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First-tier Tribunal (Tax)
You are here: BAILII >> Databases >> First-tier Tribunal (Tax) >> Greener Solutions Ltd v Revenue & Customs [2010] UKFTT 412 (TC) (26 August 2010)
URL: http://www.bailii.org/uk/cases/UKFTT/TC/2010/TC00682.html
Cite as: [2010] UKFTT 412 (TC)
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Greener Solutions Ltd v Revenue & Customs [2010] UKFTT 412 (TC) (26 August 2010)
VAT - INPUT TAX
Other
[2010] UKFTT 412 (TC)
TC00682
Appeal number: LON/2008/0863
INPUT TAX – MTIC fraud – whether agent’s knowledge attributed to company – no—whether company should have known of connection to fraud – no – appeal allowed
FIRST-TIER TRIBUNAL
TAX
GREENER SOLUTIONS LIMITED Appellant
- and -
THE COMMISSIONERS FOR HER MAJESTY’S
REVENUE AND CUSTOMS Respondents
TRIBUNAL: JOHN F AVERY JONES (TRIBUNAL JUDGE)
T MARSH
Sitting in public at 45 Bedford Square, London WC1 on 12-15 July 2010, 13 August 2010
Colin Wells, counsel, instructed by Aegis Tax LLP, for the Appellant
Christopher Foulkes, counsel, instructed by the General Counsel and Solicitor to HM Revenue and Customs, for the Respondents
© CROWN COPYRIGHT 2010
DECISION
1. Greener Solutions Limited appeals against the decision of 25 February 2008 by the Respondents (“HMRC”) not to repay £176,346.10 input tax for the period 11/06 on the basis that the Appellant’s transaction in mobile phones were connected to MTIC fraud. The Appellant was represented by Mr Colin Wells, and HMRC by Mr Christopher Foulkes.
2. The only issue in this appeal is whether the Appellant knew or ought to have known about the connection of a particular transaction with MTIC fraud. Since it is conceded that there was a VAT fraud and that the Appellant’s transaction was connected with it, it is unnecessary for us to spell out the details of the fraud. Suffice it to say that it involved contra-trading by a company called Jag-Tec Limited with the Appellant company being the exporter in the “clean chain” which involved Jag Tec paying output tax on the acquisition of goods in the clean chain in order to disguise the fact of the repayment due in the “dirty chain.”
Facts
3. We had oral evidence from officer Richard Stokes and from Mr Christopher Bruce-Payne, at the relevant time a director of the Appellant and Miss Camille Sexton, financial controller of the Appellant. Witness statements by officer Ian Simmons, officer Lydia Ndoinjeh, officer Peter Morehead, officer Graham McGuinness, Mr John Fletcher of KPMG, Mr Roderick Stone, HMRC policy adviser on MTIC fraud, were accepted by the Appellants. We had 16 ring binders of documents. We find the following facts (where we attribute a statement to a particular person we are accepting this as a fact unless the contrary is clear from the context):
(1) Mr Bruce-Payne and an army friend of his started the Appellant as a “green” company recycling mobile phones. Its business consists of making arrangements with companies like Tesco to collect unwanted mobile phones in their stores for which the customer receives club card points, a charity nominated by Tesco receives a donation and the Appellant gets the phone. This is checked at its depot, the data is removed and the phone is sold to Dubai or Hong Kong where it is ultimately sold on to India, Africa and South East Asia. In addition the Appellant purchases phones from retailers (including network operators such as Vodafone) that have been rejected by the customer during the 14 day cooling-off period. These cannot be resold as new and are also exported. The Appellant also purchases donated second-hand phones from charities. The Appellant has an established business with around 12 staff. The Respondents investigated repayment claims in March 2004 and October 2004 before the transaction in question and were satisfied that the Appellant’s activities had nothing to do with MTIC fraud. In that connection the officers discussed MTIC fraud with the Appellant and they were aware of Notice 726.
(2) The Appellant was interested in expanding into the new mobile phone market and had been approached by Orange and Motorola (which is likely to have occurred according to Mr Fletcher’s evidence when they are dumping excess stock). The Appellant has always refused such offers on the basis that they could not find a buyer but they were still interested in the higher profit margins that were available in the new phone market.
(3) The opportunity to participate in the new mobile phones market presented itself when one of the directors (Mr Erik Mhitarian) introduced Mr Ollie Murray, the sole director of MBG Associates Limited. Mr Mhitarian was the principal financier of the Appellant and was looking for higher returns for the Appellant at a time when the second-hand market was sluggish. Mr Murray was introduced as having a successful company that was experienced in dealing in new mobile phones wholesale but he did not have the capital to build up the business. An informal arrangement was made that the Appellant would finance a trial transaction, Mr Mhitarian’s company, First Quantum Property Developments, making a loan of £136,000 for up to six months with interest at 5% pa above Barclays Bank base rate, and Mr Murray would receive a share of profits of 25% (according to Mr Bruce-Payne’s witness statement; or 30% as he earlier informed HMRC). If the first transaction was successful Mr Bruce-Payne expected to enter into a permanent arrangement under which Mr Murray might become an employee in charge of this side of the business, although Miss Sexton thought that Mr Murray was trying to build up funds to expand his own business rather than entering into a continuing arrangement. This difference of view suggests that the parties had not made any decision about the future. Because the introduction came from Mr Mhitarian the Appellant did not check out either Mr Murray, although they met him, or MBG and it relied on Mr Murray’s knowledge in entering into the transaction. In particular it relied on MBG to identify the buyer and seller, conduct due diligence on them and deal with all aspects of the transaction, keeping the Appellant informed and ultimately putting forward the transaction for the Appellant to sign the final deal. Since the Appellant had not previously entered into a wholesale transaction involving new phones it relied on MBG’s expertise in relation to the transaction.
(4) The transaction is question (“the Transaction”) entered into by the Appellant was the purchase from NEX Trading Limited (“NEX”) of three types of Nokia phones (1,100 Nokia 8800 at £301.34 per phone, 1,500 Nokia N80 at £227.34, and 1,200 Nokia N91 at £279.34) for £1,007,692 plus VAT and their resale for a total of £1,048,160 (at £313.15, £235.85, and £291.60 per phone respectively) to Complementos de Exportacion Multifuncionales SA (“CEMSA”), a Spanish company, for delivery to a warehouse in Calais. The Transaction proceeded with Mr Murray on behalf of MBG doing all the detailed work in connection with the Transaction and keeping the Appellant informed of progress and documents, although he did not show everything to the Appellant. If MBG’s profit share was in fact 30% the net profit (before interest on the loan, the amount of which depended on how quickly the Appellant received the VAT repayment) from the Transaction would have been £36,508, of which MBG would have received £10,952.
(5) The full deal chain (a “clean chain”; the missing trader is in a “dirty” chain involving Jag-Tec) as discovered by HMRC of which the Transaction forms part was at all stages for the same quantities of phones (apart from one difference noted at paragraph 4(2) below, that was corrected on the same day by a credit note) was as follows:
(b) Jag-Tec Limited [UK acquirer and contra-trader]: invoiced 30 August 2006, released 27 September 2006, margin £1 per phone.
(c) Stardex (UK) Limited [buffer]: invoiced 30 August 2006, released 27 September 2006, margin £2 per phone.
(d) NEX [buffer]: purchaser order received 7 September 2006 (and again on 15 November 2006), invoiced 7 September 2006 (and again on 15 November 2006), allocated the phones on 27 September 2006, released them on 15 November 2006, margin £7.34 per phone. NEX received £1,184,038.10 from the Appellant on 16 November 2006.
(e) The Appellant: purchase order received 26 September 2006, invoiced 28 September 2006, released 15 November 2006 and (as to 500 Nokia 8800s, see paragraph 4(8) for the reason) 19 February 2007, margin £11.81 (Nokia 8800), £8.51 (Nokia N80), £12.26 (Nokia N91) per phone. The Appellant received from CEMSA £196,446.36 on 6 November 2006, £841,238.01 on 15 November 2006 and £10,475 on 25 January 2007.
(f) CEMSA: invoiced 3 November 2006, released 18 December 2006 and (as to 500 Nokia 8800s) 19 February 2007, margin £1.57 (Nokia 880), £0.47 (Nokia N80), £0.58 (Nokia N91) per phone.
(g) Vundera SIA (Latvia) (no information about further transactions).
(6) It will be seen that the deal chain started with invoices on 30 August 2006 and releases on 27 September 2006 by the first three parties; then with NEX receiving a purchase order from the Appellant and invoicing them on 7 September 2006; and the Appellant not receiving a purchase order from CEMSA until 26 September 2006, invoicing CEMSA on 28 September 2006, but with payment by CEMSA not made until 6 and 15 November 2006, and releases on 15 November 2006 by NEX and the Appellant and not until 18 December 2006 by CEMSA. It seems therefore that the Appellant was committed to purchase on 7 September 2006 and did not sell to CEMSA until 26 September 2006, but the position is confused by the Appellant giving a second purchase order to NEX on 15 November 2006 and being re-invoicing by NEX on the same date, which is after the Appellant had invoiced CEMSA on 28 September 2006.
4. This paragraph is, unless stated otherwise, restricted to facts that would be known to the Appellant in entering into the Transaction.
(1) The Appellant met the director of NEX, Mr Russell Williams before entering into the Transaction. NEX had been incorporated on 11 May 2005 although its note about its business stated that it had been in the wholesale and distribution business for over 6 years. Its VAT registration was from 1 June 2005 and the trade classification was hardware consultancy. An amended certificate was issued on 20 December 2005 showing the trade classification as “other computer related activities.” On 7 September 2006 the Appellant sent NEX a trade application request which NEX answered (NEX sent the Appellant an identical form with a similarly worded covering letter on 12 September 2006 which the Appellant completed. We also saw a form in the same format that MBG had sent to a French company, but there is no evidence that the Appellant saw it). The company details provided showed that it had a bank account with Barclays Bank plc and also with First Curacao International Bank (“FCIB”). NEX stated that it had 6 full-time employees and an average monthly turnover of £8m (which would equate to a turnover of £16m pa per employee). Mr Murray provided to the Appellant a Veracis Limited report dated 2 December 2005 (much earlier than the Transaction, indicating that it had been obtained by MBG in relation to an earlier transaction although there was no evidence of a transaction involving MBG at the time) which said that its business was sales in the grey market comprising 70% computer central processing units and 30% notebook computers. Turnover was said to be around £500K per month and had working capital of £150K. The Veracis report refers to two other sister companies, Notebook Express Limited of which the assets were said to have been bought by him in 2002, and Nex Services Limited. HMRC Redhill office confirmed NEX’s VAT registration at 19 September 2006 to the Appellant.
(2) The Appellant’s purchase order to NEX is dated 7 September 2006 and there is an identical document dated 15 November 2006. It lists the quantity and types of phones and describes them as “Warranty: international; lock status: unlocked; and Spec: European.” The total price was £1,007,692 plus VAT, total £1,184,038.10. NEX issued a pro-forma invoice on 7 September 2006 (No.31) followed by an invoice on 7 September 2006 (No.32) both of which included 1,400 (instead of 1,100) Nokia 8800 phones; and it issued a credit note on the same day for 300 Nokia 8800 phones. Taking the credit note into account the total was the same figure of £1,184,038.10 as the purchase order. On 15 November 2006 NEX issued another pro-forma invoice to the Appellant (No.33) and then an invoice (No.34) both including the correct number of 1,100 Nokia 8800 phones for the same total amount. The reason for the first invoice having 1,400 Nokia 8800 phones is unclear since the number was 1,100 throughout the chain. No explanation was given for the two sets of invoices; possibly they related to a proposed transaction that did not proceed (see next sub-paragraph); the 15 November 2006 purchase order and invoice is also much later than the Appellant’s sales invoice which was dated 28 September 2006 (see paragraph 4(5)); it is the day before payment was made (see paragraph 4(8)) and suggests that it was then discovered that the paper work was not in order. There is a similar and unexplained duplication of the documents allocating of the phones by NEX to the Appellant on 27 September 2006 and 15 November 2006, see paragraph 4(9).
(3) The originally proposed customer for the phones was Eurotronics International APS, a Danish company, of which HMRC’s Redhill office confirmed its Danish VAT registration on 19 September 2006. Mr Murray told the Appellant on 26 September 2006 that he was not happy with them in view of their unwillingness to answer “certain (otherwise very easy) questions” adding “Whilst I am sure there would have been no problem, this is not an industry where even the smallest element of risk can exist.” Miss Sexton’s recollection was that Eurotronics did not seem particularly interested in proceeding with the transaction. It is possible that Mr Murray knew that Eurotronics was not a real purchaser and that CEMSA were to be the purchaser but he wanted to give the Appellant the impression that they could rely on him being very cautious in dealing with the Transaction. On the other hand, the proposed transaction with Eurotronics would explain the two sets of invoices by NEX and it is possible that Mr Murray brought CEMSA into the Transaction as he was at the same time buying phones on MBG’s account from NEX and selling them to CEMSA on 25 September 2006 (see paragraph 5(3) below, although this would not have been known to the Appellant). We are unable to find that the proposed purchase by Eurotronics was not genuine.
(4) The new proposed purchaser was CEMSA which faxed the Appellant on 26 September 2006 saying that “Our company CEMSA was formed in July 2001 and is the product of 30 years in the international market of import and export with a variety of products such as electronics, telephones, luxury goods, watches, crystal, perfumes, liquors, etc.” Company details provided by it showed that it had been incorporated in January 2001 (although their covering fax said July 2001). It had bank accounts with Close Bank (Isle of Man) Limited and FCIB. Two trade references were given and Mr Bruce-Payne rang Mr Peter Gallagher of a Latvian company, Vundera SIA, and was satisfied by what was said but he did not keep a note of the conversation. MBG had checked CEMSA’s VAT registration with the Europa website on 30 June 2006 and had obtained Redhill confirmation on 12 July 2006 (this was in connection with a transaction by MBG in June 2006, see paragraph 5(2), although this would not have been known to the Appellant). HMRC Redhill confirmed its VAT registration to the Appellant on 5 October 2006. A Veracis Limited report was provided dated 3 July 2006. This recorded that CEMSA had had an office in Marbella since 2001 (photographs were included), that it was listed as the 10th largest company by sales in the Malaga area, and the 875th largest in Spain (the list notes that it had two employees). Its business was dealing in mobile phones, CPUs, pens, tablewares, figurines, watches and perfumes. Mr Russell was stated to have 30 years import and export experience and had been a founder member in 1980 of a large telecommunications company in Spain selling his share in 1983. Turnover was said to be Euros 165m in the previous quarter and in the year was expected to be Euros 660m (equivalent to £448.8m using the exchange rate at 31 December 2006). The Veracis interviewer met one employee and another was referred to (in addition to Mr and Mrs Russell as directors, Mrs Russell being stated not to take an active part in the business). On the basis of three active employees or directors the expected turnover would be £149.6m pa per person. A Dunn & Bradstreet report dated 21 July 2006 was supplied giving a score of 3 representing a slightly greater than average risk with a credit guide of Euros 6,611. Summaries of accounts at 31 December 2002, 2003 and full accounts for 31 December 2004 were given. Its net worth in the 2004 accounts was Euros 95,753 (Fixed assets Euros 450,471, current assets Euros 786,527, less liabilities Euros 1,141,244), and it had made a loss of Euros 240,068 in the year on a turnover of Euros 9.8m. It states that the company had 5 employees. The Standard Industrial Classification was stated to be “pharmaceutical goods wholesalers.” Under that is written “la distribucion, importacion, exportacion de productos sanitarios, fabricacion y venta de componentes electronicos…” which seems to include electronic goods. Neither Mr Murray nor the Appellant met anyone from CEMSA. As set out in paragraph 5 below (although that this would have been known to the Appellant) MBG entered into sales to CEMSA on 30 June 2006 (which would account for MBG having documents such as the Veracis report around that date) and 25 September 2006 (which was also a purchase from NEX).
(5) The purchase order from CEMSA is dated 26 September 2006 and required delivery to GR Distribution, a warehouse, in Calais. The Appellant invoiced CEMSA on 28 September 2006 for £1,048,160 stating the goods as “all stock is European spec & warranty, status: unlocked.” [The Appellant’s purchase order to NEX had stated the warranty as “international.”] The invoice stated that the goods remained the Appellant’s property until payment has been received in full.
(6) Mr Murray faxed the Appellant on 28 September 2006 saying that CEMSA “chipped us on price. However, I have spoken with Russell at NEX Trading and he is adjusting his prices in order for us to maintain our agreed 4.5% profit margin,” and stating that NEX will be sending a new invoice shortly. Mr Stokes relied on this as being uncommercial to disclose the profit margin to the seller, but there is no evidence of any change in the price. The original NEX invoice of 7 September 2006 (No.32) and the credit note of the same date dealing with the extra 300 Nokia 8800 phones in that invoice, the pro-forma invoice of 15 November 2006 (No.33) and the actual invoice of that date (No.34) (which are the only invoices issued after the alleged renegotiation on 28 September 2006), all have the same unit prices for all three types of phones. If the price had been renegotiated on 28 September 2006 (or just before; Mr Murray had told the Appellant that he was unhappy with Eurotronics on 26 September 2006 and the first approach from CEMSA was on that date) one would expect a change in price between the 7 September 2006 and 15 November 2006 invoices, which there is not. We infer that Mr Murray’s statement about renegotiating the price with NEX was untrue and was designed to give the Appellant the impression that he was doing a good job.
(7) The phones in question were held by a warehouse in Chadwell Heath, Essex operated by 1st Freight Limited (“1st Freight”) (there were doubts about whether the phones were there, see paragraph 7, but we conclude that there is insufficient evidence for us to find that they were not there). The Appellant made no enquiries of 1st Freight and did not view the phones. Mr Murray gave the Appellant a one-page “Company Introduction” prepared by 1st Freight about their business that stated that it had over 5 years’ experience of the holding and distribution of high-value goods, although the certificate of incorporation showed that it had been incorporated on 25 January 2006 and the VAT registration was from 1 February 2006. The documents do not state that it is a member of the British International Freight Association and it is understood that it is not, which could have been easily checked by MBG or the Appellant but was not. One of the services listed was “Full insurance available for goods in storage and transit.” One of the reasons why the Appellant did not transfer the phones to its own warehouse was that its insurance was limited to £300,000 and they knew that increasing it was expensive. There is no evidence that 1st Freight were asked to insure the phones.
(9) NEX instructed 1st Freight on 27 September 2006 to allocate the phones to the Appellant (on that document 1,400 Nokia 8800 phones has been changed in manuscript to 1,100). (There are two versions of this document, one of which also contains an instruction by NEX to release 5,300 Nokia N80 phones to MBG; this was a transaction in which MBG also sold to CEMSA, although this would not be known to the Appellant.) There is a further identical document excluding the release to MBG (except that the correct number of Nokia 8800 phones is typed) dated 15 November 2006). NEX also instructed 1st Freight to release the phones to the Appellant on 15 November 2006. The Appellant gave ship on hold instructions to 1st Freight on 29 September 2006 to send the phones to GR Distribution, asking for 50 photos of the stock and saying “1st Freight are to contact Greener Solutions Ltd when payment has been made in order to obtain consent from Chris Bruce-Payne of Greener Solutions.” (This makes no sense as 1st Freight would not know when payment was made. A similar error but with references to MBG and Mr Murray is found in shipping instructions dated 20 February 2006 to 1st Freight in relation to a transaction entered into by MBG although this would not have been known to the Appellant.) Some photos were provided but do not prove the existence of the phones. The CMR is dated 29 September 2006. Also on 29 September 2006 1st Freight provided an inspection report to the Appellant stating that it had “conducted 100% full inspection of the above goods and notated 100% of IMEI numbers.” It stated that “all goods were present, verified and counted for, all markings matched product and packaging, no damaged goods.” The Eurotunnel transport ticket is dated 3 October 2006, and GR Distribution in Calais stamped a receipt on the CMR on 3 October 2006. Also on 3 October 2006 1st Freight invoiced the Appellant for its services comprising 20p per unit for “Handling, Security & Dispatch” (total £760), £30 for “Administration & Allocation/Release” £20 for documentation, 10p per unit for inspection (total £380), and secure transport of £2,770, total £3,960 plus VAT. There was no charge for insurance. The Appellant instructed 1st Freight to release the stock to CEMSA on 15 November 2006. The stock was described as “Warranty: international, Lock Status: unlocked, Spec: European, Packaging: Original/boxed.” [The warranty was described as European in the Appellant’s invoice to CEMSA.] The Appellant asked 1st Freight for the IMEI numbers by fax of 3 October 2006 and we presume they were supplied in paper form shortly thereafter. Miss Sexton said that they did a sample check in Checkmend (a commercially available database of stolen goods that was used by the Appellant in its other business) of the first and last IMEI numbers and several numbers in the middle, which did not show any problems, but it was not possible to check all 3,700 numbers individually.
5. MBG entered into the following transactions in its own right:
(1) In February 2006 MBG had purchased mobile phones from Grange Computers (“Grange”) and sold them to France Affaires. The phones were held by 1st Freight and were sent to GR Distribution in Calais.
(2) In June 2006 it purchased phones from Grange and sold them to CEMSA. The phones were also held by 1st Freight and were sent to GR Distribution in Calais. Although this may not have been known to MBG, Grange were selling phones to NEX in May and June 2006, which was selling them to CEMSA.
6. The Appellant concedes that Mr Murray and MBG knew that the Transaction was connected to the fraud by Jag Tec and the missing trader in the dirty chain. Having heard the evidence of Mr Bruce-Payne and Miss Sexton we find that they had no actual knowledge of the connection of the Transaction to the fraud if MBG’s knowledge is not attributed to the Appellant.
7. HMRC officers visited 1st Freight on 26 September, 2 October and 5 October 2006. On 26 September 2006 the only phones there were Nokia N70 phones (not part of the Transaction) that had arrived the day before, and the secure storage was empty. As stated in paragraph 3(5)(a) above, the phones the subject of the Transaction were shown in 1st Freight’s records to have arrived on 27 September 2006. On 2 October 2006 on a visit between 1345 and 1410 hours officers were told that nothing had come in since the previous visit and the N70 phones had gone out on 26 September 2006, and that there was no stock in the secure storage area. On 5 October 2006 the officers noted that the secure storage was empty and were told that no goods had arrived since Monday 2 October 2006. Since the phones in the Transaction travelled by Eurotunnel on 3 October 2006 with a check-in time of 0820 (or possibly 0620: the copy is indistinct) we infer that they probably left on 2 October 2006. The officers did not inspect the loading bay storage area that day. Since it is quite possible that the phones were there on the basis that they were loaded that day, or that they left before the officers’ visit, we cannot make a finding of fact that they were not there.
8. Of the phones in the Transaction HMRC’s checks noted 18 hits on the Police Stolen Equipment National Database (SEND) or Central Equipment Information Register (CEIR), and two further hits on the CEIR database before the balance of the phones were released on 25 January 2007 (but since the numbers of the retained phones was not recorded it cannot be known whether these were in the retained batch. These imply that the phones had previously been reported as stolen or blocked, and could not therefore have been new.
9. Mr Fletcher’s evidence was that the grey market caters for market failures in price (arbitrage in different prices between countries, or box-breaking where phones are subsidised by a network operator and then unlocked) or volumes (where a retailer needs more stock or an authorised distributor has too much stock).
(1) On arbitrage, Nokia has a pricing policy that is the same in every country with exchange rates fixed quarterly. There was little opportunity for arbitrage in Nokia phones based on exchange differences between sterling and the euro in the third and fourth quarters of 2006 (0.2% and 0.3% variation respectively). Although he mentions that manufacturers give volume discounts to authorised distributors he does not deal with this as a possible reason for arbitrage. Arbitrage in new phones can also arise through staggered release dates in different countries. In an arbitrage deal the minimum information about the phones would be the warranty, battery, charger, manual and any auxiliary software, such as a CD-Rom containing applications allowing the phone to interface with a computer. Traders not sourcing stock from the manufacturer or an authorised distributor are extremely unlikely to be pursuing arbitrage opportunities.
(2) Volume shortages can arise where the manufacturer cannot immediately meet the demand of network operators who approach authorised distributors who can configure the phones for the particular network operator. A request for proposal by a retailer or network operator to an authorised distributor where there was a volume shortage was very specific as to the numbers of phones, the model, colour, the frequency, whether it was configured to a particular network, the type of charger (eg 3-pin) and language of the manual, that it was boxed including software CD, the type of warranty (eg European Limited Warranty), the deadline (eg by tomorrow close of play), and that the phones are the own stock of the seller without a chain. A trader is unlikely to be able to operate in this market without holding stock.
(3) Dumping occurs when excess stock is dumped in other markets. This is likely to apply to older models. A trader will buy from an authorised distributor or the manufacturer.
(4) In all grey market deals one expects short chains, ideally with the authorised distributor or network operator selling direct to the retailer. Longer chains can occur on the first occasion but market forces tend to eliminate intermediary traders in order to increase profits. Information about grey market opportunities was available at the relevant time from a website, www.ipt.cc. Mr Stone also mentions two other websites, www.icb.cc and www.igt.cc.
10. Miss Sexton accepted Mr Fletcher’s evidence about specification of the phones, but said that in their core business the descriptions were of the same type as in the Transactions. She said that most models were black or silver and so there was no need to specify the colour, the frequency was indicated by the model number, and whether the charger was 2- or 3-pin was not important as an adaptor could be supplied or the lead changed at a small cost.
11. Mr Stone’s evidence was that there was a steady increase in exports of mobile phones following the Advocate General’s Opinion on 16 February 2005 in Bond House and following the announcement by the UK Government on 26 January 2006 of its intention to apply for a reverse charge on mobile phones and computer chips. In January 2005 exports of mobile phones were £345m (1.8m units), which rose to £4.3bn in May 2006 (13.5m units). There was a decline following the ECJ’s judgment on 11 May 2006 on the joint and several liability measure and a steeper decline following the judgment on 6 July 2006 in Kittel. On 19 July 2006 a Business Brief was issued announcing the intention to introduce a reverse charge from 1 October 2006, although this was delayed until 1 June 2007. By November 2006 the figures were £79m (912K units).
Contentions of the parties
12. Mr Foulkes, for HMRC, contends:
(1) In relation to actual knowledge, Mr Murray’s knowledge that the Transaction was fraudulent is to be attributed to the Appellant in principle and the Hampshire Land exception is inapplicable on the basis that the fraud was against HMRC and not the Appellant. He was not trying to harm the Appellant because he wanted the Appellant to make a profit on the Transaction that he could share.
(2) Alternatively, taking into account of all the circumstances, and in particular the ones set out in paragraph 38 below, the Appellant should have known of the connection with fraud.
13. Mr Wells, for the Appellant, contends:
(1) Apart from Mr Murray’s knowledge the Appellant had no knowledge of the connection with fraud. Mr Murray’s knowledge is not to be attributed to the Appellant because of the Hampshire Land exception to the normal rules of attribution on the basis that he was defrauding the Appellant..
(2) HMRC have failed to prove that the Appellant (excluding for this purpose Mr Murray) should have known about the connection with fraud.
Law
14. In Mobilx v HMRC [2010] STC 1436 in the Court of Appeal Moses LJ (with whom Sir John Chadwick and Carnwath LJ concurred) explained Kittel at [43]:
On the meaning of “should have known” Moses LJ said:
“50. The traders contend that mere failure to take reasonable care should not lead to the conclusion that a trader is a participant in the fraud. In particular, counsel on behalf of Mobilx contends that Floyd J and the Tribunal misconstrue § 51 of Kittel. Whilst traders who take every precaution reasonably required of them to ensure that their transactions are not connected with fraud cannot be deprived of their right to deduct input tax, it is contended that the converse does not follow. It does not follow, they argue, that a trader who does not take every reasonable precaution must be regarded as a participant in fraud.
51. Once it is appreciated how closely Kittel follows the approach the court had taken six months before in Optigen, it is not difficult to understand what it meant when it said that a taxable person “knew or should have known” that by his purchase he was participating in a transaction connected with fraudulent evasion of VAT. In Optigen the Court ruled that despite the fact that another prior or subsequent transaction was vitiated by VAT fraud in the chain of supply, of which the impugned transaction formed part, the objective criteria, which determined the scope of VAT and of the right to deduct, were met. But they limited that principle to circumstances where the taxable person had “no knowledge and no means of knowledge” (§ 55). The Court must have intended Kittel to be a development of the principle in Optigen. Kittel is the obverse of Optigen. The Court must have intended the phrase “knew or should have known” which it employs in §§ 59 and 61 in Kittel to have the same meaning as the phrase “knowing or having any means of knowing” which it used in Optigen (§ 55).
52. If a taxpayer has the means at his disposal of knowing that by his purchase he is participating in a transaction connected with fraudulent evasion of VAT he loses his right to deduct, not as a penalty for negligence, but because the objective criteria for the scope of that right are not met. It profits nothing to contend that, in domestic law, complicity in fraud denotes a more culpable state of mind than carelessness, in the light of the principle in Kittel. A trader who fails to deploy means of knowledge available to him does not satisfy the objective criteria which must be met before his right to deduct arises.”
He concluded:
15. In relation to the standard of proof, it used to be said that the more serious the allegation the less likely it is that the event occurred and the stronger (or more cogent) should be the evidence before a court concludes that the allegation is established on the balance of probability. The House of Lords in In re B [2009] AC 11 has clarified this. As Lord Hoffmann (with whom, Lord Rodger and Lord Walker agreed) said:
“There is only one rule of law, namely that the occurrence of the fact in issue must be proved to have been more probable than not. Common sense, not law, requires that in deciding this question, regard should be had, to whatever extent appropriate, to inherent probabilities. If a child alleges sexual abuse by a parent, it is common sense to start with the assumption that most parents do not abuse their children. But this assumption may be swiftly dispelled by other compelling evidence of the relationship between parent and child or parent and other children. It would be absurd to suggest that the tribunal must in all cases assume that serious conduct is unlikely to have occurred. In many cases, the other evidence will show that it was all too likely. If, for example, it is clear that a child was assaulted by one or other of two people, it would make no sense to start one’s reasoning by saying that assaulting children is a serious matter and therefore neither of them is likely to have done so. The fact is that one of them did and the question for the tribunal is simply whether it is more probable that one rather than the other was the perpetrator.”
Lady Hale (with whom Lord Scott, Lord Rodger and Lord Walker agreed) said:
“70…Neither the seriousness of the allegation nor the seriousness of the consequences should make any difference to the standard of proof to be applied in determining the facts. The inherent probabilities are simply something to be taken into account, where relevant, in deciding where the truth lies.
72. As to the seriousness of the allegation, there is no logical or necessary connection between seriousness and probability. Some seriously harmful behaviour, such as murder, is sufficiently rare to be inherently improbable in most circumstances. Even then there are circumstances, such as a body with its throat cut and no weapon to hand, where it is not at all improbable. Other seriously harmful behaviour, such as alcohol or drug abuse, is regrettably all too common and not at all improbable. Nor are serious allegations made in a vacuum. Consider the famous example of the animal seen in Regent’s Park. If it is seen outside the zoo on a stretch of greensward regularly used for walking dogs, then of course it is more likely to be a dog than a lion. If it is seen in the zoo next to the lions’ enclosure when the door is open, then it may well be more likely to be a lion than a dog.”
16. Our understanding is that the dangers of the old formulation were first, that it could be misunderstood to be increasing the civil standard of proof to something above the balance of probability; and secondly, that it was illogical to start with considering the seriousness of the allegation in a vacuum and assume that all serious allegations were unlikely and therefore needed cogent proof. Now one starts with determining the likelihood of the allegation having regard to the surrounding circumstances and not in a vacuum. Having done so the only question is whether the allegation is proved to the balance of probabilities. In other words, the inherent probability itself includes the particular circumstances.
Actual knowledge
17. Since it is conceded that Mr Murray knew of the fraud, if his knowledge is attributed to the Appellant the Appellant must have knowledge of the fraud.
18. We start with the law on attribution of knowledge to companies in particular circumstances. The principles are stated in Meridian Global Funds Management Asia v Securities Commission [1995] 2 AC 500, in which Lord Hoffmann dealt with the exceptional cases where the company’s primary rules of attribution do not answer the question in relation to a particular legal rule as follows:
“One possibility is that the court may come to the conclusion that the rule was not intended to apply to companies at all; for example, a law which created an offence for which the only penalty was community service. Another possibility is that the court might interpret the law as meaning that it could apply to a company only on the basis of its primary rules of attribution, i.e. if the act giving rise to liability was specifically authorised by a resolution of the board or an unanimous agreement of the shareholders. But there will be many cases in which neither of these solutions is satisfactory; in which the court considers that the law was intended to apply to companies and that, although it excludes ordinary vicarious liability, insistence on the primary rules of attribution would in practice defeat that intention. In such a case, the court must fashion a special rule of attribution for the particular substantive rule. This is always a matter of interpretation: given that it was intended to apply to a company, how was it intended to apply? Whose act (or knowledge, or state of mind) was for this purpose intended to count as the act etc. of the company? One finds the answer to this question by applying the usual canons of interpretation, taking into account the language of the rule (if it is a statute) and its content and policy.”
He also said:
“It is a question of construction in each case as to whether the particular rule requires that the knowledge that an act has been done, or the state of mind with which it was done, should be attributed to the company. Sometimes, as in In re Supply of Ready Mixed Concrete (No. 2) [1995] 1 A.C. 456 and this case, it will be appropriate. Likewise in a case in which a company was required to make a return for revenue purposes and the statute made it an offence to make a false return with intent to deceive, the Divisional Court held that the mens rea of the servant authorised to discharge the duty to make the return should be attributed to the company: see Moore v. I. Bresler Ltd. [1944] 2 All E.R. 515. On the other hand, the fact that a company's employee is authorised to drive a lorry does not in itself lead to the conclusion that if he kills someone by reckless driving, the company will be guilty of manslaughter. There is no inconsistency. Each is an example of an attribution rule for a particular purpose, tailored as it always must be to the terms and policies of the substantive rule.”
19. Attribution can be made even though the employee was doing something that was expressly forbidden, as was the case in In re Supply of Ready Mixed Concrete (No.2) [1995] 1 AC 456, or if he was deliberately concealing information from the company. Such an approach has been applied by the Tribunal in Mobilx Limited v HMRC (2008) VAT Decision 20687 in which an employee of Mobilx, Mr Thompson was a director of another company, Greystone, which carried on a similar business with the same group of suppliers and customers and had decided to cease such business because of the danger of fraud. He did not disclose this to the directors of Mobilx and continued to assist them in carrying on the business. His knowledge as a director of Greystone was attributed to Mobilx, although there was no finding of actual knowledge of the connection with fraud.
21. There is, however, an exception to the attribution rule referred to as the Hampshire Land principle (from In re Hampshire Land [1896] 2 Ch 743). In that case the same person was company secretary of both the lender and the borrower, and in the latter capacity knew that the borrowing had not been properly authorised. That knowledge was not attributed to the lender so that the lender could claim in the liquidation of the borrower. It was accepted at p 749 that if the company secretary had been guilty of fraud his knowledge would not have been attributed to the lender “because common sense at once leads one to the conclusion that it would be impossible to infer that the duty, either of giving or receiving notice, will be fulfilled where the common agent is himself guilty of fraud.” The decision was that the same extended to a breach of duty.
22. An example of the application of the principle is the House of Lords decision in JC Houghton & Co v Nothard Lowe & Wills Ltd [1928] AC 1 of which Lord Walker summarised the facts in Stone & Rolls v Moore Stephens [2009] 1 AC 1391 at [137] as follows:
‘My Lords, there can obviously be no acquiescence without knowledge of the fact as to which acquiescence is said to have taken place. The person who is sought to be estopped is here a company, an abstract conception, not a being who has eyes and ears. The knowledge of the company can only be the knowledge of persons who are entitled to represent the company. It may be assumed that the knowledge of directors is in ordinary circumstances the knowledge of the company. The knowledge of a mere official like the secretary would only be the knowledge of the company if the thing of which knowledge is predicated was a thing within the ordinary domain of the secretary's duties. But what if the knowledge of the director is the knowledge of a director who is himself particeps criminis, that is, if the knowledge of an infringement of the right of the company is only brought home to the man who himself was the artificer of such infringement? Common sense suggests the answer, but authority is not wanting.’
He then referred to Hampshire Land. Similarly Viscount Sumner said of the Lowes (at p19):
‘Their silence was accordingly a notable breach of duty. It has long been recognised that it would be contrary to justice and common sense to treat the knowledge of such persons as that of their company, as if one were to assume that they would make a clean breast of their delinquency. Hence, for the purpose of estopping the company, some knowledge other than theirs has to be brought home to other directors, who can be presumed not to be concerned to suppress it. This was laid down, following earlier cases, in Re Hampshire Land Co, and was even then treated as incontestable.’”
23. Another example is the Court of Appeal decision in Belmont Finance Corp Ltd v Williams Furniture [1979] 2 Ch 250 in which, Belmont's directors agreed to buy a company, Maximum Finance Limited, for £500,000, although it was said to be worth £60,038. Maximum's ex-shareholders then bought all the shares in Belmont for £489,000, so committing an offence under section 54 of the Companies Act 1948. Later Belmont, in liquidation, brought proceedings for misfeasance against its former holding companies and various individuals including its directors. Lord Walker in Stone & Rolls v Moore Stephens summarises the decision as follows:
“142. For present purposes there are two essential points to note in regard to the complicated manoeuvres undertaken in Belmont. First, there was a purchase (of the shares in Maximum) at a gross overvalue, and this (quite apart from section 54 of the Companies Act 1948) was a breach of fiduciary duty by those of Belmont's directors who were complicit (see especially the judgment of Goff LJ in Belmont (No 2) at p 411). Secondly, as part of the same prearranged plan the £0.5m extracted from Belmont was then recycled by purchasing the shares in Belmont, so infringing section 54. The former shareholders in Belmont did not suffer under the prearranged scheme, since they wanted to sell the company and were no worse off through the purchase of Maximum at an overvalue (but they were held accountable as constructive trustees). The real victims, after predictions as to Maximum's profit-earning capacity proved mistaken, were Belmont's creditors (and especially its depositors, who apparently took priority to the debenture-holders).
143. Looking at the earlier Belmont decision again in the light of the fuller facts in Belmont (No 2) I think that Buckley LJ was right to say that Belmont was a victim. It lost over £0.4m in assets (though its former shareholders did not suffer that loss until the court made them accountable) and, on the Hampshire Land principle, the guilty knowledge of some of the directors was not to be attributed to Belmont. Section 54 was certainly enacted to protect company funds and the interests of shareholders as well as creditors, as Scarman LJ said in Wallersteiner v Moir [1974] 1 WLR 991, 1032-1033 but I do not see that this undermines the reasoning of Buckley LJ (who referred to Wallersteiner v Moir at p 261).”
24. In Stone & Rolls v Moore Stephens the Hampshire Land principle was fully explored although ultimately the case was not decided on the basis of it. The issue was whether the auditors were liable for losses incurred by a company where the fraudster was the sole directing mind and will and the beneficial owner of the company. As Lord Phillips said at [44] “The cases demonstrate some confusion as to the precise nature and scope of the Hampshire Land principle and doubt has even been expressed as to whether it exists.” Lord Walker summarises the authorities on the principle as follows:
“144. In all these cases there was a company which was the victim of a fraud or serious breach of duty, and the court held that it was not to be prejudiced by the guilty knowledge of an individual officer who could not be expected to disclose his own fault. (The fact that duties were owed to two different companies in Hampshire Land and Houghton is, I think, an irrelevant coincidence). This principle is sometimes referred to in the United States of America as the "adverse interest" exception to the usual rule of imputation (see for instance Rudolph and Tanis, "Invoking In Pari Delicto to Bar Accountant Liability Actions Brought by Trustees and Receivers" (2008) ALI-ABA Study Materials). It is applied, typically, in cases in which the corporate victim is the claimant and the defence seeks to rely on the corporate victim's notice, knowledge or complicity. It will be necessary to consider some recent English cases which do not fit so neatly into the same mould.
Lord Walker decided the case on the basis that the principle would have applied but for the fact that the company and the fraudulent person were effectively the same. He disagreed with the Court of Appeal at [145] that the principle applies only to the company’s claims against others and not its liability to others on the basis that it was a general principle of agency that can apply to any issue as to a company’s knowledge (Lord Mance agreed with the Court of Appeal on this point (see paragraph 28 below)).
25. Lord Brown agreed with Lord Walker saying at [198]:
“The Hampshire Land exception recognises that in reality agents will not disclose to their principals the fact that they are committing fraud, least of all when they are defrauding the principals themselves, and that it would be contrary to common sense and justice for the law to presume otherwise.”
26. Lord Phillips decided the case on the basis of the ex turpi causa principle applied to a one-man company issue, saying at [55] that the Hampshire Land principle did not have any application. However, he described the principle at [43] in this way:
“The important point to note is that Hampshire Land is an exception to the normal rules for the attribution of an agent's knowledge to his principal. It is not a rule about the attribution of conduct. Hampshire Land applies where an agent has knowledge which his principal does not in fact share but which under normal principles of attribution would be deemed to be the knowledge of the principal. The effect of Hampshire Land is that knowledge of the agent will not be attributed to the principal when the knowledge relates to the agent's own breach of duty to his principal. The rationale for Hampshire Land has been said to be that it is contrary to common sense and justice to attribute to a principal knowledge of something that his agent would be anxious to conceal from him.”
27. Lord Scott dissenting on the result, and so not attributing the fraudulent person’s fraud to the company, did not reach that result by applying the principle. He said of the principle:
“In re Hampshire Land Company [1896] 2 Ch.743 established the rule that the knowledge of an officer of a company of his own fraud or breach of trust directed at third parties will not necessarily be imputed to that company (see the statement of the rule by Rimer LJ in paragraph 39 of his judgment in the Court of Appeal). Where the knowledge in question was the officer's knowledge of his own fraud or breach of duty, Vaughan Williams J declined in In re Hampshire Land Company to hold that the knowledge was to be attributed to the company (see pp 749-750). In particular, if the director in breach of duty has an adverse interest to that of the company, the knowledge of the breach of duty will not be imputed to the company: see J.C.Houghton and Co. v Nothard, Lowe and Wills Ltd [1928] AC 1 where Lord Sumner said that it would be
‘… contrary to justice and common sense to treat the knowledge of such persons as that of their company, as if one were to assume that they would make a clean breast of their delinquency’ (p.19).”
28. Lord Mance, also dissenting on the result without relying on the Hampshire Land principle said that it pointed towards the same result:
However, he also said:
“234. …In distinguishing between primary and secondary victims, the Court of Appeal in the present case was, however, influenced by reasoning in McNicholas Construction Co. Ltd. v Customs and Excise Comrs [2000] STC 553 (Dyson J) and in Bank of India v. Morris [2005] 2 BCLC 328 (Court of Appeal). Both those cases were (as Rimer LJ noted) concerned with claims against the company by injured third parties, rather than claims by the company against others in breach of duty to it. So it is not clear why the Hampshire Land issue arose at all, and in my view the statements in them are of no assistance in resolving any issue of attribution in the present context.”
29. The principle has been considered in relation to VAT by Dyson J in McNicholas Construction Co Ltd v Customs and Excise Commissioners [2000] STC 553 in which the site managers of a construction company, McNicholas Construction (“MC”), engaged labour who did not hold a certificate entitling them to be paid without deduction of tax. They arranged for “sub-contractors” registered for VAT who held certificates entitling them to pay the labour without deduction of tax to issue an invoice for VAT to MC as if the sub-contractors had actually engaged the labour, which it was found they had not. It is important to analyse the nature of the fraud and the relevance of knowledge. The Tribunal found:
“[27] …By contrast MC's position has been neutral. It has paid amounts purporting to be VAT to the alleged subcontractors and has recovered them as input tax. It has avoided having to deduct income tax from these payments. The loss or damage to MC would arise, if at all, from the successful assessment (with or without penalties) to recover the input tax wrongly deducted by it; but that does not make it the victim of its employees' fraud such as to exclude the attribution to it of the employees' knowledge and actions.”
…
[263] Our overall impression is that MC through its employees provided its self-employed workforce with the facility of payment without proper deduction of income tax. It did this so as to keep its existing workers and to encourage new labourers to work at MC sites; in some instances, no doubt, MC responded to the expectations of and pressures put on it by gangermen and by the likes of Mr C Lee and his backers. Nonetheless the means by which the facility was provided was fraudulent and dishonest and MC's acts of claiming relief for input tax for the amounts shown as VAT on the VAT-only invoices issued in the names of the bogus subcontractors in respect of non-existent supplies were equally fraudulent and dishonest. Those employees of MC, who had suspicions and who ought to have worked at stamping out the frauds, simply did not want to know.
…
[278] In reaching, the conclusions set out above, we have taken into. account the argument for the Commissioners that MC benefited financially from its participation in the frauds. We do not find this argument convincing. So far, as the fraud on the Inland Revenue is concerned, the position of MC is neutral. For this purpose we have to compare like with like, ie comparing the position of self-employed laboured being engaged through genuine subcontractors with the position of bogus subcontractors. There was a suggestion in the Commissioners' approach that MC's position using self-employed workers and bogus subcontractors should be compared with what would have happened had those workers been directly employed by MC. If the latter comparison were used, there would no doubt be a financial advantage to MC from using self-employed labourers; it would have been exonerated from sick pay and holiday pay obligations, from NI contributions and from related administration costs. But that is not a true comparison m the present context to which we now turn. This is the situation where MC used only self-employed labour. Either MC pays the labourers under deduction of income tax, applying the SC 60 system, in which case MC hands the income tax over to the Inland Revenue; or it pays the bogus subcontractor gross on the strength of his 714 certificate. The cash outgoing on the part of MC is exactly the same in both ways. So far as the VAT side is concerned, MC’s position is also neutral. Either it pays "VAT" to the bogus subcontractor in. response to a "VAT invoice" and deducts that "VAT" as its own input tax or it pays the labourers direct and is not charged VAT.
[279] There may well be a commercial advantage to MC in participating in the frauds…. The more likely conclusion is that expressed in paragraph 263 above. MC was, we think, providing the facilities to the labourers to enable them to be paid without deduction of tax and incidentally to enable the organisers of the frauds to siphon off profits. MC was doing this knowingly but it was not actually benefiting in cash terms. If anything it achieved the commercial advantage of satisfied gangmasters and a contented workforce who regarded themselves as entitled to expect that lump fraud facilities would be available to them.”
30. What the fraudulent site mangers set out to do was to assist the labourers in receiving their pay without any tax deduction thus assisting the labourers to defraud the Inland Revenue. No harm or benefit (other than a possible commercial advantage) was intended for MC but the unintended consequence (although intention to evade VAT was inferred as being foreseeable consequence of its actions) of its entering into the transactions was that MC paid what was ostensibly VAT to the sub-contractors, which, not being VAT on any supply, was not deductible as input tax. The appeal was against an assessment to recover the input tax deducted (there was no penalty assessment). MC claimed that it was the victim of the fraud, and accordingly that the acts of the site mangers should not be attributed to it in determining whether Customs could make an assessment outside the normal time limits (which applies only if there is conduct involving dishonesty within the provisions relating to fraudulent evasion of VAT). Attribution of knowledge had no relevance to whether the assessments were otherwise valid. Dyson J agreed with the Tribunal that MC was not the victim of the fraud, saying:
“51. I turn now to consider the Hampshire Land principle. Mr Purle submits that the Tribunal was in error in not treating the case as falling within the principle. He contends that MC was in a very real sense a victim of the fraud in that it paid the VAT shown on each of the invoices, and, if the Commissioners' argument is accepted, they were not entitled to claim input relief. On any view, the company suffered a cash flow detriment in paying the VAT and only subsequently being credited with the input relief.
52. It is necessary first to examine the scope of the Hampshire Land principle. It has been variously described as an exception to the general rule of attribution, or a special rule of attribution. In the Hampshire Land case, money was lent by a building society to a company. The secretary of the building society and the company was the same person, Mr Wills. He knew that there was an irregularity in the authorisation given by the company in that the shareholders had not been told, as required, that the borrowing was in excess of the directors' borrowing powers without the shareholders' consent. The question was whether the building society could prove in the company's winding-up, or were prevented from doing so on the grounds that Mr Wills' knowledge of the irregularity was to be attributed to the building society. Vaughan Williams J held that his knowledge could not be attributed to the building society. He said:
‘... common sense at once leads on to the conclusion that it would be impossible to infer that the duty, either of giving or receiving notice, will be received where the common agent is himself guilty of fraud. It seems to me that if you assume here that Mr Wills was guilty of irregularity — a breach of duty in respect of these transactions — the same inference is to be drawn as if he had been guilty of fraud. I do not know, I am sure, whether he was guilty of actual fraud; but whether his conduct amounted to fraud or to breach of duty, I decline to hold that his knowledge of his own fraud or his own breach of duty is, under the circumstances, the knowledge of the company [sc. the society].’
53. This decision was approved and applied by the House of Lords in J C Houghton and Co v Nothard, Lowe and Wills Ltd [1928] AC 1. That was a case in which the directors who had the relevant knowledge were parties to what Viscount Dunedin said was “a fraud on the true interests of the company” (page 15). He regarded it as a matter of “common sense” that in those circumstances the knowledge of the directors should not be attributed to the company. So too did Viscount Sumner who said (page 19):
‘It has long been recognised that it would be contrary to justice and common sense to treat the knowledge of such persons as that of their company, as if one were to assume that they would make a clean breast of their delinquency’.
54. In Belmont Finance Corporation Ltd v Williams Furniture Ltd [1979] 1 Ch 250 , the principle was applied in relation to an alleged conspiracy by two directors to sell shares in the company at an overvalue in order to finance the purchase of the company's share capital in breach of section 54 of the Companies Act 1948 . The question was whether the company was debarred from seeking relief in relation to the purchase of the shares on the grounds that, through its directors, it was aware of what was going on. Buckmaster LJ asked whether the company could sensibly be regarded as a party to the conspiracy, and concluded that it could not be so regarded. The purpose of the alleged conspiracy was to deprive the company of some of its assets. The company was the party at which the conspiracy was aimed. It was the victim of the conspiracy. He explained that it was:
‘a well-recognised exception from the general rule that a principal is affected by notice received by his agent that, if the agent is acting in fraud of his principal and the matter of which he has notice is relevant to the fraud, that knowledge is not to be imputed to the principal.’
55. In my judgment, the Tribunal correctly concluded that there should be [no[1]] attribution in the present case, since MC could not sensibly be regarded as a victim of the fraud. They were right to hold that the fraud was “neutral” from MC's point of view. The circumstances in which the exception to the general rule of attribution will apply are where the person whose acts it is sought to impute to the company knows or believes that his acts are detrimental to the interests of the company in a material respect. This explains, for example, the reference by Buckmaster LJ to making “a clean breast of their delinquency”. It follows that, in judging whether a company is to be regarded as the victim of the acts of a person, one should consider the effect of the acts themselves, and not what the position would be if those acts eventually prove to be ineffective. As the Tribunal pointed out, in Pioneer Concrete the company suffered a large fine for contempt of court on account of the wrongful acts of its managers. The fact that their wrongful acts caused the company to suffer a financial penalty in this way did not prevent the acts and knowledge of the managers from being attributed to it.
56. The Hampshire Land principle or exception is founded in common sense and justice. It is obvious good sense and justice that the act of an employee should not be attributed to the employer company if, in truth, the act is directed at, and harmful to, the interests of the company. In the present case, the fraud was not aimed at MC. It was not intended by the participants in the fraud that the interests of MC should be harmed by their conduct. In judging whether the fraud was in fact harmful to the interests of MC, one should not be too ready to find such harm. In my view, the cash flow point made by Mr Purle comes nowhere near being serious enough to trigger the principle. Looking at the facts of this case from a common sense point of view, there was no VAT fraud or harm to the interests of MC. The Tribunal were entitled to reach this conclusion. It was the correct conclusion to reach.”
31. Lord Walker in Stone & Rolls at [154] said that he found it difficult to understand why as a matter of fact the fraud was “neutral” (see [55] quoted above) from the company’s point of view. It seems that the origin of this statement was the passages quoted above from the Tribunal’s decision. MC was not financially involved in the fraud apart from an unintended VAT disadvantage. Hence “one should consider the effect of the acts themselves, and not what the position would be if those acts eventually prove to be ineffective.” On that basis MC was not the victim of any fraud aimed against it, and the Hampshire Land principle did not prevent attribution of the fraudster’s conduct to MC to enable the making of assessments outside normal time limits (attribution was irrelevant to the in-time assessments). It seems to us that the attribution would not have applied in an action by McNicholas re-claiming from the sub-contractors the “VAT” they had paid, which would have been a normal Hampshire Land situation.
32. It may arise that the company is a secondary victim of a fraud directed at a third party. Of this situation Lord Walker said:
“173. …There is in my opinion a clearer and firmer basis on which to determine what (if any) significance to give to the notion of a company being the secondary victim of the fraud (aimed at a third party) of one or more of its directors. It is necessary to keep well in mind why the law makes an exception (the adverse interest rule) for a company which is a primary victim (like the Belmont company, which was manipulated into buying Maximum at a gross overvaluation). The company is not fixed with its directors' fraudulent intentions because that would be unjust to its innocent participators (honest directors who were deceived, and shareholders who were cheated); the guilty are presumed not to pass on their guilty knowledge to the innocent.
The reference to Bank of India is to Morris v Bank of India [2005] 2 BCLC 328 in which a manager of the Bank of India had authority to enter into transactions with BCCI that assisted BCCI to engage in fraudulent trading, the definition of which requires an intent to defraud creditors of the company or of any other person. The transactions consisted in BCCI depositing money with the Bank of India (“BoI”) (which was a benefit to the BoI which wanted to show high deposits at its year end) which made loans guaranteed by BCCI indirectly to people with overdrawn accounts with BCCI, thus making it look as if the interest on the overdrawn accounts was being serviced. The Court of Appeal followed McNicholas in attributing the manager’s knowledge to the BoI to make it liable for fraudulent trading even though his breach of duty was not aimed at harming the Bank. The Court of Appeal said: “The potential liability of BoI under section 213 [of the Insolvency Act 1986] is irrelevant in deciding whether BoI was a victim of Mr. Samant [the manager] and whether his knowledge should be attributed to it for the purposes of section 213.” Thus in both McNicholas and Bank of India knowledge was attributed to a company in circumstances where the breach of duty was not aimed at harming the company although it had adverse consequences for the company not intended by the person breaching his duty to the company, in the form of permitting assessments outside normal time limits to recover the input tax deduction and liability for fraudulent trading respectively. But where a company is a secondary victim of fraud the same reason for not attributing guilty knowledge to the innocent is present.
33. The principle we derive from these authorities is that the Hampshire Land principle is of general application and applies to prevent the knowledge of the agent in breach of his duty to the company being attributed to a company where the company is a victim of his fraud. In determining whether there is a fraud against the company “one should consider the effect of the acts themselves, and not what the position would be if those acts eventually prove to be ineffective.” And “In judging whether the fraud was in fact harmful to the interests of MC, one should not be too ready to find such harm.”
Application of the law to the facts
34. As set out in paragraph 20 we are concerned with Kittel for which in principle Mr Murray’s knowledge should be attributed to the Appellant. The issue is therefore whether the Hampshire Land exception applies which depends on whether on the facts the Appellant is a victim of Mr Murray’s fraud. We consider that it is. Mr Murray was engaged by the Appellant to do all acts relating to the Transaction short of signing the contracts. He owed a duty to the Appellant to enter into a genuine commercial transaction. Instead he presented to the Appellant a transaction that he knew was connected to a fraud on HMRC with the result that (if his knowledge were attributed to it) no input tax was recoverable by the Appellant, thus involving the Appellant in a considerable loss because, in the words of the ECJ in Kittel at [57], the Appellant “aids the perpetrators of the fraud and becomes their accomplice.” If the Appellant had known of the connection with fraud they would not have entered into the Transaction. Mr Murray knew that unless the Appellant entered into the Transaction, he would not benefit from a share of profits from a transaction which he knew was connected to fraud. This result was “the effect of the acts themselves, and not what the position would be if those acts eventually prove to be ineffective” because the effect of the Transaction cannot be judged without taking his knowledge into account. Naturally he hoped that the connection with fraud would not be discovered because otherwise there would be no profit to share, but the same would be true if he were stealing from the Appellant. That was a fraud by Mr Murray against the Appellant in a real sense. In our view this makes the Hampshire Land principle applicable.
35. Standing back and regarding the Hampshire Land principle as one of common sense, it seems right that where the recovery of input tax paid by it to NEX depends on the state of the Appellant’s knowledge, the knowledge of Mr Murray who was trying to benefit by persuading the Appellant to enter into a transaction that he knew was connected with fraud, should not be attributed to it.
36. Accordingly we conclude that the Hampshire Land principle is applicable here with the result that Appellant did not know of the connection of the Transaction with the fraud.
Ought to have known
37. We start by considering the new formulation of the law on the standard of proof. The problem we now face is that at the time of the deals in question our understanding is that nobody in the industry knew of the inherent degree of probability of fraud in mobile phone deals. Suppose that it had been generally known that on average one in every thousand transactions in mobile phones was connected to fraud. This was not something that could be completely ignored but equally it was not something that put a trader on notice that any odd feature of the transaction was likely to indicate fraud; the inherent probability was essentially de minimis. But suppose the probability had been generally known to be that on average one in ten such transactions was connected to fraud, then fraud is something that the trader should be actively looking out for and any odd feature would almost certainly put him on notice that fraud might be indicated. Naturally the nature of the odd feature is also relevant. An odd feature that was more consistent with fraud than not could indicate that fraud of the importer in a particular chain was more likely than not. What makes it even more difficult is that (with hindsight, and therefore something that cannot be taken into account in determining the inherent probability) we now know that the inherent probability was rapidly changing. What this evidence did not do was to give any measure of the inherent probability that was generally known at the time of the Transaction in September to November 2006, although this is after the judgment in Kittel and the announcement of the reverse charge in July 2006 then intended to apply from 1 October 2006. Indeed this evidence points to the fact that circumstances were changing so rapidly that nobody was likely to have an up-to-date view on the inherent probability of fraud but by the time of the Transaction this must have been greatly reduced.
(1) The Appellant knew about MTIC fraud. As mentioned HMRC investigated the Appellant for possible connection with MTIC fraud in relation to its core business, discussed MTIC fraud with them, and concluded that they there was no connection. Mr Bruce-Payne and Miss Sexton had read Notice 726.
(2) Mr Murray revealed to the Appellant the identities of the supplier and customer without any guarantee of working further with the Appellant. The contrary argument is that at least Mr Bruce-Payne was expecting a continuing relationship, although Miss Sexton thought that Mr Murray was looking for a profit to enable him to expand MBG. Having seen the witnesses we consider that the Appellant would not have considered itself free to use this information if it had not entered into a continuing relationship with Mr Murray and would not have considered that it had the expertise to enter into further deals in new phones.
(3) The goods were not adequately described. Mr Fletcher’s evidence made a distinction between the lower degree of specification of goods in a grey market transaction driven by the seller, as in an arbitrage dumping transaction, and the greater degree of specification in one driven by the buyer, as in volume shortage. Here the transaction is driven by the seller, NEX, as CEMSA came into the transaction later but even so there is no information about the charger (in particular whether 2- or 3-pin) or the manual.
(4) The goods had recently been imported and were being exported again. This is certainly not to be expected in the grey market. However, a possible and quite innocent explanation is that a proposed deal in the UK may have failed and so the goods were being exported again.
(5) There were no written terms and conditions. The contrary argument is in its core business that the Appellant dealt with Tesco without written terms although there were some terms on the back of their invoices. There was no evidence about whether the invoice for the Transaction, which was prepared by the Appellant, had any terms on the back. The only term on the front was the retention of title.
(6) The goods were sent to a warehouse in Calais for a Spanish customer who was not a retailer. The contrary argument is that there are provisions in the VAT Directives for triangular trading in which the goods are delivered to a different country to that of the buyer (recently considered by the ECJ in Facet BV, Cases C-536/08 and C-539/08, [2010] STC 1701) and so such trading cannot be unusual in general.
(7) The Appellant was able to take control of the goods before paying NEX while selling to CEMSA with a title retention condition. Here both NEX and the Appellant gave lengthy credit to their respective purchasers between the date of invoice (7 and 28 September 2006) and payment on 15 or 16 November 2006).
(8) The Appellant (through MBG) was able to find a customer that NEX, which stated that it had been in the business since 2002, could not; and could find a supplier that CEMSA, which stated that it had worked in the international market for 30 years could not. The contrary argument is that NEX may not have been able to finance the VAT and so was willing to give someone else part of the profit on the deal that it could have made itself.
(9) The Appellant was able to negotiate a lower price from NEX to maintain its margin. We have found that this was not true and was said by Mr Murray to give the impression that he was doing a good job, but it was reasonable for the Appellant to believe it. There is no evidence that he said that he had disclosed the amount of the margin to NEX.
(10) Although the Appellant had access to authorised distributors such as Orange, they made a deal with NEX, a non-authorised distributor. Miss Sexton said that at the time this did not occur to her.
(11) CEMSA’s trade reference was a Latvian company run by Mr Peter Gallagher. However, Mr Bruce-Payne did take up the reference on the telephone and was satisfied, although he did not keep a record of the conversation.
(12) CEMSA, a Spanish company, was run by Mr Steve Russell and had an Isle of Man bank account. The contrary argument is that Mr Russell was stated to have 30 years import and export experience and had been a founder member in 1980 of a large telecommunications company in Spain selling his share in 1983, which does not arouse suspicions.
(13) The Veracis report on NEX was out of date. The following features arise: (a) the business was 70% CPUs and 30% computers and the trade classification was “other computer related activities” without any mention of phones; (b) the Veracis report is dated 2 December 2005, some 10 months earlier; and (c) there is a large difference between the stated £8m per month turnover and the Veracis figure of £500K per month 10 months earlier. On the other hand the Appellant met Mr Williams and understood that he was then dealing in phones.
(14) Both NEX and CEMSA declared enormous turnover but had few employees. The contrary argument is that both companies appeared to be substantial businesses.
(15) The Dunn & Bradsheet report on CEMSA contained the following features: (a) the large increase in turnover since the 31 December 2004 accounts from Euros 9.8m to an estimated Euros 660m; (b) the low credit rating of Euros 6,611, which might be accounted for by the current liabilities exceeding current assets. The contrary argument is that the report did contain fairly full accounts for 2004 which showed a loss and an excess of liabilities over current assets. In any case the Appellant was not giving them any credit.
(16) CEMSA’s Standard Industrial Classification was that of pharmaceutical goods wholesalers, although there was also reference to fabricacion y venta de componentes electronicos, and its own description referred to “import and export with a variety of products such as electronics, telephones, luxury goods, watches, crystal, perfumes, liquors, etc.” The contrary argument is that telephones are mentioned and the classification might reflect their major business.
(17) Both NEX and CEMSA had accounts with FCIB. The contrary argument is that neither used such accounts in the Transaction and so there was nothing to alert the Appellant to this fact.
(18) Neither the Appellant nor Mr Murray met CEMSA. The contrary argument is that the author of the Veracis report did so, included photographs of its offices and figures showing that it was of significant size.
(19) No visit was made to 1st Freight. Such a visit might have revealed that the goods did not exist but we are unable to make a finding of fact that this was the case.
(20) Although 1st Freight’s conditions required the payment of a £2,500 deposit this was never asked for or paid. Their invoice was paid after the goods had left. The contrary argument is that 1st Freight may have been satisfied about the Appellant’s credit worthiness, although there is no evidence on this.
(21) The Appellant was not charged for warehousing of the 500 phones while the dispute with CEMSA over payment was resolved. The reason could be that they took up very little space and in any case this arose after the Appellant had entered into the Transaction.
(22) The due diligence should have led to further investigation. We have dealt with some concerns about NEX and CEMSA above. There was no due diligence on Mr Murray. The contrary argument is that he was introduced by the Appellant’s financier Mr Mhitarian and they were not likely to do anything that might have upset him.
39. We have given some contrary arguments in relation to each item. What is more important is to look at the totality of the items in the context of the Transaction itself. Unusually in chains in other MTIC reported cases this one seems far more commercial in that the Appellant’s original purchaser went off, they were told that the purchase price had been renegotiated, and there was a delay in payment until 15 November 2006 as well as a dispute with CEMSA about the final amount of the payment resulting in retention of some of the phones. The Transaction does not satisfy Mr Fletcher’s description of a normal grey market transaction but it is not clear that a normal trader would have understood this at the time. We repeat the Court of Appeal’s test:
60. The true principle to be derived from Kittel does not extend to circumstances in which a taxable person should have known that by his purchase it was more likely than not that his transaction was connected with fraudulent evasion. But a trader may be regarded as a participant where he should have known that the only reasonable explanation for the circumstances in which his purchase took place was that it was a transaction connected with such fraudulent evasion.”
This is a high threshold which we do not consider HMRC has satisfied us on the balance of probabilities, taking the inherent probability of fraud into account, is the case here.
40. We therefore conclude that the Appellant neither knew nor should have known about the connection with the fraud and we allow the appeal. In view of Mr Murray’s knowledge of the connection with fraud, which we have decided is not to be attributed to the Appellant, MBG is, in accordance with the ex turpi causa principle, not entitled to a share in the profit on the Transaction (if there was a profit bearing in mind the time the input tax has been outstanding).
41. We therefore allow the appeal and direct that HMRC pay the Appellant’s costs determined under the former rules to be determined in default of agreement by a Taxing Master on the standard basis. Any further applications for interest or repayment supplement should be made within 30 days of the date of release of this decision.
42. This document contains full findings of fact and reasons for the decision. Any party dissatisfied with this decision has a right to apply for permission to appeal against it pursuant to Rule 39 of the Tribunal Procedure (First-tier Tribunal) (Tax Chamber) Rules 2009. The application must be received by this Tribunal not later than 56 days after this decision is sent to that party. The parties are referred to “Guidance to accompany a Decision from the First-tier Tribunal (Tax Chamber)” which accompanies and forms part of this decision notice.
JOHN F AVERY JONES
TRIBUNAL JUDGE
RELEASE DATE: 26 August 2010
[1] The word “no” is obviously included in error as the Tribunal had decided that there was attribution because the company was not the victim of the fraud.