RS Global Limited & Anor v The Commissioners for HMRC

In order to place this issue in context we consider it appropriate to briefly narrate the CJEU and domestic jurisprudence in connection with Missing Trader Intra-Community (MTIC) fraud. In this regard we note that at an EU level the domestic zero-rating for exports is strictly an “exemption with credit” i.e. the supply is exempt requiring no charge to output tax, but the supplier is nevertheless entitled to input tax credit on the VAT they incur which is used for the purposes of making their supplies including their exports. In this judgment for consistency, we refer to only zero-rating.

MTIC fraud seeks to exploit the structural features of the VAT system governing intracommunity supplies through exploitation of the zero rating for exports.

The history begins with Optigen Ltd and others v CEC C/354/03 (Optigen). In that case, HMRC sought to assert that supply chains with a fraudulent objective were such that they lacked economic substance and were therefore outside the scope of VAT altogether. The CJEU rejected that proposition, noting that the definitions of taxable person and supply of goods were all objective in nature and applied without regard to the purpose or results of the transactions. It determined that as regards transactions which were not themselves vitiated by fraud the transactions were to be treated as supplies for VAT purposes.

The next relevant case, though not one concerning MITC fraud is Halifax plc and others v CEC C-255/02 (Halifax) which concerned the VAT consequences of transactions entered into for the purposes of obtaining a tax advantage. As in Optigen the CJEU confirmed that such transactions fell within the scope of the VAT system because they met its objective requirements. However, it went on to hold that as the provisions of the VAT directives, and the community law principles which underpin them, cannot be relied on for abusive or fraudulent ends, where transactions have no explanation other than obtaining a tax advantage contrary to the purposes of the relevant provisions the arrangements are taxed by redefining the supply by reference to its economic substance.

In Axel Kittel v État belge C-439/04 (Kittel), the CJEU introduced the “knowledge” principle targeted at a denial of input tax recovery for those seeking to claim input tax on the VAT incurred on purchase of goods where, due to fraud, there was a failure to account for output tax somewhere in the chain of transactions. The CJEU concluded that a taxable person who knew or should have known that his purchase was connected with fraud was to be treated as participating in that fraud with the consequence that entitlement to input tax deduction was rightly refused despite the transaction meeting the objective criteria of the VAT system.

In 2009, in Calltel Telecom Ltd v HMRC [2009] EWHC 1981 (Ch) (Calltel) the High Court considered whether the Halifax and Kittel principles should apply such that a Kittel input tax denial be limited to the tax lost as a consequence of the supply chain fraud. In that case the taxpayer contended that the Halifax redefinition should apply in a Kittel situation such that HMRC should be entitled to collect VAT by reference to the substance of the underlying transactions without fraud. The Court confirmed that in a Kittel case there was no “hypothetical normal” structure to act as the comparison of substance. As such, the Kittel denial applied to restrict the full input tax claimed. In this context, it was considered that the principle of fiscal neutrality otherwise required within the VAT system had to “give way” to the objective of combating fraud.

Mecsek extended the Kittel principle to deny zero-rating in the MTIC context. Mecsek sold goods to an Italian purchaser which undertook responsibility for transporting those goods to another Member State. Mecsek relied on the export documentation received from the purchaser and did not account for output tax on the transaction. The Italian purchaser was not in fact established at the declared address, had not paid VAT, and had been removed retrospectively from the Italian VAT register. The national authority concluded that Mecsek had failed to comply with the requirements justifying treatment as an export. The CJEU reaffirmed the established conditions for zero rating in intracommunity supplies, namely that (i) the right to dispose of the goods as owner must be transferred and (ii) the vendor must establish that the goods were dispatched or transported to another Member State and have physically left the territory of the State of supply. However, the CJEU situated those requirements within the broader Directive framework of the prevention of tax evasion, avoidance and abuse. It emphasised that, in certain circumstances, that objective may justify imposing stringent obligations on suppliers rendering the right to zero-rate conditional on a requirement that the supplier acted in good faith and take every step which could reasonably be required to ensure that its transaction did not result in participation in tax fraud.

The next significant case is that of Staatssecretaris van Financiën v Schoenimport ‘Italmoda’ Mariano Previti vof C-131/13 (Italmoda). In setting the context of its decision the CJEU reiterated that preventing possible evasion, avoidance and abuse was an objective recognised by the VAT directives and that the CJEU had consistently held that EU law may not be used for abusive or fraudulent ends. It confirmed Kittel and Mecsek. It also confirmed that the prevention of evasion, avoidance and abuse, is a general principle of law requiring national courts to interpret national law so as to achieve the aim. The CJEU was clear that the application of that interpretive principle did not result in the imposition of obligations derived under the Directive and thus did not result in the impermissible application by the state of obligations under the directive which have not been adequately transposed into domestic law.

Climate Corporation Emissions Trading GmbH v Finanzamt Österreich C-641/21 (CCET) concerned whether the place of supply of services can be affected by knowledge or means of knowledge of a fraud. The CJEU drew a distinction between a supply of goods to which Mecsek applies and a supply of services vitiated by fraud. The CJEU determined that the place of supply rules form part of the infrastructure of fiscal competence which underpins the scheme to avoid conflicts of jurisdiction and thereby ensure that double taxation and non-taxation are avoided. In drawing a comparison between goods and services the CJEU noted that fiscal competence of intracommunity supplies permits zero-rating by the supplier as the corollary of acquisition accounting by the purchaser (who simultaneously accounts for output tax on the purchase and recovers input tax in the ordinary way). The CJEU expressly acknowledged dual competence which would permit the member state of dispatch of goods to take decisions as to the availability of the export zero rate independently of the related acquisition supply. A similar correlation is excluded in the case of services which are treated as supplied in a single jurisdiction.

HMRC v Citibank NA [2017] EWCA Civ 1416 (Citibank) was a case principally addressing what was required from HMRC in terms of their pleadings in cases where they alleged knowledge or means of knowledge of fraud in and MTIC context. However, in its analysis of that issue, the Court of Appeal noted that the distinction between Halifax and Kittel is that, in the former case, the evasion/avoidance is of the taxpayer’s own tax whereas in the latter case the taxpayer is connected to such evasion/abuse through what they knew or should have known. Thus, a supply chain participant who knows or should have known of the fraud is denied the right to recover VAT even though the transaction on which input tax is claimed and the use to which the goods are put objectively satisfy the criteria otherwise justifying input tax recovery. Input tax is denied on the basis of the abuse/fraud only.

The Court of Appeal judgment in Butt v HMRC [2019] EWCA Civ 554 (Butt) considered the relationship between a Kittel input tax denial and the imposition of penalties. Mr Butt contended that where input tax was denied under Kittel principles the domestic penalty provisions did not permit for the imposition of a penalty and, on the basis of Article 6 convention rights, could not be interpreted so as to provide for such imposition. The Court considered Optigen, Kittel and Halifax. The Court noted that those cases represented an exercise of balancing the certain application of the VAT system and the objective of preventing evasion, abuse and avoidance. In that regard the Court considered that identifying the economic substance of transactions for the purposes of collecting the right amount of tax cannot, on the proper application of the CJEU jurisprudence amount to a penalty. After considering the earlier Court of Appeal judgment in Mobilx Ltd (in Administration) v HMRC [2010] EWCA Civ 517, Italmoda and Cussens and others v T.G.Brosnan C-251/16 (Cussens) (see below) the Court narrated and confirmed that a Kittel denial of input tax does not depend on domestic legislation. The civil liability to tax (i.e. the repayment or denial of input tax) arises because of the requirement to construe domestic legislation consistently with EU obligations, including the prevention of evasion avoidance and abuse. As such, the Court considered that it was entirely permissible to construe the relevant penalty provisions of VATA as applying because there had been an inaccuracy in the return claiming recovery of the VAT which was not due once Kittel was applied.

There are also five cases not directly concerning MTIC fraud which are relevant to be considered:

Although not critical to our reasoning, we also consider the judgment of the Supreme Court in HMRC v Pendragon plc [2015] UKSC 37(Pendragon)to have some relevance; this despite not having been referred to it by either party. Pendragon concerned the use of a complex scheme designed to exploit legislative provisions that permit the VAT on the sale of used cars to be charged only on the margin achieved by the taxable dealer. Having determined that the arrangements were abusive the Court considered the scope of redefinition. The Court confirmed that redefinition is purely notional and is intended to deprive the taxpayer of the illegitimate advantage sought through the abusive scheme. Redefinition entitles HMRC “as between themselves and the taxpayer, to treat them for the purposes of assessing VAT as if the abusive features had not been present”.

The Appellants submit that, where the right to zero‑rating is refused pursuant to the anti‑fraud principle derived from Mecsek and related authorities, the legal consequence is that the supply is no longer exempt, but becomes a taxable supply subject to the ordinary charge to VAT.

The starting point, relying on Twoh and CCET, is said to be that zero-rating is properly characterised as a “right” under EU law. As rights under EU law cannot be invoked for abusive or fraudulent ends once the right is denied the normal VAT position absent the right is reinstated. The Appellants submit that Mecsek is a direct application of that principle in the context of intracommunity supplies. In Mecsek, the Court held that a supplier be refused the right to exemption where it knew or ought to have known that the transaction was connected with fraud, and once it is concluded that the right to zero-rating is denied the supply is taxable at the standard rate. The Appellants’ position was said to be supported by Italmoda (at [57]–[58]) and Cussens at [32]–[34]), which it was claimed confirm that refusal of a VAT right is the consequence of the objective conditions not being met, and does not require an independent legal basis. It is said to follow that, where the right is refused, the supply does not satisfy the conditions for zero-rating and is therefore not zero-rated and must be a supply taxable at the standard rate.

Further, the Appellants rely on Dobre which is said to demonstrate that a failure to establish entitlement to exemption/zero rating, whether by lack of evidence or by reason of fraud, leads to the same legal consequence: the right is denied because the substantive conditions are not met.

The Appellants also submit, relying on UP Caffe, that the legal consequence of a Mecsek denial requires a Halifax redefinition and that makes clear that the effect of denying a VAT advantage is to restore the position that would have prevailed in its absence i.e. taxing the supply as if it were not a zero-rated supply.

The Appellants emphasise that this analysis is also reflected in Butt where the Court of Appeal treated the denial of VAT rights as an application of the general anti-abuse principle rather than the imposition of a penalty.

Against that background, the Appellants reject the Respondents’ contention that a Mecsek denial leaves the supply legally zero-rated while merely withholding the “benefit” of that status. It is said that the authorities, including Mecsek itself and Italmoda refer interchangeably to the denial of the “right” to exemption and do not support any distinction between “right” and “benefit”.

Finally, the Appellants submits that the Respondents’ analysis is internally incoherent. If the supply remains zero-rated, there can be no domestic charge to VAT, since zero-rated supplies are not chargeable. Conversely, if output tax is due, the supply must be taxable. The only legally coherent analysis is that, following a Mecsek denial, the supply is no longer exempt and is subject to the ordinary VAT charge.

HMRC contend that a Mecsek denial does not alter the legal character of the underlying supply but merely denies the supplier the “benefit” or “advantage” of zero-rating. The supply therefore remains zero-rated as a matter of law, notwithstanding the denial. HMRC rely on the jurisprudence of the CJEU, in particular Italmoda in which it is stated that a taxable person may be “refused the benefit of [exemption or deduction] rights” even where the formal requirements for those rights are satisfied. HMRC emphasise that the language of “refusal of benefit” (rather than reclassification) is determinative. That conclusion is, HMRC say, supported by the CJEU judgments in Optigen and Kittel which establish that fraudulent or unlawful elements in a transaction chain do not alter the objective character of a supply and emphasise that transactions retain their character as supplies and economic activities notwithstanding fraud in the chain.

Further support is said to be derived from the Court of Appeal’s decision in Citibank, which draws a distinction between the Halifax abuse principle and the Kittel/Mecsek doctrine; and Calltel, where the High Court held that the Halifax redefinition principle does not apply in Kittel cases. HMRC contend that Impact and Butt also confirm that the Kittel/Mecsek principle operates as a freestanding rule without changing the underlying character of the transactions. This is also said to be consistent with the statutory infrastructure as regulation 134 of the VAT Regulations 1995 (as in force at the material time) defined the relevant supplies as zero-rated with no reference to purpose and reflects the treatment of intracommunity supplies by the purchaser of the goods.

HMRC further submit that the Appellants’ “standard-rated on denial” analysis is inconsistent with legal certainty and the proper operation of VAT as a self-assessed tax. In HMRC’s submission, the customer’s correct VAT treatment must be ascertainable at the time of the transaction and cannot depend on later denial of the supplier’s benefit. Thus, where goods in fact move to VAT-taxable persons in another Member State, no UK VAT is chargeable to the EU customer on the supply; the customer should account for acquisition VAT in its own Member State, and that remains so even if the supplier is later denied the benefit of zero-rating on Mecsek grounds.

Finally, HMRC submit that the Appellants’ analysis would undermine the anti-fraud purpose of Mecsek. On HMRC’s case, denying the supplier the benefit of zero-rating imposes a real fiscal consequence which deters use of the UK as a conduit for intracommunity fraud; by contrast, if denial simply shifted liability through a reverse charge, the VAT could become economically neutral as between supplier and immediate customer and thereby blunt the deterrent effect. HMRC add that not all Member States operate reverse-charge regimes (or on the same goods), so Mecsek denials serve a wider anti-fraud function.

In our view the proper approach is to step back and consider the source and development of the Mecsekprinciple. From the cases we have reviewed and summarised we establish the following principles:

Applying these principles to the consequence of a Mecsek denial we consider that where goods have been supplied and there is relevant evidence of an intracommunity removal of the goods for the purposes of the VATA and the VAT Regulations the objective criteria for a zero-rated supply is established. Where however, the transaction is connected to fraud of which the supplier knew or should have known, a notional “redefinition” is required in order to deprive the complicit taxpayer of the advantage of not having to account for output tax on the supply. The obligation to account for output tax does not arise by virtue of a statutory charging provision but as a consequence of the freestanding principle to prevent evasion, abuse and avoidance. As stated in Pendragon the liability to account is a notional exercise intended to deprive the taxpayer of the illegitimate advantage which would otherwise accrue to a fraudulent taxpayer.

In so concluding we reject the Appellants’ submission that a Mecsek denial causes the supply to become a supply taxable at the standard rate. We do not consider that zero-rating is a right under EU or domestic law. As with the other exemptions provided for under the Principal VAT Directive (PVD) they are not rights in the sense advanced by the Appellants. Exemption applies or it does not by reference to the objective features of the transaction. An intracommunity supply of goods will be zero-rated when the conditions for zero rating apply. A taxpayer cannot choose whether to zero-rate a supply which complies with the conditions for zero-rating. Such treatment ensures fiscal competence of the suppling and receiving Member States and the neutral imposition of VAT on the supply chain participants. The only extent to which we consider that zero-rating can be described as a right is if the term is assimilated to it giving rise to an advantageous outcome.

This is to be contrasted with a right to deduct input tax. The system of VAT collection and the neutrality on which VAT is founded provides for a right to recover input tax where the VAT incurred is attributed to the making of taxable supplies. However, that right must be exercised under the carefully prescribed conditions specified in EU and domestic law. No taxpayer is required to make a claim to which they are entitled. It is a matter of choice. However, where the claim arises in connection with fraudulent or abusive transactions that right is removed, denied or refused. There is no longer an element of choice.

In reaching our view that zero-rating is not a right, but an advantage we reject the Appellants’ submissions on Twoh and CCET. At paragraph [26] and [27] in Twoh the CJEU considered the burden of proving entitlement to a tax derogation or exemption; whilst it used the language of such derogations or exemptions being rights we consider there is no particular significance to be placed on the choice of the word in preference to advantage, particularly in light of analysis in Cussens. In CCET [18] the CJEU drew a distinction between the “benefit of a right” to exemption and the right to a deduction of input tax. Whilst the distinction is less clearly delineated in paragraph [40] of the judgment, we consider that overall, the judgment supports our conclusion rather than the Appellants’ submission.

More generally, we observe that as the CJEU has not been asked to consider the specific issue before us and given that the CJEU’s primary language is not English we take little form the chosen language formulation in each case to which we were referred. We can discern no consistent pattern as demonstrated in the table below:

We also reject the Appellants’ contention that there should be equivalence in treatment where there is a denial of zero-rating because of a failure to evidence that the objective criteria for zero-rating have been met and a Mecsek denial. That submission is made by reference to Dobre. We consider that the Appellants’ reading of paragraphs [35] and [36] of Dobre overstates what is said and is, in any event, inapposite in the context of a Mecsek denial. In Dobre the CJEU confirmed that the right to claim input tax is a fundamental right, ensuring fiscal neutrality. It cannot lightly be denied but can be denied where the objective criteria of the right to claim is not met and where the claimant is complicit in a fraudulent supply chain. The case says nothing about the consequence of denial and whether they are equivalent, let alone how that might read across to a Mecsek denial.

We therefore have little hesitation in concluding that the effect of the Mecsek denial is to deprive the Appellants of the advantage of treating supplies which it knew or should have known were connected to fraud as zero-rated.

For the reasons stated we consider that a Mecsek denial represents the denial to a supplier complicit in supply chain fraud of the benefit of zero-rating. It does not denature the supply of goods as an intracommunity supply as a zero-rated supply.

Having determined the Mecsek Issue in HMRC’s favour, HMRC contend that the interpretation of section 55A is entirely academic on the basis that none of the eight counterparties were registered in the UK for VAT. Further, as all of the supplies made to those counterparties were treated by the First Appellant as zero-rated supplies and a Mecsek denial does not deprive the supplies of such status the counterparties were not required to be registered for VAT by virtue of section 55A(1) – (3).

The Appellants contend that the issue nevertheless needs to be determined in this appeal. They contend that, on its terms section 55A(6) applies a reverse charge to any counterparty which is registered or required to be registered in the UK whether or not the supply is a zero-rated supply. In this context the Appellants contend that the requirement in subsection (6)(b) to supplies of goods “to which this section applies” imports the definition provided in subsection (9) defining the type of goods and not to the circumstances in which those goods are supplied (i.e. whether they are standard or zero rated). It submits that subsection (6)(b) does not import the limitations of subsection (1)(a). The Appellants therefore contend that if, on the evidence, the eight counterparties were, for some independent and unrelated reason, “taxable persons” meeting the requirement of subsection (6)(c) the supplies made by the First Appellant would be subject to the reverse charge.

Having considered carefully the terms of the judgment of the FTTTC it is clear to us that no decision was taken as to the meaning of section 55A(6)(b) or its scope. The FTT decided that recipients of supplies which had been zero-rated but which were the subject of a Mecsek denial were not thereby taxable persons meeting the requirements of section 55A(6)(c). As we agree with that conclusion and therefore, without evidence that, for reasons unconnected with the supplies which are the subject of the Mecsek denial, the counterparties were otherwise taxable persons, the interpretation of section 55A(6)(b) is academic at present.

For the above reasons we find that the FTTTC reached the correct conclusion and though its explanation was brief it appears that it did so for the right reasons