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Hindforce Ltd v Customs and Excise [2005] UKVAT V18920 (18 January 2005)

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18920

INPUT TAX – Carousel fraud – Appellant innocent trader – Bondhouse Systems Ltd and Optigen Ltd & Fulcrum Trading Co (UK) Ltd considered – Appeal adjourned until release of European Court decision in the case of Bondhouse

LONDON TRIBUNAL CENTRE

HINDFORCE LTD Appellant

and –

THE COMMISSIONERS OF CUSTOMS AND EXCISE Respondents

Tribunal: MISS J C GORT (Chairman)

MRS R JOHNSON

Sitting in public in London on 8 September 2004

Mr A Webb, director, for the Appellant

Mr Hugh Mackay of Counsel, for the Respondents

© CROWN COPYRIGHT 2005

DECISION

This is an appeal against a decision of the Commissioners contained in a letter dated 11 March 2004 rejecting a claim for repayment of VAT in the amount of £216,300. The claim arose out of two transactions, one made on 10 July 2003 and the other on 17 July 2003. The Commissioners consider both transactions to be devoid of economic substance because they consider that the amount claimed as value added tax on the purchases was not input tax within section 24(1) of the Value Added Tax Act 1994.

The Appellant was incorporated on 8 April 1997 and has been registered for value added tax since 1 March 2000 as a trader in computer components.

It was accepted by Mr Mackay on behalf of the Respondents that in this appeal the burden of proof was on the Respondents and that the standard was a high degree of proof. He also made clear that, although the Commissioners were of the view that the two transactions were not supplies within the meaning of the VAT legislation on the basis that the transactions were devoid of economic activity because there was a "carousel fraud", nonetheless no wrongdoing was alleged against this Appellant.

The transactions in question involved the purchase by the Appellant of "platinum XXX cards" from a company called Vanguard Plc ("Vanguard"). The cards in question were internet access cards to a pornographic website. The Appellant sold the cards to a company called Solid Trading APS ("Solid") in Denmark.

The law

Article 2(1) of the Sixth Directive (77/3888), states:

"The following shall be subject to value added tax:

The supply of goods or services effected for consideration within the territory of the country by a taxable person acting as such;

The importation of goods."

Article 4(1) ibid defines a "taxable person" as:

"… any person who independently carries out in any place any economic activities specified in paragraph 2, whatever the purpose or results of that activity."

Article 4(2) ibid specifies the activities that are economic activities:

"The economic activities referred to in paragraph 1 shall comprise all activities and producers, traders and persons supplying services including mining and agricultural activities and activities of the profession. The exploitation of tangible or intangible property for the purpose of obtaining income therefrom on a continuing basis shall also be considered an economic activity."

Article 5 ibid defines the supply of goods as the transfer of the right to dispose of tangible property as owner. Article 6 defines the supply of services as any transaction which does not constitute a supply of goods within the meaning of article 5. Articles 17-20 set out the rules governing a person's right to deduct VAT charged to him.

The provisions of the Sixth Directive are implemented in the UK by way of sections 1, 3-5, 24-26 and Schedule 4 of the VATA 1994 and regulations 99-160 of the Value Added Tax Regulations 1995.

The evidence

An agreed bundle of documents was produced. The Tribunal heard oral evidence from Mr Alan Joseph Webb on behalf of the Appellant and from Mr Fu Sang Lam, Mr Roderick Guy Stone, Mr Peter David Wyatt, Mr Robert Charles Ross, officers of Customs and Excise, Mr Peter Richard Birchfield, senior executive officer, and Mr Gordon Arthur Young, another officer of Customs and Excise.

The facts

We find the following facts. Mr Webb had worked in the textile industry for some years. He had been involved in sales and marketing, and had dealt with companies outside the UK which were both inside and outside the EU. Some fifteen years ago he had gone into the computer industry. Through working in the computer industry he was aware that when purchasing computer products he had to make sure that he was dealing with the manufacturer or the main distributor of a product, and that it was necessary to make sure that a supplier was substantial. At the time of the appeal he was the managing director of the Appellant company, but his wife had originally owned the company and had been a director. She had recently resigned and Mr Webb had only become a director since the two relevant transactions. In July 2003 his wife had been a director of the Appellant company and Mr Webb worked for the company, buying and selling components.

Mr Webb had been introduced to Solid by a friend. The man Mr Webb dealt with at Solid is called Martin Matthieson. Mr Matthieson told Mr Webb that he was not interested in negotiating a cheaper deal with Vanguard. Mr Webb was asked if he would purchase things from suppliers nominated by Solid and pay the price specified by Solid. He had negotiated a deal with Solid that he would have a 4% commission on all transactions. He was to purchase the platinum XXX cards from Vanguard. It was Mr Webb's understanding that Vanguard itself was the main distributor. Mr Webb arranged transport of the cards to Denmark using a company called Walker Freight. This was not a company usually used by the computer industry. Solid paid the freight to Denmark. Mr Webb took the precaution of photographing all the cards that he was exporting. He also recorded the numbers of the cards and he obtained a letter from Solid and letters from the supplier, Vanguard, saying that they were the distributors. Vanguard was a public company which Mr Webb believed indicated that it was respectable.

The Appellant paid Vanguard for the goods in three instalments. Mrs Webb gave instructions for payments of £775,000, £300,000 and £183,000 to be made, although the instruction in respect of the last payment was never signed by her. The last sum had not been paid at the time of the hearing and the Appellant still owed Vanguard £183,000. Solid had paid the Appellant by transferring money to its bank to pay for the goods.

Although Mr Webb believed that Vanguard was the main distributor of the cards, this was not in fact the case. On 10 July 2003 a company called Phone Systems Ltd purchased 4,000 cards (with 45 hours viewing) and 2,500 cards (with 100 hours viewing) from a company called Mobile Link UK Ltd for £160,000 plus VAT of £28,000. Mobile Link had in fact had its VAT registration hijacked. This was confirmed by Mr Lam who had visited the offices of Mobile Link UK Ltd and a director of the company confirmed that sales invoices dated 10 July 2003 and 17 July 2003 for the supply of platinum XXX phonecards to Phone Systems Ltd were not theirs, they had never traded in those phonecards and had no knowledge of these transactions. The format of the sales invoices was one which was not used by the company. The following events, which the Commissioners rely on as evidence of a carousel fraud, then took place:-

• Big Store Ltd on the same day purchased an identical number of cards from Phone Systems for £160,260 plus VAT;

• A company called Powergate purchased an identical number of cards from Big Store for £160,650 plus VAT;

• Vendon purchased an identical number of cards from Powergate for £161,300 plus VAT, but only paid Powergate £1,527 and then Vendon paid a total of £188,000 to Solid on the instructions of Powergate;

• Vanguard purchased an identical number of cards from Vendon for £163,200 plus VAT;

• The Appellant purchased an identical number of cards from Vanguard for £164,800 plus VAT;

• The Appellant sold those cards to Solid at an invoice price of £171,420;

• Solid sold an identical number of cards to Ideal Hardware Ltd in Hong Kong for £171,745. (It was the Commissioners' belief that the cards were not exported to Hong Kong, but the only evidence to this effect was circumstantial evidence showing that there had been deliveries by Solid to a storage company in the UK. We make no finding as to whether or not the cards were ever exported.)

On 17 July there was a similar chain of transactions also considered by the Commissioners to show that there was a carousel fraud, as follows:

• Phone Systems purchased 20,000 cards (with 45 hours viewing) and 20,000 cards (100 hours viewing) from Mobile Link for £1,040,000 plus VAT of £18,200 (this figure is not that shown on the Appendix produced by the Commissioners, but is the figure shown on the relevant invoice, which was the second invoice which Mobile Link said had not come from them);

• Bigstore purchased an identical number of cards from Phone Systems for £1,041,600 plus VAT;

• Powergate purchased an identical amount of cards from Bigstore for £1,044,000 plus VAT;

• Vendon purchased an identical number of cards from Powergate for £1,048,000 plus VAT; but only paid Powergate £9,400 and paid a total of £1,222,000 to Solid on the instructions of Powergate;

• Vanguard purchased an identical number of cards from Vendon for £1,060,800 plus VAT;

• The Appellant purchased an identical number of cards from Vanguard for £1,071,200 plus VAT;

• The Appellant sold those cards to Solid at an invoice price of £1,114,200;

• Solid sold an identical number of cards to Ideal Hardware in Hong Kong for £1,116,200. (As with the previous purported sale to Hong Kong, the Commissioners do not believe that the cards were exported to Hong Kong, but again there is no sufficiently reliable evidence to this effect for the Tribunal to make a finding in that regard.)

The type of cards which were the subject of the various sales were previously unknown to the Commissioners. The Commissioners undertook an in-depths investigation into the various transactions involving these cards. Whilst Mr Webb personally had experience in building computer systems, and was experienced in sales, and described himself as a sourcer of products generally, there was no evidence that he had any specific knowledge of the cards in question. The Commissioners cast doubt on the commercial reality of the various transactions because the product was unknown, there was a sudden onset of trade in millions of pounds worth of the cards by traders with no previous experience of trading in that particular product. Enquiries were made in the Czech Republic and in Denmark. Information from the Czech Republic showed that over a seven month period only 13,000 "hits" had been recorded on the website in question, whereas 1.6m cards had been sold. This showed that less than 0.5% of the cards sold had been used. The banking records of Solid's UK bank account were obtained. Those bank records show inter alia a debit of £171,420 to Hindforce on 14 July 2003, a series of credits from Vendon UK Ltd on 16 July, five in total varying between £94,000 and £1,080,000, debits to Hindforce on 17 July of £900,000 and £214,200, and on the same date four payments from Vendon UK Ltd varying between £171,535 and £603,453.38. Of the 1.6m cards which passed through the records of all the various traders concerned, 1.5m of those cards were purchased by Solid.

Mr Birchfield gave evidence of an officer (who did not give evidence before us) having viewed the site in the Czech Republic using seven of the cards, who had found that in some cases the cards did not last for the length of time which they were supposed to, and in others they would not allow re-admission to the site having been used once, even though a large proportion of the 100 hours' viewing which they purported to provide had not been used. Furthermore the cards could not be activated after 31 December 2003 and it was also possible to obtain the same type of viewing or, better viewing, for free. The cards in question were scratch cards which contained a PIN number. This evidence was not contested by the Appellant.

Robert Charles Ross was the officer who had established the chains of supply. He had also made enquiries of the Danish tax authorities about Solid and the sale of the platinum XXX cards to Ideal Hardware of Hong Kong.

The records of Powergate Ltd showed that the invoices from his supplier, the Bigstore Ltd, were accompanied by instructions to pay the bulk of invoice demands to the account of Solid Trading at the London branch of the Nordea Bank Finland. Powergate passed these instructions to Vendon Ltd. Vendon's bank statements were obtained with other records from a director of the company and showed regular payments to Solid's account. The amounts were large but were not the same as the amounts contained in the payment instructions received from Powergate.

There were no purchase invoices from Solid Trading in Vendon's records to justify the regular large payments to Solid Trading. Vanguard regularly paid Vendon and the amounts paid did not correspond with specific invoices. The Appellant's records, provided by Mr Webb at the time of a visit by Mr Ross on 4 September 2003, contained credit advices from HSBC showing that Solid paid Hindforce for the cards supplied from the same bank account that Vendon had been paying money into. Because of the circularity of movement of the goods and money, Mr Ross wrote to the Appellant on 11 March 2004 informing the company of the decision to disallow the input tax claim on the grounds of non-economic activity.

Mr Webb's contact at Solid had not explained to him the inconsistency in his ordering the cards direct from Vanguard and also ordering them from the Appellant. Mr Webb had been asked to do a further deal by Solid on the same terms as previously, but he had not at the time of the hearing carried out that deal.

The Respondents' case

It was the Commissioners' case that the sums claimed by the Appellant did not constitute input tax within the meaning of the Value Added Tax Act 1994 since the chain of supply, including the supplies made to and by the Appellant, constituted a `carousel fraud', and a carousel fraud does not give rise to valid claims to input tax.

It was submitted that it did not matter whether the Appellant undertook due diligence on his suppliers or customers, nor that he would be caused hardship by the Commissioners' refusal of his input tax claim. It was the objectively ascertained characteristics of a chain of transactions that determined whether they were "economic activities" within the meaning of that term as it is understood for VAT purposes.

In the present case, the starting of the chain was the hijacking of Mobile Link UK Ltd's VAT registration number. The subsequent chain of transactions were all part of the carousel fraud. The Appellant received no supplies used for the purpose of any business carried on (or to be carried on) by it, so that any amount which it paid on account of purported VAT in respect of the purchases were not input tax within the meaning of section 24 of the VAT Act 1994, and the supplies were not supplies made in the course of business for the purposes of VAT. As there were no supplies for VAT purposes, no entitlement to claim input tax attributable to making such supplies arose under section 26 of the VATA 1994. The Appellant's purchases and sales were devoid of economic substance and were not part of any economic activity. The money paid for the cards purchased by the Appellant from Vanguard and sold to Solid in the two transactions had passed between a number of other businesses in a continuous loop and, given the circular nature of the transactions, the transactions did not amount to supplies made in the course of business but were demonstrably part of a carousel fraud.

The bulk of the invoice amounts for transactions between Powergate and Vendon were paid by Vendon to the account of Solid at the London branch of the Nordea Bank Finland. Solid was paying Hindforce which demonstrated that the money was going in circles. It was submitted that it was an inescapable inference that there was a carousel fraud. A further indication that there was a fraud was that the payment by Vendon to Solid was equal to the amount disclosed by the Mobile Link invoice to Phone Systems. It was also significant that the people below Vendon in the chain only recovered a net profit plus VAT.

The Tribunal were invited to draw the inference from the evidence of Mr Young of goods returning to the UK on the instructions of Ideal Hardware that they were the same cards and that they were being returned to the UK and not going to Hong Kong. The fact that all the transactions had taken place in one day was characteristic of a carousel fraud, as also was the fact that the majority of the people involved only made a small mark-up. The fact that the commodity was unusual was a further hallmark of the carousel fraud. Furthermore only 0.5% of the cards had been used and the website had closed on 30 December 2003.

With respect to the legislation the Commissioners contended that:

(i) A broad purposive construction was to be given to the EC legislation; equally, the UK legislation, namely the VATA 1994, that implemented the EC legislation, the Sixth Directive, must be construed in conformity with EC law; Marleasing [1990] ECR 1-4135, per the ECJ at para 8.

(ii) One of the purposes of the Treaty of Rome was to establish within the framework of an economic union, an internal, or common market (articles 93 and 94 of the Treaty). It was the main objective of the Treaty to establish the common market within which there was "healthy competition and whose characteristics are similar to those of a domestic market" (first recital, First EC VAT Directive, 67/227/EEC ("the First Directive")). The purpose of the Sixth Directive was to achieve this objective of a common market through a common system of VAT that eliminated, as far as possible factors that distorted competition or hindered the free movement of goods and services. Thus both the Treaty and the Sixth Directive were concerned (and only concerned with) real economic activity.

(iii) Article 2 of the Sixth Directive was fundamental to the concept of VAT. The purpose of the Sixth Directive was to apply a tax on the consumption of goods and services in proportion to the price of those goods and services. The tax was only intended to stick to and be borne by the final consumer: Article 2 of the First Directive and Elida Gibbs [1996] STC 1387 per Advocate General Fennelly at paras 18-21 and ECJ at paras 26-33.

(iv) The taxable person who charged tax to his customers was entitled to deduct the VAT if he was liable to account for the VAT charged to him by his suppliers. But where the taxable person effected transactions which were exempt from VAT he had no right to deduction in respect of those transactions and he was, to that extent, regarded as the final consumer, by respecting the principle of fiscal neutrality: Case 80/81 Becker [1982] ECR 53.

(v) The tax only regulated transactions of genuine economic substance. For this reason both fictitious transactions and those where there can be no competition in a lawful economic sector were outside the scope of the tax : Fischer [1998] STC 708.

(vi) This purposive approach should be applied to the interpretation of the terms "supply" and "economic activity" in the Sixth Directive ("supply" and "business" in VATA 1994).

In the present case it appeared that the transactions were devoid of economic substance, and the sums paid by the Appellant to Vanguard ostensibly as VAT were not VAT. It therefore followed that they were neither "supplies" nor a part of any "economic activity" for the purposes of VAT. This was the rationale of the principles identified in Bondhouse Systems Ltd [2003} V&DR 210 and Optigen Ltd & Fulcrum Trading Co (UK) Ltd (Tribunal decision 18113). The Commissioners relied on paragraphs 34-36 and paragraph 39 of Optigen and in the present case relied particularly on the following facts:

(i) The Appellant had sold the cards to a company outside the UK, namely Solid, in Denmark;

(ii) The transaction chain contained someone using a "hijacked" VAT registration (Mobile Link);

(iii) There were third party payments which established the circularity to the supplies of the cards between Vendon and Solid;

(iv) None of the traders in the chain appeared to take the risk of trading at a loss, and that every trader sold on the total amount of goods purchased by it with a profit margin.

It was therefore submitted that:

(i) The transactions were circular and as such did not constitute economic activities;

(ii) On that basis, with regard to the relevant purchases by the Appellant, the Appellant received no supply used (or to be used) for the purposes of any business carried on (or to be carried on) by it, and thus any amount paid to its supplier purportedly in respect of VAT was not input tax within section 24(1) VATA 1994; and

(iii) The sale made by the Appellant was not a supply made in the course of a business for the purposes of VAT and, therefore, it could not be said that the Appellant incurred any input tax which might be attributed to the making of a taxable supply within section 26 VATA 1994.

The Appellant's case

Mr Webb is not a lawyer and he relied principally on the fact that he was an innocent party who had made all the necessary enquiries, as acknowledged by the officers of the Commissioners who gave evidence, and there was nothing further he could have done to ensure that he was not party to any fraud. In other words, he was a completely innocent trader. He further relied on the fact that his purchases had been made from a trusted public company and he therefore would have no grounds for suspicion. He pointed to the fact that the Commissioners had been unable to produce any particular card to show that it was one that he himself had exported. They were working on theory only, and had no concrete evidence for that theory.

The Tribunal having called for the production of the proceedings in the High Court, Mr Webb further relied upon the submissions made on behalf of the Appellant in the case of Bondhouse in a request for a preliminary ruling under article 234 of the EC Treaty by the High Court of Justice. Those submissions are set out in paragraph 19 of the Schedule to the Order made by the High Court staying proceedings in the appeal of Bondhouse until the Court of Justice has determined the questions put to it by the High Court. Those submissions are:

"… as the purchases and supplies made (by the appellant) actually took place, it cannot be asserted that they did not amount to "supplies" or the conduct of "economic activities", for the purposes of VAT, merely because, elsewhere in the chain of supply and unbeknown to the appellant, there was a fraudster who had charged VAT to a customer and not accounted for that VAT to the Commissioners. Further there is no rational basis for the belief that transactions taking place after the fraudster had carried out the fraud or before it, and involving persons who had no knowledge of the fraud or the fraudster, formed a part of the fraud or of the fraudster's plans. The tribunal's approach is inconsistent with the general scheme of the VAT system. As a means of combating VAT fraud, it is disproportionate and capable of having a general deterrent effect on legitimate trade, contrary to article 28 of the EC Treaty. It is also inconsistent with the principle of legal certainty because it produces a situation in which taxable persons cannot even issue invoices bearing VAT or complete their VAT returns with any degree of certainty."

Reasons for decision

The case of Bondhouse concerned a dealer in computer components, principally computer processor chips ("CPUs"). In that case Bondhouse purchased from another UK company and sold to a company in another member state. Bondhouse had bought CPUs at what it considered to be a fair market price plus VAT. Bondhouse was supplied with what purported to be a VAT invoice compliant with the relevant UK rules and the supplier accounted to the Commissioners for the amount it had charged by way of VAT. Bondhouse arranged delivery of the CPUs to its customers who, in turn, paid the agreed price at what Bondhouse considered to be a fair market value. Goods and payments changed hands, and the goods supplied were as described on the invoices. Bondhouse satisfied the UK requirements that had to be met if its supplies to registered traders in other member states were to be zero-rated: its invoices quoted the overseas customer's VAT number and the goods left the UK. As in the present case, Bondhouse made a VAT return claiming a repayment of the amount it had been charged by the way of VAT which it had incurred and, as in this case, the respondents refused the input tax claimed. In that case very large sums were involved and as a consequence Bondhouse decided to cease trading. At some later stage the Commissioners accepted that some of the claim to input tax was allowable but the remainder was not. However, recognising that financial difficulties were occasioned to Bondhouse the respondent paid to it over half of the remaining sum without prejudice to their objection in principle to the claim. The tribunal concluded that 26 of the 27 purchases the subject of the claim could not be regarded as economic activities within the meaning of the Sixth Directive and were outside the scope of VAT. Accordingly, the tribunal upheld the decision of the Commissioners not to pay Bondhouse's claim in respect of 26 of those purchases, and accepted that there was in existence a carousel fraud. Bondhouse applied to the High Court for an order making a reference to the European Court of Justice for a preliminary ruling on various questions arising out of the case. That application was granted.

The case of Optigen similarly concerned a carousel fraud. In that case also it was accepted by the Commissioners that Optigen was an innocent party to the transactions comprising the carousel fraud which again related to computer chips. The tribunal directed that the following issue be determined as a preliminary issue of law on the basis that all the factual contentions set out in the Commissioners' statement of case were correct:

"Is a trader entitled to credit for input tax on goods sold to him (and sold by him to companies outside the United Kingdom) when in the chain of supply of such goods there was a "missing trader" … or a trading using a "hijacked VAT number" … without in either case the trader who is claiming the credit being in any way concerned with or having any knowledge of such other traders' failure to discharge the liability or misappropriation of the VAT number?"

Having considered whether the principles of legal certainty, proportionality, equal treatment and interpretation in favour of the taxpayer prevented disallowing input tax to an innocent party the Tribunal concluded that the Commissioners were right in saying that Optigen's transactions were outside the scope of VAT as not being economic activities, and that there was no principle of European law that prevented that result. The Tribunal answered "No" to the question posed in the preliminary issue of law set out above.

Having found the facts as set out in paragraphs 11-12 above, and accepting as we do that (a) the burden of proof is upon the Commissioners albeit to a high standard, (b) that there was a carousel fraud for the reasons advanced by the Commissioners and (c) that the Appellant was totally innocent in respect of that fraud, it appears to us that as the law stands, we can only make one substantive decision in the appeal itself, which is to dismiss it. Whilst we are sympathetic to the Appellant's case, and believe that there is merit in the submissions which he has adopted from the High Court application in Bondhouse, nonetheless the only authorities on the matter are the two decisions of the tribunal in the cases of Optigen and Bondhouse, which, whilst they are not of themselves binding on this Tribunal, they are persuasive, and we find that there is no factual basis for distinguishing the present case from either of them.

However, we do have one other option, which is to stand this case over until the Court of Justice has determined the questions put to it by the High Court in the case of Bondhouse which are as follows:

Having regard to the general principles of EC law (in particular, the principles of proportionality and legal certainty) and to article 28 of the EC Treaty:

(a) In the relevant circumstances, was the Appellant a "taxable person acting as such" within art 2(1) of the Sixth Directive when, in the twenty-six transactions, it acquired the CPUs (the product concerned in the carousel fraud in that case) from the UK vendors and sold them to the non-UK purchasers?

(b) In the relevant circumstances, was the Appellant carrying on an "economic activity" within art 4 of the Sixth Directive when, in the twenty-six transactions, it acquired the CPUs from the UK vendors and sold them to the non-UK purchasers?

( c) In the relevant circumstances, was the acquisition by the Appellant, in the twenty transactions, of the CPUs from the UK vendors a "supply of goods" to the Appellant within art 5(1) of the Sixth Directive?

(d) In the relevant circumstances, was the sale by the Appellant, in the twenty transactions, of the CPUs to the non-UK purchasers a "supply of goods" by the Appellant within art 5(1) of the Sixth Directive?

Do the questions to question 1(a)-(d) above give rise to any breach of the general principles of Community law (in particular, the principles of proportionality and legal certainty)?

Before making a final decision in this case, we allowed both parties 14 days from the date of the release of a provisional decision to submit in writing reasons why this case should not be stood over until the European Court had answered the above questions. In the event of either party requiring us to take that course, then we would have done so. In the event that neither party wished us to do so, then we would have dismissed the appeal. By a letter dated 29 November the Appellant repeated the reasons for wanting us to allow the appeal, but if we were not so prepared to do then he requested that it be adjourned until the outcome of the ruling in the European Court. In the circumstances this appeal is adjourned. Costs reserved.

Liberty to apply.

MISS J C GORT

CHAIRMAN

RELEASED: 18 January 2005

LON/04/241