The High Court held that, in respect of an (assumed) deliberate dishonest transaction by the taxpayers, Customs could lawfully decide to withhold repayment of VAT pending the outcome of an inquiry into their VAT returns leading to a final decision whether to refuse repayment.

Facts

These were three separate applications for judicial review of Customs’ decisions refusing claims for repayment of VAT overpaid in the sums of £19.5m, £30.3m and £914,000 respectively.

The common system of VAT had been open to abuse and manipulation by fraud. The simplest example was ‘missing trader fraud’ where a trader received VAT, but failed to account for it to Customs, whether because it went into liquidation with the money untraceable or because it was never a real entity at all. In the first instance, that was a loss to the person who had paid over the VAT, for which the missing trader was supposed to account, but as that customer was itself then ordinarily able to recover VAT paid over to its supplier, the loss was incurred by Customs as and when it was forced to reimburse what it had not in fact received. Such simple missing trader fraud became more sophisticated and complex, once goods were sourced from abroad. When the goods entered the UK, they arrived free of VAT and the first purchaser in the UK was liable to pay an ‘acquisition tax’: if the system operated lawfully then that importer charged VAT to the next purchaser and received it from that purchaser, and then accounted to Customs for what he had received (‘output tax’) less what he had paid out (‘input tax’).

In missing trader intra-community (‘MTIC’) or ‘carousel’ fraud, the goods, if they existed, were then the subject-matter of a series of successive transactions within the UK, being onsold, usually at a markup, with VAT returns completed by each purchaser, resulting in a small payment to the Revenue, after setting off the input tax against the output tax, until eventually the goods were acquired by an exporter. As goods when exported were no longer the subject of the VAT regime of the member state, the exporter could claim as a credit, and thus prima facie was entitled to receive from the Revenue, the total sum of VAT due and purportedly paid in respect of the goods exported. Such ‘carousel fraud’ could be repeated as often as required, because the goods were ‘returned’ to a destination outside the UK which might well be the same country or even the same, or an associated, source as the original supplier, ready to be sent round again. The individual transactions could be a matter of moments and the goods might not in fact move from a warehouse or freight forwarder either on the occasion of any one transaction or possibly at all, except that there would need to be evidence of export to support the claim for repayment of input VAT credits. The fraud was plainly committed, if the participants in such chain were dishonest, at the stage of the missing trader, although the loss might not crystallise until Customs had to pay out in full in respect of the return filed by the exporter.

The steps taken by Customs in response to the growth of MTIC and carousel frauds included the refusal to make payment to the ‘exporter’ at the end of a suspect chain (‘defaulter chain’), so that Customs, provided such refusal to allow the input tax was not successfully challenged on appeal to the VAT tribunal, avoided having to pay money out at the end of the chain. Customs suggested that what they now alleged to be occurring was a new variation of the scam described as a ‘contra-trading’ fraud. It was suggested that, instead of the exporter simply putting in a return and failing to persuade the Revenue to repay, it found an occasion to enter into a fresh transaction, in relation purportedly to different goods, with a different trader, for which purpose the exporter acted as a broker or contra-trader, in buying in those goods from abroad and selling them on to such new trader. In the course of such sale the exporter/broker/contra-trader was thus enabled to set off in his return the input tax against the output tax, being the VAT paid to it by the new trader, and thus recovering, by reference to the VAT paid to it by the new purchaser in respect of the new goods, a VAT credit which it would not be able to obtain by straight forwardly submitting the return to the Revenue.

Customs concluded that they had to take steps to prevent what they saw as a new method of achieving the same fraudulent ends, and consequently, where they were able to show that the transaction, ostensibly in different goods from those in the defaulter chain, was entered into by the broker for the purposes of obtaining such set off, and the contra-trader then exported those new goods and claimed in its VAT return as input tax the VAT that it had paid to the broker, such claim was refused. Unless there was some specific doubt about a service purportedly supplied in respect of those (contra-traded) goods, the denial of the output tax was simply in respect of VAT on the goods themselves.

The present proceedings arose because Customs had failed to pay the very substantial sums claimed on the taxpayers’ VAT returns, although they had not yet made a decision not to pay, as they asserted that they were still investigating what they concluded to be the sufficiently suspicious circumstances in relation to the contra-trading and the connections between those on the defaulter chain, culminating in the broker, and the taxpayers. Until there was a decision, there could be no appeal to the tribunal. In those circumstances, the taxpayers sought judicial review of the refusal of their claim for repayment.

Issue

Whether Customs had erred in law in asserting that they could seek to justify investigating, and in the event refusing, the taxpayers’ entitlement to the VAT claimed, because the VAT claimed related to different goods from those in the defaulter chain, to which the taxpayers were not suggested to have been party.

Decision

Burton J (dismissing the application) said that the question was whether, in respect of an (assumed) deliberate dishonest transaction by the taxpayers, Customs could lawfully decide to withhold payment pursuant to receipt of their VAT returns claiming repayment. If Customs could show that the transactions were what they claimed them to be, they had at least an arguable case that a trader who, knowingly or with means of knowledge, engaged in conduct designed to conceal, or avoid the consequences of discovery of, a fraud should be in no better position than the perpetrator of the fraud. Although the court had to bear in mind the importance of the sanctity of the common system of VAT, that system was much more at risk if firm steps were not taken by Customs to prevent the fraudulent abuse of it which, on the assumed facts in this case, would have taken place (Kittel v Belgium; Belgium v Recolta Recycling SPRL (Joined Cases C-439/04 and C-440/04) [2006] ECR I-6161 considered).

If the taxpayers were right in their contention that Customs were only entitled to refuse to pay VAT due in respect of the goods the subject matter of the defaulter chain, then Customs would be powerless to prevent massive fraudulent claims involving multiple chains in different goods. It could not be right that Community law sanctioned sophisticated VAT fraud. It was an absurd proposition that the sixth directive permitted for instance a defaulter, contra-trader and broker to conspire to create a tax loss, offset that loss into another supplier and then deliberately and fraudulently claim an input tax refund.

Finally, it was not appropriate to make a reference to the European Court of Justice at this stage as there was no doubt as to the application of Kittel to the right claimed by Customs, if they could establish the facts that the taxpayers knew or should have known that they were entering into the contra-trade transactions to facilitate a fraud on the Revenue, by the recovery, for the originator of the contra-trade, of input VAT by offsetting which, emanating as they did from a defaulter chain, would have been irrecoverable by direct claim upon the Revenue.

Queen's Bench Division (Administrative Court).
Judgment delivered 15 March 2007.