turnover, might possibly have issued warnings as to the prevalence of such fraud.

28. We considered Mr Young’s evidence, and especially evidence in cross-examination, with great care.  Ultimately we did not consider his testimony reliable and we have serious reservations about it in crucial respects.  His oral evidence conflicted with his Witness Statement in certain important respects.  (For instance the reference in para 3 to “widening customer base and providing new services” was not apt in relation to the pattern of trading at the material time.  Also, Mr Young accepted that the reference in para 7 to following always HMRC’s suggestions and notifying them of re-circulation of stock and rejecting it were not accurate).  His answers, particularly in respect of his state of knowledge and approach to his pattern of trading, lacked credibility in our view.  He was not candid in certain of his responses in cross-examination.  His estimate of VIP’s becoming involved in a chain tainted by MTIC fraud as being “a slight chance” and, when pressed, “a possibility” seemed wholly unrealistic to the Tribunal given the warnings issued by the Respondents and their officers and further likely professional advice.  More particularly we were not satisfied that he used IMEI numbers responsibly to check on the movement of phones between tax jurisdictions.  He had been advised to do so.  Moreover, he continued to trade with businesses about which Mr Morrison had warned him in particular Maximus Complete Ltd.  He did not check the credit-rating of his business contacts, which would have indicated their financial and trading capacity and ability to finance such high value transactions.  He denied there being talk generally in the trade about the use of the FCIB for MTIC fraud although in 2005 the Appellant’s facilities with the Royal Bank of Scotland Ltd and the Bank of Scotland were withdrawn and it sought an accommodation with FCIB.  He disputed that his manner of trading (with an inevitable and significant profit but without adding value) was commercially unrealistic.  He did not explain away satisfactorily the combination of “back-to-back” trading ie the same type and numbers of merchandise, being the subject of successive “deals”, all “deals” being concluded on the same day, the lack of any detailed contractual specifications and terms, and being paid by the customer before making payment to the supplier.  Even individually these factors should have seemed curious.  In the 2 months in question the Appellant’s turnover was £9.8M and £9.4M.  He did not respond satisfactorily to Mr Currie’s questions that he could not exclude the apparently unnecessary links in the “chain” and thus secure his position commercially and increase his profit.  (Mr Young explained that he found his customers and suppliers via publicly accessible websites).  All of this tended to suggest an ulterior motive, not consistent with “arms length” commercial trading.

29. The Appellant chose not to call further evidence such as that of its sole employee or any of its suppliers.  It occurred to the Tribunal that such evidence might have been helpful in relation to the Appellant company’s pattern of trading and the manner in which it conducted its business.  Records of phone calls while negotiating might have been helpful.

30. On the basis of that evidence and the documentation before us we make the following:

Findings-of-Fact

1. The Appellant is an incorporated company having its place of business at 278 High Street, Cowdenbeath, Fife.  Its business has been managed by William Wylie Young, a director, from November 2003.  From May 2004 it has traded in mobile telephones.  In 2006 its turnover was over £60M.  It had only one employee in addition to Mr Young.  Its premises are a modestly sized office, without storage facilities, and it has no technical staff.

2. From October 2003 the Appellant company has completed its VAT returns on a monthly basis instead of a 3-monthly basis.  (See Doc A-81).  Monthly repayments of VAT accelerate cash flow and facilitate trading.  Re-registration on a monthly basis is a known ploy by those involved in “carousel” fraud.  The Appellant arranged this revised basis before trading in mobile phones.

3. The Appellant’s returns for April and May 2006 seek repayments of input tax for, respectively, £1,534,685.94 and £1,524,075.00 in respect of 4 and 3 batches of mobile phones.  The Respondents have refused to make these repayments (Docs A 88-91), which is the subject of this present Appeal.  The refusal followed a process of in-depth verification by the Respondents’ officers.  (Doc A-188).

4. In addition to the regular market for mobile phones where these are sold by manufacturers and their authorised distributors, there is a “grey” market on which these are sold, which is not regulated or controlled by manufacturers.  After certain anti-avoidance measures (the “reverse charge”) were announced in July 2006 the volume of sales on the “grey” market was reduced by about 90%, which is considered indicative of the volume of fraudulent transactions previously.

5. A “carousel” fraud typically involves a “chain” of transactions starting with the importation of goods by the “defaulter”, who fails to account for output tax on their resale; then a succession of purchases and resales by UK traders (“buffers”); and finally their re-export, zero-rated, with the exporter (or “broker”) seeking a repayment of input tax.  These features are present in this case, the Appellant being the broker.  Other characteristics of carousel fraud, present in this Appeal, are the use of foreign bank facilities, in particular of the First Curacao International Bank (“FCIB”) in the Netherlands Antilles, the use of “freight forwarders” who arrange for the storage and carriage of the goods, and also “third party payments” where the first “buffer” accounts for payment not to the importer/defaulter but a third party, usually outwith the UK.

6. From 2005 UK banks refused credit to those suspected of carousel trading.  Thereafter offshore banks, including the FCIB, were used by parties involved in carousel transactions.  Its facilities were generally known to participants in the “grey” market.  In late 2005 the Appellant opened a bank account with the FCIB, its accounts with the Royal Bank of Scotland and Bank of Scotland having been closed.

7. The FCIB was closed down by the banking authorities in the Netherlands Antilles in October 2006.  Its records, including computer discs, were recovered by them.  By arrangement with UK Government these records were made available to the Respondents.  Their officials were thus enabled to download statements of the bank accounts of the Appellants and other parties in the “chain” transactions relevant to this appeal.  These statements reflect accurately the information contained in the FCIB’s computer records. 

8. In particular Docs B 84-164 reproduce bank records relating to the traders in the deal “chains” noted infra.

9. From July 2003 the Respondents’ officer, Norman Morrison, had regular meetings with Mr Young and advised him of the prevalence of MTIC and carousel fraud in the telecommunications market.  By letter dated 10 February 2005 (Doc A-83) he warned him specifically about continuing to trade with Maximus Complete Ltd and T Mobile Ltd/Trans Global Ltd.  (At para 56 of his sworn statement he identifies these two companies as being referred to in para 2 of the letter).  He issued to him a copy of HMRC’s Notice No 726 on Joint and Several Liability, which explains MTIC fraud in the telecoms sector.  (Doc A 71-72).  Additionally Mr Young was sent numerous “veto” letters advising of VAT registration numbers which ceased to be valid.  (Doc A 82, 84-87).  Further, he was advised in said letter dated 10 February 2005 (Doc A-83) that certain deals which he had entered in 2004 had been traced back to defaulting traders.  He was advised in December 2005 that goods which he had despatched to his customer, 3G Trade, in Luxembourg, were re-imported into the UK the next day.  Mr Morrison encouraged him to check the IMEI numbers of phones in which he transacted as a means of tracing whether they had been previously the subject of a carousel transaction.  Notwithstanding the Appellant continued to trade with his former suppliers and failed to use IMEI numbers to avoid involvement in a carousel fraud.

10. 84% of the phones sold by the Appellant in April and May 2006 were manufactured by Nokia.  Its pricing policy was such that there were no differentials between markets.  Accordingly there was little or no opportunity to profit from arbitrage “grey” market trading, exploiting variations in price between countries. 

11. The 7 batches of phones which are the subject of the 2 disputed repayment claims were traced individually from their import into the UK to their sales and re-export by the Appellant to its customers in Luxembourg.  The “chains” of transactions in which each batch featured are set out in diagrams (Docs A 161- A 167 and B 48, 50, 52, 54, 56, 58 and 60).  These diagrams were prepared by Mr Birchfield and other officers of the Respondents by reference to invoices and order forms and FCIB records.  In each chain all the contracts of sale are concluded on the same day.  The individual sales are “back-to-back” in that the quantities sold and purchased match in number.  There are no detailed specifications, contractual terms, or guarantees such as would reasonably be required in normal “arms-length” trading set out in the invoices and order forms.  Indeed, one model of phone ordered did not exist.  Doc B-44, an order form, refers to 4,000 Nokia 8801 handsets with European specification.  A European variant of this model was never produced.

12. Also transfers of cash in payment are recorded on Docs B-48 et seq.  Payments relating to each chain are made on the same day.  Re-circulation of cash in payment is shown prepared by reference to FCIB’s records.  The movement of cash starts with an outgoing payment by a British Virgin Islands company, Technology Plc (BVI) to the Appellant’s two customers in Luxembourg, Westcom SA and/or 3G Trade SA.  The cash then passes to the Appellant, and then through the “buffers”.  However, at a stage before reaching the importer the cash is then paid back to Technology Plc, via its FCIB account.  (This is a “third party payment” characteristic of carousel fraud).  No record of payment to in particular the importers which would enable them to pay output VAT due, could be traced by the Respondents.  (These companies did not have FCIB accounts). 

13. Characteristically of carousel fraud no value was added to the product along the “chain” by, say, modification or improvement.  No credit was offered by any of the participants in the “chains”.  The price increased invariably between import into the UK and re-export.  Almost all of this profit accrued to the Appellant, the “broker”, with minimal shares accruing to the buffers.  Its profit margin on the 7 deals was between 5.1% and 7%.

14. In each of the 7 chains the importer failed to account to the Respondents for the output VAT charged on the re-sale of the phones.  Accordingly the Respondents lost revenue in each chain.  The defaults in each chain were fraudulent.  None of the assessments made on the defaulters was the subject of an appeal or negotiation or was otherwise disputed. 

15. The Appellant’s Spanish supplier, Marubo, was de-registered for VAT purposes for fraud on 7 March 2006.  The customers of the Appellant in Luxembourg, Westcom SA and 3G Trade SA, were found to be involved in MTIC trading. 

16. In relation to the Appellant company’s dealings with the phones which were the subject of the 7 “chains” considered Mr Young failed in particular –

(i) to record the IMEI numbers of the phones and check whether there was evidence of their previously having been imported into the UK;

(ii) to carry out credit checks on each of the companies with whom he was trading and of whose involvement in the chain he was aware, to ascertain the extent of their financial resources and credit standing enabling them to finance the transactions in question; and

(iii) to apply the checks set out in Notice 726.

The responsibility to make such checks was all the more incumbent on Mr Young given his state of knowledge and the nature of the deals concluded.  (Note the information contained in the reports about Maximus Complete Ltd the Appellant’s supplier in chain 5, and Trade 247, its supplier in the other chains, dated shortly before the material dates:  Docs A 157 and 158).

17. The contracts concluded by the Appellant company did not have the characteristics of arms-length commercial trading but rather bore the hallmarks of carousel fraud.  The profit derived by the Appellant (apparently invariably in each case) from these transactions did not reflect commercial reality.  No goods were ever returned as faulty or unsatisfactory.  There were no problems of payment.  Phones suited to the Continental European market were imported into the UK then exported.  All purchases of phones by the Appellant in 2006 were traced back to defaulting traders.

18. In addition to the facts found herein reference is made to the admissions of fact in the Joint Minute of Admissions concluded by the Parties.

19. Mr Young, as the managing director of the Appellant company, knew or ought to have known in the whole circumstances that the transactions which the company entered in the said 7 “chains” were not genuine “arms-length” commercial transactions and, further, that they were likely to be tainted by MTIC/Carousel Fraud causing loss of revenue to the Respondents. 

Submissions

31. Counsel prepared Written Submissions which have been lodged in process.  These were of considerable assistance to us and we refer to their terms.  Each considers the circumstances of the present case as against the current case-law.

32. Mr Currie introduced the legal principles at issue following on the decision in Kittel.  There had to be a fraudulent tax default.  Then the Appellant’s/taxpayer’s state of knowledge – actual and imputed – falls to be considered.  Mr Currie argued that the circumstances in the present case should have put Mr Young “on his guard”.  He had to act with caution, making a “proportionate” response.  He had to take such precautions as were reasonably required, and which might even be quite drastic.  In light of the Respondents’ evidence of the factual background the burden of proof fell on the Appellant.  This had not been discharged by Mr Young’s evidence.  Mr Young had failed to act reasonably.  The 7 deals at issue in the appeal were part of a pattern of suspect trading.  Commercially they were “too good to be true”.

33. In reply Mr Findlay argued that Mr Young had acted reasonably and prudently on the basis of his knowledge at the particular time.  His business was that of “matching” seller and purchaser.  Mr Young was on good terms and co-operated with HMRC’s officials.  However, they had failed to assist him.  There was no evidence that Mr Young had any contact with any defaulter or that he had any knowledge of fraud.  His contact with the “chain” was only with the immediate seller and buyer.  He had carried out all reasonable and appropriate checks.  The taxpayer was required to make no more than a proportionate response and that decision was not to be viewed with the benefit of hindsight.  Accordingly this fell to be judged in the context of Spring 2006.  There had to be marked culpability before Mr Young could be faulted, Mr Findlay argued.  He even suggested a standard comparable to “Nelsonian blindness”. 

34. Briefly in response Mr Currie emphasised that the taxpayer bore responsibility to take all proportionate steps to ensure that it had no connection with a fraud on the Revenue.  Livewire showed this.  The facts proved showed a contrived situation as was characteristic of “carousel” fraud.  The taxpayer cannot pass on his responsibility to HMRC.  An absence of dishonesty is not the test.  Rather, what reasonably should Mr Young have done given his state of knowledge?  That test was objective, Mr Currie submitted.

Decision

35. The two issues essentially to be resolved by the Tribunal are, firstly, whether in each of the 7 “chains” there was a loss of revenue to the Respondents which was attributable to fraud, and, further, what was or should have been the Appellant company’s state of knowledge or suspicion of such a fraud. 

36. The loss of revenue in each “chain” arising from the failure of an earlier trader to account for output tax is, of course, admitted in para 4 of the Joint Minute of Admissions.  Evidence was taken from Mr Morrison that each default seemed to be fraudulent.  Assessments were made on each of the UK importers in each chain.  These were not paid.  None of the taxpayers concerned had appealed or challenged its liability nor had any of the failures been the subject of any negotiation or discussion with HMRC.  We accepted Mr Morrison’s evidence on this which in any event did not seem to be controversial.  (However, these taxpayers were obviously the persons liable for VAT and those to be pursued in the first instance.  There were four defaulters each, so far as we are aware, independent.  Unfortunately we were not informed and are not aware as to why they were not pursued for the recovery of the VAT due.  Accordingly, we can only assume that HMRC considered this course not worthwhile).  Furthermore each “chain” bore the characteristics of “carousel” fraud.  There were “third party payments”, a sequence of transfers of the same goods and same quantities, and circulation of the cash consideration paid.  The Appellant’s customers in Luxemburg were traced to other MTIC frauds, as was the Spanish supplier, Marubo, which was de-registered for VAT purposes in March 2006 (see Doc A-177).

37. More controversial, inevitably, was the second issue.  What did the Appellant company, or rather Mr Young as its sole executive director, know or should have known of such fraud?  What was his state of knowledge – actual and imputed – having regard to the relevant case-law?  What suspicions should he have had?  How should he have acted in these circumstances?  All this requires careful consideration of the principles of Community Law which govern the repayment of input tax in a context where tax evasion features. 

38. As the Respondents agreed to lead, we had heard evidence of the “chains”, the circumstances of the losses sustained, in particular whether these were fraudulent, before the taxpayer gave evidence.  We considered that by then the burden of proof had passed to the Appellant to explain the nature of its knowledge and understanding.  This seemed natural enough and eminently reasonable given that this chapter of evidence is peculiarly within the knowledge of the Appellant company’s director, Mr Young.  In particular we note the view of Lightman J in Mobile Export 365 Ltd at para 7 –

“… it is the Commissioners’ case that the Appellants are precluded from recovering VAT with regard to the relevant transactions because they knew or should have known that those transactions were connected to fraud.  The burden placed upon the Commissioners in MTIC cases of this kind is to demonstrate that, on the balance of probabilities, there has been a fraudulent tax loss and that the transactions giving rise to that loss are connected to the “taxpayers’” transactions.  It is then for the “taxpayer” to show that it nevertheless has a right to reclaim VAT because it did not know and could not have known of the connection to fraud”.

This view was echoed by the Tribunal in Dragon Futures Ltd. 

39. We agree that the standard of proof affecting the Respondents is the civil standard albeit gauged by reference to the nature and gravity of the pieces of evidence.

40. The right to deduct input tax by the “broker” in instances of MTIC fraud has been addressed by the ECJ.  Initially HMRC challenged the general right to deduct in terms of Section 26 VATA on the basis that the transactions were not genuine commercial dealings and not, therefore, “economic activities” for the purposes of the VAT system.  That proved unsuccessful but from the deliberations of the ECJ an alternative objection emerged.  In the conjoined cases of Livewire Telecom Ltd and Olympia Technology Ltd, Lewison J notes

“43… HMRC’s first line of attack on the general problem of MTIC fraud was the argument that transactions in a chain involving MTIC fraud were not genuine economic activities at all, because their purpose was not to release goods onto the market for consumption but to mis-appropriate VAT.  Thus there was no basis for the recovery of VAT.  This argument was considered and rejected by the ECJ in Optigen Ltd v C&E Commissioners”.

(In Optigen the ECJ stated (para 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 the taxable person knowing or having any means of knowing”).

Lewison J continued

“44… it was this decision that introduced the phrase ‘no knowledge or means of knowledge’.”

41. Shortly after its decision in Optigen the ECJ in Axel Kittel clarified the exception in a way helpful to the National Tax Authorities observing

“51… 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…

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 re-sale 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.

Accordingly, the Court ruled 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 value added tax, it is for the National Court to refuse that taxable person entitlement to the right to deduct”.

42. The nature and quality of the knowledge and imputed knowledge which should preclude the deduction or, as here, repayment of input tax by HMRC has been further considered by the High Court in England and by other Tribunals.  Later in his judgment in Livewire and Olympia Lewison J summarises the important European case-law principles (para 76).  For the present it may be noted –

“(i)      The objective of preventing evasion of VAT is an objective encouraged by the Sixth Directive (Kittel para 54).

(vii) A person who knew or should have known that by his purchase he was taking part in a transaction connected with the fraudulent evasion of VAT is to be treated in the same way as a person who fraudulently exercises the right to deduct (Kittel paras 55, 56).

(viii) It is not contrary to Community Law to require a supplier to take every step that could reasonably be required of him to satisfy himself that the transaction which he is effecting does not result in his participant in tax evasion.  (Teleos para 65; Netto para 24).

(ix) Likewise a taxable person can be expected to act with all due diligence and care.  (Netto per A-G).

(x) Whether a taxable person knew or should have known that he was participating in a transaction connected with the fraudulent evasion of VAT must be determined having regard to objective facts or factors (Kittel para 59)”.

Further at para 87 Lewison J states –

“87… the taking of every reasonable precaution has sometimes been referred to as a ‘positive duty’.  This is, I think, potentially misleading.  The taxable person does not owe a ‘duty’ to take precautions (unless it is a duty to himself).  The taking of all reasonable precautions (and acting on the basis of what he discovers as a result of taking those precautions) provides him with an impenetrable shield against any attack by HMRC.  The taking of every reasonable precaution is only a ‘duty’ in the sense that the so called ‘duty to mitigate’ is a duty applicable to the recovery of damages”.

The responsibility on the taxpayer, while high, is not absolute –

“The test does not require the taxable person to take every possible precaution:  merely every precaution reasonably required.  This test gives the Tribunal sufficient flexibility to decide, on particular facts, that a suggested precaution would have gone beyond what could reasonably have been expected”.  (para 123).

But “knowledge” in this context “… includes both knowledge of facts and the ability to evaluate those facts and to draw appropriate conclusions from them”.

The phrase “knew or ought to have known” was considered recently by Briggs J in Megtian Ltd (In Administration) v HMRC [2010] EWHC 18 (Ch), which we noted while preparing this decision but on which in view of its date we were not addressed.  That decision distinguishes actual dishonesty and negligence on the part of a broker.  However, in an MTIC case proof of either state of mind is sufficient to justify HMRC’s refusal to repay VAT.

43. Recently in the appeals of Moblix Ltd Floyd J suggested that a “reasonably proportionate response” for a trader in a possible carousel fraud may be “either radically to alter the method of trading or get out of it altogether” (para 85).  At para 87 he continued –

“… the [taxpayer] company has to exercise independent judgment, not delegate its judgment to HMRC.  I agree entirely with the Tribunal when it said that ‘there must come a time when a trader, told that everyone of his purchases followed a tainted chain, is compelled to recognise that without a significant change in his trading methods every one of his future purchases is more likely than not also to follow a tainted chain’.  The trader is not entitled, when that point has been reached, to wait for HMRC to tell him to cease to trade.  Moreover, as Notice 726 explained, HMRC’s advice is not intended to create a shield for fraud”.

And in the conjoined appeal of Calltell Telecom and Opto Telelinks he observed –

“7… the mere fact that a transaction forms part of a chain in which fraud occurred is not enough to justify the refusal of repayment of input tax.  To justify such a refusal the tax authorities must prove that the taxpayer was himself being fraudulent, or knew or had the means of knowledge of fraud by others.

8… it is not therefore enough for the Commissioners to confront a potentially innocent taxpayer with a single chain of transactions in which VAT has been evaded at an earlier stage, and to refuse to repay input tax on this ground alone.  A valid refusal of repayment will require more.  But the taxpayer who finds himself, by his pattern of trading, repeatedly caught up in chains which he learns are fraudulent cannot protest his innocence forever”.

44. The Tribunal in Our Communications Ltd at para 398 attempted to further refine the test as follows-

“We consider the proper approach is to ask what the reasonable business person in the position of the broker ought objectively to have known … .  This minimises the difference between ‘ought to have known’ and having ‘the means of knowledge’.  It does not require one to seek to make a window into men’s minds as a subjective approach does which can only be resolved by making objective assumptions.  This does not preclude special circumstances being taken into account where appropriate …”.

45. The state of knowledge and actings of Mr Young fall to be considered against that backcloth.  Mr Young had had regular meetings with Mr Morrison and his colleagues.  He had been warned as to the prevalence of MTIC fraud in his type of business.  He had been provided with Notice no 726 and other written guidance such as “veto” notices (Docs A 71-72, 82 and 84-87).  In particular the terms and breadth of Mr Morrison’s letter to the Appellant dated 10 February 2005 – one year before the periods of the disputed repayment claims – are particularly noteworthy.  (Doc A-83).  He had been warned about defaulters as having been involved in earlier “chain” transactions entered by the Appellant company.  He had been warned particularly about trading with Maximus.  He had been advised to check IMEI numbers of the phones to ascertain whether they had been previously the subject of “chain” contracts.  It is established that the taxpayer’s responsibility is not limited to investigating the immediate parties in the “chain” nor is it restricted by any requirement of privity of contract with the defaulting party.  Reference may be made to the decision of the Tribunal in Dragon Futures Ltd at paras 74(2) –

“The taxable person must make a proportionate response to information actually known that indicates fraud.  That knowledge is not restricted to the immediate context of the supplier or purchaser of relevant goods to or from the taxable person.  It includes knowledge of fraud in the market for the goods in question, as well as knowledge in the public domain or otherwise actually known of fraud by a specific trader.  It includes information about all known counterparties in the web of transactions of which the contract forms part, and counterparties that can be identified on proportionate inquiry made within the limits imposed by market confidentiality”.

And also at para 75 –

            “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 the time (including knowledge acquired from any enquiry or investigation), 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?”

And also to the decision of Floyd J in Calltel at para 81 –

            “… the purchaser who is not in privity of contract with the importer aids the perpetrators of the fraud.  He supplies liquidity into the supply chain, both rewarding the perpetrator of the fraud for the specific chain in question, and ensuring that the supply chains remain in place for future transactions”.

46. A proportionate reaction was required in our view.  Yet the Appellant company did not change its trading practices and methods in the 2 months in question.  It continued to deal with Maximus.  It bought from Maximus in chain no 5 (Doc A165/B56).  In the other chains, while it bought directly from Trade 247, that company’s supplier was T Mobile, which was also a subject of Mr Morrison’s warning (see Finding-in-Fact 9).  It seems that Mr Young made no enquiry as to possible links in the supply chain.  The Appellant did not use IMEI numbers as a check on the re-circulation into the UK of the phones.  It did not investigate the financial worth and credit ratings of the parties with whom it contracted to confirm their ability to finance such deals.  Had it made such enquiry about its suppliers, Maximus Complete and Trade 247, it would have been clear that their financial and credit capacity was “high risk”.  (See Finding-in-Fact 16).  Moreover, the contractual provisions are minimal.  The terms of the invoices are brief.  All this seemed extraordinary to us, given particularly the substantial sums involved.

47. The ability to make a certain and substantial profit by buying and selling on the basis of information gleaned from public sources, and that with no significant expenses or outlays, risks, or need for any significant business structure, did not apparently seem curious to Mr Young.  We noted earlier that we were not satisfied with his attempts to explain away features of his company’s manner of trading which on any view were not normal arms-length commercial transactions.  We refer to our review of his evidence in paras 25-29 supra.  By contrast in the objective view of Mr Fletcher and, also, of Mr Morrison this pattern of trading bore the hallmarks of carousel fraud.

48. In short we find that Mr Young paid a reckless disregard in his dealings on the telecoms market.  His reactions, we consider, were akin to “Nelsonian blindness”.  It seems that the advice and guidance given to him by Mr Morrison went unheeded.  As noted, when pressed in cross-examination, he would admit (at most) to only “a possibility” that the company could become involved in a fraudulent chain.  We did not accept this as credible.  Accordingly we consider that even if he did not have actual knowledge of fraud Mr Young knew or ought to have known that each of the 7 deals in question was likely to be tainted by fraud and, further, that on any view he (and the Appellant company) failed to take proportionate measures to avoid this.  His attitude falls to be viewed in the context of the circumstances of the “deals”, their nature, the warnings given, his failure to follow guidance, all these factors being taken in cumulo.  From an objective commercial viewpoint we consider that the deals were “too good to be true”.

49. That state of knowledge falls to be attributed to the Appellant company and accordingly this Appeal falls to be dismissed. 

We might add that questions of quantification of the repayment withheld do not arise.  The amount of the fraudulent default need not correspond.  We agree with the approach of the Respondents.  Quantification depends on simply the amount of input tax paid and reclaimed.  Repayment is of “all or nothing”.

Costs

50. In view of our decision we make an award of costs in favour of the Respondents.  Failing agreement these would fall to be taxed in accordance with the Tribunal Rules.

51. Finally, we would thank Counsel and their respective instructing Agents for their support and assistance not simply during the Hearing but also at the preliminary stages in meeting the timetable set for preparation.

MR KENNETH MURE, QC

TRIBUNAL JUDGE

RELEASE DATE:  10 FEBRUARY 2010