VAT Input Tax MTIC Fraud Did the Trader Know Or Should It Have Known of Fraud?

[2010] UKFTT 605 (TC)

TC00846

VAT – input tax – MTIC fraud – did the trader know or should it have known of fraud?

FIRST TIER TRIBUNAL

TAX

G COMMS LTD

- and -

THE COMMISSIONERS FOR HER MAJESTY’S

REVENUE AND CUSTOMS

Tribunal:CHARLES HELLIER (Judge)

HARVEY ADAMS

Sitting in public in London on 19,22,23,26,27,28 October, 2 November 2009, 4 January 2010 and 5 November 2010.

Orlando Pownall QC and Vivienne Tanchel instructed by Lex Partners for the Appellant

Jeremy Benson QC and Paul O’Doherty instructed by the Solicitor for HM Revenue and Customs, for the Respondents

© CROWN COPYRIGHT 2010

1

DECISION

I. Introduction

1. G Comms appeals against a decision of the respondents to deny the repayment of £2,290,960 input VAT claimed in respect of the period 04/06 (the period ending on 30 April 2006).
2. The input tax claimed related to 18 transactions (the 18 Deals) in which G Comms had bought mobile phones and exported them.
3. Normally input VAT incurred on the purchase of goods which are later sold by a business is creditable. There is no VAT on the export of goods. Thus where trader purchases goods and exportsthem,a net VAT credit will arise which, in the absence of other VAT liabilities, will be repayable. However, in a number of decisions, one of the more significant of which was Axel Kittel, Recolter Recycling SPRL v Belgian State (C 439/04 and C 440/04) the ECJ held that no credit was permissible if the trader’s transaction was connected with VAT fraud, and the trader knew or should have known that it was so connected.
4. The respondents say that in each of the 18 Deals they have traced the phones supplied to G Comms back through a chain of supplies to persons who imported the phones, onsold them, and fraudulently evaded the VAT arising on their sale. They say that in the circumstances G Commsknew or should have known of the connection of these deals to fraud, and as a result G Comms is not entitled to the input tax credit.
5. G Comms accepts that each of the supplies of phones to it were connected with fraud, but says that it neither knew nor should have known of such a connection.
6. In the same quarter of 2006 G Commsalso entered into 74 other deals in which it bought phones from a UK supplierand sold them to another UK trader. HMRC traced back 50 of these deals to defaulting traders (but had not, at the time of the hearing, traced back the other 24). In each of these deals G Comms claimed input tax credit against its output tax liability on its onward sale. No allegation was made by HMRC that G Comms knew or ought to have known of the connection to fraudulent evasion in relation to these deals, and the input tax claimed was not denied.

II.The Law

1. We heard the evidence and the parties’submissions before the Court of Appeal gave judgement in Mobilx Ltd (In Administration) v HMRC 2010 EWCA Civ 517. We agreed to delay our decision until that judgment was given. After it was given the Respondents made written submissions and the Appellant sought leave, which we granted, to make further oral submissions. We heard the parties’ final submissions on 5 November 2010.
2. There was little disagreement between the parties as to the applicable law. We apply the following principles:

(1)an input tax credit is not available where (a) the transaction was connected with VAT fraud and (b) the taxpayer knew or should have known that it was so connected;

(2)if taxpayer does not know of the connection with fraud, and takes all reasonable precautions, then he has an "impenetrable shield" and is entitled to the input tax credit;

(3)if a taxpayer does not know the connection to fraud, but does not take all reasonable precautions, then he is not automatically disentitled to input tax credit: it is only if he should have known, had he taken all reasonable precautions, of the connection to fraud that he is not so entitled. If the circumstances and what he would have discovered if he had taken all reasonable precautions would not have alerted him to the connection to fraud he is entitled to the credit;

(4)"all reasonable precautions" means those precautions which are reasonable and proportionate in the circumstances and includes the proportionate steps which would be taken as a result of taking earlier precautions

(5)the question whether the taxpayer knew or should have known must be determined at the time of the relevant transactions;

(6)the knowledge required is not of the specifics of the fraud, but that there was a fraud in the chain of supply to the taxpayer;

(7)knowledge that a transaction might be connected to fraud is not enough. What is required is knowledge that it was connected to fraud. In Mobilx the Court of Appeal made clear that a person should have known that a transaction was connected to fraud if he had the means of knowing that the only reasonable explanation of the circumstances of the transaction was that it was connected to fraud. ;

;

(8)where the taxpayer is a company, the question is the knowledge or means of knowledge of the company. In relation in particular to the question of whether the company should have known, that involves consideration of whether a reasonably competent person in the position of the company and equipped with the actual knowledge and expertise of those who act as its agents, should have known of the connection to fraud. In approaching this issue the inexperience or incompetence of those individuals is not to be taken as limiting what such a reasonable man would have done or concluded.

Burden of Proof

1. It is clear that the burden of proving connection to fraud lies on the commissioners. In Mobilx the Court of Appeal confirmed that the same burden lies in relation to knowledge and means knowledge (“should have known"). We have not found it necessary to rely upon the burden proof in reaching our conclusions.
2. It is accepted that the standard of proof is the normal civil standard of the balance of probabilities taking into account the probability of fraud in context.

Notice 726

1. Section 77A VAT Act 1994 provided that in relation to the supply of certain goods, the Commissioners could give notice to the recipient of a supply making the recipientjointly and severally liable with the supplier for unpaid VAT.
2. In August 2003 HMRC published Notice 726 "Joint and several liability in the supply of specified goods". This notice explained HMRC's views on how joint and several liability applied. Although the notice did not have the force of law it was extensively referred to in evidence before us. In that context we note the following particular provisions:

(1)“1.4 ... presently this measure only applies where there is a supply of goods or services that are subject to widespread missing trader intra-community (MTIC) VAT fraud. Currently the specified goods defined in legislation are ... telephones ..."

(2)“2.3 Why has this measure been introduced? ... It is designed to tackle MTIC fraud ... MTIC fraud is a systematic criminal attack on the VAT system ... in its simplest form the fraud, which cost the exchequer between £1.7 and 2.7 5 billion in 2001 – 02, involves a fraudster obtaining a VAT registration number in the UK for the purposes of purchasing goods free from VAT in another EU member state, selling them at a VAT inclusive price in the UK and then going missing without paying the output tax due to Customs and Excise. ... the fraud relies heavily on the ability of fraudulent businesses to undertake trade in goods with other businesses that may be either complicit in the fraud, turn a blind eye, or are not sufficiently circumspect about their trading connections ..."

(3)“2.4 …you may be held jointly and severally liable ... if we consider that you "knew" or "had reasonable grounds to suspect" that the VAT on the supply of those goods would go unpaid ..."

(4)"4.6 Can you tell me exactly what checks I should undertake? ... No. The Checks contained in this notice are guidelines for the kind of checks you could make to help avoid dealing with high-risk businesses and individuals.

(5)"8.1 checks you can undertake to help ensure the integrity of your supply chain ... The following are examples of checks you may wish to undertake to help establish the integrity of your supply chain [there then follow checks in relation to the supplier’s history, commercial arrangements, insurance, recourse for bad goods, the commercial viability of the transaction and checks to ensure the goods will be as specified or described]

(6)"8.2 checks carried out by existing businesses." The section sets out a non-exhaustive list of checks to be carried out including matters such as obtaining certificates of incorporation, VAT registration confirmations, credit or other references, and other documentation.

III. The Evidence Before Us

1. We heard oral evidence from Clive Dean, the HMRC officer who had written to G Comms appraising it of the denial of its input tax deduction, and who had traced back the phones in the 18 Deals along the chain of supply to the defaulting traders; from Russell Hall, an officer from HMRC who gave evidence of information obtained from First Curacao International Bank (FCIB) with whom G Comms had banked; from John Fletcher of KPMG who was called by the respondents to give evidence in relation to the mobile phone market in 2006; from Roderick Stone of HMRC, from Anthony Elliot-Square, a former director of the Federation of Technological Industries, who gave evidence in relation to the mobile phone market in 2006 for the Appellant; from Shiraz Ahmed, a director of G Comms; and from Harkitan Suri, an accountant who assisted Mr Ahmed and G Comms. Each of these provided one or more witness statements. We also had about 24 bundles of copy documents.
2. We received no evidence from Dilnawaz Malik, the other director of G Comms who, Mr Ahmed said,had cooperated with him in the management of G Comms’ activities, or from Mr Mohammed Hussein who was a director of United King Trading FZCO, a company which at an early stage became an 80% shareholder in G Comms. Mr Ahmed told us that MrHusseinthought it beneath him to come to give evidence to the tribunal.

Mr Ahmed

1. Mr Ahmed signed a letter (it appears to have been sent to First Curacao International Bank (“FCIB”) in 2005) which provided a reference for a Mr Choudhry, who is the sole director of RVM Ltd (we shall return to the connection with RVM Ltd later). The letter indicated that Mr Choudhry was a previous employee of the business which became that of G Comms on its incorporation in 2004, and that Mr Choudhry had three years' experience in the telecommunications market and was a trustworthy employee.
2. Mr Ahmed admitted that Mr Choudhry had not been an employee of G Comms and did not have three years experience in the telecommunications market. He had said he had written and signed the letter because Mr Malik was out of the office: Mr Malik had said that a friend of his was looking for a job and wanted a reference and told Mr Ahmed what to write.
3. We find Mr Ahmed's willingness to sign a letter which he knew contained false statements cast a shadow on his evidence to us.
4. On another occasion Mr Ahmed was shown a declaration given by G Comms to one of its customers. The declaration was signed by a member of G Comms’ staff and in one respect was untrue. Mr Ahmed did not express concern about the untruth. In effect he told us that the untruth was not material. But his attitude to the truth was in our view disturbing.
5. We have take into account these considerations in our assessment of Mr Ahmed's evidence.

Mr Suri

1. Mr Suri held a business and accounting degree, and an accounting qualification. He struck us as an intelligent man. On occasion we thought his replies were evasive.
2. Mr Suri provided accountancy and related services to G Comms, both directly, and through the medium of his company, Consult Me (UK) Ltd. We were shown a copy of an agreement proclaiming itself "dated 13 July 2004" between G Comms and Consult Me for the provision of accounting and related services to G Comms. A version appears to have been signed on behalf of Consult Me on 4 November 2005. We were shown copies of invoices rendered by Mr Suri personally to G Comms for the period June 2005 to March 2006 ( embracing the period covered by the Consult Me contract), and by Consult Me to G Comms dated April 2006. It was not clear to us why, and on what basis, the distinction was made between the personal provision of services, and that through Consult Me. It suggested to us, at best, a certain laxity of approach.
3. Mr Suri prepared the accounts of G Comms ready for their presentation to the auditors, and also its VAT returns. He participated in G Comms’ due diligence activity, principally by the preparation of a "second stage" due diligence report on suppliers and customers. We shall explain the nature of that report later.
4. On several occasions Mr Suri described his role as being limited to recording the actions of the business and its due diligence. Yet he described his job as akin to that of a finance director, and displayed a good understanding of the way the business operated. Although Mr Suri attended meetings between G Comms and its counterparties he said he had ears only for the due diligence side of these meetings. He therefore said that although he recalled that Notice 726 (see later) was discussed, he could not tell us much about other aspects of the discussions at these meetings. In the light of his understanding of the business we found this difficult to believe.
5. Mr Suri also provided accountancy services for a company called RVM limited. He was company secretary of that company and a signatory for its FCIB bank account. RVM limited was incorporated in July 2004, very shortly after G Comms, and applied to be registered for VAT on 22 July 2004 (G Comms’ application, prepared by Mr Suri, was dated 14 July 2004). RVM limited also traded in mobile phones.
6. RVM's sole director was Mr Kasif Choudhry (the same Mr Choudhry for whom Mr Ahmed signed the reference referred to above). RVM's shares were owned as to 20% by MrChoudhry, and 80% by Future Connections FZCO which appears (see below) to have been the later provider of funds for a £1.25 million loan to G Comms, and a customer of G Comms. We note that G Comms’ shares were owned in similar proportions: 80% by United King Trading, and 20% by Mr Ahmed and Mr Malik.
7. Mr Suri said that he would not have discussed Mr Choudhry with Mr Ahmed, or Mr Ahmed with Mr Choudhry. There was a confidentiality clause in his agreement (or that of his company) , and he was obliged to maintain confidentiality. Mr Suri also did due diligence for RVM, and acknowledged that some of the customers and suppliers to G Comms were also customers and suppliers of RVM. In acting for one he said he did not take account of information about the same supplier he had obtained as a result of acting for the other.
8. Given that Mr Malik knew Mr Choudhry (and that Mr Ahmed at least knew of Mr Choudhry because he had signed the reference), the similar dates of incorporation, the similar businesses, the similar shareholding arrangements, and the shared suppliers and customers of RVM and G Comms, we found it unbelievable that Mr Suri had no discussion with the directors of G Comms about RVM or vice versa. We find it likely that he made known his involvement in RVM to G Comms.

IV Our Findings of Fact

(a) G Comms and its business

1. G Comms was incorporated in July 2004. Its directors since July 2004 have been Mr Ahmed and Mr Malik. It registered for VAT from 19 July 2004, but its first VAT supplies were made in the quarter ended 30 April 2005.
2. Mr Ahmed is a qualified plumber. In 2003 and 2004 he began to think about dealing in mobile phones, and after discussions with Mr Malik (who had been trading in car accessories) set up G Comms as a vehicle for this venture.
3. Before starting to trade Mr Ahmed enquired of others about the mobile phone business, and went in 2004 and 2005 to the trade fair, CeBIT in Hanover. There in 2004 he met, by the cafe, a group of people who were wholesale traders in mobile phones (grey market traders -- we shall explain the term grey market later). He spoke to them about mobile phone trading. He met Mr Hossein, whom he understood traded in mobile phones and other electric goods through United King Trading in the UAE, and who indicated that he was interested in setting up a branch in the UK.
4. Mr Ahmed realised that if G Comms was to export phones it would need working capital because exports were VAT free and so the monies he would receive from overseas customers would fall short of what he would have to pay (with related VAT) to UK suppliers of phones located in the UK (this was therefore on the assumption that the phones he would sell to non UK customers would be located in the UK). Although Mr Ahmed did not say this to us in relation to this stage of development of G Comms, he did say that greater margins were obtained on export sales than on phone sales within the UK. We think it likely that he wished to engage in export sales and that is why he was concerned about working capital. Mr Ahmed said he approached Mr Hossein for an investment in G Comms. He entered into negotiations with him in March 2005, and Mr Hossein agreed to make a loan to G Comms. A loan of £200,000 was made on 11 July 2005. We discuss its terms later. MrHossein's company, United King Trading was the named lender and acquired, at the same time, 80% of the issued share capital of G Comms.
5. G Comms’ first transaction took place on 8 March 2005.
6. In its first quarter's trading - the period to 30 April 2005 - G Comms’ turnover was £23 million. In the four quarters ending 31 January 2006 its total turnover was some £73 million. In the single quarter 04/06 its turnover was £90 million.
7. G Comms’ staff comprised Mr Ahmed and Mr Malik, and, in the period relating to the transactions relevant to this appeal, the company employed a secretary. It used the services of Mr Suri in this period. In 2007 the team was increased in size.
8. In the period to April 2006G Comms’ fixed assets consisted of furniture and computer equipment. It had no material stock or work in progress. It traded in such a way that it neither owed money to its suppliers nor was owed money by its customers. It achieved this result by entering into "back-to-back" transactions under which it paid for the goods it bought on the same day (and after) it was paid for them by its customer. Only when it exported would the money it received from its customerbe insufficient to pay its supplier. In these circumstances G Comms would fund the difference from its own resources (which included the benefit of the loan from United King Trading and its accumulated profits).
9. Mr Ahmed said that normally transactions were instigated by requests from G Comms’ customers for particular phones in particular quantities. On receipt of a request he would phone around his suppliers to try to source the phones requested. In most cases when he could source phones of the type required, he would manage to source the quantity required. Occasionally he could find only a smaller quantity. He did not put smaller quantities from separate suppliers together to make up a sale. Nor did he buy more than he could sell. He said that he hardly ever had a request for export which had not resulted in an export transaction.
10. Once he had found a supplier who could supply the phones to G Comms there would be negotiations about price with its supplier and its customer. Once the price was fixed, purchase orders, and then invoices would be sent out and received. The deal was completed when the price was paid. G Comms would be paid by its customer and then pay its supplier straightaway. The goods would be “released” to the buyer when payment was made.

Allocation, shipping, release and payment