ON APPEAL FROM
The Upper Tribunal (Tax and Chancery Chamber)
Sales J and Judge Berner
FTC/90/2013
Royal Courts of Justice
Strand, London, WC2A 2LL
Before :
LADY JUSTICE ARDEN
LORD JUSTICE MCFARLANE
and
LORD JUSTICE BURNETT
Between :
Fonecomp Limited | Appellant |
- and - | |
The Commissioners for Her Majesty’s Revenue and Customs | Respondents |
(Transcript of the Handed Down Judgment of
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Mr Paul Lasok QC (instructed by The Khan Partnership LLP) for the Appellant
Mr John McGuinness QC, Mr Mark Cunningham QC, Mr James Puzey, Mr Nicholas Chapman and Mr Howard Watkinson (instructed by HM Revenue and Customs Solicitors Office) for the Respondents
Hearing dates: 22-23 October 2014
Judgment
Lady Justice Arden:
This appeal, from the decision of the Upper Tribunal (“the UT”) (Sales J and Judge Berner) dated 6 December 2013, is about the limits on the ability of a trader to claim repayment of or credit for VAT paid by him on purchasing goods. The usual position is that, where a trader has received VAT on sales made by him, he has the right to credit for input tax which he has paid on his purchases. If the input tax exceeds the output tax for which he must account to the respondent (“HMRC”) at the end of the relevant period, he is entitled to repayment of the difference. Those rights are fundamental to the way VAT operates. The fundamental nature of the right may be seen from, for example, the judgment of the Court of Justice of the European Union (“the CJEU”) in Case C-285/11 Bonik EOOD v Direktor na Direktsia ‘Obzhalvane i upravlenie na izpalnenieto’:
25. It should be borne in mind that, according to settled case-law, the right of taxable persons to deduct VAT due or already paid on goods purchased and services received as inputs from the VAT which they are liable to pay is a fundamental principle of the common system of VAT established by the relevant EU legislation (see Joined Cases C-80/11 and C-142/11 Mahagében and Dávid [2012] ECR, paragraph 37 and the case-law cited).
26 In that regard, the Court has consistently held that the right of deduction provided for in Article 167 et seq. of Directive 2006/112 is an integral part of the VAT scheme and in principle may not be limited. In particular, the right of deduction is exercisable immediately in respect of all the taxes charged on transactions relating to inputs (see Joined Cases C-110/98 to C-147/98 Gabalfrisa and Others [2000] ECR I-1577, paragraph 43; Case C-63/04 Centralan Property [2005] ECR I-11087, paragraph 50; Joined Cases C-439/04 and C-440/04 Kittel and Recolta Recycling [2006] ECR I-6161, paragraph 47; and Mahagében and Dávid, paragraph 38).
I shall refer in more detail to Bonik below.
The right to repayment or credit may not, therefore, be restricted by national law. However, the CJEU has also held that a trader cannot invoke EU law in order to achieve abusive or fraudulent ends. In those circumstances, EU law may deem the trader’s transactions not to have taken place so that the trader loses his right to a credit. National courts must withhold the right of deduction where the right of repayment is relied on for abusive or fraudulent ends. They must do so where the trader is himself committing a tax fraud. However, traders may also be unable to claim repayments or deductions where another party fraudulently defaults in paying VAT.
The trader in this case, Fonecomp, firstly contends that it will only lose its important right to claim a credit or repayment if it knows or ought to know that the default will occur in the same chain of supply as his purchase, but not if that default occurred in a different chain of supply. Fonecomp also contends that, in that last-mentioned situation, the relevant connection and knowledge do not exist. This is so, on its case, even where the third party who orchestrates the scheme camouflages the plan to cause a default by a party liable to pay VAT by interweaving transactions in several chains of supply. This is common in VAT fraud and is known as “contra-trading”. Fraudsters use “contra-trading” to make a substantial profit out of the VAT system. There was a third ground of appeal but this has not been pursued.
EU law does not impose strict liability on traders but holds that they are participants in the evasion of VAT if they have the appropriate level of knowledge. As the CJEU put it in Joined Cases C-439/04 and C-440/04 Kittel and Recolta Recycling [2006] ECR I-6161, the original authority establishing the “Kittel principle”:
55 Where the tax authorities find that the right to deduct has been exercised fraudulently, they are permitted to claim repayment of the deducted sums retroactively (see, inter alia, Case 268/83 Rompelman [1985] ECR 655, paragraph 24; Case C-110/94 INZO [1996] ECR I-857, paragraph 24; and Gabalfrisa, paragraph 46). 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 (see Fini H, paragraph 34).
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, irrespective of whether or not he profited by the resale of the goods.
57 That is because in such a situation the taxable person aids the perpetrators of the fraud and becomes their accomplice.
58 In addition, such an interpretation, by making it more difficult to carry out fraudulent transactions, is apt to prevent them.
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 that, by his purchase, he was participating in a transaction connected 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 It follows from the foregoing that 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, 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 that contract incurably void as contrary to public policy for unlawful basis of the contract attributable to the seller – causes that taxable person to lose the right to deduct the VAT he has paid. It is irrelevant in this respect whether the fact that the contract is void is due to fraudulent evasion of VAT or to other fraud.
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 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.
The key issue in this appeal is therefore whether, as Fonecomp argues, Bonik and other cases in the CJEU demonstrate that the Kittel principle is limited to cases where the default occurs in the same chain of supply. The need for there to be a fraud in the same chain of supply is the leitmotif of its grounds of appeal.
In Bonik, the CJEU went on to hold:
43. Consequently, since the refusal of the right of deduction is an exception to the application of the fundamental principle constituted by that right, it is incumbent upon the competent tax authorities to establish, to the requisite legal standard, the objective evidence needed to substantiate the conclusion that the taxable person knew, or should have known, that the transaction relied on as a basis for the right of deduction was connected with fraud committed by the supplier or by another trader acting upstream or downstream in the chain of supply (see Mahagében and Dávid, paragraph 49).
44. It follows that, if the referring court were to find that the supplies of goods at issue in the case before it had actually been carried out and that Bonik had subsequently used those goods for the purposes of its taxed transactions, it would be for that court subsequently to determine whether the tax authorities concerned had established the existence of objective evidence to the effect described above.
45. In those circumstances, the answer to the questions referred is that Articles 2, 9, 14, 62, 63, 167, 168 and 178 of Directive 2006/112 must be interpreted as meaning that, in circumstances such as those of the case before the referring court, a taxable person may not be refused the right to deduct VAT in relation to a supply of goods on the ground that, in view of fraud or irregularities committed upstream or downstream of that supply, the supply is considered not to have actually taken place, where it has not been established on the basis of objective evidence that the taxable person knew, or should have known, that the transaction relied on as a basis for the right of deduction was connected with VAT fraud committed upstream or downstream in the chain of supply – a matter which it is for the referring court to determine.
If Fonecomp is right, then it did not lose its right in the present case as the default did not occur “in the chain of supply” which included the relevant purchases on which it paid the input tax for which it sought credit in the VAT return. If it is wrong in this, then it is common ground that the Kittel principle is wide enough to cover contra-trading.
I have set out in the Appendix to this judgment the helpful summary by the UT of the facts found by the First-tier Tribunal. The party who orchestrated the scheme was found to be Klick Ltd (“Klick”), and the defaulting party was Softlink Ltd (“Softlink”). The goods dealt with during the scheme were mobile phones. The transactions for which Fonecomp sought a credit were Deal 1 and Deal 2 as defined in paragraph [5] of the UT’s summary.
The FTT found that all the transactions which Klick carried out in a period of three months were part and parcel of its scheme to make a profit at the expense of HMRC out of the default by Softlink, having incurred a substantial liability to VAT while other parties made claims for repayment. In the view of the FTT, even though neither Softlink nor Klick had any direct transactions with Fonecomp, Deal 1 and Deal 2 were purchases of phones previously purchased and sold by Klick during the relevant three-month period. The FTT held that these purchases were connected with the fraud, in summary because the phones had been sold “upstream” by Klick, and Fonecomp had acted in an unbusinesslike way in making the purchases. For example, it found that Fonecomp took no trouble to check the phones it was buying and selling. The FTT inferred that it must have known that the transactions were connected with a fraud.
The FTT concluded that, in the light of this connection and knowledge, Fonecomp had no right to credit for the input tax paid on these purchases.
The judgment of the UT dated 5 December 2013, from which Fonecomp now appeals, upheld the decision of the FTT. Essentially, the UT held that the FTT was entitled to reach the conclusions which it had reached on the knowledge of Fonecomp and the connection between its purchases and the fraudulent transactions leading to the default of Softlink. It is not open to Fonecomp to dispute the evidential basis for the FTT’s findings in this court. The UT did not have to deal with the all of the authorities or the points of law now taken on this appeal.
I now turn to the first ground of appeal.
GROUND 1
Mr Paul Lasok QC, for Fonecomp, formulates his Ground 1 as follows:
The Kittel principle applies where fraudulent evasion (meaning the dishonest non-payment) of VAT occurs in the same chain of supply as the transaction giving rise to the input tax deduction claim. That is the "connection" required by the Kittel principle. It does not apply to the so-called "contra-trading" scenario, where no such "connection" exists.
This is the key point on this appeal to which I have already referred. Applying Bonik, Mr Lasok submits that a trader can only lose the right to reclaim or claim credit for input tax if he has the requisite knowledge and the default was committed in a transaction which was (either upstream or downstream) in the same chain of supply.
Mr Lasok submits that Bonik shows that the Kittel principle is qualified in this regard. He calls the Kittel principle without this qualification “the wider interpretation”, and the Kittel principle with this qualification “the narrower interpretation”. His primary case is that the Kittel principle has always been the same, and has always contained the limitation that the default must have occurred in the same chain of supply. In the alternative, he submits that in Bonik the CJEU imposed this qualification. He submits that the narrower interpretation is to be preferred to the wider interpretation because it reduces interference with the right of deduction. This is, as I have explained, a fundamental right, and an integral part of VAT. It should not, therefore, on his submission be limited more than necessary. Mr Lasok submits that there have been a number of cases which apply the limitation in Bonik, to which I refer in paragraph 24 below.
Mr Lasok submits that it disrupts the scheme for the administration of VAT to have regard to contra-trading. Provisions such as input tax deduction provisions (Article 17 of the Sixth VAT Directive (77/388/EEC), now replaced by Articles 168 and 169 of Directive 2006/112 (“the VAT Directive”)) play a particular role in the VAT system. Their purpose is to achieve the role assigned to them. None of them is an anti-fraud provision.
Mr Lasok submits that under the legislative scheme for VAT a trader cannot use the input tax deduction provisions except in his own chain of supply and those provisions have no application outside that chain. Moreover, on Mr Lasok’s submission, the relevant provisions of the VAT Directive lay down the jurisdictional rules for the operation of VAT: see, for example, Case C-245/04 EMAG Handel Eder v Finanzlandesdirecktion fur Karnten [2006] ECR I-3227 at [26] to [31], [40] and [43].
Mr Lasok submits that the presence of fraud does not alter the role and purpose of the provisions of the VAT Directive. They should not be used to justify their application to situations falling outside their scope and role.
Mr John McGuinness QC, for HMRC contends that it is “extraordinary and inconceivable” to suggest that the CJEU would have intended to qualify the Kittel principle to the narrower interpretation. Fonecomp is, on their submission, unable to suggest any reason of substance why the CJEU should do this, still less why they should do this in Bonik without the benefit of an Opinion of the Advocate General or making it clear that this was a change in the law. Under the last sentence of Article 20 of the Statute of the Court of Justice of the European Union, the CJEU may determine a matter without a submission from the Advocate General only if it considers that the case involves as a new point of law (see per Lord Reed in Aimia Coalition Loyalty Ltd v Revenue and Customs Comrs [2013] UKSC 15).
I now turn to my conclusions on Ground 1. I accept that there is a detailed legislative scheme for VAT. However, in my judgment, the relevance of the scheme in the VAT Directive is that VAT is intended to operate neutrally as between traders and to be borne by the ultimate consumer of the product. VAT is a tax on consumption. This is the reason why the right of deduction is integral to the VAT system and a fundamental feature of it, as explained above. In many judgments in this field the CJEU has prefaced its ruling on the removal of the right of deduction of input tax where the provisions for VAT have been abused by setting out the nature of VAT as a tax. I take for example the following paragraphs appearing in C-80/11 and C-142/11 Mahagében and Dávid:
38. As the Court has repeatedly held, the right to deduct provided for in Article 167 et seq. of Directive 2006/112 is an integral part of the VAT scheme and in principle may not be limited. In particular, the right to deduct is exercisable immediately in respect of all the taxes charged on transactions relating to inputs (see, inter alia, Joined Cases C-110/98 to C-147/98 Gabalfrisa and Others [2000] ECR I-1577, paragraph 43; Joined Cases C-439/04 and C-440/04 Kittel and Recolta Recycling [2006] ECR I-6161, paragraph 47; Case C-392/09 Uszodaépítő [2010] ECR I-8791, paragraph 34; and Commission v Hungary, paragraph 43).
39 The deduction system is intended to relieve the trader entirely of the burden of the VAT payable or paid in the course of all his economic activities. The common system of VAT consequently ensures neutrality of taxation of all economic activities, whatever the purpose or results of those activities, provided that they are themselves subject in principle to VAT (see, inter alia, Gabalfrisa and Others, paragraph 44; Case C-255/02 Halifax and Others [2006] ECR I-1609, paragraph 78; Kittel and Recolta Recycling, paragraph 48; and Case C-438/09 Dankowski [2010] ECR I-14009, paragraph 24).
40 The question whether the VAT payable on the prior or subsequent sales of the goods concerned has or has not been paid to the public purse is irrelevant to the right of the taxable person to deduct input VAT. VAT applies to each transaction by way of production or distribution after deduction of the VAT directly borne by the various cost components (see order in Case C-395/02 Transport Service [2004] ECR I-1991, paragraph 26; judgments in Joined Cases C-354/03, C-355/03 and C-484/03 Optigen and Others [2006] ECR I-483, paragraph 54; and Kittel and Recolta Recycling, paragraph 49).
In my judgment, Bonik on examination neither demonstrates that the Kittel principle was always limited in the way Mr Lasok submits nor introduces some new qualification on the Kittel principle. Before turning to the particular issue raised by the referring court’s question and setting out the reasoning in the paragraphs which I have already quoted, the CJEU in Bonik sets out the statement of the principle in the form in which it was made in Kittel:
39. By the same token, a taxable person who knew, or should have known, that, by his purchase, he was taking part in a transaction connected with VAT fraud must, for the purposes of Directive 2006/112, be regarded as a participant in that fraud, whether or not he profits from the resale of the goods or the use of the services in the context of the taxable transactions subsequently carried out by him (see, to that effect, Kittel and Recolta Recycling, paragraph 56, and Mahagében and Dávid, paragraph 46).
As is apparent from the passage from its judgment cited in paragraph 1 above, the question put to the CJEU in Bonik and answered by it was whether Mr Bonik’s right could be affected by transactions which had occurred upstream or downstream in the chain of supply. The facts did not suggest that the fraudulent evasion of tax had occurred in any interlinking chain of supply. The specific answer in Bonik did not, therefore, deal with the question of a connection outside the chain of supply in which his purchase took place. In addition, having set out the general principle in [39] of its judgment (see paragraph 22 of this judgment), the CJEU focused on the particular issues in that case.
Likewise there was no contra-trading alleged in any of the other CJEU cases which Mr Lasok cited to us. These were: Mahagében and Dávid, C-563/11 Forvards V SIA v Vlasts ienemumu dienests, C-324/11 Toth v Nemzeti Ado, Case 107/13 FIRIN v Direktor na Direktsia, C-18/13 Maks Pen v Direktor na Direktsia and C-444/12 Hardimpex Kft (in liquidation) v Nemzeti Adó-és Vámhivatal Kiemelt Ügyek és Adózók Adó Főigazgatósága. In each case, the alleged fraud occurred in the same chain. These cases did not purport to deal with the situation where the fraud occurs outside that chain. Therefore these cases cannot constitute authority for the manner in which the Kittel principle is to be applied where there has been contra-trading. Kittel itself is expressed in terms sufficiently wide to cover contra-trading although it was not itself a case of contra-trading.
Mr Lasok submits that there were more CJEU cases using the Bonik formulation than the 5 cases to which I have referred, but he did not refer us orally to any of those further cases. His skeleton argument on this gorund refers to one further case, Case 643/11 LVK-56 EOOD v Direktor na Direktsia «Obzhalvane i upravlenie na izpalnenieto» - Varna pri Tsentralno upravlenie na Natsionalnata agentsia za prihodite but this was also not a contra-trading case. We must, therefore, assume that the remaining cases likewise are not authority on the position where there has been contra-trading.
Nothing turns on the CJEU’s use of the words “upstream” and “downstream”. Bonik may have been among the first cases in which the CJEU used these actual terms but, in Kittel at [43], [44], [45] and [49], the CJEU referred to transactions occurring prior and subsequent to the purchase giving rise to the input tax on which the trader relied, which comes to the same thing. Those words simply go to timing.
Moreover, the FTT found that Klick had not engaged in any legitimate trading in the period in question. Every transaction which it carried out in the period was infected by its fraudulent scheme. So there were in fact fraudulent transactions in the same chain of supply as Deal 1 and Deal 2. That means in fact that Mr Lasok’s submission can only be correct if the default has also to occur in the same chain of supply. There is nothing in the authorities to support the suggestion that that is a requirement.
Moreover, there is nothing to suggest that, by referring to a chain of supply, the CJEU necessarily meant a chain that was purely linear. Chains can be intersecting or have branches, as in chains of mountains. So there is no reason why the chain of supply should not be connected through a branch. It is the existence of the requisite connection between the transactions involved which makes the relationship between the transactions a chain.
Finally, there is nothing to suggest that the CJEU intended to narrow the Kittel principle to the narrower interpretation. If that were the effect of the case law, the CJEU would have excluded the possibility of removing the right to repayment from those knowingly involved in contra-trading. There is no doubt but that that involvement is an abuse of the VAT provisions. There is no doubt that the CJEU was aware of the breadth and complexity of these VAT frauds. In both Kittel and the case on which it is based, C-354/03, C-355/03, C-484/03 Optigen Ltd v Customs & Excise Comrs, the Opinions of the Advocate General stressed that the chains could be very complex. It is sufficient to set out the following paragraph from paragraph 35 of the Opinion of Advocate General Colomer in Kittel;
In reality, the methods used are as fanciful and complicated as the imaginations of the people who think them up. I therefore agree with Advocate General Poiares Maduro who, in point 8 of his Opinion in Optigen and Others, finds that in every case the bottom line is that an amount received in respect of VAT is not declared.
Fonecomp submits that its interpretation is confirmed by the way in which Kittel is applied in France but it has not made this submission good by adducing the appropriate evidence. Therefore, I can place no reliance on this point.
HMRC further contend that this court has already considered the Kittel principle in Mobilx v HMRC [2010] EWCA Civ 517, [2010] STC 1436 and approved the wider interpretation. Moses LJ, with whom Carnwath LJ and Sir John Chadwick agreed, held:
[62] 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. If the circumstances of that purchase are such that a person knows or should know that his purchase is or will be connected with fraudulent evasion, it cannot matter a jot that that evasion precedes or follows that purchase. That trader's knowledge brings him within the category of participant. He is a participant whatever the stage at which the evasion occurs.
HMRC submits that we are therefore bound to conclude that the wider interpretation is correct. On this point, I prefer Mr Lasok’s submission. I do not accept that we would be bound to follow Kittel if we considered that it was no longer good law simply because it had been approved in Mobilx. If we accept that Bonik changes the Kittel principle, then we would be bound to follow the later CJEU case law.
However, I am satisfied that the passage which I have cited from Mobilx, above, remains good law. This was also the conclusion of Hildyard J in Edgeskill Ltd v Revenue and Customs Comrs [2014] UKUT 38 (TCC); [2014] STC 1174.
In conclusion, I agree with paragraph 22 of the judgment of Judge Bishopp in Universal Enterprises (EU) Ltd v Revenue and Customs Comrs [2014] STC 1515, cited by HMRC:
“22. The argument that a trader in a clean chain cannot be affected by anything which happens in a dirty chain is in my judgment wholly misconceived. Mr Young argued that there is nothing inherently wrong with contra-trading, a statement which, put in that way, is true: a trader who both imports and exports may legitimately organise his sales and purchases so that, at the end of a VAT period, he has little to pay, or a repayment claim. If he does so for reasons of cash flow, his conduct is unexceptionable. But that is not the reason for the contra-trading seen in cases of this kind. As has been said many times, not least by the then Chancellor in Blue Sphere Global Ltd v Revenue and Customs Commissioners [2009] STC 2239 , its purpose is to conceal the fraud in the dirty chain and to make it harder to combat. The appellants' argument necessarily treats "clean" as synonymous with "innocent", but a clean chain in cases of this kind—that is, one in which each of the traders accounts correctly for VAT—is not innocent; it is an integral part of the fraudulent scheme. Even if I entertained any doubt (which I do not) that as a matter of EU law there is sufficient connection between a trader in the clean chain and the default in the dirty chain, there remains an insuperable connection with the fraudulent purpose of the clean chain.”
GROUND 2
By Ground 2, Mr Lasok raises two separate issues: (a) what constitutes the requisite connection between the transaction for which deduction is sought and the fraud; and (b) what is the degree of knowledge of the fraud which the trader must have to be treated as a participant in it for the purposes of the Kittel principle. On Ground 2, Mr Lasok in general relied, to the exclusion of the appellant's skeleton argument, on his speaking note, which he made available to the court, with some amendments made in the course of submissions.
Mr Lasok submits that a connection for the purposes of the Kittel principle in the light of Bonik can only exist if both the default and the transaction for which the right of repayment or credit is claimed occur within the same chain of supply. I have already dealt with that point under Ground 1. In the alternative, Mr Lasok submits that the transaction giving rise to the repayment or credit claim must assist in the achievement of the fraudulent scheme.
(a) What constitutes a connection between the fraud and the transaction for which the trader seeks to exercise his right to deduct?
The findings of the FTT on connection were usefully summarised by the UT as follows:
(c) Fonecomp’s acquisition of the phones in Deal 1 in July 2006 was connected with Klick’s acquisition and disposal of them in the senses: (i) that they were the same phones and were sold and acquired in transactions close in time, (ii) that the input and output VAT were offset [in Klick’s VAT return], and (iii) that the acquisition aided Klick’s sales (FTT, [203]).
(d) Fonecomp’s acquisition of the phones in Deal 2 in July 2006 was in the same sense connected with Klick’s acquisition and disposal of them (FTT, [205]).
(e) Accordingly, for each Deal, the FTT found that Fonecomp’s purchase was connected with Klick’s fraudulent arrangements in relation to, and hence was connected with, the fraudulent evasion of VAT by Softlink (FTT, [206] – [210]).
Mr Lasok submits that Fonecomp had to know in terms what the connection was. A mere general understanding that a fraud had occurred was not enough.
Because of (c)(ii) Fonecomp also had, on Mr Lasok’s submission, to know how Klick completed its tax return. That sub-paragraph also meant that traders in the same chain could avoid becoming participants by reporting associated transactions in a different accounting period to that used by the fraudster.
Furthermore, submits Mr Lasok, Fonecomp’s purchases had to assist the fraud in some way and would not do so unless they happened to be entered in Klick’s return at a time when it entered fraudulent transactions.
In the present case, the FTT took the view that the trader seeking repayment or credit must by his transaction assist the fraud, but the UT (applying the reasoning of Sir Andrew Morritt C in Blue Sphere Global v HMRC [2009] STC 2239, affirmed on appeal in Mobilx) held that this was not necessary. In the judgment of the UT, connection depended on the linkage between the transaction for which a deduction was sought and the fraud, and did not depend on the trader’s knowledge:
The assessment whether a particular transaction is connected with VAT fraud depends on objective factors which, in contrast to questions relating to knowledge or means of knowledge of the trader, may well be outside the knowledge of the trader.
Mr Lasok submits that the FTT was correct on this point.
I turn to my conclusions on this issue. Under the jurisprudence of the CJEU it is for the national court to determine if there was a connection on the facts, and this question is to be determined on the objective evidence and without reference to the trader’s knowledge.
Furthermore in my judgment, there is nothing in Kittel which would lead to the conclusion that HMRC has to show that the transaction provides tangible assistance in carrying out the fraud. If it did, it would be difficult to prove a connection with a fraudulent transaction upstream of the transaction for which the trader seeks a repayment. Furthermore, contrary to the submission of Mr Lasok, there is no warrant for reading in a requirement that, in a contra-trading case, the connection can be established only by inclusion of details of the transaction in question in a VAT return submitted by (in this case) Klick.
(b) What is the degree of knowledge of the fraud which the trader must have in order to be liable as a participant in it?
The CJEU determined in Kittel that knowledge was the essential characteristic of a participant in a fraud who lost his right of deduction. The type of knowledge required is not necessarily derived from any national law test, still less common law fraud but has been devised by the CJEU: see generally Case 296/95 R (o/a EMU Tabac SARL) v Comrs of Customs & Excise [1998] ECR 1-1605 at [30].
This court considered the extent of knowledge required by the Kittel principle in great detail in Mobilx. Moses LJ held in conclusion on this issue:
[58] As I have endeavoured to emphasise, the essence of the approach of the court in Kittel was to provide a means of depriving those who participate in a transaction connected with fraudulent evasion of VAT by extending the category of participants and, thus, of those whose transactions do not meet the objective criteria which determine the scope of the right to deduct. The court preserved the principle of legal certainty; it did not trump it.
[59] 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”. Thus it includes those who should have known from the circumstances which surround their transactions that they were connected to fraudulent evasion. 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 if it turns out that the transaction was connected with fraudulent evasion of VAT then he should have known of that fact. He may properly be regarded as a participant for the reasons explained in Kittel.
[60] The true principle to be derived from Kittel does not extend to circumstances in which a taxable person should have known that by his purchase it was more likely than not that his transaction was connected with fraudulent evasion. But a trader may be regarded as a participant where he should have known that the only reasonable explanation for the circumstances in which his purchase took place was that it was a transaction connected with such fraudulent evasion.
Mr Lasok also relies on the fact that the FTT held that Fonecomp did not know exactly how the fraud was perpetrated. In paragraph 227 of their decision, the FTT held:
We do not find that Fonecomp knew or should have known that Softlink would default or that there was a defaulter whose fraud Klick would arrange to cover up. We find instead that Fonecomp must have come to the conclusion that somehow its purchase and sale were assisting a VAT fraud by an Importer which had happened or was planned.
As the UT rightly held, these negative findings did not matter in the light of the other findings of the FTT, which are summarised in the UT’s summary. Lack of knowledge of the specific mechanics of a VAT fraud affords no basis for any argument that the decision of either tribunal was wrong in law: what is required is simply participation with knowledge in a transaction “connected with fraudulent evasion of VAT” (Kittel, [61], set out in paragraph 5 above).
The fraud may involve a complex web of transactions. As Briggs J held in Megtian Ltd v Revenue and Customs Comrs [2010] STC 840:
[37] In my judgment, there are likely to be many cases in which a participant in a sophisticated fraud is shown to have actual or blind-eye knowledge that the transaction in which he is participating is connected with that fraud, without knowing, for example, whether his chain is a clean or dirty chain, whether contra-trading is necessarily involved at all, or whether the fraud has at its heart merely a dishonest intention to abscond without paying tax, or that intention plus one or more multifarious means of achieving a cover-up while the absconding takes place.
Mr Lasok further relies on the holding of Moses LJ in Mobilx that the words “should have known” (referring to the deemed knowledge of the trader) meant “has any means of knowing”: per Moses LJ at [51]. Mr Lasok further argues that Fonecomp could not have found out about the fraud even if it made inquiries because the fraud did not relate to the chain of transactions with which it was concerned.
However, in my judgment, the holding of Moses LJ does not mean that the trader has to have the means of knowing how the fraud that actually took place occurred. He has simply to know, or have the means of knowing, that fraud has occurred, or will occur, at some point in some transaction to which his transaction is connected. The participant does not need to know how the fraud was carried out in order to have this knowledge. This is apparent from [56] and [61] of Kittel cited above. Paragraph 61 of Kittel formulates the requirement of knowledge as knowledge on the part of the trader that “by his purchase he was participating in a transaction connected with fraudulent evasion of VAT”. It follows that the trader does not need to know the specific details of the fraud.
Mr Lasok places much reliance on the decision of the CJEU on 16 May 2013 in Hardimpex. In this case the national legislation required a trader, who was seeking to deduct VAT, to have appropriate documentation for upstream transactions, which in the instant case appeared to include a transaction for which the import had been in breach of “disclosure and tax obligations”. The question referred by the tax authorities was whether this national legislation was compatible with the right to deduct in the VAT Directive. The CJEU made it clear that the trader’s inability to deduct would depend on the competent authorities’ decision on whether he knew or ought to have known, at the time he entered into the transaction for which he claimed the right to deduct, of the fraud committed by the supplier or another party involved upstream or downstream in the supply chain. (HMRC contends that it is not necessary that the fraud should be a VAT fraud). This case appears to add nothing to the principles already established in Kittel. As already noted, the alleged irregularities had occurred in the same linear chain of supply. Indeed the decision was under Article 99 of the Rules of Procedure (reply by reasoned order), which only applies where:
a question referred to the Court for a preliminary ruling is identical to a question on which the Court has already ruled, where the reply to such a question may be clearly deduced from existing case-law or where the answer to the question referred for a preliminary ruling admits of no reasonable doubt...
Conclusion
Moses LJ in Mobilx held that the Kittel test should not be over-refined. I agree. In this case, Mr Lasok has sought to adduce closely-reasoned, intricate arguments and counter-arguments. In my judgment, the propositions in Kittel are clear and simple and are not undermined by arguments of the type put forward in this case.
The appeal was premised on two alternative grounds. The first ground is based on the narrower interpretation (as defined above), alternatively on a narrowing by the CJEU of the Kittel principle in later judgments. I have rejected that ground as a misinterpretation of the jurisprudence of the CJEU. The second ground is based on an argument that Fonecomp did not know the details of the fraud found by the FTT or of the connection between its purchases and the fraudulent evasion of VAT. In my judgment, the CJEU’s case law does not require this sort of knowledge.
Furthermore, in my judgment, it is not appropriate in this case to make a reference for a preliminary ruling to the CJEU. The CJEU has made it clear that national courts should not permit the provisions of the VAT scheme to be used for abusive or fraudulent ends. Fonecomp was found to be a participant in a fraud. In my judgment, insofar as the grounds of appeal related to matters of EU law, the answers were acte clair.
I would therefore dismiss this appeal.
Lord Justice McFarlane:
I agree.
Lord Justice Burnett
I also agree
APPENDIX
Summary of the background facts from the judgment of the Upper Tribunal
The decision of the FTT: facts and conclusions
[4] The facts are extensively set out in the decision of the FTT, reported at [2012] UKFTT 102 (TC), and can for the purpose of this appeal be stated quite briefly.
[5] The two transactions of Fonecomp in issue were:
(a) Deal 1: the purchase by Fonecomp of 1,100 Nokia 9300i phones and 1,200 Nokia 8801 phones from PDA Stuff Limited for £759,226.25, including VAT of £113,076.25, and the sale of those phones to Axess Denmark ApS ('Axess'), a company incorporated in Denmark, for £679,200. The purchase and sale invoices were dated 11 July 2006; and
(b) Deal 2: the purchase by Fonecomp of 900 Nokia N80 phones and 500 Nokia N91 phones from TM Global Limited (trading as Team Mobile) for £475,875, including VAT of £70,875, and the sale of those phones to Axess. The purchase and sale invoices were dated 26 July 2006.
[6] The FTT found that Softlink had defaulted in its VAT payment in respect of transactions undertaken by it in August 2006, after the date of the July transactions carried out by Fonecomp. Softlink was not involved in transactions in the goods bought and sold by Fonecomp, but the FTT found that Fonecomp's purchases were connected to Softlink's default through what has been described as a 'contra-trader', a company called Klick (UK) Limited ('Klick').
[7] As the FTT recorded (at [5]), contra-trader is a term used by HMRC (Mr Patchett-Joyce referred to it as 'an HMRC construct') to describe a trader which (a) buys goods from a defaulter and exports them claiming, in what is termed the 'dirty chain', the input VAT ('the dirty input VAT') on the purchase; and (b) in a 'clean chain', imports goods and sells them to a third trader, and then offsets the dirty input VAT against the clean output VAT on the sale to the third trader. The dirty input VAT is by this means sought to be transmuted into clean input VAT in the hands of the third trader; or at any rate the third trader is sought to be so distanced from the default that he could not know of his connection to it, or HMRC discover it.
[8] That is a description of a straightforward example of contra-trading. More complex examples may be found, where the goods pass through a number of intermediate traders in a chain. In this case Fonecomp, alleged to be the third trader in the description of contra-trading, did not purchase the goods from Klick. It was distanced from Klick by one or two intermediate traders in the clean chain. It was alleged by HMRC that, first, the activities of Klick provided the connection between Fonecomp's purchases and Softlink's default, and secondly that there was a wider managed scheme associated with Klick's transactions, involving 37 other traders including Fonecomp, in an organised assault on the revenue which involved reclaiming the VAT on which Softlink defaulted, amounting to some £66 million.
[9] The FTT made detailed findings of fact in relation to Softlink, Klick and the alleged wider 'Klick' scheme. It concluded:
(a) Softlink had a liability to pay VAT in respect of 194 deals it had undertaken between 15 and 25 August 2006, that it did not pay that VAT and that at the time it entered into the transactions it had not intended to pay that VAT. Softlink fraudulently evaded, and at the time of the deals had intended to evade, the £66 million of VAT on its sales to Klick between those dates (FTT, [2012] UKFTT 102 (TC) at [164]).
(b) Klick's activities in June, July and August 2006 were part of a planned scheme which encompassed Softlink's default. The object of that scheme was to fuel chains of supply in June and July 2006 with input tax credits which could eventually be claimed by exporters, and to match those credits with a later fraudulent VAT default by Softlink leaving a small VAT reclaim at the end of the quarter. All Klick's sales in June and July 2006 were by this arrangement connected to Softlink's later fraudulent default. Softlink's default was planned as part of the same operation as Klick's activities in those months (FTT, [166]–[167]).
(c) Fonecomp's acquisition of the phones in Deal 1 in July 2006 was connected with Klick's acquisition and disposal of them in the senses: (i) that they were the same phones and were sold and acquired in transactions close in time, (ii) that the input and output VAT were offset, and (iii) that the acquisition aided Klick's sales (FTT, [203]).
(d) Fonecomp's acquisition of the phones in Deal 2 in July 2006 was in the same sense connected with Klick's acquisition and disposal of them (FTT at [205]).
(e) Accordingly, for each Deal, the FTT found that Fonecomp's purchase was connected with Klick's fraudulent arrangements in relation to, and hence was connected with, the fraudulent evasion of VAT by Softlink (FTT, [206]–[210]).
[10] The FTT concluded that Fonecomp's participation as an exporter in the scheme involving Klick and Softlink did not mean that it necessarily knew that it was part of the scheme (FTT, [219]). It nonetheless found that, since Fonecomp knew when it made its purchases all the facts from which it should have concluded that the deals assisted or were connected to VAT fraud, it should have known that its purchases were connected with fraud at the time it made them (FTT, [228]).
[11] The FTT summarised its reasons for reaching that conclusion at [222]–[229]. At [222] it referred to its findings in relation to the following matters as indicating that the parties to Fonecomp's transactions were not concerned with precisely what phones they were buying and selling, and hence proceeded in a manner which was at variance from what one would expect in a normal commercial transaction:
(a) the lack of specification, particularly on purchase orders from Axess;
(b) the lack of proper inspection of the phones despite their value;
(c) the purchase and sales of phones designed for the US market and sold with 'Central European spec'; and
(d) the lack of defined clear contractual terms (time of payment, title etc).
[12] The FTT found that the only explanation of these factors was that what Fonecomp's customer (and possibly Fonecomp and its supplier) wanted was that there would be a sale and export (that is, any sale and export), and was indifferent to precisely what was said to be exported because the recipient already knew precisely what it was getting because the chain had been pre-arranged (FTT, [223]).
[13] At [224], the FTT focused further on the European and US specifications of the phones that were the subject of the transactions. It referred back to its findings at [136] to [144], where it concluded that the nature of both the types of phones was such that there was no likely explanation other than that they had been imported into the UK in order to be exported. The FTT further concluded, at [225], that the only reasonable explanation of these features was that the Deals were part of a scheme for the import, onsale and later export of the phones, and that the only explanation for such a scheme was that the transactions in the phones were part of, and aided, a VAT fraud.
[14] Earlier in its judgment, the FTT had found that Fonecomp knew the mechanics of VAT fraud, it knew that its suppliers were back-to-back trading and it knew there could be VAT fraud affecting the chains of supply to it. In those circumstances, the FTT concluded that Fonecomp should have known that the factors referred to by the FTT, which it found (at [228]) were known to Fonecomp at the time it made its purchases, led ineluctably to the conclusion that the Deals assisted or were connected to such a fraud (FTT, [226]).