Deos Group.Co.Uk Limited v The Commissioners For HMRC

The purchases were of various relatively small electronic consumer goods such as Apple AirPods, Go-Pro cameras, Nintendo Switch and Microsoft Xbox games consoles and Apple iPad tablet computers.

The purchases, all of which were from Estanza, and the related onward sales of the good concerned by Deos, may be summarised as follows:

The supply chain in relation to the purchases was as follows: 2LY Promotions Ltd – AAMRL Ltd – Estanza – Deos.

The purchases were connected with the fraudulent evasion of VAT by their connection with 2LY Promotions Ltd.

Deos was incorporated, and registered for VAT, in 2017. At times relevant to these appeals, Mr Smith was group managing director, and Michelle Stoneman, Mr Smith’s partner (in the personal sense), was the sole company director; the business reality was that Deos was run by Mr Smith and Ms Stoneman.

Deos’ core business, which dated back to the late 1970s when it was started by Mr Smith’s parents, was selling and leasing office equipment, such as photocopiers, furniture, printers and office supplies. At relevant times, it had a staff of about 17 people. It operated from a medium sized unit on a small industrial estate: an office block with an adjacent warehouse facility containing office equipment and stock – photocopiers, furniture etc.

Deos’ turnover and profit, per its accounts, in the four years ending 31 March 2022, were as follows:

Deos’ core business suffered in the covid pandemic – Mr Smith told HMRC in July 2021 that Deos’ “run rate business” was down 40%; Deos sought what Mr Smith called “extra revenue streams” as a result; for example, in the early phases of the pandemic, Deos successfully entered the business of selling PPE.

In the spring of 2021 Deos started purchasing, wholesale, small electronic consumer goods (like Apple AirPods) from Thames Distribution Ltd (“Thames”) and on-selling them, in short order, to companies in the EU. Mr Smith ran this side of Deos’ business.

It was a contact at R&M Electrical Group Ltd, a longtime customer of Deos’ core business, that put Mr Smith in contact with Thames; Mr Smith’s understanding was that Thames had itself been selling electronic consumer goods, wholesale, to customers in the EU; but due to a downturn in Thames’ business (and, in particular, a deterioration in its cashflow), it now wished to sell through a UK intermediary with healthy cashflow.

The connection between “healthy cashflow” and “selling to EU customers”, was as follows: an exporter of goods to the EU needed to ‘finance’ the cost of the input tax incurred on buying the goods, over the time period between incurring the input tax (on acquiring them), and recovering it from HMRC (this was because the ‘export’ was zero-rated i.e. no VAT was collected from the EU customer); this ‘financing’ role required a company with a healthy cashflow; this was why, per Mr Smith’s understanding at the time, Thames could no longer carry on that line of business.

Mr Smith understood that Thames had initially approached R&M to see if it had the cashflow to support an “export of goods to the EU” business; R&M declined (for what Mr Smith understood to be good business reasons) but, due to the good relationship it had with Deos, R&M suggested Deos as an alternative business partner for Thames. This was around April 2021. Mr Collins of Thames met with Mr Smith and took him through the business model: Thames would supply Deos; Deos would ‘export’ to the EU customer; the goods were held in a freight forwarder, Unicorn Shipping Ltd (“Unicorn”); the goods changed hands via ‘allocation’ and ‘release’ within Unicorn; the margins were low (1.5% to 3%) – but the risk of non-payment by the customer was minimal as Unicorn would hold the stock for Deos until Deos said to release it to its customer; and Thames would introduce Deos to Unicorn and to its customers in the EU. In oral evidence, Mr Smith said that Mr Collins had also explained that customers wanted serial numbers of the goods, due to the risk of carousel fraud.

As to why there were these wholesale dealings in electronic consumer goods of global manufacturers like Apple, Mr Smith identified this as a “grey market”, in which authorised distributors may wish, for various commercial reasons, to sell stock to (unauthorised) wholesalers. Mr Smith did not have a detailed understanding of why exactly there might be demand from EU wholesalers to buy from UK counterparts in this “grey market”.

An essential aspect of Deos’ role in the business model described by Mr Collins, was to finance the cost of the input tax, as just described. Mr Smith understood that Thames was prepared to “share” the profit it made on the transactions, with Deos, on account of its playing this role.

In Mr Smith’s view at the time, the business model seemed straightforward; the margins were normal for wholesale trade in the electronics industry and commensurate with the fact that Deos took minimal risk of non-payment by the its customer.

Mr Smith carried out basic checks, via readily-available sources of information like ‘Creditsafe’ and Companies House, on Thames, and on the EU customers that Thames told Deos about.

After a few months, in August 2021, Thames stopped selling to Deos. Mr Smith understood that this was because the “profit share” arrangement was not earning Thames a sufficient return. In the meantime, Mr Collins at Thames had introduced Deos to IPT/IGT (“IPT”) (international phone trader/international general trader), a subscription-only website for companies trading in the electronics goods industry; it had a trading portal detailing companies’ stock offers. Deos joined IPT in early August 2021; following this, Deos was approached by several companies seeking to trade with it; one of these was Estanza.

Mr Smith’s main contact at Estanza was Ali Javan, a director; he dealt with him via WhatsApp, telephone and Zoom. Mr Smith understood Mr Javan to have been trading in this area for a few years.

Estanza had been incorporated, and registered for VAT, in 2014. The VAT registration document it filed showed its main business as that of a retail off-licence. Mr Javan became a director in 2021.

Deos asked for, and received, various company documents from Estanza. It also carried out basic checks, via readily-available sources of information like ‘Creditsafe’ and Companies House, on Estanza.

The cover letter to Estanza’s ‘trading account application form’, signed by Mr Javan and on Estanza’s headed notepaper (which showed a “Scotland office” in Glasgow and a “London office” in Hemel Hempstead), read as follows:

Deos signed Estanza’s terms and conditions of trade on 31 August 2021.

Between August 2021 and 20 May 2022 (Deos’ last purchase from Estanza), Deos bought 32 consignments of stock from Estanza; the purchases were, in effect, the last 18 of these.

The general pattern of Deos’ trading with Estanza was as follows:

Deos did not generally take out insurance for the goods it bought from Estanza and sold on. This was because Mr Smith understood Unicorn to carry insurance for the stock it held.

In the purchases, Deos paid Estanza for the stock (or, in two instances, attempted to do so before the payment cut-off for the day) before it was paid by its customers

Deos’ practice of lining up on onward buyer before purchasing from Estanza, was not foolproof. In March 2022, a Spanish customer of Deos’ agreed to buy €324,000 worth of electronic goods from Deos, but, after Deos had acquired (and paid for) the goods from Estanza, the customer defaulted on payment, leaving Deos to find an alternative buyer and agree a price.

It was perfectly possible for Deos to sell on to someone other than the onward buyer it initially lined up, if necessary. This happened in the purchase labelled “6” in the table above, as follows:

A few days prior to Christmas 2021, Mr Smith wrote to Mr Javan as follows:

Mr Smith chased Mr Javan on 23 December for a response; in the new year, on 10 January, Mr Javan forwarded Mr Smith’s email to Estanza’s (external) accountant, asking for their advice as to what to disclose; Mr Smith spoke directly to Estanza’s accountant on 12 January, again chasing for a response; on 14 January he wrote to Estanza’s accountant as follows, copying Estanza:

On 17 January 2022, just before noon, Estanza’s accountant sent Mr Smith a copy of a VAT return and a bank statement for Estanza showing payment to HMRC of the corresponding VAT (the accountant also gave reasons for the delay in her response, connected to confidentiality precautions around disclosing the information). The enclosed bank statement was for mid-October to mid-November 2021; it showed, unredacted, the name of one of Estanza’s suppliers, WBM Global Ltd; Mr Smith checked and found that WBM Global did not have a valid VAT number (it had in fact been deregistered for VAT with effect from 22 December 2021). Mr Smith then quickly emailed back the accountant as follows:

In a WhatsApp message to Mr Javan that day (17 January 2022) at 12:33 pm, Mr Smith said this:

“I am confident that your supplier is a missing trader as per my email … My advice to you is to get some good advice and get your ducks in a row …”

Mr Javan responded at 12:35 pm that he would be sending Mr Smith an email. Mr Javan’s email, of 4:18 pm, said Estanza had “nothing to hide” and had sent Mr Smith the documents, despite its accountants advising against doing so; it said the payment to WBM Global was not recent; the payment had settled an “old” invoice; it said Estanza had only just found out - from Mr Smith - that WBM Global had been deregistered for VAT; it observed that the deregistration had been extremely recent, in the last few days; it said that Estanza had a commercial dispute with WBM Global and had last bought from them in September 2021 and had cut ties with them some time ago; it said Estanza had no intention to buy from WBM Global again and that decision had been taken “a long time ago”.

Mr Javan’s email went on to say this:

As a result of these developments, Mr Smith saw to it that Does did not buy from Estanza from 17 December 2021 to 28 February 2022; this was because, in Mr Smith’s words, he wanted “two months of checking [Estanza’s] VAT number” before Deos bought further goods from Estanza. Mr Smith was of the view that if Estanza continued to trade, this was an indication that it was not connected with VAT fraud (presumably because HMRC were not intervening to deregister Estanza).

Deos checked Estanza’s VAT number in late December 2021, twice in January 2022, twice in February 2022, twice in March 2022, three times in April 2022, four times in May 2022, and four times in June 2022. In his witness statement, Mr Smith stated that he checked Estanza’s VAT number regularly “in accordance with HMRC’s own guidance, and also on the assumption that HMRC, as the policeman of the VAT system, would remove the VAT numbers from companies involved in fraud”.

Mr Smith phoned HMRC’s VAT helpline on 10 February 2022 in order, in his words, to “see if they could do any further checks for me”.

The call last just under 13 minutes; the HMRC operator introduced himself as “Andy at the VAT helpline at HM Revenue and Customs”. Mr Smith told the operator that he bought goods from a UK supplier and exported them. He said he wanted to check that his supplier was paying VAT to HMRC, to ensure that he was not involved in a missing trader fraud. The operator’s first substantive response was as follows:

It is clear from the context that the HMRC operator’s reference to “a MTIC check” in the extract above, was in fact to a check of the validity of a VAT number (which is what the operator went on to do).

When the operator asked whether it was because Mr Smith had reservations about Estanza, Mr Smith responded:

As the HMRC operator was checking Estanza’s VAT number, Mr Smith said this;

The HMRC operator said this:

The gist of the conversation was that, based on the information he provided, Mr Smith was advised to do “normal” commercial checks on his supplier, and to regularly check the validity of its VAT number. The following extract (just after the HMRC operator told Mr Smith he could not reveal whether Estanza was under investigation by HMRC) illustrates this:

In Mr Smith’s WhatsApp messaging with his contact at RCS Holland BV (“RCS”), the following was said:

In cross examination, Mr Smith put down some of these statements to bluster and his attempting to negotiate a better price from his customer.

An individual whose initials were RC was, for a short time, engaged as a sales agent for Deos but was unsuccessful in generating sales leads during his tenure. In more detail:

HMRC adduced evidence as follows (although this information was not known to Deos at the time of the purchases):

On 21 April 2022, HMRC wrote to Deos stating that HMRC were concerned that Deos could be at risk of involvement in supply chains connected with fraud and that this could potentially lead to Deos being unable to recover input tax it incurred; a meeting was proposed, to discuss Deos’ business activities and VAT records, at which HMRC could explain “ways to spot missing trader fraud” to assist Deos “in avoiding becoming involved in supply chains that could be linked to MTIC fraud”.

On 25 May 2022 HMRC wrote to Deos informing it that they would be checking the company’s 04/22 VAT return; the letter said that HMRC’s checks looked at the risk to the UK of MTIC fraud and VAT supply chain fraud. A similar letter in respect of 05/22 was sent on 20 June 2022.

On 5 August 2022, HMRC sent Deos two ‘tax loss’ letters (i.e. letters stating that HMRC, following enquiries, now knew that certain transactions commenced with a ‘defaulting trader’) covering transactions with Thames in the 04/21, 06/21 and 08/21 VAT periods. Similar letters were sent on 30 November 2022 in respect of Estanza and the 04/22 and 05/22 VAT periods.

Estanza was deregistered for VAT on 12 July 2022. On 1 September 2022, it was re-registered. It was again deregistered on 16 November 2022. It was ultimately deregistered for VAT on Ablessio grounds, having accumulated a very significant VAT debt.

The European court (the “CJEU”), in its judgment dated 6 July 2006 in Axel Kittel v Belgium State, Belgium State v Recolta Recycling SPRL C- 439/04 & C-440/04, held that taxable persons who “knew or should have known” that the supplies in which input tax was incurred were connected with the fraudulent evasion of VAT would not be entitled to claim a credit in respect of that input tax. In particular, at [51] and [56], the CJEU, whilst reiterating that “traders who take every precaution which could reasonably be required of them to ensure that their transactions are not connected with fraud, be it fraudulent evasion of VAT or other fraud” should not lose their right to a credit for the input tax in relation to supplies associated with fraud, stated that “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 [VAT directive], be regarded as a participant in that fraud, irrespective of whether or not he profited by the resale of the goods.”

The rationale for the above approach was set out at [57] and [58], where the CJEU noted the following:

At [59] the CJEU concluded that “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’.”

At [61] the CJEU reiterated that, “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 issues to which Kittel gave rise were addressed in the UK context by the Court of Appeal in Mobilx Limited (in Liquidation) v HMRC [2010] EWCA Civ 517. At [52], Moses LJ said as follows in relation to the “should have known” part of the Kittel test:

“If a taxpayer has the means at his disposal of knowing that by his purchase he is participating in a transaction connected with fraudulent evasion of VAT he loses his right to deduct, not as a penalty for negligence, but because the objective criteria for the scope of that right are not met. It profits nothing to contend that, in domestic law, complicity in fraud denotes a more culpable state of mind than carelessness, in the light of the principle in Kittel. A trader who fails to deploy means of knowledge available to him does not satisfy the objective criteria which must be met before his right to deduct arises.”

At [53] to [60] Moses LJ addressed the extent of knowledge required. He observed that it would offend the principle of legal certainty to deny input tax credit on the grounds that the relevant taxpayer knew or should have known that it was more likely than not that the supplies in question were connected with fraud. Instead, such denial could be made only if the relevant taxpayer knew or should have known that the supplies in question were connected with fraud:

“[56] … A trader who knows or could have known no more than that there was a risk of fraud will find it difficult to gauge the extent of the risk; nor will he be able to foresee whether the circumstances are such that it will be asserted against him that the risk of fraud was so great that he should not have entered into the transaction. In short, he will not be in a position to know before he enters into the transaction that, if he does so, he will not be entitled to deduct input VAT. The principle of legal certainty will be infringed.

[56] It must be remembered that the approach of the court in Kittel was to enlarge the category of participants. A trader who should have known that he was running the risk that by his purchase he might be taking part in a transaction connected with fraudulent evasion of VAT, cannot be regarded as a participant in that fraud. The highest it could be put is that he was running the risk that he might be a participant. That is not the approach of the court in Kittel, nor is it the language it used. In those circumstances, I am of the view that it must be established that the trader knew or should have known that by his purchase he was taking part in such a transaction …”

At [59-60] Moses LJ observed that:

“[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 inKittel.

[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.”

At [61] Moses LJ said the following about legal certainty:

“A trader who decides to participate in a transaction connected to fraudulent evasion, despite knowledge of that connection, is making an informed choice; he knows where he stands and knows before he enters into the transaction that if found out, he will not be entitled to deduct input tax. The extension of that principle to a taxable person who has the means of knowledge but chooses not to deploy it, similarly, does not infringe that principle. If he has the means of knowledge available and chooses not to deploy it he knows that, if found out, he will not be entitled to deduct. If he chooses to ignore obvious inferences from the facts and circumstances in which he has been trading, he will not be entitled to deduct.”

At [64] Moses LJ reiterated that, “[if] it is established that a trader should have known that by his purchase there was no reasonable explanation for the circumstances in which the transaction was undertaken other than that it was connected with fraud then such a trader was directly and knowingly involved in fraudulent evasion of VAT”.

At [74-75] Moses LJ referred to a tribunal’s “undue focus” on whether a company director had “exercised due diligence or done ‘enough to protect himself’”. Moses LJ then stated: “That is not the only question. The ultimate question is not whether the trader exercised due diligence but rather whether he should have known that the only reasonable explanation for the circumstances in which his transaction took place was that it was connected to fraudulent evasion of VAT.”

At [81] and [82] Moses LJ noted that the burden of proof in such cases is on HMRC but made it clear that that “is far from saying that the surrounding circumstances cannot establish sufficient knowledge to treat the trader as a participant …tribunals should not unduly focus on the question whether a trader has acted with due diligence. Even if a trader has asked appropriate questions, he is not entitled to ignore the circumstances in which his transactions take place if the only reasonable explanation for them is that his transactions have been or will be connected to fraud. The danger in focussing on the question of due diligence is that it may deflect a tribunal from asking the essential question posed in Kittel, namely, whether the trader should have known that by his purchase he was taking part in a transaction connected with fraudulent evasion of VAT. The circumstances may well establish that he was.”

At [72], Moses LJ cited, and at [83] he commended, a number of questions posed by the Tribunal including:

At [83], Moses LJ adopted the passage from [109-111] of Red 12 Trading v HMRC [2009] EWHC 2563 in which Christopher Clarke J highlighted the following:

At [84] the Court of Appeal stated that such circumstantial evidence will often indicate that

“... a trader has chosen to ignore the obvious explanation as to why he was presented with the opportunity to reap a large and predictable reward over a short space of time.”

In considering the “should have known” test, the Court of Appeal (Arden LJ) in Davis & Dann Ltd & Anor v HMRC [2016] EWCA Civ 142 said that the tribunal must guard against over compartmentalisation of the factors, rather than the consideration of the totality of the evidence. The court said the Tribunal is not restricted from relying on any circumstance which is capable of being probative of knowledge to the no other reasonable explanation standard. It was not correct to argue that, simply because there was no allegation that X was a party to a scheme to defraud, no circumstance surrounding X could be a circumstance, which, when added together with other circumstances, should have led HMRC to conclude there was a connection with fraud. Arden J then cited the last sentence of [52] of Mobilx (concerning a trader who fails to deploy means of knowledge available to him) and observed that a taxpayer may have knowledge to the “only reasonable explanation” standard if he fails to make inquiries.

In AC (Wholesale) Ltd v HMRC [2017] UKUT 191 (TCC) the Upper Tribunal decided that the ‘should have known’ test did not require HMRC to eliminate all other possible reasonable explanations in order to establish, as required by Mobilx, that the only reasonable explanation for the transactions was that they were connected to fraud. It added (at [30]):

“Of course, we accept (as, we understand, does HMRC) that where the appellant asserts that there is an explanation (or several explanations) for the circumstances of a transaction other than a connection with fraud then it may be necessary for HMRC to show that the only reasonable explanation was fraud. As is clear from Davis & Dann, the FTT’s task in such a case is to have regard to all the circumstances, both individually and cumulatively, and then decide whether HMRC have proved that the appellant should have known of the connection with fraud. In assessing the overall picture, the FTT may consider whether the only reasonable conclusion was that the purchases were connected with fraud. Whether the circumstances of the transactions can reasonably be regarded as having an explanation other than a connection with fraud or the existence of such a connection is the only reasonable explanation is a question of fact and evaluation that must be decided on the evidence in the particular case. It does not make the elimination of all possible explanations the test which remains, simply, did the person claiming the right to deduct input tax know that, by his purchase, he was participating in a transaction connected with fraudulent evasion of VAT or should he have known of such a connection.”

In E Buyer UK Ltd v HMRC [2018] 1 WLR 1524, a summary of the applicable law, at [90], included, amongst other things, the principle that in all Kittel cases, HMRC must give properly informative particulars of the allegations of both actual and constructive knowledge by the taxpayer.

In Ammanford Recycling Ltd v HMRC [2023] UKUT 302 (TCC), HMRC were arguing that a company (as opposed to an individual) had actual knowledge of connection with VAT fraud for purposes of the Kittel principles. The parties accepted that where the appellant is a company, HMRC do not have to show that an identified individual had the requisite knowledge; it is enough that someone acting on behalf of the company must have had actual knowledge that the transactions were connected with VAT fraud. HMRC had however indicated to the Tribunal at the hearing, that it was open to them, and even, they said, that they ought to, put to the appellant’s witnesses in cross-examination, that the particular witness had actual knowledge the transactions were connected to fraud; but HMRC maintained that they need not identify, in advance, in their statement of case, that the witness had such knowledge. The taxpayer argued before the Upper Tribunal that the Tribunal had been wrong to agree with this.

The Upper Tribunal agreed with the taxpayer, and said at [47]:

The Upper Tribunal also made the point, at [53], that an allegation that someone had actual knowledge that a transaction was connected to fraud, is a serious one.

In Ulster Metal Refiners Ltd v HMRC [2017] NICA 26, the Tribunal had found fraud (in a supply chain) on a different factual basis from that put forward by HMRC (and HMRC did not apply for permission to change their pleadings during the course of the Tribunal proceedings). The Court of Appeal of Northern Ireland held that this was procedurally unfair; when a tribunal wished to find for a claimant on the basis of a ‘third man theory’, it had to inform the parties clearly of the ‘third man theory’ and then afford to the parties sufficient opportunity to respond to the new case and if necessary permit an adjournment to allow the parties time to make decisions about what further investigations they should carry out, what further evidence or disclosure they should seek, what further witnesses they should call and what further submissions they should make. Those steps were central to meeting the requirement of a fair hearing.

HMRC’s primary case was that Deos knew that the purchases were connected with the fraudulent evasion of VAT: considering all the circumstances surrounding the transactions themselves, Deos’ introduction to and history with this type of transaction, and its knowledge of the risk of fraud in such a market, it must have known of the connection. Alternatively, Deos should have known of the connection with fraud.

HMRC relied on the following factors.

HMRC submitted that Deos had a general awareness of the prevalence and nature of MTIC fraud before it undertook the purchases.

HMRC submitted that a reasonable businessperson, having been told by Thames in the spring of 2021 that customers wanted serial numbers of goods due to the risk of carousel fraud, would have sought advice about VAT fraud and would have investigated the entire supply chain for the goods being purchased (not just the company that was the immediate supplier).

Clearly, by the time of Mr Smith’s email to Estanza just before Christmas 2021, Deos was aware that VAT was “rife” in the electronic goods trade. HMRC noted the references to VAT fraud in Mr Smith’s conversations with his RCS contact. HMRC submitted that those messages demonstrate the presence of fraudulent participants in Deos’ own supply chains, in that they indicate that some fake goods had been supplied by (and therefore to) Deos. HMRC submitted that a reasonable trader in Deos’ position would have been looking out for the fraudulent participants in their supply chains.

Deos was introduced to wholesale trading in electronic consumer goods by Thames, a company with which it had no previous experience. The patterns of Deos’ transactions with Thames were entirely pre-ordained: Thames provided the goods to Deos, told it who to sell to and which freight forwarder would be used. The only motive for including Deos in the transaction chain was that it had the cashflow needed to fund the input tax from the time of its being incurred to the time of its being recovered from HMRC.

It is a classic feature of MTIC fraud to have transaction chains involving back-to-back transactions, with the goods changing hands between traders whilst held in the same warehouse, with no physical possession being taken by them, before the goods are then exported: this precisely the type of transactions to which Deos had been introduced.

When the trade with Thames fell away, Mr Collins pointed Deos in the direction of IPT, which, without much further effort by Deos, led to its coming into contact with Estanza.

Estanza had a relatively short history of trade in this market. How could two parties with no significant experience in the sector (Deos and Estanza) make a legitimate profit in a competitive market, acting in the same transaction chain?

Deos was able to access a large number of transactions in significant quantities of electronic goods, matching a supplier in the UK with overseas customers.

Deos was able to access profitable sale transactions via the IPT platform with no other advertising or promotional work. This is to be compared with its core business, which appears to have relied upon traditional advertising, promotional activities, a sales team and relationships with long-standing suppliers and customers.

A reasonable trader in Deos’ position would understand that each participant in a transaction chain must add value in order to justify its inclusion in the chain.

On the information available to Deos, it was clear that the transaction chains were of a length and character that was not consistent with what would be expected of a legitimate market.

HMRC noted that Deos increased its turnover by such a significant amount with the electronics deals, which “compensated” for the significantly smaller profit margin.

The significantly smaller profit margin made on the electronics deals also meant that Deos’ profits were proportionately smaller compared with the VAT incurred on the transactions. Put another way, a failure to reclaim the input VAT incurred would cause a very significant loss. The risk to Deos, as “exporter”, was therefore significantly greater. HMRC submitted that this was consistent with the ease with which Deos was able to participate in these transactions: the “market”, HMRC submitted, was a source of relatively easy profit because the risk of significant loss through VAT denial was great.

HMRC submitted that Deos’ pattern of trading with Estanza had features of supply chain fraud, highlighting the importance of Deos being sensitive to any indication that the transaction chain may be fraudulent and too good to be true. Yet its checks were limited: they did not include credit checks or taking trade references; and Deos did not visit Estanza, to assess them and their business in their own environment.

The due diligence carried out for Estanza and for the customers to which it on-sold, differed significantly from that which Deos conducted in respect of its core business; which included creditworthiness/score and applications for an agreed credit limit.

Deos did not ask Estanza where it sourced the goods from. How was Estanza able to source the goods and make a profit by selling on to Deos, another UK trader like itself? Similarly, Deos did not ask its customers whether they were supplying to end users/retail, or whether the goods were instead going on through an even longer transaction chain.

HMRC noted that Deos did not ask Unicorn for information (without giving away the identify of the participants) about the length and nature of the supply chains to Estanza.

HMRC submitted that it was “telling” that Deos did not ask the supplier of AirPods for its core business, for information about the “wholesale” market Deos entered for the first time in the spring of 2021.

Regarding Deos’ “break” in trading with Estanza from mid-December 2021 to the end of February 2022, HMRC submitted that

As for Mr Smith’s call to HMRC’s VAT helpline on 10 February 2022, HMRC submitted that it is not accurate to say that Mr Smith was told that there was nothing more that he could do by way of due diligence. HMRC also pointed out that Mr Smith did not tell the HMRC operator of his discovery that WBM Global had supplied Estanza in September 2021 and was deregistered for VAT in December 2021.

Where HMRC were able fully to trace Deos’ transactions chains for its purchases from Thames, those transactions traced to a defaulting trader. The same is true of the purchases.

HMRC submitted that this cannot be a coincidence. It demonstrates one or more schemes to defraud the revenue, in which Deos was involved. Whilst Deos claims that it was an unwitting participant in these fraudulent deal chains, the fact that it was involved with two different suppliers whose supply chains repeatedly trace to fraud in this way leads to a clear inference that Deos was knowingly involved.

HMRC’s submitted that Deos was disinterested in the fundamental commercial terms of its dealings with Estanza: this was highlighted by Estanza’s written terms allowing only three days for returns, whereas Deos’ allowed five.

HMRC submitted that Deos’ interactions with RC (and RC’s connection with Prestek) was another feature to consider in assessing the state of its knowledge of the connection of the purchases with fraud.

Deos had available to it, at the time of the purchases, information that would have caused a reasonable trader in its position to conclude that the only reasonable explanation for the purchases was that they were connected with VAT fraud.

Deos had undertaken transactions in a new market with which it was unfamiliar, relying on what it was told by its first supplier, Thames, as to how the market existed and operated, and trusting what it was told by Thames and Estanza, its (only) suppliers, with little independent information or assessment as to the accuracy of it. At the time of the purchases, Deos knew (from Mr Collins telling Mr Smith) that HMRC had raised concerns with Mr Collins as to the Thames deals; and Mr Smith himself had had real concerns, in January 2022, as to the connection of the Estanza deals to fraud. In other words, by the time of the purchases, serious doubt existed about both of the suppliers that Deos had felt able to trust.

Had Mr Smith given thought to how the ‘grey market’ in which Deos was participating could be legitimate when Deos was able, with minimal experience, to undertake regular high value deals, and had he considered properly all of the information available to Deos as a reasonable trader in Deos’ position would, he would have concluded that the purchases were connected with fraudulent VAT evasion.

Deos submitted that HMRC had no credible basis for alleging that Deos knew the purchases were connected with fraudulent evasion of VAT; and that HMRC could not prove that the such evasion was the only reasonable explanation for the purchases. It submitted that the purchases looked like ordinary, legitimate supplies – there was nothing about them that was inconsistent with ordinary commercial trading

Deos’ submissions included that:

Deos submitted that the evidence (and associated arguments) concerning

Deos further submitted, citing Ammanford, that if HMRC wished to argue that Mr Smith had actual knowledge of the purchases’ connection with VAT fraud, the statement of case would need to (1) specifically allege that Mr Smith had actual knowledge (that can be attributed to Deos); and (2) provide particulars of the primary facts and matters relied on in support of that allegation. However, the statement of case did not do this, and HMRC did not seek to amend it. In these circumstances, Deos argued, it is not properly open to the Tribunal to make a finding of actual knowledge on the part of Mr Smith (or, indeed, of Deos).

HMRC responded that the general nature of their case was set out within the statement of case. During the exchange of witness statements, both parties adduced further evidence in response to matters raised by the other, as anticipated by the Tribunal’s directions. HMRC submitted that it was trite that where further evidence is adduced by the appellant, HMRC may respond to it and rely upon it in support of their case. HMRC also submitted that Ammanford could be distinguished and, in this case, it was perfectly clear that HMRC’s “actual knowledge” case concerned the knowledge of Mr Smith (and Mr Smith’s first witness statement acknowledged as much at paragraph 160, which said: “… I reject entirely the HMRC assertion that I, or Deos, know of a connection to fraud in the transactions in dispute in this appeal”).

We consider Deos’ state of knowledge, when undertaking the purchases, in three stages:

The documentary evidence included evidence, from December 2021 and January 2022, in which Mr Smith stated to others that Estanza, or Estanza’s supplier, was involved in fraudulent VAT evasion (see [52(3) and (5)] above). These statements were, for the most part, made in the period of a month or so between Mr Smith asking Estanza for documentary evidence of its VAT compliance (shortly before Christmas 2021) and, on 17 January 2022, Deos receiving documentation from Estanza and (later that day) receiving an “explanatory” email from Mr Javan.

We interpret this evidence largely as it appears on its face (with some reliance of Mr Smith’s oral evidence in this regard, which we found persuasive), as follows:

In a nutshell, we are persuaded that, by the time of the purchases (and, in fact, by the time Mr Smith had Deos “restart” buying from Estanza from 28 February 2022), Mr Smith genuinely repented of his views, expressed in some rather intemperate communications with Estanza and with his RCS contact in December 2021 and January 2022, that Estanza was connected with fraudulent VAT evasion.

We note that in his WhatsApp messages with his RCS contact, there are references in March and April 2022 by Mr Smith to his “last supplier” being “bent” and “a crook” (see [52(7) and (8)] above); we are satisfied that these do not denote a belief on Mr Smith’s part that Estanza was connected with fraudulent VAT evasion, either because he was referring to Thames (which, Mr Smith found out in December 2021, was being investigated by HMRC: see [52(6)] above) and/or because this was commercial bluster with a view to getting RCS to pay a better price.

In summary, the direct evidence of knowledge on the part of Mr Smith (and so of Deos) of the purchases’ connection to fraudulent VAT evasion is, in our view, unpersuasive.

The circumstances of the purchases present a mixed picture, in our view, as regards their “suspiciousness” (and we use that term as shorthand for the purchases’ circumstances justifying the drawing of an inference that they were connected with fraudulent VAT evasion).

A number of aspects of the circumstances of the purchases strike us as not suspicious:

Some of the circumstances of the purchases were not suspicious, taking into account our understanding of Mr Smith’s frame of mind at the time (we shall revisit these, in particular, at stage 3, below, where we consider matters objectively, rather than subjectively):

Some aspects of the circumstances of the purchases were at last somewhat suspicious:

In weighing up the circumstances of the purchases in the round, we do not find that they were suspicious to a degree that justifies drawing the inference that Mr Smith knew they were connected with fraudulent VAT evasion. In short, there was much about the purchases, and their circumstances, that was perfectly commercial and a natural extension of Mr Smith’s professional experience running a family business in the small business sector; Mr Smith was “hazy” about exactly how and why the consumer electronics ‘grey market’ worked as it did, but that is a far from showing that he knew that particular purchases were connected with VAT fraud; and we find, on the evidence, that Mr Smith’s response to his concerns about Estanza’s VAT compliance in December 2021 to February 2022, which concluded with his restarting to buy from Estanza, was genuine in its belief that Estanza was not connected with VAT fraud.

We conclude, therefore, that the circumstances of the purchases were not suspicious to such a degree as to justify drawing the inference that Mr Smith, and so Deos, knew of their connection to fraudulent VAT evasion.

This stage involves us revisiting the circumstances of the purchases, but through the lens of asking whether a reasonable businessperson would have inferred from them that the purchases were connected with fraudulent VAT evasion.

Once again, the circumstances of the purchases present a mixed picture, in terms of whether they would have caused a reasonable businessperson to draw the inference that they were connected with VAT fraud.

The other way of expressing this test is to ask whether there was any reasonable explanation for the circumstances of the purchases, apart from their connection with VAT fraud.

The aspects of the purchases’ circumstances listed at [122] above would not, in our view, have caused a reasonable businessperson to draw the inference that the purchases were connected with VAT fraud. In other words, they form the basis of a reasonable explanation for the purchases – their commercial rationale – which is not connected with VAT fraud.

The essential question here is whether the aspects of the purchases’ circumstances listed at [123] and [124], which are more suspicious, alter this conclusion.

Our overall view this is a case where the reasonable businessperson would have recognised, from the circumstances of the purchases, a risk that the purchases were connected with VAT fraud, but that person would not, from those circumstances, have known (or have had the means of knowing) that they were so connected. This is because, in our view, the reasonable businessperson, based on those circumstances:

In sum, the ordinary commercial explanation for the circumstances of the purchases was relatively compelling, whereas the explanation that depended on connection with VAT fraud was relatively speculative; it was therefore far from being a case where the only reasonable explanation for the circumstances of the purchases was their connection with VAT fraud.

On the basis of the foregoing analysis, we conclude that Deos neither knew, nor should have known, of the purchases’ connection with fraudulent VAT evasion. This means that the appeals fall to be allowed.

Our substantive conclusion above means that Deos’ procedural points are, in the context of these appeals, academic; in other words, whichever way we rule on those points, these appeals fall to be allowed. We therefore deal with these points relatively briefly.

On the point, based on Ammanford, which would, if Deos’ application were allowed, result in HMRC being barred from arguing “actual knowledge” on the part of Deos, the position in this case is that statement of case states (simply) that Deos had actual knowledge; it does not go on to say either that “someone” at Deos had actual knowledge, or to name such a person. At the same time, the evidence cited in the statement of case is overwhelmingly that of Mr Smith (see paragraphs 11, 12, 13, 16, 19, 21, 23, 24, 155, 160, and 171-176); Ms Stoneman is mentioned, but paragraph 16 of the statement states that Mr Smith was responsible for the purchases. Furthermore, as HMRC point out in their submissions, paragraph 160 of Mr Smith’s first witness statement contains a statement that he rejects HMRC’s assertion that he, Mr Smith, knew of a connection with VAT fraud.

It is our view that, in the particular circumstances of this case, it was clear that HMRC’s case was that Mr Smith had actual knowledge; there was, realistically, no one else they could have had in mind. In that sense, it is distinguishable from Ammanford. Furthermore, we recall that we must exercise the Tribunal’s power to regulate its own procedure, in such a way as to give effect to the overriding objective of dealing with cases fairly and justly; and that an express element of this, in the Tribunal’s procedural rules, is avoiding unnecessary formality and seeking flexibility in the proceedings. There is, realistically, no unfairness or injustice in allowing HMRC to advance a case that Mr Smith was the individual at Deos who knew of the purchases’ connection to VAT fraud: in our view, this was clear to both parties, as is reflected in Mr Smith’s witness statement. It follows that it would be counter the overriding objective to rule, on grounds of lack of formality, that HMRC may not argue that Mr Smith had actual knowledge. We therefore refuse this procedural application on Deos’ part.

On Deos’ other procedural point, it seems to us that the evidence which Deos ask be excluded, to the extent it was evidence adduced by Deos itself in witness statements of Mr Smith (and, prior to that, was not available to HMRC), and HMRC consider that it supports the arguments made in their statement of case, it must be included. It seems to us that HMRC have provided the “properly informative particulars of the allegations” as required by E Buyer; to the extent new evidence provided by the appellant, in HMRC’s view, further supports the allegations, it would be “unnecessary formality” (in the words of the Tribunal’s procedural rules, as just cited) to require them to amend the statement of case – and unfair, in our view, if, without such amendment, the evidence was available to support the appellant’s case, but couldn’t be referred to in HMRC’s.

On the other hand, if the evidence in question was in fact adduced by HMRC, or was available to HMRC when they drew up their statement of case, then it seems to us fair and just to require HMRC to seek to amend their statement of case, if they wish to rely on it.

This means that we refuse Deos’ procedural application in relation to communications between Deos and its customers and/or suppliers, but allow it in relation to evidence about RC and HMRC’s 21 April 2022 letter to Deos.

Following our conclusion set out at [134] above, the appeals against the input tax denials are allowed; and, as a consequence, the appeal against the penalty is also allowed.

This document contains full findings of fact and reasons for the decision. Any party dissatisfied with this decision has a right to apply for permission to appeal against it pursuant to Rule 39 of the Tribunal Procedure (First-tier Tribunal) (Tax Chamber) Rules 2009. The application must be received by this Tribunal not later than 56 days after this decision is sent to that party. The parties are referred to “Guidance to accompany a Decision from the First-tier Tribunal (Tax Chamber)” which accompanies and forms part of this decision notice.