IN THE PETITION A.R. COMMUNICATIONS AND ELECTRONICS LTD FOR JUDICIAL REVIEW
OUTER HOUSE, COURT OF SESSION
[2014] CSOH 125
P224/14
OPINION OF LORD BURNS
In the petition
A R COMMUNICATIONS & ELECTRONICS LTD
Petitioners;
for
Judicial Review of refusal of permission to appeal by the Upper Tribunal notified 6 September 2013
Petitioner: Edwards; Allan McDougall
Respondent: McIver; Office of the Advocate General
13 August 2014
Introduction
[1] This petition, which called before me on 12 June 2014, seeks reduction of a decision by the Upper Tribunal of 6 September 2013 which refused permission to appeal against a decision of the First-tier Tribunal (FTT) dated 28 September 2011. That decision dismissed the petitioners' appeal for repayment of input tax in terms of section 25 of the VAT Act 1994. Permission to appeal from that decision to the Upper Tribunal had been refused by the FTT on 8 December 2011 and by the Upper Tribunal on 22 December 2011. However, the matter was reconsidered by the Upper Tribunal in 2013 in the light of judgments in the Court of Justice of the European Union in the case of C-80/11 Mahageben and C-285/11 Bonik EOOD. Having held an oral hearing on the question of whether the refusal to allow permission to appeal should be reconsidered, the Upper Tribunal decided, by decision notice dated 6 September 2013, that permission to appeal should be refused. The decision notice is 6/11 of process.
[2] The question argued before me by parties was whether the petitioners had advanced any important point of principle or practice which justified this court exercising its supervisory jurisdiction to review the decision of 6 September 2013, or whether there was a compelling reason why that jurisdiction should be exercised in this case (see Eba v Advocate General 2012 SC (UKSC) 1 (Eba).
Background
[3] The First-tier Tribunal had considered an appeal by the petitioners against a refusal of HMRC to make a repayment of input tax of £1,214,801.88 paid by the petitioners in respect of sixteen purchases of mobile phones made in June and July 2006. HMRC refused payment on the basis that the petitioners knew or ought to have known that the transactions were connected with the fraudulent evasion of VAT. The fraudulent evasion was as a result of these transactions being alleged to be part of a missing trader intra-community (MTIC) fraud chain, the details of which are set out in paragraphs 7 to 14 of the FTT's decision of 28 September 2011.
[4] The pattern of MTIC fraud is well known and a brief description will suffice. Goods (in this case mobile phones) are imported free of VAT into the United Kingdom from another EU member state by a UK VAT registered trader. That party then sells the goods charging output tax for which he fails to account HMRC. The goods are sold on by that defaulting party to one of several intermediaries (called buffers). Those successive deals charge output tax on resale and deduct the relative input tax on purchase. At the end of the chain, the broker exports the goods VAT free and attempts to recover input tax which he paid on the acquisition of the goods. Thus a chain of transactions starting from the company which imports them into the United Kingdom and ending with the company which exports the goods out of the United Kingdom contains a defaulting party and is known as a dirty chain. In a further development in the pattern of MTIC fraud, contra-trading camouflages the company acting as the broker (ie the company that exports the goods from the United Kingdom) by introducing an offsetting output tax liability which he sets against his repayment claim. He, the broker, imports a separate batch of goods creating a new chain and when he resells those goods he charges output tax, thus creating a tax liability to be set against his repayment claim in the first, or dirty, chain. There is no defaulter in that second chain and it is known as a contra or clean since the relative VAT within that chain is duly accounted for.
[5] In the petitioners' circumstances, they were shown to have been involved in 30 transactions during June and July 2006, all of which were said to be part of clean chains. In 14 of the transactions the goods were sold by the petitioners to companies in the UK and were, accordingly, buffer transactions. In the remaining 16 of those transactions the goods were exported (broker deals). It was only the broker deals that were challenged by HMRC.
Submissions for the petitioners
[6] Mr Edwards for the petitioners argued that there was an important point of principle in this case. He submitted that both the FTT at first instance and the Upper Tribunal refusing permission to appeal had failed properly to apply European law and, had they done so, the petitioners' appeal against refusal of deduction of input VAT tax would have been allowed. Further, the FTT in reaching its decision applied the test of strict liability upon the petitioners which was not the correct test. In any event, since the decision of the FTT was plainly wrong in law there existed a compelling reason for this court to exercise its jurisdiction to review and overturn the decision of the Upper Tribunal to refuse permission to appeal.
[7] I was referred to the case of Kittel v Belgium 2008 STC 1537. That case demonstrated that a person was entitled to deduct input tax paid in connection with a transaction under article 17 of the EC Council Directive 77/388 (the Sixth Directive). National legislation was precluded from causing such a person to lose the right to deduct VAT that he had paid. It was irrelevant that the contract was void due to fraudulent evasion of VAT or to other fraud. However, it was open to national courts to refuse entitlement to the right to deduct but only where a supply was to a taxable person who "knew or should have known" that he was participating in a transaction connected with fraudulent evasion of VAT (see paragraphs 50 – 61 of the court's judgment). Accordingly, Mr Edwards argued that the circumstances in which the rights to deduct VAT arose were strictly limited. He referred me to the opinion of the Advocate General at paragraphs 40-44. There, the Advocate General sets out a situation where a trader knows about the fraud but does not "participate in it or derive any benefit from it". He equiparated that situation to that of a taxable person who is unaware of the deceit. Under reference to the case of Optigen Ltd v Customs and Excise Commissioner 2006 STC 419, the right to deduct is exercised "regardless of whether the VAT or other previous or subsequent transactions has been paid or not". It was a fundamental rule of the VAT scheme that at each stage of the production or distribution process the taxes levied and the VAT paid at the previous stages is deducted. I was also referred to the judgment of the court itself at paragraphs 50-59. At paragraph 50 the court stated:
"It is settled law that the principle of fiscal neutrality prevents any general distinction between lawful and unlawful transactions. Consequently, the mere fact that conduct amounts to an offence does not entail exemption from tax; that exemption applies only in specific circumstances where, owing to the special characteristics of certain goods and services, any competition between a lawful economic sector and an unlawful sector is precluded".
It went on to say at paragraph 51 that:
"It is apparent 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, must be able to rely on the legality of those transactions without the risk of losing their right to deduct the input VAT".
It followed from that that where a recipient of a supply of goods is a taxable person who did not and could not know that the transaction concerned was connected with a fraud committed by the seller, article 17 of the Sixth Directive precluded a rule of national law which involves a taxable person to lose the right to deduct VAT in a contract.
[8] However, the court went on at paragraph 55 to say that where the tax authorities find that the right to deduct has been exercised fraudulently, they are permitted to claim repayment of the deducted sums retro-actively. It stated:
"It is a matter for the national court to refuse to allow the right to deduct where it is established, on the basis of objective evidence, that that right is being relied on for fraudulent ends ".
At paragraph 56 it goes on to say:
"In the same way, a taxable person who knew or should have known that, by his purchase, he was taking part in a transaction connected with fraudulent evasion of VAT must, for the purposes of the Sixth Directive, be regarded as a participant in that fraud, irrespective of whether or not he profited by the resale of the goods".
That was because in such a situation the taxable person aids the perpetrators of the fraud and becomes their accomplice, thus the court could refuse entitlement to the right to deduct where it was 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.
[9] On the other hand, when the recipient of a supply of goods is a taxable person who did not and could not know that the transaction concerned was connected with a fraud committed by the seller, article 17 of the Sixth Directive had to be interpreted as precluding a rule of national law under which the fact that the contract of sale is void causes that taxable person to lose the right to deduct the VAT he had paid.
[10] Mr Edwards emphasised that in the present case the petitioners were found to be involved only in "contra-chains". Contra-chains were, he submitted, a “construct” of the UK tax authorities which had never been expressly recognised by the European Court and, consequently, no guidance from that court existed as to the test that ought to be applied in circumstances where only contra-chains were involved.
[11] Mr Edwards proceeded to argue that the FTT had followed what Lord Justice Moses had said in the case of Moblix Ltd v Revenue and Customs Commissioners 2010 STC 1436 (Moblix). In doing so the FTT erred since Lord Justice Moses himself had erred in going beyond what the European Court had stated in Kittel. The court in Moblix had extended the category of those who could be denied repayment of input tax to those for whom "the only reasonable explanation for the transaction in which he was involved was that it was connected with fraud". (See paragraph 59 of Moblix in particular).
[12] In making that submission, Mr Edwards stepped outside the bounds of his petition and advanced an argument not foreshadowed there. Paragraph 4(b) of the petition, on the contrary, appears to proceed on the basis that Moblix represents the law which ought to have been followed by the FTT.
[13] Mr Edwards further argued that the FTT had erred since its reasoning failed to identify, by reference to "objective factors", that the petitioners knew or should have known that he was participating in MTIC fraud. The phrase "objective factors" is used by the European Court at paragraph 59 of its decision in Kittel. It was argued that what the FTT had done was to identify matters which were entirely subjective to the petitioners by which the FTT was wrongly persuaded of the requisite degree of knowledge or imputed knowledge of participation in a fraudulent transaction.
[14] In particular, Mr Edwards relied on an exchange between one of the members of the FTT and Mr Grieve, a witness for HMRC. His evidence was to the effect that the petitioners could not have established that there was a defaulter in the chains in which the petitioners were demonstrated to have been involved. I was given a transcript of the evidence of Mr Grieve on day 11 (7 October 2010) of the proceedings before the FTT, pages 53-64. Mr Grieve stated in terms that he did not think that the trader would have been able to establish a defaulter in the chains because he only knew his customer (that is the person to whom he sold the mobile phones and the supplier) that person who supplied him with those phones. He therefore considered that the petitioners, and in particular the controlling mind of the petitioners, a Mr Rakhra, did not know that there was a defaulter or who that defaulter was in the chain.
[15] Mr Edwards submitted that it was clear that it had taken HMRC many months, if not years, to establish the identity of defaulters and it was also clear, upon the evidence, that it would not have been possible for the petitioners to identify whether or not a defaulter existed within the chains in which the petitioners had participated far less the identity of that defaulter. In the light of that finding, the remaining elements relied upon were wholly insufficient to bring home the requisite amount of imputed knowledge to the petitioners and the FTT had plainly erred.
[16] Similarly, the Upper Tribunal had fallen into error by not recognising this. The factors relied upon by the FTT were subjective and only suggestive of knowledge and could not go as far as establishing the requisite degree of knowledge.
[17] Mr Edwards also referred me to cases subsequent to Moblix, namely Mahageben KFT and David 2012 STC 1934. It was the decisions in these cases which caused the Upper Tribunal to defer consideration of the application for permission to appeal until September 2013. It was emphasised in those cases, at paragraph 45 of the judgment of the European Court, that a taxable person can be refused the benefit of the right to deduct only on the basis of the case law resulting from paragraphs 56 -61 of Kittel. At paragraph 47 it was stated that it was incompatible with the rules governing the right to deduct input tax to impose a penalty, in the form of refusing that right, to a taxable person who did not know and could not have known that the transaction concerned was connected with fraud or that another transaction forming part of the chain of supply prior or subsequent to that transaction was vitiated by fraud. The establishment of a system of strict liability would go beyond what is necessary to preserve the public exchequer's rights. The tax authority required to establish, to the requisite legal standard, the objective evidence which allows the conclusion to be drawn that the taxable person knew, or ought to have known, that the transaction relied on as a basis for the right to deduct was connected with fraud committed by the supplier or by another trader acting earlier in the chain of supply. Mr Edwards submitted that there was nothing in that case that supported Lord Justice Moses' formulation that a trader should have known that the only reasonable explanation for the transaction was that it was connected to fraud that was sufficient.
[18] Further, in the current case the FTT had proceeded on the basis of strict liability rather than on the basis that they knew or ought to have known of the fraudulent nature of the transaction.
Submissions for the respondent
[19] Mr McIver pointed out that at no stage of the petitioners' submissions had Mr Edwards referred to the decision of the Upper Tribunal which refused permission to appeal. It was that decision which was the subject of this review and it was incumbent upon the petitioners to demonstrate clearly why the Upper Tribunal erred and that that error involved the important point of principle or practice or a compelling reason existed for this court to review an unappealable decision of the Upper Tribunal (see SA v SSHD 2014 SC 1 at paragraph 15(c)). Further, at paragraph 43 of that case, the court had made it clear that the petition should:
"clearly and unequivocally aver not only a specific error on the part of the Upper Tribunal in refusing leave, but also either the point of principle/practice not yet established or the other compelling reason why an appeal should be allowed to proceed. Before the petition progresses, the court should be able, quickly and without difficulty, to identify from the averments the point or reason advanced".
In this case Mr McIver submitted the point advanced in the petition was whether the Upper Tribunal had erred in failing to identify that the First-tier Tribunal had applied a test of strict liability (see paragraph 4(d) of the petition). Further, it was averred at paragraph 4(c) of the petition that, since there was no finding of any actual knowledge on the part of the petitioners made by the FTT and the evidence led on behalf of HMRC was that the petitioners could not have established that there was a defaulter in the chains of contra-traders, there was a reasonable explanation for the transactions, namely that the trades were legitimately entered into. Accordingly, reading the petition at its highest for the petitioners, it was being said that a compelling reason was advanced namely that the decision of the Upper Tribunal in refusing permission to appeal that of the First-tier Tribunal was plainly wrong. He invited me to reject any argument based on the contention that Moblix was wrongly decided since that was not a matter focused in the petition as it ought to have been according to SA.
[20] Mr McIver submitted that the First-tier Tribunal had correctly applied the law about which there was no ambiguity or doubt. There was no important point of principle or practice involved, nor was there any error in law identified in the petition. There was therefore no compelling reason for the court to interfere. The First-tier Tribunal had proceeded to make a series of findings from paragraph 117 onwards which fully justified the conclusion that the petitioners knew or should have known that the transactions in which they were involved were connected with fraud. When the European Court made reference to “objective factors” demonstrating that the taxable person knew or should have known that he was participating in such a transaction, it simply meant objective evidence. That is something objectively established by the evidence which could be either direct evidence or circumstantial evidence from which an inference could be drawn. That is what the Tribunal did in this case. Nothing said by Lord Justice Moses in Moblix was in any way contrary to what the European Court had said in Kittel. Moblix did not suggest that strict liability should be imposed in this case and the First-tier Tribunal had not imposed such a test in its reasoning. The principle against the imposition of a strict liability test is, in any event, clearly established in both Kittel and Moblix. No important point of principle can be said to arise. At paragraph 14 of its decision of 6 September 2013, the Upper Tribunal dealt with the argument that contra-trading was not something that entitled HMRC to refuse the petitioner its right of deduction. The Upper Tribunal stated that there was no limitation in the jurisprudence of the European Court to the effect that defaults in a dirty chain cannot affect traders in a clean chain. The Upper Tribunal focused on the over-arching principle which was that the right of deduction is refused when it is established, on the basis of objective evidence, that the right is being relied on for fraudulent or abusive ends. It was enough if deemed knowledge is established by relevant evidence that the taxable person is assisting "art and part" in the perpetration of fraud, whatever chain of which he is a part. That was a conclusion properly based upon both European law and the case of Kittel. The case of Mahageben was also referred to therein.
[21] The Upper Tribunal had also proceeded to conclude that there was "an abundance of facts and circumstances from which the requisite knowledge could be inferred" (paragraph 16 and 19). It could not be said that any compelling reason had been advanced to justify this court exercising a supervisory jurisdiction over the decision of the Upper Tribunal. The grounds of appeal advanced to the Upper Tribunal had been properly engaged with.
Discussion and Decision
[22] I accept that in order to demonstrate that the Upper Tribunal erred in law the petitioners require to show that the FTT itself erred in a material respect and that the Upper Tribunal failed to give them an opportunity to obtain redress for that error. It is therefore necessary, in the circumstances of this case, to examine the terms of the FTT’s decision. I further accept that the imposition of a strict liability test would be erroneous and, had the First-tier Tribunal imposed such a test, it could be said that it erred in law in doing so. Whether that would amount to a compelling reason to review the decision of the Upper Tribunal would then require to be examined. However, I cannot accept that that is what the First-tier Tribunal did. It is clear from the terms of its decision that it imposed the correct test, namely whether it was demonstrated that the petitioners knew or should have known that they were participating in a transaction connected with the fraudulent evasion of VAT (see paragraph 114, which refers to the case of Kittel). In paragraph 113 the FTT state that "our conclusion is that the Kittel test as to imputed knowledge is satisfied in this case". They refer to certain factors which arguably indicated actual knowledge on the part of Mr Rakhra but go on to state that it should have been clear to him that the only reasonable explanation for the nature and pattern of the transactions was that they were tainted with MTIC fraud. It cannot therefore be said that the basis of the FTT's decision was simply the fact that the petitioners were found to be involved in a chain which was in fact connected with MTIC fraud.
[23] At paragraph 16 of the Upper Tribunal's decision it stated that there was an “abundance of facts and circumstances from which the requisite knowledge may be inferred”. I do not consider that it erred in coming to that conclusion having regard to the terms of the FTT’s decision at paragraphs 118 to 132. Various objective factors are set out there which persuaded it that the necessary degree of knowledge on the part of the petitioners, and in particular its controlling mind Mr Rahkra, had been established.
[24] In essence those were that the clean chains originated with three traders each of which it was proved or admitted had been knowingly involved in a fraudulent scheme to defraud HMRC of VAT (paragraph 118); these chains did not appear to be of a commercial nature and their only conceivable purpose was to disguise repayment in a related dirty chain (paragraph 119); that Mr Rakhra was aware of the prevalence of MTIC fraud and had extensive experience in the retail and wholesale markets of the telecom industry (paragraph 125); that he experienced an “unexplained, prodigious and sudden increase in turnover” which ought to have alerted the suspicions of an experienced trader such as Mr Rakhra (paragraph 127) ; that the pattern of the deals in question was such that it was all “too good to be true” (paragraphs 128 and 129); and that the system of due diligence pursued by the petitioners was clearly inadequate in the context of the arms-length trading which was carried out (paragraph 130). In addition to that the FTT drew attention to the fact that only documentation relating to concluded deals was available while no documentation in relation to failed deals was available (paragraph 131). In the circumstances which the FTT found proved, that was a relevant adminicle since it yielded an inference that there were no failed deals or even any unsuccessful attempts at concluding a deal, which was itself suspicious.
[25] On the basis of this material the Upper tribunal was well entitled to conclude as it did. It must be borne in mind that the relevant standard of proof in this case was on the balance of probabilities. In this respect, it cannot be said that the petitioners raise any important point of principle or practice or that there exists some compelling reason justifying review of the Upper Tribunal’s decision.
[26] Although the petition itself does not raise the matter of contra-trading, the Upper Tribunal also dealt with the argument that involvement in contra-trading did not justify refusal of the right to deduction. It did so expressly at paragraph 14. Having regard to what the European Court said in Kittel at paragraphs 55 and 56, I do not accept that a finding of being involved in contra-trading is outwith the scope of legitimate refusal of the right to deduct tax. It is clear that, if it can be established that the trader ought to have known that he was taking part in a transaction connected with (my emphasis) fraudulent evasion of VAT, he is to be regarded as a participant in the fraud. It does not matter that he cannot be shown to have profited by it (see paragraph 56). It is noteworthy that the Court did not adopt the position of the Advocate General in his Opinion at paragraph 60 where he suggested that the right to deduct is unaffected where the trader is aware of the fraudulent conduct but “keeps out of the unlawful agreement”. I consider that the Upper Tribunal was correct in its view that, where deemed knowledge is established, the trader is assisting “art and part” in the perpetration of the fraud and it does not matter that he is involved in clean, as opposed to dirty, chains. He is thereby taking part in a transaction “connected with fraudulent evasion of VAT” and the right to deduct is lost.
[27] Mr Edwards also argued that in his opinion in Moblix, Lord Justice Moses erred and went beyond what the court had set out in Kittel. Mr McIver did not advance any argument in response to that submission and he was entirely justified in adopting that position having regard to what the Lord Justice Clerk said in SA at paragraph 43. As was emphasised there, it is necessary for the petition to set out clearly the errors on the part of the Upper Tribunal which are to be founded upon so that the court can be addressed fully upon them by both parties and can reach a view on whether the test in Eba is met.
[28] I was not therefore given the benefit of the respondent’s submissions on this matter and cannot express a concluded view but it respectfully seems to me that what Lord Justice Moses said in Moblix involves no departure from the European Court set out in Kittel. At paragraph 58 his Lordship points out that the court in Kittel “preserved the principle of legal certainty; it did not trump it”. That was said in the context of the argument advanced by HMRC that those traders who knowingly participated in transactions which might be connected with fraudulent evasion of VAT should be denied the right to deduct. Moses LJ did not agree and did not accept that “the principle of legal certainty must be trumped by the objective recognised and encouraged by the Sixth Directive” (see paragraph 57). Accordingly, he found that the European Court had only sanctioned the refusal of the right to deduct if it was demonstrated that the trader should have known from the circumstances which surround their transactions that they were connected to fraudulent evasion. He then proceeded to explain at paragraph 59 that 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 so connected, then he should have known of that fact. In so reasoning, he was restating what the European Court had held in Kittel. It seems to me to be axiomatic that if the only reasonable explanation for the transaction is that it was connected with fraud, then the trader ought to have known that. Moses LJ is merely illustrating how the test laid down in Kittel can be achieved. He emphasises at paragraph 60 that it would not be enough to pass that test only to show that the trader should have known that it was “more likely than not that his transaction was connected with fraudulent evasion” but, if the only reasonable explanation for the circumstances in which his purchase took place is that it was a transaction connected with such evasion, that would meet the test in Kittel. He thus expressly recognises the limitations that the court was imposing in Kittel and does not go beyond them. I therefore do not accept that the FTT or the Upper Tribunal erred in law in adopting the formulation used by Moses LJ in Moblix and I conclude that no compelling reason to justify the review of the Upper Tribunal’s decision has been advanced.
[29] As to the argument that the FTT failed to identify “objective factors” which were capable of showing that the petitioner knew or ought to have known that the deals in which they participated were connected with MTIC fraud, I have outlined above what those factors were. I agree with Mr McIver that the phrase “objective factors” simply means circumstances which were proved by the evidence or which arose from proper inferences drawn from that evidence. The matters which the FTT found proved constituted such material and amply justified the conclusion that, on the balance of probabilities, the petitioner should have known that the trading was connected with MTIC fraud.
[30] For these reasons I do not consider that the petitioner has presented a case which meets the test set out in Eba and I will accordingly sustain the respondent’s second and third pleas in law, repel that of the petitioners and dismiss the petition. I will reserve meantime all questions of expenses.