The High Court upheld a decision of the VAT and Duties Tribunal ([2007] BVC 4,094) that a taxpayer was entitled to input tax credit on supplies, where it had not been established that he knew that the transactions which gave rise to his claim were shams in the relevant sense, so that even if they had in fact been part of an attempted VAT fraud, he was not disabled from pursuing a VAT credit in respect of supplies of computer software which had taken place.

Facts

The taxpayer was a shoe wholesaler and retailer who made two substantial purchases of computer software from a single supplier which he immediately exported to a customer in Canada. Customs refused to allow the taxpayer's claim for input tax credit in the sum of £154,000 on the basis that the purchases and sales were sham transactions. The taxpayer appealed, arguing that there was sufficient evidence to demonstrate that the relevant supplies had been received and made; that the supplies were of the computer software stated; and that the invoices received from the supplier accurately described the goods in question.

Customs’ principal contention was that the input tax deduction was rightly denied because the transactions were shams, or at least because the taxpayer had not discharged the burden of proving that the transactions were genuine. The VAT and Duties Tribunal decided that the taxpayer's evidence was unsatisfactory in that he claimed to have forgotten many relevant facts and the tribunal did not believe some of his evidence. Had the tribunal been asked whether the disputed supplies had been genuine business transactions, it would have had no hesitation in finding they were not. However, the only points seriously argued were whether the transactions of buying and selling two consignments of computer software were shams and whether the related invoices were defective.

In those circumstances the tribunal decided there was insufficient evidence to lead it to conclude that the taxpayer was involved in fraudulent activity and the tribunal had no option but to allow the appeal and award costs to the taxpayer ([2007] BVC 4,094; Decision No. 20,141). Revenue and Customs appealed.

Issues

Whether the taxable supplies in question had occurred in accordance with the claimed transaction; and whether the contents of the computer discs were consistent with the description of the relevant goods contained in the supporting VAT invoices.

Decision

Briggs J (dismissing the appeal) said that where the court was being asked to decide whether, where a transaction which, as documented, appeared to attract certain VAT consequences was to be deprived of those consequences because it was a sham, the critical question was whether the rights and obligations expressed in the documents, to the extent relevant for VAT purposes, were different from those which the parties intended to confer and incur. In the present case, Customs had to show that the taxpayer knew that the documents failed to reflect the underlying transaction in a relevant respect. It was questionable, in relation to a two-party transaction, whether, without that knowledge, there could be a finding of sham at all, in the relevant respect.

Sham

Where the taxpayer applying for the VAT credit knew (actually, or being wilfully blind to the fact) that he was participating in a tax fraud, the extent of his knowledge of the respects in which (if at all) the documentation failed to record the intended rights and obligations of the parties would become irrelevant.

Furthermore, the question whether a taxpayer claiming a credit was to be found to have knowledge, either that he was participating in a tax fraud, or of the relevant respects in which the documents relied upon were a sham, might be considerably affected by his knowledge that other parts of the transaction, not relevant for VAT purposes, failed to reflect the reality.

It was evident from a reading of the tribunal's decision as a whole that it had reached its conclusion without enthusiasm, mindful of the fact that there was evidence which could justify the opposite conclusion, and that it felt constrained in effect to acquit rather than convict the taxpayer of having the relevant guilty knowledge because the critical assertions to that effect had not been put to him in cross-examination.

It was a cardinal principle of litigation that if serious allegations, in particular allegations of dishonesty, were to be made against a party who was called as a witness, they had to be both fairly and squarely pleaded and put to that witness in cross-examination.

The tribunal's conclusion that it was constrained, notwithstanding suspicion, from making the necessary findings of knowledge against the taxpayer to permit the consequences of the alleged sham to be visited upon him was a correct and conventional application of that principle.

More generally, the court had been unable to discern any error of law in the tribunal's approach to the sham issue. The tribunal had concluded that the course of the cross-examination prevented them from reaching any general conclusion that the taxpayer was a knowing party to a VAT fraud, and Customs had failed to establish that the software actually supplied, both to the taxpayer and on to the customer, was fake.

That was the only basis upon which the case of sham could be made good against the taxpayer. Nor could the tribunal's conclusion on the sham issue be categorised as perverse, since the key aspects of Customs’ alternative cases had not been put to the taxpayer in cross-examination. Accordingly, Customs’ challenges to the tribunal's decision on the sham issue failed.

Contents of invoices

It was common ground that by reason of the Value Added Tax Regulations 1995 (SI 1995/2518), reg. 14(1)(g), a claim for an input credit might properly be refused by Customs if the relevant VAT invoices failed to provide ‘a description sufficient to identify the goods or services supplied’. The tribunal concluded that the VAT invoices did provide a sufficient description, compliant with reg. 14(1)(g) and Customs challenged that conclusion solely on the grounds of irrationality since, in particular, the software was described as ‘educational’ when they contained no educational content. The test therefore was whether any reasonable tribunal, properly directing itself as to the relevant law, could have reached that conclusion.

Questions as to the proper breadth to give to the use of an adjective in an invoice, and as to the applicability or otherwise of that adjective thus construed to computer software, were precisely those matters of mixed fact and law which the Court of Appeal had emphasised should be left to the good sense of the experienced and specialised tribunal of fact, and with which, on appeal, the court should be very slow to interfere (see Able (UK) LtdvR&C Commrs [2008] BTC 3). In the present case, it was hard to see how the tribunal's analysis could be faulted.

Customs further argued that the taxpayer had failed to discharge the burden of showing that the goods matched the description in the invoices. There was much force in that submission and, had the court been deciding that question itself on the materials available, it might well have concluded that Customs’ analysis was correct on the balance of probabilities. But the tribunal was the arbiter of fact, and its conclusion could only be successfully appealed if it was reached by an error of law, or was one which was perverse.

Furthermore they heard three days of evidence, albeit that much of it came from the taxpayer who was described as unsatisfactory and untrustworthy. In the end it was for the tribunal to balance the probabilities and improbabilities of the competing analyses, and to attribute such weight to each factor in that balance as they reasonably thought fit. It was clear that they directed themselves correctly as to the burden of proof.

This was a case in which there was reason to suspect a fraud of which the taxpayer was not wholly innocent, but for such a serious allegation to be made good, it needed to be fairly and squarely put in cross-examination, and it was not. It was consistent with the European jurisprudence which governed VAT that an innocent participant in another's fraud was not thereby to be deprived of any beneficial VAT consequences of the transaction in which he participated, if otherwise effective for that purpose (Kittel v Belgium (Case C-439/04) [2006] ECR I-6161).

Chancery Division.

Judgment delivered 24 January 2008.