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Dragon Futures Ltd v Revenue & Customs [2006] UKVAT V19831 (25 October 2006)

19831

LON/2004/1461

2004/1462

2004/1826

2004/1854

2004/1880

2004/2303

2005/0117

Value added tax – Input tax – Meaning of "… of which that taxable person had … no means of knowledge" – Bond House Systems Limited and other cases applied

LONDON TRIBUNAL CENTRE

DRAGON FUTURES LIMITED Appellant

and –

THE COMMISSIONERS FOR HER MAJESTY'S REVENUE & CUSTOMS Respondents

Tribunal: DR DAVID WILLIAMS (Chairman)

MR J N BROWN CBE, FCA, ATII

MR C R SHAW FCA

Sitting in public in London on 17-18 July 2006

Michael Patchett-Joyce of counsel, instructed by DLA Piper Rudnick, solicitors, for the Appellant

Philippa Whipple and Andrea Strugo of counsel, instructed by the Acting Solicitor for Her Majesty's Revenue and Customs, for the Respondents

© CROWN COPYRIGHT 2006

DECISION

This decision sets out the views of the tribunal on questions for determination as part of the ongoing conjoined appeals to the tribunal. The appeals are against decisions of the Respondents to refuse the refund of input tax on certain deals undertaken by the Appellant. All involve the sale of mobile phones and other electronic equipment to customers in other European Union states.

The questions to be determined

The tribunal agreed with the parties that it would decide, by way of a further preliminary hearing, the questions set out below. They concern the current law under which national tax authorities withhold or refuse claims for credits or refunds of value added tax ("VAT") input tax where it is suspected that there is carousel fraud present in transactions connected with the transactions that give rise to the claims. It is common ground that the key question is primarily one of European Union law, not United Kingdom law. Other aspects are matters of national law.

It was agreed that the tribunal would without further request give full reasons for its decision and would publish those reasons. The reasons are to be considered with the decisions taken in previous proceedings of the tribunal in the conjoined appeals between the Appellant ("Dragon") and the Respondents ("HMRC", which abbreviation is also used to identify the Respondents' predecessors, the Commissioners of Customs and Excise). They are, in particular, to be read with the full decision of the tribunal on previous preliminary questions heard on 10 – 18 January, 3 and 23 March and 29 April 2005 ("the main preliminary decision"). Other decisions have been issued by the tribunal in these appeals but these have been by consent.

The main preliminary decision was taken following the decisions of the tribunal in the then separate appeals by Bond House and Optigen. It was directed with agreement that further questions about these appeals should await the decision of the European Court of Justice on reference in those cases. Since the decision of the European Court, the parties have made joint application to the tribunal to allow certain of the appeals. The tribunal allowed those appeals by consent. The parties could not agree about progress in handling the remaining appeals. With consent of both parties, the tribunal agreed a further hearing to consider and decide further questions of law within the context of these appeals. There are three further questions, the first two of which were fully agreed by the parties.

The first question is:

(1) What is the legal test that must be satisfied by the parties in the light of the decisions of the European Court of Justice in the conjoined cases of Bond House Systems Limited and others, Case C-484/03, of 12 January 2006, and the conjoined cases of Axel Kittel and Recolta Recycling SPRL v Belgium, Case 439/04 and any other relevant judgments and opinions, and in particular:

(a) what is meant by the expressions "of which that taxable person had … no means of knowledge" (Bond House judgment paragraphs 51, 53, 57) and "without that taxable person having any means of knowing" (Bond House judgment, paragraphs 52, 55, 57)?

(b) is the applicable test objective or subjective?

The parties have sharply different approaches to the answer to subquestion (a). But it is common ground that the answer to subquestion (b) is that the applicable test must be objective. As Mr Patchett-Joyce put it succinctly: means are objective. The tribunal agrees.

The second question is:

(2) Does direction (20) of the tribunal's directions of 23 November 2004 on the burden of proof remain appropriate, and if it does not what is the appropriate direction, if any, on the burden of proof in the light of the answer to question (1)?

Direction (20) placed the burden of proof on HMRC, not the Appellant, by agreement. No reasons were given for the direction, but it followed the similar direction by the tribunal in the Bond House appeal.

The third question is:

(3) In any event, is it now open to HMRC to maintain their defences to the current appeals on the basis of the disputed decisions, including any amendments to those decisions, and/or the reasons for them, and/or the statements of case in support of them, or must HMRC now make new decisions?

The text of this question was determined by the tribunal as the parties could not agree it. It refers to the original HMRC decisions from which the Appellant is appealing.

A The first question: "means of knowing"

The recent European Court decisions

Since these appeals were stood over, the European Court of Justice has considered the issue of carousel frauds in several judgments. The most important is Optigen Ltd, Fulcrum Electronics Ltd and Bond House Systems Ltd v Commissioners of Customs and Excise, Joined Cases C-354/03, C-355/03 and C-484/03 of 12 January 2006 ("Optigen"). Since then, the European Court of Justice has also decided: Axel Kittel v Belgian State and Belgian State v Recolta Recycling SPRL, Joined Cases C-439/04 and C-440/04 of 6 July 2006 ("Kittel") and Commissioners of Customs and Excise, Attorney General v Federation of Technological Industries and Others, Case C-384/04 of 11 May 2006 ("FTI"). All are decisions of the Third Chamber, with the same judge rapporteur, Judge von Bahr. Advocate General Poiares Maduro was Advocate General to two of the cases, and Advocate General Colomer was Advocate General to Kittel. As this tribunal was addressed about language versions of the appeals, it notes that the language of the Court was French in Kittel but English in the other cases.

The facts in these appeals

The tribunal makes no further findings of fact in this decision. It assumes that the facts found in the main preliminary decision, so far as still relevant, are the facts and describe the factual background for the purposes of its consideration of these questions. The tribunal therefore makes no attempt in these reasons to advance or duplicate the facts as found and summarised in its previous decisions.

The factual backgrounds to the European Court decisions

The first question requires the tribunal to consider Optigen and Kittel. Both concern, as does this case, claims for the refund or credit input tax paid to suppliers of goods where those goods were then sold by the taxable persons to purchasers elsewhere in the European Union. The context in all the cases (including all the deals under consideration in these appeals) is that the chain of transactions that included the purchase and sale giving rise to the claim for credit or refund also included, at some other earlier stage in the chain, activities that were, or were suspected of being, "carousel fraud". This concept was discussed in detail by the Advocate General in Optigen and Kittel and this tribunal considered the issues in its main preliminary decision.

The tribunal agrees with the parties that it is important to note the factual backgrounds to the decisions of the European Court. Optigen concerned a series of decisions of the tribunal on reference to the European Court of Justice from the English and Welsh High Court. The joined cases considered in Optigen either found or assumed that the taxable person claiming the credit or refund was an innocent party. The taxable person was not a direct participator in fraud or alleged fraud of the public through the value added tax system. But there was fraud elsewhere in the chain of sales to and from the taxable person. The key finding of the tribunal in its decision on Bond House was:

"even though Bond House did not know of that objective [fraud] and was innocent of any wrongdoing, those operations were devoid of economic substance".

This tribunal, in its main preliminary decision, explored how far the facts of these appeals were or were not devoid of economic substance. It found that in some of the appeals the tests were fully met and that in others they were not.

Kittel concerned cases referred to the European Court of Justice from the Belgian cour de cassation. In Kittel the tax authorities decided that there was carousel fraud with regard to computer parts and that the company for which Kittel was receiver had knowingly participated in that fraud. In the other joined case, Recolta, it was considered that there had been a circular series of sales of motor cars but that there was nothing to suggest that the company involved, Recolta, or its directors knew or had any suspicion that they were involved in a fraud. Under Belgian law, "an obligation with no basis or with a false or unlawful basis can give rise to no effect whatsoever" (Belgian Civil Code, article 1131). The tax authorities contended that in both cases the underlying contracts of sale and purchase breached this provision. They were therefore of no legal effect and could not be used to found an input tax credit or refund.

There is no directly similar provision to that in the Belgian Civil Codes in English and Welsh law (or, it is understood, in the law of Scotland or Northern Ireland).

FTI is a reference to the European Court of Justice from the Court of Appeal of England and Wales following a judicial review sought in the Administrative Court by 53 traders in mobile phones and computer processing units. The application concerned the compatibility of sections 17 and 18 of the Finance Act 2003 with Community law. This was a group action that did not rely on particular facts. It reviewed the provision (now in section 77A of, and Schedule 11, paragraph 4, to, the Value Added Tax Act 1994) imposing joint and several liability on traders in supply chains for supplying telephones and computers in certain circumstances.

Sections 17 and 18 are not directly part of these proceedings. But they do concern supply chains for telephone and computer parts that show, or may show, the features to which those sections attach specific consequences. The background to FTI is therefore similar to that in these appeals.

Optigen

The focus in Optigen was on the approach that trades within a carousel fraud were not economic activities. This was based on the approach taken within the United Kingdom (and supported before the European Court by several other member states) that the chain of transactions within which a carousel fraud occurred should be viewed as a whole. The Advocate General did not share that view in his Opinion of 16 February 2005. In his view such a fraud consists of a series of consecutive but separate activities and "each transaction must therefore be regarded on its own merits" (paragraph 27). This was, in his view, consistent both with case law and the principles of the common system of value added tax and of legal certainty. In taking this view, he rejected both the analysis of the case law presented by the United Kingdom and the argument that attention should be paid to the underlying purpose of such transactions. He also rejected the argument that there was an analogy between these cases and other cases where the Court held that unlawful activities fall outside the common system of value added tax.

His conclusion was strongly against the approach of the United Kingdom and other states supporting that approach. This was because "it would drastically shift the burden of the problem from the tax authorities to the private sector, at the expense of legitimate trade and the proper functioning of the value added tax system." He concluded that comment (in paragraph 42) by noting:

" … Article 21 of the Sixth Directive gives member states the opportunity to introduce joint and several fiscal liability. A taxable person can accordingly be held accountable for the payment of VAT due by his co-contractor, if he knew or should have known of his co-contractor's fraudulent activities. Several member states have adopted measures of that kind against carousel fraud."

The Advocate General indicates in a footnote that he was aware that the United Kingdom was one such state. He identified no exceptions to the general proposition that the VAT system required that each transaction in a supply chain be looked at individually.

The European Court approached Optigen as being one where "the trader claiming the refund was in no way involved in or had no knowledge of the failure of the other trader to fulfil its obligations or the hijacking of the VAT number, and these chains of supply which included the purchases and sales of the trader were part of a carousel fraud operated by third parties without its knowledge" (paragraph 16). The Court adopted its own version of the questions posed to it by the national court. It considered that:

"the referring court seeks essentially to know whether, first, transactions which are not themselves vitiated by fraud, but which form part of a chain of supply in which another prior or subsequent transaction is vitiated by such fraud, without the trader engaged in the first transactions knowing or having any means of knowing, constitute supplies of goods … and an economic activity …and, second, whether, in such circumstances, the right of that trader to deduct input VAT may be limited." (paragraph 29).

The key phrase "without … knowing or having any means of knowing" is in French:

"sans que l'opérateur … le sache ou puisse le savoir".

The first question to be determined by this tribunal requires the tribunal to establish the scope, within the European Court's answer to that question, of the expressions

"of which that taxable person had … no means of knowledge" (Bond House judgment paragraphs 51, 53, 57)

and

"without that taxable person having any means of knowing" (Bond House judgment, paragraphs 52, 55, 57)"

The tribunal agreed with the submission that it is proper to reflect within an analysis of that answer the precise language in the judgment (in both English and French) in which the tests are formulated and their textual derivations.

The Court agreed with the starting point of the Advocate General (in his paragraph 27 noted above). It also followed the Advocate General in rejecting the argument about intention. It drew on its judgment in BLP Group, Case C-4/94 [1995] ECR I-983 to reaffirm that any obligation on a tax authority to carry out enquiries into the intentions of a taxable person is contrary both to the principle of legal certainty and to the objective character of a transaction. It follows that an obligation on a tax authority to determine the intentions of another trader, or the fraudulent nature of another transaction, in a chain of transactions "of which that taxable person had no knowledge and no means of knowledge" is contrary to those objectives (paragraph 46).

It briefly distinguished the cases based on unlawful transactions. It then concluded:

"51 It follows that transactions such as those at issue in the main proceedings, which are not themselves vitiated by VAT fraud, constitute supplies of goods … and an economic activity … where they fulfil the objective criteria on which the definitions of those terms are based, regardless of the intention of a trader other than the taxable person concerned involved in the same chain of supply and/or the possible fraudulent nature of another transaction in the chain, prior or subsequent to the transaction carried out by that taxable person, of which that taxable person had no knowledge and no means of knowledge.

52 Nor can the right to deduct input VAT of a taxable person who carries out such transactions be affected by the fact that the chain of supply of which those transactions form part another prior or subsequent transaction is vitiated by VAT fraud, without that taxable person knowing or having any means of knowing."

In French, the italicised passages are:

"51 … dont cet assujetti n'avait et ne pouvait avoir connaissance …

52 … sans que cet assujetti le sache ou puisse le savoir…"

Both texts of paragraph 52 use the key phrase in paragraph 29 of the Court's reformulation of the question put. In formulating the answer in the final paragraph of this part of the judgment (paragraph 55) the Court uses first the phrase (in English and in French) from paragraph 51 and then the phrase (in both languages) from paragraph 52. It repeats this approach in its formal answer to the question.

The italicised passages introduce a new element to the analysis from that adopted by the Advocate General. In his Opinion (quoted above) the reference to "knew or should have known" was only in the context of the suggested legislative remedy to a problem for which in his Opinion the Advocate General (as interpreted by this tribunal) could see no jurisprudential solution. The Court moved away from what might be termed a "purist" view expressed by the Advocate General to one that admits of an exception.

The view of the tribunal is that the European Court is, in using this phrase, directly reflecting in, and accepting the relevance to, its answer of the criterion stated in question (1)(c) of the questions referred to it. Paragraph (c) sets out one of the criteria by which the referring court asked the European Court to give guidance. Its text is set out in paragraph 26 of the Court judgment:

"(c) the fraudulent acts and intention, whether arising prior or subsequent to the particular transaction, of other participants in the circular chain of whose involvement the trader is unaware and of whose acts and intentions the trader has no knowledge and/or means of knowledge

(c) des actes et intentions frauduleux, qu'ils aient lieu avant our après l'opération spécifique, d'autres acteurs de la chaîne circulaire dont l'implication est inconnu de l'opérateur et alors que celui-ci ne connaît pas et/ou ne peut pas connaître les actes et intentions desdits acteurs"

The European Court altered the immediate context of "has no knowledge and/or means of knowledge" when it reformulated the referred question. In doing so it broadened it out to cover both knowledge of the acts and intentions of specific traders and also knowledge of transactions vitiated by fraud. In both cases that knowledge is knowledge of any relevant prior or subsequent trader or transaction. It did not explore, and it was not asked to explore, the assumptions behind, or variations on, the criteria set out at question (1)(c).

The parties before this tribunal had sharply differing views about the importance and extent of the exception captured by the key phrases. The starting point of the discussion of that exception is to note the acceptance by the European Court of the relevance of the criteria expressed in question (1)(c). In so doing the Court moved away from what this tribunal refers to as the "purist" approach of looking at the transaction in isolation and some way towards the approach that the United Kingdom and other member states based on the context of the transaction. But at the same time it clearly rejected the United Kingdom's broad-based approach founded on the tribunal's decisions in Bond House and Optigen.

When this tribunal agreed the questions now under discussion with the parties, this was the only directly relevant judgment of the Court.

The language of the Court in Optigen is English, and no detailed reference was made by the parties to any other language in the submissions to this tribunal. However, the tribunal was supplied with the French version and, consistent with the approach it takes to the submissions below, considers it right to note the French text together with the English text. It does so in part because of the references in later judgments to the precise language of this judgment.

Kittel has now been decided. Both parties contend that it assists that party's view of Optigen.

Kittel

The language of the Court in Kittel is French. The tribunal was referred by Mr Patchett-Joyce extensively to the French version as well as the English version. He also offered a German version. The tribunal indicated that it would not be assisted by that, and no further reference was made to the German text. HMRC raised objections to the tribunal using more than one language without notice. The tribunal indicated that it considered that the judgment was multilingual, so there was no issue of principle involved other than procedural fairness, no prior notice having been given of these arguments. It also indicated that if it considered that it was decisive to its own view to have a proper analysis of the linguistic variations in the different language versions of the text of the judgment before it, as tested against the English and French versions, it would make an appropriate direction to both parties. HMRC was content to proceed on that basis. The tribunal does not consider a direction necessary, but reflects the Appellant's argument, and its context, by setting out English and French texts of all key passages.

The Opinion of the Advocate General was given by Advocate General Colomer. The tribunal was referred to an agreed translation from the French, as the official Court version was not available. He noted that the Belgian court asked its questions by reference to the application of the principle of fiscal neutrality. The main question was whether the law making a contract of sale void caused a taxable person to lose a right to deduct VAT under the void contract where the taxable person "entered into a contract in good faith without knowledge of a fraud committed by the seller". The questions referred looked separately at the cases where the fraud was the illegal basis of the contract, and where the fraud was of VAT itself. They also asked about the case where the fraudulent evasion was known to both parties to the contract.

The Advocate General took the view that the central question had been answered in Optigen in what he regarded as identical circumstances. "… There is therefore nothing – or very little – to add, not only because this judgment is very recent, but also, fundamentally, because the solution it provides is full of common sense" (paragraph 38).

He then turned to the final question from the referring court about taxable persons aware of a fraud. In those cases he was of the opinion that:

"the solution is not so clear … there are two possibilities: (1) he is aware of the fraud, but distances himself and derives no benefit from it, or (2) he is involved in the fraud, and derives undue benefit from it" (paragraph 40).

The Advocate General considered that "the grounds of Optigen come into their own" for the first alternative. With regard to cases where the taxable person is involved in the fraud, he considered that member states have the right to introduce derogating measures under article 27(1). However, such measures are "necessary but inadequate" (paragraph 47). He therefore examined whether there is a general principle justifying a unified reaction to these cases. For that principle he turned to the "abuse of right" approach from the judgment of the European Court of Justice in joined cases C-255/02, C-419/02, and C-223/02 (the Halifax Building Society cases). That decision provides appropriate interpretation guidelines (paragaph 4). Advocate General Colomer agreed with Advocate General Maduro (the Advocate General in Halifax) that there is nothing to prevent the principle that "rights conferred under Community law may not be relied on for fraudulent or abusive ends" applying to VAT (paragraphs 52, 53).

After a full analysis, the Advocate General concluded in Kittel that:

"when a taxable person is not aware that he is part of a much larger operation intended to avoid a tax obligation, or when, knowing this, he nevertheless distances himself from the illegal agreement, his right to deduct is not affected" (paragraph 60)

but

"if he participates, in full knowledge of the facts, in a transaction of this kind, which is implemented with the sole objective of reducing a tax obligation and which constitutes the abuse of a right, the above-mentioned common system of VAT requires that he be deprived of his right to deduct" (paragraph 63).

This tribunal observes that the Opinion does not deal with the intermediate situation of the person who "should have known" or had "the means of knowing". The Opinion takes no further that aspect of the test formulated in Optigen by the European Court. But it does introduce a new element into the debate because it suggests the derivation of an exception to the "purist" approach put to the Court in Optigen from within the principles of the European value added tax system itself.

The European Court did not follow the Advocate General nor mention his analysis. It made only a passing reference to Halifax as a case "where tax is evaded by the taxable person himself" (paragraph 53).

The Court reformulated the referred questions as:

"27 By its questions, which must be considered together, the referring court asks essentially whether, where a recipient of a supply of goods is a taxable person who did not and could not know that the transaction concerned was part of a fraud committed by the seller, Article 17 of the Sixth Directive must be interpreted as meaning that it precludes a rule of national law under which the fact that the contract of sale is void, by reason of a civil law provision which renders the contract incurably void as contrary to public policy for unlawful basis of the contract attributable to the seller, causes that taxable person to lose his right to deduct that tax. That court asks whether the answer to that question is different where the contract is incurably void for fraudulent reasons of VAT.

28 The referring court also asks whether the answer to that question is different where the taxable person knew or should have known that, by his purchase, he was participating in a transaction connected with fraudulent evasion of VAT.

27 Par ses questions préjudicielles, qu'il convient d'examiner ensembles, la juridiction de renvoi demande en substance si, lorsqu'une livraison es effectuée à un assujetti qui ne savait pas et ne pouvait pas savoir que l'opération concernée était impliquée dans une fraude commise par le vendeur, l'article 17 de la sixième directive doit être interprété en ce sens qu'il s'oppose à une règle de droit national selon laquelle l'annulation du contrat en vente, en vertu d'une disposition de droit civil, qui frappe de contrat de nullité absolue comme contraire à l'ordre public pur une cause illicite dans le chef du vendeur, entraîne la perte du droit à déduction de la TVA acquitée par ledit assujetti. Ladite juridiction se demande si la réponse à cette question est différente lorsque la nullité absolue résule d'une fraude à la TVA.

28 La juridiction de renvoi cherche également à savoir si la réponse à ladite questionne est différente, lorsque l'assujetti savai ou aurait dû que, par son acquisition, il participait à une operation impliquée dans une fraude à la TVA".

In the submissions of Mr Patchett-Joyce, the scope of the French " impliquée dans une fraude à la TVA" confirmed the narrowness of the true meaning of "participating in a transaction connected with fraudulent evasion of VAT" in these questions.

The Court drew directly from its decision in Optigen in its main findings, citing expressly from paragraphs 46 and 52 of that decision. In particular, it repeated the proviso that a taxable person's rights to the input VAT credit for transactions were not themselves vitiated by fraud regardless of intention or of the possible fraudulent nature of another transaction:

"of which that taxable person had no knowledge and no means of knowledge"

"dont cet assujetti n'avait et ne pouvait avoir connaissence…".

See paragraph 43 of Kittel, citing and quoting paragraph 46 of Optigen in both languages.

The Court then applies that judgment to the case where:

"such transactions, without that taxable person knowing or having any means to know, are carried out in connection with fraud committed by the seller."

"…telles operations, sans que l'assujetti le sache ou puise le savoir, sont effectuées dans le cadre d'une fraude commise par le vendeur" (paragraph 46).

The Court states, in implicit rejection of the view of the Advocate General, that in principle the right to deduct under article 17 may not be limited. That principle must apply neutrally to all activities provided that they are themselves subject to VAT. Each transaction must be viewed separately. Further the special characteristics of the trade in illegal goods and services are not relevant. On that basis the Court states, in what Mr Patchett-Joyce regarded as the core paragraph of its judgement:

"51 In the light of the foregoing, it is apparent that traders who take every precaution which could reasonably be required of them to ensure that their transactions are not connected with fraud ["leurs opérations ne sont pas impliquées dans une fraude"], be it the fraudulent evasion of VAT or other fraud, must be able to rely on the legality of those transactions without the risk of losing their right to deduction the input VAT (see, to that effect, Case C-384/04 FTI…)."

The Court accepts that "preventing tax evasion, avoidance and abuse" ["la fraude, l'évasion fiscale et les abus éventuelles…"] is an objective recognised and encouraged by the Sixth Directive.." (paragraph 54). The alternative versions of this language emphasise the sharp differences in meaning between evasion and évasion, and differences between fraud and fraude, and serve to caution about transferring meaning between the English and French texts without considerable care. It concludes:

"56 In the same way, a taxable person who knew or should have known ["savait ou aurait dû savoir…"] that, by his purchase, he was taking part in a transaction connected with ["impliquée dans…"] fraudulent evasion of VAT must, for the purposes of the Sixth Directive, be regarded as a participant in that fraud, irrespective of whether he profited by the resale of the goods.

…

59 Therefore, it is for the referring court to refuse entitlement to the right to deduct where it is ascertained, having regard to objective factors, that the taxable person knew or should have known ["savait ou aurait dû savoir"] that, by his purchase, he was participating in a transaction connection with fraudulent evasion of VAT, and to do so even where the transaction in question meets the objective criteria which form the basis of the concepts of "supply of goods effected by a taxable person acting as such" and "economic activity".

60 … the answer to the questions must be that where a recipient of a supply of goods is a taxable person who did not and could not know that the transaction concerned was connected with a fraud committed by the seller ["qui ne savait pas et n'aurait pas pu savoir que l'opération concernée était impliquée dans une fraude commise par le vendeur…"], article 17 of the sixth directive must be interpreted as meaning that it precludes a rule of national law under which the fact that the contract of sale is void …. causes that taxable person to lose the right to deduct the VAT he has paid. …

61 By contrast, where it is ascertained, having regard to objective factors, that the supply is to a taxable person who knew or should have known ["qui savait ou aurait dû savoir…"] that, by his purchase, he was participating in a transaction connected with fraudulent evasion of VAT ["une opération impliquée dans une fraude …"], it is for the national court to refuse that person entitlement to the right to deduct."

Mr Patchett-Joyce and Miss Whipple drew directly conflicting conclusions from that judgement. In Miss Whipple's view it answers the question before the tribunal clearly and without raising any problems. And she submitted that that is also the substance of the approach of the Advocate General. It covers the facts of Dragon's appeals. Mr Patchett Joyce, by contrast, considered that it was wrong to regard this as answering the question at all. Kittel was about reliance on a contract by one party when it was void because the other party to it was fraudulent. It assists his client if the Appellant was, as he contended, clear of that narrow test. The test applies to the Appellant to the extent, and only to the extent, that the taxable person selling to the Appellant was a fraudulent party. Unless, therefore, HMRC alleges and can show that the Appellant purchased from a fraudulent seller and that Dragon either knew that or had the means of knowing that, the Appellant's appeals must succeed.

The only common ground between the parties in these appeals is that whatever the test is, it is to be applied objectively. That must follow from the European Court's long-held views, echoed again in these judgments, and this tribunal has already accepted that point.

FTI

This tribunal considers that it should also seek guidance from FTI. That decision followed an Opinion by Advocate General Maduro before the same division of the Court as that in Kittel, and was referred to in Kittel. Further, the legislation under review in FTI was mentioned as providing an answer to the problems presented in Optigen by Advocate General Maduro in his Opinion in that case (see footnote 39 to paragraph 42).

FTI concerned the statutory provisions in the Finance Act 2003 introduced by the United Kingdom Parliament as another defence against carousel fraud. The United Kingdom argument in support of that provision was supported before the European Court by several other member states and by the European Commission.

Advocate General Maduro confirmed the view he had indicated in Optigen that such legislation was consistent with the Sixth Directive. Specifically, he relied by analogy on his Opinion in Optigen to advance the further view that:

"27 In my opinion, member states may, under the Sixth Directive, hold a person liable for payment of VAT when, at the time he effected the transaction, he knew or reasonably ought to have known that would go unpaid in the supply chain."

The Advocate General refers to paragraph 41 of his Opinion in Optigen, where he comments on the principle of legal certainty. It may be that the reference should have been to paragraph 42, where there is a reference to this legislation. Reference is there made to the position of someone who knew or should have known of his co-contractor's fraudulent activities.

The European Court held that article 21, but not article 22, of the Sixth Directive allowed provisions such as sections 17 and 18, provided that they complied with general principles of Community law and in particular the principles of legal certainty and proportionality. In so concluding, the Court expressly noted that the test included the situation both of a taxable person knowing that VAT would go unpaid and also of a taxable person who had reasonable grounds to suspect that this would be so.

In reaching that conclusion, the Court cited Optigen, paragraph 52 (cited in full above), as authority for the view that:

"33 Traders who take every precaution which could reasonably be required of them to ensure that their transactions do not form part of a chain which includes a transaction vitiated by VAT fraud must be able to rely on the legality of those transactions without the risk of being made jointly and severally liable to pay the VAT due from another taxable person."

This paragraph was referred to expressly in Kittel, paragraph 51 (cited above). The cross-citations made by the Court and Advocate General in these three cases suggest not only that the views of the Court are to be drawn from across these decisions, but also that the Court is expressly signalling the interlinking of its views.

The tribunal accepts the guidance from these cases, as a matter of European law, that: (a) member states are permitted by the Sixth Directive to make provisions such as sections 17 and 18 of the Finance Act 2003, (b) the Sixth Directive itself requires common action to prevent fraud, evasion and abuse, but (c) both these approaches must operate within the primary principles of legal certainty and proportionality. The tribunal's answers to the first question must therefore be consistent with (b) and (c).

The arguments for HMRC

Miss Whipple contended that any doubts left by the judgment of the European Court in Optigen about the answer to question (1) had been resolved by Kittel. The question whether a taxable person has "means of knowledge" can be answered by ascertaining whether, having regard to objective factors, the taxpayer "should have known", by taking every precaution which could reasonably be required of him, that by his purchase he was participating in a transaction connected with the fraudulent evasion of VAT. If the taxable person should have known that he was connected to a fraud in this way, the national court should assume the knowledge and refuse entitlement to the right to deduct.

She accepted that it has always been important to distinguish between those who possess knowledge or the means of knowledge that the transaction in which they are involved is or may be part of a fraud as against the wholly innocent trader. This is confirmed in Optigen. It is confirmed again by Kittel. The two cases identify three categories of trader: the fraudulent trader, the wholly innocent trader, and the "accomplice" to a fraud. The identity of a taxable person who is to be viewed as an "accomplice" was set out in paragraph 33 of FTI (cited above). The test is therefore one of taking every reasonable precaution in a proactive manner. Guidance from HMRC assists a trader in this. A trader who ignores HMRC guidance and does not take those steps can be refused input tax on the basis of constructive knowledge of the fraud. That is not only consistent with European VAT law but also with domestic common law.

HMRC adopted the following formulation of the test in correspondence with the Appellant:

"Did the taxpayer (sic: taxable person?) deliberately or recklessly ignore

factors which indicated or may have indicated that the transactions entered into may have formed part of an overall scheme to defraud the Revenue (sic: HMRC, or the public revenue?)?"

(The comments in italics are those of this tribunal.)

The Appellant did not comment directly on that test. The tribunal's immediate comments are noted in italics. Looked at more closely, the test has elements of circularity and uncertainty in it. How is it to be decided that a taxable person was deliberate or reckless, rather than merely careless or entirely innocent, in ignoring a "factor"? What is the test for "may" – likelihood, balance of probabilities, distinct possibility? How does that equate with the test of "means of knowing"?

The test, whether formulated in this wide way or as above, is not limited directly to the purchase transaction entered into by the taxable person. That was clarified in Kittel (paragraph 56).

The arguments for Dragon

In Mr Patchett-Joyce's view, the correct test to be applied (put in generalised language) can be stated as:

"Unless the taxable person had the means of knowledge [at the relevant time] that one or more particular transactions elsewhere in a supply chain was vitiated by fraud, then the transactions are valid for value added tax purposes and unless the taxable person had the means of knowledge of those facts its right to deduct input tax cannot be affected."

The temporal element was added in argument with the agreement of the tribunal.

In developing that test, Mr Patchett-Joyce emphasised the importance given by the European Court in its decisions to the principles of legal certainty and fiscal neutrality.

He did not consider that either of the cases considered by the European Court in Kittel assisted HMRC. Both were about contracts vitiated by fraud. In one of the cases it was the taxable person that was the fraudster. That was the critical element both in the questions referred to the Court and the slightly different questions answered by the Court. In both cases there was a direct implication in the fraud. It was personal involvement directly in the fraud in one case, and personal involvement directly in the fraudulent contract in the other. The Court's analysis did not extend beyond that position, and could not properly be so extended. The narrowness of the key link was stressed not so much in the English version of the judgment ("connected with") as in the French version ("impliquée dans"), that being the original language of the Court. It followed that the judgment in Kittel applies only to the situation where the taxable person is a party (either buyer or seller) to a contact directly vitiated by the fraud.

The tribunal's view

The tribunal's concern, as Mr Patchett-Joyce rightly emphasised, is not with the taxable person who knows of fraud elsewhere in a supply chain. In practical terms, the tribunal takes that to be the case where others also know that the taxable person knows this. It is with the taxable person who does not know of fraud elsewhere (or, again in practical terms, does not admit to knowledge and cannot be shown to know), but who "could" or "should" know. That category must include traders who are genuinely innocent of all knowledge. This may include, it may be surmised, those who have been kept uninformed or misinformed by others, and who have accepted that lack of information and misinformation without identifying, or being aware of, it. It will also include traders who are aware of fraud "in the market", and who choose to go ahead without taking adequate steps to ensure that they are not themselves involved in the fraud. Miss Whipple grouped these traders as a third category of "accomplice".

It is not clear that adding categories in this way advances the analysis. At the end of that analysis, a line must be drawn – and a test must be formulated – to identify those traders entitled to receive their input tax from a contract that in principle – and viewed objectively – warrants that credit or refund, and those who are not. There can only be two categories for this purpose.

The jurisprudence of the European Court has, in the view of the tribunal, made clear the first issue of categorisation. What must be defined is the category of taxable persons not entitled to receive the input tax credit or refund. All others are entitled.

The tribunal does not consider it helpful to say that the only category entitled to the input tax credit or refund is the category of "wholly innocent" traders, whatever that might mean. The proper approach, and the one clearly taken by the European Court, is that all traders are so entitled unless they fall within an exception. That formulation also emphasises the importance of the second question put to the tribunal as to burden of proof. The reality of that question is whether it is for a trader to show it is not in the exception or whether it is for HMRC to show that it is within the exception. But, on either approach, the primary task is to define the exception ("the exception to entitlement").

It was not in dispute that one group of traders within the exception to entitlement are those actively involved in VAT fraud themselves in the relevant transaction (and perhaps in all related transactions). That is the narrow case in Kittel. It was also not in dispute that the exception to entitlement also includes those who enter a contract vitiated by the fraud of the other party to the contract, whether or not the party knew of the fraud of the other party. That is the wider case in Kittel.

Mr Patchett-Joyce's main argument takes the analysis of Kittel no further. But he admits a third group as also within the exception to entitlement, namely those who are known to have known of fraud elsewhere in a chain of transactions. The scope of the exception to entitlement would, on his submissions, require a test that included those three groups but no other taxable person. Put in the context of this case, he argued strongly that unless HMRC can show either knowledge on the part of Dragon (not contended) or that the taxable persons from which Dragon bought its goods were directly involved in fraud, then HMRC is obliged to credit and refund the input tax.

By contrast, the extreme of the arguments for HMRC (those put in the papers, not by counsel) is not far removed from the substance of the "economic activity" approach dismissed by the European Court in Optigen. All traders should know or be treated as knowing everything in HMRC guidance. They should therefore know, or be treated as knowing, of all HMRC suspicions about the market place. If they do not seek HMRC guidance they should nonetheless be treated as if they had sought it. This did not apply only to those from whom they purchase and those to whom they sold, but to all stages of any transaction that the taxable person ought to have known was a chain. By analogy, that argument could be extended to encompass two linked propositions: all taxable persons must be assumed to be aware of the joint and several liability now imposed by statute, and so are on notice of the need to look elsewhere in the chain; and appropriate notifications and guidance by HMRC also put every taxable person on notice. Put in the context of this case, that proposition is then that unless the Appellant can show that it had no means of knowing that any of the counterparties in any of the chains to which it was a party were directly involved in fraud, then it is within the exception to entitlement.

Those arguments are stated at their extremes to emphasise the distance between them. The differences involve a number of elements. A key element, directly reflected in Question (1), is the scope of the test of "ought to have known" or "means of knowing". There is a prior factor: to what does the test apply? Is it applied only to the counterparties to individual contracts, or is the test wider?

The tribunal has little hesitation in applying the test potentially across the whole of any relevant chain of transactions, and not limiting it to the contract of sale to, and the contract of sale by, the taxable person. It does so bearing in mind the evidence it has seen of the deals in these appeals already. It is over-simplistic to look only at the individual contract of sale or purchase. Of course, the European Court made it clear in Optigen that a particular claim to input tax must be based on a particular contract. Entitlement to input tax from that contract cannot be taken away simply by reference to the fact that the contract was one of a chain of transactions affected by fraud elsewhere. Kittel was also concerned with the contract of sale itself. But the Court did not blind itself, and its judgments should not be used to blind others, to the context of what it decided.

Mr Patchett-Joyce's approach can be tested by features of the market place within which his client operated. Aspects include:

(a) Third party payments were common; [the tribunal adds that this is not a comment that the Appellant engaged in such payments or receipts, but it is relevant to looking at taxable persons more generally];

(b) Goods were routinely delivered to and by third parties and inspected both by national authorities and private inspectors;

(c) Goods were routinely held subject to payment or other conditions by freighting agents or others rather than the counterparties;

(d) Goods were routinely freighted from one territory to another and insured during those transactions.

The analysis of Kittel put to the tribunal for Dragon suggested that there was a contract for A to sell goods to B, another contract for those goods to be sold by B to C, another for the sale from C to D, and so on. The reality in these appeals was a web of contracts for sale, purchase, transport, warehousing, finance, insurance, and inspection and so forth at every stage. There was much scope, as the tribunal saw on the facts, for overlaps between parties and for temporal overlaps (goods moving forward legally or physically between B and C before the transactions between A and B had been completed or the money had been paid). On a series of transactions that could be presented as a series of separate "links" A-B, B-C, C-D in the "chain" A-B-C-D, it might in fact be that D pays B not C, while B agrees with A and C that the goods be shipped directly from A to D, while E, not in the chain, is responsible to A, B, C and D for all the warehousing and shipping, and there is no evidence that B actually pays A anything.

Applying that to the context of these appeals, in most of the deals the Appellant was selling telephones with central European specifications. It did not buy them from abroad, so it knew that either its supplier or some other person imported them. And it could not, and did not, sell them into the retail market in the United Kingdom. So it knew it was involved in a chain of transactions involving two or three states. It knew the goods had to be shipped to its possession, and from its possession, across jurisdictional boundaries. It knew that it was commercially important that it minimised its risks. That involved the risk of the goods being lost or damaged in transit, and the risk of funds not arriving. That involved the need for effective contracts for freighting, funding, insurance and inspection, and timely completion of all elements of those contracts. A web of contracts is inevitable in that kind of business. A taxable person operating in such an environment can properly be assumed to know of all the constituent parts of the web in each transaction. The analysis cannot be confined to the parties to the purchase, or the purchase and sale, alone.

The tribunal does not accept that Kittel limits the extent of the knowledge base against which the test of "means of knowledge" from Optigen is to be tested in the way suggested for the Appellant. The tribunal sees nothing in any of the judgments of the European Court that suggests that the Court was taking so narrow a view. The Court rejected the purist view put to it by the Advocate General in Optigen. It accepted that the Sixth Directive allows both national legislative initiatives (in FTI), and a wider Directive-based approach to fraud. And it was clearly taking a common view across each of the three judgments analysed in these reasons. In so doing, it was accepting from FTI a wider knowledge base than the individual contracts alone for both national and Directive-based approaches.

The tribunal therefore does not accept that there is any specific limit "up" or "down" the chain to the knowledge to be considered by a taxable person. More specifically, the taxable person may be alerted to third party elements in its contracts by the terms of those contracts, by its counterparties, or by others of the web of supporting contracts that facilitate the trade. Any of those elements may put a taxable person on notice that it ought to consider steps beyond the immediate contracts of purchase and sale. That must also be in addition to what the taxable person actually knows of the market beyond the immediate contracts. This tribunal rejects the narrow knowledge base for which Mr Patchett-Joyce contended.

How is the test of "no means of knowing" to be applied to the wider knowledge base? The test put by Mr Patchett-Joyce did not answer this point – it merely echoed it. On the other hand, the extreme form of the test from HMRC's arguments (though not those of Miss Whipple to the tribunal) puts the matter very widely.

The test of "means of knowing" is objective, and must be capable of application consistently across the European Union. It must be applied within the principles of certainty, proportionality, and neutrality of the tax. While application to a particular taxable person and transaction starts with the taxable person's actual knowledge, the test must then identify the additional knowledge that a taxable person objectively should proceed to seek about a proposed transaction. Hindsight is irrelevant. The test can take into account, but cannot be dictated by, guidance offered by HMRC or any other national tax authority. It must be in terms of the actions, starting from the position of the actual taxable person, to be taken by a taxable person objectively. Those actions must be achievable so as to ensure certainty, and they must be achievable without disproportionate effort. The formulation of that test in terms only of ignoring factors that may indicate that there may be fraud is too uncertain. It risks imposing a disproportionate burden on the taxable person.

Summarising, the tribunal's view is that the "means of knowing" are to be tested objectively by the following criteria:

(1) The taxable person must be judged by both the level of actual knowledge and the actions taken, or not taken, to acquire knowledge at the time of entry into the commitment that gives rise to the input tax. Hindsight cannot be used. There may be questions in individual cases about the time of entry into the commitment. The taxpoint of a transaction may depend on how the transaction is carried out (for example, where payment precedes delivery).

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

(3) The taxable person must take proportionate steps to use all means reasonably available to increase actual knowledge. For example, in these appeals, the tribunal saw the use of: checks on the validity of value added tax registration numbers; checks on customs stamps on goods going through a customs inspection; checks with and about individual suppliers and customers, including checks with national registration institutions; checks with credit agencies and inspection agencies, including checks on the IMEI numbers of telephones; use of appropriate terms of contract. Where an initial enquiry gives rise to information suggesting the need for further enquiry, the test is reapplied to assess the need for that further enquiry. What is proportionate and reasonable is a matter of fact, and involves balancing actual cost and the opportunity cost of personal effort against risk.

(4) The taxable person, in making these checks, does not have to act to a higher standard of proof than that applied to the underlying claim. If disputed facts are determined by reference to the balance of probabilities, then that is also the standard by which the steps taken by a taxable person should be judged. A taxable person cannot be expected to take steps to ensure a transaction is clear of fraud beyond all reasonable doubt. That would be disproportionate. If, on what the taxable person knows after taking into account all actual knowledge and having made all proportionate enquiries, the better view is that there is probably no fraud connected with the transaction, then the taxable person has met the required standard.

(5) Whether the steps taken by a taxable person to avoid being connected with fraud are proportionate in an individual case must be a question of fact taking all the circumstances into account. There can be no presumption that because there is fraud in a chain of transactions then that fraud is known, or should have been known, to all others in that chain.

(6) Finally, the concern requiring investigation is with fraud on the public revenue through the value added tax system, not with other forms of fraud such as fraud on a foreign trader.

That formulation is lengthy, and is not easy to summarise into a concise test. Putting it in question form its essence is:

Has the taxable person, at the time of entering a transaction involving payment of value added tax by or to that person, and taking into account the actual knowledge of the taxable person at that time (including knowledge acquired from any enquiry or investigation), taken all proportionate steps available to it to ensure that, on the balance of probabilities, no aspect of the transaction is connected with any other party involved in, or any other transaction involving, fraud on the public revenue through the value added tax system?

The tribunal takes that view separately from the next question it must address: on whom is that burden of proof?

B The second question: burden of proof

The tribunal's original direction in these appeals imposed the burden of proof on HMRC. But it did it in specific terms, and it did so with consent of both parties following the views expressed by the tribunals in Bond House and Optigen.

The key part of the original terms of the direction is:

(20) That the burden of proof in relation to the issues in paragraph 2 shall be on the Respondents and accordingly the order of proceedings at the hearing shall be …

The issues in paragraph (2) were the issues decided in the main preliminary decision in respect of some of the deals. They were the agreed issues that the tribunal was to determine on the balance of probabilities, namely whether in relation to any deal there was a missing trader, a defaulting trader or a hijacked number; whether the purchase and sale formed part of a chain of transactions circular in nature; and whether that chain was carried out in furtherance of any activity that was not an economic activity.