First-tier Tribunal (Tax)

[2011] UKFTT 353 (TC)

TC01213

 Appeal reference: LON/2007/2065

 

VAT – input tax – denial of right to deduct on grounds of alleged knowledge or means of knowledge of fraud by others – alleged MTIC trading – admission by Appellant that fraud established and connected to Appellant’s transactions – whether Appellant knew or had means of knowledge of connection – held Appellant knew of fraud – appeal dismissed

FIRST-TIER TRIBUNAL

TAX CHAMBER

 

 

FLASHPOINT TECHNOLOGY LTD Appellant

 

- and -

 

THE COMMISSIONERS FOR

HER MAJESTY’S REVENUE AND CUSTOMS Respondents

 

 

 

Tribunal: David Demack (Judge)

Shahwar Sadeque (Member)

 

Sitting in public in London on 20 December 2010

 

Ms Vivienne Tanchel, counsel for the Appellant

 

Mr Christopher Kerr, counsel for the Respondents

 

 

 

 

 

© CROWN COPYRIGHT 2011

DECISION

 

Introduction

1.           Since late 2004, the appellant company, Flashpoint Ltd (“Flashpoint”), has traded as a wholesaler of computer chips or CPUs. In accounting period 03/06, it incurred input tax of £125,829 on standard-rated purchases of such chips, which it proceeded to sell to traders based outside the EU in 10 zero-rated sales.  It then sought repayment of the input tax.  Due to the large repayment requested the Commissioners submitted the claim to extended verification before denying it.

2.           The Commissioners denied the repayment in two letters, the one dated 23 April 2006 and the other 29 November 2007. In the letters they expressed themselves satisfied that the transactions to which the input tax claim related formed part of an overall scheme to defraud the revenue, and maintained that there were features of the transactions and conduct on the part of Flashpoint demonstrating that it knew or should have known that to be the case. The Commissioners did not allege that Flashpoint was a party to any such fraud, but said that in deciding to deny the repayment claim they had taken account of a number of factors, including:

a)     that each of the deals on which their decision had been based had been traced back to a tax loss;

b)     that the deals appeared to have been contrived in that:

 

i)      all were back-to-back

ii)    none was the subject of a written contract;

iii)  Flashpoint was exposed to no commercial risk as it paid its suppliers only when it itself had been paid.

 

c)     that the due diligence checks it carried out were limited and carried out only after the transactions had taken place;

d)     that Flashpoint’s turnover had grown “extraordinarily” with no extra staff employed; and

e)     that the company had experienced success at a speed unlikely in a business with few capital assets.

 

3.          In the statement of case the Commissioners altered their position slightly saying that only some of Flashpoint’s deals were “back-to-back”, meaning that a sale consisted of the whole quantity of the same make and model of computer chips as it had purchased.

 

4.     The Commissioners also said that they had decided to refuse Flashpoint’s input tax claim on the basis of the principles expounded by the Court of Justice of the European Communities in Kittel v Belgium and Belgium v Recolta Recycling SPRL (Joined cases C-439/04 and C-440/04) [2008] STC 1537 (“Kittel”). Shortly stated, those principles are that a trader who has participated in a fraudulent scheme involving the purchase and sale of goods, knowing or having the means of knowing that he is so participating, forfeits the right to deduct the input tax incurred in his purchase of the goods used as the vehicle of fraud.

 

5.     In Notices of Appeal dated 17 December 2007 and 15 July 2008 Flashpoint appealed the Commissioners’ two decisions claiming that they were wrong in fact and law, wrongly interpreted the relevant Community case law, were in breach of the fundamental principles of EC law, viz. proportionality, legal certainty, fiscal neutrality, and/or fundamental principles of human rights law, viz. the right to pursue a trade or professional activity to the peaceful enjoyment of property. Following the decision of the Court of Appeal in Mobilx Ltd (in administration) v HMRC [2010] EWCA Civ 517 the legal claims fell away, and were not pursued before us.

 

6.     In the events which occurred, the Commissioners were required to serve an amended Statement of Case.  In it they allege that Flashpoint knew or should have known that it was participating in a fraudulent scheme or schemes to defraud the revenue, that its due diligence was inadequate, and that there were a number of features of the transactions indicating participation in such a scheme. Looking at the whole picture the Commissioners contend that Flashpoint knew or ought to have known that its trading was part of a contrived scheme to defraud the revenue.

 

7.     The type of fraud with which we are concerned is commonly referred to as MTIC (Missing Trader Intra-Community) fraud. That is a misnomer in the instant case for the deal chains with which we are concerned are, with one exception, each said by the Commissioners to have started with a sale in Hong Kong and ended with a sale to Hong Kong. In the exceptional transaction, although the chain is said to have started in Hong Kong, Flashpoint’s customer was based in the USA.

 

8.     Descriptions of the way in which MTIC fraud operates are to be found in a number of High Court judgments and tribunal decisions. One such description is that in Powa (Jersey) Ltd v Commissioners of Revenue and Customs [2010] UKFTT 45, and we propose to follow the lines thereof.

 

9.     In the type of deals in which the Commissioners allege Flashpoint to have been involved, computer chips were purchased from an overseas trader. The chips then changed hands a number of times within the UK before being sold to another overseas trader. Commonly, all the transactions occurred on the same day as the goods entered the UK.

 

10.  The UK trader acquiring the goods from abroad charged VAT on the consideration paid by his purchaser but, instead of accounting for it to the Commissioners, he disappeared with it. The documentation relating to his purchase was never produced to or obtained by the Commissioners. For the scheme to work he must have been a VAT-registered trader who provided his purchaser with a genuine VAT invoice, on the strength of which the purchaser claimed input tax credit. The original purchaser’s own sale, and those of the other UK traders in the sequence, with the exception of the very last one, usually generated a small profit, which resulted in a small VAT liability for which those traders properly accounted. The last trader in the sequence, in the instant case Flashpoint, exported the goods in a zero-rated supply, and thus had no liability to output tax. It was, however, entitled to reclaim the input tax it had paid, and it was that claim which the Commissioners denied, and which resulted in an appeal to this tribunal.

 

11.  The Commissioners have developed a jargon peculiar to MTIC fraud. The UK importer who fails to account for the output tax charged to his customer is, dependent on the particular circumstances, known as a “defaulter”, a “hijack”, or a “missing trader”. The trader who exports the goods is called a “broker”, and those between the defaulter and the broker are referred to as “buffers”. In the instant case, Flashpoint’s input tax claim is based on its having acted as a broker. It is part of the Commissioners’ case that Flashpoint’s transactions were artificially generated, or orchestrated, and the goods were not bought or sold to meet a genuine demand, but rather simply to generate the input tax repayment sought by the broker, i.e. as a means of defrauding the Exchequer.

 

12.  Between fraudulent traders and innocents caught up in frauds are traders who know or have the means of knowing that their transactions are connected with fraud, even though they themselves are not participants and who, for whatever reason, carry on with those transactions. Such traders aid the perpetrators of the fraud and become their accomplices (see para 57 of the judgment in Kittel), and they too lose the right of deduction. As Moses LJ explained at para 41 of his judgment in Mobilx, “It [Kittel] extended the category of participants who fall outside the objective criteria [of uniform application which form the basis of ‘supply of goods effected by a taxable person acting as such’ and ‘economic activity’] to those who knew or should have known of the connection between their purchase and fraudulent evasion. Kittel did represent a development of the law because it enlarged the category of participants to those who themselves had no intention of committing fraud but who, by virtue of the fact that they knew or should have known that the transaction [in which they were involved] was connected with fraud, were to be treated as participants. Once such traders were treated as participants their transactions did not meet the objective criteria determining the scope of the right to deduct.”

 

13.  Ms Vivienne Tanchel of counsel appeared for Flashpoint, and Mr Christopher Kerr, also of counsel, for the Commissioners. Each of them produced a most helpful opening statement, for which we record our thanks.

 

14.  When the case was called on, the essential issues in it were two, namely:

 

i)      Were Flashpoint’s transactions in respect of which the Commissioners denied its input tax claims connected to the fraudulent loss of VAT elsewhere in the transaction chains? and

ii)    Did Flashpoint know that its transactions were so connected, or should it have known that they were so connected?

 

15.  Initially Flashpoint did not accept that fraud had been established in the deal chains constructed by the Commissioners leading to the identified defaulters, but by the end of the Commissioners’ case counsel for Flashpoint conceded both that it had been, and that the various broker transactions into which Flashpoint entered were part of an overall scheme or schemes to defraud the revenue. She also accepted that the Flashpoint’s transactions were connected to the deal chains identified by the Commissioners.  Consequently, we are required to decide only whether Flashpoint by its directors knew or ought to have known that by its purchases it was participating in transactions connected with the fraudulent evasion of VAT.

 

16.  We took oral evidence from the following five witnesses:

 

·       Mrs Claire Elizabeth Downton, a member of the Commissioners’ MTIC fraud  team, and the officer responsible for Flashpoint until she took maternity leave late in 2009

·       Timothy Cook,  another member of the Commissioners’ MTIC fraud team, who assumed responsibility for Flashpoint on Mrs Downton taking maternity leave

·       Dr Kevin William John Findlay, an independent consultant advising PricewaterhouseCoopers and other firms on electronics, semiconductors and software markets and technologies

·       Clive Murphy, one of the two directors of Flashpoint

·       James Norris, the other director of Flashpoint.

 

17.  The statements of those witnesses formed their evidence in chief, but in some cases it was supplemented either to bring it up to date or for completeness.  In addition we were supplied with other unchallenged witness statements but the only one to which we make specific reference is that of Guy Roderick Stone, a specialist officer of the Commissioners, who provided an overview of MTIC fraud.

 

18.  The oral evidence and the statements of the various witnesses were supplemented by documentary evidence extending to over 20 lever arch files.

 

19.  It is from the whole of that evidence that we make our findings of fact.

 

The facts

 

20.  Flashpoint was incorporated on 12 December 2003, and continues in business as a trader in CPUs. Mr Murphy and Mr Norris were appointed its directors on 14 January 2004. Mr Norris is also the company secretary. The two are the only shareholders in the company which commenced trading shortly after it registered for VAT on 1 November 2004. The company has no employees other than its two directors. At the time with which we are concerned its issued share capital was £100.  Each director accepted responsibility for different aspects of the deals. Whilst Mr Murphy was responsible for the bookkeeping and maintaining records of the company, Mr Norris carried out the various deals.  Effectively, Flashpoint’s trading operation was run solely by Mr. Norris.

 

21.   Flashpoint trades from premises at Gorseinon, Swansea, owned by Trojan Ltd (“Trojan”), a company in which Mr Murphy holds 50 per cent of the issued share capital and to which he devotes almost all of his working time. Flashpoint occupies an office in Trojan’s premises rent free. Trojan supplies Flashpoint with the services of a bookkeeper in the form of Ms Denise Johns. We were not told whether Ms Johns is paid for her work.

 

22.  On its Form VAT1 Flashpoint stated the nature of its business as “Retail of electrical products”, and its VAT registration certificate showed that as its trading class. But within two weeks of registration Flashpoint asked the Commissioners’ National Advice Service to change its trade class to one more specific to the trade in which it was engaging.  The Commissioners acted on its request, and registered it as a “Wholesaler of computers, computer peripheral equipment and software, wholesale of”.

 

23.  Mr Murphy and Mr Norris have worked in the computer industry for many years, the latter principally for Avnet-EMG Ltd (“Avnet”), one of the world’s largest distributors of computer products. Mr. Norris was said to have become Avnet’s European sales director. As holder of that office, we should have expected him to have acquired some knowledge of the documentation raised in transactions, but he claimed to have almost none, saying his only involvement with documents took place “when there were problems”.

 

24.  On 29 November 2004 the Commissioners wrote to Flashpoint informing it that MTIC fraud involving computer equipment constituted “one of the most costly current forms of VAT fraud within the EU”.  The letter went on to require Flashpoint to forward to the Commissioners, on a monthly basis, a purchase and sales listing with the identifying VAT registration numbers against its suppliers and customers.

 

25.  In the quarter 12/04 Flashpoint’s VAT return showed its outputs as £669,523, and its liability to the Commissioners as £7,275.52. All its outputs related to UK sales. On 10 February 2005 a member of the Commissioners’ Compliance Management Team contacted Flashpoint, as a new trader, and was informed by Mr Murphy that it made no sales outside the UK.  Its return for period 03/05 was a repayment return in the sum of £14,088.02. Of the almost £1.4 million of sales declared, 7.91 per cent were said to be non-UK sales.

 

26.  On 26 April 2005 Flashpoint was visited by officers of the Commissioners when they discussed with Mr Murphy the risk of fraud in the grey market in computer chips, and explained MTIC fraud to him. The officers established that Mr Murphy was aware of Flashpoint’s need to maintain a due diligence file on each of its suppliers and customers. He undertook to open such files and to make them available to officers on future visits. Mr Murphy was presented with a copy of the Commissioners’ Notice 726, “Joint and Several Liability”. Mr Norris accepted that Mr Murphy informed him of receipt of the Notice, but it was patently obvious from his evidence that he, Mr Norris, chose simply to ignore it.

 

27.  Officers paid a further visit to Flashpoint on 20 July 2005 and discussed with Mr Murphy the documents required to support evidence of export. Their visit report contained no mention of perceived inadequacies in Flashpoint’s due diligence.

 

28.  On 11 November 2005 officer Chris Williams paid yet a further visit to Flashpoint, and again it would appear that he met Mr Murphy.  The officer advised the company to carry out regular credit checks on its suppliers and customers in addition to making Redhill and Companies House checks where appropriate. In evidence, Mr Norris admitted having been made aware of the officer’s advice, and that Redhill checks included checks on the validity of VAT registration numbers. We might observe that Redhill checks would have provided information only on EU traders, so that we accept that they would not have covered Flashpoint’s customers in the Far East and the USA.  Mr. Norris did, however, admit never having made such a check on Techcomp Ltd (“Techcomp”), Flashpoint’s only supplier in the deals concerned in the appeal, relying entirely on the fact that Mr Norris had known and had regularly traded with Michael Westley, one of Techcomp’s directors, for over 10 years, and believed him to be an honest and reputable man.  Mr Norris’s reliance totally ignored the fact that, to his knowledge, others within Techcomp not known to him were involved in putting deals together which included those with Flashpoint. 

 

29.  At some stage late in 2005 Flashpoint exchanged documents with Techcomp. Techcomp was incorporated in July 2003, and was said to be about five times the size of Flashpoint.  The documents exchanged included company registration certificates, VAT registration certificates and others containing bank details. Only after the period with which we are concerned did Flashpoint ask Techcomp for a copy of its accounts, and to provide credit and other references. Whether the accounts which Flashpoint did later obtain were complete we cannot say for we were provided only with alternate pages of them. They contain nothing relevant to period 03/06.  Flashpoint also obtained a credit report on Techcomp from Creditsafe, but again only after the period with which we are concerned. In those circumstances, we regard the fact that the credit report contained no negative information about Techcomp as of no assistance to Flashpoint whatsoever. 

 

30.  Flashpoint claimed to have been aware of the identity of Techcomp’s suppliers.  Mr. Norris explained that Datech, a large multi-national company and one of Avnet’s largest customers by which Mr. Westley had been employed prior to his establishing himself in business with others in forming Techcomp, was part of the Transmeridian Group, which also owned Tiny Computers, a significant integrator at the time but which has now gone into liquidation.  Flashpoint maintained that it was reasonable in those circumstances for it to assume that Tiny Computers was the source of Techcomp’s products.  In the absence of any evidence whatsoever in support of the claim, we are unwilling to make such an assumption.

 

31.  A letter from Techcomp said to list the checks it carried out was produced to us, but as it too is dated after the events with which we are concerned and its contents could not be tested in evidence, we place no reliance on it.

 

32.  At the request of the Commissioners, Flashpoint’s directors prepared a summary of the information the company held on Techcomp in which they stated that that company had “comprehensive due diligence in place”.  However, since they made no enquiries whatsoever as to what checks Techcomp in fact carried out, we are unable to accept that statement as true: in any event, we place no reliance on the summary for it too was prepared after the events concerned in the appeal.  Techcomp was never asked whether it owned the CPUs which it supplied to Flashpoint; from Mr Norris’s evidence that appeared to him to be so inconsequential and unnecessary a question as to warrant no consideration whatsoever.

 

33.  Flashpoint made no enquiries of Techcomp as to whether it inspected goods it had bought: Mr Norris simply assumed its suppliers to be “first tier”, by which we understood him to mean OEMs, i.e. computer manufacturers/assemblers, or authorised distributors of electronic products, and thus required no investigation. 

 

34.  Mr Westley made a statement which is before us. He was not called to give evidence as he suffered a severe stroke late in 2009 from which he is still recovering. Consequently, Flashpoint invites us to accept his statement without its being tested. Why it did not call or obtain a statement from Mr Nicholas Holmes, Techcomp’s other director, was not explained to us. Mr Westley simply stated that he “personally undertook all due diligence on behalf of Techcomp”, and passed it to Grant Thornton, Techcomp’s accountants, “who would review what I had done and then carry out further investigation if this was felt necessary”. As we mentioned in the penultimate paragraph, Flashpoint did not know, or even enquire as to what due diligence checks Techcomp carried out.

 

35.  Flashpoint’s returns for the quarters 06/05, 09/05 and 12/05 were all repayment returns. The company’s turnover in those periods rose from £1.6 million in the first to £4.94 million in the last, and its non-UK sales from 73.27 per cent of turnover to 96.09 per cent. In the 14 months to 31 March 2005 Flashpoint’s turnover was £1.952 million: in the following 12 months it rose to £13.8 million.  Then it fell to £10 million and £8 million in 2007 and 2008 respectively, Mr. Murphy claiming that to be due to the Commissioners’ withholding VAT.

 

36.  It appears, and despite the absence of confirmatory evidence we are prepared to accept, that the only working capital in Flashpoint in its early months of trading was a loan of £40,000 made by Mr Norris. The company’s accounts showed no evidence of its having expended any significant amounts on advertisements or promotions as might have been expected to account, at least in part, for its large increase in turnover. No evidence was adduced to indicate when the loan was made, or when it was repaid. In evidence, Mr Norris claimed that after it was repaid his parents lent the company £70,000, but no supporting evidence was adduced to confirm that any such loan was made, when or on what terms.  However, we find that whatever sum had been lent to Flashpoint in period 03/06 it was inadequate to finance the VAT on its foreign wholesale sales pending repayment of the input tax on its related purchases.

 

 

Flashpoint’s trading model

 

37.  Before dealing with the various transactions on which Flashpoint bases its disputed input tax claim, we propose first to explain the trading model the company adopted, as described by Mr Murphy and Mr Norris. We accept that the various deals were conducted along the lines they described.

 

38.  Both directors admitted being aware of the heavy publicity given to fraud in Flashpoint’s trading sector and accepted that fraud was rife in it. However, despite accepting that trading in the Far East might involve fraud “because it is so high in the market place”, they maintained that by dealing outside the EU they were at no risk of becoming involved in it: as Mr Norris put it, “We were bulletproof”.

 

39.  Mr Norris admitted being aware that Dun & Bradstreet credit reports on trading partners could be obtained and would include any available adverse information, including whether the subjects of the reports had been involved in fraud. He accepted that Avnet, his previous employer, routinely obtained such reports, but said that Flashpoint, considering them to be unnecessary, took no steps to follow its example. Despite such reports forming an important part of a trader’s armoury against fraud, Mr Norris went so far as to admit not even knowing their cost.

 

40.  We were told that some of Flashpoint’s broker deals were supplier led whilst others were customer led, but we believe most, if not all, of those with which we are concerned, to have fallen into the former category, that is as a result of Flashpoint initially being offered CPUs by Techcomp. Mr Norris, who as we mentioned had earlier been employed as sales director of Avnet, explained that he was able from his own experience and through his contacts at Avnet to keep abreast of current prices of CPUs in the grey market. He said he could thus quickly decide whether to purchase products offered to the company. It was unclear whether he would have agreed to purchase products before he had found a buyer for them, most of the company’s sales being arranged on a back-to-back basis due its shortage of liquid capital. However, since Mr Westley in his statement said that Techcomp would not agree to hold goods for a customer until an order had been confirmed (as to which see [42] below), in our judgment the likelihood is that Flashpoint would not have entered into a contract to purchase until it had agreed a sale.

 

41.  Mr Norris claimed to conduct most of Flashpoint’s business by telephone or iPhone (as he claimed also to have done whilst at Avnet), recording details on an “A4 pad or in a diary”, and to transfer them to a rolling spreadsheet which he later emailed to Mr Murphy to enable the latter, at the end of each quarter, to complete the company’s records on a TAS accounting computer system, which it was entitled to use on payment of an annual licence fee of some £800. He maintained that in doing so he was merely following standard industry practice.  Examples of neither the pad, nor the diary, nor the spreadsheet were produced to us. In two or three cases Mr Norris emailed Mr Westley at Techcomp to confirm an order placed, and included in the email details of the CPUs and the price agreed. Although Flashpoint’s computer programme produced purchase orders for its purchases, such orders as were printed by Mr Murphy were generated post-transaction merely as part of the standard documentation produced by the system and were never sent to the supplier. In our judgment, they were not part of its true records of transactions, but rather were prepared solely for “window-dressing” purposes. Further, nothing to support Mr Norris’s claim that he was simply following industry standard practice was presented to us and, in its absence, we are not prepared to accept the claim.

 

42.  In his statement, Mr Westley explained, “When negotiating a deal with Flashpoint I would do so in a fashion I would adopt with any customer. However, because of my longstanding friendship with James [Norris] I did offer credit terms of between one and two days. I would offer a price based on the cost to Techcomp and the demand within the market. James would evaluate my offer and if he found it favourable he would give me the order. At the same time stock was being offered to other customers. The stock would be sold to whoever came back first with a confirmed order”. With two exceptions, we are content to accept that statement as fact. First, on each Techcomp invoice it is stated that its sales terms are “TT on inspection”, TT being an abbreviation for telegraphic transfer.  In other words, Flashpoint was expected to make payment for supplies on inspection of them following their receipt.  As Flashpoint never inspected the chips it purchased from Techcomp - a check which any responsible businessman would have made on such valuable goods if only to confirm their existence - the term became meaningless, and we find that Flashpoint did not pay for goods it purchased until it had itself been paid by its foreign customer. Secondly, assuming the credit terms described by Mr Westley were in fact those agreed, it was rarely, if ever, that Flashpoint made payment within the stipulated one or two day credit period.

 

43.  In relation to a supplier led deal, Flashpoint would then have sought a non-EU foreign purchaser for the CPUs offered to it by Techcomp and, having found one prepared to pay a price providing the company with an acceptable profit, would have proceeded with a purchase to cover the deal.  When asked how Flashpoint found customers, Mr. Murphy responded, “personal contact, previously known in the trade”.  And Mr. Norris explained that chips the company was in a position to buy would be offered for sale on its own and ITP websites.  He claimed that a deal could take up to a fortnight to negotiate, but that clearly was not the position in relation to the deals with which we are concerned for most purchases and accompanying sales were completed within a day.

 

44.  Techcomp always paid its supplier before it itself was paid by Flashpoint (see [64] below). Whilst that might seem to point to its having been the owner of the chips sold to Flashpoint or having title to them, and thus being able to transfer them to whomsoever it wished, we do not find that Techcomp had title to them; that would have depended on whether earlier suppliers in the chain had been paid, or obtained title despite not having paid for the goods concerned, and no evidence was adduced to deal with either of those matters.  It was patently obvious from their evidence that neither Mr Murphy nor Mr Morris knew or cared in whom ownership of the chips in which they traded vested, or had authority to deal in them.

 

45.  According to Mr Norris, Flashpoint’s only terms of trade for both purchases and sales, beyond a statement of the quantity, an inadequate description of the goods, and price agreed in its pro-forma invoices, were that the purchaser would pay for them on inspection, that the goods would not be released until paid for, and that Flashpoint would give a one year warranty as to their good condition. Those terms were nowhere recorded: in particular, they were not printed on Flashpoint’s invoice. The trading model permitted the company to take and itself provide credit, and did not require the company to enter into any formal written or oral contracts with its suppliers, customers or freight forwarders.  No provision was made for matters such as the transfer of title, delivery, returns and exchange arrangements for faulty or damaged goods. The Commissioners invite us to infer that Flashpoint’s failure to record any contractual terms is evidence that its directors knew the deals into which the company entered were part of a fraudulent scheme, so that it had no need to record such matters. We shall deal with that invitation in our conclusion.

 

46.  It was implicit in Mr Norris’s evidence that each trader in the chain would not only agree to release possession of goods it obtained to its customer to enable that trader in turn to transfer possession to its own customer, but also would transfer title in the goods to the trader.  If such releases and transfers were formally made (which we doubt), and not simply assumed by the foreign customer to have been made, they were made orally, and were not accompanied by any guarantee of payment.

 

47.  Assuming Flashpoint agreed a purchase and a subsequent sale, it would then collect or arrange for the CPUs to be collected from Techcomp, and proceed to dispatch them immediately to its preferred freight forwarder, Specialised Freight Services Ltd (“Specialised Freight”) with a pro forma invoice addressed to the customer. Specialised Freight would then prepare the air waybill and arrange for the goods to be air freighted to Flashpoint’s local agent abroad allegedly with instructions for the agent to hold the goods on its behalf pending payment by the customer. No evidence beyond Mr Murphy’s and Mr Norris’s oral claims that the goods were transferred abroad on hold was adduced and, in view of the casual way in which Flashpoint carried out its business and maintained its records, although the freight agents may impliedly have been given on hold instructions, we doubt that they were given in specific terms. Further, we are not satisfied that the goods allegedly shipped on hold were so held by its agents, but we need make no finding as to that matter.

 

48.  Mr Norris and Mr Murphy claimed that in transferring the goods abroad on hold the company was protected against loss.  Flashpoint never carried out any due diligence checks on Specialised Freight. What enquiries, if any, Flashpoint’s foreign customers made to ascertain ownership of CPUs being purchased was not disclosed in evidence and, in its absence, viewed against the wholly uncommercial and illogical way in which Flashpoint traded, we infer that none were in fact made.

 

49.  We have already noted that Flashpoint’s trading model made no provision for the inspection of goods it had purchased; its directors claim to have relied on overseas customers to inspect them, maintaining that the fact that the customers paid for them amounts to proof that the goods supplied existed and were as described. Where customers identified faulty or damaged goods, Flashpoint would give credit to their value rather than replace them. The Commissioners ask us to infer that Flashpoint’s failure to check goods it had agreed to purchase is evidence that its directors knew that the company’s transactions were not legitimate, but were a vehicle for fraud. Alternatively, they say that the directors had the means of discovering the fraud, and chose not to use those means. Again, we shall deal with the invitation in our conclusion.

 

50.  We should add that, whilst at the outset the Commissioners did not accept that goods air freighted by Flashpoint were insured, later in the hearing we were told that they did so accept. We are content to proceed on the basis of that acceptance.

 

51.  For completeness we should also explain that some of the chips in which Flashpoint allegedly dealt with were “box”, ie of the type used by computer users to replace faulty or worn out chips, rather than “tray”, ie those used by OEMs.  Although the descriptions in some of the documents before us are less than adequate and might point to them being “box”, we are satisfied that all were “tray”, albeit in at least some cases contained in boxes.

 

52.  There is one further matter with which we must deal at this point.  Although not alleged in the pleadings, in cross-examination of Mr. Murphy, Mr. Kerr sought to show that the goods said to have been the subject of Flashpoint’s transactions did not exist.  No cogent evidence was adduced to support the assertion, and we reject it: the question should never have been introduced in the absence of its being pleaded.

 

Flashpoint’s transactions in period 03/06

 

53.  In period 03/06 two companies made supplies to Flashpoint. They were Techcomp and VIP Computer Centre Ltd (“VIP”).  Flashpoint entered into 19 broker deals in the period.

 

54.  It is convenient for us to deal first with the VIP supplies. In the period 9 of Flashpoint’s broker transactions involved VIP as its supplier. Although initially the Commissioners maintained that the supplies were made in the UK, eventually they were persuaded that they were in fact made in Hong Kong. Consequently, Flashpoint had no liability to VAT on them, and made no corresponding input tax credit claim. In 7 of the 9 transactions Techcomp was VIP’s supplier. As Flashpoint was already purchasing from Techcomp, the Commissioners question why Techcomp did not cut out VIP from those deals and thus increase its profits; they maintain that the deals were contrived. The Commissioners also question why VIP should have incurred the expense of transporting the goods sold to Flashpoint to Hong Kong when it seemingly derived no benefit from doing so. The evidence offered to us by Flashpoint answered neither question, and its absence is at least an indicator that the deals concerned were not commercial. We should record that Mr Cook conceded that the Commissioners decided not to conduct extended verification on VIP as they were unable to connect its deals with Flashpoint to a tax loss or losses.

 

55.  In period 03/06 Flashpoint made a further 7 purchases from Techcomp resulting in the 10 sales with which we are concerned. We set out details of those sales and purchases in the Schedule to our decision.  Techcomp accounted for the output tax on each sale, after deduction of the input tax incurred on the corresponding purchase.  In the case of nine of the sales transactions Flashpoint’s customer was resident in Hong Kong; in the tenth it was resident in the USA. In every case the sale was made if not on the day of purchase, then very shortly thereafter.

 

56.  Flashpoint’s deals involved two types of Intel computer chips, 630 (deals 3,7,10,12,13 and 14a) and 531 (deals 6,11 and 14b). Intel’s list price for each of those two products in January, April and June 2006 was $178. However, although the list price for model 630 remained at $178 in July 2006, it fell to $163 in November 2006, but that for model 531 fell to $74 in July 2006, possibly indicating that Intel intended to discontinue its manufacture. Dr Findlay gave evidence, and we accept, that OEMs and authorised distributors of CPUs would typically discount Intel’s list prices by up to 20 per cent in the grey market, but he went on to explain that Intel effectively dictated prices in its products, so that list prices discounted by more than 20 per cent should have put traders on notice that they were not trading in a genuine market. In Flashpoint’s case, five of its purchases from Techcomp were at a discount on list price in excess of 20 per cent, in one case (deal 11) reaching 27.35 per cent. Both Mr Murphy and Mr Norris admitted being aware that off-market pricing was a potential indicator of fraud.  Dr. Findlay also accepted that system assemblers and authorised distributors might be informed of changes in market price in advance of the rest of the market, and that the Intel price lists were just a starting point for grey market prices.  Although those acceptances are relied upon by Ms. Tanchel to support Flashpoint’s case, we consider them to be of very little benefit to the company.

 

57.  There are a number of matters involving Techcomp on which the Commissioners rely to claim that it was a party to a fraudulent scheme, and they go on to say that Flashpoint knew it was such a party.  First, they observe that, in deal 7, on 6 February 2006 Techcomp sold chips to Flashpoint at a price per chip of £88.90, a mark up of 1.6 per cent, whereas Flashpoint’s subsequent sale to Eternal Electronics Inc (“Eternal”), an American company, at a unit price of £92.70 on the same day gave it a mark up of 4.29 per cent.  However, since on 1 and 2 February 2006 Techcomp exported the same type of chips to Eternal directly, the Commissioners question why Eternal did not deal directly with Techcomp in the 6 February deal; they maintain that the transactions did not take place in the true grey market.  Secondly, in deal 14b Techcomp’s mark-up at 1.17 per cent was identical to the mark-up of its supplier, Tamsa Trading.  Thirdly, the Commissioners maintain that Techcomp, a far larger company than Flashpoint with considerably greater resources, failed to exploit the opportunity to obtain higher mark-ups on deals by exploiting the export market.  In deal 3, Flashpoint’s mark-up was 8.34 the size of Techcomp’s.  In other deals Flashpoint’s similar mark up was as follows: deal 6, 2.53; deal 7, 2.68; deal 10, 2.45; deal 11, 2.71; deal 12, 3.49; deal 14a, 1.27; deal 14b, 2.88.  The Commissioners point to those facts as indicating an irrational failure on Techcomp’s part to exploit the export market.  Finally, the Commissioners observe that the remainder of Flashpoint’s deals in period 03/06, ie its non-broker deals, were UK to UK sales: it acted as a buffer and purchased chips from Techcomp and sold them to VIP.  As there was no apparent reason why, in the legitimate marketplace, Techcomp could not have sold the chips directly to VIP, the Commissioners again question whether those transactions took place in the true grey market.

 

58.  Mrs. Downton and Mr Cook, by enquiry of other officers (by most of whom we were provided with written unchallenged statements of evidence) and by interrogation of the Commissioners’ computer records, were able to trace the chains of transactions back several further steps, until in each chain they identified a defaulting trader.

 

59.  The transaction chains, as identified by the officers, were set out on deal sheets which they had prepared, and which they produced to us. They showed, so far as the officers had been able to trace them, the transactions between the various traders who had dealt in the goods before they were sold to Flashpoint, and Flashpoint’s customer.  The Commissioners maintain that the transactions revealed in the deal chains constructed were not of a kind one would expect to find in a legitimate market; however they do not say that Flashpoint knew the identities of any of the participants in the chains other than its own supplier and customer.  In all but deals 15a and b and 14a and b there was a simple sequence, Flashpoint purchasing from Techcomp and selling the entire consignment to its purchaser.

 

60.  Flashpoint had three customers in Hong Kong. One of them was Right Deal Ltd (“Right Deal”). Flashpoint collated information on that company as early as March 2005, and Mr Norris claimed to have visited it both in 2005 and 2006, but produced no records of the visits or photographs said to have been taken during the visits. Further, he also claimed to have made enquiries about its trading partners, and said he obtained nothing of an adverse nature to the company. Once more no documentary evidence in support was produced. Flashpoint did, however, prepare a document on Right Deal for the Commissioners which consisted of a summary of the information it claimed to hold on that company. The document showed Right Deal to have been incorporated in 1989, whereas enquiries by the Commissioners indicated incorporation in 2002. It also included some confusing information about Right Deal’s bankers which ought to have been investigated, but was not. Flashpoint also produced a Business Registration Certificate for Right Deal issued by the Hong Kong authorities; the certificate expired on 21 February 2006 - before the Flashpoint deals took place, but its expiration was ignored.  The Hong Kong customs authorities visited Right Deal on 6 December 2006 and spoke to Mr. Owen Yu, its director.  He informed them that he inspected goods supplied by Flashpoint before making payment for them.  Background checks on Right Deal carried out by the authorities revealed nothing of an adverse nature, and all the evidence points to its having been a dealer in CPUs.  Right Deal is said to remain a customer of Flashpoint.

 

61.  Flashpoint’s second customer in Hong Kong was Felton International Ltd (“Felton”), a company whose director Mr. Norris had known since 1997 – a fact which Mr. Cook acknowledged as providing a degree of comfort to Flashpoint. After the deals with which we are concerned were completed, Flashpoint produced to the Commissioners a due diligence pack on that company which was demonstrably inaccurate in that it included a statement that Felton was incorporated in 1988, whereas a print-out from the company’s website dated April 2007, i.e. again after the deals were completed, showed it as having been formed in 1993. The other documents in the pack included details of Felton’s bank account, and its business and incorporation certificates. We particularly record that the pack contained no letters of introduction, trade or financial records, accounts, credit checks, or identification documents.

 

62.  Flashpoint’s third customer in Hong Kong was IDA International Ltd (“IDA”).  The only documents put before us relating to that company consisted of its registration and incorporation certificates included in the deal pack for deal 12: there were no records, accounts or credit checks.

 

63.  At the request of the Commissioners, the Hong Kong FCLO (Customs and Excise Department) visited IDA on 20 October 2006 to verify a transaction in which it bought a batch of CPUs from Flashpoint on 14 March 2006.  In addition the authority conducted what it described as a “background check”.  Suffice it to say that the authority found the company to be operating as one would expect a company dealing in CPUs.  To quote from the report, “there were two female and three male staff working in the open plan office.  There were many telephone calls and conversations over phone by staff during the course of our visit.  A workman was conducting re-packing of CPUs into the carton boxes inside the back store / side office.”  We accept a submission by Ms. Tanchel that the authority’s observations provide evidence that it was conducting a business.  But whether, as she further submits, more extensive enquiries about IDA would have revealed that business to have been an entirely legitimate one, we cannot say.

 

64.  The Commissioners question why, when Techcomp had contacts in the Far East with which it could have dealt directly, it was channeling goods through Flashpoint. Mr Norris dismissed the question as a “no brainer”, maintaining that Techcomp did so due to its having insufficient capital to finance the VAT on UK purchases pending input tax repayment by the Commissioners on foreign sales. We do not accept that explanation for, in evidence, Mr Cook illustrated that in all the deals with which we are concerned, with the exception of number 11 (where the Commissioners had been unable to obtain information), Techcomp paid for the goods supplied to it and which were the subject of onward sale to Flashpoint before the latter made payment for them. Clearly, Techcomp had funds available for the purpose. We so find on the basis that in its accounts for the year to 31 August 2005 produced to us it is shown as having cash of £516,492 at the year end, and no evidence was adduced to show that in the following financial year its liquid capital position deteriorated. In contrast, Flashpoint’s accounts to 31 March 2006 show it as having cash of less than £15,000. And since, as we earlier mentioned, Flashpoint had issued share capital of but £100, even with the loans mentioned at [36], it clearly had insufficient funds of its own to pay the input tax on the goods it was purchasing from Techcomp for onward sale to foreign customers pending repayment by the Commissioners.

 

65.  Flashpoint’s one American customer was Eternal, a subsidiary of Felton.  Flashpoint produced to the Commissioners a summary of information about Eternal, but once more it was prepared after the deals with which we are concerned were completed.  Eternal provided the names of two bank referees, and three trade referees, none of which references Flashpoint took up.  Mr. Norris claimed to have been dealing with Eternal’s director since 1997, at which time the former was employed by Avnet.

 

66.  At this juncture we might also usefully mention another transaction which the Commissioners consider to contain indications of contrivance. In February 2006 Techcomp supplied a quantity of Intel CPUs to Eternal at a sterling equivalent price of £91.33 per unit. Yet in the same month, Techcomp sold a quantity of the identical units to Flashpoint at a price of £88.9 per unit, which Flashpoint proceeded immediately to sell to Eternal. As Eternal was thus in direct contact with Techcomp, the Commissioners once more question why Techcomp sold to Flashpoint when it could have made a larger profit by selling direct to Eternal.

 

67.  Flashpoint contends that its customers in Hong Kong and the USA were, and are, genuine companies, and that even had it made further enquiries about them they would have revealed nothing untoward.  In the absence of the various checks and documents we have mentioned in relation to the individual companies concerned, whilst accepting that checks were carried out by the Hong Kong authorities of the companies registered in that city and revealed nothing adverse to those companies, since the checks did not take place until some time after the period with which we are concerned, they are hardly relevant to that period. And in any event the checks so made provide no evidence that the companies concerned, even if trading legitimately in part, were not also involved in fraud.

 

68.  The only contemporaneous records of Flashpoint’s sales we find are pro-forma invoices prepared by Mr Norris and dispatched with the goods themselves. There were some purchase orders submitted by purchasers, but often they were received by Flashpoint after a deal had taken place. For instance, in deal 6, the purchase order was dated four days after the date the goods were shipped abroad; in deal 11 the order was dated two days after shipping, and in deal 14a three days after. At the end of the relevant quarter on the basis of information provided by Mr Norris, Mr Murphy input it into the computer system.

 

69.  Although Flashpoint presented us with deal packs said to contain records of its transactions in period 03/06, on examination we find them to consist almost entirely of documents generated at the end of the relevant VAT period on the basis of information input into the computer system by Mr. Murphy. We accept, as did Judge Wallace in Emblaze Mobility Solutions Ltd v Revenue & Customs [2010] UKFTT 410 (TC) that it was not “inherently improbable that the paperwork followed oral agreements or instructions by telephone and was not always produced immediately…”  However, in our judgment, viewed in the context of all the evidence before us, the vast majority of the paperwork presented to us in the instant case was created solely for “window-dressing” purposes.  We do not accept an unsupported claim by Mr. Norris that the late production of paperwork for transactions was “market practice”.

 

70.  As an example of the records Flashpoint produced in relation to individual deals, we now list those it passed to the Commissioners in relation to Deal 3. They were:

 

a)     a purchase order dated 18 January 2006 from Right Deal for 1260 Intel Pentium P4 3G 775 tray chips at a price of $211,768.20

b)     a Flashpoint “pro forma” invoice dated 18 January 2006 for 1260 chips of the same description as that contained in the purchase order again for $211,768.20 addressed to Right Deal

c)     a payment credit confirmation dated 20 January 2006 for $211,735.29 from Nat West, Flashpoint’s banker

d)     a Flashpoint sales invoice dated 18 January 2006 in all respects identical to the “pro forma” invoice but which never left Flashpoint and to which all the evidence points as having been produced at the end at quarter 03/06

e)     an air waybill for the shipment to Cohesion Air Freight (HK) Ltd, Flashpoint’s Hong Kong agent,  dated 18 January 2006

f)      a bank statement for Flashpoint’s dollar current account from NatWest showing transactions dated from 16 January 2006 to 31 January 2006 including the receipt on 20 January  2006 of $211,723.19 from Right Deal

g)     a purchase order for 1260 chips of the description contained in Right Deal’s purchase order addressed to Techcomp dated 18 January 2006 but almost certainly produced at the end of the VAT period which again never left Flashpoint

h)     an invoice from Techcomp dated 18 January 2006 for the same chips overstamped “Paid”.

 

The size of the grey market in Intel CPUs

 

71.  IDC, a highly reputable provider of statistical information to the computer industry, with long established relationships with OEMs such as Intel and AMD, and major distributors, has tracked Intel CPU production and sales for over 20 years. It has privileged access to those companies’ financial information. From market estimates made by IDC on the basis of that information, Dr Findlay estimated the annual value of the global market in Intel CPUs in 2006 as £13,171 million, of which 34.9 per cent was sold through distribution.  Of that 34.9 per cent he considered the percentage of the global market controlled by UK companies to be 2.6, and to have a value of £122 million. He further estimated the percentage of authorised distribution sourced from the genuine grey market as 6, its value being £7.3 million. And finally he calculated the value of the distribution exported by UK distributors as £1.4 million, 19 per cent of £7.3 million.

 

72.  In contrast, Mr Norris claimed the grey, or secondary, market in Intel CPUs, i.e. the market excluding sales by OEMs and main distributors, to be some 20 times the size estimated by Dr Findlay. At a late stage in the hearing, Mr Norris produced an email from Avnet stating that its annual exports of Intel CPUs totalled $2.75 million – a figure which, if accepted by us, would mean that Flashpoint’s exports in the single quarter of 03/06 amounted to something approaching one-half of Avnet’s total exports of Intel CPUs in the year. He produced no evidence in support of his claim and, in its absence, we are not prepared to accept it as accurate, or even approximately accurate. It was, however, plain that it was in part based on a substantial part of the 65.1 per cent of CPUs supplied to OEMs finding their way to the grey market.  Dr Findlay made plain that Intel would not tolerate a substantial proportion of supplies to OEMs being diverted to the grey market as that would have resulted in its pricing policy being undermined.

 

73.  Ms. Tanchel submits that Dr. Findlay made a number of incorrect assumptions about the grey market and Flashpoint’s business, and that his analysis of the size of market was fundamentally flawed in that it was predicated on the factory gate figures of European computer production, rather than on the production figures or the import / export figures of CPUs themselves.  Having carefully examined the content of Dr. Findlay’s oral evidence and the documents he produced, we are quite satisfied that our interpretation of Dr. Findlay’s evidence, as set out in the next following paragraph, is correct.

 

74.  We are unable to accept that the grey market was 20 times the size of Dr Findlay’s estimate of the true figure, or was anything like that size. Apart from anything else, had it been, it would have exceeded the value of the white market, and that is an impossibility.  On the balance of probabilities, we hold Dr Findlay’s figure to be the best possible estimate of the size of the grey market.

 

Flashpoints’ claim to continue to trade as it did in 2006

 

75.  The crux of Flashpoint’s case is that, since it continues to trade in all material aspects as it did in 2006, and has experienced no problems in doing so, indeed has prospered greatly since then, there was nothing wrong in its earlier trading practices, due diligence and record keeping.  When we say it claims to trade “in all material respects” similar to 2006 we mean that it continues to obtain and supply goods on credit, holds no stocks, makes none of the checks one might reasonably expect a trader to make of its suppliers and customers, carries out no inspections of goods, supplies them to customers in the Far East despite not owning them or having any authority to export them, and raises little more than an invoice as contemporaneous documentary evidence of its deals.

 

76.  Ms Tanchel submits that Flashpoint’s current trading practices, as explained by its directors, expose the artificiality and limitations of the Commissioners’ case since they rely in large part on the fact that, since the introduction of the reverse charge in 2007, it is no longer possible to defraud the revenue in the same way as it was earlier.  She maintains that, far from restricting Flashpoint’s ability to expand, the introduction was used by the company to exploit the situation thereby created.

 

77.  We might add, as emphasised by Mr Kerr, that it has never been the Commissioners’ case that Flashpoint was a fraudulent entity from the beginning, or had subsequently become one. Rather, he explains, it is their case that Flashpoint took advantage of a fraudulent opportunity which presented itself to the company.

 

78.  For a variety of reasons advanced by Mr. Kerr, we find that Flashpoint does not trade as it did in 2006, but observe that we are required neither to examine its current business practices nor to compare them with its earlier ones.  Nor is it for us to pass judgment on the way in which it conducts its business operations. We need only examine the evidence of Flashpoint’s knowledge or means of knowledge of a connection with the fraudulent evasion of VAT during the early part of 2006.

 

79.  Nevertheless we did allow Flashpoint’s directors to explain its current business practices.  As part of his explanation, Mr Norris said that deal packs relating to recent deals could, indeed would, be produced.  They were not; his claim that Flashpoint’s present trading methods and practices remain as they were was evidenced by nothing more than 2 purchase orders for CPUs from VIP in October 2008 and September 2009, and 2 purchase orders from Right Deal dated July 2008. Further, Mr Murphy claimed that purchases were now being made from authorised distributors and systems integrators, and maintained that that constituted one very important difference between 2006 and now. But again, evidence in support of the claim was lacking.  We were also told by Ms. Tanchel that Mr Norris would provide evidence that Flashpoint’s supply base now includes household names.  He did not do so.  In the absence of the supporting evidence, we are unable to accept that its current business practices remain as they were in 2006.

 

80.  For a number of reasons we find that Flashpoint’s trading environment and its trading practices have changed since 2006.  First, following the introduction of joint and several liability and other steps the Commissioners have taken to reduce MTIC fraud, a large number of companies have stopped trading in the wholesale mobile phone and computer chip markets resulting in more and better opportunities for profit for those continuing to trade. 

 

81.  We also find that the reverse charge has removed risk from the UK market in that it is no longer possible to defraud the Commissioners.  In so finding we have considered, and rejected, a submission by Ms. Tanchel that the introduction of the reverse charge was a decision taken by the Commissioners totally divorced from and outside the control of Flashpoint so that it could not be deemed to be part of its business model.  Existence of the reverse charge is now a fact of life which all traders must take into account, and thus must form part of the business model of each and every one of them.  Both Mr. Norris and Mr. Murphy claimed that the introduction of the reverse charge had a positive effect on their business in that they are now able to conduct deals with larger players in the market.  They maintained that it logically followed that that was testament to the viability of the general commercial opportunity afforded, which the company had exploited.  They further claimed that their business model in 2006, as used unchanged in 2010, “offered them a genuinely profitable proposition of which they took advantage”.  As we have said, we do not accept that Flashpoint’s business model in 2010 remained as it was in 2006; in our judgment, the evidence adduced did not support its claim.

 

82.  Mr. Norris stated that in 2006 Flashpoint never bought Intel products from authorised distributors but, in what he claimed to be a substantial change in trading practice, it now bought them from OEMs. Once more no evidence was adduced to support the claim and, in its absence, we are not prepared to accept it.

 

83.  Finally, Mr. Murphy maintained that Flashpoint presently traded with Tesco plc on terms agreed orally, but once more he produced nothing whatsoever to corroborate the claim.  Again, in the absence of corroboration we do not accept it.

 

The deal chains constructed by the Commissioners

 

84.  As Flashpoint accepted that each of the deal chains constructed by Mrs. Downton and Mr. Cook led to a fraudulent loss of VAT and that the company’s transaction in the related chain was connected to the loss, we propose to provide one representative example of a chain including Flashpoint’s transactions leading to a fraudulent defaulter.  We take deal 3, the first deal with which we are concerned. It began with AR Communications Ltd (“ARC”). On 17 January 2006 that company supplied Craner Technologies Ltd (“Craner”) with 4725 Intel P4 3G 775 2MB OEM chips. ARC never accounted for the VAT of £74,832.19 charged on the transaction, and was de-registered on 1 April 2006. Also on 17 January 2006, Craner sold 1575 of the chips it had bought to Techcomp for a VAT inclusive price of £167,944.22.  On the following day, Techcomp in turn sold 1260 of those chips to Flashpoint at a VAT inclusive price of £135,095.63, which proceeded immediately to sell its entire purchase to Right Deal for $211,735.29 – a sterling equivalent of £102,254.40.

 

85.  On 20 January 2006, Right Deal paid Flashpoint $211,735.29 for the chips supplied to it, payment being made by telegraphic transfer. The sum concerned, less bank charges, was credited to Flashpoint’s dollar current account with NatWest on the same day.  The copy bank paperwork for the payment by Flashpoint to Techcomp, being of extremely poor quality, does not show the value of the payment made by the former to the latter on 20 January. The Commissioners obtained two bank documents for the payment made by Techcomp to Craner. They show a first payment of £100,000 having been paid on 17 January 2006, and a second of £67,944.22 on the following day. Rather than Craner then paying ARC, it made payment to a third party, Voltrex Options (UK) Ltd. (The Commissioners believed that false documents had been created in order to suggest that a UK company had supplied ARC).

 

86.  Between 5 May 2004 and 7 December 2004 ARC reclaimed over £7 million input tax from the Commissioners, over £6 million of which was said to relate to supplies made to it by Storm Promotions Ltd (“Storm”). The Commissioners obtained evidence showing that ARC imported the goods direct from EU traders, and that the Storm deal documentation was fabricated; invoices ostensibly issued by Storm’s EU suppliers were found to have been created on computers seized from ARC’s premises. From 1 March 2005 to 26 August 2005 ARC was involved in MTIC fraud causing a loss to the revenue of over £3.5 million. On 12 May 2008 its director, Andre Olivier, was disqualified from acting as a company director for 14 years due to his either having known of fraud or having been reckless or grossly negligent as to whether ARC was involved in fraud. In February 2006 ARC went into receivership.

 

87.  The evidence relating to each of the remaining deal chains revealed a defaulting, hijacked or missing trader at the head of the chain, established a fraudulent default, and led to Flashpoint as broker.

 

Flashpoint’s knowledge or means of knowledge of transactions connected with VAT fraud

 

88.  Having dealt with the facts, we then turn to consider whether, in relation to its purchases of computer chips for onward sale to its Hong Kong and American customers, Flashpoint knew that its transactions were connected to the fraudulent loss of VAT, or should have known that they were so connected.

 

The law

 

89.  The law we must apply in answering that question is to be found in the ECJ decision in Kittel, and in the decision of the Court of Appeal in Mobilx. In Kittel, the ECJ refused a claim by the appellant company to repayment at the end of an accounting period of the excess of its input tax over output tax.  The questions in that case posited “a recipient of a supply of goods who has entered into a contract in good faith without knowledge of a fraud committed by the seller”.  The referring Belgian court also wished to know if the answer of the ECJ would have been different had the taxable person known or had the means of knowing that by his purchase he was participating in a transaction connected with the fraudulent evasion of VAT.  Having reiterated that a trader’s right to deduct in respect of a transaction was unaffected by other transactions, whether previous or subsequent, the ECJ confirmed at paragraph 51 that “traders who take every precaution which could reasonably be required of them to ensure that their transactions are 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 risk of losing their right to deduct the input VAT…”  The ECJ then dealt with the converse case stating, inter alia:

 

a.      where the tax authorities find that the right to deduct has been exercised fraudulently, they are permitted to claim repayment of the deducted sums retroactively (para 55);

b.     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 the fraudulent evasion of VAT, must be regarded as a participant in that fraud (para 56) that is because in such a situation the taxable person aids the perpetrators of the fraud (para 57).

 

90.  The ECJ concluded by determining that “…where it is ascertained, having regard to objective factors, that the supply is to a taxable person who knew or should have known that, by his purchase, he was participating in a transaction connected with fraudulent evasion of VAT, it is for the national court to refuse that taxable person entitlement to the right to deduct” (para 61).

 

91.  In Mobilx, the Court of Appeal considered the Kittel judgment in some detail and from para 75 of the  leading judgment of Moses LJ it emerges that:

 

“The ultimate question is not whether the trader exercised due diligence but rather whether he should have known that the only reasonable explanation for the circumstances in which his transaction took place was that it was connected to fraudulent evasion of VAT”

 

92.  Amongst the questions the Court of Appeal was required to answer in Mobilx was that of whether the evidential burden of proof would shift to the trader where the surrounding circumstances were sufficient to establish that the trader should be treated as a participant in fraud.  Moses LJ responded that the circumstances surrounding the transaction, such as its being of a type commonly associated with fraud, were capable of establishing that the trader should have known of the connection.  He did, however, stress that the focus of the tribunal should not be on due diligence, but rather on seeing the transaction in context.  On that point he cited the following passage from the judgment of Christopher Clarke J in Red 12 Trading Ltd v HMRC [2009] EWHC 2563 (Ch):

“109. Examining individual transactions on their merits does not, however, require them to be regarded in isolation without regard to their attendant circumstances and context. Nor does it require the tribunal to ignore compelling similarities between one transaction and another or preclude the drawing of inferences, where appropriate, from a pattern of transactions of which the individual transaction in question forms part, as to its true nature e.g. that it is part of a fraudulent scheme. The character of an individual transaction may be discerned from material other than the bare facts of the transaction itself, including circumstantial and “similar fact” evidence. That is not to alter its character by reference to earlier or later transactions but to discern it.

110. To look only at the purchase in respect of which input tax was sought to be deducted would be wholly artificial. A sale of 1,000 mobile telephones may be entirely regular, or entirely regular so far as the taxpayer is (or ought to be) aware. If so, the fact that there is fraud somewhere else in the chain cannot disentitle the taxpayer to a return of input tax. The same transaction may be viewed differently if it is the fourth in line of a chain of transactions all of which have identical percentage mark ups, made by a trader who has practically no capital as part of a huge and unexplained turnover with no left over stock, and mirrored by over 40 other similar chains in all of which the taxpayer has participated and in each of which there has been a defaulting trader. A tribunal could legitimately think it unlikely that the fact that all 46 of the transactions in issue can be traced to tax losses to HMRC is a result of innocent coincidence. Similarly, three suspicious involvements may pale into insignificance if the trader has been obviously honest in thousands.

111. Further in determining what it was that the taxpayer knew or ought to have known the tribunal is entitled to look at the totality of the deals effected by the taxpayer (and their characteristics), and at what the taxpayer did or omitted to do, and what it could have done, together with the surrounding circumstances in respect of all of them.”

93.  Moses LJ closed his analysis in Mobilx at [84] with a clear warning to traders that such circumstantial evidence will often indicate that a trader “has chosen to ignore the obvious explanation as to why he was presented with the opportunity to reap a large and predictable reward over a short space of time”.

 

94.  At paragraph 9 of the judgment in Calltel Telecom Ltd v Commissioners for Revenue and Customs [2009] STC 2164 Floyd J observed that in Commissioners for Revenue and Customs v Livewire Telecom Ltd [2009] STC 643 Lewison J “has analysed subsequent decisions of the [European] Court of Justice, which has expressed the test enunciated at [61] in Kittel in modified language.”  For example he drew attention to the fact that in the more recent decision in Netto Supermarkt GmbH & Co. OHG v Finanzant Malchim [2008] STC 3280, the European Court held at [24] that:

 

“…it is not contrary to Community law to require the supplier to take every step which could reasonably be required of him to satisfy himself that the transaction which he is effecting does not result in his participation in tax evasion.””

 

95.  The European Court in R (on the application of Teleos and others) v Commissioners for Revenue and Customs [2008] STC 706, having formulated the test identically to that in Netto (see [65] of the judgment), then said:

 

“66. Accordingly, the fact that the supplier acted in good faith, that he took every reasonable measure in his power and that his participation in fraud is excluded are important points in deciding whether that supplier can be obliged to account for VAT after the event.”

 

96.  Direct evidence of knowledge or means of knowledge is not to be expected, rather we must rely on inferences drawn from primary facts – see for example, Dadourian Group International Ltd v Simms [2009] EWCA 169 (Ch) where, at para 89, the Court of Appeal dealt with a submission to the contrary:

 

“At times [counsel] came close to suggesting that fraud can only be established where there is direct evidence. If that were the case, few allegations of fraud would ever come to trial. Fraudsters rarely sit down and reduce their dishonest agreement to writing. Frauds are commonly proved on the basis of inviting the fact-finder to draw proper inferences from the primary facts.”

 

97.  Section 18 of the Finance Act 2003 added s 77A to the Value Added Tax Act 1994. It provides that a trader buying mobile phones or CPUs may be held jointly and severally liable with its supplier for any unpaid liability to VAT on them. Section 77A(2) enables the Commissioners to serve a notice on a taxable person to whom a taxable supply has been made where at the time of supply the person supplied knew or had reasonable grounds to suspect that some or all of the VAT payable in respect of that supply, or any previous or subsequent supply of those goods, would go unpaid. The Commissioners’ Notice 726 “Joint and several liability”, issued in 2003, is that notice. In it MTIC fraud is described as “a systematic criminal attack on the VAT system”.

 

98.  At para 2.3 Notice 726 explains why s 77A of the Act was introduced as follows: “The fraud relies heavily on the ability of fraudulent businesses to undertake trade in goods with other businesses that may be either compliant in the fraud, turn a blind eye, or are not sufficiently circumspect about their trading connections. Such action whether it is deliberate participation or unwitting involvement fuels the growth of the fraud.” In Mobilx, at first instance as recorded at [9] of the judgment, the parties agreed that the guidance contained in the Notice was generally “equally applicable to the avoiding of challenges to repayment of VAT”. As Floyd J agreed, since we are bound by his judgment, we now consider the Commissioners’ guidance. At [10], the learned judge described the Notice as containing “chilling warnings about the prevalence of MTIC fraud”. He also noted that “In several places the document makes it clear that the obligation on the trader is to ensure the integrity of his ‘supply chain’.” At para 4.5, the Notice recognises the difficulty a trader may have in checking on his supplier, but says nevertheless that “we would expect you to make a judgment on the integrity of your supply chain”. The Notice gives examples of factors a trader may wish to consider in establishing the legitimacy of its supplier. They include the type and level of checks carried out to establish that integrity and the action the trader took as a consequence of those checks, aspects of payment arrangements and conditions, and details of the movement of goods involved. Para 8.1 of Notice 726 sets out a number of ‘checks you can undertake to help ensure the integrity of your supply chain’, including checking the supplier’s history in the trade, checking what recourse exists if the goods are not as described, and making reasonable checks to ensure that the goods have not previously been supplied.

 

99.  It is not for the Commissioners to say what checks a trader should carry out to ensure that it does not enter into transactions involved with fraud.  As Floyd J said in Mobilx at [87] at first instance, “… the company has to exercise independent judgment, not delegate its judgment to HMRC”. The Commissioners refuse to specify what checks should be carried out – “A definitive checklist would merely enable fraudsters to ensure that they can satisfy such a list”, Notice 726 para 4.6.

 

100.              It is common ground that the burden of proving that Flashpoint knew or had the means of knowing that its purchases were connected with VAT fraud is on the Commissioners, and that the standard of proof is the civil standard, ie the balance of probabilities.

 

Submissions of the parties and our conclusion

 

101.              In reaching our conclusion we shall, as Ms Tanchel submits we should, take account of the limited material available to Flashpoint for the purposes of the appeal, and be assiduous in ensuring that our examination of the state of mind of the company’s directors focuses entirely on the material available to them at the relevant time,  And, again as she submits we should, we shall consider the relevant documentation through the directors’ eyes, rather than those of the trained eyes of the Commissioners’ officers.

 

102.              For a wide variety of reasons, some explicit others implicit, the Commissioners claim that its transactions were contrived and / or uncommercial and / or pre-arranged.  Those reasons, in no particular order of importance, include the following:

 

1)     that each of Flashpoint’s purchase transactions and the related sale transaction took place on the same day

2)     that the company had insufficient capital to finance the VAT on its UK purchases pending repayment by the Commissioners following related foreign zero-rated sales

3)     that Flashpoint’s due diligence checks were limited, and in any event were carried out only after transactions were completed

4)     that almost all its sales were back to back

5)     that the terms and conditions on which it traded were unclear, and were never reduced to writing

6)     that no computer manufacturers, assemblers or authorised distributors appeared amongst its suppliers, or retailers amongst its customers; that Flashpoint was not trading in the genuine grey market

7)     that Flashpoint never inspected the CPUs in which it was dealing

8)     that it used but one supplier throughout

9)     that each of Flashpoint’s deal chains constructed by the Commissioners led to a defaulter

10) that Flashpoint was aware that off-market pricing might be an indicator of fraud

11) that Flashpoint as broker consistently made larger profits on sales than buffers in the various chains concerned

12) that as the result of correspondence from the Commissioners, including service of Notice 726 and repeated visits from their officers, Flashpoint had adequate notice that it was trading in a sector rife with fraud

13) that it did not know in whom ownership of CPUs in which it traded vested, and exported them without having made payment, without authority from its supplier, and without there being in place a credit agreement for their payment

14) that Flashpoint’s present  trading model differs from its 2006 model

15) that its turnover grew at an extraordinary pace without its having engaged, or having had to engage, any extra staff to cope with the increase; it had achieved success at a rate unlikely for a company with so few assets

16) that Flashpoint took no commercial risks as it made payment for supplies only after it was paid by its customers

17) that Techcomp was a party to a fraudulent scheme – a fact that was known to Flashpoint

18) that Flashpoint’s records fell far short of the standard to be expected of documents recording legitimate transactions

19) that the risks taken by its counterparties indicated their involvement in fraudulent trading

20) that trading between Flashpoint and VIP was “irrational”

21) that Flashpoint’s business model was inconsistent with legitimate trade

22) that the number of parties in the deal chains constructed by the Commissioners was indicative of their being fraudulent

23) that it added no value to goods it purchased

24) that it must have been aware that its supplier carried out no due diligence on it.

 

103.              We propose first to deal with a few matters that can be disposed of quickly and easily. However, we should state at the outset that we accept that there is a genuine grey wholesale market in computer chips, but the evidence adduced satisfied us that it was not the market in which Flashpoint was dealing in the transactions the subject of the appeal.  The wholesale market has no reason to exist other than to serve the retail one, but no evidence was presented to indicate the presence in any deal chain of a manufacturer or authorised distributor on the one hand and a retailer on the other.

 

104.              We accept that back-to-back trading may be a feature of MTIC fraud, but equally it is a feature of ordinary commercial practice.  However, viewed with all the other evidence we consider it to indicate that Flashpoint had at least means of knowledge of a connection with VAT fraud.

 

105.              That each of Flashpoint’s purchase and related sales transactions took place on one day is also a matter that could be explained in an ordinary commercial context.  But, if nothing else, the speed at which every transaction with which we are dealing was arranged also provided an indicator that it was not commercial, and was pre-arranged.

 

106.              Another matter that might also be explained in an ordinary commercial context is the use by Flashpoint in the deals concerned of a single supplier, Techcomp. Again, viewed in isolation it is not determinant of knowledge of a connection with VAT fraud, but considered together with other material, in our judgment, it is so indicative.

 

107.              Of a claim by the Commissioners that as each deal chain they constructed led to a defaulter Flashpoint had knowledge or means of knowledge of fraud, we merely observe that that was a matter of which Flashpoint would not necessarily have been aware, so that we regard it as a matter of very little importance in the overall picture.

 

 

108.              No evidence was adduced of Flashpoint adding value to the products with which it was dealing.  From its absence and the other evidence before us as to the uncommerciality of its transactions, we infer that Flashpoint was certain that it would be paid for all its supplies; the transactions bore all the hallmarks of contrivance and pre-arrangement.

 

109.              We next turn to Flashpoint’s claim to continue to trade as it did in 2006, and that the size of the grey market in CPUs was much larger than that estimated by the Commissioners. In both cases we earlier made findings of fact adverse to Flashpoint.  We need not add to those findings; they speak for themselves as indicating that the transactions with which we are concerned were contrived

 

110.              In our judgment, Flashpoint’s business model was inconsistent with its having conducted legitimate commercial transactions. The explanations offered for various aspects of its trading by Mr. Norris and Mr. Murphy were totally lacking in credibility, particularly where they claimed to have supporting evidence which they then failed to produce to us.

 

 

111.              As Techcomp was a wholesaler and so were Flashpoint’s customers in Hong Kong and the USA, Mr. Norris and Mr. Murphy must have been aware that in every chain of transactions with which we are dealing there must have been at least 5 parties (manufacturer, Techcomp, Flashpoint, Flashpoint’s customer, retailer), and where VIP was involved in a chain, at least 6 parties.  The longer a chain, the less likely it was to be commercial; the available profits could sustain only so many parties. We accept that Flashpoint may not have been aware of the number of parties in the deal chains concerned, but the absence of manufacturers, authorized distributors and retailers yet again is an indicator of uncommerciality.

 

112.              At [29] above, we indicated that Flashpoint carried out no checks on Techcomp beyond the exchange of documents in 2005.  We accept that for due diligence purposes Mr. Norris was entitled to place some reliance on his knowledge of and business relationship with Mr. Westley, but not to the extent of doing nothing to check that individual transactions with Techcomp were not connected with fraud.  Flashpoint claimed that nothing negative about Techcomp had come to light in the years since 2006, as Ms. Tanchel claims Mr. Cook agreed in evidence.  We do not accept that that is so.  As the tribunal in Powa (Jersey) Ltd disclosed at [62] of its decision in providing one example of a chain of transactions leading to a defaulter, Techcomp appeared as a buffer.  So, clearly, that company was involved in other transactions to have come before the tribunal in an MTIC fraud context. Further, in our judgment, the matters relied on by the Commissioners as set out at [57] above form clear evidence that Techcomp was a party to a fraudulent scheme or schemes. We agree with the Commissioners that the facts as recorded in that paragraph indicate an irrational failure on Techcomp’s part to exploit the export market – a failure that demanded an explanation. But since no one from Techcomp was called to give evidence, none was given to us. And whilst we accept that Flashpoint could not provide that explanation, it should have been able to explain why it was brought into transactions involving Techcomp as its supplier and VIP as its customer, as it knew that those two companies were dealing directly with each other.

 

113.              Yet another matter of which Flashpoint may not have been aware was the fact that the deal chains constructed by the Commissioners, which Flashpoint now accepts, the company obtained larger profits than did the buffers in the chains, particularly Techcomp. Since we accept that it may not have been so aware, we do not take the matter into account in reaching our conclusion.

 

114.              Albeit that we had no evidence from Techcomp itself, so that of necessity we must rely on the remaining evidence before us, we are satisfied on the balance of probabilities, and so conclude, that it knew that it was trading in a fraudulent market. It seemingly considered itself able to do so without consequence by acting only as a buffer and reaping the relatively meagre rewards available to it from doing so.  It had the capital to act as a broker and to finance the VAT on purchases pending repayment of input tax on overseas sales; it chose not to do so.  It dealt directly with some of Flashpoint’s overseas customers, so that it had the necessary contacts to trade as a broker; it chose not to do so.  It was against that background that it made the supplies to Flashpoint in Hong Kong incurring totally unnecessary transport costs in the process.  Flashpoint was aware that Techcomp was trading directly with companies with which it itself was trading, so that it too must have been aware that Techcomp was behaving in an irrational and uncommercial manner; one which warranted but was never the subject of enquiry.

 

115.              As we explained at the beginning of that section devoted to facts (see [20] et seq. above), Flashpoint began trading in the wholesale market in goods late in 2004.  Thereafter, in correspondence the Commissioners advised it of the dangers of trading in the wholesale grey market in CPUs, informing it that the market was rife with fraud.  They also provided it with Notice 726, the contents of which we explained in some detail at [98] above.  Coupled with the documentary warnings so issued, on a number of occasions officers of the Commissioners visited the company and alerted it to the widespread fraud operating in the markets in MTIC sector goods in the period concerned. We accept that it was entitled trade in those markets if it so wished, but if it were to avoid being drawn into fraud, it should have taken notice of the advice the Commissioners offered it and made checks on its supplier and customers.  Its failure to do so we consider to be yet another indicator that its directors had knowledge of its transactions being connected with fraud.

 

116.              Mr. Norris and Mr. Murphy invite us to deal with them as careful and honest traders, and as offering clear and credible explanations for all matters put to them.  In so doing they rely on a number of factors, of which the following are but some: Mr. Norris’s knowledge of Flashpoint’s products and markets is sophisticated and detailed; none of the Flashpoint’s direct counter-parties went missing or otherwise defaulted; that they had at all times co-operated with the Commissioners, and made returns in proper form; and implicitly maintain that there was no evidence of complicity on the part of Flashpoint’s freight forwarders.  We accept each of those factors as true, but reject the invitation itself.  The evidence presented to us shows that Flashpoint’s directors took a minimum of steps to choose the company’s counter-parties, and their action on the recommendations in Notice 726 as to how to avoid the risk of being drawn into VAT fraud was, in our judgment, for appearance’s sake rather than genuine. The evidence of Flashpoint’s trading was totally lacking in credibility. The directors must have known that the trading model they described was not sustainable in the real world of 2006, and could have succeeded only in one in which fraud was prevalent. As Mr Kerr submits, the trading environment the directors described was “unrealistically benign” to the extent that it was, at least, evidence of means of knowledge of a fraudulent connection.

 

117.              We also recorded earlier the checks made by Flashpoint on the various customers with which it dealt in the transactions concerned in the appeal.  In our judgment, such checks as were made, including visits to customers, intended as they were to ensure that the company was not involved in transactions connected with VAT fraud, were superficial, and in no case made to deal with matters that warranted enquiry (as indicated at [60], [61] and [63] above).  They were not of the quality required and provide clear evidence that the steps Flashpoint took to establish the trustworthiness of its customers before dealing with them were inadequate, and it knew that to be so.

 

118.              Given the size of the deals Flashpoint was entering into with its foreign customers, any company operating with normal commercial caution would have made enquiries as to those customers’ financial status, insisted on production of their annual accounts and other information as to their financial standing, made enquiries of the level of business they intended to conduct with Flashpoint, and taken up references from reputable referees.  In the absence of accounts and credit checks, Flashpoint’s directors had no financial information on which Flashpoint could have based a decision to trade with them.  That the customers throughout paid in cash for their purchases does not affect that position.  Credit checks carried out in the context of commercial transactions, whether or not such transactions involve cash payments in full before delivery of goods, are valuable independent measures of a company’s strength, and indicate its ability to conduct legitimate trade on ordinary commercial terms. In our judgment, the matters referred to in this paragraph form compelling evidence of Flashpoint having known that its transactions were connected with VAT fraud.

 

119.              A customer paying cash was not the only matter a cautious and vigilant vendor of goods should have taken into account.  He would also have wished to assure himself that his customer could and would pay before committing himself to a purchase to satisfy that customer’s specific order.  In our judgment, Flashpoint was altogether too eager to place purchase orders with Techcomp without having any assurance that it would itself be paid for them.  From that we infer that Flashpoint knew that it was taking no risk of non-payment by its foreign customers – yet more compelling evidence of knowledge of a connection with fraud.

 

120.              Bearing in mind the size of the transactions into which Flashpoint was entering, we should have expected its terms and conditions of trade, and those of its customers, to have been made plain, if not in contracts relating to specific deals then in printed terms and conditions of general application.  (As we mentioned earlier, Techcomp’s terms and conditions of trade were printed on its invoices).  In the absence of terms and conditions of trade, no provision was made for matters such as the transfer of title, delivery, returns and exchange arrangements for faulty or damaged goods.  In our judgment, Flashpoint’s failure to record any contractual terms is, as the Commissioners invite us to infer, even more compelling evidence that the company by its directors knew that the deals into which it entered were part of a fraudulent scheme; it thus had no need to record those terms and conditions.

 

121.              Further, Flashpoint’s deal records fell far below the standard to be expected of documents recording legitimate transactions of the size with which we are concerned.  As we earlier found, it kept no contemporaneous records beyond “pro forma” invoices in relation to deals which it struck.  Even in these days of electronic communications, permanent hard copy records of some sort are essential, and their absence in the instant case indicates to us that the deals were pre-arranged and thus unnecessary.

 

122.              We accede to an invitation by the Commissioners’ to infer from Flashpoint’s failure to inspect goods it had purchased, and to rely on inspection by its customers to confirm not only their existence but also that they matched the specification ordered, that the company’s directors knew that its transactions were not legitimate, but rather were a vehicle for fraud.  No businessman dealing with goods of the value of those with which the appeal is concerned would have behaved as Mr. Norris and Mr. Murphy did in failing to inspect any of the goods in which Flashpoint was trading, particularly when aware of the widespread fraud in the market concerned.  As we pointed out earlier (see [78] above), it is not for us to pass judgment on the way Flashpoint conducts its business, and in dealing with the points made in this paragraph, we have not done so.

 

123.              As we recorded at paragraph [54] in seven of the nine transactions in period 03/06 in which Flashpoint purchased CPUs from VIP, Techcomp was VIP’s supplier.  In commercial terms, it made no sense for Techcomp not to deal with VIP in those transactions for in not dealing direct VIP was merely reducing its profits.  In the absence of any explanation for the behaviour of both VIP and Techcomp, we infer that the deals concerned were contrived. 

 

124.              Further, we consider VIP’s conduct in paying the cost of transporting the goods the subject of the various transactions with Flashpoint to Hong Kong to have been so unusual as to indicate to Flashpoint that the deals were not conducted for legitimate commercial gain.  In our judgment, VIP’s behaviour is compelling evidence of Flashpoint’s knowledge of a connection with fraud.  It is simply not credible that one company pays for another company’s goods to be transported half way round the world for no apparent reason.  In so concluding, we reject a submission by Ms. Tanchel that we should consider a company the size and significance of VIP unlikely to have been involved in illegitimate trading.

 

125.              The directors must have been aware that Techcomp carried out no due diligence on Flashpoint for, had it done so, it would have had to approach them for necessary information.  The absence of such checks by Techcomp should have raised suspicions in the directors’ minds that Flashpoint was involved in transactions into which their company should not have entered without making further enquiries; transactions that could not be classified as commercial.

 

126.              Flashpoint’s directors both accepted knowing that off-market pricing might be an indicator of fraud.  The fact that no less than 5 of Flashpoint’s 9 purchases were at a discount of more than the 20 per cent figure accepted by the company’s directors as marking the limit of commercial transactions in our judgment indicates that the directors knew that its transactions were connected with VAT fraud.

 

127.              It was implicit in the evidence of Mr. Norris and Mr. Murphy that Flashpoint was able to pass title to goods which it possessed to its customers but for which it had not made payment and which were not the subject of a credit agreement with their supplier.  Quite how it was said to be able to do so was unclear to us.  In our judgment, the evidence on the point was, to say the least, vague and unconvincing: in the absence of a credit agreement Flashpoint would ordinarily have required permission to export but none was obtained.  However, Flashpoint was not alone in dealing with goods it did not own in the absence of a credit agreement or guarantee of payment; so too did all the other buffers in the various chains of transactions with which we are concerned.  As the tribunal in Pharmaquim Ltd v Revenue & Customs [2010] UKFTT 279 (TC) chaired by the present Judge, observed when dealing with a situation in context similar to the present one, it defies logic and commercial reality that each trader in a transaction chain was willing to, or indeed did, relinquish possession of goods of substantial worth the subject of a contract of at best uncertain and at worst no terms and conditions without payment having been made for them, or any security given or arrangements for payment having been made. As the Commissioners explained in the Statement of Case, the risk therefore was borne by Flashpoint’s suppliers and customers – a highly implausible fact in the context of ordinary arm’s length trading.  However, as the Commissioners went on to say, it was perfectly intelligible in the context of artificially contrived deals.  Even if Flashpoint traded with its counterparties on a basis that removed all its own risk, it should at least have questioned why those counterparties were prepared to take such massive risks on Flashpoint, a company unable to finance the VAT on its purchases from its own resources pending repayment of the input tax on its broker transactions.

 

128.              Equally illogical to us is that, notwithstanding that a supplier retained whatever title it might have had pending payment, the trader acting as broker was permitted to export the goods.  Further, despite not owning such goods or having demonstrable authority to export them, again illogically, each trader continued to trade them until the foreign customer behaved atypically and paid its supplier, whereupon payments cascaded down the chain of transactions, and title correspondingly ascended it.  Why the foreign customer unilaterally decided to pay, we are unable to understand: it was an unbelievable and illogical act, and a step no legitimate trader would have taken.  The customer was at risk on the money it had paid until the goods were released to it.  And where the money had to move from one end of a chain to the other for title to pass each party involved must have been well aware that it was not merely relying on its own counterparties, but also on all the other parties in the chain of whose number, identities and whereabouts, if we are to believe Flashpoint’s directors, were unknown to those parties.  In our judgment, it is impossible to believe that such a remarkable show of trust would have existed between legitimate traders where locating the goods after they had moved through numerous chains would have been impossible, or virtually impossible.  We regard the matters referred to in this paragraph as compelling evidence of Flashpoint’s directors knowing that its transactions were connected with fraud.

 

129.              As we observed at [35], in the 14 months to 31 March 2005 Flashpoint’s turnover was £1.952 million, but in the following 12 months it increased to £13.8 million.  That the company was able to increase its turnover so greatly, and without any increase in staff, whilst having capital at most of £70,000, in our judgment, warranted explanation.  No explanation was offered beyond a claim by Mr. Norris that that was the way in which the grey wholesale market in CPUs operated.  We are unable to accept that the genuine wholesale market operated as Mr. Norris claimed; in our judgment, Flashpoint’s transactions bore all the hallmarks of fraud, as the directors must have been aware.  If Flashpoint’s 2006 business model was, as Ms. Tanchel submits, a genuinely profitable proposition, it would have been so for hundreds, if not thousands, of small undercapitalised companies throughout the land, all of which would have been able to trade, indeed compete directly, with large public companies which had built up capital over many years is, in our judgment, further clear evidence that Flashpoint’s trade was not legitimate.  That did not happen in the real world of commerce.

 

130.              There are two other submissions of Mr Kerr with which we must deal. First, Flashpoint having conceded that its deals were part of a fraudulent scheme, Mr Kerr submits that the object of the scheme must have been to generate moneys for  disposal by its organisers, and the input tax repayment claims made by Flashpoint would have been part of the proceeds thereof. He therefore maintains that it would have been irrational of the organisers of the scheme to involve Flashpoint in the deal chains if it were not a knowing participant, for how else would the organisers have obtained the whole or any part of the proceeds generated by the repayment claims?  We agree with the submission, but in isolation it takes the question of Flashpoint’s knowledge or means of knowledge of a connection with VAT fraud little further.

 

131.    Secondly, as to a claim by Flashpoint that the quantum of its repayment claim was out of all proportion to the total value of the related defaults identified by the Commissioners, and that was inconsistent with Flashpoint having knowledge of the fraud, Mr Kerr submits that the argument is inconceived. He maintains that the repayment claim generated by Flashpoint was but part of the proceeds generated by the fraud; the remainder would have been generated by other brokers within the same fraudulent scheme. Mr Kerr observes, quite correctly, that in order to establish knowledge on the part of Flashpoint it is unnecessary for the Commissioners to demonstrate that the company was aware of the full extent of the scheme, or of the identity of the other participants in it: they merely have to establish that Flashpoint by its directors was aware that its transactions were connected to the fraudulent evasion of VAT.  Again, there is substance in the submission, but once more, viewed in isolation, it takes matters little further.

 

132.              We should record that in reaching our conclusion we have considered most carefully the submissions of both parties, and our decision reflects them as read in the context of all the evidence.

 

133.              The failure of Mr. Norris and Mr. Murphy to make full enquiries and investigations before Flashpoint entered into purchase contracts with Techcomp and sales contracts with its customers in Hong Kong and the USA meant that Flashpoint did not discover information that would have led them into making further enquiries.  The result was that, in our judgment, Flashpoint became committed without sufficient protection to enter into transactions with Techcomp linked to the defaulting traders identified by the Commissioners.  Had the directors put appropriate questions to those with whom Flashpoint was trading, we are satisfied that they would have had no alternative but to conclude that the uncommercial aspects of the deals being offered could be explained only by taking into account other transactions Techcomp had entered into, and those other transactions were connected in some way with VAT fraud.

 

134.              Our overall conclusion, based on the entirety of the evidence, is that Mr. Norris and Mr. Murphy did not take every precaution which could reasonably have been required of them to ensure that Flashpoint’s transactions did not involve it in participation in tax evasion.  That finding is justification for our holding that, applying [61] of Kittel, Mr. Norris and Mr. Murphy “knew that, by [their] purchase, [they ie Flashpoint] was taking part in a transaction connected with the fraudulent evasion of VAT”.  The Commissioners have proved that Flashpoint’s state of knowledge was such that its purchases were outside the scope of the right to deduct input tax (see [81] of the judgment of Moses LJ in Mobilx). We therefore dismiss the appeal.

 

135.              Mr Kerr made application for the Commissioners’ costs of the appeal in the event of it being dismissed. We grant his application in that behalf, and direct that Flashpoint pay the Commissioners’ costs of and incidental to and consequent upon the appeal, such costs to be calculated on the standard basis, and assessed by a costs judge of the High Court in default of agreement.

 

136.              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.

 

 

DAVID DEMACK

TRIBUNAL JUDGE

Release Date: 1 June 2011

No.	Deal No.	Supplier	Purchase invoice date	No. of CPUs	Price ex VAT	VAT	Customer	Sale invoice date	No. of CPUs	ZR sale price
1	3	Techcomp	18/1/06	1260	114975.00	20120.63	Right Deal	18/1/06	1260	120254.40
2	6	Techcomp	31/1/06	1575	116550.00	20396.25	Felton	1/2/06	1575	120604.48
3	7	Techcomp	7/2/06	1260	112014.00	19602.45	Eternal	6/2/06	630	58407.30
4	10	Techcomp	7/2/06	1260	112014.00	19602.45	Right Deal	7/2/06	630	58205.70
5	11	Techcomp	13/3/06	924	69069.00	12087.08	Felton	13/3/06	924	71619.24
6	12	Techcomp	-	630	51345.00	8965.38	IDA	13/3/06	630	52575.83
7	13 a and b	Techcomp	23/3/06	1575	133481.25	23357.22	Right Deal	23/3/06	1575	137644.92
8	14 a	Techcomp	9/3/06	630	46935.00	8213.63	Felton	9/3/06	630	48518.30
9	14 b	Techcomp	9/3/06	945	74655.00	13064.63	Felton	9/3/06	945	77130.91

THE SCHEDULE

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

125829.27

 

* Although Deal 13 was divided into 2 transactions, identified as (a) and (b), due to the deal chain leading to Techcomp having taken two separate routes, from Techcomp it consisted of a single transaction.