First-tier Tribunal (Tax)

(1)        The appellant has been unable to trade since May 2006 because of the refusal to repay input tax. The appellant says that it is not in a position to fund representation to fully argue this appeal on the merits. In the circumstances the Appellant says that it cannot have a fair hearing.

(2)        As a matter of law, even on the respondents’ factual case they have no power to deny input tax credit where the connection with fraud is alleged to be via a contra trader.

(3)        There is no objective evidence that the appellant knew or should have known that its transactions were connected with fraud.

(1)        Background facts

(2)        Analysis of the law

(2.1)       Requirement for a domestic statutory provision

(2.2)       Application of Kittel to contra trading

(2.3)       Guidance as to the practical application of Kittel

(2.4)       Fair hearing

(3)        Detailed Findings of Fact

(4)        Decision on Knowledge

(5)        Should the Appellant have known of the Connection with Fraud

(6)        Conclusion

(1) Background Facts

The Transactions and Associated Payments

(2) Analysis of the Law

(1)        where the tax authorities find that the right to deduct has been exercised fraudulently, those authorities are permitted to claim repayment of the deducted sums retroactively (at [55]);

(2)        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 fraud must be regarded as a participant in that fraud (at [56]);

(3)        that is the case, irrespective of whether or not the taxable person profited by resale of the goods (at [56]);

(4)        that is because in such a situation the taxable person aids the perpetrators of the fraud (at [57]).

“…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.”

(1)        In the absence of a domestic statutory provision, the respondents have no power to refuse the input tax credit even where there is a connection with fraud.

(2)        The principle in Kittel does not apply to contra trading.

(2.1)  Requirement for a Domestic Statutory Provision

“ Member States may impose other obligations which they deem necessary to ensure the correct collection of VAT and to prevent evasion, subject to the requirement of equal treatment as between domestic transactions and transactions carried out between Member States by taxable persons and provided that such obligations do not, in trade between Member States, give rise to formalities connected with the crossing of frontiers.

The option under the first paragraph may not be relied upon in order to impose additional invoicing obligations over and above those laid down in Chapter 3.”

 “54. … Community law cannot be relied on for abusive or fraudulent ends …

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

 56. In the same way,  a taxable person who knew or should have known that, by his purchase, he was taking part in a transaction connected with fraudulent evasion of VAT must, for the purposes of the Sixth Directive, be regarded as a participant in that fraud …”

(2.2)  Application of Kittel to Contra Trading

“The authoritative statement of the principle given by the Court at [56] and [61] of its judgment in Kittel is not qualified in this way, and such an arbitrary and excessively narrow focus would not accord with the usual purposive approach to interpretation of EU legislation.”

“The principle of legal certainty provides no warrant for restricting the connection, which must be established, to a fraudulent evasion which immediately precedes a trader’s purchase ... He is a participant whatever the stage at which the evasion occurs.”

(2.3)  Guidance as to the Practical Application of Kittel

“The test in Kittel is simple and should not be over-refined. It embraces not only those who know of the connection but those who ‘should have known’.”

“If a taxpayer has the means at his disposal of knowing that by his purchase he is participating in a transaction connected with fraudulent evasion of VAT he loses his right to deduct, not as a penalty for negligence, but because the objective criteria for the scope of that right are not met.”

“If a trader should have known that the only reasonable explanation for the transaction in which he was involved was that it was connected with fraud and it turns out that the transaction was connected with fraudulent evasion of VAT then he should have known of that fact.”

“... 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.”

“If he [the trader] chooses to ignore the obvious inferences from the facts and circumstances in which he has been trading, he will not be entitled to deduct.”

(2.4)  Fair Hearing

(1)        The respondents had refused a request for funding of legal expenses by way of an interim payment of £60,000 from the sum in dispute.

(2)        The appellant was unable to fund counsel’s opinion on the contra trading evidence. It was limited to funding counsel’s submissions on the law and a limited cross-examination of two of the respondents’ witnesses.

(3)        The appellant was unable to fund its own expert evidence to counter that relied on by the respondents.

“ It is clear from the case law that national legislation determining conditions for repayment of excess VAT which are more onerous for one category of taxable persons because of a presumed risk of evasion, without making any provision for the taxable person to demonstrate the absence of tax evasion or avoidance in order to take advantage of less restrictive conditions, is not a means proportionate to the objective of combating tax evasion and avoidance and has a disproportionate effect on the objectives and principles of the Sixth VAT Directive.”

(1)        It is central to the concept of a fair trial, in civil as in criminal proceedings, that a litigant should not be denied the opportunity to present his or her case effectively before the court and that a litigant should be able to enjoy equality of arms with the other party.

(2)        The institution of a legal aid scheme constitutes one of those means but there are others, such as procedural measures which in appropriate circumstances might include the making of an interim payment.

(3)        The question whether legal aid or some other procedural measure is necessary for a fair hearing must be determined on the basis of the particular facts and circumstances of each case. It will depend inter alia upon the importance of what is at stake for the litigant, the complexity of the relevant law and procedure and the litigant’s capacity to represent him or herself effectively.

(4)        The right of access to a court is not, however, absolute and may be subject to restrictions, provided that these pursue a legitimate aim and are proportionate It is not incumbent on the State to ensure total equality of arms between a litigant and the opposing party, as long as each side is afforded a reasonable opportunity to present his or her case under conditions that do not place him or her at a substantial disadvantage.

(1)        Mr Lewis had no opportunity to correct any errors there might have been in his witness statement.

(2)        The witness statement was adduced by the respondents and they must accept the contents of the statement. They would not be entitled to cross-examine their own witness and there was no question of Mr Lewis being a hostile witness.

(3) Detailed Findings of Fact

(1)        Are there tax losses in transaction chains  leading to dispatches by Blackstar and Digikom?

(2)        If so, do those tax losses result from the fraudulent evasion of VAT?

(3)        If so, were the appellant’s transactions connected with the fraud?

(4)        If so, did the appellant know or should it have known of the connection with fraud?

Blackstar

(1)        Blackstar was on quarterly VAT returns. It commenced trading in or about December 2004 and by period 06/06 its net quarterly sales were some £305,657,432. The return for that period showed a net repayment of VAT claimed amounting to £3,896,978.

(2)        The trading in 06/06 comprised (i) 26 “broker deals” where Blackstar purchased from a single UK supplier (Red WM Ltd) and sold to a single EU customer (Vista Assistance), and (ii) 87 acquisition deals where Blackstar acquired goods from two EU suppliers (Avoset and Prabud) and sold to 10 UK traders, including the appellant, which then sold on either directly or through another UK trader to EU customers.

(3)        The 26 broker deals all traced back to two defaulters, Fastec Solutions Ltd and Bright Time UK Ltd. The deal chains were longer than the acquisition chains and included 3 or 4 UK companies. The same companies appeared regularly in the same order. Payments were arranged so that funds did not pass to the alleged defaulters.

(4)        The 87 acquisition deals all traced to a small number of EU customers. The deal chains were shorter than the broker chains and included only 2 or 3 UK companies. The same companies appeared regularly in the same order, but were not the same as those companies in the broker chains, apart from Blackstar.

(5)        Blackstar made consistently larger profits in its broker deals (between £1 and £2 per phone) than in its acquisition deals (between 10p and £1 per phone). Brokers in Blackstar’s acquisition chains always made a significantly greater profit than Blackstar. For example the appellant made a profit of between £21.50 and £23.50 per phone against Blackstar’s profits of either 40p or 45p.

(6)        Similar patterns appear in Blackstar’s earlier VAT periods, including period 03/06 where it also sold goods to the appellant.

(7)        Analysis of cashlows based on evidence originating from FCIB shows a circular flow of funds in a sample of Blackstar’s broker transactions. In addition, there was a circular flow of funds in the three acquisition transactions where Blackstar supplied the appellant.

Digikom

(1)        Digikom was on quarterly VAT returns. It commenced trading in or about May 2005 and by period 06/06 its net quarterly sales were some £223,428,201. The return for that period showed a net repayment of VAT claimed amounting to £7,435,637.

(2)        The trading in 06/06 comprised (i) 118 broker deals where Digikom purchased from UK suppliers and sold to three EU customers (Phista Trading, Scorpion Electronics and Estocom Distribution), and (ii) 109 acquisition deals where Digikom acquired goods from four EU suppliers (Dunas & Pinheiros, Powertec, Georitual Unipessoal and Prabud) and sold to six UK traders including the appellant which then sold on either directly or through another UK trader to EU customers.

(3)        The 118 broker deals all traced back to two defaulters, Pentagon (UK) Ltd and UR Traders Ltd. Payments were arranged so that no funds passed to the alleged defaulters.

(4)        Digikom generally made much larger profits in its broker deals (up to £15 per phone) than in its acquisition deals (40p to 45p per phone). Brokers in Digikom’s acquisition chains always made a significantly greater profit than Digikom. For example the appellant made a profit of between £10.50 and £14.50 per phone against Digikom’s profits of either 20p or 25p.

(5)        Similar patterns appear in Digikom’s earlier VAT periods including period 03/06 where it also sold goods to Greystone which in turn sold goods to the appellant.

(6)        Analysis of cashlows based on evidence originating from FCIB shows a circular flow of funds in the three acquisition transactions where Digikom’s customer Greystone supplied the appellant.

(7)        Visits to freight forwarders purportedly used by Digikom disclosed no physical movements of mobile phones on dates when Digikom’s transaction documentation would suggest mobile phones were moving.

Are there Tax Losses?

Do the Tax Losses result from Fraudulent Evasion?

(1)        Legitimate grey market trading is unlikely to involve long deal chains. This is because greater profits will be available to traders in shorter deal chains and unless a trader “adds value” that trader would be “vulnerable to disintermediation”. By this term Mr Fletcher was referring to the likelihood that traders who do not add value would in practical terms be excluded from participating in any profits available in the grey market.

(2)        Long deal chains might conceivably occur, but only on isolated occasions and not where the same parties appeared in the same position in the deal chains.

(3)        The greatest profits in the legitimate grey market are likely to be earned by traders who are close to both an authorised distributor or mobile network operator on the one hand and the retailer or end customer on the other. A short deal chain is one which has only one wholesaler between the authorised distributor or mobile network operator and the retailer or end customer.

(4)        Transactions which comprised an unreasonable proportion of the total volume of a particular model of mobile phone traded in the authorised market were unlikely to be legitimate grey market transactions.

(5)        Grey market arbitrage trading in Nokia phones was unlikely to occur because of Nokia’s homogeneous pricing policy across all European markets.

Were the Appellant’s Transactions connected with Fraud?

Did the Appellant Know of the Connection with Fraud?

(1)        There is no evidence that in entering into the transactions Mr Lewis agreed key terms which we would expect to be agreed. In his witness statement Mr Lewis refers to discussion of detailed terms, mentioning price and delivery. However the deal documentation supplied by the appellant makes no reference to dates of payment or dates of delivery.  The one exception to this is purchases from Greystone where Greystone include a date of delivery on their invoice and their purchase order, although it was invariably the same date as the invoice. We find this very strange in what Mr Lewis himself described as “a market involving fast changing demand [where] prices are unstable” and a market where “a supplier would not want the goods sitting on the warehouse floor waiting for a drop in price”. Mr Lewis recognised in his witness statement the difficulties that could arise were a supplier to promise stock on a specific day but fail to keep that promise. We find it very surprising that these terms were not agreed or recorded in writing.

(2)        The key dates identified for each of the deals in the table above demonstrate that inspection of goods did not occur until several weeks after the deal was agreed and invoiced. In Deal 6 the inspection was some 5½ weeks after the deal was agreed. Generally inspection took place 1 or 2 days prior to the goods being shipped out of the UK. There is no explanation as to why the deals should be concluded and the mobile phones then left “sitting on the warehouse floor” to use Mr Lewis’ words for so long.

(3)        As far as payment is concerned, Mr Lewis said that he “would expect to be paid as soon as the customer could do so”. Again we find that strange in commercial deals involving millions of pounds. In fact the payments generally took place several weeks after the date of shipment. There were exceptions to this. In Deals 1 and 2 the appellant made a relatively small part payment shortly after the deal was agreed but most of the price was paid 4 weeks after shipment. In Deals 4 and 6 payments were made some 2 weeks prior to shipment.

(4)        In Deals 1-6 where the appellant was involved in circular fund flows it made payments to its supplier within about 10 minutes of being paid by its customer. There is no explanation from Mr Lewis as to how and why he ensured that payments were made so quickly. In his witness statement he simply states that it was important to immediately pay the supplier once the appellant had been paid by its customer.

(5)        We accept that the basis of the deals was what Mr Lewis described as “ship on hold”. The appellant was permitted by the supplier to ship the goods to a location specified by the appellant’s customer. However the goods would not be released until both the supplier and the appellant had authorised release. Release would not take place until payment had been received.

(6)        There is no evidence that the appellant gave authority for its customers to inspect the goods at any stage.  Mr Lewis in his witness statement simply refers to his “understanding” that his customer would arrange to inspect the goods. Similarly there is no evidence that the appellant authorised SPF to release the goods to its customers.

(4) Decision on Knowledge

(5) Should the Appellant have Known of the Connection with Fraud?

(1)        He was aware there was a serious risk of fraud in the market which ought to have caused him to be cautious in his dealings.

(2)        He was able to make large profits on rapidly increasing turnover in circumstances which he ought to have regarded as too good to be true.

(3)        He had no material from which he could form any reasonable opinion as to the commercial risks of dealing with Nano and Olympic.

(4)        He was being presented with deals and funding for those deals in circumstances where he ought to have realised the deals were not legitimate commercial transactions.

(6) Conclusion

JONATHAN CANNAN

TRIBUNAL JUDGE

RELEASE DATE: 30 January 2014