Red 12 Trading Ltd v Revenue & Customs

This is an appeal from a decision of the VAT & Duties Tribunal, sitting in London, released on 16^th December 2008. By that decision the tribunal dismissed, save in one respect, the appeal under section 83 (c) and/or (e) of the Value Added Tax Act 1994 of the appellant, Red 12 Trading Ltd (“Red 12”), against the denial by the respondents, the Commissioners for Her Majesty’s Revenue & Customs (“HMRC”) of Red 12’s ability to deduct input tax in respect of 46 transactions in the tax periods 02/06 and 03/06. The input tax in issue was £ 2,672,748.50.

This case concerns what is called “Missing Trader Intracommunity Fraud” (“MTIC fraud”). Anyone reading this judgment is likely to be familiar with this expression, which has been explained in several tribunal and High Court decisions. The classic way in which the fraud works is as follows. Trader A imports goods, commonly computer chips and mobile telephones, into the United Kingdom from the European Union (“EU”). Such an importation does not require the importer to pay any VAT on the goods. A then sells the goods to B, charging VAT on the transaction. B pays the VAT to A, for which A is bound to account to HMRC. There are then a series of sales from B to C to D to E (or more). These sales are accounted for in the ordinary way. Thus C will pay B an amount which includes VAT. B will account to HMRC for the VAT it has received from C, but will claim to deduct (as an input tax) the output tax that A has charged to B. The same will happen, mutatis mutandis, as between C and D. The company at the end of the chain – E – will then export the goods to a purchaser in the EU. Exports are zero-rated for tax purposes, so Trader E will receive no VAT. He will have paid input tax but because the goods have been exported he is entitled to claim it back from HMRC. The chains in question may be quite long. The deals giving rise to them may be effected within a single day. Often none of the traders themselves take delivery of the goods which are held by freight forwarders.

The way that the fraud works is that A, the importer, goes missing. It does not account to HMRC for the tax paid to it by B. When HMRC tries to obtain the tax from A it can neither find A nor any of A’s documents. In an alternative version of the fraud (which can take several forms) the fraudster uses the VAT registration details of a genuine and innocent trader, who never sees the tax on the sale to B, with which the fraudster makes off. The effect of A not accounting for the tax to HMRC means that HMRC does not receive the tax that it should. The effect of the exportation at the end of the chain is that HMRC pays out a sum, which represents the total sum of the VAT payable down the chain, without having received the major part of the overall VAT due, namely the amount due on the first intra-UK transaction between A and B. This amount is a profit to the fraudsters and a loss to the Revenue.

The tribunal held that all of the 46 deals save one were part of an MTIC fraud. One deal – deal 32 – was tainted by fraud. In respect of 45 of the deals the subject of the fraud the tribunal dismissed Red 12’s appeal. In respect of deal 32 the tribunal allowed the appeal because the case was pleaded on the basis of the fraud being an MTIC fraud, adding that, given its finding that deal 32 was tainted by fraud, albeit not MTIC fraud, whether the Commissioners chose to repay the input tax was a matter for them.

A jargon has developed to describe the participants in the fraud. The importer is known as “the defaulter”. The intermediate traders between the defaulter and the exporter are known as “buffers” because they serve to hide the link between the importer and the exporter, and are often numbered “buffer 1, buffer 2” etc. The company which export the goods is known as the “broker”.

The manner in which the proceeds of the fraud are shared (if they are) is known only by those who are parties to it. It may be that A takes all the profit or shares it with one or more of those in the chain, typically the broker. Alternatively the others in the chain may only earn a modest profit from a mark up on the intervening transactions. The fact that there are a series of sales in a chain does not necessarily mean that everyone in the chain is party to the fraud. Some of the members of the chain may be innocent traders.

There are variants of the plain vanilla version of the fraud. In one version (“carousel fraud”) the goods that have been exported by the broker are subsequently re-imported, either by the original importer, or a different one, and continue down the same or another chain. Another variant is called “contra trading”, the details of which are explained in paragraphs 9 and 10 of the judgment of Burton J in R (on the application of Just Fabulous (UK) Ltd) v HMRC[2008] STC 2123. Goods are sold in a chain (“the dirty chain”) through one or more buffer companies to (in the end) the broker (“Broker 1”) which exports them, thus generating a claim for repayment. Broker 1 then acquires (actually or purportedly) goods, not necessarily of the same type, but of equivalent value from an EU trader and sells them, usually through one or more buffer companies, to Broker 2 in the UK for a mark up. The effect is that Broker 1 has no claim for repayment of input VAT on the sale to it under the dirty chain, because any such claim is matched by the VAT accountable to HMRC in respect of the sale to UK Broker 2. On the contrary a small sum may be due to HMRC from Broker 1. The suspicions of HMRC are, by this means, hopefully not aroused. Broker 2 then exports the goods and claims back the total VAT. The overall effect is the same as in the classic version of the fraud; but the exercise has the effect that the party claiming the repayment is not Broker 1 but Broker 2, who is, apparently, part of a chain without a missing trader (“the clean chain”). Broker 2 is party to the fraud.

HMRC will have records of whatever returns have been made to them by companies registered for VAT and will know what has been accounted to them and what has not. Using those records and information provided by VAT registered companies they are able to trace a chain of transactions in respect of which output tax received has been accounted for and claims to deduct imput tax have been made. They can, thus, trace back from exporter E to (say) importer A. But at some stage the trail is likely to go cold. In the classic version of the fraud it will do so when HMRC gets to A because A and its documents have disappeared. HMRC will know that A has defaulted on its obligations in respect of VAT since it will not have received any of the output tax paid by B to A (as accounted for by B).

However, HMRC may not be in a position to know whether A is in fact the importer or whether there may have been earlier companies in the chain, either as purchasers or transferees, such that its full length was (say) Y – Z – A – B etc. In that example there will have been a defaulter (A), who will not have accounted to HMRC for VAT, but there will also have been an importer (Y). Whether or not Y or Z are liable to account for VAT may depend on the exact nature of the dealings between Y, Z and A, between whom money may not have changed hands.

In a chain of transactions between traders all of whom are honest each trader will account to HMRC for the output tax received (in respect of which the trader acts, broadly speaking, as agent for HMRC: Elida Gibbs Ltd v Customs & Excise Comrs [1997] QB 499), less any input tax incurred, which he will claim from HMRC. He will, ordinarily, need most of the money received from his sales to pay his supplier and the VAT due. The full extent of any chain will be patent. Where there is dishonesty the position is different. It is in the interests of those who seek to defraud HMRC of VAT to hide the full extent of any chain by the use of buffer companies. Such persons lack any interest in seeing that they, or the companies through whom they operate, are able to account to HMRC for all the VAT that they should.

The tribunal noted that, in some of the chains in the present case, instructions had been given for the price (or most of it) to be paid to some third party in a Member State other than the UK. The tribunal accepted that this was evidence of two things:

Articles 167 and 168 of Council Directive 2006/12/EC of 28 November 2006 on the Common System of Value Added Tax (the “2006 Directive”), which is the successor to two earlier Directives on the harmonisation of the laws of Member States relating to turnover taxes, provide:

“167 - A right of deduction shall arise at the time the deductible tax becomes charged.

168

Insofar as the goods and services are used for the purposes of the taxed transactions of a taxable person, the taxable person shall be entitled, in the Member State in which he carries out these transactions, to deduct the following from the VAT which he is liable to pay:

(a)

The VAT due or paid in that Member State in respect of supplies to him of goods or services, carried out or to be carried out by another taxable person.”

Section 24 of the Value Added Tax Act 1994 defines “input tax” as including VAT on the supply to any taxable person of any goods or services used or to be used for the purpose of any business carried on or to be carried on by him. Section 25 of the same Act provides for a taxable person to account in prescribed accounting periods in respect of supplies made by him and provides that, subject to certain provisions, he is

“entitled to credit at the end of the period [for] so much of the input tax for the period (that is input tax for supplies, acquisitions and importations in the period) as is allowable by or under regulations as being attributable to supplies within subsection (2) below”

Subsection 25 (2) includes taxable supplies. By section 24 (1) (a) “input tax” includes VAT on the supply of any goods or services. The VAT Regulations 1995 provide that a person claiming deduction of input tax must do so on a return made by him for the prescribed accounting period in which the VAT becomes chargeable.

In a number of cases the European Court of Justice (“ECJ”) has had to consider the operation of the VAT regime in circumstances where there has been fraud. These cases establish that, in certain circumstances involving fraud, HMRC has a right to refuse repayment of input tax. From these cases a number of principles may be derived.

It is well established that:

“the question whether the VAT payable on prior or subsequent sales of the goods concerned has or has not been paid to the Treasury is irrelevant to the right of the taxable person to deduct input VAT”: see para 49 of Axel Kittel v Ėtat Belge Case C – 439/04 [2006] ECR 1-6161.

In Optigen Ltd & Ors v Commissioners of Customs & Excise[2006] ECR 1-483 there was a carousel fraud. The taxpayers were, it was accepted, innocent parties to a number of transactions in the carousel. They had had no dealings with the trader that went “missing”, and had no reason to know that they were doing anything other than buy computer chips from one company and selling them to another company in another Member State. The argument for HMRC, which the tribunal had upheld, was that the taxpayers could not claim the input tax because a trader, even though innocent of either fraud or recklessness, does not have a right to a refund of input VAT on goods which it has sold to a company outside the UK when there was a defaulting trader in the chain of supply.

HMRC’s contention was that transactions forming part of a carousel fraud were not “economic activities” within the meaning of the then applicable Sixth Directive (Footnote: ¹), which by Article 4 (1) defines a taxable person as “any person who independently carries on in any place any economic activity” specified in paragraph 2. By Article 4 (2) “economic activities” were defined as “all activities of producers, traders and persons supplying services”. The transactions in issue were said by HMRC to be devoid of economic substance and outside the scope of the Directive.

In the course of his opinion the Advocate General said:

“ 20 Crucial to the United Kingdom's line of reasoning is the view that the carousel scheme must be regarded as a whole in order to determine whether VAT applies to the separate transactions therein. I do not share this view.

27 …. carousel fraud concerns a series of consecutive activities, performed by a number of traders in a supply chain. It is an essential feature of the common system of VAT that VAT becomes chargeable on each transaction in a supply chain. Each transaction must therefore be regarded on its own merits. Consequently, the character of a particular transaction in the chain cannot be altered by earlier or subsequent events”.

At paras 45 – 47 the ECJ held:

“45

As the Court held in paragraph 24 of its judgement in Case C -4/94 BLP Group [1995] ECR 1-983, an obligation on the tax authorities to carry out enquiries to determine the intention of the taxable person would be contrary to the objectives of the common system of VAT of ensuring legal certainty and facilitating application of VAT by having regard, save in exceptional cases, to the objective character of the transaction in question

46

An obligation on the tax authorities to take account, in order to determine whether a given transaction constitutes a supply by a taxable person acting as such (Footnote: ²) and an economic activity (Footnote: ³), 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, would a fortiori be contrary to those objectives.

47

As the Advocate General observed in point 27 of his Opinion, each transaction must therefore be regarded on its own merits and the character of a particular transaction in the chain cannot be altered by earlier or subsequent events.”

The ECJ held that transactions such as those in issue, which were not themselves vitiated by VAT fraud, constituted supplies of goods or services effected by a taxable person acting as such and an economic activity within the meaning of the relevant Articles, where they fulfilled the objective criteria on which the definition of those terms was 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 value added tax of a taxable person who carries out such transactions be affected by the fact that in 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.”

Similarly in Kittel v Etat Belge[2006] ECR 1-4191 the ECJ held 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 contact is void is due to fraudulent evasion of VAT or to other fraud."

In Kittel the Court held that:

“53

By contrast the objective criteria which form the basis of concepts of “supply of goods effected by a taxable person acting as such” and “economic activity” are not met where tax is evaded by the taxable person himself ……

54

As the Court has already observed, preventing tax evasion, avoidance and abuse is an objective recognised and encouraged by the Sixth Directive …Community law cannot be relied on for abusive or fraudulent ends..

55

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

56

In the same way, a taxable person who knew or should have known that, by his purchase he was taking part in a transaction connected with the 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 ought to 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”.

In HMRC v Livewire Telecom Ltd [2009] EWHC 15, para 76 Lewison J summarised the state of European jurisprudence contained in Kittel, together with Teleos Plc v HMRC[2007]ECR 1-7797 andNetto Supermarket Gmbh v Finanzamt Malchin[2008] ECR 1-771, as well as Commrs of Customs & Excise v FTI [2006] ECR 1 -4191 and Garage Molenheide BVBA v Belgian State[1997] ECR 1-7281 as follows:

In Commrs of Customs & Excise v FTI [2006] ECJ 1-4191 the ECJ dealt with the extent to which Member States might enact legislation which rendered taxpayers liable if they knew or suspected that some or all of the VAT payable in respect of the supply of goods or services to them or to someone earlier or later in the chain of supply would go unpaid.

Section 18 of the Finance Act 2003 added section 77 A to the VAT Act 1994.It related to telephones and computers and equipment such as parts, accessories and software relating to computers. Section 77 A (2) entitled HMRC to serve a notice on a taxable person to whom a taxable supply had been made where at the time of supply the person supplied knew or had reasonable grounds to suspect that some or all of the VAT payable in respect of that supply, or on any previous or subsequent supply of those goods, would go unpaid. The notice was to specify the amount of VAT that was unpaid and its effect was that the person upon whom it was served was to be jointly and severally liable to HMRC for the amount in question.

By section 77 A (6) it was provided that a person should be presumed to have reasonable grounds for having that suspicion if the price payable by him for the goods in question :

“(a)

was less than the lowest price that might reasonably be expected to be payable for them on the open market, or

(b)

was less than the price payable on any previous supply of those goods.”

The presumption was rebuttable on proof that the low price payable for the goods was due to circumstances unconnected with failure to pay VAT. The purpose of these provisions was to combat MTIC fraud, including carousel fraud.

The Court held:

“ 28 Article 21 (3) of the Sixth Directive therefore permits, as a rule, Member States to enact measures under which a person is to be jointly and severally liable to pay a sum in respect of VAT payable by another person made liable by one of the provisions of Article 21 (1) and (2).

29

However, when they exercise the powers conferred on them by Community directives, Member States must comply with the general principles of law which form part of the Community legal order, which include, in particular, the principles of legal certainty and proportionality …

30

With more particular regard to the principle of proportionality, it must be pointed out that, whilst it is legitimate for the measures adopted by the Member States, on the basis of Article 21 (3) of the Sixth Directive, to seek to preserve the rights of the public exchequer as effectively as possible, such measures must not go further than is necessary for that purpose (see, to that effect, Molenheide and Others, paragraph 47).

31

In that regard, the national measures at issue in the main proceedings provide that a taxable person other than the person who is liable can be made jointly and severally liable to pay the VAT with the latter person if, at the time of the supply to him, the former knew or had reasonable grounds to suspect that some or all of the VAT payable in respect of that supply, or of any previous or subsequent supply of those goods, would go unpaid. A person is presumed to have reasonable grounds for suspecting that such is the case if the price payable by that person was less than the lowest price that might reasonably be expected to be payable for those goods on the market, or was less than the price payable on any previous supply of those goods. That presumption is rebuttable on proof that the low price payable for the goods was attributable to circumstances unconnected with failure to pay VAT.

32

While Article 21 (3) of the Sixth Directive allows a Member State to make a person jointly and severally liable for the payment of VAT if, at the time of the supply, that person knew or had reasonable grounds to suspect that the VAT payable in respect of that supply, or of any previous or subsequent supply, would go unpaid, and to rely on presumptions in that regard, it is none the less true that such presumptions may not be formulated in such a way as to make it practically impossible or excessively difficult for the taxable person to rebut them with evidence to the contrary. As the Advocate General observed in point 27 of his Opinion, those presumptions would, de facto, bring about a system of strict liability, going beyond what is necessary to protect the public exchequer’s rights.

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 (see, to that effect,Optigen …… para 52)….”

In Garage Molenheide, to which the ECJ referred in FTI, the ECJ was concerned with four cases raising the legitimacy of certain provisions of Belgian law which allowed the fiscal authorities to retain, as a protective measure, refundable amounts of VAT. The relevant Belgian legislation (a Royal Decree) dealt with the situation if at the end of the calendar year there was a refundable amount of VAT because authorised deductions exceeded the VAT due.

Two sub-paragraphs of the Decree provided for two different rights of retention. The first provided that any excess claimed to be due was deemed to be claimed only subject to payment of any unpaid tax debts. This right of retention provided that, if those tax debts were not, in whole or in part, “certain, payable and definite” the tax credit was nevertheless to be retained by the authorities. That retention was to take effect as a preventive attachment until the dispute had been definitively resolved, either in an administrative procedure or by a final court judgment. The condition laid down by Article 1413 of the Judicial Code (that a preventive attachment may be carried out only in cases where prompt action is required) was deemed to have been satisfied.

Under the second right of retention, if there were serious grounds for presuming, or there was evidence that the taxpayer’s returns in relation to previous periods contained inaccurate information and such grounds or evidence pointed to the existence of a tax debt which could not be established before the time for the payment order in respect of the refund no payment order was to be made and the tax credit was to be retained in order to permit the administration to verify the accuracy of the information.

These retentions had the effect of a preventive attachment within the meaning of Article 1445 of the Judicial Code.

The relevant Belgian authority contended that there were serious grounds for presuming that Molenheide’s VAT return for 1993 contained incorrect and incomplete particulars. A retention notice was served on Molenheide. Molenheide contested it. In the case of a Mr Schepens the authorities served a retention notice contending that there were serious grounds for presuming that there was some MTIC carousel fraud going on involving the export by the taxpayer of expensive cars from Belgium, a claim by him for repayment of input tax and a failure to account for VAT by any of the taxpayer’s suppliers.

The ECJ held that Member States might, in principle, adopt such measures, but, since such measures would impact on the national authorities’ obligation to make an immediate refund, the Member States, in accordance with the principle of proportionality, had to employ means which, whilst enabling them effectively to attain the objective pursued by their domestic laws, were the least detrimental to the objectives and principles laid down by the relevant Community legislation. The Court said:

“Accordingly, whilst it is legitimate for the measures adopted by the Member States to seek to preserve the rights of the Treasury as effectively as possible, they must not go further than is necessary for that purpose. They may not therefore be used in such a way that they would have the effect of systematically undermining the right to deduct VAT, which is a fundamental principle of the common system of VAT established by the relevant Community legislation.”

The appellants had submitted that the effect of the first right of retention was that it was compulsory and admitted of no exceptions. This was because of the deemed satisfaction of Article 1413. By virtue of that the court was not required to consider whether such a retention was necessary or whether the matter was urgent because those conditions were irrebuttably presumed to be satisfied. They contended that the second retention had the same effect.

The ECJ said:

“51

It must be held that, where a preventive attachment procedure constitutes a derogation from the ordinary law applicable to preventive attachments, in that necessity and urgency are irrebuttably presumed, doubts may legitimately be entertained as to whether it is an indispensable instrument for ensuring recovery of sums due.

52

It must therefore be held that an irrebuttable presumption, as

opposed to an ordinary presumption, would go further than is necessary in order to ensure effective recovery and would be contrary to the principle of proportionality in that it would not enable the taxable person to produce evidence in rebuttal for consideration by the judge hearing attachment proceedings.”

On 4^th July 2007 HMRC notified Red 12 that the transactions set out in an appendix to their letter of that date formed part of an overall scheme to defraud the Revenue as a result of which HMRC denied Red 12’s right to deduct input tax in respect of the purchase of mobile telephones. The decision affected tax of £ 980,920.50 in respect of 20 transactions in period 02/06 and £ 1,691,828 in respect of 26 transactions in period 03/06. The notice set out the information and features of the trade which HMRC had taken into account in making its decision. By a letter of 26^th July 2007 Red 12’s solicitors asked HMRC to reconsider its decision. By a notice of 3^rd August 2007 Red 12 appealed to the Tribunal against that decision.

The hearing by the Tribunal of the appeal took place between 7^th and 25^th July and 1^st – 3^rd September 2008. By a decision released on 16^th December 2008 the Tribunal rejected the appeal in respect of 45 of the 46 transactions.

There were six original grounds of appeal. The tribunal is said to have erred in law in:

In order to address those grounds of appeal, and, in particular, the last, it is necessary to summarise the tribunal’s findings.

In addition, a question has arisen as to the incidence of the burden of proof. It is for the appellant to show that he is entitled to the credit which he claims. But, if he shows that he has paid input tax on a taxable transaction he has, prima facie shown that he is entitled to credit for it. The question is as to what burden, evidential or legal, lies on him and HMRC thereafter.

In the tribunal case of Dragon Futures v HMRC [2006] UK VAT 19831 the VAT & Duties tribunal, differently constituted, held (para 85) that it must be shown by the appellant that the taxable person neither knew nor had the means of knowing of any fraud, which was to be tested by seeing if the taxable person that had no direct knowledge of the fraud had taken proportionate steps to enquire.

In Mobile Export 365 Ltd v HMRC [2007] EWHC 1737 Lightman J said:

“7.

The burden placed upon the Commissioners in MTIC cases of this kind is to demonstrate that, on the balance of probabilities, there has been a fraudulent tax loss and that the transactions giving rise to that loss are connected to the “taxpayers” transactions. It is then for the “taxpayer” to show that it nevertheless has a right to reclaim VAT because it did not know and could not have known of the connection to fraud.”

In para 9 (1) of its decision in the present case the tribunal said that it adopted the approach put forward by Miss Helen Malcolm, QC, Counsel for HMRC, that there was an initial burden on HMRC to show that there had been a fraud and to raise a case “requiring an answer from Red 12, and, having done so, then the burden shifts to Red 12”.

In HMRC v Brayfal Ltd (Unreported) CH/2008/App 082 Lewison J said that:

“In cases of this kind, the burden is on HMRC to establish a fraudulent tax loss and that the transactions giving rise to that loss are connected to the taxpayer’s transactions. If that is established, then the taxpayer must show that it did not know and could not have known about the fraud.”

In Calltell Telecom Ltd v HMRC [2009] EWHC 1081 (Ch) Floyd J held that:

“7.

The mere fact that a transaction forms part of a chain in which fraud occurred is not enough to justify the refusal of repayment of income tax. To justify such a refusal the tax authorities must prove that the taxpayer was himself being fraudulent, or knew or had the means of knowledge of fraud by others.”

On 22^nd May 2009 the Chancellor handed down judgment in Blue Sphere Global Ltd v HMRC [2009] EWHC 1150 (Ch) , in which he upheld a trader’s appeal from a decision of the tribunal upholding the Commissioners’ refusal to repay input tax. In the course of his judgment he held that the test used by the tribunal to determine whether the trader had the requisite knowledge that it was participating in transactions connected with the fraudulent evasion of VAT was misleading. That test had been expressed by the tribunal inter alia as follows:

“We consider that the due diligence exercise relating to Universal [one of the trader’s purchasers] was inadequate, as was the failure to follow up outstanding questions where matters did not appear to be in satisfactory order. The exercise was not sufficient to protect BSG from the risk of involvement in transactions which might turn out to have undesirable associations.”

That test was, the Chancellor held, misleading for two reasons. First, the burden was on the Commissioners to prove that the trader ought to have known that by its purchases it was participating in transactions connected with the fraudulent evasion of VAT. It was not for the trader to prove that it ought not. Secondly, it was not sufficient to demonstrate that the trader was involved in transactions which might turn out to have undesirable associations. The relevant knowledge was that the trader ought to have known that by its purchases it was participating in transactions which were connected with the fraudulent evasion of VAT; that such transactions might be so connected was not enough; paras 51 and 52.

The Commissioners also had to prove that the trader ought to have known that earlier transactions, with which the seller of the mobile phones to the trader was connected, were transactions involving the fraudulent evasion of VAT: paragraph 53.

The Commissioners, who are appealing the Chancellor’s decision in Blue Sphere, contend that, insofar as the Court intended to alter the burden on HMRC in a simple MTIC case (Blue Sphere was a case of contra trading) the decision is in conflict with earlier domestic and ECJ authority not cited to the Chancellor.

In Calltell Telecom Ltd v HMRC (2007) VAT Decision 20266 the tribunal considered the burden of proof in the following terms:

“67

Mr Cunningham made the point that it was for a trader seeking to exercise the right to deduct to show that he was entitled to do so: Rompelman v Minister van Financiën (Case 268/83) [1985] ECR 655. He did not concede that, in a case such as this, the burden shifted to the Commissioners; rather, he said, the rule remained as it had been since the decision of the High Court in Tynewydd Labour Working Men's Club and Institute Ltd v Customs and Excise Commissioners [1979] STC 570 that, save in prescribed cases of which this was not one, the burden of proof before this tribunal lay with the appellant. Nevertheless, he accepted that it was for the Commissioners to establish the chain of transactions, the relevant default and the fraudulent purpose of the default. So much was decided by the tribunal in Bond House and that allocation of the burden has been generally accepted, including by the Commissioners themselves—see, for example, paragraph 82 of the decision in Dragon Futures. For those reasons Mr Cunningham was willing to lead the Commissioners' evidence first.

68

Where the burden lies of establishing knowledge, or means of knowledge, and whether the Appellant has taken "every precaution which could reasonably be required of them", to adopt the words of Kittel, is more problematical. In Dragon Futures, at paragraphs 85, the tribunal said that it

"sees no inherent excessive difficulty in a taxable person establishing what it did or did not know at a particular time, and the steps that it took before and at that time to ensure it met to the required standard the obligation put on it to enquire."

69

Then, after dealing with the burden of establishing the fraudulent nature of the transactions, a burden it agreed rested on the Commissioners' shoulders, it continued, at paragraph 86:

"… on other matters, and in particular on the issue of establishing whether proportionate action has been taken, the burden should rest on the Appellant."

70

Though we agree with the thrust of that proposition, we think it slightly over-simplifies the questions the tribunal must answer in cases of this kind. Any trader in the position of these Appellants will say, as the Appellants did, that he can look no further than his own supplier and customer. If there is no evidence that either the supplier or the customer was the perpetrator of the fraud, demanding of such a trader that he establish that he knew nothing of another trader, earlier in the chain, requires him, as Mr Patchett-Joyce pointed out, to prove a negative. All he can say is that he did not know. He can give evidence about the quality of his enquiries, but enquiries into his supplier, however good, will not, of themselves, tell him anything about a trader several steps removed. And knowledge cannot always be inferred merely because the enquiries made were of poor quality.

71

For those reasons we think it is incumbent on the Commissioners to raise a case, not necessarily amounting to proof but sufficient to demand an answer, that there were facts or circumstances which support, or at least are consistent with, the conclusion that the appellant knew, or should have known, of fraud in the chain. The mere fact that there was fraud will not be enough; there must be some reason which might lead the tribunal to conclude that the trader knew or could have known of it, or that he should have taken precautions. Although, as we have already pointed out, the Court of Justice, at paragraph 51 of its judgment in Kittel, referred to traders "who take every precaution" as those who are not liable to forfeit their right to deduct, it should be borne in mind that most traders do not, and do not need to, carry out extensive enquiries into the honesty and creditworthiness of their suppliers and customers. But if the Commissioners are able to mount a case which demands some explanation, the burden shifts to the appellant to show that he took the precautions which could reasonably have been required of him and that, despite his having done so, he did not know, and could not have known, of the fraudulent purpose of others.”

That position is, it is submitted, appropriate since the facts and matters relevant to the question of knowledge are peculiarly within the knowledge of the appellant.

In the event it does not seem to me necessary for me to decide the incidence of the burden of proof since, as will become apparent, the tribunal’s conclusions were, as it seems to me, not dependent upon it: see paras 72 and 75 referred to in para 60 below.

Were it necessary to reach a conclusion I should be in agreement with the Chancellor. The ECJ authorities emphasise the importance of the taxpayer’s right to deduct input tax in respect of what, viewed objectively, are taxable supplies, whilst recognising the right of public authorities to refuse repayment if the taxpayer knew or ought to have known that its purchases had a fraudulent connection. In these circumstances it seems to me that, if the Commissioners seek to deny the taxpayer a right to repayment of input tax paid on taxable supplies on the grounds of the taxpayer’s knowledge (actual or constructive) of a connection to fraud, it is for them to establish that. If, in the light of all the evidence, including that of the taxpayer, the tribunal is not satisfied that he had or ought to have had the requisite knowledge, the taxpayer will be entitled to recover. In practice before a tribunal the stage may be reached at which the evidence calls for an answer, in the sense that, if the taxpayer gives no evidence that he made any inquiries, the tribunal could conclude that he had the requisite knowledge because he either had or ought to have had knowledge of the fraudulent nature of the transaction. But, at the end of the day, it remains for HMRC to convince the Tribunal that it should so conclude.

The Tribunal had before it an agreed statement of certain facts. These included the following. According to Red 12’s VAT returns its turnover was as follows:

The Tribunal found a number of background facts (paras 13-19) about the history of the company. It then identified each of the 46 transaction chains, which are set out in a schedule produced by HMRC attached to its decision. Each of those chains had been traced back to a trader who had gone missing, or had used a hijacked VAT number, or who had otherwise defaulted on its VAT liabilities. Twelve defaulting traders were involved. In the case of each of the chains Red 12 acted as the broker i.e. it was the last UK company in the chain and exported the goods so as to be able to claim back the VAT from HMRC.

The Tribunal approached its task in this way. It first looked at each of the chains of transactions to see (a) whether there was evidence both that the goods were imported from the EU and that they were imported by the defaulter; and, if not (b) whether there was evidence, including circumstantial and “similar fact” evidence, which the tribunal accepted, sufficient to show that the goods were imported from the EU. The tribunal accepted, as I have said, evidence given to them by Mr Roderick Stone that third party payments i.e. payments made on the instructions of the defaulter for payment to be made to a third party, usually out of the jurisdiction were often a feature of MTIC fraud, since an honest trader would not usually cause to be paid away monies which he needed in order to pay his supplier and the VAT to HMRC. Such payments often involved the defaulter only receiving a fraction of the price as a “commission” for participating in the fraud. They also accepted that on some occasions it was not possible to identify the original acquirer from Europe because some freight forwarders deliberately omitted the details of the missing trader or because the buffer traders had not kept sufficient records. In addition to its initial analysis of individual deals, the tribunal looked at the inter-connectedness of the companies, what they must have known, and the probability in the circumstances of any of the particular deals being genuine.

In respect of the 12 defaulting traders the Tribunal made findings as to whether or not there had been fraud. In order to do so it sought to determine whether there had been a tax loss attributable to a defaulter i.e. a failure by the defaulter to account to HMRC for VAT, and whether there had been “an EU acquisition” i.e. whether the goods the subject of the chains of transactions had originated from somewhere in the EU other than the UK. In some cases there was direct evidence of EU acquisition by the defaulter; in others that was what the Tribunal inferred from all the circumstances. In their decisions on individual deals the tribunal found “MTIC fraud” or “fraud” or a “fraudulent tax loss”. It is clear from the terms of paragraph 21 and 77 of the decision and the tribunal’s findings in relation to the individual deals that, in cases where there was an EU importation, being all cases save one (Samson Traders Ltd – Deal 32), the fraud which the tribunal found was an MTIC fraud. Appendix 1 to this judgment identifies the defaulting traders involved, the deals with which they were concerned, the tribunal’s conclusions as to whether there was a tax loss, EU import and fraud, and brief details of the basis for the tribunal’s finding.

The tribunal heard extensive evidence occupying some 12 days. In paragraph 22 of its decision it referred to the additional matters relied on by HMRC to show fraud namely (i) that all Red 12’s suppliers and all save three of its customers banked (as did Red 12) with an offshore bank in the Netherlands Antilles whose accounts and dealings were frozen in July 2006 owing to its involvement in fraud; and (ii) that in the majority of the deals, which involved different telephones, the mark-ups achieved by each successive trader were consistent in whole pence and the increment in mark-up between each trader was consistently divisible by £ 0.05.

In para 23 the Tribunal set out the evidence relied on by HMRC, all of which it accepted (see para 73) to show Red 12’s state of knowledge. In paras 25- 42 it summarised Red 12’s evidence; in paras 43- 56 it addressed Red 12’s case; and in paras 57- 67 it addressed HMRC’s case. In paras 68-77 it set out its reasons for decision and its decision.

In essence the tribunal concluded:

So far as Red 12 not being any part (as an arbitrageur) of the genuine grey wholesale market the tribunal accepted the contra-indicators given by Mr Gary Taylor, an expert witness called by HMRC whose evidence the tribunal found reliable, namely:

The further grounds on which the tribunal reached its conclusions were as follows. Firstly, the tribunal decided that there was a “sheer improbability of [the 46] trades being genuine” having regard to the following:

As to (i) the figures are set out in para 36 above and are huge, particularly for a company with, so it appears, no staff other than a director and a company secretary and modest capital. The tribunal was given no explanation for the volume of the trades, other than that Mr Singh claimed to trust his suppliers and to be on good terms with them: (para 72). He was unable to explain why such large quantities of telephones were available, why he was able to source the precise number of telephones required by his would be purchasers, why he never had any surplus phones, why he had not tried to become an authorised distributor or why on occasion he was buying telephones originating in countries where phones were more expensive than in this country and selling them on to places where they were as a rule less expensive:(para 72). Over the period April 2004 to August 2006 Red 12 made profits of £ 4,216,527.30 and losses of no more than £ 12,770. No real explanation was given by Mr Singh as to how Red 12’s remarkable success came about.

As to (ii) the tribunal recorded (para 23(6)) that, despite repeated requests, Red 12 did not provide HMRC with due diligence on its suppliers until July 2007 and then only in respect of two companies. One of them had a credit reference of just £ 500 but Red 12 traded with it in millions and did so before carrying out any checks. It also observed that Mr Singh was completely unconcerned as to the fact that he might not be supplying what his customer wanted, was prepared to deal with customers of whom he had scant knowledge, and proceeded to trade with companies where his knowledge indicated that the trader was unlikely to be legitimate. It held that his actions were not those of a man concerned that he was operating in an area he knew to be rife with fraud, and that the very best that could be said of him was that he closed his eyes to those aspects which were unwelcome to him (para 72). No checks had been made with the freight forwarders as to where the telephones had come from or as to how many previous traders had handled them. No checks were made (such as those suggested by HMRC in VAT Notice 726) even though telephone chargers had plugs unsuitable for the UK.

Evidence of due diligence was not produced for the purpose of the hearing before the tribunal until the disclosure of a supplemental bundle of documents which HMRC regarded as inadequate. Some were in Arabic or German, which there was no evidence that Mr Singh spoke. One company to which Red 12 had sold phones in February 2006 did not have a working phone number. Its registration had in fact been cancelled by the Swiss authorities by 31^st December 2005 and it was run by a Belgian who lived in Marbella and was suspected of involvement in carousel fraud (although the tribunal accepted that Mr Singh may not have been aware of these matters). A Veracis report on one company (The Fones Centre Ltd) dated 9^th March 2006 showed that it had a high risk credit rating and County Court judgments against it: (para 23 (6)). A similar report, dated May 2005 but appending documents dated 2006, on another company (London Mobile), with which Red 12 had done more than £ 2.7 million worth of business between June 2005 and January 2006, contained a number of negative indicators and showed that it was suspected of being engaged in circulating goods: (para 23 (7)). The report contained no evidence that it was actually prepared for Red 12 (it was described as “prepared for the purpose of obtaining legal advice”). The tribunal found improbable Mr Singh’s evidence that he had paid Veracis £ 3,000 at the outset and Veracis then subtracted the cost of reports from the sum which they held on account. No invoice, evidence of payment or covering letter from Veracis was produced. Mr Singh, the tribunal held, ignored Veracis’ unfavourable reports in respect of those with whom he wished to trade in the case of three companies. He started trading with Reya without waiting for the report he had commissioned: (para 38).

Red 12 did not take down any of the IMEI (Footnote: ⁴) numbers of the phones with which it was dealing, which would make it possible to trace carousel fraud. Mr Singh rejected the advice of Mr Rupert Moyle of a firm of VAT consultants on 1^st March 2006 that he should take samples of some 10% of the numbers and retain them. A large quantity of the phones sold by Red 12 in Deal 37 had previously entered and left the UK. Had Red 12 noted the IMEI numbers it would have been aware of this. Mr Moyle ceased to act for Red 12 after he had told Mr Singh, at a meeting with HMRC, that he would not act as adviser unless Red 12 was doing proper checks:(para 37).

As to (iii) the tribunal described the majority of invoices produced by Red 12 as “singularly uninformative to such an extent that their commercial usefulness is highly questionable. They expose Red 12 and other traders in these chains to considerable commercial and legal risks” (para 35). Some of the invoices showed anomalies between the dates of purchase orders and sales invoices. When questioned before the tribunal Mr Singh showed that he did not know what accessories the various telephones came with or whether the telephone was Bluetooth enabled or not (something which makes a considerable difference to its value) and seemed to regard the precise specification as almost irrelevant. The tribunal recorded that in several cases the specifications in Red 12’s purchase orders and sale invoices were “woefully inadequate”, listing no more than the make and model, quantity and price, when mobile phone specifications cover much more e.g. the size of the memory: (paras 30 + 35).

As to (iv) the facts spoke for themselves. Red 12 did nothing but sell the mobiles on. “Spectacular amounts of trade were engendered at a time when Red 12 had no capital”: (para 23 (1)).

As to (v) the chains involved up to 10 companies from defaulter to ultimate importer from the broker. The tribunal said that it made no sense, as for example in deal 2, for 1000 mobile telephones to be imported, not by any authorised dealer, and then pass through seven different traders before reaching Red 12; and that the extensive chains had no commercial rationale. It held (para 32) that Mr Singh must have known that he was part of a chain of at least five (down to Red 12). He claimed to be ignorant of the fact that telephones were coming into the UK from the EU but the tribunal held that that had been shown to be untrue on several occasions (para 32). Red 12 deals seemed to have been part of an extraordinary number of back to back deals in a single day (e.g. deal 2 with 9 transactions) which could ordinarily be expected to give rise to difficulty in the passing of legal title: (para 33).

As to (vi) the figures for turnover were enormous, particularly having regard to the number of telephones realistically available to Red 12: (paras 36 and 61 (iv).

As to (vii), deal 25 involved the sale to Red 12 of 1457 Nokia 8800 phones, 1400 of which had come down one chain and 57 down another. Although Red 12’s invoice showed that 1457 were made in Germany, an inspection report of 7^th March showed that 1020 were made in Germany and 437 in Korea. The phones were said to have 3 different types of charger. The software in respect of 1020 phones was recorded as being in 9 languages; and in respect of the others in 11. None of these languages was Danish although Red 12 was exporting them to Denmark The inspection report for the goods did not list Danish among the options for the software languages (para 35). There appeared to be two contradictory inspection reports one of which recorded a 100% inspection between 11.25 and 12.10. The Danish purchaser sold on to a French purchaser although none of the software incorporated French: (para 30). Deal 11 involved invoices in the chain with contradictory information as to specification and key pad (para 30).

There was no example of a customer ever rejecting the telephones sold despite the curious nature of some of the goods as revealed in the inspection reports.

A large proportion of the stock in which Red 12 traded had two pin plugs for the charger. Mobile phones are not manufactured in the UK; and the UK does not have a 2-pin plug system. There was no obvious reason why such goods should have been imported into the UK when they must have been intended for sale outside it: (para 23 (2)).

In 12 deals up to and including deal 21 Red 12 purchased from NTS. In 10 subsequent deals a company called Reya Ltd, which was founded by a husband and wife team who had been in the jewellery business for 25 years and operated above a jewellery shop they still owned, was interposed between NTS and Red 12. Reya Ltd only started trading in mobile phones in September 2005. In March 2006 Red 12 had already purchased £ 5 million worth of telephones. It did not obtain a Veracis report until April 2006. The relevant deals in the chain all took place on the same day. The effect of interposing Reya in the chain was that Red 12 lost £ 87,000. Red 12 could have been expected to have contacted NTS and asked NTS for the relevant telephones before contacting Reya. Red 12 knew that there was a link between NTS and Reya since Reya is shown as a trade reference on the due diligence performed in respect of NTS. There was no evidence of any attempt by Red 12 to source from cheaper suppliers: (para 23 (10)).

Mr Singh claimed that he always obtained 100% inspection reports before finalising a deal and that he always (with the exception of two deals) requested them on the date of the deal. The tribunal found that in respect of 21 of the 46 deals the reports were dated more than a day after the deal date; that in respect of two deals the report arrived at Red 12 at 22.42 hours which made it unlikely that it influenced a contract made that day. In several deals the quantity of phones involved and the timing of the inspection was such that the sequence of instructions – report – purchase on the same day could not have been followed. Mr Singh had no idea of the time it took to perform an inspection. No copies of the inspection reports had been produced prior to the hearing other than one invoice dated 31^st March 2006.

An inspection report, provided by ASR Logistics and put forward as an example of a full and helpful report, was described by Mr Taylor as largely “spurious and unhelpful”, containing a meaningless reference to “MMC” (Multi Media Memory Card), whose cost can vary between £ 10 and £ 100, and not stating the size of the memory – a matter of great commercial importance. The goods had been shipped by the time the report was produced. It was impossible to tell when the deals were closed; who owned the goods up to the point of inspection, and who would be liable for the cost if the goods were rejected. There was, the tribunal held, “no sense of commercial reality in the way Red 12 conducted its affairs” since the nature of the trade would require the parties to be very certain where liability lay.

As to (viii) the paperwork did not enable it to be ascertained at any one time in the course of the deals who owned the goods and who would suffer loss in the event of an accident or other cause of a loss of supply. The purchase orders and invoices did not follow one after another: (para 23 (4). Inspection reports involving 100% inspection of the phones (in one case 6,000 of them) were often said to have been completed on the day of the request for them, which was impossible. In some cases, according to the documents, the inspections took place after the goods had been sold on or goods were exported by Red 12 before being released to it by its supplier, or the inspection report was not faxed to Red 12 until days after the deal was done. No evidence of insurance in the relevant period was provided (para 23 (8)). Red 12 was said to rely on the freight forwarder’s generic insurance, not specific to any of the deals in question.

A copy of Red 12’s terms and conditions (applicable whether it was supplier or customer) was provided for the purposes of the hearing, but had not previously been provided to HMRC. In them Red 12 warranted that each of Red 12’s suppliers had conducted all the enquiries and information set out in Schedule 2 (not attached or produced) and had obtained a warranty from its own supplier. The basis upon which Mr Singh felt that the terms were met was that he had done due diligence on his own suppliers. The terms did not specify when the goods became the property of Red 12. They appeared to make Red 12 responsible for the payment of insurance, which was contrary to Mr Singh’s evidence. The terms provided that the buyer would not transfer funds to any bank account held off - shore in the seller’s name. Since all of those from whom Red 12 was buying, Red 12 itself, and all but 3 of Red 12’s customers, had accounts with FCIB in the Netherlands Antilles, Red 12 was, the tribunal held, in breach of its own terms on every occasion it traded.

Mr Singh was unaware what CIF stood for, even though in at least one deal there was a reference to the sale being on those terms. There was no independent evidence that the terms were ever given to any of the suppliers and no copy was found at any of the suppliers’ premises. (Mr Singh’s evidence was that the terms were sent to everyone who enquired about trade with Red 12 by e-mail: (para 28)). The tribunal described the terms as deficient in that it was not possible to tell whether or when they referred to Red 12 as supplier or when as purchaser at any particular point:(para 23 (9))

The tribunal found that Red 12 acted on occasions as buffer trader rather than broker in respect of the same type of telephone, which made little commercial sense given the different profit levels. Mark-ups appeared to remain the same regardless of the unit price of the goods without variation to reflect quantities, age or desirability of the phones. No log was kept of telephone calls and e-mails (said to be very numerous) in respect of any deal despite advice to Mr Singh that he should do so, at least for a couple of deals. The tribunal described Mr Singh as intelligent and resourceful but found that, because of all the inconsistencies in his evidence and the commercial unreality of his trading patterns he was not a reliable witness.

1 that?

2 A. Yes, that is what it states.

3 Q. Does it also state that at the time Puwar

4 were issuing third party payment instructions?

5 A. Yes.

6 Q. Not leaving them enough money to pay the VAT

7 due?

8 A. That is correct, yes.

9 Q. And those were two of the reasons at

10 paragraph 10 to which I directed your attention in

11 the first place for deregistration?

12 A. They are referred to in that summary, yes.

13 Q. So from that can you tell whether Puwar was

14 importing mobile telephones from Europe?

15 A. From this information, yes. Puwar were

16 importing phones.

17 Q. If you look, still on page 297, the

18 investigation paragraph, to transactions, do you

19 see a list of known suppliers?

20 A. Yes.

21 Q. All of them EU?

22 A. All of them are based in the EU, yes.

23 Q. Three of them are very familiar to us, IQ

24 Trading, Sunico and Orange and Green Traders?

25 A. That is correct, yes.