VAT – Groups of companies – Input tax – Knowledge

(1) Mobile Export 365 Ltd (2) Shelford (IT) Ltd v Revenue & Customs Commissioners: FTT (Tax) (Judge David Williams, K Goddard, R Spector): 6 August 2010

The appellant companies (M and S) appealed against decisions by the respondent commissioners refusing to repay input tax on the grounds that the transactions concerned involved missing trader intra-community fraud.

M and S were two subsidiaries of a group. They traded in mobile telephones. An individual (N) was the controlling shareholder of the group and thus of M and S. There were two other directors of the holding company who were also directors of M and S. N had previous convictions in respect of missing trader fraud. The commissioners’ case was that tax loss caused by fraud was shown to have taken place in the chains of transactions leading to all the transactions relevant to the appeals and that the appellants knew, or ought to have known, that the transactions were linked to fraud. The chains of transactions were either ‘straight’ chains, where a supplier up the chain was a defaulting trader or the chain otherwise directly involved fraud, or ‘contra’ chains, where the straight chain showed no fraud in the chain itself but where a supplier up the chain was engaged in fraud related to other supplies that took place in the same VAT period; both the ‘clean’ chains and the ‘dirty’ chains were reported to the commissioners in the same quarterly VAT returns by the ‘contra trader’, so concealing the fraudulent nature of the input tax claims for the dirty chains behind the VAT returned for transactions in the clean chains. The appellants submitted that they had no knowledge whatsoever of any of the relevant details of the supply chains beyond their immediate contracting partners, that they could not reasonably be expected to have such knowledge, and that they had, throughout, both followed the commissioners’ guidance and conducted thorough due diligence on their suppliers and customers.

Held: (1) A taxable person who knew or should have known that the transaction which he was undertaking was connected with fraudulent evasion of VAT was to be regarded as a participant and therefore failed to meet the objective criteria which determined the scope of the right to deduct, Kittel v Belgium (C-439/04) [2008] STC 1537 ECJ (3rd Chamber) and Mobilx Ltd (in administration) v Revenue & Customs Commissioners [2010] EWCA Civ 517, [2010] STC 1436 followed. A trader could be regarded as a participant, and therefore someone within the Kittel test, 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. It was not sufficient for an appellant to show that he met the requirements imposed either by the commissioners or by the appellant directly with regard to due diligence in connection with the individual contracts of supply from and to an appellant. The test included those who should have known from the circumstances that surrounded their transactions that the transactions were connected with fraudulent evasion.

(2) At the relevant times the group companies were effectively controlled by N and his son. There were no divisions of any significance in the management and running of the companies or in their finances. It followed that what was known, or should have been known, by any of the companies or those managing them was known or should have been known by all of them. N was well informed about the market in which the group operated and about fraud in that market. His knowledge and thus the knowledge of the group was not limited only to the direct sellers to the group and the direct purchasers from the group.

(3) On the evidence, the commissioners had established on the balance of probabilities that there was a tax loss in each of the supply chains that led to the transactions for which the appellants were reclaiming input tax and that tax loss was connected to fraud. On the evidence, the deals did not take place in the open market after full due diligence by the appellants and at arm’s length. The evidence about international mobile equipment identification numbers indicated that telephones were being recirculated by the group’s customers. Either the group knew that that was so or it should have known from properly operated due diligence procedures. The only reasonable explanation for the conduct of the appellants in the periods in question was that they knew that the transactions they were undertaking could secure the profit levels they realised without the need for rigorous due diligence or proper safeguarding of supplies and finances, and the reason for that was that they knew that the transactions were connected with fraud.

(4) The test in Kittel, as explained in Mobilx, was satisfied with regard to all the relevant transactions. If the appellants did not know that the deals undertaken by the group at the relevant times were connected directly with fraud, and in some cases they did know that, then they should have known, because the only reasonable explanation for such ignorance was that they chose to ignore circumstances for which the only reasonable explanation was a connection between the transactions and fraudulent evasion of VAT.

Appeals dismissed.

Michael Patchett-Joyce (instructed by Khan Partnership) for the appellants; Jeremy Benson QC, Ian Hutton, David Bedenham (instructed by in-house solicitor) for the respondents.